July 6, 2007

Shares of Polaris Minerals have been inordinately strong of late, rising approximately 91% since the beginning of the year and almost 23% in the past month alone. We believe that several factors have been driving the stock. From a macro-level, we have seen a resurgence in infrastructure plays, non-residential construction companies, steel fabricators and other related businesses. This theme was highlighted on May 2, when Brookfield Asset Management proposed the distribution of its infrastructure assets into a publicly-traded limited partnership. The spin-off “surfaces” the value of currently-owned infrastructure assets and ensures access to capital to fund future growth and acquisitions. We found it interesting that more than a month later Brookfield was mentioned by a US-based television personality, which further heightened investor interest.

At ABC Funds, we are focused on bottom-up or company-specific research and analysis. Subsequent to Polaris’ first shipment of aggregates from its Orca Quarry, the Company released its first quarter operating and financial results. Although only one barge shipment occurred in the quarter, the press release and conference call provided a forum for management to discuss solid progress on the construction of the Richmond and Redwood City terminals in California. More importantly, the Company announced the repayment of US$31 million of long-term debt without penalty and is now virtually debt free. Photos were also made available on the Company’s website to demonstrate progress at the quarry and the port terminals that would be required to ramp up shipments into the California market.

Shortly after these developments, a brokerage firm initiated coverage with a target price of $22.20, almost $10 per share higher than Polaris’ previous closing price. Investors began aggressively bidding up the stock, scrambling to buy into the story. Our own valuation work is not dissimilar from this research report, whereby we calculate a net asset value based on volume, price and cost assumptions. Admittedly our model is more conservative, however we have considered several scenarios which would provide greater upside such as additional receiving terminals, an expansion at Orca and eventually production from Eagle Rock. True, the brokerage analyst did give the Company credit for all of these developments, although to be fair, he did provide a wide range of potential valuation levels under various assumptions.

Even after the dramatic share price appreciation, we continue to be excited about our investment in Polaris. We believe in management’s ability to secure access to the receiving facilities needed to grow production volumes aggressively. We also believe that the relatively stable nature of the cash flow stream would be attractive to various acquisitors, whether they be private equity, an integrated construction company or perhaps even an infrastructure investment fund. In our opinion Polaris owns irreplaceable assets of significant long-term value; it is just a question of unlocking the full potential for investors.

November 16, 2007

Polaris Minerals has just released its third quarter results, which comprise the second full quarter of production from the Orca Quarry.  Production volumes are steadily increasing and amounted to 488,414 tons over the three months ended September 30, 2007.  There is still plenty upside before the quarry reaches permitted capacity of 6.6 million tons per year.  The financial results reflect the ramp period, with revenue of only $5.5 million and a loss of $0.05 per share.  These results will show a dramatic improvement as sand and gravel sales volumes move closer to targeted levels and costs decline on a per ton basis.

The real news in the quarter was the announcement of a long-term strategic alliance with CEMEX Incorporated, a global building materials company and the largest cement and ready-mix concrete supplier in the United States.  Essentially, Polaris will exclusively supply CEMEX in the states of California, Oregon and Washington.  Currently, sand and gravel from Polaris’ Orca Quarry is being shipped through two existing CEMEX terminals in San Francisco Bay in addition to Polaris’ recently completed Richmond terminal.  Once the Port of Redwood City is operational, the Company will have access to a total of four receiving facilities.

The complex details of the transaction were discussed on a conference call subsequent to the press release.  However, the benefits to each party can be summed up as follows.  Polaris gains access to receiving facilities in regions where construction demand is expected to remain buoyant.  In turn, CEMEX gains access to a secure supply of sand and gravel in regions where shortages exist.  The arrangement includes the shared development of future construction aggregates quarries and import terminals.  Polaris and CEMEX also agreed to develop the Eagle Rock Quarry and cooperate in the pursuit of markets and terminal capacity for the crushed granite product.  It is important to note that Polaris retains the profits from the aggregate sales, which will be transacted at market prices.

The quality and the tonnage of Polaris’ Orca Quarry have never been in question; the business model simply depends on securing access to “gateways” into target markets.  We believe that Polaris has made great progress in resolving this limiting factor and is on track to successfully reach and exceed its productions targets. For example, simply adding a second shift at the Orca Quarry could double production without any additional capital.  Earnings and cash flow will show substantial improvement as the production and sales volumes continue to increase.

