I wrote a piece titled...

"Ferguson - fifty quid again, flippin' heck..."

...which was uploaded just now to the ShareProphets website.  A link to the piece (free sign-up) is here. 

European numbers today - Total, Holcim/Lafarge, British American Tobacco and Schneider Electric

Lots of European corporate numbers out (again) today.  Here are a few thoughts.

First, the French energy giant Total.  Yesterday (link here) I noted that peer BP's shares had sort of rolled over and the same is true for Total which is now back closer to that Euro50 support level after a bit of a shabby set of numbers.  More from their conference call (and presentation deck) later but given 'Operating profit per barrel was its weakest in 4-years as opex and DD&A rose 9% y-o-y and 25% y-o-y respectively' this is going to require some explaining.  Large cap energy stocks look in the avoid zone at prevailing.  

Staying with another sector that I talked about at the link above yesterday, the other half of the big European cement merger reported today with Holcim disappointing the market as FX/cost issues combined to overhang yet another good pricing performance, as shown below:

Interestingly with further falls in both cement companies today, Holcim has pushed below the level it spiked from a few months ago on the announcement of the deal in early April.  That's interesting (Lafarge is just above this equivalent level):

I have written about British American Tobacco before (link here) and, although it is not a holding, I very much respect the business model.  FX again had an influence on numbers...but aspects like pricing (to offset volume decline) remained absolutely fine:

At the margin I would personally buy/hold Imperial Tobacco (link here) or Philip Morris International (link here) with regard to the big international tobacco names given the latter's underperformance YTD but, as I said at the above link, the key is to have some exposure in the first place:

Finally, I have not written about the electrical distribution and infrastructure company Schneider Electric  before.  The shares at prevailing do not particular interest me but I did note this interesting chart in their presentation deck showing the positive thematics behind the 'new economies' (versus the 'mature' equivalents) and also in 'services' versus the implied core industrial demand growth.

It still strikes me as a tough market for industrial companies.

Caterpillar: risk-reward has intensified further on the share

Back in January I wrote that a Caterpillar share price of above US$90 was saying something optimistic about the world economy.  Well what does a US$105 share price say, especially in the context of the proximity of the company's ten year share price high?

 

Of course Caterpillar themselves have contributed to this recent share price appreciation.  Back in January they announced a new US$10bn share buyback equal to over 15% of market cap and today the company upped its corporate numbers:

 

The above has some interesting aspects especially the contrast between Caterpillar's experiences in its 'construction' and 'mining/resource' divisions with the former being revised up...and the latter being revised down. 

In terms of materiality the construction side is now a third larger than Caterpillar's resource interests and profitability is almost four times as high (on an operating profit basis).  In time the resource division offers optionality from these levels...but this is over time.  As the company's comments above note, mining capex constraints are continuing to have an impact. 

Also noteworthy was the operating profit evolution which was very cost control centric with dullness on the sales/price lines. 

 

So where does this leave us with Caterpillar shares today?  Well, investors are still paying prospectively mid-teens EV/ebit multiples for the share.  That seems full...unless you are a believer that construction related demand for Caterpillar's services will remain strong and the mining side will start to pick up. 

 

It is always better to travel than arrive and risk-reward has intensified further on the share. 

 

 



"HD Supply Soars but It Has Too Much Debt"

I have posted a new article on thestreet.com talking about the construction industry distributor HD Supply about how I am uncertain how to juxtapose a near all-time high on the share price of a company that is still running at a loss and has both a high debt burden and (potentially) a significant share price overhang.  You can find a link to this article here. 

Selling to retail and trade: some views on Kingfisher and Wolseley

Is it always easier to sell to the general public than trade practitioners?  Looking at the switch chart over the last year between Wolseley (building materials supplier) and Kingfisher (predominately a DIY retailer) it seems easy to conclude that this is the case with the latter's shares up around 50% and the former flattish. 

Both reported corporate numbers yesterday (Tuesday) and whilst Wolseley struggled to get much momentum outside of the US (although I note that finally easy comparisons allowed some positive like-for-like statistics in the difficult French market for them). Nevertheless trading profits were up around 10%. 

