Description

A-Mark Precious Metals is a long-established wholesaler and retailer of gold and silver bullion, and other precious metals products, trading at about 12x historical earnings, which has been profitable in almost every year since 2002. However, since the time of its debut as a public company more than 5 years ago, it has not seen a single sustained period of volatility in the precious metals markets that would allow it to display its true earnings potential. Gold has remained in a narrow range between $1100 and $1400 since early 2014, while silver has remained in a range between $14 and $22. As a result, the company’s earnings have also remained in a narrow range (excluding the GoldLine acquisition), between $1.00 and $1.30 per share. Once a period of volatility in the gold and silver markets returns, A-Mark is positioned to earn $3.50 to $4.00 per share and could see its stock trade at a multiple of where it is today.

Background

Established in 1965 as a numismatics firm, A-Mark first went public via a spinoff from Spectrum Group (SPGZ) in 2014. The company acts as a dealer and market maker for a variety of precious metals products, such as bars, ingots, and specialty coins, both selling these products to, and buying them from financial institutions, commodity houses, collectors, dealers, and investors. It is a distributor for all the major mints and is the largest distributor for the US Mint and the Royal Canadian Mint. In addition to the spread it makes on its fully-hedged trading activities, A-Mark provides secure storage, transportation and financing services for both wholesale and retail customers as well as custom-fabricated gold and silver bullion through partnerships with sovereign mints as well as through its proprietary mint.

A-Mark’s business makes money reliably in both good times and bad as evidenced by their nearly perfect track record of positive earnings since 2002. The only exception was in 2018 following the acquisition of GoldLine, which is discussed in more detail below. A full description of their business can be found in the latest corporate presentation and elsewhere in the corporate filings, so I will only discuss that part of the business that has the potential to generate a multiple of earnings during periods of volatility.

Volatility During 2009-2013

The last period of sustained volatility in the gold and silver markets occurred between calendar year 2009 and late calendar year 2013 when silver climbed from about $10 per troy ounce to $50 and then crashed to $20, and gold ran from $800 to $1900, followed by a collapse to $1200.

Spot Gold Price (2009-2019)

 Spot Silver Price (2004-2019)

During this 5-year period, which occurred well before the company made the extensive investments in its business that it has over the past few years, A-Mark's revenue nearly doubled from its level in fiscal 2009, while average net margins were up more than 80% over average net margins during the range-bound markets of fiscal 2010, 2014, and 2015. To avoid confusion, please note that the above charts for gold and silver are plotted in calendar years whereas A-Mark's financial reporting is based on a fiscal year ending in June.

Below is a compilation of fiscal year-end financial data for A-Mark from 2009 to 2017, assembled from the 10-K and S-1 filings, which shows the extent to which volatility in the metals markets can affect the company’s net revenues, net margins, and net income. In fiscal 2009, for example, the first year of the new bull market, prior to the fabrication and supply chain having had time to adjust, the company made a net margin of 0.41% on revenue of $4.1 billion for a total of $16.7 million in net income, which is the equivalent today of earning $2.40 per share. This is despite the fact that the revenue base of $4.1 billion in 2009 was half of what it is today. During fiscal 2014 to fiscal 2016, by comparison, a period of range-bound precious metals markets, net margins averaged only 0.13%.

TABLE 1

A-Mark Fiscal Year-End Financial Data (June 2009 - June 2017)

(in thousands $)

*The table above refers to A-Mark’s fiscal years ending June 30, whereas the gold and silver spot charts above are plotted in calendar years

During sustained periods of volatility, which the company hasn't seen since the bull market years of 2009 to 2012 and the subsequent crash of 2013, the largest contribution to earnings comes from the increased spreads they are able to make on their wholesale and retail trading activities. The company makes a two-way market in a variety of precious metals products and charges a spread over spot pricing, which can vary depending on inventory levels and demand. An American Silver Eagle, for example, which is the official silver bullion coin of the United States, and also the most popular bullion product among US investors, carries a premium of 25 cents per coin in times of slack demand but can command a premium of $4 when demand is high. These spreads sometimes run as high as 20 times the normal level when product inventories are low.

