A treasured double audio cassette sits on the shelf here: Great Parliamentary Speeches. An anorak's possession for so popular is it that Amazon (nor anyone else so far as I can tell) does not even have a photo image or stock [Update: wait, here are some].

In it is a devastating, mocking, anti-monetarist speech made in 1980 by Michael Foot, then the UK's Labour opposition leader, against the prevailing government economic dogma - which at the time looked to be seriously failing on the growth, employment and inflation fronts. The economy was, in hindsight, undergoing very painful and profound structural reform: Margaret Thatcher - you may have heard of her.

Mr Foot told a story from his youth of seeing a magician performing at the Palace Theatre in Plymouth where he grew up. The conjurer asks and gets a superb gold watch from a prominent city Alderman which he wraps carefully in a red handkerchief. He then produces an immense mallet and, to gasps, uses it to smash "to smithereens" the contents of the hanky. There is then a sickening pause from the magician and in Mr Foot's words:

"...on his countenance would come exactly the puzzled look of the Right Honourable Gentlemen*...and he would step forward right to the front of the stage and he'd say 'I'm very sorry - I've forgotten the rest of the trick.' "
Now, it is not charitable; nor was it a superb gold watch Alderman Greenspan handed to Mr Bernanke. But the latest text from the FOMC meeting concluded today contains sufficient somewhat at-odds statements:

"...some indicators of inflation expectations have risen in recent months. The Committee expects inflation to moderate"
and conditional hope:

"The substantial easing of monetary policy...should help promote moderate growth...and to mitigate risks to economic activity."
as to recall the cadence and punchline of Mr Foot's great speech - and the gales of laughter it brought from British MPs - 28 years ago.

*The then Secretary of State for Industry, Sir Keith Joseph

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Le Monde has a tidy series of articles covering what it identifies as the six themes of the current global economic crises here with accompanying graphs.

One of these ties usefully back to the earlier post + wheat comments on food prices:

Exhibit 1: Wheat volatility, volume and supply vs demand


And while I'm at it, their subprime scorecard is useful to. Though why they would want to single out the UK banks with the lower graphic is curious - don't the landesbanks deserve a share of the spotlight too? And, while it may not be subprime exactly, Spain's banks have a few issues of their own.

Add those latter two together and don't bother looking for a Teutonic bail out of EU brethren if things really go pear-shaped.

Exhibit 2: Global bank subprime impairments and UK mortgage deal volume by value

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Please pay attention. This is important.

With the FOMC statement coming out tomorrow markets have already received glaring signals of intent and rationale from certain corners of the Federal Reserve system. Observe:

Exhibit 1: Cleveland Fed's April Fed Funds futures chart, produced at end March:



Exhibit 2: Cleveland Fed's April Fed Funds futures chart, produced at late April:
The colours, man, the colours.

Carl Jung (who dat?) said that colours express the main psychic functions of man and (this part he clearly implied) central banking institutions. So obviously the shift away from an eye-troubling, acid-dropped inspired electric blue gradient powerpoint background is significant.

Feng Shui (known as "FS" from here on out) fans (reply pending from Mr Bernanke on this count) will rhapsodise about blue, its yin energy and qualities of love, healing and hope. It is, apparently, their colour of intellect and wisdom. But maybe they were unfamiliar with the depth of powerpoint's features when they decided this.

So what to make of this shift to the kind of grey background palette favoured by the New York Times' excursions into graphism? Well, it's a grey area. Some FS peddlers will see it as indicative of fear, frustration and hopelessness. Others reckon any combo of black and white is a consensual compromise and therefore an ideal balance of opposing views. Hmm. So even pure FS has its limits. Maybe academia might assist.

Rikard Küller (no, I did not make up that surname for the purposes of this piece) conducted a study in 1976 (good luck if you attempt to read it) on the effects of colour on men (and women although here, in Fed context, that is mostly incidental) in two opposite environments - one grey, the other colourful. Various medical devices monitored pulses and so forth. Grey increased heart rates, stressed the boys out and made them bored. Küller suggested that the guys could not get into the the mental 'zone' when in grey.

So just what is Cleveland trying to tell us on behalf of the FOMC? A brief 'delta colour' summary of the top two most probable outcomes (quoting liberally from "Living Colour" by Rossbach and Yun) may help further:

2% outcome. Was pink ("joy, happiness, romance") now green ("hope" "tranquility" "growth")

2.25% outcome: remains orange ("happiness and power")
Conclusion: look on my works, ye Mighty, and despair. Unimaginative, pressured and bored they may be but the Fed stays the slash and pray course convinced more and more that penalising savers - plus a whole lot of other collateral damage - is an appropriate price to pay to the desire for US growth and tranquillity. Eventually.

And that's the unadulterated power of FS for you.

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A lot has been made of the role of speculation in grains as the driver of food riots across the globe. Leaving aside definitions of ‘speculation’ what is clear is that wheat, corn and oats prices broke multi year price ceilings in mid 2006. Rice broke its ceiling in mid 2007 and has more than doubled since: only highly volatile wheat has risen further - nearly tripling before losing 40% of its late 2007 peak. But, politically, it is rice that has pulled the trigger.

