Monday, 27 July 2015

Morning Mumble: Oil and Metal woes, Diageo (DGE), China (PMI) & KMR pricing assumptions + Dialight (DIA/Dire)

Good Morning,

With the realities now being acknowledged within the commodity sector (and the analysts) the cycle is starting to enact change, with yesterday's piece in the FT Oil groups have shelved $200bn in new projects as low prices bite and Gulf news Projects worth $200b cancelled due to low oil prices. One suspects the latter was a twist on reporting from FT and CNBC. The theme being in both oil and metals, there is a headwind of efficiencies and stress on suppliers, whether labour or capital equipment. (Impact for support services?).

Having had the opportunity to meet up with a few on Friday, as the chap morphed into a three, its quite clear the consensus is now aware of what can be only described as an anomaly in China's data disclosure. If the GDP disclosure matched that of SEO's public records on profits, then one would perhaps be forgiving. 

In discussions with Li, SEO's are being somewhat generous with the facts of their profits. What has been disclosed is an outright reduction in revenues and profits, contrary to the GDP suggestions.

One could even argue that, if the accounts were fully public, we'd all have to turn into a forensic accountants. The recognition of revenues and profits including those on "goods in transit" to suppliers is near a farce. Something that perhaps capital equipment manufacturers in America have taken lessons on, or with humour, perhaps they've learnt from Diageo (DGE). We'll come back to that another time (Bloomberg: Diageo queried by SEC).

This is the latest for Diageo, earlier in the year as they resorted to a negative cashflow model for all their suppliers, by paying them after 90 days. Something supermarket suppliers have been accustomed to. DGE is under pressure to turnaround a company that has contracting market share in North America. It’s hoped higher prices will offset this, but perhaps they would be wiser to react to market trends than they have been. Being slow to react to flavoured this and that, whilst also offering conventional drinks. The concern being, have Diageo stuffed their supply chain? A temporary beat followed by misses, albeit small, time will tell. 

The market is now nervous of this rout in commodities, with the larger trading houses withdrawing from positions across the board. This is being in part replicate in agri-commodities (Agricultural Commodities). Simply, because we like simple here, the demand for commodities has contracted, more so, rather than keep a healthy balance of stocks, Chinese companies (whether state or private) have learnt from their iron ore trading comrades. Commodities are not in short supply, as the grab for Nickel pre Indonesia's unprocessed ore ban has made them realised.

The question that is now being considered, "if China isn't suffering to the level the west has been informed?" Why is there a categorical absence of speculation on Commodities (deleveraging and margin contraction)? What could be described as a temporary quad-divergence in pricing, demand, production, supply and stockpiles. There appears to be a full on headwind of over-supply, reducing demand, reducing prices and deleveraging, whilst an absence of speculation. On the flip the side, the dollar is talked up, torching those higher cost producers. 

The Caixin Flash China General Manufacturing PMI™ should perhaps be considered the most accurate PMI data for some time. Not only on the basis of a greater understanding of the Chinese economy, but more so the employment concerns that are rising in China. Perhaps the wider press would hire the odd drone hobbyist to fly over a few areas where capital equipment is stored awaiting sale. 

What does the deflationary impact and subsequent deleveraging means on a global scale? Last time the contraction occurred, there was a significant downturn and prices tanked. Whether commodities will go as low is another question, but more importantly, the bulls are not expecting a stockpiling (yet). Whether on leverage (margin), financed deals or more importantly on the bottom line there's something missing. We shall of course be somewhat fixated with the retrospective downgrades in sector and those associated. 

Last week, we have gossip of African consolidation in the Oil and Gas sector, which may actually be more credible and having potential. We had Aggreko (AGK) whom have now shown they are not immune to the cycle of power generation. There's one brave chap that believes 645 pence or thereabouts is what AGK is valued at...whom I am I to disagree. Date for diary, Interim Results for the six months ended 30 June 2015 and its Business Priorities on Thursday 6 August 2015 at 7am (BST).

