TheChek News Flow

Last year, Paul English, a co-founder of the travel booking site Kayak--which Priceline bought for $1.8 billion in 2012--looked at his calendar. Ninety percent of his meetings and outings, he realized, were with people in tech or nonprofits. He wanted to broaden his circle. So he started driving for Uber. In his Tesla Model S. On Halloween. After hosting a costume party.

"I went out driving from midnight to 2 a.m.," English says. "People thought it was kind of hilarious that someone dressed up like a vampire was driving a Tesla."

It's a gig English still does a few hours a week in and around his hometown of Boston. "If anyone asks what I do for a living, I usually say I'm an engineer, and then I ask what they do," English says. "It's more interesting to hear about other people."

English doesn't soup up his ride with bottled water or candy. But he keeps a notebook and writes down a sentence about every rider. One of his more memorable passengers was a 13-year-old girl from China, who was visiting high schools in Boston. She hoped that attending one would make it easier to get into Massachusetts Institute of Technology--where English is a part-time instructor at the business school. He mentioned that to her.

"She kind of didn't believe me," he says. "She said, 'Why are you driving a car if you teach at MIT?' I told her I have many lives."

Ubering has helped English understand how service-economy professionals are rated. His newest startup, Lola, which has raised $19.7 million and, as of this writing, is nearing its launch, will have travel agents create itineraries for consumers, who will rate their experience from one to five. At presstime, English's Uber rating was a sterling 4.97. "Being a competitive person," English says, "I wonder: Who didn't give me five stars? What did I do wrong?"

Which is exactly why he set up Lola that way. "I want my agents to be competitive," he says. "Having ratings allows you to say, 'I want to get better.' "

English has a new hobby in mind. "There's a bar right next to my office. We've talked about my helping out behind the bar on Mondays as a bar back," he muses. "It would be a cool way to get to know new people." And he could be blessedly free of worrying about his rating while he does it.

- Equities: $1.5bn inflows (first inflows in 8 weeks) (note divergence between $6.4bn ETF inflows & $4.9bn mutual fund outflows)

- Bonds: $2.9bn inflows (inflows in 13 of past 14 weeks)

- Precious metals: $0.5bn inflows (inflows in 19 of past 21 weeks)

- Money-markets: $8.4bn outflows (largest in 6 weeks)

- Japan: $0.2bn inflows (inflows in 3 of past 4 weeks)

- EM: $0.3bn inflows (first inflows in 5 weeks)

- Europe: 17 straight weeks of outflows ($0.7bn – but this is smallest outflows in 14 weeks)

- US: $1.2bn inflows (first inflows in 5 weeks)

- By sector, REITs see inflows in 14 of past 15 weeks ($0.6bn); financials see largest inflows in 6 months ($0.6bn); first inflows to tech in 7 weeks ($0.1bn)

- $1.0bn outflows from Govt/Tsy funds (outflows in 14 of past 15 weeks)

- 5 straight weeks of outflows from HY bond funds (albeit a modest $0.7bn)

- $2.7bn inflows to IG bond funds (13 straight weeks)

- Inflows to EM debt funds in 13 of past 15 weeks ($0.2bn)

- 37 straight weeks of inflows to Munis ($0.8bn)

- Largest inflows to bank loan funds in 12 weeks ($0.4bn)

- Inflows to TIPS funds in 15 of past 16 weeks (albeit small $47mn)

9 times out of 10 when we start playing around with the Banks sector we end up regretting it. It’s a

bit like poison ivy – it starts to irritate at the first touch. So it is not without much consideration and

soul searching that we upgrade the sector. The fundamentals may not be convincing, but we cite

two motivations – portfolio construction and valuation.

We are wholly suspicious of the rally in commodity stocks and industrial cyclicals. Compared to ytd

performance in these areas, the Banks sector looks increasingly like an outlier – no optimistic take

on prospects here. A UK ‘remain’ vote on the 23rd could provide the catalyst, and with the ECB

supporting the European credit market, domestic risk looks preferable to global. Further, with the

Fed apparently about to hike again, just maybe the worst of the yield curve flattening is done.

The Banks now trade on a 2016E book value multiple equivalent to 41% of the market (IBES), for a

2016E ROE of 60% of market, rising to 65% in 2018E (IBES). The sector already offers a 40%

dividend premium, and medium term there is a potentially helpful debate around the sector’s costof-

equity. The operating environment is difficult and regulation a major source of uncertainty, but

unlike many parts of the market, investors are arguably incentivised to take a little risk here.

