By Chris Berry
- With evaluation of junior resource companies challenging using discounted cash flow models, an alternative approach to understanding the various market sectors is a must.
I have written a great deal in the past about the benefits to be gained from listening to earnings calls from commodity and materials producers.
You must "read between the lines" of what is said and written, but statements made by CEOs and CFOs of large cap companies can offer insights into the strengths and weaknesses of various markets. This can only help with your analysis.
- Today, I offer some of the insights I'll be looking for when listening to select calls this week and next. I also offer a list of companies whose calls I will be dialing into.
The Keys at This Stage of the Cycle
While it was a solid first quarter for most commodities and the companies involved in exploration, development, and production, it remains to be seen if this momentum can continue in the face of a developed world that is struggling to achieve “escape velocity”. Add to this an emerging world that, according to the Financial Times, is threatening to see recent gains in quality of life fall backwards due to slower growth and it’s arguably a surprise that commodities have achieved any gains at all.
It’s not really debatable that a major producer of a commodity or material (like Rockwood Holdings (ROC:NYSE) for lithium or Mosaic (MOS:NYSE) for fertilizers) will have a solid grasp of the supply and demand dynamics of its markets. Because of this, I have advised listening to quarterly earnings calls as extremely beneficial exercises. The analysis of these company executives may not always be correct, but it does offer additional data to use when conducting your own due diligence about a commodity, market sector, or junior resource play.
Given the challenging near-term picture of the global economy, one of the first items I’m interested in hearing about is the complexion of growth. Specifically, what is the breakdown by percentage of a company’s growth between the developed world and the emerging world? In recent years, this ratio has been tilted towards the emerging world thanks to lower labor costs and a growing consumer class, so given this dynamic, I am particularly interested to see if these ratios are changing dramatically (or at all). If they are changing, it can offer you an idea of the relative health or weakness in a given economy or part of the world. With China altering its growth model towards increased internal consumption, I will want to hear insights on demand from the country and whether or not it has slowed or faltered substantially. With China as the major importer of dozens of commodities, a slowdown here could continue the malaise the junior resource sector finds itself in.
Second, I will be listening for a discussion of raw materials prices. Input prices matter to the bottom line and if those prices are rising it remains to be seen whether or not higher costs can be passed on to consumers. This is not the same dynamic with junior mining companies where higher raw material prices (for rare earths or phosphate, for example) are looked upon favorably as they can add leverage to a share price as project economics strengthen.
Third, I will be listening for a discussion of capital expansion plans – specifically increases in capital expenditure. A company re-investing in its business through increased capital expenditures is one of several ways to increase shareholder returns. What is worrisome is that this phenomenon has taken a break since the Great Recession. Companies, awash in cheap credit, would rather buy back shares or increase dividend payments to shareholders. These tactics have their merits, but do not build long-term value. Additionally, if a company is not investing in its future by increasing capital expenditures, this infers a subdued outlook on growth – not what junior resource plays want to see.
We have seen recent off take agreements announced in the graphite sector and tolling agreements in the rare earth sector however and these are good early signs of a recovery, but not an identifiable turn.
Fourth, with interest rates at historic lows, I’ll be watching for a discussion of a company’s debt load and the ability to service the debt. In stark contrast to the junior resource sector, optimal debt on the balance sheet of a commodity or materials producer is not a bad thing. One could argue that debt doesn’t matter as it allows for a company to optimize the capital structure by lowering the cost of capital through tax deductions. What is crucial is the ability to service the debt. A company's ability to service debt rather than roll it over or restructure it implies a healthy business and sector. In a deflation, however, debt works against the debtor.
Finally, I will be interested in a discussion of cash flow growth rather than earnings growth. Earnings can be massaged or manipulated, cash flow cannot. Growth in Free Cash Flow offers, I believe, a clear window into the sustainability of a business and the overall growth prospects in a given industry. A growing industry implies that there is room for additional capacity – typically supplied by junior resource companies.
There are a handful of other items I’ll be listening for including the impact of currency swings and growth in markets aside from China. However, the ones listed above offer the clearest sense of the current state of the metals and minerals markets.
Upcoming Industrial Metals Earnings Calls
This is by no means a complete list, but I will be listening to each of these in due course as they offer insights into many of the energy metals or minerals I follow. I expect this list to grow as more earnings call announcements are set:
Wednesday April 23, 2014 – 11:00 am EST – Johnson Controls (JCI:NYSE)
Wednesday April 23, 2014 – 11:00 am EST – W.R. Grace & Co. (GRA:NYSE)
Thursday April 24, 2014 – 2:00 pm EST- GrafTech International (GTI:NYSE)
Tuesday April 29, 2014 – 1:00 pm EST – Cameco (CCO:NYSE, CCJ:TSX)
Wednesday April 30, 2014 – 11:00 am EST – Exelon (EXC:NYSE)
Wednesday May 7, 2014 – 9:30 am EST – Agrium (AGU:NYSE, AGU:TSX)
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