Market Valuation

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.

by Roger Montgomery Posted in Energy / Resources, Market Valuation.

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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.

by Roger Montgomery Posted in Companies, Investing Education, Market Valuation.

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Fresh from signing up as CEO of Leighton Holdings in August 2011, Hamish Tyrwhitt seems to have streamlining on his mind.  After selling HWE Mining to BHP Billiton for $705m, Leighton have just approved the sale of Thiess Waste Management to Remondis AG for $218m.  Proceeds will be used to cut debt which hit$2.14 billion at their 31 December 2011 balance date.

With several earnings downgrades, the Leighton share price performance has been diabolical, down from $61 in late 2007 to the current $16.40 (-74%).

by Roger Montgomery Posted in Investing Education, Market Valuation.

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Early Friday morning Australian time saw coordinated easing from three of the World’s largest central banks.  Firstly, the Bank of England raised their asset purchase target from GBP325 billion to GBP375 billion.  Then the People’s Bank of China cut the one-year lending rate by 0.31 per cent to 6.0 per cent and the one-year deposit rate by 0.25 per cent to 3.0 per cent.  China’s June Quarter GDP data is due out this Friday 13 July.  Finally, the European Central Bank cut its main rate by 0.25 per cent to a record low 0.75 per cent.

ECB President Mario Draghi told reporters risk to the outlook remain “on the downside”.  The European Union is China’s largest export market.  At some stage this slowdown will weigh on China’s exports, which account for 40% of its GDP.

by Roger Montgomery Posted in Financial Services, Market Valuation.

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Roger Montgomery and Ross Greenwood discuss the recent Fairfax Media (FXJ) restructuring announcement and its implications in this edition of Ross’ program on Radio 2GB broadcast 20 June 2012.  Listen here.

by Roger Montgomery Posted in Intrinsic Value, Investing Education, Market Valuation, Radio.

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Roger Montgomery certainly thinks so – and he explains why Value Investors need to do their homework to experience exceptional returns in this Australian article published on 9 June 2012. Read here.

by Roger Montgomery Posted in In the Press, Intrinsic Value, Investing Education, Market Valuation.

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Learn Roger’s insights into the near-term future for Fairfax Media (FXJ) as Gina Rinehart increases her shareholding in this discussion with 2GB’s Ross Greenwood broadcast 30 May 2012.  Listen here.

by Roger Montgomery Posted in Companies, Investing Education, Market Valuation, Radio.

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“The more European leaders talked at a dinner last Wednesday, the grimmer Angela Merkel looked. One after another, they spoke out in favor of the joint assumption of debt and against the strict austerity course Berlin is calling for. The chancellor stared silently at the man who was responsible for this change of mood — France’s new president, François Hollande, who noted with satisfaction that there was “an outlook for euro bonds in Europe.”

Merkel disagreed, saying that euro bonds are not the right tool, but to no avail. Only a minority stood behind the German leader. Even European Council President Herman Van Rompuy said, at the end of the dinner, that there should be “no taboos,” and that he would examine the idea of euro bonds. “Herman,” Merkel blurted out, “you should at least say that some at this table are of a different opinion.”

…..

The fight has only just begun, and so it comes as no surprise that the roar of battle is drowning out everything else at the moment. But there are also signs of rapprochement. During his first official visit to Berlin, Pierre Moscovici, the new French minister of economics and finance, revealed some sympathy for the German line. He confirmed the new French government’s intention to reduce the national deficit in the coming year to below the upper limit of 3 percent of GDP, and to eliminate all new borrowing starting in 2017. He also underscored how important healthy budgets are for growth and employment. Those who have too much debt become impoverished, he said. And those who are poor, he added, cannot invest.”

From:  http://www.spiegel.de/international/europe/merkel-preparing-to-strike-back-against-hollande-with-six-point-plan-a-835295.html

I like Greg’s post on this subject here on the Insights Blog earlier today:

“With respect to Eurobonds, investors should understand that what is really being proposed is a system where all European countries share the collective credit risk of European member countries, allowing each country to issue debt on that collective credit standing, but leaving the more fiscally responsible ones – Germany and a handful of other European states – actually obligated to make good on the debt.

This is like 9 broke guys walking up to Warren Buffett and proposing that they all get together so each of them can issue “Warrenbonds.” About 90% of the group would agree on the wisdom of that idea, and Warren would be criticized as a “holdout” to the success of the plan. You’d have 9 guys issuing press releases on their “general agreement” about the concept, and in his weaker moments, Buffett might even offer to “study” the proposal. But Buffett would never agree unless he could impose spending austerity and nearly complete authority over the budgets of those 9 guys. None of them would be willing to give up that much sovereignty, so the idea would never get off the ground. Without major steps toward fiscal union involving a substantial loss of national sovereignty, the same is true for Eurobonds.”

