That said, it doesn’t always work out as planned. A prime example is Aim-traded investment company Aurora Russia (AURR: 20.5p) whose shares surged 30 per cent to a multi-year high after I advised buying them a year ago at 30.5p ('Time to play Russia roulette', 4 Feb 2013). Following asset disposals, the company subsequently bought back 36.9 per cent of its share capital at 52.3p a share last May. So after factoring in the 70 per cent-plus profit on the tendered shares, this meant the carrying value of the remainder of the original holding was only 17.7p a share, which compared favourably with Aurora's share price of 40p at the end of April. That should have been the cue to take profits on the balance too. However, I didn’t because there was still a sizeable gap between the net asset value of the company - around 55p a share last June - and a share price of 32p at the time.
That decision is looking ill judged given that Aurora Russia’s share price has subsequently given back all those gains and is trading at a multi-year low of 20.5p. As a result, my original buy recommendation is now only modestly in profit. However, just as share prices can be pushed up way above fair value, they can also fall well below too. In the case of Aurora this is what has happened.
That’s because even after a series of asset write-downs on Aurora’s remaining three investments, Aurora’s net asset value per share was still 40.7p at the end of September 2013, albeit down from 55p in March 2013. To put the value on offer into some perspective, with the company’s shares trading on a bid offer spread of 19.5p to 20.5p, then based on 74.7m shares in issue Aurora’s market capitalisation is £15.3m, or half the last reported book value of £30.2m.
That is quite an extreme share price discount once you factor in a series of transactions that have taken place since September to bolster the cash pile. It’s also worth flagging up that the company is cash rich and is not a forced seller of its assets, so can bide its time to attain the best prices from its asset disposal programme. Let me explain.
Sum-of-the-parts valuation
At the end of September, Aurora’s net cash was £4.2m and receivables of £2.9m were turned into cash after the half-year end following receipt of the final proceeds from the £30.6m sale of Aurora’s stake in OSG, a fast-growing and profitable records management provider with operations in Russia, Poland, Ukraine and Kazakhstan. This meant that net cash was £7.1m at the start of this year, or the equivalent of 9.5p a share.
That cash pile has grown even more since then because Aurora has just sold off Flexinvest Bank, a Moscow-based retail bank which is primarily focused on offering credit cards funded by both retail depositors and corporate customers. This holding was in the accounts at £6.3m at the end of September. Aurora has received net cash proceeds of £2.9m after factoring sale costs of £300,000, and the transfer of mortgages worth £2.4m, previously held by Flexinvest, to its subsidiary Kreditmart Finance. These mortgages will be sold off in due course in the open market, albeit most likely at a discount. Aurora’s investment in Kreditmart has a book value of £400,000 prior to the transfer of the mortgages.
True the sale of Flexinvest represented a 11 per cent discount to book value, but this looks a fair price once you factor in the current market conditions in Russia for banking assets, the recent withdrawal of several banking licences by the Central Bank of Russia and the likely need for Aurora Russia to provide further capital to Flexinvest over the coming year.
It also means that Aurora currently has pro-forma net cash of £10m, less its operating expenses between the end of September and the end of March. I estimate these costs at around £50,000 per month, so net funds are likely to be £9.4m at the end of the March 2014 financial year. If you then apply a pretty deep 15 per cent discount on the sale of the aforementioned mortgages in the open market, this would raise a further £2m to bolster the cash pile to £11.4m, or the equivalent of 15.4p a share. In other words, realistically by the end of this month net funds could equate to 75 per cent of Aurora’s share price.
Or put it another way, strip out that pro-forma cash balance of £11.4m (post the sale of the mortgages at a 15 per cent discount to book value) and Aurora’s current market value of £15.3m is attributing only £4m of value for the company’s three remaining investments, massively below their end of September book combined value of £17.4m.
Bearing this in mind, Aurora holds stakes in DIY retailer Superstoy, Unistream Bank Kreditmart Finance. True, all three investments are plays on the Russian economy, and credit growth and consumer spending, in particular. And it’s only fair to acknowledge that the recent events in Ukraine, and the unstable geopolitical backdrop, mean it could take some time to realise value from these Russian investments. However, as the sale of OSG and Flexinvest clearly show, there is still a market in higher risk assets no matter the back drop. It only comes down to the price a buyer is willing to pay.
