2014 – The Great Irish Share Valuation Project (Part IV)

Tags

CPL Resources, Glanbia, Grafton Group, Irish shares, Irish Stock Exchange, Irish value investing, ISEQ, ISEQ 20 UCITS ETF, Papua Mining, Petroceltic International, Petroneft Resources, San Leon Energy, TGISVP, The Great Irish Share Valuation Project

Continued from here:

Company:   Grafton Group

Prior Post(s):   2012 & 2013

Ticker:   GFTU:LN

Price:   GBP 665p

Revisiting last year’s post, I see this prediction: ‘don’t be surprised to see Grafton suggesting a GBP re-denomination later this year…they might just go the full hog & dump their Irish listing in favour of the UK.’ Six months later, that’s exactly what they announced! Which makes sense really – over 75% of Grafton’s revenue now comes from the UK. On the other hand, you’d think the bloody Celtic Tiger was back, considering how the share price has behaved – a triple in just 18 months!? I was pretty bullish originally on Grafton, but my valuation estimate’s certainly been marking time ever since…

In the latest trading update, FY-2013 revenue reached GBP 1.90 billion & like-for-like sales were up nicely across the board. Recent reports suggest the 4.2% operating free cash flow (cash generated from operations, less net capex) margin’s still running well ahead of underlying operating profit – let’s assume that’s still the case on a FY basis. And I continue to believe Grafton will, in time, revert to its prior 7.0% peak operating FCF margin. For valuation purposes, averaging the two seems fair – a margin of 5.6% still deserves a 0.5 Price/Sales multiple, in my opinion. With net interest hovering ’round 15% of operating profit, no further debt/cash adjustments are necessary. [At this point, I don’t believe a P/E multiple’s a practical (or effective) valuation alternative to also incorporate here]. Which gives us:

GBP 1,900 Million * 0.5 P/S / 232 M Shares = GBP 409p

Grafton looks pretty over-valued again this year. And lest you think I’m too severe – at the current share price, Bloomberg has GFTU on a bloody estimated P/E of 32.1!? This illustrates a common problem: Too many investors won’t even dream of buying a share ’til it doubles – then they finally pile in & make it a triple… Yes, Grafton’s clearly out of the woods now, revenue’s picking up, they’ve even made a couple of small acquisitions – but how much of a rosy future do you really want to pay for today?

But it’s worth watching for a better buying opportunity here – in due course, Grafton will surely become a full-blown consolidation machine again. Gavin Slark (the CEO, who bears an extraordinary likeness to Millie Tant!?) has proved a safe pair of hands. Now is an opportune time to begin accelerating Grafton’s expansion/consolidation strategy – his career experience to date suggests he’s up to the task. A placing (or an all-share offer) would be an ideal kick-start. And a pay-down of existing debt (from surplus cash, which has averaged almost EUR 160 M in the past 18 months) would free up useful debt capacity also. Of course, disposing of DIY & Manufacturing (now just 11% of revenue) & focusing on Merchanting exclusively is the logical end-game here – but at this point of the cycle, holding off on selling these smaller divisions is the sensible option.

Price Target:   GBP 409p

Upside/(Downside):   (39)%

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Company:   Petroneft Resources

Prior Post(s):   2012 & 2013

Ticker:   PTR:LN

Price:   GBP 6.15p

OK, let’s not torture ourselves here – I have a mercifully small (sub-1%) portfolio holding in Petroneft, and I’ve commented on it far too many times already (see here). And really, what’s there to say? The only noticeable progress in the last year is a decline in production to 2,300 bopd! It’s all an unpleasant reminder that even reserve-rich junior resource stocks can spiral ever lower if they’re cash-strapped… It also highlights how sullen & uncommunicative management can become with investors when things start going wrong. [Plus they owe investors some timely bloody confirmation of the parties behind Natlata Partners Limited & its 16.0% stake]. I must admit I’m mystified how the company’s been surviving since Jun-2013 – unrestricted cash was just $131 K, the annual cash burn rate is 7.7 million, and it also had loan amortization payments to make! Clearly, any new bank/third-party/shareholder loans should have been reported..?

