Offshore oil or gas platform

Lamprell Plc: Solid numbers, but why the review?

Offshore oil or gas platformDisclosure: I own shares in Lamprell.

This week’s 2015 interim results from Lamprell (LON:LAM) contained no nasty surprises.

A net profit of $20m and revenue of $341m is consistent with the firm’s guidance for a result heavily-weighted towards H2, due to the timing of construction cycles.

Cash flow looks strong and net cash was up slightly to $316m, representing 44% of the firm’s market cap.

Although the level of net cash varies with working capital requirements, this balance sheet strength must provide a good chunk of downside protection for investors.

The only problem is that the unexpected retirement of CEO Jim Moffatt has coincided with the firm deciding that it needs a strategy review. Should shareholders be concerned?

Just a precaution?

Thus far, Mr Moffatt appears to have done a good job of turning around Lamprell and sorting out the firm’s finances. As far as I can tell, the firm is on a sound footing both financially and operationally.

This is what Lamprell had to say in this week’s interims about its decision to launch a strategy review:

In the context of the prolonged market weakness, the Board is undertaking an in-depth review of the earlier announced strategy to ensure that it is sufficiently robust to withstand the current industry challenges. The Board remains confident the Group is well positioned to leverage growth opportunities in the medium to long term, whilst maintaining a competitive position in the short term.

The message seems to be that the firm has revised its view of market conditions and now expects them to remain softer, for longer, than expected.

There doesn’t seem to be an obvious problem. The firm’s order backlog was unchanged from the year end at $1.2bn at the end of June, while revenue coverage was 90% for 2015 and 60% for 2016, slightly higher than comparative figures from 2014.

Margins appear to remain reasonable. Lamprell reported a gross margin of 11.6% for the first half of the year, down from 13.6% last year. That translates into an operating margin of 7.6%, down from 8.4% for the same period of last year.

Unless pricing on newer work is collapsing, these margins don’t seem to be a cause for concern either.

For the time being, I don’t see any reason to change my view on Lamprell and continue to hold.

Disclaimer: This article is provided for information only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

Iron ore

Market correction portfolio update / BHP Billiton results review

Iron oreDisclosure: I own shares of BHP Billiton.

Monday’s market correction wasn’t a lot of fun.

Clearly I had made the classic value investing mistake of buying too soon with some of my recent purchases, especially in the commodity sector.

Yet the logic behind each purchase remains valid, as far as I can see, so I did the only sensible thing to my portfolio on Monday — absolutely nothing.

I haven’t bought or sold a share this week. I should say that if funds had permitted I would have topped up on a number of stocks, but sadly I was already pretty much fully invested. Possibly a lesson for the future.

What about BHP?

Moving on from that, yesterday’s results from BHP Billiton plc (LON:BLT) coincided with a market rebound. The big miner ended the day up by around 6%.

I was encouraged by the figures, too. The firm maintained its progressive dividend commitment, inching up the payout by 2% to 124 cents.

However, as I’ve said before, in my view the most important financials in the current environment relate to cash flow. A company generating positive cash flow with a well-structured debt profile won’t run into trouble.

Cashflow & capex

BHP appears to score highly in the cash flow department. After stripping out the assets that have been divested, mainly into South32, we get the following:

  • Net cash flow from continuing operations: $17.8bn
  • Net cash ourflow from investing in continuing operations: $11.5bn.
  • Free cash flow from continuing operations:$6.3bn.
  • Price-to-free cash flow ratio of 13.5 (continuing operations)

Although net repayment of debt and dividend payments totalled $7.2bn, I think this is a pretty strong cash flow result in the circumstances.

Reducing its cash balance from $8.7bn to $6.6bn also BHP to reduce net debt by $1.4bn to $24.4bn during the period, which should help to protect its credit rating.

It’s worth reiterating the value of BHP’s ‘A’ credit rating. The last time the firm issued new debt, in April, it was able to sell 2030 bonds with a rate of just 1.5%. That’s lower than most governments can manage.

