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

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


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Continued from here:

[NB: Worth revisiting Part I if you're a new reader, or you'd like a refresher on TGISVP & my approach to the whole project.]

Company: Fyffes

Prior Post(s): 2012 & 2013

Ticker: FFY:ID

Price: EUR 1.27

Seems like I picked the wrong horse, choosing Total Produce (TOT:ID) instead of Fyffes…but I can live with that, you can’t pick ‘em all & TOT’s been good to me. But maybe not good enough – because FFY popped 46% in early March, on the news of a definitive merger with Chiquita Brands International (CQB:US). [CQB also closed 11% higher on the day - since then, on average, each stock's held onto its gains]. I think we can comfortably assume the deal will go ahead (unscathed): Shareholders love it, the DoJ doesn’t give a damn what happens in Europe, and the Irish Competition Authority is presumably asleep at the wheel, as per usual. [A study confirmed the ICA has a rejection rate of just 0.7%!] Anyway, what deal dissenter would relish the possibility of mercenaries dropping in for tea & a little chat..?! ;-) At this point, let’s just rely on the merger terms for our valuation:

USD 12.25 CQB Share Price * 0.1567 CQB Share (per 1 FFY Share) / 1.3841 EUR/USD = EUR 1.39

Fyffes is marginally undervalued – it offers an attractive arbitrage for the big boys, or a cheap entry price if you’re interested in going long the new ChiquitaFyffes.

Price Target: EUR 1.39

Upside/(Downside): 9%

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Company: Keywords Studios

Prior Post(s): 2013

Ticker: KWS:LN

Price: GBP 153.5p

Keywords was a late TGISVP arrival last year, but so far so good – it seems to be adjusting well to listed life. This is encouraging, particularly when you note the video game industry’s rather turbulent transition (a new console cycle, plus the continued migration to online/mobile gaming). Management clearly signaled its acquisition strategy, and two came in rapid succession in Jan/Feb-2014: The first was Liquid Violet, for GBP 300 K cash up-front (& a further GBP 1.3 million of deferred consideration). No revenue figure was provided – the primary objective here is to cross-sell Liquid Violet’s expertise & beef up voice production services from just 8% (currently) of Keywords’ revenue.

The second acquisition was a competitor, Babel Media, for GBP 3.2 M cash & 2.2 M worth of KWS shares. This adds another 6.4 M in revenue, but EBITDA looks light at 0.4 M. However, there are obvious operational synergies to be harvested here – in fact, management’s already achieved USD 0.8 M of annualized savings, so it’s reasonable to assume margins will quickly converge to those of Keywords itself. [Babel also adds an Indian office - together with Keywords' new Singapore office, this gears up the company's exposure to the fastest growing region & 3 of the top 4 video game markets globally].

Based on Keywords’ recent results, we can peg its (post-Babel) revenue run-rate at just over EUR 24 M – unfortunately, it will need to re-build its (adjusted) operating margin from the current 14.8%. I’ll drop my valuation accordingly. to a still generous 1.67 Price/Sales multiple. We can obviously add (post-acquisitions) cash of 11.6 M, and the company can accommodate another 10.7 M of debt without a strain – as usual, let’s haircut this debt adjustment by 50% to be conservative:

(EUR 24.2 M Post Acq. Revenue * 1.67 P/S + EUR 11.6 M Post Acq. Cash + EUR 10.7 M Debt Adjustment * 50%) * 0.8222 EUR/GBP / 42 M Shares = GBP 113p

Keywords Studios is still fairly over-valued. Cash remains a significant valuation component – presumably this is earmarked for further acquisitions, so investor sentiment will be sensitive to the scale & cost of any revenues/margins it acquires (and any related integration risks). On the operating front, I suspect we’ll see good progress during 2014 – in my experience, years 2 & 3 (i.e. Xmas 2014 & 2015) offer attractive momentum in a new console cycle.

