3 reasons why Just Eat may have just peaked

Takeaway pizzaJohn Maynard Keynes famously said that “the market can remain irrational longer than you can stay solvent“.

It’s this risk — more than anything else — that makes shorting overvalued growth stocks such a hazardous occupation.

For this reason, I prefer to find additional reasons to enter into such short transactions, over and above excessive valuations.

My favourite measure is founder or director sales: this worked a treat with Ocado Group, and is also looking very promising with AO World, one of whose founder backers sold out late last year, and whose chairman Richard Rose sold 88% of his holding last week, as soon as the post-IPO lock-up allowed him to.

AO World and Ocado also suffer from another problem — they don’t really make any money. That’s not an issue for Just Eat (LON:JE), which is making plenty of cash — a fact that may explain why the placing of a 7.7% stake by four of the firm’s pre-flotation shareholders in December didn’t have a lasting impact on Just Eat’s share price.

However, despite this, I feel that Just Eat may be nearing peak valuation — or at least approaching a correction of some kind.

Yesterday’s blockbuster full-year results appeared to confirm my view: reading them before the market opened, I expected big gains when trading started, akin to those seen with ASOS last week (another overvalued stock with falling profit margins).

However, despite genuinely impressive results, Just Eat stock barely flickered higher yesterday, and has opened down by 5% today: have we just seen the top?

I think we may have done, for three reasons:

1. Consolidation and competition in the industry are becoming a real concern and could herald pressure on margins: Just Eat finance director Mike Wroe said yesterday that some of the recent merger and acquisition activity in the sector had been “pricier than we were willing to get involved with, so in that sense it has got more competitive”.

There’s also increasing competition pressure from peers such as Hungry House, and big brand takeaways, such as Domino, which runs a superb online service.

2. Yesterday, Just Eat announced a big beat on 2014 earnings, which were 4.2p per share, versus consensus forecasts for 3.1p per share. Orders rose by 52% last year, and sales were up 62%.Just Eat also issued a bullish forecast for 25% revenue growth in 2015, slightly ahead of consensus forecasts.

Yet the shares didn’t budge, and are down around 5% today. To me, this is a classic sign of a growth stock with a toppy valuation: investors are jaded and are no longer getting the ‘hit’ they need, despite strong results.

Just Eat shares now trade on 82 times 2014 earnings, and 63 times 2015 forecast earnings. To justify this high-octane valuation, post-tax earnings are expected to double in 2015, based on a 25% increase in revenue. That might be achievable if spending on acquisitions stops, but then where will the outsize growth rates come from?

3. Just Eat’s 12% operating margin appears to have been partly supported by an increase in commission charge for UK restaurants from 11% to 12%, which came into effect on January 1 2014. 

The firm says this accounted for the majority of the 10% increase in UK average revenue per order (ARPO) seen in 2014. To put this in context, ARPO rose by just 2.4% in 2013, when driven only by takeaway price inflation.

I’d suggest that without the increased commission charge, ARPO growth might have been lower in 2014 than 2013, given the widespread food price deflation being seen in the UK. To compound this, wage growth is also low, at the bottom end of the labour market, where most Just Eat customers presuambly operate.

I’m guessing that to compensate for this, Just Eat demanded a bigger slice of the cake (kebab?).

I’m not sure how sustainable this is: 12% seems a pretty hefty commission in a sector that’s quite price sensitive and must surely have fairly low margins (who’s seen a set of accounts for a takeaway/restaurant?).

Short Just Eat?

I’m not sure that Just Eat is a short just yet, although I am thinking about it. What I’m certain of, however, is that I wouldn’t want to be long of the stock at today’s price of 347p.

Update 24/03/2015: According to three RNS announcements today, three major shareholders have reduced their stake in Just Eat by a total of 4.8% since the firm’s results were published last week. The share price rose following the news, perhaps because a big overhang had been cleared? It seems bearish to me, however, that a number of major backers are choosing now to lock in some of their gains.

Disclosure: This article is provided for information only and is not intended as investment advice. The author has short positions in Ocado Group and AO World. Do your own research or seek qualified professional advice before making any trading decisions.

Victoria Oil & Gas 2015 interim results: any improvement?

