Stock stories from Kardinia Capital

25 October 2012

Kristiaan Rehder, Kardinia Capital Portfolio Manager, shares his views on Sirius Resources and Billabong, and explains why the Bennelong Kardinia Absolute Return Fund has recently been active in both stocks.

Sirius Resources

Sirius Resources (SIR) is a base metals explorer with a portfolio of projects predominately in Western Australia. The company's flagship project is the 70% owned Fraser Range project, where Sirius recently announced the greenfields discovery of significant nickel and copper sulphide mineralisation. The new discovery, named Nova, has all the attributes of a significant discovery, representing a new style of deposit in an entirely new province, with results received offering strong grade with considerable scale.

The discovery was initially identified using electromagnetic (EM) ground surveys, with Conductor 1 representing the first of potentially four conductors to be tested over the project area. All four targets exhibit characteristics (EM signatures) indicative of massive sulphide mineralisation. Early follow-up drilling at Conductor 1 has intersected high grade intersections of both nickel and copper over a 500m length.

Since the discovery hole was announced in late July, the Sirius share price has risen from $0.06 to over $2.20. The company now boasts a market capitalisation on a diluted basis of approximately $530 million and has been one of the strongest performers on the ASX this year.

Source: Kardinia Capital

Kardinia Capital (Kardinia) was first alerted to the quality of the discovery in late July, and the investment team arranged to meet with senior management to discuss the company in more detail. Following a face-to-face meeting with the CEO of the company, Kardinia undertook further work to better understand the potential of the discovery and the quality of management. By mid-August, SIR announced an equity raising of $7.6 million at $0.76 in order to accelerate its drilling program. The raising was small in size and well supported by investors. We initiated our long position via the placement (see Sirius share price chart above).

We initially looked to opportunistically trade the position. However, in light of continued strong drilling results, we concluded that further value existed as the full extent of the size and quality of the ore body became better known. A volatile stock such as SIR typically commands a portfolio position size of 0.50% to 1.00%. After initially selling shares, the position size was reduced to 0.50%, which then grew through share price appreciation to 1%. We have recently closed our long position in the stock.

Currently, we believe the market capitalisation of the company fairly reflects the potential size of the Conductor 1 discovery. It will require additional success with the drill bit on the surrounding Conductors 2 to 4 in order for the share price to appreciate further. Drilling on Conductor 4 has already commenced, with drilling on Conductor 2 expected early next year.

Billabong International Limited

Billabong International Limited (BBG) is an Australian-based company engaged in the wholesaling and retailing of surf, skate, snow and sports apparel, accessories and hardware.

The Billabong business faces numerous headwinds, including difficult trading conditions across the group, a weakening economic environment, particularly in Europe and Australia, and a highly geared balance sheet. Subsequent to the partial sale of Nixon, one of BBG's strongest performing brands, to Trilantic Capital Partners for $285m, the CEO was replaced adding further to strategic uncertainty of the group. Newly appointed Launa Inman commenced work on a full review of the business, leading to a transformation strategy designed to lift the operational performance of the group.

Source: Kardinia Capital

Billabong raised equity by way of a deeply discounted entitlement offer in June 2011. The following month, founder and largest shareholder Gordon Merchant publicly stated that he was receptive to a revised takeover offer. On 24 July 2012, TPG announced a revised conditional takeover proposal to acquire all the shares of BBG at $1.45 cash per share. TPG's bid has subsequently been withdrawn.

Kardinia Capital commenced shorting BBG in early May as channel checks pointed to an acceleration of domestic consumer weakness in April. Further, our analysis of the balance sheet suggested a capital raising was needed to lower leverage. A newly appointed CEO only heightened this likelihood.

As is typical with new positions, the position size was built up gradually as we gained confidence in the investment thesis (see Billabong share price chart above). Post the entitlement offer and placement, we closed out the short position. Gordon Merchant's public declaration that he was receptive to a revised offer, as well as an attractive valuation post the re-capitalised balance sheet, set the scene for Kardinia to move to a long position. Post TPG's revised conditional takeover proposal, we closed our long position.


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