The Experts

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Tim Boreham
Expert
+ About Tim Boreham

Welcome to the New Criterion, authored by Tim Boreham.

Many readers will remember Boreham as author of the Criterion column in The Australian newspaper, for well over a decade. He also has more than three decades’ experience of business reporting across three major publications.

Tim Boreham has now joined Independent Investment Research and is proud to present The New Criterion, which will honour the style and purpose of the old column. These were based on covering largely ignored small- to mid-cap stocks in an accessible and entertaining manner for both retail and professional investors.

The New Criterion will strive to continue the tradition in a weekly online format.

The column will not offer stock recommendations because we think readers can make up their own mind on the facts and opinions presented.

Our coverage will include both the industrial and mining sectors, including listed investment companies and IPOs. The stocks covered will not necessarily be of investment grade with sound financials. But they will have credible management and – at the very least – an interesting story to tell.

We hope readers will find The New Criterion both entertaining and informative.

Hit the ground bumming

Friday, December 07, 2018

The plunging valuations of some once-storied biotech show that as with resources explorers, there’s usually more fun for investors at the ‘blue sky’ stage. That’s when companies can spruik the potential of billion dollar blockbusters without the discipline of proving their potions actually work.

While the market never lies, some of the biotechs have blamed investors for not understanding the results.

Management’s common narrative is that while the drugs may have missed the primary endpoints (the main purpose of a clinical trial as stated before the program starts), they have shown other beneficial effects to justify the push to commercialisation.

Some companies have stoically waved the white flag and accepted that their key programs are all but dead and buried (hopefully not like their patients).

At Bionomics (BNO, 13.5c) the failure of its trial for post traumatic stress disorder cost the job of CEO Deborah Rathjen, who had led the company tirelessly since 2000.

In early October, Bionomics frankly revealed that its 193-patient, phase two trial showed that its compound BNC210 (touted as an alternative to benzodiazepines such as Valium) did not have a discernibly different effect relative to a placebo drug.

For stem cell play Mesoblast (MSB $1.32), the November 11 results of a long awaited trial of 159 end stage heart failure patients did not meet the primary endpoint of temporarily ‘weaning’ them off their implanted heart pumps.

Lest investors forget, the company played up the side benefits of reduced gastro-intestinal bleeding in a subset of patients, with a fewer rehospitalisations.

Three days later, Factor Therapeutics (FTT 0.02c) said its 157 patient, phase two trial to treat venous leg ulcers with a compound called VF001 “failed to meet all endpoints”. In essence, the wounds healed just as quickly (or slowly) relative to standard of care treatment (compression bandaging).

Factor chief Rosalind Wilson’s spin-free communication should set a template for all biotechs (and politicians): “Although the trial was well designed and executed, the outcome is that there is no clinical justification to progress further with the development of this asset for this indication.”

Over at respiratory diagnosis house Resapp (RAP, 10c), the white flag remains unfurled, with management forging ahead with its plans to develop a mobile phone app capable of diagnosing common respirator diseases with similar or superior reliability to a stethoscope.

After initial encouraging results, a study of 1,250 infants and children in August last year produced highly disappointing results, with accuracy rates for a positive diagnosis ranging between 36% and 89%.

At the time, the company blamed background noises including a second person’s cough in the recordings, as well as the clinicians treating the patients before the test contrary to instructions.

However in late October, the company issued follow-up results in relation to childhood respiratory disease

While mixed, the results missed the primary endpoint of diagnosing (or discounting) pneumonia. The shares tanked more than 50% on the day and CEO Tony Keating joined Mesoblast’s Silviu Itescu is lamenting the ignorance of the investing masses.

The question now is whether there’s any value in the affected stocks at beaten-down values.

Not surprisingly, Factor has halted all work on VF001 and will reduce costs “whenever possible.”

While Bionomics has ceased all trials involving BNC210, it says it will persevere with a trial for agitation in hospitalised elderly patients.

Bionomics also has a tie-up with Merck & Co, by which the drug giant funds is funding the development of a separate molecule as a cognition therapy for Alzheimer’s disease.

The deal generated an $US10m milestone payment last year and has a “potential” value of up to $US510m. “This is the jewel in the crown of Bionomics,” Rathjen told her swansong AGM in Bionomics home town of Adelaide.

Bionomics has $27m of cash and equivalents after a $9.9m placement to major shareholder BVF, which doubled its stake to 19.9% after subscribing to 60m shares at 16.4c apiece.

Bionomics is now subject to a corporate review by Greenhill & Co and if the numbers men recommend a change of direction, at least Bionomics has some handy cash to reinvent itself.

There has been no shortage of biotech chameleons in the past.

Backed by prominent US Republicans, Innate Immunotherapeutics last year bombed out with a closely-watched multiple sclerosis trial – and also candidly admitted to failure.

Now named Amplia Therapeutics (ATX, 23c), the company is trying to regain favour as a developer of two preclinical immune-oncology drugs.

Mesoblast is defiant about the heart trial, noting the US Food and Drug Administration sees reduced gastro intestinal bleeding and reduced hospitalisations as “a clinically meaningful outcome with a high unmet need that could meet requirements for an approvable regulatory endpoint”.

Mesoblast still has a raft of programs for other indications including chronic lower back pain, rheumatoid arthritis and diabetic nephropathy.

It also has an approved drug in Japan for graft versus host disease and European approval for a perinanal fistula treatment.

The company has also entered a cardiovascular partnership with China’s Tasly Pharmaceuticals, which has delivered a $US40m upfront payment.

Resapp is heartened enough by the childhood study to pursue US Food & Drug Administration approval for diagnosing lower and upper respiratory tract disease, as well as asthma.

