By Chris Shaw
AWB ((AWB)) has updated the market on the costs associated with its decision to close down its operations in Brazil and the news was not as good as hoped, with the division now expected to generate an operating loss of $50-$60 million for the year and incur wind down provisions of $80-$95 million.
This was worse than the market had been anticipating and causes some adjustments for forecasts, largely because the closure of the Brazilian operations had been expected to see a release of capital the group could use to pay down some of its outstanding debt.
As JP Morgan points out, only around $30 million of capital is now likely to be released, which equates to an $84 million smaller reduction in corporate net debt than the broker had been forecasting. This means the group's balance sheet is again an issue as net debt to earnings before interest, tax, depreciation and amortisation in FY11 is around 4.1x, meaning as much as $175 million in equity is needed by that year to bring this ratio down to a more appropriate level.
Around $50-$60 million of this could come from the sale of the company's stake in Hi-Fert, but there would still be a shortfall of as much as $125 million on the broker's numbers. While the issues in Brazil and recent share price strength have seen JP Morgan downgrade the stock to Underweight from Overweight, the reaction from RBS Australia has been less severe, downgrading only to Hold from Buy.
The broker cites similar reasons to JP Morgan for its move, but RBS also points out FY09 is likely to prove to be bottom of the cycle earnings for the company, meaning it expects a rebound in FY10 assuming more normal conditions in the group's Rural Services division.
RBS Australia is forecasting normalised earnings per share of 14.8c this year, rising to 16.3c in FY10 and 17.5c in FY11, while JP Morgan's estimates for FY10 and FY11 are at 16.8c and 17.5c. Macquarie is forecasting 17c in both years, while the FNArena database shows a consensus forecast for FY10 of 18.5c.
Post the update from management, Credit Suisse retains its Outperform rating on the stock, pointing out while the decision to exit Brazil will end up costing more than had been expected, it will allow for better allocation of capital across the group and this will reduce the volatility of earnings.
As well the broker notes while the group still needs to recapitalise, there is potential for its capital position to improve enough to justify further share price upside beyond what has been achieved of late (AWB shares traded down to around the $1.00 mark in late May/early June).
UBS is among those that don't agree with the Credit Suisse view, arguing instead there needs be improved clarity with respect to the company's debt position and funding for requirements such as Landmark Finance. Until this is achieved UBS is not prepared to turn more positive on the stock.
UBS rates the stock as a Hold, while the FNArena database shows a total of two Buys, five Holds and one Sell or Underweight rating. The average share price target on the stock is $1.61, little changed from $1.60 prior to the update.
Shares in AWB today are weaker and as at 1.15pm the stock was off 8c or 5.5% at $1.38. Over the past year it has traded in a range of $0.70 to $3.54.
Tag Archives: Agriculture
Sugar Proves: Everything Is Relative
By Rudi Filapek-Vandyck
International sugar prices have soared to US21.80c a pound, a price level not seen since mid-1981. Already, media reports are suggesting canegrowers in Northern Queensland -widely considered a human species soon to be extinct as recent as five years ago- are salivating about the prospect of at least 12-18 months of a continued strong pricing environment. Such prospect is being confirmed by industry watchers at Rabobank, to name but one.
Industry analysts at Salman Partners in Canada have opened the bottom drawer of their desk and let slip out some good old memories. The price of sugar may have surged to levels not seen in more than 2.5 decades. but they are still 70% below the all-time high peak of the mid-seventies, the analysts point out. They immediately add: not many things in life today are priced 70% below what they were in 1974.
What follows next can only be relived through the memories of those old enough to reminisce: "Ah, 1974, when, as we recall, restaurants used to keep their sugar bowls under lock and key to prevent us from pocketing their contents."
As one would expect that at some point farmers will increase their plantings and crops in response to the more lucrative pricing environment for sugar. Salman analysts suggest this should bode well for producers of potassium and phosporus, in other words: a higher sugar price should translate into higher demand for fertilisers.
That plus the fact that many an expert believes the outlook for sugar prices remains positive with farmers struggling in key areas such as Brazil and India due to weather related circumstances.
It may sound amazing, but if we only move back a few months further back in time (than mid-1981) sugar was priced at more than double today's price - and that still wasn't anywhere near prices reached in the mid-seventies.
US Regulator To Limit Commodity Speculation
By Greg Peel
“The first exchange-traded fund tracking the price of crude oil by investing in futures contracts is expected to begin trading on the London Stock Exchange on July 28, according to a press release by the fund's backer, Oil Securities Limited. Two classes of the ETF are expected to be listed: one priced off the Brent Contract trading in London, and another based on the WTI (West Texas Intermediate) Contract traded in New York. ‘We anticipate that the listing will open up the oil market to a very broad range of investors,’ said Graham Tuckwell, chairman of Oil Securities Limited, in the release."
And Tuckwell was absolutely right.
This is a Dow Jones report dated July 15, 2005. Prior to 2005, mutual funds and retail investors looking to invest in oil did so by buying the shares of oil producing companies. The volatile futures market was left as a preserve of actual oil producers and consumers looking to hedge their exposures, and to a handful of cowboy hedge funds and individual speculators who provided liquidity for such trades to occur. Futures were deemed too risky a proposition for mutual funds and too scary for most retail investors.
