2014 – The Great Irish Share Valuation Project (Final – Part X)

Tags

Aer Lingus Group, Dalata Hotel Group, Donegal Investment Group, Escher Group Holdings, Irish Residential Properties REIT, Irish shares, Irish Stock Exchange, Irish value investing, ISEQ, Karelian Diamond Resources, Mainstay Medical International, TGISVP, The Great Irish Share Valuation Project, TVC Holdings, Zamano

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.]

OK, it’s the final furlong..! This should be my last TGISVP post – that will make it a grand total of 80 Irish companies, all covered in very random order since February. Except this last post – I deliberately withheld DCP:ID & ZMNO:ID ’til I got around to posting separate write-ups for each, plus I’ve only just added another 3 (recent) Irish IPOs. I also debated including 3 other vaguely ‘Irish’ stocks, but decided (somewhat arbitrarily) against them in the end…

[FYI, my 3 rejections were:

– Kennady Diamonds (KDI:CN):   Dermot Desmond has long been involved here – he currently owns a 17.5% stake & the Chairman Jonathan Comerford’s actually an investment manager with IIU. However, the company has no other Irish connections, and I’ve never noticed any kind of Irish PI/institutional following for the stock.

– Kennedy Wilson Europe Real Estate (KWE:LN):   KWE’s a new fund launched by Kennedy-Wilson Holdings (KW:US), focused on investing primarily in real estate & real estate loans in the UK, Ireland & Spain. While the fund’s already completed a chunky Irish acquisition, one would expect Irish assets will ultimately be the smallest component of the portfolio (considering the relative size of the UK/Spanish economies & property markets).

– Metro Baltic Horizons (MET:LN):  MET’s another of those funds launched back in 2006 – focused on property development in the Baltic States & St. Petersburg, and targeting a minimum 25% IRR. Aaah, those were the days, eh..?! Garrett Kelleher & Dermot Desmond/IIU (again!) originally backed the company (with a 27% stake between them), and after some farcical/fraudulent events along the way, the board’s now comprised of a senior IIU executive & two other Irish directors. MET has become a cash/litigation shell & a suspension of its listing’s now imminent – but we should hopefully see some new proposals (inc. a continuation of MET’s listing) from the board shortly.]

So, without any further ado – let’s dive right in & finish up:

Company:   Donegal Investment Group

Prior Post(s):   2012 & 2013

Ticker:  DCP:ID

See my (recent) separate write-up.

Price Target:   EUR 17.77

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Company:   Zamano

Prior Post(s):   2012 & 2013

Ticker:  ZMNO:ID

See my (very recent) separate write-up.

Price Target:   EUR 0.263

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Company:   Escher Group Holdings

Prior Post(s):   2012 & 2013

Ticker:   ESCH:LN

Price:   GBP 330p

I’m slightly amazed to see ESCH shareholders still keeping the faith – in fact, they’ve pushed the share price higher (though it’s backed off from a March high of 395p). But with 42% of Escher owned by management, and another 40% in the hands of its three main institutional investors, the share price isn’t necessarily that representative of underlying intrinsic value anyway. The company’s 2013 performance definitely struck a bum note vs. the high growth/high margin story shareholders bought into so enthusiastically. Revenues only increased 8% to USD 24.7 million, putting ESCH on a 4.2 Price/Sales multiple!

That looks pretty rich when its operating free cash flow margin’s averaged just 6.8% in the past two years, while free cash flow was negligible. Even more so, when you ponder its revenue composition: A whopping 50% of Escher’s revenue comes from its top 2 customers, plus software development & consulting’s actually been the key revenue growth driver in the past 2 years (and is now almost 50% of total revenue). Now, we can obviously expect a migration from consulting revenue to recurring contract revenue, but how much & when are crucial questions. One way or the other, the transition will likely present another revenue growth challenge. [However, I’m encouraged by promising signs of diversification into e-government, and mobile loyalty, reward & payment – though I suspect these are small revenue streams for the moment. Revenue of USD 6 M deferred into H1-2014 is encouraging too – but doesn’t necessarily guarantee a blockbuster year].