Resapp also has a future in the burgeoning telehealth sector, especially in remote locations where stethoscope wielding docs are not available. 

Meanwhile, Factor expects to have cash of around $1.5m by December end –enough to reinvent itself as a cannabis or blockchain stock.

 Phosphagenics (POH) 0.2c

A developer of enhanced drug delivery devices, Phosphagenics' Waterloo moment came in the courtroom, rather than the clinic.

Many investors had been punting on the outcome of the company’s patent infringement claim against drug giant Mylan Laboratories, which had a ‘headline’ value of $US300m ($416m).

The dispute related to a research and licensing agreement to deliver daptomycin, the world’s most used injectable antibiotic.

 Given Phosphagenics’ circa $30m market cap at the time, investors assumed that an award of even 10% of the claimed amount would be highly material.

Instead the chosen adjudicator, the Singapore Court of Arbitration chucked out all of the Phosphagenics’ claims. What’s more, the company spent $5.6m on mounting the claim and now faces a yet unquantified order for Mylan’s costs, likely to run into the millions.

Under an ongoing licensing agreement, Mylan is still selling an injectable form of Phosphagenics’ tocopheryl phosphate mixture, used to treat skin and blood infections.

Phosphagenics is on the case for royalties, as well as Mylan demonstrating “commercially reasonable efforts” to commercialise the mixture (another requirement of the agreement).

Having lost 95% of its value, Phosphagenics is now worth less than its cash backing of $4m.

Some value might emerge from the wreckage, but the reality is management took a big punt on the quixotic legal system and lost. Not that the woes have stopped shareholder and former director Mark Gregory Kerr from boosting his stake on the company from 7.3% to 10.72%.

Given Phosphagenics in 2013 was almost terminally wounded by revelations of a $6m fraud -- carried out by then CEO Esra Ogru and others over nine years -- management had best avoid ladders and black cats for the time being. 

tim.boreham@independentresearch.com.au

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

 

Winning customers from Telstra

Thursday, November 29, 2018

This recent junior telco listings has been shunned by investors but it highlights the opportunities in the post-NBN world.

Vonex (VN8) 10 cents

To Vonex chief Matt Fahey, the intensifying rollout of the national broadband network (NBN) rivals the deregulation of the telecommunications sector in the 1990s as an opportunity for smaller challengers to pinch market share from the incumbent Telstra.

It’s hard to remember that before deregulation, consumers had the choice of Telecom or Telecom and the then government-owned entity (now Telstra) made it clear it was a monopoly with its often abysmal service.

 “Deregulation was huge but the NBN opportunity is bigger again in my mind because it results in forced churn, not an opportunity to be invited to change provider,” Fahey says. “You have to be disconnected from the Telstra network and you have to make a conscious choice about how to connect to the internet.”

Vonex is targeting Telstra’s soft underbelly of small to mid-sized enterprises (SMEs), a sector that’s hard to serve because they require labour-intensive individualised services and offerings. 

Unlike households, SMEs can’t be offered a uniform product, but they also aren’t big enough to justify the tailored service. “We are watching Telstra shut down 75 percent of their business centres,” Fahey says. “That would suggest a white flag to me.”

Vonex’s strategy is similar to that of M2 Telecommunications, which built a thriving business from SME customers, in effect discarded by Telstra (the acquisitive M2 eventually merged with Vocus in what became an unhappy union).

M2 exploited the ‘churn’ at the time resulting from the switch from analogue to digital phone lines.

Vonex’s focus is on private branch exchange (PBX) connections, not the old fixed-line variety but cloud-hosted packages based on internet telephony.

So far, Vonex boasts about 2,500 customers, accounting for 24,400 ‘seats’ (employees). These include multi-site operations, such as the real estate agency Stockdale & Leggo, the Liberal Party, Deliveroo, Toyota Financial Services and the Australia Federal Police.

Almost all the customers have been winkled out of Telstra.

“There’s very little competition we fight against for the deals,” Fahey says. “In time, as the NBN sees major cutover, which is what’s happening, we will see competitors emerge.”

Telstra, he adds, will retain most of their SME clients, “but it doesn’t take a lot of leakage for customers like us to really capitalise on it.”

Vonex doesn’t deploy a sales force of its own but instead signs up ‘channel partners’, local IT companies involved in telco services, such as cabling and setting up networks. “They are our sales force and they are paid on results,” Fahey says.

Vonex also operates a wholesaling business, which ‘white labels’ its technology to other providers including the listed telco and IT provider Inabox and Spirit Telecom.

Combined, the direct and wholesale divisions posted revenue of $8.07m in the 2017-18 year, up 16% and generating $1.32m of earnings before interest and tax.

Vonex reported an unflattering bottom line loss of $14.7m, although $13.5m of this consisted of share-based payment expenses.

Vonex, meanwhile, has been beavering away on a conference calling app, Oper8tor.

To be launched in Europe next year, the app aims to link voice calls from users no matter, whether they use Skype, Whats App, WeChat, Viber, Google Hangouts or another social media platform.

Fahey says Vonex has targeted Europe not just because of its capacious audience of 780 million people, but because they are more likely than Americans to provide constructive feedback, rather than just deleting an app and moving on to the next shiny thing.

While Oper8tor will be free to download, Vonex hopes to make money from advertising, premium products (without the ads) and good old mobile call charges.

“The first milestone is to get 10 million people in the European Community on to that app,” Fahey says. “This has never been attempted before. It’s a complex product and it was all developed in house.”

Vonex eventually listed in mid June this year after a tortured history, including an attempted back-door listing with Aleator Energy in 2016.