 

 

At Kingfisher self-help was again used to push profits up:

 

Additionally I noted that despite a lack of post financial crisis sales growth, they have managed to increase margins by over 2% points

Kingfisher also announced the intention to return extra monies to shareholders which implies a return yield of over 4% - probably sustainable given the 5%+ current free cash flow yield and management commentary of a 'multi-year' return opportunity. 

 

What we have here are two businesses which actually have been managed well - pull the chart back over three years instead of one and the performance differential is not so great.  The anomaly over the last year was the perception to Kingfisher who undoubtedly have outperformed underlying difficult consumer markets.  That is why they have outperformed.

 

If I look at both businesses today I see reasonable solidity, good market positions and prospective x12s EV/ebit ratios...which feels full to me. 

 

Horribly full or just full?  Kingfisher is harder to call being a more turnaround style situation but Wolseley has struggled over the last year above 3500p.  Worth noting for periods of market over-exuberance. 

 

 

 

 

Views on Holcim, Greggs, Direct Line and Anheuser-Busch InBev

A lot of results out today of interesting companies...so what are the key points?

When I last wrote about the Swiss cement company Holcim I concluded that the key was the punchy restructuring plan profit uplifts.  This very much remains the case. 

I did like the positive pricing which helped nearly offset negative volumes and emerging market operational and FX volatility. 

The shares are back at a big resistance level though - as with many construction/industrial names value (as I discussed last time) is based on extrapolated numbers.  Not impossible but needs a suitable macro tailwind.  With new money I would prefer to buy the share in the mid CHF60s

The UK bakery chain Greggs are seeing its shares slide around 7% this morning following a results statement with the key observation on their corporate turnaround to a broader 'food to go' offering that:

'the costs of this major programme of change are likely to constrain underlying profit growth over the next two years although the actions we are taking to restructure our cost base will position the business well as sales strengthen'

As I discussed here earlier in the year, the turnaround continues (better momentum in recent sales) and the 450s is a first level to put new money in.  This is also a level equivalent to a 4.5% yield. 

In the meantime, better to buy one of their legendary sausage rolls...

 

The UK insurer Direct Line has been a Financial Orbit friend at various times over the last eight months - especially when selling parent shareholder RBS placed stock.  Having twice bought the share around 210p in the summer months I cashed out in the mid 230s where I perceived a fuller valuation.  Full year results continue to show good progress and using the adjusted tangible return on equity of just over 16%, a 245p price target could be generated.  There is also dividend support as at that level a 5.1% dividend yield is apparent. 

 

 

Insurance can be a funny market (weather impacts are noted for 2014).  RBS are also - surely - likely to exit their remaining 29% stake.  This all suggests to me that opportunities will be apparent in the share but patience is required.  I have placed a flag in the 230s. 

 

Finally, the world's largest brewer Anheuser-Busch InBev produced its Q4/FY results.  Progress was as the recent norm for the group with negative volumes being offset by positive pricing / control of costs - and hence a profit rise.  This 'model' should continue. 

 

 

The company currently trades on x14 EV/ebit and a fairer buy-price today remains Euro70/US$95 as discussed before (see this link).  A good global consumer name - but just waiting for the x12 EV/ebit FY14e valuation level to kick in.  I did note that the dividend rose 21% meaning the shares are closer to a 2% dividend yield.  

 

 

 

CAT: a share price >US$90 says this...

The last time I wrote about Caterpillar I noted their cautious comments at the last set of quarterly numbers in October and that since then mining companies like Rio Tinto had talked more about capex control. 