Price Target: GBP 113p

Upside/(Downside): (26)%

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Company: Mincon Group

Prior Post(s): None – New IPO (Nov-2013)

Ticker: MIO:ID

Price: EUR 0.975

Not to be unfortunately mistaken for rubbish like Minco (MIO:LN)… Mincon IPOed in late 2013: The company was established in 1977 by the Purcells, and now has manufacturing plants in Ireland (Shannon), the US (Benton, IL) & Australia (Perth). It sells (& services) rock hammers & bits to the mining industry (& distributes related third party products) – for example, the San Jose miners in Chile were rescued with Mincon equipment back in 2010. Its products are considered consumables, rather than capital items, so customer loyalty & revenues are far more predictable – its customer base is also more diverse than you might expect, with its top 10 customers typically accounting for about 30% of revenue.

2013 was a fairly tough year for the industry, and 2014 promises more of the same – but recent results were still encouraging. Revenue declined 17%, but this was primarily due to a 43% fall in third party product revenues (after some one-off deals in 2012). On the other hand, adjusted operating profit (of EUR 15.0 million) was up an astonishing 18%, but this was flattered by some exceptional 2012 expenses (mostly bonus payments) – I estimate underlying operating profit fell marginally, which still amounts to an excellent performance. This pegs the operating profit margin at a remarkable 28.7%, which obviously masks an even higher margin for Mincon’s own product range. I do notice some cash flow shortfalls in the past 2 years, but that kind of margin still deserves a 2.5 P/S multiple. This margin would also support a good slug of leverage: I calculate EUR 43 M of debt would cap interest expense at 15% of operating profit – let’s haircut this total by 50%. We can also add cash on hand, plus net IPO proceeds:

(EUR 52 M Revenue * 2.5 P/S + 50 M Cash + 43 M Debt Adjustment * 50%) / 207 M Shares = EUR 0.98

Mincon Group’s fairly valued – a view on the commodities/mining industry may be essential here. Meanwhile, it’s worth noting Mincon’s still very much an owner-operated firm – Paddy Purcell’s a non-executive director, while Tommy & Joe Purcell are Sales Director & Chief Technology Officer respectively, plus the CEO Kevin Barry’s also been with the company for 3 decades now. This involvement’s also reflected in their continuing 58% (Purcell family) & 14% (Barry) stakes. [Incidentally, the average employee has also been with the company for nigh on a decade]. Some investors prefer to avoid this kind of ownership, others will actively embrace it. It could also prove a double-edged sword when it comes to acquisitions: Mincon’s already earmarked its available cash for a likely deal or two in 2014 – their tight-knit culture may offer a good home for similar firms, or prove a real integration challenge.

Price Target: EUR 0.98

Upside/(Downside): 0%

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Company: Ardmore Shipping

Prior Post(s): 2013

Ticker: ASC:US

Price: USD 12.77

In March, Ardmore completed a successful follow-on offering to its 2013 IPO – raising over USD 100 million of fresh equity, which puts it in an exceptionally strong position within its peer group & sector. It now has over 50% (11 tankers) of its fleet operational, with the balance (10 tankers) mostly due for (newbuild) delivery in 2015. Its focus on (mid-size) product & chemical tankers, which enjoy a far superior supply/demand equation (see here & my 2013 post), continues to shield it from most of the vagaries of the BDI – which is now down a whopping 59% YTD:

BDI Apr-2014

This equity raise actually puts Ardmore back in a net cash position. Ignoring this for a moment, gross debt of USD 119 M amounts to 59% of vessel book value, well inside the usual 50-65% range I’d expect to see. We also have 89 M invested in vessels under construction – we can expect to see a debt draw-down against these vessels in due course. Grossing up year-end equity of 232 M, Ardmore should ultimately have sufficient capital (give or take) to fund its entire 21-tanker fleet. The real problem here may be return on equity (RoE) – net income’s actually negative right now, but management predicts annual EPS of $0.46 once the entire fleet’s operational (all other things being equal). Unfortunately, that’s still a low-single digit RoE…

But in the medium-term, cash return on equity may be far more relevant – Ardmore will enjoy one of the industry’s youngest fleets, which will require the bare minimum in terms of capex/maintenance spending. If we take 2013 net cash generated from operations of 8.1 M, based on an average 7.4 owned operating vessels, the current run-rate may be around 12 M. And the entire fleet might ultimately generate 23 M – that’s almost a 10% RoE (based on year-end equity). This is all back-of-the envelope, of course, but you get the idea… In fact, it may actually understate potential RoE, as: i) Ardmore’s tanker rates were actually up around 8% in February (vs. 2013), and ii) their order book consists entirely of Eco-Design tankers, which commanded a 23% premium in 2013 vs. the actual $12,850 fleet time charter equivalent earned per day.

