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Analysts' Ideas of the Week Larger Miners Likely to Pursue Share-Based M&A Deals
August 17, 2020
www.researchfrc.com
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FRC Top Picks
The following table shows last week’s top five performers among our Top Picks,
including four junior resource companies and one mortgage investment corporation.
The top performer, Fura Gems Inc. (TSXV: FURA), was up 47.4% WoW, as it
announced plans to go private, discussed later in this report. The second-best
performer was FPX Nickel Corp. (TSXV: FPX), a company we initiated coverage on
August 11, 2020. FPX holds one of the largest undeveloped nickel deposits in the world;
our initiating report can be found here.
Top Five Performers Last Week
Overall, our portfolio (equally weighted) was up 0.7% in the past week versus the
benchmark’s (TSXV) -0.3%. Over the longer-term (six months, one-year, three-year,
and since launch), our portfolio has significantly outperformed the TSXV as shown
below.
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Performance by Sector
Our complete list of top picks (updated weekly) can be viewed here.
Weekly Mining Commentary
Most of global equity indices reported gains in the past week.
Source: FRC / Various
However, for the first time in several weeks, prices of all five mainstream metals
dropped in a single week. Silver and gold were the biggest losers. This decline was not
surprising to us as we have been calling for a correction in prices for the past few weeks.
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As shown below, our price forecasts for the full year (unchanged from last week) are lower than current prices.
Valuations of senior gold producers dropped two weeks in row, as shown in the chart
below. The global average EV / R of gold producers is currently 3.6x versus the four-
year average of 2.7x. The global average EV / EBITDA is currently 11.1x versus the
four-year average of 9.0x (Source: S&P Capital IQ). These valuations indicate that
the market expects further upside in gold prices. A major boost for the sector last
week was Warren Buffet’s investment in Barrick (TSX: ABX).
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However, valuations of base metal producers stayed relatively flat WoW. The global
average EV / R of the Diversified Metals and Mining sector is currently 1.4x versus the
four-year average of 1.5x. The global average EV / EBITDA is currently 11.1x versus
the four-year average of 8x (Source: S&P Capital IQ). These valuations do not give
us a clear indication on the market’s take on base metal prices.
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Click here to view FRC’s complete list of top picks
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Our outlook has slightly improved since last week as the U.S. has been reporting a
decline in new cases of COVID-19. Also, for the first time, India has started showing
signs of a decline. Other countries we have been closely monitoring, such as Mexico,
Iran and Spain, have also started showing signs of decline. That said, rising cases in
South America (especially Peru and Colombia) are now our primary concern.
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Source: https://www.worldometers.info/coronavirus/
Another positive development last week was that inventory levels of copper declined on both the LME and SHFE (Shanghai Futures Exchange) for the first time in several weeks.
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The decline in inventory was likely due to stronger manufacturing activities, as reflected by the charts of the U.S. and China below. Another sign of improving business activities is the reduction in unemployment rates in the U.S. and Canada in July, which we discussed last week.
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Click here to view FRC’s complete list of top picks
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China Caixin Manufacturing PMI
United States Manufacturing PMI
Source: Tradingeconomics.com
We are maintaining our prediction of a U-shaped recovery in business activities and demand for base metals. As for precious metals, we expect a rise in M&A transactions, mostly share deals (rather than cash) considering the rich valuations. Gold and silver juniors with high quality assets in safe jurisdictions will likely be sought after targets. In the following section, we review companies that announced key developments in the
past week.
Mining / Exploration
Company
Name:
Ticker
Symbol
Current Share
Price:
FRC Fair Value
Estimate:
Date of PR:
Fura Gems Inc TSXV: FURA $0.14 N/A Aug 14, 2020
PR Content Last Friday, Fura’s major shareholder, Lord of Seven Hills Holdings FZE (“L7H” - a Dubai based investment company), holding 51.5% of the outstanding shares, and Fura, came into an agreement for L7H to acquire the remaining shares for $0.15 per share, and take the company private. The acquisition price reflects a 36% premium over the previous day closing price. Fura’s board has approved the transaction, which is expected to close in October 2020.
FRC Opinion Negative - The offer price is significantly lower than our fair value estimate of $164M on Fura’s assets, which is $0.60 per share based on the current number of shares outstanding. Fura’s management stated that “despite significant marketing efforts, liquidity and access to capital have been challenging, which we believe largely result from the limited number of companies listed on the TSXV that operate in the coloured gemstone sector.” As the board has approved the transaction, we are temporarily retracting our rating and fair value estimate on Fura’s shares.
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Click here to view FRC’s complete list of top picks
PLEASE READ THE IMPORTANT DISCLOSURES AT THE BACK OF THIS REPORT
Company
Name:
Ticker
Symbol
Current Share
Price:
FRC Fair Value
Estimate:
Date of PR:
Thor
Exploration
Limited
TSXV: THX $0.22 $0.50 Aug 10, 2020
PR Content Announced updates on their progress at Segilola; the company is on schedule and on budget to complete construction; first gold pour is expected in Q2-2021.
