Markets live chat transcript for the chat ending at 12:05 on 17 Jun 2008. Participants in this chat were: Paul Murphy (PM) Neil Hume (NH)
PM:
Surprise!
NH:
We are starting early – 11.01am
PM:
Welcome to Markets Live
PM:
This is FT Alphaville’s daily stock market discussion
PM:
Straight to the key subject of the morning
NH:
inflation 3.3% last month
NH:
and the FTSE 100 up 90.3 points at 5,884.2
PM:
Mervyn King has some explaining to do.
NH:
Certainly does
PM:
Rather let things get out of control
NH:
He’s bound to have an excuse – like the seismic shift in the global balance of economic power, causing rampant demand in commoditised foodstucks, raw materials and energy.
PM:
But we still want a proper explanation – in writing.
PM:
Yes, this follows news a little earlier that inflation in Britain – CPI measure – spiked from 3% to 3.3% last month.
NH:
This is WAY higher than most City analysts were expecting.
NH:
Well 0.1% higher.
NH:
Most forecasts huddled around 3.1% / 3.2%.
PM:
So Merv has now had to write an open letter to the government explaining why inflation has deviated more than 1 per cent away from the 2 per cent upper end of the target.
PM:
3.3% is the worst number since the CPI measure was introduced in 97. And using a historical construction of CPI this is the highest rate of inflation since July 92.
PM:
Shocking.
NH:
Utterly shocking.
PM:
Got any shock reaction?
NH:
This is from Howard Archer at Global Insights
NH:
This is yet more disappointing and worrying news on the inflation front . The rise in consumer price inflation to an equivalent near 16-year high of 3.3% in May was above expectations. The rise was primarily due to sharply higher food and energy prices. Meanwhile, core inflation rose to a seven-month high of 1.5% in May, from 1.4% in April and 1.2% in March. While core inflation is still pretty muted, May’s further rise nevertheless maintains concern that higher energy and food prices are starting to increasingly filter through to have increased second round effects.
NH:
Consumer price inflation is set to go significantly higher over the coming months and could very well reach 4% in the third quarter as rising utility bills, high petrol and food prices, and a weaker pound continue to impact. Record high producer input and output prices in May – as well as widespread survey evidence showing that companies are currently still striving to increase prices to support their margins – indicate that inflationary pressures are currently elevated through the supply chain; although for now, at least, wage growth remains muted.
NH:
The interest rate outlook is currently extremely uncertain as the Bank of England grapples with the very worrying combination of elevated inflation levels and risks on the one hand, and the very real risk of recession and a moribund housing market on the other. Mervyn King’s shortly to be released letter to the Chancellor will therefore be closely scanned for guidance as to how the Bank of England judges the balance of these risks and for clues as to whether the next move in interest rates is likely to be up or down.
NH:
The one thing that can be said with a fair degree of confidence at the moment is that interest rates will not be coming down further any time soon and that if the Bank of England does act in the near term, it will be to raise interest rates. We currently think it is more likely that the Bank of England will keep interest rates at their current level of 5.00% for many months to come, before eventually trimming them. However, it is looking increasingly likely that interest rates will not be cut before 2009, unless the economy really falls off a cliff over the coming months. With consumer price inflation likely to reach 4% this summer, inflation expectations elevated and rising, and firms currently keenly looking to raise their prices to support margins in the face of elevated input costs, the Bank of England will tread extremely carefully on the interest rate path. In order to cut interest rates, the Bank of England will need clear evidence that wage moderation is continuing and that reduced demand is significantly undermining companies’ pricing power.
PM:
Ok, so no rate cuts before 2009. But we need to see Merv’s letter to get a view on how the bank balances out the risks price rises going hyper and/or the economy getting tanked.
NH:
Well the actual King letter is out now:
NH:
http://www.bankofengland.co.uk/monetarypolicy/pdf/cpiletter080616.pdf
NH:
Says expects CPI to “remain markedly above the target until well into 2009”
NH:
Says this will be the “first of a sequence of open letters over the next year or so.”
NH:
“The path of Bank Rate that will be necessary to meet the 2% target is uncertain.”
PM:
How’s the market reacted?
NH:
CPI = 3.3
FTSE 100 + 90 points.
FTSE 100 + 90 points.
NH:
Explain that?
PM:
I cant
NH:
maybe, as VP noted below
NH:
everyone is reading between the lines from this morning’s letter
NH:
and taking the view that there is no way merv will raise rates
NH:
because the outlook is too fragile
PM:
PM:
There’s also this German biz survey – the Zew sentiment survey.
PM:
There’s also this German biz survey – the Zew sentiment survey.
That’s a LOT weaker than forecast – analysts expected circa minus 42 – got minus 52.4 instead
PM:
We should get out own sentiment survey.
PM:
call it the Zoo survey.
PM:
The A-Zoo indicator. Consider that patented.
PM:
We need to be able to give these thumbs up/down emoticons to the readers.
PM:
PM:
Neil is on the phone
PM:
Here’s a free Lix
PM:
The king and Ben
Published: June 17 2008 09:54 | Last updated: June 17 2008 09:54
Ben Bernanke and King Abdullah both have good reasons for wanting the oil price to come down from almost $140 a barrel.
The US Federal Reserve chairman, backed by regional Fed heads, has tried to reposition himself from dollar-dumping helicopter pilot to bona fide inflation hawk in the past week. Meanwhile, Saudi Arabia’s king is seemingly doing his bit to take the heat out of oil prices by promising to raise his country’s production.
Mr Bernanke risks talking himself into a corner. High energy prices are fuelling fears of an inflation outbreak in the US. The economy, however, is in no fit state to stomach the usual medicine: higher interest rates. Even if the Fed were to act, a 25 basis point increase would not do much in the context of real rates running at, roughly, a negative 2 per cent. In any case, with inflation being transmitted through global commodities markets, the Fed’s power to curb it is perhaps more limited than in the past.
Riyadh, worried thathigh oil prices will spu investment in alternatives, may be of more help. But again, it is unclear if Saudi Arabia will deliver. Having scheduled a grand conference for next weekend, promising some extra oil is a smart political gesture. In addition, if the pledge of extra barrels does not cool prices, Opec can claim vindication for its position that speculation and a falling dollar, rather than tight supply, are fuelling crude prices.
The danger is that this move does not address the deep-seated fears about long-term supplies which are helping to boost crude futures. Hard core “peak oilers” might dismiss it is a short-term gesture and bid up oil futures further. In doing so, they would be calling into question Saudi Arabia’s ability to intervene in the market – an uncomfortable situation with which central bankers such as Mr Bernanke are all too familiar.
Published: June 17 2008 09:54 | Last updated: June 17 2008 09:54
Ben Bernanke and King Abdullah both have good reasons for wanting the oil price to come down from almost $140 a barrel.
The US Federal Reserve chairman, backed by regional Fed heads, has tried to reposition himself from dollar-dumping helicopter pilot to bona fide inflation hawk in the past week. Meanwhile, Saudi Arabia’s king is seemingly doing his bit to take the heat out of oil prices by promising to raise his country’s production.
