CCTV security camera

IndigoVision Group H1 results: improved trading + good value?

CCTV security cameraDisclosure: I own shares of IndigoVision Group.

Yesterday’s interim results from video security system firm IndigoVision Group were encouraging, without being outstanding.

The main points were:

  • Revenue down 3.5% to $21.8m
  • Camera volumes up 20%
  • Gross margin maintained at 52%
  • Overheads reduced by 8% to $11.9m
  • Operating loss reduced by $1.0m to $0.3m
  • Net cash up to $4.6m from $2.76m at the end of 2015, thanks to lower inventories and longer payment terms

The group reported a number of new orders and said that trading is expected to be stronger during the second half. R&D spending is being maintained to ensure products are updated and renewed.

The group anticipates “satisfactory operating results” for the year. I took comment to mean that FY result are expected to be in line with forecasts from the firm’s house broker.

These forecasts suggest the shares may be going cheap at the moment: earnings of 22.6p per share and a dividend of 7.5p are expected this year, according to Stockopedia. This puts the stock on a forward P/E of 6.5 and a prospective yield of 5.1%.

Despite the stock’s recent gains, IndigoVision also continues to trade slightly below both its book value and its net current asset value:

  • Tangible net asset value: $22.5m
  • NCAV: $16.5m
  • Market cap: $15.5m

Although the discount to NCAV isn’t large, this should provide some downside protection. The tangible net asset value of $22.5m translates to roughly 224p per share.

That would give a 2016 forecast P/E of 10 and ought to be achievable, in my view.

I continue to hold.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

Fifty pound note

Could rising debt undermine Fenner’s recovery?

Fifty pound noteDisclosure: I own shares of Fenner.

Shares in Fenner have been on a tear this week, climbing 13% on the back of an upgraded broker note and an upbeat trading statement. The shares are now worth 32% more than they were at the start of the year and my holding — which I bought too early in the mining downturn — is close to breakeven when dividends are included.

However, I can’t ignore the fact that Fenner’s net debt has risen to £150m. That’s the highest level since 2009 and looks quite demanding alongside 2017 forecast profits of just £17.4m.

An excellent Stockopedia interview with Nick Kirrage — who manages some of Schroder’s value funds — nudged me into researching this situation in more detail. (Incidentally, Nick and his colleagues blog at — worth reading for value investors.)

To get a fuller picture, I’ve gathered information about three key aspects of Fenner’s debt — borrowing levels and maturity, covenants and gearing/debt ratios.

Debt facts

At the time of its interim results (30 April) Fenner’s balance sheet looked like this:

  • Cash: £93.2m
  • Current debt (due < 1 year): £39.9m
  • Non-current debt (due > 1 year): £191.3m
  • Net debt: £138m
  • 8 Sept 2016 year-end trading update: Net debt c.£150m

According to last year’s annual report, £58.4m is due to mature in June 2017, with £38.7m due in July 2019. Beyond this, nothing is due for repayment until September 2021.

Interest costs were £14.7m last year, and were similar the previous year. That’s fairly material relative to forecast net profit of £13.6m in 2016 and £17.4m in 2017.

Currency effects: The devaluation of sterling after the EU referendum had an adverse impact on net debt, most of which is denominated in US dollars. Over the next year, this should be offset to some extent by the boost the weaker pound will give to Fenner’s US dollar earnings, which are considerable. Overall, I’m tempted to say that currency effects will be broadly neutral.

Liquidity: Current assets comfortably exceeded current liabilities, giving a current ratio of 1.64. That’s acceptable, if not outstanding.

Are the lenders happy?

Fenner’s debt level remained within its banking covenant levels at the time of its interim results. I’ve listed the two key covenant ratios below, with the covenant limits in brackets:

  • Net debt/EBITDA = 2.3x (< 3.5x)
  • EBITDA interest cover = 4.8x (> 3.0x)

There isn’t a massive margin for error here. But Fenner expects results for the year which ended on 31 August to be at the upper end of expectations. So EBITDA-related covenant problems seem unlikely for the time being. I imagine the firm’s lenders will be happy enough as long as interest payments are maintained.

Debt ratios

The standard measure of indebtedness used by most analysts and stock market data services is gearing. This measures debt relative to a company’s equity value.

Fenner’s net gearing (net debt/equity) was 50% at the end of February. However, I’m not convinced this is a very useful measure of a company’s ability to repay debt. After all, the only way Fenner could raise £150m to repay its debts today would be by flogging its best assets or issuing new shares.

Both measures would be a desperate last resort.  I’m more interested in a company’s ability to reduce debt by generating cash profits, without sacrificing planned capex or growth plans. After all, if a company cannot manage debt in this way, then its dividend will eventually be cut.

