Insightful Insights

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.

by Roger Montgomery Posted in Insightful Insights, Property, Value.able.

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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.

by Roger Montgomery Posted in Insightful Insights, Value.able.

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Roger Montgomery certainly thinks so, and he explains why in this Weekend Australian article published 21 July 2012.  Read here.

by Roger Montgomery Posted in In the Press, Insightful Insights, Investing Education, Value.able.

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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.

by Roger Montgomery Posted in Insightful Insights, Radio.

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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.

by Roger Montgomery Posted in Companies, Insightful Insights, Investing Education, TV Appearances.

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Monday’s announcement of total ANZ job ads falling by 8.9% year on year in June 2012 indicates the slowdown in many Western world economies is gaining momentum Down Under.

The ANZ Australian job ad market series (combined newspaper and online) fell by 1.2% in June 2012 on May 2012.  In turn, May’s figure was down 2.6% from April.

The 8.9% year on year decline was driven by 8.5% and 17.5% year on year declines in online and newspaper job advertisements, respectively.

by Roger Montgomery Posted in Insightful Insights, Value.able.

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Sani Group, China’s biggest maker of construction machines has announced a cut to its workforce.

Given lay-offs did not occur in the down cycles of 2005 and 2008, this is a clear sign some pain is being experienced in China’s industrial heartland.

Sany’s 60,000 staff produces concrete machinery, excavators, cranes, pile drivers and road machinery.  Its revenue exceeds RMB80 billion or US$12.5 billion.

With the tripling in demand for machinery in China since 2001, it appears Sany has recently been selling machines on generous credit terms.  As a result the machinery maker saw its net receivables double over 2011.

The slowdown in Chinese construction activity is not a good omen for the iron-ore price, currently US$135/tonne. China’s demand accounts for 63% of iron-ore’s global seaborne trade.

by Roger Montgomery Posted in Energy / Resources, Insightful Insights.

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Fairfax Media’s restructure announcement has been welcomed by the market, but what prospects does their revised business model have for future profitability?  Roger Montgomery provides his Value.able insights to ABC1’s Ticky Fullerton in this edition of ‘The Business’ broadcast on 18 June 2012. Watch here.

by Roger Montgomery Posted in Insightful Insights, Takeovers, TV Appearances, Value.able.

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As you already know, despite the enthusiasm for mining service companies back in April, we sold our holdings substantially and in some cases completely.  We have not shared our peers’ – some of whom include themselves in the ‘value investing’ camp – enthusiasm for BHP.  Our reasoning for this is our thesis regarding iron ore prices, which is unchanged from late last year.

Back then it was simply the classic investment response to higher prices.  Iron Ore prices between 1985 and and 2004 have traded between $11 and $15  and in real terms since the 1920’s prices have traded between $30 and $45. In 2004 the price of iron ore started rallying and hit $187 in 2007.

Putting aside the fact that iron ore experts now ‘guess’ $140 is the new medium term price and $100 the long term price, the rally in price from 2004 to now has produced a huge investment boom and turned millionaires into billionaires as they revalue their reserves (or other bulls value them for them).

It follows that  the investment boom will now produce additional supply.  The impact of this additional supply cannot be anything but falling prices.

Well, that was our thesis.  And then China began slowing down.  We wrote about that too

If you have been a regular to the Insights Blog, you will be familiar with some of our recent thoughts on iron ore here:

April 3)  http://rogermontgomery.com/mining-services-a-crowded-trade/

April 18) http://rogermontgomery.com/building-heaps-piles-at-bhp/

APril 11) http://rogermontgomery.com/will-china-demand-iron-or/

And you can watch this video I published here on December 8 last year:

Since July last year BHP is down 30% and RIO down 36%.  Since April and early May they are down 15% and 20% respectively.  Many investors are now thinking they are cheap.  But there is the possibility of a classic Value Trap.

Forecast valuations may yet decline further, even if share prices bounce. Here’s our thoughts…

PORTFOLIO POINT: BHP and Rio’s review of capex programs represents a stark turnaround from comments made just two months ago, and it’s a worrying sign for the rest of the sector.

BHP is trading at three-year lows, Fortescue is down 17% from recent highs and Rio is visiting lows last seen in 2008. If you own shares in any of these companies, only Telstra would have saved your portfolio from a shellacking.

