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: Dialight (DIA) almost cheery, Freeport-McMoran & Rio's Copper Confusion. The summer snow edition to finish on (with humour): RRL, AFPO's deal of the century & RRR? Phorm on Phorm

Good Morning,

In an admittance of just how bad things are, Dialight (DIA/DIRE) initiate a cost reductions. Having only sped through the RNS on the basis of having had the money and am unable to manage a position whilst on holiday, it’s surprising they haven't mentioned anything about their inventory. 

As a quick reminder, turnover up, cash down, profit down and in the absence of an effective cost management process, net debt is now around £10M. The market capitalisation is a smidge under £180M (550 pence/32.5M shares in issue). From previously having a modest dividend, this one has been torched. 

So today, they reduce the workforce near 12% (130 personnel) and incur a few costs as a result. Question being, what's taken so long to get to the consultation process? Are management so reactive to the company's position? We'll exclude save for Mr Sutsko from that having been in the position a short period of time. 

Why pay interest on debt when carrying inventory at levels near £36.5M, which raises the question of a goods/inventories impairment. We shall perhaps revisit Dialight post hols for a deeper look at these (date for diary October)...as there could just be some potential! 

Over to Dialight (bold is the addition,

Michael Sutsko, Group Chief Executive, said:

"I believe that we have a huge opportunity ahead and Dialight is well positioned to capture significant value in our rapidly growing markets. However, as sales continue to grow, the business has taken on excess costs which have resulted in our poor first half performance.

We firmly believe that our team can deliver continued growth with future resources being added in line with our strategy. This action is a key part of our plans to transform our business in the short term whilst realigning to deliver profitable growth going forward. As previously indicated, we will report back with the findings of our strategic review in October."

It’s confusing, the company didn't know its cost of sales went up disproportionately to revenue prior to Mr Sutsko's appointment? Finger on the pulse folks! This company may be in turnaround mode, but one has a suspicion there may be a requirement for some cash. The company reminded us they have significant headroom on banking covenants, maintaining financial flexibility, this maybe so, but there's also prudence. Leverage whilst struggling to maintain profits isn't always best, especially when carrying so much inventory as it's a road to ruin. 

We acknowledge the appointment of Michael Sutsko, who has only been in the hot seat 8 weeks, it’s certainly more than the board has done previously. Who'd have thought turning modestly positive, perhaps misguidedly on the hopes of a turnaround but time will tell. Mr Sutsko appears to have initiated more in 8 weeks than anything previously. This smacks of complacency on the part of the previous/current incumbents. 

One is finding it hard to balance the views within the copper industry, we have had FCX wanting to reduce higher cost production (Cost Reduction Plans for FCX), with further budget reductions in oil and gas already identified, albeit limited. Expect more in due course regarding their copper operations.

The problem is there appears to be a confusion/contradiction between what FCX are stating production cuts, to that of what Rio Tinto have inferred in terms of copper consensus and output (PDF Presentation and MP3 File of Presentation (both downloads and a must listen). Worth a note is the time of development including permitting to production around 40 mins circa in.

More is needed on this to go through the presentation including Rio's thoughts on Bauxite in Malaysia and Indonesia. Including the anomalies in Rio's costs, very similar to BHP Billiton's (BLT). Cost per tonne are circa $35-40/t, rely on the lower quoted in the results/presentation at your peril.

With enough depression in the commodities sector, Australia now get to debate the importance (or not) of Rio's assertions to expand Silvergrass. This has previously been delayed, so whether Rio are just teasing Twiggy (Andrew Forrest) or planning to ramp up a further 10mtpa. 

Interestingly, Rio mention in passing that Silvergrass is to maintain the quality of blended iron ore. Is the quality at Yandicoogina declining quicker than envisaged? Having expanded its current brownfield sites, Silvergrass's development might be needed sooner rather than later. 

