As I somberly transition back to markets, it has felt that investors would love nothing more than to watch global indices move sideways to downwards in hopes of regaining some of the relative outperformance which they’ve seen quickly evaporate over the last few weeks. This week, markets obliged and gave back last week’s gains and more as the euphoria from the recently strong NFP number faded away, geopolitical concerns arose, and growth once again showed signs of being on shakier ground. With the ever lurking sense of apprehension creeping back into markets, my sense from speaking to investors is that while a level of cautiousness is being maintained, many are also fearful of missing out on any potential year-end rally, as most have maintained historically elevated gross exposure. Furthermore, as prudence is being practiced, so is conviction, especially on the short side as the recent the waves of disruption seen across media, industrials, and retail this earnings season have only added fuel to the short fire. Clearly, the investible opportunity set remains abundant but unfortunately, the time left in 2015 does not.
With the markets now widely expecting the Fed to lift off of zero at its December meeting, the market’s attention has shifted to the pace of hikes in 2016. Interestingly, our Market Implied Pace of Rate Hikes Indicator (MSP0KE Index) has seen a meaningful rise in just the past few weeks with the index moving from a low of 2.017 in mid-October to its current level of 2.686. While this is a big move in a short time, it is worth emphasizing that this level still implies a relatively gradual lift off of 3 hikes or less in 2016 seemingly in-line with the Fed’s guidance and more importantly appropriate for the muted growth outlook both in the US and abroad. History is ultimately a good guide to the future and despite none of the prior four tightening cycles exactly mirror current economic and financial conditions, it is worth highlighting the similarities to 2004; forward P/E ratios then sat at 16.4x versus 16.7x today and both rate hikes (should December occur) were very well telegraphed. With 2004 in mind, our U.S. Equity Strategist Adam Parker has done a significant amount of work around what has worked and what has not in an environment of rising rates and a flattening yield curve. While pharmaceuticals, staples, telecom, and utilities all unsurprisingly tend to underperform when yields are rising, one very interesting observation is that financials, specifically banks and insurance companies, actually have a negative sensitivity and tend to underperform as well. Conversely, energy and materials have historically performed well, with technology, high beta, and junk not far behind. Based on this analysis, if one where to expect that the Fed will remain ahead of inflation and tighten in an orderly manner, having conviction should once again prove to be pivotal as picking either direction of risk (growth or value, cyclical or defensive) appears better than trying for a “safe” combination in the middle.
As with many factors in today’s global economy, a US Fed hike will have rippling implications across the globe. Our EU Equity Strategist Graham Secker points out that as with the US, cyclicals outperform around the start of a Fed hiking cycle – with commodities, media, capital goods, retailing, software & services and transportation among the most consistent outperformers. The worst performing have been a mix of Financials and Defensives including Banks (have never previously outperformed around the first hike). While MSCI Europe has tended to rise around 1st Fed hikes (median rally of 9.5%) it is important to note that these rallies have generally been led by an increase in EPS that was slightly offset by a small decline in P/E multiples. In a slow growth environment where Europe lags the US, there is reason to question if history will repeat here. Nevertheless, the opportunity set remains key and several companies with already compelling investment cases which could also benefit from a hike include Akzo Nobel (AKZA NA), Norsk Hydro (NHY NO), Capgemini (CAP FP), Assa Abloy (ASSAB SS), Technip (TEC FP), Total (FP FP), ITV (ITV LN), and RELX (REL LN). In LatAm, things appear more mixed as our LatAm Equity Strategist Gui Paiva notes there are two primary avenues through which hikes affect LatAm. Firstly, an indirect signaling effect of better growth prospects for the global economy and also a direct increase in the weighted average cost of capital. Of the universe of investible stocks, Embraer (ERJ), Cemex (CX), and Suzano (SUZB5 BZ) are among the list of stocks which should positively react to the start of a Fed tightening cycle. For more around the Fed Liftoff, please ask to see our global work.
Earnings season in the US is now winding now and after seeing major shockwaves to the several sectors driven by disruptive technologies and business models which are changing where are how revenues are generated. While Industrials and Media previously suffered big hit, it was retails time to play the role of punching bag as it. Through the week, our MS baskets best reflected the pain as MS Consumer Discretionary (MSXXRTL) and MS Brick & Mortar (MSXXBRMR) both slumped around 7% (vs. the SPX down 2.5%). Macy’s (M) was the first to sound the alarm after sales missed on slowing tourism spending, warm weather, and less robust center core growth. As if that was not enough, inventories were at highest level in company history, suggesting a potential race to the bottom on price for the Holidays and less orders for apparel companies. Nordstrom (JWN) followed shortly adding to broader concerns for the space given sluggish traffic trends and weakness across all concepts and categories. J.C. Penney (JCP) got punished for the guidance suggesting a 4Q slowdown, despite better than expected comps earlier in the week. The only exception from the rule came from Kohl’s (KSS), where expectations were too low to be missed again, and the company reporting better than expected comps. However, this feels more like a swan song, or as MS Specialty Apparel & Department Store analyst Kimberly Greenberger calls it, a ‘great stretch’ as their beat rests on a meaningful comp acceleration on a much tougher compare amidst greater industry headwinds. On the basis that lower oil and cheaper costs of debt should be putting more money in the hands of consumers, with the sun setting on a disappointing earnings season for many of the consumer discretionary stocks, investors seem to be asking one question…where has all the spending gone?
Jerry McGuire said it best, “Show me the Money”. For those looking to follow it, recent industry data suggests that spending on experiences versus things may be the dominating trend (see chart below) as home improvement, hotels, and leisure, and personal care have all seen much stronger growth compared to electronics, clothing, and appliances. There are clear winners here if the trend persists, including Nike (NKE), Under Armour (UA), Lululemon (LULU), Ulta Salon (ULTA), Sally Beauty (SBH), and Estee Lauder (EL) in the personal care and activewear segments as well as home improvement companies Home Depot (HD), Loews (LOW), and Williams-Sonoma (WSM). The Leisure industry, against much skepticism also appears to be on stronger footing as highlighted in our Global Content Calls this week hosted by US Hotels Analyst Thomas Allen and EU Leisure & Travel analyst Jamie Rollo. Both Europe and the US are characterized by low supply growth and strong demand and as a bonus, several European hotels also offer balance sheet and M&A optionality, including Whitbread (WTB LN), Accor (AC FP) and InterContinental Hotels (IHG) which are the top picks in Europe (please ask for details on the call).
While consumers may be shifting preferences around what to buy, they are also quickly changing where they buy as evidenced by Amazon (AMZN) which reported same store sales accelerating to 27% growth, the fastest growth in company history and 2.5X higher than the long-term ~11% average rate. These numbers are staggering in light of the fact that Amazon has called out multiple current investment areas including Prime digital content, Prime Now, same day delivery, 14 new fulfillment centers, 4 new sortation centers, AWS, India, and several new devices. If that weren’t enough, our US Internet Analyst Brian Nowak has published an extremely insightful report this week which points to Amazon’s AWS service as having the potential to disrupt $240B addressable market and unseat key competitors VMware (VMW), Citrix (CTXS), Oracle (ORCL), Teradata (TDC), Microsoft (MSFT), Akamai (AKAM), and Computer Sciences (CSC), please ask for the report). Moving back to consumer spending one final area to highlight as straightforward beneficiaries include the payments and processing companies Visa (V), Mastercard (MA), and Discover Financial Services (DFS) (Cheryl Pate reinterates her OW, see below)which have all helped to provide the pipework for which spending, both online and offline, are completed. Undoubtedly, where and how consumer spend is occurring will be a major question going forward. Hopefully, with 80 corporates and over 1000 investors attending out Global Consumer Retail conference in New York on November 17-18th we should get plenty of guidance on which companies are best positioned.
