Gapping up
Earnings/guidance: JBL +10.3%, ADBE +1.3%.
M&A: TSL +5.2% (shareholders approve 'going-private' transaction).
Drybulk/shipping stocks seeing momentum: TOPS +25.0%, CANF +19.2%, ESEA +17.6%, DCIX +13.4%, EGLE +13.0% (light volume; Oaktree Capital Management & Goldentree Asset Management filed amended 13D's), GSL +7.1%, DRYS +6.9%.
Gold/silver names higher as weaker dollar boosts precious metals: SA +2.4%, IAG +2.8%, AG +2.5%, AUY +2.3%, EGO +2.2%, GDX +1.6%, Select Russian stocks higher: MTL +4.6%, QIWI +3.2%, YNDX +2.1%, ABX +1.6%.
Other news: EVOK +38% (receives positive NDA submission guidance from us FDA for Gimoti), IONS +4.7% (earns $28 million from AstraZeneca (AZN) following AstraZeneca's completion of IND-supporting studies and license of IONIS-KRAS-2.5Rx), NOK +4.0% (still checking), MPEL +2.3% (issues update in relation to major initiatives to enhance shareholder value) SHPG +2.2% (still checking), QGEN +2.1% (still checking), CLLS +2.1% (announces recombinant DNA Advisory Committee's unanimous approval of UCART123 Phase 1 study protocols in AML and BPDCN; will host a conference call in the next coming days), MYL +1.6% (launches authorized generic for EpiPen).
Analyst actions: TXMD +9.2% (initiated with Overweight ratings at Cantor Fitzgerald), MGM +2.7% ( initiated with a Buy at Goldman), SQ +1.2% (initiated with a Buy at Needham; tgt $17), ERIC +1.7% (upgraded to Buy from Neutral at BofA/Merrill).
Early pre-market gappersGapping up: EVOK +46.5%, TOPS +25.0%, CANF +19.2%, ESEA +17.6%, DCIX +13.4%, TXMD +9.2%, JBL +9.0%, GSL +7.1%, DRYS +6.9%, TSL +5.2%, IONS +4.7%, MTL +4.6%, SDRL +4.5%, NOK +4.0%, ONVO +3.8%, SA +2.4%, QIWI +3.2%, IAG +2.8%, MGM +2.7%, AG +2.5%, AUY +2.3%, MPEL +2.3%, EGO +2.2%, SHPG +2.2%, QGEN +2.1%, YNDX +2.1%, CLLS +2.1%, HL +2.0%, CHK +1.7%, ERIC +1.7%, GDX +1.6%, DB +1.6%, VOD +1.6%, ABX +1.6%, MYL +1.6%, ADBE +1.3%, AMD +1.3%, ASML +1.2%, MDLZ +1.2%, SQ +1.2%, SAN +1.2%, PYPL +1.2%, AZN +1.1%.
Gapping down: ANTH -10.6%, VCEL -10.0%, FNSR -7.1%, HON -6.2%, WTW -3.6%, JWN -3.1%, UBSI -3.0%, ORCL -2.4%, GILD -1.5%, ANET -1.4%, SNY -1.1%.
“BREXIT is so fascinating!” exclaims a French official. Few Europeans wanted Britain to quit the European Union. But now that it is happening, foreign ministries and policy units across the EU are relishing the task ahead. As an intellectual exercise, managing the multifaceted complexities of Britain’s departure from the EU offers the kind of satisfaction rarely found in policy work. As a historic negotiation without precedent—no country has left the EU before, let alone one of Britain’s size and stature—it is a wonderful CV-builder. In Brussels, where the talks will take place, officials are scrambling to involve themselves with what one calls “the sexiest file in town”.
The preparations for Brexit on either side of the English Channel offer a Homeric parable of chaos and order. In Britain Theresa May, the prime minister, exudes swanlike calm, restricting her utterances on Brexit to warm banalities. But below the surface her government is paddling furiously to avoid being submerged by the awesome bureaucratic task bequeathed to it by Britain’s voters. One leaked note from a consultancy portrays a flailing government that needs up to 30,000 more civil servants to manage Brexit. Mrs May says she will notify the EU of Britain’s intention to leave under Article 50 of the EU treaty by the end of March 2017. That leaves barely three months to settle basic questions such as whether Britain should aim to stay in the EU’s customs union.