The compliance aspects of the listing were botched, resulting in the $5m IPO proceed being refunded to investors.

Vonex then mulled listings on both the London bourse and the local National Stock Exchange before a surprise ASX listing opportunity emerged. The company raised $6m at 20c apiece.

The indifferent investor reaction post listing means the stock is valued at only $12m, or an $8m enterprise value, taking into account the $4m of cash as at the end of the September quarter. 

tim@independentresearch.com.au

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

 

Catch me if you can

Tuesday, November 27, 2018

Whitehawk (WHK) 6.9 cents

As the former deputy head of US naval intelligence, Terry Roberts has a lot of secrets to impart but she’d you have to shoot you if she were to spill the beans.

Now the CEO of cyber security minnow, Whitehawk, what Roberts can tell small to medium enterprises (SMEs) for free is that when it comes to online nasties, they’re doing the equivalent of leaving their windows and doors open to burglars.

“The traditional (scamming) methods are effective because the majority of SMEs haven’t put basic cyber security measures in place,” she says. “Ransom and phishing are still very effective. And when they’ve found a method that works, they can hit several thousand companies in 24 hours.”

Family offices, she says are especially vulnerable because (a) they have lots of money and (b) they tend to run charitable foundations without technical expertise. Folk working from home are also suspect to entreaties from Nigerian aristocrats with disturbing tales of impending dispossession.

While cyber security consultancies abound, Whitehawk’s core offering is a broking platform that matches SMEs in the US with appropriate cyber security products and services. The service is free to users, with Whitehawk taking a clip from the providers.

Whitehawk’s risk analysis tool 360 Cyber Risk Framework is pitched at the big end of the town and recently won its maiden deal from a top-ten US bank worth $US325,000 ($450,000).

Based in Washington DC, Whitehawk also consults to government and businesses, including the US Department of Homeland Security.

While acting as honest broker between enterprises and the array of cyber providers is a neat idea, Whitehawk faces the small-tech problem of growing its revenues to meaningful levels while preserving cash.  In the June half, the company generated revenue of $US240,526 (up from $US23,163 previously), but lost $1.63m.

As of September, the company’s cash balance was $1.5m, with potential inflows of $860,000, if the shortfall from an unpopular rights issue is placed.

Whitehawk listed on January 24 this year, having raised $7.85m at 25c apiece. The shares had been going remorselessly south but doubled on November 2 after the company announced a new contract to provide the 360 Cyber Risk Framework to the US Government.

In mid-November, Whitehawk signed a partnership with the Virginia-based insurance agent Clarke & Sampson to source cyber liability cover for SMEs.

Tim Boreham edits The New Criterion

tim@independentresearch.com.au

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

 

Top secret

Monday, November 26, 2018

ArchTIS (AR9) 12 cents

A chilling aspect of cyber fraud is the vulnerability of government agencies handling sensitive information and we’ve already seen many transgressions. For example, the HR firm PageUp – which has public agencies including the Reserve Bank, Australia Post and the Attorney General’s Departments as clients – recently suffered a massive security breach.

It’s one thing to block access to the top secret, but the nature of government means that sensitive documents have to be viewed by multiple legitimate eyes within a bureaucracy.

The Canberra based ArchTIS is poised to launch a cloud-based preventative called Kojensi Gov, which enables sensitive documents to be shared without fear of leaks or other breaches.

The gist is that rather than creating a multiple of vulnerable checkpoints (such as user passwords), Kojensi creates an electronic fingerprint on the data or documents determining who can access the material and where and when.

This approach distinguishes the company from other cyber security operators that try to ensure the data is not shared.

Kojensi Gov is currently being tested by the federal Attorney General’s department, with a planned commercial launch in early 2019.

An earlier non-cloud version was trialled by the Department of Finance. archTIS has also worked with the Department of Foreign Affairs and Trade and is accredited up to ‘top secret’ status with the Department of Defence.

 “We are trying to be the Swiss banks of data, to be the world most trusted company with the world’s most valuable info,” CEO Daniel Lai says.

Archtis listed in September 21 at 20 cents apiece but has been around for 12 years, generating about $13 million of revenue over the last six years from a predecessor product.

“We have proved we can earn revenue and now is the time to launch a new product.”

In the first (September) quarter ramp-up period, Archtis clocked up revenue of $677,000, compared with $100,000 previously.

Archtis’s board includes Labor rooster and former defence minister Stephen Smith, whose contacts should prove handy, should Labor salute at the next federal election.

Archtis shares have been stubbornly underwater since listing but with $8 million of cash, the company should have enough funds to tide it over until the subscription revenues start to flow.

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

 

Fake, fake, fake

Friday, November 23, 2018

Tech Mpire (TMP) 8 cents

Nineteenth Century US department store magnate John Wanamaker famously said that half of the money he spent on advertising was wasted, but the trouble is he didn’t know which half.

The same can be said for the digital world, although the problem is more about intermediaries in the advertising chain concocting audiences that don’t exist, via fraudulent downloads.

A variation on the rort is media buyers directing ad spend (knowingly or otherwise) to unsuitable publications or those that don’t exist.

Yep, we’ve all heard about fake news. Now we’ve got fake ads.

According to Juniper Research, $US19 billion ($26 billion) of all online ad spend is fraudulent and the figure is forecast to grow to $US44 billion by 2020.

But expensive problems present monetisation opportunities of their own: Tech Mpire has launched TrafficGuard, a software-as-a-service (cloud) portal for advertisers and their agencies to weed out fake downloads and to identify safe sources for their ads.

