[This is a corrected republication of an article appearing November 18. The previous article implied Clean Seas Tuna had successfully hatched another round of fingerlings ready for transfer into ocean cages in January. In fact spawning is not due until December and thus further success following on from the successful May spawning trial is assumed but cannot yet be assured. FNArena apologises for this error.]
As the above article explains, South Australian-based Clean Seas Tuna ((CSS)) is an aquaculture company in a unique position of being first in the world to attempt to breed the highly prized Southern Bluefin Tuna (SBT). When we last checked in with Clean Seas in May, its stock price had managed to recover to 80c from the thumping to 30c it copped by virtue of the GFC. Clean Seas' earlier share price peak had been $2.00.
It was not that Clean Seas was a highly leveraged listed company staring bankruptcy in the face, it was just that Clean Seas is a speculative small-cap on a death or glory quest, and such high-risk low-caps were the first to be dumped in panic from share portfolios of 2008.
Success in an initial stage of breeding and a share price recovery saw Clean Seas raising $23m of fresh capital in May, as per the company's fully disclosed capital program, the dilutionary effect of which took the shares back to 60c. Using technology developed over a decade and input from a Japanese university (no prizes for guessing why the interest), Clean Seas had managed to breed SBT from roe into fingerlings before the seasonal cold prevented that particular experiment going any further. But a fresh round of hatchlings intended for December will, if successful, have Clean Seas ready to shift its juvenile fish into ocean tanks come January.
From there the goal is sashimi in Tokyo.
But still Clean Seas could not shake off the lingering effects of the GFC - this time beyond its control. Financiers Rabobank/Ridley Feed pulled credit lines, forcing a sudden and unscheduled equity raising of $42m which again diluted the stock by half. At this level, however, the attention of respected stockbroker Patersons was piqued.
Patersons has initiated research coverage on Clean Seas with a Buy and a 12-month price target of $1.33. The broker sees a "high-value, high-margin, high-growth business", noting SBT can sell in Japan for over 3000 yen per kilo (that's about A$36/kg wholesale).
Clean Seas' plan has always been to incrementally raise capital as milestones are ticked off in this capital intensive project - not including the last one - and Patersons sees another $110m needed before FY14. But if this were debt, Patersons calculates a "comfortable" 4.5x interest cover at the funding peak, meaning funding is not really a concern out to FY15.
Investment in Clean Seas is speculative and not for the risk averse. It's a case of either succeeding and watching the share price skyrocket or facing setbacks in what is a six-month cycle game. Patersons nevertheless feels a lot of the risk is tempered for new investors by the effect of the surprise raising and a share price now sitting around 30c.
French bank Societe Generale has made the headlines many times in the past two years, but two particular occasions stand out. The first was in January 2008 when, under cover of a US holiday, the bank dumped billions of dollars worth of shares onto the market which had been surreptitiously accumulated by a "rogue" in SocGen's midst. While the end result made little difference, that trade set the tone for 2008.
By May of 2008, SocGen was stealing the limelight once more, announcing it had moved its balanced investment portfolio to its statutory minimum weighting of 30% equity, predicting a stock market collapse of 50-75%. In January world markets had been trying to recover out of Christmas. In May, markets had managed a 50% retracement of the fall from the highs, figuring the collapse of Bear Stearns was the end of the crisis.
In both cases, SocGen helped turn sentiment around.
And the analysts weren't too far off the mark. The complacent bulls laughed off such a dire prediction in May, but we ended up down about 55%. We have now, once again, retraced 50% of the drop from the high in 2007, this time post-Lehman rather than just post-Bear Stearns. Things are clearly looking brighter than they did, and thoughts of SocGen's 75% have been put to bed. Or have they?
SocGen is not making a specific prediction this time, rather the analysts have issued a warning against a possible worst-case scenario. And it's all to do with global debt. Start shorting cyclical equities, they say, including those in emerging markets. Sell the US dollar and buy government bonds. Buy agricultural commodities and gold. Buy lots of gold.
SocGen is readying its clients for a possible "global economic collapse" over the next two years, with its warning contained in a report entitled "Worst-Case Debt Scenario". What the analysts base their fears on is simple and patently obvious, to wit, the public "rescue" of the private sector has not solved any pre-GFC problems in regards to excessive debt levels in the developed world. It has simply transferred the debt from the private to the public balance sheet.
