Philip O'Sullivan's Market Musings

Financial analysis from Dublin, Ireland

Market Musings 3/9/2012

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(Disclaimer: I am a shareholder in Abbey plc) While the macro outlook is challenging, it is interesting to see that two UK focused housebuilders have been the subject of takeover approaches from management in recent weeks. An investment vehicle controlled by Abbey’s Executive Chairman now owns nearly 62% of the company’s shares, with its offer remaining open for acceptances until 1pm (Dublin time) on 7 September 2012. Elsewhere, the Chairman of Redrow has also made a preliminary approach to buy out the firm using a consortium comprising his own investment vehicle and two funds. When management teams, who presumably (!) have access to better information than the likes of you and me, are making such moves, this suggests to me that there is decent value still to be had in the sector.


Staying with UK stocks, I sold out of Marston’s this morning. My reasons for doing so were twofold. Firstly, the three catalysts that had been identified for the stock (The Queen’s Jubilee, Euro 2012 and The Olympics) are all over and I am guessing that the regular newsflow from the many quoted UK pub groups means that the impact of these have all been priced in. Secondly, the shares have increased by over 25% (in euro terms) since I added it to the portfolio earlier this year. You can read about why I was originally attracted to Marston’s here. In terms of where the proceeds are being recycled into (Harvey Nash plc), I will upload a blog later today outlining my rationale for the inclusion of ‘an old friend’ back in the portfolio.


In other food & beverage sector news, tropical produce importer Fyffes today raised its full-year adjusted EBITA guidance to a range of €28-33m versus the previous €25-30m. This improved outlook is based on decent organic growth and FX effects in H1 2012. Extrapolating from the adjusted EBITA of €23.3m Fyffes achieved in the first half of the year and adjusted diluted EPS of 6.48c in the same period, this points to full-year earnings of at least 8.5c, putting the stock on less than 6x earnings, so clearly cheap. Its sister company, Total Produce, which I hold, reports its interim results tomorrow.


(Disclaimer: I am a shareholder in Smurfit Kappa plc) There was a bit of news out of Smurfit Kappa Group since my last update. This morning it announced the launch of a senior secured notes offering, which will raise €200m and $250m, maturing in 2018. The proceeds will be used to repay all of the existing 7.75% senior subordinated notes due in 2015. Given the relatively low rates on offer for similar rated debt at this time, this should, I estimate, shave at least €7m from SKG’s annual interest bill, as well as extending the weighted average maturity of its debt, which reduces the perceived riskiness around the group. In all, a win-win move for Smurfit Kappa. Elsewhere, the group is to invest €28m in a new bag-in-box facility in Spain, which  is a further sign of how Smurfit Kappa’s improved financial position is giving it enhanced flexibility on both the M&A and capex fronts.


(Disclaimer: I am a shareholder in Independent News & Media plc) It was confirmed that total Irish newspaper advertising declined 10% in the first 6 months of 2012. Annualising it, and putting in a little bit of a kicker for Christmas related spending, means that it’s still a circa €180m market, so not to be sniffed at despite the confident predictions of certain ‘new media’ devotees who assure me that ‘old media’ is completely toast. While I don’t for one moment dispute that old media is in long-term structural decline, my central thesis on the sector remains that it will not disappear for many years to come, with larger newspaper groups (such as INM) being able to mitigate against the effects of a shrinking market by gaining share as weaker competitors exit the industry. Of course, the extent to which equity investors can benefit from this depends on how successfully INM can prevail over its liabilities, and in this regard I was pleased to read reports of a third bidder entering the fray for INM’s South African unit. The more the merrier, clearly, as this should mean a satisfactory sale price for the business.


In the blogosphere, I was pleased to see the launch of two new blogs by Paul Curtis and Mark Murnane. I’ll be updating the blogroll later today – if there are any other investment and/or economics sites you think I should be following, please suggest them in the comments section below.

Written by Philip O'Sullivan

September 3, 2012 at 10:02 am

Market Musings 31/8/2012

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(Disclaimer: I am a shareholder in Irish Continental Group plc) The main news since my last update has been around ICG, whose shares have surged on the back of the announcement of a tender offer pitched at €18.50, or circa 15% above where they closed at on Wednesday. This announcement was contained in its interim results release, which revealed a resilient performance despite the macro headwinds. Revenues were flat, while good work on the cost side meant that EBITDA was only down €1.8m year-on-year in spite of a €4.5m increase in fuel costs. The company is also putting its balance sheet to work with its €111.5m tender offer, which I’m guessing should put net debt / EBITDA at circa 2x by the end of next year, so still undemanding. ICG has also announced the disposal of its Feederlink business for up to €29m, which looks like a great deal – 16x PBT. In all, yesterday’s news reaffirms my view on ICG – a very attractive business model (effectively a duopoly with Stena on the Irish Sea) with potent barriers to entry (capital, control of key port slots and other infrastructure), very strong cashflow generation with no major medium term capex requirements, huge operating leverage benefits once an eventual Irish recovery emerges and a fat dividend to boot.


Elsewhere, Kentz released good H1 results, with revenue +9%, PBT +36%, net cash +36% (to $241m)  while its backlog, at $2.54bn, is up 6% in the year to date. I’ve bought and sold Kentz before and would definitely consider putting it back into the portfolio at some stage – it’s a very well-managed business that is plugged into an area with buoyant long-term growth prospects where the long-term nature of work projects provides good visibility on revenues.


