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Trader Talk is produced by a team of active traders, analysts and various derivatives professionals from multiple organisations. Trader Talk provides comment on equities, commodities, and other financial instruments based on both technical and fundamental analysis.
Avoid CWC: High Debts = High Risk
A glance at the above chart of the FTSE 100 shows bargain hunters have taken advantage of the recent falls, as speculation that further US economic stimulus measures could be forthcoming.
The near 300 point rally on the blue chip index this week has been attributed to an increasing view amongst investors that Ben Bernanke, chairman of the Federal Reserve, might unveil the next round of quantitative easing (QE3) at this weeks gathering of central bankers in Wyoming, with an announcement expected on Friday.
This heightened anticipation comes despite many analysts suggesting that Bernanke will do nothing more than outline policy options available should the climate deteriorate further, leaving the door open for disappointment in the market.
The recent stabilisation in equities has also prompted some to argue that fundamentally the market is cheap. In general corporate earnings have been robust and on valuation grounds equities are historically undervalued, suggesting this is a compelling opportunity to buy stocks.
A number of global data releases helped soothe fears about the world economy. Chinese manufacturing data showed a modest improvement, dispelling rumours of significant weakening. Purchasing Managers Indices, an important sentiment reading, also came in ahead of expectations in China and the EU, providing further evidence that economic activity has not suddenly dried up.
Key US durable goods data also helped ease recession fears, as new orders for US manufactured goods rose 4% in July, easing June’s 1.3% drop and coming in well ahead of forecasts. The report offers further encouragement that a prolonged slowdown may not necessarily imply the double-dip recession that people fear.
Credit markets however signal fear of a crash, with the cost of insuring the debt of several major European banks reaching their widest ever levels. The cost of insuring RBS bonds is now higher than before the government was forced to step-in during 2008, indicating the liquidity crisis that previously damaged financial markets is threatening a return.
Furthermore, despite government bond yields in Spain and Italy remaining well below recent highs, credit default swaps in both countries, which gauge the cost of insuring against a debt-default, widened sharply this week, suggesting investors remain skeptical about the Eurozone as a whole.
Technical analysis highlights the choppy sideways trading experienced since the 1000 point fall at the start of August, with support at 4800 and resistance at 5400. The oscillators remain well off the recent lows and are trending higher, suggesting an improvement in buying momentum.
The MACD histogram has just stepped into positive territory and the moving averages have intersected to the upside, implying a new uptrend could be underway. A push through 5400 is needed for this downdraft to be considered a correction, otherwise a move below 4800 suggests we are in a new bear market, where spikes should be sold into.
In conclusion, these are deeply uncertain times and the Vix volatility index, commonly referred to as Wall Street’s fear gauge, reflects this by rising to levels last seen in early 2009.
Global economic data has shown signs of strength, providing evidence that a recession isn’t a certainty, but I believe further expansionary policy tools are required from governments in order to contain a new financial crisis and boost the sluggish global economy. Meanwhile the choppy trading is likely to continue.
As a second liquidity crunch looms, I have been focusing on highly geared companies that are vulnerable should lending conditions deteriorate.
Cable & Wireless Communications (Epic: CWC), a full-service telecommunications company, has issued three profits warnings over the past 15 months, due to continued weakness in its Caribbean business and limited growth in its other businesses.
Tough economic conditions coupled with structural problems across the Caribbean and Panama, which accounts for 60% of revenue, has resulted in sales from the Caribbean falling 3% and Panama remaining flat, despite extensive promotion to maintain market share.
With economic conditions in the Caribbean not expected to improve any time soon, the £812 million market capitalisation’s poor cash flow and extensive debts remain a real threat to the share price.
As of the 30th June 2011 net debt stood at $1.26 billion, an increase of $266 million (27%) since the 31st March 2011. Net assets at the last full-year results on the 30th September 2010 were $856 million, leaving the company on a gearing figure of almost 150%.
Cash conversion remains poor while capital expenditure continues to rise and analysts widely expect cash outflows for this year to March 2012. Net debt is forecast to rise to $1.7 billion within two years, putting them on a gearing figure of 200% and leaving them extremely vulnerable should the economy suffer another liquidity crunch.
The dividend has already been halved for fiscal year 2012 as the company will not have enough free cash to cover the dividend adequately, but the falling share price means it still yields 7%, suggesting a further dividend cut could be imminent.
Moody’s, the credit ratings agency, recently lowered its outlook for Cable & Wireless Communications to negative from stable, making its debt more costly to maintain. Their decision is based on the persistent weak operating performance, high gearing and negative free cash flow due to the aggressive dividend policy of the company.
The above chart of CWC shows the downward trend the shares have followed over the past year, with the 50 day exponential moving average providing resistance to any strength. Despite already halving since last September, the clear downward channel since May looks set to continue with the upper band at 34.1p.
At the time of writing the share price is 32.12p and I believe the shares are a short above 32.5p with target prices seen at 31.2p, 30.35p and 28.15p. A stop-loss should be set above the upper-band at 34.4p.
This report was written by Mark Allen – Head of derivatives at Simple Investments Stockbrokers. The writer does not hold a position in CWC, but client accounts may. The material in this report has come from Simply Charts and CWC’s corporate website.
