Tuesday, June 14, 2016

Energold Wants More Cash

Today Energold announced a new public offering. The company wants to sell 5 million shares at a price of C$1.0 a unit (one unit consists of one common share and one common share purchase warrant giving a right to purchase one common share at a price of C$1.75). 

It means that Energold wants to increase its cash level by C$5 million. The company states that it intends to use the proceeds to fund working capital.

Well, in my opinion, it sounds strange because Energold maintains a high level of working capital:

                        source: Simple Digressions

Note: working capital is defined as: inventory plus receivables less payables

Since 2012 the company's revenue has been going steeply down but its working capital has been relatively stable (around C$60 million). 

Generally, a company needs more working capital to finance its growth, for example to increase its revenue. However, Energold, since 2012, has been shrinking. It means that it should have needed not more but less working capital. So what is going on?

Here is the answer:

                                   source: Simple Digressions

In my opinion, Energold is getting short of cash because it holds too high inventories. Let me have a look at the company's inventories:

source: Energold 2015 Annual Report (page 51)

Basically, the Energold's inventory comprises just one category: "Supplies and raw materials". Energold defines its supplies and raw materials as:

"The Company maintains an inventory of operating supplies and drill  consumables such as drill rods, tubes, bits, casings, consumable supplies and lubricants as well as pumps, motors and other drilling equipment and parts. Procurement, transportation and import duties are included in inventory cost. Inventories are valued at the lower of cost and net realizable value. Cost is

determined on a weighted average cost method"

And then:

"The Company applies the following policies with respect to inventory accounting and valuation:

  • (i) Higher value drilling equipment parts and supplies, as well as consumable inventories are valued at landed cost, based upon country of use, less an allowance for normal wear and tear based upon management’s judgment of the expected remaining field service life of the equipment parts and supplies.
  • (ii) Each drill has a base inventory of smaller value equipment parts and supply items which are valued at landed cost"

Well, it looks like there is too much about "landed costs" and too less about "net realizable value". Note that such a high level of inventory is nothing new for the company (this level has been more or less the same since 2012). 

In my opinion, Energold needs fresh cash because the company "invested" too much in the aging inventory. 

At the time of writing this post, investors are selling Energold shares at huge volume (and shares are down 14%). It is surely a reaction to the new offering (share count will increase by 10.4%):

                                 source: www.stockcharts.com

What is more, most recently Energold shares went too high and too fast.

On the other hand,  if I am right on the company's problems, in the medium-term Energold shares are too risky. 

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