Cable & Wireless; a Bargain and Safe Dividend too!

The current wholesale sell-off in global stock markets is leading to many a baby being thrown out with the bathwater! Inevitably there are some stocks which are being sold off which are sound businesses.  There are certainly far more exciting investment opportunities out there than there have been at for a good four years.  No doubt the forthcoming economic recession will have an impact on all industries, and most companies will see a significant reduction in revenue, profits and cash flow. Many however are currently being priced as if they will go bankrupt, or head into a long painful terminal decline. Some of these very undervalued companies might even manage to grow earnings in the forthcoming recession. 

Cable & Wireless: business segments and spin-off discussions

One example is Cable & Wireless in the UK.  Cable & Wireless essentially has two distinct businesses. The growing internet and broadband division for corporate customers in Europe, Asia and the US, and the International division which includes the legacy cash generative telecoms businesses in the Caribbean, Panama, Macau and Monaco.  For years shareholders have argued that the combination of these two divisions is not strategically compelling and that a demerger would be the best way to realise value.

Earlier this year management announced that they were considering strategic options including a demerger and returning cash to shareholders.  In the following months, the share price rose 20%, dramatically outperforming the sector, but in the last few weeks it has fallen over 30%.  Part of the reason for the recent stock price sell off is that management have suggested, quite sensibly in my view, that the current market turmoil is hardly the time to be realising value via a demerger and spin-off.  This does not signify a change in strategic thinking but rather a delay until more rational markets prevail.  

Cable & Wireless’s acquisition of Thus

C&W has also recently completed a takeover of its smaller UK rival, Thus.  Even after paying £361 million for Thus, the company will still be significantly underleveraged with a net debt position of £184 million, less than 10% of equity. The purchase of Thus, following on from the acquisition of Energis in 2005 gives C&W increased market share and helps them consolidate their position as a clear number two to BT in the provision of internet services to corporate customers in the UK.

Cable & Wireless: guidance and valuation

In the June 2008 interim statement, management said it was on track to achieve its guidance of a 20% increase in operating profits for this year. Let’s be conservative and assume that current economic circumstances mean C&W will not achieve any improvement in the underlying going concern this year or next. At the current price, this would put the business at a very reasonable 6.6X cash flow.  The dividend should be secure too; giving a current yield of 6%. Throw in likely cost savings from the Thus acquisition, and a potential special dividend from the eventual separation of the two key businesses, and it seems to me that Cable & Wireless is a bargain.

Disclaimer:  Note the author may hold investments in any of the companies mentioned in this article. Any new investment should only be considered in the context of the risks in your existing portfolio.

Posted under individual stocks

This post was written by ex-fund-manager on October 31, 2008

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Index trackers may not be as diversified as you think

The whole market is on sale, 30%+ below its high.

So it doesn’t matter what you buy, you can just buy a tracker fund / index fund right? That will give you a low risk, low cost, highly diversified bet on the long term value of equities. Sure, you may want to drip-feed funds in, because it could fall another 20%.

We….ll, as ever, maybe it’s not that simple.

Industry sector weights in the ASX 100

For example, if you look at the broader Australian stockmarket, you find that actually were you to buy an ASX 100 tracker you are effectively taking a bet on two sectors in a big way, financials and mining. For instance Jun 2008 S&P sector weights show that the ASX 100 is 8.41% energy, 28.17% Financials-ex-Property, and 30.1% materials. In other words 64% of the large cap end of the index.

Industry sector weights in broader ASX indexes

So what about a broader tracker, for instance the State Street SPDRs tracker for the ASX 200?

Well this is actually a similar sector bet. For example Oct 2008 figures (i.e. even after the credit crisis fallout of the last 12 months) show a sector weight of 39% on financials, and 21% on materials, and 6% on energy, a total of 66%…

It is only when you get to the ASX Small Ordinaries (companies in the S&P ASX 300 but not in the S&P ASX 100) that financials drop to 7% but materials is still 31% and energy is still 14% taking the weight for the 3 to 51%.

You can not buy a tracker of the Small Ordinaries, you’d have to look at a managed fund like BT Microcap Opportunities or the equivalent, so in a sense this is rather academic, but it does give you a pointer to the extent that the Australian economy is dependent on these sectors, even after a commodity price fall and the banking price fall.

Sector weights in UK indexes

The FTSE 100 is 22% oil and gas, 21% financials, and 15% basic materials as of June 30 2008, another significant bet on mining and banking.

However the FTSE 250 is a significantly more diversified bet: 27% financials, 6% oil and gas, and 5.4% basic materials as of 30 June (probably significantly less of a financial and mining bet as of Oct 2008).

Non-standard ‘stylistic’ trackers can also give you some variation on the standard sectors. For example, the FTSE UK Dividend Plus tracker, which consists of the highest dividend yields in the FTSE 350 filtered by specific liquidity requirements, is 32% financials and 4% oil and gas as of 30 June.

