06 Aug Capital 19 Catch-Up
Weekly Index Movement
| S&P500 | -2.3% |
| Nasdaq | -3.0% |
| Aussie All Ords | -1.1% |
If you read the headlines last week you would have seen something like:
“Markets fall on US Credit Downgrade”
But that’s simply not true. Yes, Fitch did downgrade US credit from AAA to AA+, but that is not why stocks fell. The reasons Fitch cited, growing debt now at 118% of GDP and rising interest costs is nothing new. Everyone knew this already and whether Fitch thinks US credit is AAA or AA+ is completely irrelevant. No one cares what they rate it.
You will see a lot of talk about this being unmanagable debt etc. Which is also rubbish. Singapore’s debt to GDP ratio is 131% and Japan’s is 266%. Why isn’t anyone worried about those countries?
No, markets fell simply because the next couple of months is often a weak period and after such a strong run, traders took some profits off the table.
The two big earnings announcements last week were from Apple and Amazon
Apple (AAPL) delivered a slim beat on revenues thanks to services, which were 2% higher than expected to an all-time high; products revenues fell short as iPad, Wearables, and iPhone all missed narrowly. EPS also beat by 5% and operating cashflow topped estimates. Greater China was a bright spot with that geographic segment beating revenue estimates by 8%.
Apple now has over 1 billion users in the recurring revenue services sector. It’s clear how they intend to grow. They will incrementally increase services prices in the app store and add new services over time, such as Apple Pay.
It’s an almost fool proof business model for growth. They have a loyal, some would say fanatic, customer base that they lock into the environment.
Everyone should own this stock.
E-commerce and cloud giant Amazon (AMZN) blew estimates for almost every major metric out of the water: revenues beat by 2%, AWS revenues beat by 2%, operating margins beat by 2.3 percentage points, operating income was 63% above estimates, and sales guide for Q3 was 2% above estimates at the midpoint. Management noted a shift “from cost optimization to new workload deployment” in AWS, while the retail operation noted across the largest 60 US metros “more than half of Prime member orders arrived the same or next day”. Prime Day was also “the biggest ever”.
I’m not as keen on Amazon as I am Apple but with growth numbers like that, it is hard to argue against them.
Back home in the lucky country, the RBA decided to keep rates on hold. Much to mortgage holders relief (me included). They don’t expect inflation to come back to target this year but are afraid of pushing rates too far. They said they might rise again in future but the RBA wants to sit back and watch for now.
BHP CEO Geraldine Slattery gave a speech on why BHP isn’t doing anything with lithium and other “critical minerals”. In short, BHP is a bulk minerals business and lithium and rare earths are not bulk enough. BHP is going to stick with copper, nickel and potash, as well as iron ore and coal, and the lithium cost curve is too flat so they can’t see how they would have an advantage. (A flat cost curve simply means that everyone’s costs are roughly the same – no one gets much of a price or margin advantage).
I do respect a board who can ignore the evil temptations of diversification. BHP is one of my favourite miners.
This week I want to explain why the oil sector is so attractive. Yes Oil is down from $110 to $80 and companies are not making the record profits of last year, but stocks are not following the price of Oil lower. Woodside Energy (WDS) is up 18% in the last year while oil has been falling.
The first thing to understand about the sector is how they make profits. As is true for nearly all miners, companies have a fairly flat and known cost base. So their profits depend on the difference between the sale price of a barrel and their cost of obtaining that barrel.
Oil companies are traditionally a cyclical business and their stock prices tend to swing up and down with the business cycle
Take a look at Woodside over the last 10 years.
You don’t hold a cyclical company long term. You buy it when the price is low and out of favour and sell when it has the next leg up. Which would usually mean you would be selling this stock now and not buying it.
By the cycle is woke broke
Normally a cycle plays out like this. Some kind of supply shock causes the price of oil to rise (as happening when Russia invaded Ukraine). A high oil price tempts existing drillers to pump more and it also brings new players into the market chasing the big profits available. That all brings more supply on the scene and the price of oil drops.
But not anymore.
We have been told by the vocal minority that oil is bad. So bad we need to sit in the middle of the roads and stop people going to work to feed their families.
So no-one is spending money on bringing on new supply anymore. Why would you? It might take several billion dollars to bring a new well online and a decade of work. You then have to pump oil out for the following decade to recover your upfront costs.
Who wants to do that when governments around the world have set targets to reduce oil consumption?
No new supply means we have to run on existing supply. As every day goes past we are burning through our reserves leaving less and less in the ground. And far from going away, demand is actually increasing
The International Energy Association said this
“Global oil demand is projected to climb by 2.2 mb/d in 2023 to reach 102.1 mb/d, a new record. Buoyed by surging petrochemical use, China will account for 70% of global gains”
The situation we have is one of rising demand but reducing supply. That can only mean one direction for the price of a barrel of oil.
Throw in the Saudi’s who cut production whenever they want the price of oil higher and you can see oil companies should enjoy fat margins for many years.
We all know there is no way we will meet the government set targets for clean energy. So oil is here to stay for a long time yet.
For shareholders, there is another happy side to the story.
Because companies are not spending money on exploration or increasing production, they are swimming in cash and have been returning that cash to shareholders.
Woodside paid $3.75 cash out in dividends in the last 12 months. That is fully franked too so equivalent to $5.36.
Even at today’s 8-year high stock price that equates to a yield of 14%.
There are other oil companies around the world too. Petrobas (PBR) is the largest Brazilian oil company and listed on the NYSE. It has paid out $3.87 in the last 12 months. Based on the current stock price of $13.50 that means a trailing yield of 28%.
Another one I own is China Shenhua Energy Company (1088.HK). That just paid out its once per year dividend of $2.909 which equates to a yield of 13%.
I like to own companies from the same industry across different countries to try and reduce my sovereign risk.
There are three different ideas for you. All with very attractive yields, and as I explained last week, having exposure to these companies is a wonderful hedge against a resumption of inflation that I have a growing feeling is going to occur.
Warning
Stock values can go down as well as up. It is possible to lose 100% of your investment in a stock. Any advice given by Capital 19 is general advice only and does not take your personal circumstances into account and might not be suitable for you.