Lonmin Plc: Value buy or value trap?

Lonmin may be a falling knife. Beware.

Disclosure: I have no financial interest in any  company mentioned in this article.

Update 10/11/15: I’ve written a new post taking a look at Lonmin’s planned rights issue — click here to read.

Update 23/10/15: Earlier this week Lonmin announced plans for a $400m rights issue. The firm has managed to secure a promise of new banking facilities, conditional on the rights issue.

This was pretty much inevitable and is logical. Indeed, it’s better than it might have been. However, it’s not the first time this company has handed the hat round in recent years. I discussed the news further in an article for the Motley Fool earlier this week.

In a nutshell, my view is that we haven’t yet seen any  hard numbers to prove that cash flow has turned positive. We also don’t know how dilutive the rights issue will be and whether it will be well supported.

There’s no rush to buy until at least one of those questions has been answered, in my opinion.

——

Original article from 28 July 2015 starts here:

The recent slide in commodity stocks has been uncomfortable for shareholders in many companies, but devastating for those owning shares in South African platinum miner Lonmin Plc (LON:LMI).

The firm’s shares have fallen by 54% to 57p over the last month, taking their 12-month decline to 77%.

Lonmin shares now trade at an 80% discount to the firm’s latest reported book value. In this article I’ll ask whether this is a deep value opportunity, or simply a value trap.

1. Book value

Let’s deal with the question of book value first. According to Lonmin’s interim results, the firm had a tangible net asset value of 311p per share. At last night’s closing price of 57p, that puts Lonmin shares on a price/tangible book ratio of just 0.18.

As with anything that seems too good to be true, this is.

Lonmin announced plans to suspend operations at some of its mine shafts on Friday. Unless we see a platinum bounce or the firm manages to find a way of operating these shafts at much lower cost, I suspect the value of these assets will have to be written down sharply when Lonmin’s accounts are next made up.

Most of the big miners have been forced to write down the book value of some of their assets. Lonmin’s discount to book value is, in my view, a reflection of likely impairments and the firm’s lack of profitability.

2. Cash flow and profits?

Value investing is all about finding investments that are cheap enough to offer a margin of safety — protection from permanent loss of capital.

Lonmin admitted on Friday that its operations are currently “EBITDA negative”. Translated into English, this means the firm is operating at a loss, probably quite badly. It seems fair to assume that cash flow is negative, too.

During the first half of the year, underlying EBITDA was only $8m. Since the start of Lonmin’s H2, platinum has fallen by a further 14%, from $1,126 to its current level of about $980 per ounce.

Lonmin is attempting to staunch the losses by closing the high cost Hossy and Newman shafts and focusing on the cheapest, most easily mined reserves. However, there’s no guarantee that this will be enough to return the firm to positive cash flow or EBITDA.

Based on its perilous earnings and cash flow situation, Lonmin isn’t a value buy.

3. Cash reserves?

Companies can afford to run at a loss for a while if they have a strong balance sheet, and/or cash reserves. Lonmin has neither.

The firm’s interim results showed that by 31 March, Lonmin had net debt of $282m, meaning that the firm had used up half of its $563m of borrowing facilities. Net debt is almost certainly higher today, and in Friday’s update Lonmin confirmed that it is “reviewing the appropriate capital structure” for the company in the light of “the need to re-finance our debt facilities”.

An update is expected by the time of Lonmin’s full-year results in November. Whatever combination of debt or equity is agreed on, my view is that it is likely to be heavily dilutive for shareholders, unless they are willing to put in a substantial amount of fresh cash.

As a result, Lonmin fails as a potential value investment on balance sheet strength.

Conclusion

In my view, Lonmin fails on all three core tests of value: assets, earnings and cash flow, and cash/debt.

I’m not surprised Glencore dumped its shares in the miner: as a major shareholder holding 23.9% of the stock, Ivan Glasbenberg’s trading giant was probably keen to avoid the risk of being on the hook for any cash in a placing or rights issue.

From here, Lonmin shares could easily triple or fall to zero. Buying Lonmin stock today is a punt, not an investment, in my view. As such, I’m going to continue to avoid it.

Disclaimer: This article is provided for information only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.