Wednesday, 31 March 2010

Macro-Level Trends – Global Liquidity Movement – Looking Beyond the Surface of Ratios & Differentials

After the western stock rally of 2009/10, driven perhaps in large part by more speculative parties, caution has eased amongst the world's biggest funds slowly releasing historic levels of previously frozen liquidity. They seek as best as possible alternative safe haven homes given the paucity of western sovereign debt yields, and indeed the renewed concerns regarding sovereign default.

Perhaps the greatest of these actors are the major institutionals, often state run pensions firms and increasingly Asian, with ever increasing future legacy levels accruing as their national demographics age with increasingly inverted pyramids and ever increasing retirement expectations given the standards of living enjoyed having been through relatively recent industrial revolutions. Caught between future maturation demands and present poor returns across what were good RoI classes, they have started to employ cash by increasing exposure with their historically favourite asset-class - long-term, hard-physical asset-bases, typically 'future-proofed' & 'future-forward' infrastructure.

South Korea's National Pension Service move to purchase 12% of Gatwick Airport in the UK from US PE firm GIP is a good examplar of late.

[NB investment-auto-motives suspects that NPS took on the deal to align its future directly with that of the S. Korean economy. As a leading proponent in the creation of intelligent national infrastructure, emanating from Seoul, and as a designer and manufacturer of supporting electronics, S. Korea may well be hoping to be the world's leading force in delivering high-value intelligent infrastructure solutions as both West and East apply their massive infrastructure stimulus spending. To this end, Gatwick Airport could act as an a showcase for S.Korean systems tech, given that an airport must operate as efficiently as possible both 'air-side' and 'land-side'].

But it is not simply the 'Expectant East', others such as the high profile California's CALPERS scheme have gone as far as confronting Standard & Poors regards the integrity of the 'AAA' classification ratingg given in CDOs and ABSs. Given California's growing burden

So pressure builds the world over to find avenues of opportunities that offer both decent levels of return with the mitigation of risk. That is of course the investor's ideal, something which in today's still tumultuous western markets, is rarely apparent, as the ideal balance of risk-reward offered by healthy economies has been overtaken by general risk-adversity in low yield high-grade bonds, or for some relatively heavy 'risk-on' in junk territory, even if defaults have dropped from 14% to 5%.

Managers of large funds with a remit for a bias to safety will in reality have a broad portfolio of diverse asset classes over global geographies to review and allocate. However, an overtly simplistic yet useful tool is the comparison of Stock Market Ratios across the world, to gain a broad indication of both local economic well-being, the central pillar(s) of wealth generation, and importantly an estimation regards the level of 'investor fill' each market has experienced so indicating its place in the cycle.

Of course, each market has its own unique characteristics and whilst they can be generally grouped depending upon the similar underlying qualities that help drive the economy, the notion that they can be all laid out bare for direct cross-comparison is an anathema, even if the market data simplistically laid out as Average Yield & Average Price/Earnings, seems to beg immediate cross-border, inter-regional and continental comparison.

However, though overtly simplistic, the two data sets do provide a 'snap-shot' – albeit a very averaged out - view of specific national markets : as was illustrated as an influence in the previous post's Sterling Currency overview.

To expand this national & regional specific investment measure, the following highlights individual nation's Yield, P/E and the differential 'spread'. This latter figure, though not officially recognised as constituent part of the basic ratio analysis, can provide a useful indicator since notionally: the smaller the differential between Yield and P/E figures the greater the potential for profit-maximisation – though of course local inflationary factors and local 'currency capture' (in non & limited FX-trade environments) must be taken into consideration.

Thus the following, taken from the FT data pages on 29.03.2010, provides a basic overview :

Country/Region Yield vs p/e Spread

UK 3.0% vs 12.4 9.4

Austria 2.9% vs 22.6 19.7
Belgium 3.8% vs 17.6 13.8
Bulgaria 5.0% vs 7.9 2.9
(S.)Cyprus 5.0% vs 4.1 (0.9)
Czech Republic 5.8% vs 12.4 6.6
Denmark 1.1 vs 27.1 26.0
Finland 3.4% vs 21.1 17.7
France 3.4% vs 20.4 17.0
Germany 2.7% vs 18.7 16.0
DAX-30 3.1 vs 15.4 12.3
Greece 2.6% vs 12.0 9.4
Hungary 1.7% vs 15.7 14.0
Ireland 1.4% vs 21.4 20.0
Italy 3.1% vs 17.6 14.5
Luxembourg 2.4% vs 19.5 17.1
Malta 4.3% vs 5.0 0.7
Netherlands 3.1% vs 20.0 16.9
AEX 2.9% vs ??? ???
Norway 2.2% vs 17.2 15.0
Poland 2.5% vs 54.4 51.9
Portugal 3.6% vs 14.7 11.1
Romania 1.9% vs 12.6 10.7
Slovenia 1.5% vs 19.3 17.8
Spain 4.6% vs 11.2 6.6
Ibex 35 4.9% vs 10.3 5.4
Sweden 2.8% vs 14.0 11.2
Switzerland 2.6% vs 16.8 14.2

North America
Canada 2.6% vs 21.4 18.8
S&P/TSX 3.0% vs 19.9 16.9
USA 1.8% vs 20.6 18.8
Dow Jones 2.6% vs 16.4 13.8
S&P 500 2.3% vs 17.5 14.2

Central & South America
Argentina 6.2% vs 13.1 6.9
Brazil 3.1% vs 17.1 14.0
Chile 3.7% vs 19.7 16.0
Colombia 3.0% vs 22.6 19.6
Mexico 1.6% vs 17.3 15.7
Peru 3.2% vs 37.2 34.0
Venezuela 17.8% vs 0.4 14.4

Australia 3.6% vs 17.3 13.7
Hong Kong 2.7% vs 16.4 13.7
HangSeng 2.9% vs 15.8 12.9
Indonesia 2.0% vs 19.4 17.4
Malaysia 2.6% vs 17.4 14.8
New Zealand 4.9% vs 20.6 15.7
Philippines 2.4% vs 16.3 13.9
Singapore 2.7% vs 18.4 15.7
South Korea 1.3% vs 19.5 18.2
Sri Lanka 2.0% vs 19.9 17.9
Taiwan 2.6% vs 25.1 22.5
Thailand 3.3% vs 13.9 10.6

Japan 1.8% vs 31.4 29.6
Topix 1.7% vs 17.6 15.9
China 2.6% vs 15.6 13.0

India 1.0% vs 20.7 19.7
Pakistan 5.1% vs 10.1 5.0

Israel 2.7% vs 16.8 14.1
South Africa 2.4% vs 16.7 14.3

Russia 1.4% vs 13.3 11.9
Turkey 1.5% vs 12.4 10.9

A very brief overview highlights the best yields originating from: Argentina (6.2%), the Czech Republic (5.8%), Pakistan (5.1%), Bulgaria (5.0%), Cyprus (5.0%), New Zealand (4.9%), Spain's IBEX 35 (4.9%) and startling out in front Venezuela (17.8%). These best performers are largely either surging EM nations or arguably over-leveraged AM nations, the data but a snap-shot in time typically driven by past economic prowess and not discounting against what look to be rockier times ahead.

Venezuela's economy is typical of the region's yesteryear boom & bust cycles. It has been rocketed by the centrally governed industrial strengthening & diversification policy enabled by the petro-dollar income from state controlled oil assets. With the announced re-organisation of the PdVSA, the creation of Fonden – the National Development Fund - stabalisation of the national currency, and typically a 51% maintained stake in any JV enterprises the state is trying to create a self-sustaining economy and simultaneously move the populace inland to equalise resources, maintaining spending programmes under the 'Bolivarian Revolution' umbrella to do so. Thus private investment is riding – often in a PPP guise – the economic wave the government is trying to engender with the beneficiaries seen as heavy-hitter supporters of the Chavez administration. So here, although the data looks fabulous, as ever, the transparency, investment access and political dimensions are quite opaque.

As for other 'best performers'....

