2014 – The Great Irish Share Valuation Project (Part II)

Wexboy_Value

2014 – The Great Irish Share Valuation Project (Part II)

Link: http://wexboy.wordpress.com/2014/02/13/2014-the-great-irish-share-valuation-project-part-ii/

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Continued from here. As usual, I encourage you also click on the 2012 & 2013 links for each company, to add some valuable colour/background. Now, let’s jump right in:

Company: Circle Oil

Prior Post(s): 2012 & 2013

Ticker: COP:LN

Price: GBP 20.625p

Look at Circle Oil’s latest interims, what’s not to like? Revenue up 20%, EBITDA up 34%, and cash generated from operations (after working capital changes) up 69%. And if you annualize net profit, Circle’s trading on a 6.6 P/E! But it’s not as simple as that… Focusing on a P/E ratio’s a rather pointless (& misleading) exercise when it comes to junior resource companies. [Well, most don't have any 'E' anyway!] Even if they’re fortunate enough to be producers, they’re often melting ice-cubes – i.e. they’re exploiting a (sometimes rapidly) depleting reserve base. Basically, they haven’t diversified enough, spent enough, and/or mastered the art of reserve replacement. That’s how the majors play the game, of course – but for the juniors, it’s much more of a lucky (& lumpy) game. This is one of the main issues Circle faces right now.

[Well, two other big issues: i) About 27% of its shareholder base remains a potential stock over-hang - Libya Oil Holdings owns 18%, while Kaupthing Bank owns 9% - not surprisingly, both stakes are essentially 'frozen'! And: ii) Investors are still leery of the fact a majority of Circle's production is in Egypt. Maybe a little unfairly, as the company doesn't appear to have suffered any disruption/interference to date. But it does suffer from another long-standing Egyptian problem...getting paid! Fortunately, the situation's stabilized somewhat, but Circle continues to have more than 6 mths of trade receivables outstanding].

At the current production rate, Circle’s only got about 6-7 yrs of reserves left. That’s not something you can tag with a P/E ratio! And despite a $42 M pa exploration/capex spend, it hasn’t managed to put new reserves on the board recently. OK, I’m probably being a little harsh here – despite this spend, the company’s actually generating positive free cash flow. Far better than most junior resource companies out there…OK, we all know 9 out of 10 juniors are rubbish anyway! Because of this reserve depletion, and COP’s current (relatively small) market cap, I’ll continue to value it on an asset basis.

As of mid-2013, net 2P reserves were down to 16.3 M boe. No allocation between proved & probable is provided, so let’s assume a 50:50 split & my usual $10 & $5 per boe (respective) in-the-ground valuations. There’s $30.6 M of cash on hand, and let’s include net trade receivables of 20.2 M. [That's being kind - Egyptian receivables will likely remain a semi-permanent & illiquid asset]. We then offset 11.6 M of bank debt, and a 30 M convertible loan. [This may ultimately become equity, but the share price continues to trade below the loan's conversion prices]. That gives us:

($30.6 M Cash + 20.2 M Net Receivables – 41.6 M Debt + 16.3 M boe * 75% * $10) / 1.6611 GBP/USD / 563.4 M Shares = GBP 14.1p

Circle is looking rather over-valued now. Rather interestingly, in November, they announced a new loan facility of up to $100 M from the IFC. Putting this money to work might well generate fresh excitement amongst junior resource investors, but I struggle to understand the need for these funds. Obviously it will prove useful in repaying existing debt, but Circle has nearly $31 M of cash on hand, the convertible isn’t due ’til Jul-2015, and I’d expect current free cash flow would be sufficient for amortizing/re-financing the debt anyway. This might suggest they’re planning acquisition(s), in one form or another – I can’t help worrying they’ll take on this additional debt liability, but may not necessarily end up with any tangible assets in return…

Price Target: GBP 14.1p

Upside/(Downside): (32)%

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Company: IFG Group

Prior Post(s): 2012 & 2013

Ticker: IFP:ID

Price: EUR 1.77

Well, it’s all change at IFG! In November, a new Finance Director was appointed to the board – followed swiftly by the December resignation of the CEO, Mark Bourke (who quickly popped up as the new CFO of Allied Irish Banks). Also in December, the board definitively rejected (another) takeover approach from an unnamed suitor. There were market rumours this bidder wasn’t Fiordland (who has a 23.5% stake & has previously bid for IFG) – however, the timing of this announcement seems odd. Regardless, the underlying (Fiordland) partners continue to hold significant stake(s). As do quite a number of well-known fund managers – if there’s a potential predator lurking out there, IFG remains in a vulnerable position.