Total public and private debt in the US has now reached a level of 350% of GDP. That's like saying an individual would need to use all of three and a half year's worth of income just to pay off his credit card. Public debt alone will reach dangerous levels within two years, says SocGen, at 105% of GDP in the UK, 125% in the US, 125% in the EU and 270% in Japan. Total world state debt will reach US$45 trillion, representing a two and a half times what it was only ten years ago.
This is an underlying debt burden greater than what it was after the Second World War. One might thus suggest "well we survived that okay", but remember that following the war was the baby-boom, the explosion of mass production and the advent of the consumer society. It was a golden age of growth.
This time around, the baby-boomers are ageing and threatening to place a huge burden on the public purse. And growth is in the labour-unintensive information and technology industry. In short, there seems no golden age ahead.
SocGen believes we have all but reached a "point of no return" for government debt. Put simply, developed economies will never to be able to produce enough income to net reduce debt levels. A deflationary spiral will prevail, making the whole of the world look like Japan in its "lost decade". Emerging markets will be dragged down as well given they are more leveraged to the US economy than even Wall Street is.
Governments may only have one choice, and that is to hyperinflate their way out of debt by simply printing money. When money is printed, everything loses value, including debt. Welcome to Weimar.
Government bonds would be purchased by central banks just as has been the case in quantitative easing measures to date. Yields would fall to near zero on longer dates. Gold would absolutely soar. Food would become very expensive.
I repeat: this is not a prediction, this is a warning.
As the above article explains, South Australian-based Clean Seas Tuna ((CSS)) is an aquaculture company in a unique position of being first in the world to attempt to breed the highly prized Southern Bluefin Tuna (SBT). When we last checked in with Clean Seas in May, its stock price had managed to recover to 80c from the thumping to 30c it copped by virtue of the GFC. Clean Seas' earlier share price peak had been $2.00.
It was not that Clean Seas was a highly leveraged listed company staring bankruptcy in the face, it was just that Clean Seas is a speculative small-cap on a death or glory quest, and such high-risk low-caps were the first to be dumped in panic from share portfolios of 2008.
Success in an initial stage of breeding and a share price recovery saw Clean Seas raising $23m of fresh capital in May, as per the company's fully disclosed capital program, the dilutionary effect of which took the shares back to 60c. Using technology developed over a decade and input from a Japanese university (no prizes for guessing why the interest), Clean Seas had managed to breed SBT from roe into fingerlings before the seasonal cold prevented that particular experiment going any further. But a fresh round of hatchlings intended for December will, if successful, have Clean Seas ready to shift its juvenile fish into ocean tanks come January.
From there the goal is sashimi in Tokyo.
But still Clean Seas could not shake off the lingering effects of the GFC - this time beyond its control. Financiers Rabobank/Ridley Feed pulled credit lines, forcing a sudden and unscheduled equity raising of $42m which again diluted the stock by half. At this level, however, the attention of respected stockbroker Patersons was piqued.
Patersons has initiated research coverage on Clean Seas with a Buy and a 12-month price target of $1.33. The broker sees a "high-value, high-margin, high-growth business", noting SBT can sell in Japan for over 3000 yen per kilo (that's about A$36/kg wholesale).
Clean Seas' plan has always been to incrementally raise capital as milestones are ticked off in this capital intensive project - not including the last one - and Patersons sees another $110m needed before FY14. But if this were debt, Patersons calculates a "comfortable" 4.5x interest cover at the funding peak, meaning funding is not really a concern out to FY15.
Investment in Clean Seas is speculative and not for the risk averse. It's a case of either succeeding and watching the share price skyrocket or facing setbacks in what is a six-month cycle game. Patersons nevertheless feels a lot of the risk is tempered for new investors by the effect of the surprise raising and a share price now sitting around 30c.
Explosives and fertiliser maker Incitec Pivot ((IPL)) beat market expectations with its FY09 result and shares rallied 6.5% yesterday as investors warmed to the result. However, stockbrokers were a little more restrained in their enthusiasm, with several questioning the overall quality of the result and all remaining fully aware that 2010 will be another tough year for the company.
The company did not provide any guidance, however, it expects business conditions to be soft, particularly in the first half, given currency, global fertiliser demand, and seasonal conditions in North America.
Chief executive James Fazzino confirmed that 2010 will be another challenging year, although he felt the company was now better prepared to face the challenges ahead. He said he was confident the company is much better placed than it was 12 months ago "because the business is a lot fitter."
