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Free Cash Flow:$3.20 Billion Profit Margins:27.40%
These strong numbers, which reflect increased demand for the commodities the company is involved in, have had a positive mid- to long-term impact on the company’s stock, as you can see in Figure 18-2. Rio Tinto trades on the New York Stock Exchange (NYSE) under the ticker symbol RTP.
Anglo-American
Anglo-American PLC began mining gold in South Africa in 1917. It was a ven- ture by British and American entrepreneurs (hence the name), who saw an opportunity in developing South African mines. Ever since, it has played an important role in the development of South Africa’s gold mining industry.
Today, Anglo-American has operations in all four corners of the globe and operates in over 20 countries. It is involved in the production and distribu- tion of a wide array of metals, minerals, and natural resources including gold, silver, and platinum but also diamonds and paper packaging (it actually owns 45 percent of DeBeers, the diamond company).
I recommend Anglo-American as a long-term investment because it has been in the business for almost a century, it’s involved in almost all aspects of the mining industry, and the scale of its operations is global.
The company is listed in the London Stock Exchange under the ticker symbol AAL. In addition, it has American Depository Receipts listed in the NASDAQ National Market that trade under the symbol AAUK.
When a foreign company wants to access the American capital markets, it has the option of issuing its shares as American Depository Receipts(ADRs).
ADRs are issued by a domestic bank (such as the Bank of New York, which is actually the largest issuer of ADRs) to the American investing public, while
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Figure 18-2:
Stock price of Rio Tinto (RTP) from June 2001 to June 2006.
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the bank holds shares of the foreign company overseas. The advantage of the ADR is that it allows American investors to invest in foreign companies without going through foreign exchanges. The ADRs trade in such a way that they reflect the daily price movements of the underlying stock as it is traded in a stock exchange overseas. For more information, you can check out the Bank of New York’s Web site on ADRs at www.adrbny.com.
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Making money during the mining merger mania
Profiting from the merger activity in the mining industry can be a good investment strategy.
Since the year 2000, a number of large compa- nies have entered into merger agreements (the marriage of the Australian BHP and the British Billiton, which resulted in BHP Billiton, is a good example), and this trend is likely to continue as mining companies seek to add new capacity by merging their activities and/or acquiring smaller rivals. In 2004, for instance, there were a total of 49 deals in the mining industry valued at $5.6 Billion; in 2005 the number of deals increased to 85 with a total value of $7.4 Billion.
Due to the sustained levels of high commodity prices, mining companies have large cash reserves and are looking to spend them to beef up their operations by acquiring other compa- nies. Mergers and acquisitions present long- term value opportunities to these companies and their shareholders and are likely to continue in the years to come. During the writing of this book for example, Phelps Dodge (one of the largest copper mining companies) launched a simultaneous double bid to acquire Inco and Falconbridge, both independent Canadian mining companies, in a synchronized transaction valued at over $40 Billion.
The caveat of profiting from merger announce- ments, of course, is identifying the “hunter” and the “hunted,” the acquirer and the target. This is not easy because, theoretically, there are an infinite number of merger and acquisition
combinations in any given sector. The best way to do so is to regularly monitor the industry for news, special announcements, or unusual trad- ing activity. Specifically, keep your eye out for any announcements by companies in Forms 8K (filings with the SEC that announce special sit- uations); read news stories about the compa- nies in the industry (I recommend reading the Wall Street Journal’s“Heard On The Street”
column); and remain alert to any sudden and unusual movements in the companies’ stock activity, such as an unusual spike in volume.
(Check out Chapter 10 for more on volume and other technical metrics.)
Identifying possible merger announcements is not an exact science, but it can yield some phe- nomenal returns. So much so that a lot of folks try to get insider information regarding merger deals, which is illegal and has led to some of the biggest financial scandals. If you trade on information that is not public, you could end up going to jail. So make sure you don’t do it! Also remember that, as a general rule, you want to buy the “hunted” before any merger announce- ments because the stock price of a target com- pany tends to increase with any merger announcement while that of the acquiring com- pany decreases. The logic here is that the acquiring company is paying a premium for its acquisition and will have to bear the costs of incorporating this new entity within its corporate and operational structure.