But at this point, it seems clear PTR will survive ’til May, when it has a final 8.4 M loan payment due to Macquarie. It will obviously need to conclude a re-financing and/or a farm-out before then – management now claims to be very close to a farm-out of Licence 61. Perhaps the prudent analytical perspective here would be to presume bankruptcy – remember, just as many companies default due to liquidity (vs. solvency) issues. But I look around & all I see are numerous (worthless) junior resource companies which somehow manage to stagger on from crisis to crisis…

Let’s value Petroneft’s proved & probable reserves at my usual $10 & $5 per boe in-the-ground valuations, respectively. We’ll add 4.1 M of cash (inc. restricted), 33.5 M of debt, plus the latest cash burn rate. But obviously this burn rate has to be funded somehow..!? A re-financing will achieve little, so shareholders will inevitably be diluted, via assets (a farm-out) or shares (a placing). And God knows what a farm-out might look like, it might not even include up-front cash – so let’s presume a placing’s required (& is actually possible!). At this point, let’s also assume 1.5 years of cash (burn) is raised – which covers the rest of 2013, and leaves the company with a full year of cash on hand (the norm for juniors) in 2014. That’s a (gross) 12.5 M (GBP 7.5 M) placing, and a 35% share price discount would imply 187 M of new share issuance:

(USD 4.1 M Cash – 33.5 M Debt – 7.7 M Annual Cash Burn + 11.6 M New Placing Proceeds + 21.7 M boe Proved * $10 + 109.3 M boe Probable * $5) / 1.6652 GBP/USD / (645 M Shares + 187 M Additional Placing Shares) = GBP 53.3p

PTR continues to look massively under-valued. If they can actually solve their cash issues, and throw themselves into ramping-up production, I don’t doubt this is true – investors will surely revalue the shares to a multiple of today’s share price. But that kind of valuation step-change usually doesn’t happen overnight – if you’re a cautious investor, and choose to hold off ’til PTR’s cash issue is well & truly sorted, who cares if the price doubles initially on such news?! Despite the higher price, that would still present a far superior risk-reward opportunity.

Of course, an even better outcome here would be an (up-front cash) farm-out of non-proved/probable reserves only (since they don’t feature in my valuation at all) – but I suspect this probably won’t happen. At this point, we should also wonder whether PTR’s production difficulties to date might signal a possible re-evaluation of reserves? However, in that scenario, I suspect any reduction in intrinsic value would still offer attractive upside potential – so cash is still the real problem here ultimately…

Price Target:   GBP 53.3p

Upside/(Downside):   766%

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Company:   Petroceltic International

Prior Post(s):   2012 & 2013

Ticker:   PCI:LN

Price:   GBP 170p

Strikes me Petroceltic might be the Rodney Dangerfield of the Irish resource stock universe – doing just about everything right, but still can’t get no respect! The only real disappointment in the past year’s been on the exploration front, with their Romanian & Black Sea wells coming up dry. However, they should be reporting on their Kurdistan well, Shakrok-1, in the next month or so – in terms of the indicated resource potential, and other exploration news flow from the region, this should be the most promising new prospect for the company by far.

Of course, the real value here is PCI’s stake in the Isarene PSC (which includes the Ain Tsila gas condensate discovery). Earlier this month, the company announced a second farm-out (to Sonatrach) of 18.375%  – leaving Sonatrach at 43.375%, Petroceltic at 38.25% & Enel at 18.375%. I prefer a conservative reserves-based approach to valuation, so this will actually reduce my intrinsic value estimate for the moment – but in return the company receives a $20 million completion payment, and obviously there’s substantial future value to be realized from 140 M of carry payments (plus another 20 M of contingent payments). I calculate the Algerian portion of Petroceltic’s reserves (on a net entitlement basis) amounted to 91.1 M boe of proved & 52.1 boe of probable – we’ll now reduce these by 32% (as PCI’s share drops from 56.625% to 38.25%). The balance of reserves (Egypt & Bulgaria) are 22.8 M boe of proved & 7.6 M boe of probable, and I’ll apply my usual $10 & $5 per boe proved & probable in-the-ground valuations.

