A STOCK PRICE POISED TO MULTIPLY
Tens of billions of dollars will be spent developing the vast natural-gas reserves of northern British
Columbia and Alberta. No one notices because the energy trade has been so hurt by politicians and
climate alarmists. But liquified natural gas is vewed as green and is acceptable to most native and environmental groups, as well as to politicians at both the
provincial and federal levels. Investors always end up going to where cash is being generated, and this is one area they will flock to.
Shell-led LNG Canada has already broken ground on its fully approved $40 billion liquified natural gas terminal in Kitimat on the B.C. coast and work has begun building the infrastructure to carry gas from the fields to the coast, notably the $6 billion Coastal
GasLink pipeline. Drillers, meanwhile, are ramping up activity as they aim to be ready to start producing as soon as the pipes are open, which means they’ll start drilling this year to build reserves.
The way to profit from this trade is to invest in the most promising “pickaxe and shovel” stocks, the smaller companies that will supply this gas rush.
Long-time subscribers will remember Athabasca Minerals (ABM.V). It was the second stock ever recommend in this newsletter, at 25 cents, a little more than eight years ago. The stock would go on to provide subscribers with a return of as much as 1,100%. A decline
in oil prices and some poor management decisions by the former team (now all gone and replaced by a top-level crew) led to the stock falling from more than $3 to 10 cents.
But it’s starting to rally, and we believe that the stock is about to create a great deal of wealth again. We expect significant near- and longer-term gains from the stock, and given the relatively low risks, the value proposition looks very attractive.
Market cap: $23 Million
Shares out, diluted: 44 Million
Cash: $5.3 Million
Insider ownership: 11%
Athabasca Minerals consists of three divisions. The first owns and manages gravel pits. It just signed a big, exclusive contract to manage a large pit on behalf of the government of Alberta, in the heart of the oil sands, where gravel is in very high and constant demand. This contract, and the company’s other gravel assets, mean that it will most likely be the supplier of choice in the Fort MacMurray area for decades. Gravel isn’t sexy but it can be exceptionally lucrative if one owns it where it’s needed. The base business should be profitable for decades and has the potential to expand aggressively by merger and acquisition.
The second division is a very interesting technology play called Aggregates Marketing that looks very much like an early-stage Uber Eats or GrubHub or Skip the Dishes, except it caters to aggregates (rock, sand, gravel) rather than food. We’ve seen billions thrown at Uber Eats et al., and we think Aggregates Marketing could be worth a lot. The company is considering spinning the division out, which would create a lot of value because we think it’s easily worth more as a Venture-listed spinoff than what the entire company is trading for today.
Finally, the company’s frac sand division owns three highly promising deposits in northern Alberta and British Columbia, where fracking is commonplace, and demand is growing. There is already significant gas production in the Montney and Duvernay regions, with healthy demand for sand. But demand is going to skyrocket with Shell’s LNG project. There are other projects planned as well. This, combined with a powerful industry trend towards using local sand, makes the frac sand unit the crown jewel of the business.
We believe this division could also be spun out. In fact, we think the company could and should be split into three entities to unlock tremendous shareholder value.
Even without that we see the potential for a 7x return over a relatively short period of time.
When we first invested, Athabasca Minerals’ primary asset was a management contract for a massive gravel pit owned by the Alberta government called Susan Lake. The reason the government retained ownership of the pit is because gravel is vitally important to oil-sands producers. Without gravel they can’t operate.That was a lucrative contract because oil-sands mines use a LOT of gravel, notably for the roads in the mines, which are always expanding. They use aggregates for other things as well. At its peak, in 2012, the company earned 17 cents a share of net income from managing this pit.
But what really drove investor demand for the stock back then was the company’s Firebag frac-sand deposit, a massive field of pristine proppant that is highly sought after by drillers.
THE BUSINESS TODAY
Athabasca Minerals has changed and grown, and today the company can be broken down into three businesses.
1) Gravel – the bread and butter:
We mentioned earlier that the company managed the Susan Lake pit. It’s depleted, but Athabasca recently won the right to manage the replacement pit, called Coffey Lake. It’s smaller but by our math the contract is worth as much as $100 million in revenue with about $20 million of earnings (using Susan Lake economics as our guide). The life of the pit will depend on demand, but we peg it at eight to 10 years.
Once that pit is finished, there are no large pits in the area that can provide for the steady-state demand of 5 million tonnes a year (and much more when new projects come on). We say “in the area” because gravel is only worth something if it’s close to where it’s needed, given the high cost of shipping it relative to its value.
The only large deposit appears to be Athabasca’s Richardson, which would have a life of 40-60 years. As long as no one finds a larger, closer deposit, which is unlikely given decades of prospecting in the area, Richardson will be put into production in a few years and the company will be the predominant supplier of gravel to the oil-sands for decades.
