Hut 8: Q2 Performance And Outlook

Summary Hut 8 is diversifying its business by gaining clients for its HPC services and working towards a strategic merger with USBTC. Comparing HUT's mining efficiency and Bitcoin production with peers reveal room for optimization and growth. The upcoming halving (est. April 2024) could create the need for higher Bitcoin prices to sustain mining operations. Introduction I have previously written a recap on crypto mining stocks - Marathon Digital ( MARA ) and Riot Platforms ( RIOT ) - this month, and both analyses show similar challenges crypto mining companies face, which include lack of profitability, the effects of Bitcoin ( BTC-USD ) price volatility, mining difficulty which abruptly affects the cost of revenue, and other operational expenses. Hut 8 Mining Corp. ( HUT ), a Canada-based crypto mining company that operates several digital asset mining facilities and High Performance Computing ((HPC)) data centers across Canada, just released its Q2 earnings . In this analysis, I'll delve into HUT's mid-year performance and the outlook for the coming months, explore the strategic moves Hut 8 is making to navigate the current challenges, and compare the stock to other crypto mining stocks to gauge its valuation. Q2 Recap Q2 proved to be a testing period for Hut 8. In May, the digital asset mining company faced electricity-related issues at one of its mining facilities in Alberta, Canada, leading to a drop of 75% in the installed hash rate at the facility; this, coupled with the increase in mining difficulty, caused the amount of Bitcoin mined to drop by 58% YoY. Hut 8 mined a total of 399 Bitcoin in Q2 this year compared to 946 Bitcoin mined in Q2 2022. Hut 8's Bitcoin-producing capacity was also impacted by suspended mining activities at one of its mining facilities. The low mining output had an impact on the company's finances. HUT reported total revenue of C$19.2 million, representing a decrease of C$24.6 million YoY. No EPS surprise for Q2; the reported EPS value of -$0.06 is in line with the consensus estimate. Unsurprisingly, HUT reported a net loss. The company lost C$16.7 million in Q2. This is however an improvement over the C$88.1 million lost in Q2 2022. Reporting a value of C$(2.7 million) for adjusted EBITDA is also an improvement over Q2 2022 adjusted EBITDA of C$(98.1) million. Strategic Moves Made in Q2 To smooth mining operations, HUT revealed that it implemented a new firmware across its miners. The firmware regulates the power output capacity and keeps the miners within safe power limits. Some other notable moves the company made in Q2 include: Securing a Credit Facility: Hut 8 secured a loan of up to $50 million with Coinbase Credit, a subsidiary of crypto exchange Coinbase ( COIN ). The loan will help HUT hold its Bitcoin stash until the next halving, giving the company interim financial flexibility. The company anticipates a crypto bull run following the next halving scheduled to occur around April 2024. "It ensures that we can maintain our dynamic Bitcoin treasury management strategy going into the halving," HUT's CEO affirms. The strategy of holding a stash of digital assets (while sourcing funds from other sources) in anticipation of a future price increase is risky, in my view. An increase in the price of Bitcoin and other crypto assets, although likely, is not guaranteed, and is largely based on speculation. HUT is one of the top public companies with the most significant Bitcoin reserve. At the end of Q2 HUT had 9,136 Bitcoin held in reserve, of which 8,289 Bitcoin remain unencumbered. The company has only sold part of the BTC it mined in 2023, and continues to hold Bitcoins it mined before 2023. Gaining Clients for its HPC Business: Hut 8's strategic diversification is becoming evident as the company expands its scope beyond Bitcoin mining and takes its data center business seriously. In Q2, there was an agreement between HUT and Interior Health, a Canadian health authority, to provide high-performance computing services to the health authority. I think HUT stands to gain from this diversification. HUT could capitalize on the growing demand for data center solutions, especially in the fields of AI, data analytics, and rendering, as the popularity of artificial intelligence and rendering continues to rise. This expansion not only strengthens HUT's market presence but also highlights its adaptability and readiness to leverage emerging opportunities beyond the realm of crypto mining. Of the C$19.2 million revenue in Q2, C$4.2 million (~21%) came from its HPC business. Working Towards a Strategic Merger: Hut 8 is progressing toward a merger with US Bitcoin Corp. ((USBTC)), which holds the potential to reshape Hut 8's operations and capabilities. The merger involves expanding Hut 8's self-mining capacity, as indicated by the amended S-4 registration statement with the SEC. The combined company will become a U.S.