We also have year-end net debt of 246 M from the recent operational update, and a significant reduction in Egyptian receivables to 80 M (of which I’ll include just 50%). Things continue to look pretty good on the cash flow front – LTM net cash generated from operations was 91 M, and management’s indicated a (net) 100 M capex programme for 2014, so I’ll only include a 9 M annual cash burn. Finally, just for luck, let’s throw in the 20 M completion payment from Sonatrach:

(USD (246) M Net Debt – 8.9 M Annual Cash Burn + 80 M Receivables * 50% + 20 M Completion Payment + 84.4 M boe Proved * $10 + 42.8 M boe Probable * $5) / 1.6652 GBP/USD / 176 M Shares = GBP 295p

Petroceltic continues to offer substantial upside. The company has no cash flow or funding issues, it has now locked in over 300 M of carry/payments against its share of Isarene development, and Ain Tsila & Kurdistan both offer the near to medium-term prospect of potentially multiplying current reserves. Now it just needs some respect…

Price Target:   GBP 295p

Upside/(Downside):   73%

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Company:   ISEQ 20 UCITS ETF

Prior Post(s):   2012 & 2013

Ticker:   IETF:ID

Price:   EUR 9.942

An ETF’s the simple solution for many investors. However, that simplicity often comes at a ‘cost’, especially in smaller markets – exposure to a small number of large cap companies. [And in many markets, this is often compounded by excessive exposure to the financial sector]. In this instance, 50% of IETF’s portfolio is devoted to just 3 stocks – CRH (CRH:ID), Ryanair Holdings (RYA:ID) & Kerry Group (KYG:ID). Essentially you’re buying a handful of the biggest & perhaps most expensive Irish blue-chips.

I may be a little biased here – but I find blue-chips are inevitably priced at a substantial premium to other (smaller) Irish stocks, plus they often provide little exposure to the Irish economy! On the other hand, some investors couldn’t care less about such minor details. Take an average foreign mutual fund manager, whose investment committee just approved a sliver of allocation to Irish stocks. I mean really, what do you think he’s gonna buy? We all know the answer…in fact, I just listed his likely choices!

TGISVP is ultimately an exercise in stock valuation, I’m not trying to predict the 2014 ISEQ return here. Therefore, it’s only logical to value IETF as follows:

EUR 9.942 NAV * 1.0 P/B = EUR 9.942

Not so complicated, and not much of a view, eh..?! Actually, when it comes to ETFs, I generally think bigger is better – so it’s worth considering iShares MSCI Ireland Capped ETF (EIRL:US), which is about 4 times the size. Or the New Ireland Fund (IRL:US), a closed-end fund trading at a nice discount. I’ll cover both in due course.

Price Target:   EUR 9.942

Upside/(Downside):   0%

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Company:   Papua Mining

Prior Post(s):   2012 & 2013

Ticker:   PML:LN

Price:   GBP 24p

Jesus, anybody investing in PML needs their brain examined. Perhaps a Papuan tribesman might like to do the honours?! Oh damn, there I go again, making jokes… I posted this charming video before, it’s been the highlight of my PML analysis each year:

I recall some mumpty chump being outraged at this – I wasn’t just mocking junior resource stock investors, he apparently decided I was mocking this Papuan tribe too! [You really have to wonder how muppets’ brains work? Certainly doesn’t seem like all the synapses are firing right. Well worth a government study…maybe society could avoid an awful lot of wiped-out savings & broken marriages?] Now, why on earth would I mock a bunch of wise & noble savages, when I’m having so much fun wringing my hands over a bunch of gullible & ignorant fools?!

Anyway, the only progress in the past year would appear to be this release – which seems a remarkably long-winded way of saying ‘yes, we wandered ’round the jungle, picked up a few rocks, and drilled a few holes…’. All Papua Mining has to its name is some cash – which should be exhausted in little more than a year – plus a net payables balance:

(USD 6.9 M Cash – 0.7 M Net Payables – 5.4 M Annual Cash Burn) / 1.6652 GBP/USD / 35 M Shares = GBP 1.4p

Despite its expected & inevitable 74% collapse since my post last year, PML remains massively over-valued. All investors shareholders have to look forward to here is a treadmill of share placings to keep this jungle venture afloat.

