A World That Seems a Lot Smaller

Over the past week or so I 've been ploughing my way through the Barclay's Equity Gilt Study 2008. This Study is produced annually and presents a detailed discussion of the long-term returns available on financial assets. I was only really interested in the first two chapters on the economic background.

The key message relates to natural resources which, due to an increasing population and improving living standards, are being depleted at an accelerating pace. Looking ahead it is simply not possible for developing nations to grow to the point where their per capita use of resources mirrors that of the developed world. For example if China and India were to match US oil per capita usage this would triple global oil consumption to some 24ombpd. Since it seems unlikely that we will ever be able to produce much more than the current rate of 85mbpd something very big has to give. Take copper: For Chinese and Indian copper consumption to rise to the average of the Asian developed countries then global copper output would also need to go up threefold.
Under any growth scenario therefore huge additional investment into resource and energy supply will be needed; all the "easy" stuff has gone. Resources are finite, and increasingly harder to extract and so this has inevitably lead to the resource price inflation now being experienced.

The rather worrying conclusion that the current low inflationary environment we have enjoyed in recent years is about to change. And there isn't anything we can do about it....

Dull like a Bank is Supposed to be

Sorry for all the reports on banks but since the financial market got into such a mess last year keeping a watch on the banks seems the best way to see if we are over the worst. Lloyds TSB reported today and almost surprised by the lack of bad news to talk about. Indeed from what I have seen so far the analysts haven't much to say about them either. Treasury writedowns from market "dislocation" were immaterial at only £280m. On the face of it that might seem a lot but would normally hardly be worth writing about compared to profits of £4bn. There were many positives including profits up, EPS +17% and 5% on the dividend.
Lloyds is mostly UK centric, having disposed of it's International Operations a few years ago, and seen as a somewhat low growth and dull business. But that is exactly how a bank is supposed to be. Lloyds has stuck to the traditional domestic banking market with a conservative business model e.g no direct exposure to US sub-prime, strong capital position and efficient funding. Now the number one provider of current accounts, cards and personal loans, management didn't have grand things to say about strategy other than serving customers better, maintaining relationships through the cycle, cross selling, controlling costs and maintaining quality of business. And good for them.
Interestingly Lloyds, with all their sophisticated analysis of customer spending patterns and systems to detect borrower stress, do not note any adverse trends. UK Retail loan impairments were down and there was a reduction in customer insolvencies. Recession? What Recession?
The dividend yield is now 7.8%. On that basis why put money in the bank when you can get a much better return from owning it!

BATM and VoIP

A couple of years ago I made a very unsual investment in a technology company called BATM. Unusual for me in that at the time they were loss making and I didn't really understand their product other that it was hardware to support VoIP (Voice over Internet Protocol) and I had an idea making free calls over the internet would prove very attractive. The interesting part was the company was full of cash so could easily support the R&D and sales effort needed. Today they reported exceptionally strong results for 2007, well ahead of estimates. Sales +32%, PBT +190%. The best bit is they are only just getting started with big contracts so there is lots more to come. My investment has now doubled and needless to say I've learned a lot more about VoIP! Bloomberg interview with CEO Zvi Maron

Alliance & Leicester - Business Model Broken

Yesterday Alliance & Leicester reported their 2007 results. I didn't watch all the presentations so these views are formed mostly from reading the announcement and the FT. Underlying everything profits were up slightly on 2006 but one third of this (some £185m) was then wiped out by losses and impairments on Treasury Investments. I was surprised to read that only 27% of group revenues come from mortgages and savings. Just what kind of (ex) Building Society is this? They clearly didn't stick to their knitting. A little over half of funding comes from retail deposits and management want to increase this proportion but not compete against rivals offering loss leaders. Having had to replace wholesale funding with much more expensive facilities A&L will scale back on new lending and profits will fall. So if they are not going to chase savings and lending business just what are they going to do? (other than wait to be bought).

Incidentally probably one of the best saving deals for a long time is still available from Northern Rock; 6.35% fixed interest for a year with no notice. And being owned by the government this is now the safest place to invest - as good as gilt edged. While stocks last.

