Melting capex

Melting capex

24 Dec 2015

This seems to be a time in which people have a touching faith in the idea that progress can be achieved through international negotiations. Certainly, the mutual back-slapping following the Conference Of Parties (COP21) in Paris implied that a new era of cooperation has arrived. COP21 had 25,000 official delegates and an estimated further 25,000 fellow travellers (doubtless all busily offsetting their air miles). The direct aim of this conference was to agree to a temperature target for the earth in the year 2100. With nearly 200 nations represented, it is understandable that everyone was pleased and relieved that everyone agreed that something had probably been achieved. The obvious problem is that in 85 years (2100) almost none of the 50,000 attendees will be alive. COP21 is a group-hug endorsement of the contemporary notion that everything that is hard to face now can be flipped into the future. The tendency to defer tough decisions is arguably human nature (though there must be some humans out there somewhere who prefer to face up to difficulties – where are they?) Certainly, putting off the evil hour has dominated central bank policy for nearly ten years to the point that markets were effectively begging Janet Yellen  to pull the trigger on the first rate rise of what might turn into the new current cycle. Avoiding short-term unpleasantness has resulted in a massive build-up in off-balance sheet liabilities for future UK taxpayers through an expensive policy known as PFI. It has allowed students to be obliged to fund their own education on penal terms, using teaser rates to distract attention from the financial burden that will dog them in years ahead. The probable widespread default that will hit the Student Loans Company will be underwritten by all taxpayers in the future. While much political capital is made out of trying to deny benefits to immigrants, nobody seems inclined to address the monumental unfunded liability that arises from the need to pay pensions to and healthcare costs for our dramatically aging population. We’re probably going to need a large number of working age, tax paying immigrants to help us out at some point. The inevitable car crash that will...

Monday 19th October

Monday 19th October

14 Oct 2015

Next Monday is an evocative date for those of us who worked in the City of London in 1987. The nineteenth of October became known as Black Monday (not the first or the last) as global stock markets went into meltdown. The Dow Jones Industrial Average fell by 22.6% in that single day. At one point during the trading day it was reported that the Chairman of the SEC (the U.S. Securities and Exchange Commission) had mentioned the possibility of suspending trading. Naturally this increased the level of panic. It felt all the more dramatic because the previous Friday, the 16th, had seen the Great Storm that felled trees all over Southern England. My wife and I drove into work that morning through streets that had been laid to waste a few hours before. The City was spookily quiet and the stock market felt abandoned but was also very weak. It turned out to be an eerie harbinger of the full scale panic that was to follow. If you search for explanations of Black Monday you will generally read that the stock market was overheated, partly inflamed by excited takeover activity. In September 1987, the ad agency Saatchi & Saatchi made an approach to buy Midland Bank. Nothing better exemplified the mood of the time – that anything was possible for the new money of the eighties. The Conservatives, led by Margaret Thatcher and Chancellor Nigel Lawson, had won the General Election on 11th June, seemingly confirming that the corpse of socialism had been buried and that capitalism could bring prosperity to anyone with the ambition to pursue it. It is certainly true that the developed world stock markets had risen substantially in 1987. By mid-July the FTSE 100 was up by 45%.  In that sense, prices were high though of course that is not the same as saying that they were expensive. All value is relative, as we know. As stock markets rose, bonds fell. This is a classic danger sign. Ten year gilt yields rose from 8.8% in May to 10.1% in September. High street savings accounts paid 9%. From today’s perspective, it seems incredible that equities were so popular. In relative...

