Jackup rig

I’ve bought more Lamprell after today’s results

Jackup rigDisclosure: I own shares of Lamprell.

After halving my holding in rig-builder Lamprell last December, I’ve hung on to the remainder — despite watching the shares fall by a further 40% or so.

My thinking has been fairly simple: Lamprell’s net cash and backlog of late-stage projects have meant that the firm should continue to generate cash next year, even without much new work coming in.

When the market does start to turn and new projects are awarded, Lamprell should be able to ramp up from a strong base — in terms of both financing and recently-upgraded facilities.

The risk, of course, is that the market slump will continue longer than expected, eroding the firm’s net cash and strong balance sheet.

I decided to wait until Lamprell’s interim results were published today before making a decision on whether buy more. I was also prepared to sell, if the figures were not what I expected.

Having read through the firm’s interim results this morning, I’ve added to my holding at 58.7p per share.

Deep value?

The biggest factor behind my purchase is Lamprell’s balance sheet. Here’s how things stand (as of 30 June 2016):

  • Current assets: $651.7m
  • Current liabilities: $240.0m
  • Net current asset value (NCAV): $411.7m / c.£314m or 92p per share
  • Market cap: £203m

Lamprell appears to be trading at a 35% discount to its NCAV. A substantial slice of this is net cash of $151m. However, a substantial part of the group’s appeal is its $412m of trade and receivables.

What this implies is that the market is valuing the firm’s ongoing business and fixed assets at zero. I think that’s overly pessimistic, given Lamprell’s strong net cash position and recently-upgraded dockyard facilities.

My thinking has been that while new work may be thin on the ground for a little longer, Lamprell’s yards are currently full of major projects due for completion over the next 6-12 months. As these complete, the firm’s receivables should gradually be converted to cash.

In Lamprell’s investor call this morning, CFO Tony Wright confirmed this view. As all major projects are at a fairly late stage, the group has no customer cash on its balance sheet (i.e. advance payments) and expects net cash to rise as receivables start to fall.

I’ve definied NCAV as current assets minus current liabilities. But even if we use the more demanding Ben Graham measure of current assets minus total liabilities, Lamprell still has a NCAV of $321m, or about £244m (71p per share).

The current £203m market cap equates to a 20% discount to Ben Graham’s fairly demanding measure of net current asset value.

…or cheap for a reason?

It’s worth repeating that one reason for the shares’ discounted value may be that the market expects Lamprell’s cash to be consumed by the business of surviving the current downturn.

The group certainly does have relatively high fixed costs. SG&A costs totalled about $26m during H1, so are likely to be more than $50m for the full year.

A second concern is that the recent problems with the Cameron jacking equipment on the Ensco 140 rig have reduced Lamprell’s full-year profit by $35m. I suspect that the company will recover this money and other incremental costs incurred on similar projects from Cameron. But it may be a long and slow process, and could involve costly legal action.

In the meantime, revenue forecasts for 2017 have been cut to $400-500m and the firm’s bid pipeline has shrunk from $5.3bn last year to just $3.9bn. Lamprell has very little work lined up when current projects complete, and may even end up losing money in 2017.

Oil market outlook

The final element in my decision is that I believe the oil market is reaching a low point, and that a material level of rebalancing is likely in 2017. I don’t expect oil to trade anywhere near $100, but I don’t think it will need to in order to trigger some increase in activity levels.

Oil at $55-60 will be enough — in my opinion — to start bringing the market back to life. Costs have fallen dramatically over the last two years and investment in new fields has all but dried up. This situation won’t remain static forever.

I’ve bought more

As things stand, I reckon Lamprell shares are worth about 80p — their NCAV minus a 10% discount. But if the firm can start refilling its order books, then significant further upside should be possible.

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.

CCTV security camera

IndigoVision Group H1 results: improved trading + good value?

CCTV security cameraDisclosure: I own shares of IndigoVision Group.

Yesterday’s interim results from video security system firm IndigoVision Group were encouraging, without being outstanding.

The main points were:

  • Revenue down 3.5% to $21.8m
  • Camera volumes up 20%
  • Gross margin maintained at 52%
  • Overheads reduced by 8% to $11.9m
  • Operating loss reduced by $1.0m to $0.3m
  • Net cash up to $4.6m from $2.76m at the end of 2015, thanks to lower inventories and longer payment terms

The group reported a number of new orders and said that trading is expected to be stronger during the second half. R&D spending is being maintained to ensure products are updated and renewed.

The group anticipates “satisfactory operating results” for the year. I took comment to mean that FY result are expected to be in line with forecasts from the firm’s house broker.

These forecasts suggest the shares may be going cheap at the moment: earnings of 22.6p per share and a dividend of 7.5p are expected this year, according to Stockopedia. This puts the stock on a forward P/E of 6.5 and a prospective yield of 5.1%.