I am loathe to say 'what a difference a quarter makes' because looking through Caterpillar's Q4/FY results today, I am not sure that it does.  Big picture the world remains mixed and difficult (with my emphasis added):

'Sales and revenues for full-year 2013 were $55.656 billion, down 16 percent from $65.875 billion in 2012.  The decline in sales and revenues was primarily driven by a sharp drop in sales of new machines for mining'

And this continues into 2014:

'We expect sales and revenues in 2014 to be similar to 2013...The outlook for 2014 includes continued cost improvement, but little price realization (less than 0.5 percent), a continuing negative mix of sales and a higher tax rate...we expect mining companies will remain cautious with equipment investments and are expecting another decrease in mining capital expenditures for equipment in 2014'

So far, so akin to the tone of the October statement and the December update linked above.  So why is the share called up 6%+ in the pre-market?  The key big positive was this:

'With the expected completion of the current $7.5 billion stock repurchase program, the Board of Directors has approved a new $10 billion stock repurchase program, which will expire on December 31, 2018'.

Just to put that into context, US$10bn is equivalent to 18% of the company's market cap.  That's a pretty clear statement of intent to the market. 

Now not all companies can do this but, with the company's debt-to-capital ratio at its lowest point in more than 25 years, CAT has greater flexibility than others.  That's great news for EPS enhancing moves such as a buyback. 

Looking at the share price over the last 3 years, the early US$90s level that the share looks set to open up at today is an important level.  For the share to stay in the US$90s it means that optimism about the world's economy - as discounted by the stock market - is more than just reasonable.  Have an alternative view?  Then take the lesson of history and short the shares...

 

 

Business caution and a massive interest bill: the case of HD Supply

It is always interesting how companies present themselves.  In the case of HD Supply, a leading construction sector distributor, it is as follows:

A proud boast, but then the company does offer more than a million stock-keeping units which include things like appliances, kitchen/bath cabinets, window coverings, HVAC products, valves, fittings, metering systems, hydrants, storm drains, power equipment and meters, as well as providing a wide array of services, such as fabrication, kitting, jobsite deliver, managed inventory and Internet tools.

So a good insight into the economy then?

On that basis, it is kind of interesting to share what they are saying about the world.  Two words stand out from their 2013 end market commentary: 'increased uncertainty'. 

'Moderating strength' in residential, 'continued sluggishness' in non-residential, 'increased uncertainty' in infrastructure.  This is hardly reflective of a recovering economy. 

But what about 2014?  Better as there is talk of growth...but a 'conservative view' given the ongoing uncertainties. 

 

There was another insight I thought was interesting and worrying in equal proportions.  I noted that the company's net debt at US$5.5bn was bigger than its US$4.4bn market cap...but what was truly amazing was that for the first 9 months of this year the interest bill of US$409m but basically the same as the company's operating income generation.

Yes, interest cover was almost precisely x1. 

Now, the situation improved slightly during Q3...to a cover of x1.35 but the spectre of too much debt lingers on the mind.  This surely makes the company's shares a horribly geared play. 

HD Supply only came to the market in the Summer and the shares have been somewhat volatile since, especially as the original IPO price range was US$22-25.  Even with the lift of higher stock markets, the debt burden has overhung. 

It may not surprise that this debt burden was a legacy or private equity as Bain Capital Carlyle Group and Clayton, Dubilier & Rice each owned pre-IPO 27.9% of HD Supply, with the remaining 12.4% owned by Home Depot, which sold most of the company to those firms for US$10.3 billion in June 2007, the height of a buyout boom.  Monies raised during the IPO were used to mostly lower debt levels - hence the improved debt cover noted for Q3. 

No wonder the CFO at the time of the IPO is leaving in April next year.  There's one thing to have high debt mostly under the wings of private equity...another to do it in the public domain. 

Still, saying all this, the stock is up sharply in Wednesday's session but this may reflect technical positioning in the shares (shorts being covered etc).  Fundamentally it is still very much a turnaround hope story. 

So we have two stories here.  At an economy or market-wide level, HD Supply is telling us that the North American economies are not out-of-the-woods yet.  And at a specific level, that interest burden gives investors a very geared play. 

2014 is going to be an interesting year for both these elements.

From 'very challenging' to 'no signs of improvement' - Wolseley on Europe

I last talked about Wolseley in early October, noting in particular their assertion that Europe was 'very challenging' and using this - and other corporate and financial observations - to call for a weaker Euro. 

