Friday File: “The Third-Most Important Base Metal Is About to Rally”

by Travis Johnson, Stock Gumshoe | December 16, 2016 4:12 pm

Checking in on a natural resources tease

This week a pitch from Matt Badiali got me to thinking — it came in as a free article with a little “cross-selling” pitch from another Stansberry publication, Retirement Millionaire, and it sounded a little bit familiar… so I thought we’d start with that today and see where it takes us.

The intro from David Eifrig, who runs Retirement Millionaire, includes this :

“The Third-Most Important Base Metal Is About to Rally

“Doc’s Note: Today I’m sharing an essay from my friend and colleague Matt Badiali….

“Right now, Matt sees an excellent opportunity in an often-overlooked metal. It’s a great way to add this commodity to your portfolio and gain some exposure to the natural resource sector.”

So that seems interesting, right? What is this “often-overlooked metal?”

It’s zinc, which has gone up much more in price than any other metal this year (yes, even more than gold at its peak mid-year), so it’s not necessarily “overlooked” by metals investors… the stories about zinc’s rise and the future demand from emerging markets even hit the Wall Street Journal this week[1]… but it certainly gets a lot less press than copper or gold or even iron ore.

And what is it that Badiali is suggesting as he hints at a play on zinc’s surge? Some sort of company that is recommended by his Stansberry Research Resource Report… and in case you don’t feel like coughing up $99 to subscribe to that letter, we get some clues here:

“There’s an opportunity in zinc building toward a new bull market. That’s why this company is now planning to roll out a new zinc exploration venture at precisely the right time… when prices are starting to rebound… but everyone else is still despondent. Almost no one else is bothering to look for zinc.

“Depending on this company’s final plan, it could own around 25% of this new zinc venture. If the market soars, its new zinc assets could be worth hundreds of millions of dollars. That would put significant profits into this company’s pockets….

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“This recommendation has a proven track record of exploiting previous resource cycles as well. It has a history of hoarding assets when they’re cheap and profiting from the inevitable rebound… Its interest in zinc is just the latest example.”

That sounds like someone we know, right? That’s a pretty apt description of Brian Dalton and the folks at Altius Minerals (ALS in Toronto, ATUSF OTC in the US), and, though the clues aren’t precise enough for 100% certainty, I’m pretty sure Altius is the company he’s recommending in his Resource Report.

And it just so happens that Altius Minerals reported its quarterly earnings this week, so I’ve been meaning to take a look anyway… what a lovely coincidence, right?

For those who don’t know the company, Altius Minerals is a prospect generation and royalty company in the natural resource space, led by founder Brian Dalton and mostly focused on Canada… Dalton originally built the company on the back of a small royalty on the lands including Vale’s big Voisey’s Bay nickel mine in Labrador, and has gradually built up the assets through prospect spin-outs, nimble investments, and, more recently, larger royalty investments (not without the occasional mistake, like their star-crossed plan to build a refinery in Labrador… that endeavor’s failure crushed the company right before the financial crisis, which, in turn, made it possible for us to buy it right near their cash value in early 2009 after it was brought to my attention by a pitch from Dan Ferris, one of Badiali’s colleagues at Stansberry).

The basic nature of the company is that they try to ride the cycles in commodity prices — they invest in commodities when prices are low, and they sell or spin out assets or benefit from royalties when prices are high. They have had a few windfalls, including the sale of their uranium prospects during the 2007 uranium bubble and the takeover of International Royalty by Royal Gold several years back during gold’s big bull run, and also a few spinouts where the results are not yet clear — like Alderon Iron Ore, which was spun out of Altius and was just raising outside funds to advance the Kami iron ore mine when iron ore prices collapsed (that one’s on mothballs now — Altius still has some shares that have been written down to almost zero, and their royalty position, but they’ll need iron to recover before that mine gets funded and built).

Most of the attention for Altius, though, and most of the justification for their valuation, has morphed over to their royalty portfolio. They have held the Voisey’s Bay royalty for a decade or so, and that was a big part of what covered their operating expenses while they were staking out new prospects to sell or partner and making other opportunistic investments, but the company really dramatically changed itself from a mostly-prospect-developing company to a cash-flowing royalty owner with three large acquisitions over the past couple years: they bought the Prairie Royalties portfolio and the Carbon Development Portfolio from Sherritt in 2014 to bring on 11 producing coal and potash royalties and some future coal development potential; Callinan Royalties in 2015 to bring in a large NSR royalty on the 777 copper/zinc/gold/silver mine; and the copper stream from Yamana’s Chapada mine earlier this year.

