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

Wexboy_Value

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


Links/Charts/Files/etc:

See the Wexboy blog.

Text:

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: First Derivatives

Prior Post(s): 2012 & 2013

Ticker: FDP:LN

Price: GBP 1,070p

It’s been a wild ride for investors in the past year: A year ago, FDP looked fairly valued to me – and for much of 2013, I wasn’t far wrong, with the shares clocking modest gains. But FDP took off abruptly in November…by January, the shares had almost doubled within 2 months & tripled within 6 months. With profits down in the interim results, I suspect this rally was more of a delayed response to FDP’s Aug-Nov news flow (with new contracts reported with Republic Wireless, the NYSE & ASIC). These all highlighted the capability & flexibility of the company’s Delta products/platform to deal with Big Data, both financial and non-financial. That’s a sexy pitch right now for investors & they responded accordingly… As usual, the mugs were the last to be sucked in – it’s no great surprise to see they’ve lost a third of their investment since January, with no particular reprieve in sight.

Even at these less elevated levels, I suspect the shares remain over-valued. While FDP continues to rack up attractive revenue growth, the rest of its accounts don’t paint such a pretty picture. Operating margins continue to compress (now between 11-12%), earnings growth is non-existent & the outstanding share count is mounting steadily. More troubling is the lack of operating free cash flow (cash generated from operations, less PPE & intangibles). However, this has been offset by residential property sales in the past couple of years – unfortunately, this source of cash should dry up fairly soon. Perhaps more troubling is the continued reliance on consulting (almost 75% of revenue), rather than software sales. This is in response to the industry’s need for further cost-cutting, consolidation & compliance, rather than renewed secular growth. But it’s 5 years now since the end of the financial crisis. Perhaps there’s more of the same work to come, but I worry it’ll dry up & the company will suddenly have a death valley to cross…before we see a genuine return to growth in the finance industry.

Meanwhile, I have to scale back my valuation to a 1.2 Price/Sales multiple. Since the company remains financially strong (with additional property to sell), we can still apply a (positive) debt adjustment – but it’s much reduced now at just GBP 8 million, and I’ll haircut it by 50% as usual. And applying a P/E multiple doesn’t make much sense any longer:

(GBP 63 M Revenue * 1.2 P/S + 7.9 M Debt Adjustment * 50%) / 19.7 M Shares = GBP 405p

First Derivatives now looks wildly over-valued – my price target’s actually down on last year, but this reflects a continuing divergence between top & bottom-line. I’m sure enthusiastic shareholders will disagree (violently), but the numbers don’t lie – it’s obviously much easier to deliver strong revenue growth, if it’s at the expense of margins, cash flow & share dilution… Momentum investors are the natural shareholder base for FDP, and the recent price reversal must be sorely testing them now. If FDP’s revenue growth hits a brick wall, or goes into reverse, they’ll quickly abandon ship.

Price Target: GBP 405p

Upside/(Downside): (62)%

_

Company: FBD Holdings

Prior Post(s): 2012 & 2013

Ticker: FBD:ID

Price: EUR 17.20

It’s steady as she goes at FBD…its reliability lulls one into forgetting how spectacularly the company’s delivered in such a bad market over the last few years. In 2013, gross premiums increased by 2.0% – seemingly modest, but this is the highest premium growth since 2006. It actually masks a 0.7% decline in average rates, offset by a 2.6% increase in policy volume – reflecting another year of increasing market share (at 13.4%, FBD’s highest ever). However, 2013 genuinely looks like an inflection point for the industry – rates began hardening in H2, while insurable values also began to turn up marginally. Further premium hikes seem inevitable, as the industry suffered a combined operating ratio (COR) of 109% in 2012 & a likely worse outcome in 2013.

