A potential correction to crude oil prices poses risks to European integrated oil major’s ability to control operating costs and enhance profit margins, especially in their downstream segments, according Fitch Ratings.
Furthermore, a prolonged downturn in oil prices or continued difficulty in the refining sector could delay cash generation needed for companies to meet their strategic goals and thus have a negative impact on ratings, Fitch says in European Oil Majors – Update (Premium)
“A widening gap appears to be developing between upward crude oil price momentum in the futures market and supply and demand fundamentals on the ground,” says Jeffrey Woodruff, Senior Director in Fitch’s Corporate Energy team in London. “If oil prices start to trend lower over an extended period, European oil companies may not be able to generate sufficient operating cash flow to return credit metrics to more normal levels.”
As European oil majors increased borrowings in 2009 to fund capex and dividends during the downturn in the business cycle, their financial profiles have deteriorated alongside slower cash flow generation. Whilst Fitch rates issuers on a “through-the-cycle” basis using its conservative oil price view, for credit ratios to return to mid-cycle levels, companies will need to begin demonstrating in 2010 that business conditions are improving and cash flow generation is materialising.
Within the downstream segment, Fitch anticipates it could take up to three years to rebalance global demand and overcapacity for refined products to a level significant enough for refining profits to fully revert to the long-term average.
Examples of companies redeploying downstream assets include Royal Dutch Shell Group’s (RDSA, ‘AA+’/Stable) announced plans in February to sell 15% of its global refining capacity, and Total SA’s (FP, ‘AA’/Stable) announcement of specific refining shutdowns over late‐2009/early 2010. These announcements reflect the need for the European oil industry to battle both a drop in demand for oil products and 15‐year low refining margins.
Recent analyst comments via Alacra Pulse:
‘The underlying story for Royal Dutch Shell from 2012 is compelling,’ said Richard Griffith analyst at Evolution Securities. But he has a ’reduce’ recommendation on the shares since the recovery means Shell needs to complete a number of key projects in order to turn its finances around. (citywire)
Lucy Haskins at Barclays Capital believes Shell is being overly optimistic about the outlook for refining margins and that a mistake here could see the cashflow come in below Shell’s guidance. But even she is lifting her price target to £20.50 to reflect the higher cash generation forecasts.
Alistair Syme at Nomura doesn’t thinks Shell is appropriately priced based on its own profitability outlook.
Citigroup analyst Mark A Fletcher and Michele della Vigna of Goldman Sachs are much more upbeat. Both and have ‘buy’ views on the shares. They see good upside potential of 13.3% and 42% respectively.
“CEO delivered goals and plans during the firm’s 2010 strategy update that were more specific than in past years. While this meeting helped to identify how Shell plans to boost upstream production and retool downstream operations, it did not change our outlook or fair value estimate. “ Catharina Milostan, Morningstar
Total SA is one of the largest companies on Audit Integrity’s Western Europe Investor WatchList of companies that Audit Integrity views as having the greatest short-term equity risk.
Technorati Tags: (FP), (RDSA), BP, oil and gas, oil-refining, PulseCheck, Royal Dutch Shell, TOTAL SA
Does anybody not invested in Blockbuster in some way believe the company will survive as an independent chain of standalone video stores? The company’s options continue to narrow after its announcement that it may need to seek bankruptcy protection, as we reported earlier this week.
Standard & Poor’s today cut its rating on Blockbuster to ‘CC’ from ‘CCC’. “The negative outlook reflects our view that the company is highly vulnerable to default and that performance will be severely challenged in the near term.”
Fitch led the charge yesterday, downgrading Blockbuster’s Long-term Issuer Default Rating (IDR) to ‘C’ from ‘CCC’
Fitch remains concerned about the company’s operating model and pressures on its business due to the changing industry dynamics and intense competition from various channels. “Given the deteriorating operating performance, Fitch expects credit metrics will continue to weaken in 2010.” However, Fitch believes Blockbuster maintains adequate liquidity to make its April 1, 2010 debt payment of $43 million.
Gimme Credit analyst Kim Noland doubts that Blockbuster will be able to cut its underperforming stores fast enough to withstand a falling sales pattern.(Forbes) “The inroads into its business by competitors bode very ill for its long term health,” says Noland. “We have been critical of the in-store business model for a long time,” she adds.
