The recent spate of investor redemption requests and the UK funds’ inability to deliver on those commitments is a stark reminder (if one was ever needed) that real estate is fundamentally an illiquid asset class where a real estate fund offering daily liquidity is as real as a dragon breathing fire. It does not exist. The asset management industry ought to start setting realistic expectations around liquidity — which means, lock-up periods that at least correlate with the time it takes to close a real estate transaction — which can vary from three months to a year.
It is truly remarkable that herd-like, trend-following hedge funds — which have delivered losses to investors in 4 of the past 5 years — continue to attract capital inflows. Ultimately: strong, uncorrelated returns are always generated from independent, thoughtful, fundamental analysis of the market. In all of human history, long-term determinant of value has not been herd-like perceptions of the majority but a clear-eyed and balanced assessment of market fundamentals by the minority. Whether it is politics or economics or finance, the majority is always playing catch up with the truth.
“With the Hopes that our World is built on they were utterly out of touch,
They denied that the Moon was Stilton; they denied she was even Dutch;
They denied that Wishes were Horses; they denied that a Pig had Wings;
So we worshipped the Gods of the Market who promised these beautiful things.”
Bizarre Price Behavior amidst Painful Losses, Revenue Declines, Margin Pressures, Recessionary Markets
Persistently Serious Questions about Liquidity & Solvency
“There’s somethin’ happenin’ here
What it is ain’t exactly clear
There’s a man with a gun over there
Tellin’ me, I got to beware
I think it’s time we stop, children, what’s that sound?
Everybody look what’s going down
There’s battle lines being drawn
Nobody’s right if everybody’s wrong
Young people speakin’ their minds
Gettin’ so much resistance from behind
I think it’s time we stop, hey, what’s that sound?
Everybody look what’s going down
What a field day for the heat
(Hmm, hmm, hmm)
A thousand people in the street
(Hmm, hmm, hmm)
Singing songs and carrying signs
(Hmm, hmm, hmm)
Mostly say, hooray for our side
(Hmm, hmm, hmm)
It’s time we stop, hey, what’s that sound?
Everybody look what’s going down…”
- From the song ‘For What It’s Worth’ by Buffalo Springfield
Every once in a while a trade comes along that defies all macro-economic logic, market fundamentals, valuation metrics, technical analyses, and good old common sense.
Every thing you ever held sacred, sensible, and proper about – admittedly somewhat “inefficient” markets – is left thoroughly violated.
The third-largest French bank by market capitalization, Credit Agricole Group (EPA: ACA) (PINK: CRARY) is just such a study where laws of financial gravity don’t seem to matter.
Could Credit Agricole be an extraordinarily profitable “Short” trade?
You decide based on the facts discussed below:
Context: Treating a cocaine habit with more cocaine
Over the last few years, while their US and British counter-parts have continued to undertake drastic measures to restructure their operational and financial foot-prints, Eurozone banks have levered up even further by buying hundreds of billions of Eurozone periphery sovereign, corporate and consumer debt. This disastrous move actually gathered momentum in late 2011 on the back of the 1 trillion+ Euro LTRO facility offered by the ECB to these very Eurozone banks who, by Q4, 2011, had lost credibility in international money markets and were asphyxiating from a lack of dollar funding. Like all government interventions, what LTRO injections generated as an unintended consequence was it discouraged the technically insolvent Eurozone banks from de-leveraging their balance sheets off the hundreds of billions in bad assets that should have been sold, restructured, written down, or written off several years ago. Cut to the present, an already untenable situation of bank illiquidity has definitively (and perhaps irreversibly) morphed into an insolvency problem for banks feeding on their own region’s debt.
To quote an Octo 3, 2012 Bloomberg article on French banks:
“The investment-banking units of BNP Paribas SA (BNP), Societe Generale SA, Credit Agricole SA (ACA) and Natixis (KN) SA have 2.05 trillion euros ($2.64 trillion) in trading assets, including bonds, equities and derivatives, data compiled from the banks show. That’s a 21 percent jump in the 12 months to June and a two-year high, just shy of France’s $2.77 trillion gross domestic product.
Trading in derivatives for BNP Paribas increased 48 percent to 446.1 billion euros in the 12 months through the end of June. For Societe Generale, it rose 38 percent to 242.8 billion euros.”
Through the LTRO (Long-term Refinancing Operations: a real liquidity injection program) and now OMT ((Outright Monetary Transactions: essentially, a liquidity injection announcement to buy unlimited sovereign periphery bonds), what ECB has done is take in a cocaine addict into rehab and provided the patient with even higher doses of cocaine so it doesn’t go into withdrawals.
While the remedy for this patient was a combination of medicines that were bitter and painful and would have included:
a) restructuring irredeemable sovereign and corporate debt by letting errant financial institutions take the losses, i.e. debt forgiveness;
b) consolidating, closing and re-capitalizing insolvent financial intermediaries;
c) bring about gradual but strict fiscal discipline including change in policies as well as governance;
d) reforming inflexible labor markets to boost competitiveness;
e) privatizing inefficient and high-potential government assets,
f) and most importantly, letting the debtor nations exit the Eurozone to regain competitiveness through issuance of their own currencies.
By doubling down, however, a patient who could’ve been rehabilitated by Eurozone governments and the ECB is now terminally ill — and is about to die from off-the-charts toxicity levels (debt) that kept the patient even more high on cocaine than it was before coming into rehab.
Because it was politically unpalatable to let the Eurozone banks pay for their sins. The banks waved their considerable clout by pulling out the “systemically important” card.
And the troika (IMF, European Commission, and ECB) buckled.
Now, against this back-drop, let’s drill down to Credit Agricole’s health.
Fundamentals & Valuation: Heavy Things Don’t (and Shouldn’t) Defy Gravity
First, there’s the minor issue of solvency and leverage.
Despite being a heavily leveraged, highly unprofitable banking enterprise with subsidiaries and strategic investments in the choicest, most “eventful” of high-risk Eurozone markets such as Greece (Emporiki Bank), Spain (Bankinter), Italy (Intesa SanPaolo), and of course its home territory of France, this retail banking-focused group’s stock price has perversely undertaken a parabolic rise – up 80% since the lows of this year and 66% in the past six months alone.
Credit Agricole belongs to that rarefied top layer of a huge pyramid (oops, did I just say, pyramid…scheme) of financial services sector “Eurozone sinners,” i.e. French banks, that together account for the largest private sector balance sheet exposure to the so-called “Club Med” European periphery sovereign, public and private sector debt.
As early as the spring of 2010, The Economist estimated that French and German banks owned as much as 40% of all Eurozone peripheral debt that is estimated to run between 2 to 3 trillion Euro.
As per the 2011 Eurozone bank stress tests, exposures to just Greek debt among four French banks were:
- 1.7 billion Euro for BPCE,
- 6.6 billion Euro for Societe Generale,
- 8.5 billion Euro for BNP Paribas, and
- 27 billion Euro for Credit Agricole (roughly 150% of the other three French banks combined).