Which stands in stark contrast to FBD’s far superior COR of 94.1% in 2013 (up from 89.4%). The yoy increase arises directly from (severe) weather-related & other exceptional claims – it’s reassuring to see the company’s attritional loss ratio actually enjoyed a modest decline. Looking to 2014, management’s comfortable YTD severe weather claims are within budget, but expects a pick-up in regular claims in line with increasing economic activity. While one can never predict positive/negative claim reversals, FBD has a reassuring history of increasing market share & high returns on equity – plus a bullet-proof balance sheet (zero debt & 86% of its portfolio invested in deposits & bonds). This makes for very consistent investment returns – add in a nice bump from their (small) equity allocation, and diluted EPS (of 131 cts) held up well vs. a decline in operating earnings (to 136 cts). This delivered a 2013 Return on Equity (RoE) of 17.3% & a year-end NAV of 823 cts.

Now, there’s obviously a few different ways to measure RoE – I come out higher myself, but I also note management guidance suggesting 2014 RoE might be closer to 15%. Averaging them all out, I think my prior 2.25 Price/Book multiple still looks about right. [NB: I usually value an 8-12% RoE at a 1.0 P/B - in terms of its history, financial strength & superior industry metrics, FBD deserves the strong end of this range]. A 33.25 ct dividend is due to be paid, but that’s exceeded by likely earnings YTD:

(EUR 823 ct NAV + 40.9 ct EPS YTD – 33.25 ct Dividend) * 2.25 P/B = EUR 18.69

FBD remains slightly under-valued – I hold a 3.7% portfolio stake. With the company earning a prospective 15%+ RoE in the medium-term, I continue to look forward to an excellent compounded return on investment.

Price Target: EUR 18.69

Upside/(Downside): 9%

_

Company: Independent News & Media

Prior Post(s): 2012 & 2013

Ticker: INM:ID

Price: EUR 0.155

So, I s’pose I got it horribly wrong last year – I pegged INM as worthless! But that’s because I choose to foolishly dwell in a world where equity holders in an over-leveraged company, with declining revenues, actually get wiped out (or diluted to irrelevance) in a debt restructuring… [I really should cop on - there's been plenty of counter-examples since the bloody financial crisis!] So the loss I foresaw actually occurred, except the pain was mostly taken by the creditors & pension fund instead. The only call on shareholders was a placing & open offer to raise a net EUR 40 million, and even that was primarily funded by Denis O’Brien & Dermot Desmond (via IIU). [Which leaves them firmly in control with 29.9% & 15%, respectively. Tony O'Reilly's still a presence, but his 5.0% stake's now a mere irritant. Notably, Vincent Crowley's departure was recently announced - he was the last remnant of the O'Reilly reign]. So, where does all this leave Independent News now?

Well, I’m astonished to see investors now appear to love INM almost as much as they previously hated it… I guess now the debt problem’s fixed, people have forgotten all about INM’s other little problem…er, it’s a classic old media empire, with an apparently never-ending decline in revenues!? Anyway, I really don’t believe the debt problem’s been fixed myself. In fact, the whole restructuring exercise puzzles me – I mean, if you’re going to do something, bloody well do it right!

2013 revenue was reported at EUR 322 million (on a continuing basis), down 6.6%. Expense cuts actually delivered a stable (pre-exceptional) operating profit of EUR 33 M, so the operating margin increased slightly (into double digits, at 10.1%). But I see no end in sight for continued restructuring/exceptional expenses, and I’m still dubious of INM’s cash generation, so I continue to focus on the cash flow statement instead. This confirms operating free cash flow continues to fall well short (of operating profit) at 23 M. But this figure includes INM’s profitable South African unit, which was sold last August – I wouldn’t be surprised by a 40%+ reduction if SA were stripped out. I suspect the underlying operating margin’s probably more like 4.3%. Let’s be kind & presume an average margin of 7.2% is possible, now the debt restructuring’s given the company some breathing room – this deserves the same 0.6 P/S multiple as last year.