It is of no immediate relief where required, but general US inflation expectations are, in fact, tame. The recent sell off in US 10 year bonds was interpreted here 10 days ago as a sign of bond market fear over resurgent price pressure. That is looking a wrong view: markets continue, it seems, to believe most in the deflationary prospects being heralded by banks frightened to lend; and by contracting house prices which may be presaging rising unemployment and lower consumption.

In any case grains are not, historically, particularly correlated with financial markets - these deflationary trends would not normally be applicable to them. But as large, interest rate sensitive leveraged flows have surged into grain markets correlation has grown. And price volatility (with the curious exception of rice) has also risen dramatically.

One core question is whether or not the massive leveraged flows into grains are helping price discovery and flashing production signals to farmers. The stone hearted response is that this is irrelevant: if it is price discovery, it is a good thing for supply will rise (eventually) and bring lower prices and equilibrium. And if it is not, the market will end up impoverishing many of the black box quants playing the volatility game and mark prices lower anyway.

This line of reasoning, while neat, deals only in ends. There is little doubt that a lot of hot money is in grain prices. That is very probably not assisting price discovery mechanisms: it is true that stocks of most grains are tight but price action lately speaks mainly to noise - not trend.

Which may indeed be only a temporary state of affairs. But the crux of the matter is that at these price levels the leveraged flows into grain are an imminent source of great harm. Expectations of price volatility or, where rough rice is concerned, straightforward price rises are promoting hoarding, export controls and a vicious cycle of more leveraged buying. Meanwhile, in Port-au-Prince and company, rising food expenditures have been reducing real wages by large, double digit percentage amounts. That, literally, can to kill bystanders.

For it does not take much of this to cause catastrophe - even though the end result, in due course, will be lower prices. The last grain boom in 1972 to 1975 saw a major famine in Bangladesh triggered by a tripling of rice prices over a three-month period in 1974. A million, on some estimates, died.

Yet, leveraged money or not, grain prices have not so far breached historical highs and remain comparable to previous peaks - there is still time to make sure that the actual, unhappy, constellation of aligning stars does not lead to a disaster.

On this count, and bearing in mind the dollar pricing of food commodities, a small, visual suggestion of a readily available resource that might well put a brake on the unfolding events:


Exhibit 1: from the FAO's November 2007 Food Outlook


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Six months ago in this space appeared:

"There is something profoundly and depressingly self-serving in the arguments that the price of saving the little people and wider economy from rampant speculation in and irresponsible selling of financial instruments (exotic and vanilla) is to save, also, the prime instigators of the problems."
The logical conclusion (or maybe simply ‘next stage’ if you are Mr Bernanke) to this theme arrived when Jeremy Grantham’s quarterly letter whizzed through the mailbox late Friday night. Entitled “Immoral Hazard” (log in required) it is, fairly or not, a knife-job on Alan Greenspan. An elegant multi-stabbing, but still a knife-job. The pick of several choice quotes for this scribe is:

"Greenspan came onto my radar screen in the late sixties as a seller of economic and financial advice to the investment industry… His high point in most memories, certainly mine, was a famous call in January 1973 that, “it is rare that you can be as unqualifiedly bullish as you now can,” a few days before a market decline of over 60% in real terms… This was one of the first of a long line of terrible prognostications for which he has remarkably not been remembered, except by a handful of us amateur historians."
Mr Grantham eventually withdraws his knife from Mr Greenspan long enough to make several striking observations that anyone wondering about the Through the Looking Glass quality of US equity markets lately will enjoy.

Concluding, he unsurprisingly advises cash and the shorting of both sterling and UK property. Far more intriguing is his passing remark suggesting that emerging nation land is "generally attractive".

An entertaining read though he be classed by many a perma-bear.

NB: Yes, it's shopped

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Warning: venal weekend entry...

Amongst the many things I used to look forward to as an undergrad in the USA at the start of each academic year were the free samples and offers from companies looking to curry favour with future, gainfully employed, money spenders.

Two of the most sought after items of freeness came from the Wall Street Journal and BMG (the latter along the lines of ‘a million music cds when you agree to buy none’). BMG limited its offer to one per individual but still fell for the odd request from “Mr Archie Pelago” and “Ms Gee Raff”. The statute of limititations permits sheepish admission that that's how Oingo Boingo got into my collection.

To cut a long story short, Capital Chronicle partners with Netline Corporation who offer such deals on specialist trade publications. I am not going to embark on a hard sell here; I consider it a better than good deal; but readers can love it or leave it.

The complimentary (or trial) offers include The Economist, CFO, Business Week, Financial Week, Treasury & Risk, The Deal, Accounting Today, Broker, Global Finance, Investment Advisor, Traders and Schaeffer’s Options Advisor - amongst many more. Netline assure that there is no hidden "junk mail" agenda once signed up.

The relevant blurb "Free finance magazines” is on this page and the click-through goes to the full catalogue which covers finance and several other specialties too.

Note that the system works by geographic location and is designed to exclude Archie Pelagos: the Financial News, for example, will not send you a free sub if you are not a pension fund trustee, manager or sponsor situated in North America or Europe.

Happy weekend!