Mr Bernanke risks talking himself into a corner. High energy prices are fuelling fears of an inflation outbreak in the US. The economy, however, is in no fit state to stomach the usual medicine: higher interest rates. Even if the Fed were to act, a 25 basis point increase would not do much in the context of real rates running at, roughly, a negative 2 per cent. In any case, with inflation being transmitted through global commodities markets, the Fed’s power to curb it is perhaps more limited than in the past.
Riyadh, worried thathigh oil prices will spu investment in alternatives, may be of more help. But again, it is unclear if Saudi Arabia will deliver. Having scheduled a grand conference for next weekend, promising some extra oil is a smart political gesture. In addition, if the pledge of extra barrels does not cool prices, Opec can claim vindication for its position that speculation and a falling dollar, rather than tight supply, are fuelling crude prices.
The danger is that this move does not address the deep-seated fears about long-term supplies which are helping to boost crude futures. Hard core “peak oilers” might dismiss it is a short-term gesture and bid up oil futures further. In doing so, they would be calling into question Saudi Arabia’s ability to intervene in the market – an uncomfortable situation with which central bankers such as Mr Bernanke are all too familiar.
NH:
Are you allowed to do that – just give Lex away? Carries a premium subscription rate – 200 quid.
PM:
Whatever
PM:
NH:
You’ve been looking a bit distracted this morning.
PM:
Hmm
NH:
What’s up?
PM:
What’s up with what?
NH:
Why you looking distracted.
NH:
It’s not a penguin suit crisis is it?
PM:
Oh, great, Helen blab to you?
NH:
Well she just mentioned, casually like – “It’s such a drag when your outfit for Ascot doesn’t work out…”
NH:
And then she laughed a lot.
PM:
PM:
Yeah yeah. I obviously have a very odd sized body – and an abnormally small head.
PM:
That’s particular novelty round this desk, obviously.
NH:
You going to Ascot by helicopter?
PM:
How else do you get there?
NH:
personally I go by train or car
NH:
never a helicopter
PM:
(V good gag Seaslug)
NH:
are u in the Royal Enclosure??
PM:
What do you think?
NH:
in which case you will need to know the dress code
NH:
Royal Enclosure Dress Code
Royal Enclosure LawnHer Majesty’s Representative wishes to point out that only formal day dress with a hat or substantial fascinator will be acceptable.
Royal Enclosure LawnHer Majesty’s Representative wishes to point out that only formal day dress with a hat or substantial fascinator will be acceptable.
Off the shoulder, halter neck, spaghetti straps and dresses with a strap of less than one inch and / or mini skirts are considered unsuitable. Midriffs must be covered and trouser suits must be full length and of matching material and colour.
Gentlemen are required to wear either black or grey morning dress, including a waistcoat, with a top hat which must be worn at all times when you are in the Royal Enclosure other than within your private box or facility”. Note that box balconies, restaurant terraces and gardens will be deemed to be “within” the facility.
Overseas visitors are welcome to wear the formal national dress of their country or Service dress. Those not complying with the dress code will be asked to leave the Royal Enclosure and will be relieved of their Royal Enclosure badge.
PM:
substantial fascinator??
PM:
Can we get on with some proper work?
NH:
OK
PM:
PM:
Right – back to the furore over the new fangled short position disclosure.
PM:
SHORTS RULES PANTS, SAY CITY TRADERS
PM:
Very sensible letter here:
NH:
ye, the best I have read on the subject by a long way
PM:
That’s from David Rule – he’s the head of the International Securities Lending Association.
PM:
Sent it to Pesto at the Beeb and Warner at the Notindepdent.
PM:
Warner in particular has got a cheek – basically accusing all the hedgies of being bank robbers – when he himself is a common convicted click fraudster.
PM:
Anyway – it’s a good letter. Clearly sets out the facts.
NH:
Seen these 10 “open questions” in the paper?
PM:
Ah yes. The market wants answers!
NH:
Hedge funds and other investors say a long list of issues remains unclear under the FSA’s new shorting rule, due to come into force this Friday, writes Jennifer Hughes
● Does the rule relate to short positions entered into before a company announced a rights issue?
● Is the disclosure to be made as it happens – for example, what happens if a short seller goes above and below the threshold several times?
● Do they report that they went over, or do they just report their position at a particular point in the day. And if so, which point in the day?
● Will the FSA publish a comprehensive list of issuers undergoing a rights issue (as the Takeover Panel does for stocks in bid situations)?
● What number should short sellers base the ‘shares outstanding’ number on – the fully diluted number; the number before the rights issue; the total after the issue has been completed?
● If a fund’s options positions are to be included, should any reporting reflect whether the options can actually be exercised during the rights issue period?
● Will the new rules – which exempt market makers such as investment banks – still be applied to the proprietary trading desks of those banks?
● Does the rule cover stocks that have a primary listing outside the UK but a secondary listing on a recognised UK exchange?
● How should short sellers treat the convertible bonds and other debt-equity hybrids, which have theoretical embedded options?
● How does the rule relate to synthetic positions (such as Contracts for Difference) and those involving complex derivatives?
● Does the rule relate to short positions entered into before a company announced a rights issue?
● Is the disclosure to be made as it happens – for example, what happens if a short seller goes above and below the threshold several times?
● Do they report that they went over, or do they just report their position at a particular point in the day. And if so, which point in the day?
● Will the FSA publish a comprehensive list of issuers undergoing a rights issue (as the Takeover Panel does for stocks in bid situations)?
● What number should short sellers base the ‘shares outstanding’ number on – the fully diluted number; the number before the rights issue; the total after the issue has been completed?
● If a fund’s options positions are to be included, should any reporting reflect whether the options can actually be exercised during the rights issue period?
● Will the new rules – which exempt market makers such as investment banks – still be applied to the proprietary trading desks of those banks?
● Does the rule cover stocks that have a primary listing outside the UK but a secondary listing on a recognised UK exchange?
● How should short sellers treat the convertible bonds and other debt-equity hybrids, which have theoretical embedded options?
● How does the rule relate to synthetic positions (such as Contracts for Difference) and those involving complex derivatives?
NH:
of course, the main interesting thing to come out of this
NH:
is the fact that once u have disclosed a 0.25% or higher short positon
NH:
that’s it
PM:
No more disclosure thereafter
NH:
you don’t have to say anything else
NH:
you could go to 10% short or close and no one would know
PM:
Weird really — sounds increasingly like a panic measure from the FSA — jsut to help HBOS
NH:
been when you flick through the letter above it does not seem that evil short selling bank robbers were soley behind the lurch downward in HBOS last week
PM:
Sure
PM:
PM:
How are our brilliant banks this morning
PM:
they’re wearing the long trousers this morning.
NH:
Strides even
PM:
The brilliant HBOS was up 7.3 per cent earlier
PM:
Now up 20p at 336p
NH:
leading the FTSE 100 higher
NH:
a gain of over 6%
NH:
a big move
NH:
inspired by Cazenove it seems
NH:
published a note this morning, which says that most of the bad news is in the price
PM:
havent we heard that before?
