Friday File: Altius Checkin

by Travis Johnson, Stock Gumshoe | March 18, 2016 2:07 pm

Looking over Altius after their recent quarterly report

Several folks have asked about the state of Altius Minerals (ALS.TO, ATUSF), which I’ve written about for you many times and have owned for about seven years (time flies when you’re having fun!). They just released their quarterly filing, and the initial impression is “more of the same” — the business is chugging along, cash flow is more or less as expected from their producing royalties, and they continue to invest small amounts of capital to advance early-stage “prospect development” projects that they anticipate will become attractive to miners (or investors) the next time the commodities cycle turns upward.

You can see the management discussion and analysis here[1], which is a worthwhile overview, and the actual numbers here[2].

In the big picture, Altius’ share price will largely be driven by investor opinion about the prospects for copper, gold, coal, nickel, potash, zinc and other mined commodities, because assessments about the future value of those mined products will determine how much investors want to pay for future cash streams from those mines. What matters most is how much investors will pay for a future stream of potash royalties, or coal royalties, or copper royalties, and whether they have any lust in their hearts for the much-farther-into-the-future and huge-but-uncertain projects that might eventually be developed from their prospects.

This is the primary reason for Altius’ fall over the past year or two — lack of interest in paying for future potential in the commodities space. Investors are not excited about paying for a potentially huge iron ore royalty… because that project (the Kami mine, owned Altius’ spinoff Alderon and originally slated to open this year) has been unable to get financing and was put on mothballs a year or two ago, waiting for better iron prices (but Altius isn’t currently spending anything on that “someday” project). They don’t want to pay a premium for the steady and large royalties from Alberta coal mines, because there’s substantial political and regulatory uncertainty now about the speed of phase-out of the coal power plants in that province (but cash generation from the coal plants now is pretty much on track). They don’t want to pay much for the likely expansion of the 777 copper/gold mine because copper and gold are still (though gold has recovered some) at such low prices. And they don’t want to pay anything for the “prospects” — the staked properties or early discoveries that will eventually, if cycles turn, be partnered to a miner or spun out and more aggressively explored (and maybe even developed someday, in some cases, generating royalties).

I accept that future commodities prices are unknowable, but I count on Altius management to invest in projects when they are relatively inexpensive and make deals to sell or partner projects when they are relatively expensive. That’s their goal as counter-cyclical contrarian investors, and they don’t do it well all the time… but they do have a track record of some success with this strategy, and they are disciplined about costs and dilution, so if they’re right and these commodities enter another “bull” cycle over the next few years they will be well positioned.

The caveat that I keep in the back of my head, and the reason I haven’t committed more capital to Altius (it’s already a large holding) or gone “all in” on other commodities is that the cycle might not turn within a reasonable timeframe. So that’s the real issue for me in the long term: I’m assuming that someday prices will rise substantially again for at least a few of the commodities on which Altius’ revenues are based (potash, copper, etc.), but I am leery about assuming that the past ten years of two strong (mostly China-fueled) spikes will necessarily repeat.

Iron ore is a good example of that cyclicality (and iron ore could mean a lot to Altius in the next decade, though it means nothing to their income statement now), and the cyclicality looks a lot different if you bring your chart back more than 10 years. I’ve said this before, but I think this bears repeating before we assume any “inevitability” in commodities prices. Not all commodities have exactly this same dynamic from the “China decade,” but many are similar… here’s the 10-year chart of iron ore that makes it look like we’re buying on the down cycle.

IIOSPAO_chart10yr

And here’s the 50-year chart that we need to look back on every now and again as we question our assumptions — for the 25 years prior to this “China decade” that began in the mid-2000s, iron ore fluctuated pretty gradually between $25-35 a tonne. Is that normal, or is the $40–>$180–>$60–>$150–>$40 rollercoaster the new normal? This is just a reminder to keep some perspective and question your basic assumptions sometimes.

IIOSPAO_chart50yr

I continue to think that we are more likely to see volatility and up-and-down cycles than we are to see a long decline or flat pricing for commodities, but I’m not “betting the farm” on a bull cycle returning within a few years.

More important for short-term financial performance, and within the realm of things we can actually analyze with some rigor (unlike commodities prices in five years, or investor sentiment about commodities) is the actual production from those mines and the cash received by Altius, partly because that’s how they pay down their debt and finance additional growth and pay their (small) dividend. And on that front, Altius is beginning to show the value of diversification — and the small benefit, for a company that depends almost entirely on Canadian production, of paying costs in Canadian dollars and earning royalties based on mostly US$-priced commodities.

The numbers always look a little odd for Altius, because adjustments to the carrying value of their assets are often large enough to dramatically amplify or destroy their reported “income” — and that’s the case this time around, the recorded impairment of about $20 million for the last nine months was enough to absorb all of the income from their royalty properties. Those adjustments are non-cash though, and arguably already reflected in the market capitalization (the stock goes down when people see that their royalty properties might be worth less, or when one of their investments drops in value — like Alderon did a year ago).