Meanwhile, the business continues to trudge along. I still mourn the sale of their trustee & corporate services division in 2012 – a high margin/recurring revenue business if I ever saw one. Somewhat ironically, that’s exactly how it was presented some years back – as a real crown jewel! But reducing leverage took priority, plus a decision was made to focus on their IFA/pension management business. [I've never been able to get excited about the whole IFA business myself - asset managers offer far higher margins & much greater upside potential!]. Yes, adjusted EPS jumped nicely in the last interims, but that was mostly a one-time effect – revenue & operating profit only saw an incremental improvement, and there’s been little real progress on the earnings front in the past few years. We also continue to see a large disconnect between adjusted operating profit (at 15.5%) & operating free cash flow (at 9.0%). Averaging these (at 12.3%), I’m now marking IFG down to a 1.0 P/S multiple.

However, the company’s now in a strong financial position – we should adjust accordingly. For example, its GBP 25.6 M of cash could be paid out to investors, with no impact on the business. [Or used for acquisition(s) to bulk up & transform the (still) loss-making Irish division. Though a potential acquirer of IFG would probably take the opposite tack - sell the Irish business asap, cut costs, boost margins & seek increasing economies of scale in the UK IFA business]. IFG could prudently afford to take on some more debt too – again, let’s first assume an average operating margin of 12.3%. I calculate 18.9 M of additional debt would increase interest expense to a still reasonable 15% of (average) operating profit – let’s chop that figure in half to be a little more prudent. This gives us:

(GBP 78.1 M Revenue *1.0 P/S + 25.6 M Cash + 18.9 M Debt Adjustment * 50%) / 0.8182 EUR/GBP / 104.2 M Shares = EUR 1.33

Once again, the share price (& the takeover rumours) remain a bit of a puzzle to me – IFG looks fairly over-valued to me. Sure, the right acquirer – i.e. one with a similar UK business – could wring attractive cost savings (& potential synergies) from IFG. But a decent premium to the current share price (don’t forget IFG spiked to EUR 2.10 in December) would incorporate all this & more – at least versus my own estimate of intrinsic value! We shall see…

Price Target: EUR 1.33

Upside/(Downside): (25)%

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Company: Merrion Pharmaceuticals

Prior Post(s): 2012 & 2013

Ticker: MERR:ID

Price: EUR 0.50

Merrion’s (external) shareholders continue to buy & sell pretty much in the dark here. The company did announce in March that Novo Nordisk (NOVOB:DC) had completed a Phase I trial (which incorporated Merrion’s GIPET technology) – but I was disappointed to see this only triggered a EUR 0.8 M milestone payment. Of course, there’s talk of further milestones, and additional licensing of Merrion’s intellectual property – but nothing tangible which shareholders can use to pin down any kind of reliable value(s).

That milestone meant cash from operations was actually positive in the most recent interims (well, barely, at EUR 27 K) – however, free cash flow was still negative at (196) K, due to interest expense. The current cash burn run-rate is somewhat debatable – based on the interims, it could annualize to 0.4 M, but if we exclude further milestone payment(s) it’s arguably 2.0 M. Let’s split the difference, and call it an annual 1.2 M cash burn – which implies Merrion has just less than a year of cash on hand. However, it does have a 2.2 M value on its Citywest property, which it can hopefully sell in the next year – unfortunately most/all of the proceeds will go towards loan repayment. And total debt’s much higher at 5.4 M – let’s assume everything else nets out. Plug all this in & we have:

(EUR 1.1 M Cash + 2.2 M Property – 5.4 M Debt – 1.2 M Cash Burn) / 18.4 M Shares = Zero

In my book, Merrion’s still worthless. And even if you disagree, I may win the argument regardless… Irelandia (a Declan Ryan investment vehicle) owns the majority of the company’s debt, and Ryan’s also a major shareholder. While there are other larger shareholders, the debt puts Irelandia/Ryan in a dominant position. Even if some upside potential materializes here, Ryan could well end up seizing control of the company, and/or diluting existing shareholders’ ownership into insignificance.

Price Target: EUR 0.00

Upside/(Downside): (100)%

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Company: Prime Active Capital

Prior Post(s): 2012 & 2013

Ticker: PACC:ID

Price: EUR 0.115

Cell phone stores are like jewelry shops – a bloody infestation! Seems like they’re on every second street, in every single city you’ve ever visited. Personally, I’m lucky to visit them once every few years – which begs the question, who the hell’s keeping these places afloat?! Well, I guess I’m not their ideal customer… So, let me put my disbelief aside, and take another look at Prime Active Capital & its PAC Telemedia business – i.e. its oh so exciting chain of Verizon (authorized agent) cell phone stores.