Report on Q3 2015

Report on Q3 2015

2 Oct 2015

According a chap on Bloomberg TV, $11 trillion was lost from the value of global equities in Q3. The FTSE 100 fell by 10.2% and the FTSE 250, as usual doing better, fell by 5.8%. In the three years since I set up this website, the FTSE 100 is up by just 5.6% and the FTSE 250 by 42.2% which is a shocking disparity. The FTSE 100 is the top 100 companies by market capitalisation and contains many international banking, pharma, oil, mining and commodity businesses. The FTSE 250 is companies ranked from 101 to 350 and contains more domestic household names. I suspect that these companies are of a more easily manageable size and have more scope for growth. That may be a story worth looking at more closely but there is an interesting question to ask at once: if you own a tracker fund (as I do in a small way) what is it tracking? Most UK tracker funds follow the FTSE 100 or the FTSE All Share. Over the last five years, the FTSE 100 is cumulatively +8.4% and the All Share is +15.2%. These returns exclude dividend payments. The tracker fund should retain the dividends (after it has taken its fee) to boost the fund performance, so tracker funds should really beat the index (shouldn’t they?). These performance statistics indicate that the question of what your fund is tracking is rather important. And guess what? Over the last five years the FTSE 250 is up by 57.5%, an amazing outperformance of the other two indices. Over the last ten years it looks like this: FTSE 100 + 11%, FTSE 250 + 110%, FTSE All Share +21%. These are remarkable numbers. You might wonder why there are so few 250 trackers on offer. It might be because it’s much easier and cheaper to track an index that consists of 100 large shares rather than 250 medium-sized ones.  Or you might prefer your own conspiracy theory. Government bond markets did not share the sense of near-panic that infected equities. German 10 year Bund yields fell from 0.84% to 0.61%. UK 10 year gilt yields from c.2.1% to 1.8%. Nothing much to smell...

Dare you trust these dividends?

Dare you trust these dividends?

21 Sep 2015

Perhaps the most pertinent question for UK stock investors today is “can I trust those high dividend yields?” Glaxo has pre-announced that it will maintain its dividend at 80p per share this year and next year. That’s a yield of 6.2%. Royal Dutch appears to yield 7.5% on the basis of paying $1.88 (c.120p) also “guaranteed” for 2015 and 2016. If these companies can be relied on to continue these pay-outs, it matters little whether Janet Yellen dares to raise the federal funds rate from irrelevant to insignificant or indeed whether Mark Carney goes mad and does the same with the bank rate.  Here is what I previously wrote about the interpretation of high dividend yields. Shares that yield 5% The market does not like these companies. They are seen as unreliable. This may be because there are external threats that are beyond the power of management to prevent or mitigate or it may be that management is simply mistrusted. It might also be the case that they are mature businesses that are, rightly or wrongly, thought to be approaching the end of their life-cycle.   Shares that yield 6% The market does not trust the dividend. It expects it to be cut (or “rebased”, in modern corporate terminology). Naturally I agree with every word of this and everything that follows should be seen in the context of those comments. I will briefly discuss Glaxo and Royal Dutch before moving on to some humbler companies. There is a summary at the end. GLAXO           Price:  1296p                    Hoped for dividend:  80p                       Yield: 6.2% Glaxo is showing off by paying a bonus 20p in respect of Q4 (year-end March 2016). This seems to me an unnecessary answer to the sceptics who would anyway be confounded merely by flat progress. People dislike Big Pharma about as much as they dislike Big Tobacco and they both look like industries that spend a fortune on lobbying. Glaxo needs to generate $3.8bn of free cash flow to pay its 80p dividend without adding extra debt (nearer $5bn this year with the bonus). In 2014 it made free cash flow of $5.5bn; in the year to March 2015 free cash flow was...

Gifts in the mail

Gifts in the mail

15 Jun 2015

The privatisation of Royal Mail in October 2013 was a lesson in how the City can run rings around politicians who fancy themselves as financial sophisticates. In this case the sap-in-chief was Vince Cable, a man whose CV includes many “economics advisor” titles. Despite this supposed in-house expertise, his department for Business, Innovation & Skills hired a vast syndicate of City banks, perhaps believing in the wisdom of crowds. It is well known that the shares were priced at 330p, that the institutional offering was oversubscribed by 24x and the retail portion by 7x. Most applicants for shares got none at all but 16 priority investors shared 38% of the entire offer (representing 22% of the company). On the first day of trading the shares closed at 455p. Within a few weeks, seven of the sixteen priority shareholders had cashed out completely. The grounds on which the priority investors had been selected were said to include their willingness to be long-term shareholders. It is hard to escape the conclusion that the government behaved with a mixture of ignorance and fear. For many years, financial institutions have gorged themselves on the naivety of their customers but, as a citizen, I find it very disappointing that my elected representatives are quite so useless. The underpricing and mishandling of the IPO was something of a public humiliation that may have contributed to the ejection of Vince Cable in the recent general election. It took only until March 2014 for the National Audit Office to publish a report that criticised the government for being cautious and pointed out in restrained language that “the taxpayer interest was not clearly prioritised within the structure of the independent adviser’s role”.  Royal Mail was something of a dinosaur company in stock market terms. It was a state-owned business that retained a highly unionised workforce and huge defined benefit pension liabilities. Moreover, it was obliged to maintain a national postal delivery service while the potentially more lucrative parcel delivery service was open to new competitors who could to some extent cherry-pick the services that they fancied. Letter volumes are in clear decline as most of us prefer e-mail while parcel volumes are rising...