We cut Media back to Neutral to fund this upgrade to Banks. We think Telecom offers a better play

on the European consumer, while the declining cash flow appeal of Media erodes one longstanding

support for the sector. Given the cyclicality in advertising spend, the Agencies look

exposed to downside risk given fading momentum in lead indicators, such as the Global PMI.

* The GRDI has just broken through 2SD for the first time in over a year which, over the last 5Y, has suggested down

markets over the following 1M and 3M. While sentiment indicators are providing mixed messages at present, one that is very elevated is our FX strategists’ Global Risk Demand Index, which moved above 2 standard deviations for the first time in over a year. As the chart below illustrates, over the last five years, the GRDI rising above +2SD has typically signalled down markets over the following 1M and 3M. When the GRDI has been above 2 standard deviations in the last five years, European equities have on average fallen 0.5% over both the following 1M and the following 3M.

* The divergence between the GRDI and the USD in the last month has been surprising. For much of the last few years, it has seemed that FX markets have had an unprecedented influence on risk appetite. As illustrated below there has been a tight correlation between the GRDI and the trade-weighted USD in recent years. While stronger US macro data in recent weeks may help explain the divergence, one of the most surprising elements of the risk rally in recent weeks has been the fact that it has occurred despite the USD strengthening by over 2% in the last month.

"Real signs" of positive change in Civil Aerospace; still a bit early for us to turn Overweight

On June 2 we visited RR’s main Civil Aero (CA) facilities in Derby, UK. We came away with a much more positive impression than we did on our last visit (Sept 2013), when we wrote that “we were somewhat underwhelmed by the

sense of urgency [on cost reduction] in the CA division.” Clearly a lot has happened since then (5 group-level profit warnings, new group CEO, new group CFO, new head of CA). On this trip we met Mike Mosley, head of CA’s global operations, who was clear that RR is no longer in denial about the need for change, and that the process is underway. We remain Neutral rated on the shares given significant near-term headwinds across the group and a full valuation (on 2016-18E earnings). However, given RR’s current low earnings, any cost savings beat would have a fairly large impact on EPS estimates.

* “Real signs” of positive change: In mid-2011 then (new) CEO John

Rishton announced his intentions to cut RR’s costs and improve its cash

generation. So when we visited Derby in Sept 2013 we were very

disappointed to see little evidence of cultural change and a total lack of

posters and “visual management displays”. This may sound rather simplistic

but any investor who has visited a factory engaged in six-sigma / lean

manufacturing / kaizen etc. will be familiar with the “call to action”

motivation posted and, more importantly, the prominent visual displays

showing key metrics like scrap rates / overdue work / stock turns etc. The

good news is that Derby today has plenty of these posters (some examples

overleaf) and visual management displays (unsurprisingly we weren’t

allowed to take photos of these). We came away with the impression that

“Derby now gets it”, perhaps unsurprisingly after a slew of profit warnings.

* Better ‘line of sight’ over the business: Mr Mosley said the CA business

had robust data on the cost of products, but in the past a lot of this data was

in different silos. Today this data is being shared and RR feels that for the

first time it has ‘line of sight’ across the whole CA enterprise.

* Delayering of management: Recent management redundancies mean there

are now typically 7-8 layers between the CEO and shop floor, compared to

9-11 layers.

* More outsourcing, and more to low cost countries: For many years RR

has produced c30% of its engine parts and outsourced 70%. It is now

moving to 20%-80%. (We believe that RR could achieve this by the end of

this decade although it hasn’t given a formal target.) In addition, it is finding

new suppliers in low cost countries.

* “Pulse lines” for engine assembly: Volumes in the CA industry are

relatively low (c1,500 large aircraft pa) which means fully automated flow

production lines are not really suited to CA. However, RR is now

assembling engines on “pulse lines”, a hybrid solution where some work is

done in a stationary cell and then moved on the next station. On our last

visit, some RR engines were some being assembled on wooden pallets.

14% at M&S. However, over the last 10 years the market share held by value

retailers has grown by over 500bps and online penetration has increased by

c.15% points. This time around M&S is operating in a significantly more

competitive environment, and reducing prices by only 2%. Volume uplifts are

therefore likely to be materially lower than in the past. We reduce our FY17

PBT forecast by 14% and our FY18 & FY19 forecasts by >20% implying flat

PBT growth in these later years. We apply a 30% discount to the FY18 sector

average PE to arrive at our new TP of 307p. With a further 14% downside

implied, we reduce our recommendation to UW.