Revenues continue to grow, which is encouraging, but my personal bias is confirmed – it is a pretty lousy business. But for a surprising reason – the advent of smartphones was the real bete noire here. Who knew..?! While smartphone customers are far more lucrative, smartphones themselves represent a huge step-up in cost (vs. your classic candy bar/clamshell phone, for example) – which requires far larger subsidies from the wireless providers. In turn, they’ve relentlessly squeezed authorized agent margins to subsidize this investment, while at the same time agents’ inventory costs have soared. To add insult to injury, smartphone manufacturers are in a perpetual race to the bottom, so they also squeeze the retailers. Basically, the stores have very little power within this particular ecosystem. On the other hand, it’s worth remembering this ecosystem can’t survive without them..!

Pre-2010, PAC Telemedia was building up its store network – actually a very creditable performance, against the backdrop of a US recession. This culminated in a 2010 breakthrough, with PAC reporting a 3.2% EBIT margin. Since then, US consumers have been (rather grudgingly) switching over to 3G/4G smartphones. [You can see this (for example) in 2012 - PAC revenue was up over 11%, but unit sales were actually down over 10%]. As discussed, this has squeezed margins, which turned negative again – it’s only in H1-2013 we finally see margins getting back near break-even. PAC’s entry into buying & selling recycled phones, and providing replacement phones & ancillary services to customers, has contributed much of this recovery.

Noting the forced consolidation in the sector to date, and providers & suppliers’ dependence on this retail distribution channel, one would expect some reversion in retail margins in due course (esp. with US consumer spending picking up some momentum). In PAC’s case, let’s assume a valuation based on 50% of its 2010 margin (i.e. 1.6%) – this seems very reasonable for a sale scenario, for example, and in a more general retail context it’s obviously woefully inadequate. That margin assumption deserves a 0.125 P/S multiple. We should otherwise treat Prime Active Capital as an investment company – i.e. it has its PAC Telemedia investment, some cash & debt, plus a ludicrous expense ratio. [Stripping out an FX gain, I estimate HQ costs are now around EUR 0.7 M annually (inc. interest) - if PAC's sold & the parent company liquidated, this expense drag would obviously be eliminated]. This all adds up to:

(EUR 41.8 M Revenue * 0.125 P/S + 0.7 M Cash – 1.6 M Debt – 0.7 M HQ Annual Cost) / 22.7 M Shares = EUR 0.161

Despite its huge rally in the past year, PACC still looks nicely under-valued. But investors still need to weigh up two potential risks. First, similar to Merrion Pharmaceuticals, a major shareholder (Tony Gill, with 21%) has also lent GBP 1 M to the company (along with another director, Stephen Smith). But I don’t believe the same risk exists here, as it seems obvious (under most scenarios) the current value of PAC Telemedia’s well in excess of its debt liabilities. And second, the CEO’s now talking about potential expansion/acquisition(s) – frankly, I’m not sure the funding required is a viable option. In fact, a sale of PAC Telemedia – which has already received expressions of interest – seems far more probable an outcome.

Price Target: EUR 0.161

Upside/(Downside): 40%

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Company: REACT Energy (formerly Kedco)

Prior Post(s): 2013

Ticker: REAC:LN

Price: GBP 25.5p

REACT continues to progress with its existing projects, but we’ve seen little tangible impact on asset valuations since last year. Therefore, my 2013 (Kedco) post still serves as the best road-map. Again, we’ll ignore the vast majority of their 150 MW+ portfolio as being irrelevant & immaterial at this point. Instead, we’ll focus solely on the projects that have (at a minimum) obtained full planning approval.

The 12 MW Enfield biomass project now appears to be in the final stages of financing negotiations. Nonetheless, we’ll leave our valuation unchanged at just 20% (to reflect costs to date, plus development profit) of the expected GBP 46 M cost. [GBP 3.75 M per MW is also a reasonable valuation benchmark for biomass]. Of course, the Newry 4 MW biomass project is already up & running, and is now transitioning from 2 to 4 MW. REAC’s share ownership is 50%, but its economic ownership appears to be 92% – let’s split the difference(s), and assume they own 71% of an operational 3 MW (again, using 3.75 M per MW as an approx. reference valuation). Finally, the company now has 5 approved wind projects, totaling 2.8 MW – we’ll value these again at just 20% of their assumed final value (say, an average of EUR 1.5 M per MW). [One project, Pluckanes, has gone operational since - but the uplift in value is essentially offset by the related construction loan]. We then adjust for EUR 4.6 M of net debt, and include an additional 2.2 M of estimated annual corporate expense & interest:

(GBP 46 M Enfield * 20% + 14.7 M Newry * 3/4 * 71% + (2.8 MW Wind * EUR 1.5 M * 20% – 4.6 M Net Debt – 2.2 M Annual Corp Exp) * 0.8182 EUR/GBP) / 22.4 M Shares = GBP 54p

REAC now looks even more under-valued. Of course, the big problem here still is funding – REAC currently survives on the mercy of the banks & its main shareholder (Farmer Business Developments plc). It will obviously need to raise more equity – which will dilute existing shareholders, but hopefully will also advance its projects in terms of valuation. While the short-term outlook definitely looks pretty hand-to-mouth, there may be some good news on the horizon. If the financing of the Enfield project is completed with Foresight Group (and another co-investor), no further cash is required from REAC. This deal would also serve as an excellent template (& advertisement) for the financing & completion of other pipeline projects. See a few of these deals done, and one could expect REAC’s other projects to begin marching forward like clockwork.

Price Target: GBP 54p

Upside/(Downside): 113%

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Company: Dalradian Resources

Prior Post(s): 2013

Ticker: DNA:CN

Price: CAD 0.80

Dalradian continues to burn cash at a merry pace, but hasn’t progressed too far from its 2012 resource report & Preliminary Economic Assessment (for Curraghinalt, in Northern Ireland). However, a new resource report is promised – any upgrade of the company’s inferred gold resource (2.23 M oz) could have a substantial valuation impact… Meanwhile, let’s focus on its 10 K oz measured resource & its 460 K oz indicated resource. I’d normally ignore resources in these categories (as I’m doing with the inferred resource), but based on the PEA I think it’s justified to incorporate them into my valuation – albeit on a fairly conservative basis. My (updated) valuation rule of thumb for gold is $150 per in-the-ground oz - but I’ll haircut this by 50% for measured & 75% for indicated.

DNA has CAD 9.4 M on hand, and is now in the middle of an underwritten offering. Let’s presume the (basic) offering gets completed (within the next week) – that brings in an additional 12.1 M of (gross) cash, against the issuance of another 17.3 M shares. We’ll also deduct for the company’s annual cash burn, which looks to be around 18.1 M right now. [NB: Dalradian's abandoned its Norwegian exploration programme, on which it spent (say) 3-4 M in 2013. Arguably, I could adjust down my cash burn estimate accordingly, but I suspect this spending will just end up being diverted into incremental Northern Irish spending]:

(CAD 9.4 M Cash + 11.5 M Offering Net Cash – 18.1 M Cash Burn + (10 * 50% + 460 * 25%) / 1,000 * $150 per oz * 1.1005 USD/CAD) / 106.8 M Shares = CAD 0.212

Dalradian looks wildly over-valued here. However, a potential upgrade of the company’s inferred resource (as already noted) would produce a substantial uplift in valuation. On the other hand, the estimated initial capex cost of the project is CAD 192 M – a huge undertaking in relation to Dalradian’s current resources, or market cap! And one that will surely result in significant dilution for existing shareholders. OK, right, that’s probably the best you can bloody well hope for with most junior resource stocks..!

Price Target: CAD 0.212

Upside/(Downside): (73)%

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Company: Ovoca Gold

Prior Post(s): 2012 & 2013

Ticker: OVG:LN

Price: GBP 8.25p

Investors have generally steered clear of Ovoca in the past year… But it regularly pops up on stock screens for newbie value investors, and they get quite excited – until some message boarder smacks them down by pointing out they’d be investing in a Russian black hole mine company. Who knows…as Winnie might say, Ovoca’s quite possibly ‘a riddle, wrapped in a mystery, inside an enigma’. All I can do really is put a valuation on it – with the Russians firmly in charge here, I can’t predict if minority shareholders will ever actually realize that value.