All of those royalties are generating substantial amounts of cash flow (though Voisey’s Bay is currently not paying anything in royalties, after sometimes paying $5+ million a year in the past, because of the way Vale is accounting for profits and returns — Altius and Royal Gold have taken Vale to court over that), so Altius gets valued mostly on the continuing value of those royalties and the cash they are expected to generate each year, and to a lesser extent on the potential of their non-royalty “venture” investments in staking or investing in new ventures.

Zinc falls mostly into the latter category, though they do get some minor royalties on the zinc produced by the 777 mine. The zinc project that Badiali hints at is a new venture that they are going to take public[2], with partners, probably within a matter of weeks — it will be called Adventus Zinc, and Altius will be contributing its zinc exploration properties in Canada and Ireland to the company and also seeding it with probably a couple million dollars of “pre-IPO” funding. Brian Dalton in the conference call intimated that a filing for the IPO could be in place by Christmas, so this isn’t going to be a slow build — presumably they want to take advantage of the investor interest in zinc after that metal’s big run this year.

This is what Badiali says about zinc prices in his article:

“Zinc hit its last euphoric top in late-2006, when it sold for more than $2 a pound. The inevitable crash followed. Zinc bottomed out at $0.47 per pound in 2008. After that, zinc was caught in the natural resources bear market between 2008 and 2016. It has traded mostly sideways, fluctuating around $1 a pound…

“Zinc recently bottomed at $0.66 per pound in December 2015… Since then it has rallied. Today, it’s back up to $1.10 per pound. That’s a 66% gain in less than a year… but still a long way from the euphoric top a decade ago. But it gives us a confirmed uptrend….”

Zinc is still in roughly that same neighborhood, it popped up a bit on the election/stimulus hopes and has bounced around a little, but is now in the $1.20s — here’s what the five-year price chart for spot zinc prices looks like, according to Kitco:


But, as with all industrial commodities, it’s important to think about the longer-term picture — copper, lead, iron ore, they all went up sharply in the mid-2000s as China started really ramping up their mass industrialization and infrastructure building, driving steel demand skyward. If that was a blip on the historical record and it’s not coming back, then the $2/lb zinc price looks like much more of an outlier in the chart. Here’s the price of zinc from 1989 to the present, according to InfoMine:


So things have certainly been good for zinc this year, and there is more growing investor interest in that metal than there typically has been in my experience… but that doesn’t necessarily mean that zinc will be a boom market for the next few years and generate big returns for Altius.

And you know what? As an Altius shareholder, that’s OK. They’ve spent probably a couple million on staking and getting control of some potential zinc deposits over the years, and will sink a couple million into getting this new Adventus Zinc company started up… and then they can just wait. If zinc enthusiasm picks up, then the Adventus zinc properties will get optioned or joint-ventured or sold (Teck Resources already signed up for an “earn in” joint venture), which will help to build the company and make Altius’ share more valuable… and if those mines get built in a few years, Altius will be sitting on the back porch waiting for royalties to roll in.

As with Alderon, the cash investment is very limited and the eventual upside is very high. Alderon’s upside didn’t happen yet… and the deal did have downside for the stock from its highs of a couple years ago, since Altius for a while was valued in part based on the big potential royalty that would have brought in and the rising value Alderon would have had if they had actually built the Kami mine as planned… but that was all in the accounting as the value of Alderon was “written down” on Altius’ books, it wasn’t in the actual cash account. Altius didn’t spend much of anything to create Alderon, they just seeded it with a potentially valuable property and sent it out to raise money and grow or falter on its own. It has not yet rewarded shareholders, but Altius still owns that fat royalty on what would be a large iron ore mine… and perhaps it will be built, or sold at a higher price, in the next iron ore bull market, with no real carrying costs for Altius in the interim.

That’s the general strategy — buy or explore or invest in stuff that nobody wants when prices are low, and sell it or partner it, usually with the intention of adding to the royalty portfolio, during times when people do want more of that ‘stuff’ and prices are higher or rising. Their last impulse in this regard was with copper earlier this year, which is in a similar situation to zinc — it has not risen as sharply this year, but it is up above $2.50 again after being stuck near $2 for a year… and it is still well short of the 2011-12 highs in the $4.50/lb neighborhood (though also well above the $0.75-1.50 range where it spent most of the 1990s and “pre-China” early 2000s).