Fazzino went on to say that the long-term strategy, which gives the company the ability to mix and match its chemical plant capacity to both fertilisers and explosives for the mining industry, depending on where the demand is, will give the company the best possible exposure to both minerals and food production.
All up, the company booked a loss of $179.9 million for the 12 months to September 30, compared with a profit of $604.6 million in the year prior. The loss was well expected given a number of warnings during the year on the back of falling world fertiliser prices and as the mining industry progressed further into the current slowdown.
The result was, however, overshadowed by a $491m write down on the Dyno Nobel explosives business. Still, net profit excluding material items fell 46%, although revenue was up 17%, helped by the first full-year contribution from its acquisition of Dyno Nobel, which the company bought in 2008.
The top-line result came in above RBS Morgan's forecasts, however the broker notes that the quality of the result wasn't great. Among its laundry list of issues, Morgans cites a lower effective tax rate, a questionable phosphate rock write down below the line, while the top line result also included an $18.4m boost from a Moranbah provision relating to contract losses that were previously recognised. Take these out, and underlying earnings actually came in below the broker's forecasts.
That said, RBS Morgans admits that the "broad themes" were in line with its expectations. It notes, of course, lower fertiliser prices, reduced margins, lower volumes due to a delay in the buying season, unwilling farmers and a weak 2H09 showing from Dyno. Otherwise, the broker notes that Dyno goodwill was written down by $490m, while the balance sheet remains in good nick, with $943m of headroom.
Analysts at Deutsche Bank were also disappointed by the result quality, citing the same reasons as Morgans, while also noting that FY10 has not started well. DAP prices have fallen to US$280/t and explosives volumes are down 10-20%. North American coal production is also down 10% and the broker says it sees no signs of improvement in quarry and construction demand.
Deutsche also thinks the size of the Dyno Nobel write down is pretty solid proof of the challenges the company is facing in delivering the expected benefits and returns from this acquisition. Management had guided for an 18% return on the acquisition asset base, which adds up to US$204m in savings. Yet while the guidance was maintained, management has now delayed the timing of these benefits by 12 months to 2012.
The stock is rated a 0.2 on the FNArena Sentiment Indicator, which is based on 4 Buys, 3 Holds and 2 Sells. Deutsche is unsurprisingly one of those with a Sell, while Morgans has a Hold on the stock.
Yet there are three other brokers in the FNArean database with opinions on the result. They are UBS, JP Morgan and Credit Suisse and these three have all maintained their Buy calls on the stock. Unsurprisingly, their collective reaction to the result was a little more upbeat than what we've discussed so far.
JP Morgan sees the company as being all about global fertiliser prices and, in particular DAP prices. The broker is expecting to see improved prices in the December-March period as the North American and European fertiliser build gathers pace. With farmers having reduced their usage rates in 2009, the broker thinks that demand will almost have to rebound in 2010. And with inventories at five year lows, the broker thinks this is a potentially powerful force for prices.
Given this view, JP Morgan sees solid valuation support for the stock even under a fairly bearish fertiliser price scenario. However, the broker says that when factoring in its more positive outlook, the upside for the stock should be "material". Thus the broker believes that investors should position for this prior to the lead-up to the US and European seasons.
The result actually came in a little bit below UBS, but the broker thinks that some good cost and capex management during FY09 has set the business up to leverage the upside it sees in the DAP and Urea fertiliser markets. While the broker admits the strong AUD and breakdown in correlation with DAP pricing remains a risk, it notes management has hedged 50% of its USD fertiliser revenue at 89c.
With the company trading at 10% discount to its weighted average peers like Orica and other major fertiliser companies, even using conservative fertiliser assumptions, UBS much like JP Morgan, sees significant upside when markets come out of the current seasonally weak quarter.
Credit Suisse offer us the most upbeat assessment. First, the broker notes fertiliser earnings were a little above its expectations. Explosives exceeded the broker, which it calls "commendable" given underlying volumes fell 14%. CS admits that the result quality was a bit iffy given the same reasons cited by Morgans and Deutsche, but much like UBS and JP Morgan, the broker sees some real upside as soft commodities begin to improve.
Apart from being optimistic about fertiliser prices, CS also predicts that North American explosive volumes should start to recover, while local ammonium nitrate prices are also set to firm. Credit Suisse also sees upside eventually coming from the achievement of the Dyno Nobel synergy target and it isn't that worried about this being pushed back to 2012, as the broker never thought it was in the price in the first place.
As at 11:36 today, shares were flat at $2.79 versus a 12-month trading range of $1.63 to $3.42.
