We are pleased to offer a complimentary download via the Alacra Store of Business Monitor International (BMI)’s special report Guns and Barrels – Risk And Rewards In Iraqi Oil & Gas. The report examines prospects for foreign companies looking to benefit from the growth of the Iraqi oil and gas sector over the coming decade.
Iraq is hoping to tap the expertise and capital of international oil companies (IOCs), their state-run national oil company (NOC) competitors and service companies in order to boost the technical capabilities of its infrastructure as well as the production and export capacities of the country’s crude oil, natural gas and refined products.
BMI forecasts Iraq’s 2010 production at 2.47mn b/d, of which 1.62mn b/d will be exported, and the government plans to boost production to 12mn b/d by 2020–a production increase of 485% over the 10-year period. BMI sees this target as ambitious, forecasting 2020 output of 4.5mn b/d, but our projections still see 82% growth over the period.
While our outlook is sanguine, there are manifold risks to investment in the Iraqi oil and gas industry. In the long term, crude production growth will mean that Iraq will come under increasing pressure to rejoin the OPEC quota regime, presenting a potential cap on further output gains. In the short and medium term, Iraq’s large investment needs, political instability and security risks will all contribute negatively to the country’s energy sector aims. Furthermore, the role of ‘resource nationalism,’ particularly in a country with an insecure polity wary of foreign intervention, cannot be discounted in the upstream segment.
This can be discerned from the development contracts signed between Iraq and the various international companies jostling for position in the country’s energy investment plans. The final awardees originate from a broad spectrum of European and Asian countries, and only two US companies–ExxonMobil and Occidental Petroleum–were awarded contracts. Furthermore, the Iraqi government was keen to be seen as negotiating hard to obtain the best possible terms for the state, and the government has shown no hesitation in changing deal terms for its financial benefit. Earlier changes to contractual structures included a 5% decline rate provision for output above the applicable production targets, as well as changes in ownership structures to the benefit of the IOCs.
Nonetheless, BMI believes that Iraq’s ambitious plans for its oil and gas sector present significant investment opportunities for foreign companies. Specifically, we have identified the country’s oil services sector, refining segment and natural gas industry as particularly attractive opportunities.
Guns and Barrels – Risks And Rewards In Iraqi Oil And Gas is available for free download by Research Recap users for 30 days by special arrangement with Business Monitor International, an Alacra content partner. After 30 days the report will revert to its regular Alacra Store price of $490.00.
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A company with a high ratio of assets to liabilities should, in theory, be better placed to service its debts than one with fewer assets supporting its obligations. However, the balance sheet – the primary record of an entity’s assets and liabilities – is rarely employed by credit analysts as a standalone indicator of credit risk.
The three main shortcomings which limit its usefulness are that:
- Under the historical cost accounting convention, the amounts shown on the asset side are unlikely to be a good proxy for the real value of the entity’s resources;
- Leased assets, and the related obligation to pay the lease rentals, are mostly off balance sheet; and
- Pension obligations are not reported consistently.
However, these obstacles are not completely insurmountable because:
- The value of the assets can be estimated by reference to the earning power of the business;
- Off-balance-sheet leased assets can be factored in using either a multiple of the lease expense, or the estimated present value of the obligation to pay the lease rentals; and
- Inconsistencies in the reporting of pension obligations can be rectified by including the actuarially-estimated defined benefit obligation as a liability, and by transferring pension assets to the asset side of the balance sheet where appropriate.
Using Western Europe’s 10 largest telecoms operators as an example, this report shows that it is possible to construct a metric – the ratio of total assets to total liabilities – which not only correlates nicely with our credit ratings for the telcos concerned, but also provides additional insight into the strength of their balance sheets. However, the adjustments required are not entirely robust, and Moody’s will continue to focus on metrics which compare the cash generating capability of the entity with the level of its debt.
Excerpted from Close, but No Cigar: Why Balance Sheets Fall Short as Indicators of Credit Risk (Premium)
So far in 2010, FDA approvals of new small molecule and biological therapies have paced ahead of those in the same period last year, when 27 new treatments, including two vaccines were authorized, according to Fitch Ratings.
More late-stage project delays as well as stoppages were seen from the pipelines for Fitch-covered drug developers since the start of the second quarter. In total, 16 new drug candidates were affected by negative events including unfavorable study results and drug application review extensions at government drug agencies. The lack of drug benefits versus risks and new clinical trial requests led to the cancellation of eight late-stage development programs, some in licensing partnerships.