But with the introduction of exchange-traded funds, fund managers and retail investors alike were effectively introduced to a new investment asset class. Traded on the stock market, commodity ETFs provided a proxy for direct commodity investment. In 2005, China was on the move and commodity prices were on the way up. Direct commodity investment became a more direct means of hedging against inflation, and of speculating on now rapidly rising commodity prices. Oil, as one commodity, became the speculative plaything of hedge funds and retail investors and a mandatory asset class for pension funds. The once steady and relatively closed shop of oil trading was suddenly opened up to the herd.
Now take a look at a monthly chart of oil in the twenty-first century. Draw a line down the centre at mid-2005 and note how lack of much volatility on the left gives way to eventual extreme volatility on the right.
There you have it - herd mentality. While extreme movements between 2007 and today reflect the GFC path of the US dollar - from weakness to strength and back to weakness again - the blow-off top and blow-off bottom on the chart simply reflect the classic overshooting of speculative exuberance and speculative panic. Note the volume bars at the bottom of the chart. That's Tuckwell's "very broad range of investors".
Were oil price movements exacerbated by the GFC? Or was the GFC exacerbated by oil price movements? Either way, US market regulators now want to put a stop to such violent and destructive commodity price volatility.
And oil is not the only culprit. The first (US) gold ETF was launched in late 2004:
Silver didn't follow until 2006:
And while the first wheat ETF was launched in 2003, 2007 saw the launch of the first ETF on the world's most popular commodity price index - the Reuters/CRB index - which has wheat as a component:
Indeed, by mid-2008 there were close to 700 different ETFs on any asset class you could imagine listed in the US. It is no great surprise that acceleration in such listings began around 2004, as that was when the Fed funds rate was dropped to a record low 1%. The lack of return available on traditional yield investments and the cheap funds available to invest in growth investments fuelled not only bubbles in property and stocks but in commodities as well. In the latter case, China provided the excuse.
So again, one might be attempted to explain away commodity price volatility in 2007-09 simply as a result of the greatest financial turmoil in decades, but one can quite easily argue the point the other way around.
Note that the oil price has just fallen 12% in a week. Its recent 125% rally from US$32 to US$72 has been the sharpest ever recorded, and the June quarter increase of 41% also the biggest move on record. What caused the rally? Easy: the US dollar began to weaken again under weight of debt, causing inflation fears; China began buying, providing misconceptions of real demand; and the higher the oil price rose, the greater the risk of inflation, and the greater the risk of inflation, the greater need for funds to hedge by buying oil, and the higher the oil price rose...Which all adds up to "speculative bubble" once again.
Dow Jones reports "passive" oil positions (ie speculative rather than industry) increased by 30% to 600m barrels from the end of 2008 to the end of June. Yet every week the level of total US crude inventories broke new records.
Regulators never anticipate volatile activity in financial markets, they only ever fuel it. The rapid growth of ETFs came with regulatory approval. There are even high-leverage ETFs and short-side ETFs, all which needed to meet with regulatory approval. But it is never the regulators fault, however, when everything goes awry. It is only ever the fault of those evil speculators. Once again, regulators are looking to clamp down, via new regulation, on that which they previously endorsed via regulatory lenience.
Regulators famously barrel along with their eyes in the rearview mirror and their feet planted firmly on the accelerator.
The US Commodity Futures Trading Commission has decided to hold a series of meetings over the northern summer to discuss the imposition of limits on exchange-traded fund and index fund investment. This time it's not just recalcitrant hedge funds the CFTC is attempting to curb, but even supposedly staid investment funds such as California's biggest public servant pension fund and the Harvard University endowment fund, both of which are examples of how even supposedly risk-averse managers can be swept up on the tide of hedging-cum-speculation.
There is no suggestion yet as to exactly how the CFTC plans to implement restrictions. One presumes that whatever is decided will go some way to reducing volatility extremes. But will this take the gloss off ETFs and commodity funds as an investment class?
Consider that for a long time, futures trading - including the very oil futures which are acquired by an ETF on behalf of the investor - have themselves been subject to restrictions such as individual open position size limits and intra-day price movement limits. These limits are tweaked every now and again at the CFTC's discretion, or the discretion of the relevant exchange. Back in 2006, limits on Comex copper futures were suddenly reined in and the runaway rally halted.
Such limits didn't seem to make much difference to oil futures in 2008-09. And where were the regulators then?
CBA Questions Budget Pessimism
By Greg Peel
One thing to consider before this article proceeds is that Treasury Department is not independent of the ruling government party. It will advise the government of the day (given it is made up of actual economists and not elected politicians) on what budget policy should be but the government is not obliged to accept that advice, and nor is the Treasury permitted to do (or forecast) anything conflicting with government policy. Unlike the independent (by statute) Reserve Bank, the Treasury Department must arrive at numbers the government wants to see rather than needs to see.
There will be another federal budget brought down before the next election in late 2010 (assuming no double dissolution in the meantime). It is a typical political move in times of economic hardship to deliver dire forecasts and justify tough measures within the breathing space of incumbency. When those forecasts prove to be not so dire by the following year, the government will declare not that it was wrong, but that it has saved the day with sound economic management.
