MD writes...

Three topics readers interested in investing in UK plc might consider going forward into 2005:

Cash Flows
It is alleged that UK plc cash flows are very strong and that cash is piling up. Well, maybe. The Times ran a stupendously fatuous piece yesterday 28/12/04 entitled “UK plc builds up cash pile” by Gary Duncan. Under a graph entitled Leading Cash Rich Companies he chose to measure high free cash flow as a percentage of enterprise value. Knock me over with a feather – since when was this a recognised measure? Still, what do I know - the widely ridiculed EBITDA is still regularly quoted as well. Clearly the article / idea was planted by the scientists at the “investment banks”. Stars were M&S, BAE, and others no doubt all being touted as buys or takeover plays in 2005.

Share Buy Backs
The saddest statistic I’ve seen recently (also in The Times 28/12/04) was biggest share buy-backs of 2004 and I quote:

Vodafone £3,268m
BP £2,894m
M&S £1,755m
GSK £1,100m
AstraZeneca £1,099m
BAT £1,036m
Centrica £1,000m

Some of these companies sold part of the family silver to do this. But to what end? Note also that the much maligned Shell is no where to be seen on this list. Yet, despite its troubles, Shell is up 9% on the year vs. BP at 14%. BP Amoco is supposedly the better run company and has not had the reserve crisis of its rival. However, I question if £2.9bn is worth the candle. Certainly, pension fund trustees at some of these firms may have their doubts that buy-backs are the best use for "surplus" cash.

Shares are typically issued for 3 reasons, viz; to buy a company; to get out of gaol (otherwise known as remedying past mistakes); and to further reward already overly-well rewarded directors and senior staff. Let anyone who says that they have no cost study the above statistics.

Dividend Cover
I’ve taken a look at UK plc dividend cover. In contrast to the cash flows optimism noted earlier it makes sorry reading. When the scribe was lad it was a rule of thumb that sufficient dividend cover was not less than 3x. Here’s a surprise: hardly any of the FTSE 100 are anywhere near 3x covered. Most hover between 1 and 2. Bloody hell! Not much being held back for investment, nor for rainy days. Another price to pay for share buy-backs?

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Investing in China: a follow-up

Wednesday, December 29, 2004 | 0 comments »

Yesterday's piece was written blind. That is to say, without knowledge of the recent happenings involving China Aviation Oil, which now lend the article more resonance. The first paragraph from the Interfax report Feature: China Aviation Oil - China's "Barings" (link available via the China Aviation Oil news page below) sums up the scandal neatly:

"Last week, shocking news hit the world's financial market. China Aviation Oil (Singapore) suddenly submitted a voluntary bankruptcy petition and debt reorganization plan to avoid liquidation. According to the disclosure, CAO Singapore had incurred huge losses of USD 550 mln from oil options trading. More seriously, as a publicly traded company, its parent company, the state-owned and Beijing-headquartered China Aviation Oil Group, sold a large number of shares in the company, accounting for 15% of the total stake, on October 21, 2004, obtaining proceeds of SGD 196 mln in the process. Because this sale took place after the losses were made but before the information was disclosed, CAO may be guilty of fraud. Right now, an investigation is underway by the Singapore regulatory authorities."

The words "state-owned" just seem to jump off the page.

Here are a few more related links, none so fascinating as the near sadistic pleasure China Aviation Oil takes in lighting up its own web pages with the media coverage:

China Aviation Oil News Page
Le directeur de China Aviation Oil arrêté à Singapour (in french)
Losses at China Aviation Oil Investigated

And no, Capital Chronicle finds no joy in the story. Who would want to be in CEO Chen Jiulin (pictured above) shoes when he gets back home?

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Tsunamis do happen

Tuesday, December 28, 2004 | , | 0 comments »

(A late addition to the 2004 collection)

The big winner amongst emerging markets in 2004 was Egypt. Investors would have seen their money return over 119% (as of 27 December 2004). Contrastingly, China, everyone's favourite - or so it often seems - fell nearly 15%.

Chinese economic growth has been astounding in recent times, and state marshalling of resources has played a significant role. Equally striking have been the social gains as measured by ratios such as life expectancy (72 years) and child mortality (25 per 1000 live births).

But economic and social gains do not always walk hand in hand. The most recent work arguing this is perhaps the New York Times video report, China's Great Divide. The bottom line is that China today is in many ways a contemporary re-enactment of the worst of the Industrial Revolution in 19th century Great Britain.

But with an important difference: there is no sign of a nascent free-press or political opposition developing in China. The non-growth economic consequence of having a supreme political monolith such as the Chinese Communist Party is the constant risk of misallocation of resources and associated risk of disaster.

It was misallocation - a large increase in state procurement of foodgrains during a poor harvest year - that severely aggravated the Great Famine (1958-1961). Grain was exported while rural communities had no food. Depending on which estimate is believed, 16.5 million to 28.5 million people starved to death. A free-press and active political opposition would surely have mitigated the human and economic catastrophe.