NH:
Specifically, they say HBOS shares have “reached a level which discounts a markedly worse impairment performance versus UK peers, which in our view is unlikely to be the case.”
PM:
Hmmm
NH:
they also point out HBOS has been the worst performing major UK bank over the past month – down 33%
NH:
only the BBB bank has fallen further – off 41%
NH:
Now Caz’s has crunched some numbers and reckons the current share price is factoring in a £1.170bn (22%) reduction in 2009E PBT.
NH:
in turn that obviously means a large rise in impairment charges
NH:
but Caz thinks this discounting has gone too far
NH:
anyway
NH:
here is the note
NH:
HBOS – Thoughts on valuation [HBOS LN HBOS.L], 316p, In-line, sector – Neutral
NH:
HBOS is the worst performing major UK bank over the past month with a share price fall of 33% (only B&B is worse with -41%). The stock is now the most lowly-rated UK bank, trading at a 22% PER discount to the domestic average (4.5x 2009E earnings versus 5.8x), and an even greater discount on a P/NTAV basis (0.8x 2008E versus 1.4x). Beyond technical factors associated with the rights issue, we believe the discount reflects concerns over the outlook for impairment.
NH:
Loan impairment – what is priced in?
The discount valuation implies a £1,170m (22%) reduction in 2009E PBT. This equates to a 39% increase to our existing impairment charge estimate. The assumptions are somewhat arbitrary, but illustrate the point that HBOS’ valuation is discounting a more significant increase in loan impairment than its UK peers. For example, if HBOS experiences 130-250bp losses on its UK corporate loans then we believe it is reasonable to expect other UK lenders to report a similar deterioration, which is not currently in our numbers (eg. we estimate 80bp at Lloyds TSB in 2009E).
The discount valuation implies a £1,170m (22%) reduction in 2009E PBT. This equates to a 39% increase to our existing impairment charge estimate. The assumptions are somewhat arbitrary, but illustrate the point that HBOS’ valuation is discounting a more significant increase in loan impairment than its UK peers. For example, if HBOS experiences 130-250bp losses on its UK corporate loans then we believe it is reasonable to expect other UK lenders to report a similar deterioration, which is not currently in our numbers (eg. we estimate 80bp at Lloyds TSB in 2009E).
NH:
There is an additional risk that HBOS incurs losses on its £4.0bn investment portfolio. We estimate this includes £1.35bn indirect exposure to property-related assets (£0.9bn property companies, £0.2bn housebuilders and £0.25bn hotels). Although not disclosed, we believe the majority of these investments are in the form of joint ventures, the remainder being MBO transactions or held within private equity funds. JVs are not marked-to-market (HBOS recognises its share of profits) but MBO equity will be fair valued through the P&L.
NH:
Without further information, it is difficult to gauge the P&L write-down that might arise on this portfolio; but to illustrate, if we assume a 50% loss rate on the property exposure (and ignoring gains that might be realised elsewhere in the book) then this would account for 40% of the group’s valuation discount against other UK banks.
In our view, the shares will continue to reflect an expectation of a significant rump placing on behalf of retail investors at the end of HBOS’ rights period, which is protracted – fully paids do not trade until 21 July.
In our view, the shares will continue to reflect an expectation of a significant rump placing on behalf of retail investors at the end of HBOS’ rights period, which is protracted – fully paids do not trade until 21 July.
NH:
However, fundamentally the valuation appears to have reached a level which discounts a markedly worse impairment performance versus UK peers, which in our view is unlikely to be the case. We therefore see relative value in the stock at this price, with the catalyst being the completion of the rights issue (during the RBS rights issue, the shares reached a low a week before the fully paids started trading) and near term the shares may be supported by a pre-close update (due this week) that is devoid of significant surprises.
NH:
Of course, Caz are still a hold on HBOS
NH:
so today’s move is not entirely down to them
NH:
but there is some bargain hunting going on today
NH:
and there is also some short covering
NH:
its seems a few people short into Monday’s early strength
NH:
and have been a bit spooked by the move this morning
NH:
as such the whole banking sector is better this morning
Barclays (BARC:LSE): Last: 347.75, up 18.75 (+5.70%), High: 352.75, Low: 330.00, Volume: 54.45m
Lloyds TSB Group (LLOY:LSE): Last: 357.50, up 9.5 (+2.73%), High: 361.25, Low: 349.50, Volume: 15.54m
Royal Bank of Scotland Group (RBS:LSE): Last: 243.25, up 8.25 (+3.51%), High: 248.25, Low: 237.00, Volume: 60.73m
NH:
Barc and Lloyds have been upgraded by Dresdner this morning
NH:
sorry Barc and RBS upgraded by Dresdner
NH:
Lloyds remains a buy
PM:
Do you have the Dresdner piece by any chance
NH:
sure
NH:
We warm up to certain UK banks after recent substantial underperformance.
NH:
We upgrade RBS to Add and BARC to Hold. LLOY remains our only Buy. We still avoid smaller undiversified domestics: B&B and A&L remain rated Sell. We focus on provisions, and find that some banks already discount very negative scenarios.
Wet hink a repeat of the extreme provisioning of 1991 is highly unlikely.
Wet hink a repeat of the extreme provisioning of 1991 is highly unlikely.
NH:
We warm up to certain UK banks: RBS and Barclays still face earnings headwinds but we upgrade after substantial underperformance. We upgrade RBS to Add, as it has dealt with its capital base and credit assets, is more diversified, and has cost cutting potential.
We upgrade BARC just to Hold. Lloyds remains our only Buy, due to its higher upside and lower risk. But we are aware of the macro problems and the leverage mistakes and remain selective, keeping the two smaller undiversified domestics (A&L and B&B) as Sell.
NH:
B&B’s poor mortgage performance not an indicator for the rest of the sector:
Bradford & Bingley recently revealed that its arrears had jumped sharply, but the source of the problem appears to be its acquired loans, where arrears have reached 5%. The other banks do not have acquired loans in their UK mortgage portfolios. We also note that B&B’s average LTV at 55% is markedly higher than the more normal 45%.
Bradford & Bingley recently revealed that its arrears had jumped sharply, but the source of the problem appears to be its acquired loans, where arrears have reached 5%. The other banks do not have acquired loans in their UK mortgage portfolios. We also note that B&B’s average LTV at 55% is markedly higher than the more normal 45%.
We do not expect a return to the early 1990s in terms of bad debts, as the economic environment is fundamentally different. However, we stress-test our forecasts with a “nightmare scenario” that is not too far from those levels and find that except B&B, all the banks remain profitable. In this scenario we would be cutting our EPS by 30 to 50%, but at LLOY and RBS, current upsides seem to accommodate already those downgrades.
NH:
Mortgages: House prices and LTVs the key Some banks now show LTV tranches
which allows us to deduce levels of negative equity for a given price fall and then forecast repossessions. We now expect a 15% fall in prices plus 15% of repossession costs (with 1.2% repossession rates – 6% for the top LTV slice – well above its previous peak of 77bp in 1991). In our worst case, we assume a 30% price fall and 30% repossession costs.
which allows us to deduce levels of negative equity for a given price fall and then forecast repossessions. We now expect a 15% fall in prices plus 15% of repossession costs (with 1.2% repossession rates – 6% for the top LTV slice – well above its previous peak of 77bp in 1991). In our worst case, we assume a 30% price fall and 30% repossession costs.