So what is this base gravel business worth? If we discount 40 years of estimated earnings at 8% we get $35 million, excluding any new opportunities in gravel (even though there are some very big ones – more on that shortly). So the bread and butter business alone more than justifies the current market cap of $25 million.
2) Aggregates Marketing – the Uber Eats of aggregates:
You’ve heard of Uber Eats, the food-delivery business owned by Uber, the ride-share company. Uber Eats matches hungry consumers with restaurants and drivers. It’s the middle man, using custom technology to provide buyer, seller and deliverer with a medium in which to exchange services for money.
Formed in mid-2018, Aggregates Marketing is the same idea. Like restaurants, gravel is a very fragmented industry. Many pits are mom and pop operations that don’t have much technical or marketing savvy. They wait for the phone to ring, quote a job and hope to win it. Buyers, meanwhile, don’t want to call 10 potential suppliers for bids, go through them to pick a winner and then find a trucker to deliver it. They don’t even know all the suppliers or truckers. And they’re sometimes in a big hurry. Enter Aggregates Marketing.
Because Athabasca Minerals is well-known in the industry it gets a lot of calls from operators looking for gravel that it can’t supply. It used to politely decline or point the buyer toward another supplier.
New CEO Rob Beekhuizen looked at this and saw an opportunity. He hired staff to build a platform that would allow Aggregates Marketing to become a technology-driven middleman in the gravel business. The company has been populating its database with suppliers, buyers and truckers (the count is currently 400) just as Uber Eats (or Skip the Dishes or GrubHub) had to get drivers, restaurants and to join its ecosystem. The company has so far closed three deals, worth about $4 million in revenue. Many others, some very large, are pending.
This business makes money two ways. First, it charges a fee of 8% on the value of any contract it helps broker, similar to food delivery.
The other is to arbitrage product pricing. This is especially true on less common forms of gravel. Say a buyer places an order for a relatively scarce form of rock that he’s willing to pay $50/tonne for. Meanwhile, a seller in the area may be content to sell such rock for $20/tonne. The platform can match these two parties (with a trucker) and charge $50/tonne, thereby pocketing $30/tonne. Contracts would range from the hundreds to millions of tonnes. The margins can be eye-popping.
Anyone can see that this business makes sense for all parties involved. If it works out in Northern Alberta, and so far it looks promising, it can be expanded across the continent. And the beauty is that it requires very little investment. It’s precisely what investors are looking for today: low capex, high volume business that are hard to break in to after two or three incumbents take the lead (look at Lyft and Uber for example, with combined valuations of over $110 billion.)
Data, as they say, is the new wealth.
So what is this business worth? Uber Eats and others in this very hot space have valuations in the multiple billions (see table), but let’s not get carried away. Food and groceries are a much bigger market than gravel. Yet gravel is a very big business in North America, worth tens of billions of dollars in sales annually.
|Based on the value of Uber Eats as part of the valuation of Uber according to its investment bankers.|
As mentioned, Athabasca Minerals is considering spinning this unit off given the demand for this kind of investment, and the company’s biggest shareholders are in favour. We ascribe a spinoff value of $60 million. Obviously this valuation could rise because these kinds of businesses can grow quickly.Assuming ABM keeps 50%, that adds $30 million to the valuation of the stock.
3) Frac sand:This is the big one, and the one from which we derive the most value. We mentioned that ABM owns the Firebag deposit north of Fort McMurray. It’s 500 hectares, 80 of which are now fully permitted.
But the company has recently acquired interests in two operations with significant, high-quality deposits in the heart of the Montney and Duvernay regions, where drilling is already happening and where it’s about to get a lot busier.
Why? As mentioned earlier, Shell has begun construction of a massive liquefied natural gas project on the coast of northwestern British Columbia that will take Canadian gas and ship it to Asia, where gas prices are much higher and more stable, and where demand is growing rapidly. Including infrastructure, this is a $50 billion project, the biggest investment in Canadian history. Others LNG projects are also contemplated.
The LNG terminal will obviously create enormous demand for gas, which will in turn create enormous demand for sand. In fact, demand growth for sand will probably outstrip demand growth for gas because gas wells are using more and more sand. As this chart shows, frac sand demand rises even if drilling doesn’t:
Athabasca and its partners are busily tying up all the quality deposits in the area near where the drilling will happen, and this, if successful, could create enormous wealth for shareholders by giving the company pricing leverage.
But there’s another trend that will drive this story and attract a lot of investors, and potentially acquirers, to this story once it gets out. For the longest time, most frac sand came from Wisconsin (it’s called Northern White or Ottawa sand, although it has nothing to do with Canada). This was shipped by train and truck thousands of kilometers to northern Alberta/BC, Texas, North Dakota etc.