In terms of increased transparency, accountability and justice have matters evolved meaningfully since then? On a balanced reading of recent history the idea does not bear scrutiny. Resource misallocation continues by definition and there has been, to borrow a phrase, no great leap forward. The implications for foreign investment are significant. How would a business crisis, especially in the financial industry, pan-out in this Chinese system?

No, when something goes wrong in China, it goes wrong in a big way. Foreign investor hopes of consistently fair legal recourse and unfettered access to markets (WTO 2006 notwithstanding) ought to be seen in that light. It does not mean money cannot be made, but it does mean accepting the risk of a potentially very Bad Investment Tsunami.

(NB: life expectancy and infant mortality data for this article taken from the CIA World Factbook)

Post-script: readers may be interested in this follow-up piece which covers recent allegations of fraud on the part of a Chinese state-owned company against foreign investors.

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To Magic Moments in 2005

Wednesday, December 22, 2004 | 0 comments »

This is the final post for 2004, and it's a short one.

As an undergrad in the United States, I had a calculus professor who was also a Vietnam veteran. He invariably offered his students the following advice before exams:

"Now y'all remember - protect the perimeter"

Made little sense then, much like the calculus. But seems apt now.

Many thanks to everyone who has visited the site these last 6 months, raise your glasses and let's toast a Merry Christmas and a Happy New Perimeter-Protected 2005.

To 2005.

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Several companies were commented upon in the 26 November Capital Chronicle article Exploiting the dollar's drop. One of these was Standard Chartered Bank plc. At the time, the bank was trading at 1,002 pence per share.

Standard issued a market update on 8 December. It was not well received by most analysts who cited the following negatives:

  1. Projected increases of investment costs linked to the firm's goal of expanding its consumer banking business in countries like India and Indonesia will narrow its revenue/cost ratio

  2. Currency concerns as the dollar falls

  3. The suspect capacity of Standard to compete against giants HSBC and Citigroup both of whom trumped the firm in recent acquisition auctions in South Korea

  4. Standard is only going to make its revenue number by reducing allowances for bad and doubtful debts

There are always at least two ways of interpreting things. Let's look at that list again:

  1. The revenue/cost ratio may narrow. But these costs are investment for future growth. Unless there is evidence the money is being poorly spent it makes little sense to punish the shares because the near-term impact is a rise in cost ratios. Is the board truly expected to make an instantaneous return on investments?

  2. This is a real concern, but Standard Chartered earns approximately 30% of its revenue from its Hong Kong (HK) operations. The HK dollar is pegged to the US dollar, a natural hedge to US currency movements and, when the US$ falls, assistance against other Asian currencies. Moreover, Standard Chartered is a non-tradeable and should not be directly affected by non-HK Asia's comparative disadvantage in the export sector as the dollar falls

  3. Being outgunned by bigger rivals is a constant risk, not a new one. Yet Standard Chartered has still managed to become the largest foreign bank in India (around 10% of its revenues) holding the top spot in credit card lending and the number four slot in mortgage lending. It has also managed to develop its China operations with a 19.99% stake in newly established Bohai Commercial bank. The significance of a "new" bank is that it comes with no hidden luggage and is likely to provide Standard with a greater management role

  4. True enough. But the lower bad debt allowance is a direct result of early repayment of HK mortgages. The accounting is not gimmickry.
Standard Chartered is a defensive in the current environment, notwithstanding the constant of political risk, but carries also exposure to growing emerging asian markets. At 12x 2005 earnings it trades at a premium to UK and European banks (typically 9x-11x) but is at a modest discount to Asian counterparts (at 12x-19x). The same pattern holds for the price/book ratio. The company yields 3.3% denominated, sadly, in $US and modestly covered 1.6 times.

A holder of sterling, Capital Chronicle watches the share price decline with serious interest. The shares are trading at 958 pence at the time of writing.

The author has no shares in Standard Chartered plc at the time of writing

Further related dollar comment: although it has recovered over the last couple of days, perhaps due to short covering, downside risks remain. Macro factors apart, the US retains its laissez-faire policy; and OPEC members are happy to unload the currency as its depreciation hits their huge balances. OPEC are even making noises about pricing their product in euros.

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Wednesday, December 01, 2004 | 0 comments »

Time out.

Take a sample basket of currencies to see how they performed recently against the United States dollar.

Conclusion? Well, it's an interesting week when the Iraqi dinar, the Haitian gourde and the Zimbabwean dollar all appreciate versus the greenback.

Exhibit A: What does US1$ buys against the...

23 November
Iraqi dinar=1,461.2
Haitian gourde=35.57
Zimbabwean dollar=5,751.6

30 November
Iraqi dinar=1,454.9
Haitian gourde=35.50
Zimbabwean dollar=5,656.8

Source:, currency converter

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