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How powerful is ISLM analysis?

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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.

INVEST WITH MONTGOMERY

Roger is the Founder and Chief Investment Officer of Montgomery Investment Management. Roger brings more than two decades of investment and financial market experience, knowledge and relationships to bear in his role as Chief Investment Officer. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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3 Comments

  1. Roger, are there any such companies trading cheaply that offer differentiated/unique products (eg consumer/capital goods) and are able to cut costs while avoiding price-cutting to maintain margins? BKN comes to mind. Or do you think that even with such a competitive advantage, the pain being inflicted by commodities is likely to sting everyone in the sector?

  2. For the brave investor there may be some value in companies which are trading below the value of their NTA and carry no debt, but personally the industry faces too many headwinds to make it into my portfolio.

    When I first started watching the video I was unimpressed, thinking “it’s hardly a big call at this point to suggest that the mining services industry will collapse.” Slowly it dawned on me that the video was about 18 months or more ago. I’m well impressed Roger!

    I personally prefer to manage my own portfolio, and some close family members have asked me to do theirs. It’s one thing to manage your own money, but another thing entirely to manage someone else’s – personally, I don’t feel I’m qualified to do the latter. Instead of investing the money myself I’ll be putting this into the Roger Montgomery fund, you guys are the only fund managers (excluding maybe a low cost index fund) in the country who I would trust to manage the money of my loved ones. (even if we don’t always agree on every point)

  3. Have to pay that, Roger, you were calling this a long time back.

    Another thing that those who think it might be worth a dabble in this space should consider is that the market overall is still pretty high – so the odds of a significant rise in the tide lifting all of those leaky boats is arguably lower. So you’d be betting more on a recovery in the sector itself. You’d have to be brave.

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