The company claims that in 40 milliseconds, Traffic Guard can tell whether it will be fraudulent or not based on factors such as the speed of the download (if it’s too fast it’s not likely to be a human) or the location of the download.

“We are the Norton Antivirus of the mobile world,” says CEO Mathew Ratty. “Our pitch is making sure advertising spend shows maximum return on investment by blocking fraudulent downloads at the click level.”

The problem is prevalent when a company launches an expensive marketing campaign for a new app.

“There’s a heap of money being made in apps but that has given rise to fraud,” Ratty says.

“For example, Uber says ‘get me one million downloads in New York City’. In the background, machines or algorithms are downloading apps.

“But the downloads never open and the app is never used. So Uber spends $1 million promoting an app and half has gone out the door.”

In fact, Uber is suing Fetch for $US40 million ($55 million), alleging the mobile ad agency generated false clicks on its online ads.

Tech Mpire so far has signed on two clients for Traffic Guardian: Canadian performance marketing group ClearPier and US ad agency Omnicom. With the latter, TechMpire has exclusive rights for the Middle East/North Asia region, where Omnicom is expanding.

Tech Mpire recently sold its 90% owned revenue-generating business, Mpire Network, to Canada’s ClearPier for $900,000, plus a maximum profit share of $6 million over three years.

This performance marketing business generated $13 million of revenue in 2016-17 and ebitda of $3 million. But by its very nature, it presented a conflict of interest with Tech Mpire’s fraud-busting activities.

In the latest June quarter, Tech Mpire reported revenue of only $1.5 million, bearing in mind the company launched the cloud version of TrafficGuard in July.

Tech Mpire recently carried out a $2.39 million entitlement issue at 4.5 cents apiece, boosting cash from $4.05 million to $6.49 million.

Ratty says it’s a dynamic business because the nature of the fraud is ever changing. “Fraud is like any other virus,” Ratty says. “The fraudster will go somewhere else and mutate the fraud. We are constantly adjusting our algorithms to look for fraudulent behaviour.”

The company’s selling point it that while other mobile measurement platforms such as App Flyer exist, they will notify that download fraud has occurred rather than prevent it.

tim@independentresearch.com.au

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

 

How high can it go?

Wednesday, November 21, 2018

Elixinol Global (EXL) $2.09

The hemp producer is keeping a keen eye on Washington, not so much for the fallout of the mid-term elections but for progress on a long-awaited law to liberalise cultivation of the plants in “non psychoactive” form.

Even though hemp can be legally grown in 47 states, federal laws have classified the stuff as a controlled substance, even in low potency form (here, the federal government legalised hemp as a food in November last year).

Meanwhile, recreational weed is legal in states including California, where authorities have clamped down on outlets peddling hemp-infused products, such as bath bombs.

Go figure.

To address the glaring discrepancies, the US Senate recently passed the Hemp Farming Act Bill, which removes the plant from the controlled substances schedule, which means it will be regulated like any other agricultural commodity.

While Congressional argy-bargy continues over a peripheral issue about migrant workers, Elixinol founder and CEO Paul Benhaim expects an agreed law to be awaiting Donald Trump’s flourish early next year. Enactment would enable Elixonol – already the third biggest provider of hemp in the US – to advertise their wares openly and obtain easier access to bank funding.

Benhaim says the liberalised rules will open the way for giants such as The Coca Cola Company and pharmacy chain Walgreens to promote hemp-inclusive products.

“The market is likely to expand significantly,” he says. “But if it doesn’t go through we continue our revenue growth – 27 percent quarter on quarter – which is not bad for a worst-case scenario.”

Elixinol consists of three separate businesses: Hemp Foods Australia, the Colorado based medical hemp producer Elixinol LLC and the local fledgling medical cannabis business Elixinol Australia.

Elixinol’s subsidiary Hemp Foods Australia is Australia’s biggest supplier of hemp-derived food, while Elixinol itself does a brisk line in hemp derived cannabidiols for foods and skincare.

Developed with the help of a “holistic nutritionist”, Elixinol locally has launched a hemp-infused snack bar, Essential Hemp, in three flavours (salted caramel crunch, ginger macadamia turmeric and choc banana coconut if you really must know).

In the pantheon of ASX-listed cannabis stocks, Elixinol stands out as the only one producing recent revenue: $14.9m in the first (June) half and $10.4m in the third (September) quarter. The company posted a $600,000 underlying profit for the half.

Benhaim says the company remains profitable, although it’s spending more to enhance market share in the US, European and Japan (where it owns 50.5% of its local distributor).

In October, Elixinol raised a chunky $40m in a placement, having raised $20m at $1 apiece when it listed in January.

Benhaim has a 25-year history in the global hemp sector in industrial hemp legislation, cultivation, manufacturing and sales.

Benhaim has also penned nine books on hemp-related topics, so what he doesn’t know about that greenery is not worth knowing.

tim@independentresearch.com.au

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

 

It’s Kava time!

Tuesday, November 20, 2018

Fiji Kava (FIJ, not yet listed)

When Prince Harry supped on a ceremonial cup of kava during his and Meghan’s recent visit to Fiji, he prioritised politeness to his hosts over the dangers of possible side effects from the mild narcotic – including impotence.

Then again, given the preceding royal baby news, the Prince evidently has no issues in that department. Plenty of other Windsors – including the Queen herself—have also imbibed kava on past official visits and remain hale and hearty.

Harry’s PR for the national liquid is right royal good news for Fiji Kava, which this month closed its $5.2m IPO raising early ahead of a scheduled listing on November 29.

