A Rock and a Hard Place

Exploration spending v’s corporate saving

A key consideration in a decision to invest in a junior explorer is the explorer’s commitment to exploration. Is it a fair dinkum explorer? Does it put “money in the ground”? meaning does it conduct regular exploration programs (mapping, sampling, geophysics surveys, drilling) in the pursuit of new mineral deposits?

The answer to this question may be found by looking at the explorer’s exploration expenditure. More broadly, may also be found by comparing the company’s exploration expenditure to its administration expenditure.

Simply put… the higher the spend on exploration compared to the spend on administration, the more it is clear that the company is fair dinkum about exploring.

The company’s Quarterly Cash Flow Appendix 5B has this information. Section 1 = Cash flow from operating activities (admin) and Section 2 = Cash flow from investing activities (exploration).

A good exploration to administration expenditure ratio is 3:1 or better. For every $3’s spent on exploration, only $1 is spent on administration.

Another consideration in the decision to invest in a junior explorer is its cash management. Does the board of directors manage the purse well? Is there a healthy “treasury”? Again, this is simple enough to look up in the Appendix 5B.

It is the company’s ability to strike a balance between the commitment to explore and cash management that determines whether it is a generally well-managed explorer. An investor wants to see exploration activity, but he or she wants to know that the company has money in the bank and will be around for the duration of the intended investment period.

Exploration companies don’t operate in a bubble. When a board approves an exploration budget it is excited to be exploring, but it is mindful too of the costs involved.

How much does the program cost? Where is the next dollar coming from (to replace that which will be spent)?

When results are positive and when the market is responsive, the next round of funds will come from a capital raise. Sometimes the offer is heavily oversubscribed. Good job! The share price of the offer might be a percentage above the last raise. Again, good job!!

Exploration budgets tend to be large in strong money-markets because the company can easily replenish the treasury.

When the exploration results are not positive or neutral, and/or when the market is not so responsive, what then? Does the board approve a $500,000 airborne magnetic and radiometric survey, or a $2M drill campaign? The board has a dilemma. It is facing a paradox. It is between a Rock and a Hard Place!

Spend money on exploration and risk running the treasury low…. or reduce exploration expenditure (temporarily) to preserve the treasury?

Having enough cash in the bank is vital for the health of an explorer. Indeed “going concern” matters are more important to a board, than quarter by quarter exploration activities.

“Going Concern” is an accounting terms used to describe the ability of the company to meet its normal business activities for the duration of the following financial year – can it pay bills and not get into debt?

It is a very strict obligation of the board to not trade [operate] insolvent (2001 Corporations Act Section s588G) and there are guidelines for directors to follow (ASIC Regulatory Guide 217). Auditors independently determine if a junior explorer meets going concern every year.

Mention of the negative term “Lifestyle Company” is important here. A lifestyle company is a company that raises funds from investors then does not explore. It saves the funds for admin, salaries and director’s fees, the lifestyle.

At times, the epithet attaching to a junior explorer of a Lifestyle Company is unfair. Perhaps the board is conservative in terms of maintaining a healthy treasury?

It generally costs between $500,000 and $800,000 per year in administration costs for an active listed exploration company. The explorer would need to raise in excess of $2.5M per year to achieve an exploration to admin expenditure ratio of 3:1 to meet the above “feel good” criteria. It’s not always possible to do so.

Exploration to administration expenditure ratios decrease during poor money markets.

So the tension exists. Explore and spend…. verses …. not exploring and surviving!

An explorer that doesn’t explore will not find a deposit in its own right.

An explorer that runs out of money may be delisted.

The investor needs to be aware of this paradox: Spend or save. Most explorers manage this within acceptable parameters. Some do not. The book-ends are those that are delisted (because they have run out of money) and those that are “lifestylers”…