September 5, 2008

We recently had the opportunity to sit down with Polaris’ management to discuss the Company’s financial and operating results.   The outgoing President and CEO Marco Romero and his successor Herb Wilson, currently the Company’s Senior Vice President and Chief Operating Officer, both attended the meeting at our offices.  Importantly, the management change was a natural transition for the Company as it evolves from the startup and development phase to a commercial producer.  Simply put, different types of expertise are required during different phases of a Company’s lifecycle.

There is no doubt that from a macro standpoint, Polaris is facing some headwinds.  Housing construction, especially in the key California market, is down dramatically.  Rising oil prices and the associated fuel surcharges have compressed margins.  Further, relatively low production volumes during the ramp period mean high fixed costs per ton.  However, we believe that as production continues to ramp, Polaris will show steadily improving margins and financial results.

Examining the top line first, management was able to confirm the following key points.  Polaris should be able to grow sales volumes, despite the downturn in US home construction.   Market share will expand as local quarries steadily deplete or are closed due to environmental reasons.  They remain convinced that progress toward permitted production of 6.6 million tons per year from the Orca Quarry is on track.  In fact, Polaris has secured shipping capacity with CSL International for more than 7.8 million tons.  The acquisition of the Long Beach terminal site closed on August 5, 2008, which will add receiving capacity of roughly 3 million tons.  Finally, management noted that aggregate pricing has remained stable, despite all the turmoil, because customers are willing to pay market prices in order to ensure a consistent supply of material. 

From a margin perspective, both fixed and variable costs per ton are expected to improve in the coming quarters.  Oil prices have declined approximately $40 per barrel since the peak, which will reduce the Company’s fuel surcharge by roughly $1.00 per ton.  Recall that fuel costs are renegotiated at the end of each year and we expect the Company to benefit from stable or declining prices.  Fixed expenses on a per ton basis will continue to fall as volume reaches 2.1 to 2.5 million tons in 2008, double the amount of material shipped in 2007.  Berthing costs should also decline as the Company has received regulatory approval to use one berthing tug instead of two after demonstrating safe operating procedures.

So despite the share price performance, we believe that the underlying fundamentals of the business should improve over the coming quarters.  We still believe that Polaris controls an irreplaceable asset that could be in production for 25 to 50 years.  We also like that the Company has a clean balance sheet with no long-term debt, which should provides ample flexibility to fund the Long Beach terminal.  At the current share price, we believe that Polaris is trading at a 40% discount to its core net asset value based only on the Orca Quarry.  Eagle Rock will provide additional upside in a few years, in time to benefit from the inevitable US housing recovery.

January 2, 2009

Given today’s environment, investors need to focus on identifying the survivors.  In the resource sector, this means that a company’s operations have to be either cash flow positive at current commodity prices or fully-funded through to commercial production.  Despite the disappointing share price performance in 2008, we believe that Polaris Minerals has the cash flow and the balance sheet to weather the storm.

From a cash flow perspective, Polaris sold 694,000 tons of sand and gravel in the third quarter of 2008 and reported cash from operations of $635,000 despite elevated shipping and fuel costs.  Importantly, lower fuel costs in the fourth quarter could add $2.00 to $2.50 per ton to the gross margin, which should flow directly to operating cash flow.  We recently met with management, who confirmed that they would be cash flow positive in 2009, even after deducting planned exploration and development capital expenditures.

From a balance sheet perspective, the market had growing concerns about Polaris’ ability to refinance a bridge loan that had been put into place to fund the Long Beach, Pier B acquisition.  This one-year $20 million facility had an initial interest rate of 12% that increased to 13% and 15% if the loan remained outstanding at 91 days and 181 days respectively.  On December 16, Polaris ended the speculation and announced that it had entered into a bought deal for $25 million at a price of $1.60 per unit.  Each unit consists of one common share plus one half of a common share purchase warrant.  One full warrant allows the purchase of an additional common share at an exercise price of $2.25 per share for a period of two years following the closing of the offering.

Post closing, the bridge loan will be completely repaid and the Company will have approximately $13 million of cash on its balance sheet.  Additional sources of liquidity include $3 million from a sale/leaseback transaction involving the Company’s new berthing tugboat.  Further, the Company has approximately $5 million tied up in Asset Backed Commercial Paper, which could be returned as soon as January as per the recently announced agreement with the provincial and federal governments.

June 5, 2009

We recently had Polaris’ management into our offices for an update on the Company’s operations and financial situation.  Admittedly, it has been a very disappointing investment over the past year, given the Company’s sensitivity to the economic downturn, credit crisis and collapse of the west coast housing market.  However, management was more upbeat than we had seen in a long time.

