Small Cap Value Report (30 Sep) - ZIOC, TET, FRP, ABM, TAN, UNG

30th Sep '13 by Paul Scott

18 comments 22161 reads

Good morning! We look set for a fairly ugly start, with the FTSE 100 Futures down 66 points at 6,442. As I've been saying for a while now, in my opinion small & mid caps are in a very frothy bull market, with a lot of valuations seemingly carried upwards unendingly on momentum, but increasingly detached from sensible valuation metrics. Hence in my opinion this is a time to be top-slicing or exiting completely from anything whose valuation looks full, and sitting on some cash to await the bargains that will be thrown at us once this euphoric mood of Mr Market turns once again to despair. I don't know how big the correction will be, or when it will happen, but I reckon it's coming.

That said, there are always bargains to be found in the small caps space, they're just harder to find, and less obvious at the moment - but I'm particularly focussing on companies that are out-performing against broker forecasts - because brokers tend to be too pessimistic in an economic recovery, forgetting about operational gearing, which can see profits shoot up much faster than turnover. So situations where that is happening can end up being cheap once results are issued that beat expectations.

Zanaga Iron Ore (LON:ZIOC) is a special situation that I like a lot - their interim results are published today, and the narrative gives a decent summary of the current position. They are jointly developing a world-class (in both scale and low production cost) iron ore project in the Republic of Congo. In my view there could be further considerable upside on the current share price despite it having doubled recently. The big uncertainty is what level of dilution will be required to finance the project, using third party debt and equity. Glencore and ZIOC are jointly working on raising the financing, so I'm sure we'll get another update in due course, but so far so good. There is a cash pile of $35m as of 30 Jun 2013, and about half that is ear-marked for ZIOC's contribution to the 2014 development costs, so the cash backing behind the shares is diminishing, although the project viability has dramatically improved in recent months, with planned capex reduced from $7.4bn to the $2.5-3.0bn range, achieved by altering the plan to develop the…

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Dinocras

30th Sep '13

ZIOC: Hi Paul. Good summary of the situation here I think. Personally I'm surprised the SP didn't stick at around 30 (it spiked at about 35p on the day of the Glencore announcement & added at just above and below 30p :-( ) because the expectation was that Glencore, who have an allergy to greenfield investments, would sell their rights on. The fact that they didn't I see as a huge positive that is not reflected in the current price. With Glencore leading the negotiations for financing the project I'm expecting a very good result and a significant rise in the SP as more information on the probable final deal leaks out. But, as you say, there are still significant risks.

Glad to see the best blog on the web is back; mornings just wouldn't be the same without it.

PS: I've made a donation to your upcoming charity run. Don't forget to soak your feet in vinegar and then bake them in the oven before the run - or is that what you do with conkers? Oh well whatever - good luck.

khalidf

Hi Paul,

Good to have you back in full swing ;-)

There was an RNS on the 26th regarding @UK (LON:ATUK) - Placing and Open Offer. They have issued 10,000,000: "with certain existing and new institutional and other investors in each case at 33p per share".

This doesn't seem fair as the share price closed at 63p the day before. They are now down to about 47p.. Would you expect the price to keep falling to 33p or even lower? And why aren't all existing share holders offered this new price? I see they are only offering some to current holders: "the company is raising a further £2.0m, before expenses, through an open offer of 6,064,500 new shares on the basis of 1 open offer share for every 14 existing ordinary shares. "

Is this just way it is? A company can just issue x number of shares anytime? Heavily diluting the current shares out there?

Could you comment on Helphire Group PLC (LON:HHR)- Blocklisting Application this morning please. Is this similar to the above?

Sorry for all the questions! Any comments most welcome!

Cheers,
Khalid

ChangFai

Paul, I know its not a small cap scenario, but do have any thoughts on the Post Office IPO at all ?

intuitive6191

Probably the best bit of advice anyone new to investing could ever receive.

Imposing strict rules on Balance Sheets has dramatically improved my investing performance in the last couple of years. Sure, you might miss the odd high risk multi-bagger when a company that was insolvent (e.g. Thomas Cook prior to its refinancing) manages to survive. However, screening out the 50-100% investment losses from your portfolio before they happen, which almost always come from either companies with high levels of debt, or blue sky story stocks (the majority of which end up worthless), really does gives things a terrific boost over time.

Cisk

Khalid, Paul will correct me if I'm wrong here, but I believe there is no obligation whatsoever for companies to offer fundraising to private investors when they do an institutional placing (I mentioned the very same topic on a posting last week regarding £HSP).

Personally this situation seems crazy, as it should be illegal to offer certain shareholders preferential treatment over others. As can often be the case, share prices will be talked down in anticipation of the fundraising (as institutions will have been 'sounded out' about an impending issue), the price drops temporarily so that institutions can show a profit when the price rebounds in the period after the fundraising. And PIs lose out as they are diluted.

