Thanks to TheGoss31, bookend and others for their thoughts about reasons for the recent share price drop. I agree that the share price could go down further before the announcement, but it could also recover before the announcement as shorters protect themselves by exiting their positions. I focus more on picking good investments at the right price rather than trying to pick the bottom. In my considered opinion, the price drop has five likely causes:
*Increased shorting of TFS’s shares.
*A significant shareholder makes decision to reduce investment in TFS.
*International forces impacting share prices generally and the cost of debt.
*Momentum (panic?) builds causing some investors to sell because of the share price reduction.
*Some investors become concerned about the amount of debt relative to the reduced market capitalisation and TFS’s cash flow levels to service this debt.
Having considered and researched the reasons for the share price fall, I am as convinced as ever that TFS remains an outstanding investment at outstanding value. It is rare to have this combination.
The shorters will be starting to get very nervous about continuing to short TFS at this price, due to the limited further downside and the risk of a large share price appreciation, as happened last year around the time of the half yearly announcement. The value/risk trade off will soon be very much in existing shareholders’ favour. Selling by one major shareholder will stop. Anything can happen to international forces, but I believe that TFS’s operating model and value proposition will weather whatever happens there. Momentum will eventually be in shareholders’ favour for those with courage and patience.
Please forgive this long post, but I think it is warranted in the present climate which is making investors and traders very nervous. My analysis on the more substantive issue of cash flow, valuation and debt follows:
Cash Flow & Valuation
Cash flow will improve significantly from early FY17, after the next harvest is processed and sold. This is only around 6 months away. Cannacord’s research report on TFS’s web site predicts it to be AU$58M by FY17, after interest and tax, and around $8M after interest, tax, capex and dividends. There should be no more need for new borrowings, unless another suitable investment opportunity presents itself.
Cash based valuation measures such as cash flow per share and the EV/cashEBITDA multiple used by others in this forum recently are not the only methods which should be used to value TFS. They are very important to assess the ability to pay short term liabilities but they do not consider the present value of much higher future cash flows, the rate of growth in asset value and profit, or those parts of TFS (such as the pharmaceuticals business) with major upside potential not yet reflected in future cash flows or profits.
The forest asset value is already over $600M, and last year increased by 40%. It would be foolish to ignore this. I don't expect such a sizable increase again this year, but it should still be significant. Even if the oil price does not change (unlikely based on past average growth rate of around 15% pa), the trees grow and TFS expands its ownership of forest. and the lower price used for the valuation There are not many assets as assured of growth as TFS's forest assets, given its effective monopoly of sustainable oil until at least 2031, or longer if others don't plant large and sustainable forests shortly. The cost of setting up forests, 15 years to harvest, the scarcity of suitable land with assured water rights and the intellectual property needed to succeed indicate to me that new competitors are unlikely. Reputable companies do not want to buy oil from unsustainable, natural forest harvesting.
Harvests in the mid 2020's will be anywhere from 9 times to over 20 times the already large 2016 harvest. The net present value (NPV) of these enormous cash flows (revenue of around $1B by FY26) will be higher than brokers currently allow, as the discount rate used for calculating NPV will reduce when TFS inevitably becomes a much larger and more highly rated borrower with lower interest rates. This trend is already happening and will only improve as cash flow take off and TFS achieves greater diversity of markets and products with this year’s harvest.
Whilst the share price is being hammered it pays to remember the value and medium term outlook, not the short term world worries. Apart from the above measures, price / book value is currently around 0.66, one-third discount. Forward FY17 P/E, fully diluted for options but using all reported profits (cash and non-cash), is around 4.8 at the current share price.
Debt
TFS’s borrowings from corporate bondholders amount to US$150M at around 11% pa and another US$50M at around 8% pa, with interest payable twice yearly. TFS must refinance these no later than 15 July 2018 (more than three harvests from now). The US bondholders would be very pleased with how much safer TFS is now than when they invested their money. This is confirmed by the 2.5% to 3.5% lower interest rates for the most recent bonds. I understand that these bonds have no performance covenants, other than payment of interest. As long as the bondholders keep receiving their approximate US$10.5M in half yearly interest payments they are happy. If this is ever in doubt, TFS would take action to temporarily suspend dividends (around AU$10M per year) to add to other cash flows. This is extremely unlikely given the strong outlook for cash flows from this July/August following the much bigger harvest. Demand for the newly planted forests is strong due to the outlook for sandalwood and the limited supply of sustainable forest plantations, and TFS has had no trouble selling this amount of forest each year. Most of this cash is usually received late each financial year for tax reasons, so news flow on this front has been typically slow in the first half.
By 15 July 2018 TFS will be very much more diversified and with very much greater cash flow. TFS could add to profits by renewing the debt after 15 July this year at around 3% lower interest rates, when the early redemption penalty reduces from 8% to 4%. If the debt market turns sour for refinancing, TFS has almost 2.5 years to build up cash holdings (easier from larger harvests), sell some assets (easy for mature forests generating monopolistic earnings) and/or raise capital (very much a last resort and not needed until 2018). Hardly a cause for panic now.
The balance sheet is strong, backed by valuable forest assets, with Net Debt to Net Debt + Equity of around 33% as at last 30 June. If TFS was the slightest bit worried about their gearing, they would have been selling some of these assets rather than taking out another US$25M loan in November 2015 to buy more forest assets off investors. TFS directors and management can see the present and future value in these forests.
Investment Case
I made two substantial posts on 3 Nov 2015 and 29 Dec 2015 thoroughly exploring the investment case for TFS. Given the recent share price drop these, in conjunction with this post, could help those considering selling or buying TFS.
Investment Case Part 1:
http://hotcopper.com.au/threads/oil....2630749/page-2?post_id=16313867#.VsEOA-YatoN
Investment Case Part 2:
http://hotcopper.com.au/threads/my-2016-top-pick.2671039/#post-16696030
