Aberdeen International: Global Resource Investment Company Trading At 38% Of Its Book Value

Summary

• Buy rating for Aberdeen International; $0.18 target price.
• Net asset value per share was $0.36 in latest interim report and may be significantly higher after it sells its position in Potasio y Litio de Argentina S.A.
• Decreased expenditure in latest quarter signals improved outlook for future profitability.
• High level of inside ownership, and company repurchasing its shares.

Company Profile

Aberdeen International (OTCPK:AABVF) [AAB:CN] is a global resource investment company and merchant bank. Its net asset value, $31.7m at 30^th April 2017, is significantly higher than its current market capitalisation of $12.9m. It invests in small capitalisation companies in the metals and mining sector. 59% of its portfolio is allocated to private companies, which Aberdeen seeks to assist prior to their IPOs with its managerial expertise.

Between 8,500 and 614,500 shares were traded on any given day last week, meaning the stock is liquid enough for retail investors, managing relatively small amounts of capital, to trade at reasonable prices. However, it is out of scope for large institutional investors, which brings into question whether its stock is fairly priced.

With net income of $9.8m in the most recent financial year and a price-to-book ratio of 0.38, the stock appears extremely undervalued at a first glance, but the future profitability of the company is highly uncertain and its holdings, as well as its own stock price, are highly volatile.

Management and Governance

The management’s past performance is a key reason for the stock trading at a major discount to its book value. It has a record of destroying shareholder value and compensation has been unjustifiably high.

	2017*	2016	2015	2014	2013
Net Income	9,796,805	-9,715,382	-13,818,770	-16,292,936	-30,630,419
Equity Value	34,562,448	25,890,596	35,851,807	47,495,999	65,450,058
ROE	28%	-38%	-39%	-34%	-47%

Click to enlarge

*Year Ending 31^st January 2017

Three out of five board members have served for at least 10 years, which is against best practices for corporate governance. A long-standing relationship with the managers brings into question whether the board is acting in the best interest of the shareholders, which is a concern given the level of compensation awarded. Ideally, at least 75% of a board should be independent. Aberdeen has three independent directors, which is not in itself alarming.

UHY McGovern Hurley LLP has been an auditor since 2006. A tenure this long often brings into question an auditor’s independence and objectivity, but it would be more concerning if the auditor discontinued its relationship against the company’s will.

Encouraging signs for investors are the 20.6% insider ownership, a new interim CEO (acting since August 2016), repurchases of the company’s shares and the significant decrease in expenses in the last quarter.

In the Management, Discussion & Analysis report released on 13th June, it was revealed that the company would change its strategy to focus on more advanced, less risky investments in mining-friendly jurisdictions. However, this raises concerns regarding whether the highly-paid managers that have expertise in the industry are being utilised most effectively. They noted in the past that they create value by helping early stage companies achieve growth. On balance, though, it is preferable from a risk-averse investor's perspective to employ a safer strategy as a means of preserving the company's equity value.

Aberdeen International’s Holdings

Public Investments

Private Investments

Source: Sedar.com - Aberdeen International Management’s Discussion and Analysis for the three months ended April 30, 2017

Aberdeen had a $1.4m unrealised loss on Lithium X Energy Corp. (OTCPK:LIXXF) [LIX:CN] in the latest quarter and a realised loss of $0.2m as it sold $5m worth of shares. The lithium exploration and development company reported zero revenue and a $1.7m loss in the three months ended 31st March. The outlook for the company, though, is positive as it has a management team with a proven record of success and the demand for lithium is likely to grow with the production of electric cars.

Despite selling LIX shares, Aberdeen agreed a deal on 29^th June 2017 to sell its stake in Potasio y Litio de Argentina S.A. (PLASA) to LIX in exchange for 6m LIX common shares, $5m in cash and a possible additional 3m shares if LIX has a volume weighted average price of $3 over a 20-day trading period within the next three years. It is currently trading at $1.95.

African Thunder, which represents approximately 23% of Aberdeen’s total assets, had a $1.4m decrease in fair market value in the first quarter of this financial year. Aberdeen’s 47.6% stake in the company cost $15m, but is now worth only $5.8m.

The mining company is not currently generating revenue as it decided to temporarily suspend its mining operations at the Smokey Hills site. Despite improving operational performance, weak palladium and platinum prices continued to drag on cash flow. In the nine months ended 31st March 2017, African Thunder had used US$3.3m cash in operating activities and generated US$2.8m in financing activities from shareholders' loans.

