RJH writes...

'But why drives on that ship so fast, Without or wave or wind ?'

from "The Rime of the Ancient Mariner"

The Baltic Dry Index (BDI) is a measure of shipping rates paid to move ocean freight worldwide. Since it measures paid prices the index reflects real economic activity: it is not an index based on opinion, speculation, greed or fear. Its trend is therefore a useful yardstick against which investment market levels can be judged.

Traders of US 10-year Treasury notes have usually forecast economic prospects as reflected by the BDI correctly. Indeed, 10-year Treasury yield data has led the BDI with two exceptions in the last decade. The first of these began in the summer of 1995 when (unshippable) telecoms and IT equities sailed forward on a sea of Fed liquidity despite a falling BDI; and the second began at the trough of the market fall in spring 2003 when investors were fearful of buying equity - even as the BDI shot up.

It may be time to write-up a third divergence. At end February 2005 the BDI and the 10-year Treasury appeared to part company.

Exhibit A: BDI and Ten-Year Treasury Yields - you take the high road

With the BDI at the time of writing at 2,407 it is still at heights unscaled before 2003. However, if it goes below 1,750 with conviction - and it was at 1747 this summer - the index will simply be reverting towards its long-term mean. This is not merely technical-analyst talk: there are sound reasons why this is likely, covered here by the Economist magazine.

Treasury yields, meanwhile, have been insensitive to these developments and are continuing to reflect - perhaps above all - just how much cheap money is sloshing around. Nonetheless, for the businesses and sectors exposed one way or another to shipping activity the outlook is distinctly gusty to gale-force:

Exhibit B: BDI and Clarkson Plc, the world's largest quoted shipping broker

Clarkson Plc is an excellent company in which this scribe owned equity until earlier this year. Why sell? Because the trend of this graph suggests that investors in companies exposed directly and indirectly to shipping markets (or both, as in Clarkson's case) have continued to buy into the boom story (China, commodities, emerging market strength et al) even as demand for freight services tapers away.

Does this herald a fall in world stock markets? In itself, no. Yet it is certainly not a good sign that aggregate demand for shipped goods and raw materials is dropping sharply. Markets do not seem to be paying attention so far: the example above of Clarkson plc is a proxy of a more general observation. However, as in 1995, it is always possible market leadership may come from sectors unconcerned with freight rates and activity. But that would be a courageous and potentially expensive passage for investors to book.

Happy New Year.

Credits: The 10 year Treasury / BDI background (para 2) comes from a 2002 article by Howard Simons.

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RJH writes...

Increased merger and acquisition (M&A) activity is cited by several equity research desks in the City of London as a catalyst for positive investment returns on the London financial markets in 2006.

Indeed, in 2005 so far the purchases of O2 by Telefonica for £17.7bn and Allied Domecq by Pernod Ricard for £8bn have probably helped propel the markets. Premiums paid on such deals in addition to the reinvestment by fund managers of proceeds received are doing their part in a solid year for gains.

At the aggregate level, foreign purchases in 2005 year-to-date have been enough to make the UK a net seller of its companies to overseas investors. 2004 was also a net sale year for the UK with M&A dominated by the purchases of Abbey National by Santader Central Hispano for $15.8bn and Amersham by General Electric for $9.6bn. At end 2004, 33% of all shares listed on the London Stock Exchange were held by overseas investors. That is about the same as the combined percentage controlled by UK insurance companies and pension funds.

Long live the open economy but, without overstating the argument, as companies like these pass into foreign ownership and out of domestic bourse listing the UK investment prairie shrinks; companies smaller than those acquired become included in the main indicies such as the FTSE100; investment focus is forced upon less than large caps; management of investment risk becomes more important; and strategic/political worries about ceding control of domestic companies to foreign interests become sharper.

And at the extreme end of the argument there is the impact on the financial account of the balance of payments to consider - essentially, asset sales to help fund a persistent current account deficit. Temporary comfort but longer term difficulty.

So what has been the longer term trend of M&A in the UK?

Exhibit 1: UK abroad vs Foreign into the UK M&A, 1987-2005 ytd


It turns out that the UK is a net asset acquirer since 1987. The eleven years to 1997 saw cumulative net purchases by the UK of £20.6bn; and the next three years were dominated by a handful of monstrous deals which saw the UK become the new owner of £148.1bn of net foreign assets, most notably:

1998:
Amoco, bought by BP for $48.2bn

1999:
Airtouch, bought by Vodafone for $60.3bn
Astra, bought by Zeneca for $34.6bn

2000:
Mannesmann, bought by Vodafone-Airtouch for $202.8bn
Arco, bought by BP Arco for $27.2bn
Bestfoods, bought by Unilever for $25.1bn
Credit Commercial de France, bought by HSBC for $11.1bn

But since 2000 the UK has lost net assets of £14bn to foreign interests and, compared to the pre-1998 period, that is a sharp deterioration. It is in that context that the predictions of bonus-minded investment bankers sit: 2006 will be a bumper M&A year - deals as large as £50bn will reappear and, it is claimed, never has there been such a good time to sell. Find a credulous buyer and let the good times roll.

It will be fascinating to see how this potential cookie crumbles for the UK's net M&A position. Equally, the composition of such deals (what mix of debt, cash and equity) in what may well be a deteriorating macro-economic picture 12 months down the road may be entertaining - can you say "3G auction"?

Sources: UK's Office for National Statistics; UNCTAD World Investment Report (various years)

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RJH writes...

Keeping with Wednesday's theme, but with less words.

Exhibit 1: UK inflation expectations against the AIM

Another reason, if you needed one, to avoid or select carefully amongst equities majority exposed to the UK economy.

Sources: Bank of England; Yahoo UK Finance

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RJH writes...

"They say I slept with seven Miss Worlds. It was only four."

George Best, RIP

Everyone can disappoint expectations, even the greatest of soccer geniuses (albeit not always in the sporting arena). Perhaps unsurprising then that even the unglamorous, non-footballing and unacclaimed-by-the-opposite-sex métiers of investor and trader must consider them to prosper.

Take, for example, the talk of year-end rallies, January Effect et al just now. Bullish expectations are high; and markets have moved much faster than this scribe would have believed in those low-October moments. But reflect awhile on another set of expectations.

Exhibit 1: S&P500 vs. US inflation expectations (nominal less inflation linked 5 yr Treasury rates)

The S&P500 data, lagged in the graph by 7 months, correlates with the inflation expectations by over 85%. And this leading indicator of inflation expectations is calling an imminent drop in US equities. Money illusion for the economists, and not a bullish picture.

Exhibit 2: US inflation expectations vs the euro

Inflation expectations drive the S&P500 not only via money illusion (it would seem); they also have the effect, in this declining case, of weakening the dollar's major rivals (this graph holds for sterling also). Why mention this? Because - and this is truly Yuletide fare - there is (for now, anyway) a strong negative link between the dollar and the S&P500 (yes, yes - counter-intuitive) which at its current level is suggesting that the next fall in the S&P500 will not be of the buy-the-dip variety.

Exhibit 3: S&P500 vs. the euro:$ rate, offset by 12 months

Why the dollar weakens whilst the S&P500 strengthens (and vice-versa) is a link the scribe is unprepared to attempt meaningful explanation of here although research may reveal the answer lies simply with the bond market (or complicatedly not).

However, so long as this predictive relationship holds (86% correlated since you ask), the euro is signaling that the S&P500 may be expected to commence a retreat in earnest below its 200-day moving average around end-May 2006. But the inception of the slide will have started well before then. About now/January, actually.

Nonetheless, the problem with this entire line of reasoning is that it is not backed by the economic data in the scribe's main model. Six months may, or not, change that.All in all, unseasonally low-key thoughts revealing this writer's mastery of timing and killjoyism; qualities explicative of the lack of Miss Worlds in his life (to date). Or at least that's preferable comfort to the "butt ugly" school of thought.

Merry Christmas and a Happy 2006.

Sources: Federal Reserve Banks of New York and St Louis; Yahoo Finance; European Central Bank

Credits: The idea for this post came from an article by Howard Simons .

NB: Don't know George Best, one of the top 5, perhaps top 3, footballers of all time? Video download here.

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MD writes...

Know yourself. Nothing in excess. A pledge and ruin is near.

The three maxims of the ancient Greek city of Delphi.


Not long ago your correspondent wrote of the limp business reporting standards in the UK national press with reference to one piece in particular from The Daily Telegraph. That article suggested that GKN would be better off in the hands of Delphi. This despite Delphi at that time being to all intents and purposes bust. Well, guess what? Delphi filed for Chapter 11 protection on 8 October 2005.