Inspired by John Kingham’s work at UK Value Investor, I’ve started to look at debt relative to companies’ profit and cash flow. On this basis, Fenner looks more heavily geared:

  • Net debt/10yr average free cash flow*: 5.2x
  • Net debt/10yr average net profit: 5.4x
  • Net debt/10yr average net profit (inc. 2016 forecast): 5.6x

These ratios look fairly high to me, but they’re not disastrous. As market conditions appear to be improving, I’m inclined to wait until the firm’s final results are published in November before making any further decisions about my holding in Fenner.

*I define FCF as operating cash flow – investing cash flow (exc. acquisitions) – interest payments

Is Fenner cheap or expensive?

However, I will leave you with two other statistics which suggests to me that the shares may be approaching fair value: The PE10 is a favoured metric of value investors, as it compares a company’s share price to its ten-year average earnings. This is enough to smooth out most cyclical peaks and troughs.

Deep value investors tend to look for a PE10 of 8-12. Fenner’s ten-year average net profit is about £26m, giving a PE10 of 14.

I’ve also calculated Fenner’s 10-year average free cash flow (see definition above), which is £29.1m. That puts the shares on a P/FCF10 of 12.6, which looks quite reasonable.

I continue to hold.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

Oil platform in North Sea

Four simple reasons to avoid Premier Oil plc

Oil platform in North SeaDisclosure: I have no financial interest in Premier Oil.

Premier Oil’s interim results confirmed my view of this stock: this company has good assets and is operating well, but its debt situation means the stock remains a sell for equity investors.

Here’s are four reasons why I think big losses are likely for Premier Oil shareholders.

1. Covenants would be breached if tested

Net debt rose to $2.6bn during the period and is expected to peak at $2.9bn during Q3. The firm’s net debt/EBITDAX ratio was an eye-watering 5.2x at the end of June, significantly above the firm’s covenant maximum of 4.75x. This is why covenant tests have been suspended while refinancing discussions are ongoing — Premier and its lenders don’t want the firm to fall into default.

However, the significance of this situation is that Premier’s lenders have the firm over a barrel. Premier can’t walk away and find a better deal elsewhere. It has to reach an agreement with its lenders, otherwise it will default on its loans and risk being put into administration.

2. “A full refinancing”

Premier isn’t just tweaking the terms of its loans. In the results webcast yesterday morning, Premier’s FD Richard Rose said that the current debt negotiations are “effectively akin to a full refinancing of the group”.

Mr Rose also explained that the firm has “four or five” lending instruments, each of which has multiple lenders behind it. He estimates Premier is dealing with about 50 lenders in total. So the complexity involved in the negotiations is considerable. Reaching agreement won’t be easy and the lenders have the upper hand.

Premier is hoping to agree revised covenants and longer maturities on some of its loans. In return for this, management expects to accept higher interest rates and to use the firm’s assets to secure its debts.

Management also indicated that during the deleveraging process, Premier is likely to have to get lender approval for any major new investment plans. CEO Tony Durrant indicated that no major new investment spending is likely for the next couple of years.

Details of the refinancing should be finalised during the second half of the year. Shareholders may feel that they are safe, because Premier’s current 78p share price equates to a discount of about 40% to the group’s net asset value.

However, my view is that if Premier’s lenders are having to make compromises and wait longer for their money, then shareholders are also likely to face losses. One possibility is that lenders will get a slice of Premier’s equity, perhaps through the issue of a large number of warrants for new shares.

3. $5 per barrel

One interesting figure from yesterday’s call is that Premier’s interest costs currently amount to about $5 per barrel. This could rise as a result of the refinancing. This figure gives a real taste of the burden the group’s debt pile is placing on its cash flow.

At $50 per barrel, 10% of Premier’s revenue would be absorbed by interest costs alone. Repaying the capital on these loans at sub-$60 oil prices won’t necessarily be easy or quick, especially as the group’s cash flow faces an additional risk in 2017.

4. Hedging risk?

During H2, Premier’s existing hedging positions means that the group will be able to sell oil at an average of $65 per barrel. But in 2017, this coverage tails off. Premier’s figures indicate that current hedging will only provide an average oil price of $45 per barrel in 2017.

If the oil price doesn’t make progress above $50, then this lack of hedging could have a significant impact on Premier’s cash flow.

Only one conclusion

Premier was tight-lipped about the likely terms of its refinancing in yesterday’s call. But it’s clear from management comments that other potential sources of cash — such as pre-pay agreements for oil and gas sales — won’t be viable until the firm’s lenders have agreed a new deal.