For the uninitiated, kava derives from the root of the kava tree (piper methylsticum) and is served as a muddy brown liquid resembling the Yarra River. The bitter (some may say foul) tasting substance results in numb lips has a mild sedative effect that makes Fiji Time go even slower.

Just as THC is the active ingredient in cannabis, kavalactones give kava its mildy euphoric effect. Like alcohol, kava is a depressant.

Fiji Kava already exports kava powder under the Taki Mai brand, to Australia, the US, New Zealand and Hong Kong.

Unlike most of the listed cannabis stocks, Fiji Kava isn’t avoiding the recreational label but is positioning itself as a biotech company, undertaking clinical trials for anxiety, insomnia and pain.

Fiji Kava founder and CEO Zane Yoshida says the company’s focus is not on kava as a whole, but identifying which of the 120 different strains works best for specific medical conditions. “Not all kava is equal,” says Yoshida, who is part Fijian and has been drinking kava for 30 years.

Some of the targeted $5.2m is earmarked for a 30-70 patient placebo-controlled anxiety trial, to be done at the National Institute of Complementary Medicine’s Western Sydney campus.

As with medical pot, the kava story is about negotiating an often confusing minefield of regulations. Here, kava is listed as Schedule Four restricted substance and can only be imported for commercial use with a permit and in tablet, capsule or teabag form. However individual tourists to Fiji can bring back two kilograms in root or dried form.

Kava is also listed on the Australian Register of Therapeutic Goods as a complementary medicine. The Therapeutic Goods Administration recently introduced a higher level category that allows for bolder label claims, if such assertions are backed by clinical evidence.

“We would fit into that category very nicely,” says Yoshida, who adds that the company primarily is targeting the liberal US market (thankfully for the island nation, kava tariffs don’t feature on the Trump agenda).

Fiji Kava is not alone in pursuing the medical benefits of kava, with around 20 trials undertaken globally to date. Sponsored by Melbourne University, a 178 patient placebo-controlled trial tested kava’s efficacy in treating generalised anxiety disorder.

The study was completed in May, but results are not yet available. Two other kava trials in the US target smoking cessation.

Fiji Kava already has the backing of Merchant Funds and as the world’s first kava IPO it should at least attract plenty of investor curiosity, just as the first listed pot stocks did.

Yoshida estimates the global market opportunity at $15bn.

Medical kava usage boomed in Germany in the early 2000s, to the point where it stole 10% market share from benzodiazepines (such as Valium)

Fearing liver toxicity issues, German authorities outlawed kava treatments but this ban was then overturned in 2016.

Fiji Kava recorded sales of $53,542 in 2017-18, but otherwise does not have a trading history.

Other risks as outlined in the prospectus are the kava plantations getting blown away by the island nation’s regular cyclones, or political upheaval resulting from another coup.

As with other complementary medicines, there’ll always be debate about whether kava’s vaunted therapeutic effects are legitimate.

But such doubts didn’t stop Blackmores becoming a $2 billion market cap company with potions such as flaxseed oil for anti inflammation and rosehip extract for skin tone.

tim@independentresearch.com.au

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

 

Is Zircon a diamond in the sand?

Friday, November 09, 2018

While resources pundits regard copper as the commodity most reflective of the world’s economic strength or otherwise, the more obscure zircon arguably is an even better guide.

On zircon’s recent price strength, investors shouldn’t be fretting about a global recession or – more pertinently – a Chinese downturn.

A component of mineral sands, zircon is used widely in ceramics (as a tile whitener) and for heavy-duty industrial applications, such as nuclear reactor liners and jet turbine blades.

It’s also used to make artificial diamonds and is even being talked about as a future battery metal material.

With the depletion of some of the bigger deposits and with few new finds of note, the zircon price is on a tear: up from a recent low of $US950/t ($1340/t) in mid 2016 to $US1650/t now.

Australia is the biggest zircon producer, accounting for 35% of global output, followed by South Africa with a 28% share. Consultant TZMI expects zircon demand to grow by 2.8% a year to 2026, from the current 1.2 million tones. At the same time, supply is expected to decrease by 4.3% a year.

 “It’s a good time to be in the zircon business,’’ says Diatreme Resources head, Neil McIntyre. “We see constrained supply: mines are maturing so there’s a strong window for new projects to meet that shortfall.”

The earnings turnaround is already apparent at Iluka Resources (ILU, $8.98) our biggest mineral sands producer, which posted a June half net profit of $126m, compared with an $81m loss previously.

But after years of development and promises, three other local minnow developers are poised to become producers at the right time.

Peaking the excitement scale is Sheffield Resources (SFX, 85c), which for a small cap is in the enviable position of fully owning Thunderbird, one of the biggest mineral sands discoveries in the last three decades.

On the Dampier Peninsula in northern WA, Thunderbird is rated as a 680 million tonne resource, with 76.8mt of heavy mineral sands, mainly zircon and ilmenite (from which the paint pigment titanium dioxide is derived).

Thunderbird is close to being ‘go’, at least for the $463m first stage:  a $US175m debt facility has been arranged – although it’s non binding at this stage – and the Northern Australian Infrastructure Fund is chipping in $95m.

Management is currently negotiating an engineering, procurement and construction contract, which is expected to be fixed price in order to minimise risk.

The company targets production by the December quarter of 2020, with initial output of 122,000t, increasing to a substantial 809,000t by 2025.

A bankable feasible study in March ascribed a net present value to Thunderbird of $US507m, but that was when rutile traded around $US1380/t.

Meanwhile, Image Resources (IMA, 12c) last week announced commissioning of its full-owned Boonanarring mineral sands project in the North Perth basin, 80 kilometres north of the capital.