Unfortunately, we still don’t have adequate coverage for an expected 6.5 M interest bill for 2014 (based on the dramatic reduction in net debt to 95 M). Assuming a 7.2% average operating margin, we’d need to see a further reduction in total debt (by almost 50%, or 60 M) to limit interest expense to 15% of operating profit. [This may seem conservative, but that kind of leverage may still prove problematic for a business that remains in decline]. To this (negative) debt adjustment we should also add the remaining net pension deficit of 61 M. However, we do have an offset – INM’s 18.6% stake in APN News & Media (APN:AU) – a ridiculous trophy asset that should have been sold years ago, but at least its value has recovered somewhat in the past year (to AUD 128 M). Add all this up & we have:

(EUR 322 M Revenue * 0.6 P/S – 60 M Debt Adjustment – 61 M Net Pension Deficit + 192 M APN Shares * AUD 0.67 / 1.4952 EUR/AUD) / 1.4 B Shares = EUR 0.114

Surprisingly, Independent News is only slightly over-valued at this point. But the company still presents plenty of operational & financial risk, whereas any realistic bull case is pretty much limited to a potential stabilization & exploitation of a pretty mature business (at the very best). What’s puzzling is both O’Brien & Desmond have an eye for value, but they’re primarily growth investors – INM really doesn’t seem to fit the bill for them at all…

Price Target: EUR 0.114

Upside/(Downside): (26)%

_

Company: Dragon Oil

Prior Post(s): 2012 & 2013

Ticker: DGO:LN

Price: GBP 623.5p

It’s steady as she goes with Dragon, but the shares have received zero respect in the past year – they’re virtually unchanged. I’m puzzled at investors having so little enthusiasm for such a stable, cash-rich & low-cost producer. Particularly with Emirates National Oil Company as a 54% controlling shareholder, and presumably dying to still take over the company lock, stock & barrels. Perhaps they’re afraid ENOC will abuse minority shareholders? Well, there’s no really no evidence/history of that – in fact, ENOC was defeated in its last takeover attempt!

Maybe investors are wary of the rapid expansion of Dragon’s exploration portfolio in Iraq, Afghanistan, Philippines, Egypt & Tunisia? But isn’t signing deals & drilling exploration wells what usually gets most investors excited? I’d prefer Dragon ploughed its cash into dividends & share buybacks myself – but really, what do you expect from an oil company? Anyway, they flagged up their diversification plans for years, without getting anywhere – now they’re generating, on average, well over a billion dollars of annual operating cash, so there’s plenty of change left over despite an ambitious exploration & development budget. Maybe investors are simply worried Russia will invade Turkmenistan? Haha, what are the chances… Hmm, maybe they’ll invade via the Caspian!?

Actually, I consider their exploration efforts a necessary evil – but it’s not a financial burden, and with reserve replacement close to 100%, there’s little negative impact on the company’s value. By which I mean – I’m assigning zero value to their exploration portfolio for the moment. Hopefully this allows for a happy surprise or two down the road, but let’s not get too excited – new resources/reserves may still be a long time coming. Meanwhile, Cheleken production increased 9.1% in 2013 & Dragon seems confident of 10%+ annual increases in the next few years. But as long as investors remain relatively uninterested, I see little point in an earnings-based valuation – let’s just tot up assets instead.

The company’s still blessed with almost USD 2.5 billion of cash, plus zero debt. And proved & probable oil & gas reserves (let’s assume a 50:50 split) amount to 912 million boe, on a working interest basis – which corresponds to 403 M boe on an entitlement basis. We’ll rely on my usual $10 & $5 per boe valuations:

(2.4 B Cash + 403 M boe * $10 * 75%) / 492 M Shares = GBP 659p

Dragon remains slightly under-valued. Not huge upside, I know – but if there’s space for an oil company in your portfolio, DGO offers reliable reserves & production, with an interesting exploration portfolio thrown in as a free option. Also, with animal spirits riding high again in Dubai, I wouldn’t be surprised to see ENOC take another crack at a takeover this year.

Price Target: GBP 659p

Upside/(Downside): 6%

_

Company: Norish

Prior Post(s): 2012 & 2013

Ticker: NSH:LN

Price: GBP 39.5p

I’ve been consistently bullish on Norish, and equally scathing of its management for the past two years. This bullish view was rewarded early in 2013, with the share price doubling in the space of 7 months. But bad management almost inevitably wins out, and here we are again…the share price is back trading in the 30-40p range it’s mostly occupied for the past 5 years. Clearly I had a rush of blood to the head last year, when I highlighted the stock was potentially a triple. Not an incorrect analysis, necessarily, but that kind of upside presumes management’s at least willing to consider unlocking (and/or increasing) the company’s intrinsic value. But when you’re faced instead with apathetic management, and (it seems) shareholders, that upside may never be realized… Obviously one has to presume a binary perspective & outcome here.

