PM Bolt-On: Non Farm Payrolls & Weaklings - Freeport & Valeant wth some hindsight on IMIC (International Mining & Infrastructure Corporation)

Good Afternoon,

The UK wasn’t the only place with fireworks this with week. What with the Non-Farm Payrolls (NFP 271,000) increasing the probability of a rate rise – now the odds are looking at 85/15 in favour.

The NFP fanfare has forced investors to consider the risks of heavily leveraged companies and those made vulnerable by the liquidity contraction across emerging markets and/or commodities space.

In the longer-term there may be some reward by investing in restructuring plays like Freeport-McMoRan, but not for the faint hearted. The recovery in leveraged companies isn’t clear cut either, so expect some reality/stresses in the short-term.

Commodities producers reacted this week (selling) –

1. China’s focus on innovation and a limited response to an infrastructure stimulus. (Hopes of higher PE - long the SHCOMP on hopes and/or China 300 only on momentum).
2. Standard Chartered’s (STAN) prudence sticking the knife into the commodity sector and a realisation of avoiding a light in a tunnel or two (Qingdao). We hope for STAN’s sake it’s not a train coming towards them - Currently no reason to hold the stock.
3. Fears being realised of a credit bubble/liquidity contracting in emerging markets.
4. German Manufacturing Data (negative for copper) – answers on a post card.

& Friday’s…

5.  Boom busting NFP figure that was a wildcard and above expectations.  

Companies will need to bolster their balances sheets if they operate in a deflationary market, especially those with significant debt and limited operational free cash flow. Remind you of anyone? Not just Anglo, but the market will now belatedly start focusing on rightful candidates. We had the analogy in the morning call that “certain traders are like a bunch of hyenas!!” As if!

The open secret of “debt to revenue service costs” is finally acknowledged as a risk. Not that the writing hasn’t been on the wall for some time. Admittedly, It’s difficult to find a reason to hold US equities with the dollar strengthening. Those goliaths are going to take a haircut to earnings.

With fears of larger scale corporate default and financial bubbles, the market is now factoring in restructurings whether it be fundraising, equity issues, convertible notes or debt for equity a k a dilution for the weak.

Shareholders should be prudent to the possibilities of losing control via the back door or worse, there being limited equity left for shareholders. Freeport-McMoRan (FCX) are not immune to these woes either, but with Icahn on board at least there’s some form of hope signal for the shareholders.

Valeant - without repeating the woes of Valeant (VRX) verbatim (See Citron Research) – it is the pharmaceutical equivalent of VW as it has so many unquantifiable liabilities. With three + warnings out now, it’s likely a case of the die-hards hugging the stock. "Value seekers" will no doubt be sifting the wreckage and be tempted to trade. 

From a psychological model, with such a nuclear fallout and one suspects more to come, is there any reason to hold Valeant? What is the value? What are the risks? With the market perversely needing to be told of the value or limit the slow motion car wreck, what is the likely outcome? With such a wide range of variables, what pricing methodology does one use for Valeant? The price range here up until Thursday was $56-$103 and now, we suspect there’s more potential liabilities, so have narrowed this to $38-$44 a share.

The damage within the pharmacy/dispensary industry cannot be ignored. Pharmacists may now follow the cost conscious route across all prescriptions, not just related to Valeant medications.

In coming to a price, we’ve considered Valeant’s responses and what we assume Pershing Square may be ignoring. Of course Pershing may be selling/have sold, but in the absence of a notification, we’ll assume they’re holding.

For consideration:

1.       Was Philidor using pharmacy codes for pharmacies it had not (yet) acquired e.g. R&O?  

a.     Did they have permission to use them?

b.   What are the implications for Valeant if they are considered to a shadow director/owner of Philidor? Do the rights that Valeant acquired in Philidor mean they have also liabilities?

2.      Its been suggested that dermatology products sold through Philidor were of average profitability -  if we assume that at least some revenues comprised of generics costing $5 or less, but when combined by Valeant and branded it enabled a charge of $400 plus++. If this is correct, then it becomes very difficult to buy into the average profitability claims suggested as the ‘worst case downside.’

3.   It’s been inferred that Philidor filled/dispensed prescriptions even when they were not required / requested. If Valeant’s revenues were reliant on the revenues of 3 units when only one was needed - what are the real implications on Philidor closing/departing company? Repeat prescription business will in essence be torched?  

4.       There’s been vague disclosures as to what other 'specialty pharmacy' networks Valeant has. Will this have further implications?

In making a few assumptions from the above, it’s easy to come to conclusion that the impact on Valeant profits is likely to be double digit. As a reminder, Valeant in October 2015 disclosed they had $1,420M cash and debt of $30,883.3M. What will earnings be and the outlook? If one conducted a simple calculation, deducting net debt from the market capitalisation, what equity would left for shareholders?