I think there’s a reasonable chance the refinancing package will include some kind of dilution for shareholders.

Even if it doesn’t, shareholders should remember that both growth and shareholder returns will effectively be off the cards for the next couple of years. Furthermore, if oil stays low, Premier’s financial difficulties could become even more severe.

I can’t see any reason to own the shares at this point in time.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

An open-cast coal mine

Why I’ve sold South32 Ltd

An open-cast coal mineDisclosure: I own shares of Anglo American and BHP Billiton, but not South32.

I’ve sold my shares in BHP Billiton-spin off South32 Ltd (S32.L). There are three main reasons for this:

  1. My holding was limited to the shares I received as a BHP shareholder. As such, it was a very small part of my portfolio. I’m trying to maintain a more deliberately-constructed portfolio without such oddments.
  2. I already have considerable mining exposure through my holdings of BHP Billiton and Anglo American. Both are sizeable positions (for me). I remain confident about the medium-term outlook for both companies but don’t feel that South32 adds much to the opportunity offered by these much larger firms.

As it happens, I think South32 is a fairly decent company. The balance sheet appears strong and cash generation also seems reasonable. Had I invested in size in South32 when the shares were lower, I might have made this a core position.

However, South32 looks fairly valued to me for now. I’m not tempted to buy more. So I decided to swallow the dealing cost and sell, in order to boost my cash position ahead of my next buy.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

Lonmin underground mine (copyright Lonmin)

Lonmin plc Q3 update: does this valuation still make sense?

Lonmin underground mine (copyright Lonmin)

Lonmin underground mine (copyright Lonmin)

Disclosure: At the time of publication, I own shares in Lonmin.

Lonmin shares have tripled in value in just seven months.

I’ve become increasingly aware that unlike the other big miners, Lonmin’s share price recovery is not backed by rising profits and substantial balance sheet improvements.

After such rapid gains, I thought it was worth taking a fresh look at the stock following yesterday’s Q3 update. I’m concerned that Lonmin’s financial progress may be slowing.

The company warned that full-year costs are now likely to be between R10,400 and R10,700 per PGM ounce, up from guidance of R10,400 per ounce previously. The rand also appears to be gaining strength relative to the US dollar.

In this article I’ll ask whether Lonmin’s market cap still makes sense. Is the risk/reward balance still favourable for equity investors?

How to value Lonmin?

Profits? Lonmin’s lack of profits makes valuation more difficult. Looking back at the group’s historical performance isn’t hugely helpful either. Between 2010 and 2014, Lonmin generated an average post-tax profit of -$9.4m. During this period, platinum prices were mostly higher than they are today.

The picture that emerges is one of unpredictable profitability driven by platinum prices, the USD/ZAR exchange rate and poor cost control and labour relations.

Book value? How about the value investor’s favourite metric, book value? Lonmin’s last reported book value was about 510p per share. The stock currently trades at a discount of more than 50% to this valuation.

However, as with the UK’s banks, a distinct lack of profits could mean that Lonmin trades below book value for a long time yet. A P/E of 20 — not unreasonable for a recovering cyclical business — would imply a net profit of $95m.

On the same basis, the current share price of about 230p implies a net profit of about $43m. Yet consensus forecasts suggest a loss of $17.9m this year and a profit of just $1.4m next year.

I fear that there’s a big gap between the performance implied by Lonmin’s current valuation and the reality.

PGM prices vs. exchange rates

Lonmin’s profits could rise sharply if the price of platinum continues to recover. This could well happen, as the white metal remains well below levels seen in the past:

IG Index 5yr platinum chart

Platinum prices over the last five years (source: IG)

However, recent gains in platinum — which has risen from $1,009/oz to $1166/oz since the start of July — have not resulted in rising forecasts. In fact, the consensus view has edged slightly lower, with the Reuters consensus forecast loss per share dropping from $0.15 to $0.19 at the start of August.

One reason for this may be the USD/ZAR exchange rate, which now appears to be moving against Lonmin:

IG USD/ZAR price chart

1yr USD/ZAR price chart (source: IG)

Exchange rates are at least as important as PGM prices for Lonmin. Yesterday’s update confirmed this view. Consider these figures, which represents 2016 and 2015:

Average prices $ basket incl. by-product revenue $/oz 796 907
R basket incl. by-product revenue ZAR/oz 11,864 10,861
Exchange rate Average rate for period ZAR/$ 14.99 12.08
Unit costs Cost of production per PGM ounce ZAR/oz 10,596 10,839

Data from Lonmin Q3 2016 Production Report

The USD PGM basket price has fallen by 12% over the last year, while the same basket priced in rand has risen by 9%.

