Bitcoin miners have been on the rise for over a year now, and BTC mining stocks will face challenges in 2023, even if the BTC price is trading at $24,000.
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Mining stocks often follow the price of BTC as it directly affects the company’s earnings. These shares experienced a great decline in the last quarter of 2022, especially in December. The downturn after FTX’s collapse was exacerbated by the filing for bankruptcy of Core Scientific, the largest US bitcoin mining company.
Meanwhile, other mining stocks such as Marathon Digital Holdings (MARA) in the chart below show a weak correlation with Bitcoin price, suggesting that the December drop is perhaps exaggerated.
The downside trend reversed in early 2023 as most mineral stocks posted significant gains. The Hashrate Index mining stock index, which tracks the average price of publicly traded mining and hardware manufacturing companies, has increased by 62.5% since the start of the year. The positive price surge re-established a strong correlation between BTC price and mining stocks.
However, the mining sector is under pressure and low profit levels are expected in the long term. Starting in the second quarter of 2022, mining companies financed operations by selling BTC from reserves, selling newly minted BTC, collecting debt and issuing new shares. Unless the price of Bitcoin rises above $25,000, the industry will witness fewer takeover attempts or more treasury sales to pay off its debt.
Some mining companies work at a loss
Currently, the price-to-earnings (PE) ratio of leading mining companies is negative, indicating that they are operating at a net loss, making their stock prices vulnerable to a sharp decline.
Riot Blockchain, Bitfarms Ltd, Hive Blockchain Technologies, Cleanspark Inc, Marathon Digital Holdings and Hut 8 Mining are the largest publicly traded Bitcoin mining companies with more than 1% of the global hash rate share. The top 15 publicly traded mining companies have a share of approximately 19%.
Specifically, most companies in the industry have a PE ratio of 0 to 2, with the exception of Marathon, Hive and Hut 8. This raises concerns that these companies may be overvalued at their current valuation.
Because markets are generally forward-looking, there is no reason to reject a stock. Mining stocks are obvious options if Bitcoin has a long-term bullish run. However, these companies need to survive the bear market before the next bull run bears fruit.
Shareholders suffered losses due to bad loans
Over- or over-indebted firms that have to meet their interest obligations are particularly stressed and vulnerable to bankruptcy.
Marathon, Greenidge and Stronghold owe more than $200,000 per unit of Bitcoin mining, while Marathon’s debt rises to $1.1 million per BTC mined. Marathon has collected loans with bitcoin in its treasury, and the company currently has 10,055 BTC worth about $235 million.
At the end of October, Marathon had a $100 million loan that would be liquidated if the bitcoin price fell below the loan threshold. For example, if the loan threshold is 150%, if the Bitcoin price drops below $15,000, the company will have to sell some of its BTC to close the loans.
In this context, it’s encouraging to see that Hive, Hut8 and Riot are mostly deeply in debt and operating largely on equity. This reduces the pressure to pay debt interest rates and provides flexibility to raise funds or expand by absorbing some of the market share left by now-bankrupt mining operations.
However, there is another way to raise money. Instead of collecting debt, miners can dilute their shares. Companies raise investments from public market investors in exchange for additional stock. This reduces the shareholder ownership ratio. Hut 8 Mining and Riot had diluted 40% of their shares by the second quarter of 2022. In the third quarter of the same year, Hut 8 again diluted its stock by about 15%.
The need to raise cash exposed these indebted companies to liquidation risks, while additional dilutions significantly reduced the value of investor assets.
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Mandatory mining company treasury assets
While mining companies struggle with profitability, they decide to maintain their bitcoin treasury levels. Despite losses in Q2 2022, Marathon has managed to maintain treasury holding levels.