A-Mark is able to command higher spreads in these periods due to inefficiencies in the fabrication and distribution pipeline, which have historically caused persistent shortages in gold and silver bullion. When such a period begins, the inventory at sovereign mints is depleted first and they begin to ration coins. Private mints then take up the slack, but their inventories are also soon depleted. When all inventories have been exhausted, which can occur in a matter of weeks, they are not easily replenished due to bottlenecks in the fabrication of blanks, which are the round cookies that fabricators use to strike coins. The situation has been exacerbated in recent years as mints have tailored their operations for the subdued markets of 2014 to 2019 and are ill-prepared for a period of high demand in precious metals should one arise. Once existing inventories have been depleted, restocking of the pipeline may not fully occur until the period of high demand subsides. Below are two articles which discuss the brief period of high demand in July and August 2015, which resulted in A-Mark’s earnings leaping 371% for the quarter, and its stock price to nearly double:

http://www.mining.com/web/u-s-and-canadian-mint-dysfunction-snowballs-as-silver-coin-premiums-rise/ 

https://www.moneymetals.com/news/2015/07/13/silver-shortage-000734

With an eye to further expanding its earnings potential during periods of peak volatility beyond the boost it receives from an increase in spreads in its wholesale trading business, A-Mark made a number of investments from 2016 to 2018 that expanded trading hours, simplified and streamlined the order-taking and fulfillment process, provided the company with direct access to the retail market, and ensured an uninterrupted supply of product for its customers when demand is high and bullion inventories are low.

In 2015, the company opened its Las Vegas depository and launched AM Global Logistics. The Las Vegas depository is a 17,000 square foot facility located in the cargo terminal near the Las Vegas airport, which provides packaging, storage and same-day delivery services for A-Mark’s customers. Prior to the opening of this facility, the company relied on Brinks to provide logistics and storage. Now, ninety percent of all fulfillment and storage is done in-house. The company contracts with Brinks only to provide service for customers that prefer to store their inventory at locations other than Las Vegas. This facility allows A-Mark to capture additional margins on storage and logistics as well as to better control the fulfillment process during periods of peak demand. A-Mark has also begun providing fulfillment services for online precious metals dealers who do not have fulfillment services of their own. These companies are essentially an extension of A-Mark’s business and, in several cases, A-Mark has made direct investments in them (see 10-K “long term investments”). The Las Vegas depository and AM Global Logistics are independently-profitable, stand-alone businesses.

In August 2016, the company purchased a controlling interest in SilverTowne Mint, which is a fabricator of silver bullion products based in Indiana. Silver bullion inventory is the first to be depleted in times of high demand for precious metals and, consequently, it is also the metal in which the highest fabrication margins and trading spreads can be achieved. The depletion in inventory occurs faster than for other precious metals for the simple reason that a $10,000 investment buys only 7 ounces of gold whereas the same investment in silver requires the delivery of nearly 610 ounces, and inventories of silver are thus depleted more rapidly. SilverTowne Mint guarantees A-Mark an uninterrupted supply of silver coins and ingots during a time when other mints have run out of inventory; it enables the company to produce higher quality products; and it allows them to capture the significant increase in margins that accrue to fabricators during times of peak demand that would otherwise be forfeited to competitors. It should be emphasized that since the time the company has been public, there has not been a single quarter of sustained volatility in the gold and silver markets that would allow A-Mark to take advantage of the significant earnings potential of the SilverTowne Mint.

In 2018, the company launched a 24/7 online portal which vastly expanded the hours during which trading can take place and which facilitates a scaling of orders during times of peak demand that would not be possible for orders placed through a trading desk. The online portal allows customers to execute trades, arrange for financing, and handle storage and fulfillment logistics through the company’s subsidiary, AM Global Logistics, without having to call a broker or interact with customer service personnel.

In August 2017, the company also acquired the assets of GoldLine LLC, a direct-to-client retailer of gold and silver bullion, primarily for its extensive base of repeat customers, consisting of 150,000 precious metals and numismatic enthusiasts. The intention was to expand A-Mark’s distribution network by adding a direct-to-client, retail sales channel.  Goldline was formed in 1960 and historically used radio, TV and internet advertising to attract retail investors and collectors. Following the acquisition, A-Mark expanded GoldLine’s offerings to include new delivery and storage options through its Las Vegas hub, a host of new product lines, and new financing options through their CFC subsidiary that were not previously available to retail customers.  Nevertheless, in its first year of operation as a consolidated entity, GoldLine lost $8.6 million, including a $2.7 million asset impairment, on gross profits of $5.3 million and operating expenses of $10.6 million, resulting in the first annual loss in Amark’s history.

