2013 – The Great Irish Share Valuation Project (Part VI)

Tags

Bank of Ireland, Grafton Group, Great Western Mining Corp, Irish shares, Irish value investing, Karelian Diamond Resources, Kentz Corp, Risk Weighted Assets, TGISVP, The Great Irish Share Valuation Project, US Oil & Gas, USA Graphite Inc.

Continued from here.

Company:   Karelian Diamond Resources

Prior Post:   Here

Ticker:   KDR:LN

Price:   GBP 0.525p

Seriously, is this a company, or a joke?! It’s literally held together with spit & baling twine… I shouldn’t be surprised: It’s another Dick Conroy vehicle, and he runs it as tightly as John Teeling does his companies. The company had a mere EUR 10 K on hand at end-May 2012 (no results since!?), EUR 1.0 mio in loans, and EUR 0.8 mio in accrued director compensation. And it goes without saying the company has nothing tangible (in terms of reserves & resources) to show for its exploration efforts…

In the last year, the share price declined 70% – most of the way to my price target. Now, with an (absurd) GBP 0.5 mio market cap, KDR still remains ridiculously over-valued – in fact, it’s quite obviously worthless. Really, who on earth owns shares like this? Please contact me – I’ll shove a thermometer up your ass, and check for high fever.

Price Target:   Zero

Upside:   (100)%

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Company:   Bank of Ireland

Prior Post:   Here

Ticker:   BKIR:ID

Price:   EUR 0.137

For me, Bank of Ireland’s still a reach too far… Sure, their most recent Core Tier 1 Ratio is at 13.9%, but really, that’s just a crock! B/I only has EUR 8.8 bio of equity, supporting EUR 158 bio in total assets – see the disconnect?!

Isn’t that just 5.6% of equity? Nope, not if you rely on the magic of Risk Weighted Assets. Now, before somebody corrects me, I do understand the concept (well, say about as well as a regulator ;-)), and it has a certain charm & logic (like most dangerous ideas). I’d probably even find it handy if I was performing a comparative risk analysis on some potential bank stocks. But lift your eyes from the white paper & look around the real world – it won’t be long before you’re painfully reminded how God-awful quickly risk-free assets can turn risky! And tomorrow‘s risk isn’t necessarily a risk you’ve seen before…

If you really do want to invest in bank stocks, it seems obvious the v first requirement should be an equity ratio of at least 8%, even 10%. And that’s something you should calculate yourself – it isn’t difficult, just ignore everything management says. To mangle what Buffett said, a good investor only needs simple arithmetic: Just hit the balance sheet, and calculate equity/total assets – go on, you can simply eyeball it!

Even now, investors & home-owners aren’t quite sure if the decline in Irish property prices is actually over. Which explains the continued increase in B/I’s ‘impaired’ loans & their never-ending write-downs. Which may not be over yet: Their latest (total) impairment provision is only EUR 7.1 bio. Only..?! Well, I take a pretty simple top-down approach to loan losses: Picture the average loan B/I was making some years back – let’s say it was a house loan for a middle manager, up to his neck in debt & desperation. I’m probably being kind if I presume the LTV was only 80%. But for every 80 cts of debt, the bank’s original 100 cts of collateral has now melted away to say 40 cts, at best. Sure, they probably have impaired loans in better shape, but you can bet they’ve plenty in far worse shape too…

So, a 50% haircut on impaired loans looks about right to me, which would be about EUR 7.7 bio. Well, that doesn’t compare too badly with B/I’s current provision…except we can’t forget another EUR 5.7 bio in ‘past due but not impaired’ loans. If you’re pessimistic, you may want to assume these loans also end up impaired. If you’re optimistic, you might just be deluded..! But let’s take the middle road & assume a 25% haircut on these – that’s another EUR 1.4 bio of potential losses that could show up (and certainly haven’t been provisioned for). That all amounts to an incremental EUR 2.1 bio adjustment I’d make to B/I’s total provision & equity.

Basing a valuation even on this adjusted equity might prove too generous. Stripping out losses/provisions, underlying return on equity is in the low single digits. This can be directly traced back to the current 1.20% net interest margin – which has been horribly affected by B/I’s elevated cost of funding. Most banks need at least a 200 bps margin to start generating decent returns on equity. But it’s not at all clear when that might happen – granted, things have been feeling a little rosier recently, but we all know the European sovereign debt crisis could kick in again at any time.

But then again, B/I offers a great long-term play on the entire Irish economy. [Though I’ll humbly suggest FBD Holdings (FBD:ID) offers similar exposure, but with far less risk]. And it’s clearly in the catbird seat when les bon temps rouler, with the other Irish banks on life-support (or gone terminal). Recognizing this, let’s apply a 1.0 P/B ratio to my adjusted equity figure – despite everything, B/I actually offers some pretty decent upside.

Price Target:   EUR 0.224

Upside:   64%

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Company:   Kentz Corp

Prior Post:   Here

Ticker:   KENZ:LN

Price:   GBP 380p

KENZ has evolved totally at odds with my previous price target! In fact, the shares have fallen 16% in the past year – and I’m really at a loss to explain why… In their recent trading update, their backlog is +7% yoy at $2.57 bio, and their pipeline of prospects is +32% yoy at $13.2 bio. Their last results were equally creditable, with revenues increasing 9%, while PBT jumped 36% yoy. Unfortunately, 4% growth in diluted EPS didn’t keep abreast – a substantial portion of the (incremental) profit was earned in JVs, and dropped down into minorities. However, if there’s similar revenue & pre-tax profit growth in the coming year, we should see significant earnings growth drop directly to Kentz’ bottom line.

