Good Evening. In this month's newsletter, we explore fluctuating Crude Oil prices, the stability of precious metals, and delve into Canada's inflation landscape. Uncover the challenges of rising interest rates for small businesses and the exciting potential of the lithium market, including Volkswagen's game-changing investment. We also examine the SAG-AFTRA strike's ripple effects and introduce the world of Real Estate Investment Trusts (REITs). Keep reading for more information.
ECONOMIC UPDATE
INTEREST RATES
Where are interest rates going in the economy?
As interest rates continue to climb, 250,000 small businesses in Canada face a severe threat to their existence after seeking relief through the Canadian Emergency Business Account (CEBA) loans during the pandemic.
The government now demands full repayment of these loans by December 31, 2023, after the Canadian Federation of Independent Business (CFIB) issued an urgent warning about the situation.
Inflationary economic conditions resulting in government-induced hiked interest rates and escalated business expenses contributed severely to the crisis.
The CEBA program was initially designed to provide interest-free loans up to $60,000 but has become burdensome for struggling enterprises that are not making consistent repayments without the incentive of avoiding the cost of interest.
What does this mean for small businesses?
A newly proposed 5% annual interest charge now adds to the pressure, leaving little room for financial maneuvering.
A CFIB survey reveals that nearly 6,000 small businesses are at risk of missing the repayment deadline, with those having fewer employees being particularly vulnerable.
Some business owners are considering taking on additional loans, even amidst the increasing state of interest rates, further proving the severity of the situation.
However, this decision could further jeopardize their already risky futures by making existing debt more expensive, personal interest rates on any future loans higher, and the possibility of instating collateral more likely
Rural and remote businesses are facing an even more alarming situation as their revenues have plummeted, making it exceedingly difficult to meet pre-existing financial obligations.
Business associations have thus urgently requested a two-year extension to the repayment deadline to prevent a wave of business closures.
INFLATION
Where is inflation now?
Though a new economic report regarding the CPI, and thus, any other monetary policy changes, are not released until August 15, the effects of inflation are predominantly visible in the food and housing markets.
The Canadian inflation rate slowed to 2.8% in June, the lowest it has been in almost two years. This inflationary pause is attributable to the major price drop in gasoline the previous month; however, most other CPI components continue to increase in price on the contrary
The Triple Frontier: Gasoline, Housing, and Food
In June, a CPI increase of 0.1% followed a 0.4% gain in May, shallow increases that are evidence of economic disinflation, primarily attributed to an 18.3% YoY price drop in gasoline.
In addition, there was an increase in the ‘cost of a basket of goods and mortgage interest. Both 9.1% and 30.1% elevations respectively contributed the most to the headline CPI cost.
Since 2021 a prominent issue for consumers is that food prices have continually increased at a faster pace than the national inflation rate.
With a Mortgage Interest Cost of 30.1%, Canada has also recorded its fastest pace for this component in history. It is due to the BoC’s aggressive behavior in lending rate hikes in attempts to slow demand.
Canadians with variable-rate mortgages are taking the biggest hit as the cost of servicing loans is growing exponentially year-round. Those with fixed-rate loans having to renew while agreeing to pay much higher rates than they were paying shortly before.
Speculations of Loblaw’s Involvement in GreedFlation
In the previous newsletter, greedflation and profiteering were discussed alongside how Canadians nationwide struggle to adjust to the new living costs. It brought a lot of public scrutiny to grocery chains across Canada, such as Metro and Sobeys.
The release of Q2 earnings from companies over the last few weeks compellingly indicates how grocery stores are profiting off the food inflation the nation is facing.
Loblaws is another key player in this debate. Its second-quarter earnings report recently shows immense growth in earnings and revenue coincidentally amid the current rise in grocery costs for consumers nationwide.
Loblaw reported net earnings available to common shareholders of $508 million, up from $387 million, yielding a 31.3% increase over a year; hence Loblaw is showing profits despite lower gross margins amid increased costs.
The reason for this can be explained by how Loblaw has been receiving double-digit % supply chain increases from the same suppliers that gave them double-digit increases in the year prior.
Loblaws is reaching out to suppliers to work out a deal to decrease costs, which may help increase gross margins, and ultimately decrease the price of goods for consumers.
In the meantime, Loblaws is dedicated to ensuring that its customers get the best prices on quality products, which is why they have planned to invest in the store network and distribution centers by committing a net amount of $1.6 billion in capital expenditures.
COMMODITY PRICES
As of Aug 3rd, 1:00 PM EST (https://www.cnn.com/business/markets/commodities/) :
COMMODITY NEWS
OIL
On Wednesday, oil prices surged and reached their highest level in three months.
