Ever Wondered How Do The Analysts, Analyse? Part 1

WHAT ANALYSTS SAY: Breakaway Research provides an insight into the thought processes behind Resource Industry Analysis.

How often have you heard a company representative say ‘we are undervalued with respect to our peers’?

It is a comment we hear a lot as analysts, and the company may well be undervalued as compared to its peers – but there often is a reason for this and more often than not the market is correct.

You may notice we usually include a peer group in our research, with this comparing various metrics of the selected companies.

How we compare companies will depend upon the stage of development that they are at, such as:

Exploration companies, with no defined resources;
Exploration and development companies with defined resources; and
Producers.

In this piece we will concentrate on the first two cases as producers bring a different level of complexity to the analysis!

You will also note there is usually a disclaimer, basically saying ‘take care with comparisons’, and ‘that they are to be treated as an indicative guide only’.

This is important – there are a number of uncertainties in these comparisons.

These reasons for differences include, but are not limited to (with all other things remaining equal):

Location and prospectivity of the company’s activities;
Grade of mineralisation;
Potential size of a deposit;
What other projects a company may have in its portfolio;
Perception of management;
Cash in the bank (when the market realises that a company needs to raise cash the price is commonly discounted); and
Marketing and exposure – there are cases of companies flying under the radar, and thus not getting the exposure to potential investors that would lift their share price.

Exploration Companies – No Resources

Really the only way to compare and rank these companies is by market capitalisation, or else the enterprise value of their projects.

Even then there is room for confusion and grey areas, and as already mentioned, this is an indicative comparison method only and could almost be considered more qualitative rather than quantitative.

The first of these relates to the market capitalisation – this can be calculated in a number of ways:

Undiluted – the market capitalisation based on quoted securities only – shares, escrow shares and listed options;
Partially diluted – as above, but including those unlisted options (and in the case of the ASX, options) that are in the money; and
Fully diluted – market capitalisation taking into account all quoted and unquoted securities.

We tend to use the latter case in comparing market capitalisations; however this will vary from analyst to analyst.

The second measurement of a company’s value is the enterprise value. This is market capitalisation less cash (and cash equivalents) plus debt (including convertible notes).

Again this can be undiluted, partially or fully diluted, and gives an idea of the value of a company’s projects.

A way to think of enterprise value is as a takeover price – to take over a company, the acquirer will need to buy the shares, assume the debt and keep the assets.

An example of comparative valuations was with Rumble Resources (ASX: RTR).

This was a comparison of companies operating in the Fraser Range. We also cover PLD Corporation (ASX: PLD), which is included in the following table.

Not included in the following table is Sirius Resources (ASX: SIR), which is now a developer having discovered the Nova-Bollinger deposits and also Sheffield Resources (ASX: SFX), whose current market capitalisation of around $100 million is largely backed by the world-class Thunderbird mineral sands project.

The graph we used in the Rumble note is below. Here using the undiluted market capitalisation, and also shown current cash positions.

Rumble Resources Peer Comparison

 
Source: IRESS, company reports

You will notice the wide range of market capitalisations. This shows fundamental differences between the companies, even though they are considered as a peer group.

These reasons include, amongst others:

A number of companies, in addition to their Fraser Range properties, hold other properties, although they may be concentrating their activities on the Fraser Range; and
Some are operating in what is currently perceived as the most prospective part of the Fraser Range (there is a discussion of the perceived prospectivity of the Fraser Range in the Rumble research note), and there-fore may trade at a premium to companies outside of this central ‘Fraser Zone’.

Herein lies a difficulty – how do you value, say, just each company’s Fraser Range projects where a company has other projects?

This is generally beyond the scope of a note, with exploration property valuation being a rather inexact science – it is in effect an educated estimate!

However, what this does show is the relative leverage that can be gained from a discovery – if, say Rumble and Matsa (which has a large, diversified portfolio of projects) both made the same discovery, you would get much better leverage with Rumble.

As a final point, at the time of the Nova-Bollinger discovery, Sirius had a similar enterprise value to that of Rumble now, and it is now a +$1 billion company.

This article originally appeared in