The utterly wild ride that financial markets have endured thus far in 2022 has taken its toll on a variety of asset classes. We’ve seen perennial leaders smacked down from their prior perches, and while defensive names have led at times, it’s only on a relative basis. There have been few bright spots, and certainly not counted among those is cryptocurrencies, or the miners that generate the coins.
I’ve been bullish at times on various cryptos, and I’ve been similarly bullish at times on crypto miners, but one thing that is abundantly clear about both is that they are extremely volatile. That makes them great for trading, because moves can be quick and the magnitude is generally sizable. However, it also means losses can stack up quickly, so please size positions accordingly.
The swoon in Bitcoin (BTC-USD), in confluence with a general risk-off environment, has absolutely crushed Bitcoin miners. The group has a lot of potential upside over the long-term, in my view, and that’s particularly true from current levels. Like any other sort of mining, Bitcoin mining requires scale, and operating leverage is extremely high. That means that when Bitcoin prices are high, miners tend to see immense profitability. But operating leverage works in both directions, and right now, miners are getting the other side of that operating leverage.
However, if, like me, you believe that Bitcoin is going to go higher over time, you may find the miners to be quite the bargain right now. One such miner that certainly appears to have a favorable risk/reward outlook today is Riot Blockchain (NASDAQ:RIOT), one of the largest Bitcoin miners in the market. In this article, I’ll examine the outlook for Bitcoin itself, and its implications for Riot.
A technical view of Bitcoin and RIOT
Let’s begin with a renewed look at the chart for Bitcoin, which is showing a great deal of really ugly behavior. This is a two-year daily chart to get a longer-term perspective on the price action we’ve seen.
The main thing we need to take note of here is that Bitcoin is at a critical point right now; the support zone that is in and around $30k per coin is monumentally important. The bulls absolutely have to hold this level, or we could see another bear market type move off of the $30k level, in addition to what has already occurred.
There’s reason to be optimistic, in that the accumulation/distribution line remains very near its all-time highs even after Bitcoin has taken a 50%+ haircut. That indicates that big money is buying dips, and that’s exactly what you want to see during periods of weakness. That doesn’t guarantee us anything, but it’s a good sign.
In addition, the PPO is at extremely oversold levels that have been eclipsed only by the initial decline off the $65k level about a year ago. However, that decline held ~$30k, and conditions are very similar today. That prior swoon led to a 100%+ rally in the space of four months or so, and that’s a possibility again if the risk-off environment changes to something more palatable for cryptos.
I won’t belabor the point but the 14-day RSI, another favorite momentum measure of mine, is showing similarly oversold behavior.
The overall look here is actually quite simple; we have an extremely oversold asset that is right at critical support. If the coin holds the $30k level (or something just below that), we should be off to the races higher. If not, well, you know what happens.
Now, if we do get the “off to the races” move, that will be extremely bullish for crypto miners, including Riot. The chart for Riot is below, and it’s not pretty, to say the least.
Riot has lost more than 90% of its all-time high price in the past ~15 months. Was Riot excessively valued at $80 per share? I think it’s pretty obvious that it was. However, the business has grown enormously since then, and accordingly to guidance from management, will continue to do so. Apart from that, its correlation to Bitcoin is extremely high, so if we do get that move off of $30k that we just looked at, Riot has the potential for explosive upside.
The price chart itself for Riot is just hideous, and there’s really not a lot to be bullish about. The stock has lost support levels time and again, all of the moving averages are sharply down trending, and the A/D line is near its lows. If this were a restaurant, tech company, industrial, or just about anything else, I’d tell you to run for the hills. But because Riot’s weakness is primarily attributable to Bitcoin weakness, I think the current setup is actually favorable for the bulls, assuming you’re willing to take on the inherent volatility.
On the bright side, Riot is unbelievably oversold, having lost about 70% of its value in two months. The PPO is at -18, which is not only difficult to fathom, but is also exactly the same level where the stock bounced after the early-2021 crypto swoon. Like Bitcoin itself, Riot is setup quite well at the moment for an oversold bounce, and if that coincides with a bounce in Bitcoin, we could see the stock double or triple from here in relatively short order. That’s not hyperbole; it’s happened before and it could very easily happen again.
Let’s now turn our attention to the fundamental case for Riot, because it appears to be a pretty good one with the stock at $7.
Riot Blockchain’s Q1 earnings support higher prices
Riot reported first quarter earnings on May 10th after the close, and while earnings looked good, revenue came in shy of estimates. The stock is trading down about 1% pre-market as I write this, so the reaction is muted. However, the fact that the initial reaction is muted speaks volumes in my view, because we’ve seen growth stock after growth stock get absolutely annihilated this earnings season on any hint of weakness. Riot missed estimates by almost $2 million, and the stock isn’t budging. Seller exhaustion? That’s certainly a possibility, and would jive nicely with an extremely oversold stock.