To quote Bloomberg on French banks’ total exposure to Greece vis-a-vis its German and British counterparts:
“French banks held $40.1 billion in Greek public and private debt at the end of June, or 55 percent of all foreign claims, according to data compiled by the Bank for International Settlements. German lenders had $5.5 billion in Greek debt holdings while U.K. banks held $5.6 billion, BIS data show.”
Putting the extent of French banks’ precarious situation in context, should the $40.1 billion of Greek debt be written off in an entirely realistic scenario were Greece to default in the coming months, such an “event” will wipe out at least 40% of the market capitalizations of France’s three biggest banking groups (BNP Paribas; Societe Generale, and Credit Agricole).
How much of that Greek debt’s been sold in the secondary market yet, and at what kind of write-downs is anybody’s guess today?
Coming down to balance sheet risk, Credit Agricole holds an eye-watering 136 times in assets (1.9 trillion Euro) vis-a-vis its equity value (13.9 billion Euro).
To quote Jonathan Weil, Bloomberg View columnist:
“Total assets at Credit Agricole were 1.9 trillion euros as of Sept. 30. Risk-weighted assets, however, were a mere 298.3 billion euros. In essence, we’re supposed to believe that 84 percent of Credit Agricole’s assets were riskless, even though that obviously is impossible.
For a more realistic capital ratio, take tangible shareholder equity (which excludes intangible assets such as goodwill) and divide it by tangible assets. At Credit Agricole, the figure was 1.4 percent as of Sept. 30, which translates into leverage of about 73-to-1.”
To make a mockery of Basel III compliance, Credit Agricole refused to provide visibility on its current core Tier 1 capital levels (as a reminder, Tier 1 capital ratio principally comprises of common stock and earnings v/s risk-weighted assets).
To quote FT:
“Mr Chifflet (Chief Executive) said the whole Crédit Agricole Group – the quoted entity and the regional banks – were on track to reach a core tier one ratio of 10 per cent by the end of next year (2013). The key measure of balance sheet strength is set at a minimum of 9 per cent under the incoming Basel III rules. The bank would not disclose a figure for the end of September.”
Credit Agricole’s latest press release on Credit Agricole’s website states that the banking group’s core tier capital ratio is 11.3 per cent at 30 September, 2012.
However, the Credit Agricole release goes on to say:
“The Group also reaffirmed its target of a fully loaded Basel 3 Common Equity Tier 1 ratio of over 10% by the end of 2013, above regulatory requirements, integrating the necessary buffer to be constituted as global systemically important bank (1%).”
So, the loaded question (pun intended) is, what does Credit Agricole Group consider as “fully loaded” Basel 3 Tier 1 ratio where the banking group is falling short right now?
How is this “fully loaded” calculation different and more conservative from the 11.3% reported by the banking group that the management is not even willing to disclose the group’s current standing on this metric?
Such efforts by management to deliberately obstruct and obfuscate the true state of the bank’s health is alarming, unhealthy, and frankly, can be construed as arrogant.
After all, last time I checked, French capital markets reside within an advanced economy where management is accountable to public scrutiny — be it from depositors, investors, regulators, media, or citizenry.
Moving on to impact on Credit Agricole’s earnings from its Greek unit:
Since 2008, Credit Agricole’s Greek unit Emporiki Bank has generated losses to the tune of 4.42 billion Euro, and another 1.28 billion loss in the first six months of 2012.
In the quarter ended September, 2012, Credit Agricole took a 2 billion Euro charge in order to let go off its disastrous foray into Greek banking through its subsidiary: Emporiki Bank. The Greek subsidiary was recently sold to Alpha Bank for the princely sum of 1 Euro, and the transaction is expected to close by end of 2012 (until its not). The deal could easily unravel if “Grexit” happens. In the event of a Greek sovereign default, Credit Agricole is expected to be on the hook for a number of contingent liabilities of Emporiki Bank (which would very likely go belly-up if “Grexit” comes to pass). In addition, to wash its hands off this cash-hemorrhaging misadventure, Credit Agricole has committed to a capital injection of 550 million Euro and convertible bonds worth 150 million towards the combined entity’s equity — which incidentally would be less than worthless because all of Alpha Bank’s equity owners (including Credit Agricole) would be on the hook for billions of Euro in additional liabilities should the combined entity come under stress or go under during the next Greek restructuring or outright default.
For all the rhetoric surrounding the banking group’s “adjustment plan” to de-leverage the entity off its massive balance sheet relative to its equity, let me quote Credit Agricole’s most recent press release about its enormous Q3, 2012 loss:
“The Regional Banks registered a 3.9% increase in revenues in the third quarter of 2012, while continuing to improve their loan-to-deposit ratio, which contracted to 126% from 127% at 30 June 2012 and 129% at 31 December 2011.”
A 300 basis point change over 3 quarters for a crucial chunk of the group’s business is hardly an “improvement.” Its the proverbial management fiddling away while Rome (or shall we say, Paris) is burning.
The press release is available here: http://www.credit-agricole.com/en/News/Press-releases/Financial-press-releases/Third-quarter-and-first-nine-months-of-2012
Quoting Bloomberg’s article on the bank’s most recently quarterly loss:
“Credit Agricole recorded a 572 million-euro writedown mostly on its Italian consumer-credit business, a 181 million- euro loss linked to its sale of CA Cheuvreux, and a 193 million- euro accounting charge on its stake in Spain’s Bankinter SA. Credit Agricole is selling Athens-based Emporiki for a token price of 1 euro to Alpha Bank, it said Oct. 17. The French bank will inject more funds into Emporiki, bringing the total capital boost since July to 2.85 billion euros, and buy 150 million euros of convertible bonds issued by Alpha Bank. Credit Agricole’s corporate and investment bank had a 302 million-euro net loss in the quarter, hurt by own-debt charges and the cost of selling CA Cheuvreux. Excluding one-time items, the division’s like-for-like profit fell 15 percent to 325 million euros, the bank said.”
The pattern that emerges from all of these exits is that these transactions are large, multi-hundred million Euro write-downs attributable to a de-leveraging process that can be described as nothing less than a “fire-sale”. It begs the question: When does a business let go off assets at such deep discounts to book value?
It is when the entity’s finances are so depleted that it is fighting for its life, i.e. solvency.
Then, there is the even more pedestrian issue of profitability.
To quote Financial Times:
“The French bank, which had prepared the market last month for bad news, reported a result that was about €1bn worse than expectations of a net €1.8bn-€1.9bn loss in the three months to the end of September, marking a sharp fall from the net profit in the same quarter last year of €258m. Revenues of €3.4bn were 32 per cent down on the third quarter of last year.”
Between Fiscal Year 2010 and 2011, Net Profits declined a staggering 72.4% from 4.09 billion Euro to 1.12 billion Euro. With 3 months to go in the current fiscal year (2012), Credit Agricole has recorded a net loss of 2.48 billion Euro thus far — and the full year numbers are likely to fall further for reasons discussed in this note.
