How powerful is ISLM analysis?
Be sure to watch this video from March 2013 (almost two years ago) and then read on…
It only takes three or four minutes to learn about the forces of supply and demand and their effect on prices. It usually takes an entire semester to explain the forces of supply and demand to a first year university student so consider the few minutes you spend here a value-investing opportunity.
This week our friends at the ABC reported a painful situation in one of Australia’s important industries: “Activity in the resources sector continues to tumble, with a new government report showing investment commitments to major projects are now at the lowest level in more than a decade.”
“The Bureau of Resources and Energy Economics (BREE) biannual Major Projects Report has found that only three projects worth a total of $597 million received a positive ‘final investment decision’ in the six months to October.
“The report notes that it is the lowest number and value of projects moving to being a committed investment in more than a decade.”
With Iron Ore prices now down over 60 per cent from their highs (and we expect might fall further) and mining and mining services companies down, in some cases, even more, it’s worth reflecting on how valuable it can be to apply basic supply and demand analysis to the stocks in your portfolio.
At the time the video above went to air nationwide on the ABC, almost two years ago, Monadelphous (mentioned in the video) was trading at $24.88. Today it trades at $9.63. Decmil was trading at $2.51, and today it trades at $1.48. Macmahon Holdings, one of the most capital-intensive mining services contractors, was trading at an adjusted 30 cents. Today it trades at 7 cents. The losses have been extraordinary and many investors are now contemplating the possibility that they have reached their lows. The Montgomery Funds are in the fortunate position of having little, if any, exposure to the sector and this provides some clear air to think about whether it is the right time to enter.
Even if the iron ore and coal prices do not fall any further, there is clearly a great deal less work on the table for mining services companies. The 800-odd mining service companies that aren’t listed on the ASX are likely to have a hard time making a profit. Also when tendering for any new work, they should be expected to compete away any positive margins available to listed and unlisted companies alike. Many analysts believe their could be some ‘consolidation’ in the industry. in other words they believe there may be a few takeovers. But before getting excited about the prospects for M&A, put yourself in the shoes of a business in the space. Why would you buy a competitor if that competitor is not winning any work. You would simply let them collapse and try to win the work yourself and then pick up the equipment (if you need it) at the liquidation sale.
At this stage – keeping in mind we could be wrong – we reckon there is a risk of being premature in trying to pick the end of this commodity downturn.
Roger Montgomery is the founder and Chief Investment Officer of Montgomery Investment Management. To invest with Montgomery click the following link: find out more.