Monday, 29 December 2014

Will 2015 be the Turning Point for Metals?


Summary
  • Commodities have been in a bear market for more than 3 years
  • Some possible catalysts for a turning point in metals in 2015
  • Some possible plays identified  - VALE, BHP, TCK, TGD


3+ Years Bear Market


  • Commodities have been in a bear market since the start of 2011 (See Diagram 1)
  • Amongst the worst performing metals are Gold, Silver, Copper and Iron Ore
  • Gold  (See Diagram 2)
    • Low of 1142 $/oz in November 2014
    • High of 1895 $/oz in September 2011
    • Peak to Trough of 39.7%
    • Current (26Dec14) – 1195.8 $/oz
  • Silver (See Diagram 3)
    • Low of 15.28 $/oz in November 2014
    • High of 48.70 $/oz  in April 2011
    • Peak to Trough of 68.6%
    • Current (26Dec14) – 15.77 $/oz
  • Copper (See Diagram 4)
    • Low of 2.81 $/lb in December 2014
    • High of approx. 4.6 $/lb  in Feb 2011
    • Peak to Trough of 38.8%
    • Current (26Dec14) – 2.81 $/lb
  • Iron Ore (See Diagram 5)
    • Low of approx. 66.8 $/dmt in December 2014
    • High of 187.18 $/dmt in February 2011
    • Peak to Trough of 64.3%
    • Current (26Dec14) – approx. 66.8 $/dmt
  • Apart from Iron Ore, the other metals mentioned above are attempting to find a base
  • Contrarian bullish view on the above metals in 2015 – possible catalysts for a turning point discussed below



[Diagram 1 – CRB Price Chart]


[Diagram 2 – Gold Price Chart]
Source: Kitco



[Diagram 3 – Silver Price Chart]
Source: Kitco


[Diagram 4 – Copper Price Chart]
Source: Kitco


[Diagram 5 – Iron Ore Price Chart]
Source: IndexMundi

Possible Bullish Catalysts

1) US Dollar Correction
  • UUP is up approximately 13% since May 2014 and 11% in 2014
  • Dollar strength has accounted for significant part of decline in metal prices, with the exception of Iron Ore
    • Since 30 Apr 2014, Gold is down approximately 7.2%, Silver 18.2%, Copper 9.1% and Iron Ore 41.7%
  • In fact, Gold and Copper have held up relatively well despite dollar strength
  • US dollar is due for a correction
    • US unlikely to maintain recent Q214 and Q314 growth rates which are above trend 
2) Oil price plunge to spur global growth and keep rates lower for longer

  • Lower oil prices to have net positive impact on the global economy (Gavyn Davies), and in particular China which is a net oil importer
  • Lower inflation expectations means policymakers to expand monetary stimulus or delay tightening monetary conditions (Europe and US, China, Japan
3) Supply destruction to push demand and supply to equilibrium

  • Mining capex has fallen significantly (See Diagram 6)
  • Mine closures and suspensions have been taking place; high cost miners burning cash
    • Iron Ore – though the big 3 (VALE, BHP and RIO) are still expanding production
    • Gold
  • New investments curtailed at current prices, providing the foundation for higher prices in the next 5 years
  • Admittedly, supply demand equilibrium might not be a 2015 event
[Diagram 6 – Mining Capex]

Source: Ernst & Young Mining equipment overview – June 2014

Possible Plays

  • Iron Ore – VALE/BHP
    • VALE is more exposed to iron ore while BHP is more diversified
  • Copper – TCK
    • TCK also has significant zinc and coal exposure
  • Gold – TGD
    • Small cap gold producer with little debt
  • Haven’t found a suitable play for silver yet.
  • I intend to do individual focus pieces at a later date. 

[Diagram 7 – Valuations]

Source: Reuters/Yahoo


Risks
  • Continued US dollar strength as divergence trade continues
  • China has a hard landing
  • Supply destruction takes longer as miners continue expanding production to generate cash
Disclosure: I am long VALE and TGD. This article should not be construed as investment advice. Investors are encouraged to do their own due diligence and research.

Saturday, 27 December 2014

Weekly Summary - Week Ended 26 December 2014


Market Summary and Technical 
  • US equities edged slightly higher
    • Divergences remain apparent in market breadth indicators
    • Divergence in HYG
  • Waiting for confirmation of whether breakout in S&P 500 and Russell 2000 is genuine
  • Gold again  shows strength despite dollar strength – chart suggests bottoming process 

[Market Summary]  

[Trend Watch]

[Selected Charts]



[Market Breadth]


Readings and Trends 

  • Saudi budget deficit for 2015 expected to widen to 5 percent of gross domestic product (Bloomberg)
    • Projected revenue will drop more than 30 percent next year to 715 billion riyals
    • Oil boom in recent years hasn’t resolved problems such as high youth unemployment, where the rate was almost 30 percent in 2012
  • US GDP growth in Q314 was an annualized 5 per cent (FT