Switching to TMT stocks, betting software group Playtech released its H1 results yesterday morning, which revealed a very strong performance. It’s a stock I used to hold but which I sold on corporate governance grounds, which is a pity as I like the structural growth story around the sector, but not enough to hold a stock that has given me plenty of sleepless nights in the past!


(Disclaimer: I am a shareholder in Independent News & Media plc) INM released its interim results this morning. These revealed a 26% decline in operating profits to €25.4m on revenues that were 4% lower at €272.2m. Trading conditions are, unsurprisingly, described as ‘difficult’. I was, however, surprised by the sluggish progress on the deleveraging front. Net debt fell by €3.5m, or less than 1%, since the start of the year. Led by the drop in profitability, free cash flow halved to €12.7m (H1 2011: €23.0m), but most of this was eaten up by cash exceptional items. INM’s retirement benefit obligations widened to €187.8m by the end of June, from €147.0m at the end of 2011. A potential sale of its South African business would significantly improve INM’s balance sheet and save millions in annual interest costs, and on that note I was pleased to see the group confirm in the presentation accompanying the results that it has received 2 bids for that unit. In all, there is little to get exited about from this release. INM is under pressure due to the tough macro conditions, while its high leverage ratchets up the risks around the company. That is not to say that catalysts for a re-rating are difficult to identify. These include a sale (on reasonable terms) of the South Africa business, a recovery in its 30% owned associate APN’s share price, a resolution of its pension issues and an improvement in advertising conditions. However, identification and successful execution are, clearly, two different things, so I’m disinclined to increase my stake in INM (currently 120bps of my portfolio) for the time being at least.


(Disclaimer: I am a shareholder in France Telecom plc) There was further disappointing news from the French telecom sector, with Bouygues revealing that its profits in that area have sunk due to intense price competition from the new entrant, Iliad (whose results this morning have come in ahead of expectations). France Telecom is also being impacted by this pressure, but the impact is somewhat mitigated by Iliad’s use of FTE’s network. Speaking of FTE’s network, the group’s chairman was quoted by Reuters as saying they are in preliminary discussions with rivals about sharing 3G networks to reduce costs, which would be a welcome move.


Finally, smallcap financial IFG released its interim results today. These revealed a deterioration in profits in its continuing businesses, with UK profits falling due to falling SIPP volumes, investment in risk and compliance, and challenging conditions in the IFA space, while losses in Ireland have widened due to difficult economic conditions. The operating performance is, however, overshadowed by news of a £30m share buyback, which adds IFG to a growing list of firms (CPL, Abbey, Ryanair etc.) here that have launched similar measures in recent times. If only our plcs had the confidence to invest in growing their businesses through acquisition / greenfield initiatives that would (if done properly) augment their growth potential instead of engaging in de-equitisation. Oh well!

Written by Philip O'Sullivan

August 31, 2012 at 8:06 am

Market Musings 29/8/2012

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It has been another busy day on the results front in Ireland.


To start things off, Paddy Power released strong H1 results, with earnings rising 25%. This was despite start-up losses of €6.3m for four new online ventures and some adverse sports results. Net revenue increased in all five divisions (Online, Online Australia, Irish Retail, UK Retail and Telephone) by between 13 and 47%, which is an impressive performance. Also impressive is its branding efforts – in the year to date Paddy Power has increased its Facebook fans by 445% to 251k, Twitter followers by 308% to 133k and YouTube views by 186% to 13m. This gives the group an expanded audience to market its online offering to. As noted above, Paddy Power is investing heavily in improving its offering, particularly on the online side, while it is expanding into new markets. This increased investment is presumably why we aren’t seeing an upgrade to full year earnings guidance today from management despite the strong momentum evident across the group, however, as this investment enhances the longer-term profit outlook for the group investors shouldn’t be particularly concerned about it.


Grafton also released its interim results this morning. Reported revenues climbed 5%, but self-help measures on the cost side meant that operating profits increased by just over 19%. In addition, the group’s cash flow generation was impressive – Grafton generated operating cash flow of €55m, well ahead of its €30m in operating profits, as it reduced investment in working capital by €13.5m – a particularly impressive achievement given the increase in revenue. Net debt has reduced by €25m in the year to date to just €201m. There were significant variations in terms of the performance of Grafton’s main operating units. In the UK, revenues and operating profits rose 4% and 12% in constant currency terms, despite a tough market backdrop. In its small Belgian business, which accounts for circa 1.5% of group revenues, profits were flat despite a big increase (albeit off a small base) in sales. In Ireland, conditions remain very challenging – despite many of its competitors having reduced their presence in the market, Grafton’s merchanting revenues were -9% in H1 2012 while retailing revenue fell by 12% in the same period. Cost reduction measures helped to soften the impact on the bottom line. In all, the key message from these results for me is that Grafton is doing all the right things on the cash generation and cost fronts, but the benefits of this are being tempered by difficult end-markets.