Presently, of the 22 new drugs originally planned for registration in 2010, eight of these investigational pharmaceuticals are now under review by drug authorities.
On the flipside, two other drug projects have been discontinued and three more have been delayed into 2011. As anticipated, licensing agreements and smaller acquisitions have been favored over major corporate consolidation so far this year, as such, business development activities led to the expansion of late-stage pipelines with the addition of four new experimental drug projects since the start of the second quarter.
Despite reimbursement pressures, a positive revenue growth trend was sustained into the second quarter with Fitch-rated pharmaceutical companies experiencing a weighted average revenue growth decline to 1.5% in the second quarter from 6.2% in the first quarter, adjusting for currency changes and consolidation activities within the past 12 months involving Abbott Laboratories Inc., Merck & Co. Inc., and Pfizer Inc. Nine of the 13 Fitch-rated drug developers reported revenue increases from their pharmaceutical portfolios in the quarter. Future operational performances of these manufacturers are confronted by a slew of key U.S. drug patent expirations that started this year, lasting over the next three years. Over this timeframe, the drug portfolios with the highest exposure to patent expiry reside at Eli Lilly & Co., Bristol-Myers Squibb Co., Amgen Inc. and Pfizer.
For details, see: Global Pharmaceutical R&D Pipeline – Second-Quarter 2010 (Premium)
Guest Post by Oxford Analytica
China’s growing economic weight means that it now exerts a substantial influence on the economies of other emerging markets.
Channels of influence. China’s impact on other emerging markets operates through trade and capital flows:
- Its success as an export-platform means that for products where it has a comparative advantage — typically but not exclusively labour-intensive manufactured goods — an important element of the country’s effect is intensified export market competition.
- For many manufactures, China serves as one stage (often final assembly) in regional production chains. Here the China effect is as a source of demand for intermediate products.
- China is a major importer of a range of commodities, particularly energy and minerals.
- Chinese exports of manufactured products have served to cap manufactured goods prices for emerging-market consumers; Chinese imports of raw materials have driven up commodity prices. The result for commodity exporters is higher terms of trade and a boost to national income.
- China’s status as an efficient export platform and huge domestic market make it a powerful competitor for foreign direct investment (FDI).
- China has recently become a source of outward FDI.
Africa. Since African economies on average are relatively under-represented in global manufacturing trade, the influence of China as a competitor in third markets, or for FDI into the manufacturing sector, means mainly that its presence may close future opportunities for African economies rather than squeeze existing activities.
Latin America. On average, Latin America also benefits from the China effect in the form of higher volumes and prices for its exports. The China effect has also been felt in terms of positive FDI inflows attracted to the resource sector. The biggest difference from Africa is that there are a relatively greater number of Latin American economies exposed to China’s competitive pressures in the manufacturing sector.
Wider Asia. Comparative advantage would suggest that the China effect should be positive for resource-producing economies in South-east Asia, but more problematic for manufacturing exporters. In practice, the effect is more complex. Commodity exporters in Thailand, Malaysia and Indonesia have done well out of Chinese demand. Although China effectively has replaced regional economies in developed-country markets, these countries now export intermediate goods to China. For India, exports to China are much lower than imports from it, and the resulting large trade deficits are a steady source of irritation to New Delhi.
China’s own comparative advantage is changing. For example, strong wage growth is currently being interpreted as indicating that China can no longer rely on an endless supply of cheap labour, and will be forced to move further up the value chain:
- This shift will open up space for other producers, such as Indonesia and Vietnam.
- At the other end of the value chain, the same shift implies increased competitive pressure for regional economies such as South Korea and Taiwan.
China’s factory workers are finally seeing large pay rises. This could herald a period of stronger consumer spending in the country to help ease the persistent problem of global economic imbalances. But if this trend continues, cost pressures will increase for Chinese exporters. Together with an appreciating renminbi, it could also mean higher prices for China-produced goods.
Standard & Poor’s Ratings Services believes, however, that the impact on prices is likely to be modest to moderate for the Chinese export sector in the next two to three years.
This would allow manufacturers more time to hone their skills and move to higher-value activities. Domestic industries would also have a longer period to absorb workers previously made redundant. We believe the chances are low that the large layoffs in 2009 will recur to hurt sovereign creditworthiness amid an abrupt economic slowdown and rising social unrest.
