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Philip Morrish
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Philip Morrish is the founder and Head of Research for Intellisys and has been an UK/European equity analyst for some 30 years. During his career, based in the City of London, he has been a highly ranked analyst; ranked #1 in the Chemicals and Waste Management sectors while with Smith New Court... More
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  • Moody's Playing Catch Up, Downgrade Already Priced In

    Late Friday night (22 February), leading global credit rating agency Moody's, downgraded the UK sovereign debt rating, and that of the Bank of England, from AAA to AA1 while lifting the outlook from negative to stable.

    Moody's report stated that 'the key interrelated drivers of today's action are:

    1. The continuing weakness in the UK's medium-term growth outlook, with a period of sluggish growth which Moody's now expects will extend into the second half of the decade;

    2. The challenges that subdued medium-term growth prospects pose to the government's fiscal consolidation programme, which will now extend well into the next parliament;

    3. And, as a consequence of the UK's high and rising debt burden, a deterioration in the shock-absorption capacity of the government's balance sheet, which is unlikely to reverse before 2016.'

    Sadly, for Moody's and probably the other major credit rating agencies, none of the reasons cited are new and the downgrade will only serve to further tarnish their already seriously battered reputations and credibility.

    We have stated for a long time (i.e., since early 2009) that the UK's recession would be deeper than that for most leading industrial nations and exceed most commentators gloomiest forecasts, which proved to be the case. In addition, the subsequent recovery would be long and painfully slow and would resemble an 'L-shape' as the Government acted swiftly to rebalance the economy and worked on eliminating the inherited structural deficit. This is precisely how it is playing out!

    Table: Intellisys GDP Forecasts

     

     

    GDP % YoY2007A2008A2009A2010A2011A2012E2013E2014E2015E
    UK3.6-1.0-4.01.80.90.10.51.21.6
    Germany3.40.8-5.06.33.90.40.71.01.4
    France2.2-0.2-3.11.61.70.20.40.71.1
    Eurozone (15 countries)3.00.3-4.31.91.4-0.60.00.61.0
    USA1.9-0.3-3.12.41.81.51.71.92.3
    World5.42.8-0.65.13.82.02.52.83.4

    Source: Intellisys

    A recovery, albeit very muted due to the Government's relentless budget cutting, is underway but it does require nurturing. In addition, most major economic forecasters have managed to stay well ahead of Moody's and the other credit rating agencies, so the overall market reaction to the credit rating downgrade will probably be neutral to mildly positive. However, the political reaction, particularly from the leading opposition party that completely mismanaged the economy and created the current structural deficit, is likely to be heated.

    The report does not advocate a change in the Government's economic strategy but concurs with our view that it will only take longer to achieve the original objective; obviously, predicated on the basis that there are no new or unexpected shocks to the UK or global economy. The Government having taken and put in train all the painful processes to eliminate the structural deficit should now focus on introducing growth mechanisms in the forthcoming April Budget speech.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Feb 27 9:58 AM | Link | Comment!
  • Mining Sector - Responding To A Changed World

    Global accountancy and consulting group Ernst & Young recently published a review of the global mining sector, which concluded that the industry, generally, is facing a capital strike, and that the effects were most pronounced amongst the junior miners (i.e., explorers). The drop off in activity was apparently most acute during the second half of 2012. On a positive note they do anticipate that capital markets' appetite for the industry could begin to improve toward the end of the current calendar year.

    Table: Volume & Value of Deals (2003 - 2012)

     

     

     2003200420052006200720082009201020112012
    Volume4755965647019039191,0471,1231,008941
    Value ($m)46,18226,35065,430175,713210,848126,88460,035113,706162,439104,014
    Average value ($m)974411625123313857101161111
    Median value ($m)4.43.14.86.27.26.03.25.25.65.0

    Source: Ernst & Young (Mergers, acquisitions and capital raising in mining and metals)

    There appear to be several general reasons for the slowdown in corporate activity that can be briefly summarized as:
     

    • Global economy remaining weak
    • Softening commodity prices and rising operating costs
    • Increasing demand for improved equity returns and
    • Sharply reduced bank lending partially offset by increased bond market activity.


    None of the general conclusions arising from the report come as any great surprise to us because we had previously expressed concern about commodity prices and the sector's disconnect from the real economy i.e. commodity prices had continued to rise while economic demand was slumping. In our view, reality has finally caught up with the industry and it is belatedly responding to the changed demands of equity and debt capital markets.

