Portfolio news

In all the recent excitement, there have been various bits of news from some of my smaller holdings.

Zirax
Zirax are putting out a variety of press releases leading up to their interim results on Monday. Good that they're trying to drum up a bit of interest.

25 September 2008 Second Moscow De-Icing Contract Win
Zirax plc ("Zirax" or the "Company"), the AIM quoted speciality chemical company focused on the development, production and sale of oilfield process chemicals and de-icing solutions is pleased to announce that it has won a second contract this year to supply an additional 8,000 Metric Tonnes ('MT') of calcium chloride based de-icers to Moscow City Council for its 2008/09 winter season. Read more

18 September 2008 Zirax signs Heads of Agreement to acquire its Principal Limestone Supplier in Russia
Zirax plc ("Zirax" or the "Company") is pleased to announce it has signed Heads of Agreement to acquire its principal limestone supplier in Russia. The acquisition is scheduled to complete later in 2008 and will cost the Company Euro 400,000 (USD 560,000) for 25 million cubic meters of reserves. Read more

15 September 2008 ZIRAX secures two new supply agreements in Romania and Azerbaijan together worth USD 1.5 million
Zirax plc ("Zirax" or the "Company") is pleased to announce it has won two new contracts together worth initially USD 1.5 million, to supply Bucharest City Council with de-icing products and supply PelletOilTM calcium chloride pellets to oil drilling operations in Azerbaijan. Read more

Nothing earth-shattering there. I don't have huge hopes for the interims, but hopefully it will be a solid set of results providing a good springboard for the next couple of years.

BDI
Bond's interims are out. They don't look hugely pretty, but they're by no means disastrous. Their profit is inevitably somewhat "lumpy" since it depends on the timing of quite large contracts. They're generating good amounts of cash.

Their market cap is currently £29m at 88p. I bought my shares at way more than that - 145p. They only made £1m after tax in the first 6 months - if that continued they'd be on a P/E ratio of 15, which seems excessive. However, I think £3m would be a reasonable assumption for the year, meaning a P/E ratio of 10 (last year was £3.6m). Not great, but OK. Looking forward a few years, I think they clearly have the capacity to drive earnings higher - say £5m.

The pay a paltry 1.6p dividend - a 1.8% yield. I imagine they're looking for a 10+% growth rate for several years so they can demonstrate the famous "progressive dividend policy". At the moment I think this is doing more harm than good. Investors looking for dividends have a mouth-watering array of 5+% yields, and growth investors don't care.

I think I'll continue to hold. They don't look overvalued. I may add to my investment, possibly funded my selling off my emerging market ETFs - I have no conviction that these are worth holding, and at least I think I understand Bond's business. Life will be simpler if I consolidate some of my smallest investments - they're not large enough to provide meaningful diversity. While I think emerging economies will do well, the best way to benefit from them is not necessarily to invest in shares that track their stockmarkets.

FSA bans short-selling

Remarkable news.
http://news.bbc.co.uk/1/hi/business/7624012.stm

Motley Fool reported that RBS was up to 245p briefly, but is now down to 215p. Not sure if 245p was a glitch. It will be interesting to watch today.

Update: even more remarkable:
http://online.wsj.com/article/SB122186549098258645.html?mod=googlenews_wsj

The Fed is devising an audacious plan to bail out financial institutions. I can't help worrying about how inflationary this could be... it will be interesting to see some details.

RBS finished the day 32% up, having been over 50% up at one stage.

Here's the state of my portfolio at close of play (in order from largest to smallest market value). Not hugely pretty even after today's big gains:
RBS.L 213.50 -- bought at 246.45p = -13.37%
GNK.L 590.00 -- bought at 538.30p = 9.60%
IAPD.L 1432.31 -- bought at 1557.90p = -8.06%
IDVY.L 1767.00 -- bought at 2051.07p = -13.85%
ZRX.L 6.55 -- bought at 11.42p = -42.65%
MXM.L 183.55 -- bought at 145.79p = 25.90%
NXT.L 1247.00 -- bought at 1099.78p = 13.39%
TW.L 55.00 -- bought at 100.37p = -45.20%
QDG.L 129.00 -- bought at 150.50p = -14.28%
LTAM.L 1169.75 -- bought at 1232.87p = -5.12%
IFFF.L 1828.00 -- bought at 2167.90p = -15.68%
IEER.L 1679.00 -- bought at 2135.62p = -21.38%
BDI.L 104.50 -- bought at 145.13p = -28.00%

Down an average of 14%.

Whisper it quietly: I've bought more RBS

I was moderately determined not to buy any more RBS shares. But I must admit I had second thoughts when it briefly hit 145p over the Fannie/Freddie scare.

Now that its share price is suffering again, I decided to take one more bite of the cherry. I increased my stake by just over 60%. I bought the latest shares at 168p; my average purchase price is now just over 246p. RBS now forms about 23% of my portfolio. That's too much for such a risky share - but my portfolio is going to be about 3 times larger in 18 months, so it's less than 10% of my anticipated portfolio size.