This has serious implications for banks, regulators and the major US and other motor manufacturers who are dependent upon them. And then there are the pensioners, shareholders and debt holders. Delphi has already asked GM for guaranteed business of circa $12bn per annum and received, so far, nothing.

Understandably, GM must be loath to make any other pledges to Delphi having at the time of the spin-off of the former GM division in 1999 granted its 4,000 employees the right to return to the fold should things go pear-shaped. Counting wages and benefits this amounted to perhaps as much as an $11bn cost pledge with no similar offset on sales.

Meanwhile, Delphi's workers are pondering strike action, a result that would likely shut down GM's US production and burn through GM's cash pile (the last 10Q showed the auto ops had $13.7bn) faster than the current management is doing: GM's auto ops have lost $(6.0)bn YTD 9.

A strike, therefore, is just about the last thing GM needs now; and for UAW readers that's a survival not a negotiating assessment. Separately, the company announced yesterday the closure / running down of 12 plants and the sacking of 30,000 workers. Time will tell if this is enough to save the family home from burning to the ground but there must be doubts.

What may be concluded? Well, Visteon - the number two major US components maker - is probably not far behind Delphi despite recently handing back tens of plants and thousands of workers to previous parent Ford (one of those pledges again). GM may well fold in 2006; Ford may survive. However, it's not beyond the realms of imagination that there will be no major US-owned multinational car manufacturers within 5 years.


[Editor: And nothing stands but for his scythe to mow.]

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MD writes...

Today the break-up and preparation for sale of a great company continues apace (no doubt inspired by advisors Goldman Sachs) as Cadbury Schweppes announced on 21 November the sale of its European beverages business to a consortium of Blackstone Group and Lion Capital for £1.27bn - barely 10 times operating profits.

This business is more profitable than the main bits of the company (and significantly more so in ROS terms than the dubious Adams gum purchase in December 2003). It is also cash generative, has a better ROA than the US business and appears under-managed: they have singularly failed to exploit the opportunities of the Orangina brand and the Schweppes franchise Cadbury all but gave away in the UK to Coke. In sum, it is a great opportunity for the buyers and another missed chance for shareholders.

Ought Cadbury shareholders to be looking askance at the company's independent Non-Executive Directors (NEDs) in this story? Cadbury have six of them:

1. Wolfgang Berndt
2. Rick Braddock
3. Roger Carr
4. David Thompson
5. Rosemary Thorne
6. Baroness Wilcox

NEDs are there in the main to protect shareholders interests. It would be interesting to hear their side of the argument in going along with this deal [Editor: this site is systematically scanned by the press offices of the larger companies mentioned so who knows]. That is, after all, what their fees are for. Cadbury NED fees range from £45k to £90k before any supplements, at least half of which end up in the form of Cadbury shares (details on page 9 at this link).

Nice, but does such a deal engender the same level of NED commitment to shareholders as having NEDs buy-in from the start with their own cash? To those who doubt it, it comes as little surprise that business deals such as this sail through with little, it seems, difficulty at firms with NED fee structures similar to that of the aforementioned. Is it any wonder that so many "independent" directors are held in low esteem?

Perhaps this is harsh on the Cadbury NEDs - note to the CBRY press office: right of reply guaranteed.

[Editor: The online spellchecker suggests "cadaver" as an alternative to "Cadbury". They aren't there yet, surely?]

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RJH writes...

An opinion for his partners:

US Macro Commentary:
Markets are fearful and unsteady after various inflation-scare remarks from Federal Reserve officials. Gold prices have climbed as an inflation hedge; stagflation theorems are appearing; energy prices continue to headline; and the other usual suspects remain at large (deficits, Osama et al).

The key issue appears to be the question: is central bank policy reconciling itself to inflationary pressure in the face of already declared central government spending (particularly on disaster relief if not on the conflicts in Iraq and Afghanistan)? If yes, that seems to imply controlling inflation with higher short-term rates even at the price of economic growth. If no, the inflationary impact does not bear thinking about.

Overall, market sentiment is very poor and markets have been/are selling-off. Our own model data is mixed, but leaning positive. The yield curve flattening continues; risk aversion grows; but the PMI index is expanding and the S&P500 is higher than the 6 months prior period. Moreover, the Philadelphia Fed's Anxious Index is sanguine. Overall, the risks of a GDP contraction in the next 4 quarters look less than 10% based on the Estrella-Mishkin probability table.

The logical approach in this environment is to buy those equities that meet our technical and fundamental criteria. Poor sentiment has historically been a consistent contrary indicator: if the macro picture holds this strengthens the view that we should be looking for purchases.

Stare into the precipice and jump. Or not.

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RJH writes...

(17 October Update: Oh dear.)

Recently instructed politely to stop smoking carpet after suggesting that the bombed-out UK consumer discretionary spending sector had at least two potentially lucrative quoted companies, the scribe decided to take a closer look at the macro-data.

Exhibit 1: Last 24 months retail, GDP (by quarter) & house price data

Exhibit 1 shows the sad trend for retail, housing and GDP over the last two years. And within the slowing retail data lurks the collapse of bigger ticket items such as furniture sales. Thus a company like MFI can suffer 15% like-for-like sales drop and breach its banking covenants. Yet it is in that sub-sector one of the scribe's potential interests lies. On the one hand, short of an accounting fraud, it is hard to deny said firm's attractions; on the other, its numbers are beginning to look too good to be true in the greater context.

But what precisely is the greater context? Over the last decade GDP and retail sales have been about 70% correlated; house prices and retail sales about 69% correlated; and, for the benefit of the Chronicle's resident cynic, GDP and new car registrations about 73% correlated (car retailing being where the other potential investment is parked). Exhibit 2 illustrates.

Exhibit 2: Retail, GDP and housing data 1985-2005 (plus GDP forecasts)

Accepting as valid a 2006 GDP forecast of 2.2% growth alongside these correlations suggests aggregate house prices increase in the single digits; and that a modest pick-up in retail sales occurs. But if either development were other than patchy it would be surprising.

There are risks, of which: the UK is becoming a net importer of oil again; Government borrowing plans are at risk from fewer than forecast corporation tax receipts (to mention but one problem); and housing appears to be at the downward inflexion point in its 7 year cycle (if the existence of this cycle is accepted).

Conclusion: ease up on the carpet. Contrarianism is one thing, but at current equity prices retail investments still carry too much risk. However promising individual companies in the sector may appear, keep a watching brief for now.

Sources: Nationwide's house price index; Her Majesty's Treasury; UK Department of Transport. The 2006 GDP forecast is based on the average of 26 City of London firms and 13 non-City forecasts made in September 2005. HMT's own forecast of 2.5%-3% is excluded; and it is notable that one forecaster is predicting a contraction of -0.2%.

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RJH writes...

7 October 1571 and Don Juan of Austria leads a European Christian alliance to victory against Sultan Selim at the naval battle of Lepanto. Much as the defeat at Stalingrad in 1942/1943 showed the world that the Nazis could lose catastrophically, Lepanto destroyed the myth of Ottoman invincibility and marked the empire's first step onto the slippery slope.

Nearly 435 years to the day and the Austrians - led this time by the less romantically named Foreign Minister Ursula Plassnik - were back at it, opposing Turkey's entry into European Union (EU) accession talks. These negotiations were previously agreed to by all EU members, and were due to begin today.

For this battle, though, Donna Plassnik did not have the backing of a single ally. Or at least none that wanted to stand up officially and be counted. Austria thus backed down for the price (reportedly) of smoothing the passage of her friend Croatia's own EU accession bid.

Capital Chronicle has covered Turkey and the EU before ("Turkeys voting for Christmas"). Our view has not changed: there is a clear gap between the views of EU political leaders and those of their populations regarding the desirability of Turkey's accession. Doubters need only consult the final page of the EU's Eurobarometer's latest survey results here for confirmation. Turkey is dead last in this popularity contest with only Albania as the nearest company.

But with Turkey's accession negotiations estimated to last a decade, this episode, unlike Lepanto, is but a minor skirmish. And prelude.

[Editor: So enjoy the Turkish emerging market gains before battle is rejoined. PS - an Austrian Don Juan?]

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RJH writes...

The reason no one drops $2 billion into a new refinery to increase the supply of car/airplane fuel is that it is not profitable. It makes more sense to make investment in exploration and production rather than pay a fortune for a doubtful return within the environmental mine field that is refining. That is why the last US refinery was built in 1976.

Yet Sir Richard Branson (pictured below) sees a profitable way through this financial conundrum. He is pushing for talks with the UK finance minister, Gordon Brown, about constructing a new refinery. After all, as Sir Richard says, "The big oil companies are making extortionate profits out of the current oil price" and consumers are crying out for a Samaritan. Or, Gordon, two.