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An investment overview and company tear sheet have been posted under the ‘Research List’ tab for outpatient clinic operator US Physical Therapy, Inc (NASDAQ:USPH).

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Written 25 April 2008. Consult 'Investment Approach' tab for outline of what criteria gets a firm on the research list).


Quantitative score 70/100 on year-over-year accounting data. Qualitatively something similar. While US Physical Therapy (USPH) is in the health sector and a potential defensive, it has historically badly under performed peers in the Nasdaq Healthcare Index. In this it appears to have been a victim of its own financial conservatism. But several decisions since key management changes in 2004 suggest a cultural change. Indications are that the firm has embarked on a revised strategy that places more emphasis on using its strong cash productivity to acquire as well as grow in its usual organic way. In a fragmented market place there is scope for this method to flourish. The firm's website is here; and its latest 10K here.

US Physical Therapy with its 349 clinics is a distant number 3 in its marketplace behind Select Medical (1000+ clinics) and Physical Therapy Associates (825 clinics). It has a long share price under performance history versus peers which has seen its price/earnings rating drop steadily from the high 20s in 2003 to a shade above 20 today. This, perversely, has been the price paid for conservative management - USPH has not taken many risks despite its muscular financial profile.

There are conclusive indications that has begun to change in the last 2 years since the appointments of Messers Reading (CEO), McAffe (CFO) and McDowell (COO) in late 2004. Now settled in, they oversaw a wide ranging closure programme of marginal clinics in 2006 which shocked investors – the shares were marked down nearly 15% overnight floowing the announcement; they have made four acquisitions since 2005 the largest of which last year secured the privately held, 52 clinic STAR Physical Therapy (and, notably, which required a new $30m, expandable to $50m, revolving credit facility); and there has been over $550,000 of insider buying of its stock in March, likely a sign of renewed internal confidence given they were the first such transactions in over a year and a half.

Still, there are obstacles. Gross margins have been taking a methodical beating year over year since 2003; and the quarterly trend into Q4 2007 is especially uncomfortable because, most likely, of the STAR acquisition. The 10K on page 22 has a neat table summarising per visit revenue and cost breakdowns - both of which are going the wrong way.

This speaks to competition and regulation: health may be a defensive sector but it is also political. And in that context there is the concern that, with 207 differently branded clinics, the decentralised financial control style of USPH will not be able to make enduring improvements to its financial ratios despite its widespread use of profit share and ownership schemes with its clinic directors. It is an issue that will worsen in acquisition mode; and initiatives attacking what may now seem like financial minutiae will later look prescient investments.

The Big Picture, then, is that USPH has the balance sheet, free operating cash flow and desire to expand more aggressively than in the past. It clearly has the finances to close low margin sites in favour of acquiring higher – or potentially higher as would seem to be the case with STAR - margin ones. But some tough and detailed financial grind is required to make that game work: a successful change of company strategy depends, in this case, on an implementation of greater focus on internal financial method, measurement and culture.


Exhibit: US Physical Therapy tear sheet



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This is the kind of story that places in doubt the wisdom of investing in wine. A great Italian red adulterated (allegedly) to pander to the palates of its wealthiest customers.

Producing what others think the prettiest brunello should be - rather than what is the prettiest brunello – would be an instantly recognisable act for JM Keynes. Equity, like wine, is mostly sold, not bought. Yet, ironically, ‘meeting customer requirements’ – as in this case - now threatens an entire denominazione.

The investment heart of Keynes’ ‘prettiest’ metaphor is that equity buyers often buy their own perception of future price levels - and not the reality of the underlying earnings power of the asset. And this is another parallel with the brunello story. Wine investors will always buy Bordeaux and a handful of other regions (like Tuscany) mainly on their perception of future price levels. But wine aficionados will buy what they appreciate as sound value regardless of region.

Stretching an analogy, of course. But the point is that perception is usually more important than reality when choosing an investment. Just not for the most apparent reasons: it is the contrarian value of popular perception that is usually the most precious.

A final, somewhat related note: a decade ago nearly to the day a great investor and educator, Roger F Murray, died. A pure value investor, one of his long-held complaints was that CFOs take the blemishes and worry lines out of the accounts in order to provide as perfect a picture as possible. That’s fine with wine but not so good for investments.


Disclosure: scribe owns no DOC Brunello di Montalcino. Please send.

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Happy weekend!

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Or at least the non-food retail sector?

Typically peak to trough times of 12 to 24 months - 6 of them gone this slide.



Note - not seasonally adjusted data.

Sources: UK Office for National Statistics, HM Treasury Pocket Data Bank

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An investment overview and company tear sheet have been posted under the ‘Research List’ tab for clinical research firm Kendle International, Inc (NASDAQ:KNDL).

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Written 17 April 2008. Consult 'Investment Approach' tab for outline of what criteria gets a firm on the research list).

80/100 on a quantitative, 2007-over-2006 recorded accounts basis. Qualitatively, a well-liked and followed company recognised as a growth stock in the flourishing clinical research sub sector. Its latest 10k outlines the main risks its operations face - and with a beta greater than 2 potential buyers should question whether now is an opportune moment to purchase those risks. Despite excellent 2007 results the equity is 20% below its 16 January 2008 all-time high and, belying its health care classification, behaving like a cyclical. History shows it especially vulnerable to the combination of client concentration and contract cancellation risk – both functions of macro economic strength.