This kind of swing is one of the reasons Lonmin’s historical profits have been so volatile. As a matter of policy, Lonmin’s doesn’t hedge commodity price exposure. Nor does the group have businesses in other countries which act as natural hedges.

Thus long-term survival is dependent on having low cost assets and building up a big cash pile when times are good. I’m not sure Lonmin’s track record of three rights issues since 2009 supports such a confident outlook for equity investors.

What about cash flow?

Ultimately, a business is only viable if it can generate positive cash flow.

Last year’s $407m rights issue left Lonmin with net cash of $69m. At the end of Q3, that figure had risen to $91m, suggesting positive cash flow of $22m so far this year. This figure may have been distorted by working capital and forex movements, so I’ve done my own sums.

Using Lonmin’s published figures from H1 and Q3, I estimate that the firm has generated operating cash flow of around $40m so far this year. After three quarters, Lonmin appears to be some way short of covering this year’s planned capex of $105m — which is the bare minimum necessary to maintain and improve current operations only.

Lonmin expects the fourth quarter to be the strongest, but warned in yesterday’s updates of a number of factors which “have the potential to interfere with production” during this period. These include local government elections and wage negotiations.

My verdict

Lonmin has clearly made a lot of progress since its rights issue. Chief executive Ben Magara appears to be doing a good job of transforming and maximising the potential of the business.

I believe Lonmin does have the potential to become free cash flow positive and profitable. But I can’t avoid the conclusion that this outcome is heavily dependent on unpredictable PGM prices and the USD/ZAR exchange rate. There’s also the risk that costs will creep up again. Lonmin appears to be at the mercy of factors it cannot control to a greater extent than some other miners.

A second concern is that Lonmin’s valuation appears to price in a return to levels of profit that are an order of magnitude above current forecasts. I suspect further share price gains will be as much down to good fortune as good management execution.

On that basis, I’m going to sell my shares in Lonmin.

Update 1/9/16: Perhaps this is another reason to sell.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.


A share tip circled in a newspaper share listing

Barclays plc H1 results: mixed news, but I’m holding

A share tip circled in a newspaper share listingDisclosure: I own shares of Barclays.

Today’s interim results from value portfolio stock Barclays plc (LON:BARC) came in ahead of analysts’ expectations, hence the 6% rally in the bank’s stock.

Notwithstanding this, group pre-tax profit was down 20.7% to £2,063m. Group return on average tangible equity fell from 6.9% to 4.8%.

One bright spot was that Barclays’ CET1 ratio has risen from 11.4% to 11.6% so far this year.

For value investors, a further highlight was that tangible net assets per share increased to 289p during the first half, up from 275p at the end of 2015. Barclays’ continued actions to dispose of non-core assets, including the initial 12% placing of Barclays Africa, seem to be having a positive effect on the balance sheet. Even after today’s gains, the stock trades at a 45% discount to NTAV.

The problem — or at least the risk — is that Barclays still appears to have a mountain to climb. This is best expressed by the contrast between the profits from the bank’s core divisions and the losses from its non-core division:

  • Core pre-tax profit 1H16: £3,967m (1H15: £3,347m)
  • Non-core pre-tax loss 1H16: £1,904m (1H15: £745m)

There appears to be a profitable bank waiting to escape from a whole load of loss-making dross. The question is whether Barclays can dispose of its non-core assets quickly and cheaply enough.

A second question is whether the bank’s profit margins can survive further cuts to interest rates, as now seem possible in the UK. CEO Jes Staley said today that while a base rate cut to 0.25% would have little impact on margins, a drop to 0% could be more “significant”.

What next?

Banks have already taken longer than expected to recover. Today’s results suggest progress is being made but make it clear that there’s still much further to go. From my relatively non-expert viewpoint, the macroeconomic context doesn’t seem likely to accelerate Barclays’ recovery.

However, the bank’s balance sheet is improving and a capital raise appears unlikely. Mr Staley has already cut the dividend in half. My view is that the stock’s discount to net asset value should provide some downside protection, as long as the profitability of Barclays’ flagship UK banking and Barclaycard operations isn’t called into question.

One final thought is that on a two-year view, the chart below suggests to me that Barclays shares might be due a rebound — note the improving RSI and Momentum readings:

Barclays share price chart

Barclays share price chart July 2016 (courtesy of Stockopedia)

For now, I continue to hold.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

Onshore oil installation

What does the DNO bid mean for Gulf Keystone Petroleum Limited shareholders?

Onshore oil installationDisclosure: I have no financial interest in any company mentioned.