Well, since then Mr Draghi at the ECB has cut interest rates but as for the Euro - here shown against the US Dollar - it fell initially but has recovered back to pretty much where it was in early October:

So no change then.

There has been a change though in Wolseley's European trading...a change to the downside with continued like-for-like revenue declines. The company is fortunate that c. 75% of its business is in North America / the UK which are going ok. 

And what is the comment on European trading this time?

'So far there are no signs of improvement in market conditions across Continental Europe and we expect trading conditions to remain tough for the foreseeable future'

No signs of improvement - a bit like the lack of the move in the price/value of the Euro.  Mr Draghi, you are going to have to talk it down just that little bit more explicitly. 

 

Komatsu - construction and mining trends in a global world

I last talked about the Japanese construction/mining equipment company Komatsu back in July (see the link here).  Given the caution from their peer Caterpillar (see here) recently, we should expect some downbeat thoughts. 

Here are the two key charts from their presentation document:

First, note that overall in Komatsu's fiscal Q2 (July-Sept 2013 year-on-year) sales actually went up but look at the big 27% decline in mining equipment sales (which is inline with what Caterpillar saw). 

So what is the major difference then?  Well Japan helps and HQ proximity to China has probably given the company a better experience than Caterpillar in Asia generally.  Certainly the stronger performing Asian markets have helped.  It is also interesting to note that all the 'traditional' markets were up year-on-year, although this also had something to do with easy comparisons from last year.

The other key chart is the positive pricing - and inevitably positive foreign exchange benefits due to the weaker Yen.  The former is certainly more high quality than the later...and also reflects what Caterpillar said. 

Essentially, the big differential with Caterpillar is that Asian focus, they are struggling too with that general mining sector decline...and that is not going to reverse soon.   

Last time I looked at the company I talked about Y1900 as a level for the shares (x8 ebit).  Applying similar multiples gets a lower target today. I would say though that the tone of the statement - including the positive pricing - gives a little more hope.

The chart below suggests Y2200 as a support but given all the above, around Y2000 seems better risk-reward to me all things considered and certainly a re-review level.  That level would also be closer to a 3% yield. 

The right FX exposure - what Unilever and Wolseley might be telling us

I briefly looked at Unilever last a couple of months ago and was impressed with their price-mix progression:


Late yesterday, the company updated the market with this comment:

'Unilever will say that it has seen weakening in the market growth of many emerging countries in quarter three and now expects underlying sales growth of 3 to 3.5% in the quarter. The emerging market slow-down has accelerated as a result of significant currency weakening. Developed markets remain flat to down'.

Well using the above chart, currency weakness has been an issue for a little while.  The new element is a weakening in the emerging markets from the 5% growth level noted above.  This is a theme that will continue throughout the Q3 reporting period (and is also why I currently am struggling to find value in consumer staples/goods companies, as per this brand piece yesterday). 

The better news is that over time the emerging markets not only grow faster but ultimately - probably - have undervalued currencies (at least via the Big Mac index):

So what to do about Unilever?  Well the share price has sagged to one year lows as shown below. 

And as for valuation...the share trades in the mid x13s EV/ebit FY13e.  To get close to that x12 forward EV/ebit number we are looking for in peers such as Kellogg's or Coca-Cola this suggests below £22.  I note from the chart above, that at around the current share price there is some resistance, so I believe the actual Q3 numbers (and especially the tone of the comments) will be influential.  Currently I stay on the sidelines with the company. 

Whilst Unilever has its FX-related issues, the UK-listed plumbing and related building supplies business Wolseley had the opposite problem when it declared its final results this morning:

'The highlight of these results was another strong performance across our US business where we achieved good revenue growth and the trading margin of 7.3 per cent was ahead of the previous peak achieved in 2007'.

If we look at Wolseley's geographic business split, we can see the reason why they have done well.  The business is very US-centric:

Now, the main influence has undoubtedly been the better dynamism of the US business cycle versus - for example - the European one (described by the company as 'very challenging') but a stronger US Dollar also helped from a translation basis.