The recent federal budget contained a forecast that real business investment will fall by 18.5% in FY10. Were this to be true it would represent the biggest collapse in at least sixty years. Falling business investment is a key determinant behind the government's stark recession warnings in the shorter term. Such a fall would alone reduce GDP by 3.25 percentage points, the economists at Commonwealth Bank calculate. But those economists question the severity of this forecast.
They note that how the "capex" story unfolds is crucial to determining the size and duration of the recession. (Business investment = capital expenditure = "capex".) The RBA noted in its May Statement on Monetary Policy that it expected capex to "fall significantly" but it is Treasury who has put a number on it. The figure of 18.5%, the economists suggest, implies a combination of the winding back of capacity usage as the economy slows, the complete end of the commodity price boom, low levels of business confidence and continuing financing difficulties.
In June (as FY09 draws to a close), the Australian Bureau of Statistics will release its second estimate of intended capex in FY10. Its first estimate was released on the basis of a January/February survey. At the time, the stock market was plumbing new depths, commodity prices were depressed, global economic forecasts had turned sharply negative, business confidence was low and no "green shoots" had yet appeared on the barren ground. Yet Commonwealth Bank notes the survey results were consistent with a 10% increase in capex. That's increase, not decrease.
In order for the June ABS survey to show figures consistent with the budget forecasts, capex intentions would need to drop 17% from the first estimate, Commonwealth calculates (from $86.6bn to $66.2bn). This would need to occur following a period in which "green shoots" have appeared, the stock market has rallied 25%, commodity prices have soared (oil has doubled in price, iron ore exports to China are at a record high), Chinese stimulus is in full swing and expectations have grown for a halt in economic decline by year-end.
And if any of the capex intended in FY09 was deferred until (a hopefully brighter) FY10 then the figures would need to overcome this lag as well.
There is, however, a consideration one must concede and that is capex intentions and actual capex spend are not necessarily consistent. Minds can change. But Commonwealth economists calculate for the budget forecast to be correct because of such a low "realisation rate" of intentions, that realisation rate would have to be the lowest in the 35 year history of the ABS.
Commonwealth is not, on the other hand, suggesting the earlier 10% capex growth figure will remain the state of play. It is also forecasting a drop in capex in FY10, but only by 8% to the government's 18.5%. Behind the economists' calculations are some clear anecdotal factors:
(1) There is a pipeline of work yet to be done on existing projects worth $50bn; (2) estimates of advanced mining projects underway total $80bn (up 16% on 2008); (3) there has been a lift in the value of projects under consideration, which is a lead indicator of improved capex; (4) there are signs of stabilisation in business confidence; (5) there are signs of a turnaround in China; (6) rural investment spending is believed to be increasing; (7) the government has initiated policy measures to encourage both capex and the requisite provision of finance.
For the upcoming March quarter actual capex result, Commonwealth is forecasting a drop from 6% growth in the December quarter to an 8% decline.
But so far all we have considered is private sector capex. Let us not forget intended government infrastructure spending as part of the fiscal stimulus package. Even if the private sector reins in capex significantly, might the government's spending fill the void?
Chief economist Michael Blythe admits his team is making some "heroic" assumptions in the face of doom and gloom. But his forecast is that after a "pothole" of private capital spending in the first half of 2009 (second half of FY09), total capital spending will make an "increasing contribution to GDP growth" thereafter.
A Sweet Bull Market For Sugar
By Chris Shaw
Unlike many of its commodity counterparts the sugar market is currently running a massive global deficit thanks to a poor Indian harvest for 2008/09 and underperformance in several other Northern Hemisphere markets, all of which has set the scene for a potential bull market story.
Prices have only just begun to react, with late April seeing a surge that pushes July 2009 contract prices as high as US16c per pound, a rise of almost 30% from the January lows and one that, in the view of Barclays Capital at least, is confirming the market's bullish fundamentals.
Having run so hard Barclays analysts see scope for prices to consolidate at around the US15c per pound level but this doesn't change their view the bull run in sugar has further to go, especially as India should remain a sizable importer this year and a smaller importer beyond that time as its harvest slowly recovers to previous levels.
Such a recovery may take some time given the scope of the fall in the 2008/09 harvest, Barclays pointing out from initial expectations of a crop of around 24.8 million tonnes the revised outlook is for something in the order of 15 million tonnes. This means as much as three million tonnes of sugar will need to be imported, a far cry from exports of around five million tonnes in 2007/08.
Given a similar level of imports is likely in 2009/10 Barclays sees scope for the global market to remain in a mild deficit position in the coming year as well, offering one reason to suspect the gains in sugar prices have not yet fully run their course.
Another factor is lower production elsewhere, with harvests in both China and Mexico likely to be lower this year than last and output in Thailand expected to follow a similar trend. The analysts note there is also some pressure building in the US to lift imports, all of which sees Barclays adjust its forecast deficit for 2008/09 to 12.3 million tonnes.
The following year Barclays expects a deficit of 6.1 million tonnes, while it notes the rundown in stocks expected as a result of this year's shortfall will also offer some bullish momentum given the lack of any available safety buffer if there are any further output shocks in the market.
