TheChek News Flow

The euro is edging lower but holding up fairly well amid the latest market jitters over the continent’s upcoming elections (compared to bonds, at least). But that doesn’t mean traders are ignoring the currency, with demand to hedge against upcoming wobbles picking up.

The single currency is 0.6 per cent weaker against an upbeat dollar on Tuesday at $1.0545, and has weakened 2.3 per cent so far this month. The fall comes despite further signs of healthy growth in the eurozone economy, with figures from IHS Markit showing the currency bloc’s composite purchasing managers’ index has leapt to its highest level in almost six years in February.

That’s not exactly a stellar performance, but still puts the euro slightly ahead for the year to date, in contrast to expectations at the turn of the year that it could quickly hit parity with the dollar.

However, as ING points out:

while not necessarily reflected in the euro spot rate, the eurozone political risk is creeping more pronouncedly into euro/dollar implied volatility – with volatility premia for tenors covering the eurozone elections rising higher day by day.

Implied volatility tracks demand for options to hedge against big currency swings over a set period. Higher implied volatility reflects higher expectations of currency movements over the coming period.

Three-month implied volatility had been fading at the start of the year, but has jumped significantly since the options started to cover the weeks of France’s presidential election. The measure has also spiked noticeably as the travails of early frontrunner Francois Fillon prompted fears that Marine Le Pen’s populist Front National could win an unexpected victory.

Retailers Set to Pay the Piper, Weak Q4 Seen

Wal-Mart, Macy’s, TJX, Nordstrom and more will reveal their fourth-quarter results this week.

The holiday reckoning is here.

It’s already a given that this winter’s been an extremely tough one on most retailers, but just how bad it really was will start to be made clear as Wal-Mart Stores Inc. and Macy’s Inc. kick off the fourth-quarter earnings season today.

Nine major retailers will unveil their results this week and collectively analysts expect them to post a 12.6 percent drop in adjusted profits on a 1.1 percent gain of sales, according to data from S&P Capital IQ. (The trend is slightly better, but still down excluding the giant Wal-Mart, with the other eight retailers combined showing a 5 percent profit loss on a 0.6 percent increase in fourth-quarter sales).

In short, retailers were forced to cut prices to move goods, eating into already slim earnings.

Part of the problem is centered on the consumer, who is simply not buying apparel the way they have in the past, opting for less expensive fast-fashion looks and spending more on experiences.

But retailers are also having to spend more to reinvent their businesses, meeting the challenges of a quick-turn and much more digital marketplace.

The combination is toxic to the bottom line.

Wal-Mart is also running up against the law of large numbers, with sales slated to top $481 billion last year.

“Though Wal-Mart’s 2016 results have generally been in line to better than management had projected and the Jet.com acquisition should help drive e-commerce growth in the fourth quarter, we suspect that the company was not immune to some of the in-store traffic challenges experienced elsewhere within retail,” said Scot Ciccarelli, analyst at RBC Capital Markets. (Wal-Mart acquired e-tailer Jet for $3.3 billion last year and tapped its founder, Marc Lore, to build its online business.)

“Longer-term, Wal-Mart is making some smart strategic changes to improve its competitive positioning; however, it has become increasingly difficult for it to grow,” Ciccarelli said, adding the company “is being forced to continue to accelerate investments to defend existing market share, and many of its newer growth initiatives are margin-dilutive.”

Macy’s has it’s own, although not unique problems, including store closures and sagging results, and will also face questions from Wall Street about rumors that the company is seen as a takeover target.

On Tuesday, one of the industry’s few truly strong players, off-price giant TJX, will update its investors and although profits are expected to be down slightly, sales are slated to rise strongly, with a 5.3 percent gain.

In a sign of the times, TJX is now bigger than Macy’s on the sales line.

Nordstrom Inc., perhaps the strongest department store player now, is still seen as a solid business despite expected profit declines. Certainly, it’s not immune to the ills of the market.

Christian Buss, an analyst at Credit Suisse, said Nordstrom would “continue to grow sales and outperform peers, but believe some caution is in order near-term given highly challenging market conditions over the holiday period.”

J.C. Penney Co. will end the week on Friday with what is supposed to be the strongest bottom-line showing of the bunch, a 57.2 percent gain to $190.2 million despite a 0.6 percent sales decline.

Penney’s misadventure under former ceo Ron Johnson, which saw a dramatic strategy change lead to dramatic sales declines, has given the company a hole to climb out of — a process that maybe others are just beginning.

