We have often said that about one in thirteen or fourteen of our stock “picks” will turn out to be mistakes. If HudBay isn’t a mistake, it is certainly acting like one.
The thesis behind our investment in HudBay was that it had world class assets with low production costs. In theory, low cost production means that the mine could continue to operate at the bottom of the copper cycle while others had to shut down. Copper, while it is declining in price as inventory builds up and China slows down, is not subject to massive sources of new supply as oil is, and the trajectory for price recovery can be more easily imagined. We had great confidence in the President, David Garofalo. While the company had large debt, its source of capital expenditure requirements, the Constancia mine in Peru, was about to come on stream, reducing spending requirements and increasing cash flow to pay down the debt. It was, we felt, best of breed in the mining sector.
A Series of Unfortunate Events worthy of Lemony Snicket has befallen HudBay. The decline in copper price, even as exacerbated by fears of slowdown in China, was the start, but was not unusual. The bad environment for the stock market, which made it easier for short sellers to make money, augmented the downward trend, but this was also not out of the realm of expectations. The threat that the stock might drop under $5 was of concern, because at this level, the shares become less eligible for margin in brokerage accounts, giving the short sellers more traction. The culminating event, though, was the departure of President David Garofalo for Goldcorp when the price hovered just over $5, giving the short sellers the leverage they needed to make HudBay’s low price work for them. Given that HudBay’s operations are about cash flow neutral at current copper prices, the company’s debt becomes a concern given the low share price and makes it difficult for the stock to find support in the face of the selling.
What to do now?
We are loathe to sell the shares at current prices. HudBay’s asset value was estimated by some analysts at $25 per share not so long ago. David Garofalo confided to us after he left that he believed the shares could eventually appreciate by 6 times - from the then price of over $5 per share! – and that he is not selling any of his HudBay stock even though he no longer works there. David left behind a stable of excellent managers, one of whom, Alan Hair, has been made President. He is not only very competent in operations, he is very conservative. With the shares now trading at under $3, the company starts to become an easy takeover target, particularly for a company with enough resources to give comfort to HudBay’s debt holders.
So, for better or worse, we think the correct strategy is to hold on, which we intend to do.
Please don’t hesitate to call if you have any questions.
Rob Richards Rupel Ruparelia Richard Tattersall.