The offset to the problems in India and elsewhere have been market expectations for a sizable harvest in Brazil, especially given the likelihood this year's crop is significantly larger than that produced in 2008/09. The analysts' forecasts are for output in 2009/10 of 37.5 million tonnes compared to 31.5 million tonnes in the previous harvest, though risk remains to the downside in their view given the impact of the financial crisis on investment and new mill development.
The other factor in the Brazilian market is how much sugar goes into ethanol production and here a modest pick-up is expected, with about 43% of the crop going to ethanol against 40% previously. While this will still leave Brazil with around three million tonnes of sugar for export, Barclays points out this will largely counter-balance India's import requirements.
At the same time other countries will likely lift imports, with Russia a prime example given it imported around four million tonnes last year and this year is expected to require more given poor weather has contributed to a poor domestic sugar beet harvest.
In the view of Barclays there are other reasons ethanol demand could have a positive impact on sugar prices, as it points out higher oil prices are supportive for higher ethanol demand given the ethanol-fuel price ratio remains below 70% in most of Brazil. With OPEC production cuts setting the stage for higher oil prices over the course of 2009 the group therefore sees room for ethanol to receive additional support in the market.
In terms of what this means for prices, Barclays is forecasting front-month prices of US15.5c per pound in the September quarter and US14c per pound for the December quarter. This sets a solid platform in its view for any market developments to further tighten the market and so push prices higher in subsequent periods.
To reflect this the group sees scope for front-month prices to remain at around US15c per pound at least until there is genuine improvement in Indian production. With the likelihood certain factors turn more supportive during the coming year prices could in fact move as high as the US19c per pound levels seen in 2006 in the group's view.
Unlike many of its commodity counterparts the sugar market is currently running a massive global deficit thanks to a poor Indian harvest for 2008/09 and underperformance in several other Northern Hemisphere markets, all of which has set the scene for a potential bull market story.
Prices have only just begun to react, with late April seeing a surge that pushes July 2009 contract prices as high as US16c per pound, a rise of almost 30% from the January lows and one that, in the view of Barclays Capital at least, is confirming the market's bullish fundamentals.
Having run so hard Barclays analysts see scope for prices to consolidate at around the US15c per pound level but this doesn't change their view the bull run in sugar has further to go, especially as India should remain a sizable importer this year and a smaller importer beyond that time as its harvest slowly recovers to previous levels.
Such a recovery may take some time given the scope of the fall in the 2008/09 harvest, Barclays pointing out from initial expectations of a crop of around 24.8 million tonnes the revised outlook is for something in the order of 15 million tonnes. This means as much as three million tonnes of sugar will need to be imported, a far cry from exports of around five million tonnes in 2007/08.
Given a similar level of imports is likely in 2009/10 Barclays sees scope for the global market to remain in a mild deficit position in the coming year as well, offering one reason to suspect the gains in sugar prices have not yet fully run their course.
Another factor is lower production elsewhere, with harvests in both China and Mexico likely to be lower this year than last and output in Thailand expected to follow a similar trend. The analysts note there is also some pressure building in the US to lift imports, all of which sees Barclays adjust its forecast deficit for 2008/09 to 12.3 million tonnes.
The following year Barclays expects a deficit of 6.1 million tonnes, while it notes the rundown in stocks expected as a result of this year's shortfall will also offer some bullish momentum given the lack of any available safety buffer if there are any further output shocks in the market.
The offset to the problems in India and elsewhere have been market expectations for a sizable harvest in Brazil, especially given the likelihood this year's crop is significantly larger than that produced in 2008/09. The analysts' forecasts are for output in 2009/10 of 37.5 million tonnes compared to 31.5 million tonnes in the previous harvest, though risk remains to the downside in their view given the impact of the financial crisis on investment and new mill development.
The other factor in the Brazilian market is how much sugar goes into ethanol production and here a modest pick-up is expected, with about 43% of the crop going to ethanol against 40% previously. While this will still leave Brazil with around three million tonnes of sugar for export, Barclays points out this will largely counter-balance India's import requirements.
At the same time other countries will likely lift imports, with Russia a prime example given it imported around four million tonnes last year and this year is expected to require more given poor weather has contributed to a poor domestic sugar beet harvest.
In the view of Barclays there are other reasons ethanol demand could have a positive impact on sugar prices, as it points out higher oil prices are supportive for higher ethanol demand given the ethanol-fuel price ratio remains below 70% in most of Brazil. With OPEC production cuts setting the stage for higher oil prices over the course of 2009 the group therefore sees room for ethanol to receive additional support in the market.
In terms of what this means for prices, Barclays is forecasting front-month prices of US15.5c per pound in the September quarter and US14c per pound for the December quarter. This sets a solid platform in its view for any market developments to further tighten the market and so push prices higher in subsequent periods.
To reflect this the group sees scope for front-month prices to remain at around US15c per pound at least until there is genuine improvement in Indian production. With the likelihood certain factors turn more supportive during the coming year prices could in fact move as high as the US19c per pound levels seen in 2006 in the group's view.
Life On The Clean Seas
By Greg Peel
So voracious is the Japanese appetite for Southern Bluefin tuna (SBT) that the handful of licensed fishing families in South Australia have become multi-millionaires. Their success not only reflects the demand for this ocean delicacy, it reflects the fragile nature of SBT stock and the restrictions placed on commercial wild fishing by the relevant authorities.
