I’ve made 3 new investments over the last month or so for clients, all of which are Growth holdings. Two companies are junior gold miners and the third is a long-term compounder.
Commodities are a tough business to operate in because companies don’t have control over the final selling price of the product which leaves them at the mercy of the market. Commodities are also the epitome of a boom-bust cycle. Bear markets tend to be long and slow but low prices eventually reduce supply as companies cut back on production and then you tend to see vicious bull markets as you get supply shocks that can’t meet demand. Because of this, there are generally two rules to follow when investing in commodity stocks: 1) you want to own the lowest cost producers because they have the longest staying power to withstand a drawn out bear market, and 2) you buy when prices are depressed and no one wants to own anything related to the industry, and sell after prices have rocketed higher and investor euphoria builds. In short, don’t overstay your welcome.
I’ve noted more than once this year my view that I believe precious metals have started the next leg of a multi-year bull market. There are a a few reasons for this, most macro related, but one in particular is the lack of major new discoveries by the gold mining industry in jurisdictions that are considered safe and actually abide by the rule of law. What we’re now seeing is a wave of consolidation where the largest mining companies are buying out the most attractive junior miners rather than take the risk and time to explore and develop their own mines. I think this trend is only just beginning. We should see more junior miners being acquired at substantial premiums so I’ve primarily focused my attention here in terms of precious metal related stocks. Here are our 3 newest holdings:
Equinox Gold (EQX)
Equinox Gold is a Canadian mining company with projects in North and South America. The company is led by Ross Beaty, a highly respected leader in the mining industry, who is also the founder and Chairman of Pan American Silver, another company we’ve partnered with. The company just announced that they will be merging with Leagold, who is currently chaired by Frank Giustra, another legend in the industry. Shareholders will be voting on the merger this month and I’m confident (and hoping) it will be approved.
Precious metals mining in particular is an extremely difficult industry that is laden with poorly managed companies so experienced leadership is absolutely paramount. Any company run by leadership and insight of Beaty and Giustra is a company I’m willing to partner with. These are two of the best that also invest a significant amount of their own wealth in the companies they run – true owner-operators with skin in the game.
Ross Beaty will serve as Chairman of the new combined company and part of the financing to complete the merger also included Beaty investing another $40 million of his own money in the company (to buy stock at the market price). The merger will ultimately provide the company with increased scale and synergies, and should eventually re-rate the stock higher as some of the “junior risk” is taken out.
Novagold Resources (NG)
Novagold Resources is a gold mining company that owns a 50% interest in the Donlin Gold Project, potentially one of the richest deposits in the world, located in Alaska. Novagold was a poorly managed company on the verge of bankruptcy a decade ago when Thomas Kaplan, one of the most successful resource investors of the last 30 years, stepped in to bail out the company and take a controlling interest.
Where many resource companies go wrong is in trying to maximize production instead of maximizing profits. Rather than destroy value for shareholders, Kaplan has stated that they have basically been waiting for higher gold prices before beginning production. They’ve spent the last decade planning and prepping the project to ultimately maximize the returns earned. The company also sold another project previously owned to focus all of its efforts on Donlin. This has provided them with enough cash to run for another 5 years at least without needing to raise any additional money.
The Donlin project should produce over 1 million ounces per year with an expected mine-life of 27 years based on current reserve estimates. But what makes this project so special is that the land might hold double the reserves currently estimated. This makes the investment a very unique setup; it’s basically an asymmetric, long-term call option on the price of gold. It’s a truly one of a kind investment in what is perhaps the most attractive industry over the next 5+ years.
The Compounder: Rollins (ROL)
Rollins is a provider of pest and termite control services to over 2.4 million households and commercial properties around the world. The company has put together an extremely impressive track record of profitable growth over the last 30 years and is still run and controlled by the founding family. They operate under a franchise model in a highly fragmented industry that is expected to grow steadily over the next 20 years, providing a long run way for tuck-in acquisitions and future growth. Their most well known subsidiary is the Orkin brand, the #1 pest control provider in the US with over 100 years of history.
The company has been expanding globally and now operates in over 60 countries, but they’re just scratching the surface of the total global reach. They’ve also displayed great discipline with their acquisitions by not overpaying and focusing on strong ROIC and cash flow. Recent acquisitions have also taken them into adjacent lines like mosquito control, a very attractive opportunity given the rise in mosquito spread diseases in the recent years.
Pest control is a capital light business that generates high returns, a ton of free cash and offers a wide moat of recurring business (retention rates as high as 90%) as it operates outside the risk of technological disruption.
Earnings were hit last summer by cooler weather (the warmer the weather, the worse pests tend to be) so we were able to initiate a position in the stock about 25% off it’s all-time high. Rollins has been a true compounder of wealth that I expect to continue for years to come so I can only hope for the opportunity to add our investment at lower prices still.
As a quick side note, readers might remember about two months ago when I highlighted the Fed’s timeline of losing control of the money markets and how Powell stressed that it was calendar related, only temporary and NOT QE. I said:
Here’s the timeline of events from the Fed:
Sept 17th: We’re doing temporary Repos today and tomorrow to calm money markets and provide liquidity
Sept 19th: We’re extending Repos until Oct 10th and increasing the facility to $75 billion in overnight Repos, $30 billion of term (usually 14 days)
Oct 4th: We’re extending Repos until Nov 4th.
Oct 11th: We’re extending Repos until Jan 2020
Oct 23rd: We’re increasing the facilities to $120 billion in overnight, $45 billion in term
Oct 30th: Open Market Operations (i.e. buying T-bills) will continue into Q2 2020.
First, as you can see from the comical timeline above, there’s nothing temporary about this. This will become a permanent facility as they continually extend and increase it. Second, these Repo operations are expanding the Fed’s balance sheet again, which just increased back above $4 billion.
Well, that didn’t take long. Here’s an article from Barron’s over the weekend recapping how the Fed’s most recent meeting minutes as well as various regional Fed presidents are discussing the need to permanently intervene in the money markets:
Classic! Here’s to an exciting 2020!
-Nick