Switching to food, Glanbia made two announcements this morning. The first being its interim results, which revealed a strong performance on the nutrition side allied to favourable currency effects (reporting earnings were +8.4%, but just +1.3% in constant currency terms). Management has hiked its full year (constant currency) earnings growth outlook from the previous 5-7% range to 8-10%. The second announcement relates to the restructuring of its Dairy Ireland business. Assuming it gets cleared by the various stakeholders, there may be a near-term share price overhang as the Co-op (Glanbia’s biggest shareholder) sells a total of 6% of its stock, while there may be further downward pressure as the Co-op distributes a further 7% of the company to farmers, some of whom may sell their shares. However, in the longer term the market should reward the improved liquidity, free-float and stability of earnings arising from this restructuring of Glanbia’s Irish dairy business.


In the financial sector, KBC reduced its 1 year Irish deposit rate by 30bps. This is positive news for banks operating in Ireland as it should help making the task of rebuilding net interest margins across the sector a little easier.


(Disclaimer: I am a shareholder in PTSB plc) Speaking of Irish banks’ margins, interim results this morning from PTSB reveal a sharp decline in the NIM since the start of the year. In 2011 PTSB’s net interest margin was 92bps, but this has fallen to 76bps in H1 2012, due mainly to higher deposit costs. Total customer accounts and deposits have increased by €2.2bn in the year to date, with the majority of this due to corporate deposits (the vast majority, if you exclude the customer balances received following the acquisition of Northern Rock’s Irish deposit book), which is a welcome development. PTSB’s LDR fell to 190% at end-June from 227% at end-2011, so still unsustainably high but moving in the right direction at least. Asset quality deteriorated further since the start of the year, with 14.1% of mortgages in arrears of greater than 90 days at the end of June (12.0% at end-2011). The weighted average loan-to-value across PTSB’s mortgage book is 113%, with Irish owner-occupied at 115% and Irish buy-to-let at 137% (UK owner-occupied is 86% while UK BTL is 87%), which points to further pain ahead for the bank. In terms of self-help measures, operating expenses at PTSB were flat year-on-year at €136m, but even a significant reduction in this would be a drop in the ocean compared to the challenges in the loan book. One potential source of optimism is its excess capital – the total capital ratio was 21.5% at the end of June, well above the Central Bank’s minimum target of 10.5%. However, while the excess funds, at €2.2bn, are more than twice the group’s market capitalisation, further impairment charges will eat into this.

Written by Philip O'Sullivan

August 29, 2012 at 11:15 am

Market Musings 28/8/2012

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It has been a busy day on the results front in Ireland, particularly in the TMT sector.


To kick off, UTV Media, which has interests in the radio (local stations in the UK and Ireland, and the national talkSPORT station in the UK), television (the ‘Channel 3’ – ITV – franchise for Ulster) and new media (website design, marketing, broadband) segments, released its interim results this morning. This revealed a resilient performance in what are, clearly, challenging end-markets, with revenues and pre-tax profits climbing 4% and 3% respectively. The group continues to make impressive progress in terms of strengthening its financial position, cutting net debt by 21% over the past year to £50.0m. Across the group, UK radio revenues powered ahead, helped by the benefits of Euro 2012. Irish radio significantly outperformed, rising 4% in local currency terms, despite an estimated 10% fall in total Irish radio advertising in the first 6 months of 2012. The reason for this outperformance is that UTV’s Irish stations are all focused on the key urban markets on the Island of Ireland, which gives it a relatively more attractive proposition to offer to advertisers. On the television side, revenues and profits were down, with weak Irish advertising conditions to blame. With regard to the small new media business, margins were under pressure due to ‘competitive pricing’. In terms of the outlook, it looks like the rest of the year will see similar trends to the above, with outperformance on the radio side, underperformance in television and modest topline growth in new media. Not that investors should be too perturbed by this, as UTV is doing a decent enough job despite the challenging macro backdrop.


(Disclaimer: I am a shareholder in Datalex plc) I was pleased to see Datalex release very strong interim results today. Reflecting last year’s new contract wins (including Air China and SITA), revenues rose 18% to $15.7m. Reflecting the operating leverage inherent in Datalex’s model, nearly all of this  translated into profits – I note that in the first 6 months of 2012 Datalex generated gross profits of $2.8m, 82% of the total for the whole of 2011! This positive momentum should be sustained into 2013, with the likes of Indonesia’s Garuda and Fiji’s Air Pacific having gone live since the start of the year, while a number of other carriers including Delta are scheduled to go live later this year. On the balance sheet front, Datalex is guiding a 20%+ rise in cash reserves in 2012. Overall, these are excellent results, and continued good news on the new client wins front bodes well for the future. I’m not surprised to see the shares shoot higher in Dublin today.


(Disclaimer: I am a shareholder in Independent News & Media plc) INM completed the restructuring of its board, with the election of four new directors and the appointment of a new Chairman and Senior Independent Director. With this out of the way, hopefully the focus can move on to the more crucial issue of repairing the firm’s balance sheet, and on this front the Irish advertising trends noted by UTV must surely bode ill for INM.


Insurer FBD posted solid H1 results today. The numbers were in-line with expectations, while management is sticking to its FY guidance. Within the results it was interesting to see that FBD has reduced its exposure to government bonds by over 40% in the year to date – this is a sensible move given what I believe to be a bubble in government bonds in Europe – although its exposure to equities remains low, at just 4% of total underwriting investment assets.


United Drug announced another two acquisitionsDrug Safety Alliance (total consideration, including earn-outs, of $28m) and Synopia (total consideration, including earn-outs, of $12m). Both businesses will form part of United Drug’s Sales, Marketing & Medical division. These deals take the number of acquisitions the firm has made so far in 2012 to six (five operating businesses and one property acquisition), so bedding these down will presumably take up a lot of management’s time over the next while.


