The other week I replied to a post about a resource stock and its share price. My response was in regard to the life stages of a company as it moves from explorer to producer and the affect this can have on the capital structure. I received some positive feedback on the post so I thought I would share part of it with you again today. It is very simplified but I think it details the overall process well.
As a resource company moves from explorer to producer the share price normally re-rates in a number of ways.
If the company starts out as an explorer the share price will be largely tied to their exploration potential and any discoveries they make. The share price will normally jump in price if they announce good drilling results and a “potential” discovery.
Following this spike in the share price will typically fall. At this stage the stock is basically controlled by traders and after they have traded the run up they will move out of the stock and look for their next target.
Time then passes and if we assume that the discovery is good further drilling takes place as the company proceeds to put together a JORC estimate. Obviously it is normally two steps forward, one step back but for the sake of this example and simplicity let’s assume they have discovered something worthwhile. The share price is then likely to jump again once the JORC estimate is finally put together and people will start applying an in ground value to the resource.
The share price then drops back as traders leave it again and longer term holders realise that it takes a significant amount of capital to develop a mine. There is also other risks associated with mining approvals and licences, etc.
Assuming all is well the company will then proceed to the preliminary feasibility stage to run some basic numbers on the project. If we assume this comes back positive then the share price is likely to rise again as the first box towards developing a mine has been ticked.
As per usual it will then drop back as it is dumped by traders again and longer term investors wait for the bankable feasibility study which is required before the formal decision to proceed with the mine can be made.
Once this is released it confirms that a mine can be profitably developed and the share price may run again off this news. However, following this the share price may retrace again because the mine development costs will be high and existing shareholders face the threat of dilution (as the company may issue additional shares to raise funds).
The share price may then run and re-trace every now and then based on the issuing of mining licences, securing of finance and successful capital raisings. During this time the shareholder base is also likely to change with more investors coming on board and positioning themselves for when the company starts producing.
Finally once the mine is in production there will be a re-rate in the share price because they will have finally achieved what they wanted (i.e. a mine that is operating). The real re-rating will however come in 3, 6 or 9 months when the company proves that not only can they run a mine but that they can meet their production targets, revenue and profitability forecast.
Now that is obviously a simplistic breakdown of the process and it may take a resource company many, many attempts at exploration before they are in a position to define a resource. However we can see from the above that the reason why it can run and re-trace so much is because in the early days it is largely traders who push the price up and down. Also as an explorer the company will probably have a market capitalisation of between $20 and $50 million. To develop a mine will cost many times their market capitalisation and as a result new shares will be issued diluting existing holders. Obviously some people will sell in anticipation of this which can also have downward pressure on the price.
I would also like to add that in regard to my investment approach I primarily look for companies that have a good chance of moving into production, low/no debt and preferably a cash in the bank to minimise the potential of a capital raising. In summary if you are a long term investor it is about buying at the right stage of the company’s life to minimise the potential of adverse effects and the burning of time while you wait for the company to move to the status of producer.
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