For China’s manufacturing sector, the risk of higher costs severely denting their global market position is modest. At this time, the threat of governments in advanced economies erecting major new trade barriers is a major uncertainty. But, in our view, the factory of the world is unlikely to lose its competitiveness.
Excerpted from Why Chinese Export Prices Haven’t Surged Despite Rising Costs (Premium)
Improving corporate profits aren’t translating into increased hiring by US companies, says the Economist Intelligence Unit in this complimentary download of its latest World Investment Outlook.
A surge in corporate profits and record levels of cash on corporate balance-sheets has raised hopes in some quarters that employers will soon embark on a new round of hiring. General Electric, the conglomerate regarded as a bellwether for the US economy, lifted net income by 14% in the second quarter of 2010 and raised its dividend, which had been cut in the recession. Even two of the three embattled Detroit carmakers, General Motors and Ford,reported sizable profits.
Typically, these profits would sooner or later be translated into more jobs, either through direct hiring or more investment. But optimism on this score may be misplaced. Much of the improvement in the bottom line has come from operations outside the US. For example Wal-Mart, a giant retailer, reported that international sales rose by 11% in the second quarter whereas domestic sales shrank by 1.8%.
Furthermore, many companies are hoarding their extra cash for the time being rather than using it to hire more workers. In many cases, the jump in profits has been attributable to cost-cutting and improved productivity.
According to Thomson Reuters, more than one in ten companies has posted higher profits despite lower sales. GE was a case in point, with a 4% drop in revenue, despite the double-digit profit increase. Businesses appear to have already reaped most of the productivity gains typically achieved in the early stages of a recovery. According to the Labor Department, productivity declined in the second quarter by 0.9% at an annual rate. The drop, the first since late 2008, was ascribed both to slower output growth and rising labor costs.
The risk of a double-dip recession and, worse, a prolonged period of deflation has loomed larger in recent weeks. James Bullard, president of the St Louis Federal Reserve, warned in mid-July that the US is “closer to a Japanese-style outcome today than at any time in recent history”. Mr Bernanke reinforced this bearish view, cautioning that the economy had a long way to go to full recovery.
United States: World Investment Service has been made available free of charge to Research Recap users for 30 days by special arrangement with the Economist Intelligence Unit, an Alacra content partner. After 30 days, the report will revert to its regular Alacra Store price of $575.
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Continued pressure on the profitability of smaller US banks discourages lending and slows economic recovery, Oxford Analytica argues in this guest post.
Over the past 18 months, there has been a gradual healing in the banking sector. This improvement has been most pronounced in the largest US banks, according to the Federal Deposit Insurance Corporation (FDIC):
- The banking industry recorded earnings of 21.6 billion dollars in the second quarter of 2010, the highest quarterly profit since 2007, reversing a 4 billion dollar loss in the corresponding quarter of 2009.
- Over the past two years, the 19 largest US banks raised approximately 205 billion dollars of private capital, and redeemed 220 billion dollars of preferred shares issued under the Treasury’s Capital Assistance Program.
Despite this solid performance, the US banking system has not yet fully recovered from the crisis. Both Standard & Poor’s (S&P) and Moody’s have cautioned against overestimating the recovery of the banking system’s profitability, since a significant part of that improved performance has derived from a slowing in loan-loss provisioning that could prove premature. S&P estimates that US banks have recognised approximately 475 billion dollars in loan losses but still have approximately 365 billion to write down.
There are three particularly striking indications of continued US banking-system weakness:
- Decreased lending. Despite the record liquidity that the Federal Reserve has injected into the banking system, banks are tending to hoard these funds rather than lend to households with a view to repairing eroded balance sheets.
- ‘Troubled banks’. The number of banks on the FDIC ‘problem institutions’ list continues to rise, currently standing at around 825 of the nation’s approximate 7,800 banks.
- Massive official support. The enormous official support for the system must at some point be removed. This includes the Fed’s ultra-loose monetary policy, the 780 billion dollars Troubled Asset Relief Program and FDIC guarantees of new debt issued by banks and holding companies.
IMF stress test. The continued vulnerability of the US banking system is highlighted by a recent stress test exercise undertaken by the IMF that covered 53 bank holding companies. The scenario used assumed the following macroeconomic variables:
- US GDP growth slowing to a little less than 1% in 2011, and only picking up gradually thereafter;
- unemployment rising to approximately 10% in 2011, before declining slowly; and
- US home prices declining by approximately 5% from present levels.