FRC Opinion Positive - THX is fully funded to advance the Segilola gold project in Nigeria into production. At a grade of 4.2 gpt, Segilola is estimated to host the highest grade open pit gold deposit known in West Africa. Production is expected to be 80,000 oz per year, with an all in sustaining cost of US$662 per oz.
Company
Name:
Ticker
Symbol
Current Share
Price:
FRC Fair Value
Estimate:
Date of PR:
Kootenay Silver
Inc.
TSXV: KTN $0.49 $0.57 Aug 13, 2020
PR Content Announced results from four more holes of its 7,000 m drill program at the Columba silver project in Chihuahua state, Mexico. Best results were: ➢ 361 gpt silver over 11 m, including
608 gpt silver over 5 m, and 1,160 gpt silver over 1 m; all within 229 gpt silver over 22 m.
FRC Opinion Positive – We are pleased to see that the project continues to return high grade values. In 2019, the company completed a 41 hole / 6,853 m drill program, which was very successful with multiple holes returning high grade silver intercepts on multiple veins. Management has no immediate plans on the flagship La Cigarra project, also in Chihuahua state. Drilling at Columba is ongoing. We expect the company to start preparing a maiden resource estimate shortly.
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Click here to view FRC’s complete list of top picks
PLEASE READ THE IMPORTANT DISCLOSURES AT THE BACK OF THIS REPORT
Company
Name:
Ticker
Symbol
Current Share
Price:
FRC Fair Value
Estimate:
Date of PR:
Fortune
Minerals
Limited
TSX: FT $0.075 $0.97 Aug 10, 2020
PR Content Announced plans for exploration (induced polarization and ground magnetometer surveys) on an anomaly located 1 km southeast of the main NICO deposit. Historic drilling north of this anomaly had intersected gold, returning 1.11 gpt gold and 0.355% cobalt over 3 m.
FRC Opinion Neutral – We were pleased to hear an update from the company as the company had been relatively inactive in the past year. We believe NICO is the largest undeveloped primary cobalt project in North America, with significant quantities of gold. An updated feasibility study is expected in the near future. A previous study (completed in 2014), based on a cobalt price of US$16/lb (vs the current price of US$15), had shown an after-tax Net Present Value @ 7% of $224 million, with an after-tax Internal Rate of Return of 15.1%. FT’s current market cap is just $27 million.
Company
Name:
Ticker
Symbol
Current Share
Price:
FRC Fair Value
Estimate:
Date of PR:
Laurion Mineral
Exploration Inc.
TSXV: LME $0.20 $0.33 Aug 11, 2020
PR Content Completed a $1.10 million private placement.
FRC Opinion Positive – LME is now fully funded to pursue its next phase of exploration. The company recently completed an encouraging phase 1 drill program at its 100% owned Ishkoday project in Ontario. The project has a non NI 43-101 compliant preliminary target of 40-50 Mt grading 2.5 g/t gold, 0.5% copper, 3% zinc and 30 g/t silver. We will be publishing an update report shortly.
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Click here to view FRC’s complete list of top picks
PLEASE READ THE IMPORTANT DISCLOSURES AT THE BACK OF THIS REPORT
Cannabis
Company
Name:
Ticker
Symbol
Current Share
Price:
FRC Fair Value
Estimate:
Date of PR:
Grown Rogue
International
Inc.
CSE: GRIN $0.10 $0.24 Aug 11, 2020
PR Content
Golden Harvests, LLC (“Golden
Harvests”) has received its first Class-C
Adult Use License.
FRC Opinion
Positive – In our initiating report in July
2020, we had indicated that receipt of the
Class-C Adult Use License was imminent.
We are pleased to see Golden Harvests
receive this license on time. Prior to this
license, Golden Harvests was a pure-play
medical cannabis cultivator in
Michigan. Golden Harvests now has
access to Michigan’s emerging recreational
cannabis market.
Weekly Cannabis Commentary
Cannabis Industry Performance
Note: MCAN and XCAN were launched on November 18, 2019, and January 20, 2020, respectively.