There is plenty to like about Kendle. It is still run by its husband and wife founders of whom Candace Kendle is by training a professor of paediatrics; and Christopher Bergen a MBA also from a health care background. It has a strong record of cash generation; good earnings quality; and persistent, if not growing, margins. A transcript of its last conference call is here and is a useful primer for the 2008 outlook and strategy.

Yet for a serial acquirer with over a decade of quoted existence some of the grittier parts of financial management are disappointing – ROA and cash collection look particularly patchy. Possibly part of this is due to founder management learning on the job; and perhaps relatively new but experienced hires (finance, global clinical development and early clinical development chiefs) may spur steady improvements. One hopes so because with the major purchase in 2006 of some of rival Charles River’s operations long-term debt has never been so high nor short-term liquidity so tight.

With that in mind there is a further point that sticks out of the numbers. In the terrible equity atmosphere of 2002 Kendle was forced to recognise a $67.7m goodwill impairment (from a total of $89.7m) triggered by the 60% collapse of its market cap (10K here). That entry reduced the long-term asset base by almost 80% and shareholder equity by almost a third. When long-term debt is 11% of total assets, as it was in 2002, that’s a significant setback. But were it to happen with $230m of goodwill - or 46% of total assets - and long-term debt sitting at $200m (as it is now) it would be catastrophic.

Kendle looks a better than average potential investment with excellent cash generation and deserves to be watched. But buying its current leverage, risk and volatility profile in a poor visibility macro economic environment would be brave.

Exhibit: Kendle International, Inc tear sheet



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Ever wondered about contagion into France's housing market from subprime America? The country's national realtors federation - la Fédération Nationale de l'Immobilier (FNAIM) - has.

In its October 2007 (no. 50) quarterly newsletter on the topic the FNAIM's possibly self-serving pronouncement was:

“des risques de contagion de la crise de subprime limité...Les USA ne sont pas en France”

[“the risk of subprime contagion is limited…the USA is not in France”]
The assessment of their December (No. 51) letter was possibly even more confident.

"Alors qu’un scenario de crise des «subprimes» peut être écarté en France, les conditions de crédit restent bonnes en dépit d’un resserrement des taux"

[“…a «subprime» crisis scenario can be dismissed in France…credit conditions remain good despite a tightening of rates.”]
But come the April quarterly letter (No. 52) readers may have detected an unsubtle shift in tone:

"Néanmoins, dans un contexte de crise financière, limitée ou non aux «subprimes», et dans un climat de confiance des ménages dégradé, le spectre d’une spéculation, à la baisse cette fois, semble resurgir."

["Nevertheless, in a context of financial crisis, limited or not to «subprime», and in a climate of deteriorating household confidence, the spectre of speculation, to the downside this time, is resurfacing."]
The FNAIM team appears to have suffered a bit of a time warp between quarterly letters 51 and 52. Yet having butted upon reality considerable efforts are spent denying it as the team projects another annual increase in house prices of 2.7% in 2008:

“En dépit d’un recul des prix de -1.0%, observé au cours du 1er trimestre 2008, l’environnement du marché ne semble pas propice à la réalisation d’un scénario de baisse généralisée des prix.”

[“In spite of a decline in prices of -1.0% during Q1 2008, the market environment does not look positioned to enter a scenario of generalised price declines.”]
Which is an interesting hypothesis given that their own ex-new build graph to the left (but not, of course, their comment) shows 3 straight years of precipitously declining rates of price increase prior to this latest negative quarterly reading (one of only 2 in the last 36).

France is not the USA for sure. But its mortgage market has changed risk profile in the last five years. Traditionally a fixed rate market with over 95% of such loans before 2002 that figure is now 90% (having touched 80% at the height of the lending frenzy in 2004); average term is 21 years, up from 16 in 2002; and many more buyers are under 30 – up from one in ten in 2002 to better than one in three now. These are additional buyers, never bitten by a capital loss, to whom the last time France saw annual declines in property prices (1996) is irrelevant history.

So many observers would be pardoned for concluding the opposite of the FNAIM: demographic shifts in the market and overall conditions are actually reasonably weighted towards generalised prices declines in 2008 – particularly at the lower end with the inevitable knock on up the chain.

However, the FNAIM finds support from the (otherwise) marvellous Institut National de la Statistique et des Études Économiques (INSEE) who in its March 2008 report of French Household Income concluded that house prices would increase albeit at a slower pace.

INSEE is an amazing trove of reports and statistical method. But in this projection they use a demand driven model that focusses on purchasing power (p 105 of the above link). The notion that credit supply may be drying up is not seriously entertained; and they had not seen the Q1 data when they published.

The fact remains that Bank of France (BoF) data shows since late 2007 that tightened criteria are already in place for business lending; and the BoF anticipate housing loan demand to be hit in at least the first half of 2008.

To be clear, Gallic versions of subprime style defaults are highly improbable, nor will its corrosive social effects breach the French gates. But it is nonetheless a major dampener on credit supply whose impact here is still underestimated, misunderstood and unfinished.