BHP plans further cuts to capex for the coming year. Planned expenditure is expected to fall from $11bn in 2014/15 to $8.5bn in 2015/16, and to $7.0bn in the 2016/17.

I suspect this will be enough to protect the dividend and the firm’s balance sheet strength, although it’s not possible to be certain at this point.

Outlook

Given BHP’s balance sheet strength and cash generating ability, the firm’s 7%+ yield alone would be enough to make it a buy at the moment, in my view. A trailing P/E ratio of 13.5 backed by free cash flow is also pretty decent.

Although BHP’s earnings are expected to fall again in the coming year, I believe the big miner remains a buy, and will continue to hold.

Disclaimer: This article is provided for information 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

Hargreaves Services plc: on course but destination uncertain

An open-cast coal mineDisclosure: I own shares of Hargreaves Services.

Results from Hargreaves Services (LON:HSP) earlier this week made interesting reading.

The dividend increase to 30p per share was welcome, as it is backed by cash and covered twice by earnings per share. However, there’s no point in pretending that this payout can be maintained, as profits are falling as the firm’s primary coal market continues its structural decline.

Hargreaves says it is targeting a move to a 40% payout ratio and this is reflected in the latest broker forecasts, which show the payout dropping to 21.9p for the current year, and to 18.5p in 2016/17.

Still a coal firm

I think the biggest takeaway for shareholders is that this is still a coal firm. £33.4m of the group’s underlying operating profit of £40m came from coal production, trading and distribution last year. Operating profit from transport (which is diversifying into waste and biomass) and industrial services (outsourced coal supply chain/facility management in the UK and abroad) only totalled £5.5m.

Hargreaves has completed its simplification programme (at a cost of £12m) and is now focused on shifting its strategy for a future without coal mining. Incidentally, the cost of the simplification programme was originally expected to be around £7m, so this seems to have overrun. However, looking the this week’s accounts suggest that the bulk of the extra cost relates to derivative losses, presumably relating to the falling price of coal.

At the moment, the firm’s strategy appears to focus on onshore wind and housing development, using its land assets in Scotland and England. However, it’s too early to say how successful these ventures will be, especially in the face of proposed changes to the subsidy and tax structure for onshore wind.

Hargreaves recognises this and states that its planning is based on the assumption that the wind-down of coal power in the UK will take longer than expected, due to the need for reliable base load generation. Hargreaves’ view is that supplying coal to power stations and steel works will continue to provide the firm with a viable business until 2020.

I’m not in a position to judge the accuracy of this forecast, although it doesn’t seem unrealistic, given the current lack of investment in new power stations.

Still a buy?

One point I think is worth commenting on is the quality of the Hargreaves market communications. I find them to be unusually candid and open, on the whole, and very easy to understand. One exception is that banking covenants are not specified. Instead, the firm simply states that it is operating “comfortably below our covenant levels”. What does that mean?

If Hargreaves’ prognosis that the coal business will survive in its present form for a few more years is correct, then the firm’s shares look reasonable value.

They currently trade on around 4 times 2014/15 earnings and 8 times forecast 2015/16 and 2016/17 earnings, with a yield dropping from nearly 9% this year to just over 5% in 2016/17.

Cash generation and the balance sheet remain strong and the firm’s management has so far proved willing and able to take effective actions to reduce costs and realise value from unwanted assets.

However, one concern I do have is that the current hedging and fixed price contracts all ended in May. As the company admits, these supported the strong profits from the mining business over the last year. It’s not clear to me how this will impact forecast revenues this year, if coal prices do not pick up in the next few months.

Overall, there’s no denying that this is an uncertain picture. However, it may be worth noting that so far, things have turned out broadly in-line with management guidance. On this basis, I intend to hold unless/until something material emerges to change the picture.

Disclaimer: This article is provided for information only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

 

Should you catch a falling knife?

Lonmin Plc: Value buy or value trap?

Should you catch a falling knife?

