We boosted our stake in Denison Mines this morning by 25% following an updated analysis in which the company achieved a maximum in-house Composite Rating of 5. Denison Mines excelled in the following categories: Net Profit Margin (Phoenix), Absolute Cost Structure (Phoenix), True Value Discount, and Market Cap Growth. Our Target, however, has been lowered by 20%, as our updated calculations implied a True All-In Cost (TAIC) that was higher than expected for Phoenix, while Net Profit Margin and Absolute Cost Structure for Gryphon were average.
MTQ Scores & Composite Ratings — Study Group Comparison
For stocks under study, Absolute Cost Structures (ACS) above 70% are associated with rapid falloffs in MTQ Scores and low MTQ Scores are predictors of low Net Profit Margins.
We will be monitoring stock price performance of a basket* of stocks over the next 24 months in order to establish whether or not there is a statistically significant correlation between price performance and MTQ Scores.
If we are able to ascertain that MTQ Scores serve as predictors of price performance, those scores will become cornerstones of our stock selection process.
*Fahy Capital Management does not necessarily own shares of the stocks under study.
The Fenix Project is on the high end of the TAIC curve. It will need higher gold prices to be viable. Above $1,700, Net Profit Margin becomes sustainable. It is important to note that social investment costs will be much higher than envisioned by Atacama Pacific and that will have a further deleterious impact on margins, as has the 35% increase in Chilean Corporate Taxes since 2014.
Note: A high score (> 0.5) implies a greater-than-even chance of an enterprise exhibiting both a high Net Profit Margin and low Absolute Cost Structure at the Long-Term Price Case at which it was evaluated.
Our Hypothesis: High MTQ Scores are a reliable determinant of Future Market Cap Growth
The MTQ Score is the 4th pillar of our updated valuation methodology. It will be published in future analyses alongside TAIC, ACS and True Value.
There is a great deal of value in Ur-Energy that hasn’t been baked into price. Were shares to trade between 30-40% lower in a general market decline, we would be buyers.
At $65/lb., Ur-Energy will achieve excellent Net Profit Margins and enjoy an Absolute Cost Structure that will elude peers (On its worst day, the company’s TAIC won’t rise much above $36/lb.).
Update, 13 July ’19
We do not presently have exposure to the uranium sector in the U.S., and in light of recent developments, the likelihood of our future participation has dropped. Any consideration of a U.S. issue will necessitate a substantial discount to our estimate of True Value. In the case of Ur-Energy, an additional 20% discount to the 12 July close will be essential before a small initial stake is considered.
More likely, future exposure to the U.S. uranium sector will be gained via exposure to Cameco’s Crow Butte and Smith Ranch-Highland Projects, though at that time, we believe Cameco shares will be available to us up to 30% cheaper following a general market decline.
In Q2, we reduced our exposure to uranium and increased our exposure to gold, silver and agriculture; our allocations to platinum and rare earths remain unchanged.
At Fahy Capital Management, our investment decisions are based upon quantitative data. Analysis of that data enables us to execute in what we perceive to be a timely and prudent manner. When our data suggest the gap between price and value has closed, we sell. This approach ensures that we do not fall in love with a particular idea or stock. We perceive stocks as inventory and we like to see that inventory get worked off.
Over the course of a 12-month time frame, we typically expect inventory to be reduced by as many as 2 or 3 names, and this has proven a rate that allows us to reinvest and grow.
We remain committed to the value proposition, but how we arrive at determinations of value is changing. We have developed new formulas and new ratios that we believe better reveal the merits and shortcomings of businesses under investigation, while conferring to us an edge on the hairy margins.
We are looking forward to sharing some of our results here in our blog. Those results, however, don’t constitute a recommendation to buy or sell; it’s just food-for-thought.