Corporate lending to see deterioration with debt service burden at peaks: The
corporate debt service burden is now back at peak levels (30%). Corporate insolvencies show a strong inverse correlation with GDP growth, which we expect to fall to 1.1% in 2009. We do not expect to see 1991 levels of impairments, but think that this is the part of the loan books that has the highest potential to disappoint. As far as commercial property is concerned, we believe the scenario is much more benign than in 1991.
NH:
bickie
Reminder to readers – if you arrived late and want to stop the dialogue ‘jumping’ as you catch up, hit the ‘pause auto-scrolling’ tab at the bottom right hand corner
PM:
So a few people prepared to dip their toes back into the banking sector
NH:
seems that way
NH:
but be careful this could be another false dawn
PM:
PM:
Right — moving on from the banks to …..
PM:
The housebuilders?
NH:
our other favourite subject at the moment
NH:
Fitch has downgraded its rating on Taylor Wimpey
NH:
stock off 2p at 74.5p
PM:
Got any of what Fitch are saying?
NH:
Fitch Downgrades Taylor Wimpey to ‘BB+’; Ratings Remain on Watch Negative
Fitch Ratings-London-17 June 2008: Fitch Ratings has today downgraded UK housebuilder Taylor
Wimpey plc’s (TW) ratings to Long-term Issuer Default (IDR) and senior unsecured ‘BB+’ from
‘BBB’ and to Short-term IDR ‘B’ from ‘F2′. The Long-term IDR and senior unsecured ratings
remain on Rating Watch Negative (RWN).
Fitch Ratings-London-17 June 2008: Fitch Ratings has today downgraded UK housebuilder Taylor
Wimpey plc’s (TW) ratings to Long-term Issuer Default (IDR) and senior unsecured ‘BB+’ from
‘BBB’ and to Short-term IDR ‘B’ from ‘F2′. The Long-term IDR and senior unsecured ratings
remain on Rating Watch Negative (RWN).
NH:
The rating action reflects TW’s troubled business environment, with UK housing sales expected
to persist at weakened levels during 2008 and 2009 as a result of a worsening macroeconomic
environment, a severe contraction in UK mortgage lending and poorer sentiment among house
buyers. This, in turn, is expected to lead to a material reduction in TW’s earnings over at
least the next two years.
In view of the rapid deterioration in TW’s operating environment, Fitch’s updated forecasts
raise concerns about the company’s ability to comply with certain debt covenants over the next
18 months. The prospect of potential covenant difficulty forms a significant part of Fitch’s
rationale for the downgrade.
to persist at weakened levels during 2008 and 2009 as a result of a worsening macroeconomic
environment, a severe contraction in UK mortgage lending and poorer sentiment among house
buyers. This, in turn, is expected to lead to a material reduction in TW’s earnings over at
least the next two years.
In view of the rapid deterioration in TW’s operating environment, Fitch’s updated forecasts
raise concerns about the company’s ability to comply with certain debt covenants over the next
18 months. The prospect of potential covenant difficulty forms a significant part of Fitch’s
rationale for the downgrade.
NH:
n Fitch’s opinion, TW has options available to it which could improve its financial position
and potentially mitigate any possible covenant problems. However, the exact actions TW will
choose to undertake and the success of these actions remain uncertain, especially given the
difficult business and financial environment the company currently faces (partly reflected by
an approximate 65% fall in TW’s share price over the last 12 months). Although management
remains proactive in its attempts to tackle the challenges it faces, many key factors remain
outside of its control
and potentially mitigate any possible covenant problems. However, the exact actions TW will
choose to undertake and the success of these actions remain uncertain, especially given the
difficult business and financial environment the company currently faces (partly reflected by
an approximate 65% fall in TW’s share price over the last 12 months). Although management
remains proactive in its attempts to tackle the challenges it faces, many key factors remain
outside of its control
NH:
A failure by TW to successfully improve its financial position in the
short-term could lead to further deterioration in the credit profile, and therefore Fitch has
maintained its RWN status on TW’s Long-term IDR and senior unsecured ratings. Fitch will
continue to monitor TW’s near-term actions in an effort to resolve the watch over the next six
months. Any further downgrade could be by more than one notch.
Despite the near-term difficulties facing TW in both its UK and US markets, the ratings
continue to be supported by an expectation that the company will generate significant free
cash flow during the current downturn. This is by virtue of TW’s flexible business model,
which involves significantly reining in land purchases (supported by TW’s sizable land bank),
tightening work-in-progress (such as build costs), mothballing new developments and reducing
margins on existing sites to recycle cash out of its current developments.
short-term could lead to further deterioration in the credit profile, and therefore Fitch has
maintained its RWN status on TW’s Long-term IDR and senior unsecured ratings. Fitch will
continue to monitor TW’s near-term actions in an effort to resolve the watch over the next six
months. Any further downgrade could be by more than one notch.
Despite the near-term difficulties facing TW in both its UK and US markets, the ratings
continue to be supported by an expectation that the company will generate significant free
cash flow during the current downturn. This is by virtue of TW’s flexible business model,
which involves significantly reining in land purchases (supported by TW’s sizable land bank),
tightening work-in-progress (such as build costs), mothballing new developments and reducing
margins on existing sites to recycle cash out of its current developments.
NH:
TW has also taken
steps in recent months to conserve cash flow by suspending the remaining GBP500m of its
proposed share buyback and materially reducing headcount (including the closure of 30% of its
UK regional offices).
steps in recent months to conserve cash flow by suspending the remaining GBP500m of its
proposed share buyback and materially reducing headcount (including the closure of 30% of its
UK regional offices).
NH:
Fitch also takes a degree of comfort from the fact that TW’s management has recent experience
of implementing remedial actions during a downturn, having been exposed to a US housing market
that has been in decline since 2006. However, if some of these remedial actions, such as a
freeze on land purchases, persist for a lengthy period, the business will shrink which, in
turn, could weaken the company’s business profile over the longer-term.
of implementing remedial actions during a downturn, having been exposed to a US housing market
that has been in decline since 2006. However, if some of these remedial actions, such as a
freeze on land purchases, persist for a lengthy period, the business will shrink which, in
turn, could weaken the company’s business profile over the longer-term.
PM:
thanks for that
PM:
PM:
Interesting note below on Goldman — someone piling into the options
NH:
figures out soon aren’t they?
PM:
Due today certainly
NH:
as are Morgan Stanley, I think
PM:
Hmm
NH:
NH:
not everything is rising this morning
PM:
What’s in the dumps?
NH:
media
PM:
whats the prob?