The idea is bound to have at its centre Other People's Money (otherwise why speak to the government). Conveniently, that is what Chancellor Brown controls - the people in this case being UK taxpayers. The Debonair Fox may have spotted a chance for Mr Brown to again taxeth away from many and giveth to another. Another like, say, the Virgin Team. And, who knows, Mr Brown may well be able to create a few more public sector jobs for the project while he's at it.

One day, eventually, the right hand and the left hand will communicate. In the meantime, be on the look out for another outbreak of Millennium Dome Syndrome.

Asked for comment on the topic, well-known power-boater, ballonist, aircraft proprietor and altruist Basil Brush (also pictured below, bearing an uncanny resemblance to Sir Richard) said:

"Boom! Boom! Marvelous idea! I'll definitely be keeping the Land Rover on the road!"
















[Editor: Cynicism is a terrible thing]

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RJH writes...

Conclusion:
At mega-investment Coats (30% of GPG's non-cash assets), there has been no decent top-line growth; and an expensive drawn-out reorganisation continues. The opportunity cost of holding GPG shares in 2005 versus a simple FTSE100 index tracker has been 3 percentage points. And, based on Coats' Chairman Dr Weiss' own outlook for his baby there is little reason to expect its parent to outperform until the end of next year. Maybe.

Background:
Released this morning, Guinness Peat Group plc's (GPG) results give pause for thought...and doubt.

GPG's acquisition of Coats (background here and here and here) has been its main point of interest. Yet Coats' result is not as rosy as the prose to the latest interims suggests.

Perhaps this scribe's expectations for Coats sales growth post-Multi Fibre Agreement (MFA) were unrealistic. Yet it is still a shock that turnover (like-for-like) is only up 2% - a deterioration from the itself ordinary 3% rise reported for the first 3 months of 2005 and less, even, than the '04 interim increase.

Further, it astonishes that Chairman Weiss ventures nothing about the impact of the abolition of the MFA, the new quasi-quotas on China or the shift of textile producers' output to India. There is not, in fact, a single sentence that helps shareholders understand the dynamics of the new MFA-free world and its impact on the company.

In the full year 2004 accounts for Coats, Dr Weiss said (scribe's highlight in red):

Prospects: 2005 will be another year of reorganisation and consolidation, the full benefits of which are expected to be reflected in 2006 and beyond. Investment in new plant and reorganisation spend in 2005 is expected to remain at a similar level to 2004. As in 2004, disposal of surplus assets should largely compensate in terms of cash flow. This spend should start to reduce from 2006. Given the nature of the textiles and clothing industry, there will inevitably be an ongoing requirement for further adjustments in capacity at specific locations but the associated cost of transfer is expected to be significantly lower than in recent years.
Today Dr Weiss says:
Outlook: The trading outlook is not without its challenges. Where possible, it is intended that the remaining restructuring of capacity will be accelerated, principally in Europe. Restructuring cost is therefore expected to continue at relatively high levels until end 2006. However disposal of surplus property will continue to provide a significant offset.
To this shareholder that indicates an admission that Coats was in more of an organisational mess than GPG anticipated; that the expected return on investment has slipped out in time; and that the board has not yet found the recipe for meaningful sales growth - or that the post-MFA environment is simply not conducive to this.

A final point. It is noticeable that Coats has increased debtors and decreased creditors at the same time. As your correspondent's writing partner commented, for a company (GPG) that prides itself on cash management that is a concern. Managing a multinational in a raft of new economies, each with their own regulations, must not be as easy as perhaps they thought.

NB: The writer held GPG shares at the time of writing

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MD writes...

It is astonishing how shamelessly arrogant, greedy and frankly dangerous movers and shakers of the investment community have become. Non-bids are all the rage now: the latest is Gerry Robinson and his bid vehicle Raphoe's non-bid for Rentokill Initial.

The core message of Mr Robinson is, essentially, "Put me in charge for £50m or so (plus a salary) and I'll give you back your own money." Ah, yes - without saying how. Answer: by borrowing and issuing new shares - for Gerry.

Eh? Mr Robinson's record doesn't bear scrutiny: he doesn't grow businesses. Witness Granada and Allied Domecq, the latter a particularly good company, sold for a song earlier this year.

It emerged at the weekend that Franklin Templeton hold 15% or so of the shares and are nursing significant losses, yet support Robinson's strategy. Strategy? What strategy? Please, tell shareholders what you'll do differently. Clearly a reporting / measurement period must be drawing nigh for Franklin who will be compelled to declare a poor performance. Hasn't anyone told them that shares can go down as well as up?

Rightly, the incumbent Rentokill Initial management have told Robinson to get on his bike. Keep the faith, guys, and demolish his bid. When, or if, it arrives. The Take Over Panel [read: a tool of the investment banks] should start the clock and tell him to put up or shut up.

Meanwhile, the FSA [read: apparently looking after our interests] must step in and stop one set of self-interested investors getting privileged inside information on the books of Rentokil (and many other companies, it may be said) at everyone else's expense.

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Investment Professionals

Tuesday, September 13, 2005 | 0 comments »


MD writes...

It has long been the case that most successful investment professionals have either been lucky, at no risk to themselves with other people's money, or in possession of information the rest of us don't have. A very select few have the skill, the investment nous (as well as the understanding that cash is ultimately king) and the luck of Messrs Munger and Buffet of Berkshire Hathaway.

So no surprises then to find that some of the biggest losers in the PartyGaming fiasco (apart from the Dresdner Kleinwort Wasserstein reputation) are the investment professionals. M&G's words, not mine; and they've surely lost a packet of your and my money.

Sadly, PartyGaming still seem a fair bet (geddit?) to join the FTSE 100 this month. Tracker funds will be obliged to join this nonsense; and this scribe foresees plenty of miss-selling cases in the future.

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RJH writes...

Commonplace are media articles covering emerging market virility, particularly that of the regional grouping once known as the Asian Tigers. From the inevitability of Chinese global superpower domination within 20 years to compulsory instruction in chopstick wielding in a soon to be established re-education camp near you, emerging market publicists have outdone themselves.

But consider this table:

GDP & Related country data (right click and Open in New Window)

Conclusions:
1). Sinophobia surely is misplaced. China's absolute GDP is middling in the global scheme of things; and, frankly, the frequently cited Purchasing Power Parity of GDP flatters to deceive. PPP is helpful as a guide to long term exchange rates; it gives a clue (and not much more) to living standards; but as an indicator of global economic power it is misleading.

2). Unless one has specialist or expert knowledge, the UN Development Programme's Human Development Index is a helpful risk proxy for the chance of individual investments in emerging markets going pear-shaped due to, say, political upheaval in one form or another. The average emerging nation ranking in the table of 96 out of 177 is barely a start to the pursuit of happiness, a bumpy road.

3). A scan of the GDP/capita data (either version) reveals emerging market nations (Korea excepted) as cheap labour producer-economies highly dependent on consumer behaviour in more diversified and rich economies. Investing in them is most accurately a bet on OECD-type consumers continuing to buy there in heroic amounts - for it is certain their own consumption is bulimic.

4). With many emerging economies locked in an unenviable internecine production battle without the safety net of meaningful domestic consumption, can 644 million wealthy consumers really lift 2,890 million poor emerging market producers (or even 1,288 million) out of poverty in this century?

5). Emerging markets' aggregate GDP is probably not as large as you thought.

6). Diversified developed markets may not be low-cost producers, but they have the widest and most stable spectrum of investment possibilities.

7). Investors might usefully find a place for Korea in their portfolio - it is surely the pick of the emerging market crop for investments in growing, non-tradable consumer companies.

NB: [Editor: Many emerging markets, particularly China and much of southeast Asia, are energy inefficient. $70/barrel crude oil makes their undiversified economies that much more vulnerable to crisis/downturn.]

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Made in France

Friday, September 02, 2005 | 0 comments »


MD writes...

Three cheers to the French for clearly stating what many (outside the City, that is) believe: it is important to build champions and protect the national interest.

François Loos the Industry Minister (HMG take note – Industry Minister) articulated this earlier in the week by pointing out that business should be "shielded" from foreign take-over bids [Editor: though how "strategic" yogurt making is - see postscript below - might be, ah, questioned]. Even better, this hit the press when one of Britain's few remaining world leaders (BPP) was on the unwanted receiving end of a bid from French Champion Saint-Gobain. Couldn't have planned it better.

Vive la France!

PS: When, last month, Groupe Suez (French in case you hadn't guessed) announced it was taking over the 49% minority of Belgium's Eltrabel (the profitable and cash generative part of the business) a Belgian wag retorted that electricity was rather more strategic than Danone (the French food group recently "protected" from PepsiCo).

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MD writes...