I’ll update this post when Gulf’s board issues a statement or any further news emerges.

Update 29/07/16 @ 1945: Gulf Keystone issued a response to the DNO proposal after the market closed today.

The firm says that as the DNO proposal is for a post-restructuring takeover, the firm’s focus remains firmly on executing the restructuring successfully. Significantly Gulf emphasises that:

“we will not engage in any additional process that causes the Company to be distracted from that objective” [the restructuring]

In my view this implies support for the DNO proposal. But even if I’m wrong, this story can only end one way. Gulf Keystone shares remain dramatically overvalued, in my opinion.

Update 29/07/16 @ 1010: Gulf Keystone has issued a holding statement saying it is reviewing DNO’s proposal.

Update 29/07/16 @ 0945: Gulf Keystone shares continue to trade up on the day at about 4.2p versus the restructuring share issue price of c.0.83p and the DNO offer price of 1p.

This is crazy in my opinion. Although the DNO bid arguably undervalues the long-term upside from Shaikan, it certainly doesn’t undervalue it by a factor of 300 per cent or more. I remain confident that Gulf Keystone shares have much further to fall.

DNO makes $300m offer for GKP

Norwegian operator DNO ASA has launched a $300m takeover bid for Gulf Keystone Petroleum Limited (LON:GKP).

The cash and shares deal is intended to be implemented after Gulf’s proposed refinancing has been completed.

DNO’s offer is priced at a 20% premium to the equity value of USD 0.0109 at which Gulf Keystone plans to issue new shares under its refinancing plan.

DNO appears to have designed the offer to attract Gulf’s bondholders. This makes sense, as with Gulf in default on its bonds, the firm’s bondholders are in de facto control of Gulf Keystone.

According to this morning’s release from DNO, here’s what’s on offer:

  • For the Gulf Keystone guaranteed noteholders, the DNO terms reflect 111 percent of par value compared to 99 percent under the contemplated restructuring;
  • For the convertible bondholders the DNO terms reflect 18 percent of par value compared to 15 percent under the contemplated restructuring;
  • For ordinary shareholders, the offer represents a 20 per cent premium to the share price of USD 0.0109 at which Gulf Keystone is planning to issue new shares as part of the planned restructuring.
  • $120m of the offer will be in cash, with the remainder in shares. This will provide bondholders who don’t want to hold equity to make an immediate exit in cash (rather than having to try and dump their equity into a soft market).

There’s no response yet from Gulf Keystone’s board. I’d imagine that this is because they need to consult with their bondholders before issuing a statement.

My view is that this offer is likely to be attractive to Gulf Keystone’s bondholders.

Will anyone outbid DNO?

DNO is the largest of the Kurdistan producers in terms of both production and reserves. This morning’s statement made it clear that DNO is top dog in Kurdistan, and points out that Gulf Keystone is already dependent on its pipeline connection facilities.

I particularly liked the way that DNO emphasised that its oil is better quality (higher API number = lighter oil) than that of GKP. Here’s an extract from DNO’s proposal:

DNO has been active in the Kurdistan region of Iraq since 2004 and ranks number one among the international oil companies in oil production (50 percent), oil exports (60 percent) and proven oil reserves (50 percent).

DNO holds a 55 percent stake in and operates the Tawke oil field at a current production level of around 120,000 barrels of oil per day (bopd) of 27 degree API crude. Gulf Keystone holds a 58 percent stake in and operates the Shaikan oil field at a current level of around 40,000 bopd of 17 degree API crude.

Production from Shaikan is transported daily by road tanker to DNO’s unloading and storage hub at Fish Khabur for onward pipeline transport to export markets.

In my view, this is an opportunistic but pragmatic and fair offer from DNO. The reality is that companies in financial distress — like Gulf Keystone — can’t pick and choose. Gulf may not have the luxury of waiting until the market improves before selling up.

Gulf Keystone bulls will presumably believe that today’s offer from DNO is the opening salvo in a bidding war. Personally, I doubt this. My view is that other Kurdistan firms are unlikely to make a competing offer. DNO’s deep connections in the region give it an advantage. I can’t see an outsider wanting to get involved given the complexities and risks of operating in Kurdistan.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

A tunnel in a deep mine

Anglo American plc: good news on debt reduction outweighs concerns

A tunnel in a deep mineDisclosure: I own shares of Anglo American and BHP Billiton.

Portfolio holding Anglo American plc (LON:AAL) issued its interim results this morning.

The firm’s shares had already tripled in value from January’s low, but this didn’t stop the stock from printing further gains when the market opened.