There were two main reasons for this increase. Firstly, there were signs indicating that oil supplies were becoming tighter. Secondly, Chinese authorities committed to supporting their country’s economy, the second-largest in the world, ultimately boosting investor confidence.
The price of Brent crude oil settled at $83.64 a barrel, rising 90 cents from the previous day and reaching the highest level since April 19. Similarly, U.S. West Texas Intermediate (WTI) crude oil rose 89 cents to $79.63 per barrel, reaching its highest point since April 19, when it rose to $79.90.
A significant survey indicated that the United States experienced a slowdown in business activity to a five-month low in July. However, falling input prices suggest that the Federal Reserve's efforts to reduce inflation are progressing.
GOLD AND SILVER
The price of gold has found stability despite fluctuations in the global currency market, mainly due to the U.S. dollar holding steady.
The ongoing global economic recovery has created a mixed outlook for precious metals, with some investors viewing gold as a hedge against inflation. However, in contrast, others favor riskier assets in response to positive economic indicators.
The economic inference is that precious metals, including silver, often exhibit an inverse relationship with the U.S. dollar. When the dollar strengthens, as it has in this case, the demand for precious metals weakens as they become more expensive for international buyers.
The decline in silver prices may also be influenced by a broader market environment characterized by increased volatility and risk aversion. In times of uncertainty, investors may opt for safer assets, leading to reduced demand for silver. However, another important thing to note is that silver as a commodity is typically considered an alternative investment solution. Alternative Investments have a low correlation with the broader market exchange, despite still being price volatile due to other factors, including international currency values changing frequently. Yet, silver is still not considered a risk-averse investment opportunity amidst current international economic uncertainty.
Despite the recent decline, some investors may still view silver as a hedge against inflation, given its historical performance during periods of rising prices. However, the strong dollar's influence on silver's price remains a prominent factor in shaping investor decisions.
With inflation rates surging, concerns about potential interest rate hikes and their effect on gold prices have come to the forefront, influencing investor sentiment.
Overall, market sentiment in the gold industry remains cautious as investors await further clarity on the Federal Reserve's stance while closely monitoring economic developments for potential shifts in the precious metals landscape.
MARKET TREND
REVOLUTIONIZE YOUR LIFE WITH LITHIUM
What is Lithium?
Lithium is a soft, silver-white metal commonly called “white gold.” In nature, lithium occurs only in compounds due to its high reactivity.
Its derivative (mainly lithium carbonate) is used to treat bipolar disorder and to manufacture EV batteries.
Chile has the largest lithium reserves worldwide by a large margin, followed by Australia. Even though that is the case, Australia is the actual leader in quantitative production and, therefore, has a more significant influence over market price.
Lithium Demand
Given the forecasted increase in demand for Lithium, there are significant market opportunities within the industry for the next half-decade.
The price of lithium carbonate in China has increased by nearly 5x from 2021 to 2022; given that China is the number one importer of lithium, a recession or a decelerated GDP growth within the country may significantly impact the demand for lithium and its price, thus decreasing margins for mining companies.
Batteries account for the largest share of lithium end-usage (80% in terms of distribution). Therefore, the demand for lithium is based on the growth of the EV market powered by rechargeable lithium batteries. In fact, the demand for lithium is expected to grow at 18.32% per year until 2030.
Spotlight: Albemarle Corporation
Companies like Albemarle Corporation, the leading lithium mining company globally that has operations in Chile and Australia, depend on generating returns tied to changes in the demand and market price of lithium-based end products, such as lithium hydroxide and - more importantly - lithium carbonate.
Lithium Carbonate price, a crucial component in manufacturing EV batteries, has nearly tripled in value from 2021 to 2022 due to the strong demand for EV vehicles.
This increase in price for Lithium has been a massive boom for the lithium mining industry as revenues have substantially increased for Albemarle Corporation and many of its peers.
Lithium From a North American Perspective
The dollar depreciation will significantly impact the increase of Lithium demand in the U.S. as the dollar depreciates, the already expanding lithium battery industry will grow faster, given that exporting will become a preferred alternative. This will increase the demand for the raw material (lithium) and bolster demand within North America.
Canada ranks sixth in lithium reserves globally, holding 3% of reserves worldwide. Although previously overlooked, Canadian reserves are gaining global popularity due to the EV boom predicted to capture the majority of the US car market by 2030.
Volkswagen’s Investment in Canada
Canada and VW have agreed to invest over CAD $20 billion combined to construct a lithium-ion battery plant in St. Thomas, Ontario. It is their first outside of Europe and will be the largest manufacturing plant in Canada.