One topic which I have frequently commented on is the inability or perhaps unwillingness for US investors to search and invest in international ideas. While I am confident that most US investors understand the benefits of international diversification, admittedly, there has been little need given that since 2009, the S&P 500 has been the best performing major equity market in the world, and has posted these gains with significantly less volatility than markets in Europe, Emerging Markets, or Japan. However, the investment case for the US may be dimming as margins and valuations are both above average, rising M&A and Buyback activity suggests an aggressive corporate climate, and (of course) US Monetary policy looks set to tighten. In light of these factors, our Global MS Research team has highlighted a list of 36 international stocks to own over the next 12 months and which we believe represent the most favorable risk-reward profiles for US-based investors seeking exposure outside North America. The list is defined by companies where MS research has out-of-consensus thinking that incorporates fresh data and analysis and with stocks that have a roadmap of upcoming data and events in the next 12 months to help corroborate our analysts' investment theses and drive a change in market perceptions. A few of the names to highlight are AIA Group (1299 HK), ARM (ARM LN), ASML (ASML NA), HDFC (HDFC IN), Femsa (FEMSAUBD MM), Hyundai (005380 KS), ITC (ITC IN), CK Hutchison (0001 HK), Nestle (NESN VX), Ryanair (RYA LN), Sony (6758), Toyota (7203 JP) and Ultrapar Participacoes (UGPA3 BZ). Please feel free to ask for the full list as well as further research on any of the names.
Despite all the talks of failed Portugese governments and Catalonian secessions, this weeks annual TMT conference in Barcelona went off without a hitch. With a record number of both investors and corporates, it was standing room only for several presentations such as Vodafone (VOD LN), Telefonica (TEF SM), KPN (KPN NA), Deutsche Telekom (DTE GR), Telecom Italia (TIT IM), and Altice (ATC NA). In fact, in the opinion of many, Telcos simply stole the show. The mood from companies was positive with an upbeat outlook on fundamentals and sustainable growth, investment differentiation and new services, with CEO's going out of their way to talk about the benefits of cross boarder M&A. That being said, Tech, Internet and Media had bright moments of their own. In tech, software seemed in good form, with demand conditions going well despite a few pockets of weakness in EM. There is a growing differential in IT Services between consulting & digital versus outsourcing, with the latter still being a tough market given pricing concerns in the medium-term. Semis did not let near-term demand weakness cloud their hopes for inventory correction by the end of 2017, making sure to also highlight the new growth areas in imbedded technology and autos. In Media, it became clear that EPS momentum for names such as ITV (ITV LN), Wolters Kluwer (WKL NA), and Zalando (ZAL GR) is strong and doesn't look like it will end anytime soon. In contrast, on top of investors having to digest large EPS cuts at Mediaset* (MS IM) and Vivendi (VIV FP), as well as chunky misses from Pearson (PSON LN) and Publicis (PUB FP), the presentations revealed that those companies with issues today will likely face lingering issues through 2016. Perhaps one of the most important issues facing the group is that $28bn of advertising contracts are up for review which while being a topic at the conference this past week, will also be in focus next week on November 18th when our European and US Advertising teams host a Global Content call on the sector, please ask for details.
Friday the 13th brought a forgettable week in Asia to an end, and while it wasn’t as bloody as the slasher film, the HSI ended down (-2.15%) and benchmark indices had their worst week in some time on volumes 10% higher than recent weeks. The week started off on a bad note with the China trade data over the weekend disappointing. Exports contracted -6.9% YoY (vs cons/MSe of -3.2%/-4%) mainly due to weaker volume growth to US and ASEAN while imports also disappointed at -18.8% YoY (vs cons/MSe of -15%/-18%). The Silver lining was the marginal improvement in import growth which indicated that investment growth is stabilizing at low levels with the Morgan Stanley China Economic Index (MS-CHEX) inching higher by +0.2% YoY in October. With a rate rise in the US more than likely coming in December, Jonathan Garner, our Asia/GEMs strategist, upgraded MSCI Hong Kong. Contrary to market perceptions, the MXHK has tended to outperform the APxJ and EM equities benchmarks when US yields rise.My top picks with largest price target upside from Garner’s note: AIA Group (1299 HK), Galaxy Entertainment (0027 HK), Wharf Holdings (0004 HK), and Hang Seng Properties (0011 HK). Despite strong earnings from Tencent (700 HK), AAC (2018 HK), andimpressive 11/11 numbers from Alibaba (BABA US), there was some serious pain felt in the China internet space today as VIPS US (-26.96%) cut their 3Q revenue guidance by ~10% in an earlier-than-anticipated news release (full results expected Tuesday). Otherwise the MSCI announcement took center stage this week post the November review (effective 30th Nov). Early feedback from our quant team suggests the changes were in line with expectations for all the major US listed China Internet names. Next week we are hosting our 14th annual Asian Pacific Summit in Singapore where we will hear from more than 350 companies (look forward to seeing you there). Expect more answers to come as we will have plenty of output and feedback to bring clarity on our Asia outlook.
Japan finished slightly positive with the Topix up (+1.42%) on the week after we saw stronger-than-expected rebound in Japan Machinery orders. Private core orders rose +7.5% MoM after sharp consecutive declines in Jun-Aug, beating prior forecasts (cons. +3.1%, MSe +3.4%). However, our Japan Economist, Takeshi Yamaguchi-san, notes that monthly orders are highly volatile and he still expects capex to remain sluggish in the near term as core orders lead GDP-based by about 6months. We continue to recommend buying back Japan (TPX PT Y1,740 (+9.2%). Jonathan Garner commented this week that we should continue to see further outperformance versus APxJ and EMs off strength of the USD and economy (see chart below). Japan has already shown that reported earnings growth and ROE gains are continuing even in a weaker global macro economy, with an attractive 12-month consensus forward PE at 13.4.x, and even more so on our earnings estimates which put the 12-month forward PE at 13.0x. Looking to next week with the September GDP announcement on the 16th, I like our Japan Wage Growth Basket (MSJNWGE2 Index) –a poor GDP figure on Monday will allow Abe to come out with a better than expected stimulus package which would support this basket. Any weakness related to the print, would provide an attractive buying opportunity. Furthermore, a tighter labor market and resilient domestic demand will likely lead to further improvement in wages. Four single names I like coming out of our top 36 names for the next 12 months: NTT (9432 JP), Sony (6758 JP), JAT (9706 JP), and Murata (6981 JP).
Finally, we updated our Global Event-Driven & Cross Asset Ideas deck this week. Some of the key content pieces here that I would highlight are our new high conviction trade ideas from our Special Situations which includes Avago (AVGO), and Cross-Asset team’s view on Noble (NBL). As the market congregates around a December Fed liftoff date, we are revisiting our Reflation trade ideas and where we would be positioned across different asset classes (US High Yield, Global Financials). We have also added some thoughts on 3Q15 earnings results, volatility and hedging, a slide summarizing our forecasts regarding upcoming Central Bank action, and key ETF trades and trends (Long Japan and Europe through EWJ, JHDG and EZU). As a reminder, this is a dynamic piece that is updated on a monthly basis to keep pace with the markets and ideas fresh. Please do not hesitate to reach out for a copy of this deck.
I am off to Singapore and Hong Kong next week for our Asia Summit next week. Thankfully these long flights will at least serve as an opportunity to catch up on sleep.
Have a great weekend,
Nick
*Included in my 2015 Global Ideas Deck. Please ask for the presentation.
TRENDS & INFLECTION POINTS
Positive
ìUS – Hardlines– Following several months of year-over-year deceleration, US Economist, Paula Campbell Roberts, reports that primary data suggests improved growth in retail sales of building materials in October with Y/Y growth estimated at +1.7% and seasonally adjusted M/M growth of +0.3%. Paula and her team leverage Big Data to supplement their traditional modeling techniques and to provide advanced signals of potential inflections in economic or industry fundamentals ahead of the release of official data. It is this process that suggests Home Improvement retail is at a critical juncture. The AlphaWise Macro Home Improvement Tracker has a ~60% correlation to HD/LOW comps, affirming the importance of the tracker as an indication of trends. On a Y/Y basis, October data sequentially accelerated on a 1- and 2-year bases. This bodes well for Q3, for which their comp expectations are 6% and 5% for HD and LOW. It is also important to note that this acceleration is at odds with the broader retail segment, which appears to have slowed in October. This should give investors comfort that home improvement segment strength is sustainable.