The big caps, however, are not the only stocks that have suffered. Over recent years, it is likely that you would have observed my interest in mining services. That interest was a product of the presence of value for money.

This is a sector I know well and have covered numerous times. I have discussed and brought listed businesses – including Decmil Group (DCG), Forge Group (FGE) and Matrix Composites & Engineering (MCE) – and IPOs – GR Engineering (GNG) and Maca (MLD) – to your attention.

This was mostly at a time when there was little market interest, despite their apparent growth profiles, quality aggregated balance sheets and (now with the exception of MCE) management.

Today, however, that story is very different and I find myself erring on the side of caution when it comes to ‘picks and shovels’.

Each week, a stronger case is building that a key growth engine for capex spending by our miners is slowing – that is, commodity prices are falling.

Take one commodity I have discussed recently: iron ore.

In 2010-11, world iron ore production grew 8.1% (or 227mt) to 2.80bt. Assuming similar growth levels in 2011-12, iron ore production will grow to 3.04bt, an increase of about 237mt. (In a classic supply response, BHP production is forecast to grow by 20%, Rio by 30% and FMG by 25%.)

And assuming China consumes 60% of global production again (highly optimistic), its demand would increase by 136.2mt. However, moderating growth means current estimates for China’s iron ore requirements are half this level. With few other countries growing or competing heavily with China, who will pick up that supply overhang in a low-growth environment?

By 2015, two entire Pilbara regions (700mt) in supply terms are estimated to come onto the market. It’s a far stretch to expect China to absorb 420mt (60%) of that.

The impact, I expect, is pressure on iron ore prices.

Many other commodities are looking like they are set to suffer a similar fate. Record prices over a decade have created an investment boom that is climaxing at a time when global demand is losing interest. And you need two to tango. When soaring supply meets softening demand, lower prices follow.

So what are the implications? Put simply, for those who dig stuff out of the ground and export it, margins and cash flow will be squeezed (a situation I have been monitoring closely and alerting readers to for at least six months). It’s why I haven’t bought BHP.

In previous periods, a revenue squeeze has been a precursor to capex plan deferrals or delays lasting years. Barely economical projects are shelved as miners focus instead on financing core (capital-intensive) operations, rather than aggressive growth targets.

Indeed, the 1990s was a very different period for miners, and those who serviced the mining sector barely made it onto investment radars. Companies struggled to cover their cost of capital and total annual capex was less than $20 billion for the entire mining industry.

Today, many miners are generating returns on equity in excess of 30% (‘super profits’?) and capex runs in excess of $60 billion per annum. Are such numbers maintainable forever? No. And if it can’t go on forever, it must stop.

Just a few days ago, BHP Billiton and Rio Tinto announced that they are re-evaluating their capital expenditure programs. These comments are in stark contrast to their latest financial reports and presentations made just two months ago.

In those reports, confidence was effervescent and the deployment of $40 billion in a global cash capex spree was on the cards. Today, as China’s growth rate slows and some investors lobby for a greater focus on cost control and returning funds to shareholders, tens of billions of dollars of an extensive development project pipeline is under review.

When the two leading businesses that account for about 35% of total industry investment start to make noise, it’s time to sit up and pay attention.

We are bound to see many other miners follow suit and the chorus is growing louder by the day. Citigroup conducted a survey in April and found that 50% of all miners were considering lowering their investment budgets.

That compares to less than 20% in January.

Figure 1. A picture tells a thousand words

At the start of the financial year, capital expenditure was forecast to rise 34%, with an increase of 18% in 2013.

The forecast today is for a rise of only 13% this year and a fall in 2013. This represents a material deterioration in market conditions in a very short period of time. All of this weighs on the ‘bright prospects’ that once surrounded those companies which service the miners.

This brings us back to Decmil, Forge and investing. I bought both of these businesses in the Montgomery [Private] Fund near its inception.

Forge is a business that has a significant exposure to second-tier miners, especially those expanding their iron ore operations. Decmil, on the other hand, has around 43% of its business exposed to resources and the balance to oil & gas.

While plenty of work is still forecast to be in the pipeline for mining services companies, there are also plenty of companies trying to win it.

If we are at the peak of the current capex cycle, this is as good as it gets in terms of margins for mining services businesses and also workloads.

