Morning Mumble: Direlight (DIA), Chemring (CHG), Kenmare Resource (KMR) and Majestic Wine (MJW) their economic moat!

Good Morning,

Dialight have given strategic review & trading update. Over to Dialight (see additions by EMC in bold):

Trading Update

Trading in the three month period to 30 September 2015 was characterised by continued weakness in the oil and gas sector and reduced levels of industrial capital expenditure, particularly in North America. As a result, reported lighting revenue growth for this period was 5%. The cost reduction actions announced on 7 August are on track to deliver their targeted reduction in operating costs and we are encouraged by the strength of our order book. However, with market conditions having become more challenging during the third quarter, and Dialight's financial performance weighted as usual to the seasonally-strong fourth quarter, the Group faces an increased level of uncertainty in the remainder of the current financial year.

But...By the end of 2018, Dialight is targeting to achieve:

• Over 25% annual revenue growth
• Over 40% gross margin
• Over 15% EBIT margin
• Over 80% cash conversion

The market is wising up to the realities. See: EMC: Direlight (DIA) June 2015.

Chemring (CHG) trading update that isn't good news with a "potential" delay in the 40mm contract. The concern being, this is yet another company flag waving a rights issue so far in advance it raises significant questions about any understanding of the market. 

Admittedly, with a bit of good fortune, Chemring could turn the situation around by gain the necessary permits and export approvals associated with this contract, although one senses the board find this highly unlikely. Over to Chemring, additions in bold. 

Key points

• Despite significant progress having been made, there is potential for delay to revenues from the 40mm ammunition contract announced on 14 September 2015

• As a result of this and other issues, there is now a realistic prospect that year ending 31 October 2015 ("FY15") underlying operating profit1 could be reduced by approximately £16 million to approximately £33 million

• Order book at 30 September 2015 of £606.3 million; £344.6 million for delivery in FY16, representing more than 75% of expected FY16 revenue of £450 million

• Discussions will be held with debt providers to negotiate amendments to the operation of covenants and the waiver of any event of default that may result from the 40mm contract delay

• Proposed rights issue (the "Rights Issue") of up to £90 million in Q1 2016; fully underwritten on a standby basis by Investec and J.P. Morgan Cazenove

• Resultant medium term target capital structure of 1.0x - 1.5x net debt to EBITDA

The company's debt levels have been a concern and impeded them for some time, so Chemring elect to kitchen sink their issues today with:

"The recent progress of the Group has been impeded by its high levels of debt and associated interest costs. Significant time has been spent managing this debt, at the expense of further operational improvement and fully capturing the longer term growth opportunities open to the Group. We have therefore announced today that the Group proposes to launch a fully underwritten rights issue to raise up to £90 million, the proceeds of which will be used to fundamentally address the high levels of debt and to provide a competitive capital structure."

It begs the questions of why the rights issue isn't now...shareholder value? The cash advance whether recognised in this year or next is immaterial to the overall issues the company are facing. Target price now likely to be near 87 pence. If it quacks like a...This company has a momentual task just to maintain existing shareholder value, 

Kenmare Resources (KMR) forgot to mention some key ingredients within their  Q3 trading update. Namely the pricing environment over and above anything Kenmare can do will remain challenging. Iluka Resources is fully aware of the KMR financial position when such terms as "Super Senior Facility" are utilised it rather suggests who has the stronger hand.

A question: exactly how much time have the "board / management" spent out at Moma? More so, what is the purpose of the board if an external consultant has to be appointed to support and extend this ongoing cost control and efficiency programme? We'll ignore the stock levels and the like for now, as all the cards are in China's and Iluka's hands at the moment. 

In the current environment, Iluka Resources have no need to save Kenmare and there is a real risk of downward pressure on any offer price. For a perhaps more open outlook, please read Iluka's Q3 (see the market conditions section). 

The market is waking up to the realities of Iron Ore, scrap prices are falling quicker, steel prices down. More so, there's now evidence Steel Mills are bringing forward larger maintenance works and/or shutting capacity due to the limited demand. We acknowledge the likelihood of a larger sized steel mill default. 

With two significant events currently under way the 18th CPC and the Fed, there are likely to be considerable trading events. We have Aluminium production in China yet again on the increase, the average operating rates of Chinese copper processors is steady but nothing to shout home about, Zinc inventories in Shanghai, Tianjin and Guangdong are on the up and finally, scrap prices in China fell through the floor evidencing the realities/contradictions of the alleged balance in supply and demand.

