Few people are lukewarm on bitcoin. The digital currency typically invites sneering scepticism or fanatical optimism. Its adoption as legal tender by El Salvador this week provides ammunition for both supporters and detractors: other countries might follow, but a drop of as much as 17 per cent in the value of the cryptocurrency on that day shows exactly why they shouldn’t.
Investors can expect similar oscillations in the shares of Argo Blockchain. The London-listed company, which floated on the main market in 2018, mines bitcoin using its own vast network of machines via its six “mining” facilities. This process involves checking, recording and verifying transactions on a blockchain, a public ledger on which trades are archived. Miners earn cryptocoins for performing the task. It holds or sells the currency.
In 2019 it performed an about-turn from its initial business model of giving access to its servers and data centres for those who want to mine in exchange for a monthly fee. Increased production and a rising bitcoin price meant that revenue rose almost threefold during the first six months of this year, which lifted pre-tax profits to £10.7 million, from £500,000 a year earlier.
Yet its revenue and profitability could be as volatile as the cryptocurrency that Argo mines. Aside from the £1.1 million for managing mining machines for third parties, the rest of the £31.1 million in revenue recorded over the first half represents the value of bitcoin mined during the period on the day it was mined, rather than cash banked from bitcoin sales. Changes in the bitcoin price from the mining date to the end of June are accounted for as fair value movements on its balance sheet.
It does sell some of its bitcoin holdings, but so far this year disposals equated to only £3.1 million. Sales are dependent on working capital and future capital expenditure requirements expected of the business. If you’re founded on a bet that bitcoin is going to soar, you don’t want to flog lots of them.
It hopes to fund more of its capital expenditure by raising debt and equity from investors. In June it secured a £14 million six-month loan from Galaxy Digital, a digital asset financial services provider, using bitcoin as collateral.
It’ll need to keep investors onside because appealing to the market for cash has been a key source of funding. In the first quarter, it raised £49.2 million by placing new shares, the latter £26.8 million tranche at a 20 per cent discount to the closing price the day before announcing the fundraising. It’s looking at the American market as a potentially bigger cash cow and this week gained shareholder approval for a secondary listing in New York.
Funding is important because, if Argo is not to be entirely dependent on the volatile bitcoin price to boost income, it needs to keep increasing its mining power. More machines is one route, but the huge amount of energy involved in crypto mining means developing more data centres is the way to move the dial.
In March it spent $17.5 million on 320 acres of land to develop a data centre facility in Texas, which it hopes to complete during the first half of next year. The first phase of the development will provide access to 200 megawatts of power, enough to fuel a small city, and the cost of power in the state is low and should be more than 90 per cent renewable.
The shares have fallen by more than half since their February peak and trade at a more sceptical eight times forward earnings. Like the digital currency it mines, investing in Argo is a high risk, more dependent on narrative than reality.
ADVICE Hold
WHY The shares are inextricably linked with cryptocurrency maintaining its allure and therefore are likely to be volatile
Bakkavor
The mention of inflation has an unpredictable effect on investors. For Unilever, a giant of the consumer goods sector, it caused a sell-off, but the market looked straight past warnings of higher costs from Bakkavor. Guidance of a steady profit margin in the second half of this year led to an almost 10 per cent rally in the supermarket food supplier’s shares.
Brighter dividend prospects deserve more attention. The restoration of the interim payment, which typically accounts for 40 per cent of the annual payout, at 2.64p gives grounds to expect a 6.6p dividend this year. At 120¼p, that leaves the shares offering a bumper potential yield of 5.4 per cent.
Can the market rely on receiving that payment? Free cashflow is back in positive territory, helping to cut net debt to 2.1 times earnings before interest, tax and other charges, close to a medium-term target range for a multiple of between 1.5 and 2. It has £200 million in liquidity against its debt facilities and the pension scheme is in surplus.
As a manufacturer of fresh foods, less frequent grocery shopping hurt sales during the pandemic as consumers stocked up on products with a longer shelf life. But like-for-like revenue inched ahead of 2019 levels during the first half of the year.
In Britain and the United States the group solely supplies supermarkets, but in China its focus is on food outlets such as KFC and Pizza Hut. Business in the latter market has been slower to return after the pandemic, but is expected to recover to 2019 levels by the start of next year.
That doesn’t mean that inflation isn’t a concern. Brexit has exacerbated the shortage of staff in the UK, where European staff accounted for more than half of its workforce. It expects a 5 per cent to 6 per cent rise in wage costs this year and next, at a group level. So far Bakkavor has mitigated rising costs by automating parts of its manufacturing processes and it is haggling hard with the supermarkets.
For now, an inexpensive valuation of just under 11 times forward earnings compensates for those risks, particularly when you consider the potential dividend on offer.
ADVICE Buy
WHY Risk of inflation weakening earnings has been accounted for in valuation
