Q3 Portfolio Review


Despite US stock markets rallying northward, turbulent is one of the most appropriate words to describe the UK stock markets over Q3. Amid a background with uncertainty stemming from the Scottish Referendum, geo-political tensions in Eastern Europe, and a weakening growth story in China, the UK markets were once again very volatile, albeit they ended the quarter off their recent highs. Indeed, the FTSE 100 and AIM indexes both shed approximately 4% whilst the FTSE 250 shed around 3%. However, that masked an underlying picture, which saw sectoral weakness and higher-risk propositions increasingly exited. As a result, generating returns across a diversified portfolio remained difficult to the extent that outperformance only required a decline of less than 3% in an aggregate portfolio valuation. The potential opportunities commented upon during the Q2 have failed to materialise.

Rating Changes

There have been a total of seven rating changes during the period, six of which closed out profitably, one that did not.

Over the period, I continued to prepare in the event of a further market decline through exiting 'Buy' positions in companies that were prone to either drift on no news, or follow wider market movements. The positions that were closed out were pleasing on the whole, in light of the wider market performance.

Starting with the resource sector, most hopes for a return of bullish sentiment were dashed in the period as commodity prices continued to come under pressure. Oil prices moved from a period of strength to a period of weakness with Brent crude falling more quickly than WTI, thereby narrowing the gap between the two price indexes. Even so, both sets of prices fell with Brent below the key $100/barrel level. The fall in oil prices may sound surprising given tensions involving Russia and unrest in the Middle East, but stemmed from ample market supply and weak demand in China. Whilst oil price falls may arrest soon, that does not directly tally with moving a Sell tag on Bahamas Petroleum to No Rating. The move was the result of an excellent return combined with the share price showing support at 2p. That change has proved to be accurate since the share price has rallied on no fundamentally impressive news, and currently stands at around the opening level of 3.78p - that is partly down to liquidity.

The only other move from Sell to No Rating was of Rare Earth Minerals and took place shortly after placing the tag. The price target for Rare Earth, when the share price was 1.80, was 1.25p - 1.30p. That range was swiftly reached, but given the speed of the decline, a bounce was incredibly likely, and that event played out. The share price now stands at 1.41p. At current levels the shares look better value than previously, but the disconnect in value between Bacanora Minerals and Rare Earth Minerals is extreme. The Greenland and Australian assets that Rare Earth possesses are not particularly valuable (as a percentage of the market cap), especially with the rare earth prices as depressed as they are (historically). There is also a market risk of oversupply of lithium in my opinion, and that could pan out over the next few years - the joint venture's project alone is very significant and that aforementioned potential for global supply rises could put pressure on the lithium price down the line. Nonetheless, the JVs economics are excellent, and after some additional calculations, are still excellent even with the additional Mexican mining taxes levied on EBITDA. Bacanora would remain the preference out of two if looking at valuations alone and not sentiment.

Despite sound results at Newmark Security and Amino Technologies, both companies were moved off Buy tags to lock in profits. The rationale for the Amino move can be found in the latest article, whilst the rationale for Newmark was also presented as a short update paragraph at the end of the last article. Although the exit price was short of the price target, the market was unmoved on the results statement, likely as a result of the extremely weak newsflow. Despite the management vowing to improve shareholder communications it makes sense to wait for such changes rather than to pre-empt them. To their credit, the declared dividend provides an excellent yield and is well covered by adjusted earnings.

On the other hand, Pennant International unveiled unimpressive results and despite winning a contract just a couple of days later, there is a worry in my view that the previous prospect of revenue stacking will turn into revenue replacement. Revenue stacking is when several large contracts stack on top of each other, thereby producing strong top-line growth, whereas revenue replacement is when several large contracts do not overlap and any newly won contracts simply replace the revenue streams of previously contracts. The shares are also illiquid, so there was little incentive to retain the holding given the potential for a market decline.

There was a similar line of thought with Finsbury Food as the shares are equally illiquid. Combined with margin pressures from cocoa prices and also perhaps from supermarkets, it was sensible to exit that position too. Being flexible with positions is key if you are not 100% convinced of the fundamentals, and with the well-publicised supermarket price war, that could negatively impact Finsbury over H2.