Finally, it would be unfair not to consider Majestic Wine (MJW) whom pulled the proverbial plug out of their economic moat of six bottles or more. Apparently, MJW trialled no minimum bottle requirements at 23 stores for 5 months. Its allegedly had no impact of volumes, really?? 

The question is, did the removal of the 6 bottles or more criteria improve sales? Or just increase the cost per sale? Is this a flag waving event where they firmly placed themselves within the supermarket sector where such benefits of 6 or more bottles may have insulated them to a degree. Surely if one is an off-license location is key!

If someone could be so kind as to point out where Majestic announced to the market that they were trialling the no minimum bottle purchase, it would be appreciated. As in yesterday's announcement of a new pricing strategy stated, "follows the previously announced successful trial in selected Majestic stores since Spring 2015 proving popular with both new and existing customers." Perhaps one is just being tardy, a quick email to Majestic's IR might assist. 

With the results out on the 16th, and one has a suspicion there's been a leak to the supermarkets! Quite why Majestic Wine's didn't merely launch their own online offering of wines via post/text is a very pertinent question

Atb Fraser

Apologies for grammar a quick one!

Morning Mumble: What have Glencore conveniently forgotten to mention? Apocalypse Now?

Good Morning,

Yesterday, we had Ivan Glasenberg telling everyone how it is in the copper market. That the market has been manipulated by hedge funds (remind me what Glencore does again?) and that supply and demand is good in copper. In fact, one is inclined to think Ivan is suggesting that the market has it all wrong and Ivan is right. 

Ivan Glasenberg (NH FT Article) called upon the copper producers to shut unprofitable mines and blamed traders for pushing down commodity prices - not the fact that GLEN purchased assets requiring millions to be spent on them just to improve cost efficiencies. In the meantime, GLEN needs a little assistance from the industry just to keep themselves a float and avoid another equity raise or distressed sale of assets. 

Not content with begging/suggesting (pending on your view) for the closure of expensive excess capacity and tiptoeing on the verge of a full-blown OCPEC (Organization of Copper Producing & Exporting Countries), Glasenberg talks up copper’s prospects temporary closure of mines in Congo, Zambia should have impact on market. 

Although there was just a slight omission, something perhaps Glasenberg forgot to mention - raised by yours truly near a year or so ago on FTML. China has been switching copper for aluminium (AL), with developments improving the lifespan and reducing corrosion/deterioration of the AL offering. With 8MT's of surplus AL there's a good case for the benefits over CU. Over to the lobbists for CU hoping the Government ignores the appeal of the Ali-Switch. It’s worth remembering China want more consumption...  

The FT's Lucy Hornby in Beijing with, Copper and aluminium battle it out for Chinese grid tenders - Rout in commodities prices sparks tough lobbying for plum contract. Glasenburg's closures simply won't be enough, those laden with debt, as producers will return to the markets for equity to reduce debt and reduce costs, or go into mass mothballing/care and maintenance, there's a binary solution to the supply/demand issues. 

Obviously its wise for Ivan to do the PR whilst China is closed to build up a decent headwind. Glencore’s share price rise, save for mass PR, is unwarranted. Its likely GLEN will be forced to sell part of their agri-division to a debtholder for $2B. Modelling on Ivan suggests there’s a sutbborness to let go of anything Glencore have amassed / built up. Thus the PR in America and UK to prevent a further collapse in the share price.

We should not forget the statement by, Glencore in Hong Kong, the prudent part being , “the Board confirms that it is not aware of any reasons for these price and volume movements or of any information which must be announced to avoid a false market in the Company's securities or of any inside information that needs to be disclosed under Part XIVA of the Securities and Futures Ordinance (Chapter 571 of the Laws of Hong Kong).”

With China (the cat) being away, the mice (Glencore et al) can play, expect normality to resume around the 12th October. If the Chinese government selected an aluminium solution for its electricity grid ‘infrastructure rollout’, we shall be forced to utilise analogies to Apocalypse Now:

Kilgore: Smell that? You smell that?

Lance: What?

Kilgore: Napalm Leveraged copper producers son. Nothing else in the world smells like that.

[kneels]

Kilgore: I love the smell of napalm leverage in the morning. You know, one time we had a hill bombed, for 12 hours. When it was all over, I walked up. We didn't find one of 'em, not one stinkin' dink body leveraged copper company. The smell, you know that gasoline margined smell, the whole hill. Smelled like

[sniffing, pondering]

Kilgore: victory. Someday this war's gonna end...

