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Rohan C. Pease
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Rohan C. Pease is a graduate of the University of Arizona's Eller College of Business and Public Administration; B.A. in Finance. Focus in Energy, Mining, Basic Materials, Emerging Markets, Commodities & Currencies. My passions include F1 racing, Classic Cars, and Art. AZ - The Grand Canyon... More
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Arizona Electric Power Cooperative
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  • Breakfast At Harry Winston, Not Tiffany's
    BHP Billiton(BHP), the world's largest mining company, plans to sell their remaining diamond assets. Their diamond assets lie on the Balance Sheet in the Diamond and Specialty Products unit. The unit currently on the books for $2.8Billion generated $1.5B in revenue and $587MM in earnings before interest and taxes in the previous fiscal year ending June 30. The unit has two large assets up for grabs, their 80 percent interest in the Ekati diamond mine and a 51 percent interest in the Chidliak project. BHP has expressed clearly that the reason for the sale is that the assets are no longer consistent with the company's strategy of investing in "large, long life expandable assets." In December, BHP unloaded their interest in the Chidliak diamond project, and attention now turns to the Ekati mine.

    "As we invest more in our bigger assets, the minimum threshold for both an industry and an asset in terms of scale gets moved up," BHP Chief Executive Marius Kloppers said back in February. BHP's focus is on Iron Ore, Copper, and Coal. Mr. Kloppers is conveying that it's the notional value of the project that becomes the scope of whether to invest or divest, not necessarily the margin of the return on assets. This presents a potential win win situation for both buyer and seller.

    Interestingly, Citigroup has voiced its opinion that both BHP and Rio Tinto(RIO) should spin off their diamond units because they are "major cash drains". This will lead to large mining companies freeing up their cash flows to invest in large capital intensive projects. Companies such as Harry Winston(HWD), which have a long established history in extracting value from such assets by using their downstream operations, can step in to take advantage. HWD operates the Diavik mine which is located close to the Ekati mine. There are many similarities between these mines including the stage of the mines' lives. Both mines are in their maturity and one would postulate that they have similar capital needs.

    Citigroup analysts Oliver Chen and Kate McShane initiated coverage of HWD with a "Buy" rating and a $15 price target the day after Valentine's Day, citing the company's mix of retail and mining assets would cause the stock to be valued highly as it will allow investors to gain exposure to rising diamond prices.

    I agree with the Citigroup analysts; HWD's vertical integration uniquely positions them within the diamond industry. This view has been shared by their Chief Executive Bob Ginnicott on many of their conference calls. The company has a window into the trends of diamond pricing for both rough and polished diamonds. The company uses this info to gauge the industry and then capitalize on it by targeting consumer spending in the jewelry segment, tailoring their capital expenditures to the industry cycle, and managing overall operating costs.

    Asian Demand

    While the near term catalyst of purchasing an asset such as the Ekati mine is compelling, a quick look at the structural reasons diamond prices have risen is important to gauge if the trend is sustainable and if this purchase will provide good returns in the future.

    Diamond prices are up over 20% in the last year and have been fueled by growth in emerging markets, most notably demand from Asia. This tremendous growth in the luxury goods sector has propelled the stock prices of companies such as Coach(COH), Ralph Lauren(RL), and Tiffany & Co.(TIF). The luxury goods sector has enjoyed unprecedented growth and ability for price elasticity to increase. Recently TIF pushed through one of many recent price increases. The high end of the luxury spectrum is becoming less sensitive to pricing and this is evident in diamonds. Diamonds also serve as a readily transportable store of wealth, which is important to discerning high end consumers. I believe this demand will only expand in the future and isn't going to be on a correcting trajectory any time soon.

    Valuation

    I will refrain from delving into metrics such as price/sales, ROA, P/E, book value, etc. This info is readily available to anyone and with regards to P/E not relevant to Harry Winston's operations. I will focus on a peer comparison and chart technicals in my valuation observation. First I would like to compare HWD with the titan of the industry, TIF, which has purchased Diavik diamonds extensively for use in their jewelry. I will use the last 5 years as a backdrop for our comparison since this coincides with the timeframe of the tremendous growth of the luxury goods sector as a whole and also incorporates the impact of the financial crisis. During this period TIF has traded from a $40 per share to a current trading range of around $65-$75 per share, a 1.75x increase in value. By comparison, HWD has traded from $35 to a current price of $15 per share. If HWD traded in line with TIF during this period it should theoretically be valued north of $60 per share.

