29 Sep 2020

AIRLINES – INSOLVENCY DENIAL IMPEDES RESTRUCTURING The airline industry as we know it is finished, according to Hubert Horan, a transport and aviation consultant.  After the dotcom bubble downturn in 2001 airline revenues fell by 6% and this resulted in much consolidation of the industry with transatlantic services becoming concentrated in the hands of a handful of players. Long haul and business travel has fallen this year by up to 90%. For US airlines, whose domestic business has held up better, this amounts to a 75% fall in volumes and an 85% revenue decline.  Horan estimates that the airlines might be able to shed up to 40% of their costs over the next two years. Meaning that they will be burning cash as fast as they burn jet fuel. Back in Europe, IAG (which is the holding company of BA) reported an impressive decline of 96.7% in Q2 passenger revenues. Easyjet, which was effectively grounded by pan European closed borders saw its revenues decline by a scarcely credible 99.6% over the same period. Things started to look up for the European domestic companies in Q3 but the latest warnings of a second wave of infections have, according to Michael O’Leary of Ryanair, dealt another mortal blow to winter bookings.  The business models of Easyjet and Ryanair are based on the economics of full planes and they are both in balance sheet survival mode. Easyjet has raised a total of £2.4 billion through a combination of capital increase, aircraft sale and leaseback and government and bank loans. Easyjet burned £774 million cash in calendar Q2 so we can all do our own sums. Hubert Horan believes that all the major airlines are effectively bust and should rightly file for bankruptcy. Yet the managements, supported by government aid, are trying to preserve the companies’ equity capital (and their own jobs and shareholdings). I hear a lot about the EU’s aversion to state aid (apparently a sticking point in any Brexit deal) but it hasn’t stopped the German Federal Republic from offering aid of up to €9 billion to keep Lufthansa airbourne. Air France/KLM has done even better with €10.4 billion from the French and Dutch governments....

30 Mar 2018

In my report on Q4, I wrote that “for the third successive quarter, the markets were mysteriously calm.” The calm was disrupted in Q1 for sure: the main UK indexes fell by between 6% and 8%. The German DAX was -6.3%. Supported by a falling dollar, the US markets, though volatile, did better with the DJIA -2.5%. I hinted before that the stock markets might be vulnerable to rising interest rates or, more specifically, rising bond yields. In February it started to look as if this was happening; the US 10 year treasury yield had risen from 2.40% to 2.94%; but by the end of the quarter it was back to 2.74%. A similar pattern played out elsewhere. The 10 year gilt yield rose from 1.20% to 1.69% but ended the quarter back at 1.34%. It would seem that the wait for inflation goes on. Aside from the usual nonsensical white noise about “uncertainty” it is hard to escape the conclusion that the stock market is truly concerned about the ability of large corporations that feature in our lives daily to invest capital, service debt and pay dividends. Here is your day described in terms of dividend yields: you are woken by the ringing of the house phone (BT: 6.8%) and switch on the light (National Grid: 5.6%); you turn up the central heating (Centrica: 8.5%) and clean your teeth (Glaxo: 5.7%); you decide to go into town but your car has no petrol (BP: 6.0%, Royal Dutch Shell: 5.8%) and needs a new rear light (Halfords: 5.4%) so you decide to take the bus (Stagecoach: 9.0%, Go-Ahead: 5.8%); you do some shopping in Currys PC World (Dixons Carphone: 6.0%, Vodafone: 6.7%) and M&S (Marks & Spencer: 6.9%) before treating yourself to a pub lunch (Marstons: 7.4%, Greene King: 7.0%). Is it the end of the world as we know it? Yet, against this rather sinister background something quite different has been happening. Companies who want to buy each other seem to like these prices very much. On 22 December GVC announced its intention to buy Ladbrokes plc. On 17 January, Melrose bid for GKN; on 30 January UBM agreed to be taken over;...

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...