Securities regulator concerned private placements used to fund speculation

At least 180 Chinese listed companies will be forced to cancel or scale back planned rights offerings worth $97bn in response to regulations that target excessive fundraising used for dubious acquisitions and financial speculation.

The rules come as Chinese regulators are increasingly concerned about the trend of “exit the real, enter the fake” — a phrase used to denote companies abandoning real economic activity in favour of financial engineering. Listed companies invested a record $110bn into passive financial products in 2016 even as fixed-asset investment grew at its slowest pace since 1999. 

China’s securities regulator on Friday issued regulations that restrict the use of secondary share offerings through private placements. In addition to financial products, such share sales have largely been used to fund private-equity acquisitions, with investment targets chosen to match investment “concepts” popular with retail investors, even when the target is outside the acquirer's core business. 

Much like company name changes designed to pump up share prices by signalling a strategy shift to trendy businesses such as technology, the acquisitions are intended to attract interest from speculators.

“The secondary private placement has been used by company management as a way to securitise low quality assets so as to cash out. Small investors have been left holding the bag,” said Hong Hao, head of research at Bocom International in Hong Kong. 

The strategy of raising shares through listed companies to acquire unlisted ones is especially attractive in China, where the government tightly controls the flow of initial public offerings, and many companies have waited years for approval. Private placements were the preferred method because the rules allow pricing new shares below their current market value. 

Last year, 793 Shanghai and Shenzhen-listed companies raised Rmb1.8tn ($261bn) through private placements. Meanwhile, the 227 IPOs in those two exchanges were worth only Rmb150bn, according to data from Wind Information.

The latest rules state that the amount of shares issued through private placements cannot exceed 20 per cent of previously outstanding shares. Companies will not be allowed to conduct private placements if they have already completed a placement within the past 18 months. And non-financial companies that already have “rather large” cash balances or other financial asset holdings will not be allowed to place shares. 

Some 178 listed companies have disclosed private placement plans worth an estimated Rmb668bn that appear to run afoul of the first two provisions, according to an FT analysis of Wind data. 

The move to curb financial speculation fuelled by secondary share listings is in line with China’s broader focus on curbing financial risks this year. The central bank has guided money-market interest rates higher in recent months in an effort to deflate a bond bubble. 

The latest rules are also linked to the government’s medium-term goal of phasing out the approval requirements for IPOs and allowing the market to decide which companies can sell new shares, when they sell and at what price. 

The China Securities Regulatory Commission has noticeably increased the pace of IPO approvals in recent months. Analysts say that the agency intends to first reduce the IPO queue, which stands at 619 companies, before deregulating the IPO process. CSRC chairman Liu Shiyu said this month that he anticipated it would take two to three years to go through the latest IPO applicants. 

A relatively strong market has eased fears that increased IPO activity will siphon demand from existing shares. But analysts say tightening secondary offerings is in part an effort to rebalance overall equity fundraising towards IPOs while keeping overall volumes in check. 

“The scale of private placements over the past two years has been enormous, and growth has been very fast,” said Zhu Bin, tactical analyst at Southwest Securities in Shanghai. “The ‘bloodsucking’ impact on the overall capital markets has been devastating.”

* China is the most advanced digital market in the world

Digital payment penetration in China is 50 times higher than in the USA, largely still relying on plastic. FMCG online penetration has reached the mid-teens. Big-box retailing in China makes shopping malls and department stores in the USA look like the garden of Eden.

* Western luxury brands in China are still lagging behind

Only 21 of the 34 brands we have analysed operate an e-commerce mono-brand website in China. Even more remarkable is that the largest brands, such as LV, Hermès, Gucci, Prada, Ralph Lauren and Swatch, do not have an ecommerce mono-brand site. For comparison, 31 out of 32 brands surveyed operate an e-commerce mono-brand website in the USA, and 30 out of 32 in the UK. Digital proficiency in China is 46% – against 55% in our latest digital competitive map (DCM).

* Burberry, Michael Kors and Cartier are the only exceptions

Burberry stands out in China as strong leader on the Strategic Reach axis for exploiting all possible ecommerce channels as well as on the Digital Customer Experience Axis, excelling in customer service and style advisory. Michael Kors and Cartier are close behind Burberry on the Digital Customer Experience axis thanks to personal services and customer service.