Of course, as things stand, the return on Ardmore’s newly-raised equity will be virtually non-existent – and considering the likely time-line for fresh newbuild orders, we’ll probably see them target second-hand vessel acquisitions. In fact, this new equity grosses up to a likely 250 M of spending power, so we may even see a corporate acquisition. [They might also consider bankruptcy sales, and/or purchases of vessel/fleet specific distressed debt]. Despite this slow ramp-up in RoE, Ardmore will stand out as a shipper with plenty of capital, a young fleet, and book values which are obviously up-to-date/conservatively marked. In a different market, I suspect it would command a nice premium, but a 1.0 Price/Book multiple looks about right now when you consider the cheaper (but riskier) alternatives in the sector (and the long shadow the BDI casts on sentiment):

(USD 232 M Equity + 109 M Fresh Equity * 95%) / 26.1 M Shares = USD 12.86

Ardmore’s only marginally under-valued. But it currently offers one of the safest plays in the sector, and longer-term it may also offer an interesting derivative play on cheap US natural gas. However, significant upside potential will likely remain fairly dependent on an eventual rally in tanker daily rates.

Price Target: USD 12.86

Upside/(Downside): 1%

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Company: CRH

Prior Post(s): 2012 & 2013

Ticker: CRH:ID

Price: EUR 20.98

2013 wasn’t a great year for CRH – the new CEO, Albert Manifold, has inherited an uphill task (& a stretched balance sheet) from veteran Myles Lee. Total revenue fell marginally – again, weak trading in Europe was the culprit, but it’s notable CRH’s (2012) US momentum has mostly dissipated (with revenue up just 2%). Europe had a more pronounced (negative) impact on profitability, with CRH’s underlying operating profit margin falling to just 4.0%. [This performance also prompted a 2013 portfolio review, resulting in a EUR 0.6 billion write-down & a plan to divest 45 (primarily European) business units]. Fortunately, this kind of stagnation often benefits the cash flow statement – something we can reasonably expect again in 2014 – for 2013, this resulted in a 5.6% operating free cash flow (Op FCF) margin.

For valuation purposes, I’ll still assume we’ll see an eventual convergence towards CRH’s long-term margins of almost 10% – so let’s utilize an average 7.8% margin here. However, it’s worth highlighting fresh anxieties over Chinese/emerging market growth mean the timing of this convergence has become that much more uncertain… On the other hand, CRH is still the Irish blue chip for domestic & international investors (well, even though it’s not very Irish…) – so I’ll continue to assign a 0.7 P/S multiple.

But leverage remains a big problem – EUR 255 million of net interest expense is a whopping 35% of adjusted operating profit. But let’s be generous here & focus on CRH’s Op FCF of just over EUR 1.0 B instead…unfortunately, net interest’s still over 25% of this figure. I calculate total debt (of 5.5 would need to be reduced by about 39%, to limit net interest to 15% of Op FCF – therefore, we’ll include a 2.1 B (negative) debt adjustment in our valuation, plus a 336 M adjustment for the net pension deficit. However, cash has now accumulated to a rather ridiculous 2.5 B – I suspect management will opt for ample liquidity, but it seems reasonable to assume 50% of this cash will be used to offset debt balances/maturities. Put all this together & we have:

(EUR 18.0 B Revenue * 0.7 P/S + 2.5 B Cash * 50% – 2.1 B Debt Adjustment – 0.3 B Net Pension Deficit) / 735 M Shares = EUR 15.53

CRH remains pretty over-valued. I suspect there’s a potential takeover premium embedded in the price – considering the Holcim-Lafarge merger news, we may be on the verge of a new wave of consolidation. If that’s the case, CRH is a mere morsel – shareholders often seem to presume it’s a global player, but in reality it barely cracks the top 40 largest cement companies. Meanwhile, shareholders probably face another tough year…and it might prove tempting for the new CEO to indulge in another kitchen-sink job this year, or to even consider a rights issue.