The one company closed out at a loss was oil equipment, services and distribution company Thalassa Holdings. This was yet another example of a time when being flexible was important. Although I was previously bullish on the company, the continuous sales of shares by Henderson Global Investors was a concern that was heightened by the following comment during a trading statement: "Thalassa has experienced good trading in the year to date and continues to experience healthy levels of order enquiry. Accordingly the Board remains confident that Thalassa will deliver another satisfactory performance for the year ending 31 December 2014." Rest assured, if a company had performed well, they would have not hesitated to emphasise the point, so the use of the word satisfactory was a hint, especially with the lack of figures provided in the update. That turned out to be true as the interim results were very disappointing, with the Russian situation also taking its toll.

Portfolio Companies

The portfolio remains well diversified with companies operating in the following sectors:
- Equity Investment Instruments [CHA (S)]
- Financial Services [MFX, PMR]
- Forestry & Paper [AEG]
- Home Construction & Household Goods [TW]
- Mining [BMN]
- Oil & Gas Producers [FAST, PTR, TRIN]
- Support Services [DRV, RGS, SPSY]
- Travel & Leisure [PEL]
 
It was a mixed quarter for the remainder of the companies within the portfolio, and whilst investment cases for most remain as strong as before, I will remain flexible and close positions where appropriate, dependent upon wider market conditions. After all, if the wider markets decline materially, then share prices across the board tend to follow. Nevertheless, there are still compelling reasons to remain holding most.
 
Manx Financial Group was a new introduction to the portfolio during the period, and is now the largest portfolio slot after an additional £7,500 position was opened on the company. The financial services firm, which revolves around Conister Bank, initially rallied in the quarter up to 16.5p, but settled down post-results despite some impressive figures. The likely reason was the market picking up on the outstanding warrants that are not yet in circulation and being sceptical of management. Having talked to Juan Kelly, MD of Conister, I remain confident that this does not alter the investment case, and that even at the diluted level, Manx is good value when considering the balance sheet and potential for further incremental growth. A bullish comment was also within the outlook of the latest results: "In addition, we hope to be shortly able to announce new initiatives in foreign exchange services and also loan broking, both of which have significant profit potential."
 
The second financial services firm added to the portfolio was broker Panmure Gordon - the reasoning behind the move was that downside was capped by the strength of the balance sheet, whilst the upside was moving into view as a result of restructuring and a good pipeline of deals during H1. That enabled a sharp rise in earnings per share to 10p in H1, compared to a share price of less than 150p. Clearly that's very good, so it's a question of sustainability and market conditions will dictate that - it's worth noting that management are confident of a strong H2. The share price does remain below the review price as a result of continued share sales, but as earlier, the balance sheet makes the hold comfortable for now.
 
Mining companies were once again heading lower during the quarter with gold prices remaining depressed and base metals such as iron ore declining materially. That is bad news for the bulk of AIM firms within the space, since these are two core commodities, and the likes of London Mining, Anglo Asian Mining, Baobab Resources and Sable Mining have all been hit badly by the move. Unfortunately, despite progress at Bushveld Minerals' vanadium asset, the commodity price move has taken its toll, and Bushveld's share price has declined to just above 3.5p, and considerably off the portfolio average. The core questions for management revolve around the funding situation and progressing the asset base. Bushveld are in a unique position where they could call in cash nearly at their free will if they vote for a special dividend from Lemur, so it is slightly puzzling why that strategy is not being followed in light of the weak balance sheet, especially since it would boost the share price considerably. It would also be good to see the vanadium asset attract a higher post-tax IRR after further economical work, but the initial steps taken to enlarge and progress the resource are encouraging. In the current mining environment, this is the most attractive of the four mining assets that Bushveld has.
 
Concha is an incredibly interesting situation, as it is one of the most severe cases of corporate overvaluation that I have seen. Nonetheless, there appears to be a major keen buyer of the stock, and that helped the share price rebound from the 3p zone to as high as 4.3p - the share price is currently favourable at 3.9p versus the review price of 4.2p. Comments have been raised to suggest that a 'football app' being developed is the reason for the rise, but that argument seems thin. Simple online checks by searching for 'Chris Akers football app' do bring up results, potentially linked to the rumours, but the app (if linked to Concha - it is categorically not yet) would still not justify the market cap at present, and the concept is likely to be littered with hurdles. In any case, Concha should have released this information if it was linked to major shareholders accumulating when they released the statement of price movements when they stated that they 'knew no reason' for the rise. It remains a convincing short, although I am mindful that the trend could continue (hence why there is only a half slot in place). Whoever is buying the stock will not have unlimited funds so that buying pressure will dissipate at some stage.
 