NH:
most of the sector is heading south
NH:
on the back of a very, very, very bearish note from Morgan Stanley
NH:
basically they believe advertising is going to fall off a cliff in the next couple of years
NH:
and have taken the red pen to profit forecasts
NH:
for 2010 these are now an average of 14% below consensus
NH:
and the big call in the note is on the advertising agencies
NH:
where MS now sees negative revenue growth next year
PM:
so a real slow down on the cards
NH:
seems that way
NH:
and that has caused the sector to wobble in a strong market
WPP Group (WPP:LSE): Last: 554.50, down 5 (-0.89%), High: 558.00, Low: 550.00, Volume: 1.72m
British Sky Broadcasting (BSY:LSE): Last: 526.50, down 5.5 (-1.03%), High: 532.00, Low: 522.00, Volume: 2.18m
ITV (ITV:LSE): Last: 56.20, up 0.2 (+0.36%), High: 56.40, Low: 55.00, Volume: 5.84m
Yell Group (YELL:LSE): Last: 96.75, down 6.25 (-6.07%), High: 102.75, Low: 95.00, Volume: 4.37m
NH:
here’s some highlights from the note
NH:
Substantial forecast cuts for 2009 and 2010. Faced
with a sharply deteriorating environment for the
consumer and a more difficult environment for corporate
spending, we review forecasts for all media stocks. We
have made substantial cuts in 2009 and 2010 to
consumer related names with earnings forecasts for
advertising inventory companies cut on average by 17%
in 2010, for marketing services by 12%; for BSkyB by
10% and professional publishers are down 6%. Our 2010
forecasts are now on average 14% below consensus.
with a sharply deteriorating environment for the
consumer and a more difficult environment for corporate
spending, we review forecasts for all media stocks. We
have made substantial cuts in 2009 and 2010 to
consumer related names with earnings forecasts for
advertising inventory companies cut on average by 17%
in 2010, for marketing services by 12%; for BSkyB by
10% and professional publishers are down 6%. Our 2010
forecasts are now on average 14% below consensus.
NH:
Too early for the cyclicals. Although multiples are
frequently very low, the cyclical end of the sector
remains unattractive due to a combination of structural
deterioration, heavy downgrades and, in some cases,
leverage fears. Valuation is unlikely to return as a driver
of this sector in the coming months. We remain
Underweight on most of the broadcasters (ITV, A3, T5,
Mediaset), and lower Yell from Overweight to Equal-weight
and Trinity to Underweight from Equal-weight.
frequently very low, the cyclical end of the sector
remains unattractive due to a combination of structural
deterioration, heavy downgrades and, in some cases,
leverage fears. Valuation is unlikely to return as a driver
of this sector in the coming months. We remain
Underweight on most of the broadcasters (ITV, A3, T5,
Mediaset), and lower Yell from Overweight to Equal-weight
and Trinity to Underweight from Equal-weight.
NH:
‘Safe’ stocks to the fore. We continue to regard UBM &
DMGT as the most interesting stocks in the sector, rated
as cyclicals but with relatively robust earnings prospects.
The ‘safe’ defensives are in the Professional Publishers
where we favour Pearson and Wolters Kluwer; amongst
the satellite stocks we like SES & Eutelsat; we continue
to believe BSkyB will be resilient (though our price target
is cut 13% to 615p). Our major change in view is that we
now expect the global ad agencies will see negative
organic revenue growth (-1% from +3.75%) in 2009. We
move WPP from Overweight to Equal-weight with a
price target of 650p (was 770p).
DMGT as the most interesting stocks in the sector, rated
as cyclicals but with relatively robust earnings prospects.
The ‘safe’ defensives are in the Professional Publishers
where we favour Pearson and Wolters Kluwer; amongst
the satellite stocks we like SES & Eutelsat; we continue
to believe BSkyB will be resilient (though our price target
is cut 13% to 615p). Our major change in view is that we
now expect the global ad agencies will see negative
organic revenue growth (-1% from +3.75%) in 2009. We
move WPP from Overweight to Equal-weight with a
price target of 650p (was 770p).
NH:
Media – moving from Attractive to In-Line. Media
appears cheap on a medium term view. There are
volatile cyclical stocks that could produce very attractive
returns on a 2 year view (Pro7, Johnston). In the next
few months, however, valuations and forecasts in the
sector will remain under intense pressure and that the
catalysts for a more positive value-oriented sector call
will not be apparent.
appears cheap on a medium term view. There are
volatile cyclical stocks that could produce very attractive
returns on a 2 year view (Pro7, Johnston). In the next
few months, however, valuations and forecasts in the
sector will remain under intense pressure and that the
catalysts for a more positive value-oriented sector call
will not be apparent.
NH:
Much tougher conditions ahead
The macro environment in which our European media
companies operate appears to be taking a lurch downwards.
This is particularly true of those companies operating in
consumer related markets. Pressure is developing from the
joint perils of rising commodity prices, higher inflation, the jump
in oil prices, lower credit availability, falling house prices and
increases in unemployment. This is likely to have a direct
impact on the desire of advertisers to market to consumers and,
in some cases, on the advertisers’ financial capacity to spend
on advertising. Away from the consumer-related areas we see
pressures mounting in the corporate environment. Finance
directors looking into the second half of 2008 and into 2009 are
likely to seek to reduce controllable costs whether in
advertising, marketing, information costs, travel and other
expenses. This means that, while the thrust of this note is to
reduce expectations for consumer-related companies, we also
take down numbers for those exposed to B2b markets and
professional publishing.
The macro environment in which our European media
companies operate appears to be taking a lurch downwards.
This is particularly true of those companies operating in
consumer related markets. Pressure is developing from the
joint perils of rising commodity prices, higher inflation, the jump
in oil prices, lower credit availability, falling house prices and
increases in unemployment. This is likely to have a direct
impact on the desire of advertisers to market to consumers and,
in some cases, on the advertisers’ financial capacity to spend
on advertising. Away from the consumer-related areas we see
pressures mounting in the corporate environment. Finance
directors looking into the second half of 2008 and into 2009 are
likely to seek to reduce controllable costs whether in
advertising, marketing, information costs, travel and other
expenses. This means that, while the thrust of this note is to
reduce expectations for consumer-related companies, we also
take down numbers for those exposed to B2b markets and
professional publishing.
NH:
Why should there be any growth in 2009?
The underlying assumptions for each sub-sector and stock are
discussed individually in this note. Our broad approach is,
however, to ask the question why there should be any
advertising related growth at all in 2009.
The underlying assumptions for each sub-sector and stock are
discussed individually in this note. Our broad approach is,
however, to ask the question why there should be any
advertising related growth at all in 2009.
We can illustrate this approach with reference to the global
advertising agencies. In 2008, boosted by a strong start to the
year and by the ‘super quadrennial’ factors (Beijing Olympics,
US Presidential elections, Euro 2008) most forecasters have
assumed organic revenue growth of around 5%. In 2009
estimates for organic revenue growth tend to range in the
vicinity of 3-4%. Our starting point is now to ask why there
should be any global advertising growth in the 2009. The US
and Europe are facing recessionary pressures, the consumer
is under strain and the corporate will be entering the second
year of a slowdown.
