It is common practice in the resource space, particularly in investor presentations, to show the presenting company in a table comparing it with what they say are “peers”.  Of course, the conclusion is always that the presenting company is substantially undervalued.

The inference is that it is therefore a better value investment than the peers in the table. The problem with this approach is that it typically only considers a single metric, such as, in the case of gold, enterprise value (“EV”) per oz of reserves and resources. This is somewhat disingenuous as it is widely understood that there are many variables that affect project, and hence company, valuation.

Some of these risk factors are:

  • country – high/low
  • political/regulatory – short/long term approach
  • geographic – mountainous/isolated etc
  • infrastructure, including energy
  • grade – high/low
  • recovery – high/low
  • complexity – multiple metals/concentrates
  • mining method – low/high cost
  • processing – straightforward/complex
  • management – experience/ability
  • skills availability – local/imported
  • finance – cost of debt/equity

So, taking these variables into account, it can be easily seen that a single measure, such as EV/oz, is a misleading way to value a company and its projects.

I will discuss only one example – country risk. The map below is one evaluation of country risk from 2019. The data on the interactive map are provided by Fitch Solutions. I have arbitrarily chosen Zimbabwe and Canada in the example below.

Marsh-political_risk

Map Courtesy Marsh.com – interactive map here.

Zimbabwe has a Country Risk Index of 35.5, compared with Canada on 80.5. In effect Zimbabwe has over twice the risk of an investment in Canada. Thus, for ”identical” projects, the one in Zimbabwe would trade at a substantial discount to one in Canada. This discount flows onto other risk factors. For example, both debt and equity will be more expensive in Zimbabwe.

However, there are other factors that influence country risk. China is a large investor in Zimbabwe, along with many other African countries, and in the resource space is particularly interested in platinoids. So a substantial platinum project in Zimbabwe will almost certainly attract Chinese investment, and on more favourable terms than the risk index would suggest.

Last Word

Do not be swayed by apparently attractive comparative valuations. Much more needs to be known about a project/company before an investment decision can be made.

 

14 January 2020 Companies, Markets