ì Europe – British Property – British Land and Land Securities now trade on c.10%+ discounts to spot/last reported NAV. UK Property Research Analyst, Chris Fremantle, thinks this reflects a combination of nervousness around Fed lift-off in December, the Brexit referendum and its impact on UK property (especially in London), combined with a sharp slowdown in 6 monthly NAV growth from Land Securities at its 1H results. Chris looks at monthly readings of NAV valuation and the next 6 months' NAV growth for both diversified UK majors, British Land and Land Securities. Using regression analysis (with an R-squared of 0.75), he shows how, at an 11% discount to spot/last reported NAV, the shares are pricing flattish NAV growth for the next 6 months. Chris’s current base case forecasts suggest a higher level of growth for the UK majors in forthcoming periods (mid-single digit growth every 6 months, on average). Flat NAV growth (and flat capital growth), as implied by current share prices, is a possible outcome, particularly after 6-monthly NAV growth at Land Securities has slowed sharply from 14.5% to 5.7%. But he notes that it would require an outward yield shift to offset strong rental growth completely. While not impossible (since yields are historically low on an absolute basis), Chris sees this as a relatively bearish scenario: while short-term interest rates may rise, yield spreads are far from challenging in a historical context.
ì ASEAN – Equity Strategy – Hozefa Topiwalla, head of Singapore research and ASEAN equity strategist, asks the question if domestic savings can drive markets. He thinks it can and the probability seems highest for the Philippines market. However, Indonesian domestic equity savings may disappoint investors, whereas Thailand may have gone too far ahead and may need to normalize. He highlights cyclical risks here. He prefer Philippines over Indonesia; Thailand least preferred. Rising US Fed fund rates and importance of Chinese equities raises the importance of debate on domestic equity savings: Unlike the consumption boom, development of domestic equity savings seems far more complex due to a combination of cultural factors, regulations, investor education and distribution reach. This report undertakes a study of two main conduits for domestic equity savings – discretionary household savings (mutual funds and direct equity investments); and contractual savings (pension and insurance).
ì Asia/GEMs – Strategy – Jonathan Garner, Asia and EM Equity Strategist, upgraded MSCI Hong Kong to OW from EW but downgraded Singapore to EW from OW ahead of a potential Fed rate hike. Five key reasons for the upgrade: 1) Since the GFC, MSCI Hong Kong has tended to outperform the Asia Pacific ex-Japan / EM equities benchmark when US yields rise, partly due to a high and rising weight of insurance (AIA) within MSCI Hong Kong, which benefits from rising US interest rates. 2) He believes China contagion should now reverse – MSCI Hong Kong has lost 9% since August 2015, underperforming the benchmark by 2%, due to high correlation with MSCI China. But his team’s analysis shows that MSCI Hong Kong stocks have much lower exposure to mainland China than to Hong Kong’s economy. 3) He noted that MSCI HK profitability trends are solid, and the ROE gap between HK and APxJ has narrowed to a 5-year record low. 4) on valuation, MSCI Hong Kong's Trailing P/E is currently trading at a 6% discount to MSCI APxJ, which is 1.7 standard deviation below its 5-year average. 5) MSCI HK's fund positioning relative benchmark is at the low.
ì LatAm – Mexico Industrial Output – Industrial output rose 1.7% from a year ago in September, ahead of consensus (1.2%); on a sequential basis, output rose a solid 0.4% non-annualized (0.3% expected), the fourth consecutive gain. Industry's upswing is obviously good news--recall output went nowhere in 1H and rose 3.3% sequential annualized in 3Q--but what is more interesting is ongoing 'change in guard' as other sectors have been more than offsetting recent softness in manufacturing, which has been hurt by the “link” to US factories which in turn have struggled with strong dollar, weak global demand and fallout form energy capex plunge. The offset to 3Q manufacturing softness came from mining as oil output rose from the 2Q two-decade lows (+8.5% annualized 3Q) as did construction (+6.8%); utilities surged 11.2% annualized likely on greater use of natural gas (lower cost fuel boosts value added).
ìUS – Media & Internet – US Media and Internet analysts, Ben Swinburne and Brian Nowak report that total 3Q15 US ad spend grew at roughly 3-3.5% versus their expectation of 2.3%. Relative to expectations the two standouts in media were 1) TV, and 2) paid search. In terms of marketing spending overall, the agency North American growth rates exceeded expectations led by IPG and OMC. Online advertising grew an estimated 18.8% Y/Y (vs their estimated 17.6%) led by search, mobile display, and online video. Google US paid search grew an estimated 13% exceeding expectations of 11%...accelerating from 11% in 2Q, as mobile search growth accelerated thanks to additional ad coverage and improvement in the mobile to desktop monetization gap . The broadcast networks led the upside surprise, growing 1% versus their estimate of down 4% with all four major networks (ABC, CBS, FOX, NBC) performing better than expected.
ì Europe – Beverages – Olivier Nicolai, European Beverages Analyst, looks at the implications for Pernod Ricard (EW PT €108) and Diageo (OW PT 2,200p) if the US trade embargo were lifted and Cuban rum were permitted to enter the US market. Since the early 1960s, a comprehensive US trade embargo has prevented Cuban rum from entering the US. This market accounts for 11% of US spirits volume and generates c.$1.6bn in sales and $0.5bn in profit. Bacardi leads with a 35% volume share, followed by Diageo at 28%. Pernod would be ready to enter the new market, having registered its trademark Havanista after losing Havana Club to Bacardi. However, whether and when any further easing of sanctions will occur, including the lifting of the embargo is uncertain. The Cuba sanctions are built on a complex framework of executive (Presidential) authority and federal laws and regulations and, despite the Obama administrations recent actions, to lift it fully would require legislative action and hence Congressional approval. Pernod has a JV with Cuba distributing the Havana Club brand worldwide and hence stands to benefit the most. If Pernod took a 10% share of the US rum market, the team’s analysis suggests a positive €60m EBIT impact, or 3% accretion to FY17 EPS, all else equal. In reality, it would take time and significant marketing investments to build the brand equity. Olivier raises his FY16 EPS for Pernod (EW) by 3% and our PT from €105 to €108. Post its investor day; Olivier remains OW on Diageo, PT 2,200p.
ì China – Utilities – Sheng Zhong, China Utility Analyst, believes that solar is in the sweet spot with demand strength into 1H16, mainly driven by: 1) US order strength ahead of the end-2016 expiry of the US solar investment tax credit (ITC), and 2) a likely reduction in China's solar feed-in-tariffs (FiT) in 1Q16. She believes the demand strength should support near-term pricing and expects China's delayed FiT subsidy solution in late 2015 or early 2016, before an official announcement of FiT cuts. Amid this supportive demand outlook and polysilicon price weakness, she thinks midstream module makers are positioned to reap the benefits of such tailwinds. She initiates OW on Canadian Solar, reiterates OW on Jinko, upgrades Trina to OW, while downgrades Daqo to EW and TEBA to UW. She prefers midstream and downstream over upstream players and her stock preference are Jinko, followed by Canadian Solar, then Trina Solar. Sheng expects Jinko to expand margin in 3Q15 and 4Q15, supported by a high percentage of in-house production and a Malaysia plant at full utilization; Jinko would also benefit most if the FiT payment is approved. For Canadian Solar, Sheng expects them to shift to a build-sell business model for downstream projects. She forecasts CSIQ to start selling downstream projects in 2016, amid a challenging yieldco climate and thinks a build-sell approach would boost profit growth via faster investment return. Module margin would improve as well, with more integration and a possible overseas plant setup in 2016.
ìUS – Autos – US Autos and Shared Mobility Analysts Paresh Jain and Adam Jonas are now bullish on four out of the six publicly traded dealers, consistent with their thesis that dealers present the best risk/reward in the autos space today, given increased volatility in China, the VW emission scandal, and peakish margins. Paresh and the Autos team recommend investors reduce their exposure to OEMs and many of the supplier names and use that to gain exposure to some of the dealer names. Dealers are a safer way to get exposure to autos because: (1) No direct exposure to volatility in China; (2) No OEM pricing pressure vs. supplier as the peak of the cycle approaches; (3) Acquisition opportunity can drive sustainable double digit top line growth; (4) Parts & Services, 40% of gross profits, adds defensibility at the top of the cycle; (5) The opportunity for dealers to become a Megadealer is best for well-resources public dealers; and (6) Dealers still trader at a significant discount to auto retail and retailers in general despite the opportunity to consolidate and reposition themselves as pure B2B service players in the long run.