In the resource sector Petroceltic’s H1 release contained no material ‘new news’. Management is focused on successfully executing the merger with Melrose Resources.


And that’s pretty much all that’s caught my attention so far today. Tomorrow brings results from PTSB, Grafton, Paddy Power and Glanbia, which will no doubt provide much food for thought.

Written by Philip O'Sullivan

August 28, 2012 at 2:51 pm

Market Musings 27/8/2012

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(Disclaimer: I am a shareholder in AIB, Bank of Ireland and PTSB) Since my last update I was pleased to see that deposits at Ireland’s covered banks (AIB, Bank of Ireland, PTSB) were +10% year-on-year in July 2012. This is a helpful vote of confidence in the system, given that it suggests that overseas deposits (given the sclerotic domestic economic situation) are returning to the Irish financials.


Speaking of Ireland Inc, there has been an intense focus in recent days around the possible introduction of a property tax. Ronan Lyons, who is the most authoritative voice on the Irish property sector, has written a good piece outlining the different considerations around such a measure. I agree with him in principle that we should have such a tax, particularly given that too much of our tax revenues are dependent on flows instead of stock. I say ‘in principle’ because I have difficulty in seeing how Irish people can shoulder yet another tax at this time – we currently have a situation where more than 1 in 5 mortgages are in trouble, while more than 1 in 7 people in the labour force are out of work. Throw in the effects of rising taxes over the past few budgets and falling incomes and I think we could be facing a scenario of mass evasion / people (in many cases justifiably) pleading inability to pay similar to the household charge debacle from earlier this year. Some have argued that a modified ‘property tax’ taking into account incomes should be introduced, but that would in practice only amount to yet another income tax, which will act as a disincentive to work (given the already elevated marginal tax on incomes in Ireland).


In the energy sector, I was unsurprised to see a surge in applications for UK North Sea licences following the British government’s reversal of its previous anti-investment stance, which I had been critical of. I hope to do some work on the firms focused on the UK continental shelf (Xcite Energy in particular seems to have a lot of fans) over the coming weeks.


In the pharma space, there was an interesting article in The Irish Independent around the prospects for a sale of Elan Corporation that’s worth checking out.


(Disclaimer: I am a shareholder in Ryanair plc) In the airline sector, the Irish government made the astonishing revelation that it has yet to formally discuss a sale of its stake in Aer Lingus to Etihad. Considering that a sale of State assets has been agreed with the Troika as part of Ireland’s “bail-out” and Etihad having recently signaled that it may also bid for part of Ryanair’s stake, I would have imagined that Dublin wouldn’t have been slow out of the blocks to have proper talks with the Middle Eastern carrier. This is especially so given that Etihad can effectively only buy either the government’s stake or most of Ryanair’s holding, because even though as a non-EU carrier it can, in theory, buy up to 49% of Aer Lingus, in practice Irish stock exchange rules which say you have to bid for the whole company if you go above 29.9% rules this out for the time being at least (there are some ways of circumventing this, but they would likely prove cumbersome to execute in the short-term).


Finally, I was sorry to read that Calum has closed his blog. There is a dearth of high quality blogs in the UK and Ireland covering the stock market and the demise of yet another one is a great shame.

Written by Philip O'Sullivan

August 27, 2012 at 10:46 am

162 Group (BOD.L/CON.L/PET.L/CLON.L)

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Earlier this week I met with the team at 162 Group, one of Ireland’s most entrepreneurial businesses. Led by Dr. John Teeling, it has an impressive track record of building start-up ventures, mainly in natural resources. While these are inherently high-risk plays, recent exits from its portfolio highlights the potential upside when these things work out – since the start of 2010 shareholders have received over $250m in cash and shares from the disposals of Cooley Distillery, Swala Resources, African Diamonds, Pan Andean Resources and Stellar Diamonds. While past performance is of course no guarantee of future returns, I figured that it would be worth running the slide rule over what is left in the 162 portfolio to see what the team is presently developing.


There are three strands to the 162 Group today. The Industrial business comprises unlisted businesses in the renewable energy and beverage sectors, along with a minority shareholding in Norish plc. My main focus in this piece is on 162 Group’s Mining and Oil units, where the firm manages four AIM listed companies, namely: Botswana Diamonds, Connemara Mining, Petrel Resources and Clontarf Energy. I profile each of these in turn below.