    Reasons for the TIF premium are obvious and considerable; they have a huge brand presence. I've read reports that a woman's heartbeat will increase by 22% when exposed to the Tiffany trademark blue color. There is also the mining risk that investors may perceive with HWD, although I believe this risk is mitigated in their operations through retail and wholesale pricing.

    An important question to ask is weather Asian buyers will place as much perceived brand value on TIF jewelry as US and European consumers have historically? Will this lead to TIF losing some of its competitive advantage in Asian markets? I think that with their expanding retail business in Asia, HWD is quickly gaining on TIF and the current valuation gap could be cut in half over the next year, allowing HWD to outperform TIF 2 to 1 over that time period. Indeed, since November 2011 the valuation gap has been narrowing. Tiffany Chart
    Harry Winston Chart

    With that said HWD has had a good run of late topping $15 per share from a base of $10 per share in the 4th quarter of 2011, and a retracement to the low $13's would provide a good entry point. As a hedge to owning HWD I would short TIF as I expect it to underperform for the foreseeable future.

    Disclosure: I am long HWD.

    Mar 19 8:52 PM | Link | Comment!
  • Chesapeake, Relatively Cheap NG Play
    Natural Gas inventory of working gas underground storage stood at 2,607 Bcf as of January 15th, which is 0.2% below the 5yr historical average. Only a couple months ago storage was at historical highs and was averaging approx 16-24% above the 5yr average. The important factor in this measurement is that we have turned the corner in working gas storage.

    Below is a 5 yr chart of Chesapeake energy, notice the $30 price level over the 5yr period. When Natural Gas in storage is below the 5yr average, futures prices go up and so follows CHK, and vice versa shown vividly during 2008 when prices crashed. This is a crude (no pun intended) measurement, however I believe it is effective and shows that CHK is relatively cheap around $24-25/ share if you believe the trend in storage will continue. A break above the 200day moving average would also be a good point to be long CHK.



    Will the trend continue.....

    Short answer YES! Another crude measurement yet effective is to look at the amount of supply coming to the market. To get a proxy of this I like to look at the amount of Nat Gas drill rigs in service. Below you can see a bottoming out of Gas rigs over a 5yr period. So weather conditions aside, it looks as if storage will remain below its 5yr average for some time.



    Sources:

    Baker Hughes - Chart
    TD Ameritrade - Chart

    Disclosure: No positions in CHK, BHI, or Natural Gas Futures
    Jan 26 4:04 PM | Link | 1 Comment
  • Platinum Worth Twice its Weight in GOLD

    Platinum will reach a historical high of $2,700.00 per ounce by year end 2011. My yearend target for 2010 is approx $1,980.00 per ounce. The primary dynamic over the long term in deriving these price targets comes from looking at the relationships between the historical spread of platinum over gold and in context of power restrictions from South African state run utility ESKOM. In the short term, platinum prices will be determined by the strength of the industrial economy. Industrial strength will be measured by proxy using the following; North American Rail Traffic, both Domestic & World auto sales, distillate fuels used in utility & transportation, and a look into the scrap steel market.

     

    The WSJ reported a 4.6% increase in North America Rail Traffic during the month of December; this represented the first yr-on-yr increase in over a year. Among top rail users are the coal industry, car dealers, and construction & manufacturing firms. Increased coal serves utilities which are seeing increased demand for electricity used in manufacturing.

    “Bunker fuel” which is not traded as a financial asset such as crude oil or Nat. Gas, therefore isn’t exposed to wide speculation has made fresh highs recently. Due to its high sulfur content bunker fuel is used by power plants and maritime fleets. Therefore we will use the rising price of bunker fuel to serve as a proxy for increased demand in transportation using ships (dry bulk, container, etc.) and ultimately increased demand for world trade. The spread of bunker fuel to crude oil has narrowed to $3.5/bbl, the lowest in 3 years.

    China, India, & Japan saw an increase in diesel demand during the fourth quarter, while U.S. inventories experienced a decline.  Anecdotally the price of diesel at the pump is now again higher than the price of premium signifying a pickup in Semi-truck traffic. Diesel is also used in Rails and Farm machinery.

