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For four decades the Japanese economy secured more than its fair share of coverage in the financial press. Dominating the economic headlines were the manufacturing and export expansion of the 60’s and 70’s and the phenomenal market rally that took the Nikkei to almost 40,000 during the 80’s. Thereafter commentators focused on the lost decade of the 90’s caused by the property market crash, bank balance sheet shrinkage and the death of Japanese equity wealth by a thousand cuts.
This decade has seen the rise of China’s economic profile, with the PRC now destined to replace Japan as the world’s second largest economy. Such is the dominance of Chinese related articles it’s easy to forget Japan is still an economic goliath, albeit in relative decline. And the cause of that decline can be summed up in one word; deflation.
There’s something deeply embedded in the Japanese economy and psyche of Japanese businesses and consumers that has caused deflation to be a secular and persistent challenge for the Bank of Japan for the past 20 years. The problem with deflation is that it maintains the real value and burden of debt, whereas a healthy rate of inflation, 2-3%, over the years gently erodes the real economic cost of borrowed capital. It is inflation that has given the western economies the luxury of consuming more in the present, with debt in nominal terms eroded by the passage of time. Deflation throws another spanner in the works of economic growth. Why buy a new car, or new machinery, in fact why buy anything today that will be cheaper in a few months? The result is structurally weak demand, an interest rate so low it’s barely visible to the naked eye and a flight of capital to higher yielding currencies (the New Zealand and Australian dollars have been a favoured destination for retail and institutional investors for years). Deflation is a nasty poke in the eye for demand, capital investment and growth.
In fact Japanese interest rates have been so low for so long, the Yen has been systematically sold (shorted) not just by Japanese investors but by a legion of hedge fund managers for years with the proceeds placed just about anywhere that offered a higher return. Admittedly that carry-trade, along with most risk embracing investment strategies, grew to bubble proportions and burst in 2008 but with investors embracing risk again, greed replacing fear, that transaction (short Yen, long anything else that moves) is likely to re-surface.
Investors unsure about the viability of continued Japanese deflation, preferring to focus on the unprecedented global stimulus measures, that should be inflationary, should look closely at the latest Japanese consumer prices data. Prices fell 1.7% in the year to June, prolonging the sequence of deflationary months (year-on-year) to four in row. The main contributor to the decline in prices is energy, with oil settling into $60-$70 channel compared to last years roller-coaster ride to $147.
Investors could suggest that the global economic recovery could re-inflate energy and commodity prices, prompting inflation and thus curing the Japanese “I’ll buy it later when it’s cheaper” philosophy. Unfortunately, higher energy costs are paramount to poking the Japanese economy in the other eye. Japanese energy imports can peak to 97% of its oil and 96% of its gas needs. Japan is similarly deficient in other key energy and mineral related commodities. Higher energy and commodity prices just leave Japanese consumers with less to spend on domestic goods, further hurting demand.
Democracy is the system of one person one vote. Business is one dollar one vote. It would take a vivid imagination to think that the perfect scenario for a business; securing abnormal profits or a monopoly, is appropriate in a fair and democratic society. Likewise, the managers and shareholders of corporations need to be offered a reward for their time, skills and investment otherwise there would be no motivation to take risks or to employ workers. A fair equilibrium is the logical aim.
But the two, democracy and business, co-exist uncomfortably as there is a finite amount of wealth in the economy and that wealth needs to be shared equitably between two of the three participants in any economy: individuals, (workers, consumers and taxpayers) and businesses. The third participant is the government which should not pursue wealth or power for its own benefit but should act as the moderator and facilitator creating a scenario which allows the two other parties to prosper fairly, in correct proportion and in line with the law. To achieve this fair scenario key governmental decision makers should not have personal interests more aligned with one group, business, than the other, society.
In periods of economic growth when both the individual and corporations as a whole prosper the division of wealth between the two is naturally a concern. But those concerns are magnified significantly when the economic pool of wealth is contracting. In a recession tensions between the individual (the ‘man on the street’) and companies increase as corporations lay off staff to protect the interests of the firm’s owners. Tensions rise further when certain companies or industries receiving preferential treatment at the expense of industries with less political influence or the collective society.