As promised the summer ski edition, yesterday Range Resources (RRL) came up in conversation. Do people really "invest" in this company now? Today, they give a Trinidad update, having not had chance to follow this crap for some time, it was handy to be reminded of this EMC: Range Resources (December 2013). The chart makes for skiing and is a cautionary tale to all. Although they do assert they’re cashflow positive, at what level? At what stage does the market wake up and consider cashflow?

RRL may, it may not, who really cares? Save for some random event, its unlikely to get any more air time. Although as a positive, apparently the writing style and commentary here has allegedly improved...be your own judge!

Staying with the skiing theme, trending was African potash's COMESA deal (AFPO) with some humour that this will be the Glencore 2.0, it has certainly grabbed attention. Even Chemicals Technology picked up the story, so on to hopes of being an AIM Goliath. The perfect opportunity for those in the last placing to exit swiftly. Whether this deal amounts to significant cashflow is another matter, await terms etc...High risk punts aren't always bad, and there may just be life in the old dog yet. With a proverbial piste of a share chart since IPO. 

Maybe COMESA's customers lost the number of their current suppliers or had not considered conducting a cooperative tender process? COMESA has sought deals since 2012 at various levels. They've certainly improved agriculture, including the launch of the Regional Payment and Settlement System (REPSS). The cooperative approach and expansion of COMESA could just be the big-brother AFPO need. Sometimes it’s fun to be on a rollercoaster?

Whilst typing, one cannot help but notice Red Rock Resources (RRR), motoring away. With the final thought in this special summer snow edition is, the Phorm fundraiser. Phorm have Phorm fundraiser. You have to give companies like this some phorm of credit for just keeping going. If there's ever an AIM TV, we may see adverts for "you can give just £500 a month" to feed this board or that board. 

Limited time to discuss the UK Mail (UKM) trading statement whose indications back in May that it was going to be bad and have become rather self-fulfilling (and worse). It’s wise to read UK Mail and acknowledge the issues. Profits expected to be 40% less compared to last year...despite "opportunities." Have UKM been conservative with the guidance? 

Happy Hols, Fraser

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...

Morning Mumble: Sainsburys Food Deflation and the Piggy in the Middle, Vedanta and Dire(light) (DIA) the belated strategic review (cash needed) + Stands Energy Addition

Good Morning,

Sainsbury’s (SBRY),  Q1 was pretty much as expected and now should be referred to as the 'also ran' in the supermarket sector. Suffering 6 straight quarters of LFL sales declines. Is there actually a price war, or a disruptive element in the discounters that's forcing more competition in the market place? What should perhaps be called a deflationary war on market-share?

Tougher competition isn't aiding Sainsbury's at all, with Waitrose improving (gaining customers from SBRY). The biggest risk is SBRY has been caught in the middle between the perceived decent and the discounters (or wannabe discounters), the piggy in the middle!

On today's results it’s very hard to substantiate a holding in SBRY, where there are simply better performing stocks, and an 'unknown' potential liability in property valuations. If one was to consider the supermarkets to a horse race, SBRY are very slow off the mark (read as react), and although there's woes for the sector they're unlikely to benefit without a strategic change. Morrison's may just be placed correctly for a pricing perception benefit. 

In conducting some research, Asda's (Walmart's) "guaranteed to be 10% cheaper" gimmick is losing interest with the customers. The shoppers prefer everyday low prices (EDLP) more than gimmicks, and shoppers whom were enticed to Asda, Lidl and Aldi are returning "home" to Morrisons (MRW). 

Expect Morrisons, with home delivery roll out starting to reduce their drop in sales and slow the growth of the discounters. More so, looking at Tesco's whose emphasis is back on the customer and EDLP, Asda is likely to suffer as a result of MRW/TSCO's actions. SBRY's is in no man's land and likely to be a casualty without a distinct shift in focus, one that price is not everything but perception of value is. 