On the one hand, we should simply consider the equity tied up in the business. Each year management inevitably promises things can only get better (due to their hard-working efforts, of course), but nothing ever materializes – savings always seem to end up absorbed by another set-back. The numbers tell the real story, as usual – cold storage revenue’s up a pathetic 6.5% in the past 4 years, while profitability’s consistently declined vs. a paltry 2009 profit of GBP 0.8 million. [I tell a lie - profitability's stabilized now at GBP (79) K pa in both 2012 & 2013!]. A 1.0 P/B multiple (on equity of GBP 8.3 M) seems more than adequate – in fact, it’s damn generous when you consider Norish’s negligible returns on equity. But management has again promised a decent return next year (and the 2013 continuing ops profit seems to confirm it), and fortunately equity’s mostly composed of land & warehouses which should be fairly valued & readily saleable.

On the other hand, the company’s worth far more if the cold storage business was simply liquidated & the commodity (meat) trading business was run (or sold off) as a stand-alone business. Let’s simplify the liquidation & assume total PPE of 15.4 M can be sold off (for book value) & used to retire net debt of 7.8 M – that’s a realized NAV of 7.6 M. We also need to value the Townview Foods meat business: Unfortunately, 2013 was the year of the horse meat scandal (er, what’s wrong with horse meat?!), so revenue fell (say) 35% to 11.4 M (from an estimated 17.5 M in 2012) & the operating margin fell to 3.7% (compared to an historical average of about 6.7%). I think it’s fair to presume the most recent figures are distorted, so let’s presume an average operating margin of 5.2% – this deserves a 0.45 P/S multiple. In similar fashion we’ll apply this multiple to an average revenue figure of 14.5 M.

Now, let’s average the two approaches – which seems the only fair way to nail down a valuation here. It also reflects my renewed ambivalence regarding management. When the 2013 interims were published, I was enormously encouraged by the plan to sell the York & Leeds facilities. Surely this was sanity & a first/tentative step towards liquidation… But since then, we’ve seen two dilutive share issuances (at 40p & 35p) & a purchase of the company’s Birmingham site – certainly not the actions of a management team which seems at all interested in protecting & realizing shareholder value. Finally, before we lay out our valuation, we should note the latest 2.2 M placing/open offer is still in process – but it’s obviously dilutive, so we’ll assume it gets completed & include it in our valuation to be conservative:

((GBP 8.3 M Equity * 1.0 P/B + 7.6 M Cold Storage NAV + 14.5 M Meat Revenue * 0.45 P/S) / 2 + 2.2 M New Equity * 95%) / (11.2 M Old + 6.3 M New) Shares = GBP 76p

Norish remains substantially undervalued. But remember this upside’s only an average: If management’s really that dreadful, they’ll continue to pour good money after bad into cold storage & the superior Townview business is sure to end up caught in its clutches too. On the other hand, the upside may be much higher, if management: a) finally realizes the only value in cold storage is the actual sales value of the underlying property portfolio, and b) focusing all investment on Townview, which I suspect is capable of delivering on a multi-year high growth revenue strategy. An aggressive share buyback programme wouldn’t bloody hurt either..!

Price Target: GBP 76p

Upside/(Downside): 93%

_

Company: Conroy Gold & Natural Resources

Prior Post(s): 2012 & 2013

Ticker: CGNR:LN

Price: GBP 1.55p

Conroy can still generate a nugget of good news flow every now & again: The management team continues to highlight the (conceptual) potential for 15-20+ million oz of gold within the 30 mile gold trend covered by their licences, they’ve discovered zinc exploration grades of up to 30%, they continue to obtain great results from their BIOX process testing, etc. But there’s still no answer to the one key question – how can a GBP 5 million market cap company, which already lives hand-to-mouth for its cash, hope to raise the USD 78 M capital cost of its proposed Clontibret, Monaghan, gold mine?