The onus is on the government to ensure fair allocation of stimulus and support so that both individuals and companies exit the recession together, as far as that is possible. But if the country is still struggling to recover, unemployment is rising and the average individual is still suffering whilst certain corporations are already, again, enjoying abnormal profits then the division of wealth and the legislation that created that scenario is flawed. Also, corporate earnings can only grow quicker than GDP growth if the finite wealth of society is being re-allocated from the individual to corporations.
The past 25 years has seen the economic balance of power shift too far from the fair equilibrium. The few are benefiting at the expense of the many. Goldman Sachs is a beneficiary. Wall Street as a whole is another beneficiary. Main St has suffered. But the individual, the workers, the micro-engines of the economy have suffered most. Unfortunately, one dollar one vote is more popular than ever in Washington.
GS to 29th July 2009
A couple of years ago, earnings growth obsessed investors and banking analysts treated Banco Santander almost as an after-thought. For every mention of Banco Santander in the UK investment press there were 10 articles on each of the other big banks; Barclays, RBOS, LloydsTSB, HBOS and HSBC. Santander just wasn’t very exciting. Plus, the London investment community, deeply in love with its own Anglo Saxon model of capitalism was ever so slightly amused at the thought that our European cousins in the Mediterranean might articulate banking management skills equal, or god forbid superior, to those in London or Edinburgh.
Now, as the country continues its efforts to formally exit the worst financial crisis in living memory the enigma that is Banco Santander is better appreciated.
But in all logic the bank should be suffering a maelstrom of problems. Santander is domiciled in Spain, arguably the most vulnerable economy in Western Europe. The group also, in 2004, acquired one of the largest British banks, Abbey National, and it would be fair to expect Abbey to have a similar depth of exposure to struggling UK consumers and the housing market as the much maligned Northern Rock, RBOS, HBOS or LloydsTSB do, (the latter two now forming Lloyds Group). But Santander isn’t in a mess, nor was it on the verge of collapse like so many banks late in 2008. It didn’t dominate the headlines with news of government bail-outs or queues of panicking savers urgently trying to extract their cash. Quietly, professionally and with minimum fuss the Spanish bank has consolidated it position, strengthened its brand in the eyes of risk-averse consumers and built a reputation amongst banking sector observers for financial integrity and stability that most other Western banks can only dream of.
Santander’s strategy of geographical diversification and a commitment to building a relatively prudent book of loans and mortgages has protected its balance sheet from the worst excesses of the debt bubble, though obviously some additional bad debt provision has been necessary. The bank should be congratulated for having paid close attention to the Good Risk Management textbook, the book HBOS management left on the shelf, collecting dust, thinking it was a secret Martian code too complex to be deciphered.
Reviewing the financials from the latest quarterly report also reassures. The group’s attributable profit in Q2 has progressed to Euro 2,423m from Euro 2,096 in the prior quarter, whilst year on year performance is a modest 4% lower. The UK contributed 16% of profits, Latin America 34% and Continental Europe 50%. H1 2009 loan provisions rose 61% to Euro 4,626 from Euro 2,880 in H1 2008 causing a 19% descent in earnings per share which otherwise would have made strong progress. A proportion of the bad debt provision maybe ‘returned’ to the P&L if actual bad debts are less than the provision. Of course it is also possible that the provision is inadequate but with a diversified business model and exposure to the relatively healthy Latin America region, the future remains brighter for Banco Santander than many of its competitors.
The chart below highlights the growth in the bank’s NYSE listed ADR (Banco Santander Cent Hisp) which is deep in over-bought territory with a 14-day RSI of 77.38, so investors should add the firm to their watch list and reconsider the question of buying if better value returns.
