This is mainly due to the fact that investors had underestimated the potential for the company to realise value from its investment portfolio close to the book value of the assets held and return the capital to shareholders. In fact, for an initial investment of 25.25p a share back in February 2012, we have since received capital returns totalling 21p a share and still hold equity worth 17p. Or put it another way, for a net investment of 4.25p a share the remaining holding is worth 17p.
Not that it has been a one way street as I was wrong-footed six weeks ago when the company announced that its Brazilian biodiesel investment, Bionasa, was experiencing severe financial difficulties. Trading Emissions had invested, through its subsidiary, £37.9m to acquire 25 per cent of the equity of Bionasa in the form of preferred shares in 2007. The conversion of its preferred shares into a controlling 99.4 per cent equity interest in Bionasa has been the subject of an arbitration process under the auspices of BOVESPA, the stock exchange of São Paulo, since 2010. Bionasa's plant was commissioned and became operational over two years ago, but it has not produced or delivered biodiesel since December 2012 and has been experiencing increasing liquidity difficulties during 2013.
Senior management of the Brazilian subsidiary are working to explore financing options for Bionasa to enable the business to recommence operations, but I am not hopeful and neither is the board of Trading Emissions. In fact, the company has written down that investment massively in its latest accounts and the £30m write-off here largely explains the £27m reported pre-tax loss recorded for the financial year to June 2013.
That's not to say there isn't value in the shares as there clearly is; factoring in the payment of a 15p a share cash distribution to shareholders a few months ago, the company's reported net asset value is now 30.1p a share of which net cash accounts for 9.1p a share. In other words with the shares trading on a bid-offer spread of 15.75p to 17p, over half of the share price is backed by cash.
Value in private equity portfolio
Interestingly, and even after the aforementioned asset write-down, the directors of Trading Emissions estimate that the fair value of the private equity portfolio at the end of June was £62.1m, or 24.9p a share. That is almost 9 per cent more than the reported book value of £57m, or 22.9p a share, which is calculated in accordance with international financial reporting standards (IFRS). The difference between the two valuations is mainly due to the requirement to consolidate controlled subsidiaries into the company's financial statements. Moreover, the actual value of the private equity portfolio is 17 per cent above the worse case scenario I outlined in my article six weeks ago ('Trading Emissions bombshell', 20 September 2013).
In order not to compromise commercial negotiations, Trading Emissions does not disclose the carrying values of individual private equity investments, but it's worth noting that "detailed negotiations continue in respect of the sales of most of the private equity investments. While there is no guarantee that acceptable final terms can be agreed, prospective buyers of three of the more significant holdings are investing significant time and resource in order to acquire the assets". Or put it another way, there is a realistic chance that Trading Emissions will announce more sizeable asset disposals and, in turn, be able to declare another chunky return of cash to shareholders.
That is far more likely now that the carbon portfolio only has a net liability of £400,000, or minus 0.17p a share, compared with a net liability of £17.1m at the beginning of the financial year. Given that delivery of fixed price carbon contracts is at a negligible level, no hedges were in place either at the financial year-end or currently. Namely, the carbon liability is now immaterial.
Implications on investment portfolio
By my calculations, once you strip out Trading Emissions' cash pile of 9.1p a share from its adjusted book value of 32.1p, then investments worth 23p a share are being attributed a value of only 8p in the current share price. But on the basis that the largest three investments alone are combined worth more than 8p a share, and realistically realisable too, then the current valuation of the company is clearly anomalous.
Conservatively, if you value the entire private equity portfolio on a discount of around 25 per cent to book value, and factor in wind-up costs for the company of around £10m, or 4p a share, then I arrive at a break-up value of the company closer to 24p a share. In the circumstances, I continue to rate Trading Emissions' shares a buy on a bid offer spread of 16.25p to 17.75p and believe that a fair value around 22p to 24p is a more reasonable valuation. The obvious catalyst for a rerating would be news of further asset disposals to support another significant capital return.
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MORE FROM SIMON THOMPSON ONLINE....
In the past week I have published six other articles last week on the following seven companies and portfolios:
■ First Property Group ('On rock solid foundations', 28 October 2013)
■ US Dog share portfolio ('Dog shares barking back', 28 October 2013)
■ Sanderson ('Running bumper profits', 29 October 2013)
■ IQE ('A conundrum to solve', 29 October 2013)
■ Netplay TV ('Strong buy signal', 31 October 2013)
■ Greenko ('Value Plays', 4 November 2013)
■ KBC Advanced Technologies ('Value Plays', 4 November 2013)
■ Thalassa ('Cashed up for earnings upgrades', 4 November 2013)