At worst your SMSF hangs in the balance.  At best expect a wild ride.

Posted by Roger Montgomery, Value.able author, Skaffold Chairman and Fund Manager, 29 May 2012.

by Roger Montgomery Posted in Global markets, Market Valuation.

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Forget Europe. That’s old news. The next surprise might just be a bursting of Japan’s bond bubble.  Nay, a bursting of Japan itself?

According to Fitch, gross general government debt of Japan is likely to reach 239 percent of GDP by end-2012, the highest for any Fitch-rated sovereign. Moreover, Japan’s Fiscal Management Strategy envisages declines in the government debt/GDP ratio only from fiscal year 2021.

Would you lend Japan money (or any country with these financials) at rates approaching zero?

Strong private savings contribute to the country’s persistent current account surpluses. But that’s all going to change as ageing baby boomers (who the government has been borrowing money from at near zero rates – its called financial repression) start to ‘dissave’. As they get older they will stop saving and start needing the cash to finance retirement and healthcare. The result is that the government will need to turn to foreign investors for cash and they are not going to accept zero rates when the country has debt of 240% of GDP.

According to Bloomberg: “How low can bond yields go without triggering a meltdown?

“This question gains urgency as 10-year government yields disappear before the world’s eyes. At 0.83 percent, the lowest level since 2003, they hardly compensate investors for the risks inherent in buying IOUs from the most indebted nation. Public debt is more than twice the size of the $5.5 trillion economy. Worse, it’s still growing. Fitch Ratings today lowered the sovereign-credit rating by one step to A+ with a negative outlook because of Japan’s “leisurely” efforts to cut debt.

“Ignore news that gross domestic product rose an annualized 4.1 percent from the final three months of 2011. The only reason Japan is growing at all is excessive borrowing and zero interest rates. The moment Japan trims its debt, growth plunges, deflation deepens and politicians will demand that the Bank of Japan do more. That’s been Japan’s lot for 20 years now.
Yet what if the BOJ isn’t just setting Japan up for the mother of all crises, but holding the economy back?

“A bizarre dynamic is dominating Japan’s financial system, one evidenced by two-year debt yields falling to about 0.095 percent. That is below the upper range of the BOJ’s zero-to-0.1 percent target for official borrowing costs. It’s below the 0.1 percent interest rate the BOJ pays banks for excess reserves held at the central bank. Such rates raise serious questions.

“The BOJ does reverse auctions where it buys government debt from the market. Last week, it failed to get enough offers from bond dealers. Now think about that: The BOJ prints yen and uses it to buy government debt from banks, which typically hoard the stuff. Last week, banks essentially said: “No, thank you. We’d rather have these dismal interest-bearing securities than your cash, because there’s really nowhere to put that cash anyway.” Banks certainly aren’t lending.

“Politicians are pounding the table demanding that the BOJ expand its asset-purchase program. That, of course, isn’t possible. The BOJ can hardly force banks to swap their bonds for cash. So Japan is left with a problem unique to modern finance. Banks like to keep more cash on deposit at the BOJ than they need to in order to earn a 0.1 percent rate of return, which is pretty good by Japan standards. To pay that rate, the BOJ creates new money, which does nothing to help the economy.

“This dynamic keeps Japan’s monetary engine in neutral at best, and at times running in reverse. Japan’s central bank is essentially now there to support bond prices. It’s a huge intervention that gets little attention. Headlines roll every time the Ministry of Finance sells yen in currency markets. The BOJ’s debt manipulation barely registers.”

Why today?

Last year it was Iron Ore and recently it was minings services for which we suggested conventional wisdom should be questioned.  I am posting this topic today because Fitch Ratings lowered Japan’s credit ratings citing rising risks to the sovereign credit profile due to higher public debt ratios.

The long-term foreign and local currency Issuer Default Ratings were lowered to ‘A+’ from ‘AA’ and ‘AA-‘ respectively. The Negative outlook on ratings was maintained.

“The country’s fiscal consolidation plan looks leisurely relative even to other fiscally-challenged high-income countries, and implementation is subject to political risk,” Andrew Colquhoun, Head of Asia-Pacific Sovereigns at Fitch.

The agency warned that a lack of new fiscal policy measures aimed at stabilizing public finances amid continued rises in government debt ratios could lead to a further downgrade.

Posted by Roger Montgomery, Value.able author, Skaffold Chairman and Fund Manager, 22 May 2012.

by Roger Montgomery Posted in Foreign Currency, Global markets, Market Valuation.

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On ABC Radio’s ‘The World Today’ Roger Montgomery discusses with David Taylor why he can foresee a corrections to the US equity markets. Read/Listen here.

This program was broadcast on the 19th March 2012.

by Roger Montgomery Posted in In the Press, Market Valuation, Radio.

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