The contrast with the EU’s institutions, and the larger capitals, is striking. The 27 remaining EU countries quickly established a common line towards Britain on matters like the indivisibility of the EU’s single market. At a summit on December 15th, as The Economist went to press, they were due to issue a formal declaration outlining the format for the talks to come. The Brussels institutions have largely established their respective roles, bar a wobble from the European Parliament, and now spend their days in quasi-academic contemplation of trade models or security co-operation protocols as they wait for the games to begin. Officials everywhere insist that their priority will be preserving the interests of the EU, not keeping Britain happy. “This is a negotiation where we have to defend Europe, not undo it,” says Guy Verhofstadt, the European Parliament’s Brexit point-man.
European officials have refused to engage with Britain until Mrs May triggers Article 50. But they observe goggle-eyed the spectacle unfolding across the Channel. Some British ministers appear to believe that the entire relationship can be recast, rather than merely the divorce settlement finalised, in the two-year period Article 50 allows. European negotiators who think it is essential to act as one are staggered to hear some ministers cling to the delusion that Germany’s need to sell cars to British motorists will ensure that Mrs May secures a good deal.
Gloom is thus descending on the European side. The EU will probably insist on settling the terms of Britain’s withdrawal before discussing future arrangements, and each is ripe for the fiercest of rows. Top of the list is the departure bill that the European Commission, which will lead the talks on behalf of the EU, will place before Britain. The commission puts the sum at up to €60bn ($64bn), roughly equivalent to three-quarters of Britain’s projected budget deficit for 2016-17. Brexiteer diehards, and their allies in the pit-bull press, will transfer their fury from the domestic “Remoaners” they accuse of holding up Brexit to perfidious Europeans making outrageous demands. One EU official puts the chances of Britain walking out of the talks next year at 50%.
Even if catastrophe can be averted, the negotiations will offer endless opportunities for rancour. Take the question of what to do with the 2.8m EU citizens living in Britain and the 1.2m Britons in the rest of the EU. At first blush it seems simple: both sides agree to guarantee the ongoing rights of citizens who arrived before a given date—perhaps the notification of Article 50. Indeed, Mrs May has sought to strike such a deal before beginning the formal withdrawal talks (concerned that she was seeking to play divide-and-rule, her European counterparts rebuffed her).
But closer inspection reveals a never-ending string of complexities. Do governments have the administrative wherewithal to process applications for permanent residence? Will the children of EU citizens have the right to cheap university tuition? What about accrued pensions or other benefits? None of these questions is intractable. But each requires detailed negotiations and technical work. The same goes for other matters to be tackled in the withdrawal talks, from the pensions of British Eurocrats to the management of safety at Britain’s nuclear plants. Untangling a 43-year-old relationship, it turns out, is devilishly complicated.
Triumph of the won’t?
This in turn explains why concluding a separation deal within two years will not be easy. (In fact the months needed for procedural matters and ratification will cut the negotiation time to around 15 months.) The scale of the task, and the economic thump many Europeans think is heading Britain’s way—inflation, diverted investment and swooning public finances—mean some still harbour a hope Brexit may be averted. But that misreads the British mood. If things turn sour the blame will be heaped not on Brexit, but on the obstructionist EU.
The ingredients for Brexit—a departing country confused about its leverage, a club distracted by other problems and determined to avoid more fractures, a procedure without precedent, a tight deadline—make a combustible mix. Yet both sides should feel the historic weight of these talks. Although Britain will be the first victim if things go wrong, a club assailed by crisis on all sides knows it cannot afford to oversee a Brexit debacle, however fascinating the exercise. For the EU, at least, that means placing hope in a British government that it fears may not warrant it. “From a rational point of view, we can’t fail,” says an official in Brussels. “But I’m not sure the rationality is there in the UK.”
Airbus Delays Delivery of Long-Range A330neo
It is the latest in a string of setbacks which have hit the world’s second-largest airplane maker after Boeing
Airbus Group SE has delayed delivery plans for one of its newest long-range planes, adding to pressure on the European plane maker to meet commitments to airline customers.
TAP Portugal Chief Executive Fernando Pinto on Friday told The Wall Street Journal the carrier’s first A330neo plane wouldn't arrive until March 2018. Airbus had initially promised the plane would be delivered around the end of next year.
Airbus is upgrading its A330 widebody with engines made exclusively by Rolls-Royce Holdings PLC. The enhancement, called the A330neo for new engine option, promises greater fuel efficiency and range. Airbus declined to comment.
