How to find undervalued ASX explorers

One of my favourite metrics to look out for among ASX-listed explorers is cash – the more cash (relative to market cap) – the more interesting it gets.

In this education piece, we're going to take a look at why cash matters and how it can surface some interesting opportunities.

Enterprise value

Before we dive in, we must talk about enterprise value (EV). It's a measure of the company's total value, often used as a more comprehensive alternative to market capitalisation.

EV is equal to market capitalisation plus total debt less cash.

• If xyz company has a market cap of $10 million with $5 million in debt and no cash – It would have an EV of $15 million

• If xyz company has a market cap of $10 million with no debt and $5 million cash – It would have an EV of $5 million

• If xyz company's valuation has tanked to just $3 million and still retains $5 million cash – It implies the company has more cash than the sum of its market capitalisation and debt

In the context of finding interesting explorers, a low (or negative EV) is a good thing as it implies:

• Potential undervaluation as the company itself is worth less than its cash position

• Leverage as a discovery or positive news can drive up the company's valuation

Think of it like this: You're buying a $3 million mystery box that comes with $5 million cash. The mystery box might come with nothing (e.g. no discovery and/or poor newsflow) or something awesome. If there's nothing, you've still got some cash to fall back on.

Case study: DY6 Metals

DY6 Metals (ASX: DY6) was one of those IPOs from 2023 that bombed. The stock listed on 6 June 2023 and finished the session at 20 cents per share (which was also its IPO offer price). By May 2024, the stock was down more than 80% from its offer price to lows of around 3.8 cents.

DY6 is a rare earth and lithium exploration company operating a number of prospective projects in Southern Malawi. At 3.8 cents, the company had a market cap of around around $1.5 million but its March quarter report noted a $3.06 million cash position.

In other words:

• Enterprise value: DY6 had a negative EV of $1.56 million

• Cash per share: DY6 had a cash per share of around 7.6 cents per share vs. its share price of 3.8 cents per share

As long as the company does not burn through an immense amount of cash – All it needed was some good news. And it delivered.

On 27 May, the company reported the results of historical drilling that confirmed the potential for its Tundulu Project to host significant rare earth mineralisation.

The stock finished the session up 334% to 16.5 cents or a market cap just shy of $5 million. So now we have a situation where the company has a positive EV of around $2 million ($5 million market cap less $3.06 million cash). In other words, the market is assigning some value to its discovery and/or assets.

Case study: Prospect Resources

This is one of my favourite EV plays (but this series of events will rarely happen).

In April 2022, Prospect Resources (ASX: PSC) sold its Arcadia Lithium Project to its Chinese partner for US$343 million cash and elected to return most of the proceeds back to shareholders in the form of a special dividend.

In share price terms, the stock was trading around $1.00 and set to pay out a 79 cents per share dividend.

When the stock traded ex-dividend, it plummeted an outsized 93% to 7.5 cents.

Prospect had a cash balance of $34 million post distribution and set its eyes on a new project called 'Step Aside' – which was literally down the road from Arcadia.

At 7.5 cents, the company had a market cap of around $38 million or an EV of just $4 million. The stock quickly pushed back towards fair value over the next two sessions, up as much as 74%.

Case study: Spartan Resources

Spartan Resources (ASX: SPR), formerly known as Gascoyne Resources, suspended mining operations at its Dalgaranga mine in late 2022. It's shares were suspended for around 4 months to secure a $50 million funding package to progress its Never Never discovery.

The stock resumed trading on 9 March 2023 and fell 40% to 10 cents or a market cap of around $60 million. While nobody wanted to touch the failed gold company, its story quickly became a discovery story – and its been trending higher ever since.

Spartan Resources 12-month price chart (Source: Market Index)

How can things go wrong?

While it sounds like a fool proof strategy – there are a few things you should worry about.

• Cash burn: The company could burn through an immense amount of cash in the subsequent quarter and bounce from low/attractive EV to something more moderate.

• Extreme pessimism: A low or negative EV often arises when there is extreme investor pessimism or significant challenges facing the company. This can be hard to shake off, even if it trades at an attractive EV.

• Financial distress: A low or negative EV can signal financial distress or significant underlying problems. The market might believe the company's future is bleak and chooses to value it less than its cash.

• Timing: In the case of DY6, it was trading below cash from February to late-May. During this time, the stock fell from around 7.5 cents to 3.8 cents. So things would've gotten pretty dark if you thought 7.5 cents was a good deal.

• Liquidity: Microcaps can be pretty illiquid – there's just not enough buyers and sellers. This means if you wanted to buy, you might need to buy at a substantial premium to its current share price and vice versa (selling at a discount).