The Resilience of Barclays

Barclays reported on their 2007 results today and I watched the webcast of the presentation and related interviews. After all the press speculation and turbulence through the latter half of the year management seemed reasonably happy to report profits which were flat on 2006 and, despite some hysterical prior speculation about shortage of capital, a Tier 1 ratio which was above target. As if to push back further against critics the dividend was increased by 10%.

It must be very hard for top management in a bank like Barclays being questioned by analysts from competing banks and whom, were they employed by your own bank, would be relatively junior executives many rungs down the ladder. Indeed from the questioning it seemed some do not really understand bank balance sheets very well, although Barclays are to be commended for improving their disclosure of the "unusual" assets currently giving rise to angst. Mind you they needed to. No longer do bank assets comprise simple loans to be analysed by industry and geography but the now infamous and eclectic collection of exposurers to ABS CDO, Sub-prime, Alt-A, Monoline Insurers, SIV, SIV-Lite and Structured investment vehicles.

OK the outlook is more uncertain (or at least this time we know we don't know whereas usually we don't know we don't know) but for a strong, diversified and multinational business (mainstream UK Banking is only 1/3rd of profits) the current P/E of 7.3 and yield of 6.9% seem likely to prove ridiculously low.

A Day for Share Buy Backs

From a quick piece of analysis I note that today 15 FTSE 100 companies announced they had bought back of some of their own shares: BT, Glaxo, Unilever, Diageo, Compass, Shell, BP, M&S, Reuters, Schroders, Whitbread, Legal & General, National Grid, Anglo American and Old Mutual. I own 4 of these. I have no historical analysis at all and have not looked deeper to analyse how many shares were bought in each case, but this looks to me like a fairly exceptional event for one day and a clear demonstration (across 15% of the largest UK listed companies) of strong corporate balance sheets coupled with low share prices. In the case of BT for example the yield is so high that there is a clear near term cashflow benefit from increasing borrowings to retire equity thereby saving on the dividend!

Searching for the Standard Life Expectancy

After my comments back in November (How To live Longer) increasing longevity has finally hit the front page. Many pension funds will suffer a further hit from changes to mortality assumptions now being proposed by regulators and this must surely finally mark the end of the defined benefit system.
Meanwhile Standard Life has done a great deal to offload over half of their £12bn pension annuity liability exposure to Canada Life International Re thereby significantly cutting the risks from increased longevity. Apparently this transaction also increases embedded value profits by some £100m a year, releases some cash and frees up capital. It sounds too good to be true. With that kind of deal to do so what if they lost out to buy Resolution - anyway as of today Pearl still haven't closed that deal. The paper profits I was showing on Standard Life post IPO have since evaporated but it is now trading well below embedded value. The institutions are still very underweight this stock so it should come back strongly once confidence returns.

Visibility and Certainty

Every so often I get a flash of inspiration as to what make a good "Buffett Style" investment. Today my idea can be encapsulated as "Visibility and Certainty". Take the example of National Grid which yesterday pretty much (as far as an company would be able) announced its dividends for the next 4 years through to 2012. This comprises a 15% increase for the current year and 8% thereafter. Also yesterday Shell did a similar thing by declaring it's dividend for Q1 2008 at 40c or 11% up on Q4 2007.
In the case of Shell analysts fuss about near term production declines and high capex, seemingly ignoring record profits, buy backs over the past 3 years totalling $17bn, over 8% of market cap and a strong longer term portfolio leading, in time, to production growth. I listened in to the Shell media and analyst conferences and noted a couple of interesting points:
Shell CEO Jeroen van der Veer has now made public his thoughts on medium term energy supply and stated again that he sees "easy" oil production (i.e. excluding oil sands and very deep water) peaking around 2015. To compete with the NOC's the best strategy is therefore to position the company with assets that perform better at high oil prices and build expertise in complex operating techniques. Oil will become more expensive but this will create an unbrella for alternatives to become more economic. On 2008 JvdV noted that the US comprises about 20% of global oil demand and even if there is some reduction as a result of the economic stuation, growth in the Middle East and Far East make it very likely that global demand for oil products for 2008 will, in any event, exceed that of 2007.