Argentina is a typically more stable nation compared to its northern counterpart, but it too seeks to diversify and strengthen away from its agricultural base, and seemingly following Venezuela's lead in oil extraction and export, has muted the fractious possibilities of drilling in the waters of The Malvenas / Falkland Islands – with the obvious irritation to UK international relations. This may be a vote-winning propaganda message at a time when the economy is in danger of slowing due to global contraction, but it does not add confidence for FDI; something Argentina may feel is in natural retrenchment anyway, hence its oil stance.

New Zealand stands in a similar spot given its heavy reliance on exported agricultural goods, but will undoubtedly simply continue to focus on Asian demand of meats etc. The Czech Republic has suffered less than other CEE countries given its proximity and relationship with Germany and the re-cycling of monies earned from outside the region and repatriated with returning EU workers, buoying residential property, retail and other sectors. As with Poland, the German relationship will be key as the Czech Republic maintains its localised role as lower-cost producer for German consumption. Cyprus & Bulgaria look in a weaker position given their respective reliance upon Greece and Turkey, neighbours which although diametrically opposed in terms of economic strength appear to be far more inward looking over the coming years given collapse of W.EU demand and importantly for Greece & Bulgaria the credit markets and its effect on public employment.

Looking at stock market valuations via the price/earnings measure, Poland, Peru, Japan, Denmark & Taiwan hold the greatest valuations at present with 54.4, 37.2, 31.1, 27.1 & 25.1 respectively. By established, conventional standards these are indeed high, when norms run between multiples of 10 – 20 x future earnings. However, as we saw with China's capital markets during their heyday in the run-up to the Olympics (reaching 30+ x), these valuations tend to be the result of non-conventional (by historical standards at least) factor(s). Typically the primary cause is inflation driven increased liquidity, the price spiraling effects of which can be exacerbated from circulation around/within a (near) captive currency market. This seems the case for Poland where returning migrants with wealth along with FDI have created a cross-the-board asset inflation, perhaps most noticeable in equities. Peru's boost from the commodity bull market, though a little dampened is still running with exports to Brazil & China the income of which in Peruvian Nuevo Sol has supercharged domestic capital markets, possibly also as a result of government interaction to buoy Peru's economy and international standing. Japan's high valuation is a result of the individual, corporate and institutional savings glut, essentially re-cycled Yen that provides personal and national feelings of security,
and a weather against externally created future systemic shocks The Denmark case appears similar is as much that the Euro-pegged Krone may have been domestically used to buoy capital markets during a period of immense western market volatility, instead of flowing-outward, so as to help stabilise the strength of the national economy; it's performance also assisted by the 'Flexicurity' labour market policy which enables companies to quickly adapt to changed conditions.

As stated, when seeking profit maximisation possibilities, one looks to the differential (or 'spread') between these two ratios. It is an inverse measure, so that theoretically the closer the figures are indicates a greater yield and lesser stock price/cost.

Here the immediately obvious best performers are (Southern) Cyprus (-0.9) & Malta (0.7). It is apparent that these figures, whilst attractive, relate to very small Southern European Island local economies which tend to a subordinate role in their related larger national economies – ie Greece & Spain – and undoubtedly benefit from protected and positive trade flows as a result of national policy toward agriculture, resource extraction and low-value secondary industries. Thus these star performers cannot be realistically compared to far deeper, broader and importantly transparent capital markets elsewhere, instead typically volatile relative to the level of government interaction and the level of domestic (possibly self-regarding) investor activity. Of the Bulgaria follows with a score of 2.9, it sits as a philosophical 'half-way house' situated between the characters of a small local entity (as described) and an increasingly maturing market structure given its EU membership ambitions. The 'spread' figure thus reflects this typical dynamic of a mechanism that operates in this transient territory, with A & B sections to Official & Unofficial markets, constituent players primarily related to oil/gas, mining, agriculture and machine parts – and thus highly correlated to the swings of W.EU & CEE macro-demand. With a 'spread' of 5.0 comes Pakistan, much like Bulgaria regards its original economic-base activities, but perhaps a further evolved Service sector, with the steadying influence of the US since 2004 (given Pakistan's Non-NATO Ally status) including US FDI and the sizable commercial trade interests with neighbouring India and China. That spread also perhaps indicates a cautious optimism as Pakistan rapidly moves beyond its 2008 economic crisis with the monetary and advisory support of the IMF, the 2010 onward growth rate expected at 4%+. Spain and the Czech Republic appear together at 6.6, yet it is expected that these two nations are travelling in opposing directions of economic fortune. Spain's sovereign indebtedness puts it amongst the harshly acronymed 'PIGS' group, a section that faces harsh, ongoing and possibly long, economic re-structuring which needs to both settle its over-leveraged and still over-valued property base whilst simultaneously creating new industrial/service foundations that must ultimately be globally competitive – this will not be an easy task. As the biggest player Spain has perhaps the hardest task, but positively (along with Portugal) it has the best cultural links to largely buoyant S.America; thus the possibilities of greater melding of cross-Atlantic interests – especially via banking (eg Santander etc) will need to be a major element of its future planning. For the short and medium term however, Spain looks to be effectively shrinking as its property-base valuation all too slowly diminishes so undermining the re-sparking of the economic engine. The Czech Republic, on the same 6.6 'spread' standing however, appears a better proposition given its rapid level of economic maturation and importantly being a beneficiary of Germany's overtly strong economic base; with in certain ways the country almost acting as an implicit economic annex.

To summarise, we can see that often beneath what appear outstanding Yield, P/E and 'Spread' figures many micro and macro factors come into play for the institutional investor. Critically at such still relatively fragile times is the question of market integrity, whether underpinned by true and proper, and critically exercised, regulation. As such doubts are trying to be eased even in the most advanced markets via the likes of the UK's FSA and US's SEC, it puts a greater onus on these typically developing capital markets to do the same, with the ambition to equalise confidence.

Importantly, such shifting times for these (and indeed all) countries and their capital markets, begs the question of national economic policy and the regional and global role that a country can credibly play. Given the ever pressing demand for personal and commercial mobility, still very high on the industrial agenda is the ambition for adoption, creation or re-invention of the local automotive sector, to something beyond the sales, service and repair of imported motor vehicles.

Part of the Czech Republic's success and Spain's downfall has been the differing approaches taken toward their indigenous auto-sectors. Of course given 1980s/90s history of FDI and Japanese & German 'transplants', and re-invention of SEAT cars under VW, Spain enjoyed the earlier economic injection which went on to propel standards of living and so the house-price bubble. From an Automotive standpoint the Czech Republic is simply latterly re-playing that model, but its innate geographic position leaves it in a less precarious position looking forward. The capital market masters of Spain must develop new realms for its auto-sector, perhaps better aligning SEAT with the high profile efforts in Spanish eco-tech so re-creating SEAT as a value-adding R&D hub, not simply the money-absorbing 'runt' of the VW brand stable it has seemingly becomes, even after much effort to re-invent it time and time again.

This is but a simple observational case for what ultimately should be a pertinent point of national economic modelling looking into the future. These ground-works should be being created today.

Ultimately, investors – institutionals especially – will look well past the surface-level data as presented in the FT, WSJ and increasingly elsewhere on the web. Capital Markets' 'Ratios and Differentials' provide an entry point of analysis and evaluation, but ultimately both Western & Eastern pension funds, insurance companies and similar conservatively driven asset-managers need to see national economic structures which make sense relative to national competence set against regional and global B2C and B2B demands. Even as the sociologically good ideology of an increase in public transport services takes grip amongst international politicians and green-activists, the reality is that the perilous state of many (esp Western) national budgets cannot possibly support the dream. So as transport systems become privatised or re-structured under privatisation – which in turn has a knock-on effect to its support-services base as we see with Jarvis plc's demise – so the question of personal and commercial mobility arises once again – a question that requires suitable solutions generated via private capital sources; which are at last being re-built in the West via personal and corporate balance sheets.

