When Deep Value Surfaces: OPG Power Ventures

My weekly Friday evening ritual of manually entering into a spreadsheet the current values for each investment held (to force me to keep everything under review) has become progressively less appetising as 2018 has worn on: a significant decline across virtually all sectors and geographies held, particularly acute in the UK small cap and emerging market investments in which I’ve been overweight for a while.

Yet not all is negative, and the one recent bright spot, besides reassuring me that I’ve not lost all my stock-picking ability, is an opportunity to reflect on wider investment lessons.

The most recent investment I’ve made is on the face of it one of the least likely and most questionable. 
OPG Power Ventures is an Indian power generating company listed on the AIM market in London. That one sentence alone would be enough to deter most investors.

However, value investing, particularly of the ultra-contrarian deep value variety, requires the ability to explore what appears profoundly unattractive.

OPG appeared on a very rough and ready Web FG list of AIM companies ranged from high to low dividend yield earlier in 2018 and had been on my watch-list since then. Further investigation revealed a share price that had fallen unrelentingly since the heights of over one pound in 2015 to 17p mid-year.

The perfect storm of rising coal prices – the major input to its energy generation – high debt, poor management and performance of a power plant in Gujarat culminated in a set of final results for year end to March 2018 greeted by the shares falling to just over 10p, with a loss of £101m on annual revenue of £140m, the one pence dividend being paid in scrip form rather than cash. Uninvestable, surely?

Yet the results contained perhaps the beginnings of a recovery path. The company henceforth was to focus on its profitable Chennai plant, repay debt, deconsolidate the Gujarat misadventure and continue the development of solar energy production.

Signs of progress, but not enough to persuade me to invest.

Then, rather more rapidly than expected on Tuesday November 27^th, interim results to 30^th September 2018 gave substance to the turn-round story: profit before tax of £7.3m, earnings per share of 1.67p for the half year; underpinned by an increase in electricity tariffs for 2018/9 and reducing coal input prices.

The shares began a rapid ascent from 11p to 17p on the day, and have continued since to close on Friday 21^st December at 26p.

Unfortunately, away from my computer for a few hours on the day of the announcement, I was only able to initiate and then top up a position at an average entry price of 17p.

I do not regard OPG as a strong conviction long-term hold, particularly in the light of the management’s questionable track record from 2015-2018, but given the turn-round underway there is, in my view, still some latent value here.

Price to book is still well under 1.0; and so long as the coal price does not rebound the implied forward PE is firmly in single-digit territory.  The latest research note from Cenkos is estimating full-year earnings to March 2019 of 3.6p and then 6p for the following year as further debt repayment aids free cash flow. In a December interview the OPG finance chief suggested next year’s dividend would be honoured in cash.

Wider investment lessons

1. Stay alert at 7 a.m. each weekday morning for Stock Exchange RNS announcements, particularly from smaller companies, as these tend not to be flagged in advance and produce sharp movements in these relatively illiquid, under-researched opportunities.

2. Earning maximum returns requires decisive action at the point of maximum aversion. For OPG investing just after the September results was the turning point.

3. Waiting for complete confirmation of a deep value recovery story may limit returns. When deep value begins to surface, you have to plunge in to reap the fullest rewards.

4. Value investing, like all investing, depends on judgement in the face of incomplete information.

As Seth Klarman put it in a late 2000s question and answer session marking 75 years on from the publication of Graham and Dodd's classic text Security Analysis:

“[Value investing…]  necessitates dealing with imperfect information — knowing you will never know everything and that that must not prevent you from acting.

It requires a precarious balance between conviction, steadfastness in the face of adversity, and doubt — keeping in mind the possibility that you could be wrong. Ultimately, Graham and Dodd teach us not only about investing, but also thinking about investing. At the core of its wisdom are not mechanical rules to be blindly adhered to, but a way of thinking that allows us never to be blinded by rapidly changing facts or conditions. Mechanical rules are dangerous — requiring the world to be more constant and predictable and analyzable than it can be. "

From Outstanding Investor Digest, 17th March 2009