-domiciled entity. Where Does HUT Stand Among Mining Peers? A Bitcoin mining company's financial growth and profitability are largely based on the number of blocks won in the competition for block rewards and the cost of producing a Bitcoin. Hence, mining companies constantly upgrade hardware (for improved hashrate) and explore efficient energy and cooling options. An important aspect of their financial reporting entails highlighting the progress made in hashrate scaling, savings on energy cost, number of Bitcoins mined, cost of mining a Bitcoin, and total Bitcoin held in reserve. These factors greatly influence their financial statements. Data as of Q2 2023 HUT MARA RIOT Hashrate (EH/s) 2.6 17.7 10.7 Number of Bitcoin Mined 399 2,926 1,775 Number of Bitcoin Held 9,136 12,964 7,275 Data culled from each Q2 report by Author Based on the data in the above table, I'd firstly like to gauge how efficient HUT's mining operation is, in comparison to its peers, in terms of hashrate and the amount of Bitcoin produced using this simple formula: Mining Efficiency = Bitcoins Mined / Hash Rate. Based on this formula HUT's mining efficiency is 399 Bitcoin / 2.6 Eh/s = 153.46 Bitcoin per exahash (EH/s). Marathon Digital scores 165.39 Bitcoin per exahash and Riot Platforms scores 165.42 Bitcoin per exahash. This gives a simple yet profound overview of HUT's resource optimization and operational strategy. Based on this calculation, both Marathon and Riot mine ~11.9 more Bitcoin per exahash in comparison to Hut 8. The number of Bitcoins mined per exahash reflects how efficiently a company utilizes its hashing power to generate Bitcoins. On the one hand, the above metric reveals HUT's lower operating efficiency when compared to MARA and RIOT. HUT has faced operational challenges, which have impacted its operating efficiency. On the other hand, the lower amount of Bitcoin produced per EH/s demonstrates that HUT could potentially optimize its operations to enhance its capacity. In simpler terms, there is significant room for growth. I am optimistic because of the ongoing merger of equals with USBTC and the prospects for HUT8 in this arrangement. USBTC is set to host 150,000 mining rigs for top US mining companies, including Marathon Digital. I believe that HUT would benefit from USBTC's extensive network of managed hosting facilities, as well as the options of utilizing green power in the US. As USBTC will be providing hosting services for MARA's rigs, HUT will have the advantage of adopting the same technology stack utilized by MARA. This alignment will ensure that HUT is on par with MARA in terms of technological capabilities, and probably in Bitcoin produced per exahash. Analysts expect better earnings for HUT, evident in its Forward P/E of 12.37x, which is considerably lower than the sector median of 26.13x. HUT's EPS estimate for FY2023 is $0.21, while RIOT's expected EPS FY2023 is -$0.99, and MARA's is -$0.35. Risk There are some risks to consider when holding a mining stock like HUT in your portfolio. Bitcoin Price Volatility When crypto prices rise, mining companies like HUT can generate higher revenues from the sale of mined coins. However, during periods of price decline, revenues can decrease, impacting the company's top line. Also, mining operations require significant upfront capital expenditures for hardware and infrastructure. Volatility can impact HUT's ability to plan and allocate resources effectively. This is why mining companies are seen raising cash from financing by borrowing or issuance of new shares, which leads to debt obligations and stock dilution. Upcoming Halving and Mining Difficulty The upcoming Bitcoin halving (estimated to occur around April next year) will reduce the block rewards in half. Bitcoin halving events are closely associated with changes in mining difficulty. By then, Bitcoin will need to trade at a much higher price for mining companies to stay afloat and not incur a loss on each mined Bitcoin. Conclusion Comparing Hut 8 to its mining peers reveals insights into its efficiency and growth potential. While Hut 8's operating efficiency might currently lag behind some peers, the lower amount of Bitcoin produced per exahash presents the company with room for optimization and expansion. The pending merger with USBTC would reshape Hut 8's capabilities, and I believe the company will leverage technological advancements that will align it with the industry leaders. The crypto mining sector remains tied to Bitcoin price volatility; it is crucial to monitor events and developments closely if you hold this stock in your portfolio.