Monday, 22 March 2010

PESTEL Trends – Global Finance - The International Currency Debate

Financial debate continues to centre around the macro-economic factors which, by historical standards, are massively shifting the shape of currency markets. These consequences in turn shape investment sentiment; both spend level and timing, in both public and private spheres.

In the West the primary concern relates to sovereign debt levels, its affect on national credit ratings and the knock-on effect into currency valuation, which in turn effects the fiscal and monetary behavior of evermore integrated yet fractured and fractious inter-regional economies. Whilst portions of the storm seem to have passed, the reality means a very different future for government, public and investors alike. The stability seen through much of the latter half of the 20th century which led much of cross-the-board investment practice no longer exists, whilst the vibrancy of the 21st century credit bubble now seems very distant. The level of life-support provided by over-reactive left-of-centre governments has shackled what were once respected nations with onerous debt and policy constraint. The question of moral hazard in the western financial sector still exists this time underpinned by greater practical interventionism to save any 'on the brink' institutions now that depleted coffers negate monetary injections. And having 'saved' the economy – though in reality only having temporarily slowed the re-valuation mechanism – a 'flat-lining' of both consumer demand pull and corporate productive push demonstrates the innate caution that exists and appears not to alter anytime soon.

In the Middle-East the GCC states appear to have withdrawn from their ideas of a regional mono-bloc currency, having been an ideal inched toward during the boom years. The real-estate melt-down having blown confidence in everything but the core energy sector, with available liquidity moved to safe-haven instruments and blue-chip, typically energy-affiliated sectors and corporations. As Abu Dhabi acts as the implicit economic backstop for the region, given that 90% of Saudi Arabia's income is oil derived exporting to the US and Dollar-pegged Asian countries, there now seems little to gain from formally forming its own inter-regional currency group. Though the Dollar may be near an all time low from a global 'basket' perspective, the GCC Dollar-peg is here to stay for the foreseeable future so as to enable fluid trade both westward and eastward, and to provide the confidence to re-buoy GCC efforts to continued diversification the activities of the local economic base in the mid-term.

Asian countries - excluding China & India – have become increasingly strained as higher-margin exports to the West plummeted and the necessary heavier reliance on Chinese demand has meant reduced margins and so had an impact on the level of domestic economy growth. That slowdown has in turn hit local public & private and importantly FDI investment. Even though Asia remains the most prominent growth region both local and foreign liquidity has become more and more cautious and reactionary, hence the 'flight to safety' to US Dollar and Japanese Yen that has been a pronounced event of late, even when their domestic economic indicators are counter-pointed.

But of course the world's eyes are upon China and the US given their respective latter-day roles as economic demand-driver and financial safe-haven. Undoubtedly, it has been this schizophrenic schism which has added much of the market volatility seen over the last year.

US Dollar -
The previous fall from grace with record levels of international devaluation in the modern era appears to have settled. After such heavy-handed quarter-on-quarter actions of QE and a maintained near 0% base rate (set ongoing at 0.25%) the resultant devaluation should have theoretically been positive for export growth. But little evidence really vindicates that hypothesis, with instead the US's relatively high-value export products and services consisting of capital goods, affiliated know-how in 'demand-hold' circumstances as foreign countries slow their own investment programmes. Instead there appears greater use of non-US cross-regional trade, using an emerging bi-lateral trade agreements to effectively swap domestic commodities for foreign (lower-quality) capital goods – and vice versa.

Moreover, that initial competitive gap created from a de-valued $ has been minimised as others - having watched the US$ slide - recognised their own national/regional comparative cost-competitiveness decreasing. And so other countries & economic blocs have expectantly followed suite from Yen to Sterling to Euro, with of course a static Renminbi.

In short, the US Dollar leads the global race to slowly and stably devalue, to once again gain a pre-eminent global trade position whilst also simultaneously effectively forcing necessary cost-restructuring upon its own domestic base. Although a well recognised requirement, it is the speed and the manner in which this has and is being done which, arguably, is becoming more and more detrimental to its international standing.

The recent news that the 2-year US government bond now yields approximately 3.5 basis points more than Berkshire Hathaway's (and a number of other 'blue-chips') similar offerings, demonstrates the caution in money markets over the near-term future of US stability. [NB the rarity of this event is self-pronouncing]. And that is in itself is a concern for the Dollar's international rating and points to the possibility of a 'Dollar-drop' if the previous run of good news stories are overtaken by a run of bad news stories.

Renminbi/Yuan -
The PRC administration is keen to obviously continue its march of economic progress, yet with US$ deflation recognises its own increasingly perilous position as a major exporter to NA given the concomitant FX pressure. Moreover, it has come under political pressure from Washington to appreciate its currency so as to re-balance the overt Eastern bias of global liquidity. Given the apparent precariousness of the US$ this would presumably be done largely via buy-back sales of China's US$ cash & bond reserves, expectantly buying-back these reserves at less than today's record high open market rates, or swapping near-term maturities for less costly long-term debt.

Yet, as the likes of various WSJ columnists and Morgan Stanley's Stephen Roach (MD – Asia) rightly state: in the face of Western economic collapse, it has largely been China's role of global economic engine that has been perhaps the saving grace. With that attitude as the 'set-tone' in Beijing, and its recognition that EU & BRI[C] leaders are keener than ever to court China with the real vacuum of US economic leadership, the PRC is unlikely to take Washington's remarks seriously and will continue to state that the Renminbi correctly valued at present, much of this sentiment actually representing the view that the global market slow-down, by de-facto, equates to a reduced value of the Renminbi/Yuan.

The drop-off of global demand for Chinese consumer orientated goods requires that the PRC undertakes an inward-facing stance to keep national growth at acceptable levels, something it has long recognised and seemingly planned for.

Thus, as reports now indicate, a major element of this re-orientation is a process of commercial and industrial consolidation and self-containment using the technical, operational and strategic lessons learned from domestic JVs to drive improvement in 'proprietary Chinese' R&D, development and manufacturing capabilities.[NB the laxness of R&D law was typically a precursor to this phase]. This period of industrial and financial consolidation will seek to improve overall national competence, both by satisfying domestic commerce and the population. With improved national products, services and brands walking business and the consumer up the quality-expectational curve.

This then raises general quality for the next – higher-tech achieved- export push, when it tries to equal the West's capabilities, especially in eco-tech, at comparatively lower prices with a retained US$-peg.

For the present, given its level of US$ holding, and increased trade relations with Asian neighbours, Middle Eastern oil & gas exporters and S. American materials/commodities exporters, it seems the PRC will give Washington little heed to its FX policy lectures, indeed given the ratcheting down of Japan's industrial cost-base (ie achieved via the Toyota, Sony etc problems) there seems real pressure from its Asian peers to devalue once again as China in turn follows the Japanese lead to maintain the necessary Japanese FDI to assist its own industrial ambitions. .

Thus there may well be a re-ratcheting of the whole ASEAN structural cost-base, which will affect China and India so as to maintain corporate margins, FX differentials and so national growth.

Rupee -
India's currency has been rising year on year, much to do with the drop in the US$, drop in Euro and relationship to Dollar-pegged Asian & Arabic currencies. Adding to that pressure has been a strongly performing national stock market so creating a climate of recycled profits onto investment and in certain sectors – such as IT – a level of slowly spiralling wage-push inflation in the more industrially advanced regions.

This highlights that the economy continues to effectively operate as 2 tier 'open & closed' system. The open element being improved banking & financial de-regulation assisting the efficacy of capital markets, attracting FDI and so feeding investment in industry. But in contrast the closed element protecting – for political reasons – the agricultural sector, food retailing sector and specific labour-intensive areas which historically account for a large percentage of the monetary base. Thus India continues to be locked into a catch-22 situation, the innate sociological and cultural base (of tiered co-dependability) denying the necessary state-created social 'safety-nets' and so prohibiting major structural reform across all sectors.

Thus, India's labour policies are little changed – which largely for political reasons – means that employment takes precedence over economic efficiency (eg ship dismantling sector). Cross-country infrastructure is notably poor which essentially maintains the nation as distinct regional economies, each self-serving.