Price Target: EUR 15.53

Upside/(Downside): (26)%

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Company: Paddy Power

Prior Post(s): 2012 & 2013

Ticker: PWL:ID

Price: EUR 54.30

So, who’s betting on Paddy Power? Less & less investors it seems… For years, PWL marched steadily higher, but since end-March last year the stock’s been steadily deflating instead. It’s now off almost 25% from its EUR 71.40 high & continues to look vulnerable – unless PWL regains the EUR 54.20-55.15 support zone (which it appears to have broken in the past few days), we could be looking at an (alarming) test of the psychological EUR 50.00 level very soon. Of course, this retracement stands in marked contrast to the ISEQ’s gain in the last year. It also appears to be valuation related, as PWL’s interim results (reported in August) were quite promising – it was only in November’s interim statement that management flagged a substantial slowdown in profitability. Then final results came in March, and they certainly put a kink in the Paddy Power growth story.

The top line continues to look attractive – with net revenue growing 17% in constant currency terms, but the operating profit margin contracted to 18.4%, while adjusted diluted EPS growth slowed drastically to 5% (also on a cc basis). This was blamed on adverse sports results in H2-2013, new product fees, adverse currency movements & new investment in the Italian market. Of course, the key question for investors is: What happens next? Is this a hiccup, or the start of something worse?

Well, Paddy Power’s a great brand – the continued top-line growth’s encouraging, and I suspect there’s plenty of acquisition & organic growth opportunities ahead. The balance sheet’s strong (a EUR 0.5 billion plus acquisition wouldn’t be a problem!), and I’ve seen no warning signs in the cash flow statement. Growth companies experience hiccups far more than investors like to remember, or acknowledge – those with pre-existing/underlying problems often flame out, but true growth companies adjust & quickly bounce back on track. For me, the only real problem with PWL has been valuation…

Looking back to 2009-11, the operating profit margin averaged 23.6% – despite the decline in 2012 (to 20.8%) & 2013 margins, it seems reasonable to assume it will expand again as revenue continues to grow, PWL’s luck takes a turn for the better, and current investment(s) pays off. Let’s average out to a 21% margin here, and bear in mind the company’s superior operating free cash flow in the past few years – that’s still worth a 2.5 P/S multiple. To this, we’ll add available cash of EUR 175 million, plus a debt adjustment of 409 M (which would bump interest expense up to 15% of current operating profit – as per usual, let’s conservatively haircut this debt figure by 50%). Paddy Power obviously has ample fire-power on hand, I suspect it’s time for them to now contemplate a more substantial & transformative acquisition. Considering the earnings growth history here, plus continued top-line growth, let’s also assign a 17.0 Price/Earnings multiple:

(EUR 2.52 Dil EPS * 17.0 P/E + (EUR 745 M Revenue * 2.5 P/S + 175 M Cash + 409 M Debt Adjustment * 50%) / 49 M Shares) / 2 = EUR 44.18

Paddy Power remains somewhat over-valued. If we see 2014 deliver results more in line with historic performance, PWL could easily end up trading around fair value. Hmmm, if only things were so simple… Investors clearly remain cautious re valuation/prospects, but they’ll be paying close attention to management cues & guidance at the upcoming (May) AGM – a promising outlook might well re-ignite enthusiasm for the stock…and place it well out of my reach, again!

Price Target: EUR 44.18

Upside/(Downside): (19)%

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Company: Kenmare Resources

Prior Post(s): 2012 & 2013

Ticker: KMR:LN

Price: GBP 13.25p

Kenmare’s one of the few Irish resource stocks that’s clawed its way up to producing status, so I derive no pleasure from the validation of my consistently bearish stock perspective. But perhaps Moma has always been a project too far…for a company with such humble origins. And for the risks involved, the company was ridiculously overvalued (back in 2011 & 2012, when the share price set a 60p+ double-top) – and now, of course, it’s simply over-leveraged. Potential salvation lies with ramping up production asap – unfortunately, commodity prices have declined significantly, and now Kenmare basically lacks the financing to accelerate production. In fact, revenue’s gone into reverse, declining over 40% in 2013 – while operating cash generation barely funded the company’s interest bill.