 Investment Implications and Opportunities 

  • To remove TWM hedges if breakout in S&P 500 and Russell 2000 confirmed
  • Oil Price Rebound in the next 2 years likely
    • OPEC producers will have to watch their budgets and for social unrest at current oil prices
    • US producers have been announcing capex cuts
    • Some analysts are predicting a prolonged period of $20 oil
  • US growth when it returns to trend will not replicate the growth rates of the past 2 quarters
  • Global growth likely to benefit from supply induced lower oil prices as central banks ease further or delay tightening (Gavyn Davies)
  • 2015 could be the turning point for metals and gold
    • Interest rates to stay low
    • Global growth could benefit from lower oil prices
    • US dollar correction likely
    • Favourite Plays – to follow up with individual pieces (hopefully can find time)
      • Iron Ore – VALE and BHP
      • Gold – TGD
      • Copper – FCX 

 [Disclosure: I am long call options in TWM; long VALE and TGD]

Tuesday, 23 December 2014

Ensco PLC – Cycle-Low Valuations

Following my previous article on some possible investment ideas in the Energy sector, this article focuses on ESV.  Apologies for the delay – been too busy to do focus pieces like this.

Investment Thesis
  • I can do no better than point you to Rupert Hargreaves’ article
  • Strong cash generating company.
  • One of strongest balance sheet in industry provides flexibility
  • Undemanding valuations – priced at 2009 levels
  • ESV should be viewed as a 5 year holding as the industry supply and demand is not expected to reach 


Overview and Business

  • Plenty of newbuilds will increase supply in the next few years (See Diagram 1)
    • Dayrates and utilization expected to decrease
  • Ensco currently has 64 Rigs – 26 floaters and 38 jackups
    • Five floaters reclassified as held-for-sale / cold stacked
  • 7 Rigs under Construction – major capex in 2015 (see Diagram 2)
    • Includes 3 ultra deepwater 


[Diagram 1 - Global Offshore Drilling Fleet]
Source: Oct 14 Presentation



[Diagram 2 - Capex]
Source: Oct 14 Presentation

Financials
  • Solid balance sheet amongst peers (See Diagram 3)
  • Further, Company has backlog of $11 billion – to put this into perspective, this is more than 2 times 2013 revenue
  • Recent actions by management has increased financial flexibility
    • In Sep 14 - issued $625.0 million aggregate principal amount of unsecured 4.50% senior notes due  2024 and $625.0 million aggregate principal amount of unsecured 5.75% senior notes due  2044 – Company gains long-term capital at very attractive interest rates
    • In Sep 14 - Extended Five-Year Credit Facility maturity date from May 7, 2018 to September 30, 2019; commitment increased from $2 bil to $2.5 bil – Facility is currently unused
  • Company has funded capex through operating cash flow (See Diagram 4)
    • Negative cash flow in 2011 due to acquisition of Pride  International, Inc for consideration of $7.4 billion, including $2.8 billion of cash
  • High capex of $2 bil (See Diagram 2) can probably be funded almost exclusively with cash flow
  • However, if dividends are maintained, this will require an additional cash outlay of $527 mil which will probably have to be funded with debt
    • View any price weakness on dividend cut as a great opportunity to add shares
    • Dividend cut will also strengthen the Company’s balance sheet
  • Looking out for capex numbers in 2016 and 2017 – want to see free cash flow sufficient to cover any dividends paid 



[Diagram 3 – Leverage Ratios]
Source: Oct 14 Presentation


[Diagram 4 – Financials]
Source: Company Filings

Valuations 

  • Current P/B of 0.63 reflects 2009 low valuations
  • Forward P/E of about 6.2
  • Target Prices – $57.50 (mid-cycle at 1X 2014e book value) and $74.80 (top of cycle at 1.3X 2014e book value)

[Diagram 5 - Valuation]
Source: Reuters


[Diagram 6 – P/B] 

Risks

Further short term fall in share price is possible – oil price could drop further; dividend cut - opportunity to add more shares

Further debt could be taken on to fund capex and dividends – but company has sufficient financial flexibility for now

Disclosure: I am long ESV. This article should not be construed as investment advice. Investors are encouraged to do their own due diligence and research.  