In the small caps it would appear there's a sense of déjà vu. Those that remember the views expressed here EMC: International Mining & Infrastructure Corporation (IMIC). To quote yours truly:

International Mining & Infrastructure Corporation plc (IMIC) loan conversion shows the faith in the company, a mere 30% discount to the SP. One hopes you've sense my irony with the mere...the 1 year chart must surely look like the cellar steps! Next stop 10 pence? 

It would be wise to think how the terms are fair and reasonable as Strand Hanson Limited, the Company's Nominated Adviser (NOMAD), consider that the terms of this transaction are fair and reasonable insofar as the shareholders of IMIC are concerned. Its not something I shall be complaining about having rated this as a sell since they acquired Afferro Mining Inc.

IMIC was suspended after the resignation of their NOMAD Strand Hanson in October.  As a positive those holding the Afferro Mining Inc. bonds of yesteryear get a few more shares (whether they’re tradable is another issue), with the conversion notice yesterday.  Is IMIC now extinct? Or can they pull off the unthinkable in the current mining space? Perhaps even find a NOMAD?

So whether it’s goodbye or see you in another form? Who knows…It’s wise to keep an eye on the assets of the micro craps, perhaps not the companies that trade them left and right, but follow the assets.

In other news, the South African and Australian “anti-EMC fan club appears to have gone silent!” Surely it’s not the Zumba Iron Ore share price? Atlas or perhaps Slater & Gordon?

The final thoughts go to Anglo American (AAL) having a rights issue?? The odds are getting higher! BHP Billiton (BLT) tailings damn could be a significant liability...what are the implications and costs? We have varying ranges and estimates as high as $2B excluding losts dividends and as low as $450M, 

Atb Fraser

Morning Mumble: China's Sensible Mini-Me HK and Retailers...Glencore goes long Copper! (Perversely for everyone else.)

Good Morning,

Last week, Nikkei Hong Kong PMI® was released with the dramatic title, PMI falls to lowest level since April 2009. The last time the data was this negative was in 2002 and 2009. The indicators are not great, with a lowering in new orders enabling companies to complete pipeline work. This may be a swallow in the grand theme of things, but we shall watch for a continuance before we long lithium pharmaceuticals. 

One item from Li, is the factories now avidly marketing their wares (inventories) at rocket bottom prices. From some shoddy capital equipment to very decent drilling machines for oil, all are being marketed with discounts that are notable. Could the shale suppliers being under further pressure? 

We shall revisit this over the coming weeks, now the parade is over and they can continue the witch-hunt. As a simplistic recap, production down, services demand down, innovative development and investment down. China has forced a new low, companies can recommend a buy on their own company – A Chinese investment bank rates its own stock — thinks it's definitely a buy. 

Now who do you believe? Man Group China head says she was not investigated by authorities, but was merely meditating. One had to reread this to make sure there was no confusion between meditating and medicating! Of course Li Yifei "had been attending industry meetings and taken a 5-6 day trip to meditate." So for those that don't reappear, say those that worked at CITIC or similar, should we contact the Guinness Book of Records, not only for the longest meditating period but largest event of its kind? 

We had Markit France Retail PMI® that had very similar themes to the BDO High Street Sales Tracker that was reported Thursday. Although as a snapshot in time, predominantly based on weather, it's not necessarily all bad. With some sectors and retailers likely to be more resilient and / or benefit, but there is a theme, with some buying opportunities presenting. Perhaps when considered against household debt (excluding mortgages), there is a very simple answer for the decline in sales? Save for more holidays abroad.

With retail shoppers making decisions on holidays or retails sales, choices are now having to be made. Watch for those margins, as sales competition hots up, especially if there's discounting the autumn/winter season, more so than normal. 

Associated British Foods (ABF) pre-close trading update gives out the positives, save for FX and sugar. Why is ABF not split into two? The argument for a split is getting ever stronger, save for some improvements in sugar more recently on the back of El Niño (FT)

Earlier in the year retailers evidenced improvements in pricing. These benefits are likely to be offset by competitiveness due to weather (lack of punters) and the need for seasonal stock changes. ABF via Primark have shown they’re not insulated either despite lower prices. Concerning that with their pricing perception in Primark stores, customers want even cheaper clothes!?

BDO analysis suggests inventories up, sales under-pressure and weakness in the wider and or global economy it's not looking great. (The last sentence may apply to different regions).

Like the Hong Kong PMI data, it’s noted that key reports are trending with as "bad as, not since levels seen in 2009 etc...” The read across to Kingfisher and Merlin entertainment does not looking brilliant, over to BDO. 

The strength of the pound is proving somewhat detrimental to high street retailers’ revenues. Consumers are spending more on items abroad to take advantage of the exchange rate, whilst tourists – particularly from the Eurozone – are less willing to spend. The continuing political and macroeconomic uncertainty, coupled with the threat of an interest rate rise in mid-2016, is also weighing on consumers’ minds.