A voluntary bankruptcy, while painful, may be its only way out, Needham analyst Charles Wolf says. (TheStreet)
Wedbush Morgan analyst Michael Pachter said it was important to note that Blockbuster’s possible move toward bankruptcy was voluntary.(Reuters)
Audit Integrity has had Blockbuster on its radar for a couple of years. “Since March of 2008, the AGR Bankruptcy Risk Model has rated Blockbuster in the 8th percentile or lower, with a rating in the lowest 1% for the past two months.”
Blockbuster Inc. (BBI) Chief Executive Jim Keyes on Thursday reiterated to Dow Jones Newswires that the movie-rental giant’s problems are not insurmountable.
Keyes said Blockbuster is making “very good progress” as it talks with debtholders about possible restructuring moves, as it negotiates with movie studios, and as it continues to pursue the possible sale of international assets.
“There’s nothing wrong with this core business that can’t be fixed,” Keyes said.
We’re not persuaded.
For latest analyst comment on Blockbuster see Alacra Pulse.
Technorati Tags: (BBI), Blockbuster, video
Guest Post by James A. Kaplan, Chairman and CEO, Audit Integrity
Getting older has its comforts. One of them is that you get to experience a number of historic events and can gain perspective on consequences that result from those events.
It’s been well over a decade since the Japanese economy imploded. That implosion was based on a speculative frenzy that drove values to the extreme, where it was discovered the effects of gravity could not be overcome.
The Japanese government’s response to this dramatic situation was to slash interest rates and rapidly increase government spending. (Note: they did not substantially increase their money supply.) The government claimed to be making substantial efforts to correct the impact of the shrinking private economic sector. The private economic sector, while paying lip service to growth opportunities, continued to stagnate as the banking/industrial complex refused to take risks. The national economy floundered between underwater loans and lack of demand. To this day, over a decade after the implosion, Japan is still struggling with lackluster economic growth.
That sounds a lot like déjà vu, doesn’t it? Of course, in the “good old U.S. of A.,” we are different – or so we say. As best I can tell, our response to date looks much like Japan’s response of a decade ago. The Fed has lowered the cost of short-term borrowing to nearly Zero (a rate that discourages long-term savings) and increased government spending to the point where the credit of the United States is in jeopardy. Financial institutions continue to stagger under the weight of non-performing loans. Industry is reluctant to invest without evidence of a pick-up in demand, while consumers’ wealth and savings have dropped so precipitously they are reluctant — or unable — to spend.
One can only hope that the rapid increase in money supply, both domestically and globally, will result in a different outcome than that suffered by the Japanese. I would not like to see the U.S. endure a protracted economic struggle. However, if we look specifically at the actions of our commercial banking system, we find little comfort.
Commercial banks hold over $1.7 trillion of commercial real estate, and are reluctant to write down their holdings. In fact, FASB has changed its interpretation of FAS 115-2 and FAS 124-2, making it extremely easy to avoid recognizing loss in value.
According to the Congressional Oversight Panel, over 2,988 commercial banks are classified as having a high commercial real estate concentration. The FDIC currently has 702 publicly-held banks on its watch list.
Much like Japan, we have turned a blind eye to a major potential implosion, and in fact, are working hard to cover it up. Of course the banks are taking FASB’s lead and not writing down assets. Remember, unwillingness to fairly reflect values was a criticism placed on Japanese banks one decade ago. .
Bank charge-offs of the 4th Quarter of 2009 totaled $59 billion, an increase of 47.7% year over year. The bulk of these charge-offs related to single-family home loans – not to distressed commercial real estate. I believe the real charge-off rate should be three to four times higher than the banks are willing to admit.
A charge-off rate that more accurately reflects commercial real estate values would drive banks into a substantial negative earnings position. That’s a position no one likes to be in, but denying it does not change the fact that a bank in that kind of financial distress represents a substantial risk to stakeholders, taxpayers, and the economy overall. We’ve seen the impact “Extend and Pretend” has had historically, and the results are not pretty.