To no great surprise Cadbury Schweppes announced today (1 September 2005) that they were selling - oops, sorry slip of the tongue - seeing if anyone was interested in buying their European beverages arm. The question I ask myself is, "why"? Say it louder chaps - "WHY?" By their own figures the business represents 10% of group revenue and 11% of group profits at an operating level (and enjoys better margins than the rest of the business). Well done chaps! Showing all the signs of a fee-driven City deal here.

Justifying the deal the company spouted wonderful double speak:

"The overriding goal is to deliver superior shareholder returns."

Fell at the first hurdle then, and:

"This is supported by two commercial goals which are to profitably and significantly increase global confectionery share and profitably secure and grow regional beverages' share."
And fell again at the second. Where is the "securing of regional beverages' share" in this deal?

Overall, Group operating margins were 14.4% at the half year 2005. The sale of a business with margins of 18% hinders Cadbury's efforts to improve on this. Nor will the deal do anything to maintain their position as the world number 3 carbonated soft drinks group: £650m of revenue does not grow on trees.

Bizarrely, up until last year Cadbury Schweppes were intent on growing this business. In 2001 they part-acquired Orangina; and in 2004 they acquired the balance of the business. So why the change of heart? Is the answer related to return on assets? Well, the business matched the group in 2004 (11.4% vs. 11.5%) so no.

In conclusion, a very bad deal which gives up strong margins and market share in key markets; and which loses all the upside of the new opportunities in the UK and elsewhere for Orangina (now they can market it in the UK).

But doubtless the future has been superbly conceived in some advising merchant bankers medium term plans: sell the worldwide beverages thus setting-up the rump up for sale to Nestle, Hershey or some such group.

PS: Note to City Editors - none of the above was hard to find or produce from Company supplied information. Please, get your acts together and start doing analysis and decent commentary rather than believing all the financial PR guff.

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RJH writes...

Context & Company:
Sanctuary has seen bid talks broken off recently; it has renegotiated finance terms with lenders; and has issued disappointing trading updates. If it is to be bought, and that is surely what lenders are craving, the plc has a serious negotiation to undertake from a weak position.

The Sanctuary Group plc described themselves in their last annual report thus:

Sanctuary is one of a kind. We are a diversified international music group with a unique approach: we call it the 360 degree business model.

The shares have declined from 42p in mid-June to 9.5p today - a 77% drop in less than 3 months.

Yet Sanctuary manages an impressive array of popular artists (amongst other related activities). Can the equity behind such popular products really stay depressed? Or is a share snapback due, even if only on a contrarian basis?

Opinion:
[Background track, Guns N Roses, Ain't it fun]: Red carpet interview quote - colourful and glossy reports, man. Dude - possibly the best posed board photos in town (check out Merck "Bad Boy" Mercuriadis' shot). And - mate - hip, fly, cool, wicked "passion for music" company products. Yeeeeaaah!

[Background track, Jadakiss, Kiss of Death]: Shareholder view - who has been (not) running the company? Read the interims - did the £88m of debt appear as unexpectedly as the prose suggests? Now management says it is at "a higher level than the Board is comfortable with going forward."

[Fade to Elton John, I guess that's why they call it the blues]: Part of this debt increase financed the acquisition of Twenty-First Artists from Sir Elton John. Yet turnover is still declining at the half (-4.5% and a frightening -12% pre-acquisition). The interim report talks about slippage but that's a veritable slip, collapse and hospital job.

[Fade to Robert Plant, Trouble your Money]: And what does this sentence from the interims mean?

"In line with its strategy, the Group has stepped up its infrastructure to support its longer term expectations in growth of sales and profits."

If it quacks, it's a duck - and that is unidentified, unquantified additional cost already en route. Swiftly on the heels of that declaration comes:

"The Board intends to cut costs, but not at the expense of damaging the Group's prospects".
Hardly meaningful contributions to managerial science or transparancy by the Sanctuary board; and less helpful than unambiguous commitment and plans of What They Will Do.

Financial Condition
Of course, much of what was in the interim report has been overtaken by events. Nonetheless, potential investors ought to consider more than the possibility of a bid from Warner (or whomever).

[Fade to Groove Armada, But I feel Good]: When goodwill is 60% of fixed assets, balance sheet liquidity is often worth looking at. Net current assets are £26.6m shy of long term liabilities at the half. Ignore goodwill and intangibles (yes, arguable since it's the Sanctuary record product catalogue) from the fixed asset total and saleable gear sits at £31.7m. And they'd never get close to that in a fire sale. Now, while this may be an original view of liquidity, some investors like their comfort. Especially when management are in an uninspiring phase.

[Fade to Slayer, Hell Awaits]: Liquidity is threatened by cash bleed, hence (so it seems) the urgent need for a bidder. Cash lost at the half totaled £7.3m, and you may want to read note 8 of the accounts. When (and during a poor top line period) finance managers and/or the board reduce creditors and increase debtors, shareholders are entitled to wonder what is going on. This combined action hemorrhaged £22.3m of cash and deserves more explaining and remedial plans than are evident in the report. Does anyone actually manage working capital month in and month out?

[Fade to The Who, The Real Me]: The scribe would feel more forgiving if Sanctuary did not have episodes resembling previous (Editor: note for non-UK readers - as in "previous convictions"). The 2004 annual report speaks touchingly of the "360 degree" model and its subsets, one of which is entitled "Financial Discipline". This scribe reads the blurb, looks at the numbers and concludes this is a plc run by the marketing and sales functions. What kind of financial discipline is it, for example, to issue loan notes of £28.3m in Feb 2004 (in itself an interesting story) followed by a £11.4m provision against these a bare 7 months later (see note 13 of the 2004 annuals for the detail)? This was classed an exceptional; but similar risk assessment methods will cause more such platinum non-musical hits going forward.

Redeeming features?
[Fade to Destiny's Child, Show me the Way] If the divi is maintained (ah, recall that cash bleed in urgent need of attention) yield is 5%+. The Capital Chronicle screening model (warning: eps & divi based, not holistic) likes it up to 12.8p. So at the current 9.75p it looks good - bombed out, even, at current PE levels (3.1 now, 4.2 next year - but based on eps estimates made prior to the latest trading updates).

Large trade bidders with proven, long-term financial management skills (and stronger balance sheets) must surely be eyeing-up Sanctuary as a tasty morsel ripe for integration into their businesses. Four times '06 earnings? And the buyer gets the 150,000 tracks in the Sanctuary music catalouges?

For their part, shareholders should hope existing Sanctuary management can pull a cat out of the bid-bag at a lot more than the current share price. But don't bet (much) on it, negotiations have failed once already.

Finally, as a go-it-alone proposition potential shareholders should factor in the company's recent financial management position / record / ability; and condition of the prevailing retailing environment, at least in the UK. On that basis the shares are a contrarian bet too far for this correspondent.

[Fade out with James Blunt, Tears and Rain]


NB: All background music the work of artists - sorry, arteests - currently associated with The Sanctuary Group plc. Value that.

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Between moules-frites and sancerre, MD writes...

The scribe went to the Made in Belgium exhibition last week (10/08/05) at the Dexia Art centre in Brussels. For those who don't know (and, let's be fair, that'll be most of you) it celebrates 175 years of Belgium as a stand alone country. Interestingly, the English commentary at the expo missed out some parts of the exhibition which focused on recent history, but I'll leave the detail for you to find out for yourselves (Editor: surely not the Eddy Merckx vs Lance Armstrong debate?).

The exhibition provided a potted history of all things Belgian and events in the territory from pre-history to the present. It was in comparison a marked contrast to the absolute crap dished up by HMG at the millennium dome.

However, and as ever in Belgium, there are some notable omissions: nothing on Hergé the creator of Tintin (some nonsense about his estate not being invited to participate in time); ditto, nothing about Johnny Halliday (Editor: still collecting his albums?); and and no doubt others.

In the industry sector contemporary achievements were presented and a number of companies in the engineering field caught the eye (notably in transmissions and aerospace). GKN might usefully investigate some of these for its cash pile (see previous post). But I also noted some potentially interesting companies as investments (some of which are quoted in New York and/or London). Readers seeking international diversification might want to research:

* Dexia (according to some the best bank here)
* Group Delhaize (int'l supermarket group; equity is up 400% since early 2003)
* UCB (biopharma group)
* Solvay (chemicals & pharmaceuticals)

NB: 5 famous Belgians - Eddy Merckx (The Cannibal is the greatest cyclist of all time), Jacques Brel (the late great ne me quitte pas musician), Jackie Ickx (motor racing, 6 time winner of Le Mans 24 hours), George Remi (aka Hergé of Tintin fame), Peter Paul Rubens (just google him if you don't know).

