During this ongoing five-year bull market I have been in the fortunate position of not having to be the bearer of bad news that often, but clearly given the number of recommendations I make then there will always be occasions when I hoist the white flag and admit defeat. And that’s exactly what I am doing with shares in Aim-traded carbon credit investment company Trading Emissions (TRE: 14.5p).
To recap, I included the shares in my 2012 Bargain shares portfolio and even after a lacklustre performance in the past six months, the vast majority of my repeat buy recommendations have produced decent returns. That was 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, the company has paid out dividends and made capital returns of 21p a share. That means for a net investment of 4.25p a share the remaining holding is worth 14.5p.
The problem I now have is that Trading Emissions’ latest interim results for the six months to end December 2013 included some sizeable asset write-downs on the company’s private equity portfolio and that has changed the investment case materially. To put this into perspective, at the end of June the private equity portfolio had a carrying value in the accounts of £57.1m in accordance with international financial reporting standards (IFRS). The directors’ fair value at the time was £62.1m. The difference between the two valuations was mainly due to the requirement to consolidate controlled subsidiaries into the company's financial statements. But at the end of December the board had reduced the IFRS value of these assets by a thumping £13.1m to only £41.9m after adjusting for disposals made in the six month period. The new book value of the private equity portfolio is the equivalent of 16.76p a share. The fact that the board’s fair value estimate of these investments is £47.4m, or 19p a share, offers little comfort given the scale of the overall write-downs.
True, Trading Emissions net cash was £18.6m at the end of December and this has been boosted by £5.8m since the financial year-end, to give a proforma cash pile of 10p a share. The plan is for a further cash distribution to shareholders to be announced before the end of the financial year. So on the face of it the shares still offer value as net cash accounts for two thirds of the share price and the shares are trading a third below net asset value of 22.3p.
But I am not at all encouraged by the cautious statement from the board on the likely proceeds of the disposal programme and the potential for further write-downs on its investments. I now believe that achieving anything near even the written down IFRS book value of the private equity portfolio is going to be a hard task. Realistically a discount should be applied to the value of this portfolio given the board now states “that it is becoming progressively more difficult to sell”. I also have to factor in the time it is going to take to realise value from these investments.
Therefore, applying a 20 per cent discount to the value of the private equity portfolio and adjusting for the cash proceeds received since the December half year-end, I reckon the company will do well to achieve around 11.5p a share of cash from this portfolio. True, Trading Emissions also has 10p a share of pro-forma cash on its balance sheet, but once you factor into the equation wind up costs of say £10m, or 4p a share, and a carbon credit portfolio with a liability of 0.4p a share, then at best I now think a total distribution of only 17p a share could be forthcoming. But this is clearly going to take time, and much longer than I anticipated when I last recommended buying the shares at 17p (‘Cash rich Trading Emissions undervalued’, 5 November 2013) when I estimated a return of 22p was likely. The difference is accounted for by the asset write downs and the deterioration in the climate to sell these assets at anything close to book value.
In the circumstances, I am calling time on the holding and would recommend selling in the market at 14.5p.
Please note that I have written another column today: Shining Bright. I am currently 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), and Pure Wafer (PUR). I will also be updating my recommendations on Moss Bros (MOSB), IQE (IQE) and GLI Finance (GLI) after these three companies report financial results on Wednesday, 26 March.