Fire-sale of assets can be expected to continue as part of the bank’s “adjustment plan” — so more losses can be expected in the coming quarters. There’s no way out to profitability for the short-to-medium term.
Yet, what can only be described as an affront to the markets, the company is still contemplating whether it will pay out a dividend this year or not. You can’t make this stuff up.
To further quote Bloomberg on Credit Agricole’s investment banking activities:
Credit Agricole is also shutting its riskiest investment- banking businesses. The bank has stopped most of its equity derivatives and it has no proprietary trading activity, according to a Sept. 26 presentation. The lender is selling its brokerage CLSA to China’s Citic Securities Co. in a transaction valued at $1.25 billion.”
Of course, the worst is yet to come.
As the French economic indicators deteriorate (including 10% unemployment levels at a 13-year high), consumer and small business lending (Credit Agricole’s forte) will fall further in the coming quarters — which will in turn impact net interest income and margins. With deep and wide provincial exposure through its regional banks, Credit Agricole’s retail banking loan provisions are expected to rise significantly — much like their Spanish local lending counterparts or “Caixas”. So, one can expect both a top-line and a bottom-line contraction in the coming quarters for Credit Agricole as well as for its peers. Crucially, Credit Agricole is expected to be impacted much more than its other two large French banking peers since the other two (BNP Paribas and Societe Generale) do have more income diversification through investment banking and trading lines of business while Credit Agricole is well on its way to exiting.
To add fuel to fire, Francois Hollande, President of the French Republic wants to bring about a radical transformation of French banking sector with a view to ring-fencing riskier investment banking and trading activities from the more staid, low margin retail and commercial banking businesses. While the objective is admirable, the impact of greater (and no doubt more onerous) regulation and fragmentation of the French banking sector will raise the cost of doing business for French banks precisely at the worst time — thus putting liquidity, margin, and ultimately, solvency pressure on full service banks like the French triumvirate.
Speaking of margins:
Among its large banking peers around the globe, the bank’s lack of profitability (Net Margins) at -4.0% can only be matched by industry laggards like Lloyds Banking Group (-4.1%), UBS (-1.2%) and Morgan Stanley (-0.8%). These are, might I add, the most dilapidated homes in a bad neighborhood where several other troubled Eurozone peers are generating double digit profits. For example, Banco Santander (17.4%), BBVA (14.2%), Natixis (13.0%), BNP Paribas (11.5%), and Commerzbank (11.6%). Along that sliding scale, even other large European players are eking out single-digit net profits: Deutsche Bank (9.2%), Banco Popular (8.7%), Caixabank (5.5%), ING (4.1%), Societe Generale (3.3%), and Credit Suisse (3.3%).
Furthermore, at -5.2% Return-on-Equity, Credit Agricole is in the august company of “fallen angels” like Lloyds Banking Group (-2.2%), Royal Bank of Scotland (-6.9%), and Bank of Ireland (-9.1%) — each of whom required a full or partial government bailout wiping out much of existing shareholders’ equity.
Macro-economic Maelstrom: Tale of Five Fat Tails
The breathtaking disconnect between Credit Agricole’s stock value and ground reality is particularly accentuated by what is happening right at this moment on just the macro-economic front (without even getting into the Middle Eastern and Asia-Pac geo-political escalations):
S&P has recently downgraded French banks and put Credit Agricole on a “negative” watch.
Meanwhile, as the German and French economies enter discernible slowdowns of their own, how much political capital do the leaders have left to thrust on their citizens any more bailout guarantees (de-facto wealth transfers) from creditor Eurozone members to a growing list of debtor nations with yawning deficits just to keep the current face of the Eurozone intact?
France’s Southern European neighbor is dragging its feet on an ECB intervention through the OMT program while the Spanish provinces threaten secession as a bargaining chip to change the fiscal balance-of-power between the federal and state governments. At the same time, the Spanish continue to lose precious time as state government bailout aid fund is all but spoken for and more requests are on the way. Bad loan provisions at banks continue to rise, unemployment is hitting Franco-era heights, yields are artificially in control (on the OMT promise and CDS bans), and the socio-political climate is about to explode (with suicides and evictions tearing at the core of this already strained society).
The island’s banks are practically insolvent and this tiny Eurozone member is expected to seek a bailout of 20 to 30 billion Euro of its own — mostly to keep, what else, the country’s banks afloat and their rich Russian oligarch depositors liquid. While the bailout requirements are a small amount relative to the kinds of guarantees and disbursements already made by Eurozone members towards the likes of Greece, Ireland and Portugal, yet Cyprus might just end up beating Greece to the tape in the first full-fledged default of a Eurozone sovereign triggering an avalanche of bank-runs and defaults elsewhere in the Eurozone.
4. United States:
The 2012 sequel of the fiscal cliff-hanger starring President Obama and Speaker John Boehner has officially been released post-US elections. Regardless of the outcome, much drama is most assuredly going to unfold.
Of course, the big elephant in the room is Greece tip-toeing again to the brink of another restructuring cliff (pardon the mixed metaphor). This time involving OSI (Official Sector Involvement) aka hard restructuring or debt forgiveness, and possibly, another round of PSI (Private Sector Involvement) who have already been arm-twisted to taking hair-cuts before. Wonder, what their hairdo will look like before the Greek saga comes to its long-winded end. Credit Agricole will be one of the lenders most impacted by any further restructuring, re-profiling, and the like. To state the obvious: the huge and real social pain being exacted by the downward debt-deflation austerity measures is reaching boiling point.
The beginning of the end of the Eurozone (at least as we know it) is very near.
Any of the above risks may very well be the trigger for a downward re-pricing of most capital markets that leading economist and fund manager Marc Faber mentions as the impending 20% correction. Which is just as well, because the current gap between the financial and real economies is getting to breaking point.
Given the above tail-risks very much on the near-term horizon, does any responsible fiduciary, hedge fund manager or asset manager believe that Credit Agricole (or for that matter any other major Eurozone bank) needs to trade at or near its 52-week highs.
Strange Price Behavior: Good News is Good News; Bad News is Better
I do dozens of equity trades a month. Given my ‘Short’ position in Credit Agricole being my largest (long or short) in the portfolio, I have paid particular and real-time attention to its deteriorating fundamentals and its strange stock price behavior — particularly over the last two “eventful” months since the Draghi OMT announcement.
Having reflected on Credit Agricole’s price behavior, I can plainly state that the stock price is tone-deaf, impervious and idiosyncratic (in a not so healthy way) to the banking group’s astonishingly ugly and quickly deteriorating fundamentals — let alone — to the broader macro-economic and geo-political tail risks of a somewhat orderly Greek exit and subsequent disorderly Eurozone contagion; the rapidly contracting French economy and softening of the rest of the Eurozone core (Germany, Finland, The Netherlands, Belgium and Austria); the rising tensions in the Middle Eastern and Sino-Japanese conflict and of course; the forthcoming hairy, painstaking negotiations surrounding the US fiscal cliff.