VW’s loss of market share in China was a main motivator to geographically diversify its operations and develop a home market in North America, the world’s largest auto market.
To put some numbers on the production capabilities, the plant will produce 1 million car batteries annually. VW plans to release 25 new EV models over the next few decades, hoping to provide the majority of the batteries for these models through the Canadian plant.
What This Means for Canada
This VW investment proves Canada can compete with the dominant presence of the US Inflation Reduction Act, which qualifies EV batteries for subsidies if made in the US.
The St. Thomas plant is expected to create 3000 direct jobs and 30,000 indirect jobs, CAD $200 billion in value, and of course . . . will indirectly result in cleaner air.
What did this cost us? Canada agreed to subsidize around CAD $13 billion over 10 years with VW only investing a measly CAD $7 billion. The funding matches what the US Inflation Reduction Act would have offered.
Volkswagen’s Next Move
VW will now turn their attention to investing in Canadian mines to supply the plant with lithium.
VW’s plan is to invest in enough mines to supply half of its own battery demand while also selling to other outside customers. They already agreed with Ford to supply 1.2 million vehicles with battery cells.
With few automakers holding direct stakes in mining companies, VW aims to control supply for lithium batteries globally through their large investments in mining companies.
Could Arbor Metals Be the Chosen One?
Arbor Metals (TSX-V: ABR) could be on VW’s radar with a mining location in the James Bay region of Northern Quebec, close enough to be a convenient supplier for VW’s plant.
Arbor’s operation in the James Bay region is located on the Jarnet property, an area rich in lithium that has proved to be a key area for mining companies.
Why is Arbor Metals so promising? A similar company located on the same property, Patriot Battery Metals (TSXV: PMET), has seen stock surges exceeding 500% in the span of a year.
Over the last five years, Arbor Metals has seen 126% annualized returns signaling that the company is highly undervalued. Their access to the Jarnet property also puts the company in a prime position, as the James Bay region is becoming the hub of lithium mining in Canada. The company also launched a 2023 exploration program where satellite imagery and infrared surveys allow them to pinpoint high-yielding lithium sites on the Jarnet property.
Final Thoughts
To satisfy the skyrocketing demand for EVs, automakers will need to take a page out of VW’s book, increasing capital injection in gigafactory projects to increase their production of lithium batteries. Considering the demand for lithium will grow with more factories. On the other hand, lithium is a bottleneck in the battery production process, and lithium mining companies such as Albemarle Corporation and Arbor Metals are clearly undervalued.
With over 120 countries agreeing to net zero emissions by 2050, EVs will only become more prevalent as we get closer to 2050 since cars contribute to 39% of the world’s emissions.
However, a curve ball by the name of sodium ion could derail lithium’s rise, as it is a more abundant and cost-friendly alternative to lithium. However, sodium ion degrades faster and has a lower energy density (meaning less energy is used while creating a larger footprint).
If sodium ion or another alternative to lithium gains popularity, it could negatively affect companies such as VW that already have the infrastructure needed to produce lithium batteries while simultaneously hurting mining companies that are centralized around lithium mining.
INDUSTRY UPDATE
SAG-AFTRA STRIKE
What is it?
There are a few acronyms you need to know to understand this strike; the first being, SAG-AFTRA, meaning Screen Actors Guild - American Federation of Television and Radio Artists. SAG-AFTRA is the union that most recently went on strike against AMPTP, the Alliance of Motion Picture and Television Producers. The SAG-AFTRA joined the WGA (Writer’s Guild of America) who have been on strike since the spring. The SAG-AFTRA - WGA unification is stirring up significant headlines as the two unions haven’t been on strike together since 1960.
Essentially, any member of the SAG-AFTRA is not allowed to act, sing, dance or perform any form of work in front of the camera, including promotional work. The strike has led to significant shutdowns of high-profile productions, including the new Spiderman sequel, Deadpool 3, and others for the foreseeable future.
Why & What are the Implications?
The actors are striking due to two main concerns: residual pay and artificial intelligence (AI).
