This week, we review a relatively unknown Canadian-based gold producer with mining operations located in Colombia, that posted nearly 30% year-over-year revenue gains in the 3rd quarter of 2015, even as gold prices were decreasing. Gran Colombia Gold (TPRFF) has been increasing its production at its Segovia mining project over the past year, which contributed to its 18.5% annual production increase thus far reported in 2015 over 2014 levels. More recently, the company has successfully restructured its long-term debt, which we see as a very rare opportunity for investors to profit from big capital gains from its deeply discounted 2018 Silver notes. Couponed at 1%, this debt instrument carries with it an option for bondholders to convert (at anytime, as explained further below) to what may be significantly undervalued stock, especially in light of recently improving gold prices. Prior to the finalization of restructuring, the company’s interest coverage in Q3 of 2015 was about 2.7x’s. Although we expect coverage to be less in the forthcoming Q4 2015 (year end) report due to weaker 4th quarter gold prices, a short production interruption, and restructuring expenses, with the new terms and lower cost taking effect in Q1 2016, interest expenses should be nearly one-half of what they have been in 2015. Consequently, we estimated the change would effectually double the earnings/interest coverage ratio, to over 5 1/2 x’s, before adding in any increase in revenues projected to result from higher gold prices.
Also of key significance are the company’s improving labor contracts and relationships in Colombia, and it decreasing all-in-sustaining costs (AISC) per ounce of gold. After considering its projections for greater production and improving cash flow (which will be used to buy back its debt), we believe that higher gold prices will continue to kick the market’s valuation of this company, and its bond prices, significantly higher. Given the apparently overlooked and somewhat obscure nature of this US dollar debt instrument (which only has about $71 million face value outstanding), it is more difficult to project exactly what price or yield we can reasonably expect it to acquire at. Priced at the currently indicated offer of about 50, the yield to maturity would be over 32% (nearly all of which would be in long term capital gains.) However, this does not include any additional capital gains that may seem likely to result from the broader market’s discovery and higher assessment of this company’s fundamental enterprise value. Therefore, we not only love the 32% YTM achievable only through the coupon and discounted price of this US dollar debenture, we see the uniqueness of this high yielding convertible note (and its hidden value) as an undiscovered anomaly in the markets, and are marking it for an oversized position in it to both of our high yielding global income portfolios, FX1 and FX2, as well as our Distressed Debt 1 LP fund.
About the Issuer
Gran Colombia Gold is a Canadian-based gold and silver exploration, development and production company. Its primary focus is in Colombia, with its Segovia, Marmato and Zancudo projects located in the north central region of Colombia. Gran Colombia is currently the largest underground gold and silver producer in Colombia. The company is currently advancing a project to develop a modern large-scale gold and silver mine at its Segovia operations. The company’s most recent mineral resource reports indicate proven gold reserves to be 12.251 million ounces contained within its Segovia and Marmato projects.
Gran Colombia recently posted its 2015 annual production numbers and they are impressive. Gold production increased by 18.5% over 2014 levels and silver production increased by 17.4%. These increases came in spite of the security concerns in late 2015 at the company’s Segovia project (see the “Risks” section for more information on this).
Restructuring Debt and Convertible Play
In December 2014, Gran Colombia missed interest payments on both its Gold 2017 (couponed at 10%) and Silver 2018 (couponed at 5%) debentures. In 2015, the company underwent numerous changes, culminating in significant improvements in both production and revenue operations. Payments were subsequently resumed on its debt obligations, and a restructuring proposal of its long-term debt was finalized January 2016. Under the restructuring terms, the 10% 2017 Gold notes were exchanged for 6% couponed convertibles maturing in 2020, while the 5% 2018 Silver notes were exchanged for 1% couponed convertibles maintaining the same maturity in 2018. These notes now pay 1% annual cash interest, or a PIK interest at twice that rate (i.e., 2%), and are also convertible to Gran Colombia common shares of stock at a conversion price of US$0.13/share (calculated using full face value) anytime prior to maturity. With bonds currently priced at 50% of face value, investors are effectively receiving “free” 2½ year call options (trading at or near par with its strike price) as a result of its convertibility feature, and any increase in the underlying stock price should result in a corresponding increase in bond pricing. Recent share prices for Gran Colombia (since January) have ranged between CAD $0.07 and $0.125 (US$0.05 to $0.09). Extending Q3 2015 operating income of $9.88 million US to an annual figure would indicate Gran Colombia’s operating income is well over 4x its current market cap of $8.67 million (CAD $11.92 million), which leads us to believe that the market has significantly undervalued this company.