    Unlike Ernst & Young, Intellisys does not anticipate that capital markets' conditions will ease much before 2014 at the earliest. We anticipate that global economic growth will remain subdued and will remain at sub-historic trend growth rates until the leading industrialized economies overcome the drag created by rebalancing their economies and eliminating and/or reducing their structural deficits; a process that takes many years to fully and successfully implement.

    Table: GDP forecasts

     

     

    GDP % YoY2007A2008A2009A2010A2011A2012E2013E2014E2015E
    UK3.6-1.0-4.01.80.90.10.51.21.6
    Germany3.40.8-5.06.33.90.40.71.01.4
    France2.2-0.2-3.11.61.70.20.40.71.1
    Eurozone (15 countries)3.00.3-4.31.91.4-0.60.00.61.0
    USA1.9-0.3-3.12.41.81.51.71.92.3
    World5.42.8-0.65.13.82.02.52.83.4

    Source: Intellisys, IMF and OECD.

    Although a recovery is under way, the on-going weaker demand would suggest further dampened appetite for hard commodities resulting in persistently softer prices.

    Commodity Prices

    Gold (click to enlarge)

    Source: DigitalLook.com

    Silver (click to enlarge)

    Source: DigitalLook.com

    Platinum

    (click to enlarge)

    Source: DigitalLook.com

    Copper

    (click to enlarge)

    Source: FT.com

    Over at least the past 6 years, the sector has very actively capitalized upon the well documented price rises of hard commodities to fund volume growth. However, the more detailed findings of the Ernst & Young report indicate some fundamental changes about how the industry is being financed and the corporate responses to those changes.

    Table: Capital Raising by Asset Class - Proceeds (2007 - 2012)

     

     

    $m200720082009201020112012Trend
    IPOs21,40012,4062,98717,94817,4491,388q
    Follow-ons66,80248,75173,80649,70549,74525,950q
    Convertible Bonds12,86512,23814,4315,4772,3653,537p
    Bonds36,35838,14661,01672,50283,804112,539p
    Loans110,787171,69162,420183,875187,059105,981q
    Total248,212283,232214,660329,507340,422249,394q

    Source: Ernst & Young

    Charts: Capital Raising by Asset Class 2007 and 2012

    2007

    Source: Ernst & Young; Intellisys

    2012

    Source: Ernst & Young; Intellisys

    In general, the industry is composed of three segments - Major Producers, Advanced Juniors and Explorers - and each is responding differently to the changed capital markets climate.

    The Majors, in direct response to their equity investors' concerns about falling share prices and declining profitability ahead of massive planned capital spending, are concentrating upon maximizing returns on capital and capital recycling. This capital allocation rethink has manifested itself in thorough and on-going reviews of corporate portfolios, the redistribution and diversion of capital from high cost to high return projects and the divesting of non-core assets. In addition, the Majors are using the corporate bond markets to refinance their balance sheets on favourable long-term rates. The successful implementation of these new strategic plans should result in progressively widening profit margins, sustainably improving capital returns and higher dividend distributions, which should encourage equity investors to rebuild exposure.

    The Advanced Juniors are similarly re-addressing their capital allocation plans but they have to be somewhat more creative in securing their long-term capital requirements because they are unable to readily access the investment grade bond markets like the Majors. They have successfully accessed the high yield and US private placement markets as well as encouraged long-term investors to take strategic equity stakes and/or provide off-take financing. However, most Advanced Juniors are reluctant to dilute existing shareholders through equity placements although some have benefited from a 'stock selective' mood swing by institutional investors in favor of quality, de-risked investment opportunities with reasonable visibility and near-term returns. However, given the limited availability of broadly distributed quality company research, many of the Advanced Juniors already fail to register on the Institutional Investor radar screen. Moreover, many of the resultant 'individually creative' but complex capital funding solutions for the Advanced Juniors will tend to discourage an early 'en masse' return by equity investors because each of the companies will have to demonstrably prove its particular business and financial model.

    Finally, the capital strike by risk adverse equity investors has pushed the Explorers back into survival mode. With more and more of these companies showing signs of financial distress, this group either has to accept last resort funding proposals that often result in loss of control over projects or onerous terms, or brutally pare back activity and costs in the hope that they can survive until a more favourable funding climate emerges. Generally, these companies' shares will only appeal to those equity investors with an ultra-high risk appetite.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Tags: Mining
    Feb 27 9:51 AM | Link | Comment!
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