China's GDP And Infrastructure Spending Supports Construction Equipment And Raw Materials

From the Chinese National Bureau of Statistics (www.china.org.cn/business/2012-01/17/content_24426253.htm)

Chinese economy grew by 9.2 percent in 2011 from a year earlier, the National Bureau of Statistics (NBS) announced Tuesday.

GDP growth for the fourth quarter last year stood at 8.9 percent year on year, said the NBS. The quarterly growth was the slowest in 10 quarters. China has set the full-year growth target at 8 percent in early 2011, after its economy grew 10.3 percent in 2010.

The country's economy expanded 2 percent in the fourth quarter on a quarterly basis, NBS chief Ma Jiantang said at a press conference.

According to preliminary statistics, the country's GDP reached 47.16 trillion yuan (7.26 trillion U.S. dollars) in 2011, Ma said.

Impressive numbers given the situation in the rest of the world. Q4 growth managed to beat estimates of 8.7%.  The release goes on to say:

NBS data showed China's industrial value-added output growth decelerated in 2011 from a year earlier to 13.9 percent year-on-year. The country's fixed-asset investment, a measure of government spending on infrastructure, rose 23.8 percent year-on-year. Retail sales, a key indicator of consumer spending, rose 18.1 percent year-on-year in December 2011, up from the 17.3-percent growth seen in November.

The infrastructure spending continues on a torrid pace and should continue to support construction equipment and raw materials/mining. I would expect metal/mining and equipment stocks to perform well today as participants focus on this news (as well as German investor sentiment) rather than the looming default of Greece.
On Monday, China's top statistical official Ma Jiantang stated that price increase pressures continue to pose a threat despite the lower 4.1% CPI in December.

In the short run, fixed-asset investment, which remains a major engine driving economic growth in China, is expected to maintain rapid growth in 2012, while residential consumption, another growth engine, will keep stable growth this year, he said.

www.china.org.cn/business/2012-01/17/content_24425203.htm
This continues to support the prospects of both resource economies and companies.

Alcoa - Bonds Look Cheap

Alcoa's (Baa3/BBB-) earning are out and look decent.  I have been waiting for the earnings to take a look at the bonds.  The company has been somewhat of a leper for a while now as it is somewhat overlevered and underearning.  Things are improving here.  Do I think the ratings will stabilize in investment grade space?  Yes, I do.  Do I see upgrades?  Not in the near-term as the company must show it is serious about debt reduction (through greater reduction in actual debt rather than increases in equity or EBITDA) and continue to de-lever their balance sheet.  Alcoa’s debt-to-capital ratio stands at 34.8 percent at the end of the fourth quarter, 90 basis points better than the third quarter of 2010, and 390 basis points lower than the fourth quarter of 2009.  Problem with this is that the company has an expressed target of 30-35% debt/capital, so its not gonna get much better from here.

Liquidity improved, with $1.5 billion in cash on hand at the end of the fourth quarter compared to $843 million at the end of the third quarter of 2010.  I would expect that liquidity (in terms of cash) will be somewhat reduced as the company increases capital expenditures.  CAPEX came in for the full year at $1B, down from '09 full year of $1.6B.  While yes, this does increase free cash flow, it will not help grow the business.  Depreciation was $1.4B, so essentially, the business shrunk (yeah, from an accounting perspective).  Capex is expected to come in somewhat higher this year ($1.5B +) which is necessary for maintenance (about $500MM for growth capex) and should help smooth things out.

Accrued pension and post-retirement have shown a marginal improvement as well (which will reduce adjusted debt metrics), but I would like to see a more meaningful reduction.  The company has stated it is evaluating the pension issues and will come up with a minimum funding target.  I would still like to see them go beyond the minimum and take a chunk of their pension down.  Pensions are the same as debt (or very close).

Outlook:

The company has said:  “In 2011, we see aluminum growing another 12 percent on top of last year’s 13-percent improvement. We are well positioned to outpace the recovery in the markets we serve and grow shareholder value.”  This is evidenced by the company restarting three smelters in the US which will increase Alcoa’s aluminum production by 137,000 metric tons over the course of 2011 and by 200,000 metric tons on an annual basis thereafter.

I agree with their assessment of the near-term business conditions and growth prospects (especially should China - isn't it always about China? - reduce their smelting capacity) and therefore think the company is in decent shape in the near to intermediate term.  We should see further financial improvement which should drive spread tightening.  I would be a buyer of the bonds.

