Hut 8 Mining: Caution Is Still Warranted, But I'm Upgrading To Buy

Summary Hut 8 Mining still has one of the largest BTC treasuries of any public Bitcoin mining company. With HPC services failing to wow, HUT is still a viable Bitcoin proxy. Until the US Bitcoin merger is finalized, there may be better Bitcoin proxy bets in the public equity markets. But BTC looks strong and HUT should do well as long as BTC is moving higher. It has been a bit of a reset year for Hut 8 Mining ( HUT ). Historically a crypto mining pure play, more recently, Hut 8 has branched into high performance computing, or HPC, services. The company has dealt with a variety of challenges to its mining operations over the last 18 months. 3-year trend (BitInfoCharts) In addition to Bitcoin ( BTC-USD ) mining profitability collapsing following the late 2021 BTC price high, Hut was also somewhat reliant on Ethereum ( ETH-USD ) mining up until "the merge" in September 2022, and energy-related issues at its North Bay facility. Crypto winter has been particularly brutal on the BTC mining space and it has resulted in bankruptcies and consolidation. As HUT investors still wait on an official closing of the company's merger with US Bitcoin, I think it's worth looking at how Hut 8's BTC stack has evolved in the four months since I last covered HUT for Seeking Alpha. Hut 8 Mining - Production vs Stack Author generated image (Hut 8) Given the challenges mentioned above, it may not be a surprise to see the degree to which HUT's monthly BTC production has fallen. For much of 2022, HUT was producing over 300 BTC per month. That figure has been under 200 for 10 consecutive months and nearly fell below 100 in August. For quite some time I've been of the opinion that the main selling point for going long Hut 8 is the enormous BTC stack that the company holds for a business of its size. HODLS as of 9/30/23 BTC Treasury Total HODL Value Market Cap Treasury/MC Riot Platforms ( RIOT ) 7,327 $252,437,131 $2,226,365,268 11.34% Marathon Digital ( MARA ) 13,726 $472,901,878 $2,203,322,403 21.46% Hut 8 Mining 9,366 $322,686,798 $509,380,354 63.35% Bitfarms ( BITF ) 703 $24,220,459 $453,623,210 5.34% CleanSpark ( CLSK ) 2,240 $77,174,720 $768,815,494 10.04% Source: Company filings, author calculations at $34.7k BTC price As of article submission, the price of a Bitcoin is $34.7k. Using that figure and the reported BTC holdings for each company at the end of September, Hut's current market capitalization is 63.4% backed by the Bitcoin on the balance sheet. That is by far the largest BTC treasury to market cap backing of any public Bitcoin mining stock and the next closest is Marathon Digital at 21.5%. However, what had previously been an entirely unencumbered Bitcoin stack now has a bit more complexity. Author generated graphic (Hut 8) Earlier this year when Hut 8 announced the planned merger, the company disclosed that it would potentially start selling BTC from its HODL stack to fund operations. Rather than continuing to dilute shareholders to raise capital, Hut has instead decided to utilize liquid assets on the balance sheet when necessary. I think this has been the right call. But it should be noted that only 78% of Hut's HODL stack is currently unencumbered. Beyond that, we've seen more of that stack being utilized over the last two months. And if the previous four months are any indication, we may see even less BTC in the unencumbered category in the company's October production update. That's a purely a guess on my part, but until this merger is finalized, Hut's monthly production doesn't appear to be strong enough at current BTC prices. Q3-22 Q4-22 Q1-23 Q2-23 TTM Cost of Revenues $33,000,000 $33,600,000 $18,700,000 $18,000,000 $103,300,000 Total Opex $8,000,000 $8,300,000 $5,400,000 $7,900,000 $29,600,000 BTC Mined 982 698 475 399 2554 Breakeven Price $41,752 $60,029 $50,737 $64,912 $52,036 Sources: Seeking Alpha, Hut 8, Author's calculations Utilizing cost of revenue and total opex against the company's mined BTC over the last four quarters, I see a company that has one of the higher breakeven BTC prices in the sector at just under $65k per coin in Q2. It's Still All About Bitcoin Even though Hut 8 is attempting to build out an HPC services business, we've yet to see that segment really take off for the company. In fact, in Hut's Q2 earnings filing we actually saw HPC revenue decline sequentially both in aggregate and as a percentage of total revenue: Q2-22 Q3-22 Q4-22 Q1-23 Q2-23 Total Revenue $43,845 $31,671 $21,833 $19,021 $19,183 HPC Revenue $4,711 $4,403 $4,487 $4,495 $4,192 HPC % of Total 10.70% 13.90% 20.60% 23.60% 21.85% Source: Hut 8, 000s of CAD At least for now, Hut 8 is still primarily a Bitcoin proxy company. So as Bitcoin goes, so too will Hut go in my personal opinion. Pertaining to BTC specifically, there are a lot of positive signs and potential catalysts. If we learned anything from the Cointelegraph debacle earlier this month , it's that the approval of a spot Bitcoin ETF is definitely not priced in yet. BTC Daily (TradingView) Beyond the notion that positive news hasn't yet been priced in to Bitcoin, it could also be argued that negative news has been priced in already. The NY attorney general is suing Gemini, Digital Currency Group, and Genesis for alleged fraud. We continue to see potential issues at top crypto exchange Binance and crypto has been in political crosshairs following carnage in the middle east. Yet Bitcoin hasn't batted an eye to any of this bad publicity. For me, there's a signal there. Risks It's important to keep in mind that the block reward halving is now just 6 months away. When the block reward is halved, it will essentially mean the BTC-denominated revenue from mining will be cut in half. This a major concern for every public Bitcoin miner and may position these companies as better trading vehicles than actual investments for the time being. Transaction fees as a percentage of the block reward haven't lived up to the potential that we saw back in May with the emergence of Ordinals and BRC-20 token swaps. We also don't yet have an official closing of Hut's merger with US Bitcoin and I see longing HUT shares as a bit of an unnecessary gamble until that deal is finalized. Summary There are certainly interesting aspects of Hut 8 that I think warrant some attention. Like other crypto mining entities in the public markets, Hut 8 is trying to get traction in HPC services. To this point, I'd argue that revenue growth story has been bordering on non-existent. However, as we approach the Bitcoin halving, I am of the opinion that we are now at the point were taking some speculative shots on public miners makes sense. But until the merger is completed, Hut's story is less clear than some of its peers. From where I sit, the major selling point today for HUT is still the large stack and given the declining number of unencumbered BTC, I'm less excited about HUT compared to other companies that are growing unencumbered holdings while maintaining significantly larger operations. All that said, I'm actually going to upgrade HUT from a "hold" to a "buy" simply because I think we've seen the cycle bottom for BTC and I believe Hut shares will rally with the sector.