NH:
Our prognosis is to assume zero
underlying growth in advertising growth globally (declines in the
US and Europe offsetting growth, itself slowing, in emerging
economies) and then to reflect the absence of the 2008 super
quadrennial ‘boost’ (150 bps of growth). As a result, our
forecasts for WPP and Publicis now assume a 1-2% decline in
organic revenue growth in 2009.
underlying growth in advertising growth globally (declines in the
US and Europe offsetting growth, itself slowing, in emerging
economies) and then to reflect the absence of the 2008 super
quadrennial ‘boost’ (150 bps of growth). As a result, our
forecasts for WPP and Publicis now assume a 1-2% decline in
organic revenue growth in 2009.
This is, let’s face it, only a reflection of the views of WPP’s CEO
Sir Martin Sorrell, who for a long time has warned of potential
global advertising slowdown in 2009. In individual countries
and advertising types, the slowdown may be both more sudden
and more marked. Last week, Roger Parry, speaking in his role
as Chairman of UK advertising agency Media Square observed
of the UK advertising market
‘the amazing speed with which the advertising economy has
tanked out in the last six months… the level to which
confidence has fallen is really scary’
PM:
er, all rather scary
PM:
for a service that relies on advertising
NH:
and Sir Martin is cheery fellow isn’t he??
PM:
and Sir Martin is cheery fellow isn’t he??
PM:
Parry is rather bearish as well
PM:
Ivy regular, Mr Parry
PM:
May become irregular
PM:
Let’s move on from media. It makes me nervous generally
NH:
me too
PM:
PM:
any other highlights??
NH:
a real lack of RAW market info again this morning
NH:
in fact a total lack of RAW
PM:
NH:
but we have been keeping a close watch on Smiths Group
NH:
stock has gained 47p to £11 this morning
NH:
a near 4.5% gain
PM:
Why?
NH:
a UBS upgrade
NH:
it’s all about upgrades/downgrades this morning
NH:
no gossip out there at all
NH:
anyway, they have set a £13.50 target price
NH:
because are bullish on CEO Philip Bowman’s plan to turn round the company
NH:
specifically they say Bowman will set aggressive targets for each division
NH:
and reading between the lines, UBS sees this as making the company a more credible break up target
PM:
Hmm
PM:
when Bowman was first appointed everyone thought he had been brought into to sell the company
PM:
and given his track record – Allied Domecq (sold to the French), Scottish Power (sold to the Spanish) that was an obvious assumption to make
NH:
but perhaps he thinks margins need fattening up before the company is dismembered
NH:
here’s the note
NH:
We are raising our price target on Smiths Group to £13.50 from £12.50 after a detailed analysis of peer group margins and valuation ranges. We believe the new CEO, Philip Bowman, will set challenging targets for each division which will lead to an acceleration in organic profit growth.
NH:
Increasing EPS forecasts by 10% for 2009/10
We believe the new CEO will target 20% operating margins for the group by year two. Our analysis says this is very achievable and would still leave it behind the margins earned by many of its peer group. As such, we have raised the UBS EPS forecasts for Smiths by 10% for 2009/10. On our new forecasts, Smiths will achieve low double-digit EPS growth for the next f.ive years
NH:
Break-up still a likely option – more than £15 a share is possible
While Mr Bowman will add an organic growth story to the Smiths investment case, we believe a break-up of the group is still likely. On our new forecasts and applying a 20% control premium for the businesses, we believe a break-up value could exceed £15 per share.
While Mr Bowman will add an organic growth story to the Smiths investment case, we believe a break-up of the group is still likely. On our new forecasts and applying a 20% control premium for the businesses, we believe a break-up value could exceed £15 per share.
Valuation: £13.50 price target
Our £13.50 price target is derived from our sum-of-the-parts valuation. Given the different characteristics of the Smiths divisions, we believe this is the best way to value the stock. Our sum-of-the-parts valuation gives a base price of £12.41, to which we add a premium for the likelihood of the eventual break-up of the group. Smiths is in the UBS Corporate Change Portfolio and the M&A Conviction List.
NH:
NH:
EJ
NH:
the small cap oil stuff
NH:
one story was Bowleven, which was in the paper this morning
NH:
and the other one was utter tosh
NH:
and I am not mentioning it
PM:
NH:
but we do have some stuff on Aero Investory
NH:
there was question below about Bridgepoint
NH:
just to recap
NH:
small cap company
NH:
supplies spare parts to the airline industry
NH:
received a very preliminary bid approach yesterday
NH:
we discovered the bidder was private equity
NH:
Bridgepoint
PM:
And the price?
NH:
we are told they have offered 900p a share
NH:
although everything is very preliminary
PM:
where are the shares trading at the moment??
NH:
up 4p at 635p
NH:
mind you they did climb 25 % yesterday
NH:
so there could be some profit taking
PM:
900p???? That sounds rather high
PM:
Sure that’s the right figure?
NH:
yep
NH:
and there is also the slim possibility of a bidding war
NH:
KKR just bought a Canadian company operating in the same space as AI
NH:
I think the reason the stock is trading at such a discount is because the talks have clearly been flushed out very early
NH:
and therefore could collapse
NH:
the company also had a lot of debt
NH:
and operates in an industry that is challenged
NH:
structurally if you believe a note out of Collins Stewart this morning
PM:
a toxic combination
NH:
Indeed
NH:
anyway here’s a note from Numis Securities on the bid approach
NH:
and check out the line on management LTIPS
NH:
they kick in a £15
NH:
no wonder, this people close to the company are calling this an unwelcome, hostile, unsolicited bid
NH:
Aero Inventory shares closed up 27% after the company confirmed that it had received a “highly preliminary” bid approach, a somewhat rare event in the UK A&D sector.
This followed a month of significant share price underperformance (-24%) and in our view vindicates the value opportunity of Aero’s maturing business model.
NH:
Compelling value opportunity: Recently the shares have been hit by a combination of
rudimentary market fears; Aero’s is a small cap with high debt and exposure to commercial aerospace – three distinct negatives in the current environment.
rudimentary market fears; Aero’s is a small cap with high debt and exposure to commercial aerospace – three distinct negatives in the current environment.
As a result the valuation became heavily discounted at just 6.1x CY2009 (a 48% disc. to the sector) / EV/EBITDA 5.2x.
NH:
Trend to outsourcing – large market opportunity: Airline woes have been exacerbated by the pace and scale of recent fuel price increases and as a result the need to save costs hasbecome critical. This we believe will ultimately accelerate the trend by airlines to outsource non-core operations and hence lead to further business opportunities.
Therefore, while we accept that Aero’s is not immune to airlines’ plans to reduce capacity, the key growth driver remains new contracts which are coming thick and fast.
NH:
Private Equity: AI could be attractive to PE; indeed KKR owns one of its major customers, ACTS. AI needs cash to fund further new contracts which PE could more readily provide than the equity market. The FT today cites an unsolicited approach from PE firm Bridgepoint attracted by potentially a high return in the medium term from such a low valuation.