With the strike continuing to unfold, the entertainment business is struggling as many ongoing productions have halted more specifically. Industry consequences aside, there have been many macro implications due to the strike. Cast members, set employees, and many others are consistently put out of work and, thus, forced to move out or sell their belongings to compensate for lost. With Hollywood, a primary driver of revenue, population density, tourism, and temporary residency demand in California, on the path to being shut down, fewer people are buying and renting in the area alongside those directly affected by the strike who are also moving out. This is significantly affecting economic flow within the state, particularly with respect to the decrease in real estate demand and entertainment diversions. Financial ramifications may surpass $150 Million per week, according to Forbes, who also claims that alongside drastic changes in real estate demand, the disruption in releasing new content related to production delays might drive consumers towards alternative entertainment options due to a trickle effect of rising ticket prices. From an international point of view, the strike is also catastrophic, stalling all international travel related to production and effectively ruining any film festivals that have now been put on pause. Since the festivals won’t have many actors attending and will only be able to screen films that have already been finalized pre-strike, many of the typical attractions of international film festivals like TIFF will be missing. This will result in lower attendance, resulting in a loss of domestic economic activity that usually occurs due to these events.
Key External Drivers
Security and Compliance: Businesses prioritize secure data storage, driving demand for colocation facilities with robust security and compliance capabilities.
Digital Transformation: Increasing adoption of digital technologies fuels demand for scalable data center colocation services.
Percentage of Business Conducted Online: Growing online business leads to increased demand for colocation, while a decline poses a potential threat to the industry.
Customer Overview
Colocation data center space is sold on the basis of individual cabinets or cages, typically on short-term, 1 to 3 year license agreements, as opposed to long-term leases. Customers pay a one time installation fee, colocation service fees and a fixed monthly fee for contractually committed amounts of power per month
Key Players
Equinix (16.3% Market share)
Ntt Data (10.9%)
Digital Realy Trust (7.5%)
Other (65.3%)
Growth Opportunities
The industry is expected to grow at a CAGR of 2.3% YOY from 2022-2027. It previously grew at a rate of 5.4% from 2017-2022, and currently processes 13.5 BN in revenue. Overall, the key factors driving growth over the next few years are; are increasing data storage demands, expansion of edge computing, and the adoption of hybrid and multi-cloud strategies. Additionally, international expansion into growing digital economies and a focus on sustainability and energy efficiency will contribute to industry growth in the coming years.
FINANCE CONCEPT OF THE MONTH
REIT'S
REITs, Real Estate Investment Trusts, are firms that own and/or operate real estate properties. The majority of REITs are sold on the stock market; however, shares can also be traded privately.
They generate income by renting out real estate to various groups, such as homeowners, corporations, governments, or other parties. At least 90% of a REIT’s taxable income is redistributed to shareholders through dividends.
REITs can operate any type of real estate, including apartments and offices, or even malls, healthcare facilities, and cell phone towers, and thus, are a great source of diversification within an investment portfolio.
REIT Investment Benefits
Strong, stable dividend income
High liquidity
Gained exposure to the world of real estate without managing inconveniences like tenants, maintenance, and legislative responsibilities
However, REITS also face some drawbacks. Notably, shares don’t undergo significant appreciation, limiting income to dividend gains, while a higher tax rate is placed on those dividends.
The next time you’re looking for an attractive investment opportunity to diversify your portfolio, consider the income stability offered by REITs!
RECRUITING QUESTION
You are a PE firm acquiring a company. The company has $100 of EBITDA through all 5 years that you are holding it. It has a 4x EV/EBITDA multiple. At the end of the 5 years, the PE firm sells it for $400 and you get to keep all excess cash flows. The company the PE firm acquired has an interest rate is 10%, D&A of $40, CapEx of $40. It is sold for a MOIC of 2.4x. What was the original equity invested into the company? Hint: There is a question you have to ask the interviewer here
Answer:
Steps:
1. Ask for the tax rate - They say assume it’s 40%
a) Always show the interviewer you know this at the start
2. First determine the purchase price of the company
a) $100 EBITDA * 4x EV/EBITDA = $400 purchase price
3. Next determine the excess cash remaining
a) (let b = amount of debt)
b) ((($100 EBITDA - $40 D&A)-(10%*(b) interest rate))*(1-40% tax rate)) + $40 D&A - $40 CapEx = $(60-(0.1*b))*0.6 ← For each of the 5 years
i) **Remember not to forget tax shield**
4. Total free cash flows
a) $(60-(0.1*b))*0.6 x 5 years
5. Determine the Debt used
a) MOIC = (Net cash outflow)/(initial equity invested)
b) MOIC or 2.4 = (400 + (((60-(0.1*b))*0.6) x 5) / (400 - b)
c) b = $180.95, therefore, the initial debt used was $180.95
6. Then subtract the debt from the total purchase price to find equity used
a) $400 - $180.95 = $219.04
7. Therefore the initial equity used was $219.04 in this transaction
SECOND YEAR RECRUITING TIMELINES