Management’s lack of transparency regarding the entity’s current core Tier 1 capital ratio, and absence of a fair and conservative assessment of its risk-weighted assets, is further exacerbated by the fact that stock has recently been trading at or near its 52-week highs — almost in spite of the “short sellers” who have been trying to wake the markets up from their QE and OMT-induced stupor.
Upon touching a 52-week low of 2.88 Euro, the stock traded below 3 Euro for much of the summer 2012. Then, it started its somewhat inexplicably steep climb well before the ECB President Mario Draghi’s so-called “game-changer” announcement of OMT aimed at bringing peripheral Eurozone bond yields down to more manageable levels. Of course, it’s another story that a single shot is yet to be fired from Mr. Draghi’s OMT bazooka since the early September, 2012 announcement of buying “unlimited” peripheral Eurozone sovereign bonds against “strict conditionality”.
After the OMT and QE-Infinity announcements, the stock went off like a rocket comfortably piercing its previous 52-week high of 6.29 Euro and setting a new 52-week high of 6.55 Euro. Arguably, part of the near vertical stock price climb could be explained by a “short squeeze” of investors who bet heavily during the summer that the long-anticipated break-up of the Eurozone was around the corner.
Then, of course, came along the (un)expected wider-than-expected quarterly loss ending September, 2012 of 2.85 billion Euro for the group. The loss was merely greater by 1 billion Euro than the consensus estimate. Clearly, certain “recreational/medical” substances that were recently put to ballot in the US are already freely available and extensively used among the analyst community tracking this stock.
Guess what the stock did on this “earth-shattering” earnings announcement:
The young guns manning supposedly sophisticated artificially “intelligent” algorithmic trading machines initially had the audacity to fly off the handle (as is customary on most days), and take the stock higher than its opening price before reality began to sink in that, maybe just maybe in the face of this mind-numbingly large quarterly loss, this day was not a good day for such blatant exuberance toward the stock price — lest regulators get alarmed and other market participants feverishly start “raisin’ cane” about the issue. Ultimately, on the day of this spectacular loss in earnings, the stock traversed a downward trajectory of 11% of rather vigorous trading activity through the day, and then within minutes very large blocks of shares pulled the stock right back up erasing half the losses. Such moves don’t pass the smell test.
Is it a case of putting lipstick on a pig with exposure to the PIIGS?
On most other days, the stock defies gravity. There have been instances where the bank’s “high beta” price behavior puts Silicon Valley small cap tech and bio-tech stocks to shame — rising (and a few times falling) as much as 5 to 8% on an intra-day basis.
There seems to be significant amount of doubt and trepidation in the markets about the true and “fair” value of the stock.
Then, there are days when the stock’s high correlation breaks down vis-a-vis its two larger, better-capitalized, and profitable French banking peers: BNP Paribas (EPA: BNP) and Societe Generale (EPA: GLE). Predictably, more often than not Credit Agricole rises more than twice its two French peers or falls less than half vis-a-vis the other two. Such price action can mean one of two things: Either the market is placing greater value and confidence in Credit Agricole compared with its other two French rivals (hard to imagine). The other conclusion, obviously is, something smells fishy here. Imagination would come in handy as to who and why is behind such odd price behavior.
Yet another example, on Nov 7, 2012, the Bid price (5.90 Euro) was higher by 2.1 cents than the Ask Price (5.921) for a good 5 minutes between 3.25 pm and 3.30 pm GMT, while the algos were busy “blindly” buying trying to prop up the stock price. Such dissonance has become a regular occurrence with this stock.
Are those who are trying to prop the price of this stock over-playing their hand through their not-so-intelligent algos?
Could it just be that certain vested interests are working hard to deploy cheaply accessed capital towards bolstering shareholders’ equity — in the process boosting the bank’s Tier-1 capital ratio and magically transforming an otherwise insolvent and illiquid bank seem solvent, liquid, and even attractive?
Or is it that some large, powerful pools of capital are angling to gain from this speculative, high-beta play with a view that the French government will succumb to the “too-big-to-fail” card and back-stop the insolvency scenario for Credit Agricole?
Wouldn’t Mario Draghi, President – European Central Bank, be pleased to know that his LTRO-injected liquidity is being put to good productive use to prop up equity values of otherwise failed banks?
Surely, Joseph Schumpeter’s soul would be utterly amused that “creative destruction” of capitalism is being frustrated and obstructed right in his homeland: Europe.
In the face of all the performance issues, market challenges, and macro-economic risks, in whose vested interest is it to keep Credit Agricole’s equity price propped up at such a patently (un)fair value?
Conclusion: Welcome to The Twilight Zone!
Looking at Credit Agricole’s long list of cardinal sins that it is yet to seek recompense for, it still appears that management of balance sheet/solvency risk, liquidity risk, and event risks seems like a novelty for lesser, more conservative, and faint-hearted banking cousins at the lower tier of the Eurozone banking pyramid (scheme), and not for this historic French banking champion.
Its long list of “accomplishments” in banking over-reach and over-leverage can only be explained by the belief in certain investment management industry quarters that the banking group is systemic to the French economy, and therefore, it enjoys an implicit back-stop guarantee from the French republic. What such investors fail to appreciate (fully at least) is that such a back-stop would come with onerous costs. Nationalization and State intervention is a French tradition. Should the bank fail, current shareholders will get severely diluted or entirely wiped out. Junior bond-holders might follow close behind.
Quoting an October 25, 2012 Bloomberg article on France’s 60 billion Euro (thus far) assistance to its banking sector:
“PSA Peugeot Citroen SA (UG)’s troubled finance arm brings the state’s backing for the nation’s banks to more than 60 billion euros ($78 billion).
The government yesterday said it will guarantee 7 billion euros in new bonds by Banque PSA Finance, the consumer-finance unit of Europe’s second-largest carmaker. The aid comes on top of support for Dexia SA (DEXB), the French-Belgian municipal lender, and for home-loans company Credit Immobilier de France.
The French government is also providing a guarantee of about 28 billion euros to bolster Paris-based mortgage bank Credit Immobilier de France, or CIF, as it’s known.
France is already backstopping 36.5 percent of 73.5 billion euros of outstanding state guarantees on the debt of Brussels- based Dexia, which was the first victim of the sovereign debt crisis at the core of Europe. Belgium wants it to do more.”
These guarantees and capital injections cannot be generously dispensed ad infinitum without ramifications for France’s own credit rating. So, as the French fiscal situation becomes increasingly vulnerable, the spigots are to be turned off fairly shortly.
Investors beware. As leading Harvard and Stanford historian Niall Ferguson points out about empires, and I para-phrase: Collapses are never linear. Initially, they are slow and gradual and then they are swift and precipitous.
