COMMODITIES

The firm’s battered stock can be attractive for those prepared to wait for the turnaround, writes Shirley Won of The Globe and Mail.

The beating that Sprott’s (Toronto: SII) shares have taken in recent months may have made them an attractive entry point for investors looking to play a bullish outlook for gold and silver.

Forty percent of Sprott’s $9.7 billion in assets under management are invested in bullion, while the precious-metals exposure rises to 70% when one includes the gold and silver equities in its mutual and hedge funds.

Eric Sprott, the firm’s founder and architect of the dominant precious metals theme, is a big believer that the price of gold and silver as stores of value will climb, as governments debase their currency by printing money to stimulate their economies. While the metals stocks have sharply lagged their bullion peers, the firm argues that these oversold stocks are poised for a rebound.

"We believe that the prime catalyst for this stock continues to be a rally in precious metals equities," says Scotia Capital Markets’ Phil Hardie. "Given recent weakness, we believe the valuation is now looking quite reasonable for those who ascribe to Sprott’s underlying investment themes."

Shares of Toronto-based Sprott, which closed up 42 cents at $4.54 a share, have tumbled 51% over the past year. The performance of Sprott’s larger funds have been hurt by the recent downturn in commodity stocks, prompting analysts to reduce their targets for Sprott from the $4.50- to $5.75-a-share range.

On Wednesday, Sprott reported a 60% jump in first-quarter profit to $16.9 million, or ten cents a share. The increase was largely due to gains from proprietary investments, while net fund sales in the quarter rose to $540 million from $260 million a year ago.

The asset increase stemmed mainly from strong sales of its listed bullion funds, including Sprott Gold (PHYS) and Silver Physical Silver Trust (PSLV), which offset $171 million in net redemptions in other funds.

"If you have a mid-to-long term view on Sprott stock…buying it at this level is a good idea, especially if you have a positive outlook on commodities, because it looks like the worst may be over," said Canaccord Genuity analyst Scott Chan. "Sprott is a good, indirect way to play it."

Chan, who has a "hold" rating on Sprott, has just halved his estimate for the firm’s fund performance fees to $20.5 million this year. But those fees could turn around quickly "if the market goes their way," similar to after the 2008 market crash, when improved returns in 2010 generated $200 million in those fees, he said.

"I think [the stock] is going to be range-bound from here until the relative fund performance improves, and people start to get more visibility in earning performance fees," Chan said.

CIBC Capital Markets analyst Paul Holden, who rates Sprott stock a "sector performer," also sees limited upside near-term for its stock, because many of the firm’s funds are still significantly below their high-water marks to earn the lucrative fees.

But Sprott has a better pipeline of potentially growing assets compared to some other public companies, he indicated. The company, for instance, plans to launch a new hedge fund aimed at institutional investors, and list a new fund that will invest in platinum and palladium bullion.

M Partners analyst Adam Seanor is sticking with his "buy" rating on Sprott for valuation reasons, and because of the firm’s intent to broaden its investor base.

The firm is "taking the right steps in diversifying the business and expanding the product options for clients," said Seanor. Sprott, once known as an equity shop focused on smaller-company stocks, has been adding conservative bond and balanced funds to its lineup.

The stock is attractive because it is undervalued, trading at an enterprise value (market capitalization plus net debt) to assets under management of 6.6%, versus a historical average of 12.2% and an all-time low of 5.6% in 2008, he said. "It is relatively cheap compared to historical valuations," he said.

Tickers Mentioned: PHYS, PSLV

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