Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
find out about investing with montgomery
Over the past fifty years, US housing starts have averaged 1.5m per annum. Currently, starts are less than half the long term average.
In recent months there have been some tentative signs of recovery from this record low base. According to the Economist, America’s houses on average “are now among the world’s most undervalued: 19% below fair value, according to our house-price index”.
While Deutsche Bank have cut their 2013 and 2014 housing start expectations in Australia to 128,000 and 144,000, respectively,they are looking for a jump in US housing starts to 1.0m by 2014 and 1.4m by 2016, as follows.
Could it get any worse for Iron Ore? It Just did!
News Flash! Shipping more iron ore volumes at lower prices is the same as JBH and HVN selling more TV’s a lower prices. Margins compress and profits don’t meet expectations.
Back in April, when we began more urgently warning investors to look carefully at profit assumptions for the big material stocks, our theory was that iron ore prices would decline because of a massive supply response. It really was basic supply and demand. Economics 101. You can read our warning here: http://rogermontgomery.com/is-the-bubble-bursting/
Back on December 8 2011, with BHP trading at more than $37.00 we again warned:
“I now wonder whether we are seeing the bubble slip over the precipice? Falling property prices (10 per cent of the Chinese economy) leads to lower construction activity, leads to declining demand for Australian commodities, leads to falling commodity prices, leads to big drops in margins for a sizeable portion of the [Australian stock] market index…”
The doubters and many analysts that cover the sector however told us that lower prices would just mean that BHP, RIO and FMG would simply ship more volume. Remember share price performance over the long run follows profitability not profit.
And here’s the latest…
According to a news article that landed in the Bloomberg terminal this morning (see screenshot), Rio de Janeiro-based Vale, the world’s largest iron- ore producer, said second-quarter profit plummeted 59 per cent after prices for iron ore, nickel and copper declined.
Net income dropped to $2.66 billion, or 52 cents per share, from $6.45 billion, or $1.22 per share a year earlier. Vale was expected to post per-share earnings of 73 cents. The selling price of iron ore and most of Vale’s main products is lower than in 2011. This explains the decline in earnings.
Net sales fell 21 percent to $11.9 billion despite an increase in supply / production at Carajas, its biggest mine. Vale reportedly sold its iron ore at an average $103.29 per metric ton, down from $145.30 last year – something we have been warning for 6 months may happen. Nickel’s average sales price dropped 31 percent and copper declined 15 percent.
The stock has fallen 24 percent in the past 12 months, twice the 12 percent decrease in Brazil’s benchmark Bovespa Index. Management has put the focus of the fall squarely on slowing economic growth in China, the world’s biggest steel producer.
Returning to BHP, just 12 months ago, analysts had forecast 2012 net profits of almost $22b rising to $23b in 2013.
Those forecasts now stand at $17b and $18b respectively, representing a massive 22%-23% downgrade. And like Vale, BHP has also materially underperformed the ASX 200 index.
And given the significant miss by Vale analysts this morning, we reckon forecast earnings for BHP, RIO, FMG, MIN, AGO, BCI might disappoint again in the near future.
The answer in future periods may in fact lie in the Shanghai Re-bar prices and we have been watching this closely. Why? Because this is the most-traded steel futures contract and last week it hit a 2012 low.
Are iron ore prices, currently trading around China’s cost of production of $120/t, about to follow Re-bar prices despite most predicting the price simply cannot fall past this point?
The last time Re-bar prices were at this level, iron ore prices were also significantly lower.
When I was last on the ABC’s Inside Business program (watch it here: http://rogermontgomery.com/an-important-announcement/), we discussed Fortescue Metals CFO stating that their long-term iron ore price target is $100/t. I wonder how long we will have to wait until that forecast is also revised lower? As always, time will tell. Vale’s news is not a good omen.
On Monday night I attended a conference call with the exceptionally articulate George Papandreou, Prime Minister of Greece from October 2009 to November 2011. He said a sudden exit from the European Union would be chaotic. Greek GDP could quickly decline by 20% and the cost of major imports of oil and foodstuffs would go through the roof.
While Greece accounts for only 2% of the European Union GDP, Papandreou felt the threat of kicking Greece out could set a precedent for Portugal, Italy and Spain, which together account for 23% of European Union GDP. It would mean the beginning of the unraveling of Europe and create further weakness with massive consequences.
As we have been actively commenting since the start of the year, a key thematic concern we hold for investors in both Mining and Mining services businesses was the potential for commodity prices and in particular Iron Prices to begin to fall. In such an environment, falling prices would result in lower profits and cash flows for our miners and hence we could see significant future risk of projects being either scaled back or shelved in future periods.
Our view is anchored by a supply response in two new Pilbara regions coming on stream over the next few years and also falling demand from the world’s biggest consumer of additional supply, Asia (China).
With Iron Ore falling to $123.6/t, down 9% in two weeks; we are now at a critical juncture.
Critical because this is the price considered by many to be the ‘floor’ / the most Iron Ore prices can fall given China’s own estimated cost of production is $120/t. This compares to Australia/Brazil at $40/t and Canada/USA/Europe $65/t. A price lower than $120/t would make China’s Iron Ore production uneconomic and hence, a fall below this level “just cannot occur”.
Our experience with commodity producers is a little different. Our experience tells us that marginal producers are the first to lose when commodity prices fall materially.
And in this light we continue to expect over the coming months and years we will see lower prices and perhaps, marginal / high cost producers suffering and mining services starved of work. Even if they are operating at full steam right now.