This is sad & familiar reality for so many junior resource stock investors – the odds of ever reaching this point are already low, and inevitably accompanied by repeated cash calls & massive dilution. But then the resulting reward’s a total impasse – go it alone & it simply can’t be done, so inevitably new partners & investors have to brought in…which generally implies another massive dilution just as investors thought they’d finally get to unlock their well deserved reward.

There’s no reason to change my valuation approach here. Conroy still has 260 K oz of indicated gold resources, to which we’ll assign a $150 per oz in-the-ground valuation – however, we’ll haircut this value by 75% to reflect the indicated status of the resources. The company had a mere EUR 72 K of cash on hand as per its latest results, but it’s raised a gross GBP 1.2 M since in equity & debt conversions. Unfortunately, it also has a EUR 1.0 M shareholder loan outstanding, plus 0.8 M of net payables, and it’s burning cash at an annual rate of 1.2 M. Putting all this together:

(EUR 0.1 M Cash + GBP 1.2 M Cash Raised * 95% / 0.8222 EUR/GBP – EUR 1.0 M Debt – 0.8 M Net Payables + 0.3 M Indicated Gold oz * $150 * 25% / 1.3869 EUR/USD) * 0.8222 EUR/GBP / 352 M Shares = GBP 1.3p

Surprisingly, Conroy is only slightly over-valued. The only value here though, on a net basis, is the value of their gold oz in the ground – which might seem rather academic at this point. However, talking about a gold mine at this juncture seems even more academic..!? In my opinion, the limited funds available would be better spent on proving up more resources – I suspect this strategy would offer far more obvious & immediate reward for shareholders.

Price Target: GBP 1.3p

Upside/(Downside): (17)%

_

Company: Greencore Group

Prior Post(s): 2012 & 2013

Ticker: GNC:LN

Price: GBP 261p

Aah, Greencore – my bete noire, my dodgy egg sandwich… How astonishing & ridiculous is it to note GNC’s quintupled since my first TGISVP review a little over two years ago. Can selling sandwiches to supermarkets really be that exciting?! I think bloody not… FY-2013 was virtually acquisition-free for Greencore, so 3.0% revenue growth’s probably fairly representative of its actual growth potential. [And all this growth came from the US - the UK, Greencore's main market, was basically stagnant]. Granted, operating profit increased 8.1%, and adjusted EPS by 13.3% – quite respectable, but the bottom-line won’t sustain this level of out-performance with that kind of top-line growth. And the company’s tax rate is now an astonishing 1% (due to the utilization of Uniq tax losses) – a reversion to a more normal tax rate, in due course, will prove an enormous headwind.

The other big problems here are poor cash flow & excessive leverage. Plus the company’s recurring exceptional (?!) expenses, of course – noting the relentless quest for lower unit costs, coupled with the usual margin pressure from the supermarkets, I don’t expect these to end anytime soon. Greencore reported an operating margin of 6.4% (which tells you a lot about the reality of their business anyway), but operating free cash flow (Op FCF) margin came in at just 3.8% (mostly due to GBP 20 million of exceptional cash expenses). And that’s no once-off phenomenon – 2012 Op FCF margin was 4.8%, while 2011 was only 1.4%. Awarding a 0.4 P/S multiple is quite generous, in the circumstances.

Of course, we’ll adjust for the company’s excessive leverage: Interest expense (at GBP 15.6 M) is a whopping 34% of Op FCF – we’d need to see total debt (of almost a quarter of a billion) cut by around 56% (or 138 M), to limit interest expense to 15% of Op FCF. We’ll also throw in a net pension deficit of, coincidentally, another 138 M. [It's worth noting, in terms of potential future volatility, gross pension assets & liabilities are in a pretty daunting range of 400-500 M. btw Greencore also has a net payables position of almost 200 M - if suppliers ever turn nervous, this could turn into another funding headache]. This gives us:

(GBP 1,197 M Revenue * 0.4 P/S – 138 M Debt Adjustment – 138 M Net Pension Deficit) / 406 M Shares = GBP 50p