OIL…….Something Happened

OIL…….Something Happened

7 Jan 2015

The recent sharp fall in the price of crude oil is one of those rare financial events whose importance is appropriately reflected in press headlines.  Oil has a strong claim to be the world’s most important commodity and also the most political. OPEC was founded in 1960 by the charming quintet of Iraq, Iran, Saudi Arabia, Kuwait and Venezuela. According to its website: “OPEC’s objective is to co-ordinate and unify petroleum policies among Member Countries, in order to secure fair and stable prices for petroleum producers; an efficient, economic and regular supply of petroleum to consuming nations; and a fair return on capital to those investing in the industry.” Were these companies rather than sovereign nations, this would be an illegal price rigging cartel subject to enough lawsuits to employ every lawyer until the end of time. As it is, it’s a legal price rigging cartel that everyone else has to live with if they wish to continue consuming oil. In 1973, OPEC became explicitly political when the US supported Israel in the Arab-Israeli war. It banned exports to the US and the barrel price of crude quadrupled from $3 to $12. It was a shocking inflationary impact that the world did not need. The Iranian revolution in 1979 saw a further leap from $14 to $40. The next great move came in the 21st century as global economic growth was propelled by developing countries such as China and India that became huge importers of oil. The price touched $140 until the financial crisis torpedoed the world economy in 2008 and the price fell right back to the 1979 price of $40. It is worth making a couple of points here. One is that the oil price has shown itself to be very volatile with changes in marginal demand having a huge impact. The other is that, partly thanks to OPEC, the market’s opinion of whether oil is cheap or expensive has largely relied on referencing its own history – the most unsophisticated way of valuing anything. That having been said, it is obvious that oil over $100 makes costly oil supply viable, notably from Canadian oil sands but also from fracking. The world...

Grocers minced

Grocers minced

24 Mar 2014

“FTSE 100 sees supermarket shares shelved as Morrisons wages price war.” Last Thursday week (13 March), shares of William Morrison fell by 12% to 206p. They have fallen by 32% since their 2013 peak of 302p in September. In a show of empathy, Sainsbury’s shares were -8% and -26% from last year’s high and Tesco’s -4% and -23% respectively. The strategic announcement from Morrison has emphasised what we already knew – that discounters like Lidl and Aldi have been winning market share from the “Big 4” supermarkets (the other one, Asda, is a subsidiary of the US giant Walmart). This stock market fallout has delivered some shares that ostensibly now look cheap. As ever, the way to judge is to ask what the valuations tell us about the outlook for the businesses and to decide whether this view is realistic, optimistic or pessimistic. But first, some background. Due to the fact that we all go shopping, my observation is that people tend to overestimate the value of their own opinions about retailers. (This is true of many other topics: house prices, because we all live somewhere; climate chance, because we all notice the weather; healthcare, because we all get ill; bankers, because we all use banks.) On that basis, I must assume the same is true of me. So let’s get my prejudices out of the way. First, Lidl and Aldi are private companies from Germany. In my experience, which is somewhat out of date, shopping in Germany is a grim experience, evocative of Britain in the 1970s. If German retailers compete on scale and price, it is because they have nothing else. It is still the case that the collective German psyche has a horror of inflation (I have a 50 million mark note from the 1920s on my desk) and until 10 years ago, the law regulated prices and shop opening times in a way that suggested that shoppers needed to be protected from greedy retailers. The only Lidl outlet I know (in rural France) usually has just one member of staff on the checkout and the last time I was there (buying Chardonnay at less than €3 a bottle) the customer...