Aren’t trackers about not guessing themes?

None of this is to say that we should be trying to guess what themes will do well (for instance a tracker that is heavily weighted to financials and diversified might not be a bad thing to buy at the moment).

It is also the case that not all trackers are equal. So-called ‘Enhanced Trackers’ where the managers have some freedom to track the index somewhat more loosely and use derivatives, supposedly often perform better over the longer term by anticipating index departures and arrivals, but more of that later.

Posted under index trackers, investment strategies

This post was written by mike on October 19, 2008

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Humorous reasons to buy equities

I received this in an email this morning – don’t know where it originated but it is a good laugh with more than a grain of truth in it.

“I am going to leave you with 21 reasons to buy some beaten up equities.
1.        Good news is taken as bad news (the market is totally glass empty)
2.        Every guest on CNBC is talking about buying US T Bills at record low yield
3.        Every other guest on CNBC is talking about buying gold at a record high (in A$)
4.        Marc Faber was just on CNBC
5.        CBA, the strongest bank in the world right now, struggles to get a placement away at a 15% discount despite the fact they bought a good asset very cheaply from a distressed seller
6.        Volatility is unprecedented
7.        Hedge Funds are massive forced sellers of everything
8.        Central Banks and regulators are pumping more liquidity than at any time in history
9.        Cash rates are going sharply lower; cash will be an underperforming asset class
10.        Equity risk premiums are enormous meaning that real investment risk is low.
11.        The credit markets have bottomed
12.        Fear is the no.1 investment factor
13.        Every headline in the mainstream press is about the equity market
14.        The coffee shop guy kindly asked me today “Charlie are you ok?”
15.        We are all addicted to CNBC: ie we are all focused on the extreme short-term.
16.        Commentators who have predicted 10 of the last 2 recessions are all over the press
17.        Main St now gets we have a problem (ie it’s a known known)
18.        Stocks and currencies are being sold irrespective of fundamentals
19.        The Oil price is down $62 from its high.
20.        Inflationary pressure is dead
21.        Even my Labrador is bearish”

Posted under market timing

This post was written by mike on October 13, 2008


At what point is it worth buying broader US market index funds as a foreigner?

When is it worth stepping back into the US market as a foreigner (in a broadly diversified drip-feed way)? With the S&P 500 now sitting 50% below its peak you could be forgiven for thinking there might be a bargain out there.

Here are some things it might be worth taking into account:

  • market valuations
  • currency risk
  • appropriate indicators like risk aversion 
  • average length of recessions

Not on this list are technical indicators – apologies, basically we are not amongst the true believers.

Market Valuations on the S&P 500

Market valuations on the S&P 500 had it on a forward concensus PE of around 12 at the end of September putting it around 11. Since then it has dropped another 10%+ (end of September S&P 1099, today Oct 9th  984). However some estimates have it on a forward basis of 15 or even 19 or higher (at the $48 a share earnings estimate mentioned in this article on the Big Picture blog) on the basis that analysts have been known to be over-optimistic about earnings …

15 actually might well be the long run average but in previous recessions PEs have actually got down to 10 (see this article to see historical PE fluctuations) implying a further fall might be entirely possible.

Currency Risk on US Equities

One would think that in the medium term the $700 billion bailout last week is not good news for the US dollar (for example, it will represent a 24% increase in the 2008 US Federal Budget):

“total government commitment and proposed commitments so far in its current and proposed bailouts is reportedly $1 trillion compared to the $14 trillion United States economy” [Wikipedia]

 However in the short term there has been a flight to US dollars in relation to UK sterling and Australian dollar by around 12% and 30% (!) respectively (it is likely the A$ has been punished by the fall-off in commodity prices as well as general risk aversion).

At the risk of trying to predict the future of currencies (a mug’s game as everyone from Warren Buffett to your neighbour Frank can tell you) one would have to wonder when the immediate perceived risk related to bank solvency starts to decline whether the $US is in for a fall – essentially this bailout has given everyone a new reason to dislike it.

How risk averse are equity investors at the moment?

Very averse … The VIX volatility index aka ‘the fear gauge’ which measures the cost of options hit a record high yesterday (Oct 8th) and this kind of VIX level has previously been associated with market bottoms.

Average Length of Recessions

The ‘average’ recession is about 12 months but on the plus side it does seem that recessions have become both less frequent and milder (see NBER study information in previous link). Is the current credit squeeze different – almost certainly – but equally there are many other things that are different in 2008 as well, ranging from technology to world trade.

The ‘Bottom Line’ – buy the S&P 500 now or wait?

At the moment I am inclined to wait. Mainly because I would like to see the US dollar come off a bit as opposed to any other reason. However the other indicators are looking pretty positive. It is of course impossible to pick the exact bottom but if you were within say 15% of the bottom in 2002 you still would have been up 50% within say two and a half years.

Posted under index trackers, market timing

This post was written by mike on October 9, 2008

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