Historically, Escher has managed to clock up 30%+ operating margins – which intuitively makes sense for this kind of business – unfortunately, those margins are likely to remain out of reach in the near/medium-term. Right now, for valuation purposes, let’s bridge the gap by assuming ESCH can re-attain half those margins – and I mean on a cash flow basis – which deserves a 1.5 Price/Sales multiple. With cash & debt broadly similar, and free cash flow roughly neutral, we can ignore any potential cash/debt adjustments:

USD 24.7 M Revenue * 1.5 P/S / 1.6719 GBP/USD / 18.7 M shares =    GBP 119p

Escher remains substantially over-valued. While a share price of 330p might reflect the future outlook for ESCH, it certainly doesn’t appear to adequately reflect the gap (& the risks) between today’s financials & that potential future… Time will tell – investors may simply prefer to keep focusing on a diet of fresh contracts/news flow, rather than profits.

Price Target:   GBP 119p

Upside/(Downside):   (64)%

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Company:   Karelian Diamond Resources

Prior Post(s):   2012 & 2013

Ticker:  KDR:LN

Price:   GBP 2.225p

Wow, what a crazy ride it’s been for KDR’s shareholders… They’ve certainly bounced back nicely from the share price collapse I (correctly) predicted two years ago. In fact, in the past year, KDR managed an astonishing near-1,000% rally at one point! The graph is just as astonishing:

Yup, I didn’t see that coming..! Incidentally, it’s worth taking a closer look at the actual chart, and KDR’s news & placing history – the serendipitous timing of some of the splendiferous diamondiferous news flow, price rallies & share placings is even more astonishing! 😉 Well, perhaps it’s bested by the chuckle-muppets who actually own this PoS: As they so frequently remind us on the message boards, they’re masters of timing – always catching the tops & bottoms just right – so I suppose we should presume they’ve banked astonishing profits..?! But the chart above is also a reminder KDR’s rapidly returning to earth again. And the long-term chart’s a prescient reminder of what it’s really like for shareholders:

All in all, the recent price surge was really just a pleasant diversion – KDR still has nothing tangible to show for itself (in the way of booked reserves, or resources). However, it’s managed an astonishing 4 placings in the past 6 months, more than tripling its outstanding share count – a grim reminder any possible shareholder value here (however remote) will surely be diluted away. Totting up cash, debt, net payables, annual cash burn & cash raised since (plus debt/payables written off) will nail down a valuation for us:

(EUR 0.0 M Cash – 1.2 M Debt – 1.5 M Net Payables – 0.3 M Annual Cash Burn + (GBP 2.7 M Placing Cash * 93% + 0.9 M Debt/Payables Write-Off) / 0.8135 EUR/GBP) * 0.8135 EUR/GBP / 287 M Shares = GBP 0.3p

KDR remains horribly over-valued – I think we can safely assume shareholders will end up disappointed here all over again.

Price Target:   GBP 0.3p

Upside/(Downside):   (84)%

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Company:   Aer Lingus Group

Prior Post(s):   2012 & 2013

Ticker:  AERL:ID

Price:   EUR 1.50

Aer Lingus continues to crank out the cash. The short haul business remains very competitive, but that’s nothing new… Long haul’s a very different story – none of the airlines flying into Ireland has any interest in killing the golden goose with a price war. In fact, the latest round of US airline consolidation simply encourages them to slap passengers around even more – I’m sure they plan to raise prices significantly, particularly on transatlantic routes where they perceive US passengers to be relatively price insensitive. AERL’s nicely positioned for this, with its 2014 transatlantic capacity up 40%+ (from 2012 levels) after the recently announced expansion of its Shannon-Boston/New York routes & its new Dublin-San Francisco/Toronto routes.

With the Irish economy now offering a more attractive (i.e. cheaper) tourist destination, and a steady revival in domestic demand, AERL’s only real problem is the old reliable…Aer Lingus staff! The mind boggles at the entitlement mentality that still exists (this AIB story is hilarious too) – you have to wonder if the workforce somehow believes it’s still  working for a government-owned company. [Hmm, Leo Varadkar (the Bobby Jindal of Ireland?!) probably likes to give that impression when he’s  out campaigning]. Now the union’s back up to its old tricks, threatening/calling industrial action every few months.