Victoria Oil & Gas customer site

Victoria Oil & Gas is supplying gas for heat and power to industrial customers in Douala, Cameroon (image copyright Victoria Oil & Gas)

Having slated Victoria Oil & Gas plc (LON:VOG) after the publication of its 2014 results, I decided to take a look at the firm’s interim results, which were published at the end of February, to see if anything had improved.

The main areas that concerned me in the 2014 results were:

  • High levels of cash consumption
  • Stressed working capital situation with high levels of bad debt and likely bad debt
  • Excessive remuneration for staff and related parties — I’ve previously highlighted how Chairman Kevin Foo’s interests didn’t appear very well aligned with those of shareholders. Put differently, this company appears to be skilled at enriching its management but not its shareholders.

Have things improved?


Victoria’s cash balance fell from $17m to $5.8m during the period, while total borrowings rose from  $10.7m to $12.4m, an increase of $1.7m. In total, the firm appears to have consumed almost $13m of cash between June and November 2014.

However, in Victoria’s defence, some of this expenditure should have been funded by the firm’s 40% partner, RSM, which has subsequently paid up most of what it owed.

Victoria didn’t provide a pro rata breakdown of RSM’s payments across its accounting periods, but did say that it had received $6.9m from RSM to cover its share of expenses from February 2014 onwards, while a further $1.2m was still outstanding at the time of publication.

I’ve guesstimated the amount of this expenditure incurred during Victoria’s H1 (June- Nov) as $6m, meaning that Victoria’s net cash consumption during H1 appears to have been around $7m.

Working capital

Perhaps my biggest concern in 2014 was the apparent poor quality of Victoria’s receivables, and its fairly grim payables situation.

During H1, Victoria’s payables actually fell, from $12.5m to $10.5m, so I’ll focus on receivables here.

There was a slight improvement in receivables, too. Trade and other receivables (excluding monies owed by RSM) rose by 23% from $4.8m to $5.9m during the first half, as you’d expect given higher gas sales.

However, debtor days (the average time taken for customers to pay their bills) was 106 days, a modest reduction on the 120 days reported last year.

We won’t learn how this translates into good and bad debts, plus subsidised (never to be repaid?) customer installation costs, until this year’s annual report is published, but limited progress does appear to have been made.

Excessive related party remuneration

I’ve written about the gravytrain being enjoyed by top management at Victoria before. The firm’s interims suggest that the influx of cash from RSM, coupled with rising revenues, have given renewed momentum to the firm’s remuneration habits.

Total related party transactions — described as “payments to directors and other key management personnel” rose from $1.6m during the first half of last year to a nice round $2.0m during the first half of the current year.

One area of particular growth was “Directors’ remuneration – cash payments”, which rose from $716,000 during the first half of last year to $1,183,000 in the current year. That’s 10% of revenue!

Still a sell?

My conclusion after reviewing Victoria’s 2014 results was that the firm was putting a too much of a favourable spin on its receivables, and continuing to burn cash.

Although the subsequent growth in gas sales and the new supply agreements with the local power company are a big bonus, in my view, the firm’s interim results suggest my conclusions from last year are still broadly valid.

The increase in debt is worrying, and even if this is brought under control with more regular payments from RSM, I believe Victoria’s $100m valuation is ample, if not excessive.

Upside to valuation?

Victoria says annual production for 2015 is expected to average 10.4 mmscf/d, around 2.5 times the current average of 3.9 – 4.4 mmscf/d.

To keep things simple, let’s assume that means H2 revenues will be 2.5 times H1 revenues. Therefore, using the last 18 months’ figures as a guide, this is how Victoria’s 2015 income statement might look:

  • FY2015 revenue of c.$40m;
  • Gross profits c.$11.2m
  • Administrative expenses: $10m
  • Sales and market expenses: $0.8m
  • Operating profit: <$0.5m
  • Post-tax profit: c.$0.00

This is –obviously — a simplification, but as I’ve said before, it’s hard to see how Victoria will make a meaningful profit in the foreseeable future, unless perhaps gas sales rise much higher and actually manage to grow faster than the firm’s considerable overheads… (Remember, the firm’s forecast in 2011 was for sales of 44mscf/d in 2014. Actual sales were less than 4mscf/d).