For Toulouse, France-based Airbus, it is the latest in a string of setbacks which have hit the world’s second-largest airplane maker after Boeing Co.
Airbus is struggling to meet a target to deliver more than 670 planes this year. The company has to deliver at least a record 94 planes this month to achieve that promise to shareholders. Plane deliveries are crucial to Airbus’s cash flow.
Airliners have been slow to go out the door at Airbus because of supplier problems. Pratt & Whitney, the engine unit of United Technologies Corp., has fallen behind in building engines for some Airbus A320 single-aisle aircraft. Airbus has had some of the planes it had already built stuck on the ramp awaiting engines.
United Technologies Chief Executive officer Gregory J. Hayes this week told investors the company was making progress in catching up with building engines, but the job wasn’t done. “There is still a handful of parts out there that we’re chasing,” he said.
Delays in obtaining plane seats and toilet doors also have set back delivery of A350 long-range planes. Airbus promised to hand over at least 50 of those this year. It had delivered only 34 in the first 11 months of the year.
The plane maker this year also said development of its largest twin-engine long-range plane, the A350-1000, had fallen behind plan. The plane, which first flew in November, won't be delivered until the second half of next year. Airbus previously had forecast a mid-2017 handover to the aircraft’s first planned operator, Qatar Airways.
Airbus has sold 186 A330neo planes. TAP has ordered 14 of them. Mr. Pinto said the airline also planned to lease 6 more of the planes.
Ofgem suspects UK energy groups of manipulating wholesale prices
Concerns that companies are providing false information about generating capacity
Electricity generating companies have been threatened with fines and criminal prosecution if they are caught trying to manipulate the wholesale energy market after suspicious activities were reported to the industry regulator.
The warning relates to concerns that UK power companies could be trying to artificially inflate the selling price of their electricity by providing false information about the generating capacity they have available.
In a letter to companies this week, seen by the Financial Times, Ofgem said concerns had “been raised with us in respect of certain behaviours that may be taking place in the market”.
These concerns related to the accuracy of notifications that companies are required to make to National Grid, the system operator, and the rest of the market about available capacity and planned output.
Companies could potentially game the system by under-reporting their intended generation on a particular day to lower the market’s expectations for supply. This would push up prices, to the benefit of the company when it subsequently delivered more electricity than anticipated.
The potential rewards for such manipulation are heightened during the winter months, when energy demand is at its highest and special payments are available from National Grid to secure extra capacity when supplies run low.
Prices have risen as high as £1,500 per megawatt hour at peak times in recent weeks, compared with average wholesale prices below £50 for much of the year. One operator was paid as much as £2,500 per MWh during a supply crunch last year.
Spikes of this kind can greatly increase the profits of power generators and cause big gains or losses among energy traders; ultimately higher wholesale prices feed through to the bills paid by households and businesses.
People familiar with Ofgem’s thinking said the letter was intended as a “shot across the bows” of the industry, with the threat of a formal investigation if further signs of market abuse arise.
“Ofgem takes its responsibilities with respect to market conduct very seriously and monitors the market to probe potential breaches,” the letter said, highlighting the regulator’s power to “publicly censure, place unlimited financial penalties or institute criminal prosecutions”.
It marks the second time in just over a year that Ofgem has written such a letter. Whereas the previous warning in September 2015 covered a range of potential abuses, including manipulation by traders, this week’s is focused specifically on information disclosure by power generators.
Electricity markets have been especially volatile in recent weeks because of the temporary shutdown of several French nuclear reactors for safety checks and damage to power cables beneath the English channel — both of which have disrupted the flow of electricity from the continent which usually supplements domestic generating capacity.
Ofgem’s letter promises to further intensify political scrutiny of the power industry, which has also come under attack over its conduct in the retail market.
Ofgem this week launched a league table to name and shame suppliers with the highest proportion of consumers on expensive standard tariffs, less than a month after Philip Hammond, chancellor, said the government would “look carefully” at whether the retail market was “functioning fairly”.
Why Russia will stick to its pledge to cut oil
The Russian oil industry has the motivation and the ability to meet its pledge to lower production
Russia and other unaligned producers agreed earlier this month to join OPEC in cutting oil output, saying they would reduce supplies by 558,000 barrels per day. On top of Opec’s pledge to cut 1.2m b/d the path to a rebalanced oil market much is now clearer.