It is a buyers market and likely to remain so through end 2008.

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In a post of 24 March a sometimes contributor to this space wrote:


"Amongst all the turmoil in the credit markets one major player has been conspicuously quiet. This despite some aggressive practices in the GE Money division which includes home loans there has been barely a peep, granted they sold a US sub-prime mortgage business last year but one does wonder that given their huge asset base and financing requirements that no mention has been made good or bad as to their funding position."

Today GE reported quarterly earnings off 6% due mainly to a dire performance in its Financial Services division where net earnings fell 21%. Simply, credit turmoil prevented asset sales and GE (probably) took the opportunity to clear the decks with large impairment and mark-to-market losses. But there were also disastrous profit declines at this scribe's former employer GE Healthcare (-17%) and Industrial (-16%).

Already some are taking this as proof that GE Infrastructure, the star this quarter, ought to be spun out. Yet the key point is not whether conglomeration is working the 'GE Way'; but what this says about the macro economic picture. On this front CEO Jeff Immelt presents a revenue case that supports the decoupling arguments: non US growth was comfortably double digit across "virtually every business".

What is left is a sharp US divide between the financial and non-financial; how the travails of the first are creeping into the performance of the second; and how badly the rest of the world will be affected.

That's confirmation, not addition, to the known dangers still not fully accepted in equity markets. Dow and SPX futures have sunk hard (-120 & -15 respectively) in partial acknowledgement.

UPDATE: FT coverage of the conf call.

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Interesting divergence....

NB: The Russell references here and here

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Tim Price has an alternative career in comedy waiting for him. A small excerpt from his latest output:

"Hopes for a recovery in Wall Street earnings have for several quarters hinged on the prospects for the successful completion of a 40p private placement of a bag of Salt and Vinegar flavour crisps on behalf of the Walkers Crisps Company. Lead underwriters JPCitigroupMerrill, a subsidiary of the US government, and Northern Rock SocGen KFW Nomura, a wholly owned subsidiary of Tesco plc (Neasden branch), are rumoured to have “solid” interest for the underwriting, most notably from Asia, itself a subsidiary of Texas Pacific Group, but declined to go into further detail."
The full piece is here.

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Alternative suggestions:

"Deleveraging Climax"
"Mortgage Backed Security Annullments"
"Solvency Dilemmas"
"Risk Management Void"
"Counterparty Conundrums"
"The that-sucking-noise-was-your-capital-base vacuum"

[please add your own]

An imperfect but useful leading indicator.

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A friend said to me yesterday that the market falls were over, surely. He brokers insurance and does not have to get his equity calls right. What he has is an acute case of Bad News fatigue filling the vacuum left by time in between slowly unfolding events.

There is relative cheapness around between equity sectors and between market capitalizations. But historical bargains are mighty few and only then after detailed, company specific, bottom up trawls. As the IMF thoughtfully reminded everyone yesterday credit remains a bit of a problem. Especially if you need some. Residential through to corporate credit is squeezed and it is quite impossible to work out the size of the overall problem - whatever surprisingly precise number the IMF might come up with.

The ultimate culprit is leverage against poor credit risks and from this, amid all the chatter, there are only two exits. The credit risk improves; or the lender takes a write-off (or its logical extension, the lender fails - another form of write-off). The FT has had a few articles covering the form this danger is taking in today's leveraged context - counter party risk - of which these are 1, 2 and 3 examples worth looking at.

Pictorially it is not easy to argue that this has been taken on board by equity prices compared to the 2000 peak - even after making an allowance for 9/11.



Sideways continues to look the most optimistic short-term possibility; but a shock crisis in some financial looks better odds given that interbank lending spreads remain persistently in Bear Stearns territory.

As a footnote, three wonderful articles (and graphics) in the NY Times today – A boom that wasn’t; Asian inflation; and Farmers spurn conservation.

The first two do not make for the greatest news for US consumers or proponents of decoupling. The third piece with its intriguing graph is potentially good news for food price levels a few harvest from now (but not good news for ducks). 35-odd million hectares taken out of production since the mid 1980s is an astounding 8% of US land under cultivation.

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An investment overview and company tear sheet have been posted under the ‘Research List’ tab for North American Galvanizing, Inc, the Nasdaq-quoted (NGA) corrosion protection for fabricated steel specialist.

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(Written 8 April 2008. Consult 'Investment Approach' tab for outline of what criteria gets a firm on the research list).

90/100 quantitatively on recorded 2007 over 2006 accounts. Qualitatively the equity is set to decline along with US capital project spending - the typical how-far-how-deep collateral victim of macro uncertainty. But the firm’s stunning financial turn around from being a below average multi-business performer to the number 2 or 3 specialist in its niche leaves it superbly placed in a fragmented sector ready for consolidation. The latest 10K is here.

Infrequently does a company that has done as consistently well on its internal financials as North American Galvanizing (NGA) appear. The only half reasonable complaint is dilution of the equity base in 2007 – and that has been rectified since by a $2m share buyback plan. In broad terms there is nothing else in the annual financials worth picking over. Where the firm is vulnerable – on zinc prices, for example, its second largest expense – it is as a result of uncontrollables.