Dalton explains Altius’ strategy with these metals as “buying below the incentive price” — which means that they want to build exposure to these metals by staking or acquiring potential projects when the price of the metal isn’t high enough to incentivize a miner to build a new mine but demand is rising (or expected to rise) and threatening to eat into supply in the coming years.

That long-term focus, the underlying strength of the royalty portfolio, and the potential leveraged exposure to rising commodity prices are why I give Altius shares a lot of leeway, and why I consider that holding to be a core piece of my portfolio’s commodity exposure. Altius Minerals has sometimes been my largest individual stock holding as the price has fluctuated over the years, but is currently about my fourth or fifth largest position, roughly the same size as my holdings in Apple or Alphabet and half the size of my allocation to Berkshire Hathaway or Facebook, right now it’s roughly 6-7% of my individual stock portfolio (which is about half of my investment portfolio — the other half is in funds of various kinds, or in cash).

So what’s the situation now with this company? How did the quarter look?

Well, the stock is down pretty sharply today — probably partly because of the rising dollar and falling copper prices this week, perhaps partly because of continuing uncertainty about the value of Altius’ thermal coal royalties in Alberta as the Alberta government makes deals with power producers to pay them for earlier shutdowns of their plants, or maybe just as a reaction to the bump up in the price in recent weeks.

The coal issue does have a pretty substantial impact, though the size is nowhere near being clear. Alberta’s government is trying to accelerate the phase-out of coal for power generation — which doesn’t directly impact most of Altius’ coal royalties, since most of those plants didn’t have planned lives past 2030 anyway, but it certainly impacts the potential that those royalties could surprise on the upside… and if the plants shut down before then or produce less power in the intervening 15 years, certainly Altius will make less money than planned, in addition to seeing the value of their other potential coal resources in Alberta lose value).

That coal issue remains a thorny one not just for Altius, but for much of Alberta. I was comfortable with Altius’ purchase of those royalties mostly because they are tonnage royalties. That means Altius gets a fee per tonne for the amount of coal used by the power plants, which are mostly located right at the mouth of the coal mine, they don’t have to care what the price of that coal is, and as long as Alberta doesn’t shift their power generation dramatically away from coal within 10-20 years, then the royalties are hugely valuable and not particularly market-sensitive.

Moving gradually beyond coal is not a surprise, but rapidly accelerating the phase-out of coal in Alberta did come as some surprise with Alberta’s new government. Altius will continue to earn millions each year from those royalties until the companies close down, but upside is limited… and the big question now is whether Altius, like the big power plant operators, will enjoy any “buyout” from the government as a result of this change. I have no idea, but Brian Dalton is optimistic that they will be heard after the big payouts agreed to with the major power producers to shut down their plants early.

That doesn’t mean Altius is guaranteed to see some recovery from this writedown of the value of their coal royalties, but it’s possible — keeping in mind that the reverse is possible, too, Alberta is also revising their power purchase agreements and putting in pricing caps and other changes that could hurt the power producers and possibly reduce their coal consumption before 2030. Lots of uncertainty, which investors tend not to like, and the ruling NDP in Alberta politics that is driving these carbon tax and coal phaseout plans is not terribly popular at the moment, though they don’t have to hold new elections for another couple years. I’ve grown accustomed to the uncertainty, and will keep sitting pat on my Altius shares.

The actual numbers are, in a word, fine. No big surprises. The numbers were up quite a bit over the year-ago quarter, not really because of organic growth or better pricing but because the latest acquisitions (the 777 mine and the Chapada copper stream) weren’t in last year’s numbers. Total revenue, almost entirely from royalties, came in at $9.9 million, which is 23 cents in revenue per share. Altius doesn’t generally have much in the way of earnings, because the royalties are held in subsidiaries and joint ventures, but they have access to the full cash flow (the subsidiary arrangement is why you see things like “attributable revenue per share” instead of just “revenue per share” in their numbers).

So on a price/attributable sales basis, Altius is trading at right around 13X revenues if we annualize this quarter (“annualize” being a fancy term for “multiply by four”) — that’s a little better than Franco-Nevada (FNV), which I think of as the “gold standard” in royalties, which trades at 16X sales, but the precious metals companies, royalty or otherwise, tend to pretty much always trade at a premium to base metals companies. Royal Gold (RGLD) and Sandstorm Gold (SAND) trade at lower price/sales ratios than Altius, though I haven’t looked to see whether their accounting is different in some way (Altius’ reported price/sales in their filings is actually 40, not 13, because of they way they account for the “attributable” revenue of their joint ventures and subsidiaries, I haven’t checked to see whether RGLD or SAND has similar accounting complexities but I’m not aware of anything obvious in that regard).

