UK Equities: BARC, RIO & MRW

Barclays Bank PLC (BARC.L) 279.00p
Long term holders of Barclay’s shares, multi-year equity supporters of the international bank, have suffered this past year. The stock fell from a 12 month high of 475p to a portfolio crunching 50p, then back up to the recent high of 320p. The share price volatility perfectly articulates the roller coaster journey from the end of the last bull market through the near-collapse of the credit markets and into the current and ongoing economic and banking sector recovery. Barclays, as mentioned in last week’s review, didn’t need a UK government bail-out and it was able to pass the stress tests without discomfort for a good reason. It raised substantial cash from Middle Eastern investors late last year in a deal announced on the 31st October. Management felt they had little choice. The sector was still in free-fall. Western institutional investors were hoarding cash, avoiding risky assets like the plague, and the only players in town awash with cash and confidence were Gulf billionaires, rich from proceeds of enormous oil and gas reserves. So Barclay’s management put on a brave face, welcomed these new and strategic long term investors and received the inevitable verbal broad-sides from the UK institutions that missed out on the equity issue (launched at a significant discount to the 2008 average stock price). This week, news that one of those long term strategic partners, International Petroleum Investment Company (IPIC), had taken advantage of the recent stock rally to off-load 1,304,835,721 shares, albeit at a large discount to the day’s price, was a further kick in the teeth to the mutual fund and pension companies that failed through indecision, or an alleged lack of invitation, to participate in the autumn equity raising. It’s impossible to blame IPIC. Their agenda is to manage their own portfolio, maximising risk-adjusted returns and to take advantage of opportunities as they arise, not to fix the balance sheet inadequacies of London listed banks. But next time a major UK institution needs a serious injection of cash, I suspect management will try just a little harder to work with local partners many of which would have supported the firm’s stock for decades, before embracing new long-term strategic partners with the gift of discounted stock.

Rio Tinto PLC (RIO.L) 3,004.25p
Rio Tinto management have been busy this week. Unfortunately, they have been busy making the writer look like a fool. I made the mistake of interpreting management’s statement regarding the proposed strategic alliance with Chinalco, quoted verbatim from their 2008 annual report below, as their intention to actually complete a deal with Chinalco, and as closure on a possible BHP Billiton deal. The contents of my last review of Rio Tinto, 5 weeks ago, articulated as much.

“On 12 February 2009 we announced the intention to form a major strategic partnership with Chinalco, a leading Chinese diversified resources company that the board unanimously recommends to shareholders.
Chinalco’s cash investment of US$19.5 billion will strengthen our balance sheet on terms that add value to the Group and increase our flexibility to grow as markets recover. It will strengthen Rio Tinto’s position in the industry during a period in which China’s importance in the global economy is growing rapidly.”

Now, in hindsight, Rio’s thinking behind the statement is clearer. Commodity prices had collapsed, the firm was desperate for an equity injection to ease their debt burden and Chinalco were the only firm at the commodity dating-agency with the cheque-book in hand. How 4 months has changed things! Commodity prices have recovered strongly; western institutions are again looking to part with cash in the pursuit of risky assets and BHP Billiton, like every faithful and patient admirer has forgiven Rio Tinto for flirting elsewhere and has agreed an engagement, if not a marriage.

So after priming myself with business as usual research for much of the week, in anticipation of providing a gentle Rio Tinto update, I found myself choking on my Friday morning latte reading eight, yes 8, stock market announcements from Rio Tinto explaining the firm’s new found love for the hard cash of UK institutional investors and it’s satisfaction at signing an agreement with BHP Billiton, regarding its prize Western Australian iron ore assets.

Friday’s announcements confirmed two key events. Firstly, Rio is to commence with a rights issue consisting of 21 New Rio Tinto plc Shares offered for every 40 existing shares at £14 per share and for the Australian stock market, 21 New Rio Tinto Limited Shares offered for every 40 existing shares at Aus $28.29 per share. The new cash will raise approximately US$15.2 billion (gross). The equity issue will enable Rio Tinto to honour its Alcan facility debt repayment obligations fully in 2009 and most of its 2010 liability. Net debt will be reduced to approximately US$23.2 billion.

The 2nd event, of larger strategic significance, is the 50/50 joint venture agreed with BHP Billiton encompassing both firm’s iron ore interests in W. Australia. Rio predicts the synergies gained from the venture will be worth around $10bn between the two parties. There are significant logistical, as well as financial, advantages of the JV too. More efficient management of port capacity, the alignment of separate mines under a single management structure and a co-ordinated expansion strategy will all ease the burden on stretched Western Australian infrastructure. Rio Tinto will also receive from BHP Billiton US$5.8bn for “equity type interests to equalise the contribution value of the two companies”. It’s great news for shareholders and I am presuming, hopefully, that the statement will be executed, thus preventing me from having to do another u-turn on my analysis some weeks hence. Lastly, if I held Rio Tinto stock, (I don’t), I would take up the rights issue.

WM Morrison Supermarkets PLC (MRW.L) 249.00p
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 in 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, discussed in this weekly review some months ago, 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 released a Q1 statement, on June 4. Within the 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.

Since the stock was reviewed last, the price is largely unchanged, which considering the corporate progress made suggests there is growing value at the current price. Reflecting on the sector as a whole, speculators tend to reduce exposure to defensive supermarket shares into a recovery seeking the more leveraged returns available in other traditional growth industries. However, within the sector, it’s difficult to pick another stock at WM Morrison’s expense. And I would be in big trouble with the ‘higher authority’ if I did.