Below is a select list of mid-sized commercial banks that I believe are representative, to a greater or lesser degree, of the problems the industry faces. They are all talking a good game. I certainly endorse the power of positive thinking – but not when it is used to distract investors from the truth.
Technorati Tags: commercial-real-estate, regional-banks, U.S. banks
Big banks, except those in emerging markets, will probably destroy value over the next four years (McKinsey)
MGI: New sectors such as cleantech are too small to make a difference to economy-wide job growth.
Excellent microcosm in 7 minutes of how American homeowners got overleveraged (podcast by NPR’s Tamara Keith)
Audit Integrity Updates Investor Watchlist for Western Europe
Credit Suisse scorecard of OECD countries most likely to face government debt funding problems (via @FTAlphaville)
Social spending is up to 24% of GDP in OECD countries, driven by healthcare and elderly costs (OECD)
Technorati Tags: big banks, home-equity-loans, social spending, sovereign-debt, unemployment, western europe
Research Recap frequently highlights Audit Integrity’s accounting and governance risk reports as we believe them to be helpful tools at a time when corporate governance and risk are increasingly complex and important factors in investment decisions. From time to time, Audit Integrity’s methodology and motivations have been questioned (mostly by those who don’t like what the company is saying). Now Audit Integrity has provided a compilation of academic studies that support the company’s approach and results.
The results have consistently shown a clear correlation between Accounting and Governance Ratings and major negative events – regulatory actions, shareholder litigation, material financial restatements, bankruptcy and severe stock declines.
The AGR rating and risk models are designed to be predictive of such events, with all but the restatement model indicating the likelihood of the event occurring over the next 12 months (for restatements, the model identifies the risk for any time in the future.)
Granted that the report was produced by the company and may not be comprehensive, it provides a solid argument that the company’s AGR ratings should be taken seriously by any investor looking to manage exposure to accounting and corporate governance risk.
The full report can be downloaded here.
Technorati Tags: accounting, Audit-Integrity, corporate-governance
Audit Integrity Updates Investor Watchlist for Western Europe
McKinsey roundup of top business risks for 2010 according to EIU, Eurasia and WEF
AT&T likely to retain iPhone exclusivity thru 2011: Credit Suisse’s Jonathan Chaplin
Q&A with Simon Johnson (Obama unlikely to reform banking much as lobby is too powerful and he’s too centrist )
Watch out: Martin Lukes is out of jail..
Worrisome chart of UK and US debt as percentage of GDP exceeding Greece’s (Economist)
Investors shower funds on start-ups for more efficient buildings, grids, but cool on biofuels (WSJ)
US Commercial Property Values Tick up in January and are now up more than 10% since mid-‘09 (Green Street Advisors)
With No Help in Sight, More Homeowners Walk Away – if home value dips below 75% of mortgage( NYTimes)
More readily than ever before, US consumers paying credit cards prior to mortgages (TransUnion)
Technorati Tags: (T), AAPL, Apple, AT&T, commercial-real-estate, debt, iPhone, mortgages, Toyota, twitter updates
Audit Integrity caused quite a stir among Research Recap readers a week ago with its ranking of Sirius XM Radio (SIRI) as the most risky media and entertainment company, based on its corporate governance practices. Now the company has received a number of upgrades by analysts in the last few days. So who’s right?
Audit Integrity’s forensic analysis of accounting and corporate governance practices distinguishes between the companies of greatest and least risk using its Accounting and Governance Risk (AGR®)) ratings. Companies in the bottom-ranked Very Aggressive AGR category “have had consistently opaque financial reporting, weak corporate governance, and as a group are expected to have inferior performance relative to their peers over the next three months on a total return basis.”
Even though Audit Integrity assigned Sirius XM a “Very Aggressive” rating, the company’s 12-month total return was over 400%, which Audit Integrity explained as “simply a function of the market responding to the pendulum having swung too far in the downward direction in 2008.”
The company’s share price has rallied sharply in the last few days to over $0.90 after Lazard Capital and Wunderlich Securities analyst Matthew Harrigan both picked up coverage of the stock with a Buy rating and $1 target.