It’s fetched as much as $150/tonne. Given that 70-80% of the price of aggregates is transportation, why would producers pay so much for this sand? Because it was deemed the best. Frac sand needs certain properties to be used successfully as proppant. It needs to be very hard (this is referred to as crush strength), very round (to maximize flow), clean and of various sizes. The Wisconsin sand has the best overall properties.
But a big shift has recently taken hold in the industry: Drillers are settling for lesser quality but much cheaper local sand, because they’ve found that the tradeoff between price and quality is well worth it. You can read more about this trend by clicking the links below:
Worthless Just Two Years Ago, West Texas Sand Now Brings in Billions: Bloomberg
In-Basin Frac Sand Sweeping The Industry: Feeco International
Drillers have finally decided that shipping sand thousands of kilometers is not worth the massive transport cost and are looking for proppant closer to where they drill. ABM’s strategically located deposits will make it impossible for Wisconsin to compete given that 75% of the cost of sand is transportation.
So prices for Wisconsin sand have been falling along with demand for it, while prices for local (so-called in-basin sand) have been going up. (In-basin means the sand never gets on a train, but rather is close enough to be shipped by truck.)
This trend has taken serious hold in the Permian region of Texas and it’s a trend that Athabasca is trying to cash in on with its two additional sand investments in the heart of the Duvernay and Motney regions. Both of the investments are roughly 50% stakes with options to go to 100%. Drilling results appear positive on the Duvernay side. with Montney results expected soon.
But there’s an important difference between what Athabasca is doing and what happened in the Permian. In the Permian, no one amassed a dominant position in sand. The result is fragmented ownership and limited pricing discipline. Athabasca, by contrast, is quietly trying to tie up all the quality product in the Duvernay and Montney, and if successful they will be, with three deposits, the dominant source of local supply.
Now if you think about that, and remember that transportation is the biggest part of the cost of frac sand, you can see the advantage. If ABM’s main competition comes from out-of-basin sand, the company will have a huge advantage on cost.
The economics of the frac sand deposits are pretty straightforward. A plant to process sand costs $40 million (about $24 million can be debt) and can produce one million tonnes of sand a year. See the table for estimates based on two plants, one for each deposit. We used discounted market pricing and please note that we assumed a partner or off-take agreement would mean relinquishing half the value, which is most likely very high:
Note that we only used a 3x EBITDA multiple.
Now what does that means per share? The question requires an estimate of share issuance. And here’s where things get interesting. Banks will finance about 60% of the cost of a plant, meaning ABM needs $16 million for the first one. The company is attempting to pre-sell blocks of frac sand to drillers which would provide non-dilutive financing. They have had several meetings with one large driller, and are at earlier stages with others. The CEO has also been to Wisonsin twice this year at the invitation of a sand producer in the state, and we understand that an experienced party from Texas has been to the Duvernay site and to Calgary twice. We think we know why. And we think the company will succeed in finding a partner for the first plant, allowing the second to be built from cash flow. There is also the possibility of using a smaller, much less expensive mobile plant to start out with.
We think with sensible dilution the frac sand deposit, taking into account the likelihood of off-takes or partnerships, could conservatively be worth $150 million.
The hair on the story:A few years ago Athabasca Minerals sued Syncrude, the big oil-sands producer, for non-payment on some gravel the Syncrude took from Susan Lake (which lies partly on Syncrude land). Syncrude responded with a frivolous $65 million lawsuit, alleging that Athabasca hadn’t properly reclaimed the land where the gravel pit had been. Because Syncrude intends to mine the area underneath the bottom of the pit, it will ultimately have to finish the reclamation, and claims that Athabasca left a mess.
We’ve read the lawsuit and consulted with lawyers, and we are of the firm belief that the lawsuit is completely ridiculous. Syncrude has a different regulator than Athabasca, with different rules. Athabasca, we know, has followed its reclamation regulations to a T, and the regulator has confirmed this. Clearly the government would not have awarded the company the contract to manage Coffey Lake if it had a poor reputation in terms of reclamation, given how important the green image is in Alberta.
The parties are negotiating a resolution, and we expect it soon. If that happens expect the stock to pop because we know of many big investors who are prepared to buy stock once the lawsuit disappears. Syncrude has already offered a settlement, but reneged, which won’t help them in court, should it go back there, which we doubt.
But here’s an even better outcome: spinning out all of even some of the divisions protects them from the lawsuit because it’s against the parent company. It’s worth noting that the board has already divided the company into three distinct corporate entities.
Our sum of the parts gets to a valuation of $3.50/share. This assumes 80 million shares outstanding (from the current 45 million). That implies the potential for excellent upside. As for downside? We think the gravel business alone is worth the current stock price, especially given the company has about $6 million in cash and no debt, so we would describe risk as limited.
On balance, we view this as a very attractive proposition.