  • Botswana Diamonds (Ticker BOD.L, Market Cap £3m). Through this vehicle 162 aims to replicate the success it had with African Diamonds. The firm holds exploration licences in Botswana and Cameroon as well as early-stage diamond licence applications in Zimbabwe. Its main activities are in Botswana, which has been described as the ‘Switzerland of Africa’ due to the stable political backdrop and business-friendly climate. In addition, Botswana is the world’s largest producer of diamonds by value. The firm’s latest presentation gives a good overview of its activities and plans.  While not exactly flush with cash, management’s strong track record in diamonds and industry relationships should prove helpful in agreeing partnerships to exploit any high-potential opportunities the firm manages to identify.
  • Connemara Mining (Ticker CON.L, Market Cap £3m). This business holds 34 prospecting licences in Ireland, with a focus on zinc (Ireland produces 25% of Western Europe’s zinc) and gold. Connemara has agreed joint ventures with Teck (the world’s third biggest zinc producer) in respect of 21 of its licences (zinc and lead prospects) and with the privately-owned Hendrick Resources for another 5 (gold prospects). Its sole venture licences are mainly located close to established zinc and lead hotspots (e.g. Lisheen, Galmoy and Silvermines). The partnerships help bring financial muscle and technical expertise to Connemara’s prospects. In its recent results release management said the company “has adequate funds for all proposed expenditure in the next year“.
  • Petrel Resources (Ticker PET.L, Market Cap £4m). This oil stock has three strings to its bow – firstly, in Ireland, it has license options for two packages of blocks in the Porcupine Basin, and with interest in offshore Ireland on the rise after recent positive exploration news from the likes of Providence Resources, this could prove to be a very interesting asset. In Ghana it is awaiting ratification (a decision is expected in Q4 of this year) for a high potential spot relatively close to previous Tullow Oil finds. Finally, in Iraq it has some early stage assets. It does trade at a modest discount to its end-2011 net cash, but of course developing its assets will not come cheap.
  • Clontarf Energy (Ticker CLON.L, Market Cap £4m). This firm offers a mix of production (stakes in two gas producing fields in Bolivia) and exploration (Peru and Ghana) assets. The Ghanaian interest looks particularly attractive – assuming ratification is received (it is hoped before the end of the year) it will comprise a 60% stake in the field Petrel Resources is similarly awaiting approval to acquire a 30% interest in that is relatively close to Tullow Oil’s finds in that country.


Overall, to me the listed companies in the 162 portfolio are all reminiscent of options – the very low market capitalisation relative to the potential upside from a successful commercialisation of their asset bases means that the potential (emphasis) returns are very high. Of course, so are the risks, not least in terms of potential dilutions through farm-outs or placings. So, these are not, for now at least, the type of stocks you’d recommend to widows or orphans. At the same time, for more adventurous investors looking for a high-risk punt, all four of these appear worthy of doing some more work on. It should also be noted that management are significant investors in each of the four listed companies, which points to aligned management and shareholder interests.

Written by Philip O'Sullivan

August 25, 2012 at 10:37 am

Market Musings 24/8/2012

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Since my last update Greencore announced a bolt-on acquisition, buying a ready meal facility from the Hain Daniels Group. This will help support the market share gains the group has been achieving in that segment in the UK. Furthermore, it is encouraging to see this additional capacity has been delivered through acquisition rather than greenfield investment, given that any incremental industry capacity would give the multiples something with which to play food manufacturers off against each other.


Elsewhere in the food and beverage sector, Diageo released its full-year results. Davy provides a good summary of them here, while the presentation is also well worth a look. I’m a big fan of Diageo’s business model, which offers strong diversification both in terms of geography and product categories, and also a play on the emerging middle classes in the developing world. However, trading on a PE approaching 17x, it is not one for me at this point.


(Disclaimer: I am a shareholder in Abbey plc) Yesterday afternoon the independent directors of Abbey released their response document following the recent receipt of a mandatory offer from Gallagher Holdings. Unusually, the directors have opted to sit on the fence and not issue a firm recommendation to shareholders on whether or not they should accept this offer, preferring instead to set out the pros and cons of the proposed takeover. I can’t help but wonder if Abbey’s independent directors would have come down more on the side of the Gallagher bid had the offer being pitched much closer to the firm’s NAV.


(Disclaimer: I am a shareholder in RBS plc) The Financial Times reported that RBS is under investigation in the US over alleged dealings with Iran. Should RBS be shown to have broken the US’ rules, I assume the damage will be confined to a manageable sum, as we recently saw with Standard Chartered’s £215m fine. This would represent a third hit to the group after the IT debacle and LIBOR issues earlier this summer, but given the one-off (and, in two of the three cases, legacy) nature of these problems I wouldn’t be too concerned. Regular readers of this blog will be aware that I am presently taking a contrarian view on RBS and am considering raising my shareholding in the business, which is trading on less than 0.5x NAV and which is unloved as the market focuses on one-off issues instead of the recovery in profits that is clearly underway.


Staying with the banks, IBRC, which comprises the former Anglo Irish Bank and Irish Nationwide Building Society, released its interim results this morning. An examination of the IBRC loanbook reveals a grim picture, with 76% of loans (pre-provisions) at the end of H1 2012 classified as either past due or impaired (end 2011: 72%). In terms of the different segments of the loan book, the percentages classified as either past due or impaired are as follows: Commercial 76%, Residential 75%, Business Banking 79%, Residential Mortgages 59% and ‘Other Lending’ 80%. The elevated levels evident across all components of the loan book starkly illustrates the challenges facing the group (and, by extension, the Irish taxpayer).  Gross customer lending was -5.5% in the first 6 months of 2012 to €27.5bn, with the stock of loans -5.4% in Ireland, -6.4% in the UK and flat in the US (this may be down to USD strength). Provisions were €1.1bn in H1 2012, so still at worrying levels (the 2011 total was €1.6bn). On the operational side, IBRC continues to manage costs relatively tightly – operating expenses fell 18% year-on-year in H1 2012. However, the costs of running the bank are the least of our concerns. In terms of what the ultimate bill for IBRC will be, clearly, this is highly susceptible to macroeconomic and political factors over which the bank has no control. At the end of June it had €1.5bn in surplus regulatory capital, so for the time being at least management’s guidance that the final bill will come in below the Central Bank / Financial Regulator’s estimates looks OK but, clearly, the risks at this time appear to be skewed to the downside.