Debt on track

The big news was that Anglo expects to hit its $10bn net debt target this year, without needing to make any further divestments.

According to chief executive Mark Cutifani, the only dependency is that the asset sales already announced this year — principally the $1.5bn sale of Anglo’s niobium and phosphate assets — complete on schedule.

The group is thought to be negotiating a possible sale of its Australian coal assets to BHP Billiton, but there was no news on further asset sales today.

Mixed performance

The group’s financial performance during the first half was more mixed. Underlying EBIT (operating profit) fell by 27% to $1.4bn, due to lower commodity prices.

However, costs are falling. Copper equivalent unit costs fell by 19% versus the first half of 2016, and Anglo has now locked in $0.3bn of this year’s planned $1.6bn of cost savings and volume improvements. Anglo’s pre-tax loss shrunk from $1,920m last year to just $364m.

Attributable free cash flow of $1.1bn was a big improvement on $0.2bn for the same period in 2015. Attributable ROCE remained unchanged at 8%.

Which earnings are real?

Earnings per share for the six months to 30 June 2016 were ($0.63), $0.34 or $0.54, depending on which version of Anglo’s earnings you choose to believe!

Here’s a quick summary of what each version of profit represents:

  • Statutory or reported earnings per share = ($0.63) — this includes all exceptional costs and one-off items, including non-cash impairments and gains. This is the version of profit required by IFRS accounting standards, as used by UK plcs. Anglo’s decision to apply a $1,248m non-cash impairment charge to its coal assets made it certain that H1 reported profits would be negative, but in cash terms the group’s mining business was profitable.
  • Headline earnings per share = $0.34 — headline earnings is a performance measure defined by the Johannesburg Stock Exchange, on which Anglo also has a listing. Based on this document on the JSE website, the purpose of headline earnings appears to be provide a more accurate view of operating profits, excluding the one-off losses and gains that result from revaluing an asset. This is particularly pertinent to mining and energy companies, who tend to revalue assets upwards and downwards as commodity market conditions change. These non-cash charges don’t generally affect operating performance. I’d suggest that this headline earnings figure is the most realistic measure of Anglo’s H1 trading performance. It also seems to correlate best with current consensus forecasts for earnings of $0.50 per share in 2016.
  • Underlying earnings per share = $0.54 — in addition to headline earnings, Anglo also provides its own underlying earnings per share figure. Based on note 10 to the H1 accounts, this is a more generously adjusted figure than headline earnings. Costs which do not qualify for exclusion from headline earnings are excluded from underlying earnings. I’m not certain, but the disparity between H1 underlying earnings of $0.54 per share and consensus forecasts for FY adjusted earnings of $0.50 per share suggest to me that analysts’ view on what constitutes a reasonable adjustment to earnings may not be as generous as that of Anglo’s management.

While I don’t tend to rely on consensus earnings for valuation, the momentum implied by a continue trend of forecast upgrades or downgrades can be a useful indicator of likely performance.

Consensus forecasts for Anglo’s 2016 earnings have now risen from a low of $0.16 per share in January to $0.50 per share. I take this as a positive sign.

My view

Today’s results were slightly better than I expected and suggest Anglo American’s turnaround is proceeding to plan. The stock looks cheap relative to historic profit levels and remains at a 15% discount to tangible net asset value.

While future profits may not match historic highs, I’m fairly confident that there is more upside to come.

I continue to hold.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

Glass skyscraper building

ShareSoc Leeds growth company seminar 19 July 2016 review (TOWN, FISH, INS & IHC)

Glass skyscraper buildingDisclosure: I have no financial interest in any company mentioned.

As a North Yorkshire resident, I can’t generally justify travelling to London for investor events. So I was happy to receive an invite to the inaugural ShareSoc Growth company seminar in Leeds on Tuesday 19 July.

The Leeds seminar was apparently ShareSoc’s first Yorkshire event and featured presentations from four small-cap companies:

  • Town Centre Securities (TOWN)
  • Fishing Republic (FISH)
  • Instem (INS)
  • Inspiration Healthcare (IHC)

The evening followed a pleasant format, with a break half-way through and a buffet at the end, giving everyone a chance to speak to each other and to the execs from the presenting companies. Drinks and refreshments were available throughout and the organisation was excellent.

The location was a central Leeds hotel, just five minutes from the station and from a nearby multi-storey car park.

A similar event is planned in Altrincham in on 27 September and again in Leeds later this year, so if you’re interested in attending (it’s free), keep an eye on the Events page on the ShareSoc website.

Here’s a quick round-up of my notes from the event.

