Good morning! Firstly a reminder that it is the usual monthly investor evening & dinner in Beckenham tonight, called Mello. I am told that around 60 of us will be descending on "Sea Salt" restaurant for a lively evening of two presentations (from me to begin with, followed by Netplay TV, then dinner), with drinks & networking. Those of you who are booked in are asked to definitely turn up (or cancel if you can't make it), as organiser David Stredder is concerned that it may cause problems with the restaurant if there are too many no-shows, since the large numbers booked in means that he's asked them to allocate the whole restaurant to us only. Contact details are here.
NetPlay TV (LON:NPT) should be an interesting presentation. The shares look really good value at first sight, but there is a big question mark over sustainability of earnings after forthcoming Govt taxation changes. Directors becoming repeated sellers of shares personally from Sept 2012 onwards is not exactly a positive sign.
The FTSE 100 Futures shot up overnight, perhaps Ben Bernanke has said something? Anyway, at present the market is set to open up 68 points at 6,652.
I called in to see Zanaga Iron Ore Co (LON:ZIOC) on Friday afternoon with some fellow investor friends, and discussed their series of exciting announcements on Friday confirming that, much to our surprise, Glencore has decided to progress their jointly-owned iron ore project in the Republic of Congo. It's a vast resource, and Glencore has already spent around $300m on the feasibility study.
Glencore has overhauled the project such that the capex requirement has been reduced by about two thirds, from $7.4bn to somewhere in the £2.5bn to $3.0bn range. This has been achieved by planning to develop the resource in stages. The initial stage is little more than scraping the purest product off the surface, and putting it in trucks (this is called "DSO"), so production could start as early as 2015, and then gradually increase in stages as the capex is completed.
The house broker, Liberum, has done a very quick analysis of the deal, and believes ZIOC shares are worth 114p to over 200p, depending on what assumptions are made in the calculations. My feeling is that we could be looking at upside to 200p in the long run, and that's certainly not an upper limit, because the calculations used by Liberum don't include subsequent stages of the project.
I'm mystified as to why the share price fell back on Friday after an initial spike, to end at around 28p - probably day traders banking their profits and moving on? It seems to me there is plenty of upside on that, so I remain a holder. The most likely outcomes are either for ZIOC to be bought out completely for its stake of just under 50% in the project, or for its share of the capex that cannot be financed through debt, is likely to result in some dilution of ZIOC in the project - i.e. it might end up with a free carry of say 25% in the project. Not bad going, considering this is likely to end up one of the largest & lowest cost iron ore producers in the world, with reserves so large that they will effectively last for as long as human timescales extend.
Exciting stuff, although I stress that resources stocks are not my specialist area, although I can recognise a good risk/reward situation in any sector when I see it, which is very much what this was at my entry price of around 11p, when it was only a bit above net cash. It has now morphed into something a lot more exciting, so risk is now lower, and reward much bigger. So despite having almost tripled in price, I shall be sitting tight for the time being. As always, please do your own research, this is just my personal opinion, not any kind of recommendation.
Next I've had a quick read of the interim results from French Connection (LON:FCCN). My strategy here is to hold the shares for as long as their Balance Sheet remains strong, and a turnaround looks possible. I had already decided to dump the shares today if trading was reported to have got significantly worse. It hasn't - they look to have stabilised trading, with a slight improvement in losses from last year's H1. The Feb-Jul period is expected to be loss-making, with H2 usually around breakeven or a small profit, so the full year result this year is likely to be c.£5m loss perhaps.
There was a loss of £6.1m in H1, slightly reduced against the same period in 2012 of £6.3m loss. Their big problem is the UK/Europe retail division, which is delivering absolutely terrible results - so bad that it shouldn't really exist - last year (ending 31 Jan 2013) it made an operating loss of £16.0m on turnover of £103.4m. The true figure was nearer to £20m loss, once overheads are included.
So it is slightly encouraging to see that this division has this time reported slighly reduced losses, of £8.2m in H1 of 2013, against £9.2m in the prior period. That was on like-for-like sales down again, by 4.5%, however half of that fall was due to moving the sale period. Gross margins are a bit better at 55.5% (compared with 54.7% last year H1), suggesting that more stock is being sold at full price, which is good news. Gross margins really should be much higher than that though, more like the mid 60%'s, which suggests to me that FCCN are still getting their product pricing badly wrong - you can clearly see that just by visiting any shop - and see prices that are sky high compared with competitors. So customers hold back on buying, and just wait for the half price sale. Not a very good strategy from the company.