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Specialized Mining Companies
The benefit of investing in diversified mining companies, like those profiled in the previous section, is that you get to “buy the market” in one fell swoop.
However, what if you spot a rally in gold, copper, or another individual metal and want to profit from this specific trend? In this case, the most direct expo- sure through the equity markets is by investing in companies that specialize in specific metals. I identify and evaluate some of these companies in this section.
Newmont Mining — Gold
Newmont is headquartered in Colorado but operates gold mines all over the world. It is the largest producer of gold in South America, one of the most important gold regions, and has wholly owned subsidiaries or joint ventures in Australia, Canada, and Uzbekistan.
I recommend Newmont because it is a premier player in the competitive gold mining industry. It has some competitive advantages, including its control of 50,000 square miles of land containing over 90 Million Equity Ounces of gold.
(Equity ouncesis the amount of gold measured in troy ounces multiplied by the current market price of gold as measured in US Dollars.) In addition, it has a strong balance sheet and is in strong financial condition. Check out some of Newmont’s numbers (2006 Figures):
Market Capitalization:$23.8 Billion Revenues:$4.6 Billion
Net Income:$502 Million Free Cash Flow:$47.8 Million Profit Margins:9.70%
If you’re looking for a well-managed company with extensive experience and operations in the gold mining industry, then you can’t go wrong with Newmont.
(Make sure to read Chapter 15 for in-depth coverage of the gold industry.)
Silver Wheaton — Silver
Silver Wheaton focuses on one thing and one thing only: silver. While some mining companies may have small operations in secondary metals, Silver Wheaton generates 100 percentof its revenues from silver mining. Specifically, the company operates mines primarily in Mexico and Sweden. The company’s modus operandi is to purchase silver directly from the mines and sell it on
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the open market for a profit. As a result, the company has very little — if any — operating overhead. This results in strong revenues and cash flows, as you can see:
Market Capitalization:$1.95 Billion Revenues:$80.53 Million
Net Income:$33.89 Million
Operating Cash Flow:$38.7 Million Profit Margins:42.08%
Silver Wheaton may not generate the same kinds of revenues as Anglo-American or other large mining conglomerates, but it’s a well-run company with high profit margins and stable revenues.
Silver Wheaton’s numbers reflect a strong operating background. It is actually the second producer of silver, in terms of annual output measured in troy ounces. It produced over 15 Million Troy Ounces in 2005.
While I was writing this book, UBS (the Swiss investment bank) initiated research coverage of Silver Wheaton. It issued a “buy” rating for the stock, which is a good sign for the company.
For more information on the silver industry, including the top producers, the largest consuming segments, and an analysis of additional investment methodologies, please turn to Chapter 15.
Phelps Dodge — Copper
Phelps Dodge has been in the copper business for over 150 years. It started as a mining concern and played a key role in the industrialization of the United States. Copper was in high demand by the growing nation, and Phelps Dodge was there to supply it. Today, Phelps Dodge is still the market leader when it comes to copper production, and it also has significant operations in the pro- duction of molybdenum and molybdenum-based chemicals.
Molybdenum (pronounced mah-lib-den-um) is known as a transition metal because it’s principally used as an alloy with a number of metals. It has wide applications in industry, used, for instance, in the construction of oil pipelines, aircraft engines, and missiles.
Phelps Dodge has two distinct entities that operate independently of each other: Phelps Dodge Mining and Phelps Dodge Industries. In addition, during the writing of this book, the company entered into a deal to acquire two mining companies: Inco and Falconbridge, both of Canada. This deal, which
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is still ongoing as of the writing, is sure to expand what is an already large company, as you can see from the company’s 2006 figures:
Market Capitalization:$15.86 Billion Revenues:$8.63 Billion
Net Income:$1.55 Billion
Operating Cash Flow:$800.2 Million Profit Margins:17.43%
Because of the increasing price of copper, the company’s primary commod- ity, the Phelps Dodge stock has performed well in recent years, as you can see in Figure 18-3.
Phelps Dodge has an active hedging program, where it enters into agreements with other market participants through the futures markets in order to hedge against price risk. However, not all hedgers are created equal and Phelps Dodge has taken some hits in the past as a result of its hedging activities.
