U.S. and the Americas Investment Perspectives

Transcription

MORGAN STANLEY RESEARCH
Morgan Stanley & Co. LLC
NOVEMBER 2, 2011
North
North
America
America
INVESTMENT
PERSPECTIVES
HIGHLIGHTS
19 Morgan Stanley Blue Paper:
The China Files China’s Appetite
for Protein Turns Global
Hussein Allidina et al.
29 Retail, Hardlines Cautious View —
Still in The Hangover;
SPLS Added to Best Ideas
David Gober, Cynthia Rupeka, Shaun Kolnick
39 Amazon.com
Conservative Revenue Guide,
Investment Spend Continues
Scott Devitt, Andrew Ruud, Zachary Arrick
Strategy and Economics
3
Morgan Stanley Best Ideas List
5
US Equity Strategy Materials Are Material
Adam S. Parker et al.
7
9
US Credit Strategy The Unintended
Consequences of Low Yields on Credit
17
Chetan Ahya, Derrick Kam, Jenny Zheng
19
Rizwan Hussain, Maya Abdurahmanova
Opinion Changes
US Interest Rate Strategy
Now the Hard Work Begins
21
p Downgrades
Global Cross-Asset Strategy
DM Deleveraging, EM Stressing
23
Europe Equity Strategy Latest EU policy
Initiatives Not Enough to Change Our View
Graham Secker
Dr Pepper Snapple Downgrade to Underweight
Ahead of Expected Weak 20 12 Outlook
Dara Mohsenian, Kevin Grundy, Ruma Mukerji,
Alison M. Lin
Global Equity Strategy E-Beta Cuts Both Ways
Gerard Minack
15
Bank of America Earnings Pressure,
Delayed Catalysts — Equal-weight
Betsy L. Graseck, Michael J. Cyprys
Gregory Peters et al.
13
Morgan Stanley Blue Paper: The China Files
China’s Appetite for Protein Turns Global
Hussein Allidina et al.
Jim Caron
11
Asia-Pacific Economics Why China Needs
Consumption and India Needs Investment
25
Education Managementt Corp.
Move Back to Underweight; Stock Price
Appears Disconnected from Fundamentals
Suzanne E. Stein, Thomas Allen
(continued)
Morgan Stanley does and seeks to do business with companies covered in Morgan Stanley Research. As a result,
investors should be aware that the firm may have a conflict of interest that could affect the objectivity of Morgan Stanley
Research. Investors should consider Morgan Stanley Research as only a single factor in making their investment
decision.
For analyst certification and other important disclosures, refer to the Disclosures Section.
+= Analysts employed by non-U.S. affiliates are not registered with FINRA, may not be associated persons of the member and may not be subject to
NASD/NYSE restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account.
November 2, 2011
Investment Perspectives — US and the Americas
Table of Contents (Continued)
47
Opinion Changes (continued)
27
p Downgrades
McDermott International
Lowering Estimates and Price Target, Going to
Underweight; Heightened Execution Risk
49
51
New Coverage
53
55
Autos & Auto-Related DoJ Investigations Are a
Clear and Present Overhand for Suppliers
International
Integrated Oil and Refining & Marketing
WTI-LLS Spread Should Find Support in November
57
Evan Calio, Hussein Allidina, Ben Hur, Jacob Dweck
59
61
Ann Inc. Management Meeting:
We See Compelling EPS Growth
Amazon.com Conservative Revenue Guide,
63
Scott Devitt, Andrew Ruud, Zachary Arrick
Apple China Handset Survey
Points to Surge in iPhone Growth
65
Lojas Renner
Downgrading to Equal-weight on Credit Concerns
Lore Serra, Jeronimo De Guzman, Franco T Abelardo
Cavium Networks 2008 Redux?
67
Sanjay Devgan, Sean Hazlett, Michael Kim
45
Greater China Consumer Asia Insight:
Top Picks amid Uncertainty
Angela Moh, Lillian Lou, Robert Lin
Katy L. Huberty, Jerry Liu
43
Global Hardware Technology China Handset
AlphaWise: 3G Plows Full Steam Ahead
Jasmine Lu, Tim Hsiao, Bill Lu, Navin Killa, Gary Yu,
Katy L. Huberty, Adam Holt
Kimberly C. Greenberger, Laura Ross, Jay Sole, Sharyn Uy
41
Europe Reinsurers Falling Yields Weigh on Industry;
Munich Re Is Key Pick
Maciej Wasilewicz
Company Analysis
39
Asia IC Manufacturing Asia Insight:
Foundries – Samsung vs TSMC
Bill Lu, Keon Han
Midcap Banks NIM Compression in 3Q11 Offset by
Earning Asset Growth — Group Still Looks Attractive
Ken A. Zerbe, Josh Wheeler, Jonathan Katz, Giselle Cheung
37
Walker & Dunlop Protection in a Downturn;
Head Start in a Recovery
Cheryl M. Pate, Vincent Caintic
Ravi Shanker, Adam Jonas, Yejay Ying
35
Salesforce.com Strong Transaction Growth,
Large Deals Should Pace Q3
Adam Holt, Jennifer Swanson, Jonathan Parker
Industry Analysis
33
Red Hat RHEV-ing Up the Engine with
Upcoming 3.0 Release
Adam Holt, Keith Weiss, Jonathan Parker
Retail, Hardlines Initiating with Cautious View:
Still in The Hangover — SPLS Added to Best Ideas
David Gober, Cynthia Rupeka, Shaun Kolnick
31
NuStar (NS/NSH) Modest Growth Ahead
Stephen J. Maresca, Robert S. Kad, Abdiel Santiago,
Shaan Sheikh, Brian Lasky
Ole Slorer, Igor Levi
29
Interpublic Group Late Cycle, Margin Upside
Benjamin Swinburne, Micah Nance, Hersh S. Khadilkar
Samsung Electronics
The Anatomy of the System LSI Strength
Keon Han, Young Suk Shin, Mike Chung
Freeport-McMoRan Copper Fundamentals
Still Strong; Reiterate Overweight
Paretosh Misra, Evan Kurtz, Wes Sconce, Piyush Sood
US Economic Outlook
Value
2009
2010
2011e
2012e
GDP Growth (%)
(3.5)
3.0
1.9
2.0
CPI Inflation (%)
(0.3)
1.6
3.2
1.9
e = Morgan Stanley Research estimates
2
November 2, 2011
NORTH AMERICA
Best Ideas
Best Ideas are our leading stock investment insights — the
best combination of highly differentiated research, favorable
risk-reward profiles, and clear catalysts:
corroborate our analysts' investment theses and drive a discernable change in market perceptions.
