Category Archives: The In & Out

Cheap…

… and even cheaper, soon?

The bulls are running at full speed, the atmosphere reminiscent of the annual spectacle in Pamplona, Spain. Yet the more that a consensus builds, the closer we are to a possible turn in sentiment.

The increasing spread between the number of investors who are bulls and bears (not that there are many left!) brings to mind the late Sir John Templeton’s astute observation: “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.”

Value investors will be watching the action closely.  In general, the indices may have defied gravity, this year, but there are, of course, some stocks that have taken a severe beating for no good reason other than simply being out of fashion.  These are healthy companies, now trading at historically low levels and offering excellent yields.  Time to have a nibble?  Pinkers thinks it’s too early.  A market correction will be broad and ruthless, affecting both the over- and the undervalued.  That’s the nature of the beast.

However, when sentiment finally does turn, here Pinkers’ favourite cookies:

Glencore Xstrata has just just announced that it will be dropping the ‘Xstrata’ from its name.  Thank God! Overdue, too.  So much for the ‘merger of equals’… It was always a takeover engineered by the brilliant Ivan Glasenberg and his management team who have been ruthless at cutting out the dead Xstrata flesh, closing flashy offices worldwide and shutting down redundant mines only contributing to an oversupply of raw materials.  As a result, synergies are probably up to three times greater than initially forecast.

Like all mining stocks, Glencore has been dragged down by uncertainty over China’s growth figures and a general turn in the commodity cycle.  Pinkers thinks this is now overdone.  Unlike other companies in the sector (such as Rio Tinto) Glencore is much better diversified: Represented in both trading and mining it has an unrivalled control over the supply chain. Furthermore, the company has quietly built up a strong presence in ‘soft’ commodities (grown rather than mined).  Most importantly, however, is the fact that Glasenberg and team are all top ten shareholders with significant stakes in the company they run. The incentive to make a success of it cannot be ignored.

Floated at 550p, the shares are currently trading at a 52 week low of 300p with a yield exceeding 3% . Strong buy!  Yes, just right for widows and orphans!

The other candidate to watch is BHP Biliton: Much better diversified than Rio Tinto and… much cheaper!

Shale.  This year was all about shale.  ‘Peak oil’ is history.  Not that shale oil extraction is a new thing: The first patent was granted by the British Crown in 1684 and the earliest description of the process dates to the 10th century.  What is new is the technology deployed, offering a more cost-efficient way of large scale industrial extraction.

The US appears to be the main beneficiary with large deposits and analysts have forecast that the world’s largest economy could be energy self-sufficient within 5 years.  The end of OPEC and the dawn of a a new era of limitless supply of hot chocolate?  Of course, not.  The issues and mostly unanswered questions surrounding shale extraction are by far more complex: Different types of oil for different uses, distribution (construction of pipelines), refinement (most refineries in the US are OPEC owned!), political and environmental concerns… to name but a few.

Last but not least, when it comes to ‘miracle solutions’, the old adage applies: “If it’s too good to be true, it probably is.”

The hard facts paint an altogether different picture: The oil price has proved remarkably resilient; oil majors such as Shell have pulled out of shale projects due to higher than anticipated costs; ‘conventional’ oil exploration around the world is more active than ever; geopolitical risks continue to put a spanner in the works… and so the list goes on.

Investors in Premier Oil, one of the ‘oil tiddlers’, have had the pleasure of seeing the company’s share price collapse over the last 12 months.  On top of ‘shale-mania’, Premier had the cheek to team up with Aim-listed Rockhopper to farm in the smaller explorer’s licence interests in the North Falklands Basin, including the Sea Lion discovery.  The transaction was completed in October 2012 and Premier assumed operatorship of the Sea Lion area development in November 2012.  Premier paid an initial payment of $231 million plus an exploration and development carry of up to $48 million and $722 million, respectively.  At the time, Premier insisted this would be funded from continuous cash flow.  Now there is talk of a search for a partner, not exactly instilling confidence.  Furthermore, Argentina’s president Cristina Fernandez de Kirchner, facing trouble on the home front, predictably used the Falklands as a vehicle to divert attention away from domestic issues.

In summary: Poor Premier Oil suffered a triple-whammy!

Yes, the company’s involvement in a project that carries a degree of political risk and uncertainty should be reflected in the price. However, Pinkers thinks that investors have overreacted.  Oil exploration is inherently risky but let’s not lose faith altogether and remind ourselves that higher risks also offer the potential of higher rewards.  Now trading at a 52 week low with a P/E ratio of less than 8, this company is certainly worth a punt.  However, be prepared… in the world of oil anything can happen… at any time… without prior warning or shall we say ‘forward guidance’?  One only has to mention the dreaded ‘M’ word (for Macondo well!).

As for the ‘majors’, Pinkers likes Royal Dutch Shell ‘B’: excellent yield and perhaps a little safer than BP?

Another sector that has been deeply unfashionable, this year, is Support & Construction.  Traditionally listed as two separate sectors, Pinkers lumps them together as the lines have become increasingly blurred.  The best companies now have a foot in both camps, following a migration from construction to higher margin support.

A shift back to fundamentals should give this sector a significant boost: The markets will increasingly focus on earnings once the current uncertainty surrounding tapering has been removed.  Support & Construction should benefit from a stronger UK economy and a generally improved outlook across the globe.  An added bonus is the high potential of M&A activity in this sector – too many companies doing the same and/or similar things and consolidation would clearly offer huge cost synergies.

Balfour Beatty used to be construction only (and still listed as such) but has been transformed into an integrated infrastructure services group with operations in over 80 countries.  It offers both the ‘hardware’ and the ‘software’ to fund, deliver, operate and maintain major infrastructural projects.  As such, it is not only well diversified ‘within’ and less reliant on the highly cyclical side of the construction business, but offers a platform model similar to that of tech giants such a Google and Apple. The company offers a juicy yield of 5% and carries little debt.

Carillion, listed under Support, is a complete ‘no-brainer’: At the current level of 300p the P/E ratio is beginning to equal the dividend yield (8 : 6!).  Yes, this can be a warning sign that a company is either in serious trouble or that the divi is about to be cut.  However, this simply is not the case with Carillion: This is an extremely well-run outfit, chalking up a string of private and public contracts in recent months.  The debt is manageable, too, and it is almost odd that it hasn’t been at the receiving end of a takeover.  It’s churning out cash!

Finally, the potential synergies between Balfour and Carillion are hard to ignore.  WIth market caps of 1.8 and 1.3bio respectively, a merger would make perfect sense, potentially creating a new Footsie 100 candidate.