HIVE - CleanSpark Is Our Top Bitcoin Mining Stock Pick

2023-09-27 00:22:13 ET

Summary

• Bitcoin has outperformed other asset classes with an average annualized return of 60% since 2014.
• The approval of a spot Bitcoin ETF by the SEC could lead to an influx of $300 billion into Bitcoin.
• CleanSpark is ranked as the top Bitcoin mining company, with low valuation ratios and strong growth metrics.

Bitcoin has been the best-performing asset class over the past decade by a wide margin. Detractors come out of the woodwork and like to focus on the massive corrections that occur regularly in this sector. Yet, the average annualized return for Bitcoin since 2014 has been 60%. This compares to an average annualized gain of 5% for gold, 9% for the S&P 500, and 16% for the Nasdaq 100.

Those massive drawdowns have proven to be excellent buying opportunities over the past 14 years since Bitcoin was launched and the trend appears to be continuing with the price up 60% year-to-date in 2023 after the massive correction in 2022.

Bitcoin mining stocks offer investors leveraged gains during bull cycles but also leveraged losses during bear cycles. As I believe that we are in the early stages of a major bull market cycle for the cryptocurrency sector, this could be an opportune time to buy crypto mining stocks at discounted prices.

There are several significant catalysts upcoming for Bitcoin, but one of the most important is the April 2024 halving, an event in which the supply output will be cut in half. This will reduce the inflation rate for Bitcoin from 3.6% to 1.8%. The price has historically rallied in the months leading into the halving and then advanced sharply in the months following it.

The other major near-term catalyst is the likely approval of the first spot Bitcoin ETF in the United States. While the SEC has previously denied applications by smaller player, we now have the world's largest asset managers applying to list a spot Bitcoin ETF.

These include BlackRock, Fidelity, Invesco Galaxy, Franklin Templeton, WisdomTree, VanEck, GlobalX, ARK Invest, Valkyrie, and Bitwise. In total, these managers are estimated to have around $18 trillion of Assets Under Management ((AUM)). If these managers put just 1% of the wealth they control into Bitcoin, it would represent $180 billion in new capital inflows into an asset with a market cap of just $500 billion.

The approval of a spot ETF by the SEC could lead to an influx of $300 billion into Bitcoin.

- Mark Yusko, CEO of Morgan Creek Capital

This estimate does not include any multiplier effect from other institutions finally having the green light to start investing. And it is worth noting that a spot Bitcoin ETF is much different than current iterations, as it will create real demand for scarce Bitcoin in the marketplace. This projected spike in demand would be coming at a time when the percentage of Bitcoin held by long-term holders continues to increase and the amount available on exchanges to trade continues to decrease. This has the potential to cause a powerful spike higher in the price, which is still trading 60% below the late-2021 record highs.

The next SEC ruling on BlackRock's Spot Bitcoin ETF is on October 17th. They could postpone a decision again, but experts see increasing odds of approval.

Bitcoin Mining Offers Leveraged Returns

Crypto mining is a process that blockchain networks use to finalize transactions. It's called mining because it also releases new coins into circulation. Crypto mining requires significant computing power from specialized machines purpose-built to solve complex problems. These Application-Specific Integrated Circuit "ASIC" miners are the workhorses and main capital investments for crypto mining companies.

Crypto miners ensure each transaction is legitimate, helping verify and secure blockchain networks. This mining process allows Bitcoin and some other cryptocurrencies to function in a decentralized manner without oversight from a third party, like a bank. The largest asset manager in the world, BlackRock, has been snapping up crypto miners, likely positioning itself ahead of approval for a spot Bitcoin ETF and the coming April 2024 Bitcoin halving. They are now the second-largest shareholder in 4 of the top 5 cryptocurrency miners.

But Blackrock is not alone, the investment giant Vanguard , with $7.7 trillion in assets under management, has also accumulated a stake of over $600 million in top Bitcoin miners. This has come mostly indirectly through index funds, but is still significant due to the sheer size of their investment. And Fidelity was an early investor in crypto miners, purchasing a 7.4% stake in Marathon Digital ( MARA ) for $20 million in July of 2021.

Crypto firms also received good news this month as the

Financial Accounting Standards Board (FASB) approved a change to fair-value accounting. Companies record their crypto at the historical price they paid and review their holdings every quarter for impairments. Holdings are considered impaired even if the price of a cryptocurrency falls temporarily during the reporting period, and values can't be upwardly revised if the price recovers.

The new accounting rules mark an improvement over the current method as companies will be able to record gains and losses immediately and classify crypto assets like Bitcoin and Ethereum as financial assets. The rules are expected to take effect in 2025.

Crypto miners are down significantly from their 2021 highs. During the time period when Bitcoin crashed from $69k to $15k (78%), most crypto miners were down over 90%. Then when Bitcoin doubled from $15,000 in November of last year to over $30,000 in July of this year, most crypto miners realized gains of 4x to 5x. In this time period, the upside leverage was significantly higher than the downside leverage, offering an attractive risk/reward set-up for investors.

With crypto prices having pulled back from recent highs and Bitcoin around 12% off the July highs, crypto miners have corrected by around 50% from their 2023 highs. With several bullish catalysts ahead for the cryptocurrency sector, I believe this current pullback offers an excellent buying opportunity.