In addition to the changes covered above, the accrued and unpaid interest on the original Silver Notes was added to principal for the restructured notes. Finally, at maturity, Gran Colombia has the option to repay principal (including accrued and unpaid interest) by issuing common shares at a 5% discount to its market price at that time.
Most importantly, this restructuring gives Gran Colombia flexibility in times when cash flow might be tight due to capital expenditures and / or fluctuating commodity prices. With the company posting excellent gains in production for the first nine months of 2015, which grew 24% year-over-year, it appears this restructuring will give Gran Colombia ample cash flow to support its growing operations.
Over the past five years, gold has varied in price from a high above $1,800 an ounce in 2011 to a low last year around $1,050 an ounce. Last year in 2015, gold prices ranged between $1,300/ oz. near the beginning of the year, fell to a low of $1,049/ oz. and ended around $1,060 / oz. Last year, during a period where, overall, gold prices declined, Gran Colombia grew its revenue by 13% for the nine months ending September 30, 2015, primarily due to the company’s increased gold production.
With respect to where gold prices are headed, there are opinions supporting both increases and decreases in 2016. Year-to-date, gold prices have rallied, trading at $1,237 an ounce by the second week of February, up 17% from the start of the year. With gold and interest rates being historically negatively correlated, most agreed at the end of 2015 that gold would continue to steadily decline as it did last year, especially given the Fed’s rate increase in December, along with plans to increase rates at each of its committee meetings this year. However, the most recent testimony of Federal Reserve Chairwoman Janet Yellen before the House and Senate committees in early February, revealed that the central bank has increased concerns over the path of interest rate increases, citing falling stock prices, stresses in China and other foreign economies that could impede domestic economic growth. Recent global economic volatility, including the negative interest rate policies of the European Central Bank and the central banks of Japan, Denmark, Sweden and Switzerland, have driven many to seek the safety of gold, which was likely a key factor in the early 2016 price increase. Add to this the fact that Janet Yellen told Congress that the Fed still considers a negative interest rate policy as an option if it is judged as warranted, and one could see where gold may continue to increase this year.
In its latest reported quarterly results, Gran Colombia posted some very encouraging numbers. Namely, the company increased its revenues 27% (from $30.9 million in Q3 2014 to $39.3 million in 2015). Adjusted EBITDA also increased handsomely, from $1.8 million in Q3 2014 to $13.3 in Q3 2015.
Amongst gold mining companies, one of the metrics used to evaluate the company’s costs and profitability is the all-in-sustaining cost (AISC). This figure represents the total cost to the company to bring gold to market, including cash costs for mining, exploration costs as well as general and administrative costs. Obviously, the lower the AISC, the higher the profits per ounce of gold. Gran Colombia has been striving to reduce its AISC and from its most recent quarterly results, it appears to be working. AISC in Q3 2015 came in at $789, as compared to Q3 2014 of $1,216. And the nine months ending September 30, 2015 also showed progress, with AISC coming in at $867, as compared to $1,206 for the same period in 2014.
Q3 2015 also showed healthy interest coverage for Gran Colombia. Operating income totaled $9.882 million with interest expense of $3.543 million, for a coverage ratio of 2.8x. With the restructuring, the interest expense will adjust according the terms of the new notes. Both the restructured Gold and Silver notes have a PIK toggle feature, but if Gran Colombia elected to pay the annual interest payments in only cash (Gold 2020 notes have a 6% annual cash rate with a balance of $104M and Silver 2018 notes have a 1% annual cash rate with a balance of $71.2M) using Q3 2015’s operating income as a benchmark, that would put quarterly interest coverage at 5.6x moving forward. Of course, this assumes Gran Colombia pays all interest payments in cash, which it has the option to pay in either cash or additional notes. In general, as interest coverage increases, the default risk for a bond decreases. It is extremely unusual for a bond to have solid interest coverage and an outstanding yield.