Atb Fraser

Morning Mumble (Shhh don't tell anyone): Voilà Freeport-McMoran (FCX), Mr Debt with implications for Vedanta, FQM, and the turnaround of HSP? + "The largest "Sale of Things" in 6 years

Good Afternoon,

Whilst no one is looking I've managed to sneak a couple of things in, including the Wolf Minerals (WLFE) call that wasn't that informative if I'm honest. They did highlight the reduction in global output as higher cost producers either close, mothball or are placed on care and maintenance. It didn't help dialling in late as I forgot the time difference. 

Having had my fair share of alcohol on a sunny cliff side restaurant, it dawned on me whilst looking down, what about that rather large entity known as Freeport-McMoRan (NYSE: FCX) Mr Debt! We know and understand leverage, it's not a good idea to be "over-leveraged" in a space of falling commodities nor so where one of the main consumers is "unwilling to pay much of a premium to operating costs."

Often there's a perception that leverage is prudent, it’s got tax benefits etc...Simply, that's a positive in small doses, but to bet the ranch on loans/bonds that in percentage to equity are just plain silly. More so, a common mistake of those trading CFD's/Spreadbets that perhaps have more aspiration than the reality of their consequence. The commodities sector is a prime example of what was wrong with Northern Rock. Plains Exploration simply was a wrong purchase for FCX, not now, but at the time it was wrong, no hindsight is needed. 

The behemoth of companies that have bet on such expansion with debt. They've been covered for a long time, finally the realities are bearing down on these leveraged plays. The Yuan / RMB depreciation is unsurprising, for those following the debacle of the Chinese companies with high inventories as a result of over production and cheap borrowings,. We know too well the outcome, voilà solar panels, housing, copper, iron ore, coal, stock-market, infrastructure projects, government revenue streams declining including corporate taxation and land sales (albeit improving) etc...

With Chinese inventories expanding at factories, gate prices under pressure and limited sales, they've got to entice customers somehow. So why not devalue their entire offering and have a "sale of things." 

The devaluation is the primary example of what "has been banged on about here" for how long, to quote one avid critic. More so, one suspects its as a result of the FED's guidance and strengthening of the dollar, perhaps an FX play that could wobble the potential for America. Least we note forget, the Yuan RMB is "almost" a dollar, commodities, goods, services often represented in USD terms. 

With misguided expectations, the ramifications will have wider implications than are being felt in the aluminium sector, steel, plastic goods space etc...etc...The Chinese are now entering the market with oversupply of semi-processed and finished goods. Shipping rates anyone? 

With Freeport-McMoRan guiding on the requirements of $1B of cash required, it would be rude not to consider the fact they need more than that paltry $1B suggested. The balance sheet by EMC estimates is near $21.2B Debt and limited cash (estimates: $340M).

FCX debt is simply unsustainable in the current commodities cycle, especially as Plains Exploration was more prudently called "Pains Exploration." FCX needs around $2.5B and the market should be aware $1B is only a temporary measure, whereas something more prudent would be to raise near $2.5-4B to enable the finalisation of capital commitments on projects and give sensible space and time to a restructuring. 

FCX could even utilise FQM's excuse for a capital raising that was on the basis of "a stronger copper market following a period of weakness"? (EMC: FQM 30 July 2015). Maybe even throw in a bone or two about consensus on WTI being circa $59/bbl in 2016 to tempt those believers and copper at $3.50/lb by year end...

If one was leveraged a la Vedanta (VED) or Freeport-McMoRan (FCX) the outlook isn't great. Vedanta are trying to raid the Cairn India's cash pile. This is insufficient, allowing for all their operations (capex needs) and now zinc suffering with a 10% drop since their announcement that they were rather "upbeat on." EMC: VED (31st July 2015) and FQM's Bitter Sweet Pill (EMC: FQM). 

Will FCX have to offer a large discount or motivate the stock, the latter is more unlikely than the former. Although FCX shareholders appeared to have celebrated FCX needing $1b when it's rather like putting a band aid on a share bite. 

We had a day of comedy yesterday. There was a celebratory notice by Vedanta commencing iron ore operations at Codli in Sanguem Taluka in Goa with 3.1m/t's hitting the market. Are we missing something? Perhaps the get out of jail free card is the terminology "The Company is likely to recommence operations from August 10, 2015." Surely an announcement on the same day and being 5 hours ahead of the UK reduces the chances of operations not commencing? Perhaps that's being too picky, after all, a quick trawl here and grammar and perfection don't exactly go hand in hand.

So with a global surplus, what more did the commodities sector want than more than another 3.1mt's of iron ore with a potential 2M further to come?  Hip Hip Hooray, what next African Minerals (AMI) making a return? Although with humour, one wonders if that was the only commodity to suffer due to a few accounting issues at AMI. This dropped in the inbox yesterday, Theophilus Gbenda Blog (2012), surely not but the infrastructure deal does give food for thought. 