Value:

AA      (Baa3/BBB-)  6.15    20   @ 210/200
AA      (Baa3/BBB-)  5.72    19   @ 195/185
RIOLN (A3/BBB+)    3.50    20   @ +79
BHP   (A1/A+)         6.50   19    @ 53/43
CLF    (Baa3/BBB-)  4.80   20    @ 185





Some stats and thoughts (emphasis mine):

2010 Full-Year Highlights

• Revenue of $21.0 billion compared to $18.4 billion in 2009, up 14 percent
• Income from continuing operations of $262 million includes a negative impact from special items of $297 million
• Cash from operations of $2.3 billion, compared to $1.4 billion in 2009
• Free cash flow of $1.2 billion, a $1.5 billion improvement over 2009 - (driven by changes in working capital - notably inventories)
• Debt reduced, cash on hand of $1.5 billion
• Debt-to-capital ratio reduced to 34.8 percent, 390 basis point improvement over 2009 - (due mainly to increases in the equity line ad debt is down by less than $600MM)

Improved earnings were driven by higher pricing, continued strengthening in most end markets and improved productivity as a result of the company’s Cash Sustainability Program. Results were offset somewhat by a weaker U.S. dollar and higher energy and raw material costs.

4Q 2010 Highlights

• Income from continuing operations of $258 million, which includes a net benefit from special items of $35 million
• Net income of $258 million
• All-time record cash from operations of $1.4 billion
• Record fourth-quarter free cash flow of $1.0 billion
• Adjusted EBITDA improves to $782 million, 13.8 percent margin up from 11.4 percent in the third quarter of 2010 and 3.4 percent in the fourth quarter of 2009
• Revenue of $5.7 billion, up 7 percent from third quarter and 4 percent from year-ago quarter
• Projecting global aluminum growth rate of 12 percent for 2011

Metals and Mining - Can You Dig It?

As commodities continue to roar into the new year, we continue to see deals being proposed (and upped) as more firms continue to try to source raw materials and financial players see the potential for decent returns.


I believe we will continue to see more deals taking place and more capital being spent on purchasing and developing resources.  This will, of course, continue until firms start paying uneconomic prices for resources, believing that growth - and hence prices - will continue to rise for the foreseeable future.  Thats said, you don't stand in the way of a speeding train - you try your best to board it, ride it and jump before the tracks give way.



From the FT:

The rival bidders for Baffinland Iron Mines have both sweetened their bids over the new year period, escalating the battle for control of a vast undeveloped iron ore deposit in Canada’s high Arctic.

Nunavut Iron, an acquisition vehicle backed by Energy and Minerals Group (EMG), a US private-equity firm, said late on Friday night that it would offer C$1.45 a share for Baffinland, valuing the company at about C$570m.

Nunavut’s move came less than a day after ArcelorMittal, the world’s biggest steelmaker, lifted its bid to C$1.40 a share.

ArcelorMittal is bidding for all Baffinland’s shares while EMG would buy only 60 per cent.

The battle underlines a global scramble for access to raw materials amid concerns of looming shortages. The latest offers value Baffinland at double the amount offered by Nunavut when it made its first hostile approach in September.

With planned annual production of 18m tonnes over a life of at least 20 years, it is viewed as one of the world’s best undeveloped deposits. Baffinland plans to develop the deposit into a mine at a cost of C$4bn.

 Full story here: FT on Baffinland

And how has that train performed so far, you ask?  Here's the parent sector:

And the sub-sector:

Pretty well I have to say.

Drilling down (yeah, I am that clever):

Source:  Finviz.com

Looking at the above table with respect to forward P/E, it would appear that there is further room for growth.

I am still a buyer of select basic materials (metals/mining) debt and equity as there is still room for fundamental growth and momentum.  That said, I am also wary of M&A activity as the potential balance sheet erosion could affect these firms.  As always, analysis is the key - look for balance sheet headroom, covenant headroom and business location.

Mining Victory in Australia

A victory for ore and coal mining companies in Australia.  Essentially, the government has restricted its ability to raise taxes/royalties in the future.   This adds to the attractiveness of the mining space across the capital structure.


WSJ:

Australia's mining giants won support on key concessions in the battle over taxes on the country's $71 billion iron-ore and coal-mining industry, dealing a blow to government efforts to limit credits on future royalties.