The default risk is Gran Colombia Gold’s ability to perform. With its recent debt restructuring, the company has created much more favorable terms for its long-term debt, which will allow greater cash flow flexibility while maintaining bondholder integrity. In addition, with its recent investments into its Segovia mining project, the company has been able to greatly increased its gold and silver production. Combined with its decreasing AISC per ounce of gold, Gran Colombia appears to making a remarkable turnaround and poised for a breakout year in 2016.
Gran Colombia’s mining assets are all located in Colombia. Mining in other countries can carry additional risks as the political and economic climates are often very different from our own. Colombia has recently struggled to maintain orderly mining operations in some of the areas where Gran Colombia maintains its mines. In October of last year, a military group was responsible for the death of one of the mining managers, after the company Samasa, who manages gold production at Gran Colombia’s Segovia project, refused to pay the “gold tax” demanded by the military group. Production was suspended for several days. However, Gran Colombia successfully renegotiated labor contracts and continues to work with local and national governments to get help monitor this situation and to maintain community safety as well as normal mining operations.
As a majority of the GCM’s revenues are from its sales of silver and gold, the company is exposed to volatility in the prices of these commodities on the open market. However, the prices of silver and gold appear to have not only stabilized in the past six months, but may have reversed course and be headed higher in 2016.
The hardest risk for us to identify is the geopolitical risk. It is our opinion that diversification into a wide variety of global debt vehicles often reduces risk. Our strategy here, as with other Yankee bonds, is to focus on core services that add key economic value to the countries they are associated with. GCM continues to operate as a key player in this sector, as it has been for many years, maintaining a very good working relationship with the government of Colombia.
This Yankee (US dollar) convertible bond may have similar features and maturity length to other bonds previously reviewed on Bond-Yields.com, such as the highly successful and rewarding 14.38% Brigus Gold (now Primero Mining) and the 9% Lakeshore Gold bonds.
Summary and Conclusion
In the investment world, sometimes adversity presents opportunity. Gran Colombia has spent the past year restructuring its balance sheet in order to provide the company the opportunity to grow its production from its mines in Colombia. In the midst of this, it still managed to increase revenues nearly 30% in a commodities market that saw the price of gold steadily declining. The convertibility feature of these Yankee bonds also gives investors the advantage of possible significant additional returns should the underlying stock appreciate past its strike price. With the possibility of gold remaining at its current (over $1200/oz) levels, or appreciating further, Gran Colombia stands to post an outstanding year in 2016. Therefore, we are adding these low cash flow, but very high yielding bonds, to our FixedIncome1.com and FixedIncome2.com high yield global income portfolios.
Issuer: Gran Colombia Gold
Ticker: GCM.TO (TSX)
Price: $0.09 CAD (02/26/2016)
Conversion Option Price: $0.13 USD (~$0.18 CAD)
Coupon: 1% Cash / 2% PIK rate
Yield to Maturity: ~32%
About Durig Capital
At Durig Capital, we provide investors with a specialized, transparent fiduciary service at a very low cost. To obtain higher yields and keep costs as low as possible, we typically bundle smaller retail orders into larger institutional sized orders with many global trading firms and bond platforms. Our professional service enables access to a greater spectrum of bonds, higher yields, and lower price points.
Most of our client accounts are custodied in their own name at TD Ameritrade Institutional, a large discount service provider that is SPIC insured.
Disclosure: Durig Capital and certain clients may have positions in Gran Colombia Gold’s 2018 convertible debentures.
Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports. We welcome inquiries from other advisors that may also be interested in our work and the possibilities of achieving higher yields for retail clients.
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