Small cap resource stocks are not ‘buy and forget’ stocks: the outlook for such firms can change fast.
Both Rare Earth Minerals (LSE: REM) and Ithaca Energy (LSE: IAE) updated the market with new information this morning: do investors need to take action or are both shares still a hold?
Rare Earth Minerals
David Lenigas lithium play Rare Earth Minerals announced this morning that a new mineral resource estimate (MRE) for its flagship Sonora Lithium Project in Mexico has “more than doubled” the estimate of metal contained in the project.
The new MRE, which was carried out by independent UK firm SRK Consulting, reported a combined indicated and inferred resource of 7.42 million tonnes of lithium carbonate equivalent (LCE), a 226% increase on the previous combined estimate.
This looks like good news — but REM’s share price has edged lower this morning, so it’s worth asking why investors haven’t reacted more favourably.
2 concerns
Today’s statement refers to indicated and inferred resources. As REM warns in the footnotes of today’ announcement, these estimated resources have not yet been proven to be commercially viable and converted into reserves.
Oil investors may remember how Gulf Keystone Petroleum’s share price collapsed last year, after the firm failed to convert the majority of its resources into reserves.
My second concern is cash: a recent scoping study produced for REM estimated that investment of $666.1m would be required to bring the Sonora Project into production. The two companies which own the project — REM and Bacanora Minerals — have no revenue and total cash, I estimate, of less than $35m.
It’s clear that the money to develop this asset will have to come from major new investors, who could end up owning a sizeable slice of REM’s current share of Sonora, substantially diluting the interests of current shareholders.
In my view, the buy case for REM isn’t clear — with the firm already valued at £80m despite having no cash and no reserves, further gains could be relatively modest.
Ithaca Energy
Shares in North Sea oil producer Ithaca Energy have risen by 87% since 30 March, thanks to a solid set of full-year results and a sharp recovery in the price of oil.
Ithaca issued its first-quarter results today, reporting first-quarter production of 12,489 barrels of oil equivalent per day (boepd) and cash flow from operations of $88.5m, thanks to an extensive hedging programme that covers 6,800bopd at $74 per barrel until June 2017.
Ithaca also benefited from a fall in operating costs, which fell to $35 per barrel of oil equivalent (boe) during the first quarter, 30% lower than during the same period last year.
Despite Ithaca’s strong performance over the last six weeks, the firm’s share remain 25% lower than they were six months ago, when the oil price crash was just getting started.
The firm’s long hedging programme and ability to generate strong operating cash flow in current market conditions suggests to me that Ithaca’s management is strong, and that the company has good quality assets.
With net production due to rise by an expected 16,000 boepd after production from the Stella development starts during the first half of next year, I believe Ithaca could deliver further gains from here.
