Pathfinder Small Cap Quarterly Report
September 30, 2021
The Pathfinder Small Cap mandates invest in high-torque, early-stage companies that have the potential to generate superior returns.
Pathfinder Partners’ Fund
The Partners’ Fund had a net return of 3.8% in the third quarter of 2021 and 21.5% YTD. This compares to the TSX Venture Exchange which had a return of -10.6% in the third quarter and -1.9% YTD. Our annualized 7-year return is 20.5% compared to the TSX Venture Exchange’s return of -1.3% per year over the same period. The table below provides a performance summary:
Our top contributors for the quarter were Next Hydrogen Solutions Inc (TSXv:NXH) which contributed 2.6% to gross returns, and Sigma Lithium Corporation (TSXv:SGMA) which contributed 2.0%. In addition, fund holding Nanotech Security Corp (TSXv:NTS) was acquired and added 1.1% to gross portfolio returns for the quarter. Our main detractor was Trevali Mining Corporation (TSX:TV) which contributed -0.5% to gross returns.
The TSX Venture continued to decline from its high in February. In hindsight, our characterization of the market being in a ‘speculative frenzy’ was spot on. We noted an unusual number of companies taking advantage of strong market conditions to go public and looking back, their valuations were exuberant. Our process of actively valuing our holdings and reducing our position sizes when the valuation of a company exceeds our internal estimates has allowed us to protect against downside in the last six months; we are in a strong position with cash to take advantage of any great ideas or dislocations in the market.
Many of our best ideas are coming from newly listed companies that have gone public within the last 12 months and are trading below their go-public prices. We track all new public listings in Canada and can report that there are dozens of IPOs (Initial Public Offerings) and RTOs (Reverse Takeovers) that have declined substantially. Several of them currently have market capitalizations that are less than the amount raised in their go-public offering, implying a negative value for the ‘as-then’ company immediately before listing. Not all are attractive investment opportunities; there are many that will soon be worthless, but as a category they represent an attractive hunting ground for new ideas. A select few of the “recently public” are good companies with solid management whose valuations were just too high at the time – and can you blame them for accepting a financing offer from bankers at an inflated price?
We have been active for many years in the global ‘Clean Energy and Sustainability’ movement, and as an evolution of that investment strategy we have begun establishing a foothold in the carbon reduction industry. This is driven by governments and major multinational companies announcing their intention to go to ‘net zero’. We are invested in companies that are poised to benefit directly from the trend to measure and quantify the cost of carbon. This includes companies that will benefit from the creation and development of carbon credits as well as companies developing proprietary carbon capture design techniques. For example, one investee has developed a carbon capture process to treat flue gas, a waste stream from most industrial processes and is working to commercialize their technology with several multinational E&P customers. With carbon tax increases and carbon infrastructure becoming more of a reality, industrial emitters of CO2 will hopefully see transportation and sequestering costs come down and can start looking at capturing carbon as a value proposition instead of an environmental mandate. These projects will generate carbon credits that can be traded and monetized via exchanges at a time when sources for credits are limited and global demand continues to grow.
In terms of company-specific updates, we had some positive developments in our portfolio this quarter. Nanotech Security (TSXv:NTS) announced that they were being acquired by Meta Materials (Nasdaq:MMAT) on August 5th, with the deal set to close October 5th. The price of the takeout was $1.25/share which was over our cost basis of roughly $0.35/share for a gain of 250%. Nanotech had won recurring contracts from Central Banks for note security features and was continuously developing new IP to use in said bank notes. Our thesis of significant upside potential was also recognized by Meta Materials, and their $1.25/share offer was a 66% premium on the previous day’s close price of $0.75/share.
Abaxx Technologies (NEO:ABXX) received their “Approval in Principle” (AIP) license in August to act as an Approved Clearing House (“ACH”) from the Monetary Authority of Singapore. This approval, along with their September 2020 “AIP” as a Recognized Market Operator puts the company as one of the few integrated exchange and clearing houses in Singapore. The next steps involve onboarding clearing house members, continued development of products that will be available at the launch of the exchange, and lastly the final regulatory approval as an Approved Clearing House and a Recognized Market Operator. Abaxx’s exchange technology focusing on LNG commodity trading couldn’t have been better timing considering the current fundamentals of the gas market.