ì India – Economics – The government has announced FDI liberalization relating to 15 sectors, including construction, banking, defense, wholesale, retail and e-commerce. The reforms are focused on improving ease of doing business through rationalization of foreign investment process, fast-tracking the decision-making process by putting more FDI proposals under automatic approval, and increasing the FDI cap in certain sectors to promote Make in India. Chetan Ahya, Chief Asia Economist, believes this latest policy decision shows that the government remains committed to the reform process. He expects the government to continue to take policy action to improve the productivity dynamic and growth mix through reduction of redistributive policies and focus on increasing capital spending. The government could face some challenges on policy actions which require legislative approval, as it is in a minority in the upper house of parliament. However, he believes that policy actions which need executive decisions such as Tuesday's decision on FDI liberalization or the recently announced package for state electricity boards will continue to flow through. The key reform whichrequires legislative approval is GST (Goods and Services Tax). He will be tracking closely the progress the government makes to get the GST bill passed during the next parliamentary session (Nov 26 to Dec 23). If the government is unable to secure opposition support, the implementation of the GST could be delayed to April 2017 from the current target of April 2016.
Negative
î US – Retail Sales – The Department of Commerce issued a soft retail sales report, continuing a sluggish recent trend in core retail sales and pointing to a deceleration in consumer spending growth in Q4. US Economist, Ted Wieseman, reports that retail sales rose 0.1% overall in October after zero growth in both September and August. Motor vehicle unit sales held at a ten‐year high in October, so there wasn't any sequential growth, and auto dealers' receipts fell 0.5% as sales incentives were ramped up. The core retail control gauge including restaurants ‐‐ total sales ex autos, gas, and building materials ‐‐ rose 0.3% in October after offsetting revisions to September (0.0% v. 0.1%) and August (0.3% v. 0.2%), extending a sluggish back‐to‐school shopping period into the fall, in line with his AlphaWise retail sales tracker.
î Europe – Spanish Banks – Alvaro Serrano, Spanish & Nordic Banks Analyst, expects lower Euribor to continue to pressure margins, and forecasts NII down -4.6% on average in 2016E, with ROTE estimates from 6.9% to 12.5%. BNKIA and BBVA remain top picks, with UW ratings on POP, SAB & BKT. He lowers NII estimates by 2% and now expects -4.6% in 2016E. NII was down an average 2.8% qoq in Q3, broadly in line with expectations, with CABK showing the worst performance (-8.3% qoq) as anticipated in its profit warning in Q2. He expects an average 1-2% loan growth in 2016. Loan production continues to improve, with new SME loans up 17% yoy and large corporate up 38% yoy in Q3, and should drive growth in the stock of loans in 2016E, offsetting contracting mortgages and public sector loans. Asset quality is seen as the key differentiator for profitability and continues to improve, with loan loss provision charges falling to 50bp from 90bp in Q2, and NPLs in absolute terms down -4.2% qoq. Bankia remains Alvaro’s top pick; the bank reduced the stock of its NPLs 8% qoq in Q3, which was the biggest reduction of its peer group. He also factors in the disposal of the entire repossessed portfolio in 1Q16, which should drive a reduction of provisions to 35bp 2016E vs. 52bp in Q3. The stock is trading on 1.05x P/TBV, and he sees upside to his 40% dividend payout 2016E
î China – Economics – Junwei Sun, Greater China Economist, believes the downside surprise in the October trade data suggests still significant headwinds. The YoY contraction in export growth widened to -6.9% YoY in October (vs. -3.7% YoY in September), compared with consensus expectation of -3.2% YoY and MS forecast of -4.0% YoY. The fall in overall export growth was likely mainly due to weaker volume growth, which was also reflected in the sluggish Korea export growth data. By destination, this was mainly driven by a renewed YoY contraction in shipments to the US and ASEAN. Meanwhile, import growth surprised to the down side, too, at -18.8% YoY in October (vs. -20.4% YoY in September). As the slower volume growth was likely the main driver of the weaker export growth for China (and also Korea), Junwei Sun think this underlines that external demand growth is not yet on a firmer footing. However, she doesn’t expect Chinese policy makers to use significant RMB depreciation to stimulate export growth. She continues to expect some stabilization in RMB NEER in the coming quarters, though USD/CNY exchange rate is likely to remain largely stable before the announcement of IMF’s SDR review. Meanwhile, the marginal improvement in import growth likely indicated that investment growth is stabilizing at low levels, thanks to the recent policy easing measures. However, the disinflationary pressures are likely to persist, calling for a continuation of policy easing to support domestic demand growth.
î LatAm – MSCI Outflows – The inclusion of Chinese ADRs into MSCI China is the biggest change in the index since 2010, and the Latam Strategy Team estimate this should generate circa USD500m in outflows from Latin America upon the first stage of the ADR inclusion. In addition, the region's weight in the MSCI Emerging Markets benchmark should decrease from 13.2% to 12.6% (-60bp). Therefore, in addition to the stocks deleted and the ADR inclusion impact, we could see further outflows of circa USD350m from the region - for a total USD1bn or 0.25 days of ADTV. In the MSCI Latin America Index, there were no additions but there were 10 deletions: 1) Ecorodovias (ECOR3 BZ), 2) Banrisul (BRSR6 BZ), 3) Via Varejo (VVAR11 BZ),4) AES Tiete PN (GETI4 BZ) 5) Usiminas PN (USIM5 BZ), 6) Cyrela (CYRE3 BZ) 7) Banco Davivienda (PFDAVVND CX), 8) Isagen (ISAGEN CX) 9) Almacenes Exito (EXITO CX) and 10) Concha y Toro (CONCHA CC) in Chile.
îEEMEA – Turkey – MS Turkey economist, Ercan Erguzel, was in NYC this week meeting with investors and the sentiment remains quite bearish. In a low oil price environment, Turkey should be a beneficiary (100% importer) but the political situation is clouding the situation and could potentially make 2016 even harder than 2015. The president, Erdogan, is within reach of being able to change the constitution in parliament (extend his reign?). Also, the fiscal account is at risk given the political promises to the populous, and since this has been the main positive as of late (vs a poor external account and FX deval.), if they run a 2% fiscal deficit that may trigger a rating downgrade. Although not our Turkey economist’s base case, 2016 can be another bumpy year depending on risk factors including: i) Additional TRY depreciation; ii) Complacency of the CBT’s response; iii) Moody’s downgrade on December 4; iv) Ongoing political uncertainty; and v) A further decline in GDP growth triggering problems in employment, budget revenues and banking sector NPLs.
î US – Truck – US Machinery analyst, Nicole DeBlase, reports thatNAFTA Class 8 truck orders surprised to the downside in the critical month of October (25.2k vs. expectations for ~30k), and she believes this is stoking fears of a 10%+ Y/Y decline in industry production in 2016e. Nicole is becoming increasingly pessimistic around the outlook for NAFTA truck, and expect orders to continue to disappoint in Nov/Dec due to an uptick in cancellations and heightened dealer inventory levels. Internationally, she has been encouraged by accelerating registration data in Western Europe (she forecasts high-single digit growth in the region during 2015-16e), although demand remains decidedly negative in Brazil (weak economy, FINAME issues) and China (pre-buy hangover). India is enjoying robust 30%+ Y/Y production growth.
î Europe – German Property –Bianca Riemer, European Property Analyst, believes that new regulation could weigh on residential construction volumes despite growing demand, putting further upward pressure on prices and rents, as well as on existing land banks. Top pick remains Deutsche Wohnen (OW, PT €33). The government is introducing new energy efficiency regulation (EnEV) for new builds from January 1, 2016, which will increase new build costs by 7%. Bianca thinks this could put pressure on residential construction margins and thus volumes, as average housebuilder margins currently are only about 15-20%. At the same time, net migration has been on the up since 2011, leading to increased household formation and therefore housing demand and prices. Net migration historically has been a lead indicator for significant rises in house prices with a lag of a few years. Despite these rises, German house prices remain relatively affordable compared to other OECD countries and mortgage rates are at historical lows, while the aggregate level of mortgage lending has not increased significantly in the recent past . The listed residential landlords have land reserves that remain valued at relatively low valuations in their books. Her top pick Deutsche Wohnen, which is the listed stock with the largest exposure to Berlin (70%). When speaking to management of various companies, they indicate that they are housing refugees in individual units, but would refrain from renting out large parts of their vacant portfolio so as not to change the tenant mix too much.