The company currently has $20.1 M of cash. It also owns 1.4 M shares of Polymetal International (POLY:LN), plus I calculate it has another 1.6 M (approx.) of other (gold-related) equities. Against this, we currently have an annual cash-burn of 8.7 M (possibly too severe an estimate). Unfortunately, the company now confirms 14.6 M of deferred consideration (in respect of prior Russian acquisitions) will fall due within the next 6 months. There’s no problem paying this, but I’d previously assumed there would be an accompanying proving-up of reserves. Unfortunately, at least in my book, that hasn’t happened – though I’m guessing this updated Stakhanovskiy resource report may have crystallized the liability? Now, back-of-the-envelope, I believe 231 K oz of measured & indicated resources are probably equal in value (roughly) to the deferred consideration – but in this particular instance, I’m not prepared to make an exception (to my normal practice) & put a tangible value on these resources yet. That puts us at:

($20.1 M Cash + 1.4 M POLY Shares * GBP 642p * 1.6611 GBP/USD + 1.6 M Equities – 8.7 M Cash Burn – 14.6 M Deferred Consideration) / 1.6611 GBP/USD / 87.4 M Shares = GBP 9.2p

Ovoca still looks slightly under-valued – and there’s clearly some upside potential within my valuation. But who can tell if my conservative bias provides a sufficient margin of safety for investors re the Russian factor? Interestingly, Damille Investments II joined the register in April (actually buying their 5.5% stake from @WShak1 & @paulcurtis123) – it’s a very small position for them, but it will be interesting to see if they attempt their usual brand of activism here.

Price Target: GBP 9.2p

Upside/(Downside): 11%

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Company: UTV Media

Prior Post(s): 2012 & 2013

Ticker: UTV:LN

Price: GBP 243.5p

Last year, UTV finally escaped the old media dungeon. Which was a little ridiculous to begin with, as I think UK/Irish TV companies’ prospects remain relatively healthy – and anyway, UTV’s more focused on radio now! The share price rallied with a vengeance, far quicker than I’d maybe expected, homing straight in on my price target. However, I’m perhaps more puzzled than elated at this point…

Because the business has actually been moving backwards ever since my Jan-2013 TGISVP post! We see this in the FY-2012 results, released in Mar-2013, and also in the 2013 interims. In fact, management was reduced to offering shareholders two old reliables: i) Ah sure, we’ll make most of it back in the last quarter, and ii) Thank God…2014 is a World Cup year!

LTM revenue has declined to GBP 113.7 M, while the operating profit margin’s compressed to 16.9% – for me, that pulls UTV’s valuation down to a 1.75 P/S multiple now. At this point, adding some kind of P/E multiple’s a rather pointless exercise. While I’m a little puzzled & surprised at the scale of the revenue/margin decline in the past 18 months, I don’t see any kind of secular decline/threat – it seems to be purely advertising-related. We can also be hopeful the Irish/UK business environment presents more upside potential at this point, than risk. And speaking of risk, interest coverage still looks fairly reasonable (despite the margin decline) – so we face no real financial risk, or need for a debt adjustment:

GBP 113.7 M Revenue * 1.75 P/S / 95.2 Shares = GBP 209p

UTV looks a little over-valued at this point – but the intentions of its largest shareholder may prove a more important factor in the next year. Organo Investments has sold out as the share price rallied (they’re now below the 3% reporting limit), but TVC Holdings (TVCH:ID) has been hanging tough here. Considering the share price rally, plus the reversal in fundamentals, one has to think there’s increasing pressure for TVC to now contemplate an exit. [And get back to their actual investment mandate - bloody venture capital...or at least private equity investing!] But disposing of an 18% stake at a good price isn’t the easiest of propositions… Beating the bushes for a potential bidder might be the better option here – I have to wonder if that’s what some investors have been speculating already?

Price Target: GBP 209p

Upside/(Downside): (14)%

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OK, that’s all for now folks! I’ll add my usual TGISVP file here:

2014 – The Great Irish Share Valuation Project – Part II

[NB: I've also updated share prices (plus FX rates, etc.) for last week's batch of stocks, and then ranked all stocks according to their upside potential - so as we progress with the valuation phase of TGISVP, readers can keep a running track of the highest potential stocks to consider more closely.]

kerosene

Interesting analysis wexboy. Im looking .forward to the rest of your reviews.

manonboard

Cheers Wexboy. Its great to see the process being explained so well. Learning alot.

Thronegames

Why did you pick those particular stocks to review? I'm asking the question genuinely. OMG they chew me up on this board and I'm only asking questions! But I will keep asking...

Sonnenblumen

Thronegames wrote: »

Why did you pick those particular stocks to review? I'm asking the question genuinely. OMG they chew me up on this board and I'm only asking questions! But I will keep asking...

A fair Q and I was wondering myself. Hardly household names most of them?

Wexboy_Value

Ta, folks.

Covering all Irish stocks...in random order - hence the selection above!

MoneyCrowd

REACT Energy

Of course, the Newry 4 MW biomass project is already up & running, and is now transitioning from 2 to 4 MW.

Pretty sure Newry is at a standstill at the moment.
Not running/not generating would imply no cash coming in.