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Gold miners are popular these days – the VanEck Vectors Gold Miners ETF (GDX) has outperformed the S&P 500 handsomely this year. Geodrill (OTCPK:GDLLF) is not a gold miner and does not mine gold, but it provides an essential service to gold miners and explorers – namely it drills earth and rock samples from deep underground that allow to probe for the presence of metals and determine their characteristics.

The investment case for Geodrill is based on miners substantially increasing exploration spending after strong gains in the price of precious metals over the past year. Apart from these positive cyclical expectations, the company is well run, has a solid track record of delivering organic growth and trades at an undemanding valuation.

Company Overview

Geodrill is an exploration driller and operates primarily in West Africa, but is looking to expand to Latin America (Peru & Brazil) this year. The company operates a fleet of 67 modern, multi-purpose drilling rigs, which it employs to drill holes for its customers (90% of revenue is gold-linked) to probe the contents of ore deposits. Revenues are a function of the number, depth and kind of holes drilled and not directly tied to the price of gold. However, the price of gold drives Geodrill’s customers’ (mining companies) appetite for drilling. The increase in the price of gold by around $600 per ounce since last year will have a meaningful positive impact on margins in an industry where all-in sustaining costs (AISC) are around $1100/oz. Higher cash flows and margins will drive more exploration. Higher exploration spending in turn drives higher utilization and pricing at drillers like Geodrill.

Geodrill Share Count has remained stable (source: Bloomberg)Geodrill Share Count has been stable (Source: Bloomberg)

The company was founded in 1998 by current CEO Dave Harper, who still owns 40% of the shares. In 2010, Geodrill sold its stock at the Toronto stock exchange at C$2.00/share via an IPO under the ticker GEO. Since then, Geodrill increased the number of drill rigs from 18 to 67, revenues roughly doubled to US$76m and debt was fully paid off. Recently, the shares change hands at C$1.85, and the market cap is US$67m.

Diamond Cores with gold veins (Source: Pretium Resources)(Source: Pretium Resources)

Diamond Cores with gold veins

The two most common types of drilling are Reverse Circulation and Diamond Core. In Reverse Circulation, crushed rock chips are delivered back to the surface, where they are stored in sample bags. Diamond Core Drilling collects entire cores (or cylindrical samples of rock), exactly as they sit underground, which allows geologists to visually inspect the rock, veins of minerals etc. (more information on the type of drilling can be found here). Geodrill offers these as well as variations of these types of drilling to its mining customers.

GEO(Source: company materials)

Geodrill’s West African markets

Western Africa (Ghana, Ivory Coast, Mali and Burkina Faso) is not the easiest environment to do business in, in terms of transparency, public institutions and security. Indeed, two of Geodrill’s employees have died in an attack in Burkina Faso in late 2019, when the convoy was attacked by terrorists. This had an impact on the company’s Q4 results. More recently the COVID-19 pandemic also impacted business in Q2 2020 as borders were closed and other restrictions imposed. Despite these challenges, EBITDA margin reached 19.6% on a TTM basis (US$15m), while the balance sheet shows a net cash position of US$4.8m.

GEO insiders were buyers during March/April weakness (Source: Bloomberg)Geodrill insiders were buyers during Q2 weakness (Source: Bloomberg)

Geodrill has the traits of a well-managed, quality company. The CEO likes to remind investors how a customer who started working with him in 1998 is still a customer of the company today (short although dated interview available here). Unless there is a good reason, customers tend to stay with the operator who is reliable. The company claimed previously that it has higher capacity utilization than competitors and rated higher on quantitative measures such as Average Revenue Per Operating Rig. Most listed competitors have disappeared as stand-alone entities. Geodrill not only survived, but grew in strength, while the best is still ahead.

Why now is the time to buy?

The gold mining industry has gone through a period of cleansing. After the gold price dropped in 2013 to close around $1000, certain mines had to shut as they were not economical, while the lower-cost producers faced a long period of low margins. In this environment, costs were cut heavily. Priority was given to sustaining production, while exploration was usually cut to the bone. However, after these seven lean years, we have entered a much more favorable price environment. The mood in the gold sector has markedly changed since the May of this year. Capital is fairly easy to come by (many juniors have come to the market with capital raises) and growing resources through exploration is back in vogue.

Historical Capex spending by GOLD and NEM vs Gold PriceHistorical Capex spending by GOLD and NEM vs. Gold Price (source: author calculations)

In this chart, capital expenditure of two large gold producers (Barrick Gold (NYSE:GOLD) and Newmont Mining (NYSE:NEM)) is shown against the gold price. I am using Capex as a proxy for exploration spending, even if actual magnitudes may differ. Capex fell from a peak of 10bn in 2012/13 to just over 2bn in 2016/17 (-80%), and has since risen to 3.4bn as of Q2 2020 (-66% from peak) – a rather small bounce given the scale of the drop. We can observe that the previous drop in the gold price has led the drop in spending and I would expect the recent rise in the gold price to lead to higher capex and drilling. Geodrill should be a key beneficiary of this trend in the coming quarters and years.

Geodrill Revenues and Margins (source: author calculations) (Source: author calculations)

Geodrill Revenues and Margins

As this cycle unfolds, there should easily be 200% upside on the shares. The current 4.2x EV/EBITDA valuation is too low and reflects a lack of interest in a small illiquid stock. A mid-cycle multiple of 6x is realistic (GEO traded around 6x-8x in 2011/12), while revenues and margins will be driven higher as capacity utilization tightens. EBITDA and revenues are starting off a low base given the impact of COVID-19 and the terrorist attack over the past 12 months. The big increase in spending by miners is yet to come through in Geodrill results, and assuming bullish gold market narrative is correct, could last for a while.

In brief, Geodrill is well positioned to almost literally “sell shovels in a gold rush”, while its share price hardly reflects these positives.

GEO CN Price Chart

Disclosure: I am/we are long GDLLF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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