To ask a question: is the recent moratorium of all Greenfield exploration activities by BHP a sign that they see the world in a similar light?
My Thoughts from the weekend:
A year ago we felt like Churchill – a voice in the wilderness – when we said Iron Ore prices could get ugly. On Friday they did….again. But more on that another time.
The number of overseas visitors we are meeting that tell us Sydney and Australia are “expensive” has got me thinking that Australians and Australia really needs to take advantage of the high Aussie dollar while it lasts.
Feeding ten people in Thailand at a local restaurant and ordering entree, mains and dessert for everyone as well as cocktails, beers, wine and mocktails for the kids amounts to 2000 baht or A$65.00. Thats a main course, a glass of water and a side of fries in Sydney. Its not surprising then to see so many Chinese, Russian and British tourists taking advantage of Thai hospitality.
Thinking about British investors; some have, over their lifetime, amassed, a million pounds. You would think that anyone in this position would be thinking “I’ve made it!” But they can now look forward to retirement with their next egg earning…wait for it… £7,500 per year! No wonder the UK student one of my colleagues is billeting here in Sydney has complained about how expensive Sydney is. The same might be said by Japanese tourists who are likewise earning less than 1% interest on their lifetime savings.
And last week I entertained two Singaporean investment professionals that couldn’t believe how expensive our harbour city had become for them. Coming from Singaporeans and Londoners, that’s really saying something.
These examples may only be anecdotes but my experience as an unconventional investor has taught me that aggregated anecdotes equals the whole.
Australia is uncompetitive.
I just bought a pair of italian shoes online and initially baulked before handing over my credit card details because the price was presented in Euros. But after doing the conversion I realised the depression in Spain (and it IS a depression) had opened another door for Australian shoppers looking for bargains (they have long enjoyed the bargains offered by the US). Additionally another nail has been driven into the coffins of Australia’s department stores.
It’s not often I can clearly see the headline many years in advance but unless our Australian dollar falls back to US70 cents the headlines will read: DJ’s and MYER are now in Run Off!!!!! Even a merger of the two wouldn’t help.
But hope for Australian retailers may be on the horizon. In the last week a consulting exploration geologist and an asset management consultant – both consulting to BHP, RIO, and others – have told me that projects are being shelved and deferred at a rapid pace. In some cases only from Q3 and Q4 to 2013 initially. In other cases, where the miners were shouting only six months ago (when we were writing our bearish opinions on Iron Ore and China); “get as many drills and people as you can, just get it done”, they are now saying “we may look at it again in a couple of years.”
Meantime American banks have been aggressive in cleaning up their banking system. The Economist notes that “the five biggest banks wrote off more almost $500 billion in the aftermath of the financial crisis and raised $318 billion in fresh capital.” No eurozone bank has yet set aside more than $30 billion.
In short I don’t believe a high Aussie dollar can be sustained – at least against the US (unless Agriculture can meet the slack from lower materials prices). And lest you want to be a tourist that complains of high prices when travelling abroad in the future, you need to think about how the above influences will impact your buying power.
The other thing that has caught my attention is the massive growth that will occur in superannuation. Currently there is $1.3 trillion and assuming certain growth rates, expect it to hit $4 trillion in fifteen years. The demographics will ensure that from 2028 (perhaps a couple of years later because of the change from 9% to 12% contributions) we will start seeing outflows putting pressure on inflows. But in the meantime the impact of this? Not enough high quality listed companies, prices of high quality listed companies being the only ones to sustain high price earnings multiples and lots of business for underwriters and Equity Capital Markets execs as a flood of baby boomers float their businesses to meet the tidal wave of superannuation money. Oh and expect a lot more investment into offshore stock markets and international fund managers like Magellan.
That latter point could be another reason to take advantage of a strong Aussie dollar now.
Roger Montgomery certainly thinks so, and he explains why in this Weekend Australian article published 21 July 2012. Read here.
I thought the downgrade in earnings by a major stockbroker of the Chinese cement stocks by 20-30% for the years to December 2012 and 2013 was revealing. Anhui Conch, for example, one of China’s largest cement producers, is expecting its sales volume to grow by 17 percent per annum from 158 million tonnes in 2011 to 251 million tonnes in 2014. While the average selling price per tonne for 2012 is down 15% to 20% on 2011, and the gross margin has halved. This drives home the cyclical nature of the industry and in the past year the Anhui Conch stock price has also halved to HK$20.
Roger Montgomery thinks not – and in this interview with Radio 2GB’s Ross Greenwood he discusses why Singapore’s pervasive attractiveness for investors is likely to remain for some time. Listen here.
This interview was broadcast 18 July 2012.
Roger Montgomery certainly thinks so, and he discusses with Ticky Fullerton how his Value.able investing strategy provides much lower valuations of the current market in this interview on ABC’s The Business broadcast 18 July 2012. Watch here.
Major mineral sands producer, Iluka Resources, announced this week its 2012-2014 Key Physical and Financial Parameters Guidance” released in February 2012 was “now redundant and as such no longer applicable”.
Discussions with both zircon and high grade titanium ore customers about ordering volumes for the December 2012 half-year have indicated “lower ordering patterns or an unwillingness to commit to volumes except on an “as needed” basis”.
Deteriorating economic conditions, subdued customer confidence in China, continuing weakness in the main ceramic export markets for Spain and Italy and some softening in the US manufacturing sector were all to blame.
We assume these same factors would be affecting most materials exporters. Remain cautious.