During the second quarter of 2006, for instance, the company’s net income fell to $471.1 Million from $682.3 Million the previous year-over-year quarter.
This was a direct result of losses it incurred in hedging-related activity. So even though the price of copper was robust during this period, and the com- pany would have benefited from these strong prices, its external activities were negatively affected. Always make sure you know what’s going on with a company before investing in it.
You can find more information about the copper market and industry in Chapter 16.
Alcoa — Aluminum
Alcoa is a household name and for good reason: It is the largest producer of aluminum, which is the most ubiquitous metal in the modern world. Cars,
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0 20 30 50 Figure 18-3:
Stock price of Phelps Dodge (PD) on the NYSE from June 2001 to June 2006.
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soda cans, and fighter jets are all partly made from aluminum, and Alcoa is the primary supplier of this metal in the market today. Alcoa, whose acronym stands for the Aluminum Company of America, is involved in all phases of the aluminum supply chain. It provides aluminum-based products to a wide range of customers, including the aerospace and automotive industries, individual and commercial enterprises, the manufacturing sector, and the military.
Another reason I like Alcoa is that it is making some aggressive moves overseas and signing strategic, long-term pacts with some of the top aluminum produc- ers. It recently entered into a partnership with the Aluminum Corporation of China (NYSE: ACH), China’s largest aluminum producer, and is positioning itself to capitalize on the Chinese market, possibly the largest aluminum market in the future.
The following numbers are proof of Alcoa’s influence in the market:
Market Capitalization:$25.89 Billion Revenues:$28.45 Billion
Net Income:$1.83 Billion Free Cash Flow:$289.38 Million Profit Margins:6.56%
As you can see in Figure 18-4, the stock’s performance has been choppy in recent years, so you want to make sure you research the company as much as possible before you take the plunge.
Make sure to read Chapter 16 for a close examination of the aluminum market.
Arcelor-Mittal — Steel
While writing this book, I had the pleasure of watching one of the most heated takeover battles in recent memory involving two steel behemoths:
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Figure 18-4: 40 Stock price of Alcoa (AA) from June 2001 to June 2006.
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Mittal Steel and Arcelor. Mittal Steel, under the management of Indian-born steel magnate Lakshmi Mittal, launched an unsolicited bid to acquire Arcelor, the Luxembourg-based high-end steel manufacturer, in January 2006. After a long, protracted five-month takeover battle, which involved poison pilland white knighttakeover defense strategies, the boards of both companies agreed to a merger of equals.
In Mergers & Acquisitions (M&A), companies use a number of strategies to fend off hostile takeovers. Two of the most popular defense strategies include pursuing a merger or acquisition with a “friendly” company, known as a white knight. The poison pill strategyinvolves making the company unattractive to the acquirer, such as increasing levels of debt or increasing the number of shares outstanding to dilute their value.
The new company combines the Number 1 and Number 2 steel producers in the world and will control over 10 percent of global steel output. Arcelor- Mittal is going to be a truly global steel manufacturer with operations in all four corners of the globe and across all stages of the steel-making process. If the performance of the new company is anything like the recent performance of Mittal stock, shown in Figure 18-5, then you would be missing out on some healthy returns.
Turn to Chapter 16 for an in-depth examination of the global steel industry.
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20 Figure 18-5:
Stock price of Mittal Steel (MT) on the NYSE from June 2001 to June 2006.
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Part V
Going Down to the Farm: Trading
Agricultural Products
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In this part . . .
Food is the most essential resource in human life.
Investing in this sector can also help improve your bottom line. In this part, I introduce the major sectors in this sub-asset class and show you how to profit from grains such as corn and wheat; tropical commodities like coffee and orange juice; and livestock that includes live cattle, feeder cattle, and frozen pork bellies. Get the scoop on this crucial sector.