Banco Santander STD to 29th July 2009
Some weeks ago, the NIESR (National Institute of Economic and Social Research), released a relatively upbeat review of Q2 economic activity. Their thoughts, that Q2 Gross Domestic Product could be flat or marginally positive, were broadly in line with the growing number of cautiously optimistic predictions. March was to be the trough, the bottom, of the British economic cycle and April through June was to see expanding output and the start of the recovery after a year of contraction. The prediction was not a shoot from the hip exercise. Data across the economy had been improving for some months encompassing retail sales, the housing market, risk appetite, merger and acquisition activity, corporate profits and the back bone of every recovery, confidence.
Friday’s first official estimate of UK GDP is therefore a kick in the teeth for optimists. The Office for National Statistics reported a -0.8% decline in Q2 GDP quarter on quarter, against consensus forecasts of a -0.3% contraction. It’s highly unlikely ongoing revisions to the data will retrospectively propel the economy from contraction to growth, the gap is too big. The UK economy has therefore contracted for 5 consecutive quarters and has fallen over the period by -5.7%, resulting in the worst 12-month decline in economic output since 1955.
Predictably, analysts rushed to speculate. The Bank of England would have to re-think its stimulus policy. The £125bn quantitative easing program, recently put on hold, would have to be expanded. Interest rates would have to stay low, for longer.
In currency and bond markets guess-work was not required. Sterling fell against the dollar and government bonds rose as investors exposed to the UK economy de-risked their portfolio. Trading rooms across London were consistent in their analysis of the GDP data with “awful” being the singular opinion.
GSK, the global pharmaceutical group has made enormous efforts over the past 2 years to re-structure its business, broaden its product range, reduce costs and fight back against the growing threat of generic drug providers. The latest quarterly review provides evidence GSK is making strong progress in the pursuit of those strategic aims, though management admit more work is required before analysts will permanently re-classify GSK as a solid growth stock. Sadly, it has taken the H1N1 pandemic (Swine flu) to further boost medium term growth potential with GSK, thanks to its deep pockets and significant development capabilities, quickly and efficiently scaling up its influenza treatment portfolio.
A brief look at financials shows mixed results to date. Q2 earnings per share in sterling terms grew 14% (pre-restructuring costs) to 31p, whilst the headline eps figure came in at 28.3p (50.6p in H1 2009). The dividend was increased 8% to 14p. New product sales rose sharply in the latest quarter to £377m, up 42%, relative to £265m in Q1. Despite the impressive new product sales growth, revenues overall were 2% lower with US sales a disappointing 15% weaker, more than offsetting emerging market growth.
But the future looks bright. GSK has invested around £1.25bn in influenza treatments, has 6 products filed with the US FDA and another 30 products in late stage development. GSK is also working with 50 governments regarding distribution of its Relenza flu treatment and has well developed plans to build its customer base in Japan, where it is planning multiple product launches. The firm has also enjoyed significant success in Europe with its anti-obesity drug, Alli, which is already one of the fastest growing OTC (over the counter) drugs in the region. GSK are planning to commence distribution of Alli globally in forthcoming months.
GlaxoSmithKline has already secured annualised cost savings of £900m and is confident the target of £1.7bn in pre-tax cumulative savings will be achieved by 2011.
Strategically, the firm also remains committed to further building its product range, distribution reach and simplifying its operating business model. By the end of 2009 GSK will be producing Relenza at a rate of 190m doses annually. If the current new product sales growth rate is indicative of the ongoing potential, and if the winter flu season is as bad as health professionals predict, the firm will enjoy a substantial earnings boost suggesting forward looking valuations of the stock are not stretched despite the recent market-wide rally.
GSK Weekly to 23rd July 2009
Carphone Warehouse is Europe’s largest mobile phone retailer. CPW is also the UK’s most prolific supplier of residential broadband solutions, a position strengthened following the recent acquisition of Tiscali. But the group isn’t famous for being aggressively acquisitive. Most of the growth over the past two decades has been achieved through organic expansion and CPW now controls an impressive percentage of market-share from its 2,400 stores across Europe.
Such size facilitates stronger bargaining power with suppliers and creates brand value but the bigger the operation gets, particularly businesses like CPW exposed to consumer discretionary spending, the more its growth is dependent on the domestic and international economic growth rate and the financial well-being of customers. It’s therefore pretty impressive that Carphone Warehouse is on track to meet revenue and new customer targets for the year despite the UK and European recession.