There are of course, a few people who benefiting directly from Victoria’s rising revenues: the beneficiaries of the 4.5% royalty payment that comes directly off the top of the firm’s revenues. This would have been more than $500,000 during H1 alone…

Victoria Oil & Gas remains a sell, for me — especially as the firm could, in the next few years, face competition from BowLeven, whose Etinde gas field lies just offshore from Douala. BowLeven already has an outline agreement to supply a nearby fertiliser plant with gas, starting at the end of 2015…

Disclosure: This article is provided for information only and is not intended as investment advice. The author has no financial interest in any company mentioned. Do your own research or seek qualified professional advice before making any trading decisions.

Is Lancashire Holdings really cheap?

Scales of justiceFull disclosure: early in January 2015, I purchased shares in Lancashire Holdings Limited (LON:LRE).

At the time they were trading at around 550p and seemed very cheap. Two months plus a 20% gain later, I’m not so sure. To be honest, I’m not sure my reasons for the purchase — into a value portfolio — stack up all that well.

Obviously I’m not complaining — a 20% return in two months is not to be sneezed at — but I am thinking about selling.

I try to continuously evaluate my investments with an open mind, as I believe that from fixed viewpoints cometh many losses… In this article, I’ve tried to explain the thought processes that led me to buy, and now consider selling, Lancashire Holdings.

1. Cheap valuation?

Lancashire’s shares nose-dived at the end of November, after two founder non-executive directors left the board, just a few months after the firm’s founder, Richard Brindle, also left the firm.

Such departures are often a sign of bad news, but so far there hasn’t really been any, making the short spell the shares spent between 500p and 550p look like a good buying opportunity for income seekers.

That’s when I bought in, tempted by a 2014 forecast P/E of less than 8 and a near-10% dividend yield.

I was also reassured by the firm’s low valuation relative to its history of strong earnings: although specialist insurers like Lancashire inevitably have good and bad years, the firm’s 10-year average earnings of 73p per share gave a PE10 of 7.6 at my 552p purchase price, and of 9.1 at the current price of around 665p.

Lancashire’s other metrics also seemed impressive. Since 2009, the firm’s combined ratio has ranged between 45% and 70%, which seems outstandingly low compared to mainstream insurers, which generally seem to operate with a combined ratio above 90%. Return on equity was good, averaging 18.8% between 2009 and 2014.

Finally, shareholder returns were clearly a priority, so I was happy to buy in to what looked like a cheap and very profitable firm, even though it wasn’t trading below book value. (I’ve previously used book value successfully for insurers, buying into Aviva and Friends Life Group when they traded below book value — both subsequently enjoyed a strong re-rating).

2. Maybe it’s always this cheap?

So far, so good. But as Lancashire’s share price rapidly re-rated over the last two months, I started to wonder where this would lead — how would I judge when the shares were fully valued?

As the portfolio containing the shares is value only, not income, then holding for the dividends, regardless of valuation, wasn’t an option.

Here’s how Lancashire’s current 2015 forecast P/E compares to some of its peers:

  • Lancashire: 2015 P/E 10.7
  • Amlin: 2015 P/E 12.1
  • Hiscox: 2015 P/E 14.5
  • Catlin: 2015 P/E 12.3

On this basis, Lancashire still looks a little cheaper than average, although not by a huge margin.

However, another consideration is the historical norm: some companies always trade on low multiples, for various reasons.

A look back at the figures suggests Lancashire could be such a company. For this list, I’ve calculated an approximate trailing P/E for the shares using the share price in March after the listed year’s results would have been published (e.g. share price in March 2014 following publication of 2013 results):

  • 2010 P/E: 5.0
  • 2011 P/E: 9.7
  • 2012 P/E: 10.7
  • 2013 P/E: 9.5
  • 2014 P/E: 8.6

It’s very approximate, but this list suggests to me that today’s forecast P/E of 10.7 is about right. Lancashire has not tended to trade much above this, relative to actual earnings.

3. I don’t understand it

My last point above brings me onto the final reason I am considering selling my shares in Lancashire Holdings: it may be a great business (I believe it is), but I don’t really understand it very well.