4 under-performing stores have closed, and another 3 are due to close in H2, so that's encouraging. If they can just survive long enough to hand back the leases on expiry to landlords, then eventually FCCN could gradually change into a wholesale & licensing business, which it's actually quite good at. They're hopeless at retail though - a lot of the turnaround actions taken are just retail basics, that should have been done all along. The whole thing reeks of bad management, but that's why the shares are cheap.
So looking at valuation, with 95.9m shares in issue, FCCN is only valued at £30.2m at the current share price of 30.5p. Since it is currently loss-making and not paying a dividend, you cannot value it on a PER or divi yield basis. So the only meaningful way to value it is to estimate what profit it might make if the turnaround succeeds, and then put that on a PER, and/or to think about Balance Sheet NAV, and the value of the brand. Also one should consider what value it might achieve on a disposal via a trade sale. Luxury brands can command huge values, although in this case the founder has a blocking stake of about 42%, so it hinges on what his intentions are.
Net cash has actually risen against last year, due to squeezing stock levels down. There is £22.3m of net cash, and the Balance Sheet remains very strong, with £87.7m in current assets being 209% of the £41.9m current liabilities. Long term liabilities are negligible, at £0.9m. Therefore by my estimates, there is enough fuel in the tank to continue for several more years at the current level of losses, so solvency is not an issue yet.
So with net working capital less all creditors of £44.9m, FCCN is one of the very few companies on the market that is actually valued at less than its own working capital - i.e. there is effectively a negative valuation being put on the business. That seems very extreme to me, especially considering the wholesale & brand licensing parts of the business are profitable, and clearly have value.
So I remain of the view that this could be turned around, and it has bought more time to continue with the turnaround plan. I'm happy to hold, and believe the upside could be considerable if/when a turnaround really gains traction. However, I'm also keeping a close eye on the door, indeed am standing right next to it, in case a rapid exit is needed on any further lurch down in trading performance. The outlook sounds moderately encouraging, with a positive reaction to Winter collections from wholesale customers having increased the wholesale order books. That should be an early indicator of improved retail sales later this year, for their crucial autumn/winter season.
Forget menswear & slogan T-shirts, they are irrelevant. FCCN is all about womenswear, and in particular dresses, which are their main speciality. The current season stock looks very nice to me, but still considerably over-priced. Womenswear is an incredibly competitive market place, and with much cheaper alternatives out there, it's difficult to see where FCCN goes unless they either embrace much lower selling prices, or get out of retail altogether and just become a wholesaler & licensing operation - which in my opinion is the obvious solution to their current woes.
However, from an investor point of view, it remains an interesting situation, with good multi-bagger potential from this very low valuation, if they get things right. Downside risk is contained by a Balance Sheet that remains very strong. However, the clock is ticking, and if the turnaround doesn't happen within the next year, then I'll probably move on.
Edit: Just to clarify, I am NOT saying that FCCN is a great business. It's got serious problems, and if they don't turn things around in the next year or two, then who knows what happens next? They have shop leases that they can't get out of, prices are too high, lots of problems. HOWEVER, at a £30m market cap, I see it as an interesting risk/reward situation as an investor. So I'm not waving a flag for the company, saying how great it is, or in denial about it! It could go either way, and I don't have a strong view on the likely outcome. However to me as an investor, if the odds of them turning it around are say 50:50, then the upside reward is a multi-bagger, to say 120p+ (as indeed happened in 2010-11), whereas the downside risk is down to maybe 20p at which point I throw in the towel & sell. So it's assymetrical risk/reward, skewed in my favour, at the moment. That could change, and if it does, I'll sell up & move on.
Sorry, I got rather bogged down in looking at FCCN, and can't find anything else of interest to write about today, so think I'll leave it there.
See you same time tomorrow!
(of the companies mentioned today, both Paul and a Small Caps Fund to which Paul provides research services, have long positions in ZIOC and FCCN)