If Bitcoin climbs 15% back to recent highs, this could equate to gains of 60% to 80% in the value of mining stocks (if recent trends repeat). And if the Bitcoin price is able to return to the late-2021 highs of around $69,000, this 155% move in Bitcoin could equate to gains in excess of 600% for top crypto mining stocks.

Marathon Digital reported a Non-GAAP direct cost per coin of approximately $18,900 in the latest quarter. The company reported a total margin excluding D&A at 32.5% of revenues. Most bitcoin miners are reporting gross profits in 2023, but are still operating at a net loss. The reason is due to selling, general, administrative, depreciation and amortization expenses. This is why we have included a ratio of SG&A to revenues to see how lean each company operates.

I estimate that the Bitcoin price needs to rise into the $35,000 to $40,000 range for most miners to start seeing a positive net income. Our current price target for Bitcoin by year-end is $45,000, so it is possible that Bitcoin miners could be reporting substantial cash flows and positive net incomes heading into 2024.

Comparative Analysis of Top Bitcoin Mining Stocks

Given our view that crypto prices are likely to trend much higher over the next 12 months and the demonstrated leverage available from top Bitcoin mining stocks, I decided to run a comparative analysis of the top miners.

This analysis looks at a variety of metrics to measure valuation, growth, profitability, operational efficiency, balance sheet health, Bitcoin mining efficiency, and how much Bitcoin each company holds on the balance sheet relative to their overall enterprise value.

I highlighted the best data points in each category by assigning a gold, silver, or bronze shading. I gave 3 points for each gold, 2 points for each silver, and 1 point for each bronze assignment, coming up with a total score and ranking.

I then summed up all the points to get an overall ranking. CleanSpark ( CLSK ) came in at #1, Hive Digital Technologies ( HIVE ) was #2 and Marathon Digital Holdings came in at #3 according to our rankings.

CleanSpark had the lowest price/book ratio at under 1, the lowest debt/asset ratio at just 8%, and came in second place in terms of quarterly revenue growth (Y/Y), gross profit margin, and Bitcoin mined in the latest quarter per exahash of processing power. CleanSpark also ranked third in terms of EV/Sales at 4.6 and 3-year compound annual growth rate ((CAGR)) at 139%. I would like to see them work on reducing overhead costs and increasing the amount of Bitcoin held as we move toward the next halving.

CleanSpark is a leading bitcoin mining company listed on the Nasdaq and incorporated in Nevada. They own and operate five bitcoin mining facilities in Georgia and co-locate miners in upstate New York.

The company has a deployed hashrate of 9.3 EH/s and is fully funded to 16 EH/s at full deployment. CleanSpark's hashrate has grown by 210% year over year. They have located facilities in areas where their power cost is as low as 1.5 cents and averages 4.1 cents per kilowatt-hour (kWh). This is quite impressive considering that the average commercial electricity rate in the U.S. is 12.8 cents per kilowatt-hour (kWh).

By running at max operating power when electricity costs are lowest, and optimizing when electricity costs are higher, we have been able to achieve some of the best margins and highest realized hashrates in the industry.

- Gary A. Vecchiarelli, CFO

Not only has the company used the bear market cycle in Bitcoin to increase its hashrate (mining capacity), but they have also used this period of lower prices to aggressively increase the amount of Bitcoin held in their treasury. As you can see from the chart below, they went from holding 100 BTC in February of this year to holding 1,677 in August, an increase of nearly 17x!

CleanSpark mined 659 Bitcoin in August, 1,624 Bitcoin during Q3 and 4,729 year-to-date in 2023. Q3 revenue was $45.52M (+46.8% Y/Y) and GAAP EPS was -$0.12, but beat expectations by $0.05. The loss was mainly driven by depreciation amortization and another measure of profitability, adjusted EBITDA, was $13.3 million in Q3, an increase of $8.2 million or 160% Y/Y.

Risks

Mining operations require significant capital expenditures for hardware and infrastructure. Bitcoin mining companies like CLSK are currently losing money and could require additional funding that dilutes shareholders should crypto prices fail to rally as we expect.

Rising energy prices and the increasing hash rate could negatively impact margins. The higher the Bitcoin hash rate climbs, the more computing resources that are necessary to solve problems and mine Bitcoin. Hash rate recently hit an all-time high and could continue climbing. This translates into higher overall hardware costs for miners and declining profitability.

The upcoming Bitcoin halving in April of 2024 will reduce the block rewards in half, which will negatively impact the financials of mining companies. This is because the miner that solves the problem first and is awarded the Bitcoin will get half of what they are current getting. The Bitcoin price will need to trade significantly higher for the mining companies mentioned in this article to return to reporting positive earnings.

Conclusion

While I advocate for holding actual Bitcoin in cold storage as the best overall way to participate in this sector, investors might also want to consider investing in Bitcoin miners, as they typically provide leverage gains and can offer a way to diversify exposure to the cryptocurrency sector.

CleanSpark is my top pick, but investors might consider owning a small basket including other top names such as HIVE Blockchain Technologies ( HIVE ) or Marathon Digital Holdings. All of these names should experience a significant increase in revenues, EBITDA, profits, and valuations as the price of Bitcoin moves higher in the months ahead.

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