Investment Comment Inco’s recap plans make it a buy

With a resounding 72% of shareholders approving Inco Ltd.’s controversial recapitalization plan, investors continue to support the company’s share price around the $39 mark. The recapitalization plan, which is comprised of a poison pill and a $10(US) special dividend, will enable Inco to deal with its windfall cash hoard and with any potential hostile takeover attempt.

Although many analysts and investors attacked the plan as being unfair to minority shareholders and a ploy to entrench management, the fundamental question remains, is Inco a buy or not?

According to Philip Martin, a mining analyst at Gordon Capital, the answer is yes. Writing in Gordon’s Metals Guide, Martin concludes that “Inco represents excellent value, with or without the recapitalization.”

This is based on a forecasted nickel price ranging between $3 to $4(US) per lb in 1989. Current spot prices are over $6.50(US) per lb. At a price of $4 per lb, Inco will earn approximately $4.15 per share after the recapitalization. This will generate a price earnings multiple of less than five times. After the special dividend is paid out, Inco’s share price is forecasted to range between $30-$35 in 1989.

Investors who voted against the recapitalization plans have also been concerned about the amount of debt Inco will add to its books in order to payout the billion dollar dividend. At current nickel prices, the company was positioned, before the recapitalization, to pay off its long-term debt sometime in 1989. Earnings at $4 nickel would have been $4.60 per share which represents a 25% return on equity.

The dividend will add $500 million(US) to Inco’s long-term debt. However, at $4 nickel prices, cash flow will be sufficient to reduce debt levels to manageable levels in 1989. The debt to equity ratio is estimated at 34:66 next year. Earnings of $4.15 per share translate to a return on equity of 49%. Importantly, the interest rate coverage on the long-term debt will be a healthy 9.7 times.