They suggested that the Company’s end markets had finally stabilized, that customers were beginning to bid on construction projects again and that the stimulus package was starting to encourage new activity.  Operationally, the Orca quarry is performing well, full shift hours had been restored and an updated technical report extended the life of the quarry past 2025 assuming peak annual sales volume of 9.6 million short tons per year by 2015.  Financially, the balance sheet has been cleaned up, the fuel surcharges are working and the Company expects to be cash flow neutral this year.

In response, the shares have moved dramatically from the 52-week low of $1.10 to trade around the $2.70 level.  The market is starting to price-in a turnaround in economic activity.  It is now just a question of the timing and pace of a recovery in demand. Thankfully, we believe that the Company has managed to weather the worst of the storm.

October 9, 2009

Despite the turmoil and, quite frankly, disappointing investment performance, we continue to believe in the long-term potential at Polaris Minerals.  Jobs across the western United States will eventually return, housing will recover and construction spending will ramp up.  Management at Polaris rightly took the painful steps to preserve cash and protect the balance sheet during the downturn.  While waiting for the macro economic recovery, we need to focus on management’s efforts on running the business.  Recently, we were encouraged to see that they entered into an agreement that should reduce the need for future capital and improve the economics of the project.

Recall that in early January 2008, Polaris acquired a site for a future terminal in the Port of Long Beach, California.  The Company acquired the 12.6 acre site and completed extensive due diligence to ensure that any environmental issues could be resolved.  In August, the Company closed the deal and entered into a bridge financing in the amount of $20 million.  This expensive facility was finally replaced with an admittedly dilutive equity offering late in December 2008.

However, management has just announced that they have secured an option to lease an existing marine aggregate importing terminal in the Port of Long Beach.  The 8.3 acre site is privately owned and is already permitted to receive and distribute up to 3 million tons of construction aggregates per year.  It is located on a deepwater channel in the Port and is close to Interstate 710, which allows easy access to the greater Los Angeles area.  Once the Company completes their due diligence and lease negotiations, the new site will render the Pier B land redundant.

Herb Wilson, President and CEO, summed up the transaction succinctly, “We are very pleased to have the opportunity to evaluate this alternative facility which only recently became available.  We believe that it could be developed sooner and with significant capital savings over Pier B.  Should due diligence confirm these views, we expect to commence the development of this new site and proceed with the sale of the Pier B land”.

Unfortunately, this alternative did not exist at the time when Pier B was originally purchased, but here are the economics of one option versus the other.  The Pier B land originally cost approximately $20 million, of which the Company was responsible for about $15 million including all the due diligence and environmental work.  Polaris and its partner would have had to share the $40 million or so in costs to build the terminal on this site.  This implies a total cost to Polaris of $35 million.  The second option, leasing the existing facility, would require capex of approximately $10 million, which the partners would split 50/50.  So the capital savings are in the range of $30 million net to Polaris.  The $5 million capital cost of the existing terminal option should be easily covered by selling the Pier B land.  Lease expenses are expect to be in the range of $1 to $2 million per year, which should be covered by operating profits once the facility is up and running.  All told, we greatly prefer this new option for the development of terminal capacity in the Port of Long Beach.

September 10, 2010

Unfortunately, Polaris Minerals has become an orphaned stock.  Despite its irreplaceable assets and successful production startup, the investment thesis has failed to play out within a reasonable amount of time.  We had surmised that Polaris would be able to gain market share as government spending on public infrastructure projects offset the decline in housing related construction activities.  However, California, one of Polaris main target markets, has been unable to resolve its budgetary issues and projects have stalled.  Sales volumes and therefore revenue have failed to meet even our modest expectations.

Polaris has, thus far, managed to protect its balance sheet despite the reported losses.  As at June 30, 2010 the Company had working capital of $7.1 million, including cash of $2.7 million on the balance sheet and minimal long-term debt.  Over the course of the downturn, management restructured shipping agreements, renegotiated fuel surcharges and cut costs aggressively.  Looking forward, we are waiting for the sale of the Pier B property, which was originally purchased for approximately $20 million, to further bolster the Company’s cash position.  An offer has been received and completion of the sale is expected sometime within the next twelve months.  However, the timing of the closing and receipt of the cash is still uncertain.

While we are tremendously disappointed with how low the stock has fallen, the fact is that Polaris’s long-life quarries and port facilities are worth significantly more than its currently oversold market capitalization.  Although we have been patiently awaiting a turnaround in California’s aggregate demand, Polaris’s low valuation, in the short run, could attract an opportunistic acquisitor to purchase these assets at a rock bottom price.