Speaking of the difficulty with the GoldLine acquisition management recently commented:

The market conditions were such that the company was not right-sized for market demand and we were a little slow to react in cutting op-ex. Now we’ve cut the op-ex dramatically and you’ll see in quarters going forward that we’ve really brought that down so that they are capable of operating profitably going forward. The op-ex is at a level now where it just can’t do the kind of damage that it did in the last fiscal year. The sales team and support team – everything had been built for a more active market.

And in the Q3 2019 conference call, which took place on May 9, the CEO of A-Mark, Greg Roberts, further clarified that:

As it relates to Goldline as a stand-alone, I would say that we’re still probably three months to six months away from that stand-alone profitability number.

Management also stated in the same conference call that the revenue required for GoldLine to breakeven on a stand-alone basis had been reduced to between $3 million and $4 million per month, which gives us enough information to estimate the earnings contribution from this segment during a period of high volatility.

GoldLine Earnings Estimate During Periods of Volatility

As mentioned previously, A-Mark can earn spreads in its Wholesale Trading segment up to 20x higher during periods of peak volatility. A-Mark’s GoldLine segment, while targeting a slightly different customer base, should also see the same increase in spreads as the rest of A-Mark’s business. In the quarter ending September 30, 2015, which is the only quarter in recent history to have witnessed two consecutive months of sustained volatility, revenue for the quarter was up 33% over the average quarterly revenue of 2014 and 2015, while gross margin was up 67% and net margin was up 110% (see Table 2 below).

TABLE 2

Change in Income Statement Metrics for the Volatile Quarter of Sept 2015 as Compared to Average Quarterly Results During the Non-Volatile Years 2014 and 2015

(in thousands of $)

During a quarter in which all three months of the quarter experience volatility, as opposed to the quarter ended Sept 30, 2015, in which there were only two, it follows from the above data that revenues would be up by 49% and gross margins by 100%. If we apply these metrics to GoldLine as an approximation of how the segment will perform under similar circumstances, starting at a breakeven level of $42 million per year ($3.5 million per month), we see that a sustained period of volatility lasting one year would contribute $5.2 million in earnings to A-Mark’s bottom line, or about 73 cents per share.

Annualized revenue at breakeven........$3.5 million x 12 = $42 million..................March 2019 conference call

Implied Gross Profit at breakeven.........$42 million x 0.079 = $3.3 million............Segment information 2018 10-K

Implied SG&A at breakeven..................$3.3 million..............................................Implied from conference call

49% increase in revenue.......................$42 million x 1.49 = $62.6 million............Increase based on volatility in quarter ended Sept 2015

100% increase in Gross Margin............7.9% GM x 2 = 15.8%..............................Increase based on volatility in quarter ended Sept 2015

Net Income (pre-tax).............................($62.6 x 15.8%) - $3.3 = $6.6 million

After-tax Net Income.............................$6.6 million x 0.79 = $5.2 million

Pro forma Net Income per share...........$5.2 million/ 7.08 million shares = 73 cents/share

The results of the above analysis, which uses the most recent period of volatility in 2015 as a template, is in agreement with the magnitude of the increase in revenue and net margin we saw during fiscal 2009-2013, shown earlier in Table 1. In that period, revenue jumped by nearly 50% at the start of the bull market and continued to increase for the next four years, finally leveling off at nearly 100% above 2009 levels. Similarly, average net margins during fiscal 2009 and fiscal 2011 to 2013 were 80 percent higher than during the doldrum years of fiscal 2010 and fiscal 2014 to 2015, which is a similar magnitude of increase to the one we see during the brief period of volatility in the quarter ended September 30, 2015. (see Table 2 above).

It is important to emphasize that neither the GoldLine business segment whose theoretical earnings we have just evaluated, nor the SilverTowne Mint, nor the 24/7 online portal, were part of the company during the September quarter in 2015, when the company tripled its earnings to 76 cents per share and saw its share price rise to $22.

Wholesale Trading Earnings Estimate During Periods of Volatility

We can use the same analysis to estimate A-Mark’s earnings in the Wholesale Trading & Ancillary Services segment during periods of volatility. In fiscal 2014 and 2015, neither the SilverTowne Mint nor GoldLine had yet been acquired, and neither the 24/7 online portal nor the Las Vegas hub had yet been built, so the earnings for those fiscal years are a good benchmark for what A-Mark’s wholesale trading business can do independently in times of low volatility. To estimate how much this segment will contribute to earnings in times of high volatility, we can apply the same metrics we calculated for the two-month period of volatility ending in September 2015 found in Table 2. Using this as a template, A-Mark’s wholesale trading business as a stand-alone entity would see revenue increase by roughly 50% and gross margins by 100% during volatile periods. Using the quiet markets of 2014 and 2015 as a base, earnings per share would increase from an average of $1.08 to $2.54, solely from A-Mark’s wholesale trading business, as can been seen from the table below:

TABLE 3

Net Income for Hypothetical Year of Volatility Using Adjusted Net Income for 2014 and 2015 as a Base - Wholesale Trading Only

(in thousands of $)

Secured Lending Estimate During Periods of Volatility

A-Mark’s Secured Lending segment operates through its wholly-owned subsidiary, CFC, which is a California-licensed finance lender that originates and acquires commercial loans secured by bullion and numismatic coins. The company securitizes these loans by issuing privately placed notes, which are secured by the loans in its portfolio as well as the bullion and numismatics collateralizing those loans. The loans are subject to margin calls and can be liquidated by the company if loan-to-value ratios of 60-70% for numismatics and 70-80% for bullion are not maintained. The company has never suffered any losses or write-downs of its loan portfolio since its inception in 2005.  The secured loans originated in 2018 and 2019 carry interest rates of approximately 9.7%.

Below is a table of interest income for the company from 2011 to 2018. The company has never carried large cash balances on its balance sheet so these numbers are mostly reflective of the interest earned on its loan portfolio. Data from 2009 and 2010, which were important years in the gold and silver bull markets, are unfortunately not available.

TABLE 4

Interest Income and Expense Fiscal 2011-2018

The fiscal years from 2017 onward are not useful for comparison against periods of high volatility because the company made significant enhancements and additions to its secured lending business during those years which affected both interest income and net interest margin. In 2017 the company acquired the assets of GoldLine and began offering inventory financing to its customers. The company also began a program of purchasing loans from outside originators to add to their portfolio of self-originated loans. In fiscal 2018, the company began securitizing its loan portfolio and executed a $100 million securitization offering.

By contrast, during the years between 2011 and 2015, the lending business mostly ebbed and flowed with changes in market conditions. In the last years of the 2009 to 2012 bull market, for example, interest income jumped 37% from $8.9 million to $12.2 million. During the volatile downward moves of fiscal 2013, interest income dropped 36% from $12.2 million to $7.8 million. During the range-bound period of fiscal 2014, interest income dropped another 28% from $7.8 million to $5.6 million. This is convincing evidence that periods of volatility and high demand have a measurable effect, not only on trading spreads, but also on the secured lending business as well. While not much data is available, it seems apparent that swings in interest income of 30-40% are common during periods of high volatility. Therefore, it would not be unreasonable to model a 30% improvement in net interest income during such periods. Using fiscal 2018 net interest income of $2.2 million as a base, the secured lending business could earn a pre-tax profit of $2.9 million during a year of volatility, or about 33 cents/share after tax.

The most difficult piece of A-Mark’s business to model is SilverTowne Mint, of which the company owns 55%. There is little information provided for the mint in the financial statements except for a mention that current production is 12.5 million ounces and maximum capacity is 20 million. There are no publicly-traded mints whose financials might be available for comparison and the financials of the sovereign mints, while available, are not very useful. Rather than add an insubstantiable amount to my earnings projection, I prefer to assume that SilverTowne mint simply provides the means for A-Mark to continuously supply product during a period when it would otherwise be difficult to acquire and thereby allows the company to avoid scaling back their sales efforts for lack of inventory during times of peak demand.

In sum, when we add together the estimated earnings from the three business segments during times of sustained volatility: the $2.54 in estimated earnings from A-Mark’s wholesale trading activities; the 73 cent contribution from GoldLine; and the 33 cent contribution from the Secured Lending segment, we see that A-Mark could earn $3.60 per share on an annualized basis in times of peak demand, which is a substantial increase over the $1.00 to $1.30 per share it earned in each year between fiscal 2014 and 2017.

Future Volatility

Short term periods of volatility lasting only a month or two can have a significant effect on A-Mark’s earnings and can move the stock dramatically as we saw in the quarter ended September 2015, when earnings for the quarter jumped 371% over the previous year and the stock moved from $11 to $22. But it is the protracted periods of volatility, particularly the long upward and downward trends in the precious metals markets, such as those from 2009 to 2013, that will have the greatest effect on the company’s earnings and stock price over time. Those of you who have studied historical patterns in the markets going back several decades may have noticed that the length of time a market spends in a tight trading range is often correlated with the size and duration of the move that a market will eventually make, either to the upside or downside, once it breaks out of the range. The longer the market is contained within the range, the greater the potential move once it emerges. Richard Wyckoff first observed this phenomenon in the late 1800’s and it still remains one of the best indicators (although far from perfect) of how far, and for how long, a market will trend.