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MD writes...

Whilst seasoned City types know the truth (apparently), the average punter regards the financial pages as a generally unbiased view on all things in the world of business and commerce. Subject, of course, to the paper's editorial slant.

However, this writer's ire was raised somewhat last week when the Daily Telegraph did a particularly sloppy piece (05/08/05) on GKN plc's recent results. Unfortunately, the article is evidence (if proof were needed) that the financial pages are frequently simple mouthpieces for the investment banks. Real news analysis struggles to get a look in.

I quote from the "Questor" column edited, if that's the right word, by Philip Aldrick.

"GKN is the market leader in...The management has proved highly
competent..."

and then he completely lets himself down with:
"...but its operations would sit more comfortably with a major US parts supplier like Delphi or Visteon."
My gast was flabbered, my gob was smacked! Who writes this nonsense? (Editor: you do).

Has it not escaped his notice that Visteon is to all intents and purposes bust and Delphi close behind, not to say many other US parts suppliers? Why would this be better for the company? Would it increase revenues? No - arguably they would decline as manufacturers demanded bigger discounts as part of a bigger group. Would innovation increase? I doubt it, not much left cash you see after a purchase.

And, oh, by the way UK Plc would lose out as R&D shifted, dividends flowed the other way, the balance sheet became more highly geared and the tax take dropped. Still, you know this makes sense...it would provide fat fees for the deal driven "advisors" in the City.

We, and the Telegraph, deserve better than this nonsense.

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How to invest. Step 2 - avoid risks with no obvious counterparty, aka don't arrive early. MD emails his reply to RJH...

RJH,

My comments for what they are worth.

Recommendation:
A bit like Matalan they've grown very fast; there has at some point to be a slow down. Now seems to be the time when that will happen. Whether they are lucky with the cycle and the fyr September 2005 results are good and it's in the first half of the new financial year that things turn down big time - I can't say. But I think the point is we're 18 months too late. Too risky for me so now so I'll avoid.

But I'd buy on signs of economic recovery. And yes, I know we're not, apparently, in a recession.

Rationale:
I've had a look at the spreadsheet and the assumptions (for a growing business) seem reasonable - if you think growth will continue. I've also just this minute found the interims (via Google) which, perhaps curiously, aren't on the investors page nor are the 2003 results - a poor year. Their absence is, I'm sure, an oversight! I also note these are draft audited not the pukka job.

* Management appear to act quickly - so probably a sound team;

* I note that they quote the order intake for 33 weeks (ie 8 month performance) is up 6%, so well shy of the growth they've reported of 19%;

* I also note that a (new) director (Editor: the Finance Director) bought in July;

* I see they have also closed another depot (Hitchin), there will be some costs for that (though may be they are already booked), there may be distribution problems as a results but probably not significant;

* Looking at the prior year to 2004 I noted:

(a) "progressive dividend policy" - euphemism for over distributing
(b) "major and specialist player" - erm, can you be both?
(c) [2003]"..disappointing result being well documented" (not to me)
(d) only recognise sales when delivered (I assume already paid for) and thank goodness for that
(e) "unique mezzanine floor layout" - well knock me over...
(f) "...20-25 suppliers...approx. 75% UK based...& regional exclusivity"
(g) admin expenses up sharply 18%...can't all be staff costs can it?
(h) Web site - "Cor Blimey guv - just like the Sun & it has an 'enders chap flogging the stuff!"

* Cautionary note - retail is very tough at present, particularly furnishing;

* health of housing market has a major impact on their volumes;

* they are (I think) heavily biased to the north where spending power may be squeezed more;

* I'm guessing like-for-like will show a decline in the second half; they are expanding very (too?) aggressively; and they will be (are) caught in the upwards only rent reviews;

* how secure are their cash flows - is it all via a fin co?

Usual disclaimers.

MD

NB: RJH Verdict - still attracted by that cash pile. But share price at 327p does not cover the risks, even assuming enhanced divi payment. Mid-2006 (pre-green shoots if in a recession) may well be the moment for what, at that time, looks a contrarian move into cash and cash-flow rich retailers like SCS.

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How to invest. Step 1 - seek views from a cynic. RJH emails MD...

MD,

Am I mad?
I frankly hesitate to admit serious intent on this - a sofa maker. Had assumed housing market would have been screwing the bejesus out of it but, if so, effect well hidden (SCS Upholstery; EPIC=SUY, 329p. Buy-model likes it up to 310p).

I believe, and I realize this strays somewhat into the realm of the Unknowable, that even with a second half pbt affected by 7 new shop openings (no rev, only costs, for a quarter post-open) that the final dividend will be raised at least 20% for a full year payout of circa 17p (yield over 5%). On past form (function of pbt it would seem), that may be conservative - turnover going great guns and cash piling up. And therein lies the trap - an awful sales performance is curtains (or is that cushions?) for awhile.

Scene setting:
Having grown dramatically 1999-2004, usually at the expense of b/s liquidity, SCS now are in a position where it is clear they cannot (sensibly) open stores quickly enough to have turnover match previous trend. It is/has been a company where growth comes from expansion, not like-for-like (although that has been remarkably good over the last 18 months). Five years ago the annual report said they aimed to have 70 stores by now. They will have 73 by year-end. There's still growth opps but it'll be low double digits (turnover) for the medium term unless they go mental.

But here's the thing:
Their cash pile, on this slower capex-growth outlook, is large and set to increase: £19.2m on total assets of £61.6m at '05 half. That's 58p/share (shares at 327p) and 31% of total assets. Net current assets are £4.8m. I estimate (see attached) fyr '05 cash will increase to £25m or circa 76p/share (perhaps another 5-8 % points of total assets) on turnover of £158.3 and pbt of £16.4m.

Thinking of writing to the Finance Director - what's going to happen to that underperforming cash going forward?

RJH

5 year SCS Upholstery results/FYR '05 estimates spreadsheet

NB: MD replies tomorrow

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Amena

Friday, August 05, 2005 | 0 comments »


MD writes...

France Telecom has waded in and is taking over Amena the number 3 mobile telecom provider in Spain thus consolidating their position in Europe. Why O2 plc didn't have a go puzzles me what with their existing relationship, the high proportion of Brits in the Spanish market and so on. Still, UK plc doesn't grow businesses does it? (Editor: but like the Murphy's, I'm not bitter)

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MD writes...

Continuing speculation in the market about the imminent sale of their European drinks business. The European business is, in fact, an object lesson in How Not To Do It. However, Schweppes still has a good European franchise and appears particularly strong in Spain (amongst other places). Yet where is the advertising? Certainly there is none that I am able to recall in the UK.

A few years ago they purchased Orangina - yet can you get in the UK? No, or at least not through the regular distribution channels. It's a great product but they've no doubt been stitched up by Coca-Cola and are not permitted to distribute in the UK. It looks as though the only place it is seriously pushed is France. It is a similar tale for the other Schweppes fizzy drinks.

The mooted sale price of circa £1bn sounds low. Well done chaps - really earning your bonuses.

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Red Letter Days

Friday, August 05, 2005 | 0 comments »


MD writes...

Some schadenfreude about the demise of Red Letter Days and it's venomous chief exec Rachel Elnaugh notorious for her comments on the BBC TV Programme "Dragon's Den" (where inventors /entrepreneurs tout their ideas to a panel of "successful" entrepreneurs).

Clearly the Red Letter Days business model is badly broken - last year they managed to lose £4.7m. This year they've lost £700k on a turnover of £17m. Total debt is £12m so things appear to have been wrong for while. How they got into this position is unclear assuming they were getting the punters money well before they pay for the punters jolly.

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What price an identity card?

Friday, August 05, 2005 | 0 comments »


MD writes...

Whatever the rights and wrongs of ID cards - and most clearly they will do nothing to significantly enhance security in these troubled times - the UK Government bureaucrats are nothing if not persistent and continue to push the slim case for the cards.

What particularly surprises is the lack of a clamour about the proposed costs (together with completely untried technology). Suggestions have been made that the UK card will cost anything from £100 to £300 (€150 to €450)! You can buy a working car for the latter amount (Editor: OK, we'll review your fee). Having done some research I can't believe the brass neck about this amount. In Belgium the cost is €10 to €15 depending upon where you live - and people still object. In Spain the cost is similar to Belgium (and, incidentally, passports are a fraction of the cost in the UK). So why so much in the UK? Another stealth tax?

On a cautionary note regarding the untried technology, in Belgium new cards have a chip which holds the address of the holder. Unfortunately, there are no data readers around so people with the new card have to have a piece of paper with their address written on it.

And that, we are told, is progress.

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US Protectionism, a model?

Friday, August 05, 2005 | 0 comments »


MD writes...