As global fish stocks come under threat from over-fishing, aquaculture is slowly becoming a booming industry in this country. Trout farming has long been successful and Tasmanian-based Tassal Group ((TSL)) has proven the potential in highland salmon farming. Tassal shares rallied from $1.00 to $4.00 over three years before the GFC took its toll.
However the farming of ocean species is...ahem...a different kettle of fish altogether. The interestingly named Kinki University in Japan has nevertheless seen success in "closing the life-cycle" of the Northern Bluefin tuna, which basically means it has successfully turned little fish hatched scientifically into big ones. Utilising the knowledge and assistance of Kinki experts, South Australian-based Clean Seas Tuna ((CSS)) has been undertaking a world-first project in attempting to commercially breed the SBT.
It has not all been smooth sailing. First attempts by Clean Seas saw success in turning eggs into larvae and that was about it. But this week the company has announced it has now successfully bred fingerlings. Success unfortunately finally came towards the end of the tuna breeding season, meaning the waters off South Australia will now become too cold for the young sushis-in-waiting to be released out of their land-based breeding tanks and into caged waters to grow. The commercialisation of the breeding program must thus wait another 6 months.
But Clean Seas is now in "unchartered" waters, as noted by the analysts at RBS. This was always going to be a speculative venture, but a venture with tremendous upside. The global wild catch of SBT has been declining for 50 years, leading to ever increasing fishing restrictions. Clean Seas holds the only captive SBT broodstock in the world and if further success is achieved, the aquaculture production of SBT is "unlimited", RBS notes. The company expects to be able to put 25,000 fingerlings into commercial production - into ocean cages to grow - by the end of 2009.
The venture is nevertheless not cheap, and Clean Seas has flagged it would need to raise a further $100m in some debt but mostly equity over the next two to four years. Flushed with recent success, Clean Seas this week successfully raised $23.9m through both a share placement and a rights issue. The raising was 20% dilutionary.
The potential within Clean Seas has not been lost on the market. The issue was placed at 55c but out of its trading halt the shares are back trading at 75c. For the two brokers in the FNArena universe which cover Clean Seas, the fingerling milestone has meant a de-risking of the project and a subsequent jump in current valuation. RBS previously applied a 50% risk discount to its discounted cash flow valuation. The broker has now increased its forecasts to arrive at a valuation of 81-93c for the shares but also reduced the risk discount to 25%. This has resulted in an increase in the 12-month target price from 41c to 69c.
JP Morgan has similarly raised its target from 50c to 60c.
The shares are currently trading above these levels, but Clean Seas is not a stock for which one might quibble over 10c. This is a long term investment prospect for the patient, offering the potential for significant reward and the reality of significant risk. We all know just how ecstatic zoologists around the world are when they successfully breed certain animals in captivity. Nature does not yield willingly.
And the risk lies not simply in the ability to nurse little pelagic fish into big ones in cages. Clean Seas is having to raise funds - both equity and debt - in the middle of the GFC. The same GFC has seen Tassal's share price halve in value.
Both RBS and JP Morgan thus are maintaining Hold ratings on the stock. Caution reflects the risks involved and the fact the stock is already trading above risked valuations. But there is also somewhat of a downside safety net. Clean Seas already boasts a commercially operational Kingfish farming program.
The other point to note is that each milestone, if achieved, will be met by further dilutionary capital raisings, although both brokers factor this into their valuations. RBS is assuming that of the $100m required, $76m will be raised as equity.
Maybe Clean Seas might consider starting a wasabi farm as well?
Chinese Buying Dominates Commodities Prices
By Chris Shaw
April trade data out of China show continued strong domestic demand for commodities, Barclays Capital noting imports of copper, soybeans, iron ore and crude oil are respectively up 62%, 55%, 33% and 14% from the same month a year ago. The increases mean imports of iron ore and copper have easily hit new all-time highs.
In the group's view this buying by China has been the key to limiting what could otherwise have been a huge build up in global surpluses, rising inventories and lower prices. Barclays also points out nowhere else in the world in recent months has there been any noticeable recovery in commodities demand.
With the strong buying from China prices for these commodities, and copper and soybeans in particular have pushed higher, the question now in the group's view is whether the trend in imports and the corresponding increase in prices is supportable going forward?
To try and determine an answer Barclays has examined the factors driving China's import growth in recent months, its conclusion being the nation's de-stocking process appears to have both begun and finished earlier than elsewhere in the world.
China's copper imports began declining in the June quarter last year, buying of soybeans and iron ore began falling in the December quarter and in January respectively and adjustments in the oil market flowed through in the March quarter of this year.
Barclays believes the introduction of the Chinese government's fiscal stimulus package has clearly helped turn around demand as re-stocking has become the key factor in driving imports higher in the past couple of months. This is especially the case given China's commodity output is falling in the case of iron ore, flat with respect to both soybeans and crude oil, and not growing fast enough to meet demand in the copper market.
As well, the Chinese government has made it clear it intends to take advantage of lower prices to build up strategic reserves in some commodities, with the moves in both copper and soybeans equating to about 3% of global supply on Barclays' estimates.