Additions and removals of stocks are published as part of
regular, stock-specific reports.
Differentiated research. We seek out-of-consensus thinking
that incorporates fresh data and analysis. Analysts are expected to identify "what's in the price" and present a compelling
challenge to market assumptions on key investment debates.
Favorable risk-reward profiles. Scenario analysis lies at the
heart of our disciplined approach to research, so we look beyond single-point estimates and price targets. We examine the
full risk-reward profile of the investment, assessing the range of
plausible outcomes and the scenario skew as indicators of
analyst conviction.
Important Note: Best Ideas is not and should not be considered a portfolio. Each investment idea is chosen based on
its own merit and without any consideration of the other investment ideas chosen. Specifically, there has been no effort
to mitigate the risks of investing in any collective group of Best
Ideas. Concepts important to a balanced portfolio, such as
negative correlation and diversification, have not been considered. Treating Best Ideas as a portfolio will subject you to
the risk of losing all or a substantial portion of your investments.
Clear catalysts. We require a clear roadmap for upcoming
data and events in the following few months that can help
Morgan Stanley Research
Stock Selection Committee
Company
Ticker
Nov 1
Price
Price($) Target
Valuations ($):
Bull Base Bear
EPS ($)*
2011 2012
Annual
Consensus
Growth
in EPS*
P/E*
EPS ($)*
2011 2012 2011-2013 2011 2012
P/B
2011 2012
Amazon.com
AMZN.O 212.11
260
330
260
152
1.96e 3.90e 1.28e 2.12e
72.3%
108.2
54.4
12.2
BorgWarner
BWA.N
73.85
88
100
88
50
4.35e 5.70e 4.41e 5.37e
23.4%
17.0
12.9
3.4
2.7
CBS Corp.
CBS.N
24.61
31
39
31
15
1.86e 2.26e 1.87e 2.23e
20.0%
13.2
10.9
1.6
1.5
CenturyLink
CTL.N
34.54
50
55
50
34
1.75e 1.87e 1.68e 1.79e
6.1%
19.7
18.5
1.0
1.0
General Motors
GM.N
23.33
45
68
45
10
4.70e 4.80e 4.28e 4.37e
14.3%
5.0
4.9
1.2
0.9
Marathon Petroleum
MPC.N
36.00
58
66
58
31
8.45e 6.59e 8.20e 6.57e (17.9%)
RenaissanceRe
RNR.N
66.50
87
100
87
60 (1.83)e 10.20e (1.79)e 8.22e
Schlumberger
SLB.N
71.13
105
160
105
46
Staples
SPLS.O
14.27
20
25
20
Teradata
TDC.N
56.75
65
81
65
Target
TGT.N
52.61
64
76
64
40
Union Pacific
UNP.N
96.83
107
115
107
78
Dividend Yield
Company
Ticker
2011
2012
9.7
4.3
5.5
1.2
1.0
NM
NM
6.5
1.1
1.0
3.71e 5.26e 3.67e 4.95e
43.1%
19.2
13.5
2.8
2.5
12
1.37e 1.53e 1.39e 1.53e
12.9%
10.4
9.3
1.6
1.5
44
2.26e 2.54e 2.26e 2.59e
15.5%
25.1
22.3
6.3
5.0
4.22e 4.22e 4.23e 4.34e
7.8%
12.5
12.5
2.4
2.3
6.52e 7.90e 6.53e 7.77e
18.5%
14.9
12.3
2.4
2.2
FCF Yield Ratio
2011
2012
RNOA
2011
2012
Net Debt/EBITDA
2011
2012
Interest Cover
2011
2012
Amazon.com
AMZN.O
–
–
1.2%
2.1%
(25.8%)e
(77.8%)e
NM
NM
NM
(42.5)e
BorgWarner
BWA.N
0.1%
0.0%
2.4%
2.6%
16.4%e
21.6%e
0.2e
NM
14.1e
21.3e
CBS Corp.
CBS.N
0.6%
0.9%
5.1%
5.9%
9.1%e
10.5%e
2.2e
1.8e
5.9e
6.9e
CenturyLink
CTL.N
9.0%
9.2%
17.5%
19.1%
4.7%e
5.1%e
2.2e
1.9e
2.4e
2.6e
(30.0)e
General Motors
GM.N
0.0%
0.0%
6.2%
18.2%
11.5%e
9.0%e
1.7e
1.1e
(48.5)e
Marathon Petroleum
MPC.N
1.3%
2.6%
17.4%
20.6%
22.0%e
18.7%e
0.3e
NM
NM
NM
RenaissanceRe
RNR.N
1.6%
1.7%
0.6%e
16.1%e
30.5e
1.4e
0.5e
12.5e
Schlumberger
SLB.N
1.2%
1.4%
1.3%
3.9%
13.6%e
17.0%e
0.7e
0.5e
23.3e
27.1e
Staples
SPLS.O
2.9%
3.2%
8.0%
10.3%
12.5%e
12.9%e
1.7e
1.5e
4.5e
4.8e
Teradata
TDC.N
–
–
3.1%
3.6%
89.5%e
40.8%e
NM
NM
NM
NM
Target
TGT.N
1.9%
2.1%
1.8%
21.7%
10.8%e
9.1%e
2.6e
1.9e
5.8e
5.9e
Union Pacific
UNP.N
1.2%
1.5%
3.8%
3.6%
12.8%e
14.2%e
1.5e
1.3e
7.0e
8.1e
* Uses consensus methodology; all other metrics use ModelWare methodology. For valuation methodology and risks associated with any price targets above,
please email morganstanley.research@morganstanley.com with a request for valuation methodology and risks on a particular stock.
