Mirach Energy: Jack In The Box

Rosesyrup Research

Mirach Energy: Jack In The Box

Current Price: $0.197

Target price: $0.018

Call: Short

Potential Return: 10.73X

Before we proceed to the analysis, readers need to understand all the following is my opinion only and in no way represents fact of any kind. No allegation of any kind is made here.

As a fundamentalist, I can never stress enough how important an annual report is. In fact accounting figures in the report are the only way we know how well a company performed for the past 1 year or quarter. For this reason, regulators over the world have placed strong legal burden on directors and auditor to ensure the financial statements present a true and fair view of the company economic affair.

Although Mirach's report has the assurance of its directors and auditor, I choose not to place any faith in what I read from the report due to the following red flags:

• 1.       Change of CFO

With effect from 1 July 2014, Dr Hu Xiao Ying will be replaced by Mr Cheah Soon Ann Jeremy as CFO.  The former was appointed as CFO in 2012 September and held office for about 1 year 10 months. Due to the strategic natural of the position, the average term of CFO is about 3-5 years.  It is very rare for CFO to step down in less than 2 years.

The company did not proceed to give any further reason as to why the CFO stepped down but claimed that Dr Hu will continue to serve as Supervisor of Prisma Kampung Minyak oil field under the company. This is mind blogging. Definitely the remuneration package of supervisor can't compare to that of a CFO, and Dr Hu his PHD and experience as CFO could have seek employment elsewhere. But this sound like a good way to dismiss Hu's service without the need to give any explanation.  

• 2.       Change in Auditor

Right after the previous CFO stepped down, Mirach proceeded to change its auditor from  RT LLP to  Ernst & Young LLP. I did a quick check on RT LLP and it is still in business. So why is there a need to change auditor?

Annual report is like the report card of the management and auditor is like the examiner. It takes time for the new auditor to fully understand and appreciate the business before deciding to gives its management some leeway, whenever appropriate, in accounting. So what makes the management abandon the old teacher who tend to give lenient grade and choose a new teacher who is more stringent? Management is just acting in contrary to its incentive and it does sound dubious.

• 3.       Accounting Quality : Revenue

If the abrupt change in CFO and auditor weren't enough to raise alarm, the annual report should do the job. The following is an extract of Mirach's Operation Review (Pg 08 of 2013 annual report):

" For the financial year ended 31 December 2013 (“FY2013”), Revenue of USD5.1 million was derived from the Group’s continuing operations compared to that of USD1.05 million

in the financial year ended 31 December 2012 (“FY2012”). The main revenue of USD4.0 million was derived from providing the investment advisory services to the Group’s partner in their oil field acquisition in Indonesia."

By claiming that the $5.1M is from the company continuing operation (note the word continuing), Mirach is trying to imply that it is recurring in natural. But can we really expect such revenue to recur in the future? If we read further, we find that $4M (of the $5.1M) is derived from providing acquisition advice to another company. Can we expect that same company to do acquisition every year and therefore engage Mirach's service annually?

The last time I check, such revenue is usually one off instead of "continuing" ! To think that management have the cheek to even "fool around" with how the top line of the income statement is perceived already signal some governance problem.

• 4.       Goverance Issue: Interest free Loan

As of the end of 2013, the company is effectively providing an interest free loan to its associate CPHL cambodia in which it has  48% stake. Quantum of the loan amount to around 35% of the company total asset.

Since Mirach has minority stake in CPHL, why did the company give interest free loan to the associate? By doing so it is benefiting other shareholders of CPHL more than benefitting Mirach shareholders.  Can't the associate apply for bank loan?

Although the company believes that the loan is highly recoverable but  CPHL is a highly leveraged loss making company.

Valuation

In the face of such poor accounting quality and possible "jack in the box" (governance issue) down the road, I placed little faith in whatever I see in the accounting statement and therefore prefer to value the firm with NAV, with the following adjustment to the 2013 December  book value of course:

·         Assume default of associate (USD$18512000)

·         Removal of intangible asset which is mainly made up of Unproved Concessionary right in Cambodia. (USD$8696000)

·         Loss in H2 2014 (USD$2817000)

·         Exchange rate of USD$1 to SGD$1.249

Adjusted NAV per share = $0.018 (My target price)

Well, not all readers are convinced that the company has weak governance, in that case they might want to value the company with the usual P/B ratio.

Average P/B ratio of oil company now = 1.72

Price = 0.032 (aggressive target price)

From the following chart, the market seems to agree with me that NAV is a good way to value the company. As we can see, before the usual price movement which was queried by SGX, Mirach had been pretty stable at 0.05 cents (NAV claimed on the company website).  

I personally suspect that the usual price movement is a designed attempt by big buyers to lure small investors in. As we can see from the huge increase in volume (before price movement), a very bullish signal sufficient to lure retailers using technical analysis. After the manipulation, price has been falling as the big buyers take profit and market comes to its sense that Mirach isn't worth that much. Therefore my call is to short Mirach and take advantage of the market irrationality! Potential return = 10 times.

 Oh yeah one more thing I learnt from my experience in the energy sector. Energy companies are deemed to be very risky business and to limit that risk to shareholders, companies usually rely on huge amount of debt financing in order to take advantage of the limited liability natural of a company. But for Mirach case, the level of liability is really low in comparison to peers and there is nearly no bank loans taken up. Is it because the company can't obtain any loan from bank? Afterall all banks would request to examine the firm business and financial statements in detail before promising to make any loan.

Happy shorting this Jack in the box!