Several months ago CSR ((CSR)) announced plans to de-merge the business into a building products company also containing its aluminium operations and a sugar business. This process continues with the company yesterday announcing an equity issue to raise $375 million, management noting the money will ensure the sugar company is adequately capitalised once it lists.
At the same time the company announced interim earnings that were ahead of market forecasts, though as Deutsche bank notes the result of $96.6 million was helped by the bringing forward of some earnings in its sugar business thanks to the timing of the crushing of crops.
Elsewhere in the result Citi notes margins in the building division improved on the back of cost cuts, helped by both lower labour and freight costs and cost outs in the bricks and roofing operations. Results for aluminium were solid in the broker's view, while the big drag was the Viridis glass business, which along with reporting a loss of $5.6 million saw a write-down of $250 million.
Deutsche bank notes this means almost half the invested capital in the business has been written down as it follows on the heels of a $280 million write-down at the full year result six months ago. As Deutsche Bank notes, the write-downs confirm the company paid too much when it bought the business in 2007, while it suggests the achieving of targeted earnings from the business may be something of a stretch going forward.
Factoring in the equity issue and the interim profit result has seen brokers adjust earnings forecasts, JP Morgan cutting its earnings per share (EPS) forecasts by 10-11% through to FY12 reflecting result related cuts of 4-5% and 5-7% adjustments for the equity issue. Post the changes the broker's normalised EPS estimates stand at 10.2c in FY10 and 14.5c in FY11, while Deutsche Bank, which was at the top end of the consensus range leading into the interim result, is at 12c and 15c respectively.
Credit Suisse is forecasting EPS of 10.1c and 15.3c respectively, while the 0.4% and 7.4% reductions made by Bank of America Merrill Lynch mean its forecasts now stand at 11.1c and 15.5c respectively in FY10 and Fy11. Consensus forecasts according to the FNArena database are 11c and 14.7c for FY10 and FY11.
Brokers overall remain mixed on the outlook for the shares, as evidenced by ratings in the FNArena database showing a total of three Buys, five Hold and two Sells. Deutsche Bank sees the stock as fair value at current levels while JP Morgan, which has an Overweight rating, suggests the de-merger process could see additional value unlocked, particularly if sugar prices remain at current high levels. As well, the broker has the company's building products business as its preferred exxposure in that sector. Maquarie agrees, seeing the raising as improving the group's balance sheet, so leaving it better placed for the de-merger process.
But Bank of America Merrill Lynch retains its Underperform recommendation and takes the view the de-merger of the sugar business is unlikely to create any value, especially given the costs of the process are expected to add up to around $60 million. The equity raising comes at a strange time in the view of Credit Suisse, though the broker does see it as removing some uncertainty surrounding the overall de-merger process and also opens up scope for international interest in the sugar business given it will be appropriately capitalised.
While there have been some changes to earnings forecasts there has been little movement in price targets, the database showing the average target for the stock is now $1.94, up from $1.92 prior to the latest announcements. Shares in CSR today are suspended as the company prepares for the issue but last traded at $1.985, which compares to a range over the past year of $0.905 to $2.31.
You'd almost have to have been living under a rock if you haven't read at least something about sugar over the last few months.
Normally seen as one of the duller commodities, sugar has attracted a lot of attention lately. While some might feel the increased profile has developed into an overblown investment case, commodities analysts at Barclays Capital think there's plenty of upside left in the sweetest commodity.
The team at Barclays likens it to "a perfect storm", with the data out of both India and Brazil looking "irrepressibly bullish". India had a really poor harvest in 2008-09, mostly because of inadequate Monsoon rains. But the market was also burdened by some severe distortions in the cane pricing mechanism and competition from strong gur prices. Gur, or jaggery is a traditional unrefined non-centrifugal sugar consumed in Asia and other developing regions of the world.
The current 2009-10 Indian crop is if anything, looking even worse. Crops are suffering at the hands of an even drier Monsoon season, which Barclays advises is the worst for several decades. Coupled with the poor harvest last year, the Indian market has been pouring out a continuous stream of reduced output estimates.
There were hopes that Brazil would be able to offer some support to the ever increasing tightness falling Indian production was placing on the sugar market, but it's not panning out that way. As while Brazilian production is up close to 12% in year on year terms, poor weather conditions in both June and July this year are casting some serious doubt on how much help that country's sugar output will be able to offer.