Calmly seeking companies with long-term strategies

Calmly seeking companies with long-term strategies

6 Dec 2013

It may seem odd but it is harder than you might think to find companies with clear and measurable strategies. It is depressing how many listed companies offer nothing but a “mission” to be the “best of class”, to be “passionate about their customers” (yuk) and to pursue “value for all stakeholders”. In these challenging times when (thanks to QE) all assets are being priced as if they offer outstanding long-term value, I am inclined to seek companies with reasonably clear medium to long-term strategies. These generally feel obliged to keep their shareholders up to date with progress. Their executives generally accept that their careers depend on their achievements. If the strategies are realistic, they should be quite easy for investors to understand. To be fair, it is easier for a business to offer a clear strategy if it needs to undergo some kind of transformation. It is tougher for e.g. Coca Cola whose strategy understandably consists of flooding ever more of the world with its yummy syrup. The same could be said of Microsoft which has torched billions and billions of dollars trying to add other products to its ubiquitous desk software. There is no call to criticise successful businesses for failing to reinvent themselves – all we need to do is to check their attitude to shareholder value. But if we want to make serious money we should be looking for successful transformations. The simplest but most dangerous transformations are those, like Enterprise Inns, that involve financial rehabilitation. Share investors can be well rewarded if the equity portion of the business rises as the debt decreases. The purpose of this piece is different. It is to look for companies that are taking on the challenge of adapting their business model to changing times. Beware of companies that focus purely on financial targets, especially when these are linked directly to executive remuneration. A German company that I once followed made a quite inexplicable acquisition. While the company’s core business was in software with an operating margin of 25%, it bought a ragbag IT service company with a margin of approximately 0%. The justification offered by the management in defence of the deal was...

Yields are usually for a reason

Yields are usually for a reason

12 Jun 2013

Investment is betting on probabilities, not on outcomes. How can we judge if the probability of an event is over-priced or under-priced? Do not try to guess the probability of an outcome with a view to pricing it. Do ask when the price is telling you about the probability – then ask yourself if this is reasonable. For obvious reasons, investors are now very interested in dividend yield but they also have reasons to be worried about the stock market. Commentators seem to be evenly split between those who are looking down and suffering vertigo and those who say that equities continue to offer attractive value compared to what else is on offer. According to my own investment rules, you will find me in the second camp for as long as that proposition continues to be true. Dividend yields are as reliable a measure as any for judging what the market thinks of a company. Then, as the quotation from my fourth investment rule (Probability) says, we can ask ourselves whether this is reasonable. Below is a table of current dividend yields from shares that I follow. There is a wide range which, if the market is efficient, should tell us that we can choose between relatively safe companies with relatively low yields and relatively risky with commensurately high returns. Before I discuss any individual stocks, I will characterise what these various yields imply.     Price Yield BG 1165 1.4% Fuller Smith & Turner 925 1.5% Domino’s Pizza 670 1.5% Travis Perkins 1520 1.6% Experian 1175 1.9% Regus 165.00 1.9% Home Retail Group 152 2.0% Diageo 19.15 2.2% Interconti Hotels 1835 2.2% Smith & Nephew 755 2.3% Rentokil 88 2.4% Millennium 549 2.5% Cranswick 1120 2.7% Stage Coach 287 2.7% Kingfisher 344 2.8% Hays 90 2.8% BT 312 2.8% Synthomer 194 2.8% Sage 348 3.0% Rexam 505 3.0% Micro Focus 659 3.1% Unilever (€) 31.4 3.1% Reed 736.0 3.1% Tate & Lyle 811 3.2% Greencore 130.00 3.3% St Ives 160 3.3% Greene King 750 3.4% Debenhams 92 3.6% Morgan Crucible 277 3.6% M&S 448 3.8% Pearson 1173.0 3.8% UBM 690.00 3.9% Mitie 253 4.1% Costain 254 4.2% Tesco 343 4.3% Marstons 142 4.4%...