Given that current technology would facilitate cheap and quick fundraising to individuals, it's really no excuse not to offer it.

Just a quick word about a potential internet threat

If you are researching ZIOC please be aware that when you access this report in the ZIOC regulatory news the website link in this report is highly suspect.

It suggests that it links to the offical company website - when it does not. It takes you to a slightly different web address which just contains advertising links.

This is very disappointing considering that this news item has supposedly come direct from the company or its advisers. Very very poor.

Cheers for the comment Cisk

Mark Simpson

There is a requirement to offer placings to all shareholders (called pre-emption rights) but most companies have a agm resolution to waive these. The rationale is that if companies need to raise cash quickly it can be easier and cheaper to place with a few holders than create prospecti and send to all holders etc. Occasionally I've seen this resolution voted down but usually only when you have an activist investor that has picked up 25%+ of the shares themselves - probably for the reason that the largest holders are the most likely to be offered cheap placing shares. This can seem like tough luck for the PI but in my experience the share price can often drift down below the placing price in time anyway and give PI's the opportunity to remain undiluted. Not looked in detail at @UK (LON:ATUK) but only being able to get a placing away at 33p when the SP is 67p isn't really a sign of strength so although the 33p level looks low PI's may get the chance to also top up at that level soon.

On further research it appears the PR department at ZIOC is a bit of a shambles. In addition to the issue above where they gave the wrong link to their website I noticed this below in the Stockopedia company profile.

The Company is focused on managing, developing and constructing iron ore project capable of mining, processing, transporting and exporting 45 metric tons per annum of iron ore concentrate from the Republic of Congo.

45 metric tons (tonnes) per annum would give a total annual revenue of about 500 quid! I suspect that they mean 45 million tonnes pa?

A lot of red flags here for me.

shauniekent

Intuitive c'mon. If thats putting you off zioc then i think you're red flags trigger happy :-)
In fact if they were producing that then theyd be further advanced than at present ;-)

Monty9

Soak your conkers in vinegar? that'll sting...

I used to be involved in PR many years ago and found that there was direct correlation between attention to detail and how the company is run in general.

Here we have a company that cannot give its correct web address in a RNS or even be bothered to correct a very obvious error in its company profile.

If this wasn't enough it is a blue sky company trying to sell a success story about iron ore, a product which is forecast to have a worldwide glut and price collapse in next few years.

Dont be too surprised if the shorters get stuck in here at some stage.

cig

1st Oct '13

Excuse my naivety, but if someone brings $1 billion+ to Zanaga Iron Ore (LON:ZIOC), why would they leave much upside to existing shareholders when they can easily buy the whole thing for spare change (the £40m EV)? Or is the play about a takeover premium?

Paul Scott

Hi intuitive6191,

I agree that attention to detail is important, but you're getting a bit hysterical over a broken link on their website - just drop them an email & they'll fix it, that's what I normally do when I find a link doesn't work.

On your other points, it's isn't a blue sky company at all - the resource is proven up to a high level of resolution, due to the fact that Glencore/Xstrata spent $300m+ funding the Feasibility Study. This is a massive, proven iron ore project, right at the bottom of the cost curve.

You're right that the price of iron ore has been forecast to fall, but those forecasts have been wrong. Increased demand from China & recovering economies elsewhere are increasingly make people think that the additional 4% in global supply that's coming on stream will fairly quickly be absorbed.

However, the real crux of it all is that everyone was expecting Glencore to abandon this project, as they have publicly, repeatedly stated their aversion to greenfield projects, and have scrapped a lot of the Xstrata projects they inherited. However, in this case, Glencore and ZIOC issued this announcement jointly, outlining how they are progressing the project, and jointly seeking the project finance.

I've researched this share in a lot of detail, and the deeper you look into it, the more compelling the investment case becomes.

Glencore and ZIOC are motivated to secure funding together, since both sides have to sign off the capex. So ZIOC cannot be cash called - and there is clearly a very collaborative relationship between ZIOC and Glencore to have got the project to this stage, and an astonishing situation when you consider that Xstrata/Glencore funded the entire $300m+ feasibility study - think about that for a minute!

The best situation for ZIOC is if we're just bought out, but the beauty is that management own about 75% of the equity, so can name the price for a takeover bid, as they can block it. So we are looking at multiples of the current share price before management would even consider an offer, in my opinion.

There are still unknowns here, but given that Glencore actually developing the project was considered to be so unlikely that the market had effectively priced the shares at virtually zero premium to net cash when they were at the recent 10p per share lows, the price now that Glencore are progressing it seems arguably cheaper, despite having doubled, given that we now have a project that is now very likely to go ahead.