The portfolio has retained a selection of stakes in oil and gas companies despite the oil price decline, which was unexpected. The rationale behind holding Fastnet Oil & Gas and Petroneft Resources remain in place. Fastnet remains heavily backed by cash with farmout upside at both the Moroccan onshore and Celtic Sea assets. Although the timing for the Celtic Sea assets remains difficult to predict, the Moroccan onshore asset is very interesting with the high chance of success that will attract retail investors once the drilling plans are released to the market, probably during Q4. Recall that there is a 70% chance of success and the gas play has already been confirmed by previous wells - Fastnet's share price had advanced to as high as 8.5p during the quarter, which was above the minimum 50% forecast rise, although the portfolio position was not changed as a spike was likely in that case. It now lies at just above 6p.
 
Click to enlarge
Petroneft's share price is also (roughly 7.5%) above the review price, which may seem surprising given the events in Russia, but that is testament to the solid progress that is being made at new drills (including the T-5 well where regular newsflow should be released), and that market confidence is slowly being regained. Oil India's presence alone is likely to be a major reason for the increasing interest. If flow results at T-5 are positive, a significant medium-term price breakout looks probable since the technical picture is highly encouraging. Traders will be looking for a convincing price break of 6.5p to target materially higher levels. As per the chart on the right, the technical set-up continues to look extremely bullish.
 
On the contrary, Trinity Exploration & Production's share price performance has been extremely disappointing, with the share price slipping through several key support levels at 100p and 85p before crashing downwards in recent sessions as the market was unimpressed by the interim results of the group. For a company producing the best part of 4,000 barrels a day and having the quality of assets that it does, a share price of circa 60p and an estimated enterprise value of around £77m, is extremely harsh. It is a near certainty that the decline was exacerbated by a distressed institutional seller. The balance sheet is weak, but the company are in the process of sorting out non-dilutive financing solutions, so the market capitalisation is extremely low. Questions do remain about how they progress the assets beyond that, but it makes logical sense that if they were in such a tight corner, they would not have purchased Blocks 1a/b off Centrica - therefore, the market reaction appears overcooked. Nevertheless, it remains the case that the share price is approximately 40% off the review price, and the price performance has been thoroughly disappointing. I continue to monitor the situation closely, and await news on "industry sourced solutions to strengthen its balance sheet."
 
Moving to a completely different sector, it was a similarly mixed performance for Paragon Entertainment, whose share price performance started brightly but quickly waned as the company unveiled two profit warnings as customer delays meant that revenues have now been pushed from 2014 to 2015. The share price does remain marginally above the initial review price, but considering the share price had hit over 4p, the fall back to a share price of 2.25p and market capitalisation of £4.5m is also disappointing. As with all other positions, I may remove in the event of market weakness. Interestingly, former CEO (now Sales Director) Mark Pyrah purchased a material £26,000 worth of shares at 2.6p post the second profits warning, and a follow-up article on Paragon will be released in due course, outlining the reasons for the profit warning and looking at whether the outlook has changed. The fact that Paragon remains part of the portfolio should provide a clue.
 
There are now three support services firms within the portfolio: Driver Group, Regenersis and Spectra Systems. Following a lacklustre half-yearly report from Driver Group back in May, yet a re-iteration that results would meet market expectations, Driver failed to release a trading update in July as they did last year. Ordinarily that would be a negative signal for shareholders, although that was not a trend prior to 2013 so I have undecidedly retained one position whilst closing the second position, such that the portfolio average is still marginally above the current share price.
 
Positively though, there have been two credible developments over the quarter with the first being a key framework agreement to support construction major Kier with dispute resolution and project management services - Kier are a near £900m business. CEO Dave Webster commented, "I am particularly delighted for our teams across the UK to be working with a world class construction company such as Kier helping with project delivery in the challenging construction market place." The second was an unquantified contract win with a major petrochemicals firm: "SABIC, headquartered in Riyadh (Saudi Arabia), is one of the world's top 6 petrochemical companies and is the largest non-oil company in the Middle East." A trading update is due for release by Driver over the next few weeks and although the GBP:ZAR exchange rate will likely have continued to hamper the South African operations, the core business is likely to be in good shape, so the question is whether or not they hit market expectations. If they do then they are trading on a PER of 12.6, falling to a prospective 9.7 for 2015, which is attractive, but with currency headwinds it appears difficult.
 