The poor weather means an increasing number of available crushing days are fruitless, while the overall sucrose content of the delivered crop is also lower than normal. This has seen the team at Barclays cut its latest Brazilian crop estimate by 2Mt.
Barclays also notes the apparent emergence of a sugar shortage in the US, while there is also evidence of sustained increased demand in both Russia and China. This leads the broker to think that on the demand side, the v-shaped recovery in the global economy that many are now predicting will provide further upward pressure for sugar prices.
Add all of this together and Barclays expects sugar prices will average US22c/lb in Q409, increasing to US24.5c/lb in H110, with the team thinking the strength of current fundamentals will begin to significantly override what are currently " indifferent signals" arising from recent price moves.
While the tight supply environment looks sure to continue over the next few quarters, the next obvious question must be: how long will these dynamics actually remain in play?
Barclays doesn't believe the aforementioned difficulties the sugar industry is currently undergoing will lead to a permanent structural loss of production in India or other major producing countries.
Instead, the bank sees current market dynamics as simply an unfortunate and low probability confluence of circumstances on the supply side, which it thinks will have unwound themselves by 2011. However, Barclays notes that higher prices in almost all agricultural markets tend to send a positive output signal to the supply side. But as it takes 12-18 months for a sugar crop to mature, any assumption of a bumper 2010-11 crop may be a bit premature at this point.
And in India especially, the current weakness in stock levels will support prices for a while to come yet. Especially when factoring in higher oil prices and moderate support from the demand side on the back of the recovery in the global economy. Even if significantly increased production from next year onwards translates into price declines, Barclays thinks they will be moderate. As such, the bank predicts the average sugar price in H210 will still be around be US21c/lb.
While slightly better than late August guidance suggested, the FY09 profit result from crop protection specialist Nufarm ((NUF)), released yesterday, was still a poor one. Weak glysophate margins in the US and credit issues in Brazil belied some resilience in Australasia and Europe, but at the end of the day a drop in US gross profits from $55m in 2008 to a loss of $21m in FY09 told the story. The result was also of poor quality, with a lower than expected tax rate fooling all analysts and an increase in total debt flying in the face of post-GFC market deleveraging.
But the story was a GFC one, and all analysts agree that FY10 has dawned much brighter for Nufarm. Management highlighted a partial recovery in glysophate demand, an end to credit issues in Brazil, and growth in the company's non-glysophate offerings as providing potential. Nufarm's glysophate cost base is also now on par with indutry peers allowing the company to compete more evenly. All brokers have raised earnings forecasts for FY10-11 in the expectation of a solid return to strength, albeit in a still oversupplied glysophate climate.
But it's all academic anyway. Moves by analysts to reassess target prices based on higher earnings forecasts have been overridden by yesterday's announcement of a Heads of Agreement (HOA) having been signed by Chinese company Sinochem for an exclusive, non-binding takeover proposal at $13.00 per share. The offer will also include payment of the upcoming interim dividend, extending the offer's value to $13.15. The HOA ratifies Sinochem's earlier indication of interest.
There is little disagreement among analysts that the price is a reasonable one. GSJB Were notes that if one assumes an enterprise value to earnings ratio (EV/EBITDA) of about 10x based on previous transaction in the agricultural chemical sector, one arrives at a valuation range of $11.50 to $14.00 with a midpoint of $12.75. No analyst is querying the price, including Macquarie who had previously assumed an offer of $14.00. With Nufarm shares having traded as low as $7.30 late last year, shareholders should be happy their stock is in play.
Except it isn't. No analyst expects a counterbid to emerge, and the path from the HOA to an actual takeover is a long one. The HOA merely allows Sinochem exclusive access to Nufarm's books in good faith for the purpose of conducting due diligence. This process will begin on October 15 and end on November 18. Assuming Sinochem is happy with what it finds, the next step is to enter into a Transaction Implementation Agreement which should be signed on December 3.
The deal must then be put to shareholders for approval, and the Australian Foreign Investment Review Board must be given its usual couple of months to assess the impact of the sovereign takeover. Chinese authorities must also grant approval.
Realistically, securities analysts suggest, nothing's going to happen until at least March. That's a long time for investors to be licking their lips over a $13.00 payout for a stock which yesterday was trading around $12.00. And so it is shareholders have voted with their feet this morning, sending Nufarm shares down 3% on a day when the ASX 200 has surged a net 1.8%. Take the money and run appears to be the mantra.
