Riding the cycles
Takeaways: With Hellenic worries on the back burner, equity markets have flirted with new highs. However, geopolitical machinations continue to provide reality checks and Greece will be back – soon. The commodities sector is obviously still coming to terms with new economic realities. M&A activity dipped in metals and mining again in 2014; but deals should be part of the restructuring armoury as the sector gears for recovery. Elsewhere, the imperative to transact remains strong and activity remains buoyant. The opportunities presented by diverging economies and monetary policies are also coming to fruition, as the euro and Eurozone yields fall and US companies arbitrage. Companies can make hay in this low yield environment; but there are signs of high yield disquiet – in words, rather than volumes.
I’ll be back….
Greece lives another euro day. Four months is no time at all. Time enough, perhaps, for the new government to prove their mettle and win back the trust needed for a more fruitful creditor relationships. But, it won’t be easy. Greece has some hefty payments to make in the next few months and uncertainty has hit growth – and tax collection. The ‘new’ deal is hard sell politically too. Cracks could become chasms if the next new deal isn’t….’newer’.
Recent Troika actions suggest it’s becoming amenable to an easing of Greece’s austerity programme. The EC didn’t punish France or Italy this week for missing its debt targets. The IMF has already admitted it’s been a bit harsh. The ECB really wants to encourage growth. However, the latest negotiations have exposed debt restructuring as the Troika and Eurogroup’s Rubicon. On this basis, the chance of Greece leaving the euro is arguably only slightly diminished.
But it’s not happening now and this, it seems, is enough to propel equity markets to new highs – even if Janet Yellen seemed a mite less patient on interest rates. Elsewhere, the global game of geopolitical wack-a-mole continues, providing the potential for market shudders. Recent ratings agency actions on Russia and its banks highlight a growing concern over diminishing reserves, sinking growth and bad loans – potentially rising to 17-25% this year, according to S&P. The rouble has rallied on $60 barrel oil, but this provides only limited relief – and Russia’s economy was dipping before oil prices fell.
Where next for the commodity sector?
A trillion dollar question if ever there was one. The recent oil price rally appears limited – albeit with lingering uncertainties around further intervention. The metals and mining sector would appear to be more closely correlated to economic cycles, which gives hope for 2015 – although it’s never that simple an equation.
Global growth looks set hit its highest level since 2011 this year; but numbers only tell part of the story – type and location matters. The metals and mining sector is still working through the impact of China’s relatively abrupt macroeconomic rebalancing, which has left a legacy of oversupply. Faster US growth raises the prospect of higher interest rates in stark contrast with most of the rest of the world, thus adding to emerging market uncertainty and dollar strength – which naturally pushes commodity prices lower. The length of the last cycle also means many management teams have only dim memories of managing in such a challenging environment.
Platinum has come under particular pressure with prices hitting their lowest level since 2009 this week. The sector is effectively in supply deficit, however a large above ground accumulation of platinum continues to dampen prices. The level of oversupply is highlighted by a 11% fall in prices during 2014 – a fall that came in spite of a five month closure of South African mines, source of 80% of global production. This overhang appear to be diminishing – with some uncertainty around amounts held and recycling levels – however market sentiment remains cautious. Use in diesel autocatalysts accounts for about 40% of demand. This is a market that is growing now, but whose outlook is clouded by an end to India’s diesel subsidy and expectations of a long-term phase out of diesel cars in Europe. In response to these pressures, mines are closing; however at current prices more than half of the platinum mining industry is expected to make a loss after maintenance capital expenditure, according to JPMorgan.
Elsewhere, such as in base metals, the bottom may be closer – but the bounce will be modest. Cuts will continue across the board – as per Glencore’s coal announcement yesterday.
Given these challenges we’d expect transactions to be part of mining companies’ armoury – as they are increasingly in oil and gas – as businesses position themselves for the next stage in the cycle. However, our research shows that deal activity fell for the fourth consecutive year in 2014, with risk aversion and capital discipline continuing to stymy capital availability and expenditure. The sector is at a crossroads. The question remains as to when the major producers will have both the confidence and permission to invest in the next wave of growth. We believe standing still is not an option, and companies face the challenge of building portfolios that can best cope with volatility and take advantage of the opportunities it presents. Buy, build or return? We explore these questions in “Mergers, acquisitions and capital raising in mining and metals”
The beat goes on….
Greek crisis, what crisis? European equity issuance has enjoyed record-breaking start to the year, leading global activity for the first time since 2005, according to Dealogic. The UK IPO market has also woken up again. Although, valuations have been muted, leaving the door open for other buyers, with more than lip service being given to a ‘dual track’ process. Note KKR’s swoop to buy Trainline, previously on an IPO track.
Whilst it would perhaps be pushing it to say we’re in a ‘sweet spot’, there is a strong imperative and increasing ability to do deals. There is enough growth to inspire increasing confidence, but companies are still looking for an extra boost from additional market share or geographical diversity. The need to take out cost, due to sector adversity, or to assimilate new technologies is also driving companies to transact. In terms of firepower, European buyout firms now have just under $300bn (€265bn) of ‘dry powder’, according to Preqin, whilst US private equity has $685bn ready to be put to work – a historic high.
Meanwhile, European debt markets are looking exceptionally favourable as the divergence opportunity we highlighted last year comes to fruition. The promise of ECB QE – and ‘negative inflation’ – has pushed Eurozone sovereign yields to record lows. This week Germany sold five year bonds with a negative yield for the first time and Ireland’s ten year bond is trading below 1%. This is pushing investors into other parts of the Euro debt market and US companies are starting to take advantage of the low yields and weakness of the euro against the dollar. Sales by US borrowers in Europe so far in 2015 are $16.5bn, according to Dealogic- compared with $50bn last year. We expect an increasing amount of cross-border activity as this divergence becomes more marked.
US bond sales into Europe are in investment grade, but again as demand rises and yields fall at this end of the market, investors are being pushed along the curve….where there is some disquiet. A group of Europe’s biggest money managers have written a letter to bankers bemoaning slipping standards – as they did in 2011 on similar lines. Thus far concerns are being expressed in words, not volumes. Sales of European high-yield bonds are at record highs, although it’s never a market to be taken for granted.