When the US isn't telling the rest of the world how they should open their markets and embrace US companies (ie let them buy everything not nailed down) it is also on the quiet one of the most protectionist countries in the world. Witness the recent Unocal CNOC takeover soap opera.

HMG, please take note and do your best to stop yet another major UK company going overseas: BPB is about to go the way of Allied Domecq. Other likely candidates in the firing line include Pilkington, BAe Systems, British Gas, GKN, Cadbury’s, LTSB and Smiths.

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MD writes...

To no one's great surprise the banks, whilst delivering solid numbers (HSBC on Monday, HBOS on Wednesday, RBS yesterday (04/08/05), are raising provisions significantly - and this in a still benign environment. Alliance and Leicester delivered flat profits; and Northern Rock is I suspect anything but - particularly as it has chased market share.

Elsewhere, Lloyds TSB delivered it's usual uninspiring fare. Philip Hampton, former Lloyds Finance Director, could not resist a dig in a 31 July interview in the Sunday Telegraph:

"When I joined, Lloyds TSB was the biggest bank in the world. It's now the fifth biggest in the UK. I didn't enjoy it, and I don't think they enjoyed it either...I think the company needs radical change. It's still got the largest UK current account share at 22 percent or so. But they sold all the international businesses...It's got no growth prospects and no plan to address the lack of growth prospects."
My thoughts exactly - I could never understand why they sold the NZ bank. It had a great franchise, great ROE etc. As far as I can see they've shrunk the bank so that some rich US or European Bank can waltz in and take over a strong UK franchise...allowing Chief Executive Eric Daniels et al to go off with fat payoffs.

Still, HMG might always intervene in such an event and prevent any takeover à la Bank of Italy.

On second thoughts, fat chance of that.

NB: Author owns / beneficially owns shares in HSBC

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MD writes...

In my last blog fired in anger, I wrote that the proposed sale of PacifiCorp was a bad deal for the seller, Scottish Power. Following a comment from one of our readers I felt the need to review my initial statements. Here are my observations (from last accounts plus spreadsheet attached below):

* PacifiCorp grew revenues by 8% YOY in $ terms in 2004/05. Not
shabby for a utility;

* Predicting growth in expanding markets;

* The commentary suggests that regulatory price increases have been generally favourable;

* PacifiCorp delivered 25% of group revenues in 2004/05 (despite being adversely affected by the $ weakness);

* Despite this PacifiCorp ROS is 24% vs the UK business' 15% (Op Inc pre goodwill);

* Post goodwill the situation deteriorates. But despite this goodwill effect (related to the original acquisition) the ROS is still consistently better than the UK business;

* PacifiCorp delivers 45% of group Op Income (pre goodwill) - slightly less than the UK business, in prior years it delivered significantly more;

* Thus the headline numbers suggest that this is a sound business - quick to turn very significantly should the £ weaken vs the $ and, failing a $ recovery, deliver sound performance.


So no downsides? Well, not quite. Much of the asset-base is very elderly. Recent investment has centred on wind/renewables, no bad thing in itself; future committed investment includes new gas-powered stations (NB there is also a, perhaps belated, recognition by the authorities that the lights must stay on). There is clearly a need for significantly increased investment to upgrade / replace old coal and HEP assets (although this is not required overnight, and will generate a return).

Conclusions:
* Still a bad, value destroying deal, particularly as it results in a significant write off;
* The justifications for the deal are specious;

* The deal ignores the future upside;

* Sets the company up for a takeover;

*Always a concern when the company chairman is Charles Miller-Smith, the man who brought ICI to its knees through a botched acquisition and a ludicrous "progressive" dividend policy. Mr Miller-Smith shrinks rather than grows businesses.

Well-done guys.

Download the Scottish Power/PacifiCorp numbers to Spreadsheet

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MD, fresh from swimming with dolphins in the Med, writes...

After a brief summer break the jot is back, crosser than ever. Well, nearly.

Your scribe has recently enjoyed two weeks in southern Spain on the Costa del Sol. Or the Costa del Golf, as it likes to style itself. Personally, I like to think of it as the Costa del Bling. For those who've never been, Marbella apparently has more Rolls-Royces than anywhere bar London. I can certainly vouch for this: Bentleys, Porsches and the like are two a' penny. Where else did you last see a top of the range Mercedes with Russian plates tooling around? Ditto as the place to see and been seen you can hardly beat Puerto Banus where scantly dressed (even if apparently fully clothed) women of all ages abound.

The region has a little bit of a reputation for hot money with stories aplenty of Russians turning up with suitcases stuffed with dollars and euros; I know of an individual who only a couple of weeks ago was due to start work on a building project and was rung the weekend before the start of the job - "Don't bother turning up on Monday - your employer is in gaol!"

However, like the weather some things never change. England, sad to say, have just been whipped in the 1st Test by the Aussies (Editor: but they have started the 2nd well this am) and the Windies are down and out in Sri Lanka.

Latest opinions to follow shortly.

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US headline economic data through July is good. So good it tests credulity. The choice for the incredulous remains being right too soon, or making money whilst the sun shines.

Still, one wonders why, of the indicators below, only the yield curve looks worrying. Flattening in itself does not herald a recession. But it does, usually, mean that money supply is becoming tighter and pessimism for growth and inflation is rising. Yet with real US rates remarkably low it is difficult to escape the conclusion that, whatever the yield curve says at the moment, the US economy is in stimulus mode - not the opposite.



Notes: "Triggers" consistent with indicator levels for previous recessions in the last 40 years; S&P500 M-6 column shows 6 month % change; ISM M-6 column shows 6 month indicator points change.

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Ebbers gets 25 years

Wednesday, July 13, 2005 | 0 comments »


Now all CEOs know how much the "Your Daddy ain't your Daddy but your Daddy didn't know" defence is worth if the judge and jury don't buy it.

Are Mr Lay's legal team paying attention?

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Stage 10. Grenoble to Courchevel, July 12 2005. That's just down the road from here.

The official schedule said the riders would pass at 10h48. With 10 minutes to spare, your overly keen correspondent was deposited, with recently purchased bike, in the outskirts of the village of Champ (that's him on the "a" of the "D10.a" in the fabulously rendered Google Earth image below).

Suddenly, blaringly appeared the first in a long caravan of advertising vehicles (see, for example, the Credit Lyonnais cyclist in the first photo). Mobile phone operators, confectioners, car makers, baguette merchants, cheese specialists, mineral water companies, coffee distributors, power tool sellers, hawkers of "official" tour merchandise as well as a cavalcade of other businesses hoping to up their profile roared by in outlandish motors.

The common factors? Loud music and gyrating nubile young things hurling samples of their employers' goods to all and sundry (OK, not those of the power tool, phone or car companies). Some forgot to duck; and others may later recall with embarrassment their mad scramble for small packets of Haribo sweets, Ancel Bretzels d'Alsace (de-francofied, that translates as pretzels) and Grande Mère coffee. Think small boys diving for coins.

Meanwhile, the rest of the crowd were sucked forward onto the tarmac in anticipation. Surely this ridiculously long pre-cinematic feature style advertising caravan heralded the imminent arrival of the peloton?

Alas, nearly two boiling hours later and with onlookers by now in severe need of those free mineral water bottles (bretzel effect) the riders crested into view. Occupying the entire width of the road they emerged from the heat haze of the tarmac driving before them a wave of warm air. In ten seconds they were past, followed closely by their support vehicles. Quick. But amazing.

There followed the ride home (a small 15 km or so) with next to no meaningful gradient. When small boys began overtaking him on foot the scribe knew the time for a rest had come. He paused in a bus stop near home, panting shamelessly. Thankfully onlookers had no idea how short my trip had been.

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Psst...heard the one about the UK's Olympic bid?



Jokes aside, you wouldn't be happy either. French hotel, construction and restaurateur companies certainly weren't.

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Which way blows the economic wind?

Anyone with substantial (and no-brainer) energy holdings likely enjoyed an outperforming half-year and Q2 compared with any main index. The scribe is sort of content to report that the holdings he manages are up 7% year to date and over 4% in the quarter (the S&P500 is down (1.4)% and up 1.2% over the same periods). "Sort of content" because: this result was less skill than, well, going with the obvious; and measuring performance over 6 months is arbitrary and hardly informative.

Nonetheless, next quarter and the full year may prove more awkward terrain: the macro-economic outlook is slowly but surely deteriorating (see the 5 point matrix below). Even energy prices cannot remain robust indefinitely within a weakening economy (unless the demand curve really has shifted outwards, and the jury will be out on that for awhile yet):

Possibly the most significant message of this matrix is that the flattening US yield curve (the June 10 year note minus 3 month Treasury bill yield is now down to 0.9 points) has begun to signal a small chance - around 8% - of a recession one year out. This is derived below from the reliable Estrella-Mishkin recession probability model.