Last week Standard & Poor’s upgraded Sirius XM’s debt rating to B with a positive outlook, and yesterday Moody’s followed with a Caa1 rating and a Stable outlook. Then Moody’s upgraded Sirius XM’s debt rating slightly. As 24/7 Wall Street’s John C. Ogg notes, “As with all ratings of this sort, the ratings are still well into junk territory and come with the concerns despite the raised ratings. Moody’s noted that leverage remains very high at about9.7-times incorporating standard adjustments. This is based upon long-term capital reinvestment needs of the company/sector, but the improved liquidity offers additional flexibility to execute its growth plan and potentially reduce leverage. Moody’s noted that despite a $100 million cash flow announcement, SIRIUS XM would have ‘been a user of cash absent a significant working capital inflow during the year.’”
JP Morgan had a Neutral rating on SIRI in a Jan 19 report and saw “limited room for upside” from the price then of $0.67. the same day RBC Capital Markets had the company at Sector Perform with Speculative Risk. Barrington Reasearch on Dec 29 lowered its target for SIRI to $1.10 from $1.25 but maintained its market Outperform rating.
Satwaves believes “shares of Sirius XM are poised for yet another explosive upside move, based on recently reported call option activity,” and has a target of $1.25.
One factor in Sirius XM’s favor: if potential car buyers deterred by Toyota’s quality problems opt for Chrysler, Ford, GM or Honda vehicles, the company could benefit from factory activation agreements with those automakers. XM radio is a factory-installed option in only a handful of Toyota models. Ford’s just announced 24% increase in sales in January won’t hurt.
So is Sirius XM radio risky or rewarding? The answer is that these two attributes are not mutually exclusive. Audit Integrity’s rating is just one piece of information investors should consider. As history has shown, corporate governance is important. And certainly the company’s debt load, dependence on the automobile market and threats from emerging competitors such as Pandora are significant risks. But those risks should be already reflected in the company’s stock price, meaning there may be potential upside for risk-tolerant investors.
See Alacra Pulse for latest analyst comment on Sirius XM.
Technorati Tags: (F), (GM), (SIRI), Chrysler, Ford, Honda, Sirius XM Radio
Let’s hope The New York Times’ (NYT) plan to charge for online content works: the company is ranked one of the most risky media investments based on Audit Integrity’s accountancy and governance risk. It is exceeded only by Sirius XM Radio (SIRI).
Scripps Network Interactive (SNI) has the best risk ranking among media companies.
Interestingly, the higher risk companies have been performing better than more conservative companies, the opposite of the usual case.
The current market environment is showing classic signs that it is, for the moment, disregarding risks.
Audit Integrity says this “is simply a function of the market responding to the pendulum having swung too far in the downward direction in 2008.”
Full free report and raking available here.
Technorati Tags: (NYT), (SIRI), (SNI), media companies, newspapers, Scripps Network Interactive, Sirius XM Radio, The New York Times
Guest Post by James A. Kaplan, Chairman and CEO, Audit Integrity
“The Big Zero,” a recent op-ed piece by Paul Krugman of the New York Times,was a real eye-opener.
The author points out that this has been a decade of Zero job creation; Zero economic gain for the typical family (median household income adjusted for inflation, actually fell); and Zero stock returns, with the market closing just above the 10,000 mark at the end of 2009.
He goes on to quote a speech given in by Laurence Summers, then Deputy Treasury Secretary:
“If you ask why the American financial system succeeds, at least my reading of the history would be that there is no innovation more important than that of generally accepted accounting principles: it means that every investor gets to see information presented on a comparable basis, that there is discipline on company managements in the way they report and monitor their activities…. There is an ongoing process that really is what makes our capital market work and work as stably as it does.”
In other words, in 1999 Americans were told they had honesty in corporate accounting, which in turn allowed investors to make good decisions and allowed the financial system to function. But in fact, the opposite proved to be true.
Operating under the guise of FASB transparency and Sarbanes-Oxley compliance, many of America’s largest corporations have been robbing the store as shareholders and employees suffer. Over the last decade executive officers’ compensation has grown from over $24 billion to a total of $55 billion – an aggregate increase of 129%, or 144% computed on an individual basis.
The Analyst’s Accounting Observer reports that by 2008, S&P 500 companies were awarding $44.5 billion in stock grants and options to their executives while contributing only $39.5 billion to pension plans for all other employees.