The risk then is when this re-stocking process has been completed China's import demand will weaken. Given there is little demand growth elsewhere in the world at present, nothing appears likely to take up the slack. As the analysts points out, such an outcome implies commodities prices are likely to weaken if Chinese demand falls.
But as Barclays notes, such a scenario is a shorter-term outcome as China remains resource scarce and domestic output of key commodities simply cannot keep pace with future demand growth. This suggests in the longer-term the China story with respect to upward pressure on commodity prices remains intact, even if prices decline in the June and September quarter as the current pace of Chinese imports eases.
April trade data out of China show continued strong domestic demand for commodities, Barclays Capital noting imports of copper, soybeans, iron ore and crude oil are respectively up 62%, 55%, 33% and 14% from the same month a year ago. The increases mean imports of iron ore and copper have easily hit new all-time highs.
In the group's view this buying by China has been the key to limiting what could otherwise have been a huge build up in global surpluses, rising inventories and lower prices. Barclays also points out nowhere else in the world in recent months has there been any noticeable recovery in commodities demand.
With the strong buying from China prices for these commodities, and copper and soybeans in particular have pushed higher, the question now in the group's view is whether the trend in imports and the corresponding increase in prices is supportable going forward?
To try and determine an answer Barclays has examined the factors driving China's import growth in recent months, its conclusion being the nation's de-stocking process appears to have both begun and finished earlier than elsewhere in the world.
China's copper imports began declining in the June quarter last year, buying of soybeans and iron ore began falling in the December quarter and in January respectively and adjustments in the oil market flowed through in the March quarter of this year.
Barclays believes the introduction of the Chinese government's fiscal stimulus package has clearly helped turn around demand as re-stocking has become the key factor in driving imports higher in the past couple of months. This is especially the case given China's commodity output is falling in the case of iron ore, flat with respect to both soybeans and crude oil, and not growing fast enough to meet demand in the copper market.
As well, the Chinese government has made it clear it intends to take advantage of lower prices to build up strategic reserves in some commodities, with the moves in both copper and soybeans equating to about 3% of global supply on Barclays' estimates.
The risk then is when this re-stocking process has been completed China's import demand will weaken. Given there is little demand growth elsewhere in the world at present, nothing appears likely to take up the slack. As the analysts points out, such an outcome implies commodities prices are likely to weaken if Chinese demand falls.
But as Barclays notes, such a scenario is a shorter-term outcome as China remains resource scarce and domestic output of key commodities simply cannot keep pace with future demand growth. This suggests in the longer-term the China story with respect to upward pressure on commodity prices remains intact, even if prices decline in the June and September quarter as the current pace of Chinese imports eases.
Where’s The Value In Incitec Pivot Shares?
By Chris Shaw
Incitec Pivot ((IPL)) yesterday report an interim profit result of $170 million, which in headline terms was slightly better than some in the market had expected. The issue for some stockbrokers was, however, the quality of the reported result. JP Morgan noted the financial result was helped by a lower tax rate plus a lower net interest expense, meaning operationally Incitec released a relatively weak profit report.
Further disappointment came in the form of a reduction in full year earnings guidance, management indicating full year profit now is likely to be closer to $380 million against previous expectations of a number closer to $450 million thanks to lower than expected fertiliser prices and a higher Aussie/US dollar exchange rate.
Despite the weak operational result the share price rallied by about 5%, Credit Suisse attributing this to the market looking through what had already been expected to be a weak result to what could flow through in the future. CS also puts the rally down to improved confidence no equity raising will be needed short-term given management's comments to this end.
Yesterday's price gains follow on from recent strong outperformance, Citi noting the stock has gained a little more than 40% from its lows as the market has turned its focus to the likelihood of stronger fertiliser prices and volumes in FY10. The problem, in the broker's view, is both are unlikely. Citi agrees volumes should rise but adds there are few catalysts to push prices higher in the medium-term.
As a result the broker sees downside risk to earnings forecasts in both FY09 and FY10, even after cutting its own net profit forecasts by 13% and 14% respectively post the interim result. In earnings per share (EPS) terms this sees Citi forecasting 24.3c and 25.8c, while Credit Suisse is at 24.7c and 35.7c. Deutsche Bank is at 23c and 22c. Consensus estimates according to the FNArena database are 24.5c and 29.2c respectively.
Given the weak earnings growth forecast by Citi the broker views the stock as expensive and has downgraded to a Sell rating, pointing out at current spot prices the shares would be trading on a FY10 P/E (price to earnings ratio) of 12.4x, which is a 14% premium to the All Ordinaries Index and peer Orica ((ORI)).
Deutsche agrees and has similarly downgraded the stock to Sell, pointing out on its numbers the stock is trading at a premium to North American peers of more than 30% at present share price levels. While fertiliser price expectations are part of its view the broker also continues to see the proposed Moranbah ammonium nitrate plant as dilutive to group value given, on its estimates, the project investment will only generate a pre-tax return of slightly more than 7%.
But valuations are relative and on Macquarie's numbers the stock is presently trading at a discount of a little more than 30% to the broader market, leading Macquarie to retain its Outperform rating post the interim result. UBS agrees, rating the stock as attractive enough on fundamentals to justify a Buy rating, especially as long-term gearing should improve in 2011 when Moranbah is commissioned.
