Wednesday, 20 August 2014

Financial Orbit wrap 20-08-14

Five sentences or graphics which sum up the Financial Orbit output over the last 24 hours across the website, twitter account and anything else thought about...

1. Fortescue in Australia are hoping this happens...


2. ...whilst in Asia I ponder the scope for a lower yen, the impact of Chinese anti-trust fines and corporate insights from Ping An and Bank of China plus the Big Mac index in a different way/form:


3. I buy a starter position in Carlsberg noting shabby Russia related trading but good price-mix...

4. ...'hold' for the time being in Staples despite continued tough trading and...

5. ...continue to be frustrated by Glencore although I do note this very interesting chart in their presentation document.  Now just to work out if if it best to be anti-consensus or not...

Staples - some bad, some hope and a couple of levels

Regarding Staples I almost feel as if I should just replicate large elements of my prior note.  The good news is that the company retained (earlier in the year downward revised) guidance.  The less good news is that the Staples share price continues to look...volatile (or is that support at the c. US$11 level I can spot?)


So we all still know what the problem is: sales down, margins down...and by the time you get to the year-on-year EPS line a substantial decline - still.  Pretty ugly.


No prizes for guessing the main culprit...the physical stores number remained poor and despite continued growth of Staples.com it is not offsetting despite various branding, 'specialist' initiatives and efforts.  80 stores were closed during Q2, 140 planned for the full year.


The commercial business was better in the sense that sales went up but margins did compress mildly but operating income did at least rise with growth in facilities and breakroom supplies, print, and furniture, partially offset by a decline in ink and toner.

Meanwhile the international operations remained loss-making - just why these are not sold escapes me especially as European online (online!) was blamed for the continued poor trading.

And the US$600m guided full year free cash flow is equivalent to a c. 8% free cash flow yield - more than enough to cover the 4%+ dividend yield.

Sum-of-the-parts thoughts? Core North American stores FY US$300m of ebit at a depressed x6 multiple gives US$1.8bn.  The better Commercial operations of FY c. US$550m of ebit at a x10 multiple makes US$5.5bn.  Meanwhile the International operations I value at just x0.1 of sales i.e. c. US$400m.

Add all that together and that gives US$7.7bn.  The EV is about this today but with free cash flow of US$600m (around half available ex the dividend) this gap can extend further.  Additionally I note the comment on the conference call that:

'We’re on track to eliminate at least $250 million of annualized cost in 2014 and we’re pursuing additional expense reductions beyond our previous target of $500 million by the end of 2015' 

The real hidden value of Staples though lays in simplification (getting rid of international?) and domestic store closure which places greater emphasis on the dot com operation where there is real potential.

You have to wait for a discount on that conservative sum-of-the-parts to buy more Staples shares (US$10?) but if you own some I don't think it makes much sense to kick them out now.  In the US$13s maybe start losing a few. 
As I noted the last time I wrote about the company:
'Staples is wounded but not broken...even though investors should expect the company to continue shutting shops over time.  Inherently they are well-advanced in their own online activities, have seen their number 2 and 3 competitors merge (good for margins) and retain strong brand recognition...The company retains optionality...but has to prove that it has stabilised, especially on the store front, in North America whilst the International assets have to move into profit...or be exited/sold.   Given the cashflows, I would not be surprised if private equity will circle too'. 

It is going to be a big 'back to school' trading period for Staples whichever way you look at it.  Sub US$11 I think you buy more, US$13s lose some.  Pick up the dividend in the interim and keep your fingers crossed.  

Glencore - some great presentation slides (even if I never seem to buy the stock)

Glencore is a frustration to me.  It is a fascinating company with an interesting 'marketing' and 'industrial' split and their presentation documents always have some compelling charts contained within them (as we shall see again in a moment).  I have not bought the stock yet since IPO which, in itself was no bad decision...
 

...but the failure to execute at that c. 300p level still frustrates.  I know why: a valuation in the x14s EV/ebit and a sub 2% yield.  If you want value in larger cap mining you can find it elsewhere.  Still I was impressed by the statistic that the company has returned the equivalent of the IPO proceeds already.


The quality of the Glencore numbers this time was ok although ultimately it was the less compelling 'FX' line which drove the ebit improvement during the H1 year-on-year period:

 Marketing (not 'trading'!) was the standout and this useful graphic shows its relatively solid contribution.  This division has surprised a few people since the floatation.


There were three presentation slides which did stand out from a more general perspective.  First, the sheer underperformance of the mining / related sector over the last three years.  This was implied as a driver to the BHP Billiton announced spin-off yesterday (link here) and Glencore had an excellent chart on this:



Ok, so if this is a more interesting-than-average area what commodities to look at?  Here was possibly the most fascinating chart: the sheer differentiated range of consensus commodity hopes.  The iron ore profile not exactly what Fortescue (whose numbers I wrote up earlier, link here) would want to see but it is interesting to see what is anticipated to be good...and what is not.


Funnily enough of course, Glencore's four key areas in the metals 'industrial' space are all looking reasonably primed...

...highlighting again that for this and the marketing/trading profits reason Glencore is a different beast from the other large cap global miners.

Now to watch for the (pairs) trading opportunities...and to try and execute this time.  

Carlsberg - do you buy today?

I titled my last Carlsberg report 'the inevitable Russian rouble impact' (link here) and opined that:

the shares trade on x11.6 EV/ebit for FY14e with a 1.1% dividend yield (some progression was announced here but still a c. 20% payout ratio only).  The valuation is getting there and improvements are being seen...but the more compelling opportunity to buy remains at DKK530 and then DKK500 given general volatilities (the Russian rouble at a 5 year low today for example) and the slightly shabby cashflow generation recently'

Well the chance is undoubtedly going to come today to play given where the share is...