Results out for Hargreaves Services (HSP) that will need more time. See: Closing HSP short Positions. If there were some decent results in the coal space, these were them. 

Fraser

Morning Mumble: SHCOMP, A buffet of commodity woes (Short32) and the implications for Alumina Ltd, Rio's Coal, Hargreaves Services (HSP) and SXX the gamble.

Good Morning,

One may require a nice ice-tea or G&T in certain circumstances. 

Trading on the SHCOMP (Shanghai Stock Exchange Composite Index) was volatile, a plunge from opening of near 5% following by gains of some 10% from the low. Closing near the high for the day at 4,277.223. Margins and leverage appear to be the issue, with the drop being covered post the closing of positions. Has the Chinese Government saved the day? 

Remaining short on Amur Minerals (AMC) but also banking considerable profits, this company is over-priced for the stage it’s at, the cash it has, and the economic potential (or lack of) for the asset . Those following the wider story will note how logistics will become a nightmare and funding is of a scale, that even Sirius Minerals (SXX) with decent support and decent geopolitical headwinds, will still have to be very persuasive about.

AMC PEA (Preliminary Economic Assessment) / PFS (Pre-Feasibility Study) suggested the viability isn't for this time, especially as Nickel has limited to no support and volatile. Maybe in years to come, utilising a telescope and some hope for "guidance." The SRK guidance / consensus of future prices was based on a different climate around 8 years ago. The super-cycle may shift such a degree it becomes economic sooner than envisaged, but the odds are currently against that. 

Nickel is currently trading $5.2231-$5.2345/lb and has been as low as $5.11-14/lb overnight. Those aware of the position of Nickel will not be surprised by the moves over the past week. Concerns regarding the limited growth in the very sectors that are the highest users of Nickel. Watch the $5:08/lb.

For those, including some analysts that have a wish to improve their understanding of the sector (present company included), consider the Nickel Institute (Materials and uses), for a brief helicopter view of the commodity. Often giving a better understanding of the market than covering it with "linked to steel demand." Not the greatest month either for South 32 whose woes despite being Short32 are increasing as commodities take a further hit. 

South 32's (S32/Short32) 'portfolio' of assets produce alumina with the Chinese prices still falling and the Australian prices attempting to keep up, aluminium (sub key $0.80/lb at 0.76/lb), coal (enough said), manganese (anti-dumping investigation and sub critical $2 at $1.93/kg, nickel $5.23/lb), silver ($15.7/Oz.), lead (fairly consistent but trading at a crucial support level of 0.80/lb and zinc (consistent trend currently $0.92/lb). Life isn't too great for South32, although its one to play in any whiffs of recovery. 

The market is not ignorant to the Alumina downgrades across the sector, with producers "almost" scaling back production but never getting round to it. The poker face is in-danger of forcing the wheels off the higher leveraged players. The favoured pure play short is Alumina Ltd that mirrors the market woes. Playing the OTC (OTCMKTS: AWCMY) and ASX: AWC. In the absence of a recovery in both the ex-works price for alumina and such a swelling of inventory in the pacific, ASX: AWC will struggle with share support. 

With Mick Davis buying (possibly) Rio's coal assets (FT), the Yorkshire Post highlights the industry woes where the Hatfield Colliery is closing. This was expected, but the timing has been brought forward by a year or so. The government is unlikely to offer support despite it being tabled in the commons.

Mick's timing is likely to be very well orchestrated. Having sat on his hands and refused to pay anywhere near the expectations of the industry, could RIO's capex needs force their hands with their thermal coal operations. Alternatively, Mick could buy S32 once it's been giving a thorough kicking by the market for being "unfortunately" aligned to the downward cycle of commodities.  

Perhaps time to review Hargreaves Services (HSP), having closed again recently, with Net Assets Circa £150M and net debt around £20M. The company is now priced towards the top end of any valuation, but more than likely nearing the bottom than of this massive drop. With the sentiment in the coal sector and the decision by major investors/funds to avoid any exposure, the stocks have been punished. 

Yesterday was the last opportunity to dump the warrants in Sirius Minerals (SXX) ahead of the committee meeting today. With the stock suspended today awaiting the announcement it's D-Day. With the no person wishing to appear the guilty party, from a psychological perspective on is betting on a deferral to the Secretary of State. 

Having taken profit the outcome is immaterial, the speculators have scope for considerable gains but not without risks. 3 pence circa on refusal. 5 pence on deferral, 38 pence on approval (guesstimates). With an 85% probability of approval/deferral, it shall be interesting! 