Now, Riot boosted Bitcoin production during the quarter ended March 31st by 186% to 1,405 coins, a new record for the company. We’re going to see new records every quarter for the foreseeable future as Riot continues to ramp capacity, and that’s a big part of the growth story here. The company is still scaling with new machines, and it is aiming to be in the top two or three miners in the market in terms of absolute mining capacity. As we know from oil companies, precious metals miners, and the like, scale is everything, and Riot is doing everything it can to achieve that scale.
During the quarter, mining net revenue was $58 million, up from just $23 million a year ago. That’s to be expected given the 186% increase in coins mined, but importantly, even as the price of Bitcoin remained weak, margin on mining revenue was flat at ~67%. That’s critical, because the operating leverage I mentioned earlier comes into play in a big way as the price of Bitcoin moves around. If the price of Bitcoin rises, Riot stands to see sizable margin gains on coins mined, in addition to the ones that are held on its balance sheet. Both are value generators for shareholders, and that’s the bull case here; to capture the increased value of Bitcoins the company has already mined, and will mine in the future.
Riot did see much higher expenses during the quarter, with total costs and expenses rising from $16 million to $42 million year-over-year. That meant that adjusted EBITDA rose only fractionally despite the massive increases in revenue, and that’s something the bears will hang their proverbial hat on. However, remember the operating leverage concept, as this should be worked out as the price of Bitcoin rises. Keep in mind also the rise in expenses is expected given the scaling effort that is underway. While I want to see Riot get expense growth under control, I also want Riot to invest properly in future growth, and it is. So for now, I’m in wait-and-see mode on expense growth, and I don’t think it’s a reason to panic.
The company had $114 million in cash at the end of Q1, and at the end of April, which was one month subsequent to the end of the quarter, the company had 6,320 Bitcoin on its balance sheet. That’s good for another ~$190 million at current prices, so Riot has plenty of cash and equivalents to continue to scale indefinitely. Riot management believes in the long-term potential of Bitcoin, which is why the company holds most of the coins that it mines, and I believe that is the correct strategy with Bitcoin at $30k. For now, I believe this gives shareholders an upside option on Bitcoin prices, and I’m happy to see Riot continue to hold its coins rather than unload them.
Also subsequent to the end of the quarter, Riot deployed ~3.5k S19J Pro Antminers at its Whinstone facility, and it now sports capacity of 4.7EH/s. That’s in line with prior guidance, and the company reiterated guidance of 12.8EH/s by January 2023. That means that Riot is still on track to roughly triple capacity from today’s level over the next eight months or so, all while the stock has lost ~90% of its value in the past year-plus. That’s the opportunity here.
Let’s now take this info and see what we might reasonably expect from Riot in the months and quarters ahead. We’ll start with revenue estimates, which are plotted below.
We can see revenue is expected to be ~$430 million this year, right at double what it was in 2021. We’re then looking at ~$670 million in 2023, or another ~55% higher from 2022’s record. Keep in mind that capacity alone should ramp ~3X from 2021 levels into 2023, and that doesn’t include any price appreciation from Bitcoin. In other words, these estimates represent a sort of base case, and if we do get that move off of $30k for the coin itself, we could see substantial upside to these numbers. Of course, that works both ways, so these estimates could come down, but given what we’ve discussed here, it looks to me like the risk is to the upside.
What’s really interesting is that earnings estimates remain buoyant for Riot, all while the stock gets pummeled.
Analysts have Riot earning $1.44 per share next year, for a forward P/E of about 5. Not only is that not growth stock territory, but Riot is being priced like almost none of those earnings will actually come to fruition. So what you have to ask yourself is, what if the company can get anywhere close to that level of earnings? The outcome would almost certainly be a much higher share price, because there is almost no business in the world that has a normalized earnings multiple of 5, and especially not one that is growing revenue by leaps and bounds. Something has to give, and I think at this point the stock is priced where the risk is firmly on the side of the bears, as all Riot has to do to achieve a higher share price is keep plugging away with its current plans.
Finally, let’s take a look at price-to-sales, because I think this is also pretty telling.
Riot is going for just over two times sales today, which is a trough valuation by any measure. The company was valued as high as 50X sales last year, and while that’s not going to happen again, Riot also spent a lot of time in the high-single digits and low double digits in the past three years. Again, if we even get anywhere close to those levels, Riot has enormous upside potential.
Summing all of this up, I see Q1 earnings and the reiteration of capacity guidance as more than enough to make a fundamental case that Riot is quite undervalued at $7 per share. I also think the technical picture supports the potential for a big rebound in the near future, for both the stock and for Bitcoin. I still believe Bitcoin is going a lot higher than $30k, but I also recognize the risk that it breaks support at $30k, and that it takes Riot and other miners with it in another move lower. However, if that happens, you simply stop out of your position and move on. If, on the other hand, Bitcoin does hold and move higher, we could easily see Riot trade back into the $20s or $30s on a relief rally alone, with more potential following.
All things considered, Riot looks like a strong buy after Q1 earnings reaffirmed its growth trajectory, and I want in.