The one big unknown is how much dilution ZIOC will have to accept to get the funding in to progress this project. The most likely scenario is that the Chinese will be brought in as a 3rd partner, along with perhaps 80% debt financing - perfectly feasible given that this is a Glencore project - nobody is going to question their creditworthiness, are they?

So exciting times ahead I think.

Regards, Paul.

garbetklb

2nd Oct '13

Zanaga

Thanks for the very informative write-up Paul.

I find the story pretty compelling, have a few shares and will probably buy a few more to take me up to a bit above my normal "punt" level recognising that the downside is a probably 100% loss but the upside could be substantial. As background, I'm not normally a punter and don't have a v good track record with miners!

I have a couple of apparently minor niggles :

Looking at the Glencore website and filtering down to Iron Ore operations, they only list two. Both in West Africa, one at pre-feasibility, one at feasibility, but neither of them are Zanaga; that surprises me. A positive would be that they have no other Iron Ore projects so are "light" in their exposure.

In the press release, Zanaga's logo appeared in the left position and they were listed above Glencore in contacts. This might sound incredibly trivial, but I'd expect the dominant party to want to appear in control of a project if they are serious about it.

And I've just been a bit surprised - in their supplemental press release, Zanaga have mentioned one of their 2 largest shareholders as "Garbet Ltd" - emphatically nothing to do with me! Garbet's not a v common name - I'll investigate!

Garbetklb

Hi Garbet,

OK, reveal yourself - you're a ZIOC mole, lol! ;-)

Seriously though, yes the founder Directors of ZIOC own about 75% of the equity, so we're very much along for the ride. However, they are big heavyweights, and have reputations in the sector to protect, so I'm pretty comfortable with who's in charge here - it's not your usual "liar standing by a hole in the ground" type of set-up. Just look at the market cap when it was floated.

Make no mistake that Glencore are behind this project - this is the RNS issued by Glencore itself on 13 Sep 2013. The project is still subject to completion of the Feasibility Study (although most of the work has already been done), and licences from the Republic of Congo Govt (who are massively supportive of this project as it will be a major boost to their tiny country's GDP - something like an extra 20-25%!).

However, given that Glencore have binned many of the former Xstrata greenfield sites, the fact that they have very publicly backed the ZIOC project is a sign of serious commitment here. Glencore have dramatically improved the project dynamics, reducing the capex requirement from $7.4bn to in the $2.5 to $3.0bn range, and ZIOC speak very positively of the working relationship with Glencore.

So in my view there's everything to play for here, on a genuinely world class scale project, with a world class project partner not only committed to driving the project forwards, but also to arranging the financing together too.

The house broker is talking about a share price c.100-227p, but that doesn't even include any value for the later development stages. The company itself is not shy about 200p, so there really is multibagger potential here. I'm very surprised the shares only doubled from near-cash levels, after such an astonishing announcement that Glencore are taking the project forwards to the next stage, when everyone had assumed it was dead in the water.

As ever, please DYOR!

SevenPillars

22nd Nov '13

Zanaga Iron Ore down to 15.5p, was near 30p on this news, and dropping like a stone, or should that be a like a chunk of iron ore, assuming they find any. Has anything changed about the company.

Hi Seven Pillars
Anyone who invests in ZIOC needs to understand the somewhat complex iron ore market and the headwinds that it faces. From 2014 to 2017 it is forecast that multiple projects will come online and that a significant oversupply situation will result. Some forecasters suggest that iron ore will hit $80 per tonne – at which point it’s hardly worth getting out of ground.

If this wasn’t bad enough, China (who consume nearly half the world’s steel production) decided that whatever price they were paying for iron ore for their own steel mills was too much. As a result, China has taken issue with the traditional spot pricing of ore and has set up their own exchange. The objective is fairly simple, to force the spot price down.

China is also a significant producer of iron ore. Their product by all reports is a fairly poor grade and difficult to mine. They can however make the decision to subsidise production if this helps with tanking the spot price. I don’t know what goes on in China (who does) but the last time ore hit $90 per tonne it was traditional producers who felt the pain and China seemed quite at ease with the situation.

I understand that ZIOC have said that their ore is cheap to mine. This might be the case. Of course when mining actually occurs there are many problems such as strikes or governments moving the goalposts which can increase costs.

Their licence may be worth something – but I wouldn’t want to guess. I think that cig made a useful observation when he said that there might a bid premium here, though from what share price that might occur is anyone’s view. I would guess that the Chinese eventually control the iron ore market and start to acquire foreign assets on the cheap. Under that scenario I can’t see that ZIOC managing to produce a stellar return. I could of course be wrong. As I said, its complex.

Small Cap Value Report (30 Sep) - ZIOC, TET, FRP, ABM, TAN, UNG

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Paul Scott

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