Here's the interesting observation though.  Since the end of July when the Wolseley results were finalised, the US Dollar (as represented by the DXY, the trade weighted US Dollar index, below) has fallen sharply:

Now, my call is that the US Dollar probably rises from here, but the scope for some Q3 results translation surprises from the US may exist. 

Wolseley interestingly trades on a similar multiple to Unilever and despite a 3.4% odd special dividend today (their balance sheet is ungeared) that is a full valuation. 

So the moral of the above?  FX exposure does matter.  The trouble is, we live in a confused world where everyone appears to want a lower exchange rate - therefore this theme is volatility adding for equities.  The next big call on the FX front is probably a lower Euro vs the US Dollar as economic reality (recall Wolseley's words 'very challenging') hit home.

Europe: it isn't easy - thoughts from CRH

I like CRH the Irish/UK listed building and construction materials company.  They are proven dealmakers with an eye for value and, over time, if the Irish economy had been run by the CRH management it would have been in far better shape. 

CRH's message today though is one of continued caution for Europe.  I thought this was the most important chart in their presentation.  Note in particular that horrible combination of falling volumes AND falling prices.  The geographic split is interesting too.  Inevitably there are weather-related impacts but on an underlying basis the only conclusion is that conditions remain tough/mixed at best.  The company would be running at an operating profit in its European materials business otherwise. 

The US business is better (a little over half the business on a revenue basis) although as shown below for the US materials business, pricing is not uniformly positive and volumes and costs are moving around. 

The real news/driver for the shares is in Europe.  Cost-cutting efforts have been raised and a potential Euro300m could cut from the cost base (70% viewed as 'permanent') over the next couple of years.  That is helpful for a company with an EV of around Euro16bn but frankly the cyclical and operational realities matter more. 

Given depressed profitability, valuation work is not easy but here is a thought.  Sub Euro15 the share is below book value.  That seems a reasonable level to me given I believe CRH is a tight ship and the book is there/thereabouts.  Some support/resistance at that level I note:

Such a valuation-form also implies that some broad sector peers such as Saint Gobain remain at least 10% overvalued. 

European numbers today - from cement to insurance to cosmetics to cigarettes

Holcim, the Swiss-listed cement/aggregates company interestingly started off their presentation document for the H1 13 results by talking about its cost cutting / optimisation efforts.  As with any global industrial company, this makes huge sense.  You cannot fault the materiality of what they are trying to achieve: an uplift in 2014 year-on-year of over CHF1bn in operating profit from just 'cost leadership' and 'customer excellence' techniques.  For a company that is likely to make around CHF2bn in operating profits this year that is some potential augmentation to results. 

Cement is increasingly about the emerging markets and, in this regard, there were two interesting slides from the Holcim presentation.  First, note how their two major emerging market zones in Asia and Latin America dominate operating profit -

Second, the outlook comments are significantly more optimistic regarding Asia and Latin America than the other parts of the world. 

Today Holcim looks an expensive share trading on FY13e x17 but - as hinted above - it all depends on what you start to factor in from the cost optimisation noted above and the potential emerging market tailwinds.  The share currently is pretty much in the middle of its 52 week CHF60-80 range.  Moving decisively into the bottom half of this range probably creates an opportunity. 

Staying in Switzerland but switching to the financials, Zurich Insurance Group bemoaned weather losses and the low yield environment as this pulled down their underwriting profit and investment income.  Zurich, like other Swiss financials (UBS, Credit Suisse) has learnt that the only game to be playing is a 'prudent' one, so I was not surprised to see this chart in their presentation deck: the Z-ECM (Zurich Economic Capital Model) at 114% is getting close to flagging more risk. 

I was not expecting to see this though.  Farmers - getting on for a third of their operating business profitability - just has not performed.  Some serious changes/improvements needed here. 

From a headline level, the company trades on x1.1 price:book / 11% return on equity which is there or there abouts.  To drive this share then we are going to need to see some more risk and better execution especially at Farmers.  There feels easier calls to me. 

