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Continued from here:

Let’s throw in a final negative – hmm, again, I’m not sure it’s a negative, maybe we should tick it as a neutral?!:

d) I was surprised to see a recent announcement confirming Bernard Olivier‘s been appointed CEO of Bezant Resources (BZT:LN) (which has granted an intriguing option on its Mankayan project to Gold Fields (GFI:SJ)). He wants to be CEO of two companies simultaneously?! Jesus, my ambition is to be CEO too…but just for one day, and then gracefully retire on a quite modest package..!

Then again, I note he was already Technical Director of Bezant, an Executive Director position. And Bezant doesn’t have a CEO!? So, I’d have to assume Olivier has been (virtually) running 2 companies for the past couple of years, quite successfully. Also, Richland Resources (RLD:LN) is technically a holding company, its main operations are managed in its TanzaniteOne Mining Ltd. sub. Perhaps we can give a pass, but it’s an unusual situation, and it behooves the Richland board to justify it to their shareholders. Now, let’s look at the positives:

i) Richland’s a unique company, in a unique niche of the gemstone industry. Mostly by design, it’s become the mini-De Beers of the tanzanite industry.

It cuts and polishes its own stones, and appoints its own sight holders. It has created a unique retail/tourist offering in Tanzania with The Tanzanite Experience (with possible opportunities to franchise it internationally in the future).  Don’t forget the Waterford Crystal Visitor Centre is one of the Top 10 most popular tourist attractions in Ireland! More importantly, it also created The Tanzanite Foundation which promotes and develops tanzanite through its marketing efforts, grading system, education and exposure, and collaboration with leading designers and jewelry manufacturers.

Much like De Beers, Richland’s in a position to significantly influence perception, pricing and development of the global tanzanite market. This is a long term positive. In fact, in light of tanzanite’s rarity, Richland’s shareholders could possibly be better served (at some point in the future) by a restriction in production, rather than a continued increase. We may discover some day that Richland is a luxury goods stock hiding within a junior miner.

ii) Richland’s expanding its portfolio. In Jan-2011, it released the maiden JORC compliant resources statement for its 75% owned tsavorite project. Tsavorite is a brilliant green gemstone, also first named and marketed by Tiffany & Co (TIF:US). It’s harder than tanzanite (at 7-7.5 on the Mohs Scale), with a correspondingly higher price (2-4 times that of tanzanite).

This resource may potentially be the world’s largest single-source of tsavorite. On an Indicated resource basis only, it’s estimated to contain 1.4 to 3.5 million carats. Richland’s now performing bulk sampling. With the project only 20 km from existing operations, this has the potential to be a low risk/low cost operation.

In Jun-2011, they announced an option on an established sapphire project in Australia. I’ve already cited this as a negative..! But of course it could also be greeted by the market as a positive catalyst if a deal is finalized. Yes, the upfront exercise cost is (in theory) inexpensive, but if completed my opinion would depend on the level of disclosure regarding capex/working capital required, plus the quality of any resources/reserves statement (if any).

Finally, they recently announced a new JV structure with a group of local miners who own 18.75 ha located only 2.5 km from Richland’s mine. Richland will take on all mining & exploration costs and, after a 40% cost recovery, will split profits 60:40 in its favour. This deal seems pretty generous, but the annual economics will improve over time. Also, it may serve as a model for further consolidation locally (with less upfront cost), presumably will improve overall mine cash costs, and may even prevent some unauthorized undermining.

iii) I previously mentioned Gemfields (GEM:LN), a peer company to Richland. In fact, it’s a little more than that – it has a 10.1% stake in Richland!. This is a legacy of a failed, and acrimonious, takeover attempt in 2008/09 at GBP 45p per share. Rather bizarrely, during the takeover battle, there was a re-nomination effort for Ian Harebottle (ex-CEO of Richland, who departed in Feb-08) to Richland’s board. Shortly after, he was actually appointed CEO of Gemfields, who also brought on board Adrian Banks, ex-MD of TanzaniteOne Trading.