RBS Australia is more cautious, pointing out while earnings guidance for the full year has been revised lower, the fact significant earnings headwinds remain in play suggests even the revised forecast by company management may prove to be too high. This is enough to justify a Hold rating.
Factoring in the downgrades by Deutsche Bank and Citi sees the stock now rated as Buy four times, Accumulate once, Hold three times and Sell twice, with an average share price target of $2.47, up from $2.43 prior to the interim result. Shares in Incitec Pivot today are litle changed despite a weak overall market and as at 11.20am the stock was up 1c at $2.48.
Incitec Pivot ((IPL)) yesterday report an interim profit result of $170 million, which in headline terms was slightly better than some in the market had expected. The issue for some stockbrokers was, however, the quality of the reported result. JP Morgan noted the financial result was helped by a lower tax rate plus a lower net interest expense, meaning operationally Incitec released a relatively weak profit report.
Further disappointment came in the form of a reduction in full year earnings guidance, management indicating full year profit now is likely to be closer to $380 million against previous expectations of a number closer to $450 million thanks to lower than expected fertiliser prices and a higher Aussie/US dollar exchange rate.
Despite the weak operational result the share price rallied by about 5%, Credit Suisse attributing this to the market looking through what had already been expected to be a weak result to what could flow through in the future. CS also puts the rally down to improved confidence no equity raising will be needed short-term given management's comments to this end.
Yesterday's price gains follow on from recent strong outperformance, Citi noting the stock has gained a little more than 40% from its lows as the market has turned its focus to the likelihood of stronger fertiliser prices and volumes in FY10. The problem, in the broker's view, is both are unlikely. Citi agrees volumes should rise but adds there are few catalysts to push prices higher in the medium-term.
As a result the broker sees downside risk to earnings forecasts in both FY09 and FY10, even after cutting its own net profit forecasts by 13% and 14% respectively post the interim result. In earnings per share (EPS) terms this sees Citi forecasting 24.3c and 25.8c, while Credit Suisse is at 24.7c and 35.7c. Deutsche Bank is at 23c and 22c. Consensus estimates according to the FNArena database are 24.5c and 29.2c respectively.
Given the weak earnings growth forecast by Citi the broker views the stock as expensive and has downgraded to a Sell rating, pointing out at current spot prices the shares would be trading on a FY10 P/E (price to earnings ratio) of 12.4x, which is a 14% premium to the All Ordinaries Index and peer Orica ((ORI)).
Deutsche agrees and has similarly downgraded the stock to Sell, pointing out on its numbers the stock is trading at a premium to North American peers of more than 30% at present share price levels. While fertiliser price expectations are part of its view the broker also continues to see the proposed Moranbah ammonium nitrate plant as dilutive to group value given, on its estimates, the project investment will only generate a pre-tax return of slightly more than 7%.
But valuations are relative and on Macquarie's numbers the stock is presently trading at a discount of a little more than 30% to the broader market, leading Macquarie to retain its Outperform rating post the interim result. UBS agrees, rating the stock as attractive enough on fundamentals to justify a Buy rating, especially as long-term gearing should improve in 2011 when Moranbah is commissioned.
RBS Australia is more cautious, pointing out while earnings guidance for the full year has been revised lower, the fact significant earnings headwinds remain in play suggests even the revised forecast by company management may prove to be too high. This is enough to justify a Hold rating.
Factoring in the downgrades by Deutsche Bank and Citi sees the stock now rated as Buy four times, Accumulate once, Hold three times and Sell twice, with an average share price target of $2.47, up from $2.43 prior to the interim result. Shares in Incitec Pivot today are litle changed despite a weak overall market and as at 11.20am the stock was up 1c at $2.48.
ABB Far From A Done Deal
By Greg Peel
Yesterday ABB Grain ((ABB)) confirmed it has received a "conditional and non-binding" approach from Canadian company Viterra to acquire all of its shares. The offer consists of a mix of cash, Viterra shares and franked dividends, which equates to somewhere between $9.00 and $9.50. ABB shares are today trading at $8.60 but a week ago they were closer to $6.20. ABB management announced it had been in discussions but gave no assurances a transaction will take place.
And it probably won't, neither at the price or indeed perhaps at all.
Viterra is Canada's largest agribusiness company, with operations across North America and Asia. Its businesses are diversified across crop and equipment sales and service, handling and marketing, livestock feed, food processing and financial products. ABB Grain was once the Australian Barley Board - a government sponsored cooperative of barley farmers united to source export contracts and organise grain handling. Its counterpart was the Australian Wheat Board, now AWB ((AWB)). ABB is now incorporated but while malt remains a focus, its interests have long ago expanded beyond barley specifically. Since 2002, notes Macquarie, ABB has consistently expanded through a combination of organic and acquisitive growth.
Australia is the biggest producer of grain in the southern hemisphere. Viterra has a stated strategy of expanding its horizons, which clearly must include the southern hemisphere, and has recently raised capital to that end.
But this is not an opportunistic takeover attempt. ABB is not a company in dire straits, beaten down by GFC impact and the need to either refinance burgeoning debt, sell assets quickly or raise capital. Its balance sheet is actually in very good shape and only recently ABB tried to talk AWB into a merger, although talks broke down. In the meantime, ABB has further expansion projects on the board, and clearly it is itself in an acquisitive position.