Kingfisher (KGF) may be insulated thanks to a growth in French housing purchases by speculators/investors, although spend is normally lower than those buying a ‘home’. We won’t have to wait too long, with the interims due on the 15 September 2015. One can barely contain the excitement with an update on KGF’s “One” and their 'sharp' decisions in September. 

The news is filled with Glencore. As the share initially shot up today on news of a rights issue that was absent entirely of pricing or indicative terms. Please remember, as per Ivan’s statement it has not been determined whether it will be a rights issue. It does appear to be 100% underwritten (so perhaps the market thinks it’s irrelevant), for now. This is in addition to Glencore’s African Copper - Operational Update.

The market, like in the Platinum Group Metals sector, needs a casualty and Glencore have come up with the answer. Putting two large projects under "Doctors Orders" (Care and Maintenance) until improvement works have finished. 

The suspension of production at Katanga and Mopani for 18 months up until the completion of the expansionary and upgrade projects. This includes the whole ore leach at Katanga and the new shafts and concentrator at Mopani. A suspension of operations will remove approximately 400,000 tonnes of copper cathode from the market. 

Glencore blamed the decline in copper prices on aggressive short-selling in their full year interim results webcast. Today's news is starting to make one think that Glencore did not have any idea of the amount of physical in the market place nor in fact much understanding of the current cycle. More so, the surplus is significantly higher that Glencore anticipated by the very cut of near 400K/t’s. If this was not the case, they would have identified suspending production at Katanga and Mopani in their interim results webcast, rather than belatedly. The copper price has improved a smidge of 4¢ since the interims, so what changed?

Glencore have pulled 266K/t's annualised basis from the market, (for 18 months/note for diary) As a result, if copper cannot sustain a comeback to near $2.50/lb and potentially $2.85/lb on the back of Glencore's news, then there is something substantially wrong in the global economy (and/or China).

Is China really sick? Or just slowing? The copper price will give a very good indication over the coming months. Not only immediately will the market react, but due to inventories, a slower appreciation is likely over the next 9 months. (Keep an eye on car sales). A complete gift to Freeport-McMoRan et al (VED, ANTO, KAZ), where any 10¢ appreciate per lb is worth between $300-500M to FCX.

Glencore have come out to state how bad it is, but of course for Glencore it’s not bad at all, Ivan Glasenberg, Chief Executive Officer, and Steven Kalmin, Chief Financial Officer, made the following statement:

"Notwithstanding our strong liquidity, positive operational free cashflow generation, lack of debt covenants, modest near-term maturities and the recent affirmation of our credit ratings, recent stakeholder engagement in response to market speculation around the sustainability of our leverage, highlights the desire to strengthen and protect our balance sheet amid the current market uncertainty.

The measures we have announced today do not affect our core business activities and overall franchise value and have been designed to sensibly accelerate the deleveraging of our balance sheet, maximise future cash flow generation in the current weak commodity price environment and substantially improve our financial and credit metrics, stability and strength, in the event of a prolonged weaker pricing environment.

We remain very positive on the long-term outlook for our business and this is reinforced by senior management's commitment to take up 22 per cent. Of the proposed equity issuance. Copper and zinc are both supply-challenged and an essential ingredient of future global growth. In seaborne thermal coal, a capex drought and low prices have helped rebalance the market. We are confident that thermal coal's position and availability as the lowest cost fuel source for many large economies will underpin its key role in the global energy mix for many years to come.

We have today an extensive portfolio of long-life, low-cost industrial assets, benefitting from the unique capabilities of our marketing business. We reiterate our 2015 full year marketing EBIT guidance of US$2.5 billion to US$2.6 billion and remain confident of our long-term guidance range of US$2.7 billion to US$3.7 billion."

Culling dividends, full year and interim for 2016, cutting production etc...All should have been conducted at the interim results where "Captain Kirk and Scotty" could pull the levers (EMC: Glencore 24th Aug 2015). Have another look at the Webcast from the 25 August 2015, re: Dividend etc...Then consider the news today. 

The fundraising suggests there was an over-confidence in Glencore's senior management at the interims in August. Did they really have sufficient flexibility in the accounting model (in the current market), with some prudence in light of current market conditions? Common-sense?

In the absence of this capital raising, the balance sheet cannot be "stress-tested." Glencore appears very desperate to be doing the fundraising without giving an indication of anything, price, timetable or whether the larger shareholders have approved of such an action. 

If Qatar Holdings, or Harris Associates had agreed to the fundraising, would there have been a need to underwrite? All this of course is allegedly in the interests of the longer-term shareholders, no strong-arming to avoid being diluted!?

What is noteworthy is the significant amount of "debt reduction" in the near-term. Why was this suddenly needed, market confidence? Or common-sense business practice that should have been identified at the interims? Estimated to be near $6B in a very short time frame. So who is next...? Anglo after the dip in diamonds?

Atb Fraser