Against the above discussed macro-economic and micro-economic backdrops, to see Credit Agricole go nearly vertical in the last few months, no one will blame you if you thought you were in the yesteryears’ TV show: The Twilight Zone — where everything was topsy-turvy; everything was bizarre.
Ultimately, certain laws of financial gravity are inviolable:
1. We are the market.
2. Market forces are irrepressible.
3. All mis-priced assets have their day of reckoning; mean reversion is a reality.
Profit from this one.
“This is the end
This is the end
My only friend, the end
Of our elaborate plans, the end
Of everything that stands, the end
No safety or surprise, the end.”
- From the Song: The End by The Doors
Sources: BBC, Bloomberg, CNBC, Credit Agricole Group, The Economist, Financial Times, Google Finance, Marketwatch, Reuters, Seeking Alpha, S&P, Wall Street Journal, Zero Hedge.
Here’s an idea for Toblerone — the beloved Swiss chocolate brand of tens of millions of chocolate lovers all over the world.
Imagine a Toblerone bar whose signature chocolate triangles change in flavor from one triangle to the next across all of their four delightful options.
Triangle 1: Milk
Triangle 2: White
Triangle 3: Fruit & Nut
Triangle 4: Dark
Triangle 5: Honeycomb Crisp
And the sequence would repeat itself.
This new Toblerone could be branded as ‘Toblerone Blend.’
Imagine “all four flavors in one!”
Image Courtesy: Kraft Foods
A few salient reasons why Insurance Australia Group (ASX: IAG and PINK: IAUGF) is an eminently short-able stock:
The stock trades at 42 times P-E — which is 2 to 3 times as much as its peer group anywhere in the advanced economies; the stock is just plain expensive — both by global and Australian insurance sector standards.
To put things in perspective, on one end of the spectrum, there’s the American Insurance giant AIG (NYSE: AIG) that trades at 3.0 times P-E. On the other end of the insurance sector spectrum for a $1+ billion market cap insurer, there is Insurance Australia.
Even comparing insurers of similar market cap, the Dutch insurance provider Aegon (NYSE: AEG) trades at 12.0 P-E and generates revenues far higher than Insurance Australia (5 times as much in revenues to be precise). Intact Financial (TSE: IFC) — a Canadian insurer of similar market cap — trades at 15.5 P-E.
Whether it is Price-to-Sales or Price-to-Book or any other valuation metric, IAG is dearer than virtually any of its global or regional peers by a distance.
IAG’s Price-to-Sales Ratio is 0.98 vis-a-vis the global insurance industry average of 0.54. The company’s principal Australian peers trade at Price-to-Sales ratios of 0.79 for QBE (ASX: QBE) and 0.73 for Suncorp (ASX: SUN).
IAG’s Price-to-Book Ratio is 2.03 vis-a-vis the global insurance industry average of 1.19. For QBE, this ratio is 1.35 and for Suncorp: 0.83.
So, the company’s global and Australian peers command much lower valuations on both these metrics.
Infact, IAG’s Price-to-Tangible Book Value is a staggering: 3.5 vis-a-vis the Insurance industry’s Price-to-Tangible Book Value of: 1.0.
Net margins are very ordinary: 2.9% — which is discernibly lower than even its immediate Aussie insurance sector peer group: QBE Insurance (3.8%) and Suncorp (4.5%).
In essence, on a relative value basis, IAG offers no major industry-leading data point to justify its premium pricing.
As per data compiled by Reuters, IAG has a long-term debt-to-equity ratio that is nearly twice (38.2) the industry average (22.1).
Compared with a year ago, the insurer’s revenues have grown by 14.7% for the most recent quarter (MRQ). On the other hand, the company’s earnings have shrunk by 29.2% MRQ. Even on a trailing twelve month (TTM) basis, the company’s revenues have risen by 12.8% but its earnings have fallen 17.2% from A$250 million in FY 2011 to A$207 million for FY 2012.
Clearly, the markets are rewarding unprofitable growth. The company’s management would potentially defend unprofitable growth by stating that they have entered fast-growing emerging markets like Indonesia and Vietnam. But as one does more research, one learns that there is brutal price competition and a crowded marketplace for any new entrant to contend with in these Southeast Asian markets.
The stock has also made a dramatic run year-to-date for no apparent positive reason, up 41.2% where S&P/ASX 200 has risen only 6.7%. Meanwhile, IAG’s immediate Australian competitors have been trailing far behind with QBE Insurance (QBE) going sideways down -0.3% YTD and Suncorp (SUN) up 8.5% YTD.
Trading at A$ 4.25, the stock’s been breaching 52-week highs on a regular basis. It hasn’t seen such peaks since May, 2008. We all know what happened next to the global economy and world markets. There is little evidence to support its ascent except the company’s growth rates which have been driven by unprofitable expansion into a significantly more competitive insurance market such as the UK — where by the way, the company has stumbled. Due its poor performance, the company’s UK unit is under review for a possible fire-sale.
Australia’s fortunes are largely tied to those of the world — and particularly to those of emerging Asia. As growth rates stall or even decline in various parts of the world as well as in Asia, Australia’s steady, multi-year run of GDP expansion is poised for a reversal. As goes Australia (and to a lesser extent New Zealand), so goes Insurance Australia Group. As it is, the company’s ‘promising’ Asian operations only account for roughly 5% of the group’s revenues. The UK unit is unprofitable. So, for all intents and purposes, there is enormous ‘concentration risk’ in Insurance Australia’s business.
Of course, there are several other strong reasons to support the ‘Short’ thesis on IAG common stock but we can limit our initial assessment to the above.
The catalyst for the decline in Insurance Australia’s stock price will be the slowdown in the Australian economy that is already underway — which would have a chain reaction on the value and volume of policies issued by Insurance Australia — this would then, in turn, affect margins — and thus impact dividend payouts — until the institutions holding on to IAG’s stock begin to desert their positions seeking a steady yield elsewhere. That’s when the stock will begin to unravel.
How, then, can the high valuation and rising stock price of Insurance Australia be explained?
I had an idea about a capital markets game the other day. It is discussed below.
The oldest, the most universal, and perhaps, the greatest game in the history of human kind is: Trading.
It is hard-wired in our DNA to engage, to deal, to play, to out-wit, to conform, to rebel…to trade.
We like to play games.
We like to flirt…with risk.
The thrill of a “killer” deal satisfies our reptilian mind.
Trading harnesses our intellectual, emotional, and physical energies.
It is, therefore, a powerful visceral experience.
To paraphrase Prof. Robert Schiller, it connects us with our “animal spirits.”
Also, lest we forget, from the bazaars of ancient India to the souks of medieval Silk Route to the high streets of Victorian England to the dark pools of global finance, trading has always been (and always will be) as much a “social” experience as it is a “transactional” one.
In essence, trading is the widest (if not the lowest) common denominator of social interaction for human kind.