Oriflame is a Swedish-listed cosmetics/related direct selling peer of Avon.  What is thematically interesting about this company is that (ex Scandinavia) it is very emerging markets centric:



So what is there not to like?  Well the business has gone through its good and bad moments during the last few years.  Q2 margin guidance shows some of the issues: price-mix (+5%) and sourcing cost control has been good but higher rates for their 'consultants' combined with emerging market FX weakness have pulled margins back. 

 Digging a bit more deeply though and the issues are Russia-centric with like-for-like sales in the country down 7%.  Russia can only be described as a work-in-progress.  Elsewhere in the world - from Turkey to Indonesia to Mexico - sales and margins are rising. 

 

Numbers-wise, after a 5% fall in the shares today, the company is trading on an EV/ebit FY13e of around x9 with a 8% free cash flow yield (and a headline dividend of 7%+).  Net debt is x1.5 ebitda so the dividend maintenance is just ok I would say. 

This is a company which moves around in sentiment and operating terms.  Russia remains uncertain but I am heartened by the other parts of the world.  The company is coming up to the key Christmas trading season too which I believe will act as a catalyst.  At a current share price just north of SEK200, the shares are nearer the bottom of the (rough) SEK175-250 range for the last year.  At a current market cap of Euro1.3bn equivalent not a large company but I would say interesting at prevailing.

Finally, the Imperial Tobacco interim management statement showed sensible progress.  At roughly x10 P/E this is the sort of higher yield company with pricing power I can make the numbers work on...unlike many other consumer staple types. 

Shares bouncing back today but still too out-of-favour versus reality:

Key charts from Asia today

Asia remains an attractive insurance growth market.  Numbers from AIA on Friday showed continued strong growth sourced from their pan-regional exposure as shown in this chart from their corporate presentation:

 

 

The company also continued to generate cash as shown by the current status of its surplus capital, again in a chart taken from their corporate presentation.  The dividend yield of around 1% if well-covered:

 

 

 

This is a thematic growth company due to continued Asian insurance demand and, now that AIG have exited the shareholder base, it has clean ownership.  Currently the company stands at a forward multiple of just over x18 p/e i.e. a peg ratio (at the just declared historic growth rate) of around x1.  Not cheap but high quality.  To buy the company or not becomes more influenced by tactical technical factors.  We have to watch that the share today (HK$36) does not break the all-time high around HK$37.  Outside this, HK$33s and HK$30s are the two buy levels.  I would double-up on the latter. 

 

Staying with financials, we move to Japan and Nomura who had corporate numbers out today.  Results showed good progression, across all three of their divisions, as this chart from their presentation shows:

 

 

Japanese retail remains the key to their business though and additionally they maintain their number one ranking in Japanese equities, bond and capital market activity.  Internationally though progress remains a bit more mixed -

 

 

Return on equity improved year-on-year to 11.3% but with a current book value of Y640 per share this makes a static fair value in the mid Y700s which is where the share currently trades.  Nomura then is a clear buy if you anticipate better Japanese market conditions.  The fact that YTD the share has moved between Y500 and Y1000 shows the volatility of this perception.  With the Nikkei weak in recent sessions as the over-exuberance of earlier in the year continues to unwind, Nomura - down over 5% today - is one to watch closely.  I think we are building into a trading opportunity.

 

Finally in Japan we also had numbers out from Komatsu, the Japanese equivalent of Caterpillar.  Unsurprisingly they talked about similar issues to CAT and were especially negative about trading and sales opportunities in China and Indonesia.  These countries impacted the year-on-year numbers:

 

 

For the current year (their year ends 31st March 2014) Komatsu are hoping for an improvement in operating profit to Y300bn.  I am not entirely sure where this is coming from given the earlier comments about China and Indonesia but clearly just by looking at their big markets, they would be hopeful of progression in Japan and the US plus continued cost reduction and pricing initiatives. 

 

Even using the above operating income number as the prospective one the share currently trades on x9.1 March 2014 EV/ebit.  To help factor in numbers risk I would want to see a valuation of x8 on this measure.  That's Y1900 (current share price Y2165).  Given Y585bn debt and no free cash flow (post dividend) generated during the last year I think this is the correct watch level.