Description

Geodrill LTD (GEO CN $3.14) is a drilling company that extracts mineral samples seeking gold (90%+ of revenues) and other ores for major, intermediate and junior mining companies in Africa and South America.  GEO trades at only 2.4 times trailing EV/EBITDA despite having a business that is highly recurring revenue, free cash flow positive and growing at high single, low double-digit rates on both revenues and profitability.  I believe that this low trading multiple will expand as investors realize that 1) we are in the beginning of a long cycle of growth for the industry; 2) increasing free cash flow allows GEO to continue returning capital to shareholders through dividends and share buybacks; and 3) larger drillers look to purchase smaller drillers to consolidate the industry.  I believe that in a sale GEO is worth at least 5 times EV/EBITDA which would value the business at CAD $7.29 based on analysts’ 2024 projections.

History

Geodrill was established in 1998 by Dave Harper, its current CEO, with one rig and one contract. Over the last 24 years it has grown organically into one of the leading exploration drilling companies in the world with a fleet of 76 drill rigs operating in Africa and South America (see chart below). The Company operates in Burkina-Faso, Cote d’Ivoire and Mali in West Africa, Egypt in North Africa, and Peru and Chile in South America.  South America and Egypt were added in 2020 and 2021, respectively and have become successful, profitable markets for the Company.

Geodrill provides Reverse Circulation, Diamond Core, Deep Directional Navi Drilling, Air-Core, Grade Control, Geo-Tech and Water Borehole drilling services to major, intermediate and junior mining companies and operates the largest most modern fleet of multi-purpose rigs in its markets.  Geodrill’s multi-purpose rigs (see definitions below) offer the versatility of providing both Reverse Circulation (“RC”) and Diamond Core drilling and can be switched mid-way through a hole with minimal effort or downtime.  This provides clients with the flexibility and advantage of drilling both RC and Core methods in the same hole with the same rig, eliminating the need to have two types of rigs on site, thus reducing standby, preparation and mobilization charges normally associated with switching rigs, therefore improving overall efficiency and lowering the customers’ all-in average cost per meter. Geodrill also provides Air-core drilling, a popular method used by junior exploration companies in early-stage exploration.

Drilling definitions are as follows:

Reverse Circulation – RC drilling is the most popular method undertaken by GEO’s customers and is typically drilled to depths of up to 400 meters.  RC drilling produces a hole size 140mm and is generally faster than diamond core drilling and generally produces better samples than rotary air blast (RAB) drilling. Reverse Circulation is more expensive than RAB and Air-core drilling but less expensive than Core drilling.  RC drilling produces rock chips rather than a Core sample. The RC method produces sample from depth by pulverizing rock with compressed air and a percussive hammer and returns it to surface through an inner tube and collects it through a cyclone then into a sample bag. Reverse Circulation is often used in conjunction with a multi-purpose rig to drill RC pre-collars with Core tails. This method is used extensively for exploration and resource drilling.

Core drilling is a system that drills and collects a core (cylindrical) sample in the state it is found. The system known as ‘wireline coring’ is used to make cuts until the core barrel is full.

Air-Core Drilling uses steel or tungsten blades to bore a hole into unconsolidated ground. The drill cuttings are removed by the injection of compressed air into the hole. This method of drilling is used to drill the weathered regolith (loose, heterogeneous material covering solid rock) as the drill rig and steel or tungsten blades cannot penetrate fresh rock. Air-core drilling is relatively inexpensive and is often used in first pass exploration drill programs. Air-core drills 75mm to optimal depths 75 meters and is performed using a smaller mobile rig known as an Air-core rig.

Geodrill has built a strong reputation for quality and reliability in the drilling industry which has translated into long-term contracts and relationships with major customers such as Newmont Mining (NEM), Barrick (GOLD), Centamin (CEY LN), Endeavour (EDV LN) and others.

These relationships last for long periods of time and are recurring in nature as it can take decades to fully exploit a mine’s ore beds.  The following slide from GEO’s 3^rd quarter 2022 presentation highlights this relationship.

Senior management has built GEO organically since inception and owns nearly 50% of the common stock.  GEO has used its free cash flow to invest in drilling rigs, open new markets, reduce debt and pay dividends.  There are 4 Canadian Investment Banks that follow the Company and all have buy ratings with an average price target of CAD$4.50 per share.

Industry

The drilling industry for mining companies is very different than for oil and gas companies.  Mining operators typically have mines that have useful lives measured in decades.  The miners drill to add new reserves and to replace the depletion of existing reserves.  GEO plays in all cycles of a mines life and has many relationships that stretch over a decade. 

While the mining industry goes through boom and bust cycles depending on commodity prices, the drilling industry is much less susceptible to the highs and lows due to the need to always replace depletion.  Currently, it is believed that mining is in an early stage of expansion based on demand from infrastructure spending, the need for metals for electric vehicle adoption and a catch-up needed to recover resources after many years of low capital spending by miners. 

Fortunebusinessinsights.com expects the drilling rig market to have a 7% CAGR until 2028.

There are not many industries expected to grow at 7% with recurring revenue business models trading at about 2 times EV/EBITDA.

Gold

Greater than 90% of GEO’s revenues are driven by the drilling of gold ore.  World gold production has been relatively stable since 2016 at approximately 3,600 tonnes per year as is seen in the slide below. 

