Profit and loss report not the issue for Arcon


THE results from Arcon International Resources, out tomorrow, will show losses of under £500,000. These losses are likely to be some 40 per cent higher than the loss of £280,000 recorded in the previous year.

However, the latest figures may well be distorted by a writing down of some of its investments. One investment which is vulnerable to a write off is its 0.5 per cent stake in the Claymore Field in the North Sea. A high cost production field, it is susceptible to oil prices. And as oil prices were flattish in the second six months to August 31st 1995, it would not be surprising if the investment is either partly, or fully, written down. This would account for most of the loss.

However, as Arcon has not yet started to produce zinc and lead from its Galmoy mine, the profit and loss account will be pretty immaterial. More important will be the state of its balance sheet, the anticipated prices of zinc and the dollar, and the prospects for increasing its reserves of ore.

There is no need to speculate about the state of its balance sheet. It will be strong, indeed very strong, after the rights issue which raised £41.5 million in April, 1995. It would have had the benefit of this for four months.

After capital expenditure at Galmoy and the repayment of old loans amounting to £18 million, it would have had a positive cash flow of some £10 million. That positive position, however, will quickly change in 1995/6 as capital expenditure increases. The result will be a cash outflow of some £7 million.

Despite initial problems when it encountered water at the mine, Arcon is likely to be in production in November, 1996, with possibly small quantities of ore being shipped in September. New mines often encounter teething problems but these do not usually affect their long term future.

The timing of production appears to be opportune. Zinc prices have been depressed since 1991, following dumping by China and Russia. But the stocks of zinc at the LME (London Metal Exchange) have been falling for the past 18 months. These stocks, for example, amounted to 1.185 million tonnes in December 1994. These are now down to 647,000 tonnes. The stocks are getting close to a demand/supply equilibrium. And some reports say that China may become a net importer in a few years time, as the demand for consumer products in that country increases.

The expectation of increased demand is confirmed by the expectations for prices with an average of 52 cents per pound anticipated for 1996 (it is 49 cents now), rising to between 57 cents and 58 cents next year. When mining consultants CSMA made projections for Arcon last year, it based its calculations on the 58 cents figure and came up with a net present value of £39.8 million, or 31p per share.

It can be hazardous predicting the direction of the dollar.

CSMA used $1.53 compared with the existing price of $1.58.

The consultants reckoned that a one cent per pound movement in the zinc price has an impact of £2.2 million on the net present value of the Galmoy deposits. And each cent movement in the dollar/pound exchange rate alters the net present value of the deposits by £900,000. The existing dollar exchange rate would imply a £4.5 million reduction in the estimated net present value, representing 1.5p per share. This value comes down further, to 29p, when the issue of 7.6 million new Arcon shares to Quest Capital Corporation last September, is taken into account.

This 29p equates with Friday's share price (12 months high 39p, low 17p). The price is comfortably above the ex rights price of 24p and well ahead of the 17.1p effectively paid by Quest. It is also well above the executive share option price of 18.5p over the next 11 years. This option involves 4.35 million shares.

And Dr Tony O'Reilly is not losing out. While he purchased his original 22.3 per cent stake at a price of 80p he was able to average down by taking up his heavily discounted rights entitlement, and other shares as underwriter. His average price per share comes to 26p for the 43 per cent holding which cost him £32 million.

The net present value would, of course, change if new reserves are found. A feasibility study showed an estimated 6.18 million tonnes of mineable ore grading 11.3 per cent zinc and 1.12 per cent lead. Its estimated life is 10 years but recent drilling is understood to have extended the life by more than two years.

Arcon is fortunate that production at the mine is likely to coincide with the new upward cycle in the price of zinc. If it concentrated as much production as feasible into that cycle, it could pay off borrowings before the estimated three and a half to four years. Nevertheless, it looks as if it will not be in a position to pay dividends until the year 2000, or later.