Price Target:   GBP 1.4p

Upside/(Downside):   (94)%

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Company:   Glanbia

Prior Post(s):   2012 & 2013

Ticker:   GLB:ID

Price:   EUR 10.84

Two years ago, I considered Irish blue-chip agri/food businesses to be fairly valued, or perhaps mildly over-valued. Now I struggle to understand them. Granted, we’re talking about businesses that proved relatively immune to the credit crisis & subsequent economic decline, but underlying fundamentals certainly don’t appear to justify current valuations. I have to wonder how many investors re-entered the Irish market with great trepidation, and just enough courage to buy defensive stocks like Glanbia? A great idea to begin with, but a dangerous one when taken to an extreme… We see this elsewhere, particularly in the US – defensive stocks have been embraced by an army of nervous but greedy investors. And as their share prices march steadily higher, investors unfortunately end up believing the gains actually endorse the quality & safety of these stocks! And so the cycle unfolds – belief is always strongest just before a fall…

In the case of Glanbia, and Kerry Group (KYG:ID), shareholders will doubtless cite the abolition of milk quotas in 2015 as a huge positive – I’d take that with a salt lick myself… Investors always believe earnings are about to explode & will inevitably find the perfect reason to explain why. Personally, I find history a more reliable guide to the future, rather than greedy fantasy. Anyway, nobody knows for certain what quota abolition will actually usher in, or whether it’s even meaningful in a global context. And predicting the consequences for Glanbia – which still has Glanbia Co-operative Society as a 41.3% stakeholder – is that much more challenging. It’s not very difficult to picture a scenario where the interests of the company, the society & minority shareholders potentially begin to diverge…

So let’s just stick with the available facts & figures here: Glanbia definitely cranked out some impressive 20%+ earnings growth in 2011 & 2012. Of course, it would be nice to presume a step-change from the previous 2008-10 growth rate of 10.4% pa, but unfortunately it now appears FY-2013 growth may have slumped to around 6%. Crunch it all together, and a 14.0 P/E multiple looks about right.

But if we pause & look under the hood, things don’t look so pretty… Glanbia’s current EBITA (plus share of JVs & associates) margin’s at 8.5% – near-double digit margins in Global Nutrition & Ingredients are held back by sub-5% margins in Dairy Ireland and JVs & Associates. [Obviously, Glanbia sees its future in the growth of its higher margin businesses]. Unfortunately, there’s a huge chasm between what we see in the P&L vs. the cash flow statement. An off-year or two is maybe acceptable over an entire cycle, but a consistent cash shortfall year-in year-out can’t be ignored. For 2010-12, operating free cash flow averaged just 56% of Glanbia’s EBITA (plus share of JVs & associates), while the LTM were even worse at just 46%!

Applying a 50% valuation haircut here seems unavoidable, so an average cash margin of just 4.5% only deserves a 0.4 P/S multiple. [Plus we should think about net interest – currently at 10% of total operating margin, but more than double that percentage in relation to operating free cash flow. On average, let’s assume it’s just about level with my usual 15% limit – so I’ll be kind, and resist applying a negative debt adjustment here]:

(EUR 0.538 EPS * 14.0 P/E + 2,350 M Revenue * 0.4 P/S / 296 M Shares) / 2 = EUR 5.35

Glanbia is wildly over-valued – it will be interesting to see how this one plays out… One has to wonder what exactly investors are hoping for here – even if they’re prepared to ignore the cash flow statement (and yes, many will!), GLB’s 20.2 P/E ratio appears to discount all but the rosiest of scenarios. But maybe shareholders get lucky here & avoid a large setback – the share price could simply trade sideways for years, ’til the fundamentals catch up – except they won’t feel lucky…

Price Target:   EUR 5.35

Upside/(Downside):   (51)%

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Company:   San Leon Energy

Prior Post(s):   2012 & 2013

Ticker:   SLE:LN

Price:   GBP 4.1p

Oisin Fanning pulled on his best pair of jodhpurs & has since ridden SLE nearly into oblivion:

But the company still manages to sport a GBP 100 million+ market cap, courtesy of an astonishing 2.5 billion share count! It also boasts a remarkable proliferation of press releases – judging by Fanning’s breathless commentary in nearly every single RNS, he must live in a perpetual state of ‘delight’. We should all be so bloody lucky… But despite the folderol, the only reserves to show for it come from a new Turkish acquisition. Doubtless this is fresh fodder for future releases, but we do have to hat-tip Fanning’s deal-making skills again – SLE only paid $4 M up-front, the consideration is primarily a carry commitment (for the seller’s remaining 20% interest) & a potentially substantial royalty share of future production revenues. In return, San Leon will now own 75% of a gross 7.8 M boe of proved & probable reserves (with excellent prospects for a further reserve upgrade).