It is in this context, Alpha Trade is proposed as a global, multi-platform, real-time game where ‘Alpha Traders’ compete in a “winner take all,” real money contest for generating the ‘Alpha Trade.’
Game Description / Rules of Engagement:
- Alpha Traders pay a “commission” of $9.99 per trade of ‘real’ US dollars to put on a trade worth $100,000 of ‘Alpha Dollars’ per trade in a single security or asset.
- Notably, Alpha Traders can put on as many trades as they like so long as they pay $9.99 per trade.
- The Alpha Trader chooses the entry and exit prices for his/her trade at the time of putting on the trade.
- At the end of each trading session, the trade that generates the highest absolute return earns real money in US$ worth the entire sum of “commissions” placed by all the “Alpha Traders” for that specific trading session. The ‘Alpha Champion’ takes it all.
- Larger the number of trades, bigger the ‘Alpha Pool’ of commissions, and greater the size of the prize.
Alpha Trade sits at the intersection of three powerful and sustainable global forces where: Behavioral Finance meets Social Networking meets Online Gaming.
The game is laced with skill, thrill, intuition, risk, luck, timing, emotion, intelligence, knowledge and much more.
Why the game will have legs is because it is also a pure, unvarnished meritocracy.
Rules are plain and simple.
Winning is clear and absolute.
Hence, the Alpha Trade is also, at once, incredibly timely and utterly timeless.
After all, in a world where the “other 99%” feel the game is increasingly rigged, Alpha Trade is a “fair” trade; a “just” game.
You pick the right stock, you will win. You don’t, you won’t.
You eat what you kill.
And yet, it also has elements of an “asymmetric trade” as a $9.99 gets you ticket to the dance where you can:
“Win it all!”
The target demographics are: 15 to 65 year old expert, intermediate and beginner traders. The game has incredibly wide and global appeal due to the reasons stated in the context discussion above.
Revenue Model / Streams:
The Alpha Company will be the developer, marketer and distributor of the Alpha Trade game.
The company’s revenues would come from the following sources:
- Transaction Fees ($1 per trade);
The advertisers (and sponsors) could be institutions who are looking for new brokerage clients, or money/asset management clients, or high quality trading talent, or simply, for support within the buy-side community to meet their commercial and marketing objectives. The advertisers could be:
- Retail Brokerages
- Mutual Funds
- Investment Banks
- Universal & Retail Banks
- Money Management Firms
- Hedge Funds
- Financial Media (Bloomberg, Thomson Reuters, CNBC, Financial Times, Wall Street Journal, etc.).
In due time, additional revenues could be generated through:
- Licensing (for TV and Movie deals);
In order to initially generate “buzz” and comfort, a “floor” will have to be set for the minimum daily cash prize for the “Alpha Trade of the Day” prize. For example, a minimum of: $1000.
This $1000 cash prize will be one of the best marketing expenses in the initial phase of the Alpha Game’s launch.
In a steady state, this prize floor can be achieved by approximately 100 trades made by Alpha Traders in any trading session. Let us remember, each Alpha Trader is allowed to make unlimited number of trades in any given trading session.
Access & Distribution:
‘Alpha Trade’ will be available to anyone, anytime, anywhere through almost any device.
The game will be launched for the web interface and for Apple, Google-Android, and potentially, the Microsoft tablet/smart phone ecosystems.
Coverage & Ubiquity:
There are three major trading sessions each day around the world:
Following are the asset classes that Alpha Traders could trade:
- Commodity Futures;
So, in effect, Alpha Traders could trade almost any time in these major liquid asset classes around the globe within any given 24-hour trading cycle.
Critical Success Factor(s):
- Alpha Traders to put on trades on a regular basis;
- The group of Alpha Traders to grow at a healthy pace.
Stock Wars is, perhaps, the only other tangentially similar competitor with a weak following where users are asked to develop portfolios not pick specific trades. Tradefields is another, even weaker competitor.
Product Extension / Scalability:
In Phase 1 of the game’s launch, there would be one “Alpha Trade of the Day” winner across the three different trading sessions (Asia-Pacific, Europe, and Americas) in a 24-hour cycle in one asset class: Stocks.
In Phase 2, there would be “Alpha Champions of the Day” winners across four different asset classes (Stocks, Commodity Futures and Currencies).
Eventually, Alpha Traders could choose to place trades for any of the following trading periods depending on their preferred time horizons across the four asset classes:
- Day Trading Period
- Weekly Trading Period
- Monthly Trading Period
- Quarterly Trading Period
- Annual Trading Period.
Key Uses of Funds:
- Product Development
- Advertising & Marketing
- Business Development & Strategic Alliances
Amount of Financing Required:
Gross Margins / Bottom line:
- Seed Round: TBD – better done in-house within Kapitall
- Series A, B, C, etc. Rounds: VC’s and Strategic Investors.
Potential Strategic Partners / Investors:
- Financial Information Providers: Bloomberg, Thomson Reuters, CNBC, Marketwatch, Google Finance, Yahoo! Finance, etc.
- Retail Brokerages: Interactive Brokers, Schwab, Fidelity, TD Ameritrade, ETrade, etc.
- Gaming Companies: Zynga, Sony, Microsoft, Electronic Arts, Activision Blizzard, etc.
- Acquisition or IPO within a 3-year window.
Alpha Trade has the speculative immediacy of a daily opportunity “to win” and “to win big.”
There is a sense of tension, timing and momentum investing on the day trading contests.
There is a greater sense of skill, independent thinking, and value investing baked into the quarterly and yearly trading contests.
There is a bit of both on the weekly and monthly trading contests.
There is something for all stripes of investors.
As the winning amount of cold, hard cash is unknown on any given trading session, there is a sense of mystery, adventure and attraction for Alpha Traders to keep coming back to the game.
On the other hand, there is a minimum “floor” for the cash prize.
Notably, most games in the online world take people’s real money for them to buy virtual goods, and it ends there.
In the Alpha Game, you stand to get more – much more – back in real money.
So, the Alpha Game will be unique, trend-setting, game-changing (pun intended), and to use a 90’s dot com word, a “sticky” one.
Day in and day out…around the world…over the years.
With a view to informing the readers of this blog of value (and sometimes, ‘deep value’) investment opportunities on a regular basis, I am launching this blog-stream that will offer up a few specific investment ideas.
Before I get into specific names, let me define ‘value’ as I see it. There are certain metrics which — either in combination or on their own – will qualify specific investments as deep value in my view:
1. P-E Ratio: Any equity trading less than P-E ratio of 10 or less.
2. 52-Week Trading Range: Any equity that trades within 25% of its 52-week low (in combination with the other metrics).
3. Dividend Yield: Any company that offers a Dividend Yield of more than 3% (in combination with the other metrics).
4. Positive Cashflow Entity’s Negative Event-driven Moves: Any cashflow positive company with net margins of 10% or more whose equity has seen more than a 20% price reversal within a week (in combination with the other metrics). Such equities are particularly well-suited for tactical, opportunistic, event-driven ’snap-back’ trades.
