Investors’ Chronicle: Hochschild Mining, Persimmon, Goodwin

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BUY: Hochschild Mining (HOC)

Profits have climbed on higher silver and gold prices, while an interim dividend announcement has been delayed because of a reserves issue, writes Alex Hamer.

The historically strong silver and gold prices of this year helped Hochschild Mining in the first half, which posted higher profits despite rising costs. Silver and gold aren’t as lofty as last year but $25 (£18) an ounce (oz) and $1,800 an ounce (oz) respectively were still enough for a healthy increase in free cash flow at Hochschild, from negative territory last year to $54m. 

The miner’s net cash position also grew to $51m, from $22m at the end of 2020. 

Hochschild has not declared an interim dividend yet, however, because of a compliance issue with “certain historic dividends” for which the company “did not have sufficient distributable reserves at the appropriate point”. 

Subject to creating these reserves, the interim payout will be announced by the end of the month. 

Other difficulties might be harder to fix. Chief executive Ignacio Bustamante said the company was “deeply affected” by a traffic accident that killed 26 workers in June, on top of the ongoing pandemic issues and a new “far-left” government in Peru that would likely raise taxes and push tougher “social investment requirements”. 

However, Hochschild has reiterated production and cost guidance for the year of 31-32moz silver equivalent and $14.1-14.5/oz silver equivalent, and analysts forecast a hefty increase in full-year adjusted cash profits compared to last year, from $271m to $442m.

Despite this outlook, Hochschild is trading almost a third down year-to-date, to 154p. A sizeable interim dividend may get some more investors onside.

BUY: Persimmon (PSN)

Despite continuing sector doubts, there is no escaping the housebuilder’s huge profitability, writes Alex Newman.

As is customary, Persimmon pulled back the curtain on its key metrics in a trading update at the start of July, making statutory half-year results something of a foregone conclusion.

But an initially indifferent reaction from the market suggests some investors were possibly clinging on for a capital distribution surprise, despite a previous warning that the fast-tracked 110p dividend paid to shareholders on August 13 will be this year’s last. With the next regular payout not due until June 2022, income investors have a while to wait for their next annuity.

On balance, there was little else to darken spirits. Chief executive Dean Finch says he expects “a more normal seasonal trading pattern to reassert itself” in the housing market, at least compared with the significant disruption seen in 2020. Yet stacked against 2019’s “more appropriate comparison”, forward sales are still up 9 per cent in the first 33 weeks of the year.

This, together with a 4.9 per cent year-on-year rise in average new selling prices, explains the surge in revenue, although average national house price inflation is much higher. The group is therefore well placed to service and benefit from rampant demand. For its part, broker Jefferies forecasts a higher proportion of affordable home sales in the second half, and for average price rises of just 0.9 per cent for the full 2021 calendar year.

That could be bad news if rising input costs continue, but on current evidence Persimmon still makes a lot of cash on each house it builds. The new house operating margin may be adrift of 2018’s 31.8 per cent peak, but a rise from 26.6 to 27.6 per cent in the six months to June is still very strong.

“We’re managing the balance of inflationary pressures well and currently anticipate that our industry leading returns will remain resilient,” says Finch. On current evidence, the housebuilding sector oligopoly, and Persimmon’s place in it, looks assured.

Analysts at Numis raised their earnings forecasts to 252p and 268p per share for 2021 and 2022, respectively, while cautioning that a reduction in outlets in the period could pare back volume growth, particularly when compared with peers.

But there is no escaping the enormous profitability of this business. Persimmon’s underlying return on capital is now just above the three-year average at 37.9 per cent, while the post-tax return on equity – a more meaningful yardstick for shareholders’ equity and dividends – is now 22.6 per cent.

An 8 per cent prospective yield and plenty of cash on hand should provide comfort, along with a solid land holdings replacement rate, and volume growth of around 10 per cent.

HOLD: Goodwin (GDWN)

The engineering group reckons it has gone past peak sales from the oil industry but is placing hopes on nuclear and radar products, writes Arthur Sants.

Goodwin is going through a transition.