DISCLAIMER: Please note that these comments are based on my impressions from the seminar. They are not advice or buying recommendations. I haven’t looked closely at these companies’ finances but would certainly do so before considering investing. Please do your own research if you’re considering buying (or selling) these stocks.

Town Centre Securities

A small cap (£151m) REIT focusing owning and developing provincial retail property. Headquartered in Leeds, where 55% of its portfolio is located. Other major sites are in Manchester, Glasgow, Edinburgh and increasingly some of the outlying London towns, e.g. places like Watford.

Family owned, with the Ziff family controls a total of 61% of the shares, according to executive chairman Edward Ziff, who is the founder’s son. Listed since 1960 and has never cut its dividend — although the payout also hasn’t increased since 2011.

On the face of it, this looks a well-run company which has adapted to the decline of the small town high street by withdrawing from smaller towns and focusing on larger properties in key cities. The group is currently in the middle of its second successful foray into the parking business, although Ziff warned they might sell at an opportune moment, as they’ve done before.

One potential concern here is that gearing is high by REIT standards, with a loan-to-value ratio of almost 50%. This compares to c.35% for larger REITS such as British Land and SEGRO (disclosure: I own shares in SEGRO).

Ziff was unapologetic about this and says the group’s stable lease income has historically enabled the  firm to maintain high gearing without problems. He made the fair point that Town Centre Securities didn’t have to raise cash following the financial crisis, unlike a number of its peers.

A set of financial data for each company was provided by Stockopedia, which highlighted an interesting quirk. Stockopedia show’s the firm’s earnings per share falling dramatically in 2016. But this isn’t the case.

According to FD Duncan Syers, this is the result of accounting rules requiring the group to state earnings per share including a property valuation surplus. True earnings last year were 12.1p, inline with forecasts for the current year.

My view: Town Centre Securities currently trades at a 20% discount to NAV and offers a yield of about 3.7%. Earnings and dividend growth seems likely to remain slow, something Ziff blamed on the low interest rate environment. The shares look reasonably valued at the moment, but I might be tempted if they fell further.

Fishing Republic

Fishing Republic is a retail roll out that’s targeting the creation of a nationwide chain of large format (4,000 sq. ft+) fishing tackle shops.

The group floated on AIM in June 2015, and has opened or acquired four new stores since then, taking its total to 10. When questioned about expansion plans, CEO and founder Stephen Gross said that the group was comfortable with the rate of expansion it had managed since the IPO, from which I’d infer that four large stores a year is achievable, perhaps more.

Questioned about the size of the target market for acquisitions, Gross said that there were 2,300 tackle shops in the UK, of which about 100 are large enough to meet Fishing Republic’s requirement for a large format store.

Questions regarding the rate of stock turnover and working capital were raised in the context of Paul Scott’s comments on Stockopedia. FD Russell Holmes said that stock turn varies widely — some stock turns over very quickly, e.g. bait and consumables, while some is much slower. Overall he’d expect established stores to have a stock turnover rate of 3-6 months.

My view: I can see that a strong brand plus a large choice of stock in-store will help Fishing Republic build up a loyal client base. This will help to generate big ticket sales and gain market share. But it does seem to require the group to tie up a lot of money in stock. The company invested almost £1m in working capital last year, versus forecast sales for this year of £6.5m. Cash generation could be a concern here.

If historic operating margins of 10%+ can be maintained, along with decent like-for-like growth on top of acquisitions, then this model could work. The group recently raised £3.75m in a placing from a group of investors including former Tesco boss Sir Terry Leahy (disclosure: I own shares of Tesco). This year’s interim results should provide a more accurate view of progress.


Instem provides software and related services which helps life sciences and pharmaceutical companies manage and compile the data they need to test, develop and gain approval for new products. The company has an impressive roster of clients, including most of the big pharmaceuticals.

As you might imagine, developing and testing new drugs involves a lot of data. Because patent protection starts from a relatively early point in the development process, there’s money to be made from speeding up this timeline. Doing so extends the time during which the drugs can be sold with patent protection — i.e. at much higher prices. The impact of the ‘patent cliff’ seen over the last few years has brought this into sharp focus, both for investors and for the industry.

Instem’s goal is to make itself an indispensable service provider whose software helps speed up drug development. A 98% customer retention rate suggests that Instem’s products are quite sticky. Once years’ of test data are populated into a system, shifting to an alternative isn’t attractive.

Looking at the financials, Instem’s revenues have risen by 63% since 2010, but profits haven’t followed suit. The company says this has been due to investment in a more comprehensive global sales and support network.

My view: CEO Phil Reason says the firm’s expansion is now largely complete and that results should start to follow. Current broker forecasts are for earnings of 10.4p per share this year, putting the stock on a P/E of 22.

