To The Moon

Summary

• Despite missing consensus estimates, Marathon's financial performance demonstrated significant growth compared to the previous.

• Regulatory scrutiny and Bitcoin price volatility remain challenges for Marathon Digital's future profitability.

• The company's commitment to enhancing hash rate and mining capacity, along with proprietary firmware development, demonstrates a strategy for operational efficiency.

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Marathon Digital Holdings $Marathon Digital Holdings Inc(MARA)$ released its Q2 earnings report on August 8. Despite Bitcoin's (BTC-USD) 78% price gain YTD, the mining company didn't show profitability in its Q2 earnings. Marathon reported a 228.5% YoY increase in revenue, and a Q2 net loss of $21.3 million, resulting in a per-share loss of $0.13. Net loss increased by 195.83% over Q1's net loss of $7.2 million. This financial performance mirrors the complex interplay between the cost of Bitcoin production, the market price of Bitcoin, and other operating expenses such as energy costs.

Marathon's revenue has seen a rebound this year, following a very bleak 2022 plagued with implosions and bank runs that affected the crypto space. Marathon Digital reported $81.8 million in Q2 revenue, below consensus expectations. The increase in revenue is attributable to an increase in the number of Bitcoin mined per day in Q2. Despite the missed consensus estimates, Marathon's financial performance demonstrated significant growth compared to the previous year.

Bitcoin production was 314% higher YoY at an average of 32 Bitcoin per day, but the average Bitcoin price was 14% lower, impacting revenues. Hosting and energy costs increased to $55.2 million due to higher Bitcoin production. Marathon's liquidity position seems strong with cash and cash equivalents of $128 million and approximately 12,538 Bitcoin with a carrying value of $234.4 million and a fair value of $382 million at the end of Q1.

A Look at Q2

Revamped Hashrate and Mining

Marathon Digital

(Source: Marathon Digital)

Marathon's operational hash rate increased by 54% in Q2 compared to Q1, and a record 2429% YoY, reaching 17.7 EH/s. The operational hash rate continued to climb after Q2, hitting approximately 19 EH/s in July. Marathon has doubled its operational hash rate since the start of FY2023, positioning itself as the top mining company in the Bitcoin mining space.

The total Bitcoin mined in Q2 increased by 33% from Q1. Marathon reported 2,926 mined Bitcoins in Q2, which is 731 Bitcoins more than the total Bitcoins mined in Q1. This increase in mining was supported by the company's expanding hash rate and improved uptime made possible by the introduction of an unnamed "dashboard" software that helps monitor and control output, uptime, and hash rate.

Bitcoin NFTs and their Effect On Mining

Coin Metrics

The November 2021 Taproot upgrade to the Bitcoin protocol has resulted in the ability to do more on the Bitcoin network, besides peer-to-peer crypto transfers. Non-fungible tokens (NFTs) have been introduced to the Bitcoin network through the Ordinals protocol. Token creation capabilities were only available on smart contract networks like Ethereum (ETH-USD) and Solana (SOL-USD) before the Ordinals protocol. Bitcoin tokens, known as BRC-20 tokens, reached a total market cap of $1 billion in May, bringing a new wave of activity to the Bitcoin blockchain. Creating a BRC-20 token incurs fees paid to miners. In Q2, about 7.6% ($184 million) of total miners' earnings ($2.4 billion) came from fees. BRC-20 tokens largely influenced a surge in earnings from fees for Bitcoin miners. Several reports confirm this.

Outlook and Forward Guidance

Predicting the future path to profitability for mining companies could prove to be more difficult than for companies in other sectors. Regulatory headwinds abound in the blockchain space, and mining companies are not immune from regular scrutiny. Marathon Digital has experienced its fair share of the SEC's scrutiny, even being served with an SEC subpoena in Q2. Also, with Bitcoin being its main source of revenue, volatility in the price of Bitcoin severely influences Marathon Digital's earnings and cash flow.

In the Q2 earnings call, Marathon Digital's team reiterated its commitment to increasing the company's hash rate and mining capacity to reach 23 EH/s by year-end. Some of the technological and energy efficiency improvements highlighted in the call include the development of its proprietary firmware for mining equipment, which demonstrated better security and overall efficiency when benchmarked against other industry alternatives, according to Marathon's management. I think investment in proprietary firmware gives Marathon an edge to fine-tune its miners to outperform competitors.

Marathon's Q3 and Q4 profitability prospects largely depend on the price action of Bitcoin and the direction the crypto market goes. Bitcoin entered and has been in a consolidation phase since early July. I wrote an analysis that pointed to Bitcoin likely entering a consolidation phase in early July. For about four weeks the price of BTC has ranged between $28,000 support and a new resistance at $30,500. I see Bitcoin continuing its movement in a tight range, but a breakout is imminent as halving nears and a pre-halving rally begins. I'd also like to point out that a pre-halving rally is likely but not guaranteed, as Bitcoin market cycles differ and previous rallies do not guarantee a recurrence.

Stock Price

Crypto mining stocks have seen impressive returns YTD. Marathon's stock has increased 368% YTD, bouncing significantly from last December's dip. The stocks of Hive Digital $HIVE DIGITAL TECHNOLOGIES LTD(HIVE)$ and Riot Platforms $Riot Blockchain, Inc.(RIOT)$ have had a similar movement as Marathon's stock. These three stocks have outperformed Bitcoin YTD.

Seeking Alpha

The huge YTD price increase makes mining stocks risky to hold at the moment. The next Bitcoin halving is estimated to take place in April 2024. With halving just a few months away, there is a risk of reduced revenue as the Bitcoin block reward gets cut in half. The Bitcoin halving can also lead to an increase in mining difficulty, prompting mining companies to procure more powerful hardware to be able to effectively compete for block rewards. The more powerful hardware in turn results in higher energy costs. Procurement of more powerful hardware and the resulting energy costs create more operational expenses at a time of reduced revenue and is always a major challenge for miners.

Conclusion

Marathon Digital's improved operational efficiency in Q2 scores great points for the company. However, the upcoming Bitcoin halving and potential volatility make the challenge of maintaining profitability persistent. Mining stocks' impressive YTD gains are accompanied by risks tied to the approaching halving and its impact on revenue and operational cost. Staying away from mining stocks at this time can be considered a safe bet.

Source: Seeking Alpha