Gravitas: Commodity Tailwinds

September 06, 2024 | Michael Newton


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The Newton Group Insights

Commodity prices are falling across the board. Below is a chart showing prices of oil, natural gas, iron ore and copper. The simplest explanation of the simultaneous decline is that global demand is soft. The US economy is still growing at a respectable pace, likely north of 2% in real terms. But GDP growth in the Euro area rose at just 0.6% annually in the past quarter, and China’s economy, while a little tricky to read, is probably expanding at less than 5% — poor by its standards. And China’s commodity-hungry real estate sector is still stalled. Growth in China’s property sector, which takes about 40% of its total steel supply, is collapsing. Already down 30-40% year to date. As ever, there are some geopolitical events at play in oil, too. The Opec+ countries continue to squabble over production cuts. But demand seems to be playing the bigger role. The same goes for other commodities markets. My view is that demand may improve in the coming months, but only marginally. The end of the global rate-rising cycle may help commodities demand. But there is an upside here. Falling commodity prices make it less likely that, as the Fed eases policy, inflation will reignite. A soft landing takes a lot of luck, but circumstances seem to be co-operating. The main takeaway is that lower oil prices tend to extend economic cycles, while higher prices often end them. Despite clearly weaker commodity price fundamentals, we would caution you against underweighting the Energy sector in diversified equity portfolios. It is the only group which reliably outperforms during a geopolitical crisis, and the sector is very cheap, and therefore merits continued exposure.

Should you have any questions or concerns, please feel free to reach out.

Portfolio Notes

(+) indicates a positive development, (-) indicates negative, and (~) indicates neutral

(~) Alimentation Couche-Tard (ATD-T) delivered EPS of $0.83, just below consensus of $0.84. As with many retailers across North America, a weak lower-end consumer is impacting sales volumes. ATD is no different with same store sales negative across geographies. On fuel margins, they were weaker in North America, but up in Europe. Overall, the quarter itself shouldn’t do much to help ATDs struggling shares, in our view. What really matters is the 7-11 offer, in which the company provided no additional details. However, Seven & I has sent a letter to ATD saying that its offer price is ‘insufficient’ and that competition law concerns remain. Nevertheless, the company will continue to discuss ATDs offer. A potential deal would be transformational for ATD, making it the world's largest c-store operator, and makes strategic sense to us. We continue to view the name as a core holding. That said, despite valuation now around its long-term average, we believe the overhang of a significant potential equity issue to fund this deal could keep a lid on the shares over the near-term. Owned in Core and ESG+ Portfolios.

(~) Super Micro Computer (SMCI-US) Chief Executive Charles Liang wrote a letter to the company's customers and partners and said that neither the recent delay to its annual report nor the recent disclosure by Hindenburg Research that it is short the company's stock will impact the pair. "Neither of these events affects our products or our ability and capacity to deliver the innovative IT solutions that you rely on every day," Liang wrote in the letter, which was also filed with the Securities and Exchange Commission. "Our production capabilities are unaffected and continue operating at pace to meet customer demand. Our world class engineering and support teams are also unaffected and continue to build and deploy large scale AI Total Solutions." Liang added that the company is "well-positioned" to deliver its product portfolio to its customers and help them meet their IT issues. In addition, Liang also said that Super Micro will have more to say about Hindenburg Research's accusations that he characterized as "false or inaccurate." "Separately, you may have also heard about a recent report from a short-seller hedge fund that contains false or inaccurate statements about our company including misleading presentations of information that we have previously shared publicly," Liang said. "We will address these statements in due course." Owned in Opportunity Portfolio.

(+) Tesla (TSLA-US) Shares of the electric vehicle company jumped this week after Tesla said it would roll out its advanced driver assistance in Europe and China in the first quarter of 2025, “pending regulatory approval.” The technology is marketed by Tesla as “Full Self Driving,” and upgrades Tesla’s Autopilot driver assistant. Owned in ESG+ Portfolio.

(+) TransDigm Group (TDG-US) announced that it is planning, subject to market and other conditions, to offer an incremental $3.0B of new secured debt. The offering is expected to be comprised of $1.5B of new senior secured notes and $1.5B of new term loans to be launched concurrently. TransDigm Group intends to use the net proceeds of the incremental debt, together with cash on hand, (i) to fund a special cash dividend to the holders of its common stock in the range of $3.5B to $4.5B, (ii) to make cash dividend equivalent payments on eligible vested options under its stock option plans and (iii) for related transaction fees and expenses. Owned in Core, Cash Flow and US Portfolios.

(~) Verizon Communications (VZ-US) has confirmed a prior report, that it will acquire Frontier (FYBR) for $20B in cash or $38.50 per share cash representing a premium of over 40% to Frontier's shares. The acquisition of Frontier makes strategic sense by enhancing Verizon’s ability to provide bundled wireless/broadband/TV offers to consumers at a time when both AT&T and T-Mobile are also investing significantly in building out their respective fiber networks. While the proposed acquisition price implies a full valuation for Frontier, we believe the unique nature of the assets and the ability to provide VZ with immediate fiber scale versus a multi-year organic buildout justifies the valuation. The deal does not change our thesis on the name as we continue to like VZ for its stable utility-like business, which we expect will continue to deliver modest growth and healthy margins. The stock remains attractively valued at a forward P/E multiple of 8.9x compared to its 10-year NTM P/E average of 11.0x, with an attractive 6.5% dividend yield. We would continue to own the stock and be buyers for income-oriented investors. Owned in Cash Flow Portfolio.

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