Sunday, 21 December 2014

Weekly Update - Week ended 19 December 2014


Market Summary and Technical 

  • Rebound in US equities – correction over or setup for further downside?
    • Despite rebound, divergences apparent in market breadth indicators
  • S&P500 bounced off support at 1970; at resistance now
  • Russell 2000 held 1150 support; Resistance at 1200 to 1210
  • Gold shows strength despite dollar strength – further upside once dollar begins its 










Readings and Trends 

  • Federal Reserve replaces "considerable time" with “patient” – Tim Duy’s read is that Fed is seriously looking at mid-2015 to begin the normalization process
  • EM currencies have been selling off – notwithstanding whether they are oil importers or exporters (FT)


 Investment Implications and Opportunities 

  • Timmins Gold (TGD) Update
    • announced the acquisition of the Caballo Blanco Gold project for $10 million in cash and 16 million in shares
    • ‘projected production from the project would nearly double Timmins Gold's annual production to over 220,000 oz Au with the addition of ~90,000 oz Au at a projected cash cost of $784 per ounce’
    • ‘pre-tax NPV of US$128.2 million and IRR of 37.5% at a gold price of US$1,200 per ounce and a discount rate of 5%’
    • ‘Initial capital costs of $84.8 million’
    • Capital outlay should be manageable given low gearing – getting a good price close to a possible bottom for gold prices
  • Energy counters in bottoming process – I might look to add shares in ESV, GLF and NOV in the next pullback  
  • Broader market correction – possibly interrupt by Fed statements this week – but for how long
    • Market breadth shows divergence
    • HYG looks like a dead cat bounce 



 [Disclosure: I am long call options in TWM, ESV and GLF]

Sunday, 14 December 2014

Weekly Update - Week ended 12 December 2014


Market Summary and Technicals 

  • After VIX ended below 12 last week, we had a huger jump this week
  • Broad based decline across sectors – not just energy
  • HYG breakdown this week
  • Market Breadth confirms decline
  • US dollar with a slight pause
  • Russell 2000 close to important support at 1150 









  • Low inflation figures from China – CPI up 1.4% yoy and PPI down 2.7% yoy
  • BIS sounds warning over a stronger US dollar
    • Dollar denominated debts harder to repay
    • Capital outflows 





Investment Implications and Opportunities 

  • Energy counters yet to form a bottom
  • Broader market correction underway?
    • HYG broke support this week.
    • Market breadth deteriorated
    • Small caps at critical support
    • Maintaining TWM hedge


 [Disclosure: I am long call options in TWM]

Friday, 5 December 2014

Weekly Update - Week ended 5 December 2014

Market Summary and Technicals 

  • Emerging markets continue to underperform
  • Are markets too complacent ? Vix down more than 10%
  • Gold up despite continued dollar strength – Gold could be in the bottoming phase, especially since the dollar is due for a pullback
  • HYG indicating some stress in credit markets
  • Market Breadth deteriorating – near term divergence has appeared  


  




Readings and Trends 
  • Shanghai Composite up this week, continuing its outperformance in the last few months – 39% gain this year (By the way, wall street analysts are now deciding to raise their target prices for the Shanghai Composite, in the same way they are now almost unanimously negative on offshore drillers)
    • People seem to be speculating on further monetary easing – if so, commodities will benefit
  • Fed and ECB reacting in opposite fashion to the oil shock – see this article by Gavin Davies
    • ECB cut its growth and inflation forecasts and now says it “intends” to expand its balance sheet to around €3tn to boost inflation, rather than simply “expecting” to meet this objective (FT)
    • Meanwhile, Fed vice-chairman Stanley Fischer suggested that the Fed might soon drop the assurance that it would not raise rates for a “considerable time”, replacing it with alternative language that is less constraining on its future actions
    • Further impetuous for the Fed in the form of strong Non-farm payrolls numbers yesterday
  • S&P 500 earnings growth rolling over or merely a pause?
    • Something to watch for in the next few months
    • Brian Gilmartin at fundamentalis thinks earnings growth apart from the energy sector should remain strong
    • I’m undecided whether this sudden drop in oil prices is a net positive or negative 
Source: Yardeni Research, Inc.


Investment Implications and Opportunities 

  • Gold play - my favourite play is Timmins Gold Corp (TGD), a small cap gold producer with a pristine balance sheet
  • Still waiting for energy counters to form a bottom to add positions - see my previous article for some ideas 
    • Ultimate bottom might not be in yet given that energy companies with high debt are in trouble – quoting from FT – ‘Currently, nearly a third of speculative grade debt issuance by energy companies trades so poorly it qualifies as being classed as distressed, indicating a high likelihood of being restructured’
    • This is why I place an emphasis on companies with a strong balance sheet and cash flow generating ability
    • On the positive side, oil companies have already delayed capex decisions on new projects – positive for oil prices in the longer term
  • Added TWM (2 times inverse short Russell 2000) as a hedge this week

 [Disclosure: I am long TGD, call options in TWM]

Thursday, 4 December 2014

Gulfmark Offshore Inc – Lower Offshore Capex Prized In?



Following my previous article on some possible investment ideas in the Energy sector, this article focuses on GLF.