 Deflation rate in the clothing market is -6%, but we expect the average

selling price at M&S to fall by only 2%. Although M&S is lowering

headline prices, we expect this to be materially offset by reduced markdown

activity. Overall therefore we expect an average achieved selling price

reduction of only c.2% in Clothing, versus deflation in the Clothing market

of -6% in the last year. We note that in FY07 Clothing market deflation was

-4% versus price reductions at M&S of c.6%.

 Gross margin story has run its course. The moving parts in the M&S

Clothing & Home gross margin where we have some visibility, and can

therefore attempt to estimate, would imply a FY17 gross margin decline of -

20bps. This implies a gap of at least 70bps that M&S must bridge to reach

guidance of +50-100bps (JPMe +50bps). We therefore believe that the risk

to this range lies to the downside.

 Cautious on the Food outlook. We forecast a flat FY17 Food gross

margin. But with ongoing pressure in the market and some signs of LFL

weakness, we believe the risk to the Food gross margin lies to the downside.

 Reduce TP to 307p. The shares have fallen 34% since November 2015.

However, based on FY18E EPS, where we now assume only flat PBT

following a decline of 10% in FY17E, the stock is trading at a discount to

the sector of 18%, versus a 4-year historic average of 22%. As recently as

January M&S was trading at a discount of 30%. We apply a 30% discount/

FY18 PE multiple of 10.0x to arrive at our new, Mar-17 TP of 307p.

May sales in Core Europe +6.9% YoY (adj): Growth decelerated to the slowest pace since October after adjusting for selling day effects (+19.1% growth on reported basis). Growth fell from the +9.1% (adj) pace recorded in April and reduces year-to-date growth to +9.3%. All four countries in Core Europe slowed from April, with Germany weighing in particular, and recording its slowest growth for nearly two years. The prior-year Core Europe comparative was a relatively challenging +9.2%. Renault sales rose strongly in May by +22.8% after a disappointing April, to lead growth in the European OEMs.

Amadeus gave upbeat messages at its CMD for both Distribution and PSS (Altea/ Navitaire), and while its

€1bn 2022 revenue target for the New Business Units (NBUs) is unchanged since its last CMD in 2013,

we feel it has demonstrated clear progress in Airport IT and Hospitality (albeit much of the latter has

been acquired). We are less convinced on Payments, BI and Rail IT. However, the positive messaging

around incremental revenue opportunities in both Distribution was somewhat undermined by a 2015-

2018E 3-6% CAGR growth target, while a target for IT Solutions of 10-20%pa growth also looks

prudent given Navitaire alone in 2016 brings around 17 points of growth. 2018 cons. of €4,931m sales

and €1,845m EBITDA each represent an 8% CAGR: in-line with the aggregate 2018 goal for a "high

single-digit CAGR" in both.

Mgt framed its 2018 opportunity at €10bn in Distribution, €8bn in Airline IT and €12bn in the NBUs (up

from €10bn in 2013), albeit with Payments ballooning to a €2.3bn opportunity from €0.3bn. The core

Hotel IT opportunity is estimated at €3.5bn (little changed from 2013's €3.0bn). Here, IHG is on track to

start migrating hotels over to Amadeus' Guest Reservation System in 2017. The NBUs in total currently

generate €300m sales at a 33% contribution rate (implying a strong 76% for the rest of IT Solutions).

We estimate past hotel acquisitions account for perhaps half of the revenue run-rate, while expect

Airport IT makes up much of the rest. Mgt is targeting €400-600m sales in 2018 at a 40% contribution

margin and €1bn at 40-60% in 2022.

Amadeus expects to generate €1bn of excess cash by the end of 2018 assuming a 1.25x 2018 leverage

ratio (target 1.0-1.5x). Mgt wouldn't be drawn on whether acquisitions or buybacks were more likely,

but this clearly leaves it with optionality.

The CMD showcased the strength of Amadeus' mgt team and the breadth of its opportunities. However,

y'day marked the anniversary of Lufthansa's announcement of Lufthansa's GDS surcharge. With no sign

of them changing track and ongoing pressure by airlines to "own the customer" more, we see today's

valuation as full enough.