Conditions are said to be soft in the specialist and reinsurance sectors at the moment, due to an influx of new capital seeking higher returns. Lancashire is showing discipline and maintaining solid profit margins, but it’s also benefited from a period of low claims. I don’t really understand how things will pan out, over the next year or two.

Ultimately, I don’t think Lancashire currently fits my criteria for a value investment: a company that is trading at a low valuation relative to its likely earning potential or book value, offering the opportunity for a re-rating.

Given this, I am probably going to sell mine over the next few day, although I believe Lancashire shares could make an excellent long-term income stock.

Disclosure: This article is provided for information only and is not intended as investment advice. At the time of publication, the author owned shares in Lancashire Holdings Limited and Aviva. Do your own research or seek qualified professional advice before making any trading decisions.

African Minerals Limited: Chinese partner takes control of debts

Iron oreFinal update 26/03/2015: Shares in African Minerals will be delisted at 0p on 31 March following the appointment of administrators today. Sadly for shareholders, my original prediction of wipeout was correct.

Updated 06/03/2015: African Mineral has gone into administration and the firm’s AIM NOMAD has resigned. AML accepts it has lost control of its main assets, and the shares will be delisted if another NOMAD cannot be found in a month. Game over, I fear.

[Updated 03/03/2015 — see end of article]

In November, when shares in African Minerals Limited (LON:AMI) were suspended, I warned that the firm’s debts meant there was only one likely outcome for shareholders: a complete loss.

So far, that prediction is looking accurate. After admitting that it was in default on its debts on 10 February and warning that even a successful refinancing would be likely to leave little or no value for shareholders, on Friday (27 Feb), the firm issued another update revealing how things could go from here — and raising some new questions about what on earth is going on in Sierra Leone.

Chinese move in for the kill?

AML’s money problems have been exacerbated by the fact that its Chinese backer, Shandong Steel Hong Kong Resources Ltd, a subsidiary of Shandong Iron and Steel Group (SISG), has refused to release some of the funds it had previously offered. It’s not clear what the full story behind this is — I suspect blame is, at least, equally divided, if not weighted towards AML — but that’s now irrelevant, at least for AML shareholders.

On Friday, AML announced that the lenders of its pre-export facility, a $250m finance facility,had transferred their interests in the facility to a new lender, Shandong Steel Hong Kong Zengli Limited, which is another subsidiary of SISG.

I’m sure you can see how this is going: SISG now owns around one-third of AML’s debt, in addition to owning a 25% stake in the project.

Here’s what I believe will happen next: AML’s pre-export facility, on which it has been in default since November, is secured using AML’s shares in two key subsidiaries, Tonkolili Iron Ore Ltd and African Railway & Port Services Ltd. As their names suggest, these are the two key operating companies which actually own the mine assets in Sierra Leone. 

What I believe will happen now is that some of AML’s shares in Tonkolili Iron Ore Ltd and African Railway & Port Services Ltd, used as security for the pre-export facility, will be seized by the new lender, SISG subsidiary Shandong Steel Hong Kong Zengli Limited, in order to address the current arrears.

Given that AML still has a problematic $400m bond on which it is also in arrears, you might expect this latest development to speed up the firm’s move towards administration and winding up.


Can’t go into administration

Friday’s announcement also included a second piece of news: AML has been issued with an interim injunction prevenuting it from unilaterally taking any steps that will lead to the dissolution, liquidation, winding up or placing into administration of any of the defendant companies.”

The injunction is valid until 2 March 2015 (today, as I write) and appears to relate to “shareholders agreements” between various AML subsidiaries and SSHK, the SISG subsidiary that is a 25% shareholder in the project.

We don’t know the story behind this, but a hearing is scheduled for today for “the hearing and determination of the application”.

I’ll update this article as and when more information becomes available.

Update 03/03/2015: As I predicted above, the new lender of the pre-export facility, which is a subsidiary of AML backer SISG, has made moves to take control of Tonkolili Iron Ore Ltd and African Railway & Port Services Ltd, shares in which were used as security for the loan.

According to today’s update, SISG is trying to take 100% control in one fell swoop, through its two subsidiaries:

The Lender has taken control of the Holding Companies by appointing new directors who have a voting majority, and has taken steps to take control of AML’s 75% shareholding in the operating companies by appointing replacement directors to those companies. The Lender’s sister company, Shandong Steel Hong Kong Resources Limited (both ultimately owned by Shandong Iron and Steel Group), owns the 25% in the operating companies not held by AML.