Gold miners have been exploiting their existing deposits to increase profitability and reduce risk, however they have now hit an inflection point whereby they now need to begin prospecting for new deposits to offset depletion.  This quote from the LBMA, a market-standards and reporting service, estimates that,

“In order to sustain production at or above current levels, significant capital will need to be deployed by miners in order to develop projects or expand existing operations to offset declining production from aging mines. With current prices, which at time of writing are around $1,850/oz, well in excess of the 90th percentile of the all-in sustaining cost curve, which sits at $1,300/oz, the vast majority of gold mines are making very healthy profits. These margins should allow the industry to deploy capital to develop new projects, with the average capital cost to construct a new gold mine approximately $200/oz over the life of mine.”

Geodrill and other drillers should benefit from an expansion in new and existing mining projects to be exploited over the coming cycle.

Part of this increase in production is needed due to the popping of the cryptocurrency bubble.  Cryptocurrencies were being used by many people to store value despite their uncertain stature in the world of finance.  I believe that, currently,  investors are shifting back to Gold from cryptocurrencies due to its history as a safe haven and store of value during times of instability.  From 2013 to late 2015 gold was in a downward trend.  It reversed course in early 2016 and is now trading at all-time highs.

Financials

GEO has been profitable since 2016, which was the bottom of the last mining downturn.  Its gross margins were 40%+ when the last down cycle ended in early 2016 and now sit at 29%+.  This depressed gross margin isn’t due to pricing pressure from miners, but due to GEO’s expansion into three new market areas (Egypt, Chile and Peru).  Once these markets start to mature, GEO should be able to expand gross margins back into the mid 30% range.  Sell-side analysts are only looking for gross margins of 31.3% and 32.0% in 2023 and 2024 respectively. 

GEO has spent the last few years using its free cash flow to increase its fleet of drilling rigs, increase dividends and paydown debt.  The Company sits today with USD $15.1MM in cash against USD $4.6MM in debt.  This positions GEO to continue growing its fleet to meet rising demand from its customer base while maintaining financial flexibility to enter new relationships in targeted market areas adjacent to existing locations.

Geodrill’s income statements from 2016 on show strong growth in EBITDA even with the effects that the pandemic had on the world economy.  Analysts have EBITDA growing from USD $38.2MM in 2023 to $42.7MM 2024.  I believe that there is upside to these estimates as it gives the Company no real credit for its start-up markets becoming profitable.  The income statements dating back to 2016  are shown below.

Geodrill’s balance sheet is very clean with no intangible assets, goodwill or pension liabilities.  This business has grown organically since its inception and now sits with net cash on its balance sheet.  It began paying a semi-annual dividend back in 2021 and has just increased it for the second time since then.  The balance sheets are shown below.

Comparable Companies

There are five public drilling companies that are comparable to GEO.  These companies are traded in Australia and Canada and most of them directly compete with GEO for customers.  There have been merger and acquisition transactions in drilling during the last five year.  DDH1, an Oaktree Capital company, consolidated a number of drillers in Australia during this period for multiples around 4.5 times EV/EBITDA, including Swick Mining Services. 

The Company’s comps trade at multiples above GEO’s.  This may be due to a number of factors including GEO’s size and its exposure to West Africa.  Many of their competitors also have exposure to emerging markets since there are many successful gold mines in these locations.  Emerging market countries value and need to produce commodities, especially gold, so that they can maintain access to established currencies.  Many of these commodities trade in US dollars and this benefits drillers as their costs are in local labor and currency but they sell  based on dollars. 

The chart below shows GEO’s discount to its publicly traded peers. 

Country Risk

As mentioned in the above section, GEO may be trading at a discount to its peers due to its exposure to the West African countries where it drills.  It is not unusual for many of these countries to have political upheavals due to power struggles between different factions.  However, the one commonality between these groups is that they still need the hard currency that mines and other commodities produce.  To date, there have been no disruptions in GEO’s drilling programs due to any of these regime changes. 

The newer locations in Chile, Peru and Egypt are much more stable politically than West Africa and do offer some diversification of risk.  While this risk may deter some investors from considering this investment, it should not be a deterrent for industry players as they deal in these same markets. 

Valuation and Price Target

I believe that Geodrill would be an attractive target to other drillers due to its long-term relationships with mining companies in operations that would help those drillers diversify operations and benefit from synergies.  The CEO and Founder, Dave Harper who owns 39% of GEO, has said publicly that he is open to a sale of GEO at EV/EBITDA multiples at 5 times and above.  My price target is based on GEO’s 2024 EBITDA and an exit multiple of 5 times EV/EBITDA.  In the chart below I detail what this final stock price would be under different exit multiples.  I use a 5 times EV/EBITDA multiple to get my price target of CAD $7.22 per share.  Note that each ½ turn on the multiple is worth about CAD $0.63 per share.

Conclusion

Geodrill represents an inexpensive way to invest in the current upcycle of mining exploration and production.  GEO trades at a very low EV/EBITDA multiple despite as operating in an industry expected to grow at 7% per year over the next few years with a strong balance sheet, highly recurring revenues and significant free cash flow.  Management is incentivized to build shareholder value and has publicly stated that it is interested in monetizing their shares in a sale.  My price target of CAD $7.29 in 2024 represents upside of 132% over the closing price on 3/21/2023.

Catalyst

1. Continued growth in profitability and increasing dividends

2. Acquisiton by a larger drilling company 

3. Stock buybacks utilizing free cash flow