With that in mind, and coupled with prices increasing to levels I deem attractive for what are businesses with high operating leverage, I have decided to read the writing on the wall and position our investments in a more conservative manner. I sold our Forge holding some weeks ago and also scaled back our holding of Decmil.

It is possible I am early to leave the party – the band is still playing. But the mining industry is bracing for a pullback in investment spending, as the biggest companies reassess their capital expenditure plans amid escalating costs and an uncertain growth outlook. I anticipate that analysts will revise their earnings forecasts lower for 2013 and beyond.

The valuations I look at in Skaffold will also fall, I expect, as those earnings revisions are fed through. Of course, I could also be completely wrong but I reckon the big mining companies’ historical predilections for over-paying for acquisitions (another reason I have been loath to invest) may just revisit them.

The combination of a contracting market and high operating leverage means I simply prefer the safety of cash. Better to be confident of a good return than hopeful of a great one.

This article was first published on May 16, 2012

by Roger Montgomery Posted in Energy / Resources, Insightful Insights, Intrinsic Value.

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Facebook floated last week and amazingly it has been holding above its IPO price of $38 per share. I say amazingly because I reckon its value to be substantially lower. I will publish my completed calculations in the near future

Here’s a taster:  “For a purchaser of Facebook shares today and wanting 15 percent per year over the next five years (doubling your money),  Facebook’s market capitalization has to double to $200 billion without any additional shares being issued (options to be exercised will put paid to any fairy tale notions about that). Google is valued by the market today at $200 billion.  Both businesses are similar in terms of margins etc so arguably Facebook needs to increase its sales tenfold in the next five years to achieve the same valuation as Google today.  But keep in mind, Google has about $40 billion of cash in its accounts.  Facebook has nothing like that.”

For now I thought the trading in Facebook on its first day was a useful entrée to the world of High Frequency and Algorithmic trading and I also thought that comic Andy Borowitz’s tongue-in-cheek look at Facebook provided a welcome break from the doom and gloom pervading investment markets.

From: http://www.borowitzreport.com/

MENLO PARK, CA (The Borowitz Report) – On the eve of Facebook’s IPO, Founder and CEO Mark Zuckerberg published the following letter to potential investors:

Dear Potential Investor:

For years, you’ve wasted your time on Facebook. Now here’s your chance to waste your money on it, too.

Tomorrow is Facebook’s IPO, and I know what some of you are thinking. How will Facebook be any different from the dot-com bubble of the early 2000’s?

For one thing, those bad dot-com stocks were all speculation and hype, and weren’t based on real businesses. Facebook, on the other hand, is based on a solid foundation of angry birds and imaginary sheep.

Second, Facebook is the most successful social network in the world, enabling millions to share information of no interest with people they barely know.

Third, every time someone clicks on a Facebook ad, Facebook makes money. And while no one has ever done this on purpose, millions have done it by mistake while drunk. We totally stole this idea from iTunes.

Finally, if you invest in Facebook, you’ll be far from alone. As a result of using Facebook for the past few years, over 900 million people in the world have suffered mild to moderate brain damage, impairing their ability to make reasoned judgments. These will be your fellow Facebook investors.

With your help, if all goes as planned tomorrow, Facebook’s IPO will net $100 billion. To put that number in context, it would take JP Morgan four or five trades to lose that much money.

One last thing: what will, I, Mark Zuckerberg, do with the $18 billion I’m expected to earn from Facebook’s IPO? Well, I’m considering buying Greece, but that would still leave me with $18 billion. LOL.

Friend me,

Mark

Following that lighthearted distraction, if you are interested in how High Frequency Trading and [some examples] of Algorithmic (Algo) Trading looks in the real world, watch this:

As the following chart reveals (you will have to suspend reality and imagine that the future always looks exactly the same as the past) some analysts think Facebook’s growth will mimic that of other high profile social networks.  No doubt the underwriters of Facebook will hope they’re wrong.

Either way it will be more than a little interesting to watch. Did you buy shares in Facebook?  If not, why not? And if you did, what were the reasons?

Posted by Roger Montgomery, Value.ableauthor, SkaffoldChairman and Fund Manager, 21 May 2012.

by Roger Montgomery Posted in Insightful Insights, Value.able.

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