This is exactly what JP Morgan was advising this morning, noting the upside to the offer price was little comfort for six months of waiting. Similarly Deutsche Bank maintained the FNArena database's sole Sell rating, suggesting the glysophate outlook remained challenging. JP Morgan downgraded from Overweight to Neutral now the cat's out of the bag. RBS Australia followed a similar route, downgrading from Buy to Hold on a pre-assumed $13.00 target.
Credit Suisse, by contrast, upgraded Nufarm from Underperform to Hold in lifting its valuation from a stand-alone $10.20 to the $13.00 offer price. Credit Suisse is among a posse of brokers who do not see any barrier to the deal going ahead in the end. Macquarie notes that an important consideration is Sinochem's ability to fully fund Nufarm's growth ambitions.
Not all agree, however. JP Morgan raises the issue that Nufarm is the dominant player in the local crop protection market and this could raise some domestic concerns. The FIRB has been clearly in the spotlight of late, rushed off its feet as offer after offer from China materialises for Australian resource companies. The rejection of a Chinese offer for 51% of rare-earth metal miner Lynas last week and a subsequent indication from the FIRB that stakes of only 15% would be permitted for existing companies, and 50% for greenfield projects, indicates the government is not going to allow the farm to be sold out from under it to Australia's biggest customer. As to how a glysophate producer fits in among the metal and mineral considerations is anyone's guess. (One presumes, however, that there will be no disapproval from Chinese authorities.)
GSJB Were also points out the small matter of managing director's Doug Rathbone's 11.3% stake in Nufarm. Rathbone recently sold 1.75m shares at $11.25 but his stake remains sufficient to block any takeover.
So the bottom line is that the Sinochem bid is merely in infancy, that the price is unlikely to improve given a lack of obvious contenders, that the offer price is not one of significant premium over the recent share price level given the time to potential settlement, and that there are barriers to consider despite many brokers assuming no disapproval.
The FNArena database now shows seven Hold ratings and one Sell, with BA-Merrill Lynch moving to No Rating as is the broker's takeover offer policy. The average target price has today increased from $11.91 to $12.41 with three brokers assuming the $13.00 bid as a target.
Interest in commodity investments continues to be strong as Barclays Capital notes August data showed inflows of US$2.3 billion in the month, an amount at least double the amount recorded for any previous August in the group's database with exchange traded products or ETPs proving to be the most popular.
While the commodities sector remains popular, the group points out the market price drivers currently appear to be in somewhat of a state of flux as the previous strong correlations with other growth sensitive assets are now weakening. The big impact of this is individual market factors are becoming a bigger and more important driver of commodity price performance.
For the agricultural commodities this has meant poor performance of late as previous strong performers such as sugar have fallen sharply in more recent sessions. Soybeans have also been weak, while the group notes cocoa prices are now showing some renewed strength. There have been similarly mixed results in the base metals sector as supply issues have driven lead prices higher at the same time as the nickel price has weakened.
In terms of demand fundamentals, Barclays suggests the recent flow of economic data is still broadly supportive, so it sees recent price activity as something of a consolidation before prices again push higher. The base metals sector is a good example as while strong gains in recent months have seen some profit taking, this is expected to be only a temporary phenomenon.
According to Barclays, the market remains positive on the copper outlook, even allowing for a degree of scepticism with respect to just how strong OECD demand will be through the second half of the year. While this is seeing some players move to the sidelines, the group points out price dips are attracting some buying support, with the US$6,000 per tonne level likely to provide strong support.
Similar periods of consolidation before subsequent moves higher also appear likely in the zinc, tin and nickel markets, though the group concedes sentiment has turned more bearish for aluminium and prices are subsequently being pressured lower. Lead has been the star performer thanks to the supply side issues mentioned previously and with strong Chinese demand still evident, prices continue to move higher and Barclays has lifted its estimates to reflect this, now forecasting a price of US$2,400 per tonne in the December quarter of this year and US$2,200 per tonne in the first quarter of 2010.
For aluminium the group expects an average price in the December quarter of US$1,950 per tonne, while in the first quarter of 2010 it sees prices averaging US$1,850 per tonne. Its copper forecasts for the same periods stand at US$6,750 per tonne and US$6,250 per tonne, while for nickel it expects average prices of US$21,000 and US$22,000 per tonne respectively. Barclays forecasts for tin are US$16,000 and US$16,500 per tonne, while for zinc it is forecasting US$2,000 and US$2,100 per tonne.
