As I noted a couple of weeks ago investors have yet to fully factor in the news that Heritage and its Nigerian partners in OML 30, one of the largest onshore licences in the country, with eight producing fields and associated infrastructure, have received 'Pioneer' tax status with the Nigerian government. In practise what this means is that Heritage has a five-year tax holiday from the marginal petroleum tax rate of 65.75 per cent on these activities. The net impact is a material enhancement in the value of the assets. Factoring in the tax change, analysts at investment bank Citi have doubled their core net asset value per share estimate to 315p.
They also trebled their earnings estimates for this year and next to 129c (78p) and 168c (101p), respectively, reflecting the fact that Heritage now retains all of the net income from its production share from OML, rather than only a third if it had to pay petroleum tax on these earnings. As a result, Heritage shares are now only trading on little over three times current year EPS estimates. My 300p target price does not seem unreasonable and I continue to rate them a great buy at 239p.
Unfortunately, success with Heritage Oil has not been enough to compensate for the mounting paper losses at Edinburgh-based oil and gas company Cairn Energy (CNE: 164p). In fact, Cairn’s share price has slumped by almost a quarter since I last advised holding on six weeks ago (‘How the 2013 Bargain shares portfolio fared’, 7 February 2014). Investor sentiment had taken an almighty knock after the board disclosed that the Indian tax authorities are investigating the company’s tax assessments as far back as the March 2007 tax year.
There is no suggestion that the company’s board has acted improperly. In fact, in full-year results this week the board categorically stated that “it was compliant with tax legislation in place at the time in each relevant jurisdiction, including India, and will take whatever steps are necessary to protect its interests”. But while this investigation is ongoing, and there is no indication as to when it will reach a conclusion, Cairn is unable to sell its remaining 10 per cent stake in Cairn India, a holding that is currently worth £1bn (£602m), or 104p per Cairn share. Worryingly, according to some analysts, it is rumoured that Cairn received a $1.3bn tax demand from the Indian tax authorities in February, although the company has not stated this is the case. The risk now is that a protracted investigation will impact Cairn’s ability to fund its exploration campaign as the plan was to rely on the proceeds from the sale of the Cairn India shareholding, and net funds of $1.25bn on its balance sheet (£750m), to finance its development programme.
In the meantime, and given the uncertainty over liquidity, the company has suspended its share buy-back programme. That’s only sensible. Unfortunately, the bad news doesn’t end there either as Cairn has also written down the value of its interest in the Catcher field in the North Sea by a thumping $251m. Add to that unsuccessful exploration costs of $213m, a goodwill impairment charge of $324m, a mark-to-market loss of $267m on the value of the holding in Cairn India, and Cairn racked up an eye-watering loss of $1bn in 2013.
In the circumstances, it’s hardly a surprise that investors have been bailing out of the shares. Admittedly, if the company makes a substantial discovery on any of its exploration wells it could make mockery of a share price trading at just half book value. But with the flow of bad news never ending, I am belatedly calling time on this holding and booking a substantial loss.
Undervalued and unloved
The other poor performer in my 2013 Bargain share portfolio, Aim-traded investment company Polo Resources (POL: 16.25p), remains as unloved as ever with its shares trading on little over half book value per share of 31.3p.
It’s not as if the company hasn’t been crystallising value in its investment portfolio as Signet Petroleum, in which Polo owns a 42 per cent stake, has just announced a farm-out deal with Shell in Namibia and has carried out a share buy-back to return cash to its shareholders. Polo received $22.8m (£13.7m) in cash as a result and this was importantly free of any tax liability. That cash return was the equivalent of 5.1p a share, or almost a third of Polo’s own share price, and compares favourably to the historic cost of the company’s investment in Signet ($42.7m) when you take into consideration Signet's remaining assets.
These assets include an 80 per cent operated interest in the Mnazi Bay North licence offshore Tanzania where 2D and 3D seismic data indicates an up dip extension of the neighbouring BG/Ophir Chaza 1 huge gas discovery; a 90 per cent operated interest in Block 03 offshore Benin; a 87.5 per cent operated interest in Block C in Lake Tanganyika Burundi; a 10 per cent interest, carried until the first exploration well, in Block SL-7A-10 offshore Sierra Leone in the Equatorial Atlantic Margin; and retained cash to provide working capital and to progress a new bid opportunity.
