Rio Tinto's $3bn Mozambique coal impairment-implications for India

Last week, RioTinto(the global miner) announceda $2.8bn writeoff of its Mozambique coal mines. Since companies like Jindal Steel, Tata Steel and Mercator Lines have coal mining operations in Mozambique, I thought of analyzing this situation if it holds any insight for investors. For some background, note that by acquiring Riversdale’s operations in Mozambique, Anglo-Australian RioTinto took control of 22 exploration licenses in Tete, including 65% of the Benga mining project (Tata Steel from India holds the other 35%) and the 100% of Zambezia project. Benga mine was under prelimnary production while Zambezia was under exploration. Under RioTinto's original plan Coal would have to be moved from its mines then loaded on to a train so it could travel 600km to the Zambezi River where it would be taken to the coastline 
http://www.riotinto.com/documents/110605_Andrew_Woodley_Riversdale_Mozambique_Coal_Conference_slides.pdf

But Rio could not win the approvals to ship the coal down the Zambezi. To compound its challenges, coal prices have stayed weak and Rio appeared to overestimate the amount of coal it could access in Mozambique. As per the Reuters article below, 65% of the Mozambique coal holding company is now valued by RioTinto at $600MM, thereby giving a total enterprise value of $1bn. Even giving a 50%(very conservative considering it was the higher potential mine) valuation to Benga, that gives it an EV of $500MM. 

http://www.reuters.com/article/2013/01/20/australia-rio-mozambique-idUSL4N0AP0I820130120

Given that Tata Steel paid a bargain basement price of $88MM for its 35% stake, it need not fear any impairment even using the same assumptions
Even for Mercator Lines which I wrote about earlier below, the Kotak Report in below PDF of 23Aug2012, assigns a value of around Rs 12 to the coal mining operations+coal trading operations. By coincidence, the market values the company at the estimated NAV of the ships only, without giving value to the volatile coal business, or the troubled mining business.
http://financeandcapitalmarkets.blogspot.in/2011/09/why-mercator-lines-is-buy-thanks-to.html
http://www.business-standard.com/content/research_pdf/mercator_230812.pdf
 
Lesson:- Companies like RioTinto have global experience of navigating these issues. The fact that they failed to do so in Mozambique, should be a cautionary note to the other Indian companies who rushed to do business in Africa-for example Karuturi which faced flash floods wiping out its first year crop in Oct-12 http://financeandcapitalmarkets.blogspot.in/2011/12/karuturi-global-africa-agriculture.html And before according premiums to the relaxed regulatory regime in those countries(like for African farmland/mining concessions), do accord the regulatory risk and enhanced NGO scrutiny.
 

From Rs 120 to Rs 4.5 in 3years-the riches to rags tale of Raj Oil

In Sep-09, one of the IPOs which slipped through the cracks was Raj Oil Mills(better known for its brands like Cocoraj). The IPO was oversubscribed and hence issued shares at the higher end of the band Rs 100-120. Since then, things have only gone downhill for the company(but not its promoters, that is how India Inc works-companies go under but their promoters don’t). The stock caught my eye during a routine stock screen thanks to it having low price to book, and being in the edible oil space which has seen acquisitions by foreign players(like Bunge acquiring Amrit Banaspati). Interestingly, when I analyzed it today, the share hit the upper circuit AND the lower circuit on the same day! It opened at Rs 5(previous day close), jumped to Rs 5.2, and then fell within minutes to Rs 4.5. The delay in executing my order saved me in this case. After some due diligence, I realized that there are some corporate governance and operational issues with the companies, but that its promoters and some mysterious GDR subscribers think it worth double the current share price(or even 1.5x the price it was when they took the decision). That, coupled with the absence of any financial jugglery redflags, low promoter holding making it vulnerable to a takeover etc, makes this a BUY. Further analysis and statistics are below.

•  The annual report of FY12 was uploaded on the website somewhat late and does not inform the reader much, however gives a reassurance about the financial issues http://www.rajoilmillsltd.com/pdf/ROMLAnnualReport201112.pdf
• As per the annual report, the company had defaulted on its debt and some statutory dues, and was in talks with Edelweiss Assets Reconstruction Co. Ltd.(EARC) for restructuring of its debts from Banks and Financial Institutions to correct its working capital position and to reschedule its debts in line with projected potential earning
•  However, recapitalization is on track, with the fact that in Jul-12, the company allotted 700,000 Global Depository Shares representing 35,000,000 Equity Shares of the Company of the face value of Rs.10 each at a price of US$11.084 per GDS aggregating US$7,758,800. Also, in Sep-12, the AGM approved preferential allotment of 2crores warrants, at issue price Rs 12. Promoters must pay 25% of that upfront i.e Rs 3, and must decide on exercise within the next 18months. So upfront, the company has raised Rs 48crores(42 crores from GDR and Rs 6 crores upfront from warrants). This should take care of atleast the immediate debt maturity, albeit diluting shareholders a lot
•  A red flag is the resignation of the statutory auditors M/s. Agarwal, Desai & Shah, Chartered Accountants, Mumbai, who have cited pre - occupation in other matters and hence not offered themselves for reappointment. Another equally obscure firm has been appointed, which does not bide well for shareholders.  
•  Something to ponder is the identity of the GDR holders who decided to purchase stake at premium in such company. Let us hope it is not a case of roundtripping as investigated by SEBI earlier. 
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       In the past 2-3years, the promoter holding was diluted due to banks invoking pledges, sales of stake in between etc. But with the preferential allotment of 2 crore shares @ Rs 12, they are back on track, to asset some control and hold premium in case of merger(is this the reason for the hasty allotment)?   

Skumars-capex spending amidst declining cash flows reason for low valuations?

A friend pointed out the low valuation multiples of Skumar(low in terms of price to book, P/E etc). A cursory scan convinced me of the apparent veracity of this case, and hence I decided to probe more in depth, starting with the latest annual report FY2011-12 http://www.sknl.co.in/pdf/SKNL_AR-12_Web.pdf

I noted from the financials that though the company has quite a bit of debt, it turned around the operating cash flow situation in FY12 with efficient working capital utilization. However, as the savings went into capex, the net cash position and leverage did not improve.
 

The company trades at P/BV of 0.19 and dividend yield of 5.5%, but this despite being profitable. As the profits do not reflect in FCF/OCF, maybe that is why investors are shying away from this stock. Otherwise, a textile company with 45+ global brands and global presence(as evident from the above map) should not be undervalued. There are some negative qualitative factors though, which are material, which I reproduce from the annual report. 

• Aggressive accounting by the company. As mentioned in the auditor's report, they capitalized Rs 85 crores brand spending, which is debatable under accounting norms

•  Financial Management could be better-this is a company which defaulted for some time on bank dues, which still spending on capex!

• Suddenly started commission to non -executive directors in FY12-Rs 90 lakhs!

However, promoters exercised warrants at Rs 64.33 when the prevailing market price was hardly 50% of that. This shows some confidence, as they would have forfeited only 25% of the exercise price, and yet been in a profit. Maybe they expected it to appreciate, but still that was a good reason.

CONCLUSION:- It is not very clear as to WHY the company is spending on capex again. The investor relations PPTs/concall transcripts on website are outdated. So without clarity on whether the capex is being well spent, entering this company is risky given the qualitative factors. Upside trigger could be the Reid & Taylor IPO finally happening as planned.