AGK, may have some resilience and it's perhaps premature to suggest 645 pence is a decent target. After taking on debt to return monies to shareholders, this is just one company that is going to suffer with a focus on its own equity and margins. With AGK's exposure to shale, EMEA and Asia, Pacific and Australia (APAC), whilst considering Japan, revenues are now under pressure. APAC revenues are reliant on a mining model...whilst also being exposed to New Zealand, and Indonesia.

Aggreko is now suffering from previous FDI, in all their operation areas, where energy generation shortfalls have been addressed. AGK's cycle means they're more than likely to survive, whereas APR will, but with a different valuation and reduced ability to generate to revenue (profit). This will be read across the market about cashflow and leverage (debt).

On a similar theme, one had thought Kenmare Resources (KMR) had rented some diesel-powered electricity generators from AGK. Perhaps they can remain fully operational during the Southern Hemisphere summer months of December, January and February when supply is most unstable but not any other times? Were these generators not meant to be on stand-by? Insufficient? 

Iluka Resources, whom have cleverly engineered a waiting game. If Carlsberg did takeovers, Iluka Resources would be the model. They've sat back and let Kenmare Resources (KMR) destroy their value and any argument for a price increase. KMR should simply roll-over. Today's Q2 & H1 2015 Production Report is dire, over to KMR,

Overview

  • H1 2015 production was constrained by 57 days of storm related grid power outages in Q1 and sporadic power outages in Q2, as a result of remedial work to the power line.
  • Power stability is expected to improve significantly following the installation of new power infrastructure in Q3.
  • Ilmenite production in H1 decreased 27% to 324,100 tonnes (H1 2014: 445,600 tonnes).
  • Zircon production in H1 increased 11% to 23,800 tonnes (H1 2014: 21,400 tonnes).
  • Total shipments of finished products in H1 increased 3% to 412,000 tonnes (H1 2014: 399,000 tonnes).
  • Cost control measures succeeding and achieving significant cost savings.
  • Project Loan Amendment dated 29 April, 2015 now effective.

Statement from Michael Carvill, Managing Director: 

"Production in H1 2015 was severely impacted by weather related power outages in Q1. Production in Q2 improved, though remained hampered by remedial work to the power line and unofficial industrial action in June - reducing operating hours for the plant. The outlook for production in H2 looks stronger as the national power utility commissions equipment that will increase grid power capacity and stability."

Date for diary, 28 August 2015.

The positive for Iluka/KMR is ilmenite is likely to have some positive support over the coming year. With Chinese domestic production reduced significantly. Remembering that ilmenite is a by-product of Chinese iron-ore mining, with their costs and any by-product credits making production unwarranted. With costs under control, the electrical issues need to be fully considered. If Iluka are to do anything, it will be sooner rather than later. 

With the appointment of John Ensall as the Lender Approved Non-Executive Director. We could "perhaps suggest" a few areas where some savings could be made. With the board costing near $2.2M year, is a little headroom, save $1.5m attributable to three directors. 

Lonmin (LMI) continues to fall, flying through the FTSE 350 quicker than it did 250. LMI needs cash at all levels and with its work force and furnaces now considered a liability, one would be wise not to catch the knife. It'll no doubt bounce or be bought out, does anyone need to rush or pay much of a premium? We'd be surprised. 

With Nickel dropping below its key $5/lb support level, should we start to consider the likes of Horizonte Minerals (HZM). with their price assumptions on the PFS. Remembering its sensible to sell projects on past economics with "headroom" and cream for an increasing price  Just how much cash does the company have left? EMC: HZM Sarcasm, how times change both in Nickel and viewpoint. From previously being a bull in the Nickel space, when the Chinese withdrew from being a buyer in the Market (October 2014). 

At the weekend I was asked about my view for Dialight (DIA), today's  half yearly report validates the . EMC view (January 2014) and EMC June 2015 . Although as we're now being respectful, we'll ignore the abuse at the time. Its certainly getting there, and the view has not changed. We call this progressive long-term investing, just short. Perhaps one could be described as a stale short in DIA?

Atb Fraser

Hopefully it makes sense...

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