Harebottle replaced Sean Gilbertson as CEO. Gilbertson’s the son of Brian Gilbertson, who was ex-CEO of BHP Billiton (BLT:LN) and now heads Pallinghurst Resources (PGL:SJ), Gemfields’ 63% controlling shareholder. Gemfields has also been broadening its portfolio recently, adding rubies and amethysts, and has plenty of firepower now with cash on hand comfortably exceeding Richland’s market cap. What more can I say? Gemfields is the v definition of an informed activist shareholder!

iv) Now a little detour into technical analysis: For the past 6 years, the share price has been relentlessly declining, and now trades 97% lower than its ’06 high. This obscures the fact the price has been basing/flatlining for the past 3 years, and has actually traded in an absurdly tight GBP 7.75 p to GBP 9.5-10.5p range since last summer. This has all the makings of a significant breakout and, considering the technicals and fundamentals, I’d bet that would be on the upside. If we do see a break above this range, I’d venture we see a sharp initial move to GBP 14.5p, or even GBP 16.5p.

I’m also heartened to see Richland doesn’t feature in the Top 100 over on Aim Soiree..! Another good sign! (Also encouraged to see Petroneft (PTR:LN) now in 99th place – maybe if it falls off the list, we’ll actually have a good buying opportunity in due course). OK, let’s tackle valuation:

Richland Resources     (xlsx file)

Richland Resources     (xls file)

P/E Ratio:  First, I’ve annualized Richland’s H1 2011 figures. Normally, I focus on a company’s Last Twelve Months’ (LTM), but as we’re in 2012 and Q3 Revenues were up 24% YoY, I think this is entirely reasonable. At the current GBP 9.625p price, Richland’s worth $17.97 million. This puts it on a current P/E of 5.7. Seems entirely undeserved. I’m opting for a Fair Value P/E of 15, which equates to a GBP 25.3p share price.

Shocked? Well, I’d be more shocked at the 5.7 P/E! A 15 P/E seems reasonable in light of the current high level of revenue/earnings growth, the medium term 9.4% carat production growth rate and the still depressed tanzanite price. In theory (!?), producing/profitable miners should be priced on a decent/premium P/E multiple, as earnings usually represent only a small (realized) slice of their total reserves/resources value. It’s a little more complicated than that, but P/E multiples should correlate with the expected life of a company’s reserves/resources.

P/S Ratio:  Let’s try a more corporate approach. The current operating profit margin is 21.6%. Obviously, historic OP % has been terribly volatile but, for the reasons mentioned above, let’s accept the current margin as somewhat sustainable. This seems a good consensus – the market appears to be in an upswing, but this approach ignores that margins could easily hit 30%+ again – of course, it also ignores some poor/negative historic margins…

Current OP % deserves, say, a 1.75 P/S, which is conservative against my own mental scale. However, Richland has Net Cash of $0.4 million on hand, and a v low annual interest bill of $142 K. This financial strength/capacity prompts me to bump up the Fair Value P/S to 2.0, corresponding to a GBP 22.3p share price.

Asset Value:  As I’ve mentioned before, Asset Value is a key valuation driver for a natural resource stock. By this, I don’t mean B/S Equity – you need to calculate a Fair Value for Reserves/Resources in the ground, plus/minus certain B/S items. I also don’t mean use any mine/project NPVs that the company may provide either… Bit of a tall order, eh?!

As I’ve been writing recently (see Kenmare), I’ve (painfully) arrived at some rules of thumb for resource stocks over the years. In short, using 10% of the price above ground (i.e. the spot price) is a useful guide to valuing what is below ground. This might seem ultra-aggressive (damn the media who focus on the above ground end-price of a resource – yeah sure, dig up every last speck of that resource tomorrow, for free, and sell it..!) It reflects a suitable discount for the political and mining risks involved, the costs (and lost yield) of extraction, the uncertain future price direction/volatility and, of course, the long timeline involved.