As a notionally self-sustaining food producer - without the need for basic food imports - and the food-corruption riots of 2007 passed, the rise in external Rupee valuation has been of little consequence to most Indians. whilst the comparatively small band of internationally travelled wealthy & middle-class note their improved FX circumstances. But of course it is the corporate exporters are feeling the FX pinch, exporting companies such as Suzuki-Maruti and materials miner/processor Vendanta seeing income margins shrink, though thankfully counter-acted by the improvement in global small car sales (relative to India's small car export policy) and the stabilisation (and expected upturn) in mining and processing sectors.

As a less export driven nation compared to China, Taiwan, S. Korea its innate FX sensitivity is less, and given that India looks to maintain its growth levels where others have slowed, stalled or stagnated, the BoI may well enjoy the rising strength as it it turn is able to buy greater $, Euro., £ & Yen reserve holdings which in turn give greater political clout amongst the 'G8-G20' nations and enable the continued purchase of western companies to assist its own higher-value industrial capability ambitions.

Thus the Rupee could well be on a sustained path of higher valuation, the present export cost-base disadvantage obviated in time at the unit margin level by greater production process efficiencies throughout the value-chain that come with a mix of domestic conglomerate groups and increasing domestic consumer demand - a mixed marriage of cost optimisation and increased scale.

Euro -
The previous collapse of the US financial and banking sector in 2007/8 - with accordant US$ valuation ramifications- and global demand contraction, meant that the Euro's innately high cost-base (even with CEE off-setting) was always bound to become a problem for the EU's Generals. A problem they would have to face pro-actively or re-actively, either en mass or individually.

Untenably high labour costs and diminishing returns on CEE integration have eroded EU competitiveness in all but the highest value sectors in which its players do maintain global advantage.
But the EU economy is obviously not all 'high-end' value creation and the recent years of credit-enables consumption highlighting for many EU members the growing disparity between import and exports most obvious in Balance of Trade figures. Unsurprisingly the credit-retraction shock hit those economies that had enjoyed large paper-based gains over the previous decade (including the UK) but most prevalently damaging to those nations that had experienced rapid rises in living standards based on a nationally thin asset-bases – typically credit driven property, tourism and public sector employment.

[NB investment-auto-motives believed in 2007 that the EU would be the hardest hit, the Southern region most so, given the extent of fundamental economic 'dis-jointing' that occurred between tangibly real and intangible perceived wealth creation].

The current fall of the Euro – something which ideally could have been centrally manages – has instead been precipitated by the capital markets' exposure of the 'PIGS' economies, and demonstrates the lack of individual governmental oversight to create robust economic structures during the boom years. Thus the expected fracturing has occurred, though in a more pronounced manner than expected given the role of invisible off-balance-sheet instruments sold to the likes of Greece that were designed to flatter the credibility of an economy running on empty.

But this is North-South fracture is positive in as much that it highlights the need for economic re-assessment and reform amongst the PIGS, and by virtue of capital markets' discreditation creates necessary downward pressure on the Euro. This, by welcome consequence, allows the more fiscally responsible and pragmatic core EU members of German and France to gain from the single-currency devaluation in terms of their own RoW exports, and importantly acting as 'proactive guides' allows them to take the reigns of EU industrial reform and consolidation in due course.

The stability of the Euro depends upon the stability – and commercial competences - of its members. So the unhappy Greece episode is a wake-up call to 'the PIGS' to set their house in order to both help themselves and stabilise the bloc en mass. Implicit threats of Euro exclusion by Germany & France are probably being aired to enable greater Berlin & Parisian oversight if a EU 'in-house' assistance package is ultimately necessary for Greece via a psuedo EMF - if the bond markets and IMF ultimately prove unsatisfactory solutions on the bases of interest rate costs and domestic rule strictures.

Markets will want to see such a foundational underpinning before the Euro settles at a new meaningful FX floor rate, and that may take some time given the political complexities involved, which means a continued, though slowed, welcome slide for the Euro that aids international competitiveness and so re-energises the bloc-economy.

Importantly, the continued over-pricing of Southern EU property-base (and probably certain CEE regions) must be a core focus for rationalisation, so as to re-set the PIGS' economic models, its deflation – even with a portion of temporary negative equity - allowing the component parts of the national economies to rationally better weave together.

Sterling –
The Pound's demise has obviously come as a result of general economic malais compounded by the perilous state of public finances, quite possibly the worst in the advanced Triad region. Like the US, the supposed momentum for exports has not yet arrived, instead leaving the guardians of the UK economy facing the challenge of creating a new, largely self-sustaining, nationally broader, economic model.

In the near-medium term Sterling itself looks to continue to suffer from this lack of fundamental national economic strength, and it is imagined that the BoE's Monetary Policy Committee will maintain the Weak-Pound stance given a few of the favourable results now emerging. A highly visible result is the inflow of foreign liquidity into the UK's capital markets, the present yield and price/earnings ratios of (respectively) 3% vs 12.2 demonstrably better, on the surface at least, than many others. The Weak Pound also presents opportunities for a continuation of foreign interests in UK companies, as witnessed with the Kraft-Cadbury acquisition, and noted in the Indian Rupee overview.

Given the new mantra to head toward a more high-tech, high-value national economy, future government interventionism to stop this march of progress by defending under-performing 'old-hat' companies from foreign acquisition appears very unlikely, instead the new blue or red government – or indeed possibly green or rose coloured, with a Liberal mix of yellow in the case of a hung parliament – will be looking to re-invent 'old-hat' sectors as re-attuned and 'born-again' (eg Nissan in Sunderland, Ford in S. Wales and Essex).

As for Sterling itself, that subtle showman Jim Rogers looks to be attempting to chip away at its current credibility with the tongue-in-cheek disingenuous quote that he “won't be touching the Pound in my lifetime!”, but saying he'll be interested when he sees further devaluation with the quip “how “cheap is cheap?...under a dollar?”. Given the present state of the UK and US economies, and the historic valuation gap, that may be too much to ask for given the 30%+ Pound devaluation required, but an ongoing slow degradation looks feasible, until either the Conservatives win office with a momentary blip-up in price, but not until a fundamentally strong fiscal policy, backed by a strong national industrial/commercial plan, is tabled.

To conclude, most economies are having to re-orientate to meet the host of new challenges presented after the global economic storm, but none more so than the Triads who are trying to feel their way through under very testing conditions.

Centre stage is the question of national & regional credibility as a 21st century component part of the global economy, and that innate question besets the innate value of their national/regional currency.

In the meantime, that emerged credibility gap presenting a 2-speed world between slow advanced countries and medium pace EM regions will be the source of commercial arbitrage for corporations operating within these distinct zones via M&A and between these zones via geographic expansion.

This very basic observation should to be heeded by all constituents of the Automotive sector, and its cross-border value-chain, as the question of innate value is set against the contextual background of historically re-shaped currencies.

Monday, 15 March 2010

Company Focus – Halfords Group plc – Animal Spirits for Farming the Recession

Economic downturns whilst broadly damaging, do of course play into the hands of those companies well suited to the more austere climate; especially those that re-orientate themselves to match not only periodic recessions, but the general shift of socio-economic and geo-economic trends to maximise their market appeal.

With an attitude of 'animal spirits for farming the recession', Halfords – the retailer of car parts, car accessories, bicycles, mobility products and now garage network owners - could well be starting their Board meetings with an adapted mantra from Orwell's Animal Farm...“2 wheels good, 4 wheels better!”

Since its formal 1902 origins in Halford Street, Leicester, its ironmonger founder Frederick Rushbrooke soon recognised the innate sales growth potential for products that revolved around personal mobility, serving-up bicycle parts and accessories to the Edwardian working classes.

Within 30 years the company had 200 'Halford Cycle Co.' shops nationwide, and in 1945 utilising depressed asset values, undertook vertical consolidation by acquiring its supplier The Birmingham Bicycle Co. Of course since the introduction of Austin 7 in 1922 motoring had become ever more prevalent amongst the expanding middle class, but in a post WW2 era when (petrol) rationing and coupons were still the order of the day, mass mobility in large part meant the bicycle and motorcycle.