Additionally, equities are modestly but bearishly weaker versus 6 months ago; and the ISM Purchasing Managers Index continues its decline towards the key "50" mark. A surprise drop to less than that with July 1's release (08h30 EST) would be a huge red flag (consensus is 51.5).

On the other hand, risk aversion - as measured by a widening spread between AAA rated bonds and the 10 year Treasury note - has not increased: the spread narrowed over the last 6 months and, it seems, indicates continuing risk appetite for non-sovereign paper.

Another positive is the last reading of the excellent Philadelphia Fed "Anxious Index". This shows professional economists confident of decent GDP growth 2 quarters forward. The intuitive reaction of anti-economists that this ought to be a contra-indicator does not, on the index's historical record, yet bear scrutiny.

So, bar a shock, no tipping point looks probable in the second half of 2005 although, clearly, the possibility should be kept in mind. But the US economy does have vulnerabilities: employment, sales, inventories and order data were all weaker in May (see the Chicago Fed National Activity Index for detail) and may be harbingers of the slippery slope. An unexpected piece/trend of bad data - a personal favourite being rising inflation, the chance of which is being almost entirely ignored by financial markets - could hasten any descent.

NB: The triggers shown in the matrix are consistent with calibrations that have marked the conditions for every US recession since 1962.

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Summer in the south of France and a young(ish) man's thoughts turn to...the local economy

Primarily a university town - which is how the scribe first came to spend time there over a decade ago - Montpellier now bills itself as a "technopole" despite tourism being the main support of the economy (and the reason scribe and wife just concluded a long weekend there).

The scribe's concentration not being required for the ample distractions of the seaside (or at least that's what the wife said) the beach at Carnon inspired the following thoughts instead:

* 80% or so of the region's population are squeezed into the littoral, reflecting the decline of agriculture, the rise of service industries around urban centres and the demographic trend of northern retirees seeking warmth;

* property prices are robust with an unscientific survey of apartment prices in and immediately around Montpellier showing them to be, in some cases, about 80% of London's;

* service industry is over 50% of local GDP; manufacturing is 13%; agriculture 4%; construction about 6%; and "administrative services" (code for government spending) about 25%;

* in spite of the arrival of foreign business attracted to the city by fiscal sweeteners, local unemployment at 14% is higher than the national average of 10%. It is said (though not by Adam Smith) that this persistent over-supply of educated graduates attracts firms looking for low cost labour;

* yet some evidence (other, that is, than the bald unemployment number) shows that only small numbers of the university students (25% of Montpellier's 400,000 population) end up employed by businesses attracted to the city by the various national and regional fiscal incentives on offer. IBM (the city's largest IT employer) claim, for example, to take on only 5 permanent staff from the universities per year; and

* plausibly related to high unemployment, this scribe was awoken on his first morning in the city, three floors up behind closed windows and air conditioning by the sounds of three men beating a fourth. The next morning he witnessed petty theft by a group of young men from a convenience shop. Both incidents occurred in the modern and new Parc Marianne area of the town.

It is certain the suite of fiscal incentives aimed at developing technology incubators, centres of biomed/pharma research excellence et al around Montpellier has attracted capital, including substantial foreign human capital, and had wider impact: the forerunner of the Palm Pilot was born there; the city now has a stunning blend of medieval and contemporary architecture; and infrastructure compared to the early 1990s is improved (but not perfect - the GPS mentioned in New York City notes proved essential).

Nonetheless, from some angles the economic recipe served up looks a strange brew if it was also intended to provide an outlet for all those grads pouring out of the (free, hence their hordes) Montpellier university system. The region still lags in national employment and productivity rankings; and government expenditures, including those spent on welfare, are a full 5 percentage points higher than the country's average.

Sources: National Institute for Statistics and Economic studies - France, Foreign Direct investment Magazine, Invest in Montpellier, official city website

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Timely advice of the day

Tuesday, June 28, 2005 | 0 comments »


From Dow Jones Newswire (motto: "News to profit by")


*DJ Morgan Stanley Upgrades Oil & Gas Sector To Attractive

(End) DJ Newswire
June 28, 2005 02:57ET (06:57 GMT)
Copyright (c) 2005 Dow Jones & Company, Inc.


Gee, guys, do you really think so?

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A small post dedicated to tomorrow's triple witching hour and those further ahead...

Triple what?

MoneySense Canada (byline: "for Canadians who want more") offer this definition:

"Triple witching is a term coined in the 1980s to explain the volatility associated with quarterly expirations of stock options, index options and index futures. Triple witching occurs on the third Friday in March, June, September and December."


The volatility of triple witching Fridays is due to (and confined to it based on the data below) extra volume: stock options that are exercised create large additional volume; as does the index arbitrage typically associated with the trading of big equity positions that this engenders. The data this scribe analysed showed Freaky triple witching Fridays can average close to 25% more volume than an ordinary trading day (1990-2005).

Yet the same 15 year's worth of data covering the S&P500, the Dow and the Dax does not reveal obvious differences in price variance at the aggregate level. That is, the daily points range (high minus low as a percentage of close) of all days versus triple witching days displays similar average, standard deviation, median, skew and kurtosis characteristics.

What the data does show, however, is an interesting stat for the Dax:

The pattern is more pronounced for the S&P500 (64:36); and less for the Dow (52:48).

Not a tip or trading recommendation. Only context.

Sources: Yahoo Finance; MoneySense Canada

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A subscriber asked in a comment to an earlier post what CC considered to be the implications of the French rejection of the EU Constitution.

CC's broad, simple and possibly philistinic answer is set out below:

Conclusions:

* "emerging market" investor bulls of Turkey may wish to reconsider their accession thesis. The last time Turks got into Europe was 1453 when Sultan Mehmet II was The Man. The resulting exodus of Byzantine intellect to Florence, Ferrara et al from Constantinople spurred the rise of the Renaissance (Mehmet got zero credit for this by the way) and led to an early example of euro-unification amongst the Italian city-states faced with the eastern threat;

* perceptions of insurmountable cultural differences with Turkey remain and are much greater on the ground than has been assumed on planet EU. Different groups have different reasons for holding these perceptions (when Jean-Marie Le Pen and Valerie Giscard d'Estaing agree it is rare day) but held they are.

* the French will always find any compromise involving their socio-economic model difficult to make despite (or for cynics of welfare "because of") persistent high unemployment. At last count this stood at about 10% in total and 22% for those under 25 years old;

* the EU may now look forward to either years of re-negotiation of the Constitution, or years of (fruitlessly) trying to convince citizens of the actual version's worth.

Discussion:
In France the "Non" answer to the Constitution of the debate brought together those:

* who believed France's social model would be weakened;

* that it would impose an "anglo-saxon" model favouring big business at the expense of farmers, workers and public services;

* that it threatened the country's sovereignty and identity; and

* that it would quickly let Turkey into the EU.

These were reactions to two key elements of the proposed Constitution: the EU gaining new powers from member-states over asylum and immigration policies; and the adoption of qualified majority voting.

Clearly, giving the EU new powers was going to sell badly to subscribers of the idea that the EU Council lacks legitimacy and is too distant from the populace. That these new powers included Justice policy (under which asylum and immigration fall) a bare 5 months after having agreed to accession talks with Turkey in December 2004 did not ease the task.

Indeed, the rejection of the Constitution in France arguably most reflects the opposition to Turkey joining the EU. In spite of a spirit of modernism, political secularism and a rich ethnic mix unknown in most EU nations (summed up well here), Turkey getting into the EU at all is doubtful - whatever the supposed irreversibility of the European Council decision on accession talks last December.

On this point, readers may want to cross-reference the views, for example, of the 400,000-odd French voters of Armenian descent; or the result of the Dutch referendum; or the Cypriot government (yes, an EU member) who Turkey refuse to recognise; or those EU citizens who wonder about the wisdom of extending the borders to Iraq and Syria; or EU immigrant-worriers fixated on the long-term unemployment rate of 24% in Turkey (population 68 million); etc.

On the other hand, for profit-seeking investors free of such mundane baggage, the economic case against the Turks (skint and plenty of them) does not stack up. Morgan Stanley have argued that even the poorest accession nations have historically converged with the EU average GDP per capita rate remarkably swiftly and without impacting the Union's overall growth rate.

That said, Turkey would be starting off at the unprecedented low rate of 29% of the EU 25 average. Accession brings with it EU investment (public and private) as well as aid but without these it is a reach to see quantum-leap improvements in the country's real GDP growth rate (3.4% average 2000-2003); or a reversal in the massive declines in foreign direct investment that have occurred over the last 3 years.