Oil prices have climbed from $48 per barrel in late November to $55 this week. At this point, commodity and equity markets are, however, beginning to ponder whether these pledged cuts will be realised.
This is not surprising given OPEC’s patchy record adhering to quotas and the participation of Russia and other non member countries. Some question how serious Russia might be about following through on its own 300,000 b/d commitment, while others wonder if Moscow even has the legal or technical ability to deliver those pledged cuts.
For our part, we think Russia is highly motivated to follow through with its proffered cut for two reasons.
First, Russia reportedly played a key role in both deals, with President Putin personally acting as a deal-maker between Iran and Saudi Arabia to bring the original OPEC deal and then committing Russia to a 300,000 b/d reduction to catalyse non-OPEC participation.
As such, the Russian government, including President Putin himself, have made a substantial reputational commitment to making the deal work. In that light, it is not surprising that the Kremlin has already begun detailing specific country-wide targets of 200,000 b/d of reductions for the first quarter of next year and an additional 100,000 by mid-year, signalling to oil markets its seriousness.
Second, the maths of higher prices versus lower production provides significant stimulus for the Russian government. This is based on the fact that oil taxation has traditionally provided almost half of the country’s tax revenue and because the Russian oil tax regime is highly geared to the price of oil.
For example, extraction taxes and export duties combined go up $8.3 per barrel for every $10 rise in oil prices. The net effect of a 300,000 b/d output cut and a $10 oil price increase would be a 28 per cent increase in oil tax revenues in US dollar terms, and 15 per cent in local currency terms, giving a material boost to the government’s efforts to balance its budget.
As for Russia’s ability to cut output and questions about the Kremlin’s legal authority to dictate production levels, while the government may lack formal control over output, it has substantial informal influence over the industry. We think Russia’s oil producers will be willing to work with the government to meet the production cuts.
Indeed, we think the first step in reducing output will likely involve the government asking producers for voluntary cuts.
Why would producers voluntarily reduce output? We think most Russian oil companies have at least some older fields that are at best marginally profitable, with economic rents predominantly going to the government as taxation: One large Russian oil company estimated in March that ‘over 30 per cent’ of its producing fields were uneconomic. While this could partly be due to the low oil prices at the time, it also lends credence to our suspicion that there may be a material amount of Russian production that remains on-line to generate tax revenues for the government than profit for the producing company.
Additional cuts could come from slowing brownfield drilling, a delayed but potentially powerful method of adjusting production. To illustrate, consider that a 15 per cent decline rate on 11.2m b/d of production implies Russian oil companies have to bring on 140,000 b/d of new production each and every month just to maintain current output levels. This calculation roughly fits the observed numbers in Lukoil’s West Siberian fields, where the company cut drilling by 40 per cent in early 2015 and quickly saw 8-9 per cent year-on-year production declines emerge, which didn’t stop until drilling was ramped back up this past summer.
Applying that 8 per cent decline rate to total Russian production would imply about 5 months needed to meet the entire 300,000 b/d production cut target. However, we would expect Russia to be a bit wary about encouraging that large of a drilling cut, as there would be undesirable knock-on effects on employment and economic activity until the production target was hit and the rigs put back in the field to stabilise production.
The Flows
Great Rotation: huge weekly equity inflows ($21bn = 9th largest ever), bond outflows ($4.4bn = 7th consecutive week), cash outflows ($11bn), gold outflows ($0.7bn).
Melt up: $63bn inflow to equities since election vs. $151bn outflows Jan-Oct.
Rally starts: The rally started in Feb. 2016 with a. bearish Positioning (BofAML Bull & Bear indicator = 0, cash = 5.6%, UW’s in EM & energy >2SDs), b. bearish Profits (PMI’s crashing toward 45, global EPS negative), c. Policy impotence (“Quantitative Failure”).
Rally ends: The rally ends (correction likely Feb-April’2017) with a. bullish Positioning (BB index = 8, cash around 4%, OW’s in stocks, Japan & banks >2SDs), b. bullish Profits (global PMI’s >55, US wage growth >3%), c. Policy hawkishness (Fed/macro jacks up short end of yield curve).