I suspect this story will run & run for most of 2014, but eventually a pension settlement will be reached – ideally, it also includes some limited agreement on pay restraint & labour flexibility. Aer Lingus already has EUR 140 million on offer (in line with a Labour Court recommendation) to plug the IASS pension deficit – at a guess, they’ll raise this another 50% in the end. Playing it safe, let’s assume the final settlement’s actually a cool quarter of a billion – in return, AERL can surely expect at least 2-3 years of peace from the workforce. [Yes, I agree, it’s a bloody steep price to persuade employees to do the jobs they’re paid for…frankly, the best long-term project for the company is to rebuild the workforce from the ground up. As the joke goes: ‘How do you know she’s with Aer Lingus? ‘Cos her daughter works for Ryanair..!‘]

Unfortunately, shareholders should approve this corporate bribe. [Hmm, if AERL was American (owned), wouldn’t this fall under the FCPA?!]. Because things will probably start to get interesting after a pension/labour settlement’s reached… The company could finally return surplus cash to shareholders, ideally via a tender offer – even the government might approve! In addition, Ryanair Holdings (RYA:ID) has now been defeated (essentially), and will be forced to reduce its 29.8% AERL stake to 5% (or less). This could well attract interested suitors, or partners. [Etihad Airways appears to be signalling its continued interest with a recent stake increase to 4.1%].

Meanwhile, let’s pin down AERL’s current valuation. The company’s adjusted operating free cash flow (Op FCF, after adding back aircraft operating lease costs of EUR 45.2 million) margin remains pretty stable at 8.1% – which deserves a 0.75 P/S multiple. Arguably, AERL’s entire EUR 1 billion cash horde should be available to shareholders, but we’ll make two significant adjustments: i) interest expense plus lease costs amount to 46% of Op FCF – if we target a reduction in this ratio to 15%, management might prudently set aside cash to offset/reduce debt/leases by 68%, and ii) as above, we’ll assume a EUR 250 M pension/labour settlement:

(EUR 1,425 M Revenue * 0.75 P/S + 1,018 M Cash – 464 M Debt/Leases * 68% – 250 M Pension Settlement) / 532 M Shares = EUR 2.86

Arguably, Aer Lingus is the cheapest large-cap Irish stock out there, plus it offers attractive exposure to a reviving Irish economy & consumer to boot! I have few concerns about the company’s operating & financial performance in the next year or two, so the main priority really for current & potential investors is to monitor/evaluate news flow in relation to the workforce, the IASS pension deficit & the fate of Ryanair’s stake.

Price Target:   EUR 2.86

Upside/(Downside):   91%

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Company:   TVC Holdings

Prior Post(s):   2012 & 2013

Ticker:  TVCH:ID

Price:   EUR 0.92

I get the feeling some readers might think I was bearish on TVC in the past two years… Not at all – I saw decent upside for TVC in both 2012 & 2013, and I was also very bullish on its major holding UTV Media (UTV:LN). But yeah, I was distinctly bearish on  TVC’s corporate governance. Management enjoys a cushy number here, and I haven’t heard a peep out of shareholders about high operating expenses & the glaring lack of new (unquoted) investments over the years. Frankly, I’m astonished by the recent wind-down announcement – I suspected a possible corporate event was inevitable, but not this…

And the (main) reason cited seems pretty laughable: ‘the very substantial amount of Irish and international funding seeking investment opportunities similar to those sought by TVC’. So, we’re expected to believe TVC’s been competing tooth & nail with other Irish/international investors to provide venture capital to ‘early stage & expanding Irish companies’?! I must have missed that particular investment wave myself… But perhaps the answer’s staring us in the face – the Chairman, Shane Reihill, owns about 30% of TVC: Maybe he just wants to cash out & move on to greener pastures? All in all, Reihill & John Tracey (TVC’s CEO) have really made out like bandits bankers here:

– TVC floated in 2007, with investors actually paying a premium to NAV. This basically reflected TVC’s purchase of Trinity Venture Capital Ltd. (founded by Reihill) for EUR 22.7 million, including EUR 12.5 M of goodwill. To this day, I’m mystified by this goodwill – what extra secret sauce did investors think they were acquiring? A fund management business? No. [There was some talk of organizing investment syndicates, but details were skimpy & it came to naught]. The unique skills & experience of Messrs. Reihill & Tracey perhaps? If so, why the generous compensation packages ever since?