It’s also worth noting that Polo received contingent bonus rights on the sale of Signet's interests in block 2913A/2914B in Namibia as part of the Shell farm-out deal. These are dependent upon the achievement of future resource and/or reserve levels in these blocks. True, because of their nature they may end up having no value, but they are option money nonetheless. Polo also received a 42 per cent interest in a second entity formed by Signet solely to progress a bid for a potential new transaction. Should the bid prove unsuccessful, a further cash buy-back is planned which would result in an additional return of funds to Polo.
Interestingly, Polo holds an 8.32 per cent interest in Regalis Petroleum which in turn has a 70 per cent working interest in Block 2813B Namibia in the Orange Basin, nearby the Kudu discovery and the former Signet Petroleum block. Following the successful sale of Signet's interests in Blocks 2913A/2914B, Regalis now intends to seek a farm in partner for Block 2813B this year.
The true value of Polo
Clearly, the major problem for investors in Polo is ascertaining a realistic value on these interests. In my opinion, the true value in these assets will only become apparent when First Energy Capital, which has been appointed by Signet to assess strategic alternatives for Mnazi Bay, including potential farm-out opportunities, concludes its discussions with potential partners for Signet. That is the great unknown and in the absence of any equity research to rely upon, investors in Polo are completely in the dark. That said, chairman Michael Tang, who acquired 11.77 per cent of Polo's share capital at 40p a share last May through his investment vehicle, Mettiz Capital, clearly sees significant potential for value creation from the investment in Signet, and Polo’s other interests. His buy in price was more than double the current share price.
He has a point as Polo is currently sitting on cash and liquid investments of $40.2m (£24.2m), or the equivalent of 9p a share. That’s more than half Polo’s current share price. The remaining stake in Signet is in the books for $19.9m (£12m), or almost 4.5p a share. But given the farm-out of the Namibian interests with Shell resulted in a share-buy-back that boosted Polo’s cash pile by 5.1p a share, I would be astonished if the remaining interests in Signet do not achieve a substantial return on their book value in the accounts.
In my view, Polo’s investment in Signet and cash on its balance sheet alone easily more than justify the current share price, so investors are in effect getting a free carry on the company’s other investments, the largest being the Nimini Komahun Gold Project in Sierra Leone, in which Polo holds a 90 per cent stake. The last resource estimate showed Nimini has an indicated gold resource at the site of 550,000 ounces and another 340,000 inferred ounces of gold, bringing the total potential resource to 890,000 ounces. The investment in Nimini is in the books for around £33m, or 12p per Polo share. Realising value is going to take time, but clearly the investment has some worth.
It’s worth pointing out too that from a technical perspective, Polo shares are now very oversold with the 14-day RSI showing a reading around 30. At 16.25p, they are also trading close to a major support level around 15.5p, dating back to the lows of late 2008. The latest drift towards this support reflects investor disappointment that not all of the cash return from Signet was returned to Polo’s shareholders.
Instead, the board of Polo is redeploying the funds in further investments and made two small acquisitions in a couple of Australian listed companies this week: an A$1.2m (£655,000) investment for a 12.7 per cent stake in Celamin Holdings NL (CNL:ASX) a company holding phosphate interests in Tunisia; and an A$1m (£550,000) investment for a 4.2 per cent shareholding in Blackham Resources (BLK:ASX), a company focused on the development of its wholly owned Matilda Gold Project in Western Australia. It’s worth pointing out that these are tradable investments and there is no harm in diversifying the portfolio and redeploying cash into other areas where the board believe there is scope to generate decent long-term returns.
True, Polo’s share price is a third below my recommended buy-in level of 24.5p when I included them in my 2013 Bargain shares portfolio, but with the price close to support and the 14-day RSI very oversold, I see the risk to the upside from here ahead of news of further potentially lucrative farm-out deals by Signet and an additional return of cash to Polo.
In the circumstances, I would use the near 20 per cent slide in the share price since the full-year results as a speculative buying opportunity with Polo share priced on a bid-offer sptread of 16p to 16.25p.
Please note that I am working my way through a very large number of announcements from companies on my watchlist including: LMS Capital (LMS), BP Marsh Partners (BPM), Eros (NYSE: EROS), First Property (FPO), Trading Emissions (TRE), Thalassa (THAL), PV Crystalox Solar (PVCS) and Pure Wafer (PUR). I intend updating my views on all these companies once I have had the opportunity to appriase the new information released.