Remember, mining companies think v differently about acquisitions – they don’t pay v much attention to current revenues or earnings! My rules of thumb just skim the surface of their approach, but if you’re in the mood for calculating DCF/IRR analyses for multiple companies, and/or monitoring deal metrics, I think you’ll see over time that they are a reasonable approximation.

Also, if the spot price is dramatically different from medium or long-term prices, think about opting for the medium term price, or some combination of both. I also haircut Probable Reserves (vs. Proved Reserves), and only include some Resources on occasion. You can generally wipe your arse with most miner’s statements on Inferred/Contingent/Mineralized/etc. Resources…

The big problem with Richland is that they’ve no Proved/Probable Reserves..! However, this is not uncommon for tanzanite, or the wider gemstone industry (inc. diamonds). The specific geology of gemstone deposits often appears to make it problematic for companies to upgrade Resources to Reserves. I’m not thrilled about this. But considering the industry, and the fact Richland has mined 2+ million cts pa on average in the past 4-5 years (with no decay in yield), I’m prepared to live with it.

So let’s look at what they do have: (btw I’m going to completely ignore the tsavorite resource for valuation purposes). Their Competent Person’s Report (CPR) confirms a Recoverable Resource of 63 to 83 million carats, or an average of 73 million carats. On the other hand, they’ve regularly stated that their mine has an estimated life of up to 20 years, at an average 2.2 million carats per year. This is significantly lower than the Recoverable Reserve, so let’s assume the 20 year life will be reached. This gives us an average Resource of 58.5 million carats. Let’s haircut this by 50%, to reflect the fact we’re dealing with Resources, not Reserves (this is a fudge, but like I said, it’s the best we can do here – and Resources that are throwing off 2+ million cts a year are a lot more reassuring anyway).

Medium term revenue per carat is just over $15. This would suggest a suitably discounted $1.50 per carat value in the ground. But let’s haircut this also, and opt for a lower Fair Value of $1 per carat, actually close to 10% of the company’s current revenue per carat. Hopefully we’ve hacked/slashed enough now, so we just need to include some other B/S items: Inventory‘s at $6.3 million, and should be easy to realize. Adjusted Cash is $4.7 mio – reasonable to include $3 mio of Receivables due within 6 weeks from their Jun-2011 sales. Finally, we’ll include $1.4 mio of Debt, and what have we got?:

(58.5 mio carats * 50% * $1.00) Resources + $6.255 mio Inventory + $4.746 mio Adj Cash – $1.371 mio Debt = $38.9 million = GBP 20.8p Fair Value per share

Incidentally, and rather bizarrely, this is exactly equal to the company’s Equity of $38.9 mio. Wow! With an overlap on the various approaches above, averaging a final valuation is the most obvious thing to do:

(GBP 25.30p P/E Val + GBP 22.25p P/S Val + GBP 20.82p Asset Val) / 3 =            GBP 22.8p Fair Value per share, for an Upside Potential of 137%

If you prefer some pie-in-the-sky, just look back to peak figures and estimate a potential valuation if that kind of performance can ever be revisited… Vs. the relevant Peak metrics, Richland currently trades at a 1.8 P/E, a 0.4 P/S, and a Dividend Yield of 66%!

Considering everything, Richland presents a relatively low risk investment opportunity in real assets. It appears to be significantly undervalued based (mostly) on current metrics, and could potentially offer exponential upside based on its prior share price history and a possible return to peak revenues/earnings. I now have a 1.7% portfolio stake.

  • Mkt Price:  GBP 9.625p
  • Mkt Cap:  GBP 11.4 mio
  • P/E:  5.7
  • P/S:  0.9
  • Tgt P/E:  13.5
  • Tgt P/S:  2.0
  • Fair Value:  GBP 22.8p
  • Upside Potential:  137%
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