– Since TVC floated, total operating expenses have amounted to an approximate & astonishing…wait for it, wait for it…EUR 22.1 million!?!

– I haven’t seen all the gory details, but executives & staff will actually receive severance now TVC’s glory days are over.

– Finally, I’m sure Reihill & Tracey will be back with a new venture in the none too distant future. Surely TVC shareholders deserve even a tiny slice of any future action in return for their unstinting generosity over the years?! Please sir…

But investors will probably have to make do with whatever smidgeon of porridge’s left over here: NAV now breaks down to EUR 67.3 M of cash, a 27.5 M stake in UTV Media, a 5.6 M unquoted 24.4% stake in CR2 & 0.6 M in net working capital. We should revalue the UTV stake, plus we’ll add a full year’s worth of operating expense (to be safe). There’s also outstanding options – the last annual report listed 2.5 M options outstanding (with an average EUR 0.80 strike), but management’s presumably snaffled up more since then. In fact, the proposed 91 M distribution’s noted as equivalent to EUR 0.95 per share on a fully diluted basis, suggesting 4.3 M options are now outstanding. Oddly enough, there’s no mention of any option-related cash inflow – 3.4 M of cash (say) isn’t to be sneezed at – shareholders would do well to track it down… I’ll simply assume it’s soaked up by fees, expenses, severance, cigars, fine cognac, etc:

(EUR 67.3 M Cash + 9.6 M UTV Shares * GBP 220.25p / 0.8135 EUR/GBP + EUR 5.6 M CR2 Stake + 0.6 M Net Working Capital – 2.8 M Op Expense) / (91.5 M Shares + 4.3 M Options) = EUR 1.011

TVC’s only marginally undervalued at this point, but it’s still interesting as a specific event-driven opportunity. Management promised a EUR 91 M capital distribution to shareholders in cash & UTV shares (equivalent to EUR 0.95 per TVC share) for July. Assuming the cash component (63.5 M) remains constant, we’re now looking at a total distribution of 90 M (or EUR 0.935 per share) based on the current UTV share price. [Implying a 7.6 ct post-distribution NAV – equivalent to management’s 9 ct indicative NAV, after adjusting for an additional 0.9 M of operating expense I’ve included in my NAV calculation & some rounding]. Go long TVC now, and your main exposure’s UTV Media price risk. However, UTV’s now a much smaller NAV component, plus I reckon it trades close to fair value at the moment – it might be worth a flier for the next few months, otherwise you may wish to hedge your exposure with an appropriate UTV short position.

Assuming a EUR 0.935 distribution’s locked in, you’ll realize a small profit vs. TVC’s current share price & also enjoy a free bet on TVC’s residual value – essentially, the eventual realization of its current CR2 stake (plus related appreciation/depreciation) less ongoing operating expenses for another few years (potentially). [Or think of it as creating a stub equity position…at a negative cost!] Either way, it promises a rather astonishing IRR, no matter how big or small the eventual payout. 😉

Price Target:   EUR 1.011

Upside/(Downside):   10%

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Company:   Mainstay Medical International

Prior Post(s):   None – New IPO (Apr-2014)

Ticker:  MSTY:ID

Price:   EUR 20.449     (average of MSTY:ID & MSTY:GR prices)

[NB: MSTY trading volume/price action’s been sparse & unreliable so far – an Irish & Euronext share price average makes for a more sensible reference price.]