Written by Philip O'Sullivan

August 24, 2012 at 9:39 am

Market Musings 22/8/2012

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Having been on holidays in Finland and Estonia for the past week, today’s update represents something of a ‘revision session’ as I look through what has been happening since my last update on the stocks that comprise my investment universe.


(Disclaimer: I am a shareholder in AIB plc) To start off with the banks, according to press reports, AIB is looking to reduce its pension deficit by transferring loan assets into it. This is a common-sense move by the bank, which reported a pension liability of €1.5bn at the end of June, and I wonder if it might provide some food for thought for other businesses that find themselves asset rich but cash poor.


(Disclaimer: I am a shareholder in CRH plc) Ireland’s biggest company, CRH, tempered its full-year guidance when it released interim results a few days ago. Having previously forecast that it anticipated “overall like-for-like sales growth in 2012 and a year of progress for CRH”, it now says: “we expect that EBITDA for the year as a whole will be similar to last year’s level”. Tougher macro conditions are to blame, which are clearly beyond the control of the group, although it is mitigating these pressures through cost take-out measures and a focus on cash generation (cash earnings per share, at 85.8c in H1 2012, was well above the 67.1c achieved in H1 2011). On the M&A front the group stepped up its activity here, agreeing to total consideration of €235m for 17 deals in the first six months of the year up from the €172m spent in the same period last year. Overall, the high implied rating that CRH trades on allied to tough end markets means it is difficult to see the shares push significantly higher from here in the short term. This is compounded by a paucity of obvious near-term catalysts for the stock – its next investor day isn’t until November and its next development update isn’t expected until early 2013. One thing that could change that is a substantial earnings-enhancing deal, but on the M&A front it should be noted that CRH’s style is to go for modest bolt-ons over spectacular large transactions (recent chatter around India notwithstanding).


Elsewhere in the construction space Kingspan released good H1 numbers, which came in ahead of market expectations. Encouragingly, there was a good lift in margins (up 100bps to 7.00%) which underlines the strength of this performance. That Kingspan is outperforming the market shouldn’t be seen as a big surprise, however, given that its insulation base gives it a structural edge over more cyclical building materials companies. The benefits of recent acquisitions, particularly as they are integrated into the business, points to a solid outlook for this firm despite the macro headwinds.


In the energy space Dragon Oil released solid interim results. Management is sticking to its medium-term targets, and given its track record few would argue with them. It was interesting to see Dragon Oil is bidding for licences in Afghanistan – these are located in the more stable northern region of the country.


In other resource sector news, Petroceltic announced a merger with Melrose Resources. I don’t follow either company closely, but on paper this looks like a sensible deal which creates a reasonably sized group focused on the Black Sea, North Africa and the Mediterranean Sea with a blend of production, development and exploration assets – hopefully a case of the whole being more than the sum of the parts.


(Disclaimer: I am a shareholder in PetroNeft plc) Wrapping up on what’s been happening in the energy sector, there was an interesting deal in Siberia which has read-through for PetroNeft. TNK-BP sold $400m worth of assets in the region at an implied price of $2.56 a barrel – this is 3x the implied value of PetroNeft, all of whose assets are located in the region.


(Disclaimer: I am a shareholder in Independent News & Media plc) In the TMT sector INM’s 30% owned associate, Australasian media group APN, released its interim results. While its underlying performance was in-line, it took a huge (A$485m – a 70% write-down) charge against the value of its New Zealand print assets. This distracted from a stable topline (continuing operations’ revenues +1% yoy) while underlying operating costs fell 3.3% yoy to A$357m and finance costs were nearly 10% lower yoy. Net debt has fallen to A$470m from A$637m at the end of 2011, helped by the restructuring of the outdoor business. Ominously for INM, APN cut its interim dividend from A3.5c to A1.5c, so INM’s cashflow won’t be helped by lower dividends coming from the southern hemisphere this year.


In the healthcare segment there was a good bit of news from United Drug in recent days. In its Q3 IMS management revealed that it now expects 8-10% earnings growth in 2012, a big increase from the previous guidance of 4-8%. The company also said that it is considering moving its listing from Dublin to London, which surely increases the pressure on the Irish Stock Exchange to seek a deal with another European exchange before it loses any more top plcs. The group also bolstered its Packaging & Specialty division with the acquisition for $61m of Bilcare’s UK and US clinical supplies unit. This is a sensible deal which further enhances UDG’s presence in that space.


And finally, one thing that might provide a lift to my readers in Clonmel today is that C&C’s Magners appears to be making a big marketing push in Finland – in a few of the bars in Helsinki I visited (where a pint* can set you back nearly a tenner!) I noticed that all the bar staff were wearing Magners branded t-shirts and the bottled stuff was widely available. Cider is wildly popular in Scandinavia (Kopparberg hails from Sweden) – by way of illustration, in terms of draught most of the pubs I was in only had two taps – one for either Koff or Karhu and one for cider. Magners is also stocked by the Finnish alcoholic beverage retail monopoly, the charmingly named Alko. So, while I don’t claim to have conducted exhaustive field research (not least given the prices the pubs charged!) it does highlight that Magners is making progress outside of its traditional markets. In its FY12 results C&C revealed that, outside of Ireland and the UK, worldwide Magners volumes grew 28% over the past financial year, with circa 10% of Magners revenue now coming from outside of the British Isles.