3
November 2, 2011
NORTH AMERICA
Best Ideas
Research Updates on Best Ideas
Amazon.com (AMZN, $212.11, Overweight, Attractive Industry view)
Scott Devitt
The company continues to innovate with a focus on future profit pools, not yesterday’s. Our key takeaways from CQ3:11 are
that global macro and consumer spending pressures could make CQ4 tough, Amazon.com continues to invest in its business. We
believe continued investment in fulfillment centers and Amazon Prime penetration will payoff in sustainable, profitable growth. AMZN
remains our preferred way to play the global secular transition from offline retail to online eCommerce.
See page 39
BorgWarner (BWA, $73.85, Overweight, Attractive Industry view)
Ravi Shanker
BorgWarner not yet associated with DoJ investigations related to suppliers. Recent antitrust investigations of several suppliers
could carry a significant overhang in the medium term. Although at this time we are not modeling any negative outcomes for suppliers
involved, we prefer shares of suppliers such as BorgWarner that have not yet been associated with these investigations.
See page 31
General Motors (GM, $33.33, Overweight, Attractive Industry view)
Adam Jonas
October sales data: A gentle dose of reality. A first look at GM’s US October sales data shows negative surprises in terms of
volume, mix and inventory. Pricing was decent, in our view. The company expects total industry sales for October that implies a 13.4
million unit light vehicle SAAR, in line with consensus expectations and our 13.3 million forecast. October’s result is a gentle dose of
reality that GM must give back some of the share it had borrowed from competitors.
See “GM Gives Back Some Share, Days' Supply at 2.5-yr High”, November 1, 2011
Marathon Petroleum (MPC, $36, Overweight, Attractive Industry view)
Evan Calio
We’re buyers of MPC on weakness. The spread between West Texas Intermediate (WTI) and Louisiana Light Sweet (LLS) crude
oil prices has narrowed by $7 to $21/bbl in the last 2 days, pulling Mid-continental refiners’ share prices down ~12% over that period.
We believe that Cushing storage will resume filling for the entire month of November, leading crack spreads to expand in 4Q (due to
critically low inventories), and consequently 3Q EPS beats and 4Q11 raises that should drive the group higher.
See page 33
3Q EPS beat Street estimates and we see more catalysts into year end. We expect MPC to continue to outperform into year-end as
the stronger simple cracks, 3Q11 beats translate into 4Q11/2012 positive EPS revisions, wider heavy sour differentials and a stabilizing $15-20/bbl WTI LLS differential benefit MPC’s already strong cash balance sheet.
See “3Q11 Big EPS Beat: $3.16/sh and $8.28/sh Gross Cash”, November 1, 2011
Staples (SPLS, $14.27, Overweight, Cautious Industry view)
David Gober
SPLS — Initiating coverage at Overweight, stock added to Best Ideas list. Our work indicates that office-supplies shares imply
long-term earnings declines, but based on our AlphaWise survey, we estimate 2-3% revenue growth. This expected growth drives our
Overweight rating on SPLS the most stable player and industry leader.
See page 29
Target (TGT, $52.61, Overweight, In-Line Industry view)
Mark Wiltamuth
Target announced that CFO Doug Scovanner will retire on March 31, 2012. Target has not announced a replacement yet. We
are confident that the company will be able to attract another strong CFO, but this news will likely be met with some nervousness by
investors who are focused on a timely and smooth start to Target Canada in 2013 and a balance sheet reset following the planned
credit card sale slated for late this year/early next year.
See “Quick Comment: CFO Retirement a Loss”, November 1, 2011
4
November 2, 2011
October 30, 2011
US Equity Strategy
Materials Are Material
Adam S. Parker, Ph.D.
Adam.Parker@morganstanley.com
Brian T. Hayes, Antonio Ortega, Adam
Gould, Phillip Neuhart
More balanced view of materials. We have been underweight materials due to concerns over estimate achievability,
particularly margin expectations. However, modestly improving economic data in the US, lower incremental margin estimates, and valuations now in the cheapest quintile vs. history
have caused us to become more neutral than negative. Balance sheets are vastly improved from the greater than 100%
net debt-to-equity the sector had in 2003, although inventory
levels compared to sales are becoming a modest impediment,
more so in metals than chemicals. We are not shifting to
overweight because, while improved, estimate achievability
remains low compared to our top-down estimate. Because
materials represent only 3.5% of the S&P 500, we have not
written a sector-specific note this year, but with higher relevance globally and in advance of the Morgan Stanley Materials
conference on November 17th in New York, we address the key
issues in today’s work.
Stock selection in materials. Within materials, we favor
higher-quality names, which have historically outperformed
during risk-averse periods. In fact, the quality-junk spread is far
wider in materials than it is in the broader market. With the
market rewarding high quality over low quality during EPS
season, this is an important focus. Valuation-based metrics,
inventory, and sales stability are the most effective metrics for
picking stocks within materials.
Commodities vs. commodity equities: Several investors
have asked us about these relationships, and we address
these for FCX, NEM, DD, DOW, and MON (see discussion in
our full note). Commodities outside of gold have generally
become more correlated with the important equities. Further,
materials stocks have become more correlated with each other
and with the broader market. With betas well above one and
very high volatility recently, diversifying exposures is important,
as in the end materials are a levered beta on China demand.
NEM, CF, ECL, SHW are stocks with low correlation to others
in the sector.
Since the middle of the year, the materials sector has
underperformed the broader market, even after accounting
for its recent rally (Exhibit 1). The materials sector constitutes a
small percentage of the S&P 500, about 3.5% based on market
capitalization. However, the sector represents a much greater
weight in Europe and Asia (Exhibit 2), where materials are
9.8% and 11.2% of the market capitalization, respectively. So
this is more of a global China demand story outside of the US
from the point of view of a US portfolio manager.
