This week I am taking a closer look at FTSE 100 constituent Rio Tinto, which is a leading global mining company that has been in business for 140 years. Geographically, its key assets are in Australia and North America, but it also has significant businesses in Asia, Europe, Africa and South America. By revenue, the biggest contributors are Iron Ore (c.51%), Aluminium (c.20%), Copper (c.11%) and Coal (c.10%). By profit, though, the relatively high margin iron ore business leads to it contributing roughly 75% of group profits at present. As such, iron ore pricing expectations are a key driver of the share price. Indeed, valuations of mining companies are highly sensitised to long-term commodity price estimates and according to one analyst every $5/t adjustment to long term iron ore pricing moves the Rio valuation by 400p.
So what is the outlook for iron ore? Current prices are around $140/tonne but the consensual opinion is that prices will drop to under $100/tonne over the next 3 years as a result of oversupply (375Mtpa of new iron ore capacity are expected to enter the market over this period). On the demand side it is unsurprisingly China that dominates, accounting for over 50% of global iron ore demand for its steel production. However, whilst Chinese steel production is currently growing at around 4%pa it is thought that it could turn flat by the end of the decade if scrap steel generation rises and demand growth tails off.
It can safely be said, then, that the outlook for pricing is fairly gloomy. From an investment standpoint, though, the more important aspect is the extent of any decline and the industry’s ability to mitigate it through revised growth plans. If one believes current projections are overly pessimistic then a value opportunity may exist.
In the latest edition of the NW Brown Newsletter, we focus on various aspects of the activities undertaken by NW Brown on behalf of our clients, but does so from a slightly different view point – that of how do we respond to someone who asks about our impact on the environment..
This week Oliver Phillips focuses on China’s Third Plenum…
Points of View: China’s Third Plenum
Last month China held the Third Plenum of the 18th Chinese Communist Party Congress. Third Plenums refer to the third time new leaders of China lead a plenary session of the Central Committee (a who’s who of China’s most influential Communist Party officials). They generally take place a year after new leaders take office, after they have established their power base, and are renowned for being used to announce major reforms. Indeed, previous Third Plenums have had a major impact on not only China’s development, but the global economy as a whole.
So what has been announced this time? After a typically short announcement at its conclusion, details have been gradually emerging over the course of the month. A key thrust seems to be that free markets will play a bigger role. In particular, the role of the market in resource allocation has been upgraded to “decisive” from “basic”, and the “push for domestic reforms though further opening-up” has been reiterated. China’s long-standing “one child” family planning policy has also come under the spot-light of reform. A few days after the plenum it was announced that the policy is to be loosened; something that should come as no surprise given the unfavorable demographic profile it is set to create (a low birth rate combined with increased longevity eventually leads to a dramatic ageing of the population). It is conservatively estimated that the birth rate will grow from 16m to 18m births a year as a result.
Overall the reforms announced to date seem to be broadly positive and a genuine attempt to rebalance and reform. Still, the emphasis on continued public ownership suggests the process will be a gradual one at best.
This week Oliver Phillips focuses on Tate & Lyle….
Stocks in Focus: Tate & Lyle
This week I am taking a closer look at Tate & Lyle. Most people still recognise the Tate & Lyle brand from packets of sugar in the supermarket. However, the company severed its historic links with the sugar industry, which stretched back more than 130 years, after agreeing to sell its European refining business to a US firm in 2011. The £211m sale to American Sugar Refining (ASR) included Tate’s Golden Syrup factory in London as well as a perpetual worldwide license to use the famous brand name.
These days the company focuses on producing a number of other ingredients such as sweeteners and low-sodium salt alternatives. Specifically, the business is split into two sections: Bulk Ingredients (BI) and Speciality Food Ingredients (SFI), which account for 45% and 55% of operating profit respectively. Bulk ingredients such as high-fructose corn syrup and bioethanol are widely produced and therefore compete on price, meaning margins are low. In contrast, speciality food ingredients such as SPLENDA Sucralose and SODA-LO low sodium salt alternative are usually patented products that attract much higher margins.
Going forward the company is focused on growing the innovative, higher margin SFI part of the business using cash generated from the BI business. As part of this strategy the company recently opened a new food innovation centre in Chicago aimed at designing and developing new food and beverage products that meet the increasing consumer demand for health, convenience, value and taste. Indeed, it has grand aims to be the leading global provider of speciality food ingredients and solutions. This won’t happen overnight but does seem a sensible long term strategy given “globesity” trends that are driving demand for healthier and more natural food ingredients.
Although it may be the world’s biggest economy, the U.S. also comes with massive debt levels. With a good credit worthiness, getting more finance is not normally a problem, however, they have a constitutionally enforced debt ceiling in place. Back in July 2011 we saw the debt ceiling increase to $16.699 Trillion. More importantly however was that this was the first time in recent memory that this increase was hard fought, due to the problematic power sharing between the Republican and Democrat parties. As of May 2013 however, this debt limit was once again reached and until October, the U.S. was financing its debt through “extra-ordinary measures”. Once this had been exhausted, serious talks were necessary in order to raise the debt ceiling. Eventually, an 11th hour agreement was reached in October to raise the ceiling enough to keep paying its debtors for the next few months, but not without Congress trying to use the negotiations to bring in other financial changes. In particular, a number of members of the opposition Republican party were fighting for president Obama’s “Obamacare” to be delayed or scrapped. Whilst this didn’t happen, it is certainly an issue that will come up in the next round of discussions in January and February. It is widely anticipated that a longer term debt ceiling will be implemented, but the consequences of a technical default on its debt, should a deal not be reached, could send one of the largest shockwaves in living memory through the financial markets.