Price? The FT suggests a bid at a premium to the 52-wk high of 720p. Also, given the
supportive s/h base and mgt’s +ve view (LTIP vest at a SP of £15 or above in 2 years), we suspect a bid would need to be higher than the current price. Applying Hampson and Umeco’s CY2009 P/E multiple implies a target range of 770p (our fundamental PT) to 930p. BUY
PM:
thanks for that
PM:
NH:
hmmm
NH:
a bit of RAW just in
NH:
some warm buyers of Sainsbury around
PM:
NH:
not immediately clear why
NH:
trading update tomorrow
NH:
can’t believe people are buying ahead of that
NH:
or for a bid from Qatar
NH:
given their recent bust up with Paul Taylor
NH:
all very strange
NH:
stock up 5.5p at 341.25p
NH:
will put a few calls out this afternoon
PM:
Interesting. One to watch
NH:
NH:
RIGHT
NH:
LIBOR fix is out
PM:
Come off the top a tad
PM:
5.94750 v 5.95500
PM:
for 3m £
NH:
down a touch
NH:
anything from Goldman yet??
PM:
Nothing as yet
NH:
NH:
LSE on the move
NH:
looks to be a day of short covering
NH:
stock suddenly up 55p at 955p
PM:
taht is a big , sudden move
NH:
Whitbread also strong on the back of their trading update
NH:
which looks to have gone down well
NH:
shares up 52p at £12.74
PM:
Got any comment on the whitbread update?
NH:
plenty of stuff
NH:
this is from ABN Amro
NH:
TOP STORY: Whitbread* (Buy, TP 1,555p) – Good 1Q trading update
NH:
Overall: Another strong update from WTB with group LFL sales growth of 7%. This is an acceleration from the last quarter of 2007/8 when group LFL sales growth was 5.4%.
NH:
Divisional splits for Q1: Premier Inn (70% of the group) 10.7% which represents an acceleration from the 9.2% reported for Q4 2007/8; Pub restaurants (20% of the group) 1.7% underlying which is broadly in line with the 2% for Q4 2007/8; Costa Coffee (10% of the group) 6% slightly softer than the 6.8% for Q4 2007/8. These are a good set of LFLs driven by; room rate growth at Premier where room rates were up 8% in the quarter; volume growth
NH:
at Pubs where covers growth was up 6.9%, and; price, volume and spend per head all running at 2% each at Costa Coffee.
NH:
Consumer behaviour: There are some signs of changing consumer behaviour; Premier Inn is seeing occupancy modestly weaker at weekends and to some extent midweek (down 1.8% points); spend per head in pubs is also down a little as consumers trade down.
NH:
Costs: Input cost inflation remains a challenge; LFL costs are rising around 4 to 5% at Premier Inn, 5 to 6% at pub restaurants and by 3 to 4% at Costa. The group needs to continue to drive both price increases and efficiency gains to offset these cost pressures.
NH:
ABN AMRO view: The headline LFL sales number of 7% is the key barometer today for the stock; we expect WTB to move better on the back of it. On consensus 2008 EPS of 90p the stock is trading on PE 13.5x. We stick with buy although we are wary about the sustainability of current trading conditions which are clearly still very strong at present.
PM:
Obviously that Premier rebranding did the trick — those blokes with ladderes
NH:
and that cost what? £20m for a few new signs??
PM:
Something like that
NH:
nice work
NH:
if u can get it
PM:
NH:
although here has not made an appearance this mornig
NH:
I dug some stuff out for Money and his friends on Rank
NH:
seems to be a very popular stock amongst you all
NH:
here it is
NH:
from JP Morgan
NH:
Split premises and primary
gambling activity Gambling
Commission
gambling activity Gambling
Commission
NH:
The Gambling Commission has released a consultation document
that is aimed to clarify whether premises can be split and apply for
separate gambling licences and highlight the importance of the
primary activity of the gambling licence. Two key issues arise: 1.
Some companies appear not to have been operating within the spirit
of the Gambling Act and 2. The Gambling Commission seems to
view machines as a less desirable form of gambling. Any changes
are unlikely to be enacted before October 2008 and this may delay
any potential respite from the Minister of Culture, Media and Sport.
that is aimed to clarify whether premises can be split and apply for
separate gambling licences and highlight the importance of the
primary activity of the gambling licence. Two key issues arise: 1.
Some companies appear not to have been operating within the spirit
of the Gambling Act and 2. The Gambling Commission seems to
view machines as a less desirable form of gambling. Any changes
are unlikely to be enacted before October 2008 and this may delay
any potential respite from the Minister of Culture, Media and Sport.
NH:
We have forecast no uplift from increased machine numbers so there
are no changes to our forecasts from this announcement.
are no changes to our forecasts from this announcement.
• Bingo halls have split premises to increase gaming machines.
Rank announced at the May trading update that they had put 23
adult gaming centres (AGC) into bingo clubs. The consultation
paper suggests that it is possible to split premises but the
customers should appreciate they are in a different premises not a
different part of the same premises. We believe that it is likely that
local planning authorities (who implement this guidance on a case
by case basis) may go as far as requiring separate entrances to
ensure customers are clear about the different premises. It would
be more expensive for Rank to offer AGC or betting shops but not
impossible. However, given cash constraints we expect Rank to
delay any further introductions until clarification in October.
NH:
• Gambling Commission appears skeptical of gaming machines.
The consultation paper is trying to increase the uniformity of local
planning applications but we believe there is an undercurrent of
anti-gaming machine sentiment. It is clear that not only does the
Gambling Commission want operators to act within the spirit of
the law but “…also considers that it is undesirable in terms of
minimising the risk of problem gambling, for betting, bingo or
casino premises to offer only or predominantly gaming machines.”
Although the Gambling Act is less than 12 months old the
Commission is once again highlighting the problem gambling
aspect of high stake machines. This may be an issue for the UK
bookmakers if there is a material increase in problem gamblers in
the next Gambling Prevalence study published in 2010.
The consultation paper is trying to increase the uniformity of local
planning applications but we believe there is an undercurrent of
anti-gaming machine sentiment. It is clear that not only does the
Gambling Commission want operators to act within the spirit of
the law but “…also considers that it is undesirable in terms of
minimising the risk of problem gambling, for betting, bingo or
casino premises to offer only or predominantly gaming machines.”
Although the Gambling Act is less than 12 months old the
Commission is once again highlighting the problem gambling
aspect of high stake machines. This may be an issue for the UK
bookmakers if there is a material increase in problem gamblers in
the next Gambling Prevalence study published in 2010.
PM:
thanks for that
PM:
Still nothing on Goldman?
NH:
no, but they issued a interesting note on the US banking sector
NH:
Timing the turnaround: Credit, Capital, Consensus and Curve
NH:
Timing the turnaround – 4 factors needed
NH:
We identify four “C” factors to spur a turnaround,
which may still be 6-9 months out:
which may still be 6-9 months out:
NH:
1) Credit does not peak until 2009: home prices
have driven credit deterioration and we believe
they will keep falling through the year end. As a
result, we do not see a peak in losses until 2009.
Moreover, we see “rolling peaks” across asset
classes. To reflect our revised loss estimates, we
have lowered estimates by an average of 9%.
have driven credit deterioration and we believe
they will keep falling through the year end. As a
result, we do not see a peak in losses until 2009.