î China – Telecoms – Gary Yu, Greater China Telecoms and Media Analyst, reiterates his preference for CM (OW, PT HK$110) to CU (resuming coverage at EW, PT HK$11.5, previously OW, PT HK$15) and CT (EW, PT HK$4) given relatively resilient earnings and continued 4G momentum. Gary expects 4Q15 earnings for the Chinese telcos to be adversely affected by implementation of data carry-over on October 1 and completion of tower disposal on October 31, offset by one-off tower disposal gains. He forecasts a one-off delay in revenue recognition for unused data in 4Q15, and potentially lower top-up and/or excess usage charges in the near term, resulting in revenue loss of Rmb12.4 bn for CM, Rmb2.8 bn for CT and Rmb3.1 bn for CU. On tower disposal, assuming the telcos do not reach a tower lease fee agreement with China Tower by the end of 2015, Gary expects CM, CT and CU to record provision on tower lease fees of Rmb4.6bn, Rmb2.7bn and Rmb2.7bn in 4Q15. To factor in both aspects, Gary lowered his 2015-16e EPS (normalized) for CU by 42.9% and 12.8%, respectively; while reducing his 2015e EBITDA and EPS (normalized) for CM by 6% and 10.5%, but his 2016e EBITDA and EPS (normalized) at lower rates of 4.7% and 6.7% as he expects data carry-over to have limited impact on recurring revenue and earnings beyond 4Q15 for CM. Gary raised his 2015-16e EPS (normalized) EPS by 1.1% and 4.6% for CT, respectively, due to slightly lower interest expenses. Despite the stock trading at a trough valuation of 3x 2016e EV/EBITDA, CU-H's earnings appear highly vulnerable to the uncertainties mentioned above due to low earnings bases.
îEEMEA – South African Equities – The global environment remains a serious challenge for SA. USD strength has been re-ignited with the much better-than-expected jobs report last Friday and Chinese data has continued to disappoint. El Nino fears have been building for a while but they hit home last week with water restrictions imposed across Johannesburg and Gauteng. A severe El Nino, as it may turn out to be, probably means that international food prices will continue to rise. From a trade perspective, there is clearly a negative impact from El Nino. A reduction in net exports of 2.1mn tonnes of maize would cost ZAR6.8bn at current prices, which is equivalent to 0.6% of the total SA annual import bill. The research team in SA believe the stocks most likely to benefit from El Nino would be Woolworths (EW) and Illovo sugar (OW). Relative losers in this case are potentially Sappi and Pioneer Food (both rated UW).
î US – Restaurants – In a collaborative research effort, US Economist, Paula Campbell Roberts, and US Restaurants analyst, John Glass, highlight that primary data suggests limited services restaurant SSS year-over-year growth slowed to +2%, below the prior month's +3%, likely as a result of a harder comparison to last year. Their analysis suggests that consumers decreased check sizes during restaurant visits versus reduced traffic. Based on historical data from January 2010 to September 2014, they find that the quarterly index (aggregated from monthly data) has high correlation (80%) with the industry US Same Store Sales (SSS) data on a quarterly basis. Within the Limited Service Restaurants category for the same time period, the correlation is higher with the QSR group (88%, accounting for over 2/3rd of the sales), than Fast Casuals group (66%), or Pizza group (61%).
î China – Retail/O2O – Rob Lin, China Internet and Other Services, and Hong Kong/China Discretionary Analyst, believes big-box retailers' digital transformation in a slowing retail environment will be difficult and near-term outlook of offline retailers is negative. He initiates coverage on Suning and Yonghui with Underweight and PT of RMB 16.1 and 10.4, given their significant A-share premium. He prefers H-share to A-share big-box retailers and prefers Intime & Springland among the HK listed big-box retailers under his coverage. He cut FY15/16/17e earnings by -8.5%/0.5%/-0.8% for Sun Art but raised price target to HK$6.8 from HK$6.1 and maintained EW rating, mainly to reflect near-term pressure on SSSG. He believes its potential partnership with internet players could be a share price catalyst in the next six to 12 months. Rob thinks big-box retailers are mired with challenges: 1) slow / declining SSSG given overcapacity and slowing macro growth; 2) declining B2G gift card sales which he thinks are unlikely to trough until early 2016 despite signs of a narrowing decline; and 3) ongoing market share losses to online retailers. However, evidence suggests a profitable O2O partnership model is emerging in China. Digital transformation supports a better medium-term outlook and leading retailers are likely to benefit the most from an expanding digital catchment area.
îEEMEA –Qatar Banks – Dan Cowan, EEMEA banks analyst, thinks banks have reached a point where tighter system liquidity and capital requirements could affect credit supply, shifting focus from growth to NIM preservation. The team wrote earlier this year that a robust pre-2022 World Cup infrastructure programme was likely sufficient to support Qatar's credit demand. However, the combined effects of persistently low oil prices, tighter system liquidity strict capital requirements and continued project pipeline re-evaluations suggest this may no longer be enough. Dan lowers his average loan growth forecast as he thinks we may be at the point where a continued system liquidity squeeze could start to affect banks' capacity to satisfy credit demand. Dan expects banks to prove more selective in their credit supply, focusing on NIM preservation over the outright pursuit of growth. Dividend cuts are still the base case and overall, a slower growth outlook drives a downgrade from EW to UW for CBQ, and OW to EW for Doha.
CHARTS
P&C Insurance Underperforms in Rising Rate Environment
Despite fundamental headwinds (decelerating P&C pricing, core margin deterioration, slower reserve releases, and lower investment returns), P&C stocks have averaged +7.7% YTD returns outperforming the S&P 500 and Financials (XLF) by ~600bps and ~700bps respectively. US P&C Insurance analyst, Kai Pan, believes rising interest rates could be a headwind for P&C stocks, reflecting the negative impact on book value and potential loss cost inflation. Historically, P&C shares have underperformed the S&P 500 by -100bps during period of rising 10-year yields as investors rotate out of P&C into banks and life insurers. Download the Complete Report
Robust Demand: Household Formations Surge While Homeownership Rates Slide
Constrained credit continues to force a majority of these new households into renting. While the homeownership rate did increase 30bps in 3Q 2015, it remains close to a 48-year low. Securitized Products Strategist, James Egan, believes that the rate will fall further from here as tight mortgage credit conditions are expected to keep new households in the rental market as opposed to owning homes. Download the Complete Report
Triple Net & Healthcare REIT Performance vs 10-year Treasuries - Are Higher Rates Priced In?
US REITs analysts, Haendel St. Juste, Vance Edelson, and Vikram Malhotra highlight that REITs underperformed broader markets last week and now trail the S&P by 4.5% year to date. Lodging & Apartments were the best performing subsectors, while Manufactured Housing and Healthcare were the worst. REITs now trade 3.7x (28%) above & 177 bps (24%) below their long-term average multiples and implied cap rates. Download the Complete Report
Recent CEO Turnover at 5 of the 12 Morgan Stanley Covered Companies
Environmental, social and governance (ESG) analysis adds insights to the quality of a company's management and infrastructure, helping investors analyze the LT sustainability and growth outlook. US Retail, Food, and Drug analyst, Vinnie Sinisi and Sustainable & Responsible Investment analyst, Eva Zlotnicka lay out ESG frameworks within the sector to help investors make more informed investment decisions. Factors including management compensation and board structure are helpful when assessing alignment with shareholders. On average, ~55% of CEO/CFO compensation comes from stock/options and ~80% of board members are independent. Comps, EPS growth, ROIC, and shareholder return are appropriate metrics for performance-based compensation. Download the Complete Report
1st Fed rate hike is normally good for Value
The first rate hike of a new monetary policy cycle has not historically led to the end of that economic cycle. Rather, previous performance patterns suggest that it confirms the durability and validity of economic growth. Consequently the first rate hike tends to coincide with a period of Value outperforming Growth with the former benefitting more from perceptions of a broader and longer economic expansion and the latter more at risk from a valuation de-rating associated with higher interest rates. A rotation away from Growth and into Value would strongly favor commodity sectors and financials at the expense of defensives.