* Actually, being good Europeans the Finns sold 0.5 litre drinks in pint glasses.

Market Musings 13/8/2012

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Since my last update Insulation giant Kingspan announced two acquisitions, buying ThyssenKrupp’s European insulated panels business for €65m and a Middle East composite panels and roofing business, Rigidal, for $39m. These are sensible deals that strengthen Kingspan’s presence in those markets and the acquisition price paid for both is quite undemanding – the ThyssenKrupp business was acquired (if you strip out the €15m pension contribution) for 0.5x its gross assets, and while it is at present modestly loss-making (operating margins are -1.5%), once it is integrated into Kingspan’s existing European operations the synergies should see this rebound into profit, and with the former ThyssenKrupp business having achieved sales of €315m in the year to the end of March 2012 this deal could prove a very tidy bit of business for Kingspan in time. By this I mean that if , for example, the minus sign before its operating margin is replaced by a plus you’re looking at a 10% pre-tax ROI (ex the pension contribution), and given that Kingspan’s insulated panels business achieved trading margins of 6.7% in 2011 the returns over time will presumably be much higher than the example I provide above. As regards Rigidal, a price of 1x sales is undemanding for something that has, according to Kingspan, “an extensive route to market in the Gulf region”, which is an area that currently contributes a small fraction of Kingspan’s annual revenues.


(Disclaimer: I am a shareholder in PetroNeft plc) This morning saw another operations update from PetroNeft. Interest in every one of these updates centres on (i) production trends; and (ii) financing. There was no update today on (ii), while on (i), the company says production is ‘stable’ at 2,000bopd, and while this is lower than the 2,200bopd reported in June I am less concerned than I otherwise might be given that in the intervening period two wells were converted to water injectors for planned pressure support while other points of note include: drilling of the first of ten new production wells on the Arbuzovskoye oil field has commenced and is expected to come into production in September 2012; while the Arbuzovskoye No. 1 well is producing lower than normal output due to an electrical fault with a pump that is scheduled to be replaced. What this all means is that, at least in theory, PetroNeft shareholders could be looking forward to a short-term recovery in production which will either help with securing longer-term funding or make the stock more attractive to a potential suitor.


Elan Corporation announced plans to split the company into two units. Under the plan the group will split into one unit focused on its existing Tysabri blockbuster drug and mainly late-stage  projects, and another more early stage drug delivery business platform whose employees will, I assume, be highly incentivised to deliver on the R&D front in the short term given expected cash spend of $50-60m per annum and start up capital from Elan of $120-130m.


Harvey Nash, a UK staffer I’ve held in the past, issued a solid trading update this morning. Despite the ‘challenging environment’ it expects to report solid revenue (+15%) and profit (+6%) growth in the 6 months to the end of July. It’s a stock I like, offering the right sort of diversity for a staffer – geographic, industry and also a mix of permanent/temporary/outsourcing services for clients. I hope to do some work on this company soon with a view to seeing whether it’s worth buying back at current levels – while I know some of the newsflow out of the sector of late hasn’t been too encouraging, the low multiple HVN trades on mitigates against a lot of the macro risks.


Finally, I’m going to be travelling from tomorrow until Tuesday week, so you can expect some ‘radio silence’ from me until then. However, as always the markets will continue to churn out plenty of newsflow. The key things to watch out for over the coming days, at least from an Irish corporate perspective are:


(Disclaimer: I am a shareholder in CRH plc) CRH reports its interim results tomorrow. Many of its peers have updated the market in recent weeks, and the sector commentary has been full of reports of tough conditions in Europe but a better picture in the US. This narrative was pretty much mirrored in its trading update back in May. It will be interesting to see if there has been any changes in the trends noted across its operations, particularly in the US where there has recently been signs that things could be getting a bit softer, while another area of focus will be on the acquisition front – CRH reported H1 ‘acquisition and investment initiatives’ totaling €0.25bn in July, and more recently it has been linked with a potential large deal in India.


Another firm reporting H1 results tomorrow is Dragon Oil.  It recently noted some minor production issues, but these should be resolved in the near term with the installation of sand screens. The company also recently upped its 2012 development well target to 16 wells from the previous 13, which gives further confidence that it will meet its medium term production goals. I don’t think there’s any real scope for any surprises tomorrow given how recently it last updated the market and its relatively ‘boring’ (at least where oil companies are concerned!) business model, and with the shares supported by the ongoing $200m buyback and trading at a reasonably big discount to NAV I wouldn’t have any major near-term concerns around the stock.


Next Monday Kingspan will report its interim results. The group issued a very solid trading update in May, despite what it described as a “subdued global construction market environment” and it will be interesting to see if it is noticing any changing trends across its world-wide operations since that update.

Written by Philip O'Sullivan

August 13, 2012 at 7:28 am

Bank of Ireland: H1 Results Thoughts

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(Disclaimer: I am a shareholder in Bank of Ireland plc and AIB plc) The main news, at least from an Irish plc perspective, today is Bank of Ireland’s interim results. Six months ago, when the group issued its FY2011 numbers, I wrote that: “[The] results are a bit of a mixed bag, and to tell the truth, they are a little bit worse than what I had expected“. This morning’s interim numbers have produced a similar reaction from me.