Now that we’ve defined ‘value,’ let us move on to the first edition of ‘value’ recommendations. In this edition, I would like to cover a few mining stories:
1. Vale (NYSE: VALE):
- The world’s largest iron ore producer trades at a modest P-E multiple of less than 6.0
- This Brazilian miner offers a generous dividend yield of 5.1%
- The stock is currently trading roughly 15% above its 52-week lows
2. Anglo American (PINK: AAUKY)
- This large, diversified global miner trades at a P-E multiple of a little over 7.5
- It trades within roughly 20% of its 52-week lows
3. Cliffs Natural Resources (NYSE: CLF)
- This American-headquartered miner trades on a multiple that is a little over 6.0
- It offers a healthy dividend yield of 3.5%
4. Barrick Gold (NYSE: ABX)
- The world’s largest gold producer trades on P-E of just over 9.0
- The stock is trading within 5% of its 52-week lows
5. BHP Billiton – ADR (NYSE: BHP / NYSE: BBL)
- The world’s largest miner trades both its ADR’s on NYSE below P-E multiples of 8.5
- Both of the company’s ADR’s provide a dividend yield higher 3%
In the coming weeks and months, more such ‘deep value’ investing ideas are to follow.
Barrick Gold: World’s Largest Gold Miner and Producer
With 140 million ounces of proven and probable gold reserves and 7.8 million ounces of gold production, Barrick Gold (NYSE: ABX) (TSE: ABX) is simply the world’s largest gold exploration and production company.
Much has been said about gold as a prime “haven” asset to protect against the global macro-economic and geo-political vicissitudes of our times. With its size, experience, expertise and resources, Barrick Gold is positioned extraordinarily well to capitalize on this theme of gold reigning supreme on world markets on a secular basis.
As of December 31, 2010, the company also held 6.5 billion pounds of copper reserves and 1.07 billion ounces of silver contained within gold reserves. In July, 2011, “Barrick acquired Equinox Minerals which adds a further 4.5 billion pounds of copper reserves from the Lumwana mine and 1.2 billion pounds of copper reserves from the Jabal Sayid project.”
To cite a few highlights from Barrick’s 2010 annual report:
- Record adjusted net income from $1.81 billion in 2009 to $3.28 billion in 2010
- Record adjusted operating cashflow from $2.90 billion in 2009 to $4.78 billion in 2010
- Increased dividend by 20% from $0.4/share in 2009 to $0.44/share in 2010
- Record realized price of gold from $985 per ounce in 2009 to $1,228 per ounce in 2010
- Industry’s only ‘A’ credit rating.
When it comes to profitability, using 2010 figures, Barrick generated operating margins of 42.1% and net margins of 29.4% — numbers that would be the envy of companies in any industry – including the basic materials sector. In 2011, the company’s performance has further improved. Its gold margins on a net cash cost basis have improved by an impressive 32% from a Q1, 2010 figure of $821/oz. to Q1, 2011 figure of $1081/oz. The company’s realized gold price has improved year-over-year by 25% from $1,114/oz in Q1, 2010 to 1,389/oz in Q1, 2011.
Infact, as we speak, Barrick’s Q2 results have shown a further improvement in net margins of another 500 basis points over last year’s results in a markedly slowing global economy.
While, at approximately $1800 an ounce, a section of the investment community may argue that gold is a “crowded trade.” On an inflation-adjusted basis, however, the precious metal needs to climb up to US$ 2300 to 2500 per troy ounce before it even reaches its all-time highs. So, at circa $1800/oz., we are nowhere near gold’s all-time peak yet.
Barrick Gold, at 13 times last year’s earnings per share, is still reasonably priced for being the world’s largest miner and producer of – arguably – the world’s most sought after commodity at the present time. So much so that, despite having better fundamentals than its competitors across a variety of metrics, the stock trades at a healthy discount vis-à-vis its peer group (except Newmont Mining which trades modestly lower than Barrick at 12.9 times trailing earnings; please read my previous post on Newmont Mining: here).
Here are a few valuation data for Barrick vis-à-vis its peer group:
Looking at the above P-E multiples, Barrick is trading at roughly half to one-quarter less than its smaller rivals such as Goldcorp, AngloGold Ashanti and Kinross Gold. On Price-to-Book and Price-to-Sales metrics, Barrick places well in the middle of the rankings versus its peers.
According to Ford Investment Research: “…Barrick Gold Corp.’s earnings have increased from $2.90 to an estimated $4.32 over the past 5 quarters, they have shown strong acceleration in quarterly growth rates when adjusted for the volatility of earnings. This indicates an improvement in future earnings growth may occur.”
What this also means is a positive momentum in the stock price of the company.
Crucially, from a shareholder’s perspective, the company improved its Return-on-Equity from 12% in 2009 to 19% in 2010.
Switching gears to industry challenges: One of the biggest issues facing the precious metals industry is the ability to replenish its reserves. Barrick Gold has done an admirable job in this department. In the company’s President & CEO – Aaron Regent’s words: “The Company has consistently replaced its reserves in each of the last five years, and we did so again in 2010. Gold reserves now stand at about 140 million ounces, the largest in the industry. In addition, measured and indicated gold resources grew 24% to 76 million ounces and inferred gold resources increased by 18% to 37 million ounces. Complementing our gold reserves and resources are 6.5 billion pounds of copper reserves, 13.0 billion pounds of measured and indicated copper resources and 9.1 billion pounds of inferred copper resources, plus 1.1 billion ounces of silver contained within gold reserves.”
So, one can safely assert that Barrick is doing a competent (if not a stellar) job in replenishing its reserves in a fiercely competitive, capital-intensive environment where transformational discoveries of new mines is more an exception than a norm.
What also, often goes, unnoticed is Barrick’s significant presence in the global copper market. While 4/5th of Barrick’s revenue contribution comes from gold, roughly 20% of its top-line comes emanates from copper sales. In a rapidly urbanizing world – particularly among the growth economies of Asia, Middle East and Latin America – copper will continue to enjoy robust demand across myriad industries from infrastructure to construction to electrical equipment, among others. Game-changing copper reserves, on the other hand, have not come online for a significant period of time. Hence, outlook for copper is bullish beyond the short-to-medium term window while the Eurozone sorts out its sovereign debt issues and the emerging economies take a breather from a decade long spate of high single-digit GDP growth.
In a period fraught with geo-political unrest in many parts of the world, Barrick enjoys a distinct advantage over other miners by having majority of its reserves and production capabilities located in politically stable parts of North America, Latin America and Australia/Pacific. Furthermore, its geographic presence is well-diversified to hedge against concentration risk as well as from a potential fall-out from “nationalization” of mining assets in any one part of the world.