The eyes are on Gold at the moment for a place of safety. With dwindling demand and reducing supply in the current climate, it’s that favourite sport of kick the higher cost producers. Tungsten's brief recovery has ended with a damp squid at $217/MTU.

No time to fully cover Obtala Resources' (OBT) final results, with the over-expectation becoming a disappointing reality with this stock, expect further selling after a period of hope. Returns and cashflow are key and in the absence of guidance of earnings, revenues any speculation is limited to hope. Perhaps one for those brave folk that can convince themselves the returns on assets of circa £100M are favourable. Quite how investors are meant to buy a stock with little guidance for an agricultural business also in timber? 

Atb Fraser

Morning Mumble: The Mammoth (Rio) attempts to please the market and support its own SP

Good Morning,

Rio's full year got shareholders salivating with the headline "Rio Tinto delivers underlying earnings of $9.3 billion and announces a 12 per cent increase in full year dividend and a $2.0 billion share buy-back." The Australian market action was perhaps the best response, flat. 

With a reduction in CAPEX and debt, plus $500m tender and share buyback $1.5 billion will all support the SP and get the analysts chomping at the bit. Rio have been saved by the aluminium improvements compared to last year, EBITDA up near 55% and earnings a respectively handsome 124%, with copper not performing too badly either EBITDA: 33% and underlying earnings, 11%. The recent commodity falls are predominantly outside of the majority of this periods reporting.   

A quick glance at the numbers, it’s wise to remember prices for iron ore have “nearly” halved in the reporting period and copper slipping significantly, with further dips predicted. Rio believe there's around 125 million tonnes of high cost production from China and non-traditional seaborne suppliers to exit the market in 2014, with further exits anticipated in 2015. This is assured as casualties unfold and give up the fight. China may however find a benefit in supporting native production to maintain the status quo of low prices and reduce monopoly.

With write-downs on foreign exchange debt, reducing CAPEX (likely impact on earnings post 2017) and impairments already in the bag, the underlying earnings were set to benefit. Next year may be a different story, with demand under pressure, aluminium and copper (likely to be under-pressure again soon). 

Indonesia's unprocessed export ban has benefited those operating elsewhere (namely Australia and Philippines) and has created an increased demand for alumina and bauxite (but for how long). China has suffered from a surprising lack of stock and turned to Rio et al to fill the void. Any change in Indonesian policy is likely to impact hardest on Rio. In summary, Rio is now the stimulus and dividend play of the market, putting Glencore's (GLEN's) update yesterday to shame. Over to the share buyback to support Rio's SP in the longer term, just like GLEN’s (sarcasm).

With the share buybacks continuing there's no reason for a realistic 3600 pence tp + some hope value, where perhaps the market should be revising the returns downward in light of the obvious happening within commodities. Before holders gets excited about reversal of impairments (write-backs) in Rio, at $1.049 billion (net of tax) of book value for aluminium and bauxite, its worth remembering they've already been written-down near $29-30 billion. A positive in significant cost improvements and high regional market and product premiums, aka Indonesia's loss is Rio's gain but nothing to shout about. 

BCN (Bacanora Minerals) takes the gloves off and announce EGM requisition with the proposal for David Lenigas to join the board. BCN outline the case simply with the search for a technically orientated CEO, which should be sufficient. REM (Rare Earth Minerals) already have representation on the board in the form of Kiran Morzaria, its wise to read the disclosures (and the respective companies’ performance) to consider the pros of any further REM volunteers and employees being strategically placed.

If REM wish to play hard ball with BCN both entities will only be doomed. BCN may wish to throw a spanner in the works and raise some cash and dilute REM. BCN would be wise to contact those valuing decent projects above any association with REM. Lithium is the way forward, but sometimes the assets have more attractions than the associated parties, see: LGO commentary and Victoria Oil & Gas. 

With Brent, WTI, Gold and Copper all taking a breather whilst everyone has a hug in the Ukraine, perhaps next week will bring more volatility. Its nice to see a stale bull in CPR APR Energy reducing his lithium intake as the stock has a change of direction in his fortunes with the Australian Pilbara announcement. Is the company is on the turn? With mutterings of some positive tendering and perhaps even a quick decision coming out of Libya. Over to Aggreko (AGK). 

SuperGroup (SGP) announce that Susanne Given, Chief Operating Officer, has stepped down from the Board as a director with immediate effect and will leave the business in order to explore other opportunities. We'll leave that one for another day...

Atb Fraser