Of course with such an expansive network of branches, the subsequent 1950s/60s re-growth of the British motor industry on the back of increasing national wealth witnessed a concomitant reaction from Halfords, balancing bicycle stock with that of car parts. At a still relatively austere time before cars became the commoditised almost disposable items of today, the personalisation of a car for the long-hold original owner or subsequent 2nd,3rd,4th,5th hand owners, servicing, repair and accessory items became the dominant income stream, with by 1968, 300 stores. Such an expansive retail network of course didn't go unnoticed by outside interests with either (vertically) synergistic operations (ie Smiths Industries) or indirect (lateral) complementary activities (ie Burmah Oil).

Burmah Oil acquired Halfords in 1969 whilst it was riding high on buoyant global oil demand, obviously seeing an opportunity to target regions of the UK sell petrol and parts, assisted by its motor-racing sponsorship in the early 1970s, associated with the likes of James Hunt. At a time when most young men were buying their first car, family men were upgrading their cars and executives were enjoying the then status of the company car, Hunt was the 4-wheeled David Beckham of his day and the created tri-lateral connection of him, Burmah Oil and Halfords made for a potent mix right-up to the 1974 oil crisis and Burmah Oil's over-reach and exposure.

Later owners included the Ward-White group, the Boots Group, CVC Capital Partners private equity who then publicly floated the company in 2004.

Since that time, a deeper strategic outlook has emerged seen with:

1. collaboration with Japan's Autobacs Seven Co
2. broader product outlook has evolved with greater segmentation of its retail-lines,
2a.enhanced with organically introduced or acquired branded identities
(eg Bikehut, Apollo & Ripspeed),
3. introduction of new product & service lines (eg electric wheelchairs & electric bicycles)
4. expansion of seasonal retail lines (eg caravanning and camping)
5. expansion of customer-lifestyle retail lines (eg car & home baby products)
6. 446 store network

Thus since the rational adoption of the edge-of-town superstore format some time ago, the company has been seen to stretch its retail scope and coverage. That was undoubtedly a necessary exercise, especially given the volume throughput levels Halford's could leverage when ordering mass volumes of the low-cost items that were made available from Chinese, Taiwanese and other production sites over the last decade.

The emergence of the CEE as a previously strong, now economically flat but stable, entity was also recognised, as a natural correlate opportunity with Poland and the Czech Republic given the trend of relative population migration between these countries and the UK. As a result Halfords seized the opportunity to open 5 stores in the Czech Republic and 1 in Poland.

This growth model whilst powerful may have been viewed as becoming less potent in the medium term, slowing its contribution to the bottom-line in the years ahead as sales volumes of non-essential consumer goods naturally decrease in recessionary times, both in the UK and in the CEE. And so the board rightly looked elsewhere for supplementary revenue that would have a natural fit to Halford's operational space.

Thus it came as little surprise to investment-auto-motives when it was announced on 18th February that the company had bought Nationwide Autocentres network of 224 outlets for £73.2m (7.2 x FY10 EBITDA) from its cash-pile, relative to a Group Net Debt of 1.1x EBITDA. It views the service and repair industry as worth £9bn annually, 56.8% of which is derived from servicing and MOT test certificate issuance – which obviously has a repair correlate.

The driving trends considered were:

A. recognition that car ownership periods were once again extending
B. thereby aging the UK's privately held 'carparc'
C. the public's dissatisfaction with the less than reputable independent garages
(that make up much of the nation's garage trade)
D the average person's inability to understand and repair their car
E. the opportunity to access SME & corporate fleet services demand.

Hence the recognition of the opportunity awaiting Halford's, the ability to sell an additional higher-value services to the current Halford's customer (keeping their car longer, out of warranty and into annual MOTs), and to attract new custom from disgruntled ex-patrons of the private trade.

Moreover, the present low-inflation / high-unemployment environment means that bought-in parts are being held at static cost and the required semi-skilled technician labour can be bought at low rates, the hand-over to Halford's also generating the opportunity to renegotiate new terms with present Nationwide employees. Moreover, the combined procurement volumes of standard car-parts via a central purchasing unit means that scale efficiencies can be utilised in driving down bought in unit costs and critically creditor terms, so in due course assisting cash-flow.

Critically since the new MOT regulations were introduced some years ago over-hauling the inspection system. The additional vehicle assessment hardware was duly acquired by MOT practioners to meet new DVLA standards, and critically interface with a DVLA central database. In short, much of the UK's garage trade has had to conform to the enhanced standards. With such a broad, capital intensive exercise already undertaken and in place for the years to come, it means that Halfords' ongoing acquisition path of the additional 200 garages can be done without the level of major capital expenditure to upgrade new sites typically required. Not quite, but largely limited to new corporate signage and internal/external decoration in accordance to the Halfords design standards.

The corporate ambition is to naturally re-brand the garages as Halfords Autocentres and open a further 200 stores offering “dealership quality at lower prices” - obviously in accord with the mood of the age and satisfying the needs of the old and new B2C customer-base (78%), and the newer B2B base (22%).

Autocentre's productivity levels will undoubtedly be an area that sees initial focus. Management has presented comparitive KPI figures for 2005 vs 2009, which were obviously designed to impress, and whilst that 4 year period saw sales growth, per job income rise, the productivity per technician rose only by 1.4 jobs (ie cars) per week – ie 0.35 of a job (car) improvement per year. This must surely be the next area for betterment, with possibly earlier and later opening hours and improved workflow through the garage, where basic engine bay servicing elements and similar can be done 'off-ramp'.

[NB the use of ramps for all vehicle work appears professional but often leads to temporary workshop slow-down, and part-moved cars to 'movement paralysis'. Moreover many less motivated technicians will use the excuse to slow their own workload, especially if on standard wage/salary, thereby seriously slowing volume job throughput].

Given the slow productivity improvement between 2005-09, consideration of work-flow re-organisation will probably be an initial focus of Halfords Autocentre management, possibly instigating additional hardstanding maintenance zones and possibly the idea of technician's piecemeal pay structure, with safeguards to ensure that technician's work standards are maintained and improved where there is a temptation to put job turnaround speed above job quality.

Furthermore, the auto-servicing arena is not completely foreign to Halfords, and presumably there are senior staff that served during its edge-of-town superstore expansionary period when it previously had an agreement to service and warranty repair Deawoo cars sold via the then new and separate GM-Daewoo network. That also presumably means that the typical 'flexi-warehouse' space of a typical superstore which once housed Daewoo service equipment (ramps, special tools etc) was replaced with normal retail shelving when Daewoo UK 'expired' . With a natural contraction of retail space required as a result of reduced consumer demand means that the space could be recaptured for car-servicing with the instillation of suitable partitioning etc.

Moreover still, many Halfords stores sit in close proximity to used car superstores. The sales of used cars has increased in recent years as new car sales slowed, and those fiscally constrained buyers will be seeking an option to the high costs of dealer servicing or the lost confidence of small garages – hence the very type of affordable maintainance Halfords Autocentres offers.

As for the continued roll-out of conventional Halford stores, it seems the most probable path will be the expansion of Poland given the country's bucking of the EU trend by maintained growth momentum, so one of the few growth stars of the present climate. Poland is also a large recipient of grey-market previously German & Czech registered vehicles. The possible slow/stagnation of Czech business for Halfords means that the assets (shop-fittings & products) of one of its lesser performing Czech stores could be easily transported over the border to set-up a second Polish store.

More investment-auto-motives suspects that just as the company Board has set-up shop in these 2 core CEE countries, so it will latterly expand the new Halfords Autocentre venture into these regions, riding the UK-Czech-Polish consumer cross-pollination and the growing trend that motorists will either choose not to self-service or self-repair their cars as their living standards improve, or that rising emissions regulations and advanced auto-technology will prohibit DIYers.