Platinum prices fell by 6% in the quarter, causing a $0.6m decline in the fair market value of African Thunder, but this amount was entirely offset by the 9% increase in palladium prices, which increased the fair market value by a similar amount. The reduction in market value of the company was driven by a decrease in forecasted discounted cash flows estimated by its own management.

Since 30^th April 2017, the value of Aberdeen’s holding in Fura Gems [FUR:CN] has increased by 47% to $3.5m. The value of its position in Blue Sky Energy [BSI:CN] has fallen to $1.9m, whilst its position in QMX Gold Corporation (OTCPK:QMXGF) [QMX:CN] is now worth $2.4m.

Valuation

The company’s management repurchased $1.2m of shares in its most recent financial year and $0.2m the year before. This signals its belief that the stock is undervalued. Companies that repurchase their own stock have historically outperformed those that do not.

	2017	2016	2015	2014	2013
Repurchases	1,204,985	245,829	-2,000,000*	122,838	408,230
Dividends	0	0	0	0	1,734,088

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*$2m of shares issued in 2015.

The shares look very cheap with a trailing P/E ratio of just 1.4, but there is a risk that the company’s equity will diminish if it cannot reduce the proportion of its expenses to its assets. Its equity value, $34.6m, is now close to a quarter of what it was in 2011, $136.3m. Only $6m of this amount was returned to shareholders through net repurchases and dividends, but Aberdeen’s share price is only 18% of what it was when its annual report was released in 2011.

Its trailing price to sales ratio, 0.8, is far below its industry average of 2.9, and the industry average price to book ratio, 1.4, is nearly four times higher than Aberdeen’s. Its net asset value per share is $0.36, but if the historically negative return on equity is not improved, the shares could become worthless.

The value of Lithium X’s consideration to buy Aberdeen’s holding in PLASA is worth around $10m more than the $6.8m stated fair value in Aberdeen’s latest interim report, even under the assumption that Lithium X’s shares do not trade at a VWAP of $3 over a 20-day period within three years. Assuming no change in the value of Aberdeen’s other investments, shareholders' equity per share would be $0.47 after the deal is completed. This suggests that, even if Aberdeen continues to trade at the same price-to-book ratio, there should be a 30% increase in its share price.

A realistic target price is therefore $0.18, but the market has not reacted to the significantly reduced expenses in the latest quarter, which would justify the stock trading closer to its book value.

Potential Catalysts

Potential catalysts for a convergence of the share price with net asset value include realised and unrealised gains from investments, a takeover announcement, news of large repurchasing of shares and private investments becoming public companies. If any of these events occur, shareholders could see the value of their shares double, but there is a risk of significant losses if the company’s earnings do not consistently improve.

Its average annual return on equity since it became a global resource company in 2007 is -9.8%. This indicates that unless last year was a turning point, investors’ main hope would be that the company is acquired or becomes private. The acquisition price would likely be close to the book value of the company, which could nearly triple an investment at the current share price.

In its latest interim report, Aberdeen reported expenses for the quarter ending 30^th April 2017 of $613,169. If this decreased level of expenditure is sustained for the next three quarters, a realistic 7.7% return on net assets would be required to cover expenses.

Risks

Investors will be concerned by the $5m operating, general and administration expenses for the latest financial year, which represent over a third of total revenue and roughly a seventh of total assets. A 15.8% return on the company’s investments would be required to cover this amount of expenses, unless other revenue (advisory fees, interest and dividends), which totalled $236,782 (compared to $601,502 in the prior year), is increased. Such a high return would be difficult to achieve in the increasingly competitive institutional investment industry. However, expenses could be half of this amount if they remain stable for the remaining quarters of this financial year.

Particularly alarming expenses include compensation of directors, officers, employees and consultants, which increased from $2m in the previous year to $2.6m in the latest financial year. Travel expenses increased significantly from $271,211 to $329,154, as did shareholder communication, which rose from $201,279 to $252,554.

Although, the company had a return on equity of 28.3% in its latest financial year, it is unrealistic to expect that it can sustain this level of return. Before the 12 months ending 31^st January 2017, the last time the company reported a profit for the year was in 2011. If the proportion of profitable years to unprofitable years does not improve, shareholders’ equity could be wiped out completely.

Investors can hedge the risk of Aberdeen’s public investments falling in value by shorting them. However, they cannot do this for its private investments, and although metals and mining indexes can be shorted, the risk of Aberdeen’s expenses outweighing its investment gains cannot be hedged.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I am/we are long AABVF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.