Anyone following the lithium sector and Pure Energy Minerals (TSX-V:PE) (FRANKFURT:A111EG) (OTCQB:HMGLF) knows that on September 16th the Company announced the signing of a conditional supply agreement with Tesla Motors Inc (NASDAQ:TSLA). Now that the dust has settled, it’s time to take a closer look at Pure Energy Minerals. Herein, is a rough comparison of valuations, including of a newly producing company, Orocobre Ltd. Recall that Pure Energy’s conditional supply agreement is only the second announced by Tesla, both for lithium. The other is with Bacanora Minerals. The merged Western Lithium & Lithium Americas, is also a useful comparison.
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A simple valuation exercise
Orocobre reached initial production this year. Its Enterprise Value, “EV” [all figures in C$] is ~ $275 million (Note: Orocobre owns 66.5% of the equity in the producing lithium asset, with Toyota and the local government owning the remainder). Bacanora has an Enterprise value of ~ $135 million. Western Lithium’s EV (post Lithium Americas merger) is ~ $72 million and Pure Energy Minerals’ EV is ~ $36 million. How does one compare these 4, each at different stages, each with company specific challenges and attributes?
First off, including the Major lithium producers in the valuation exercise, FMC Corporation (NYSE:FMC), Albemarle Corporation (NYSE:ALB) and Chemical & Mining Co. of Chile (SQM) is an impossible task. Each derives substantial revenue from non-lithium activities, i.e. they’re not pure-play lithium companies, not even close from an investment perspective.
Pure Energy Minerals trades at a large valuation discount, warranted?
Pure Energy Minerals trades at an 87% discount EV to Orocobre, a 73% discount EV to Bacanora and a 50% discount EV to Western Lithium. Are these substantial discounts warranted? On average, that’s a 70% discount to the other 3 pure-play lithium companies. In my opinion, Pure Energy is trading cheap vs. these select lithium entities.
Clearly, I like Pure Energy Minerals. I like Western Lithium and a smaller company with property in both Nevada & Argentina, Dajin Resources. I’m on record proclaiming that lithium demand could double every 3 years. These particular juniors have very strong upside potential over the next 6-18 months. A rising tide lifts all boats. Other lithium juniors could be home runs, however it would take several years for these out-of-the-money junior’s ships to come in.
That’s why Pure Energy’s 8,000 + acre lithium brine project, containing 816,000 metric tonnes of Lithium Carbonate Equivalent, (NI 43-101 compliant Inferred resource, July 2015) is special. Located next to the only producing lithium mine in North America in Clayton Valley, Esmeralda County, Nevada, halfway between Las Vegas and Reno. Infrastructure, labor, power, roads and equipment are available. This is Nevada, one of the safest and most prized jurisdictions on the planet.
On a relative basis, Pure Energy appears quite undervalued, [NOTE: this is entirely my own analysis]. Data as of Sept. 30th: EVs include in-the-money options & warrants, the pro forma shares outstanding and cash proceeds received, as applicable.
++ Orocobre, market cap, $286mm, EV ~ $275 million
++ Bacanora, market cap, $140mm, EV ~ $135 million
++ Combined WLC/LAC, market cap, $77mm, EV ~ $72 million
++ Pure Energy Minerals, market cap, $48mm, EV ~ $36 million
Pure Energy Minerals (TSX-V:PE) (FRANKFURT:A111EG) (OTCQB:HMGLF) trades at an 87% discount to Orocobre. Make no mistake, I don’t suggest the Company’s EV should be close to Orocobre’s, but closer than it is. Each is trading well below its respective 52-week high. Western Lithium is ~ 70% below its 52-week high, Pure Energy nearly 50% and Orocobre ~ 45%. Hypothetically, assume that the EVs of Orocobre, Bacanora and Western Lithium were to rebound by 50%. That assumption would put the respective EVs at:
Pro forma EVs upon a hypothetical 50% increase in valuations
++ Oracobre, EV ~ $413 million
++ Bacanora, EV ~ $203 million
++ WLC/LAC, EV ~$108 million
Next, assume that Pure Energy’s EV doubles, (I’m not forecasting that)
++ Pure Energy Minerals, EV ~ $72 million
Under these assumptions, entirely my own, Pure Energy Minerals’ EV would still trade at roughly a 60% discount. The Company’s stock has considerably more fundamental upside. To reiterate, even upon an increase of 50% for the, “comps,” Pure Energy could double and remain at a meaningful valuation discount. Therefore, leverage to the upside is A Lot Stronger. That should be somewhat intuitive given that the Company has the lowest EV to being with. However, that’s the point! Interestingly, Pure Energy would have to trade at an EV of ~ $105 million to achieve a 50% discount to the others, in this scenario.