ABB 's share price has fallen from a high of over $10 (including one brief spike to $12) from a combination of broad GFC selling and more recently the global crash in grain prices. Nor has ABB escaped the ravages of the Australian drought, although only this week solid rains right on cue were enough to fool some commentators into initially believing it was rain, and not a takeover offer, which had made ABB's share price shoot up. And grain prices have been on the improve. Macquarie is forecasting a 40% increase in earnings at the half-year result, due May 26.
In other words, while there is consolidation underway (and needed) in the Australian agriculture sector, and the same is happening globally, ABB does not actually need to be taken over at this point, and certainly not cheaply.
So the first question to answer is: Is a bid of $9.00-$9.50 a good one?
GSJB Were believes it is reasonable. The analysts had already ascribed a $9.54 discounted cashflow value to ABB and note that assuming a "normal" crop year - meaning not drought-affected - the offer range represents a PE ratio of 15.3-16.1x and an enterprise value to earnings ratio of 11.5-12.0x. These numbers, GSJBW analysts say, are in line with average transaction multiples in the sector.
Deutsche Bank, on the other hand, suggests the offer does not make enough allowance for synergies and a good old takeover premium. Deutsche suggests a price of $11.00-$12.00 might be needed before anyone can get interested. Both Deutsche and Weres make the important point that there's more than just money to consider.
ABB began as a farmers' cooperative and to this day 75% of its share register is represented by said farmers. One can imagine that the cockies were mostly somewhat sceptical about this incorporation business, which came about during Howard's long-running "everything must go" sale. If it ain't broke, why fix it? And now someone's suggesting they hand all responsibility for Aussie grain handling and export distribution to a bunch of cowboys from the other side of the Pacific, in exchange not for cash but for a combination of cash and shares in this foreign business.
We all know just how much farmers believe they are the salt of this earth, and how much we all owe them for multiple generations of ancestors tackling the sunburnt country and tilling the fields and providing all Aussies ever since with their sustenance. Are they really going to up and sell that all to Canada?
From the outset of the incorporation of the Australian Barley Board, it was built into the company constitution that no one shareholder could acquire more than 15% of the voting shares. This was to protect the farmers' collective against some unscrupulous monopolist either from the next town or worse - from the Big Smoke. In order for Viterra - or anyone else for that matter - to take over ABB this constitution would have to be changed, and that can only be done by a majority vote of shareholders.
There might be some struggling farmers out there who'd love to take the money and run. But for the rest it's a matter of what price is good enough to sell out? Is any price good enough?
Ahead of the takeover offer, brokers in the FNArena database already had a 7/1/0 B/H/A ratio on ABB with an average target of $7.98. There has been no change this morning other than Macquarie (Outperform) having to withdraw its recommendation given it is advising on the deal. Given GSJB Were thinks the bid is about right, it has not budged from Hold. The target, on the other hand, has only lifted to $8.11.
There is little belief in this first bid, or perhaps any bid from Viterra, succeeding.
No Short-Term Positives For Commodity Prices
By Chris Shaw
Commodities enjoyed a positive start to 2009, but as Barclays Capital points out, this is quickly fading. Sentiment continues to deteriorate on the back of weaker demand side signals, with energy and some base metals among the hardest hit this week. Economic data are not helping, as on the group's forecasts, global GDP will contract in the June quarter.
Also not helping sentiment is the fact the rate of stock-build among the commodities has increased in recent months. This is evidenced by the current contango (forward prices higher than spot prices) in most markets. The group notes production cuts in a range of commodities are helping improve market balances, but until there are signs of improving demand, these cuts alone are unlikely to be enough to remove the pressure on prices.
The weaker prices have seen the amount invested in commodity markets fall significantly in recent months. Fourth quarter numbers for 2008 are showing a decline of 27% in quarter-on-quarter terms to US$154 billion. Energy markets saw modest net outflows thanks largely to index-linked withdrawals, while the agricultural commodities sector experienced outflows of almost US$800 million from ETPs and US$2.0 billion from indices.
The precious metals sector was the only one to see positive flows in the quarter thanks to strong ETP inflows.
In strategy terms, Barclays suggests any potential upside in the energy sector remains fragile, though longer-term the trend is likely to be towards higher prices. This is because the pace of supply side cuts has now overtaken that of the demand side, and demand itself is not getting any worse.
The recent gains in base metal prices can be attributed to index rebalancing, in the group's view, and with this support dissipating it sees scope for further price falls given fundamentals continue to worsen. This means any price rallies in the sector should be viewed as selling opportunities, particularly as LME stocks continue to increase.
Copper is most at risk, in the group's view, given its price remains well above current production costs. There is also a risk that the market will price in a further build up in stockpiles. In contrast, aluminium, nickel and zinc are already near their weighted average production costs, which suggests downside for these metals is more limited.
The gold price should continue to be driven by the actions of investors (as opposed to consumers). Barclays sees support coming from expectations of a weakening in the US dollar through the course of the year and a shallow recovery in the oil price.
Agricultural prices appear to have limited downside in the group's view given the emergence of some supply side concerns, particularly for soy beans.