Sirius Minerals (LSE: SXX) and Renold (LSE: RNO) are two companies I’ve written about positively in the past. The former is the FTSE 250-listed developer of the world’s largest polyhalite deposit. The latter, which released its half-year results today, is an international supplier of industrial chains and related power transmission products.
Both companies’ shares are currently well below their previous highs. As such, there’s considerable upside potential for investors today, if they can regain their former levels. But can they do so?
Back on track
Renold’s shares are trading at 36.5p (up 5.5% today), but remain well below this year’s high of 54.5p in January. I tipped the company as a recovery stock in May at 26.5p on the view that certain problems it had suffered were short term and eminently fixable. Today’s results show the business firmly back on track, after it successfully passed on increased raw materials costs to customers and resolved some machine breakdown issues.
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Revenue for the six months ended 30 September was up 6.3% at constant exchange rates. Underlying operating profit advanced 36.7%, and earnings per share (EPS) increased 44.4%. The company said it’s on course to deliver a full-year result “slightly ahead of the Board’s previous expectations.”
Prior to today’s numbers, City analysts were forecasting EPS of 4.8p for the year, while I’d pencilled-in “towards 5p.” Based on 5p, which looks reasonable, the price-to-earnings (P/E) ratio is just 7.3.
Current net debt of £31m doesn’t look too onerous versus a market capitalisation of £82m, but the balance sheet also shows a large pension deficit of £95m, down from £101m this time last year. The size of the deficit makes Renold a higher-risk stock. But the company has a multi-decade funding plan in place, and the cheap P/E and good progress of the business lead me to rate it a ‘buy’.
Equity dilution
I turned bearish on Sirius Minerals on 3 September in an article with an admittedly somewhat inflammatory title: Could the Sirius Minerals share price crash 50% by the end of the year? Much as I admired the company’s achievements to date, I felt the share price of 36p didn’t adequately reflect the risk of a dilutive equity fundraising, as part of the upcoming stage 2 financing. Reluctantly, I rated the stock a ‘sell’.
Three days later, Sirius announced it had increased its stage 2 capital funding requirement from $3bn to between $3.4bn and $3.6bn. At the same time, it said it wouldn’t seek to increase debt financing above its previous $3bn target. With the spectre of a dilutive equity fundraising entering stage left, the shares dived and are currently trading at around 23p.
When the share price was at its 45.5p high (in August 2016), there were 2.3bn shares in issue, giving Sirius a market cap of £1.05bn. Today, at 23p, the market cap is actually higher (£1.08bn), because there are now 4.7bn shares in issue. With further dilution very much in the offing after the increase in capital funding required — and there also being no guarantee lenders will agree to advance the full $3bn of debt Sirius is after — it’s hard to see the shares making a swift return to 45.5p. I’m minded to avoid the stock at this stage, and await greater visibility on the level of dilution.