An important story not yet touched upon is that while Pure Energy trades at an unwarranted discount, it has had a string of positive catalysts and is expected to potentially make additional de-risking. No, I’m not dwelling on Tesla Motors Inc (NASDAQ:TSLA), there’s other news in the works as well. For example, the Company is working closely with technology partners Tenova Bateman and South Korea’s giant POSCO. Pure Energy Minerals is about to embark on another exploration program to firm up the conservative assumptions used to calculate its Inferred resource estimate. The Company is also working on a Preliminary Economic Assessment, expected to be released in the first half of 2016. Not only is Pure Energy Minerals trading cheap to the other 3 companies mentioned, it’s not trading cheap on any rationale fundamental basis.
Any investment in a small cap natural resource stock, even in the lithium sector is highly speculative. Despite strong fundamentals, lithium remains a contrarian wager. For taking on the crowd, the conventional wisdom on what I believe are oversold stocks, all 4 of them, one requires as much bang for one’s buck as possible. Trying to poke holes in the stories of others is not necessary. I believe demand for lithium will be so surprisingly strong that Orocobre, Bacanora and Western Lithium are indeed cheap, but not nearly as cheap as Pure Energy Minerals.
Lithium prices one of the few metals or minerals to move higher
Lithium supply/demand fundamentals paint a rosy picture. Still, while fundamentals are strong, valuations are down significantly. An astute reader might ask, how can that be? Lithium companies are being thrown out with the bath water. Virtually every natural resource company is oversold, unloved, ready to be dumped on any increased trading volume. Good news is not receiving appropriate attention. This is equally true with, for example, gold and silver stocks… great drill results, no reaction in the stock price. I imagine this goes without saying for most of us.
Conclusion:
Pure Energy Minerals (TSX-V:PE) (FRANKFURT:A111EG) (OTCQB:HMGLF) is a real company, with competent management and a disciplined execution plan, producing tangible results. The Company has delivered on important milestones, namely the Inferred Resource Estimate in July and the conditional supply agreement with Tesla Motors Inc (NASDAQ:TSLA) in September. Tesla’s terms are not as relevant as the vote of confidence provided on Pure Energy. The Company is focused on near-term catalysts. These include an expanded drilling program designed to update the conservative assumptions used to calculate the Inferred resource estimate and a Preliminary Economic Assessment. Therefore, the valuation discounts seem excessive.
With the recent elevated attention, (GoogleFinance: average 30-day trading volume on PE.V + HMGLF is 1.25 million shares) the Company could be an attractive takeout target. Any number of companies, ranging from current producers, new entrants and others could have interest in bidding for this undervalued company. I ask readers and investors alike, which company’s stock has the best chance of doubling? I believe that fundamental (risk), to the downside in Pure Energy’s valuation is fairly limited given Tesla’s perceived stamp of approval. A high-risk, contrarian view, requires strong upside potential. A double in Pure Energy Minerals’ stock is not a stretch, it’s very possible.
Disclosure: Several of the companies mentioned herein have small market caps, including Pure Energy and Dajin Resources, small market cap stocks are highly speculative, not suitable for all investors. I, Peter Epstein, own shares of PE.V. and DJIFF. Mr. Epstein, CFA, MBA is not a licensed financial advisor. Readers should take that fact into careful consideration before buying or selling any stock mentioned.
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