Still, having said all that, the prior year comparables are soft - NGA has emerged from fairly dire straits rather than making its astounding progress from an already efficient position. Today it is one of the largest galvanizers in the US with a 10 plant network, one of them the largest in the southern half of the country. Notable competitors include Aztec with a larger but older set of plants; AAA Galvanizing, a private mid-west based firm; and the north-east based Voigt & Schweitzer, originally German but owned since 2005 by the UK’s Hill & Smith Holdings plc.

It is the future that looks tricky. Previous price rises in zinc were passed onto customers, a feat only possible in periods of strong demand; and the nightmare scenario is sharply lower US capital project spending by (in particular) the petrochemical, utility, paper and public sectors coupled with uncomfortable zinc appreciation (in a reversal of its current trend).

Some market perspective is helpful. Six years ago the US Federal Highway Administration published a study “Corrosion Costs and Preventive Strategies in the United States” a mercifully brief synopsis of which can be read here. The study suggests that corrosion costs the US 3.1% of GDP annually, a figure curiously rounded up to 4% on at least two galvanizing industry association websites. Either way, it is a big number – circa $276bn and much of it maintenance as well as new project spending.

Separately, the US Department of Commerce, in a decade old study, estimated the ‘hot dip’ galvanizing (HDG) market in the US to be $1.4bn. HDG is NGA's sector and is the most widely used form of anti corrosion for fabricated steel. On both a life-cycle cost (in most cases) and straight forward durability basis, it is the method of choice for large projects. There exists a superior, near zero-emissions, galvanizing process called thermo-diffusion but it relies on comparatively small ovens rather than large molten zinc dips and is thus limited to the protection of smaller pieces of metal.

The bottom line is that while old technology HDG is not about to disappear in spite of a distinct lack of environmental credentials; and there is also a political will (it seems) to widen the use of anti-corrosive treatments it is difficult to see galvanizers enjoying the strong demand that has characterized the last two years. Yet it is also difficult to see their markets – mostly built around long term planning expenditures or periodic maintenance – collapsing.

Against that backdrop the ungeared NGA generates so much cash that its likely medium term outcomes will include some combination of:

  1. More share repurchases
  2. The start of dividend payments
  3. Incremental, tactical market positioning acquisitions
  4. A larger, company transforming transaction with a regionally complementary rival
There is no way to sex-up glavanizing as an investment story. But beyond the quarterly noise the impressively run and performing business operations of NGA should at least be on the watch list.

Exhibit: North American Galvanizing tear sheet




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My wife returned from London recently with a tin of Plantation Reserve sugar, made in Barbados. A 500g tin cost £2.99 at Tesco.

The sugar No. 11 contract (which is the benchmark for raw sugar futures trading) for May closed on Friday at US$0.1157 per pound. The Plantation Reserve product equates to US$5.43 per pound or about 47 times the market price of the raw product it is made from. Rip off?

Sugar is a tricky commodity. Until the price spikes of 1974 and 1982 gave birth to alternative sweeteners that took away great chunks of the soft drink market it was a classic boom and bust commodity. Ironically, the rise of the artificials brought a semblance of price stability, made it simpler to plan the huge industry capex requirements against a multi-year crop and capped the world price at 15 to 16 cents per pound.



Until, that is, 2006 when ethanol, Kyoto emissions targets, developing country demand and speculation moved prices into what appears to be a new historical phase. But hardly one a small, expensive producer can ride.

This image was made near a sugar factory (now defunct) close to where I grew up – Buckley in St George, Barbados. Which is why I got the tin. In primary school factory tours were common and intended to impress on young citizens not only the unforgettably sweet smells of molasses boiling and sugar turning in the centrifuges; but also the importance of the industry which, despite the echoes of slavery, was a vital foreign exchange earner.

That it was still then so important is curious. Global sugar production changed dramatically in the 1800s when the steam engine brought with it huge economies of scale. Before, being a small island and, by definition, adjacent to a port meant human, animal and wind driven sugar harvests were a winning combination. Afterwards, a single Cuban centro could produce the annual output of 100,000 tons of a Barbados (in its heyday) and get it to market with ease. Small producers from then learnt to survive on subsidies and aid.

On its way to becoming part of a so thoroughly commoditized trade there have been various other lows for Bajan sugar. None lower, perhaps, than those of the mid 1990s when domestic sugar was scarce locally and rum exporters could not hit European Union (EU) quotas. And against this miserable backdrop the EU recently decided to cut its sugar price supports to the Caribbean by 36% come 2009. This in order to ‘level’ playing fields. Where the heavy subsidies to sugar beet growers in the EU fit into that notion is uncertain.

Still, necessity is the mother of invention. Rather than abandon sugar Barbados opted to innovate it. It is doing so in two notable ways: the first is via an expanded production and marketing segmentation of top grade rum led by multiple international award winning blends like local favourite Mount Gay Extra Old. Sugar and its derivatives are worth 17% of the value of exports; but within that rum exports have been worth more than raw sugar shipments for nearly a decade.