Source: TMX Money, FRC
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Over the past week, the Horizons Marijuana Life Sciences ETF (TSX: HMMJ / “HMMJ”), the Standard & Poor’s/MX International Cannabis Index (“MCAN”), and the Standard & Poor’s/TSX Cannabis Index (“XCAN”) generated a return of -3%, -1%, and -4%, respectively. The worst performer on the list of companies that we track is the Supreme Cannabis Co., Inc. (TSX: FIRE). On August 14, 2020, FIRE terminated its consulting services agreement with Kush Enterprises Canada ULC (“KKE Canada”) to develop and launch a line-up of premium cannabis products. We are not privy to any other news related to the poor weekly performance of FIRE. The best performer on the list of companies that we track is Organigram Holdings Inc. (TSX: OGI). On August 14, 2020, OGI sent its first shipment of bulk dried cannabis flower to Canndoc Ltd. (“Canndoc”), one of the largest medical cannabis producers in Israel. Cannadoc is a subsidiary of InterCure Ltd. (TASE: INCR). We are not privy to any other news related to the strong weekly performance of OGI. Valuation of Select Canadian LPs
The following shows the average Enterprise Value to Revenue (“EV/R”) of the Canadian
cannabis companies that we track.
Average EV/R (October 2019 – August 2020)
Source: S&P Capital IQ, FRC
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Source: S&P Capital IQ, FRC
The average EV/R, as of August 17, 2020, is 8.9x – a deterioration from 10.5x a week
ago. The average EV/R, from October 7, 2019, to date, is 11.9x. As a number of
companies are not EBITDA positive, we have refrained from tracking the average
Enterprise Value to EBITDA (“EV/EBITDA”).
Below, we outline the level of dried cannabis inventory in Canada.
Increasing Dried Cannabis Inventory
Dried cannabis sales represent an integral part of Canada’s cannabis market. Although
there is no official data to testify to the proportion of dried cannabis sales to other
cannabis products, our research has indicated that dried cannabis sales represent
up to 70% of Canada’s cannabis market. With that in mind, it is integral to look into
the level of dried cannabis inventory and identify the level of pricing pressure that these
products may face. The following shows dried cannabis inventory by month of federal
license holders.
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Dried Cannabis Inventory
Source: Statistics Canada
As indicated above, inventory of dried cannabis has been steadily increasing –
unpackaged inventory was 669,787 kg in May 2020 – a month-over-month
increase of 8%. Given the large amount of dried cannabis inventory in the market, we
believe it is indicative of high forward pricing pressure. To illustrate this, Delta 9
Cannabis Inc. (TSX: DN) reported Q2-2020 financials today, with an average wholesale
cannabis price per gram decreasing 16% quarter-over-quarter (“QoQ”) to reach $3.77.
With the pile-up of dried cannabis inventory, it is likely that licensed producers (“LPs”)
will sell their product at a discount to clear inventory. We believe this is already being
seen in the marketplace, with the flood of “value brand” cannabis products by LPs such
as Canopy (TSX: WEED), Tilray (NASDAQ: TLRY), and Aurora (NYSE: ACB).
As indicated by our Canadian dried cannabis pricing chart, the price of dried cannabis
has shown a historical downturn. We fully expect this downtrend to continue into the
foreseeable future.
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Click here to view FRC’s complete list of top picks
PLEASE READ THE IMPORTANT DISCLOSURES AT THE BACK OF THIS REPORT
Canadian Retail Cannabis Pricing
Province (As of 2020/8/17) Average Price per Gram Average Price per Gram THC Average Price per Gram CBD # of Products Min. Price Max. Price
Alberta 11.52$ 11.53$ 11.37$ 294 3.93$ 22.00$
B.C. 10.18$ 10.28$ 8.22$ 226 4.48$ 80.29$
Manitoba 11.73$ 11.75$ 11.57$ 263 5.66$ 20.43$
N.B. 10.07$ 10.20$ 8.90$ 153 3.57$ 16.28$
N.S. 10.51$ 10.58$ 9.82$ 163 5.36$ 42.85$
Newfoundland 10.17$ 10.17$ 10.19$ 133 5.64$ 15.40$
Northwest Territories 11.54$ 11.54$ 3 12.08$ 13.00$
Nunavut 11.73$ 11.84$ 12.41$ 36 9.43$ 17.91$
Ontario 9.77$ 9.95$ 8.41$ 247 4.20$ 23.98$
P.E.I. 10.34$ 10.40$ 9.50$ 134 2.20$ 23.30$
Quebec 9.20$ 9.12$ 9.83$ 187 4.85$ 14.55$
Saskatchewan 12.81$ 12.83$ 12.46$ 121 5.66 38.50
Yukon 14.61$ 14.78$ 13.35$ 8 12.69$ 16.15$
CANADA 11.09$ 11.15$ 10.50$
Source: Online Provincial Cannabis Stores, FRC
The average retail price per gram decreased 0.24% week-over-week to reach
$11.09. Over the long-term, we continue to reiterate our view that the retail price per
gram of cannabis will decrease to combat the black market for cannabis. According to
Statistics Canada, the average per gram price of illegal cannabis in Q4-2019 was
$5.73. The following shows the trend in pricing for illegal cannabis:
Illegal Cannabis Pricing
Source: Statistics Canada, FRC
Canadian Retail Cannabis Stores
As of August 17, 2020, there are 1,062 retail cannabis stores across Canada – a
nominal increase from a week ago. The following shows the week-over-week growth
rates:
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PLEASE READ THE IMPORTANT DISCLOSURES AT THE BACK OF THIS REPORT
Week-over-Week Store Count Change
July 20, 2020 July 27, 2020 Aug 4, 2020 Aug 10, 2020 Aug 17, 2020
0.7% 0.4% 1.9% 2.4% 0.0%
Source: Provincial Websites, FRC
Number of Retail Cannabis Stores in Canada
Source: Provincial Websites, FRC
The following shows the number of retail cannabis stores by province/territory:
Source: Provincial Websites, FRC
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Click here to view FRC’s complete list of top picks
PLEASE READ THE IMPORTANT DISCLOSURES AT THE BACK OF THIS REPORT
As shown above, Ontario and Quebec are the two largest underserved provinces for
cannabis, with a population / store (“P/S”) of 105k and 204k, respectively.
