Resource plays at deep discount?

Let me start with a confession: I am extremely partial to small caps. Particularly small caps that are not yet on a major exchange.  I expect that alone is reason enough to scare away many readers.  Yet that is exactly what makes bulletin board stocks so interesting to me: high risk, high reward.  Two Canadian investment and merchant banks that invest in junior resource companies are currently trading at significant discount to their NAV:  Aberdeen International (AABVF, market cap $76M), and Pinetree Capital (PNPFF, market cap $314M).

In many ways, the two companies are mirror images of one another.  Both have primary exposure to precious metals – about 45% of the total portfolio for each (AABVF here, PNPFF here) – and each also has exposure to energy, agriculture, base metals, and more emergent resources.  Both have a history of successful venture capital allocation, as evidenced by the following chart of NAV returns.

NAV SPY DBC GDXJ PNPFF AABVF
1 YR 30.7% 34.5% 33.8% 95.5% 34.8%
3 YR 3.3% -1% 13.5% 55.7%
5 YR 2.9% 0.8% 58.7%

If one accepts the notion that both companies have a strong history of asset allocation, the next question is whether they are valued in a manner that reflects the performance of the underlying assets, and reflects management’s track record of outperformance.  In short: no.  Below is a chart documenting the historical premium/discount to NAV for PNPFF and AABVF.  (Since their quarterly reports don’t line up, I’ve paired the December PNPFF report with the January AABVF report (and left is as December), and the June PNPFF report with the July AABVF report (leaving it as June) to streamline the information).

PNPFF AABVF
MO/YEAR NAV PRICE PREMIUM NAV PRICE PREMIUM
09/04 0.93 0.44 -52.7%
09/05 1.48 0.89 -39.9%
12/05 1.87 1.58 -15.5%
06/06 2.71 4.33 59.8%
12/06 4.24 10.20 140.6% 0.42 0.70 66.7%
06/07 4.97 9.50 91.1% 0.85
12/07 4.20 4.26 1.4% 0.90 0.45 -50.0%
06/08 3.79 2.32 -38.8% 0.46
12/08 1.33 0.82 -38.3% 0.98 0.12 -87.8%
06/09 1.91 1.73 -9.4% 0.24
12/09 2.55 2.14 -16.1% 1.18 0.43 -63.6%
06/10 2.20 1.16 -47.3% 1.57 0.71 -54.8%
12/10 4.74 4.14 -12.7% 1.51 0.90 -40.4%
06/11 4.30 2.64 -38.6% 1.57 0.71 -54.8%

It looks to me like there’s a pretty decent case to be made that both companies are compelling buys based simply on discount to assets.  That’s not taking into account their outperformance as asset allocators.  The market is certainly discounting them heavily for their own status as small/micro-caps and their dependance on the volatile junior resource market.  Certainly if the markets sell off heavily, they are part of a sector that is likely to take heavy losses.  It’s also worth noting that when the resource markets heats up, these companies can fly, as evidenced by the extreme premiums in 2006-2007.

Of the two companies, AABVF has had the stronger NAV performance since its inception in 2006.  That outperformance has been reflected in stronger share performance, though it still tends to trade at a steeper discount to NAV than PNPFF.  Below is a ratio chart of AABVF divided by PNPFF over the last 2 years.  The outperformance by AABVF has been pronounced.

While PNPFF is more of a straight investment company that holds a larger portfolio and a larger percentage of publically traded companies, AABVF has done a few things that would reflect the behavior of an older company.  This year, they’ve instituted a semi-annual .01/share dividend, giving it a yield over 2%.  Aberdeen has also bought back over 16% of their share float in the last 4 years.  In addition to the shareholder-friendly actions of management, the company receives cash in the form of 1% Royalty deal for the life of the mine, estimated to be worth $40-50M in 2009 (x2 at current gold price).
What could act as a catalyst to push AABVF and PNPFF share prices upwards?  Since both are focused primarily on the precious metals sector, I think gold might provide an interesting clue.  AABVF has outperformed GLD  over the last two years, and is pulling back to a rising support trendline that has followed its outperformance of GLD, as seen in the chart below:
In general, gold miners have dramatically underperformed gold itself over the last ten years, though in the last 2 years, junior gold miners have fared a good bit better than large cap.  Recently, gold (GLD as my proxy) relative to S&P (SPY as my proxy), has pushed above its upward consolidation pattern.  This may be indicative of new highs to come in gold (or least a leg up in outperformance vs. S&P), and may lead gold miners higher.
If that’s the case, AABVF and PNPFF would likely participate to upside.  AABVF is in a nice uptrend, but not especially close to any key technical support by my estimation.  PNPFF, on the other, appears to be near a decent entry price, having traded down towards its rising support trendline from the 2009 lines.

Global growth and monetary policy may both have a large impact on how the investments of these two companies pan out.  But for the moment, AABVF and PNPFF appear to be interesting opportunities based on their strong history of growth via asset allocation and their steep discounts to Net Asset Value.

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