12/11/2024

The market doesn’t like the Lycopodium trading update:

Analysts don’t cover LYL, so investors are on their own when it comes to price targets and valuation. I suspect the knee-jerk reaction today is due mostly to dividend uncertainty, but there will be a drop in earnings also. Projected dividends of 0 to 15 cps is disappointing if that’s why you own it. Over the last 3 financial years the annual dividend has been 81cps, 77 cps and 81 cps.

Does this mean the business is tanking? No. Far from it! However, the NPAT guidance of $40 million to $45 million is lower than I was expecting. FY24 earnings were $50.7 million. If we take the mid-point of guidance, $42.5 million, that’s a 16% drop in earnings. I was expecting earnings to be at least flat in FY25. That’s still a net profit of about $1.07 per share. At $10.70 that puts it on a PE of 10 times FY25 earnings. That’s not expensive.

FY25 ROE will remain strong at c. 33% (ie. 42.5 million / $127.4 million x 100). I was expecting a FY25 ROE of 35% so a slight disappointment here.

For a rough valuation pending a deeper dive into the future prospects of the business, I’ll use McNiven’s Formula and the latest guidance and assume ROE can be maintained at 33% going forward, equity of $2.88 per share, payout ratio of 14%, 86% of earnings reinvested at 33%, I get a valuation of $13 for a required return of 15% per annum.

While a low dividend/payout ratio seems disappointing, for a business like Lycopodium with a high ROE it’s actually a better use of capital than paying out dividends and increases the valuation of the business.

I’ll take a deeper dive over coming days, however I’ll probably add more if it drops below $10.50 again. I hope it doesn’t!

Held IRL (4.5%)

8/09/2024

@Bear77 has already covered the FY24 results in detail. I agree with @Bear77 that Lycopodium is a very high quality business and it is also one of my favourites. Bear mentioned the high ROE. I don’t get the same ROE as reported by management in the results (42.2%). FY24 NPAT was $50.7 million and Equity was $127.4 million, which makes FY24 ROE 39.8%. Some companies calculate ROE based on shareholder equity at the start of the year, some mid-year, and some the end of the year. On Commsec data ROE is calculated based on the equity at the end of the financial year. For consistency in comparing and valuing businesses I calculate ROE based on shareholder equity at the end of the financial year.

While FY24 NPAT came in at the top end of guidance, 2H24 NPAT was $20 million compared to $30 million for 1H24.

At this stage management has not provided guidance for FY25, rather some broad outlook statements:

• Strong long-term demand outlook for minerals and metals relevant to the ongoing energy transition will continue to attract capital to build global supply

• Demand for gold remains high, with production expected to increase as new projects and mine expansions become operational

• Demand for iron ore is expected to continue to increase steadily over the coming years, supported by new infrastructure investment in China and India’s growing infrastructure spending

• Australia’s railway construction and maintenance activity outlook is strong, supported by a number of significant publicly funded projects

• Domestic manufacturing continues to present opportunities for the Industrial Processes sector, as does the ongoing development of emerging markets in support of the energy transition, including waste and recycling, water and wastewater, and hydrogen

• Transformation of the global energy sector from fossil-based to zero-carbon sources represents a period of innovation and opportunity in the development of new systems that can operate on low carbon energy sources, whilst maximising waste recovery and reuse

• Lycopodium’s expertise will remain sought after given the macro environment and other drivers

There’s nothing much here to hang a valuation on with a high degree of confidence!

While Lycopodium is slowly diversifying, it remains highly exposed to gold projects in Africa, as can be seen in the slides below:

The gold price continues to hit all time highs and while the gold price is strong Lycopodium should continue to do very well.

My last valuation of $15 was over 6 months ago and was based on an ROE of 38%. I’m tempted to pull this back a little given 2H24 NPAT was quite a bit weaker than 1H24. I think there’s a possibility FY25 earnings could be lower than FY24 given the current pressure on commodity prices other than gold, which make up the next largest component of Lycopodium’s business.

Using McNiven’s Formula assuming a more conservative ROE of 35%, equity of $3.22 per share, 40% of earnings reinvested at 35%, 60% of earnings paid out as fully franked dividends (9.4% gross yield), and a required annual return of 14% I get a valuation of $14. At the current share price of $11.75 I think Lycopodium is a BUY and will likely add more shares before it goes ex-dividend on the 19th September.