Lonmin may be a falling knife. Beware.

Disclosure: I have no financial interest in any  company mentioned in this article.

The recent slide in commodity stocks has been uncomfortable for shareholders in many companies, but devastating for those owning shares in South African platinum miner Lonmin Plc (LON:LMI).

The firm’s shares have fallen by 54% to 57p over the last month, taking their 12-month decline to 77%.

Lonmin shares now trade at an 80% discount to the firm’s latest reported book value. In this article I’ll ask whether this is a deep value opportunity, or simply a value trap.

1. Book value

Let’s deal with the question of book value first. According to Lonmin’s interim results, the firm had a tangible net asset value of 311p per share. At last night’s closing price of 57p, that puts Lonmin shares on a price/tangible book ratio of just 0.18.

As with anything that seems too good to be true, this is.

Lonmin announced plans to suspend operations at some of its mine shafts on Friday. Unless we see a platinum bounce or the firm manages to find a way of operating these shafts at much lower cost, I suspect the value of these assets will have to be written down sharply when Lonmin’s accounts are next made up.

Most of the big miners have been forced to write down the book value of some of their assets. Lonmin’s discount to book value is, in my view, a reflection of likely impairments and the firm’s lack of profitability.

2. Cash flow and profits?

Value investing is all about finding investments that are cheap enough to offer a margin of safety — protection from permanent loss of capital.

Lonmin admitted on Friday that its operations are currently “EBITDA negative”. Translated into English, this means the firm is operating at a loss, probably quite badly. It seems fair to assume that cash flow is negative, too.

During the first half of the year, underlying EBITDA was only $8m. Since the start of Lonmin’s H2, platinum has fallen by a further 14%, from $1,126 to its current level of about $980 per ounce.

Lonmin is attempting to staunch the losses by closing the high cost Hossy and Newman shafts and focusing on the cheapest, most easily mined reserves. However, there’s no guarantee that this will be enough to return the firm to positive cash flow or EBITDA.

Based on its perilous earnings and cash flow situation, Lonmin isn’t a value buy.

3. Cash reserves?

Companies can afford to run at a loss for a while if they have a strong balance sheet, and/or cash reserves. Lonmin has neither.

The firm’s interim results showed that by 31 March, Lonmin had net debt of $282m, meaning that the firm had used up half of its $563m of borrowing facilities. Net debt is almost certainly higher today, and in Friday’s update Lonmin confirmed that it is “reviewing the appropriate capital structure” for the company in the light of “the need to re-finance our debt facilities”.

An update is expected by the time of Lonmin’s full-year results in November. Whatever combination of debt or equity is agreed on, my view is that it is likely to be heavily dilutive for shareholders, unless they are willing to put in a substantial amount of fresh cash.

As a result, Lonmin fails as a potential value investment on balance sheet strength.

Conclusion

In my view, Lonmin fails on all three core tests of value: assets, earnings and cash flow, and cash/debt.

I’m not surprised Glencore dumped its shares in the miner: as a major shareholder holding 23.9% of the stock, Ivan Glasbenberg’s trading giant was probably keen to avoid the risk of being on the hook for any cash in a placing or rights issue.

From here, Lonmin shares could easily triple or fall to zero. Buying Lonmin stock today is a punt, not an investment, in my view. As such, I’m going to continue to avoid it.

Disclaimer: This article is provided for information 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

Anglo American interim results: dividend held, challenges remain

An open-cast coal mineDisclosure: I own shares in Anglo American, Rio Tinto and BHP Billiton.

Half-year results from Anglo American (LON:AAL) today coincided with another lurch down for the commodity market, but I don’t think there was anything specific in the firm’s results to single it out.

As I write, half an hour before markets close on Friday, Anglo is down 3%, BHP is down 4% and Rio is down 3.6%.

(Lonmin is down 18%, but that’s another story — one which I plan to take a closer look at in another post in the next few days. I’ve viewed Lonmin shares as toxic for the last two years, but is it time to take a punt on this firm, which trades at around a 75% discount to book value? We will see.)