...and today's Q2 statement which observes reasons for why to pull back reported operating and adjusted net profit hopes.  


Here is one other quick observation though.  The positive price-mix continues apace...and with the flat price-mix in Western Europe, in Russia (!), Eastern Europe and Asia they are all high single digit.  
 That is interesting...and why the above advice still holds.  A day for a starter position?  Despite the scary technical look of the Carlsberg 3 year chart sub DKK500...yes.

Charts today - expensive sectors, Apple, oil and cybercrime

Four charts that spoke to me today.

GaveKal Capital had this fascinating chart on a very interesting posting which observed:

'Not A Single Developed Sector Is Trading Below 22x P/E'


Reiterates my view that this market is all about alpha and not beta...

One stock that has done very well is Apple.  Excellent chart via @Brady_FBN indicating that Mr Cook has almost doubled the shares under his CEO tenure.  (I also note the potential double top at US$100!!)


So my question is, in this Bank of America-Merrill Lynch chart highlighted by @liamdenning is correct...then why is the oil price not materially higher?  Conditions for an energy price spike in the winter building?


Finally from @EY_UKI a warning that cybercrime is a worry...especially in the UK.  I agree on the global theme...one of the reasons why I am long Symantec.


Asia today - price fixing, Japanese trade data, climate impacts, Big Mac index and is Ping An a buy?

Lots of interesting numbers out in Asia today including the Australian-listed Fortescue in the iron ore space who I wrote up here.

Before we get onto a couple of Hong Kong names, a touch of macroeconomics.  As this report noted
China found 12 Japanese auto-parts makers (including four bearings manufacturers) guilty of price fixing and imposed 1.24 billion yuan's worth (c. US$200 million) in fines.  My observation - akin to the conclusions of this recent Daimler piece - is that the amount per company seems...quite low.  Fear is higher than reality...

Otherwise, despite a rise in exports, Japanese trade data remained poor including higher imports (fuel) and a 25th consecutive deficit.  The yen did push down a little against the US dollar as shown below...good news for my recently doubled short position:


Another story doing the rounds today are the comments from the Asian Development Bank who are observing the potential longer-term climate impact on growth in South Asia.  Really longer-term observations...but 20%+ GDP declines should catch the attention! 


A reason to be avoiding the region?  No.  A reason to be worrying about global climate change impacts?  Yes.  Especially for your pension fund assets. 

Finally I liked this posting in the South China Morning Post on (all in Hong Kong dollar terms) how many Big Macs can be purchased for working for one hour on the local minimum wage...



Interesting to compare the US or Turkey/Poland versus Western Europe or even Mexico versus the US.  

Let's turn to these Hong Kong listed companies now.  I have talked positively about the insurer AIA a number of times before (most recent write-up here) and one of their peers Ping An produced some solid looking numbers today: 

'China’s second-largest insurer, said first-half profit grew 19 percent as premium income climbed and banking revenue increased. Net income rose to 21.4 billion yuan ($3.5 billion), or a diluted 2.55 yuan a share, from 17.9 billion yuan, or 2.26 yuan, a year earlier. A 34 percent profit increase at unit Ping An Bank Co. (000001) and higher premiums earned helped...boost profit'

This latter point is very important.  Ping An's profitability is just over 60% insurance and much of the rest is banking...



...and this is a 'proper' bank in the sense that loans are materially higher than deposits:


So what about bad loans which we are told to worry about in China?  Well usefully they provided this chart:


Now this is interesting because Bank of China numbers are also out and they observe that:

'The bank's non-performing loan ratio increased slightly to 1.02 percent at end-June compared with 0.98 percent at end-March, pushing it above the 1 percent maximum level that the Chinese banking regulator has said is healthy'

Hmm.  It has already been widely observed that Chinese banks appear 'cheap' on a global price-to-book basis.  The trouble is sometimes areas can be cheap for a reason.

I guess what I am trying to say is that insurance and not banking appears to be the way to access Chinese/Asian financial sector opportunities.  On this basis, as per the chart below, AIA remains less volatile and more interesting.



A level for Ping An?  A movement of HK$5 either way from here would increase my interest would be the only conclusion I would have.  

Fortescue - iron ore, debt and China = embrace the volatility (both ways)

Fortescue are nothing if not confident.  Australia's new big iron ore producer has to be otherwise metrics such as net debt of around half the company's c. A$14bn market cap and a prospective consensus rating of around x6 would get you down.

Still, the numbers are getting better with the usual combination of higher volume and lower prices was apparent.  This combination was a net positive but the really positive aspect was cost control...



...and this helped flow into the free cash flow statement which is required given the net debt burden:


At this point I could start talking about big free cash flow yields and the like, but here's the problem: the iron ore price has been dodgy and rolling over year-on-year the realisable price is clearly falling.  



Of course the hope - as previously expressed by BHP Billiton and Rio Tinto - is that China continues to demand product or alternatively...


...expensive capacity (in places like China) gets taken out.  Very plausible over time...but shorter-term, the scope for volatility is clear.   

Especially with that debt burden.  Interesting that the Fortescue share is almost perfectly in the middle of its three year price range...



...and if unsurprisingly the volatility is apparent as per this chart comparing the performance of the Fortescue share with BHP Billiton over the last three years:


My view?  Geared trading counter towards China sentiment and related, scope currently to buy at A$4, sell/short at A$5 ceteris paribus etc.  If you don't like to play such volatility look away and take a look at the newly announced 'core' BHP Billiton share...