* Asset Class Flows
Equities: $20.7bn inflows (9th largest week on record; note $31bn ETF inflows vs $10bn outflows from mutual funds) Bonds: $4.4bn outflows (7 straight weeks = longest streak in 3 years)
Precious metals: $0.7bn outflows (5 straight weeks)
* Equity Flows
- EM: $1bn inflows (largest in 7 weeks)
- Europe: $0.7bn inflows (only 8th week of inflows YTD)
- Japan: modest $0.7bn inflows
- US: $18.5bn inflows
By sector: 12 straight weeks of financials inflows ($0.6bn), 6 straight weeks of REITs outflows ($1.2bn)
* Fixed Income Flows
- Inflows to TIPS 25 of past 27 weeks ($0.3bn)
- 6 straight weeks of outflows from EM debt funds ($1.2bn)
- 5 straight weeks of inflows to bank loan funds ($1.5bn)
- Largest inflows to HY bond funds in 9 months ($4.7bn)
- Largest outflows from IG bond funds in 21 weeks ($4.7bn)
- 7 straight weeks of outflows from muni bond funds ($2bn)
- Moderate outflows from Govt/Tsy funds ($1.9bn)
Europe 2017: All Alone at the Orphanage
The bottom line is that Europe is cheap, the corporate sector in most cases is running free cashflow while investor sentiment is bearish. A change in the inflation temperature might be the first catalyst to reignite investor appetite. By a process of elimination the European equities score well on valuation although earnings assumptions look a little rich. One lesson learnt from the recent sell-off in US treasuries was the fact that low PE and PB stocks fared very well.
Telcos underperformed the market by a very disappointing 15ppts in 2016. Positive themes for 2017 remain better top-line growth, cost cutting, operating leverage, valuation and dividends. We retain our Attractive industry view
Why did thesector underperform?Failed M&A (UK,France), regulation (BT Openreach, Enel fibre, Iliad Italy) and sector rotation (into cyclicals, Exhibit 3) drove underperformance (Exhibit 1). This was very disappointing, when considering better qtly results (Exhibit 43), EBITDA and DPS growth.
Four reasons why weexpect better performancein 2017.
1) Better revenue trends in fixed-line.
2) European mobile has finally turned positive (YoY growth).
3) Cost-cutting & operating leverage.
4) Compelling Euro Telco valuation and dividends. M&A could also re-surface as a theme (France, cable/mobile?). Cyclicals have outperformed defensive equities by 20ppts (YTD, Exhibit 3).
• Stocks for 2017. In this outlook report, we focus on identifying drivers in stocks that are independent of the macro environment to pick potential winners for 2017. This isn’t to dismiss the relevance of macro considerations and indeed what will be a likely year of ongoing political risks. In their recent 2017 Outlook, our Global Equity Strategists set out in detail how such factors will influence the investment backdrop. However, the inherent volatility and uncertainty that is likely to prevail and what, excluding commodities, remains a world of midsingle-digit EPS growth, still suggests the ability of companies to generate returns through their own efforts remains key.
• We look for companies where a potential story of “change” in 2017 exists at the company to drive returns and in that regard reprise the theme of our 2016 stock picking report, 16 for 2016. This might be driven by M&A, a business portfolio shift, new management/strategy or a structural change in the dynamics of the market for a given company. In the investment summaries detailed by our analysts, we have highlighted where potential surprises in terms of catalysts lie on the 2017 calendar. Alongside our analysts’ assessments, our HOLT team have provided their valuation and style perspectives.
• We include 16 stocks rated Outperform, 2 stocks rated Neutral and 2 stocks rated Underperform. The inclusion of Neutrals reflects where a transformational change may not be a central scenario but flags a potential credible development that would represent a material shift and move the needle should it happen. In Outperforms, where the story may already be tangible, we highlight names where our analysts believe it is not fully appreciated by the market. Finally, for our Underperform names, we flag potentially significant changes that, though perhaps less likely, would reverse hitherto negative sentiment.
• Our surprise packages. The prevailing Outperforms in our stock list are Bankia, BAT, Danske Bank, Diageo, DONG Energy, DSM, Enel, G4S, IAG, IHG, LSE, Petrofac, Philips, Royal Dutch Shell, RPC Group and Zurich Insurance. Neutrals are Anglo American and H&M, and the ‘wild cards’ amongst our Underperforms are AstraZeneca and Burberry. For those who look back to our 2016 edition, they will find that 10 out of the 16 stocks outperformed their local index, suggesting that even in what seemed a very macro driven world, bottom-up drivers still mattered.