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Today I’m looking at Rare Earth Minerals plc (REM) which is an AIM investment company, i.e. it makes mostly non-controlling investments in other listed and unlisted companies. These types of companies are referred to as Investment Trusts on the main market. In this article I’ll review Rare Earth Minerals plc and give a verdict on its current valuation.
How do I value at Investment Company?
As with all investment companies trusts you should look at three factors, these are as follows:
- Do you believe in the investment Case?
- Is the past performance of the company and/or the management reasonable?
- Is the share price discount or premium to Net Asset Value (NAV) acceptable?
You need to answer all three questions with a resounding ‘Yes’ to invest in Rare Earth Minerals.
1) Do you believe in the Investment Case?
This company invests in Lithium Exploration companies, Rare Earth Minerals is therefore partly a macro play on the Lithium price. As Lithium is not exchange traded is it is not straightforward to get an accurate spot price, however industry sources who are following negotiated contracts state that the price per Metric Tonne has increased by 300% between 2005 and 2016. The current estimated spot price of Lithium Carbonate is $8,000 per Mt.
Is the demand for Lithium likely to persist? The most common use for Lithium today is a component of rechargeable batteries, with the big lithium guzzlers being electric car makers such as Tesla, an industry still in its infancy and in my view with plenty of growth opportunity. Demand to me looks good for this shiny metal.
What about the supply? According to a 2008 US Geological Survey global reserves were estimated to be 13 Million tonnes. However, according its estimates we are currently producing at 0.6m a year. Do we have a crunch here? Surely on those projections we will have used up the global resources by 2040.
I very much doubt it, recent exploration activities have resulted in a formation in the USA that could contain as much as 18 Million Mt of Lithium. As the price of lithium increases, exploration becomes more attractive and thus I am sure the reserves at 13 MT are vastly understated.
Some are of the view that demand growth will outstrip supply availability so on this basis you can be fairly bullish on the Macros. However,the market is currently an oligopolistic structure, i.e. just a few big players who account for most of global production. According to Macquarie some of these players are restricting capacity to keep prices high. The new players like Bacanora Minerals will challenge this and force the oligopoly to increase output to maintain share, this could put a cap the prices. I’d be surprised if the Lithium price falls significantly.
2) What is past performance like of the company and/or the management?
I’ve plotted REM’s NAV per Share vs. the price of Lithium Carbonate to the end of 2015. It certainly looks as though shareholder value is being created through REM’s investments.
I don’t have any view of the management but the expense to NAV ratio is very high, Rare Earth Mineral’s has a handful of investments and yet has administration expenses of £2.25m in 2015, this is 13% of NAV and before any financing costs. The average Expense ratio for investment companies investing in UK companies is 1.61%, so REM is 10 times the average. Why is this so high? REM is an early stage investment company so I am prepared to cut it some slack, but this still seems way too high.
What does the discount or premium to Net Asset Value (NAV) look like?
I estimate that the current premium NAV over the market capitalisation of REM is a whopping 287%! See below for how have I arrived at this figure.
It is typical for an Investment company to be trading at a slight discount to NAV, mainly to reflect the issue of liquidating large positions. Some investment companies do trade at a premium, 3i a private equity fund for example is currently trading at a premium of 20% over NAV. This is for two reasons, 3i has an excellent track record at delivering shareholder return, its investments are unlisted and hence usually recorded at cost, private equity by definition are in business to deliver a return on its unlisted investments. The premium therefore reflects the markets expectation that 3i will deliver 20% return on its current investments.
80% of REM’s portfolio is listed and 20% is unlisted, so the market is currently placing a humungous value return on the unlisted assets, i.e. those held at cost. The unlisted plays are Greenland, Yangibana and 30% JV interests in Mexilit and Megalit concecssions in Sonora Lithium area. Note the JVs is with Bacanora one of REM’s listed investments.
The house broker WH Ireland has calculated risked NPVs on these unlisted assets of £24m, so adjusting the Unlisted portion investments above:
Still a huge 152% premium over NAV!
I don’t think it is unwise to have some lithium exposure in your portfolio. However, the share price of Rare Earth Minerals PLC is at a gigantic premium to its NAV, even after considering the unlisted investments. I’m not saying REM is a bad company, although I do question why it has such high admin expenses. REM has though delivered some decent increases in NAV per share, however this increase is largely though increases in market capitalisation of its listed investments.
My advice would therefore be that if you are a lithium lover, you may as well buy shares in the secondary market, i.e. direct holdings in Bacanora, Mcarthur and European Metal Holdings and you could effectively replicate the same assets as REM at a much cheaper price.