Despite the stock’s recent gains, IndigoVision also continues to trade slightly below both its book value and its net current asset value:

  • Tangible net asset value: $22.5m
  • NCAV: $16.5m
  • Market cap: $15.5m

Although the discount to NCAV isn’t large, this should provide some downside protection. The tangible net asset value of $22.5m translates to roughly 224p per share.

That would give a 2016 forecast P/E of 10 and ought to be achievable, in my view.

I continue to hold.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

Fifty pound note

Could rising debt undermine Fenner’s recovery?

Fifty pound noteDisclosure: I own shares of Fenner.

Shares in Fenner have been on a tear this week, climbing 13% on the back of an upgraded broker note and an upbeat trading statement. The shares are now worth 32% more than they were at the start of the year and my holding — which I bought too early in the mining downturn — is close to breakeven when dividends are included.

However, I can’t ignore the fact that Fenner’s net debt has risen to £150m. That’s the highest level since 2009 and looks quite demanding alongside 2017 forecast profits of just £17.4m.

An excellent Stockopedia interview with Nick Kirrage — who manages some of Schroder’s value funds — nudged me into researching this situation in more detail. (Incidentally, Nick and his colleagues blog at thevalueperspective.co.uk — worth reading for value investors.)

To get a fuller picture, I’ve gathered information about three key aspects of Fenner’s debt — borrowing levels and maturity, covenants and gearing/debt ratios.

Debt facts

At the time of its interim results (30 April) Fenner’s balance sheet looked like this:

  • Cash: £93.2m
  • Current debt (due < 1 year): £39.9m
  • Non-current debt (due > 1 year): £191.3m
  • Net debt: £138m
  • 8 Sept 2016 year-end trading update: Net debt c.£150m

According to last year’s annual report, £58.4m is due to mature in June 2017, with £38.7m due in July 2019. Beyond this, nothing is due for repayment until September 2021.

Interest costs were £14.7m last year, and were similar the previous year. That’s fairly material relative to forecast net profit of £13.6m in 2016 and £17.4m in 2017.

Currency effects: The devaluation of sterling after the EU referendum had an adverse impact on net debt, most of which is denominated in US dollars. Over the next year, this should be offset to some extent by the boost the weaker pound will give to Fenner’s US dollar earnings, which are considerable. Overall, I’m tempted to say that currency effects will be broadly neutral.

Liquidity: Current assets comfortably exceeded current liabilities, giving a current ratio of 1.64. That’s acceptable, if not outstanding.

Are the lenders happy?

Fenner’s debt level remained within its banking covenant levels at the time of its interim results. I’ve listed the two key covenant ratios below, with the covenant limits in brackets:

  • Net debt/EBITDA = 2.3x (< 3.5x)
  • EBITDA interest cover = 4.8x (> 3.0x)

There isn’t a massive margin for error here. But Fenner expects results for the year which ended on 31 August to be at the upper end of expectations. So EBITDA-related covenant problems seem unlikely for the time being. I imagine the firm’s lenders will be happy enough as long as interest payments are maintained.

Debt ratios

The standard measure of indebtedness used by most analysts and stock market data services is gearing. This measures debt relative to a company’s equity value.

Fenner’s net gearing (net debt/equity) was 50% at the end of February. However, I’m not convinced this is a very useful measure of a company’s ability to repay debt. After all, the only way Fenner could raise £150m to repay its debts today would be by flogging its best assets or issuing new shares.

Both measures would be a desperate last resort.  I’m more interested in a company’s ability to reduce debt by generating cash profits, without sacrificing planned capex or growth plans. After all, if a company cannot manage debt in this way, then its dividend will eventually be cut.

Inspired by John Kingham’s work at UK Value Investor, I’ve started to look at debt relative to companies’ profit and cash flow. On this basis, Fenner looks more heavily geared:

  • Net debt/10yr average free cash flow*: 5.2x
  • Net debt/10yr average net profit: 5.4x
  • Net debt/10yr average net profit (inc. 2016 forecast): 5.6x

These ratios look fairly high to me, but they’re not disastrous. As market conditions appear to be improving, I’m inclined to wait until the firm’s final results are published in November before making any further decisions about my holding in Fenner.

*I define FCF as operating cash flow – investing cash flow (exc. acquisitions) – interest payments

Is Fenner cheap or expensive?

However, I will leave you with two other statistics which suggests to me that the shares may be approaching fair value: The PE10 is a favoured metric of value investors, as it compares a company’s share price to its ten-year average earnings. This is enough to smooth out most cyclical peaks and troughs.

Deep value investors tend to look for a PE10 of 8-12. Fenner’s ten-year average net profit is about £26m, giving a PE10 of 14.

I’ve also calculated Fenner’s 10-year average free cash flow (see definition above), which is £29.1m. That puts the shares on a P/FCF10 of 12.6, which looks quite reasonable.

