December 4 – December 10, 2015

Negative corporate outlooks in light of commodity woes, debt downgrades, and declining global GDP. Oil and gas shake down. It seems that the natural cycle of things is that the new/upcoming global hegemon exploit its former developing nation peers.

Before I focus on what I perceive to be the main themes from the week, I want to draw special attention to a few of the “Other Interesting Articles” at the bottom of the post.

  1. Several large Chinese insurance companies are buying large and controlling stakes in public Chinese real estate development companies (WSJ: Why China’s Insurers Are Bidding Up Property Stocks 12/9) – prior to 2010 they were not allowed to own property assets. Unlike many insurers in Western markets that take debt positions or will buy properties outright due to their risk-averse nature, these insurers are buying direct stakes in speculative developers at heightened stock market valuations (largely due to the bidding among insurers) at time when there is an oversupply of product in the market.
  2. Thought your home interest rate was low, imagine being paid to borrow. That’s the situation that many Dutch are finding themselves in (those with floating rate mortgages – very common in Europe). WSJ: Less Than Zero – Living With Negative Interest Rates 12/8.
  3. If you’re in real estate, check out this article (The Real Deal: Can Blackstone’s real estate business keep growing? 8/26) from August that I just came across. Note the comment about the lack of margins in the net lease business, especially with interest rates likely to increase (really these investments are macro positions on the direction of cap rates considering you have very minimal control over the income). Related to this, see a post in ValueWalk about Kyle Bass accusing United Development Funding (a public non-traded mortgage REIT) as a Ponzi scheme, and comments in general about the public non-traded REIT sector.
  4. As a compliment to one of the themes from this week, The Economist put out “Pipelines in America – Running on empty” highlighting that the mid-stream model is not as secure as many believe, which of course led to Kinder Morgan (one of the leaders in the pipeline business) to cut its dividend by 75% this week (see the Lex Column in The Financial Times “Kinder Morgan – plus ça change”).

On to the three overarching themes that will pull in a number of articles.  First a continued decline in corporate growth prospects has now led to two venerable companies (DuPont and Dow Chemical) merging, see Dennis Berman’s “Dow-DuPont Merger – Better Living Through Layoffs” in The Wall Street Journal.  Further continued corporate debt downgrades have resulted in there being only three US companies with a AAA credit rating, see Eric Platt’s “Corporate debt downgrades hit $1tn worth of issues” in The Financial Times, which of course due to the commodities slump (see Clifford Krauss and Ian Austen’s “If It Owns a Well or a Mine, It’s Probably in Trouble” in The New York Times) has one of the three – ExxonMobil – being reviewed for a possible downgrade.  Second just how bad is it in the oil and gas business…Asjylyn Loder’s “Billions of Barrels of Oil Vanish in a Puff of Accounting Smoke” in BloombergBusiness points to the coming reckoning in how oil companies recognize reserves on their books.  Third is an article (“In Nigeria, Chinese Investment Comes With a Downside”) by Keith Bradsher and Adam Nossiter in The International New York Times that points to the double edge sword that is globalization.

*Note: bold emphasis is mine, italic sections are from the articles.

Dow-DuPont Merger – Better Living Through Layoffs. Dennis Berman. The Wall Street Journal. 9 Dec. 2015.

In this article Berman aptly describes this merger and the many that have preceded it this year as “An America playing not to lose.”  For three main reasons:

  1. “The economy at large isn’t producing enough growth to keep stockholders content. For the largest companies – who are more or less indexed directly to U.S. and global growth – there is little they can do but keep cutting costs. Eventually, this takes the form of mergers, and 2015 has produced over $4 trillion of transactions. The vast majority of them are ‘in industry,’ which is banker-ese for cost cutting exercises.”
  2. Activist investors… they have forced boards into an intellectual sameness, and certainly a fear of reproach.”
  3. American companies are concerned by the likes of Huawei, Haier, Xiaomi, and others.

“And then perhaps the final, creeping fear: If the likes of Pfizer Inc., Anheuser-Busch, DuPont, UnitedHealth Group Inc. and American Airlines Group Inc. have lost faith in the future, why should we feel any different?”

Corporate debt downgrades hit $1tn worth of issues. Eric Platt. The Financial Times. 4 Dec. 2015.