In terms of the “story,” Hudbay has not invested in expanding the 777 mine’s reserves yet, so that royalty (the one they acquired in the Callinan deal) is still at risk of petering out in a few years if the mine life doesn’t get extended with more exploration… the coal royalties were lower, though the met. coal royalties bumped up a bit (that’s their small exposure to steelmaking coal, not the thermal coal used in power plants), the potash royalties are low because potash prices are low, but the continuing expectations for consolidation in that market should help because Altius’ royalties are on the largest and cheapest mines in Saskatchewan, and Altius has started to see some benefit from the rise in commodity prices this year but the real impact hasn’t fully hit because there’s a lag before higher spot prices make it to production companies and then to the royalty owners.

The adjusted EBITDA is right in line with last year, there’s some slight growth because of acquisitions (which included some share dilution, so on a per-share basis there’s really no growth at this point), and they should have adjusted EBITDA of probably something like C$25 million for the year. The market cap is about C$540 million, so, as was the case last time I looked at the stock in this way, Altius is still not cheap — that’s a Price/EBITDA ratio of about 22, or, if you include the net debt of about $25 million (that’s generously giving them credit for their investments in other companies in addition to their cash), it’s EV/EBITDA of about 23. That’s a valuation as steep as the royalty companies — Franco-Nevada has an EV/EBITDA of 21 right now.

That’s OK with me because of the optionality hiding inside Altius’ portfolio — they’re not just about commodity prices and the impact on their potash and copper and coal royalties… they’re also designed to reap windfalls from time to time as prices reset and properties get more valuable. Maybe that’s because the Kami mine project gets restarted eventually (Alderon is still around, still looking at the possibility of leveraging the closed nearby Wabush mine[5] to help cut costs at Kami), maybe it’s some clarity on coal in Alberta, maybe it’s rising copper or gold helping their Chilean or 777 projects or their newly partnered Newfoundland gold deposit, maybe it’s this new zinc joint venture… I don’t know what the future holds, but there are a lot of levers for potential improvement, and as we wait to see what happens Altius is still investing small amounts to build other potential long-term projects and still looking at other ways to play the price cycle in commodities, and they can easily manage their relatively small debt and keep going as they are without spending much cash if there aren’t growth opportunities. It might not work, but I think they get it right often enough to be optimistic.

I’m not buying more right now, to be clear — I’m just sitting on my position. Altius is not an obvious bargain here unless you have a crystal ball that tells you some of their levers will bring upside next year… but I have no inclination to sell, and the price today seems perfectly reasonable to me as a part of the commodity-related allocation in my personal portfolio.

Which brings me a general update.

I started up our premium membership program here at Stock Gumshoe more than eight years ago, and I’ve always offered pretty much what I offer now: More commentary, the Friday article each week that’s just for Irregulars, more of my opinion about specific stocks I like, and access to the list of stocks I own. Other features have come and gone, including some guest commentary (including the popular Dr. KSS biotech articles in recent years), and our most popular premium feature is probably really the “Irregulars Quick Take” summary box, not necessarily the Irregulars-only articles I write for you… but as I see more and more questions about what the stocks are that I’ve suggested, and what I own, I’m starting to realize that part of the Irregulars “feature” set is confusing and not terribly helpful.

So starting next year, I’m going to shake things up a little bit… I will get rid of the current Irregulars tracking spreadsheet with its core, speculation and watchlist ideas that I’ve written about for you, and will focus more on the stocks I actually own and report more about them so these features will be more like the tracking of a “real money” portfolio… with the basic theory that the things I actually put my money into are the investments that most interest me, and also investments I’m likely to follow more closely for you.

That doesn’t mean that I’ll stop writing about stocks I don’t own, since there will sometimes be stocks that I think are interesting even if they aren’t good fits for my portfolio, or times when I don’t have cash to buy something but do wish to share an idea with you, but I’ll organize it differently and will hopefully be able to present a clearer picture of my sentiment about and analysis of these favorite investments in the new year… stay tuned, that will all come through as I do my annual review next month.

Thanks for reading, and I hope you enjoy your weekend!

  1. hit the Wall Street Journal this week:
  2. new venture that they are going to take public:
  3. [Image]:
  4. [Image]:
  5. still looking at the possibility of leveraging the closed nearby Wabush mine:

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