Clearly attributing a 77 per cent discount to the value of Aurora’s 24.3 per cent stake in Superstoy, a leading DIY retailer in Russia, is ludicrous. The holding was last valued at £6.3m at the end of September. True, the 14 per cent slide in the sterling Russian Ruble exchange rate since then will mean the sterling value of the holding will have to be marked down to £5.4m in the year-end accounts, assuming no impairment cost on the investment. I estimate Superstoy is generating annualised underlying cash profits of around £6m (before pre-opening expenses for three stores opened last year) on sales of £160m, so a valuation for the whole company of around £21.6m hardly looks exacting.
I also need to factor in the depreciation of the Russian Ruble to Aurora’s investment in Unistream. On this basis, the carrying value of that holding falls from £10.7m at the end of September to £9m now. On an annualised basis, Unistream was on course to make a pre-tax profit of around £1.6m on revenues of £40m last year. Aurora owns a 26 per cent stake in the bank, so a £36m value for the enterprise doesn’t seem unreasonable.
The bottom line is that valuing the stakes in Kreditmart at £400,000, Unistream at £9m and Superstoy at £5.4m, then these investments are realistically worth a total of £14.4m, or £10.4m more than the current market valuation of Aurora implies. That’s a hefty 14p a share of potential upside. But that counts for nothing without a catalyst to kick start Aurora’s share price. The good news is that we will not have long to wait for one to emerge.
Return of capital
It seems to have been completely missed by investors that Aurora’s board have stated in a release last month that they will be making an announcement on a further return of capital. It’s only reasonable to assume that this will be carried out by the same tender offer process as last year with shares in the company being purchased most likely at the March 2014 year-end net asset value.
To quantify how this will impact the company, I have assumed a net asset value of £26m at the end of March 2014 after factoring in the write-downs on the stake in Flexinvest, and adjusted the carrying value of the investments in Unistream and Superstroy for the depreciation in the Russian Ruble in the past five months. Based on 74.7m shares in issue, this implies a March year-end net asset value per share of 34.8p.
So, if Aurora retains £4m of cash and returns £7.4m back to shareholders - equating to half its current market value - this would result in the repurchase of 21.3m of its 74.7m shares in issue at around 34.8p each. That would leave 53.4m shares left in issue to give the company a market value of £11m post such a capital return. The scale of the capital return has yet to be announced, so these figures are for guidance only. But on this basis, net cash would still be around £4m, and the stakes in Unistream, Superstroy and Flexinvest would be worth a further £14.4m. In other words, even after massive writedowns, the shares would still be trading on a cash adjusted 50 per cent discount to the written down value of those assets.
True, some share price discount is in order given Aurora’s board has a tough task to sell assets into a weakening Russian economy, and one facing geopolitical risk too. However, the current discount is extreme and in my view a substantial capital return, or a resolution of the Ukrainian crisis, unlikely as that seems at the moment, would see the huge risk premium embedded in Aurora’s share price reduce significantly and lead to a sharp re-rating.
There could even be news later this year on asset disposals as the board are in talks with prospective investments managers for Aurora Russia's remaining assets. The current management arrangement terminates by mutual consent at the end of April, so there could be fresh impetus from a new asset manager to realise value for shareholders from Aurora’s investments.
Technical set-up and target price
Having hit a five-year low last month, shares in Aurora are very oversold and with the 14-day relative strength indicator (RSI) showing a reading of 40, there is ample scope for a recovery. The price looks to be bottoming out too, having trended sideways since December and has been holding the 20p level. Some investors may wish to wait for a price move above 22.5p, which would confirm the base and signal a chart break-out. However, the fundamental investment case is strong enough to buy before then given that I believe a valuation in the range 27p to 30p a share is achievable.
So, taking all the above factors into consideration, I continue to rate Aurora shares a value recovery buy trading on a bid-offer spread of 19.5p to 20.5p.
Please note that I have written another column today (Going through the roof, 10 March 2014). I am currently working my way through a large number of announcements from companies on my watchlist and which I plan to update. These include: LMS Capital (LMS), BP Marsh Partners (BPM), Eros (NYSE: EROS), First Property (FPO), Trading Emissions (TRE), 32Red (TTR), Polo Resources (POL), Global Energy Development (GED) and Raven Russia (RUS).