In the precious metals market Barclays notes gold continues to have difficulty holding the US$1,000 per ounce level and some further slowing in momentum in the short-term could happen in its view given currency markets continue to drive the gold price at present. But with the potential for rising inflation still a concern, and given the group's view the US dollar could weaken further, prices are expected to eventually resume their uptrend, helped also by technical buying and further hedge-book buybacks. Barclays is forecasting average gold prices of US$980 per ounce in the December quarter and US$1,050 per ounce in the March quarter of next year.
Oil prices at present are trading in the upper half of the US$65-$75 per barrel band, Barclays noting price support is coming from both an improving macroeconomic outlook and some signs of improvement in the market's supply and demand balance. OPEC is maintaining its quotas and this is maintaining some supply side pressure, so as the current inventory overhang is reduced prices should remain supported. On the group's numbers the West Texas Intermediate price will average US$76 per barrel in the final quarter of this year, increasing to US$85 per barrel in the first quarter of 2010.
Among the agricultural commodities while sugar prices have dropped 10% in a week the group notes this is after prices hit their highest levels in more than 28 years, so it remains positive on the outlook given Indian demand remains strong and supply is still relatively tight.
Grain market fundamentals are not as attractive and prices have slipped on the back of solid supply and favourable weather conditions. An upward revision to expected US soybean and corn production is likely with this week's USDA WASDE report given higher yields and the good weather conditions of late, so Barclays doesn't yet see a positive turning point for the grains.
Last year di-ammonium phosphate (DAP) prices reached as high as US$1,230 per tonne on the back of what Bank of America-Merrill Lynch calls a "perfect storm" of a combination of record high grain prices, overstocking and record high input costs, but then fell away almost as quickly.
In the last six weeks or so the broker notes the DAP market has enjoyed increased activity and this has improved the pricing outlook, though it doesn't expect a return to the boom prices of last year as it sees grain prices remaining well below their levels of last year, and any pick up in demand is likely to be met by higher operating rates and new supply. As well, a higher level of caution from distributors should see inventories remain near or below what are normal levels in its view.
Looking at the market picture for the next few months, the broker expects a steady rate of improvement in demand given the South American planting season starts ths month, there is likely to be some restocking in the US ahead of the October/November application season and buying from India appears to be on the increase.
China won't be an exporter in coming months given high export tariffs at present, and with a number of major producers fully booked for the next two months the broker sees prices as being reasonably well supported in the shorter-term. To reflect this it has lifted its DAP price forecast for FY10 to an average of US$380 per tonne, up from US$350 previously, though it sees prices falling back to the US$350 per tonne level in FY11 as new capacity enters the market.
The broker's long-term price forecast for DAP is US$330 per tonne, which is based on its estimated break-even point for non-integrated producers and assumes prices of US$250 per tonne for ammonia, US$40 per tonne for sulphur and US$120 per tonne for phosphate rock.
Incitec Pivot ((IPL)) is Australia's leading listed DAP producer, and not surprisingly the company's share price has moved in line with fertiliser prices in recent years, soaring when prices hit record levels and struggling in recent months as prices retreated.
This is no surprise as Merrill Lynch notes DAP prices are the key single driver of earnings for the company, estimating for every US$10 per tonne change in the DAP price there is a 2.2% impact on net profit. Reflecting the changes to its fertiliser pice expectations, the broker has adjusted its earnings forecasts for the company and in earnings per share (EPS) terms now expects 21.6c this year, 24.4c in FY10 and a similar outcome in FY11. Consensus EPS forecasts according to the FNArena database stand at 21.2c this year and 24.5c in FY10.
The changes mean the broker's price target on the stock has increased to $3.10 from $2.40 but there is no change in its Neutral rating, as with the stock trading in line with its discounted cash flow based valuation of $3.08 the broker sees the shares as fair value. This is particularly the case given ongoing concerns about declining ammonium nitrate volumes, free cash flow generation and the potential for a cut to current earnings guidance.
The broker is not alone in its cautious view on the stock as the FNArena database shows a total of one Buy, seven Holds and two Sells, with Credit Suisse this week downgrading to Neutral from Outperform given it, too, sees the stock as now trading around fair value.
The database shows an average price target of $2.85, which is below the current share price and highlights the valuation concerns of some of the brokers. It is worth noting a number of brokers who cover the stock have not updated their numbers for several months, though with the company having a September year-end this should change in the next month or so.
Shares in Incitec Pivot today are slightly higher today and as at 11.00am the stock was up 3c at $3.13.