Let’s value those reserves at our usual $10 & $5 per boe in-the-ground valuations, assuming a 50:50 split between proved & probable, respectively. The only other ‘tangible’ resource asset here is SLE’s 4.5% NPI in Barryroe. Considering the lack of progress (or a farm-out), plus the collapse in the Providence Resources (PVR:LN) share price, I think it’s now prudent to apply a 50% haircut to the EUR 39 M balance sheet value of this asset. We then add cash – which has since been replenished with a recent GBP 31 M placing – less a small amount of debt, less a rather chunky EUR 37 M in annual cash burn:

(EUR 11.2 M Cash + (GBP 31 M Placing * 93% / 0.8246 EUR/GBP) – EUR 2.7 M Debt – 36.9 M Annual Cash Burn + (7.8 M boe 2P Reserves * 75% * $7.50 / 1.3735 EUR/USD) + EUR 39.1 M Barryroe NPI * 50%) * 0.8246 EUR/GBP / 2,532 M Shares = GBP 1.9p

San Leon remains substantially over-valued at these levels – though I’m astonished to see Toscafund steadily building up a 21.1% stake here…what’s their bloody take on all this?! But it’s clear most shareholders are no longer in the mood for all this news flow, or even fresh deals – now they just want to see value delivered, in the form of a chunky reserve statement.

Price Target:   GBP 1.9p

Upside/(Downside):   (54)%

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Company:   CPL Resources

Prior Post(s):   2012 & 2013

Ticker:   CPL:ID

Price:   EUR 7.20

I’ve been consistently bullish on CPL – a marvelous call, if I say so myself, with the stock now almost a triple since my 2012 TGISVP post. And I’m sure it would have been even more marvelous if I’d actually managed to find some room in my portfolio for the bloody stock… But I suspect there’s a couple of fund managers kicking themselves also – two years ago, CPL’s market cap was below the radar for most, now it boasts a EUR 200 million+ cap but also trades on a far higher multiple.

However, CPL’s definitely been firing on all cylinders in the last couple of years, seemingly impervious to the state of the Irish economy – and now it provides investors with attractive exposure to what’s finally an improving economy. Noting its earnings momentum in the last couple of years – 30%+ growth in FY-2012 & 2013, and 17% in its recent interims – assigning a 20.0 P/E multiple seems barely adequate. [Which highlights the illogic behind the 20+ P/E multiples we’re now seeing on some Irish blue-chips, which boast earnings growth that’s only a half or a third of CPL’s!]

I’m a little disappointed at the slow rate of expansion in the company’s operating margin (now at 3.6%). Plus I’m frustrated to see much of the company’s operating cash generation being absorbed by working capital – LTM operating free cash flow margin’s a mere 0.2%, although the 2012-13 average of 1.6% is probably more representative. However, very strong double digit revenue gains in the past few years certainly helps to compensate. And I’m also aware of the huge margin potential here – CPL previously enjoyed a peak operating margin of 9.5%. Mash all this together, and at this point a margin of 5% (approx.) looks about right for valuation purposes – on which a 0.5 P/S multiple still seems fair. To this we can add an adjustment: CPL has zero debt, so it can afford to take on EUR 38 million of debt & still limit interest expense to 15% (of operating profit). Let’s count 50% of this debt figure towards our valuation, and also include 22 M of surplus balance sheet cash. [CPL has a history of useful bolt-on acquisitions – they can clearly afford to be a little more aggressive now with their strategy]:

(EUR 0.379 EPS * 20.0 P/E + (353 M Revenue * 0.5 P/S + 38.0 M Debt Adjustment * 50% + 22.1 M Cash) / 30.5 M Shares) / 2 = EUR 7.36

CPL remains marginally under-valued. Of course, it may arguably offer greater upside potential – that is presuming it continues to clock up the same kind of revenue & earnings growth in the next year. But that certainly seems like a safer bet than the ones some investors are now making on other less deserving stocks…

Price Target:   EUR 7.36

Upside/(Downside):   2%

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OK, let’s wrap this up for the moment – here’s my usual (updated & re-ranked) TGISVP file:

2014 – The Great Irish Share Valuation Project – Part IV