An asset-based valuation remains the only logical approach to valuing Kenmare. I’ll be kind & use the same in-the-ground prices as last year (approx. 10% of medium/long term average spot prices): A price of $18 per tonne for ilmenite looks spot on, the $100 price for rutile’s mostly irrelevant, and a $133 price for zircon’s generous considering recent grading & pricing. As usual, I’ll assign a 50% haircut for probable reserves, and 75% for measured & indicated resources - here’s the latest reserve/resource statement. [NB: As I understand it, the Namalope resources should be Indicated (not Inferred)]. To this we can add USD 68 million of cash, USD 363 M of debt, and an annual (free) cash flow burn of 81 M. [Virtually all capex - though it's not clear Kenmare will actually manage this kind of capex spend in 2014...]:

(USD 68 M Cash – 363 M Debt – 81 M Annual Cash Burn + 19.6 Mt Ilmenite * $18 + 0.4 Mt Rutile * $100 + 1.4 Mt Zircon * $133) / 1.6833 GBP/USD / 2,782 M Shares = GBP 4.3p

Kenmare remains substantially over-valued. The bigger problem might now be the financial stress/risk placed on the company – which is always difficult to handicap. In my experience, once the debt restructuring process begins, it tends to continue…and we’ve already seen a rescheduling of the company’s debt repayments. It would be foolish of investors to assume Kenmare’s lenders have infinite patience, or to hope KMR can somehow enjoy a debt write-down without severely impacting/diluting current equity holders. In fact, at this point in the cycle, lenders might actually be incentivized to swap their debt for the upside potential of equity – right-sizing the company’s production & capital structure would position fresh equity nicely for an eventual commodity price rally. But hey, what do I know – the most likely course of action will probably be the good old junior resource stock standby: Management will bury their heads in the (mineral) sand, wait for the share price to totally collapse, and then they’ll finally launch a massively dilutive placing…

Price Target: GBP 4.3p

Upside/(Downside): (67)%

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Company: IMC Exploration Group

Prior Post(s): 2013

Ticker: IMCP:PZ

Price: GBP 2p

Hahahahahahahahahahahahahaahahahahahahahahahaha…

Ahem, sorry – I couldn’t help myself there for a minute. But seriously, I thought long & hard (OK, more like 30 seconds) about including IMC here – the last thing I want to do is suggest the company’s some kind of legitimate investment possibility. On the other hand, it’s too hilarious to omit…plus it’s always good to warn of an inevitable share price collapse. [Hmm, if the shares end up being suspended/de-listed in the dead of night, what's the bets some die-hard shareholder insists I made the wrong call!?] This PoS stock springs from the same stable pub Liam McGrattan & Nial Ring production line as my old favourite…yep, US Oil & Gas (USOP:G4)! [Nice to see a touch of the McDonnell magic here also - wife Lisa is a 6.6% shareholder].

But IMC’s equally impressive, judging by the 354 g/t gold interval they reported just over a year ago in Co. Wexford – a fantastic discovery, and surely a match for that ocean of oil USOP reported under the Nevada desert! Have a read, they kindly provide a treasure trove of media coverage here – though the articles seem to have dried up a year ago. Now, isn’t it a shame they didn’t include the entertaining little article about the company’s extraordinary tiff with ex-Chairman Hugh Gibney – though they did see fit to publish an RNS about it.

Now, there is the minor matter of cash, or lack of it – IMC’s only got two grand on hand, vs. an annual cash burn rate of EUR 271 K. [Rather bizarely, no cash flow statement was included in the recent final results]. However, the company has agreed a 200 K convertible loan note deal with Liam McGrattan to provide liquidity. The company also managed, rather surprisingly, to acquire a tangible asset – by issuing 16 M shares in return for 320 K shares in Global Resources Investment Trust (GRIT:LN). [Rather bizarrely, GRIT doesn't appear to have traded yet, so let's reference its fast-declining NAV instead]:

(EUR 2 K Cash – 271 K Annual Cash Burn + 320 K GRIT Shares * GBP 73.2p NAV / 0.8222 EUR/GBP) / 69 M Shares = GBP 0.02p

By some sheer marvel, IMC isn’t actually worthless…yet. But it is ridiculously over-valued!

Price Target: GBP 0.02p

Upside/(Downside): (99)%

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OK, time to wrap this up again for the moment – here’s my usual (updated & re-ranked) TGISVP file:

2014 – The Great Irish Share Valuation Project – Part VIII