For mineral sands, the region is like what Kalgoorlie is for gold: both Iluka and US titanium giant Tronox in the area, which lies on an ancient beach. And the project’s proximity to Perth means the project will be a cheaper drive-in drive-out than a costlier and less hospitable fly-in fly-out one.

“The company has been working diligently over two years to move a company into production,” Image chief Patrick Mutz told the recent Australian Microcap Investment Conference.

Indeed, If Image can get its ducks in a row – and they look to be falling in place – Boonanarring could be producing by as early as Christmas, based on a simple dry shovelling operation.

The company is fully funded, not only to complete construction but we have the funds for the working capital through the commissioning to ramp up to positive cash flow.

Rutile is the key ingredient in mineral sands, which in Image’s case means an exotic mix of zircon, rutile, leucoxene and ilmenite.

While zircon will comprise 30% of the heavy mineral concentrate produced, it is expected to account for three quarters of the projects revenues.

On paper at least, the project economics look compelling.

Updated in June, the bankable feasibility study values the project (net present value) at $235m, with a project cost of $52m and a payback period of 13 months.

The project is forecast to produce earnings before interest of tax of $278m over the life of the project, although zircon’s further price strength mean these numbers could be conservative.

The company envisages annual output of 220,000t of heavy mineral sands, containing 60,000-70,000t a year of zircon.

In comparison, Iluka expects to produce about 335,000t this year.

Overall, Boonanarring is rated as a 19.8mt resource, grading 7.2% heavy minerals.  As Mutz proudly notes, that’s more than twice the grade of a typical deposit globally.

“In addition, there’s very little trash heavy mineral (in the concentrate),” he says. “Heavy mineral content is not all saleable and sometimes (the saleable content) can be as low as 30%”.

Still in WA, Diatreme Resources (DRX, 2c) is further down the evolutionary curve with its Cyclone project in WA’s Eucla Basin, also a well-known mineral sands address.

But once again, Diatreme could be timing its run with a Winx like perfection.

Diatreme expects a long-awaited definitive feasibility study, presumably confirming the robust economics of the 80,000 tonnes a year (of zircon) operation, to be released “imminently”.

Only one of three discoveries of size over the last decade, Cyclone is rated as a 138mt deposit at an average grade of 2.3%.

Management has targeted production by 2020, with a 10mtpa operation sustaining a 14-year mine life.

The mine is based on slurrying the ore to a wet concentrator plant, trucking the produce to the Forrest rail siding on the transcontinental rail line and then freighting it to Port Pirie.

“As we enter the final stage of the bankable study, we are looking at options for offtake and venturing or processing in China,” McIntyre says.

Diatreme is not just a mineral sands story: it owns a silica sands project in Far north Queensland, Cape Bedford, which is expected to start mining the 21mt resource as a simple quarrying operation.

Down the road from the world’s biggest silica mine, the Mitsubishi owned Cape Flattery, Diatreme will tap the buoyant demand for these sands in construction, notably high end glass.

Both Image and Diatreme management argue their shares are undervalued, given the progress their companies have made. “We’ve been in an orphan period in which no one cares about you because you are spending money but don’t have anything to show for it,” Mutz says.

Sheffield shares have retreated sharply after hitting $1.20 in early October, despite talk that Thunderbird would make for better economies if it were in the hands of a major.

In other words, Sheffield is a takeover target.

In the case of all three stocks, investors should be aware that once a developer turns miner and starts digging dirt, the shares tend to underperform because the stock is being valued on the drudgery of reality rather than blue sky.

Pundits who believe in the minerals sands story could well consider Iluka: rather than revelling in the buoyant prices, the shares have slumped 30% since late August because the company’s costs guidance for the calendar 2018 year were higher than expected.

Iluka’s $3.65 billion market cap compares with $218m for Sheffield, $123m for Image and $23m for Diatreme.

tim@independentresearch.com.au

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

 

How about a beer?

Friday, November 02, 2018

Gage Roads (GRB) 9.9c

The Perth-based boutique brewer’s CFO, Marcel Brandenburg, hesitates when asked to define what a ‘craft’ beer actually is.

“It’s a contentious issue,” he told a recent annual Australian Microcap Investment Conference. “In the US, they try to define it by the size of the brewery.

“In Australia, we define it more by flavour profile, anything that has a hoppy, floral taste profile.”

A simpler definition is any brew made in a smaller batch-style facility, no matter the level of floral hoppy after tones. But the contentious aspect is that six of our top 10 selling ‘boutique’ brewers are now owned by the big guys.

This includes the top three: James Squire (Lion, owned by Kirin of Japan), Yak Ales (Foster’s owner Anheuser-Busch) and Little Creatures (Lion/Kirin). In 2015, Asahi of Japan picked up Mountain Goat and in 2017 beer wannabe Coca Cola Amatil snapped up Feral Brewing.

For Gage Roads, it’s a case of bucking the trend, winning back its independence after buying out its 25% owner Woolworths. Two years into its five-year proprietary brand strategy, Gage Roads has made inroads into transforming its business from a contract brewer for the grocer to pushing its own higher-margin brands.

Founded in 2004, Gage struggled for critical mass before the 2009 deal with Woolworths delivered enough volume to justify building what’s now WA’s biggest brewing facility.

The trouble is, there wasn’t a lot of profit in contract brewing, while Gage’s higher margin own brands – sold exclusively through Woolworths – had become the country’s fifth biggest craft brand.

But the only way for Gage to take care of its own destiny was to win back its independence — and the ability to sell through other channels including Coles, pubs and restaurants.

