By James Steels / @steelsjh

The newsflow (and share price reaction) coming out of Sandstorm Metals and Energy (“SND“) warrants some commentary. Let me be clear upfront – I have been DEAD wrong on the timing on this one. With an average cost of $3.25 per share  initial purchase at $4.00 and a second purchase at $2.50) at today’s closing price of $1.84 the value of my shares are down a whopping 43%. Ouch.

For new readers – a quick recap. Sandstorm Metals & Energy is the smaller sister company of Sandstorm Gold.  SND’s business model, in simple terms, can be thought of as a bank for development-stage resource companies. SND puts up capital for these development-stage companies and, in return, receives a stream which allows SND to purchase output from the mine at below market prices.

This model gives SND  no exposure to the rising costs of production, allows the company to participate in the upside of commodity prices – all with no exposure to cost overruns. Further, the business model has low administrative costs, requires no sustaining capital expenditures, and enjoys benefits when a streaming partner increases the size of the deposit through exploration at the mine site.

Over the past two weeks, some significant news has come out pertaining to SND which has resulted in the share prices getting slammed. Lets take a look.

First, it would be appropriate to address the sluggishness before the big drop off in early July.  Sandstorm had some heavy run up in 2012 to over $5.50. I personally attribute this excitement to the appearance of CEO Nolan Watson on Mad Money and the halo effect coming from a recommendation for SND’s sister company – even if there was no economic significant of the relationship between the two companies other than common management.

More recently, the gold markets have hit a slump and SND’s sister (Sandstorm Gold) has gotten hit. It appears once again that SND’s association with its sister has influenced its share price – even with no material news regarding SND developing. So much for efficient markets.

In July, the more material news developed and true fundamental investors needed to sharpen their pencils quickly.

Developments at Donner Metals

On May 15th, Donner announced initial production from its Bracemac McLeod mine. It was a great sign for SND given that Donner was to be the company’s first material stream. Although, the celebrations finished quickly when the Donner suprised the markets and set out to raise $4.5MM via issuing new shares.

Donner’s shares reacted violently and were slammed after the announcement. This demonstrates the complete lack of appetite in the market for junior mining companies attempting to raise capital – its a disaster out there. The shares slumped much below the offering price and it was clear that Donner was not going to be able to raise the cash (why would you purchase shares at the issuance price when you could buy on the market cheaper?).

I took a quick look at Donner’s financials as I wondered why the capital raise was so necessary – they appeared to have an undrawn line of credit with Sandstorm as well as sufficient working capital. I quickly reached out to Sandstorm to get some guidance. I was informed that the JV agreement Donner has with its partner (Glencore Xstrata)  requires mandatory cash-calls on a month-to-month basis to ensure the mine has significant working capital. The monthly amount of the cash-call is tough to estimate and Donner needs the cash to meet possible commitments. While the mine is producing zinc and copper, payments are not expected to be received from purchase for upwards of 90 days which is creating a cashflow crunch at Donner.

At this point, SND went into crisis mode given that they were concerned over Donner’s financial challenges. SND has over $25MM invested in Donner and they want to be able to benefit from their first material stream. In they step. On July 8th, SND announced that they would be waiving the payments required by Donner under the stream until 2014.  This, I have a problem with and find concerning.

It looks like SND is stuck between a rock and a hard place. The company essentially gave up 7 months of cashflow from its first stream in order to give Donner a “break”. While this is likely the best of a bad situation, it is frustrating to see our company give up our stream entitlement with no-consideration payable to Sandstorm. I would have been much more satisfied if SND received a long term note (say for $7MM due 5 years from now) to nominally compensate SND shareholders for giving Donner the break. After the announcement, the shares began their free-fall as investors lost confidence in management’s ability to get streams up and running in SND.

Donner has since managed to raise almost $2MM (the majority participant for the equity raise was Sandstorm). I noted this amount was significantly less than the initial target ($4.5MM) and I reached out to a VP of SND to explain same. I wanted to know if SND’s cashflow models predicted that Donner would be able to make its cashflow commitments given the lower amount raised – I wanted to ensure  we did not go through this next month. Here is the response I got:

“The amount that was raised by Donner could be enough to get their joint venture to positive cash flow, if they get some help from the spot price of zinc. At current commodity prices, Donner will likely need some additional funding to meet their future joint venture obligations.”

Unbelievable. I wish they had just got it done and over-with.

Developments at Serra Pelada

Last week, another of SND’s streaming partners, Colossus Minerals, announced that there will be a moderate delay of initial gold production related to its Serra Pelada mine. The estimate for initial production has been pushed out until 2014. SND’s shareholders jumped to the conclusion of the demise of the company’s next-to-be online stream (SND has a Palladium stream on Serra Pelada which is expected to come online in Q4 2014) and sent SND’s shares down almost 20%.

I reached out to the company who informed me that investors have over-reacted.  Palladium production was always and continues to be scheduled in late 2014 and the delays at Colossus only relate to the gold side of the business. This is not expected to effect the economics of the palladium stream. The clarification by SND to the market has helped but the shares remain below the levels that were experienced before the initial Colossus announcement.

Apparently, Sandstorm still is very interested in the Serra Pelada asset and would be interested in increasing the size of its stream. As Colossus will need the cash given the delay in gold production, we will have to keep our eyes open on and developments in the deal and the pricing that Sandstorm can achieve (If they do a deal, I bet the pricing of  same will very attractive given the large fall-back in gold prices and drop of in Colossus shares).

As it turns out, Sandstorm posted a short video profiling the Serra Pelada mine on its youtube channel today. I have included same below for easy viewing.

Overall

It is important to constantly re-evaluate the companies you own, follow the newsflow carefully and continually reassess if the reasons that you made your initial investment still exist. If the underlying business becomes unattractive or the company fails to execute on its business plan, it is usually time to drop out. SND is getting pretty close to this point in my eyes.

Nonetheless, I am still a big believer in the streaming business model.  The current weak commodity prices and some delays in SND’s key streaming partners have put the lid on SND’s shares.  I believe, at this time, these are temporary issues.

At the next quarter, keep an eye on cash levels – if SND needs to raise cash (my models had a $1MM per month inflow coming in from Donner that will no longer exist), it will be extremely dilutive to existing shareholders and would likely have me re-think holding this investment.

Sandstorm Metals & Energy is now a show-me story. Lets see if management can show us.

Disclaimer: I own equity in Sandstorm Metals and Energy and Sandstorm Gold, which are mentioned in this article. This post does not constitute investment advice. We seek safe harbor. 

The post News Review: Sandstorm Metals and Energy appeared first on SteelsCorp.