Rum is still not a dynamic category in the US, but it offers premiumization potential
Since 2010, rum has been losing share of the total US spirits market. Bacardi is the market leader in volume terms but, owing to its lower price point, has the same value share as Diageo. Rum has been losing share to other spirits categories, despite its affordable price point. Our team believes the ageing potential of rum, its versatility for bartenders in the on-trade, its variety of flavors and heritage could trigger a premiumization trend in the long term, and appeal to millennials. More effort around educating the consumer could be made following a similar strategy to that applied to whiskey, tequila, Cognac, gin or premium vodka. Download the Complete Report
On a relative basis, the correlation between MSCI China and MSCI Hong Kong has been somewhat broken recently
MSCI Hong Kong has lost 9% since August 2015, underperforming the benchmark by 2%, which is due largely to its high correlation with MSCI China. However, Jonathan Garner, Pankaj Mataney, and team, Asia and EM Strategists, show that MSCI Hong Kong stocks have much lower exposure to mainland China than to Hong Kong's economy. Large cap stocks, such as like CK Hutch (0001.HK, OW), offer exposure to DM assets, and AIA (1288.HK) and Hong Kong & China Gas (0003.HK, EW), offer exposure to the more resilient parts of China economy, i.e., Insurance and Utilities. Download the Complete Report
Consensus CY2015 EPS trend: Japan the only major market where consensus earnings are being revised up
Pankaj Mataney and Johnathan Garner, Asia/GEMs strategist, revise up bottom-up consensus EPS estimates are being up for Japan whereas for other markets they have been revised down. Japan has also beaten the upwardly revised consensus estimates now 11 quarters in a row. They expect Japan to beat consensus earnings in the next quarter too given that they are above consensus on their EPS forecast for fiscal year March 2016 at ¥107 versus Consensus ¥105 (March 2017 MS EPS forecast ¥117 versus consensus ¥113.5). In contrast, APxJ/EM region has missed consensus earnings estimates in 11 of the last 13 quarters. Download the Complete Report
KOSPI Consensus Sales Estimates Trajectory
A weaker local currency has helped export-driven earnings in Korea; operating profit margins have continued to expand and now stand at 7.7% in the 3Q15 results, a 30bps improvement from Q2, and the highest level since 2011. Q3 and Q4 top-line growth has started to rebound since the MERS outbreak after bottoming in early October. Jonathan Garner, Pankaj Mataney, and team, Asia and EM Strategists, note limited downside risk to the market index, which is currently nearing 1.0x P/B. Their KOSPI target of 2,100 reflects 4% EPS growth and a 9.7x mean revision target P/E multiple. The less bad earnings in 2H15, some signs of stabilization in China/EM growth data and recent heavy fund outflows raise the probability of a sustained bounce for Korean equities in the near term, in their view. Download the Complete Report
Japan Machinery Orders
Source: Cabinet Office
Takeshi Yamaguchi-san, Japan Economist, reports that Japan Machinery Orders had a stronger-than-expected rebound, but Oct-Dec forecast shows sluggish recovery: The private core orders rose +7.5% MoM after sharp consecutive declines in Jun-Aug, beating prior forecasts (cons. +3.1%, MSe +3.4%). That said, he thinks it is important to note that monthly orders are highly volatile. The average core orders in Jul-Sep fell as much as 10.0% QoQ, despite the sharp rebound in Sep. The Cabinet Office’s forecast survey expects +2.9% QoQ in the core orders in Oct-Dec, but the recovery seems sluggish after the sharp fall in 3Q. The private core orders lead GDP-based capex by about 6 months, so he expects capex to remain sluggish in the near term.
PBR’s Lower Production Growth Makes it Less Levered to an Oil Price Recovery
Operating results deteriorated sequentially, missing Bruno Montanari’s (our LatAm Oil & Gas analyst) estimates, although came in line with the consensus. But Petrobras generated a sizeable loss in 3Q15 and leverage escalated, as expected. Special items have become the norm in PBR's results and Bruno wonders if all those provisions reversals should continue to be normalized. In the past four quarters, Bruno counts 15 adjustments in his model, which feels recurring in some ways. And even with R$4.5B* added back to EBITDA, we still saw a 10% miss vs. Bruno’s number (30% was the reported EBITDA miss). E&P disappointed on high exploration costs, while Refining was weak on lower fuel sales and higher costs. Gas & Power was the only positive surprise, with higher margins coming from the reduction of discounts. Oil prices remain low and the BRL is bound to devalue from here, deteriorating the B/S. Remain UW. Download the Complete Report
EM Funds Report Outflows of US$2.26bn this week
Excluding China A-share equity fund flows, this week's outflows from EM funds amounted to US$1.43bn. Active funds have continued to report outflows since May 2015. Within dedicated EM equity funds, EM Asia regional funds reported the largest outflows of US$1.59bn, with half of the outflows from China-A share funds. GEMs regional funds and EMEA regional funds also reported outflows of US$0.62bn and US$0.06bn respectively, while Latam regional funds reported marginal inflows of US$0.02bn this week. At the country level, Taiwan, India and Malaysia reported the largest outflows relative to AUM this week, while Thailand, Chile and Greece were the only EM markets to report inflows in the current week. Download the Complete Report
RESEARCH
ì US – ACE Limited – US P&C Insurance analyst, Kai Pan, is resuming coverage of Ace Ltd at Overweight with a $132 price target. ACE has acquired Chubb, a deal with overwhelming support from shareholders expected to close in 1Q16. The merger unites two leading underwriting franchises to become: #1 global P&C by underwriting income, #2 US public P&C company by market cap, #2 US commercial lines insurer, and a leading US high net worth (HNW) personal lines carrier. Kai believes management targets are achievable: (1) $650m cost synergies by 2018 and (2) substantial revenue growth by 2020. Specifically, he estimates every incremental ~$100m in cost savings, or ~3% premium growth, could add ~2% to earnings. His price target offers ~16% upside and a compelling 3:1 bull/bear skew. CB has historically enjoyed a premiums valuation vs. ACE (1.5x P/B vs. 1.2x), partly due to its storied high net worth personal lines franchise. With the old Chubb accounting for ~40% of the combined business, he anticipates potential re-rating of the new "Chubb" to the blended ~1.3x or higher. Download the Complete Report
ì Europe – Unicredit –Alvaro Serrano, Spanish & Nordic Banks Analyst) reiterates his OW rating (PT €7.10) on the back of a more proactive approach to costs and AQ improvements. The new plan aims for €1.6bn cost cuts (vs. MSe of €900mn) targeting Western Europe and the corporate centre costs in particular. He forecasts a CET 12.1%, vs. the 11.5% targeted by UCG as they assume lower payouts. The retained earnings, progress in non-core RWA reduction, and disposals contemplated should reduce concerns around capital going forward. Unicredit has sold €7bn of non-core assets since 2013; however management targets only an additional €6bn disposals over 2016-18. Alvaro believes this doesn't factor any benefits from the bankruptcy reform or a possible bad bank vehicle, which makes him more optimistic. He forecasts €0.7bn losses (vs. €1bn in the plan) and 19bn reduction in RWAs by 2018. He expects 9.7% ROTE18E with the stock looking cheap on 0.8x TBV. Download the Complete Report
ì Japan – Seven Bank – Hideyasu Ban-san, Japan Financial Analyst, upgrades Seven Bank to EW from OW on solid earnings and recent share price action. Seven Bank posted F3/16 1H NP up 3% YoY, within range of expectations and 51% toward FY guidance. However, he raises his PT as he reflects medium-term overseas earnings prospects in his base case. Loan business and overseas transfer business fared better than original estimates, prompting upward revisions, but the top-line impact was only a few hundred million yen (less than 1%). The bank lowered its estimates for business in N. America slightly to reflect one-time expenses, but also had a limited impact. He sees little noise obscuring the profit outlook for F3/16-17. He continues to expect that the outlook for medium-term earnings growth supported by profit contributions from N. America business, which are expected to kick in from July 2017, will have a big influence on valuation multiples. Download the Complete Report
ì LatAm – YPF – The impending regime change in Argentina has raised uncertainty towards energy policy in the coming year. There has been no official announcement from presidential candidates about changes to the current pricing policy. Bruno Montanari (our LatAm Oil & Gas analyst) built a simplified interactive model where you can build your own scenarios. To recap, the current crude price policy has a peg of 8:1 to the international benchmark, while fuel prices are being kept stable in USD-terms. But given the depressed level of international prices, Argentina shifted from selling hydrocarbons at a substantial discount to a large premium: ~40% in crude oil and ~70% in fuels. While Bruno believes that this level of premium is not sustainable in the long-run (our base case has a 20% reduction of fuel prices in USD terms in 1H16), the evolution of oil prices could rapidly correct the distortion. Download the Complete Report