 Investment Thesis

  • Strong cash generating company.
  • Capex expected to be lower in 2015, giving flexibility for further share repurchases.
  • Undemanding valuations – expected decline in offshore rig demand seems priced in.

Overview and Business

  • Currently owns 74 vessels and manages 6 other vessels in Gulf of Mexico, North Sea and South East Asia. Exposed to offshore rig demand.
  • Contracted to sell 2 vessels in 4Q14, so will end FY 14 with 72 vessels. At tail end of a 12 vessel new-build program that was initiated in 2011 – 4 more vessels to be delivered in FY15 for $87.5 million of remaining capital commitments.
  • Chart below on vessel age is illustrative as to how management added so many vessels during the peak of the cycle in 2007 and 2008. Something to watch for in the future to see if the company has learnt its lesson. 
  • Utilization has remained strong in 2014, though negative pressure on utilization can be expected in FY15 and FY16 as demand for offshore rigs is reduced. 

Source: Dec 14 Presentation

Source: Dec 14 Presentation


2009
2010
2011
2012
2013
TTM
Utilization - %
North Sea
88.8%
93.5%
92.4%
89.6%
90.1%
89.9%
SEA
90.0%
78.5%
85.1%
79.4%
77.3%
78.0%
Americas
73.3%
73.0%
80.5%
82.5%
91.2%
87.1%
Total
81.4%
81.0%
85.4%
84.2%
87.7%
86.4%
Average owned vessels
North Sea
24.8
25.0
24.8
24.2
25.8
30.4
SEA
11.5
14.0
14.0
14.9
16.0
15.7
Americas
35.0
35.0
35.0
31.9
28.7
28.6
Total
71.3
74.0
73.8
71.0
70.5
74.7

Financials


2009
2010
2011
2012
2013
TTM
Cash Flow from Operations
171
91.6
97.5
102.7
126.7
174.2
Cash Flow from Investing
-68.2
-53.9
-49.4
-198.8
-210.1
-162.3
Free Cash Flow
102.8
37.7
48.1
-96.1
-83.4
11.9
OCF/Share
6.80
3.59
3.77
3.92
4.84
6.61
FCF/Share
4.09
1.48
1.86
-3.67
-3.19
0.45
EPS
2.01
-1.36
1.93
0.74
2.70
3.06
BVPS
38.42
36.37
37.45
38.20
39.94
40.62
Net Debt
268
229
179
316
440
486
Net Debt / Equity
27.1%
24.2%
17.9%
30.7%
41.4%
45.5%
Dividend per share
10
0
0
100
100
100

 Source: Dec 14 Presentation
Source: Q314 10Q

  • Clearly not a growth stock. But strong cash flow generation ability – TTM operating cash flow per share of 6.61, meaning P/OCF ratio of just 3.94.
  • Company has plenty of financial flexibility - most of debt maturity in 2022. Company also has a $300 mil facility which has not been drawn down.
  • Expecting free cash flow situation to improve from 2012 and 2013 – new build program ending. 
  • Higher FCF would mean greater flexibility for buy back more shares (approx. 1.88 mil shares repurchased in 2014 so far)
  • Current dividend should be safe and reflects a yield of about 3.8%. 

Valuations 


GLF
Last Price
26.61
Shares outstanding - mil
26
Mkt Cap
701
Equity
1,070
Net Income (TTM)
82
Price to Book (MRQ)
0.65
BVPS
40.94
Payout Ratio
32.99
Return on Equity (TTM)
7.66
Return on Equity - 5 Yr. Avg.
3.14
Total Debt to Equity
48.51
Multiples

P/E Ratio (TTM)
8.51
Price to Tangible Book (MRQ)
0.67
Price to Cash Flow (TTM)
4.43
Price to Free Cash Flow (TTM)
0
Dividend Yield
3.84
Growth past 5 yrs (%)
18.38
Est Growth for next 5 yrs (%)
10.00
Analyst Forecasts

FY14 eps
2.37
FY15 eps
2.38


2009
2010
2011
2012
2013


P/B





Avg
TP
High
0.96
0.94
1.33
1.46
1.35
1.21
49.75
Low
0.40
0.61
0.80
0.70
0.84
0.67
Median
0.68
0.78
1.06
1.08
1.10
0.94
37.31

  • Valuations are not demanding
  • Slightly over 11X forward P/E
  • Current P/B of 0.67 reflects bottom of cycle valuations; low in 2009 was about 0.4X P/B
  • Target Prices – $37.30 (mid-cycle at 0.9X 2014e book value) and $50 (top of cycle at 1.2X 2014e book value) 


Risks
  • To monitor cash flow situation
  • Valuation, though undemanding, could fall further. But this is likely to provide an opportunity to add more shares


Disclosure: I am long GLF. This article should not be construed as investment advice. Investors are encouraged to do their own due diligence and research.