Elders Limited (ELD), or what we used to call Futuris Corporation, is one of Australia's largest rural services companies. However, Elders, and the rural services industry has seen some pretty tough times over the past two years, as have managed investment schemes and the automotive sector, which are two of the group's other key segments. However, with an improving outlook, moves to address a stretched balance sheet undertaken and a strategic review in progress, some renewed interest in Elders among the Australian stockbroker community is emerging.
There's no doubting the volatile conditions over the last few years due to the dry conditions in eastern Australia and volatile fertilizer prices. Combined with an excessive amount of debt, these elements have taken their toll on the stock. But the company's new management team has moved to restructure the business, sell non-core assets and raise a large amount of capital in order to help fix the balance sheet.
And it's the confirmation of this capital raising and a clearer picture of a new, de-leveraged Elders that has piqued the interest of analysts at Deutsche Bank, who yesterday resumed coverage of the stock.
The broker notes that Elders has traditionally run with a significant level of debt. In fact, net debt as at 30 June 2009 was approximately $1bn compared to a market capitalization of around $300m. Tough trading conditions aside, the broker blames this high level of gearing as being the main factor that made the company difficult to manage (and invest in) over the last few years.
The company has moved to reduce its debt levels, primarily by selling off 10% of its 50% joint venture in Elders Rural Bank to Bendigo and Adelaide Bank, who own the other 50% and more recently, by undertaking a large capital raising. All up, Elders raised $475m in new capital via an underwritten placement at $0.15, with $75m more to be raised if the share purchase plan is fully subscribed. Although, this is still to be approved by an EGM in mid-October.
The moves have Deutsche thinking the company's debt issues are pretty much resolved, with pro-forma net debt falling to just $178 million on its forecasts. Deutsche thinks this will be a much more manageable level of gearing going forward.
Analysts at Macquarie come up with a slightly higher number, figuring that post the raising, pro-forma net debt will be reduced to $253m. Looking forward to FY10, Macquarie has pencilled in a net debt level of $300.3m, assuming a $475m capital raising comes off along with the sale of the group's insurance, hardwood forestry and fertiliser businesses.
However, this debt reduction has come at a price, with Macquarie cutting its FY10-11 EPS by 55% because of the capital raising. On the other hand, FY10-11 net profit should jump more than 74%-85% on its numbers, due to significantly reduced interest costs as a result of the improved debt position.
So with this issue soon to be behind the company, Deutsche thinks the focus will now shift to the group's Transformation Program. The good news here is that Deutsche expects this will improve earnings going forward. The broker forecasts that EPS will grow in excess of 20% per year in FY11 and FY12, which is when it expects the transformation program will have its greatest impact.
The program, which was announced in December 2008, includes a complete re-orientation of the company to become a customer facing business rather than a product-centric business. It will also see the replacement of state offices and management structures to a regionally based and sales focused system, while non-performing and non-core operations are to be phased out.
There is also a chance that the transformation program could be completed ahead of schedule, which means upside risk to the broker's nearer-term forecasts. However, warns Deutsche, should the program fail to increase earnings and reduce working capital, there is significant downside risk its numbers.
That said, the focus still seems to be shifting to the upside and while the FNArena sentiment indicator is at zero, with 4 Holds and nothing else on the stock, it seems that after the tough times, brokers are at least discussing the upside and not just mentioning the downside anymore.
The latest to put out an opinion on the stock is RBS, who today confirmed Elders is a significantly different company to the old industrial conglomerate known as Futuris. The broker calls it a turnaround story under a new management team. The call now is whether one can trust that management will increase underlying earnings margin in the Rural Services business from 2.5% to 5-6% over the next three years.
While the broker thinks this is not without risk, RBS does think it can be done by implementing best-of-practice retail standards, that should come about as part of the transformation plan. On top of that, RBS notes the managing director has a track record of doubling margins at his previous job as head of Coates Hire.
The last vote of confidence came from major shareholder QBE, who the broker notes has independently tested the margin goals during its refinancing process.
With the stock trading at an expensive looking 18.5x FY10 EPS on Deutsche's numbers and also in-line with the broker's 25c target price, Deutsche Bank believes a Neutral call is the right one for now. But with the FNArena consensus target price at 35c and the outlook seeming to be on the improve, it will pay to keep an eye on what the FNArena broker universe has to say about this stock in the months ahead.
Yesterday, shares in Elders were flat at 25c versus a 12-month trading range that runs between 21c to $1.65 just 12 months ago.