But for the near and medium term beyond the integration of its new garage network, David Wild and his lieutenants will be focused on maximising the per sq metre income from its stores relative to general and seasonal trends, rationalising the new garage network it has bought to improve operating margins and viewing how the 2 may be merged to create a powerful network of branches that offer practical & pleasure goods with a synergistic maintainance and fitment service.

Wild (CEO), Wilkes (COO) & Wharton (FD) will be hoping that Halfords' promotion efforts via BTCC motorsport sponsorship and TV advertising will underpin the promise of cross-selling in these re-orientated stores – where a customer can walk through the aisles, choose upgrade parts and accessories and have them fitted on-site or indeed during a routine service the client is tempted to view the equivalent of a new car dealer's options and accessories list, and so bump-up Halford's servicing margins...ideally an upgraded media system or perhaps a bike rack and maybe 2 bikes to boot! And beyond the family market is Ripspeed's client base of young men and women with few responsibilities and money to spend on performance and cosmetic kits for overtly pandered hot-hatches. Halfords may not have the kudos of say 'West Coast Custom', but just as Ripspeed brought glamour to its London customers in its hey-day, so Halfords could, if better managed, do the same by exploiting Ripspeed's(original) Mini heritage to the masses who currently drive (2000+ 'New') Mini, older models ripe for aftermarket personalisation.

And lastly, given the network expansion of Halfords' property interests, it will undoubtedly review the potential for operating an additional 'PropCo' operating model, so possibly enabling a new division to be created (if not already) that is able to convert any/specific leasehold properties to freehold and so capture the year on year improved valuation, set within the Group's asset-base.

The commercial property sector is indeed sitting in a trough at present, but unlike typical retail premisis on the high-street, in shopping malls or dedicated edge-of-town sites, it is suspected that much of Autocentres' premises will be based on urban light-brown, semi-industrial plots, with far greater (latter-day) change of use opportunities if/when considering plot sale divestment policy or in-house redevelopment such as corporate-assisted social housing.

George Orwell took the road to Wigan Pier to view the social impact of the depression era, and whilst in a very different world 80 years later, Halfords recognises the commercial opportunity by facing today's headwinds full-on, revisiting its past and expanding its future:

“2 wheels good, 4 wheels better!”...the type of animal spirits much needed today when 'farming' the recession.

Tuesday, 9 March 2010

PESTEL Trends – The Western Economic Model – Regenerating Tangible Added Value...Part 3

The aforementioned 'call to action' for the creation of a new industrial template – with auto playing an important role - of course presents major challenges to any successive governments seeking to re-balance the UK's wealth generation model (ie Industry vs Service vs Finance sectors)

Undeniably there has been a gradual change in the structure of British economy over the last 40 years, as heavy industry has migrated to more suitable regions, the service sector has flourished and perhaps most apparent to government the massive growth of the Financial Services sector due to national and international growth.

That is an inevitable consequence of general wealth generation domestically and the fact that London defends its predominant position as a destination of choice amongst global capital markets - often the exchange of choice for new and secondary IPOs.

With the personal rewards on offer in the City versus comparatively poor rewards in other realms, unsurprisingly the sector has also attracted the best and brightest from graduate level to later year 'career shifters' and been a major influence regards dedicated new entrepreneurial activity – indeed it was this fact that set the context for the bridging the 'intelligence chasm' between industry, investors and government that drove the creation of investment-auto-motives.

Even with progressive competition from New York, Hong Kong and Beijing, London today still sits at the commercial epicentre of global commercial affairs, as depicted by the FTSE 100 / 250. Its age-old, proven track-record, plethora of multi-sector prime operators and support players, aswell as a balance of self-control relative to 'light-touch' regulation elevates the City as perhaps the most responsible yet progressive of financial hubs.

To that end, unsurprisingly the Top (FTSE) 20 highlight the importance of financial intermediaries along with other mature sector household names:

Financials - Banking, Insurance, Pensions (HSBC, Barclays, Standard Chartered, RBS, Lloyds),
Energy - Oil (BP, Shell) Gas (BG Group),
Telco - (Vodafone),
Pharma - (GSK, AstraZenica),
Mining - (BHP Billitonn, Rio Tinto, Xstrata, Anglo-American),
Tobacco - (BAT),
Consumer - (Tesco, Diagio, SABMiller, Unilever)

Given the need to essentially transform the UK's (and in due course Western Europe's) economic model, of these corporations, only Vodafone can be regarded as a late 20th century commercially transformative 'disrupter'. A new entrant 'sector transformer' in the typical sense whose characteristics are seen to be akin to any successful eco-tech venture in the near to mid-term. Hence the Telco business model via Vodaphone and peers is as close a pseudo-industrial equivalent to the successful dotcom companies that are taken as a benchmark for high-potential 'eco-tech'.

But it must be noted that Vodafone was always in reality heavily biased to its service content, the reality of its true industrial base always intended to be light – the erection of a 'simple' low cost mast network, the use of (bought-in) proprietary handsets, as an on-seller of reputed branded handsets, with focus on service package provision (B2B & B2C). Moreover, the firm's true growth came not organically, but from national and international 'bolt-on' acquisitions, M&A and partnerships.

Thus, to use Vodafone as a directly applicable model for 'eco-tech' (especially regards the auto-industry) maybe somewhat naïve, even if well intended. There are undoubtedly 'lessons to be learnt as has been the case in the push for a modelled auto-industry (from INDEGO to Better Place to GM's appointment of ex-AT&T Whitacre), yet as a the UK's prime reference, case-study enterprise, its 'reflection' may ultimately be less useful than than often espoused by the sector-transformative rhetoric heard. When seeking to re-create an entrenched industry, it is finite, applicable detail that is required, not broad, hypothetical generalities.

Thus it may be 'only' within the 'FTSE 30 & 40' that we start to see the placings of other auto-relevant sectors, in the guise of traditional Engineering & Energy companies which through phases of consolidation and scientific improvement, have climbed the 'value-ladder' in respectively specialist application fields, or by re-packaging their commodity offerings.

#23 Energy (National Grid)
#25 Energy (Centrica)
#27 Aerospace & Defence (BAE Systems)
#29 Energy (Scottish & Southern)
#34 Aerospace (Rolls Royce Aero)

[NB the UK's eponymous GKN fell out of the FTSE100 in 2004].

Given that the eco-tech realm must be (hardware and software) engineered, some may see it as a concern to see that the only few big UK Engineering companies sit in the 'late 20s', compared with say Germany's crop in the DAX30 (inc VW, Daimler, BMW, MAN, Continental, Siemens, Thyssen-Krupp), or the ranking of France's CAC40 constituents (inc PSA, Renault, Michelin).

Of course, given that London is such a large financial global hub the FTSE intrinsically holds a greater number of international companies with larger rated MarketCaps, so the rankings of the UK's finest would be expectantly lower. Yet still a counter-viewpoint will argue that the EU inter-national difference between the UK and the Continent (ie national 'deference') to the automotive sector is plain to see. And it is that productivity difference that will have a very large impact in this 'post-apocalyptic' economic world in creating economic growth. In effect, the UK presently has all to play for.

The argument runs that given the importance & poignancy of personal mobility - and the entrenched 'added value' therein - since the fall-away of GKN from the FTSE100 in 2004, the remaining core of the UK's automotive industry is now ever more distant from investor attention; especially 'deep-capital' institutional attention.

Today in the UK it is the more visible Trade section of the auto-industry that automatically draws investor attention; ranging from Inchcape, Lookers and Pendragon to Halfords. Their upstream counterparts in supplier and development realms - such as Smiths Group (having acquired TI Group) and Tomkins - perhaps loosing profile since peers (such as Lucas, TRW etc) were absorbed into foreign ownership and their ostensibly 'low-mid-tech' products are seen as lacking competitive edge; hence investor interest..