AML says it is seeking legal advice on the effectiveness of these action, but as far as I can see, SISG has AML over a barrel.

We’re still waiting to learn more about the injuction preventing AML from going into administration.

Disclosure: This article is provided for information only and is not intended as investment advice. The author has a short position in African Minerals Limited. Do your own research or seek qualified professional advice before making any trading decisions.

Petropavlovsk PLC rights issue explained: why are the shares down 65% and what are the nil-paid rights worth?

If you’re a Petropavlovsk PLC (LON:POG) shareholder, you have noticed the value of your shares fall from around 15p to 5p when markets opened today.

What’s happened?

Yesterday (26 Feb) Petropavlovsk shareholders voted to approve a rights issue, which will raise $235m that will be used to repay some of the firm’s $1bn net debt.

The rights issue is a 157 for 10 issue at 5p per share, which means that for every 10 shares you already own, you have the right to buy 157 newly-issued Petropavlovsk shares at a price of 5p per share.

The reason the existing shares fell in value today is that the nil-paid rights were admitted to trading and the existing shares started to trade ‘ex-rights’ — i.e. buyers of the shares from today do not have the right to buy new shares in the rights issue.

What are my choices?

In a rights issue, you have the right, but not the obligation, to buy new shares. So there are two choices:

1. Take up your rights

If you are happy to put new money into Petropavlovsk in order to maintain the size of your shareholding (as a percentage of the total share count) then you can buy some or all of the shares you are entitled to.

Your have the right to buy 157 new shares at 5p for every 10 Petropavlovsk shares you own. You don’t have to buy the full allocation, however — you can just buy part of it if you wish.

For every right you don’t take up, you will be entitled to receive payment for the value of your ‘nil paid right’ — the unusued right to buy a new share, which someone else can then buy instead.

2. Sell your nil-paid rights

Nil-paid rights are, as the name suggest, rights for which you have not paid. However, these do have a value and if you don’t want to take them up yourself to buy new shares, you can sell them. (This is normally handled automatically by your broker if you don’t take up your nil-paid rights within the specified timeframe — phone and ask them if you’re unsure of the details.)

My calculations suggest that the value of each nil-paid right in this rights issue is approximately 0.6p.

That equates to around 9.4p for each Petropavlovsk share.

[Update 05/03/15: The price value I suggested above for the nil-paid rights was correct in theory and indeed was true in practice on the day the nil-paid rights were admitted to trading, when POG shares were trading at around 5.6p.

However, investors have proved unwilling to pay that much for the nil-paid rights, which are now worth around 0.13p (POG shares are currently trading for around 5.13p).

How it works: Remember, buying a nil-paid right gives you the right to buy a share at the rights issue price, in this case 5p. Therefore while the rights issue is underway, the value of one nil-paid right plus the cost of the rights issue price should equal the current share price.]

Here’s a quick explanation of how I calculated these figures:

Petropavlovsk shares closed at about 15p on the day before the rights issue started.The price of the rights issue shares is 5p.

Value of 10 old shares @ £0.15 = £1.50

Value of 157 new shares @ £0.05 = £7.85

The ex-rights share price is simply the average of the new and old share prices:

Ex-rights share price = (£7.85+£1.50)/167 = £0.056 or 5.6p

The value of each nil-paid right is the difference between the ex-rights price and the rights issue price:

Value of nil-paid rights = 5.6p – 5p = 0.6p per right or 9.4p per Petropavlovsk share (each old share gives rise to 15.7 nil-paid rights)

What next?

If you’re a Petropavlovsk shareholder, you now need to decide whether to take part in the rights issue and buy some new shares, or whether to simply sell your nil-paid rights.

If you don’t take up your rights, most brokers will usually sell your nil-paid rights for you automatically, but it may be worth checking this with your broker, to ensure you don’t miss out.

I hope this is of some use — fell free to leave a comment below if you have any questions.

Disclaimer: This article is provided for information only and is not intended as investment advice. The author has no financial interest in any company mentioned. Do your own research or seek qualified professional advice before making any investment decisions.