The Global Economy 30th April 2009

The US equity market closed the month with strong progress banked despite the grim economic data, discussed below, and the growing threat of the Mexican swine flu. The S&P 500 index, the most appropriate measure of equity risk appetite for large capitalisation stocks gained 11% in April, its strongest monthly performance since 1991. Market speculators are usually content to look long into the future to justify today’s buys and the trend of accumulating high-growth potential equities before the first green shoots of an economic recovery have surfaced, has occurred again in this recession, like recessions before.

Even the weak US GDP news, released Wednesday, failed to dampen April’s performance. US economic activity in the first quarter contracted 6.1%, annualised, a faster rate than predicted as businesses ran-down inventories and exports sunk on weak demand. The disappointing data was noticeably worse than the consensus 4.9% reduction anticipated, and within a whisker of the 6.3% contraction suffered in Q4 which commentators hoped would represent the trough in the economic cycle. The US economy has now been in recession for 16 consecutive months and if the trend continues for a further month would result in the longest period of negative economic activity since the 1930’s. A return to positive growth is expected by the 4th quarter 2009 as factories increase output to meet industrial and retail re-stocking. The US Commerce department identified over $100bn of reduced inventories during Q1 which accounted for around a 1/3rd of the fall in Q1 GDP. Exports slumped 30%, following a 23.6% fall in previous quarter whilst corporate investment dived almost 38%. On a more positive note consumer spending stabilised in the period help by the first growth in durable goods spending in a year. US mortgage applications remain at severely depressed levels.

Market liquidity and the willingness of banks to lend to each other are improving. The 3-month USD, EUR and GBP interbank rates have all fallen consistently over the past 4 weeks with Sterling enjoying an unprecedented sequence of successive daily declines in the key borrowing rate. The improvement, from distressed levels, is further evidence of the willingness of investors and key institutions to take on risk. The Euro and Dollar rates have retreated to the lowest level since September 2008, when the global banking sector was on the verge of collapse. The interbank rate is fundamental to the economy and lending as it is the benchmark against which many corporate loans and financial products are priced. Lending beyond 3-months remains stressed with interbank borrowing beyond 90 days very illiquid, but there are definite signs of improvement especially for short duration loans. A similar picture of recovery and increased confidence can be seen in the US municipal market, the source of much US state borrowing. Yields on marketable state debt have steadily reduced with bond prices rising, as more investment managers have been prepared to re-enter the market. Yields should fall further when economic data improves as the spread, the difference between the Federal Reserve official rate and the interbank rate, is still exceptionally wide in relative terms.

In Europe, some of the countries suffering the most from the global recession are countries, like Ireland and Lithuania, which grew the quickest in the preceding 10 years. Forecasts for the Irish economy are being downgraded with alarming frequency with the Economic and Social Research Institute now predicting a 9% contraction in the current year, downgraded from the previous negative 4% forecast. Unemployment, now at 11.4%, is to worsen to 16% during 2010, whilst property prices are vulnerable to a 33% fall from the 2007 peak. Increased emigration, which assisted the economy during previous recessions by offering employment opportunities to those who were unable to secure work at home, is now less of a viable solution. Many of the traditional destination markets for Irish job-seekers, such as the UK, Australia and Canada are also suffering due to the high synchronisation of the global downturn. Lithuania is in an even worse mess with GDP falling 12.6% in the quarter, relative to the Q1 2008, a near 40% annualised contraction, giving the Northern European state the unenviable title of the fastest shrinking economy in the E.U. Thing’s don’t look so bad in the London suburbs after all.

UK Company Focus Rio Tinto PLC (RIO). Rio Tinto, the international mining company, has a wealth of interests across the commodity extraction sector including copper, coal, uranium, diamonds, gold and iron ore. Rio shares grew strongly into 2008 and the stock reached a peak of £70.78 before falling to earth like a weapon of monetary destruction (to £10.49), late in 2008, magnifying the collapse in market-wide investor sentiment and resource prices. Investors also sold off the stock, bored with the ‘will they or won’t they’ BHP Billiton acquisition saga which seemed to last so long investors could be forgiven for nostalgically trying to find first mention of the planned deal in the Bible. Since the December 2008 stock price low, Rio has bounced more than 150% but is still some way off its average 2008 price let alone its high, which occurred less than 12 months ago.

2008 was such a contrasting year for Rio share holders with substantial success in H1 the polar opposite of an appalling 2nd half, any rational discussion would require a book to adequately discuss all the global and domestic influences contributing to the price volatility. Rio Tinto is after all, like other FTSE 100 stocks, supposed to be the meat and drink of ‘medium’ risk diversified equity funds which grace the portfolios of million of UK unit trust and pension fund investors. ‘Medium’ risk? The very phrase seems sarcastic, in retrospect.

During the first few months of 2009, Rio has worked hard to tighten the business model; cutting costs, divesting non-core assets, realising $2.5 billion in the process as well as proactively avoiding any measures that would result in a significant increase in net debt. Production strategy in response to the global recession is harder to assess as productivity improvements have partly off-set deliberate reductions in output elsewhere and the production picture varies greatly from resource to resource. Q1 2009 saw uranium output steady at approx 3.4 million pounds relative to the same period a year earlier. Iron output was 15% lower year-on-year, whereas copper and coking coal output were up 33% and 32% respectively. The Rio Tinto CEO, Tom Albanese, stressed throughout the Q1 update, a continued focus on cost reduction and a determination to adjust supply through 2009 to more accurately meet demand, which is expected to stay weak through Q2 before recovering later in 2009. Rio’s eagerness to complete the Chinalco transaction and to negotiate the deal through the global regulatory mine-field remains a priority. Such is the volatility of the stock, often moving more than 5% on a single day it will remain a favourite tool for day-traders as well as buy and hold investors retain a bullish view on the resource sector over the medium to long term.