And the second is through the creation of a new market – ‘gourmet’ sugar. Which gets back to Plantation Reserve. It turns out that small has advantages after all. In the same way Bordeaux growers will bend your ear forever about the geology of their plots Barbados is a porous coral island with a thin, calcium-rich topsoil. This combination and the pattern of rainfall, it is suggested, leads to a raw product and then a rum that does not just fluke all those awards year after year.

And neither, probably, has the new derived gourmet sugar fluked its way in the UK into 1,200 Tescos, 151 Waitroses, Selfridges, Harrods and Fortnum & Mason. Various culinary commentators judge it excellent and, considering its origins and the political background, it is also a worthy, feel-good product that is not begging favours to be bought. If Plantation Reserve is the hit its distributor list suggests, planned expansion will guarantee circa 15% of the Barbados’ sugar production. Simple, effective classic value-added investment - and perhaps the only way to maintain the beauty of the rolling cane fields so essentially to King tourism.

A final, equity investment related point: the locally quoted company behind it (although in partnership with a government entity and the country’s National Trust) is Goddard’s Enterprises. Market capped at about US$200m it turned over US$387m last year; has a free operating cash yield around 7.4%; trades at a price to sales ratio of 0.52; and enjoys a classic, though in mini form, conglomerate profile.

Usual disclaimers.

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A little over a quarter ago this update on the Baltic Dry Index was posted here. Today the graph looks like this:


A very useful comment last time pointed out that it is also worth watching forward freight agreements (FFA), derivatives used by shippers to (amongst other things) insure against rate volatility, when guessing the direction of freight rates. In December, Q1 2008 FFAs were in contango versus spot - at odds with the message of the then version of the above graph. One quarter of actual data later suggests the BDI/10 year Treasury measure was the better leading indicator.

But this is deceptive. FFA data is not strictly comparable to an index: they are traded against routes rather than composites; and they are driven by expectations, rather than real-money-down as with the BDI and Treasury data. As of yesterday all routes on available 2008 contracts were in either very gentle contango or very gentle backwardation versus spots. Or sometimes both depending on the period considered (ie a gentle hump for a given route graph). Prices into 2009 and out were well below spot.

The point, however, is that over the next quarter FFAs show broadly steady rates whilst the BDI/Treasury measure shows them dropping again. How either indicator, one short term the other shorter still, can be used to inform the commodity super cycle and decoupling debate is questionable. Moreover, there are additional considerations when interpreting both data sets - but especially the BDI.

China has embarked on staggeringly large investments in shipyard construction which, if all completed, will double shipping capacity by 2010. How this supply side factor will impact freight rates is a riddle, wrapped up in mystery, inside an enigma. Potentially, it will badly distort the underlying reality, or surreality depending on one’s level of free-market dogma, of the super cycle picture as it is conveyed by the level of the BDI.

And, over on the demand side, China’s growth as a steel and cement exporter; a coal importer; and its huge iron ore requirements (around 12% of the BDI by itself) have transformed the index to a large degree into a metric of the poster-comrade’s economic health. It is ironic that shipping, previously a prime example of a highly economically liberal industry, is now more or less a plaything of the world’s largest centrally planned economy. Not that ship owners are complaining about it.

But the overarching prop of the commodity super cycle case – and that for the decoupling thesis – is not merely that China is buying a lot of "stuff". It is the idea that political pressure to deliver, particularly in China and India, social improvements in public goods and services has lent the commodity cycle an unstoppable long term momentum. This is seductive, but it does not necessarily equal decoupling in the short and medium terms.

The argument is, in fact, a simple variant of the too-big-too-fail thesis and is as much an act of faith as an exercise in logic. In blunt terms, be it even a cycle within a super cycle, there are limits to compensating a declining export sector by stoking domestic demand. And, as for the longer term, assuming the various political landscapes as constants - as the super cycle thesis appears to – has been shown many times by history to be an unsteady foundation upon which to build.

Still, here's hoping this one holds.

Sources: Clarksons Shipping Intelligence; Imarex (International maritime Exchange); Barry Parker, bdp1 Consulting Ltd

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An investment overview and company tear sheet have been posted under the ‘Research List’ tab for Diploma plc, the London Stock Exchange listed specialist distributor with distinctly defensive characteristics and robust cash generation qualities.

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(Written 3 April 2008. Consult 'Investment Approach' tab for outline of what criteria gets a firm on the research list).


Quantitatively 55/100 on the recorded 2007-over-2006 accounting data. Qualitatively needs much narrative. Diploma is a ‘large’ small cap and an acquisitive distributor of specialist materials. The company spent over £30m on four business in 2007 and inventory turns, return on assets and short term liquidity are under pressure as a result. This accounts for the 55/100. But a longer term analysis (the tear sheet covers the 7 years since it transformed itself completely into its current form) and a glance at the share performance shows it to be a financially robust cash generator, ungeared and an excellent investment at the right price – possibly even in the face of an economic slowdown. Which, in historical terms, is about 20% less than where it is now (158p). The company is due to report its interim numbers on 12 May.