I also struggled with including Mainstay – it’s really a US (& Australian) company, so it felt like another of those pharma/biotechs HQed in Ireland, but with little real substance here (shhh, don’t tell the IRS!). But it’s the first such company to seek a new listing on the Irish exchange, it has 2 Irish directors & an Irish CFO, it relocated to Ireland two years ago (& obviously won’t have taxable income for the foreseeable future), and the prospectus also states the CEO relocated to Ireland in 2012. So let’s include it…which is perhaps unfortunate for me – because valuing this one might prove a challenge too far! Hey, a single dud out of 80 isn’t so bad, eh..?! 😉

Mainstay has zero revenues – its main asset is ReActiv8, an active implantable medical device designed to treat people with Chronic Low Back Pain (CLBP). Design is now complete, the company’s now recruiting for human trials, and the main 2014/15 focus is on obtaining CE Mark approval & building up an EU sales team. The initial target market’s estimated at 2 million people in the US/EU, with an estimated price point of EUR 15 K. With medical device companies easily commanding 3-4 times sales multiples, Mainstay obviously has huge commercial potential. Like all medical device/biotech companies really…

But trying to assign probabilities & determining a current valuation that’s sensible is next to impossible, even for knowledgeable & experienced medical device/biotech investors. And it obviously depends on how much proprietary info the company’s willing to share. It’s certainly beyond me…I have to revert to an asset based valuation. [Which doesn’t mean I’m necessarily averse to investing in such companies, but for me it makes no sense to try cherry picking success (& value). A portfolio approach is sensible though & it can add welcome diversification to one’s own portfolio – in fact, I’m currently mulling such a fund investment at a 42% discount to book (a rare attribute in today’s market!)].

Mainstay has USD 8.8 million of pre-IPO net cash, and based on its EUR 21.15 IPO price it’s raised another EUR 15.3 million (net of IPO expenses). Annual cash burn is USD 7.1 million (for 2013, though it may well accelerate) – clearly, the company will require substantial additional funding before it ever reaches profitability. For the moment, I simply value it at net cash less annual cash burn:

((USD 8.8 M Cash – 7.1 M Annual Cash Burn) / 1.3600 EUR/USD + EUR 15.3 M IPO Cash) / 4.3 M Shares = EUR 3.85

Mainstay’s obviously wildly over-valued. It’s encouraging to see Sofinnova still invested here with a 41% stake, plus Dan Sachs MD (investor & founder) with 12% – and Medtronic (MDT:US) has a small 5% stake, but it’s a nice reminder they could be a potential partner/acquirer at some point in the future. But even if you’re prepared to assign plenty of hope value here, a current market cap of EUR 88 M looks pretty steep on a discounted basis when you consider the costs, the risks & the dilution that lie ahead…

Price Target:   EUR 3.85

Upside/(Downside):   (81)%

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Company:   Dalata Hotel Group

Prior Post(s):   None – New IPO (Mar-2014)

Ticker:  DHG:ID

Price:   EUR 2.85

Dalata’s really just another cash blind pool – this time one focused on Irish hotel acquisition – bolted on to an existing & much smaller hotel management business. [Run by Pat McCann (a former CEO of Jurys Doyle Hotel Group), and currently operating 40 hotels (with over 6,100 rooms) – over a quarter are located in Dublin, and a third have been re-branded with Dalata’s own Maldron Hotels brand]. This is a somewhat perplexing reversal of the normal trend towards separating out hotel ownership (into REIT structures) from asset-light hotel management. You have to wonder if a REIT was originally considered (implying the hotel management entity would have remained private) – perhaps the prospect of long-term related-party deals for the management of acquired hotels was a bit much for investors to swallow? Obviously, an eventual spin-out of the management business could be attractive…

Unfortunately, much of Dalata’s current management business comes from banks & receivers. If we assume a continuing revival in the Irish economy & tourism, as Dalata predicts, these contracts may end as ownership migrates back into private hands. On the other hand, new (passive) hotel investors may actually be keen to outsource management. Dalata now intends to buy 16-25 hotels – we can assume the majority  of these already have & will maintain contracts with its management business. [Dalata also plans to develop new hotels for the under-supplied Dublin market]. Bearing in mind these risks, plus the lack of a premium valuation as long as the management business remains buried inside what’s essentially a hotel ownership structure, I’d haircut my valuation accordingly. The business reported 2013 revenue of EUR 60.6 million & an operating profit margin of 8.1%. I’d normally assign a 0.75 P/S multiple, but we’ll apply a 50% haircut in this instance. We also have EUR 255 M raised from the IPO (net of expenses, at EUR 2.50 per share), plus EUR 4.1 M of net debt:

(EUR 60.6 M Revenue * 0.75 P/S * 50% Haircut + 255 M IPO Cash – 4.1 M Net Debt) / 122 M Shares = EUR 2.24