Its revenue last year dropped because of weakening demand from the oil industry for its valves and the decline in air travel hurt its radar systems business. It doesn’t expect the oil industry to ever return to its pre-pandemic trading levels. The group’s profits have yet to recapture highs set during the oil boom in 2014.

Fortunately, Goodwin is starting to benefit from efforts to diversify into nuclear waste, propulsion and naval hull products. Despite Covid-19, the order book at the end of April stood at £165m, which was down by a tenth on 2020 but about level with 2019.

Goodwin’s mechanical engineering business, which accounts for two-thirds of sales and 54 per cent of profits, bore the brunt of reduced oil and gas demand. Sales were down from £100m to £87m. Sales at the company’s other division, refractory products, were flat. The refractory business makes industrial linings that resist extreme temperatures and recently launched an exciting new product into the resurgent jewelry market.

While revenue overall dropped 9 per cent, a reduction in cost of sales meant gross profit increased 12 per cent to £39m and operating profit rose by a third to £17m. The previous financial year had seen a jump in costs.

Customers’ capital expenditure slowed during the pandemic but Goodwin should now benefit from the economic recovery. The airline industry’s recovery in particular should aid a return to profitability for its radar business. In addition, the company now sells complete radar systems rather than just individual parts, which should boost margins.

The structural decline in oil is a concern. But diversification and product innovations are encouraging. Still, until there is more evidence of things coming good, we’re sticking with a hold rating.

Chris Dillow: Gilt risks for equities

Recent history shows that bond sell-offs have been good for shares. This may not remain the case.

Rising yields because of fears of rising interest rates are very different from rises because of stronger economic growth.

Many believe there’s a risk of a big sell-off in bonds. It’s easy to see how this might materialise. Yields are being held down by promises from the Federal Reserve and Bank of England to keep short-term interest rates low. If, however, inflation proves to be more of a problem than they expect, they could withdraw such assurances thereby removing the anchor that is holding yields down.

What would this mean for equities?

If recent history is a guide, it would actually be a good thing. Many sectors have done well in times of rising yields. Since 2004, the All-Share index has been positively correlated with gilt yields, rising by an average of more than 10 per cent in 12-month periods in which five-year yields have risen by a percentage point. Many sectors — especially cyclical ones — have been even more strongly correlated with changes in yields.

Sadly, however, we should not assume that the recent past is a good guide to the future.

The effect on equities of a rise in bond yields depends upon why yields rise. For most of the past 20 years the few bond sell-offs we’ve seen have been due to economic recoveries. These are circumstances in which we’d expect equities and especially cyclical stocks to do well.

But they are not the only circumstances in which yields could rise. If bonds sell off because of increased fears of inflation and higher interest rates it’s not at all obvious that shares would benefit. In fact, if investors fear that higher rates will lead to slower growth they might well dump equities. In such an event, the winners would be defensive stocks that hold up well and cyclicals such as construction, would suffer.

We can put this another way. In theory, higher bond yields could hurt equities simply because they mean that investors apply a higher discount rate to future dividends. We’ve not seen this happen in recent years because rises in the risk-free discount rate have been offset by falls in the risk premium and rises in expected growth. But we’ve no guarantee that this will remain the case.

There’s a danger that the current economic upturn will prove to be disappointing, perhaps because smaller companies cannot grow and might collapse under the weight of the extra debt they took on during the pandemic; or because consumers have fallen into more frugal habits; or because memories of the recession have a lasting effect in depressing animal spirits. If so, fears of rising rates would recede, dragging yields even lower.

It’s tempting to add that fears of big rises in bond yields have proven consistently wrong in recent years. Since the mid-1990s yields have generally undershot expectations. But those who warned us of bond sell-offs have been like the boy who cried wolf. The point of that story is that the wolf did eventually eat the boy.

The fact is that we know much less about the future than we like to think. We don’t know where bonds are heading, so we must diversify. Going all-in on equities is a dangerous bet. And cash is a useful protector against nasty surprises — in both directions.

Chris Dillow is an economics commentator for Investors’ Chronicle

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