Petropavlovsk PLC (LSE:POG) has been on my radar for a while, and I’ve been consistently disappointed in its investment thesis. The biggest risks I see are around the sustainability of its future growth, the opportunity cost of investing in the stock accounting for the returns I could have gotten in other peers, and its cash-to-debt management. It’s crucial to understand if a company has a strong future based on its current operations and financial status.
Firstly, a quick intro on the company – Petropavlovsk PLC operates as a gold exploration, development, and mining company in the Russian Far East. Started in 1994, it operates in United Kingdom and is recently valued at UK£229.28M.
The first thing that struck me was the pessimistic outlook for POG. A consensus of GB metals and mining analysts covering the stock indicates that its revenue level is expected to decline by -10.66% in the upcoming year, however, future earnings are expected to grow. On average, POG’s bottom-line should see an annual growth rate of 47.98% going forward, leading to an unsustainable margin expansion driven by a mix of falling sales from core activities and possibly cost-cutting. In addition to this, at its current level of earnings generated, POG produces worse returns to shareholders (7.16%) compared to its industry peers (11.12%), which isn’t a good sign. One reason I’d expect a company to produce below-industry returns right now is if it’s in a reinvestment phase, and gains will become evident in the future. However, for POG this clearly isn’t the case, and leads to a big question mark around the sustainability of its current operations.
Minimizing the downside is arguably more important than maximizing the upside. Generally the first check to meet is financial health – a strong indicator of an investment’s risk. Alarm bells rang in my head when I saw POG’s high level of debt, which has been increasing over the past five years, exceeding its total level of equity. Furthermore, its interest payments as a result of this high level of debt, is not adequately covered by EBIT, at 2.93x. However, its cash generated from its core activities makes up a reasonable portion of debt (0.21x). There’s room for improvement on the debt level front, which could be lowered to a more prudent amount. The current state of POG’s financial health lowers my conviction around the sustainability of the business going forward. POG has high near term liquidity, with short term assets (cash and other liquid assets) amply covering upcoming one-year liabilities. POG has managed its cash well at a current level of US$11.42M. However, more than a fifth of its total assets are physical assets and inventory, which means that in the worst case scenario, such as a downturn or bankruptcy, a significant portion of assets will be hard to liquidate and redistribute back to investors.
POG currently trades at UK£0.068 per share. At 3.3 billion shares, that’s a UK£229.28M market cap – which is expensive for a company that has a 5-year cumulative average growth rate (CAGR) of -21.19% (source: analyst consensus). With an upcoming 2018 free cash flow figure of US$15.00M, the target price for POG is US$0.011 is below than the current share price. Therefore, the stock is trading at a premium. Although, comparing POG’s current share price to its peers based on its industry and earnings level, it’s undervalued by 73.08%, with a PE ratio of 7.4x vs. the industry average of 12.81x.
POG is a fast-fail research for me. Good companies should have good financials to match, which isn’t the case here. Given investors have limited time to analyze a universe of stocks, POG doesn’t make the cut for a deeper dive. For all the charts illustrating this analysis, take a look at the Simply Wall St platform, which is where I’ve taken my data from.