Moreover, we see “rolling peaks” across asset
classes. To reflect our revised loss estimates, we
have lowered estimates by an average of 9%.
NH:
(2) Capital raising becomes harder: We think
there is still $65bn to go relative to $120bn raised
so far by US Banks. Only 4 out of 42 deals we
track are in-the-money so far. This will make the
next round of deals harder and more expensive.
there is still $65bn to go relative to $120bn raised
so far by US Banks. Only 4 out of 42 deals we
track are in-the-money so far. This will make the
next round of deals harder and more expensive.
NH:
(3) Consensus range needs to narrow: revisions
are a lagging indicator. That said, we watch for a
tightening of the consensus range, which is at
record highs. When the range tightens, it will
signal confidence in where book values stabilize
are a lagging indicator. That said, we watch for a
tightening of the consensus range, which is at
record highs. When the range tightens, it will
signal confidence in where book values stabilize
NH:
(4) Curve is at risk: a steeper yield curve has
helped, although even here this has recently
reversed in part amid Fed tightening risk.
helped, although even here this has recently
reversed in part amid Fed tightening risk.
NH:
Still Cautious on Regional Banks
The most common question from investors is
when to buy the weaker banks. In prior cycles,
weaker banks do not outperform until the whole
sector turns. With the turnaround still some time
away, we believe it is too early to invest in weaker
banks on the back of depressed valuations.
We expect capital to be a continued differentiator
and recommend our capital trade: banks with
capital outperform those without (Bloomberg
vs. ). We favor trust
banks to regional banks given stable earnings and
capital catalysts. Both Bank of New York Mellon
and State Street are rated Conviction List Buy. We
remain Cautious on regional banks amid credit
deterioration and rate M&I as Conviction List Sell.
The most common question from investors is
when to buy the weaker banks. In prior cycles,
weaker banks do not outperform until the whole
sector turns. With the turnaround still some time
away, we believe it is too early to invest in weaker
banks on the back of depressed valuations.
We expect capital to be a continued differentiator
and recommend our capital trade: banks with
capital outperform those without (Bloomberg
banks to regional banks given stable earnings and
capital catalysts. Both Bank of New York Mellon
and State Street are rated Conviction List Buy. We
remain Cautious on regional banks amid credit
deterioration and rate M&I as Conviction List Sell.
NH:
Capital structure trades: credit vs. equity
Our credit views are the opposite of equity in
certain names: buy bank credit risk where the
capital raise has taken place, and sell “stronger”
banks credit in anticipation of them putting capital
to work. Specific pair trades: long C debt/short
equity, and long WFC equity/short debt.
Our credit views are the opposite of equity in
certain names: buy bank credit risk where the
capital raise has taken place, and sell “stronger”
banks credit in anticipation of them putting capital
to work. Specific pair trades: long C debt/short
equity, and long WFC equity/short debt.
PM:
thanks for that
PM:
PM:
Here’s some more from that note:
PM:
Banks will not turn until a peak in credit costs is in sight. We note that 1Q 2008 was the first quarter since 1985 where credit
costs did not fall in the first quarter suggesting that the year end clean up process was more than offset by the rapid rate of
deterioration in banks loan portfolios in the first quarter. Moreover, based on a detailed assessment of the expected timing of
defaults and credit losses implies peak provisioning is unlikely until early 2009. Hence, we believe that a broad based rally in
bank shares is unlikely in coming months and re-iterate our underweight stance on the regional banking sector.
• Even compared to previous banking crisis, weaker banks have underperformed the sector by a greater magnitude.
However, the underperformance can be attributed to the greater impact of the banking crisis this time round on forecast
earnings, book values and returns. Hence, the performance gap be explained by fundamentals as weaker banks have been hit
extremely hard, and the whole sector has been hit harder than even the 1990-1992 cycle (see Exhibits 1-3).
• We estimate the recapitalization process is now two thirds complete for the US banks. However, while insolvency risk has
been significantly reduced, “weaker” banks which have recapitalized will: (1) looking to reduce assets despite their strong Tier
1 ratios resulting in slow earnings growth, and (2) suffer from low returns as a result of decreased leverage. Moreover, weaker
banks are unlikely to benefit from consolidation as bank deals always slow when credit is deteriorating and larger banks are
hamstrung by their own problem assets as well as accounting requirements to mark targets to market.
• Consensus estimates are a lagging indicator of share price declines; in the 1990, 2001 and current cycles the stocks peaked
before estimates did (usually by 8-9 months), and in 1990 and 2001 stocks troughed before estimates did (usually by 4-5
months). That said, we watch for a tightening of the consensus range, which is at record highs. When the range tightens, it will signal confidence in where book values stabilize.
• Fed easing and a steeper curve have been precursors to previous turnarounds. Arguably, this has already happened,
although the Fed easing cycle has ended and the market is increasingly pricing in risk of Fed tightening in 2009. Moreover, one of the benefits of Fed easing has always been securities gains, which is not happening this cycle as banks are still sitting on near record unrealized losses.
costs did not fall in the first quarter suggesting that the year end clean up process was more than offset by the rapid rate of
deterioration in banks loan portfolios in the first quarter. Moreover, based on a detailed assessment of the expected timing of
defaults and credit losses implies peak provisioning is unlikely until early 2009. Hence, we believe that a broad based rally in
bank shares is unlikely in coming months and re-iterate our underweight stance on the regional banking sector.
• Even compared to previous banking crisis, weaker banks have underperformed the sector by a greater magnitude.
However, the underperformance can be attributed to the greater impact of the banking crisis this time round on forecast
earnings, book values and returns. Hence, the performance gap be explained by fundamentals as weaker banks have been hit
extremely hard, and the whole sector has been hit harder than even the 1990-1992 cycle (see Exhibits 1-3).
• We estimate the recapitalization process is now two thirds complete for the US banks. However, while insolvency risk has
been significantly reduced, “weaker” banks which have recapitalized will: (1) looking to reduce assets despite their strong Tier
1 ratios resulting in slow earnings growth, and (2) suffer from low returns as a result of decreased leverage. Moreover, weaker
banks are unlikely to benefit from consolidation as bank deals always slow when credit is deteriorating and larger banks are
hamstrung by their own problem assets as well as accounting requirements to mark targets to market.
• Consensus estimates are a lagging indicator of share price declines; in the 1990, 2001 and current cycles the stocks peaked
before estimates did (usually by 8-9 months), and in 1990 and 2001 stocks troughed before estimates did (usually by 4-5
months). That said, we watch for a tightening of the consensus range, which is at record highs. When the range tightens, it will signal confidence in where book values stabilize.
• Fed easing and a steeper curve have been precursors to previous turnarounds. Arguably, this has already happened,
although the Fed easing cycle has ended and the market is increasingly pricing in risk of Fed tightening in 2009. Moreover, one of the benefits of Fed easing has always been securities gains, which is not happening this cycle as banks are still sitting on near record unrealized losses.
PM:
Right — we are done
PM:
Thank you for joining us today
PM:
Thanks for all the comment and debate
NH:
we are done
PM:
back tomorrow at 11am