I continue to hold.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

Oil platform in North Sea

Four simple reasons to avoid Premier Oil plc

Oil platform in North SeaDisclosure: I have no financial interest in Premier Oil.

Premier Oil’s interim results confirmed my view of this stock: this company has good assets and is operating well, but its debt situation means the stock remains a sell for equity investors.

Here’s are four reasons why I think big losses are likely for Premier Oil shareholders.

1. Covenants would be breached if tested

Net debt rose to $2.6bn during the period and is expected to peak at $2.9bn during Q3. The firm’s net debt/EBITDAX ratio was an eye-watering 5.2x at the end of June, significantly above the firm’s covenant maximum of 4.75x. This is why covenant tests have been suspended while refinancing discussions are ongoing — Premier and its lenders don’t want the firm to fall into default.

However, the significance of this situation is that Premier’s lenders have the firm over a barrel. Premier can’t walk away and find a better deal elsewhere. It has to reach an agreement with its lenders, otherwise it will default on its loans and risk being put into administration.

2. “A full refinancing”

Premier isn’t just tweaking the terms of its loans. In the results webcast yesterday morning, Premier’s FD Richard Rose said that the current debt negotiations are “effectively akin to a full refinancing of the group”.

Mr Rose also explained that the firm has “four or five” lending instruments, each of which has multiple lenders behind it. He estimates Premier is dealing with about 50 lenders in total. So the complexity involved in the negotiations is considerable. Reaching agreement won’t be easy and the lenders have the upper hand.

Premier is hoping to agree revised covenants and longer maturities on some of its loans. In return for this, management expects to accept higher interest rates and to use the firm’s assets to secure its debts.

Management also indicated that during the deleveraging process, Premier is likely to have to get lender approval for any major new investment plans. CEO Tony Durrant indicated that no major new investment spending is likely for the next couple of years.

Details of the refinancing should be finalised during the second half of the year. Shareholders may feel that they are safe, because Premier’s current 78p share price equates to a discount of about 40% to the group’s net asset value.

However, my view is that if Premier’s lenders are having to make compromises and wait longer for their money, then shareholders are also likely to face losses. One possibility is that lenders will get a slice of Premier’s equity, perhaps through the issue of a large number of warrants for new shares.

3. $5 per barrel

One interesting figure from yesterday’s call is that Premier’s interest costs currently amount to about $5 per barrel. This could rise as a result of the refinancing. This figure gives a real taste of the burden the group’s debt pile is placing on its cash flow.

At $50 per barrel, 10% of Premier’s revenue would be absorbed by interest costs alone. Repaying the capital on these loans at sub-$60 oil prices won’t necessarily be easy or quick, especially as the group’s cash flow faces an additional risk in 2017.

4. Hedging risk?

During H2, Premier’s existing hedging positions means that the group will be able to sell oil at an average of $65 per barrel. But in 2017, this coverage tails off. Premier’s figures indicate that current hedging will only provide an average oil price of $45 per barrel in 2017.

If the oil price doesn’t make progress above $50, then this lack of hedging could have a significant impact on Premier’s cash flow.

Only one conclusion

Premier was tight-lipped about the likely terms of its refinancing in yesterday’s call. But it’s clear from management comments that other potential sources of cash — such as pre-pay agreements for oil and gas sales — won’t be viable until the firm’s lenders have agreed a new deal.

I think there’s a reasonable chance the refinancing package will include some kind of dilution for shareholders.

Even if it doesn’t, shareholders should remember that both growth and shareholder returns will effectively be off the cards for the next couple of years. Furthermore, if oil stays low, Premier’s financial difficulties could become even more severe.

I can’t see any reason to own the shares at this point in time.

Disclaimer: This article represents the author’s personal opinion 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

Why I’ve sold South32 Ltd

An open-cast coal mineDisclosure: I own shares of Anglo American and BHP Billiton, but not South32.

I’ve sold my shares in BHP Billiton-spin off South32 Ltd (S32.L). There are three main reasons for this:

  1. My holding was limited to the shares I received as a BHP shareholder. As such, it was a very small part of my portfolio. I’m trying to maintain a more deliberately-constructed portfolio without such oddments.
  2. I already have considerable mining exposure through my holdings of BHP Billiton and Anglo American. Both are sizeable positions (for me). I remain confident about the medium-term outlook for both companies but don’t feel that South32 adds much to the opportunity offered by these much larger firms.

As it happens, I think South32 is a fairly decent company. The balance sheet appears strong and cash generation also seems reasonable. Had I invested in size in South32 when the shares were lower, I might have made this a core position.

However, South32 looks fairly valued to me for now. I’m not tempted to buy more. So I decided to swallow the dealing cost and sell, in order to boost my cash position ahead of my next buy.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.