ì US – TE Connectivity – TEL announced the sale of its protection business for $350mn in cash, another important step toward improving mix around harsh connectors and sensors and a positive development for growth/margins. US Semiconductors analyst, Craig Hettenbach, believes that with over $3bn in cash already on hand to fund a $3.75bn buyback, acquisitions could be next. The sale is valued at 1.8X EV to Sales, with the business generating $190mn in sales in FY15 and having 20% EBITDA margins. Management continues to take aggressive steps to improve the positioning of its product portfolio, announcing its 2nd major asset sale this year and 13th sale since the spin out from Tyco in 2007. The net result is a substantially better mix of business, as reflected in OMs that have expanded by 300 bp from 13.2% in FY12 to 16.3% in FY15. Craig likes the opportunity for multiple expansion as margins expand and sensors supplement growth, with the potential to increase to 16-18X from 15X today. Download the Complete Report
ì Europe – Covestro –Paul Walsh, MS pan-European Chemicals Analyst, initiates on OW with a €36 PT, implying c.28% upside. It is a well invested, cyclical but diverse business where returns and cash conversion are improving. With a ~4.4% '16e dividend yield, Covestro is best in sector, ahead of BASF. Its policy is to pay out 30-50% of net income, but importantly pay a stable to rising dividend. Rising EBITDA, lower capex, refinancing initiatives, lower restructuring charges and WC discipline drive a '16e operating FcF yield of ~11.5. Additionally, assuming Covestro's EV holds current levels, the speed with which Paul sees it paying down debt should see a ~€1.6bln shift between the group's debt and equity out to '18e, equivalent to ~8-9% on the share price p.a. In contrast to Covestro's polycarbonate and polyurethane activities, its coatings business enjoys low levels of capital intensity, high margins (EBITDA margin ~23% in '16e), high returns (~19% post-tax ROA) and low levels of cyclicality. This is a business that should be worth 8.5-9.5x '16e EBITDA, but is currently valued at just 4-4.5x. Download the Complete Report
ì Australia – Westpac Banking – Richard Wiles, Australia Financial Analyst, upgrades Westpac from underweight to equal weight. In his view, WBC is managing a challenging operating environment better than peers. He upgrades given a clearer commitment to margin over market share, ongoing cost discipline, a stronger capital position and a lower risk profile than the other major banks. WBC's share price has fallen ~15% since April, but its balance sheet is now stronger and the margin outlook is better. He thinks the risk / reward has improved and WBC is managing a challenging operating environment better than peers. His price target increases ~6%; a higher capital ratio and more re-pricing warrant a higher trading multiple. In his view, WBC's recent leadership on home loan re-pricing signifies a clear commitment to boost margins. He sees re-pricing as the best outcome for shareholders because capital intensity has increased, investment property loan growth is capped, competition for new owner occupier loans has intensified and industry lending standards have been "somewhat weaker". Download the Complete Report
ì India – IDFC Bank – Subramanian Iyer, India Financials Analyst, initiated on IDFC Bank at overweight, his preferred space in Indian financials. It screens well on CET1 and coverage, has an existing profit center, i.e. its corporate franchise, that it can leverage to grow, and good management. He is positive on the bank. IDFCBK listed at 1.6x F17 BV and currently is trading at 1.5x F17 BV, based on his estimates. He expects the near-term stock performance to be muted, but expects the stock do well over the longer term as management executes on the growth plans. A common question from investors regarding IDFCBK is, Why should one own IDFCBK stock at above 1.0x BV when ROE is likely to be less than 10% (COE being 13.5%) in the next couple of years? In his view, long-term investors realize that IDFCBK will be in an investment phase in the next 2-3 years to create a retail franchise for the future. Hence, while valuing the bank, they are more likely to focus on long-term potential and less likely to focus on near-term earnings. This is because the latter would neither reflect the earnings power nor the growth potential of the bank. Download the Complete Report
ì LatAm – Adecoagro – Javier Martinez’s (MS Agribusiness analyst) two key calls of the year, the recovery of sugar (+58%) & ethanol (+38%) and the turnaround of Argentina agribusiness, are playing out. AGRO farming margins in Argentina should more than double in the next two years; the elimination of export taxes and export restrictions for wheat and corn, and a weaker currency being the drivers here. On top of that, Javier sees ~USD100mn FCF in FY16 implying a ~8% yield. The stock has lagged other sectors in Argentina and Javier sees this as a buying opportunity. Download the Complete Report
ì US – Amazon – Amazon Web Services (AWS) should drive ~60% of AMZN forward profitability over the next two years given acceleration in public cloud adoption. Strong sales and improving mix in core markets are driving record margins and any pullback in investment should highlight this trend. In his new valuation methodology, US Internet analyst, Brian Nowak values Amazon's core North American retail, International retail, and AWS businesses separately. Brian’s new price target values AWS at $63bn (5.3X 2016 revenue, a 25% premium to the SaaS comp group) and the core retail business at $300bn. Download the Complete Report
ì Europe – L’Oreal –Erik Sjogren, European Consumer Goods Analyst, neutralizes his UW on L’Oreal and increases his PT to €180. He has had a sell on L’Oreal for a while concerned that a slower beauty market and increasing competition would force them to have to spend more on A&P and reduce margins. This played out and the strong margin growth has slowed down – however, Erik has been surprised by the resilience (until recently) of L'Oreal's multiple, which, contrary to his expectations, has seen the stock outperform. Erik believes that 2016 will mark an inflection point for L'Oreal. He expects operational momentum to gradually improve in 2016. Risk-reward also looks more attractive, reflecting the improving outlook for operational performance and the stock's recent de-rating versus peers. As such, he increases his 2016- 17 EPS estimates by c.3-4%, which puts him in line with consensus. Erik’s work on the sources of pressure on growth in the last few years and the overlap with Coty leaves him more confident that L'Oreal's organic growth should return to the 4-5% range from 2016. He sees the potential for competitive pressure in Consumer to ease (partly on Coty's focus on integrating the brands it is acquiring from P&G) and more effective innovation, both enabling better market share performance, particularly in the US, which has held back growth in 2014-15. Erik expects EBIT margin progression accelerating to 40-60 bps pa from 2016 through operational leverage on improving growth and continued efficiency gains, contributing to higher organic EPS growth. L'Oreal is set to return to an accumulating net cash position from YE15, with continued potential for bolt-on acquisitions and/or increasing returns to shareholders. Download the Complete Report
ì China – Autohome Inc. – Amanda Chen, China Internet and Other Services Analyst, remains OW on Autohome but reduced PT to US$36 due to earnings downward revision. Despite near-term headwinds, she expects its core business to maintain solid growth with healthy margin (+35%) in 2016. Investment in new businesses may drag non-GAAP net margin but should balance customer interests and support long-term growth. Amanda lowers Autohome 4Q revenue growth expectations from 49% to 33% and expects its core business growing 38% YoY to Rmb4.7bn in 2016e due to soft PV sales growth. However, she expects non-GAAP margin to improve slightly in 2016 as most opex for the new business was done in 2015, potentially leading to some operating leverage. However, she remains positive on its transition strategy in 2016, as Autohome now provides four new car transaction related services and two used car related services, within which new car B2C business, call center service and used car transaction will be the focus. Amanda believes these initiatives can effectively balance the interest between OEMs and dealers, and won't affect ATHM's core business revenue for the next 2-3 years. She lowers 2015-17e revenue by 3%/1%/2% respectively to reflect soft guidance and lowers 2015-17e non-GAAP net profit by 3%/1%/2% respectively mainly due to soft topline and operating expenses from the new businesses. Reiterate OW. Download the Complete Report
ì LatAm – BB Seguridade – BB Seguridade reported solid results amid a very challenging macro environment. Recurring net income growth of 20% is particularly impressive, and most subsidiaries are still seeing strong top-line growth. Net income growth was driven by a 33% y/y jump in financial results (due to higher Selic rates) and 16% y/y growth in operating results (due to positive secular insurance trends). Financial results represented 27% of net income (vs 31% in 2Q15 and 25% in 3Q14) while operating results represented 73% of net income (vs 69% in 2Q15 and 75% in 3Q14). For the first nine months of the year, BB Seguridade's recurring net income is up 27% y/y (operating results +20% and financial results +45%). Reiterate OW rating on BB Seguridade. Download the Complete Report
Negative