I can see that helping manage big data for pharmaceutical firms could be a big business. But I’d want to do more research to understand the size of the potential market and the position of Instem’s competitors.

I’d also take a closer look at the firm’s accounts — Instem is quite an old business and a quick look shows a £3.9m pension deficit that required a £427,000 cash payment last year. These are material figures versus a forecast 2016 net profit of £1.7m.

Inspiration Healthcare

Inspiration Healthcare arrived on AIM last year by reversing into medical equipment firm Inditherm. Thus all the historic financials available on Stockopedia and elsewhere for Inspiration Healthcare are misleading — they refer to Inditherm, not Inspiration.

Inspiration specialises in selling medical equipment for neonatal intensive care and operating theatre applications. It started as a distributor, but is moving progressively into selling its own equipment, which offers greater growth and profit potential.

The company was founded in 2003 by CEO Neil Campbell and sales director Toby Foster, who were at the presentation. They came across as expert and enthusiastic and clearly have a successful long-term partnership. There’s certainly a key person dependency here — if either were to leave the company, shareholders would be right to be worried, in my view.

The firm does a lot of business with the NHS — Campbell estimated that some of its core neonatal intensive care equipment has a penetration rate of 70-80% in UK hospitals.

Overseas growth — selling its own product range — is an opportunity that could deliver long-term gains. However, this may come at a measured pace, due to the time which can be required for regulatory approvals.

The UK’s leadership in medical training appears to be a key advantage in terms of overseas growth. Doctors from all over the world are trained here. They then do rotations in NHS hospitals, where they gain exposure to Inspiration’s equipment. On returning home they then act as advocates for its adoption in their own countries.

Inspiration stock is very tightly held by Campbell, Foster and the two other founding investors. Free float is just 20% and the spread is pretty painful. Campbell says they are aware of this problem and are working on a way to release stock into the market without (in their view) selling too cheap or spooking the market with an apparent founder exit.

My view: According to Campbell, the company has always been cash generative and remains so. Forecasts for this year and next put the stock on a P/E of about 17, which seems reasonable for a company with a track record of steady growth. As with Instem, I’d want to do more research to understand the competitive landscape and growth potential.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

Onshore oil installation

Answering questions about Gulf Keystone Petroleum Limited

Onshore oil installationDisclosure: I have no financial interest in any company mentioned.

I’ve received a couple of emails from readers regarding Gulf Keystone Petroleum (GKP.L).

The bulletin boards are awash with complaints suggesting that the board of directors have failed in their duty to shareholders — and that a takeover bid at a ‘fair’ price may be just over the horizon.

Rather than responding to emails individually, I thought I would comment on some of the points raised here.

For what it’s worth, I think a takeover bid is unlikely.

I think the real problem is that shareholders have misunderstood the significance of Gulf Keystone’s debt. The interests of the firm’s lenders rank above those of shareholders. Because Gulf is in default, shareholders are not entitled to anything until the firm’s lenders recover both the money they’ve lent and the interest due on it.

This is  how corporate financing works — debt is senior to equity.

It’s exactly the same as when a homeowner is in arrears on their mortgage. The mortgage lender can repossess and sell the home without any regard for the interests of the homeowner (who is the shareholder in this scenario).

A takeover would be expensive

The other point is that Gulf’s debt would inflate the true cost of any takeover.

For example, in a regular takeover situation, a buyer would have to accept and fund Gulf Keystone’s $575m of bonds, plus interest. In April, Gulf said that $71m of expenditure would be required just to maintain production at 40,000 bopd. So that’s $646m in total, plus interest, without any production increase and with the shares valued at 0p.

Adding interest payments plus a notional (and very generous) 20p per share would take this total close to $1bn.

And that’s without considering the investment needed to increase Shaikan production to Gulf Keystone’s medium-term target of 100,000 bopd. We don’t know what the cost of this would be, but Gulf said earlier this year that $71m would be needed just to maintain production at 40,000 bopd, while $88m would be needed to increase production to 55,000 bopd.

It’s probably fair to assume that the total needed to get to 100,000 bopd would be significantly higher, or else the firm would have mentioned it in April’s update.

Given the low oil price and the difficulties that Kurdistan producers have in collecting payment for oil exports, an upfront investment of $1bn+ in Shaikan may not be a very attractive opportunity. The return on investment could be lower and slower than expected.

What next?

As I write this on Monday morning (18 July), the shares have spiked up by 20% to 3.8p. In my opinion, this is a good selling opportunity. I expect them to fall to the refinancing price of 0.82p and perhaps below in due course.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.