AnalytixInsight (TSXv:ALY) also made progress on the regulatory front, receiving European approval for InvestoPro as a financial broker. This is significant since their partnership with Intesa Sanpaolo (Italy’s largest bank, 27th in the world at CAD $1.4T assets) already drives 2.5M visitors per month, and with the European approval, Intesa can now transfer their stock trading accounts over to InvestoPro. Additional regulatory approvals are being worked on, such as InvestoPro’s payment processing that will allow users to make payments and money transfer between accounts. The blue-sky success story here would be becoming the ‘Robinhood of Europe’, and we look forward to seeing results over the coming quarters.
Voxtur Analytics (TSXv:VXTR) made a splash with their news that United Wholesale Mortgage (NYSE:UWMC), America’s largest wholesale mortgage lender that drives 700k mortgage appraisals per year will use Anow software (acquired by Voxtur in March 2021) so that appraisals can be done without a third party Appraisal Management Company, as was traditionally done to ensure the appraisal met all regulatory standards. Not only will this speed up mortgage approval time and therefore mortgage throughput for UWM, but by removing the Appraisal Management Company the costs for an appraisal will be much less. We believe the third-party appraisers using Anow software will now keep more profit than they would have through a management company. This incentive will hopefully drive appraisers to adopt Anow, growing their market share throughout UWM’s business and into others.
While our focus is on long-term results and not unpredictable short-term market moves, we are very pleased to have protected capital during a downturn in the TSX Venture exchange over the past six months. While certain areas of the market are frothy in our opinion, we are starting to see an increasing number of attractive investment opportunities which has historically boded well for future returns. Boom-bust cycles are rampant in small caps stocks and we are anticipating a capital-deployment cycle in the coming quarters where we ‘plant seeds’ after ‘harvesting’ profits throughout an ebullient 4th quarter of 2020 and January/February of this year. After waiting patiently throughout the summer and attempting to be extremely selective, we are finally beginning to see opportunities that check all the boxes for a great investment opportunity.
Pathfinder Resource Fund
The Resource Fund had a net return of -6.0% in the third quarter of 2021. This compares to the benchmark which was down by -3.1%. Since inception (July 16, 2018), the Resource Fund has returned 23.2% annualized versus the benchmark of 2.5%.
This quarter was filled with volatility for resource stocks and commodities across the board. We saw a substantial increase in aluminum and coal prices, weakness in precious metals, and heightened volatility across the base metals sector. Metallurgical coal prices were up +100% and thermal coal increased +50% for the quarter while gold and silver were down 1.6% and 15.6% respectively. Aluminum outperformed the base metals sector, up 13.4% for the quarter while copper was up 4.6%. Zinc and Nickel were essentially flat.
Much of the turmoil in the quarter was related to risk of contagion by the potential collapse of China’s Evergrande Group and more recently China’s power supply crisis. Evergrande is the second largest real estate developer in China, but debt ridden and on the brink of default with over $300B of liabilities. The fear of Evergrande’s collapse had a direct negative impact on the price of commodities that are used in construction as a potential decline in housing development would decrease demand. In our view, the recent downward pressure on copper, at least, is temporary and our demand driven thesis is still intact as demand is set to outpace supply in the long term. Evergrande is set to formally enter default on Oct. 23, which is the date the grace period ends for their missed bond payment.
China is also amidst a power crunch after implementing restrictions on imports of Australian thermal coal and suffering from challenging weather conditions. In the spring, a severe drought in China’s Yunnan province cut hydroelectric power generation, and subsequent flooding in other areas forced the closure of ~60 (25% of production) coal mines. Given that over half of China’s electricity comes from coal, this has resulted in power cuts and production disruptions across different manufacturing sectors, leading to a tightening of supply. Aluminum, steel, and zinc smelters have been ordered to lower power consumption which limits output of these metals. More recently, we have seen this power crisis spread worldwide with spiraling natural gas prices in Europe and an emerging coal shortage in India. This is causing second- and third-order effects in supply chains and commodity prices. Whether this “energy crisis” is a short-term blip or continues throughout winter remains to be seen.