    Auto sales have stabilized at approx 10.4 M SAAR units during 2009 in the U.S. and are forecast to increase to 11.5-12M for 2010. The cash for clunkers program increased demand, gave an adrenalin shot in the arm to the industry, and spurred growth in GDP. Wilbur Ross has recently announced that the U.S. should implement a longer lasting cash for clunkers program which would be simpler in its structure. In China, during 2009 auto sales eclipsed the U.S. for the first time in history and rose to approx 13.6M SAAR, and are forecast to top 15M this year. Net personal income for China’s 1.3 Billion people is on the rise, this will undoubtly translate into increased demand for cars.

    The Scrap Steel market was former Fed Chairman Alan Greenspan’s favorite single economic indicator during his tenure. He would look to the pricing of scrap steel to determine when industrial demand growth was taking hold. To the left is a chart from the LME for scrap steel prices during 2009.

    Although steel prices have undergone a major shift from being diversified across the world, to now where production has been more concentrated in Asia, industrial manufacturing is shown to be on the mend as prices in the U.S. have been picking up. Note: It appears the flood of scrap steel from Cash for Clunkers shows up in the dip in scrap steel price from Q3-Q4.

     

    Historical Spreads –

    Below is a chart of Gold to Platinum ratio from Bespoke Investment Group. You will notice that platinum has been outperforming gold since platinum bottomed out around 750 last year when the relationship was 1 to 1. I believe this trend can continue until around 0.55 – 0.53, which translates into platinum trading at a 1.8 – 1.88 premium to gold. The minimum of 0.4 on the chart translates to a premium of 2.5, this is simply just the inverse so I may express in terms of platinum/OZ.

     As you can see from the chart below Platinum topped out at approx 2290 during the first half of 2008 during serve power restrictions in South Africa disrupting supply of the precious metal. Since then platinum has rallied and more recently has broken past the 1520 level which was a 50% retracement from the low of 750. The next level of resistance would be at around 1700 which represents a 61.8% retracement from the lows.

     
     

    Price Target –

    Looking at the above economic indicators it appears that industrial demand is taking hold while inflation is moderate and fear gauges (GOLD) is slowly starting to dissipate. This was my thesis for the long platinum/short gold trade. With demand picking up for Platinum Group Metals (PGM’s) any disruption in supply could cause the price to skyrocket. That is concerning considering that South Africa still has limited power supply from its state run electricity company ESKOM. In 2008 during the last power restrictions ESKOM announced plans to build additional capacity for its mining interests, this was projected to take at least 4 years (very capital intensive, I work for a utility). The market has put this on the back burner as demand dropped, however with the World’s platinum mines being concentrated in South Africa, this is still a big problem when demand comes back.

    So let’s look at some potential price targets:

    Using the historical spread from Bespoke’s chart we can say that Platinum under stress should trade at 1.8-2.5x the price of Gold. Using various scenarios for gold @1100, @1200, and @1500 we can infer the following;

                                    @1100                  @1200                                  @1500

    1.80x                     1980                       2160                                       2700

    1.88x                     2070                       2255                                       2820

    2.50x                     2750                       3000                                       3750

    To put the above in context Platinum hit an inflation adjusted high of $2322 in 1980.  Recently a slew of analysts have come out with Gold targets for $1500, assuming we get there a 1.8x premium for 1500 gold is 2700 an OZ for Platinum. As you can see from the chart, there are a couple scenarios that will yield 2700/OZ Platinum. Also, just a side note, the new PGM’s ETF’s should cause prices to elevate higher due to asset allocation by institutional investors and speculators, however none of these measures are included in the analysis, as they say it’s just icing on the cake!

    Thus my YE2010 target is $1980 and YE2011 target is $2700, as always I recommend you hedge any long position you have, and in this case I have used Gold.

     

    DISCLOSURE

    I have no long or short positions in Gold, Platinum or PGM’s or equities whose price is derived from the underlying metal.

     

     

     

     

     

     

     

     

     

    Sources                :

    Bloomberg

    LME

     WSJ

     Kitco.com

     Autoblog.com

    Bespoke Investment Group



    Disclosure: I have no long or short positions in Gold, Platinum or PGM’s or equities whose price is derived from the underlying metal.
    Tags: Platinum, Gold, PGM's
    Jan 19 5:46 PM | Link | Comment!
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