Getting back to Anglo, today’s results were broadly as expected. Underlying EBIT (operating profit) of $1.9bn was 36% lower than during the same period last year. This fall was simply due to commodity price reductions, which also prompted the firm to make $3.5bn of impairments, including $2.9bn at the Minas-Rio iron ore project.

The interim dividend was maintained, to some investors’ surprise. However with the prospective yield now at 6.8%, this situation can’t last forever. Unless iron ore prices, or perhaps copper and platinum, rebound fairly soon, a dividend cut seems inevitable, in my view.

Better than expected?

The good news for shareholders is that Anglo is still profitable at an operating level. The firm also said today that it’s targeting a further $1.5bn of cost cuts during the second half, including $800m of operating cost cuts. An additional $1bn will also be cut from planned capital expenditure. These savings may go some way to help offset commodity price weakness.

Better still was news that the sale of its Lafarge business has enabled the firm to reduce net debt from $13.5bn to $11.9bn. This was much needed.

However, looking ahead in the near term, we have to accept that there isn’t much that Anglo CEO Mark Cutifani can do about commodity prices. He may also struggle to achieve an acceptable price for any asset sales, making this route unappealing.

On this basis, it makes sense to look at cash flow. Can Anglo remain self-sufficient without slipping further into debt? If so, then I may consider buying more shares and averaging down my holding.

Cash flow analysis

Let’s take a look at the cash flow statement for H1 2015 (you can see the full accounts here):

  • Net cash inflows from operating activities: $2,715m
  • Net cash used in investing activites: $2,343m
  • Net cash inflows from financing activities: $24m*

At first sight, this doesn’t look too bad and suggests that Anglo did generate some free cash flow in H1. However, that’s not really the case, at least not from an equity investor’s perspective.

I always calculate free cash flow as operating cash flow – investing cash flow – interest payments.

This is because from an equity perspective, free cash flow is only relevant if it still exists after a firm’s debt commitments have been satisifed. Remember that debt always ranks above equity. As Afren shareholders have found recently, trying to deny this basic reality can prove costly…

Anglo’s free cash flow before interest payments was $372m. Unfortunately this was wholly absorbed by interest payments of $456m. There was no free cash flow to fund the $876m of dividend payments made during the period.

However, Anglo’s financing cash flows show that borrowing fell by a net $545m during the first half, and that the firm issued $2,159m in new bonds. We also know that net debt fell by $1.6bn after the half-year ended, thanks to the Lafarge sale.

The net effect of these refinancing activities has been to reduce short-term debt and moderately increase long-term debt. Pushing repayment dates further into the future is sensible, especially given that the firm’s newer borrowings may be at lower rates than the retired debt. I’d expect Anglo’s interest payment for H2 to be slightly lower than H1.

I’d also hope that some of the firm’s targeted operating cost savings of $800m will feed through to operating cash flow in H2. However, offsetting this will be the full impact of recent commodity price falls, many of which took place towards the end of the first half. Unless prices rebound during H2, my view is that operating cash flow is likely to fall again during the second half of the year.

The verdict?

It’s a complex picture with a number of moving parts. Assuming commodity prices don’t fall much further, my feeling is that the gains and losses will broadly offset each other during the second half. This will give a similar picture to that which we’ve seen today — cash flow breakeven excluding dividend payments.

Anglo does still have more than $7bn of undrawn borrowing facilities, so it isn’t going to run out of cash. However, it makes no sense for the firm to to use borrowed money to pay dividends for more than a short period.

I’m tempted to average down on Anglo next week, but will mull it over during the weekend before making a final decision. The big risk, of course, is that we haven’t yet seen the bottom for commodities…

N.B. 27/07/15: I’m not going to average down on AAL for now, as I don’t want to go any more overweight in commodities than I already am. But I would be tempted to expand a smaller position.

Disclaimer: This article is provided for information only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.