To navigate this turmoil, we rely on a diversified portfolio which allows us to rebalance into different sectors and dynamically react to changing market conditions. One such area is ‘green’ metals and Environmental, Social, and Governance (ESG) focused companies such as Sigma Lithium (TSX:SGMA) and Giyani Metals (TSXv:EMM). China’s power woes are a stark reminder of the need to shift to clean energy with lithium and manganese as key metals to meet this demand. Lithium is one of the main components for the batteries used to store energy and because of its low electrode potential and low atomic mass, it has a high charge and power-to-weight ratio making more compact, powerful, and ideal for energy storage. Similarly, high purity manganese is essential for the battery market and, outside of China, is only produced by three companies, not including Giyani. However, not all ‘green’ metal mining companies are equally focused on ESG despite the push for responsible mining lately.
Sigma Lithium is a hard rock lithium company focused on producing environmentally sustainable battery-grade lithium concentrate in Brazil. The Company hopes to enter production by late 2022 and achieve net-zero carbon emission targets by 2023. They will use 100% hydroelectric power, recirculate 90% of water consumption, and dry stack all the tailings. Sigma has strong stakeholder relationships with the local community and has been active in the community, spearheading various Covid‐19 prevention initiatives in hospitals and clinics. They anticipate producing over 500 direct jobs and over C$200M in royalties in the next 15 years. This focus on environmental, social, and governance is a key advantage for SGML as automakers and investors look to acquire responsibly sourced metals. As the project advances towards production, we believe SGMA is strategically positioned to capitalize on the increasing demand for “green” lithium.
Giyani Metals is developing their manganese project with a feasibility study expected by year end. A preliminary economic assessment tabled in April of this year indicated a very economically favourable project with an NPV10% of C$442M and IRR of 80%. Since that study, EMM has discovered additional horizons of mineralization and grown the resource. EMM is focused on attaining industry leading standards on carbon emissions through solar power generation for processing, electrification of their mining and transport fleet, and working with local communities as stewards of the environment. These practices have attracted Volkswagen to sign an NDA with Giyani as a potential manganese supplier. The high purity of manganese lowers production costs and reduces energy consumption making EMM a very attractive supplier.
ESG has been in the forefront in many sectors for some time now but has become a key focal point for mining companies recently as retail investors and larger funds shift towards ESG friendly companies. We foresee Sigma Lithium and Giyani leading the way in the mining sector and predict that ESG responsible companies will be attractive to not only acquirees but investors as well.
National Instrument 31-103 requires registered firms to disclose information that a reasonable investor would expect to know, including any material conflicts with the firm or its representatives. Doug Johnson and/or Pathfinder Asset Management Limited are an insider of companies periodically mentioned in this report. Please visit www.paml.ca for full disclosures.
*All returns are time weighted and net of investment management fees. Returns from the Pathfinder Partners’ Fund and Partners’ Real Return Plus Fund are presented based on the masters series of each fund. The Pathfinder Core: Equity Portfolio and The Pathfinder Core: High Income Portfolio are live accounts. These are actual accounts owned by the Pathfinder Chairman (Equity) and client (High Income) which contain no legacy positions, cash flows or other Pathfinder investment mandates or products. Monthly inception dates for each fund and portfolio are as follows: Pathfinder Core: Equity Portfolio (January 2011), Pathfinder Core: High Income Portfolio (October 2012) Partners’ Fund (April 2011), Partners’ Real Return Plus Fund (April, 2013), and Partners’ Core Plus Fund (November 2014).
Pathfinder Asset Management Limited (PAML) and its affiliates may collectively beneficially own in excess of 10% of one or more classes of the issued and outstanding equity securities mentioned in this newsletter. This publication is intended only to convey information. It is not to be construed as an investment guide or as an offer or solicitation of an offer to buy or sell any of the securities mentioned in it. The author has taken all usual and reasonable precautions to determine that the information contained in this publication has been obtained from sources believed to be reliable and that the procedures used to summarize and analyze such information are based on approved practices and principles in the investment industry. However, the market forces underlying investment value are subject to sudden and dramatic changes and data availability varies from one moment to the next. Consequently, neither the author nor PAML can make any warranty as to the accuracy or completeness of information, analysis or views contained in this publication or their usefulness or suitability in any particular circumstance. You should not undertake any investment or portfolio assessment or other transaction on the basis of this publication, but should first consult your portfolio manager, who can assess all relevant particulars of any proposed investment or transaction. PAML and the author accept no liability of any kind whatsoever or any damages or losses incurred by you as a result of reliance upon or use of this publication.