The telecoms group is also owner of the TalkTalk brand, which currently forms part of a European joint venture, the other partner being Best Buy, the US electrical retailer. Whilst the synergy in consumer products, retail experience and distribution expertise appears to make sense, CPW remains committed to de-merging TalkTalk from Best Buy Europe and the management team’s recent update reaffirmed the re-organisation is on track for mid 2010 completion. Such a strategic change is an obvious distraction particularly at this stage of the economic cycle so for TalkTalk to surpass analyst’s forecasts for customer growth, gaining 47,000 new broadband accounts in the most recent quarter (consensus estimate was 37,000) is no mean feat. Post de-merger the Best Buy Europe business is planning to open a chain of electrical stores across the UK next year, a brave decision considering the dubious health of so many UK retailers, though to be fair there will be no shortage of prime sites to rent cheaply following the demise of Woolworths and other UK retailers. CPW confirmed finance has been agreed for the new stores so it looks like the venture is a definite go, recession or not.
The group, in line with the industry trend, continues to gain broadband and mobile phone business whilst fixed line telephone revenues contract. That trend will continue as new consumers, predominately younger customers, embrace mobile communication and internet solutions rather than the inflexibility of a home based fixed line telephone which fails to meet their mobile social needs. Another more recent, recession prompted, characteristic of the business is the lower churn rate as consumers persist with existing monthly contracts and phones reluctant to shop around for a new contract and phone which often entails an element of pay-up-front plus monthly cost. That shorter-term trend should reverse somewhat into 2010 though CPW is likely to be a beneficiary of churn, at the expense of the competition, if the latest quarter is a reliable guide.
Overall there are more positives than negatives to reflect on but the risk embedded into the 2010 Best Buy expansion persuades me to remain neutral towards the stock, rather than buy, but I am infinitely more amiable towards CPW stock than Vodafone (VOD) or British Telecom (BT.A) which have vulnerable distribution models and deep corporate problems respectively.
160 million people a day use products manufactured by Unilever. The firm has 400 brands of which 13 are “Billion Euro brands” including Dove, Knorr, Flora, Lipton and Sunsilk. In a recession when consumers have less cash to spend there is naturally an inclination for shoppers to fill their baskets with supermarket own-label products rather than branded goods which are usually more expensive. Investors in Unilever shares therefore awaited the Q1 2009 update with caution, in the knowledge that the firm is currently facing extreme pressures on both margins and revenue.
The firm has held up relatively well in the circumstances. Q1 organic growth was 4.8% with double-digit progress in emerging markets off-setting weakness in Western Europe. Earnings per share though, after restructuring, disposals and pension costs were down 13%, (EPS 44% weaker including exceptional items). News that turnover was 0.7% lower in the quarter relative to the same period a year earlier also required deeper investigation. The near flat performance was aided by the organic growth, detailed above, but held back but currency movements and weaker volumes. Overall, the financials were probably as good as could be expected in such difficult markets. Unilever, deeply aware that the global recession will may last through Q4 2009, has also been busy restructuring and acquiring margin-enhancing brands to strengthen its portfolio adding the Baltimor and TiGi brands to its stable. Unilever also successfully raised additional capital of $1.5 billion and £0.35 billion via two over-subscribed bond issues earlier in 2009, no mean feat under the circumstances. The firm is also acutely conscious that one of its core markets, Europe, remains particularly weak and detailed a determination within its Q1 update to invest more in product development and marketing to support key product lines adding to the Euro 927 million invested in research and development during 2008.
Looking forward, a workforce of 174,000 primarily based in 270 manufacturing sites, located in over 100 countries, looks increasingly vulnerable to cost-cutting attention if the global recession persists longer than anticipated. Meanwhile, for investors, there is a multitude of higher-growth potential shares available home and abroad that are better positioned to offer leveraged returns on the back of improving risk appetite towards equities and the 2010 global economic recovery.