Exhibit 1
Materials Have Underperformed Since Mid-Year
1.02
S&P 500 Materials Sector Relative Performance
Indexed to July 1, 2011
1.00
0.98
0.96
0.94
0.92
0.90
0.88
0.86
Jul-11
Aug-11
Sep-11
Oct-11
Source: Factset, Morgan Stanley Research
Exhibit 2
Materials Has a Smaller Weight in the US versus Other
Regions
Materials Sector Weights
As of October 2011
15%
11.2%
9.8%
10%
5%
3.5%
0%
S&P 500
Europe
Asia
Incremental margin expectations trending down. We believe the incremental margin expectations for Materials are still
too high, but the good news is they are not as inflated as they
were six months ago before the sharp sell-off. The 2012 incremental margin expectations from the bottom-up consensus
forecasts for materials peaked in April and have trended lower
since that time (Exhibit 3). We view this as a positive, as the
EPS expectations should be more achievable today than they
were earlier in the year (even if they are still too high). The
sector’s 2012 incremental margins are expected to modestly
contract to 16.9% from 18.7% in 2011.
5
November 2, 2011
Exhibit 3
Exhibit 5
Incremental Margins Within Materials Have Trended Lower
Since the Second Quarter
Materials Names Favored by Our Quantitative
Models
Q1 or Q2 in MOST and BEST
Materials: 2012 Incremental Margins
and Overweight or Not Rated
60%
50%
40%
30%
20%
10%
Jan-11
Mar-11
May-11
Jul-11
Sep-11
Quality matters in the materials sector. During risk-averse
regimes, high-quality materials names strongly outperform junk
(Exhibit 4). We used our proprietary framework for classifying
stocks on a quality spectrum, and the performance difference
between quality and junk is even more pronounced within
materials than the broader market. So paying attention to
quality really matters in this group.
Ticker
DOW
LYB
AA
CF
VMC
ASH
UFS
HUN
WLK
GEF
CDE
CYT
CBT
SOA
HL
FUL
MTX
SWC
OMG
Name
Dow Chemical Co.
LyondellBasell Industries N.V. Cl A
Alcoa Inc.
CF Industries Holdings Inc.
Vulcan Materials Co.
Ashland Inc.
Domtar Corp.
Huntsman Corp.
Westlake Chemical Corp.
Greif Inc. Cl A
Coeur d'Alene Mines Corp.
Cytec Industries Inc.
Cabot Corp.
Solutia Inc.
Hecla Mining Co.
H.B. Fuller Co.
Minerals Technologies Inc.
Stillwater Mining Co.
OM Group Inc.
Model Quintile
MOST
BEST
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q2
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q1
Q2
Q1
Q2
Q1
Q1
Q1
Q2
Q2
Q2
Q1
Q1
Q1
Q2
Q1
Q1
Q1
Q2
Q1
Q1
Quality
Ranking
4
1
4
3
4
4
4
4
3
3
4
4
4
4
4
3
2
4
4
Source: Factset, Morgan Stanley Research.
Exhibit 6
Materials Names Disfavored by Our Quantitative Models
Q4 or Q5 in MOST and BEST
and Underweight, Equal-Weight or Not Rated
Exhibit 4
Higher Quality Materials Equities Outperform During Risk
Aversion
12%
Materials Sector Quality-Junk Annualized Return Spread
During Risk Seeking and Risk Aversion
1980 Through October 2011
10.2%
10%
8%
6%
4%
2%
0%
(2%)
(1.9%)
(4%)
Ticker
PX
PPG
BLL
RGLD
ANV
SMG
SON
TIE
PKG
CRS
ARJ
GSM
BCPC
SWM
IPHS
CCC
CLW
Name
Praxair Inc.
PPG Industries Inc.
Ball Corp.
Royal Gold Inc.
Allied Nevada Gold Corp.
Scotts Miracle-Gro Co.
Sonoco Products Co.
Titanium Metals Corp.
Packaging Corp. of America
Carpenter Technology Corp.
Arch Chemicals Inc
Globe Specialty Metals Inc.
Balchem Corp.
Schweitzer-Mauduit International Inc.
Innophos Holdings Inc.
Calgon Carbon Corp.
Clearwater Paper Corp.
Model Quintile
MOST
BEST
Q5
Q5
Q5
Q4
Q4
Q4
Q4
Q5
Q5
Q5
Q4
Q4
Q4
Q4
Q5
Q4
Q5
Q5
Q4
Q5
Q5
Q5
Q4
Q5
Q5
Q5
Q4
Q5
Q5
Q4
Q4
Q5
Q5
Q5
Quality
Ranking
1
2
2
3
3
3
1
4
3
3
3
3
1
3
3
4
4
Source: Factset, Morgan Stanley Research.
Risk Aversion
Risk Seeking
Stock Screens
Exhibit 5 lists materials companies rated Q1 or Q2 in our MOST
(3-month) and BEST (24-month) alpha models, and that are
either rated Overweight or not covered by our analysts. Exhibit
6 is a screen of companies rated Q4 or Q5 by BEST and
MOST, and rated Underweight, Equal-weight or not covered by
our analysts.
Changes to the MOST Alpha Portfolio – This week, we are
removing Albemarle (ALB, $55) and adding LyondellBasell
(LYB, $34) and Halliburton (HAL, $39) to the portfolio. We are
overweight utilities, health care, and staples. Our underweight
sectors are discretionary and industrials.
6
November 2, 2011
October 28, 2011
US Credit Strategy
The Unintended Consequences of
Low Yields on Credit
Rizwan Hussain
Rizwan.Hussain@morganstanley.com
Maya Abdurahmanova, CFA
about 15 bp at the long end of the Treasury yield curve. Following the announcement stocks rallied, rising 8% by July and
16% by year-end, while corporate credit spreads were much
more volatile and lagged the move in equities, at least in the
initial few months. Arguably, Operation Twist was much
smaller in nominal terms than today’s program; however, when
compared with GDP or the size of the Treasury market at the
time, it is comparable enough to draw parallels between the
Fed’s two actions and their impact on the risky assets.
Maya.Abdurahmanova@morganstanley.com
Why the ‘underperformance’? Credit investors are frustrated by the sense that credit recovery has been slower relative to other risk assets. While there may be many possible
drivers, we believe low risk-free yields present some ‘unintended consequences’ that have left investment-grade credit
as a laggard, in particular. We delineate here related challenges presented by low nominal yields to investment grade,
despite our generally constructive view on credit spreads (for
details see our October 28 Credit Basis Report). For most cash
bond investors, yields and spreads are not two separate
propositions, and hence, yields matter as well.