So why invest so much money in an admittedly risky share?

I think a fair P/E ratio for a big bank is about 12. RBS's future earnings are uncertain, but I'm going to put them at about £6bn after tax in "normal" economic conditions. The final consideration is the risk of (a) significant dilution, or (b) total failure.

Let's assume RBS gets into trouble: depositors are withdrawing cash and/or other banks won't lend to it. What's going to happen?

• The government will not allow savers to lose money - that would be political suicide.
• They can't arrange for a buyer for RBS - it's too big. So the A&L option is out.
• The government cannot afford to take RBS onto its books - again, it's simply too big. So the Northern Rock option is out.
• Another big rights issue is not going to help a liquidity crunch. And getting that away in the current market would be impossible.
• There's no point flogging shares to outside investors, since even another £12bn is not going to be enough to cover the loss of interbank lending or customer deposits.

That pretty much rules out all the options that would punish shareholders. The only remaining options are:

• Government promises that all savings are protected in the event of a bank going bust. Savers are no longer spooked.
• Bank of England extends its special liquidity scheme. RBS no longer so reliant on wholesale lending, and paradoxically will now find it easier to get such funding.

Either of those would be provide a stupendous boost to UK bank shares, not just RBS. The government doesn't want to do it, but I don't think they will have a choice. If RBS gets the jitters, then Barclays for one will also be vunerable. A solution to benefit all banks would be required.

So what are the odds that RBS will get into trouble? I'd say about 1 in 4. They have access to liquidity from the US, UK and European central banks, which gives them more options than a bank like HBoS. They've savagely written down their subprime assets, raised capital and are deleveraging. They don't have such a scary UK mortgage book as HBoS or B&B. But, their shares seem to be the focus of a lot of short-selling, and I think it's possible for shareprice volatility to spook the other banks into freezing their lending. And they do rely on about £150bn of interbank lending.

If RBS did get into trouble, then I think there is around a 3 in 5 chance that they will be bailed out without any shareholder dilution.

So, that adds up to a 10% chance of shareholder wipeout. Let's be conservative and double it. That's an 80% chance that RBS is worth £72bn, and a 20% chance it's worth nothing. So fair value is approximately £57bn. That's 350p per share. 168p is a screaming bargain.

Other risks
To be fair, I'm probably over-egging the chance of total failure, and underestimating some more moderate risks, such as increased impairment charges due to a UK recession. On the whole I think things will probably balance out, so my fair-value assessment is pretty close.

New share: Next

Per my last post I was planning to buy some more Quadnetics shares. I've had a change of heart, and instead I've bough some shares in Next.

I bought at 1088.86p. It forms 6.7% of my portfolio at close of today.

So why Next? I've so far been holding fire on Retail shares, expecting a better purchase price next year. But having looked at Next, M&S and Debenhams, I think they're all cheap and Next is the pick of the bunch. I don't expect it to survive unscathed, but I think it's the only one of the three that could take a hit of 10% of revenue (assuming costs remain the same) and keep on going without a major crisis. Debenhams would take a big loss. M&S would break even. Next would still make a moderate profit. Obviously if sales really fall that much they would save money on the cost of sales, lay off staff, etc... It was just an idle test of their profitability.

Cash flow is also extremely strong. M&S spends all of its cashflow on purchase of property, plant and equipment. Who knows what that really means? Next spends its cashflow on share buybacks and dividends. Nice.

Next is the pick of the bunch because:

• It has a substantial margin which provides a buffer in a downturn.
• It has a fantastic history of buying back shares.
• It doesn't have excessive gearing.
• In the long-run it is focusing on the right market.

I would like to see Next fall in price next year and give me the opportunity to buy more shares at a cheap price. But given that I've decided I want to take a significant position in the share, I see little point delaying my first purchase. Here's hoping I make a short-term loss and get the bulk of my shares at a favourable price.

Emerging ETFs

I'm starting to rue my investment in emerging market ETFs. Not because they've fallen in price, but because I'm not convinced they're the best way to take advantage of emerging markets, and also because the amounts I've invested are too small to make sense.

For now, since I expect a strong cash inflow over the next few years, I won't sell. But if an opportunity arises that requires the sale of my emerging ETFs, I won't hesitate. Their days are numbered.

Quadnetics preliminary full-year results

Quadnetics preliminary full-year results are out:
http://www.quadnetics.com/ir/Press_Centre/News/Latest_News/Preliminary_Results_for_the_year_ended_31_May_2008/news.aspx?id=436

No big surprises. Stripping out exceptionals and assuming a realistic tax rate their profit is £2.6m. The market cap of the company is about £22.5m at the moment, so that's a P/E of about 8.5.

The balance sheet looks very healthy. £8m of cash. NTA of about £15m.

I remain very positive about this company, and per my original post I think fair value is around £60m. I plan to buy some more shares later this week.