Held IRL (4.9%)

21/02/2024

Lycopodium (LYL) released another great 1H24 result today. This is a very high quality business operating in a cyclical industry. It is diversified and is starting to grow revenue in some less cyclical sectors, for instance: “Transformation of the global energy sector from fossil-based to zero-carbon sources represents a period of innovation and opportunity in the development of new systems that can operate on low carbon energy sources, whilst maximising waste recovery and reuse” (1H24 Presentation). However revenues are heavily skewed towards resources in Africa.

It’s a high quality business because currently it has a very high return on equity (38%). If you look at the presentation LYL say their ROE is 25.5%.

Here they are calculating their ROE as the 1H24 NPAT/ Equity. I questioned this in their previous results meeting and they agreed it was only calculated on the half. It needs to be calculated using full year NPAT. LYL reaffirmed guidance for FY24 to be $46 - $50 million. That looks a tad conservative too, given they’ve already achieved $30 million of that. @Bear77 would agree (since it will be in the top 3 companies on Strawman today) that LYL is just one of those quiet achievers that just plugs away doing marvellous things with your equity without crowing before the eggs are laid!

My calculation of ROE based on equity at the end of Dec 2023 ($127.1 million) and mid-guidance of $48million is 38%. This might not hold up through a depressed cycle so we need to keep a close eye on it. LYL generally pay out approx 70% (50% for this half) of their earnings in dividends, and the dividends are fully franked.

For FY24 I am expecting a fully franked dividend of 84cps (70% of guidance EPS, $1.21cps). That’s a forecast yield of over 6% fully franked, or 8.5% including franking credits.

Valuation

Turning to the valuation using McNiven Formula assuming ROE 38%, Equity $3.07 (Dec 2023) 30% of earnings reinvested, and requiring a return (RR) of 15% I get a valuation of c.$15 per share, the same as my previous valuation but now I feel the valuation is slightly more conservative. While the cycle is strong LYL should continue to do well.

Held IRL (3%)

14/11/2023

My valuation and justification remains unchanged from 3 months ago (see valuations at LYL). The last three months have panned out even better than I expected and today’s FY24 guidance confirms LYL is expecting continued growth which puts ROE to remain in excess of 40% over the next 12 months. The business is virtually debt free with $82.4 million of shareholders total equity of $113 million sitting in cash. Investors could expect dividends in FY24 to be between 9% and 10% fully franked (over 13% gross yield including franking credits). This is while it continues to reinvest 30% of earnings back into growth.

01/08/2023

Lycopodium said in its guidance update on the 11th April that in the final quarter it is “continuing to see a high level of activity across all operating sectors, delivering a robust order book of projects and feasibility studies across a broad geographic footprint. We are also seeing a strong study pipeline which bodes well for the future. This significant level of activity across all sectors of operation continues to translate into healthy financial performance. The Company now provides an updated guidance for the full financial year, with forecast revenue of $320 million and forecast net profit after tax (NPAT) of $45 million.”

What to expect for FY23:

• FY2023 NPAT of $45 million represents a 45% ROE, and is 67% up on last year (FY22 of NPAT $27 million)
• FY23 Net Profit Margin 14%
• FY2023 EPS $1.13 (80 cps FY22). FY23 PE 8.9 based on the current share price of $10.06
• Debt free
• $2.40 per share held in cash ($95 million cash, 39.7 million shares)

At 45%, Lycopodium’s ROE will be the highest in over a decade, and this is the seventh successive year where ROE has been higher than 15%.

FY23 Earnings and ROE represented in red (Adapted from Commsec data)

I don’t know of any other business which has zero debt, holds 24% of its market capital in cash, and at the same time is expecting ROE of 45%.

Source: Simply Wall Street

Shareholder equity is $2.60 per share of which $2.38 is held in cash and equivalents.

At $9.70, Lycopodium’s shares are trading close to their all time high of $10.60. In January 2016 shares were trading for $1.16, so along with it’s fully franked dividends it has realised excellent returns for shareholders over 7 years.

