The anatomy of a turnaround gold stock
Following two Canadian contrarians in their adventures with a junior gold stock leads to some valuable insights on turnaround stocks.
This story is about patience.
And it’s about starting over. Two contrarian investors purchase a stock for the second time and follow it as it makes its way up a steep ladder.
In this case, it’s a junior gold stock. A timely stock, the way gold has been on people’s minds this past year.
But it also stands as an example of how to approach turnaround stocks. When do you buy? How long do you hold?
The stock is Richmont Mines (TSX-RIC). The buyers are the two investors who publish Contra the Heard. These contrarians do not offer specific buy, hold or sell advice. They purchase stocks and comment on their progress four times a year for their subscribers.
They leave no nugget of information unturned as they follow each stock through thick and thin. It takes time.
“For many traders, the time frame in which a position is exited and re-entered is usually referred to as last quarter, or February, or sometimes even Wednesday,” they say. “But at Contra, this occurs infrequently. Our focus on turnaround situations can be a slow process, involving full operational cycles.”
In this case, we can add an extra chapter to their story — Richmont has just released its third-quarter results this morning.
Ebb and flow
There is a big advantage in going through a full sequence of owning, holding and then selling a stock, say the Contra Guys.
“We learn more thoroughly about the business and its managers, as well as the industry in which it operates, and we gain a sense of the ebb and flow of the share price.”
On their second go-round with Richmont, they stumbled out of the gate, by their own admission. When they re-bought it a year ago, it was $1.81. Later, investors could have “loaded up” on it at $1.21.
Whatever the price, the jumping-off point for this and many junior gold stocks came with the lows of November and December.
Richmont’s trading volume started to pick up in January and kept it up in February, and “combined with the attractively low share count of 26 million, this meant it could go higher and faster than many comparable juniors,” the Contra Guys explain.
Swing hard to starboard
As the depth of the financial crisis in the United States became apparent, expectations for gold were raised.
“The potential for the metal to breach the USD$1,000 barrier set the pendulum swinging hard to starboard, and Richmont’s shares climbed to within a whisker of $5.00, better still than our 2002 sell price of $4.60.”
It has since retrenched and sits today at $3.05. The $1,000 barrrier is well behind us. Or as the Contra Guys put it: “Hey, a G-note for an ounce of all that glitters is old news. You can only get folks to prick up their ears if your new call for gold is USD$2,000 — maybe even $3,000 for hard core gold bugs.”
The company had also issued some uninspiring news.
Treasure of the Sierra Madre
“To the surprise of those who follow Richmont,” the investors tell us, “it floundered in the second quarter.” Lower gold sales and higher operating costs led to a net loss of $1.4 million.
“How is this scenario possible when gold is going through the roof, you muse?” Although the selling price of gold was 18 per cent higher, it wasn’t enough to offset the 23 per cent drop in sales volume. This in turn was largely due to reduced production at the company’s Beaufor Mine.
Total revenue dropped from $15.6 million in the same period last year to $14.2 million, and operating costs went up by $1 million. The average cash cost per ounce rose from USD$598 to $745.
The main problem, say the investors, was the lower grade taken from the Beaufor and Island Gold mines. “Perhaps they can learn from Walter Huston’s character in the film The Treasure of the Sierra Madre, who had a few trade secrets for finding the high-grade stuff. Dig deeper?”
Shania Twain’s birthplace
Richmont was not standing still, however. Taking its cue from gold’s price strength, it earmarked more than $3 million into exploration. It is re-starting production at its Francoeur mine in 2011, where studies show promising probable reserves.
It is also stepping up exploration at its Beaufor and Island Gold mines. And in the first quarter of 2010, it plans to drill the first 5,000 metres on the Cripple Creek property, just west of Shania Twain’s birthplace in Timmins, Ontario, the Contra Guys helpfully point out.
At this point, we can step in with the latest results to see how all this is progressing. Released today, Richmont’s third quarter results are certainly more encouraging than they were a quarter ago.
Revenue for the third quarter was $19.1 million, 16 per cent better than the $16.5 million of a year ago. The number of ounces sold was not significantly higher, but of course the selling price was.
Richmont also claims that it has made “notable strides” in lowering its cash cost per ounce at Island Gold and Beaufor. It has $25.7 million in working capital and no debt, and its projects are all on schedule.
In short, the company is gleaning more rewards from the rising price of gold than it did a quarter ago.
Here is how the Contra Guys summed up their position (without the benefit of the third-quarter results, of course):
“Our target of $6.24 may even look conservative if, as some suggest, gold eventually explodes while the U.S. dollar falls off the flat edge of the earth. But the price of gold is volatile and not immune from dropping with the whole market if economic numbers get spooky. Any investor who has yet to own a gold stock should expect to see some dips that’ll provide an opportunity.”
That’s why turnaround stocks only pay off with patience. You don’t just take the bad with the good, you treat the bad as a shining opportunity.
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