Beyond the obvious FTSE listings, there are many more that have a theoretical influence and bearing upon the future of UK Autos and 'eco-tech; in general. The FTSE-techMARK100 is directed at high-tech' and innovative companies, whilst latterly the creation of various 'Responsible Investment Indices' track the performance of those that meet CSR-based criteria, but invariably drags as a consequence of failed Kyoto & Copenhagen. Indeed, the ability to demonstrate a truly tenable 'eco-index'; and may not appear until the ideals and realities of carbon-credit trading market becomes a stable, credible entity; this still looks some time away.

Instead as a proxy, the FTSE-techMARK100 is typically used as the viewing-pool when assessing eco-relative progress: technical breakthroughs, feasible R&D spin-offs (incubators & VC backing) with possible emergence of B2B & B2C products. Presently, commercial entities in the techMARK100 with material relevance to automotive include: Cobham (inc Frazer-Nash Research), QinetiQ, Aveva and Ultra Electronics.

This focus on publicly listed companies obviously overlooks privately owned entities. Taken from The Times' 'Top Track 100', such influencers include:

R&D and Assembly Base - Caparo Group (inc Caparo Vehicle Technologies), JCB
Development - Arup Engineering.
Supply Base - TI Automotive, Unipart Group, Marshall Group, Doncasters Group,
Retail/Trade Base - Arnold Clarke, Greenhous Group, JCT600 Group, Listers Group
Aftermarket Base – Kwik-Fit

In addition beyond these relatively 'large Cap' companies, the UK possibly has the world's most extensive network of Niche Producer / Assemblers; from the renowned few (eg McLaren, Noble (Fenix), Marcos, Ginetta, Westfield and of course Morgan) to the myriad of little known plentiful Kit Car firms, often family owned, or part of a small synergistic conglomerate.

[NB Aston Martin Lagonda & Lotus are not shown given their comparitive sizable 'mid-scale' volumes. Also note that AML operates what is notionally known as a craft-shop for limited edition and personalised models - using non-standard leathers, veneers, paints etc; but in reality essential skills-base is semi-skilled as is necessary
to add the required dimension of cosmetic difference. (The definition of craft-talent here is in the William Morris vein of the singular constructor/adapter, yet with a pro-free-market individualist stance, instead of Morris' more socialist view)].

Unfortunately there often exists a level of distrust and friction between the small operators and the investment community. The past has witnessed internal strategic power struggles as investors naturally seek to maximise their returns via financial leverage, asset divestment or alternative exit strategies, going against the grain of originator's intent. Equally history shows how niche car companies have been created or re-directed as little more than emotion-led capital attraction schemes, little business development and brand building resulting after dissappearance of the original 'club' set-up capital.

Thus, note that for many small companies the Morgan Motor Co. business model seen as a template of self-sustainability. And whilst the UK's aim is obviously to progress a high-value, intelligence intensive R&D auto-realm, the re-creation a modern-day crafts-based labour force at the 'micro' level – as Morgan does – plays a role in manufacturing high-value tailor-made products].

And of course, pertaining to certain sections the core product's value chain, or circumnavigating the whole, is the world of auto-industry strategic and operational consulting.

Unlike the previous John Harvey-Jones' recommendation for Morgan to modernise its production methods – though acute in parts – investment-auto-motives has longed believed that 'Morgan Way' has facets of merit that can influence the future of specialist UK auto-manufacture.

But to re-quote Sir John on one perceptive matter... “if we imagine the UK can get by with a bunch of people in smocks showing tourists around medieval castles, we are quite frankly out of our tiny minds”.

Thus though the UK is notionally 'post-industrial' with only 14% of GDP generated by manufacturing, it undeniably has a broad span of capabilities, each link of that value-chain varying in 'strength & connectedness' given historical events.

But of course labels abound, and just as we are 'post-industrial', so there is a sense that we are 'post-advertising' given its declining influence, and even 'post-marketing' given the growing trend to avoid consumer tracking. Ultimately semantics are of little use, what matters is an understanding of how the UK must be strategically positioned relative to other countries, and how its core competencies must be evolved and re-shaped.

As demonstrated by the FTSE100, in recent decades the UK's value-creation base has been largely led by financial, energy, media, telco and retail sectors. As with other M&As, the sale of Cadbury to Kraft only serves to show how the basic mass-consumer industries that formerly build the UK's economy are today better served from other countries or by foreign owners in the search for scale efficiencies and global marketing reach - it's the natural evolution of the globalised capital markets which the UK itself benefited by.

Yet the UK chocolate industry, like its brewing cousin, is far from dead, with a new crop of higher value 'chocolatiers' and micro-brewers reinvigorating their respective sectors...a poignient philosophical lessons for UK Autos plc.

Ultimately, it will require a synthesis of the following issues and more within a coherent policy format to achieve the required transformation of the indigenous UK sector.

- Recognition of the full span/reach of the auto-sector across the broad value-chain
- Parallel learning, case-study lessons (eg Vodaphone plus others) for each sub-sector of that chain.
- Development of pathways for improved scientific & technical cross-fertilisation
- Creation of 'white space' for cross-sector product experimentation
- Far greater government oversight of publicly funded 'eco-tech' ventures

Commercial IPR Leverage
- Applied 'in the bag' R&D from other non-auto indirect sectors & vanguards (eg BAE to Dyson)
- Applied product development methodologies (philosophical & operational) from BIC within the auto-sector and from elsewhere
- Applied process and materials 'technology-transfer'

Industry Structure
- Greater interaction between domestic industry and foreign 'transplant' tech & IPR capabilities.
- Greater interaction between domestic industry and other sectors
(eg motorcycles, light aircraft, private marine)
- Creation of a central 'knowledge-bank' re: companies' competence, resource & IPR
- Connectivity enabled by use of centralised IT database and progressive intel-mgmt
- Connectivity aim to enhance robustness of sector
(ie stretching from NPD exploration via more Joint Ventures to 'dormant' asset/plant lease-lend)

Legislative Regulation
- Regulatory change in roadway definition & use
- Regulatory change in vehicle definition & use

Consumer Orientation
- Consumer attitudinal change towards 'eco' from “worthy” to “aspirational”
- Consumer attitudinal change regards the very idea of 'the car' and its DNA

- Re-examination of Education's remit in creating the creative commercial minds of tomorrow.
- Greater connectivity of education and commerce with vitally necessary cross-disciplinary learning
(eg the sciences mixed with the arts mixed with business)
- Far greater focus on automotive industry history, practice and methods:
(Cardiff Business School – Brunel Univ. - Imperial Univ. - Coventry Univ - RCA cross-pollination)

[NB plus much more].

This to be achieved via utilisation of the home-grown, indigenous high-value Automotive Consulting base, constituents of which ably demonstrate themselves as world-class - an enabler for our own island, and that island's influence over the globe.

Wednesday, 3 March 2010

PESTEL Trends – The Western Economic Model – Regenerating Tangible Added Value...Part 2

To follow-on from the Societal perspective described in the previous post, the following 2 commentaries take a closer look at the Commercial.

As previously stated, business commentators and politicians alike highlight that the economic downturn has bottomed-out and slow recovery has begun. It seems that such leaders have had enough of the 'talking down' of the economy, even if a weighty proportion of metric indicators, along with general sentiment, don't necessarily reflect that optimism.

[NB. Of just as great concern is John Auther's recent Short View note that risk-averse global capital is reverting back into a still stagnant US so supporting a fundamentally weak Dollar and still fragile domestic economy].

Since the start of the Q209 equities rally, the constituent characters that make-up the capital markets view a parallax-biased world. One driven by the extremes of 'on-off' speculation and risk-aversion, much depending on event-driven sentiment. And it seems that such volatility will continue as the global economy lurches from one systemic pillar - and associated problem - to the next. Having been through the Credit Crisis, Banking Crisis, Sovereign Debt Crisis, all look-on with concerns of an Sterling and Euro FX Crisis emerging.

Even so, with many of these crises that form the systemic whole behind us, it is now time to review the very foundations of society and commerce - foundations that must support the future.

As investment-auto-motives has stated in the past, the evolution of the West's credit and asset bubbles demonstrated how the notion of true value and productivity had been surpassed by financial engineering at all levels - corporate, consumer and government, promoted by over-zealous financial innovators.