With this in mind, the current range in gold between $1200 and $1400 is the longest and tightest range in its history, dating back 100 years, and there is a reasonable argument from an historical standpoint, based on the 5-year duration of this tight trading range, that whatever move finally occurs will be sustained for quite some time in one direction or the other. The same can be said for silver, which has different fundamentals than gold, but which nevertheless has moved in sympathy with gold for much of its history.

Compensation Controversy

An article on Seeking Alpha from April 2016, linked below, highlights several concerns regarding A-Mark’s corporate governance and executive compensation that were present at the time the article was written. The fiscal 2015 compensation agreement for A-Mark’s top three executives contained a guaranteed cash payout based on pre-tax profits, which in a year that the company earned pre-tax profits of $25 million would have been approximately 19.4%, or $4.85 million. In the article, the author argues that such compensation was not only excessive, but that A-Mark’s profits are tied more to volatility in the precious metals markets than to the quality of execution by management and that these payouts were therefore giving management a free option on future volatility rather than compensating them for actual performance. He also points out that management and directors own a near-controlling interest the company, making it almost impossible for small shareholders to effect any changes.

https://seekingalpha.com/article/3963226-executive-compensation-structure-makes-mark-sell-price

The terms of management compensation have been changed since 2016 and now cap the maximum cash bonus at 125% and 150% of base salary for the President and CEO respectively, which would be a maximum cash bonus of about $1.4 million combined. It should also be noted that management was not awarded any bonus in 2018, a year in which the acquisition of GoldLine resulted in a net loss.  Nevertheless, due to the high level of control by company insiders this is an issue that should be monitored. Discussions are currently underway regarding new employment agreements so the final compensation package for fiscal 2019 is currently unknown.

Management and directors of A-Mark own 42% of the company, or about 3 million shares, and are strongly incentivized to see the stock price higher. A move in the stock from $12 to $32, for example, would represent a gain on those shares of about $60 million. In the case of the CEO, Greg Roberts, who owns 1,043,000 shares, a move to $32 would increase the value of his holdings by nearly $21 million, even before considering the gain from incentive options.

Is the Quarter Tracking Well?

There is an easy way to monitor whether A-Mark is experiencing a quarter of high demand and therefore higher earnings. The US Mint publishes monthly sales volumes of gold and silver on their website https://www.usmint.gov/ which is updated at 5pm EST daily. If the numbers for the latest period are not materially greater than for the previous period, A-Mark’s earnings are probably seeing little change. If, on the other hand, there are significant volume increases shown in the reports, if the US Mint announces it is going on allocation, or if the mint begins running out of coins, it’s a good indication that A-Mark’s earnings will be significantly higher.

For example, the following link to sales of American Eagles in 2015 on the US Mint website show the increase in demand for Gold American Eagles in July, August and September, that led to the jump in A-Mark’s earnings for the quarter ended September 30, 2015, discussed in Table 2. The monthly sales data is updated every weekday at 5pm EST, so with a little due diligence, one can predict in advance whether A-Mark’s earnings for any given quarter will be significantly higher due to volatility.

https://www.usmint.gov/about/production-sales-figures/bullion-sales?program=American+Eagle&+AmericatheBeautifulSilverBullion5ozCointype=&+AmericanBuffalotype=&+AmericanEagletype=Sales+totals+by+Month&AmericatheBeautifulSilverBullion5ozCoinSalestotalsbyMonthyear=&AmericanBuffaloSalestotalsbyMonthyear=&AmericanBuffaloYear-datedcoinssoldyear=&AmericanEagleSalestotalsbyMonthyear=898&AmericanEagleYear-datedcoinssoldyear=

Conclusion

A-Mark Precious Metals has not seen a single sustained period of high volatility in the gold and silver markets since the time of its spinoff in 2014. As a result, investors have forgotten, or simply never knew, that A-Mark is a cyclical company with peak earnings much higher than they are today. AMRK stock is currently trading at roughly 12x its historical run-rate of $1.00/share that the business earns during periods of lackluster demand and 3.3x my earnings estimate of $3.60/share during periods of peak demand. It is therefore ripe for a huge revaluation to the upside when a period of volatility in the precious metals markets finally returns.

Catalyst

 Volatility in the precious metals markets, particularly silver