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Sunday, September 18, 2011

Why Mercator Lines is a BUY thanks to coal play.

In June-11, the CEO claimed that the expected valuation of Mercator's coal mining assets would be $150MM for 20% or an implied equity valuation of $750MM for all the assets( http://www.moneycontrol.com/news/ipo-upcoming-issues/mercator-lines-to-launch-ipocoal-division-by-year-end_561459.html). But surprisingly, the global coal prices have only risen till then, but the company's share price has fallen around 40% and the total mcap is just $140MM. Instead of screaming 'BUY' from the rooftops, I thought I'll explore the possible reasons for that, and invite reader comment on the same. For those who have not heard of the company, it is a shipping company which has ventured into dredging, coal mining and oil & gas. It essentially aims to replicate Adani. Read about the company here(http://www.mercator.in/investors/mllinvestorppt.pdf) and download its FY11 annual report here(http://www.mercator.in//investors/AnnualReport/Mercator%20Annual%20Report%202010-11.pdf). The possible explanations for it-other than calling it a case of the bi polar Mr Market of Graham fame-are
  1. Coal Mines not as promised:-The coal mines are in Mozambique(85% stake in 1BN tonnes estimated reserves) and in Indonesia(230MM tonnes). The present coal profits-around 20 crores/quarter-are derived from the Indonesian mines. Now, the CIA World Fact book shows that Mozambique is a debt laden poor company with crumbling and inadequate infrastructure. Mercator's 30yr license was to commence from last year(2010) but it is still looking for a partner to operate the mine. The fact that they have not yet found a partner  in the M&A crazy world of coal acquisitions, that too in the next big continent('Africa') speaks volumes for the asset quality-because the global majors are not that slow....
  2. Shipping business value destroying? Holding companies are valued at even less than the cash on their books(like Piraral Holdings) because investors are worried that good assets will go to stem the cash drain from bad assets/ill advised actions. But this rationale does not really hold, because the company WAS profitable till the crisis, and is still recognized as an efficient operator. 
  3. Market has priced in political risks of expropriation?:-If we content that the Indonesian export tax on coal will make exports uneconomic, then the entire coal IPO valuations stems on Mozambique. Given that the royalty is just $1/ton(sounds too low right?), Mozambique may be tempted to do an Indonesia and hike the royalty. It may even go further to nationalize the mines-but given the diplomatic relations etc involved, that seems a tad bit unlikely. 
  4. Market still views it as a shipping company:-Despite the company's efforts to change its name, market itself as a coal company etc, it is still viewed, monitored and valued as a shipping company. But whatever the value is, would it be negative?
  5. Consolidated v/s Standalone numbers:-The Jun-11 quarterly consolidated EPS is Rs 0.6 but the standalone(only shipping) is a loss of Rs 1.61. Investors who do not read beyond the fineprint and panicked at thestandalone loss, may have dumped it.
  6. Unsure IPO prospects:- Where the global markets may have frozen, investors may be sceptical about the prospects of the IPO happening. But at any EV, it is a no brainer!
  7. No clarity on holding structure:- The group organizational chart is not given, and it is difficult to ascertain the vital element of which company holds the coal mines(i.e which SPV). Mercator claims it to be housed in Singapore and ultimately Mozambique, but little clarity on that.
  8. Why have other investors not caught on yet? Maybe this stock is off their screens, and in the flight to safety this may have been ignored...
None of these reasons(except 1 and 3) hold much water. And for the huge margin of safety, I think this is a classic Graham stock, which is hurt by the distressed shipping sector valuations.  Other non financial advantages are
  • Qualified and stable management team since inception-promoter CEO is from IIT Roorkee, aptly complemented by a Chartered Accountant, the Jt MD. 
  • Loyal independent directors:-Unlike some other companies, it has not seen an exodus of independent directors in the wake of Satyam. But then, it did have a clean image. 
  • Trading at historically low multiples:- P/BV is around 0.6. 
Recomendation:BUY @ CMP Rs 25. It seems a no brainer and multi bagger.


chandresh phulphagar said...

hi i think you are right do you have chat id so that we can chat on this company

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