But it is not the economic issues that dominate. It is the cultural ones - including the racist and religious arguments - that stand foremost. In such a climate it is difficult envisaging any EU25 head of state wanting to go before his electorate in order to make Ankara's case for accession to the union. That would be a great deal like the proverbial turkeys voting for Christmas.

Sources: Eurostat (unemployment & GDP/capita data); OECD Turkey Country Statistical Profile 2005

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Tea-leaf of the day

Wednesday, June 08, 2005 | 0 comments »


A picture (below) that appeals to the Tobin's Q in this scribe. From chartoftheday.com:

Today's chart illustrates the overall trend for the Dow. Back in April, the Dow broke below its long-term uptrend (green line). More recently the Dow has retraced back up to the original trend. For the technical analyst, this type of retracement is fairly common if not expected. However, in the realm of technical analysis, the green line that was once considered support now acts as resistance. Stay tuned...

Hey, wait a moment - are fundies and techies agreeing on something?

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A rant from MD, CC's UK scribe...

If ever one wanted to blaspheme, this is one of those moments. Scottish Power - once a small company focussed on generation of hydroelectric power in the Scottish Highlands - went on a spree. The rocket scientists who work there (not many, it has to be said) latched onto the idea of buying a larger company in the US to give them "breadth, diversify their earnings and to move away from the regulated UK market" which was paying for it all. Paid top dollar and then suffered the Mother and Father of all melt downs when wholesale prices in the US collapsed.

Not content with this destruction of capital and despite things being on the (eventual) mend, they decided to flog the business last week on the grounds that they would have to spend $1bn annually (£600m in real money) for the next five years investing in the business.

Now, call me an old cynic, but the purchaser is Mid-American Energy, a company controlled by one Warren Buffet and a chap who knows a bargain when he sees one. The US has learnt from the debacle of a few years ago that you can't let the lights go out. I believe he's got a bargain and the prats (yes, that's right the prats) at Scottish Power have been stiffed. Mr Buffet doesn't get it right all of the time but he does better than most and I'm betting on him not having given the Scottish Power suckers an even break.

Still, maybe there will be a change of heart - regulatory approval will take a while as in the unregulated US some 14 authorities will have to give their nod.

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From the desk of SJ...

Malcolm Glazer appears to have completely messed up on the timing of his purchase: the UK economy is heading for a down turn; Man U are not what they were; and there must be a worry about how long present manager Alex Ferguson will stick around.

[Here follows a paragrpah of gratuitous editorial spin]

And there's still, of course, no word yet on Ricky Hatton's availability as either manager or midfield enforcer (with a concerned Roy Keane apparently pondering contesting Ricky mano a mano for both posts if necessary).

[Resumption of normal service]

Glazer has loaded-up the company with £745m of stupendous debt. Yet Manchester United's turnover is, what, £175m? Servicing the debt will cost at least £50m annually (ie over £135k per day).

You have to hand it to the former key shareholders Messrs Magnier and McManus. They've walked off, hand in hand into the sunset, with a £90m gain. Not bad by anyone's standards.

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Our resident car freak writes from Brussels

To no one's surprise (with the exception of Her Majesty's Government and the unlamented responsible Secretary of State, Ms P Hewitt) MG Rover last month finally succumbed to the weight of nose-diving sales, lack of new product and no means of raising further cash.

Though not quite in the same straits, GM announced yesterday that US sales in May were down 13%; Ford announced a similar 10% reduction (making 12 straight months of decline for old Henry's baby); and even Honda saw a drop of 14.7%.

On the other hand, the main highlight of May's US sales data was Nissan's 6.6% increase and the continuing advance of other Asian manufacturers (well, bar Honda for last month at least) at US car firm's expense: the total market share of Detroit's car makers fell over a percentage point to 57.6 percent in May from 58.7 percent a year ago.

These data are indicative, in fact, of the parlous state of most car manufacturers. Here's a quick run down on the condition of my top ten:

General Motors
Strengths: Size / Global Presence, GMAC, access to Korean product.

Weaknesses: Poor profitability, size, too many plants, too many brands, poor product (have you ever looked at a Hummer?), junk bond status, high labour costs US/Europe, failed to invest in the business, consistently over optimistic, image.

Toyota
Strengths: Size / global Presence, quality, value for money, manufacturing expertise, profitability.

Weaknesses: Dull product, from No 1 the only way is...

Ford
Strengths: Per GM, plus share of Mazda, family influence, Non-US (ie European) product is very good, potential of Jaguar, Land-Rover and Volvo.

Weaknesses: Per GM, plus share of Mazda - it continually disappoints just when all think the corner has been turned, family influence (pressure to sell out).

Daimler-Chrysler
Strengths: Size / global presence, financially sound (just)

Weaknesses: Chrysler (though getting better), "Smart" car brand, lost their quality image, Mercedes over priced, high European & US (Chrysler) cost base

VAG (VW)
Strengths: Size, perceived quality (especially Audi), strong product range Audi/VW, Skoda.

Weaknesses: Competing brands (market confusion), low profitability, Seat (underinvestment in product), Piechesreider.

Renault / Nissan
Strengths: Nissan (see sales table above), now a major player, Carlos Ghosen, implicit support of French state, profitability.

Weaknesses: Renault (quality & productivity issues), question marks over product strategy, Carlos Ghosen (should he encounter the proverbial bus).

BMW
Strengths: Image, profitability, engineering strength, Mini brand, family control.

Weaknesses: Real danger of brand dilution (eg BMW "1" series), Mr. C. Bangle (chief designer of current stupendously ugly range until promoted), mass market and high price don't mix, family control (pressure to sell...)

PSA (Peugeot Citroen)
Strengths: Family control, profitability, implicit support of French state, no US presence, strength in Africa.

Weaknesses: Ageing product, Citroen seen as cheap - struggle to gain pricing power.

Honda
Strengths: Engineering excellence, profitability but low(ish), No. 1 engine manufacturer, breadth - lawnmowers to cars to outboards.

Weaknesses: Relatively small, trying to position itself as a BMW beater, still thinks it's a sexy company (have you seen the FRV?).

Kia
Strengths: Home market support, growing fast, cheap(ish).

Weaknesses: Product - why buy when you can have Japanese?

So there you have it. Honourable mentions should go to Porsche (for convincing the market they wanted a Cayenne and for getting VW to pay for half its development) and the minnows of the UK market including Noble, Morgan, TVR, Caterham and Lotus.

Data source: The Detroit News Auto Insider

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The Church in medieval times was the era's super-multinational - revenue streams flowed in from all across the known western world. Amongst the biggest earners were holy relics: a relic attracted pilgrims; pilgrims brought money; and that money super-charged the local economy. Holy relics were the equivalent (sort of) to modern-day Toyota factories.

And so it is, too, with the US quarterly GDP figure. Just replace "pilgrims" with "investors" and "local economy" with "equity markets".

Exhibit A, below, explains: the S&P500 performance and the level of quarterly GDP growth are 37% correlated over the last 10 years to Q1 2005. Not everyone may have complete faith in the link, but who wants to ignore it?


Exhibit A: quarter-over-quarter GDP & S&P correlation, 1995-2005 + forecast


















But here's the funny bit: use the previous 10 year period (1985-1995) and the data produces a negative correlation of -35%. And over the whole period 1985-2005 the link is a paltry 6.3%.

Annual data provides a better feel - but only if the S&P data is advanced a period. Exhibit B illustrates:

Exhibit B: year-over year GDP & S&P correlation, 1960-2005 + forecast


















Decade by decade the relationship has been:

1961-1970 = 74.3%
1970-1980 = 63.5%
1980-1990 = 2.6%
1990-2000 = 61.4%
2000-2005 = 68.6%

Which, despite the severe breakdown over 1980-1990, suggests the S&P has been highly predictive of the economy, as measured by changes in GDP. GDP forecasts, therefore, become especially valuable so long as their credibility in equity markets remains good.

Unfortunately, though, these data cannot provide a touchstone for measuring fair-value in the market. And, whether it is shares in General Electric or a lock of St Jude's hair, buyers are supposed to ensure they do not pay over the risk-free rate for their investment returns.

Both replacement-cost and normalised p/e value models show the S&P 35% to 50% above trend (exhibit C, for example, uses Tobin's Q to show fair value versus US equities prices). On these measures equities are generally poor value; and so it is a stretch for this scribe to become too enthused by the latest positive US GDP revision (Q1 2005).

Context, eventually, matters.

Exhibit C: Tobin's Q measure of fair value, 1900-2005

















Sources: Yahoo Finance; US Bureau of Economic Analysis; Philadelphia Federal Reserve Board; Smither's & Co. website

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