Looking out into the future, the company is aiming for a gold production target of 9 million troy ounces by 2015. Assuming such production growth occurs on a linear basis, this target represents a modest increase of 300,000 ounces a year from its current level of 7.8 million ounces. The company is not resting on its laurels either; in order to continually strengthen its pipeline of reserves, Barrick’s 2011 exploration budget has increased to $320-$340 million.
Ultimately, Barrick trades in commodities that provide tangible sources of stability and security on the one hand (gold) and growth and development on the other (copper). So, whether one is bullish or bearish on the outlook for the global economy, at less than $50 a share, the stock is a “Buy” over the next 6 to 12 months.
Sources: Barrick Gold, Ford Investment Research, Google Finance.
Images Courtesy: Barrick Gold.
Brokerage: TD Ameritrade & Interactive Brokers.
Disclosure: The author plans to initiate a long position in the company’s stock within the next month. All data has been sourced from publicly-available sources.
What gold producer sells at 2 times book value?
Which global miner has the lowest beta among its peer group?
Which resources company trades lower than 12 times its earnings?
Newmont Mining — a Gold and Copper exploration and production company with mining operations spanning five continents around the world with “proven and probable gold reserves of 93.5 million attributable ounces, copper reserves of 9.4 billion attributable pounds” and an aggregate land position of approximately 27,458 square miles (71,118 square kilometers).
In 2010, the company had attributable gold sales of 5.4 million ounces and equity copper sales of 327 million pounds. Its recent acquisition of the Conga Project in Peru and Tanami Shaft Project in Australia will be adding “400,000 attributable ounces of gold and up to 100 million pounds of copper production per year” by 2015.
According to Newmont’s website, these were but a few highlights from the company’s performance in 2010:
- Record revenues of $9.5 billion, up 24% from 2009;
- Record net cash from continuing operations of $3.2 billion, up 109% from 2009;
- Gold operating margin increased 30% from 2009 on an average realized gold price increase of 25%.
Pick any one of those highlights and one can assume that the company being discussed is a growth company (with a momentum stock).
The stock, however, has been trading in a fairly narrow 52-week range of $50.05 and $65.50 with a P-E multiple that is more reflective of a value stock.
Is there a reason why it should not break out above its upper limit of the trading range?
According to Vickers Stock Research: “NEM pays an annual dividend of $1.20 which, at its current stock price, produces a yield of 2.16%. This is the largest of any company in the Gold & Silver industry, where the average yield is 1.56%…”
According to a company press release: “The third quarter 2011 dividend of $.30 per share (a 50% increase over $.20 per share for Q2, 2011) was declared in consideration of Newmont’s second quarter 2011 average realized gold sales price of $1,501 an ounce .”
In contrast, the company’s 2010 Gold Operating Margin is $737/oz.
At the time of writing this piece in late July, 2011, Gold has crossed the $1600 per ounce mark and is trading comfortably above that level. In a “risk-off” environment, when Gold keeps breaching its all-time highs on a regular basis, Newmont Mining (one of the largest Gold producers) deserves to enjoy a little more buoyancy in its stock than what it has experienced in the recent past. On the one hand, given its exposure to gold production, Newmont is poised to gain in a continued period of “risk-off,” de-leveraging global economy where fiat currencies are being debased across several major jurisdictions. On the other hand, even in a “risk-on” environment when Copper demand begins to soar again thanks to expansionary tailwinds in a rapidly urbanizing global economy, Newmont — being one of the largest copper producers in the world — is positioned to perform exceedingly well as a “long Copper” play.
At an operating margin of over 42% and a net profit margin of approximately 32%, Newmont is one of the most profitable minerals and metals producers — large or small — in the world. The miner enjoys gross margins that are more than 10% higher than its peer group. Furthermore, Newmont is sitting on cash and cash equivalents of more than $4 billion within an asset base of $25.7 billion.
Over the last 5 years, the company’s Earnings per Share (EPS) has grown a staggering 49.41%.
At a P-E ratio that is higher only to Freeport-McMoRan (FCX) within its peer group, Newmont is a “value” stock in a growth sector.
Kinross Gold (KGC), for example, trades at a healthy 16.37 its earnings and Goldcorp (GG) trades at almost twice as much as Newmont at a P-E multiple of 22.13. By the time one gets to AngloGold Ashanti (AU), one is looking at an unbelievable P-E multiple of 105.85.
Whether you look at Return-on-equity or Return-on-assets, Newmont ranks among the top 3 of its peer group.
Here’s a tale of relative value analysis that is as stark as it gets for companies that are delivering virtually identical numbers: The company that Newmont resembles most in terms of gross revenues, net profits, net profit margins, and a whole host of other metrics is Barrick Gold (ABX).
Exhibit 1: Profitability
Net profit margin
Here’s a rhetorical question: Which company is more profitable?
Exhibit 2: Debt
Long-term debt to assets
Total debt to assets
Long-term debt to equity
Total debt to equity
Which of these two companies is less indebted?
Exhibit 3: Returns
Return on avg assets
Return on avg equity
Return on investment
Again, which company provides a higher return?
Exhibit 4: Pricing
Finally, let us look at the all important metric of reserves:
As of December 31, 2010, Newmont had “proven and probable gold reserves of 93.5 million attributable ounces, copper reserves of 9.4 billion attributable pounds.” Barrick, on the other hand, had “140 million ounces of proven and probable gold reserves. In addition, Barrick has 6.5 billion pounds of copper reserves and 1.07 billion ounces of silver contained within gold reserves.”
Barrick has roughly 50% more gold reserves — which admittedly would allow it to command a premium over Newmont based purely on the metric of gold reserves. Gold, however, is not the complete story. When it comes to copper reserves, Newmont Mining has roughly 1/3rd more than Barrick Gold.
In a certain snapshot in time, if we consider valuations based purely on gold reserves (and silver within it), Barrick should be roughly 50% more valuable as a company. That said, given that Newmont has a third more copper than Barrick, it would recoup approximately 7.5% of the value back (adjusting for the price of copper vis-a-vis gold).
Here’s the clincher: With all these metrics where Newmont beats Barrick Gold consistently (except in the key metric of gold reserves), guess which company is more valuable (as of late July 2011)?
It is Barrick Gold at $47.54 billion.
And, what’s Newmont Mining’s market cap?
So, the market is placing 75% more value on Barrick Gold than it does on Newmont Mining. It is established, however, that even when considering mining reserves as a sole determinant of value, Barrick is a little over 40% more valuable than Newmont.
So, which company would you pick based on the above valuations? What company’s stock would have greater upside potential?
In conclusion, one can’t help but wonder: Is Newmont undervalued…by as much as 35% or more?
Seth Klarman: How’s that for margin of safety?
Michael Burry: Is this enough of a value stock for you?
Need one say (or question) more.
Sources: Reuters, Google Finance, Vickers Stock Research, Cooper Financial Research, Barrick Gold, Newmont Mining.
Disclosure: The author owns a long position in the company. All data has been sourced from publicly-available sources.