Food cycles, mean the deflation at the checkout is likely to slow, and in parts reverse. As an indicator, one often follows Pork for various reasons (and also having to price it most days). Unusually, pork normally appreciates around Chinese New Year (it did not) and more importantly, in June prices start to appreciate, the historic seasonal trend. 

The pork prices, including the pork riblets, semy meaty that all good supermarkets should stock, have remained relatively "flat" since February/March. There has been little appreciation (3-5%) in prices that often occurs around June and July. 

Demand simply is not peaking as expected, and if one considers a longer-term price from 2013/4, with an increase in supply both in the UK and Europe, the prices have been capped out. The supermarket prayers of food inflation won't be for another 6 months at least. It will come, but simply not yet.

Yesterday, VED responded to press speculation about their corporate structure. How VED do this and what the tax implications are is another story. India's retrospective tax obligations are very public (Vodafone and Cairn Energy (CNE). 

The minority protection afforded to holders of 26% or more is circumventable by buying out the businesses, but may create an unwelcome tax liability. Whether the tax liability is better than the potential dividend distribution tax that would be imposed by cashing out Cairn India, is a question for the accountants. 

There's been some debate in the mailbox about the woes of Vedanta (VED). Continuing on from EMC: VED Robbing Peter to pay Paul, VED are stuck between a rock and a hard place, with debt being their biggest hurdle. 

Merging the entities to simplify the structure is challenging but not impossible, however there will be liabilities. The Indian's have realised the risks in holding their stock and being left  out in the cold, the stock slid near as much in Mumbai as it rose on the LSE, yesterday.  However, today, Cairn India took off today, near 12% up, one assumes the Indian market knows more than LSE. Trading up as high as 12%, currently just off 9%. 

VED's recent appreciation in price is unjustified, with a gross debt of $16.7 billion and net debt increasing to $8.5 billion. Mainly as a result of VED increasing their stakes in Vedanta Limited and Cairn India Limited to the tune of $0.8B. A tightly held stock, so expect the irrational price appreciation to continue, at least for the time being. With the change in name of Sesa Sterlite to Vedanta Limited in April, it's only a matter of time before VED as a group become a single entity with operating divisions/companies, rather than "majority interests" in a complex structure. 

No doubt the economic times will update the market before the Indian Market or LSE have an RNS, Vedanta Update & Search Cairn India, which appears faster than the Borg! 

As Leggie rightly points out, one of my favourites, Dialight (DIA). They have come out with a trading update. This "company" was of focus some time back, EMC: DIA January 2014 but the opinion has not changed. Recently Michael Sutsko from Laird Plc was appointed Group Chief Executive. It begs the question why the dividend was paid on the 2nd June! Michael has his work cut out, over to DIA...

In its AGM Trading Update of 15 April 2015, Dialight said that Group revenue growth for the first quarter had exceeded expectations but that we had a number of operational inefficiencies.

However, since April the Group has also experienced a slowdown in the rate of orders in the Lighting segment in both the US and Europe which is likely to result in a shortfall in full year revenue. In consequence, the Board expects that underlying operating profit for 2015 will be significantly below expectations and that the results for the first half will be less than the prior year.

The Board believes that this reduction in orders is linked in part to a slowdown in the oil and gas sector.

In the light of this adverse financial performance, and in conjunction with the previously-announced exercise to develop the Group's production infrastructure and processes, Michael Sutsko, the new Group Chief Executive, is leading a strategic review of the business. This review will focus will on the markets in which the Group currently operates, together with an attendant review of its operations, supply chain, and product development. 

The Board remains convinced of the longer term prospects for the Group and it expects to update the market with the findings of this review in the autumn.

As a consequence the target price of 315 pence is under review. 

Atb Fraser

Thanks Leggie for this: Stans Energy Files Additional Arbitration Claim Against Kyrgyz Republic. Diary date 29th June 2015 to see whether the Stans case is likely to go the distance if the Kyrgyz Republic do not see common-sense.