The latest commodity price slump strengthens the argument that investors should prioritise balance sheet strength when investing in miners, particularly in the small cap arena. Stratex International (STI:AIM) looks a bargain at 4.62p as 82% of its £21.6 million market cap is covered by cash.

The market is valuing the company’s gold mining assets at £3.9 million if you exclude the cash on its balance sheet. This looks too low for a business which is soon set to earn maiden income from a producing gold mine and has no financial obligations related to mine construction costs.

We recognise that an exposure to gold could be seen as a weakness in the current environment. Yet there appears limited downside because of the cash position; and significant upside potential thanks to the near-term cash inflow and track record of exploration success.

Aligned interests

Stratex is sitting on a large cash pile after selling assets in Turkey. Chief executive officer Bob Foster (see Mr Market, page 32) says the company won’t pay a special dividend or conduct a share buyback and the money instead will be kept for investing in new projects.

You could argue the cash pile makes the business a takeover target for resource groups in desperate need of liquid funds. In 2009 Petropavlovsk (POG) used shares to buy Aricom for its cash. Last month, oil and gas group Vanoil Energy (VEL:TSX-V) made an all-share offer for cash-rich Fluormin (FLOR:AIM) which it says offers ‘an invaluable source of capital’.

Foster reckons Stratex has a ‘poison pill’ thanks to the presence of large miners on its shareholder register who are bought into the company’s exploration ambitions. AngloGold Ashanti (AU:NYSE), which has an 11.5% stake, has a joint venture with Stratex on prospects in Ethiopia and Djibouti where exploration news on these assets is scheduled for May and June. Teck Resources (TCK:NYSE) owns 7.65% and Antofagasta (ANTO) has 2.2%, the latter working with Stratex on copper/gold exploration in Turkey.

As for the cash pile, Stratex wants to back exploration assets that either need money to take a discovery to the resource stage, or to go from resource to economic evaluation.

Foster says one avenue under consideration would be to join a consortium to back a larger project, potentially in the $25 million range. This could include a project whose resource has the potential to become significantly bigger through additional drilling.

Near-term cashflow

Even if Stratex starts to dip into its cash pile, more cash is expected from 2014. This is when the Altintepe gold mine is set to begin production (early in the year) in Turkey. Stratex has no financial commitment to building the mine; it simply sits back and waits for its 45% share of profits. Contract miner Bahar is funding all development costs to earn a 55% interest in Altintepe. It will get 80% of cashflow until capital expenditure is paid off. Foster reckons this will be one year after start-up.

Altintepe needs an environmental impact study approved and receipt of a forestry permit before construction can commence. There are positive signs that these could be forthcoming. The mine should run for 10 years and is forecast to produce 30,000 ounces of gold per year. A back-of-the-envelope calculation suggests $500 per ounce cost (as per Stratex estimates, based on economics from its recently-sold Inlice project) and $1,200 per ounce selling price, giving Stratex a 45% share every year of $21 million operating profits.

The proceeds will pay for plc overheads and provide cash for exploration including work in Senegal where drill results on the Dalafin project are expected next month, followed in June by an update on investigations in Liberia. Stratex will also get up to a further $20 million payable through a 1% royalty on Oksut, one of the gold projects sold earlier this year.

Stratex International (STI:AIM)

Buy 4.62p Stop loss: 3.7p

» Shares Summary

• Cash-rich

• Clear strategy

• Proven value generation skills

Sector: Mining

Sub-sector: General Mining

» Vital stats

Market value: £21.6 million

Prospective PE Dec 2013: n/a

Prospective PE Dec 2014: n/a

1-month relative strength: 10.4%

1-year relative strength: -45.1%

Prospective dividend yield: n/a

Bid/offer spread: 5.3%