To me, Greencore continues to look ridiculously over-valued – I never learn, do I..? But I have to ask – why exactly does it deserve an 18.4 P/E?! [Based on adjusted diluted EPS. NB: For once, basic EPS is higher than adjusted EPS, but that's due to exceptional tax credits]. Considering the history of cash flow shortfalls, I think it’s entirely appropriate to focus on free cash flow (FCF) here, rather than reported EPS. FY-2013 FCF amounted to a mere GBP 31.6 M (and 2012 FCF of 42 M wasn’t much better in absolute terms) – that puts GNC now trading on 33.6 times FCF, vs. the 6.4 FCF multiple implied by my target price.

OK, one might argue both multiples sound equally crazy – but for an obviously over-leveraged sandwich maker, I’d happily bet underlying intrinsic value’s far bloody closer to my multiple than the market’s. In all likelihood, the outcome will be binary here: Investors often prefer to keep believing in the emperor’s new clothes. As the all too familiar circular logic goes, the share price went up…so it must be a great company, right?! Well, unless things go horribly wrong (or a short selling research firm publishes a report)…then everybody will suddenly want to put the boot in!

Price Target: GBP 50p

Upside/(Downside): (81)%

_

Company: Hibernia REIT

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

Ticker: HBRN:ID

Price: EUR 0.995

Hibernia was the second Irish REIT out of the gates last year, after Green REIT (GRN:ID). Maybe it’s an unfortunate accident of timing, but for me it seems like a bit of a me too affair… Then again, a lot of investors seem to share the same opinion, with GRN trading at a huge premium to HBRN. And things may have gotten that much more difficult now – Green recently completed a new EUR 400 million placing & open offer, and Irish Residential Properties REIT (IRES:ID) has just IPOed as the third Irish REIT. I suspect this may leave a majority of investors in the GRN camp for Irish commercial property, and the IRES camp for Irish residential property – with nary a look-in for HBRN. Again, this seems borne out by their respective share prices (IRES also trades at a premium to HBRN, albeit small). However, despite the prior track records, I think there’s very little specific evidence here for investors to try pick winners & losers.

HBRN’s another cash box, complete with a newly created investment manager, Nowlan Property REIT Management – which is jointly owned by WKN & Frank Kenny. William Nowlan is the founder of WKN, and the former Head of Property Investment at Irish Life Assurance. Frank Kenny’s the founder of Willett Companies in the US, but previously worked for Nowlan in Irish Life. Base investment fee’s 1% of NAV, the performance fee’s set at 15-20% depending on the level of out-performance, the LTV ratio’s limited to 40% for the moment, while a 10-15% annual return’s been promised to shareholders.

HBRN will focus on Dublin commercial property, with a likely sub-allocation to retail, industrial & residential. Cornerstone investors included TIAA-CREF, Putnam, Moore Capital, Quantum & Wellington upon admission (owning 34% of the company, in aggregate), while subsequent investors include Mainstay Marketfield & Marshall Wace. [It's disappointing to see the board, founder group & WKN staff only owning about 1% of the stock upon admission]. About EUR 130 M has been spent to date, primarily on a Dundrum residential portfolio (which requires further development) & on New Century House, an IFSC office building yielding 5.9% once rent abatement ends in Oct-2015.

Valuation’s pretty simple here – 1.0 P/B is sensible for any Irish REIT at the moment:

(EUR 385 M IPO Cash – 12.6 M Expenses) / 385 M Shares = EUR 0.97

Hibernia looks marginally over-valued at this point. I think we’ll continue to note pressure on the GRN share price particularly, but unfortunately I don’t expect to see HBRN enjoy any kind of positive switching effect.

Price Target: EUR 0.97

Upside/(Downside): (3)%

_

OK, at this point, that’s another wrap – all comments/questions welcome, as usual. Hey, we’ll be coming up on the home stretch pretty soon now..! :-) Here’s my usual (updated & sorted) TGISVP file:

2014 – The Great Irish Share Valuation Project – Part IX

Cheers!