Like the new Irish REITs, Dalata’s quite over-valued at this point – in fact, only Green REIT (GRN:ID) is more expensive. While I’d clearly be sensitive to price, DHG has an enormous advantage – it’s a twofer, maybe even a threefer, i.e. it’s a property play, but it’s also an Irish tourism/domestic spending play. The domestic angle’s debatable, as many Irish consumers have opted for bargain staycations in recent years, so we may see them heading abroad again for holidays in increasing numbers as the economy revives. Which might suggest Aer Lingus (see above) is the superior tourism/domestic spending play…but throw property into the mix & Dalata bears watching.

Price Target:   EUR 2.24

Upside/(Downside):   (21)%

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Company:   Irish Residential Properties REIT

Prior Post(s):   None – New IPO (Apr-2014)

Ticker:  IRES:ID

Price:   EUR 1.01

Maybe I didn’t search hard enough, but where’s the company’s goddamned website? Despite managing to raise a fairly remarkable EUR 200 million, the company appears to be held together with spit & baling twine so far… They don’t even have a bloody Irish property expert on the team yet!? [An experienced Irish CIO has apparently been identified, but hasn’t yet been announced. I mean, really…how did they sell this thing?] And it’s sponsored by a Canadian REIT, of all things – Canadian Apartment Properties REIT (CAR-U:CN) will own an initial 20.8% stake & have a service agreement in place with the day-to-day Dublin team. [Actually, they really sold this thing…Franklin Templeton, Irish Life & Fir Tree Partners own almost 45% between them!]

IRES comes complete with an initial portfolio of 338 residential units (over 4 properties, in Dublin) worth about EUR 46 million (almost 100% debt-financed, which will be repaid from the IPO proceeds). They’re targeting 8.6-10% gross yields, which should equate to 6-7% on a net basis – add (up to) 50% gearing, and they expect 10-15% annual returns (& a 4.5-5% dividend yield). But this is pretty much virgin territory – residential landlords are invariably private buy-to-let owners in Ireland. And any multi-unit residential properties in the hands of institutional investors are unlikely to be for sale anyway at this point in the cycle. I’m reminded here of the fairly recent & dubious US institutional craze for assembling single home rental portfolios – which now seems to be rapidly running out of steam…

But if the time was ever right for institutional Irish residential ownership, arguably it’s now – trust the bloody real estate agents to have their pitch ready! IRES estimates 10-15,000 foreclosed/distressed units should come on the market in 2014/15. And for the next few years, at least, we’ll probably see a continued bias towards renting rather than buying – as much by choice as necessity. We shall have to wait & see how easily they can assemble a high quality/manageable portfolio… Meanwhile, valuation’s pretty simple:

(EUR 1.6 M Pre-IPO NAV + 192 M IPO Cash) / 202 M Shares = EUR 0.958

IRES is marginally over-valued. Actually, I’m a bit surprised to see it’s the cheapest of the new Irish property REITs/companies. Despite its obvious handicaps, in the absence of any kind of listed Irish house-builder (and no, Abbey (ABBY:ID) isn’t one, I’m afraid..!) IRES is always going to attract specific investor interest. [Hibernia REIT (HBRN:ID) actually strikes me as the real me-too runner-up of the new crew]. Considering their relative price declines, and the huge over-hang of buy-to-let & negative equity residential properties, I’d probably lean more towards an Irish commercial property bet myself…but again I’ll remind readers there’s still plenty of high potential property companies scattered across the UK & Europe at far more attractive NAV discounts. 🙂

Price Target:   EUR 0.958

Upside/(Downside):   (5)%

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OK, fin… All final TGISVP comments, suggestions, encouragement, thanks, sneers & so on – here please, thank you.

And here’s my last TGISVP file, with the usual updates – all 80 stocks are re-ranked according to their latest share price, so hopefully they offer up some interesting investment candidates (you should obviously check for any important news/results since my write-ups)

2014 – The Great Irish Share Valuation Project – Part X

NB: As usual, I expect I’ll be tracking the performance of my usual TGISVP Alpha & Beta portfolios for the rest of the year on the blog.

Cheers!