Consequence #1: Policy pushing investors out the risk
curve, skipping over IG credit. Recently risk markets have
vacillated between fear and greed with each emerging headline, here and abroad. But what has been critically missing is a
sense of fiscal and monetary policy working hand-in-hand.
Lately, investors have finally gotten a sense of coordinated
action from news of actionable steps to stem the European
debt crisis, hints from Fed officials of potential moves that
would qualify as QE3, announced modifications around the
Home Affordable Refinance Program (HARP), and a more
unified voice across the aisles in Washington.
Looking further out the risk curve, as we highlight in Exhibit 1,
the differential between high-grade bond yields and the dividend yield on the S&P 500 is now as low as it has ever been.
With companies themselves now acknowledging a slower
organic growth environment post-crisis, and equity investors
also expecting to be compensated increasingly through income, beyond price appreciation derived from earnings growth
and multiple expansion, dividend-rich stocks could provide an
increasing allure for some bond investors as well. Our US
equity strategist Adam Parker recently identified a list of companies with sustainable dividend yields between 3% and 6%
(Dividend Yield Will Rise: One Way or Another, September
18), and we suspect many bond investors are performing a
similar look across the equity-credit divide.
Exhibit 1
Compressing Differential Between Bond Yields and Dividend Yields Favoring an Allocation Shift?
%
12.0
9.0
6.0
3.0
However, more pointedly, through quantitative easing the Fed
is essentially attempting to force investors out of the safety of
Treasuries, while also driving inflation expectations higher.
That results in the potential for negative real yields on Treasuries in the extreme, and less than palatable real yields on
other high-quality spread products, such as IG corporates.
There are parallels between the Fed’s Treasury purchase
program today and its precedent known as Operation Twist in
1961. Similar to today’s program, the original Operation Twist
was aimed at lowering interest rates to stimulate the weak
economy and involved large purchases of longer-term Treasury securities by selling (or issuing in the case of QE2) of
shorter-term government liabilities. The program announced
by the Fed in February 1961 resulted in a cumulative drop of
0.0
1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011
IG Corp YTM - SPX Div Yield
US IG Corp YTM
SPX Div Yield
Source: Morgan Stanley, Bloomberg, the Yield Book
Consequence #2: Spreads remain tied to high rate volatility. While ongoing developments in Europe remain the primary
driver of sentiment and US credit spreads of late, views on rate
volatility explain much of the moves in credit over a longer
period as well. Rising rate volatility and expectations thereof
have historically resulted in wider spreads, and vice versa. So
while Treasury yields are off their recent lows, the continued
outsized volatility in a normally sleepy corner of the bond
markets may be another factor keeping spreads wider than
would otherwise prevail in a lower volatility world. Credit investors are demanding compensation not only for equity
7
November 2, 2011
S&P 500 Corporate Pension Funding Status at New Lows
140%
130%
120%
110%
100%
90%
80%
To be clear, we do not envision a 2006-style releveraging of
Corporate America by any means, as corporate fiscal conservatism is likely to reign as long as growth remains subpar.
But tweaks to favor equity investors over bondholders could
play out through 4Q and into 2012, should financial market
volatility subside from current levels and management teams
look to bolster equity returns through some financial leverage
given diminishing operating leverage.
9.0
70%
60%
8.0
7.0
6.0
5.0
4.0
Funded Status
Consequence #4: Fuel for reigniting shareholder focus.
One consensus view coming into this year was a pending great
migration from bonds to equities in investor portfolios, as the
end of QE2 and sustained growth through 2011 would provide
the tailwind for such an asset allocation shift. As it often does,
the actual market outcome resulted in the pain trade for most,
with growth now challenged and Treasury yields touching new
lows a few weeks ago. But now a budding concern should be
whether or not issuers will sell bonds at these low yields to buy
stocks (their own or those of acquisition targets), accelerating a
move to shareholder-friendly activity and other capital-structure
management.
10.0
81%
88%
89%
91%
98%
105%
77%
82%
84%
71%
Meanwhile, the proposed HARP changes announced on October 24 may offer another example of how NIMs could compress through policy action. However, the consequences for
banks could actually be less problematic, given any forthcoming (and yet to be formally detailed) agreements regarding
‘representation and warranties’ litigation pending against the
banks. As our large-cap US banks analysts noted, should
there be waivers/elimination of these claims by the Federal
Housing Finance Agency, the immediate impact would be a net
positive, while the medium term would be negative with higher
prepay speeds lowering NII. Long-term effects, however,
would be positive.
Exhibit 2
116%
117%
116%
119%
106%
109%
105%
100%
103%
103%
110%
116%
112%
129%
121%
100%
Consequence #3: A challenge to banks – less NIM, but
don’t blame ‘HARP 2.0’ yet. With short-end yields effectively
pegged to near zero, and various forms of QE driving long-term
rates lower as well, banks and other investors have seen net
interest margins (NIM) and net interest income (NII) shrink at a
time when the industry is facing additional challenges of
weaker economic growth, slower loan growth and credit improvement, regulatory uncertainty, and credit rating downgrades. This has implications for both equity and credit investors, with equity investors seeing the earnings shortfall, and
credit investors seeing less retained earnings to bolster the
capital position of the banking industry.
Consequence #5: Problems for the pension funds. A
well-publicized challenge presented by low fixed income yields
today is the effect they are having on ‘savers’ of all sorts.
Institutional and corporate pension plans are the most relevant
example, with challenges both on the asset and liability sides
resulting from low bond yields. As we show in Exhibit 2, the
move lower in stocks through 3Q and falling bond yields have
fully reversed the progress made since 2008 (and then some)
in narrowing the funding gap of S&P 500 corporate pension
plans. Earlier this year, as average plan status rose closer to
100%, managers were looking to pare equity exposure and
immunize liabilities by purchasing high-quality fixed income.
Liability-driven investment (LDI) flows and mandates were all the
rage in high-grade corporates, driving a significant flattening of
long-dated credit spread curves, as spreads rallied overall.