Regenersis was a new addition to the portfolio just this week after so full details can be read in the latest review. This position was a departure to those previously, not just in terms of size, but also because Regenersis is a company that will be more prone to react to wider market movements. For that reason I will be very flexible with the Regenersis position and reduce in the event that wider markets show sign of considerable weakness. I recommend placing a stop-loss or taking small profits if you detect weakness. Nonetheless, the sell-off appears extreme and the growth story remains intact.
 
Spectra Systems continues to perform well both operationally and in terms of its share price. Recent results show that the market cap is still very well supported whilst the underlying business is strong with multiple potential growth avenues: "The Board therefore believes that the Company, by achieving key business milestones, will continue to perform well for the remainder of 2014 and continues to have excellent prospects." The last set of results show that tangible assets are nearly 350% of total liabilities and net tangible assets alone cover nearly 80% of the market capitalisation, without even accounting for the revenue-generating business or potential upside of Aeris. Spectra therefore remains a hold.
 
Further details were released yesterday by Active Energy Group whose H1 results were uninspiring. Despite that, the best part of H1 was spent restructuring so the numbers are not a surprise. The focus needs to be on their portfolio of assets; Wood-chipping, pelleting and the Canadian forestry assets. Combined, they still make the market capitalisation look very low indeed, and CEO Richard Spinks has been vocal in the sheer potential of Canada. Indeed, that talk was followed up by yet another ~£17,000 share purchase yesterday at around 3p, and that is very pleasing. That share purchase is made even more significant since a purchase had been made by Spinks back in July and this was after his house in Donetsk was essentially lost to pro-Russian rebels. These are very significant votes of confidence and it's not difficult to see why. Even if the Canadian venture KAQUO sell 20,000 hectares (out of 200,000) at a base case of $2,000 per hectare (transaction amounts would likely be $4,000 to $5,000), then KAQUO would raise $40,000,000, or $18,000,000 net to Active Energy. And that is just 10% at the lowest conceivable transaction value. Of course, realising such amounts will take a considerable period of time, but there is strong potential for a rapid return of capital to the company in the event that they seek to monetise part/all of the Canadian assets, alongside their Metis partners, at an early stage. Such a return would make a mockery of the market cap and fund major expansion of the other two businesses.
 
Finishing off the review of portfolio companies is Taylor Wimpey, which is the company providing exposure to the still strong UK housing market sector. As is the case with other housebuilders, the share price performance is not really a reflection of the fundamental strength of the business - rather it's a reflection of the market's caution towards housebuilders due to the speed of the rise in house prices in London and certain other regions. Regardless, they put in another strong performance and upped their proposed 2015 special dividend payout. The company trades on a prospective 2015 multiple of just 7.9 and a prospective consensus yield of 7.3%. Therefore, for investors who are not sceptical about the overall market or the housing market crashing, the company is trading on very attractive multiples indeed - especially for a large cap stock. Therefore, whilst the share price performance has been stagnant, there are still compelling reasons to hold the company in the portfolio in the interim, whilst concurrently following the state of the UK housing market.
 
Overall, the third quarter has been far from phenomenal, but the site portfolio has continued to deliver a respectable performance amidst the volatile market background, with a further six positions closed out profitably. Ten of the fourteen portfolio positions open are in profit although the price performances of certain companies including Trinity Exploration and Bushveld Minerals have clearly tarnished the overall performance of the portfolio. With market conditions likely to remain volatile, and commodity prices a key consideration for several portfolio stocks, I re-iterate the need to remain flexible with portfolio positions and I will not hesitate to close out positions if weakness looks likely, or to simply lock-in gains. I will however continue to seek out attractive new company valuations during any unjustified price declines. A turbulent quarter to say the least!

4 comments:

  1. Thanks El1te, your tips and research are extrememly appreciated by many of us personal investors! Let's hope for a phenomenal fourth quarter! :)

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  2. Ditto :0)! A great performance over said quarter (except trin and bmn :0]) as aim is back to performing like a drunkard

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  3. Interesting comment. I look forward to Petroneft news and Paragon comment
    JB.'

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