The below chart shows Canadian retail dried cannabis flower pricing since we began
price coverage.
Canadian Retail Dried Cannabis Flower Pricing
Source: Online Provincial Cannabis Stores, FRC
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Click here to view FRC’s complete list of top picks
PLEASE READ THE IMPORTANT DISCLOSURES AT THE BACK OF THIS REPORT
Disclaimers and Disclosure The opinions expressed in this report are the true opinions of the analyst(s) about any companies and industries mentioned. Any “forward looking statements” are our best estimates and opinions based upon information that is publicly available and that we believe to be correct, but we have not independently verified with respect to truth or correctness. There is no guarantee that our forecasts will materialize. Actual results will likely vary. Companies mentioned in pages 2 and 9-12 are covered by FRC under an issuer paid model. FRC or companies with related management, and Analysts, may hold shares in some companies mentioned in this report including Aphria, Barrick, Supreme. Distribution procedure: our reports are distributed first to our web-based subscribers on the date shown on this report then made available to delayed access users through various other channels for a limited time. To subscribe for real-time access to research, visit https://www.researchfrc.com/website/subscribe for subscription options. This report contains "forward looking" statements. Forward-looking statements regarding the Company, industry, and/or stock’s performance inherently involve risks and uncertainties that could cause actual results to differ from such forward-looking statements. Factors that would cause or contribute to such differences include, but are not limited to, continued acceptance of the Company's products/services in the marketplace; acceptance in the marketplace of the Company's new product lines/services; competitive factors; new product/service introductions by others; technological changes; dependence on suppliers; systematic market risks and other risks discussed in the Company's periodic report filings, including interim reports, annual reports, and annual information forms filed with the various securities regulators. By making these forward-looking statements, Fundamental Research Corp. and the analyst/author of this report undertakes no obligation to update these statements for revisions or changes after the date of this report. Fundamental Research Corp DOES NOT MAKE ANY WARRANTIES, EXPRESSED OR IMPLIED, AS TO RESULTS TO BE OBTAINED FROM USING THIS INFORMATION AND MAKES NO EXPRESS OR IMPLIED WARRANTIES OR FITNESS FOR A PARTICULAR USE. ANYONE USING THIS REPORT ASSUMES FULL RESPONSIBILITY FOR WHATEVER RESULTS THEY OBTAIN FROM WHATEVER USE THE INFORMATION WAS PUT TO. ALWAYS TALK TO YOUR FINANCIAL ADVISOR BEFORE YOU INVEST. WHETHER A STOCK SHOULD BE INCLUDED IN A PORTFOLIO DEPENDS ON ONE’S RISK TOLERANCE, OBJECTIVES, SITUATION, RETURN ON OTHER ASSETS, ETC. ONLY YOUR INVESTMENT ADVISOR WHO KNOWS YOUR UNIQUE CIRCUMSTANCES CAN MAKE A PROPER RECOMMENDATION AS TO THE MERIT OF ANY PARTICULAR SECURITY FOR INCLUSION IN YOUR PORTFOLIO. This REPORT is solely for informative purposes and is not a solicitation or an offer to buy or sell any security. It is not intended as being a complete description of the company, industry, securities or developments referred to in the material. Any forecasts contained in this report were independently prepared unless otherwise stated, and HAVE NOT BEEN endorsed by the Management of the company which is the subject of this report. Additional information is available upon request. THIS REPORT IS COPYRIGHT. YOU MAY NOT REDISTRIBUTE THIS REPORT WITHOUT OUR PERMISSION. Please give proper credit, including citing Fundamental Research Corp and/or the analyst, when quoting information from this report. The information contained in this report is intended to be viewed only in jurisdictions where it may be legally viewed and is not intended for use by any person or entity in any jurisdiction where such use would be contrary to local regulations or which would require any registration requirement within such jurisdiction.
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