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Chapter 19
Breakfast of Champions: Profiting from Coffee, Cocoa, Sugar, and
Orange Juice
In This Chapter
Recognizing the value of investing in coffee Developing a trading strategy for cocoa Evaluating the sugar markets
Outlining a strategy for trading orange juice
The commodities I present in this chapter — coffee, cocoa, sugar, and frozen concentrated orange juice — are known as soft commodities. Soft commodities are those commodities that are usually grown, as opposed to those that are mined, such as metals, or those that are raised, such as live- stock. The softs,as they are sometimes known, represent a significant portion of the commodities markets. They are indispensable and cyclical, just like energy and metals, but they are also unique because they’re edible and sea- sonal. Seasonalityis actually a major distinguishing characteristic of soft commodities because they can only be grown during specific times of the year and in specific geographical locations — usually in tropical areas. (This is why these commodities are also known as tropical commodities.) In this chapter, I show you that there’s nothing soft about these soft commodities.
Give Your Portfolio a Buzz by Investing in Coffee
Coffee, which originated in Arabia sometime in the 15th century, is today the second-most widely traded commodity in terms of physical volume — behind only crude oil. Coffee is an important global commodity because folks just 27_049286 ch19.qxp 10/26/06 4:01 PM Page 285
love a good cup of coffee. In this section, I show you how to stay grounded while investing in this market.
Coffee: It’s time for your big break
Like a number of other commodities, coffee production is dominated by a handful of countries. Brazil, Colombia, and Vietnam are the largest producing countries, as you can see in Table 19-1.
Table 19-1 Top Coffee Producers, 2005 Figures
Country Production
(Thousands of bags)
Brazil 32,944
Colombia 11,550
Vietnam 11,000
Indonesia 6750
India 4630
Ethiopia 4500
Mexico 4200
Guatemala 3675
Honduras 2990
Uganda 2750
Source: International Coffee Organization
Large scale coffee production is measured in bags. One bag of coffee weighs 60 Kilograms or approximately 132 Pounds.
If you want to investigate the ins and outs of the coffee markets further, I rec- ommend consulting the following resources:
International Coffee Organization:www.ico.org
National Coffee Association of the USA:www.ncausa.org
If you’re interested in researching the coffee markets more thoroughly, I rec- ommend Mark Pendergrast’s excellent book Uncommon Grounds: The History of Coffee and How It Transformed Our World(Basic Books). This book will help you understand the mechanics of the global coffee trade; you may then capi- talize on this information by applying it towards your trading strategy.
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Brewing the right investment strategy
Just like choosing the right flavor when buying your cup of coffee, knowing the different types of coffees available for investment is important. The world’s coffee production is pretty much made up of two types of beans:
Arabica:Arabica coffee is the most widely grown coffee plant in the world, accounting for over 60 percent of global coffee production. Arabica is grown in countries as diverse as Brazil and Indonesia. It is the premium coffee bean, adding a richer taste to any brew, and, as a result, is the most expensive coffee bean in the world. Because of its high quality, it serves as the benchmark for coffee prices all over the world.
Robusta:Robusta accounts for about 40 percent of total coffee produc- tion. Because it’s easier to grow than Arabica coffee, it’s also less expensive.
You have several ways to invest in coffee production. One way is by buying coffee in the futures markets, and the other is by investing in companies that specialize in running gourmet coffee shops.
The coffee futures contract: It could be your cup of tea
The coffee futures markets are used to determine the future price of coffee and, more importantly, to protect producers and purchasers of coffee from wild price swings (see Chapter 9 for more on futures contracts). In addition to the hedging opportunities, the coffee futures markets allow individual investors to profit from coffee price variations. The most liquid coffee futures contract is available on the New York Board of Trade (NYBOT).
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The New York Board of Trade: The place for trading places and soft commodities
Besides being tropical commodities, the com- modities I analyze in this chapter have another common characteristic: They all trade on the New York Board of Trade(NYBOT). The NYBOT is one of the oldest exchanges in the United States and is the premier location for the trade of agricultural commodities. The NYBOT also offers futures contracts that track cotton, ethanol, and wood pulp (pulpis used to make paper), as well as products that track several
financial futures, such as the Euro (the currency), the New York Stock Exchange Composite Index, and the Reuters/Jefferies CRB Index. The NYBOT is also where the movie Trading Places, with Eddie Murphy and Dan Aykroyd, was shot.
In the final scene of the movie, Murphy and Aykroyd corner the orange juice market and, in the process, wipe out Randolph and Mortimer Duke.
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