Historically, there has always been an argument justifying astronomical executive salaries (see “Why Has CEO Pay Increased so Much?” by New York University’s Xavier Gabaix & Augustin Landier[3]). After all, aren’t these the people making the important decisions that increase corporate profitability and enrich their investors?
That doesn’t seem to be the case. Since 1999, earnings per share for the S&P 500 have grown from $56.13 to $59.65, or 6.22%, a paltry sum – particularly when compared to the 144% growth rate in C-suite salaries.
I wonder how it is possible to justify more than doubling executive compensation while revenue growth, earnings, and other financial measures have deteriorated so dramatically.
By what logic are we paying them so much to run our investments into the ground? Did management deserve the $30 billion dollar increase – or would the companies’ owners (shareholders) have been better served if they had received $30 billion in dividends? In short, this decade can be considered an age of C-suite “robber barons,” and shareholders are the ones they are robbing.
In all fairness, recent years have been a struggle. Expectations were not met on many fronts, and U.S. economic domination began to wane. I could accept the argument that those C-suite managers did their best to mitigate negative results — but I struggle with the disproportionate size of their rewards, much of it created through incentive options which were “timely exercised.”
There is no evidence that increased compensation has a positive impact on corporate results. In fact, Audit Integrity’s studies over the last decade-plus have shown quite the opposite, particularly in regard to excessive incentive compensation. Incentive compensation as a percent of total compensation for CEOs and CFOs is a significant measure in determining the probability of a company’s poor future performance. Companies with abnormally high incentive compensation often end up as poor performers because management manipulates short-term returns to the detriment of the companies’ long-term interest.
This observation is not new. In a rallying cry for a return to shareholder capitalism, in which a company’s decisions are made by the owners, rather than “managerial capitalism,” Martin Hutchinson quotes none other than Adam Smith on conflict of interest:
“Economic theory is pretty clear on the advantages of shareholder capitalism, in which there is no separation between the ownership of businesses and its decision-making. The benefits of the price mechanism, in which economic actors compete with each other for advantage, have been with us since Adam Smith famously wrote, ‘It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.’ Thus selfish people acting in their own interest and controlling their own capital produce benefits for society as a whole.
“However, Smith recognized that when managers were separated from capital, a very different picture emerged. ‘The directors of such companies … being the managers of other people’s money than their own, it cannot well be expected that they should watch over it with the same anxious vigilance … Negligence and profusion must always prevail, more or less, in the management of such a company’.’”
Not only does short-term incentive compensation provide managers with outsized rewards; it also results in increased C-suite turnover by removing any interest in the company’s long-term health – which is the very purpose for which incentive Options were designed. Trustworthy companies, by contrast, perform well over the long term (see http://www.trustworthycorporations.com). None of the companies on the list offer a high ratio of incentive compensation.
Click here for a list of companies which have excessive C-suite compensation compared to their industry peers, and an Accounting & Governance Risk (AGR®) ranking in the bottom decile.
It is incumbent on us to take a more active role in compensation issues. I encourage stakeholders in these companies to realign their executives’ compensation and focus on management goals that will provide Bang for your Buck before the decade is over.
Technorati Tags: activist shareholders, bonus, corporate-governance, executive compensation
Audit Integrity has added three large cap companies to its WatchList of European companies with the greatest short-term equity risk. Selection criteria include: the lowest Accounting and Governance Risk (AGR) Rating of “Very Aggressive, ” and an Equity Model Ranking of 1 (Substantially Underperform Market).
The companies are airline Deutsche Lufthansa AG (LHA), toll road operator Ferrovial SA (FER) and building materials supplier Lafarge S.A. (LG).
Mid-cap chemical company Arkema SA (AKE) also was added to the WatchList, along with 8 small cap and 5 microcap firms.
Audit Integrity also removed several companies from the list, including Commerzbank AG (CBK), UniCredit (UCG) and Vodaphone Group plc (VOD) as their equity ranking rose above 1.
The full list is available here.
Technorati Tags: (FER), (LG), (LHA), Ferrovial, governance, Lafarge, Lufthansa