Dividends

At a historic payout ratio of 70%, the final dividend is likely to be over 40 cps, fully franked. The interim dividend paid was 36 cps, fully franked. Shareholders can expect a grossed up annual yield of circa 11% (including franking credits). There is plenty of cash sitting on the balance sheet, so there is also the possibility of a special dividend, a share buy back or an acquisition some time in the future.

Valuation

Over the last 4 years the average PE ratio has been 12.5 (calculated from Commsec annual average PE data). The current PE ratio based on FY23 earnings is 8.6, well below the historical average. Given business performance has vastly improved over 4 years (ROE has more than doubled), I think it is reasonably conservative to use an average PE of 12.5 for valuation. This makes Lycopodium worth over $14.00 per share.

Given the improving business performance I would prefer to use McNiven’s StockVal Formula for valuation. Assuming ROE continues at 40%, reinvested earnings 30%, equity $2.60, you could pay up to $12.50 and still get a 15% annual return (including franking credits).

Even though Lycopodium is trading near all time highs, I think it is excellent value at the current share price. At $9.72, you could expect an annual return of c. 18% including franking credits.

You could pay up to $17 and still receive an annual return of 12% (including franking credits).

I think Lycopodium is currently one of the best (if not the best) mining services businesses on the ASX. I’ve been adding shares below $10 and have lifted my valuation to $15 per share.

Disc: Held IRL (0.8%).

17/04/23

The Lycopodium share price has shot past my previous valuation of $10.00. Is it now overvalued? Not if you base your valuation on the updated guidance with NPAT expected to be $45 million for FY23. That will put FY23 ROE at 43% ($45 million NPAT / $103.5 million equity). That’s the highest ROE in 10 years, and possibly the highest on record for LYL.

Source: Commsec

Lycopodium is definitely in a sweet spot at the moment with ‘a high level of activity across all operating sectors, delivering a robust order book of projects and feasibility studies across a broad geographic footprint.’ The increased activity is driven by battery minerals, gold and copper. While we continue to see strong activity in these sectors we can expect LYL to thrive. I think we will see this across the board in other mining service companies also.

My previous valuation was based on a ROE of 35% and a required return of 15% p.a. I feel comfortable bumping the ROE for LYL up to 40% for an updated valuation. Still requiring a 15% p.a. return on my investment my updated valuation jumps to $12 (McNiven’s StockVal Formula). If you were happy with a 12% p.a. return you could pay up to $16 while ROE remains over 40%.

A caution though, this is a cyclical industry and at these share price levels it’s important to keep a close eye on future guidance and the health of the miners.

Disc: Held IRL (0.6%)

Feb 2023

Thanks @Scott for your 1H22 results straw and valuation. This is an excellent result for Lycopodium, and their best return on equity (ROE) in a decade (39%). Unfortunately, they did themselves a disservice in the presentation:

I asked MD Peter de Leo on the conference call this morning if this was based on the return for just 6 months rather than an annual ROE, which he confirmed.

Those who follow my straws would know that ROE is the first metric that gets my attention. I’m looking for businesses with a track record of consistently strong and preferably growing ROE. I try to find businesses with a minimum of 15% ROE and preferably higher than 20%. There are plenty of businesses with ROE higher than 20%, but most trade on high multiples of PE and PB.

Lycopodium is a quality business and has averaged ROE of between 15% and 25% over the past 6 years. This year ROE will be close to 40%. That’s the best ROE in a decade.

However, Lycopodium is also a cyclical business with over 90% of its revenues coming from resource companies. Earnings can fall away rapidly when the shine goes off mining.

None the less, it has a track record of high ROE, and I expect ROE to be in excess of 30% for a few years to come. With NPAT guidance of $40 million, or $1.00 per share, that puts LYL on a FY23 PE of 8.3X. How many businesses can you buy with a PE of 8 and a ROE of 40%. Not many!

If I use McNiven’s StockVal formula, assuming normalised ROE of 35%, a dividend payout ratio of 70%, franking of 100%, and a required annual return of 15%, I get a valuation of $10.04, say $10.00.

I don’t think this is a business you buy and hold for ever. Having said that I have held LYL for several years. The time to sell is when the pipeline of work with resource companies starts to dry up. The project pipeline for Lycopodium still very strong so it’s a strong hold for me.

Disc: Held IRL (0.6%)