Two years ago, management bit the stubbie lid and bought out Woolworths’ 25% stake.

Over three years, Gage hopes to get its own brands – including its eponymous Gage Roads, Single Fin Summer Ale, Alby and Breakwater Pale Ale – to 70% of sales compared with about one-third of sales in the 2016-17 year.

Having invested $27m on German brewing and packaging equipment, Gage Road’s jewel is a state-of-the art brewery with capacity of 17 million litres a year, of which 12 million litres is currently deployed.

The $4.9bn, 1.2 billion litre a year Australian beer market in essence has been flat for years, growing at a 2% clip. But craft now accounts for 11% by value and 5% by volume and has grown at a 16% compound annually in the last three to five years.

Based on the US craft beer experience, Brandenburg says there’s plenty of room to grow. But given the top eight brands here account for 89% of the growth, the key is to have recognisable brands with a strong shelf presence.

Hipsters also won’t pay through their pierced noses for the boutique experience: on Gage’s reckoning, a case of grog won’t sell if it costs more than $62 per case, or $22 per six pack.

Rather than spending millions on billboards and other advertising, Gage Roads has tied up key venues and events in exclusive beer supplier arrangements.

These include Perth’s new Optus Stadium and NIB Stadium, Fringe World (WA’s biggest outdoor event), Cricket Victoria and the Rugby Sevens competition.

In June this year, Gage Roads acquired the Broome-based brewer Matso’s from the Peirson-Jones family for $13.25m cash, plus 35m Gage Roads shares over three years based on performance hurdles.

Matso’s is famed for its mango and ginger beers, which aren’t exactly everyone’s taste but are high selling, high margin products nonetheless. The added benefit for Gage is these lines don’t compete with its own beers.

Brandenburg dubs the acquisition, which is expected to boost earnings per share by 35% this year, as a no brainer.

 “We had made their product under contract so carried the operational risk, so all we are doing here is on boarding the brand and capturing the brand owner’s margin.”

The Matso’s buy has boosted Gage’s earnings per share by 35% to date and no doubt is a key contributor to Gage’s recent share price strength.

Joyously, Gage Road’s dash for freedom has helped the bottom line, with the company reporting a 2017-18 net profit of $2.06m, up 3% on revenue of $33.2m (up 22%).

“We are now at a point where we feel we can match it with any supplier,” Brandenburg says.

Having traded at 7.5c a year ago, Gage shares hit 14c in early September but have since drifted to around the 10c level for a market capitalisation of just over $100m.

The dilemma for management and employees, who account for 23% of Gage stock, is what to do when one of the beer multinationals comes a knockin’.

Broo (BEE) 10c

Unpatriotically, Gage and Chinese aspirant Broo are the only ASX-listed beer exposures after Lion Nathan and Foster’s Group fell into foreign hands some years back.

Broo got investors frothy in November last year when it announced a partnership with a mob called the Beijing Jihua Information Consultant, to market and distribute Broo’s beers in China for seven years.

Under the take or pay arrangement, Jihua will take 1.5 billion litres at a fixed rate per litre, generating aggregate revenue for Broo of $120 million. The first three years’ revenue is accrued and then paid to Broo at the end of this period.

Broo shares spiked about 30% on the news (to 39c) but the gains were short lived, probably as investors remembered that the difficult Chinese market proved an expensive failure for even the deep-pocketed Foster’s and Lion.

Broo listed in mid October 2016 at 20c a share.

On Friday, Broo reported September quarter distribution volumes of 19.2 million litres, which implies there’s still work to do to get to that 1.5bn litre run rate.

Broo makes Broo Premium Lager and Australia Draught, both emblazoned with a garish kangaroo emblem. To suit Chinese tastes, the alcohol content was lowered and the bitterness toned down.

Broo’s brews will be marketed as premium (rather than boutique) drops, priced similarly to the offerings of other foreign devils, such as Heineken and Budweiser. The company plans to market Australia Draught aggressively in the on-premises tap market, which Grogan describes as one of the most lucrative in the world.

Locally, Broo also has ambitious plans to build a $95m green-friendly brewery on land acquired on the outskirts of Ballarat for $2m in early 2017. Green principles, such as minimal water and chemical usage, work nicely with the hipster-oriented craft beer theme.

With a 480 million litres capacity, the brewery would be one of the biggest in Australia and would also involve contract brewing. The site would also incorporate an Australian beer museum and a “cultural engagement hub”, which come to think of it sounds awfully like a pub.

Broo owns the hip Sorrento Brewhouse and Mildura Brewery Pub and both look like decent cash cows, delivering most of Broo’s 2017-18 revenue of $2.58 million.

Broo’s September quarter report showed revenue of $646,000 and a $1m loss. Broo lost $4.43m last year and $3.4m in 2016-17 and has chewed up $12.5m over the last five years.

 With a September cash balance of $832,000, Broo clearly needs a deep-pocketed backer to realise its green dream.

Meanwhile, Broo expects first revenues from the Middle Kingdom to trickle in in November 2020.

Tim Boreham edits The New Criterion. tim@independentresearch.com.au

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

 

Bunker down with these D-E-F-E-N-C-E stocks

Friday, October 26, 2018

Given the current swooning stock market, there’s plenty of talk about defensive stocks, but, in the case of some of our listed defence suppliers, that concept has a more literal hue.

In theory at least, suppliers to the military machine should be as resilient as grocers or utility companies because defence expenditure globally continues to increase no matter what the economy – or the Dow Jones — is doing.

With Canberra splurging $200 billion on extra defence spending over the next five years (including long-term contracts for frigates and subs and the $5.2 billion Land 400 vehicle program), perhaps now’s the time for investors to be bunkering down with the handful of ASX defence exposures.