On a cash flow basis, which is how I try to think about Altius operations these days, they are on pace for roughly $25 million in adjusted EBITDA (adjusted to take out the impact of assets that rise or fall in value) from more than $30 million in attributable revenue (most of that revenue comes from their royalty income, which is actually earned by subsidiaries so it’s not on the top line of their income statement). Their debt costs are about $8 million a year for the next few years (though they often try to accelerate that repayment), and they don’t usually have much in taxes at the corporate level (most of that, mining taxes, comes out of the royalties before they hit Altius’ income statement), so they have plenty of cash flow still to support the small dividend and keep spending a few million dollars a year advancing other projects.

For the last nine months (ending 1/31/16), here are the basic figures that I think are important:

Attributable revenue: C$25.62 million
General & Admin costs (including share based comp): C$4.5 million
Exploration & Mineral Leases: C$1.6 million
Interest & Amortization: C$10.25 million

So what I think of as the operating cash earnings for those nine months comes in at about C$9.25 million. We can’t count on getting a clean number if we just annualize that, because royalties wax and wane in the amount of cash flow they provide and expenses are not necessarily steady quarter over quarter, but it’s probably roughly fair for our “back of the napkin” valuation purposes to annualize it and say their “run rate” is about C$12.35 million in cash flow per year after expenses. Some of that will go to buy back extra debt, some to pay the dividend, but there is flexibility there.

What there isn’t is a bargain based on current operations. The market cap is about C$460 million, so you can see that it’s not cheap on a “earnings” or cash flow basis — that’s about 37X that “operating earnings” estimate. Which means that investors are assigning some value to Altius’ increasingly diversified asset base in both royalties and exploratory projects, but that’s going to remain a pretty squishy thing unless and until there’s a strong move up in a bunch of commodities.

And absent a big shakeup in the price of copper, gold or potash the operating cash flow isn’t going to change dramatically over the next year. Alberta coal used in electricity will continue to generate something like 40% of Altius’ revenues for the next year or so, probably for longer than that, so shocking changes in coal would have the biggest impact, and arguably are having the biggest impact on sentiment for Altius (the worst case scenario would be the abrupt closure of all the coal plants with no renumeration, which seems very unlikely given their core role in generating power — more likely they steadily get used less over the next 15 years).

Here’s the outlook from Altius, in case you’re not reading the actual reports:

“The Corporation will continue to balance its capital allocation strategy between debt repayment, shareholder capital returns, direct royalty acquisition opportunities and low cost exploration initiatives.

“The Corporation expects portfolio royalty revenue to remain stable in the coming quarter. Commodity prices remain relatively weak and currency benefits strong, although both trends have shown modest reversals thus far in the current quarter. Electrical coal royalty revenue is based on a per tonne inflation indexed rate and will not be affected by weak market based thermal coal prices or currency rates although political uncertainty could be a factor in the longer term.

“We will continue to evaluate opportunities to add high quality, long life royalties to our portfolio that complement our long-term goal of becoming a substantial diversified metals royalty company. We believe that most commodity prices, particularly in the case of base metals, are below sustainable levels on a long-term basis and that current market conditions are therefore presenting an attractive entry point for royalty investments.

“Low-cost exploration and generative activities will also continue to focus on the build-up of high quality projects in globally significant mining jurisdictions. The ongoing underinvestment in global exploration is providing a counter-cyclical opportunity to acquire mineral rights that we believe will become highly sought after as exploration investment rebounds to sustainable levels.”

I think it’s important to have some long-term commodities exposure in a portfolio (though that’s not everyone’s opinion, of course), and I continue to think Altius Minerals, with its inexpensive investment in future potential, track record of occasional windfall buy low/sell high investments, and strong current cash flow, represents a good balance between risk and reward. What has driven the shares back up from the recent 30-40% dip recently is, I think, either a return of animal spirits for commodities focused investors, or a growing comfort level with the fact that Altius’ large coal royalties are not likely to disappear overnight. Or maybe a bit of both.

What gives me some confidence is the fact that the diversification is beginning to work. Coal royalties at some plants are down a little bit, but others are picking up production… potash prices are down a little, but that means Potash Corp is going to shut down some expensive mines and mine more at the cheap ones, including the big ones where Altius has a royalty on 100+ years of reserves. Commodities as a whole have been mostly weak for a year or two, but they do not all move in concert at the same time.

So yes, I continue to hold Altius as my primary position in commodities. The operating results continue to be much better than the reported earnings. And I continue to think that their “buy low” strategy, though they might have muffed it a bit in miscalculating the value of the Sherritt coal royalties, are likely to work out as the cycles wax and wane. I give these shares a lot of room, and although it’s nice to see them come back up a bit after the swoon they took starting in November, I no longer fool myself into thinking that I can tell when things might turn for Altius — I just have a lot of confidence in the company as a broad commodity cycle allocation. Whether that works depends on investor feelings about commodities, and on an eventual turn in the prices of gold, copper, potash, nickel and coal — or, more accurately, an eventual significant upturn in the prices of at least two or three of those commodities.

Endnotes:
  1. management discussion and analysis here: http://altiusminerals.com/uploads/January-31,-2016-MDA-FINAL.pdf
  2. actual numbers here: http://altiusminerals.com/uploads/January-31-2016-FS-FINAL.pdf

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