It should be noted that, particularly at this troubled time, but it’s also generally true, that banks’ results are always subject to a certain degree of volatility given the vast number of moving parts at play. This makes forecasting numbers with a high degree of accuracy a challenging task – how, to take two examples, is one supposed to adequately model for either: (i) the accounting impact of fair value movements in derivatives that economically hedge the Group’s balance sheet; or (ii) economic assumption changes for Bank of Ireland’s life assurance unit. These two items combined had a €59m positive impact on Bank of Ireland’s bottom line, and were indeed equal to circa 100% of its H1 2012 pre-provision profits!


With this in mind, when I look at the Irish banks I run through a check-list of five key items to see how they are performing against all of them. I find that a more useful method of evaluating their performance than simply focusing on headline numbers that can be heavily influenced by accounting adjustments, such as those mentioned above, that have limited read-through for the underlying performance of the group. Obviously, in the longer term the headline numbers themselves will take on more relevance, but given the present volatility their usefulness is, in my view, somewhat limited.


The five key areas of interest to me are: (i) Trends in pre-provision profits; (ii) Trends in deposits; (iii) Trends in the net interest margin; (iv) Progress on deleveraging; and (v) Trends in impairments. Below I evaluate Bank of Ireland’s performance on all five metrics.


To start with trends in pre-provision profits – here Bank of Ireland saw a 65% decline to €58m relative to H12011. This was all down to the margin. Net interest income slid by €177m (-17%), which more than offset the positive trends seen in all of the other line items between it and pre-provision profits, namely: government guarantee fees (a €25m reduction year-on-year), net other income (a €43m improvement year-on-year), operating expenses (a €1m reduction year-on-year). The conclusion from me from examining the trend in pre-provision profits is that Bank of Ireland is doing a good job on the levers it has control over.


Next we look at deposits. Earlier this month AIB said that its customer deposits rose €2.9bn (+5%) in H1 2012. I would have expected at least the same again from Bank of Ireland. However, BKIR’s Irish retail deposits have actually fallen by €1bn in the first six months of the year. This was more than offset by a €2bn rise in UK retail deposits, while other deposit headings remain stable. This relative underperformance may well be explained by Bank of Ireland having recently taken (necessary) steps to lead price reductions in deposit rates here, so there could be an element of savers ‘shopping around’ going on. With other banks having followed BKIR’s lead, hopefully it will win back some of this money over time. However, my conclusion from Bank of Ireland’s deposit trends is that, while not a major cause for concern, they will need to improve their performance here to help strengthen its funding base.


The net interest margin is a source of disappointment to me. At 1.20% it is 13bps lower than year-earlier levels and below the 1.24% reported by AIB in the first half of 2012. Action to reduce the level of deposits covered by the Irish government’s ELG scheme means that margins after taking that into account are 0.88% for Bank of Ireland and 0.90% for AIB. Given that Bank of Ireland has a arguably superior mix of loan exposures to AIB, this margin underperformance is as surprising as it is disappointing.


Deleveraging is something that will, thankfully, no longer be an area of particular attention come 2013. Bank of Ireland has already met its PCAR targets, having offloaded €10bn of loans more than a year ahead of target. The other pillar bank, AIB, in contrast, is only 70% of the way through this process. So, top marks to Bank of Ireland here.


Impairments are clearly an area of focus for the Irish banks. Given the heroic achievements of Katie Taylor in yesterday’s Olympic boxing final, you’ll forgive me for the analogy that our financial system has suffered a ‘one-two combo’ in terms of being smacked first by land and development loans (now mainly housed in NAMA) up front and then a second blow from mortgage losses as unemployment has moved upwards. Total loan impairments in H1 2012 for Bank of Ireland were €941m versus €842m in H1 2011. Mortgages were to blame here, as impairments in that area rose to €310m from €159m a year ago. Consumer and SME impairments saw an improvement, while property and construction losses were flat. Given the troubled economic backdrop, I would imagine that losses will get worse before they get better, although I note management says: “While the Irish economy remains challenging and our impairment charges remain elevated, we expect the impairment charges to reduce from this level, trending to a more normalised level as the Irish economy recovers“. The ultimate impairment bill is, to use Mr. Rumsfeld’s parlance, a key ‘known unknown‘ for Bank of Ireland.


In all, as I said in the opening the results are a bit of a mixed bag, but overall the key negatives (deposits and margin)  outweigh the positives (good work on costs, no major surprises on the impairment front). I’m not surprised, therefore, to see the shares open weaker this morning. In terms of how I approach Bank of Ireland as an investment case, I think the market has already priced in a lot of the risks it faces, with the shares trading on less than half its expected end-2013 NAV per share. However, the regular occurrences of either flare-ups or grounds for optimism in the Eurozone crisis means that, for high-beta stocks like Bank of Ireland, the near-term outlook for its share price remains volatile. I remain of the view that there is longer-term upside in this name for patient investors, while for short-term traders its elevated levels of both liquidity (especially by Irish standards) and volatility makes it a great trading stock to punt around on in the intervening period. Mind you, this also means, in my opinion, that it’s not really one for widows and orphans!

Written by Philip O'Sullivan

August 10, 2012 at 9:21 am

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