Although the process will be painful, it is surely time now for the West (UK and US in particular) to grasp the nettle regards the dismal public finances which if unattended will continue to strangle what should be a mixed, yet still pro-capitalist, economy. For it is that ambitious verve, that entrepreneurial drive, which will in large part regenerate desperately needed wealth creation.

In truth today the UK and US appear to sit in an idealistic bubble, many politicos' beliefs fed by their own rhetoric and perpetuated by miles upon miles of journalists' PR-driven column inches.

This eco-era is supposed to be the savior of the West, yet whilst progress is being made it is undeniably slow. The inability to consensually ratify Copenhagen given the costs to the present perilous economy, means that any government/regulatory push to 'greenify' industry and consumers has been largely halted by the headwinds of economic reality. Disheveled national budgets prohibit nationally sourced incentives, add to which the impact of 'liquidity cautious' companies and risk-averse investors. The latter demonstrated by the virtual collapse of Venture Capital funding, which has of course historically provided the seed money for sector transformative products and services.

Hence the green era set in motion still looks decidedly light in colour - more opaque verdigris than deep olive. Accordingly commercial expectations of a massive consumer-led green revolution have faded fast, from their initial unrealistic expectations.

[NB auto industry studies in the mid-1990's and over the following decade regards the importance of eco-friendly cars to consumers demonstrated the issue to be low on their agenda, only brought to bare with oil/petrol price spikes and the opportunity to buy new (eco-cars) at discount via scrappage schemes. That general past reluctance may well have been more entrenched behind the lip-service given the relative high cost-slow breakeven associated with eco-tech].

Even so, with realistic reduced or flat demand-pull some companies are under-taking supply-push.

Major commercial players such as Marks & Spencer here in the UK are indeed playing a role, with beyond its in-house 'No Plan B' initiatives, an externally directed effort to energy-lag its workforces' home attics. However, such cases look very much like an alternative (probably tax-efficient) form of PPI, used as a lever where the state itself has been unable to effect change upon its citizens. The M&S 'directive' stands in contrast to a similar attic-lagging project rolled out by the London Mayor's office, but this grande initiative hence stumbled over the bureaucratic reality that the Mayoral Office cannot enforce the roll-out via autonomous local borough councils.

[NB This initiative of overlapping the notions of 'work' and 'home' could well be M&S's attempt to expand its consumer finance ambitions, probably initially into employee mortgages, then hence moving on to customer mortgages possibly via a banking licence or in league with a major bank ; since M&S and its backers (large equity & FI) undoubtedly recognise the deflated price of the UK housing stock and the eventual need to extend its personal finance activities beyond store cards, insurance and personal loans].

So certain major corporations are, small step by small step both in-house and customer-facing, appear to be contributing; having set out feasible targets. However, others seem to have over-played the eco-promise.

GM's recent announcement that it will discontinue its (Chevy Volt-based) Cadillac Converj concept, highlights how the eco-bar has been dramatically lowered; thereby infact reducing its commitment to what was lauded as large, step-change, enabler.

[NB. investment-auto-motives has, as previously stated on many occasions, long been skeptical about the technical and commercial feasibility of the GM Volt, especially given its $40,000+ price vs $20,000 Honda Insight or $22,000 Toyota Prius. (Expect to see Prius match insight on pricing given the Toyota debacle). Hybrids are only now starting to prove commercially viable, largely on a consortium basis for most automakers, whilst electric vehicles will only be able to realistically exist within their own co-designed 'micro-environs' as we see with North American NEVs within essentially closed communities. Hence a truly bright future for e-vehicles depends upon a en mass changed social fabric].

So where does the ever extolled green revolution sit today?

We are in reality seeing the inching forward of practical solutions and drawing back of the impractical.

And that, quite rightly, will set a rational contextual background for the eco-investment mentality. In doing so it will set a conservative tone regards acceptance of proposals set out by companies and entrepreneurs seeking backing. The oft over-hyped 'change the world in one easy step' inventors with wild-card schemes - such as the global CO2 air filtration machine - will be replaced by far more realistic 'incremental opportunists'. Individuals and groups who work pragmatically in accord with real-world restrictions (micro & macro) and can ideally incorporate the tenants of low-risk, low-cost and scalability across multiple market segments an geographies.

Fundamentally, it means reviewing the broad spectrum of possibility across all human activity with a discerning commercial acumen. It may mean that instead of seeking the far-reach scientific panacea, it engenders a view across neighbouring and disperate sectors to identify complementary technical and service solutions. Of consequence is the fact that this process is not purely the domain of the West, since Eastern intellectual force has grown to become weighty and in the future prolific.

So the West, the UK perhaps in particular, must address its place in the world.

Politicos and the like hark the typical rhetoric... “the land of opportunities presented by 21st century high-tech, high-value industries”...typically identifying "the creative industries", Info-Tech, Bio-genetics, Pharmaceutical and of course (Advanced) Energy. Yet we must add to this the somewhat hidden but vitally important sector of Defence, militarily developed technologies often the spring-board for latter-day broader private commercialisation.

But in reality the power of the competitive advantage the UK (& US) seems to innately believe it holds may infact be far weaker than imagined. This is exemplified by the Anglo-Swedish firm AstraZeneca, with its restructuring announcement that sees a consolidation of its R&D activities, with aligned 'high-value' job losses. That act alone demonstrates the commercial pressures in a R&D led organisation, pressures which politicians and business commentators cannot disregard.

And whilst the R&D / IPR 'future-promise' is a central, meaningful mantra, recognition must also be given to the intrinsic complexities of managing an increasingly 'people-soft' based economic system. Complexities which exist from the ground-up of state education all the way through to the organisation of corporate cultural creativity (CCC). Hence it questions the very structural basis of a modern western society.

The issue in the short term has ramifications that stretch well beyond the hypothetical operational management of firms or schools, and drills right down into the heart of investor attitude.

IPR-based sectors whilst undeniably important are also harder to orchestrate to provide continued year on year success unless a firm is fortunate to create a 'wonder' product and associative new segment from which it thenceforth maintains its leadership, as we've seen with Microsoft, Apple, Google, Facebook, Linked-In etc. Thus using IT as the case-construct, early phase investors can do well if a new company gains true market traction and swells enormously in its formative years.

But much of the investor base (from institutionals to skeptical private individuals) – especially today - want a Buffett-eque style of constant returns with secured initial capital set against hard physical assets, as historically typified by manufacturing and other traditional sectors in which labour was a component (replaceable) part of the economic system (ie Smith's: land + capital + labour = rent/profit)....yet today and increasingly tomorrow, people/labour have become the primary element of the investment equation.

Of course the rise of the corporation through the 20th century ring-fenced overt dependence on 'people-soft', yet it is also recognised that the traditional corporation must change to survive...the question is how?

Ultimately the idea of 'high-value' spans a plethora of sectors, from certain media-space through to specialist aero components and systems through to scientific instruments. In essence it means a knowledge-economy created from a merging of discipline-based education/training allied with personal curiosity and experimentation.

'People-soft' centres like Silicon Valley, the Cambridge Triangle and the Pune Valley have helped to set the socio-industrial templates that endeavour to create the best conditions for success, but the need to essentially re-create that 'free' academic campus feeling also increases the peril of remoteness from commercial reality and investment return necessity, and has been a major focus of the investment community's vision for tomorrow.

So today we see the best practices of the academic laboratory and the commercial R&D centre being assessed so as to try and create a commercially controllable environment for innovation – the term 'innovation' in itself a very blunt descriptor for the full spectrum and levels of variant activity.

Thus for the UK and US the real challenge is to spark, encourage, grow and harness the innate ability of their respective and combined populations. But this nurturing ability will need to be directed toward a credible industrial/commercial template. Presently it is the construct of such a template-form which is the major issue for strategic governmental research, assessment, debate and policy-creation.

The UK Auto sector must demonstrate its role in driving the UK economy, identifying its role for value-creation within a regional and global contexts.