Thursday, September 3, 2009

From The Mailbag: Brinx Resources

Brinx Resources (BNXR) is an oil exploration and development company. The discount the company trades at to its cash balance (about 25%) prompted a reader to ask about its suitability as a value investment. Personally, I would stay away.

As we've seen before, it's not enough that a company trade at a discount to its cash balance in order to qualify as a suitable investment. Outside of its cash balance, Brinx does not have any other material current assets. On the other hand, it does have some liabilities which reduce its net current assets to a value barely above its market cap.

The company is also looking to use that cash to buy oil properties. This is a note from their latest quarterly report:

We are attempting to expand our property base by locating other resources properties. Accordingly, we have hired consultants to gather data on properties that may be of interest to us. As of the date of this filing, we have not found a suitable acquisition.

In the meantime, the company does not currently generate enough revenue to meet its costs (having sold some of its assets), which acts as another drain on its cash. Furthermore, as the company is heavily reliant on the price of oil, the value of its resource properties (which have already been impaired to some extent due to the reductions in the expected future cash flows of these resources) could fluctutate dramatically.

As such, the assets of this company just don't provide enough of a margin of safety. When buying a company this small and this illiquid, buying net current assets, even if predominantly cash, at a small discount just doesn't cut it. The price of oil could go up or Brinx could discover a great oil resource on its land, either of which would serve to reward shareholders. In both cases, however, the investor needs something positive to happen in order to realize a large upside, making this a speculative play rather than a value investment. Before investing in a company such as Brinx, value investors should look for a massive margin of safety, not a small discount, in order to ensure both upside potential and downside protection.

Disclosure: None

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