19
8
19 6
8
19 7
8
19 8
8
19 9
9
19 0
9
19 1
9
19 2
9
19 3
94
19
9
19 5
9
19 6
9
19 7
9
19 8
9
20 9
0
20 0
0
20 1
0
20 2
0
20 3
0
20 4
0
20 5
0
20 6
0
20 7
0
20 8
0
9/ 20 9
20 10
11
E
market volatility, but also for underlying risk-free yield volatility.
So, in truth, it is not just low yields today that are problematic –
volatility of those yields matters as well.
Citigroup 20-year discount rate (year-end)
Source: Morgan Stanley Global Capital Markets & Pension and Endowments Coverage
Groups
Today, closing the gap through investing in bonds will be much
more challenging. On the investment side, we do see plan
sponsors looking for ways to leverage expectations of a continued
low-default environment. However, if a quick reversal in equities
to new highs and a spike higher in fixed income yields do not
result, we expect to see more debt issuance through to 2012 to
raise cash in plugging pension funding gaps.
Low yields, stiff headwinds. Each consequence noted
above (and others not addressed) could serve as a standalone
research topic. In the weeks to come, we plan to detail some of
the challenges unique to today’s low-yield environment in
greater detail, and to explore how they are presenting headwinds for IG credit spreads. But here we acknowledge that,
while the recovery in credit spreads has been disappointing
relative to equities, the issue of historically low yields is certainly among many factors at the heart of the matter.
8
November 2, 2011
October 27, 2011
US Interest Rate Strategy
Now the Hard Work Begins
Jim Caron
Jim.Caron@morganstanley.com
x
Risk premiums may rise in November after falling in
October, because the US fiscal debate begins in the next
few weeks.
x
What’s in the price? US front-end forward rates have
cheapened and do not fully reflect this risk. We view
owning front-end forward rates as the most efficient way to
hedge against a rise in risk premiums and protect October
gains.
x
Receiving 3y1y rates is an optimal way to express this
view as it provides a rolldown cushion of 22 basis points
over three months.
As a result, we are looking to enter trades that will benefit if they
do.
A looming fiscal tightening in the US. In Exhibit 1, we see
that, although risk premiums have fallen from extreme levels,
they remain high. As a result, we do not think the Fed will stop
trying to add monetary accommodation any time soon. Furthermore, in advance of supercommittee activity, we think the
market will start to price an increased probability of a reduction
in fiscal stimulus by the start of 2012, the impact of which will be
immediate in some cases. For example, one of the topics the
committee will address is extending the payroll tax cut. If the
cut is not extended, this would result in an immediate 2% rise in
payroll taxes in the first paychecks in January. This looming
fiscal tightening will hang heavily over the markets.
Exhibit 1
Risk Premiums Could Rise in November
12-month Rolling Z-Score
3.0
Sep. 2011: SPX 1160; 10y Real 0.12%
2.0
x
Entering forward curve steepeners is a lower-beta
expression of this view. 3y1s10s and 3y2s10s are most
attractive.
As we head into November, the optimism from October may fall
away and markets will have to justify the favorable price adjustments that came as a result of falling risk premiums (Exhibit
1). We recommend owning front-end forward rates to hedge
this risk and protect gains made in October.
Catalysts for rising risk premiums in November. Risk
premiums fell sharply in October due to positive surprises,
namely stronger than expected US economic data and progress made by policy makers in Europe. But this may change
in the weeks ahead. In the US, there are three conflicts that
need to be resolved, all related to federal spending. First, the
budget for fiscal 2012 – which began October 1 – still needs to
be determined. Second, the special deficit-reduction committee (the “supercommittee”) is meeting to try to find $1.2 trillion
in savings over the next 10 years. And third, President
Obama’s $447 billion stimulus plan, which is a mix of spending,
tax increases and cuts, will be debated.
The risk is that we see a replay of the debt-ceiling debate with
the same effects on the US economy. Also, European policy
makers will be expected to ‘ante up’ a more detailed plan
deemed credible by the markets to effectively address the
crisis in Europe. They will no longer get credit for meetings.
These events could cause risk premiums to rise once again.
1.0
Oct.
0.0
-1.0
-2.0
-3.0
Jan-98
Feb. 2011: SPX 1340; 10y Real 1.34%
Jan-00
Jan-02
Jan-04
Jan-06
Jan-08
Jan-10
The equity risk premium is calculated by assuming that the market is fairly valued at each time
point and that the ROE reverts-to-mean in a three-stage DDM. The idea is for this equity risk
premium to represent the spread over Treasuries at which you need to discount the expected
future equity cash flows of the index to get to the current market value (see Capital Structure
Insights, Nov. 16, 2006). Source: Morgan Stanley
Another point of debate exists outside the supercommittee, but
is still related. On November 18, the US government runs out
of funding and a Continuing Resolution needs to be passed by
Congress to fund the government and avoid a shutdown. We
do not expect this to create the same level of anxiety we saw
during the debt-ceiling debate in August because the supercommitee will be reporting just 5 days later, on Nov. 23, with a
goal of cutting spending by $1.2 trillion over the next 10 years.
It will nevertheless remain a market concern. August’s weak
economic data make it pretty clear that markets do not like
ambiguity from Washington, which increases the risk of weak
economic data in November. And with Congress required to
act on the supercommittee’s proposal by Dec. 23, the likelihood
of negative headlines in the middle of the holiday shopping
season means that December data may be at risk too.
9
November 2, 2011
Buy front-end forward rates to hedge against rising risk
premiums. Adding it all up, we think risk premiums may rise or
at least stop falling in November. As we see it, the time is ripe
to re-enter trades consistent with our longer-term themes of
rolldown and carry. November may remind us of the serious
risks the US economy still faces and that front-end interest
rates may stay lower for longer, even beyond June 2013, the
date through which the Fed said it planned to keep rates unchanged. Owning front-end forward rates looks attractive to
us.