î US – Oracle – Oracle’s new database designed for the cloud, “12c”, has failed to serve as a substantial CY15 catalyst while investor concerns have built around the core business and are likely to weigh on the multiples. In addition to lackluster 12c bookings inventories investors are increasingly cautious due (1) an increasingly competitive environment; (2) negative cloud transition implications; and (3) a general lack of excitement from customers for moving to the new version of the database. US Software analyst, Keith Weiss, believes that while valuation remains undemanding at 12X EV/CY16e FCF or 15X CY16e P/E, ORCL likely sees limited upside to his $45 PT without increased clarity on these key catalysts. Download the Complete Report
î Europe – Rolls Royce –There are bad calls, and then there is Rolls Royce. One of my most haunting long picks for ’15, Rolls expects 2015 profit to be at the low end of its previously guided range (so £1,325m for PBT and 55p for EPS) but both MS team and consensus are already there or thereabouts. For 2016, however, Rolls is now guiding to a YoY profit headwind of £650m (vs £300m on 6 July). £250m of the additional headwind is in Civil Aerospace (£100m due to lower OE & AM demand on engines for corporate & regional jets and £150m due to reduced utilization of older wide-bodied aircraft with Rolls engines), implying the EBIT margin could move to as low as 4%. The remaining £100m is in Marine due to a continued deterioration in the offshore end market, taking that division into loss making territory. As shown in Exhibit 1, applying a headwind of this magnitude to the team’s 2015 estimates would imply £717m of PBT and 29.6p of EPS for 2016, c.32% below current consensus. Download the Complete Report
î Australia – Santos – Stuart Baker, Australia Energy Analyst, downgrades Santos to equal weight from overweight as Santos has terminated the "Strategic Review" (SR) underway since August 21, 2015. One of the key objectives of the SR was to "restore value". Apart from minor asset sales, he believes nothing has emerged from the strategic review other than a deeply discounted equity issue to raise A$3bn, the effect of which is to reduce his DCF valuation from A$8.42 to A$5.78/share.In his view, the objective of restoring value remains unmet, and after testing the market for asset sales, his conviction that the equity represents a deeply discounted asset play is diminished. The Balance Sheet however, has been substantially repaired, with net debt falling to circa A$6bn following asset sales and issuance. Santos expects to have its BBB investment grade credit rating confirmed. Based on his oil price inputs, FFO/ND exceeds 35% in 2017 and improves thereafter, and is still higher than 30% when stress tested against $50 oil prices in perpetuity. Download the Complete Report
î LatAm – Brasil Foods – Jeronimo de Guzman (LatAm food & beverage analyst) is downgrading BRF shares to EW, as his previous thesis that the company’s commercial efforts could drive sales growth despite a weaker domestic consumer environment has not played out. Jeronimo’s review of consumption drivers and recent results shows that demand has been hit more acutely than expected. Competition has also been stronger than expected, with recent results showing JBS Foods outperforming BRF on both volume and pricing in domestic processed foods while increasing profitability. Valuation looks attractiveat a P/E of 16x 2016e, but reflects lower visibility. To be more positive, Jeronimo looks for more clarity on the timing and magnitude of margin recovery in Brazil and more evidence of the sustainability of international margins. Download the Complete Report
îEEMEA – Vakifbank – Sam Goodacre, EEMEA banks analyst, takes a new look at Vakifbanks provisioning profile and lifts his '16-17e EPS by 23% on lower future cost of risk. Yet 11% sustainable ROE remains meaningfully lower than cost of equity and with more upside elsewhere he reiterates his UW, increasing his PT by 35% to TL 4.20, a function of his higher earnings that drive sustainable ROE 170bps higher (+18%) to 11.0p.p. and of his higher book value. The current valuation discount to peers is 25% and below the long-run average of 33% - and despite increasing his sustainable ROE by 170bps, he still sees the relative ROE discount widening. The market may focus more on the relative returns profile, which he feels appears less attractive going forward. In short, it is lower COE that has driven the decent stock performance over the last two months, and from here on in Sam sees little earnings upgrade risk that could catalyse re-rating. Whilst his price target implies limited absolute downside (-7%) he sees more upside at peers and reiterates his relative preference for Halkbank (OW) versus Vakif (UW). Download the Complete Report
î US – Autodesk – US Software analyst, Keith Weiss, is downgrading Autodesk to a less bullish position after a recent run-up in the shares. Given an elongated subscription transition, where near-term earnings and cash flow are modest, Autodesk investors need to take a view on what the company can earn through FY22. This long duration investment thesis yields a wide range of potential scenarios (and valuations) to consider, in terms of how the transition plays out. Perhaps most importantly, to accrue the 6.8M gross subscriptions Keith forecasts in FY22, Autodesk must sell significant new functionality to both existing and new customers versus just converting existing users. For this reason, investing for growth could create more significant value over time versus significant near-term expense control initiatives. Download the Complete Report
î Europe – Media & Internet – Downgrades outweigh upgrades this quarter. Relatively poor results season in Europe. By Media standards Q3 has been a relatively poor results season. With 18 results announced so far and a few still to go, beats have safely outnumbered misses (8 vs 4). Outlook statements have a net negative balance of 2 and forecast downgrades outnumbered upgrades 4 to 3. Notably no companies have managed to combine a full house beat, outlook upgrade and forecast increase. Two combined a miss, deteriorating outlook and downgrade - Publicis and Pearson. Download the Complete Report
î China – Daqo New Energy– Shen Zhong, China Utilities Analyst, expects the price of solar polysilicon to remain subdued, given high inventories, as companies maintain high production to lower their average production cost, amid the low price environment. The current even lower price in the global polysilicon market, vs. in China, is also a headwind for price recovery in China. She significantly cuts her Daqo net profit forecast as she expects sharp ASP decline, though such should be offset partly by Daqo's rapid production cost reduction. She believes the stock price already factors in the positives of cost reduction and volume increase.She doesn’t expect polysilicon prices to recover meaningfully, which will pressure Daqo's profitability even if the company's production cost is being reduced significantly. Daqo is trading at a ~14x 2016 P/E multiple, which she thinks reflects market expectations of fast cost reduction. Daqo is also trading at a 0.6x 2016 P/B multiple, which she thinks is fair, given the 5% ROE she projects for 2016. Without any signs of a polysilicon price recovery, such as industry production cuts, inventory digestion, etc., she suggests investors await a better entry point. Download the Complete Report
î LatAm – Itau Unibanco – Jorge Kuri’s (LatAm financials analyst) investment thesis is playing out. NPL cycle has proven worse than management guidance and market consensus. ITUB has underperformed. Jorge cut EPS and target again as Brazil looks even more complex. Jorge’s new 2015 EPS estimate is US$0.98, down 12% from US$1.11 before. Jorge’s 2016 EPS estimate is now US$0.83, down 12% from US$0.95 before. And Jorge’s new 2017 EPS estimate is US$0.88, down 15% from US$1.03 before. In local currency, Jorge’s new net income estimates are down 11% in 2015, down 6% in 2016, and down 6% in 2017 versus his previous forecast. Download the Complete Report
î US – Macy’s – M’s 3Q15 earnings report was worse than many investors feared, as the company delivereda 1c EPS shortfall (56c vs. MSe 57c) driven by a -3.9% comp decline (vs. MSe -0.5%) partially offset by delayed markdowns, expense shifts, and the highest share repurchase activity since 2008. 3Q's -5.2% sales decline, the seventh consecutive top-line disappointment, and US Department Stores analyst, Kimberly Greenberger, thinks 4Q's reduced earnings outlook suggests near-term challenges could extend well into 2016. More macro factors such as warmer weather and a slowdown in tourism pose additional threats to M’s future sales growth. Kimberly’s updated PT reflects 11x her revised 2017e $4.40 EPS (vs. prior $4.50). She applies an 11x earnings multiple (vs. prior 12x) given the lack of earnings visibility, muted store traffic, and challenged fundamentals. Download the Complete Report
î LatAm – Petrobras – Operating results deteriorated sequentially, missing Bruno Montanari’s (our LatAm Oil & Gas analyst) estimates, although came in line with the consensus. But Petrobras generated a sizeable loss in 3Q15 and leverage escalated, as expected. Special items have become the norm in PBR's results and Bruno wonders if all those provisions reversals should continue to be normalized. In the past four quarters, Bruno counts 15 adjustments in his model, which feels recurring in some ways. And even with R$4.5B* added back to EBITDA, investors still saw a 10% miss vs. Bruno’s number (30% was the reported EBITDA miss). E&P disappointed on high exploration costs, while Refining was weak on lower fuel sales and higher costs. Gas & Power was the only positive surprise, with higher margins coming from the reduction of discounts. Oil prices remain low and the BRL is bound to devalue from here, deteriorating the B/S. Remain UW. Download the Complete Report