Philip O'Sullivan's Market Musings

Financial analysis from Dublin, Ireland

Market Musings 7/6/2012

with 2 comments

Markets have been extremely volatile in recent days due to a combination of ratings agency downgrades, dodgy economic signs and a view by some investors (this one included) that the worse things get from a macro perspective, the more likely it will be that Central Banks introduce further quantitative easing.

 

This brings to mind something that I have been meaning to mention for a while – I often get queries from people about “what my X month price target for XYZ stock is”. The simple truth is that nobody, except perhaps a market maker in the most illiquid of stocks, has a clue about what price a stock will be trading at tomorrow, let alone in a few months. In a world where we cannot rely on meteorologists to call tomorrow’s weather with 100% accuracy, it would be ill-advised to have that degree of confidence in someone who pontificates on the equity markets! For the record, whenever I express a ‘price target’ for a company, this is my estimate of the underlying equity value of the company, as opposed to a target I see it hitting in any specific timeframe. This is especially true in the current environment, where markets oscillate violently between ‘risk-on’ and ‘risk-off’. All I can do is stick to my central thesis for this year, which I wrote back in December, and which I see no reason to change, given how my thesis, shown below, has played out so far:

 

Looking ahead to [2012], I see no grounds to assume that the macro situation will be materially different to that which we saw in 2011. Sclerotic growth across the leading Western economies, limited credit availability, rising unemployment, political uncertainty and austerity are all likely to be key themes over the coming 12 months. Added to the mix is likely to be a pronounced deterioration in the Chinese economy. I am gravely concerned at the rise in economic nationalism and see further policy incoherence at a European level as countries pull in different directions. However, my sense is that the euro will survive, given that its failure would lead to a deep and prolonged depression on a scale not seen for close to a century. That said, its survival will come at the expense of a weaker euro as monetary policy here is loosened to ensure its survival (given the lack of political consensus on how to fix the issue, I don’t see a solution that doesn’t involve some form of quantitative easing).

 

For me there are five key tactics to mitigate against this pressure:

 

  1. Choose firms with strong balance sheets
  2. Choose defensives over cyclicals
  3. Choose firms with significant exposure to markets outside of the Eurozone
  4. Hedge against inflationary pressures / political risk
  5. Choose firms with attractive and well-covered dividends.

 

Moving on to corporate news, Dragon Oil, which I traded in-and-out of earlier this year, announced a $200m share buyback. Opinions vary on this move. Steve Markus, who I have great respect for, and who is a must-follow on Twitter, said he: “would rather have the cash!” I wonder if more shareholder value would have been delivered had Dragon cast an eye at some of the financially constrained smallcaps (particularly some of the ones you can find on AIM) that are trading at bargain basement prices. Another Irish listed oil stock, Tullow Oil, reported a chunky (31m of net pay) oil find offshore Côte d’Ivoire.

 

(Disclaimer: I am a shareholder in Ryanair plc) We had a lot of news from the airline sector. Aer Lingus released its latest traffic statistics this morning. These were unambiguously good numbers, with load factors +2.9ppt and flown passengers +2.4ppt. I was particularly impressed by the 12.7% rise in long-haul (transatlantic) passengers, a factor of the 10.5% increase in RPKs. Another Irish airline reporting a rise in passenger numbers was Ryanair, which revealed a 5% yoy increase to 7.51m in May, bringing Ryanair’s total number of passengers carried over the past 12 months to 76.6m.

 

In other airline sector news, it was reported today that Kerry Airport’s revenues fell 40% last year. Credit is due to local management, who, demonstrating the county’s well-earned (I may be showing my Cork bias here!) reputation for parsimony cut administration costs by an admirable 35% in response.  Some months ago I wrote of the need for airports in the south and west of Ireland to consolidate, and even after the government’s decision to cease funding for Galway and Sligo Airports I wonder if they’ll be the last to see their government support pulled. Indeed, in this regard I was interested to also read today that Spain is to at least partially close 30 of its 47 State run airports.

 

In the construction space, Grafton put Irish DIY chain Atlantic Homecare into examinership. This is a smart move by management as it should allow it to close underperforming stores and save on the rent bill.

 

(Disclaimer: I am a shareholder in France Telecom plc and Independent News & Media plc) In the TMT sector, France Telecom’s unions were unsuccessful in their moves to force a dividend cut. However, I fear that this may prove to be round one in this battle, given the potential for increased political interference in the company, a concern I’ve previously noted.  In other TMT sector news, it was confirmed that Dermot Desmond has increased his stake in Independent News & Media ahead of tomorrow’s AGM. With yet another INM non-exec confirming their resignation, it will be interesting to see what new faces are co-opted to fill the gaps on the board after a wave of recent departures.

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Written by Philip O'Sullivan

June 7, 2012 at 7:38 pm

2 Responses

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  1. Hi Philip. Very kind of you to mention me in such a flattering light! Agree with everything you say above, especially with regard to sticking to your original thesis.

    Steve Markus

    June 7, 2012 at 7:59 pm


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