The US 3y1y point stands out most. Based on our term
structure of 1y forward rates, the curve segment between US
3y1y and 2y1y is steepest and therefore the rolldown advantage of owning the 3y1y point is most attractive, with 22 bp of
rolldown over 3 months (Exhibit 3). So, for those who track the
1y forward term structure as a metric for gauging risk premiums, and if one believes that risk premiums may rise, we
recommend receiving 3y1y rates. Effectively, we think a lot of
good news is already in the price for the 3y1y point, and 22bps
of rolldown provides a sizeable cushion in the event rates rise.
One way we measure macro risk premiums in the rates market
is by analyzing the change in the slope of the front-end forward
rate curves. The premise of this analysis is that a steepening in
the slope of the front-end forward curve represents a lowering
of risk premiums because rising front-end forward rates tend to
be correlated with central bank rate hike expectations that
come in times of economic strength. Of course, there are
nuances to this metric that must be taken into account, such as
the Fed’s pledge to keep rates low until mid-2013.
Exhibit 3
In Exhibit 2, we show the shape of a term structure of 1-year
rates from spot out to 5 years. The US forward curve is roughly
flat out to 1y1y but then starts to steepen. A more relevant
observation is the change in the steepening of the curve
starting at the 2y1y compared to where it was a month ago.
This is consistent with our view that the change in steepness
represents a decline is risk premiums during October, which we
illustrated in Exhibit 1.
The 3y1y point also stands out in the UK. In Exhibit 3, we
list the top five rolldown trades in the US and for Europe and
the UK as well. We illustrate the non-US points because there
is considerable focus on Europe and UK central bank policy
and what the path of front-end rates may be. Given that central
bank policy may remain accommodative for longer in Europe
and the UK, receiving front-end forward rates looks attractive to
us there as well.
Exhibit 2
Enter forward curve steepeners. One of our base case
assumptions is that the Fed is trying to increase inflation expectations in order to reflate asset prices and ease financial
conditions (Keeping It Real, October 20, 2011). This is why we
believe real rates will outperform, especially in the back end.
Thus it follows that rising inflation expectations may also buoy
back-end forward rates relative to front-end forwards. Not
surprisingly, 3y1s10s and 3y2s10s steepeners also look most
attractive and are a lower-beta way to position for front-end
forward rates to outperform.
Term Structure of 1y Forward Rates
Rates (%)
3.50
3.00
Kink at 1y1y point
for all curves...
… and steepening
thereafter
2.50
2.00
1.50
1.00
Top Rolldown Trades: US, Europe & UK
Top 5 US Forward
US Rates
US 3y1y
US 3y2y
US 2y2y
US 2y3y
US 3y3y
3-month
Rolldown (bps)
22.0
18.8
18.4
17.4
16.1
Top 5 Eur/UK
Eur/UK Rates
UK 3y1y
UK 3y2y
EU 2y1y
UK 0y1y
UK 3y3y
3-month
Rolldown (bps)
13.2
12.5
12.2
12.1
11.9
Source: Morgan Stanley
0.50
0.00
spot
6m1y
US as of Sep 30
1y1y
EUR
2y1y
3y1y
UK
4y1y
5y1y
US as of Oct 27
Source: Morgan Stanley
10
November 2, 2011
November 1, 2011
DM Deleveraging, EM Stressing
Gregory Peters
Greg.Peters@morganstanley.com
Neil McLeish, Gerard Minack, Jason Draho
Investors face a multi-year global deleveraging cycle
fraught with numerous negative feedback loops. Unfortunately, developed markets are the epicenter of this deleveraging, and they face a long, difficult road to economic recovery as a result. Consequently, one of the negative feedback loops that investors must contend with is how DM deleveraging affects the emerging-market growth engine over the
medium term. Eurozone banks are at center stage in this
current deleveraging phase. In their urgency to shrink balance
sheets and recapitalize, European banks are likely to reduce
balance sheet/investment — and disproportionately, their EM
asset exposure. This is far from the EM/DM decoupling thesis
that many market players have espoused. In particular, we
believe that investors have not properly calibrated the intensity
of the negative feedback loop between DM and EM via the
ever-important funding channel.
Eurozone bank deleveraging not only exacerbates EM
funding market stress, but also could impair EM growth.
These markets were already stressed because of the systemic
risks posed by the Eurozone debt crisis and were the primary
driver of EM currency weakness in September (Exhibit 1).
What worries us is that the prospect of EM asset sales and
capital withdrawal can only add to the pre-existing stress.
Indeed, even an orderly balance-sheet reduction creates potential problems.
Exhibit 1
EM Funding Market Stress and Currency Weakness
Tracked Closely the Past Two Months
40
35
92
To understand why the emerging markets are especially vulnerable to European bank deleveraging, some numbers may
help. Western European banks have roughly $35 trillion in
assets. Of that total, the lending exposure to the US and EM is
about equal at $3.7–3.8 trillion. But the situation was quite
different pre-financial crisis, when US assets were double that
of EM (Exhibit 2) . This convergence happened because of a
fall in US exposure, while lending to EM grew almost 300%
between March 2000 and March 2008.
European Banks Now Lend as Much to EM as the US
6000
European Bank Lending to the US, EM (USD Bn)
94
30
96
25
98
20
100
15
102
104
10
5000
US
4000
3000
EM
2000
106
5
0
Sep-09
The DM-to-EM feedback loop consists of four stages. The
first is the likely deleveraging by Eurozone banks. This could
approach €2 trillion, with a large chunk (over €500 billion)
coming at the expense of EM. The second stage is the potential impact on EM. This stage depends on the financial interconnections via DM, which have grown sharply in the past
decade, and the vulnerability to an external funding withdrawal.
The latter depends on the third stage in the loop, which is the
potential EM policy response — monetary, fiscal, and otherwise — to the deleveraging. While EM officials have some
policy flexibility, their hands are not as free as in 2008, or even
last year. The last stage is calibrating the negative impact on
EM flows back into DM. As the main engine of global growth,
any slowdown would be an additional headwind for the already
fragile DM recovery.
