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Three shares that'll crash and burn before you can count 1, 2, 3…

by , 29 September 2014

A recent survey of on international stock exchange, the ASX, found that as much as a third of the 2,100 companies listed there are at risk of financial catastrophe.

In fact, 58% of the bottom 500 companies on the ASX published warnings they could go bust within 12 months.

But surely this isn't the case in South Africa, is it?

Well if that’s what you thought, you’re sadly mistaken my friend!

African Bank’s recent demise might be fresh in everyone’s minds. But there’s a boatload more companies that have gone bust on the JSE in the past year. Think of Alert Steel, BioScience, Brikor, Great Basin Gold and more recently Miranda Mineral Holdings…

But the thing is – you can avoid these 'crash and burn' shares - if you know what to look out for.

So today I'm going to explain how to spot a share set for a crash and reveal three of the most dangerous shares to avoid right now.

Watch out for these shares– They’re at risk of going bust!

Share #1 – I’ve warned you before, I’ll warn you again!

Firestone Energy is a small coal exploration company with an asset in the Waterberg. It’s been punted wildly as a hot buy. But this company is standing at the precipice.

When it last reported results it had R76,000 in the bank. It’s taken a $3 million loan from its biggest shareholder in order to keep the company afloat. But this won’t last long. In the past two years the company has lost $10.3 million – so this $3 million loan won’t even last it another year – then it’ll have to come begging for money again.

And if you think things will turn around you're badly mistaken. You see – the company has only exploration assets. No mine. So it’ll need upwards of R500 million to build the actual mine – with cash it doesn’t have.

If Firestone doesn’t go bust it will be de-listed. Its main shareholder will probably buy out remaining shares in the company and investors will be left high and dry. Avoid this share at all costs.

Share #2 – This ‘once-a-bluechip’ share is running out of asset value quickly

Evraz Highveld Steel was a market giant once…In 2008 the company was trading at R188.75 – that meant the company had a market cap of R18.72 billion. Today the share is at R5.55 and the once gigantic company is worth a mere R550 million. But I don’t think the crash is over.

In fact – if the company doesn’t receive a major cash injection in the coming year there won’t be much left of it.

You see, the net asset value of a company is an indicator of what it is really worth. What assets it has to generate money from. Each time a company profits it adds cash to the bank or expands the business by building more buildings, factories etc. But when a company loses money its net asset value drops. When a company borrows money its net asset value also drops.

Well, in Evraz Highveld Steel’s case its net asset value is heading for zero quickly.

What am I talking about? Well, in 2009 the company had a net asset value per share of R31. When it reported results in December 2013 it had a NAV of R14.

Since then the company has released quarterly results indicating 105.9cps loss. If it repeats this ‘performance’ for the entire year the share’s NAV will be around R10.

The even bigger problem though is that Highveld doesn’t have cash. When it last reported the company had R143 million left in the bank, from R282 million in December 2013 and R379 million in September 2013. In short, the company is losing around R100 – R140 million cash a quarter. But one more quarter of that and there’ll be nothing left.

In fact, buried in the 170 page long annual report Highveld released for its 2013 financial year the company’s auditors note the company is at risk of going bust by 31 December 2014:
“We draw attention to the going concern paragraph in note 1.1 to the financial statements which indicates that the Company is using committed loan facilities that are payable on 31 December 2014 and is trading in an environment where there are threats to production stability and market demand for the Company's products...These conditions, along with other matters, indicate the existence of a material uncertainty which may cast significant doubt on the Company's ability to continue as a going concern.”

In short what this means is that the company has a R304 million loan it needs to pay back in December 2014. The problem is, as I’ve shown you that Highveld doesn’t even have that much cash and is actually burning through the little it has. So I’m sure that considering these facts you can see the chances of Highveld surviving are slim – barring a rights offer or capital injection from its shareholders. But I for one wouldn’t invest more cash in a dying company like this…

Share #3 – They pulled a fleece over investors eyes – but now it’s caught up with them

Mine Restoration Investments listed on the JSE in 2012 with big promises of technology that could fix the acid minewater problems in Joburg. They raised a lot of cash and investors were very optimistic.

To date nothing’s been done with regards to acid minewater.

Now the company is producing coal briquettes from fine coal most coal producers just throw away. It’s a smart and very novel business idea. But it’s not enough the keep the company’s head above water.

At this stage the company is issuing new shares to directors as well as converting its loans to shares in order to survive.
Whilst this has saved MRI from complete bankruptcy, it means shareholders like you and I would have been completely diluted with shares now worth nothing.

In addition to this, the company’s directors did not publish an auditor's opinion on whether it’ll be able to survive the next year or not.

However, the directors did say their coal briquetting project will be enough to keep it going in the next year.

But I’m not so sure about that – You see, already the MRI has had to change strategy. It’s no longer producing briquettes but only producing coal fines. They say the “market for briquettes is not yet fully commercialised”.

Now in my mind that means – ‘We’re unable to sell the stuff – now we’re resorting to an alternative’.

To me this shows management isn’t as on top of their own business as you’d expect. And this makes me cautious.

Most importantly perhaps is the fact that the share is trading at 7c now from a listing price around triple that. The company also made a loss of 3.94cps in the past year. Another year of that and the company will have wiped out another half of its own value!

It’s simple really – companies going bust are a reality today. But if you’ve paid any attention to the above three companies you’ll have noticed they’re all resources based.

Does this mean you need to avoid all resource shares? Certainly not – but you need to be specially cautious of them – because these three aren’t the only ones I’ve identified that could go bust in the next year or two…

Here’s to unleashing real value

Francois Joubert

Editor, Red Hot Penny Shares

Editor's Note: To find out more about Francois' thoughts on the resource shares to avoid - and the ones to buy - click here.

Three shares that'll crash and burn before you can count 1, 2, 3…
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