“More than $1tn in US corporate debt has been downgraded this year as defaults climb to post-crisis highs, underlining investor fears that the credit cycle has entered its final innings.”

“S&P has cut its ratings on US bonds worth $1.04tn in the first 11 months of the year, a 72% jump from the entirety of 2014. In contrast, upgrades have fallen to less than $500bn, more than a third below last year’s total.” S&P has more than 300 US companies on review for downgrade.

Basically, “The Fed’s quantitative easing program helped to defer a default cycle and with the Fed poised to increase rates, that may be about to change.” – Bonnie Baha, head of global developed credit at DoubleLine Capital.

“Some 102 companies have defaulted since the year’s start, including 63 in the US. Only three companies in the country have retained a coveted triple A rating: ExxonMobil, Johnson & Johnson, and Microsoft, with the oil major on review for a possible downgrade. Keep in mind that in 2010 there were over 20, over 40 in 2009, and close to 80 in 2000.

Then of course the Third Avenue Focused Credit Fund has just blocked the remainder of its investors from redeeming their money.  As David Reilly of The Wall Street Journal aptly put it “canary in the high-yield coal mine or an isolated blowup?”

If It Owns a Well or a Mine, It’s Probably in Trouble. Clifford Krauss and Ian Austen. The New York Times. 8 Dec. 2015.

“Nearly 1,200 oil rigs, or two-thirds of the American total, have been decommissioned since late last year. More than 250,000 workers in the oil and gas industry worldwide have been laid off, with more than a third coming in the United States.”

International mining company Anglo American is cutting its workforce by 60%.  “In July, the company outlined plans to cut 53,000 jobs after reporting a loss of $3 billion for the first half of the year. Now, Anglo American plans to reduce its current work force of 135,000 to 50,000 employees.”

“Even with prices falling rapidly, American oil production has only declined to 9.2 million barrels a day, from a record high of 9.6 million barrels a day in June.”

“Many international oil projects have been canceled and production should fall more rapidly next year. But it probably won’t be quickly enough to stabilize prices. That is because companies are getting more production out of their investments as efficiency has improved. And some need to keep producing to keep up with their debt payments.”

Billions of Barrels of Oil Vanish in a Puff of Accounting Smoke. Asjylyn Loder. BloombergBusiness. 9 Dec. 2015.

“In an instant, Chesapeake Energy Corp. will erase the equivalent of 1.1 billion barrels of oil from its books.”

“Companies such as Chesapeake, founded by fracking pioneer Aubrey McClendon, pushed the Securities and Exchange Commission for an accounting change in 2009 that made it easier to claim reserves from wells that wouldn’t be drilled for years. Inventories almost doubled and investors poured money into the shale boom, enticed by near-bottomless prospects.

But the rule has a catch. It requires that the undrilled wells be profitable at a price determined by an SEC formula, and they must be drilled within five years.

“The reckoning is coming in the next few months, when the companies report 2015 figures.”

“There was too much optimism built into their forecasts,” said David Hughes, a fellow at the Post Carbon Institute and formerly a scientist with the Geological Survey of Canada. “It was a great game while it lasted.”

The rule change will cut Chesapeake’s inventory by 45%.  Denver-based Bill Barrett Corp. will lose as much as 40%. Houston-based Oasis Petroleum Inc. will lose as much as 33%.

“Drillers met the rule’s profitability provision last year due to a quirk in the SEC’s pricing formula. The agency’s yardstick is an average of the prices on the first day of each month during the calendar year. The price came to $95 a barrel at the end of 2014, even though oil was trading below $50 by the time the companies reported reserves in February and March. The 2015 average, including the Dec. 1 price, comes out to $51 a barrel.”

“Writedowns, which are reported on a quarterly basis, point to sizable revisions. The 61 companies in the Bloomberg North American Independent Explorers and Producers index have announced impairments of $143.8 billion in the past year.”

“Some of the wells may never be drilled, while others may return to inventories if prices rise.”

“The question is, how are these reserves going to come back?” said Subash Chandra, an energy analyst with Guggenheim Securities in New York. “Because if you have to spend within cash flow, those reserves aren’t coming back. Not unless we get a spike in prices, or we return to levered growth.”