I think a lot of investors simply find it hard to wrap their heads ’round the risks an engineering contractor like Kentz presents. I can definitely sympathize… Sometimes, no matter how much analysis you do, there’s the risk you wake up some day to learn of a project that’s gone horribly wrong – and suddenly the company’s finances are hanging by a thread. One fairly drastic solution is to avoid the sector altogether – no harm in that, I often say ‘If it’s too difficult, just move on!‘.

But Kentz’ exposure to natural resources, and the growing number of complex/multi-billion dollar projects in the sector, is a secular trend I’d like to embrace more. The fact most of their exposure comes from oil, gas & petrochemical projects is doubly encouraging for me – I particularly like the increasing emphasis on gas & LNG. Kentz has an impressive history of revenue growth, margins are consistent & increasing, and there’s no history of project disasters. Their prudence is also reflected in the fact 70% of their contracts are on a reimbursable basis (and another 8% are unit rate reimbursable), and by the $220 mio of net cash on the balance sheet.

Kentz’ operating margin (adjusting for average minority interest in the past year) remains around 6.3%, so a 0.6 Price/Sales ratio still looks about right, together with a substantial debt adjustment to reflect their financial strength (they’re interested in acquisitions). Recent EPS growth was surprisingly low, but should be balanced against historical growth & a likely re-acceleration in earnings – a 15 P/E ratio now seems a fair compromise (though I suspect it might prove conservative in due course). This drops my price target marginally (vs. last year’s), but with the yoy drop in the share price, Kentz offers significant upside.

Price Target:   GBP 552p

Upside:   45%

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Company:   Great Western Mining Corp

Prior Post:   Here

Ticker:   GWMO:LN

Price:   GBP 3.25p

The O’Connells are firmly in the driving seat here, with a major stake, but I can’t help noticing GWMO comes from the same stable – or should I say, pub – as the likes of US Oil & Gas (USOP:G4) & a couple of others. It mystifies me how the rest of the portfolio have been (unsurprising) duds, while USOP managed an astonishing $450 mio market cap at one point?! Perhaps they should all merge – some of that USOPian desert ‘magic’ might rub off…

[Actually, I take it back. There’s a much better company for USOP to merge with – it’s called USA Graphite Inc (USGT:US). It’s another Nevada desert dweller, but boasts the usual multi-billion dollar potential. Sound familiar? It’s also enjoyed a ridiculous amount of ramping – at one point, if I recall, a paid ramper claimed the $1 share price would reach $72! Needless to say, this piece of crap has collapsed instead, even more spectacularly than USOP. Put them together, and I’m sure you’d have an unstoppable double-barreled drilling/digging machine – they could adopt USOT as a new ticker?! ;-)]

Actually, seriously, a merger might be the best news all ’round for GWMO. ‘Cos if you consider their current cash-burn rate, vs. their latest cash (EUR 0.3 mio) & placing (about EUR 0.6 mio), the company is otherwise worthless. [Rather than pointing out how worthless most junior resource stocks are, perhaps I should just remind shareholders how long they’ve been peddling their promises… Might be more effective? If GWMO’s prospects are so great, how come it’s got nothing tangible to show for itself almost 9 years after incorporation?]

Price Target:   Zero

Upside:   (100)%

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Company:   Grafton Group

Prior Post:   Here

Ticker:   GN5:ID

Price:   EUR 4.80

I saw significant upside for Grafton last year, but nothing like the near-doubling in the share price we’ve actually seen. I guess investors now see a tipping point, with UK revenues slowly & steadily advancing, and Irish revenue decline now limited to low single digits. To me, that seems a little too enthusiastic… I was certainly positive on the stock, but that was based on a sustained rebuilding of margins (complemented by hefty operating free cashflow (Op FCF)), rather than a sudden acceleration in revenues.

And the recent surge in EUR/GBP spells looming trouble for revenue & earnings – 75% of Grafton’s revenues now come from the UK, but it still reports in EUR. If the current 0.86+ rate (or even 0.88+) is sustained, don’t be surprised to see Grafton suggesting a GBP re-denomination later this year. And if there’s scope for a UK index admission, they might just go the full hog & dump their Irish listing in favour of the UK.

Meanwhile, they continue to keep their heads down, and are making steady progress. Their latest trading statement confirms revenues of EUR 2.17 bio for 2012, and an adjusted operating margin of not less than EUR 70 mio. I think it’s reasonable to expect Op FCF will continue to run well in excess of that, which suggests a FY Op FCF margin of 4.3%. This now puts interest coverage within tolerable levels, with further improvement to come.

At worst, I think any 2013 currency impact will be glossed over as a once-off – at best, it won’t even be an issue. Continued progress on revenue & margins will absorb some of the brunt anyway. I think it’s reasonable to stick with my existing investment thesis – Grafton will eventually build Op FCF margins back up towards peak levels (around 7%). This will be achieved through further rationalization, and slow but steady growth. Acquisitions will likely feature again, fairly soon, once confidence improves further & the company frees up some cash/debt capacity. Averaging current & prospective margins, an improved 0.5 Price/Sales ratio seems justified – Grafton appears to be fairly valued right now.

Price Target:   EUR 4.68

Upside:   (3)%

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As usual, I’m attaching my latest/detailed Excel file here. For all previously reviewed companies (year-to-date), share prices have been updated (plus FX rates & certain other inputs), so the attached file is actually a real-time ranking (by potential upside) of all companies covered.

2013 The Great Irish Share Valuation Project VI     (xlsx file)

2013 The Great Irish Share Valuation Project VI     (xls file)