Diploma plc have a 2007 annual report of superior quality worth reading. Logical and factual, it bears many of the outstanding features that US GAAP demands without the excessive detail to drown in. The essence of the document is that the business consists of three separate units, each running on its own cycle, each specialising in a high value added niche and each making sales on customers' operational expenses (either consumables or maintenance) rather than via capex. The units line up thus:

1) Life Sciences: serves the pharmaceutical, biotech, environmental, health and safety & clinical application sectors. Turnover of £44.7m (32% of total); free cash flow (as defined by Diploma) £5.2m (25% of the total)

2) Seals: driven by heavy construction in North America (infrastructure programmes, not houses) with - despite the aforementioned after-market focus of the total company - 18% of sales coming from outright sales for earth moving equipment. Turnover of £36m (25%); FCF £5.6m (27%)

3) Controls: UK and German macroeconomic growth are the key drivers (with one so far offsetting the other this cycle). A niche focus on defence, motor sport (including F1 and NASCAR) and aerospace provides some insulation from the cycles. Turnover of £60m (43%); FCF £9.9m (48%).
The temptation is to underestimate the defensiveness of the sum; yet the shares have a beta of 0.5 and the long term graph shows an equity doing the opposite of the market during the 2000 to 2003 bath. Admittedly, that was not a classic industrial recession; but the point bears scrutiny.

In ratio terms, the longer-term performance of the firm as it has existed in its current form is mixed. ROA and gross margin improvement has been excellent; but inventory turns and cash collection merely average with no discernible focus. Yet this is still a company with no debt and strong free operating cash flow generation currently yielding almost 8%. Other things being equal, should that yield rise 2.5 to 3 points, thus providing some margin of comfort in uncertain times, it would make the buy case look very attractive. That equates to a share price of circa 120p to 125p; and the technicals do not suggest that level to be out of reach.

Finally, value buffs may be interested to note the directors are currently valuing 150 acres of land in Lincolnshire (owned since 1973) at £500,000, but nil on the balance sheet. In 2003 7 acres were sold for £2.6m; in 2004 7.9 acres for £4.2m; and in 2006 12.2 acres for £11.5m (all stripped out of the tear sheet data). The land is mainly agricultural and although the 2005 accounts state some of it may be suitable for development by this year the Directors were saying it was not for sale in the foreseeable future.

Exhibit: Diploma plc tear sheet


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April Fool’s in France means the avoidance of a poisson d’avril. If you have children and occasion to lament their attention span, it is a marvel to witness the planning and preparation of the poissons. There is, for some reason, a special motivation in being able to pin these drawings (intricately executed) on ‘friends’ thereby triggering great rejoicing in their humiliation as ‘poissons d’avril’.

I speak as a victim, reduced to vulnerability by a daughter wanting to give me a hug (how sweet). She unhugged and departed (entirely straight faced, the conniving little cow), less one colourful fish labelled ‘See you at lunchtime, Daddy’ now affixed to my back. I then proceeded to post office, bank and so forth thus attired.

At left is a foldable model my eldest boy also tried to pin on me. He failed having ceded first mover advantage to his sister. But I liked the design so much I called it ‘leverage', have pinned it above my desk and am thinking of sending copies to UBS. Amongst others.

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The Federal Reserve and the European Central Bank announce a supranational quasi sovereign wealth fund.

Speaking from his now official apartment at the Philadelphia Mint Chairman Bernanke set out the rationale for the new supranational fund named “Interbank Cheer”, a near perfect anagram of its architects ‘Bernanke’ and ‘Trichet’.

“As I have said before when facing difficult times, there are two possible mistakes: one is to go on too long, and one is not to go on long enough. We’ve decided the first is preferable.

This new fund will invest in US mortgage backed securities and begins its operations respecting the spirit and letter of that strictest of market dictums: buy low. But that does not mean we cannot look forward to selling them dear at our leisure. As a very great man once said, 'I may not be here when we do, but we as a people will get there'. This is sound use of the public purse.

Let me address, too, some of the concern, misplaced in my view, about overlap with Fannie Mae and Freddie Mac. As I’ve said before capping the size of their portfolios helps control potential systemic risk. And that’s why we are slicing and dicing this completely different type of risk via a new entity. A new entity partially funded, I should add, by the sale of pre-1982 pennies which contain 95% copper worth nearly triple the face value of the coin itself. I thank, Alan, my predecessor for that. And the idea, too. True, most of them have already been smelted and shipped to China by our dynamic private sector but I don’t think we’ve completely missed the boat.

Finally, before handing over to the ECB President, let me add that a helpful side effect of the fund is that it will also stabilize prices across many asset classes. Which, of course, we don’t target. But it’s a definite nice to have in today’s context, isn’t it? You may recall my saying ‘if Wall Street crashes, does Main Street follow?’ The answer is still ‘not necessarily’. But why risk it?

Jean Claude?”

“Merci Ben. I too would quote a very great man: ‘When the seagulls follow the trawler, it is because they think sardines will be thrown into the sea’. Evidemment, we all know that excessive, volatile and disorderly movements are undesirable for economic growth. So is a dollar at levels making EU manufacturers, how do you say, brick it. Clarity, transparency and a logical approach are required to draw a line under the ongoing disorder.

This is the line; there will be no more sardines; and I remain vigilant.”


Check your calendar...

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