The tax proposals have been a flashpoint of national debate this year, prompting the ouster of former Prime Minister Kevin Rudd and almost toppling the now minority Labor government.

The government's Policy Transition Group, chaired by former BHP Billiton Chairman Don Argus, said after five months of consideration that future royalty increases imposed on mining companies by Australia's state governments should be credited against federal taxes.

The government had previously insisted that only current royalties, not future ones, would be credited to the miners.

The Minerals Resource Rent Tax will impose an effective tax of 22.5% on mine operating profits more than 7% above the long-term government bond rate—equivalent to a profit margin of 12.56% based on the current yield on 10-year government debt—once miners earn more than 50 million Australian dollars a year in profits. In contrast to the previous, it will apply only to coal and iron ore—the most-profitable mined commodities.

Coal - The New Black Gold?

New York Times:

At ports in Canada, Australia, Indonesia, Colombia and South Africa, ships are lining up to load coal for furnaces in China, which has evolved virtually overnight from a coal exporter to one of the world’s leading purchasers.

The United States now ships coal to China via Canada, but coal companies are scouting for new loading ports in Washington State. New mines are being planned for the Rockies and the Pacific Northwest. Indeed, some of the world’s more environmentally progressive regions are nascent epicenters of the new coal export trade, creating political tensions between business and environmental goals.

Traditionally, coal is burned near where it is mined — particularly so-called thermal or steaming coal, used for heat and electricity. But in the last few years, long-distance international coal exports have been surging because of China’s galloping economy, which now burns half of the six billion tons of coal used globally each year.

Vic Svec, senior vice president of Peabody Energy, the world’s largest private coal company, said it was “planning to send larger and larger amounts of coal” to China.

“Coal is the fastest-growing fuel in the world and will continue to be largely driven by the enormous appetite for energy in Asia,” he said.

 The growth and shifts in coal exports to China are impressive, flowering even during the recession. Seaborne trade in thermal coal rose to about 690 million tons this year, up from 385 million in 2001.

The price rose to $60 from $40 a ton five years ago to a high of $200 in 2008. Coal delivered to southern China currently sells for $114 per ton. 

Although it has plentiful domestic supplies, China imports coal because much of its own is low grade and contains impurities. Coal from the Powder River Basin of Montana and Wyoming tends to be low in sulfur, for example, allowing power plants to burn more without exceeding local pollution limits. 

Another emerging customer is India, whose coal imports rose from 36 million tons in 2008 to 60 million tons in 2009, the last full year for which data is available. 

Read the rest here:  NYT on Coal

Personally, I am a believer in coal and the ability to use coal in a "cleaner" state.  read up on coal gasification and sequestration.  Like it or not, The US produces an awful lot of coal and has some of the highest quality stuff - high BTU, low sulfer.  Always look at the difference between thermal coal and met coal and who produces which (production of both helps partially mitigate the volatility in met coal prices). 

In equities, I like the diversified miners (Vale, BHP, Rio) and think that there continues to be upside in the names.  Peabody Massey and Arch are interesting, but the focus can cause volatility and while multiples on all miners are high, they are higher on coal focused (although I keep in mind that increased demand will also help jack go-forward earnings and lower forward multiples).

From a debt perspective, I like BHP, but worry about their big game hunting (where to now that POT went up in smoke? - Come on, that's humor!), leaning more towards RIO and Vale.  Cliffs is another I like (more ore biased and also looking for an acquisition - hedgies blew apart the alpha deal).  Also digging into Alcoa as there might be something there.

No preferred that I am aware of in the sector.

US Steel - Lower Entry Points for Bonds Ahead

US Steel (X - Ba2/BB) results:

US Steel's Q3 '10 earnings reflected sequential declines in production, shipments and average realized prices (more of the same expected in Q4 '10).  The company ran negative working capital of over $500MM, leading to continued negative free cash flow of nearly $1B.  X is the most recent to provide a somewhat weaker outlook for the industry and we should not expect the company's credit fundamentals to improve in the near to intermediate term.  Should the company continue to be a net consumer of cash, I believe that their current ratings are at risk for downgrade.  I am underweight the sector.

