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. (TSLA). Now that the dust has settled, it’s time to take a closer look at Pure Energy. 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 merged Western Lithium & Lithium Americas, is also a useful comparison.
A Simple Valuation Exercise, Pure Energy [PE.V] @ $0.35/share
Orocobre reached initial production this year. Its Enterprise Value, “EV” [all figures in C$] is $275 million (Note: Orocobre owns 66.5% of the producing lithium asset), with Toyota and local government owning the remainder). Bacanora Minerals, the northern Mexico junior with the first signed agreement with Tesla, has an EV of $135 million. Western Lithium’s EV (post Lithium Americas merger) is $72 million and Pure Energy Minerals’ $36 million. How does one compare these 4, each at different stages, each with company specific challenges and opportunities?
First off, including Major lithium producers in the valuation exercise, FMC Corporation (FMC), Albemarle Corporation (ALB), Chemical & Mining Co. of Chile (SQM) and China’s Tianqi (which acquired Talison) 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 Trades at a Large Valuation Discount, Warranted?
Pure Energy Minerals trades at an 87% discounted EV to Orocobre, a 73% discount to Bacanora and a 50% discount to Western Lithium. Are these substantial haircuts warranted? On average, that’s a 70% discount to the other 3 pure-play lithium companies. In my opinion, Pure Energy is trading too cheap vs. these select peers.
I like Pure Energy. 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 likely 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 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, pro forma shares outstanding and cash proceeds received, as applicable].
++ Orocobre, market cap $286 mm, EV $275 million
++ Bacanora, market cap $140 mm, EV $135 million
++ Combined WLC/LAC, market cap $77mm, EV $72 million
++ Pure Energy Minerals, market cap $48mm, EV $36 million
Pure Energy trades at an 87% discount to Orocobre. Make no mistake, I don’t suggest the Company’s EV should be close to Orocobre’s, just 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 50% and Orocobre 45%. Hypothetically, let’s assume that the EVs of Orocobre, Bacanora and Western Lithium were to rebound by 50%. That assumption would put their EVs at:
Pro forma EVs upon 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, (No, I’m not forecasting that),
++ Pure Energy EV $72 million
Under these assumptions, entirely my own, Pure Energy’s 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 very meaningful valuation discount. Therefore, leverage to the upside is a lot stronger. A fact that should be intuitive given that the Company has the lowest EV to being with. However, that’s the point! All else equal, Pure Energy would have to trade at an EV of ~ $105 million to achieve a 50% valuation discount to the others.
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. No, I’m not dwelling on Tesla, there’s other news in the works. For example, the Company is working closely with technology partners Tenova Bateman and South Korea’s giant POSCO. POSCO’s involvement with the Company is very important, yet also ignored. POSCO compared many junior lithium stories from around the world and chose Pure Energy as one to work with, another huge vote of confidence. Pure Energy 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 trading cheap to the other 3 companies, it’s 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, one requires as much bang for one’s buck as possible. Trying to poke holes in the stories of others is not necessary. Demand for lithium will be so strong that larger peers are cheap, but not nearly as cheap as Pure Energy.
Lithium Prices One of the Few Metals or Minerals Moving 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 also true for gold & silver stocks… great drill results, no reaction in the stock price.
Pure Energy is a real company, with solid 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. 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 recent elevated attention, (GoogleFinance: average 30-day trading volume on PE.V + HMGLF = 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 or tripling? 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. That upside potential is real for Pure Energy at $0.40/share.
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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