Stockhouse Ticker Trax is equity specific research (Canadian listed and market cap < $300 million) published every Monday to paid subscribers. Our free Friday column may feature companies previously featured to paid subscribers (with a minimum one month delay) or discuss topics of interest to the general investment community and relevant to overall portfolio management.

This week’s discussion topic

I.   TSX & TSX.V Junior gold stock analysis – Shockingly low gold ounce valuations

This has been one of the roughest years for junior companies (in all sectors) since Q4/08 and Q1/09.

Since the spring (and even while gold was going through $1800) I have told paid subscribers that the junior gold companies should only be valued in the range of $30 to $50 per ounce because that appeared to be the going rate for valuations across the board.

That valuation became a significant bone of contention amongst speculators, analysts and newsletter writers.  A couple months ago Marcus New (Stockhouse CEO) was in New Orleans at an investment conference and one evening this became the topic of conversation. Marcus stuck to the same opinion that valuations were grossly depressed and we shouldn’t be using many of the numbers that were floating around.

Most people were trying to use studies they had seen from the brokerage firms or using the half dozen acquisitions we had seen this past year to justify saying that these junior gold companies should be worth anywhere from $75 to $250 per ounce. While it is fine to say they “should” be worth xx per ounce, reality is another thing. What good does it do to overpay for a company and assume the risk when the market is saying they have no interest in paying more?

So in November I decided to try and prove the point. We found about 60 companies on the TSX and TSX.V with a minimum one million ounces gold and all the way to eight million. I cut several out completely because they had very weak balance sheets and in this economic environment, a lack of cash is going to have dramatic consequences when valuations are depressed already.

If a company has little cash but also a huge amount of stock outstanding, they will need to finance at low prices and the dilution (and its impact) become dramatic. For this reason alone we left some companies out. You will see, however, that there are several companies included with very limited working capital (also shown as Net Debt). We still needed as many companies as possible to make the study useful so I targeted 50 companies (we ended up with 48). No doubt we missed some companies but this should be an excellent representation to arrive at a realistic valuation.

Something very interesting that emerged over the past month was that I picked four companies from this list to feature to paid subscribers. Of those four, one was Crocodile Gold (TSX: T.CRK, Stock Forum), which was written up November 30th at 36 cents.  This past week there is a takeover attempt at 56 cents.

The company was chosen for various reasons (infrastructure, working capital, producing, etc.) but prior to the takeover the valuation per ounce of gold was approx. $25. Had we taken into consideration the value of their plant and equipment, that number would have been significantly lower.

We used an industry norm in the investment banking industry called Net Debt. This takes a company’s cash and cash equivalents (or liquid investments) and pulls out all debt. It gives them no value for accounts receivable or other physical assets like equipment because you never know what those assets could be liquidated at – but debt is usually debt.

We then took its reported ounces of gold (based upon 43-101 reports that are the standard for the TSX) and after factoring in the trading price (to calculate market capitalization) arrived at a market valuation for those ounces of gold.

Several other factors come into play when determining fair value but as you will see, the valuations are incredibly low – especially when gold is trading above $1500 per ounce.  A small handful of companies are trading near or above $100 per ounce but they are rare.

You will see we also included Grayd (TSX: V.GYD, Stock Forum), which is being bought out above $200 per ounce. For months many analysts (including high profile newsletter writers) have been telling subscribers that $150 to $250 per ounce should be the benchmark to use for valuation on most companies (because of situations like GYD). However after looking at this table, I am sure you will agree this is a very arguable fact.

The real challenge is trying to identify which of these companies will make that valuation leap because of exploration upside potential, or because a major feels their gold is cheap enough to acquire yet realistically the project can be put into production (taking into consideration operating and capital costs).

We will update this table once a month so gold investors can monitor any changes in valuation or risk. I pay particular attention to how much cash they have and share structure. If a financing is going to be required in Q1 or Q2 2012, carefully assess the impact this will have and how much lower it will drive the gold valuation.

We have sorted the same table four ways so you can determine which format is the most useful.

(Please click on the individual table to see bigger size)

Measured Mineral Resource: is that part of a resource for which quantity, grade or quality, densities, shape, and physical characteristics are so well established that they can be estimated with confidence sufficient to allow the appropriate application of technical and economic parameters, to support production planning and evaluation of the economic viability of a deposit. The estimate is based on detailed and reliable exploration, sampling and testing information gathered through appropriate techniques from locations such as outcrops, trenches, pits, workings and drill holes that are spaced closely enough to confirm both geological and grade continuity.

Indicated Mineral Resource: is very similar to the Measured classification but the resource can be estimated with a level of confidence “sufficient” to evaluate economic viability of the deposit. This classification is much stronger than Inferred but still makes a significant number of assumptions. Most junior exploration companies in Canada report Measured & Indicated (M&I) in the same category.

Inferred Mineral Resource: is that part of a resource for which quantity and grade or quality can only be estimated on the basis of geological evidence that involves limited sampling and reasonable assumptions. The estimate is based on limited information gathered from locations such as outcrops, trenches, pits, workings and a very limited number of drill holes. The inferred category is similar to saying “we have a reasonable expectation the minerals are there but have yet to prove it through sufficient drilling”. Moving a resource from Inferred to M&I can be time consuming and expensive.

[*] Adam Deadlock is a 2012 graduating finance student from the University of Calgary, Haskayne School of Business. Adam does part time research and analysis for various Ticker Trax projects and also for MicroCap.com. He is part of a small group of Haskayne students involved in the Calgary Portfolio Management Trust (CPMT) initiative. CPMT students manage a substantial equity portfolio and build their skills in research and spreadsheet modeling.