In Nigeria, Chinese Investment Comes With a Downside. Keith Bradsher & Adam Nossiter. The International New York Times. 5 Dec. 2015.

Don’t misunderstand, China is not unique in seeking to capitalize on the natural resources of developing countries while also creating new markets for its national companies to sell their wares and to build infrastructure – in effect sending its capital infusions back home.  Great Britain and the United States are old hands at this game as are many others.  What’s interesting is how aggressively China has stepped into the void when others have pulled back.

“President Xi Jinping of China, who was in Africa this week emphasizing economic diplomacy, just committed $60bn in development assistance to the Continent.”

However, Africa is not a place for the faint of heart.

“Nigeria endured coups and a civil war in the 1960s, then effectively nationalized many foreign-owned companies in the 1970s. Nigeria developed a reputation for breaking or renegotiating contracts, antagonizing many foreign partners.

 The risks have prompted Western companies to demand very fat profits before putting money into the country – returns on the order of 25 to 40% a year. Their Chinese counterparts have been willing to accept 10% or less.”

Doesn’t mean the risk has gone away – rather it is more likely that they have increased.

Mostly state-owned Chinese construction companies have started $24.6bn worth of projects since 2005, the highest of anywhere in the world, according to American Enterprise Institute.”

“A little-known Chinese government agency, Sinosure, has guaranteed the loans. Sinosure insured $427bn worth of Chinese exports and overseas construction projects around the world in 2013, the most recent year available. The Export-Import Bank of the United States, by comparison, issued just $5bn worth of credit in each of the last two years.”

Yes, the Export-Import Bank lost its funding briefly in 2015 (which has since been restored), but the magnitude in contribution differences in meaningful.  Further, China has to be wary of Africa’s bite.

In Nigeria (the largest economy in the continent) “Government revenue has dropped by more than half since the fall in world oil prices, so the country may not have the money to make good on the Chinese deals.”

Other Interesting Articles

The Economist


A Wealth of Common Sense: What Happens When There Are Fewer Suckers at the Poker Table? 12/3

BloombergBusiness: Manhattan Apartment Vacancies Rise to the Highest in Nine Years 12/9

BloombergBusiness: Here’s How Much the U.S. Middle Class has Changed in 45 Years 12/10

FT: The fall and rise of technology juggernauts 12/3

FT: Losses mount in China’s overcrowded steel sector 12/4

FT: Sovereign wealth funds withdraw $19bn from asset managers 12/6

FT: China working age population ‘to fall 10% by 2040’ 12/9

FT: Kinder Morgan – plus ça change 12/9

GlobeSt.: REITs Prefer Asset Sales to Stock Issues 12/8

NYT: Beijing, With Red Alert for Smog in Full Force, Closes Schools and Limits Traffic 12/8

NYT: Chinese Glacier’s Retreat Signals Trouble for Asian Water Supply 12/8

NYT: High-Yield Fund Blocks Investor Withdrawals 12/10

The Real Deal: Can Blackstone’s real estate business keep growing? 8/26

WSJ: Surprise – Your Life-Insurance Rates Are Going Up 12/4

WSJ: China’s Reserves: Blink and Miss It 12/7

WSJ: Where Rich Chinese Are Stashing Their Cash – America’s Hotels and Strip Malls 12/8

WSJ: Less Than Zero – Living With Negative Interest Rates 12/8

WSJ: Chanel Pays Record Price for Retail Space 12/8

WSJ: World’s Biggest Wealth Fund Given Property Push 12/8

WSJ: China Economy – Easing Cycle Keeps on Spinning 12/9

WSJ: Why China’s Insurers Are Bidding Up Property Stocks 12/9

WSJ: Junkyard Dog: How Oil-Fueled Debt Caught Up With Chesapeake 12/10

2 thoughts on “December 4 – December 10, 2015”

  1. It’s reminiscent for me to see you mention Sinosure. I was meeting with a t-bird alum in Jo-burg a couple years back and he discussed how difficult it was to sell American products in Africa. The financing provided through EXIM was inferior to that of the Chinese and it was a severe competitive disadvantage. Maybe in hindsight, it will show this was a good thing for American firms should defaults start tallying up.

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.