Bottom line stats:
FCF:  -$926MM
Total Debt:  $3,659MM up $300MM this year.
CFO YTD:  -$478MM
CFO Capex coverage:  N/A (cash USED in operations)
Debt/Capitalization:  +300bps from 12/09 to 44.7%


Headline Numbers:

• Net sales of $4.5 billion -4% from Q2 '10;
• Loss from operations of $138MM;
  
• Net loss of $51MM for Q3, down $26MM sequentiall and up $252MM YOY.  Net income was propped up by currency gains of $139MM (second quarter loss was due to currency losses);
• Cash used in operations:  -$478MM (9mo), capex: $426MM, dividends: $22MM.  Negative free cash flow of $926MM.
• U. S. Steel had $643MM of cash and $2.2B of total liquidity as compared to $947MM of cash and $2.5B of total liquidity at June 30, 2010. 

Segment Results:

• Flat Rolled:  Q3 loss of $174MM, down $272MM sequentially and up $204MM YOY.
• Loss due to decreased shipments (-6% to 3.8mm tons) and production volumes, decreased average realized prices ($688/net ton, -$12 from Q2), increased costs for facility repair and maintenance, and consumption of higher cost coal, coke and iron ore purchased to support earlier facility restarts. Capacity stood at 77% (down from 82%).
• USS Europe:  Q3 loss of $25MM, down $44MM sequentially and down $32MM YOY
• Favorable currency transactions offset by higher raw materials costs and increased facility repair and maintenance costs. Realized prices increased $61 to $748 but shipments decreased 4% to 1.3mm tons.  Capacity stood at 77% (down from 89%).
• Tubular:  Q3 income of $112MM, up $12MM sequentially and up $132MM YOY
• Income up due to higher average realized prices (+$63 to $1,559/ton). and decreased costs for steel substrate, which were only partially offset by slightly lower shipments (-3% to 422k tons)
• Other:Q3 income of $7MM, down $21MM sequentially and up $2MM YOY
• Down primarily due to real estate sales in Q2.
  

Outlook:

"Our current order entry rates reflect the uncertain economic situation in North America and Europe, with spot customers reducing inventory levels in light of short lead times, while our contractual customers' order rates are consistent with traditional downtime taken late in the fourth quarter."

Outlook By Segment:

• Flat-rolled are expected to be in line with the third quarter, expects to operate at an overall lower raw steel capability utilization rate due to lower expected shipments and realized prices;
• USSE expected to be comparable to the third quarter as lower raw materials costs and reduced spending on facility repair and maintenance are offset by lower shipments;
• Tubular segment expects to remain profitable in the fourth quarter, but expect lower results as compared to the third quarter.  Customer inventory levels are at the high end of the normal range.

Value:

X       7.375  4/20      (Ba2/BB)       +400/10yr

MT    5.250  8/20      (Baa3/BBB)    +250/10yr

NUE 4.125  9/22        (A2/A)             +132/10yr

While X presents some value to HY accounts at +400, I believe it is going lower and will have better entry spots.  This sentiment can be extrapolated to the entire sector.  NUE and MT have widened as well, but there should be lower entry spots.  Underweight the sector.

Rare Earth getting Rarer

From the NYT:

China, which has been blocking shipments of crucial minerals to Japan for the last month, has now quietly halted some shipments of those materials to the United States and Europe, three industry officials said this week. 

The signals of a tougher Chinese trade stance come after American trade officials announced on Friday that they would investigate whether China was violating World Trade Organization rules by subsidizing its clean energy exports and limiting clean energy imports. The inquiry includes whether China’s steady reductions in rare earth export quotas since 2005, along with steep export taxes on rare earths, are illegal attempts to force multinational companies to produce more of their high-technology goods in China. 

Despite a widely confirmed suspension of rare earth shipments from China to Japan, now nearly a month old, Beijing has continued to deny that any embargo exists. 

Industry executives and analysts have interpreted that official denial as a way to wield an undeclared trade weapon without creating a policy trail that could make it easier for other countries to bring a case against China at the World Trade Organization.

 rest of story here: NYT on Rare Earth


Finding ways to play the rare earth sector is difficult, one could look at Molycorp (MCP), General Moly (GMO), or Thomson Creek Metals (TC).

 I am nervous on MCP due to the run-up it has had and the fact that their mountain pass mine will not begin production until 2012 (many a slip twixt cup and lip).  Like TC, but it has languished and have to learn more about GMO - would appreciate any feedback on the name.