4 Oct 2014

The stock market remained nervous, reportedly seeing below-average turnover in Q3. The trend that began in Q2, of the shares of smaller companies performing worse, continued. The FTSE 100 fell by 1.7% and the FTSE 250 by 2.9%. For the third quarter in a row, yields on European government bonds fell to previously unimaginable lows. German 10 year Bund yields have fallen below 1% (now 0.93%). To put this in some context, 10 year Japanese bond yields were around 1.9% before the financial crisis bit in 2008. Japan is considered to be the reference case of a country suffering from long-term deflation. Its 10 year yield is now 0.53%. Since June 2008, Japanese yields have declined by 72% and German by 80%. As I have noted before, the bond markets are shrieking the news that global growth has made a long-term shift to lower levels. Many will argue that this is bound eventually to be reflected in lower corporate profits. It is hard to argue with that but wrong to assume that share prices are consequently too high. When yields on all financial assets are falling, investors are paying higher prices for them. A dollar of corporate profit literally becomes more valuable than it used to be. Many stock market commentators, seemingly obsessed with short-term news and the aphrodisiac of growth, appear to be incapable of understanding this. Given that the cloud of deflation continues to hang over the world (see above), the traditionally nervous month of October will probably produce plenty of gloomy headlines. In my post about the supermarkets, I pointed out that, when operating leases are included as liabilities, Morrison was much cheaper that Tesco and Sainsbury. Well, the gap has reduced but not necessarily as anticipated. Morrison’s price has fallen but the others have fallen further. Tesco’s accounting practices have caught up with it and I must say that, as yet, there is no price at which I would buy it. At last I have noticed the beginning of a backlash in the press against Lidl and Aldi – our nostalgia for the 1970s must surely be limited. Sainsbury has promised a strategic review, a development that appears to have...

21 May 2013

Back on 14 February, when I wrote recommending Go-Ahead Group, I included summaries of my views on the other transport stocks, including this on FirstGroup: At 189p, FirstGroup has a market capitalisation of £911m but an enterprise value of £3357m due to £2446m of net debt (including pension liabilities). Its historic dividend yield of 12.5% tells us that the market expects the company to cut or skip its dividend (decision due in May). This would be a speculative investment and is too dangerous for my taste. With revenues of £6500m, this business is not going to disappear but the risk is that it will end up being mostly owned by creditors rather than current owners of the equity. And so, it came to pass, more or less. Yesterday equity owners were asked to put up a fresh £615m to defend the equity’s role in the company’s balance sheet against the creditor wolf pack: or as the rights issue press release coyly puts it – to “support the Group’s objective to remain investment grade”….Let’s hear it for investment grade! Yay! The poor shares swooned yesterday – down by 30% to 156p. It’s strange how bad news seems harder to predict than good, no matter, apparently, how explicit the evidence of publicly available facts. It may be that the terms of the rights’ issue – 3 new shares for every 2 existing shares at 85p each – were pitched at such a low level that the odour of desperation was repellent. In passing, fees of £30m (nearly 5% of gross proceeds) for an issue that surely does not need to be underwritten demonstrate that there are still bankers out there whose skills surpass mortal understanding. Never mind. It is not immoral to make a mistake, nor to be stupid, nor to wonder whether new investors might at some point take advantage of the pain of others. At today’s cum-rights price of 156p, FirstGroup has a market cap of £750m and net debt (including pension liabilities) of £2280m for an enterprise value of £3030m, or 0.44x revenues. These ratios will change after 11 June, when the shares trade ex-dividend but, on the face of it, the value...

14 Feb 2013

One of the earliest stock market bubbles was in railway companies in the 1830s and 1840s. At the time, rail was the new technology replacing canals and it is not difficult to understand why people with capital to invest were excited. As with all predictable technology-driven changes, it took much longer than its early supporters expected. (I will briefly digress on why this might be. My theory is that obvious technological change attracts opposition from “old-technology” incumbents. Stuff than comes from nowhere (YouTube, Facebook) happens with shocking speed. In the case of the English railways, canal operators lobbied aggressively against them. When roads in turn began to compete with railways in the 20th century, no doubt the rail companies behaved in the same way). Many of the issues that mattered to the railways in the 1840s are still making news. New railways had to be approved by Acts of Parliament and landowners complained about plans to lay tracks over their property. Over the years, governments have veered between light touch regulation of transport infrastructure and complete nationalisation. British Rail was a state monopoly between 1948 and 1994 (from what I remember, these were not golden years of commuting) and was then clumsily privatised. Since then we seem to have been in a state of hybrid private ownership including the foolish listing and insalubrious de-listing of Railtrack. Operating franchises have proved hard to price correctly (to say the least) but we have more or less arrived at the point where trains and buses are mostly operated in the UK by five companies. Arriva was acquired by Deutsche Bahn in 2010. The other four are all still listed; FirstGroup, National Express, Stagecoach (which owns 49% of Virgin Rail) and Go-Ahead. I am not particularly interested in the operational details of running bus and train services but simple analysis of the four companies indicates that running buses is more profitable than running trains. Operating margins from bus services are typically +/- 10% whereas trains seem to struggle to hit 5%. One of the most basic ways to compare companies within the same sector is to look at the ratio of each company’s enterprise value to its revenues....