European asset managers have had bond inflows double that of equities so far in 2017. Bonds have now retraced most of their outflows since the US elections in early-Nov, according to EPFR. This is despite expectations for rising yields and positive equity markets. We think this reflects both client risk aversion from uncertain macro (Brexit, Europe elections, Trump) and structural trends. Higher bond yields are attractive for institutions seeking income and liability matching, while regulation is also supportive (Solvency II). Within bonds, high yield, investment grade and EM debt are preferred to

government and other low-risk bonds. Unless interest rates rise sharply in Europe and/or the macro outlook becomes clearer for equities, we think demand for fixed income will remain resilient. This reinforces our preference for Continental EU asset managers given their relative fixed income exposure and the mix pressure on UK managers’ fee margins.

What is the upside? The bear case is compelling: challenges in “old” Danone (execution issues in Dairy, regulation in China Baby, destocking in China Water plus input cost pressure) added to challenges in “new Danone” (deteriorating topline, organisational disruption and execution issues). 

New Levers …the bear case is easy to make with challenges in “old” Danone and challenges in “new”,and feedback from investors remains consistently negative. However, we point to 3new levers: S&S, Protein,and WWAVE and ask what is the upside? Our bull case points to the most significant potential upside in our Staples universe +70% and +31% on our base case (just -15% on our bear case). 

Structural+ Strategic …The Baby (ELN) and Waters sectors remain structurally attractive in our view. Add the Protein plan to the mix, the pressure to execute, plus WWAVE, plus strategic optionality,and we see a compelling case. The stock is very close to the classic combination of trough LFL, trough EBIT, trough margins and trough multiple … 16.5x ‘18e “old”, ~14x “new” combined. 

Protein … We expect Danone to deliver peer leading LFL, margin and earnings growth FY18-20e. We estimate 3-5% LFLgrowth, with ~450bps of margin flexibility through 2017-20e for “old” Danone and even assuming low restructuring costs and modest re-investments, we expect Danone to deliver ~100bps margin improvement 2018-20e and ~40bps margin improvement in 2017e despite the input costheadwinds. …and WWAVE increasingthegrowth profile of thegroup. We believe as a standalone business, WWAVE can sustain a ~7% organic sales CAGR during 2016- 20e, with MSD-HSD growth continuing through 2020 – driven by increased penetration in core categories and accelerated growth in adjacencies (e.g. protein powder,yogurts,growing 13-14%). Although the company has generally lagged its categories in recent months, we believe these issues are largely related to correctable execution issues and/or organizational disruption associated with the announcement of the pending Danone acquisition.

TOTAL (onto CL), RD Shell (off CL) and ENI are our Buys 

- TOTAL (added to the CL) offers strong CF generation (6%-8% 2017-19E FCF yield), high growth from 2017-18 start-ups (4% production CAGR to 2020E) and an attractive portfolio of new investment opportunities. 

- ENI (Buy) is in the middle of a transformation into a higher-return business, driven by exploration success, disposals and a strong project pipeline. Management continuity will be key, in our view, to deliver this. 

- RD Shell (off CL, remains Buy) continues to focus on capital efficiency after the BG integration, with a FCF turnaround to support a 7% dividend yield. 

- Repsol (Neutral) comes off the Buy List on strong share price performance. 

- Statoil (Sell): Our 2017/18 EPS estimates are 37%/54% below Bloomberg consensus on lower oil and gas price assumptions, despite Statoil’s significant cost reduction efforts.

Switzerland’s trade surplus hit its highest ever level last month, with falls in vehicle imports and continuing stress in watch exports offset by a gain in pharmaceutical exports.

The country saw its trade surplus balloon to SFr4.73bn compared to SFr2.69bn the previous month, which the Federal Customs Office said was a new monthly peak.

Exports and imports both declined on a seasonally adjusted basis by 4 per cent and 5.3 per cent respectively compared to the previous month.

But exports rose 2.3 per cent in real terms from the same time last year, driven by a new monthly record for exports of chemical and pharmaceutical products, while imports fell 6.8 per cent on the same measure, continuing the negative trend for Swiss imports since the summer of 2016.

Watch exports were down 12.7 per cent compared to January 2016 in real terms, adjusted for working days, while chemical and pharmaceutical exports rose 7.2 per cent on the same measure and 17 per cent in nominal terms.

Vehicle imports led the overall fall in imported goods, declining 27.7 per cent in January from the same time last year.

Switzerland has struggled to climb out of deflation as the strong franc has driven down the cost of imports. But the country saw its first year on year increase in consumer prices in two years in January, figures earlier this month showed.

Last year was the worst for Swiss watch exports since 2011, according to the Federation of the Swiss Watch Industry, amid falling sales in Hong Kong.