UL weekly to 22nd July 2009
I have been advised by a higher authority that the weekly shopping bill, the cost of an over-flowing trolley of provisions, is £20 a week cheaper at Morrisons relative to another leading supermarket chain. I have also been advised by the same higher authority that the quality of merchandise is at least equal to other leading supermarkets and that there is now an army of housewives who have, for the foreseeable future, changed their supermarket of choice.
WM Morrison’s ongoing expansion into the South is clearly working. However, tempting as it is to close my review of the company citing indisputable evidence that Morrisons is doing very well, and will continue to gain market share at the expense of the big three, I will persevere and humbly attempt to add a few relevant facts to the analysis. Fortunately, the information is easily at hand as the management of Wm Morrison Supermarkets PLC, kindly release regular updates like the 1st quarter statement, on 4th June and this morning’s Q2 update. Within the earlier bullish report is confirmation that like for like sales grew 8.2% (ex fuel) in the first 13 weeks of the current financial year and that 500,000 more shoppers visited Morrisons each week relative to the same period a year earlier. Total sales improved 9.2%. The firm also moved to stabilise its staff pension scheme, the Achilles heel of many FTSE 100 balance sheets, confirming that a more conservative strategy had been implemented following a cash injection, revised mortality assumptions and a reduction in the fund’s exposure to volatile equities. The good news continued. Management reflected on the 2nd credit rating upgrade in as many years with Moody’s strengthening WM Morrison’s rating to A3, investment grade, in recognition of improved balance sheet “prudence” and strong financial performance.
Today’s update confirms growth seen in Q1 continued into Q2 and “that the company’s full year results will be ahead of its earlier expectations”. Not surprisingly the stock responded positively to the update and is up 9% on the day to 277p as I write. Despite the spike in price, value remains and it’s difficult to pick another stock within the sector at WM Morrison’s expense. And I would be in big trouble with the higher authority if I did
International Ferro Metals (IFL) is one of the lesser known commodity plays listed on the London Stock Exchange. The firm is one of the leading global producers of ferrochrome, an essential ingredient in the manufacture of stainless steel. Commodity geeks will cite 18% of stainless steel consists of chrome. I am in no position to argue.
IFL’s mine and processing operations are located near Johannesburg, South Africa. The firm proudly states its cost ratio resides in the lowest quartile relative to like-for-like producers encouraging commodity investors to dig a little deeper and in search of further reasons to invest as the global economy recovers, and with it presumably demand for steel. In fact steel is arguably the most cyclically sensitive commodity based asset and production data from the company not only reinforces this view but puts in total clarity the vulnerability of chrome producers to the ebbs and flows of fast changing global demand.
Production in the 3 months to end of June totalled 18,437 tonnes compared to a painfully low 1,168 tonnes in the previous quarter. That data at first glance implies a business back to normal level of output, until a year-on-year comparison is made. In the same quarter a year earlier the production was 56,608 tonnes. Production does not, of course, always equate to sales and the volatility in revenue as also startlingly varying from 10,484 tonnes in Jan-Mar 2009, to 89,091 tonnes during April-June 2008.
The next inevitable question addresses current inventory levels. I predict a lot more picks and shovels are now being put to work. As at the 30th June, the firm had less than 9,400 tonnes of ferrochrome ‘on the shelf’ for sale. That is a lower level of inventory than was sold in the catastrophic depths of the global recession during the first three months of 2009.
Elsewhere on the balance sheet cash levels remain adequate, the firm clearly has a skill for controlling output and therefore costs and it’s certainly one for the watch-list.
Chief Executive David Kovarsky added the following statement to the firm’s production update: “The furnace restart in April to monetise our inventory went very smoothly and we are on track to achieving our production target for this three month campaign. We are encouraged by the perceived improvement in market conditions, specifically by the increase n ferrochrome demand and spot prices as a result of the Chinese stimulus programme. We will continue to monitor the market to assess global inventory levels, demand and pricing going forward. The combination of our healthy cash balance and recently upgraded facilities means that IFL can respond quickly to a sustained increase in demand.”
He makes it sound so easy.