Despite the relative mildness of the IMF’s adverse scenario, its stress test suggests that the banking system faces significant downside risks:
- Approximately one-third of US banks would experience a capital shortfall, even assuming a not particularly stringent capital threshold.
- An adverse economic scenario would hit smaller banks the hardest — they would require 22 billion dollars additional capital.
Outlook As long as growth remains mired below trend, bank loan losses will continue to rise as profitability declines at small and medium-sized institutions — which could require additional capital. This is likely to prolong the period in which banks are reluctant to lend, serving as another drag on the anaemic economic recovery.
A surge in speculative-grade debt issuance as investors seek yield, has resulted in the issuance of more than $200 billion of speculative-grade debt so far this year, Moody’s Investors Service said in a new report on refunding risk.
“Strong new issuance has definitely alleviated near-term refunding concerns,” said Moody’s Vice President and Senior Credit Officer Kevin Cassidy, author of the interim report. The study updates the findings of the annual refunding studies published by Moody’s earlier this year.
U.S. non-financial speculative-grade companies have chipped away at maturities this year, with about two-thirds of the new debt used to refinance existing debt.
Almost $60 billion of speculative-grade bonds are set to mature by 2012, down from almost $90 billion noted in the February 2010 annual refunding study.
“The $550 billion of speculative-grade maturities in 2013 and 2014 noted in our February refunding report are probably much lower now because of the robust issuance in the first half of 2010. But maturities after 2014 have likely increased because most companies did not permanently reduce leverage, they just refinanced existing debt,” Cassidy said.
About $310 billion of bonds are set to mature between now and 2012. “Total bond maturities will increase each year,” said Moody’s Analyst, Tiina Siilaberg, co-author of the interim report. The bond maturities are expected to increase from $29 billion in 2010, to $130 billion in 2011, reaching $151 billion in 2012.
Overall, the debt burden falls more heavily on investment-grade companies. They have bond maturities of $255 billion due between now and the end of 2012, compared with $55 billion of speculative-grade bonds coming due over that period, the report said.
“We believe most speculative-grade and investment-grade companies should be able to refinance their upcoming bond maturities between now and 2012 as long as the U.S. continues on a path of economic recovery—even if it is sluggish,” Cassidy noted.
However, certain conditions could make it difficult for companies to refinance, including a diminished appetite by lenders, the risk of a double-dip recession, an extended period of weakness in the labor markets or a prolonged period of below-normal growth. “This is especially true for lower-rated companies,” said Siilaberg.
For details, see “U.S. Non-Financial Corporate Bond Issuers’ Debt Maturities: Manageable Through 2012, but Expected to Soar Thereafter“
The Basel III capital requirements for banks came as a relief to most banks when they were finalized last weekend. Goldman Sachs was already in relatively good shape on this score, and received an upgrade from Zacks on Monday in this complimentary download from the Alacra Store.
We are upgrading our recommendation on Goldman to “Neutral” from “Underperform.”
Second quarter earnings were significantly ahead of the Zacks Consensus Estimate, reflecting lower operating expenses. Fundamentally, we expect the companyto benefit from its well managed global franchise, strong capital base and leading position in investment banking, capital markets, trading, private equity and asset management business.
Though the new financial regulatory reform will remain a challenge for Goldman s top line, we believe its proactive measures to strengthen its business model while complying with such regulatory changes is encouraging. Additionally, following the SEC settlement, we believe that much of the overhang on the stock is removed and along with expectations for an improved operating environment in the upcoming quarters, Goldman is poised to grow in the long term.
Our six-month price target of $158.00 equates to about 10.7x our earnings estimate for 2010. This price target implies an expected total return of 5.1% over that period, which is consistent with our Neutral recommendation.
[Zacks target price is at the low end of the range of analyst 12-month price targets, according to Alacra Pulse.]
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While the pace of defaults remains elevated, a record number of loan resolutions in August again tempered the effect of $3.1 billion of new delinquencies, according to the latest U.S. CMBS delinquency index results from Fitch Ratings.
Recent defaults on five loans greater than $100 million contributed to a 23-basis point net increase in the U.S. CMBS delinquency rate to 8.48%. Meanwhile, $2.1 billion of loans were resolved or liquidated last month.
‘Though special servicers are working out loans at an increased rate, the volume of new delinquencies has not yet subsided,’ said Senior Director Adam Fox. ‘Highly levered loans originated at the market’s peak continue to default as borrowers seek modifications or hand back the keys to underperforming assets.’
For details see Record Loan Resolutions Stem Climb in Delinquencies (Premium)