As in warfare, there are winners and losers in the defence supply game: some of them are shooting blanks and some are still recovering from their past travails.

1. Xtek (XTE, 50c)

An example of the latter is the Canberra based Xtek (XTE, 50c), which supplies (or intends to supply) small unmanned aerial systems (drones), ballistics, body armour and helmets to the Australian Defence Force and other friendly parties.

Xtek chairman and 13% shareholder Uwe Boettcher says the outlook is also bright for defence suppliers because of new rules mandating 50% local content in any supply deal (this involves getting in the good books of the lead contractor).

Defence minister Christopher Pyne is also focused on defence exports and has told our high commissions to have a dedicated person pushing our defence wares (to friendly countries, of course).

Xtek’s armoury of goodies includes techniques to make body armour 30% stronger and much lighter than the standard issue version and helmets to withstand a bullet from an AK-47.

Xtek in 2017-18 reported revenue of $17.3m and a net profit of $139,000.

Most of the turnover derived from a contract with Aerovironment of the US to be exclusive local supplier for the drone manufacturer.

As agency work, it’s high turnover but low margin. But maintaining the fragile devices is much more lucrative, and given Xtek already does the maintenance, it’s in pole position to win a long-term maintenance contract from the military bods.

 What would such a deal be worth? Mr Pyne in August last year announced a $100m contract through Xtek to acquire and maintain the birds. 

Of this amount, $42m has been expanded on the drone acquisitions, with most of the remaining $58m likely to be spent on maintenance. 

Xtek’s second great hope lies with its own mapping software called Xatlas, which converts video feed from drones to real time maps.

For example, a drone flies over an enemy territory and then again in hour, the updated map can detect a change in the sniper’s position.

That sounds handy.

Xtek this month received its first order, from the Australian Defence Force. The deal worth a humble $70,000 is more a case of the military testing the software in view of a more material contract.

Xatlas is also expected the software will be sold by Aerovironment – which moved 25,000 drones last year – as an optional extra.

In the meantime, Xtek is talking to 15 international customers about potential armour supply deals, while testing of it polyethylene helmets is being funded to the tune of $1m by the US military.

The equipment is based on the company’s XTclave autoclaving technology, which involves ultra light and strong composites being made under extreme pressure.

“We are sufficiently confident about these discussion to build a fully fledges factory to make commercial quantities,” chimes Boettcher.

The facility will have a vaunted capacity of 40,000 armour plates capable of generating $20m annually from a global market worth $US3.5bn.

Xtek has guided to $26m of revenue this year, $20m of which is contracted. But as the fine print says, this excludes any potential drone maintenance or armour plating revenues.

Now backed by instos including Kentgrove Capital and Alto Capital, Xtek has come a long way since three years ago, when Boettcher was forced to lend the company $500,000 to stay afloat.

2. Electro Optic Systems (EOS) $2.83

The hitherto obscure entity is best known for its facility that tracks objects in space, notably harmful debris, for both defence and commercial applications.

But Electro Optic Systems is fast emerging from under the radar in a different capacity: manufacturing a range of remote controlled weapons systems with improved “lethality” to ensure that friendly forces can outgun the enemy.

Crucially, the soldiers can operate the guns, while safely bunkered in the vehicle.

Unlike most of its ASX tech peers, EOS is starting to make serious money.

In August, EOS won a pivotal contract to equip remote weapons systems for the second phase of the Land 400 program, which involves the army procuring 211 armoured combat reconnaissance vehicles.

The top brass have also specified the EOS systems for phase three of the Land 400 program, which involves the army buying 450 infantry fighting vehicles by 2024.

The win was a prestigious one, but in reality 95% of EOS’s output is exported. With the hardware denominated in $US, EOS has no problem with the falling Aussie dollar relative to the greenback.

EOS reported $620m from committed contracts at end of first (March) quarter, growing to $800m by the end of the September quarter.  Management expects sales of $900m by the end of the calendar year.

Revenue wise, the company expects to turn over close to $100m by the end of 2018, rising to $180m next year and $275m by 2020.

Profit-wise, EOS expects to post $10m this year, having recorded a $5m surplus in the first half. Based on the contracts in hand, management is confident enough to forecast $20m next year and $27m by 2020.

The company currently has $58m in cash and will not need to raise funds unless new orders are received

Based at the company’s $30m tracking facility at Learmonth in WA, the space tracking side is expected to become profitable in the first half.

3. Quickstep Holdings (QHL, 7.5c)

As a supplier of carbon fibre parts to the Joint Strike Fighter (JSF), Quickstep shares should have had a supersonic trajectory but like our fleet of F-35s, they’ve been grounded.

The JSF contract, via lead contractor Northrop Grumman, is augmented by a deal with Lockheed Martin to provide wing flaps for C-130J/LM-100J Hercules aircraft until late 2019.

It’s hard to pin down what’s amiss, but a revolving door of CEOs hasn’t helped. Philippe Odouard, who now heads Xtek, was replaced by Dave Marino, who re-focused the company on specialty high-performance car parts.

Having decided that car executives were even harder to deal with than military brass, Marino was replaced in favour of Mark Burgess.

Quickstep grew its revenue from $51.9m to $59m in 2017-18, with ebitda of $1.2m and a net loss of $2.9m, compared with a $6.7m deficit previously.

Quickstep shares have marked time over the last year but have lost 67% of their value over the last five years, much to the chagrin of long-term shareholders, including Washington H Soul Pattinson.

Tim Boreham edits The New Criterion tim@independentresearch.com.au

 

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