Exhibit 2
90
MS Funding Stress Index (left)
EM FX (inverted, right)
Given that many emerging economies still rely heavily on
US-dollar funding and credit extension from DM banks, any
contraction of credit is a headwind at a time when EM growth is
already slowing. Of course, not all EM economies are equally
at risk; we believe central and eastern European countries are
the most vulnerable. Yet, it is unlikely that more than a scant
few EM countries would get by entirely unscathed either. Our
EM strategy team doesn’t see a more durable recovery in EM
risk markets until there is a meaningful easing in funding and
financial market stress (see Global EM Investor: Banking on a
Solution, October 21).
108
110
Jan-10
May-10
Sep-10
Source: Bloomberg, Morgan Stanley Research
Jan-11
May-11
Sep-11
1000
0
Mar-00
Mar-02
Mar-04
Mar-06
Mar-08
Mar-10
Source: Bloomberg, IMM, Morgan Stanley Research
11
November 2, 2011
This rapid credit growth in EM, while it was already falling in the
US, suggests that non-core assets in EM are especially vulnerable to European bank deleveraging. Domestic political
pressure in Europe will make it difficult for the banks to reduce
lending to their own domestic consumers and small and medium-size enterprises when growth is already so weak. The
financial crisis provides a guide for how large the EM asset
reduction could possibly be. For example, European banks
reduced total lending to EM economies by 20%, or about €500
billion, between March 2008 and June 2009. That amount,
coupled with the €1 trillion in assets expected to roll off, is a
rough range of the expected EM capital withdrawal impact.
Far from decoupling, EM and DM financial interconnections are greater than ever. The major sell-off in EM currencies in September, and the fact that EM equities have
lagged DM stocks for quite some time, seemingly refutes the
claim that EM markets have decoupled from DM (or the beta
has dramatically lessened). In fact, EM and DM are arguably
more integrated than ever, both on trade and financial linkages.
On the latter, EM gross foreign assets and liabilities, measured
as a percentage of GDP, have resumed their rapid growth after
a sharp decline during the financial crisis. Moreover, EM collectively runs a negative net foreign asset position, with the
Asia-Pacific region being the exception. In other words, most
emerging economies still rely on funding from DM. Importantly,
this external funding need is present whether or not a country
has a current account surplus.
Exhibit 3
EM External Funding Needs Total €1.5 Trillion on a
12-Month Rolling Basis (€bn)
Clearly, the risk that credit becomes more scarce and expensive in EM threatens growth projections, which are already
slowing. Domestic production, measured by PMIs, is falling
across all regions, and external demand, measured by export
growth rate, has slowed to a crawl. What effect deleveraging
will have on EM growth depends on not only how and where
European banks choose to sell assets, but also the policy
response, and that varies by country.
Investment implications — more reasons for caution. The
potential negative feedback loop between European bank
deleveraging and EM is another reason to remain cautious on
risk assets, in our view. The magnitude of deleveraging via EM
and the sensitivity of EM growth and financial market stress are
uncertain. But “EM” is a broad term that masks considerable
diversity, and thus vulnerability, across these countries. Below
we highlight the main investment themes stemming from the
DM-EM deleveraging feedback loop:
x On a regional basis within EM, we would strategically underweight assets in Central/Eastern Europe relative to
Asia-Pacific, given the high exposure of the former region to
European banks.
61
Argentina
Brazil
Chile
Colombia
Mexico
Peru
Poland
Czech
Hungary
Romania
Russia
Turkey
Israel
South Africa
Egypt
India
China
Korea
Malaysia
Thailand
Indonesia
Philippines
AXJ
CEEMEA
Latin America
Coming full circle — feedback loop back to DM. Slower EM
growth stemming from European bank deleveraging in turn has
negative implications for DM, thus completing the feedback
loop. Our economists estimate that about 80% of global GDP
growth in 2012 will be due to EM. Hence, any slowdown there
has outsized effects, as exports to EM are one of the few engines of growth for DM. This is a key point about the deleveraging and balance-sheet retrenchment in developed
economies, as the real risk is to economic growth due to credit
contraction and asset price deflation, not just in DM, which is
well known, but also in EM, which isn’t.
153
31
15
x Among EM assets, currencies are the most at risk to deleveraging because of the potential stress in the funding markets
and the risk of capital flight. Our EM strategy team suggests
going long the US dollar vs. the currencies of Hungary, the
Czech Republic and Poland as CEE economies and banks
have the most relative exposure to European banks.
84
8
100
42
46
29
26
205
53
38
x Sovereign spreads could widen as investors liquidate or
hedge positions and price in the contingent liability risk of the
government having to support domestic banks if funding is
withdrawn. We discuss the potential credit impact due to the
contingent liability in our Cross-Asset Navigator of November 1
(see the full report for details on the topics covered here).
11
122
142
145
7
36
43
3
499
549
352
0
100
200
300
400
500
600
12
November 2, 2011
October 28, 2011
Global Equity Strategy
E-Beta Cuts Both Ways
Gerard Minack
Profits always improve faster than GDP in a recovery, but in
this cycle the outperformance was unprecedented. Exhibit 4
shows the four-quarter dollar change in total US incomes, with
Gerard.Minack@morganstanley.com
6
GDP
5
30
P RO FI T S (RH S )
25
2014
2010
2006
2002
1998
1994
1990
1986
1982
1978
0
1974
0
1970
5
1966
10
1
1962
15
2
1958
3
1954
20
1950
4
STANDARD DEVIATION
35
* ROLLING 5 YEAR STANDARD DEVIATION OF 4QTR %
CHANGE IN REAL GDP AND DOMESTIC NIPA PROFITS
Source: BEA, Morgan Stanley Research
Exhibit 2
Earnings’ Rising Macro Beta
US EARNINGS LEVERAGE*
12
* RATIO OF ABSOLUTE CHANGE IN 5 YEAR EPS/ 5 YEAR GDP CHANGE
EARNINGS SERIES IS TRAILING S&P500 GAAP TOTAL EARNINGS/EPS
10
8
E /G D P
6
E P S/G D P
4
2010
2005
2000
1995
1990
1985
1980
1975
1970
1965
0
1960
2
Source: BEA, Standard & Poor’s, Morgan Stanley Research
Exhibit 3
A Recovery Corporates Didn’t Pay For
10500
HOUSEHOLDS AND THE GOVERNMENT
INFLATION-ADJUSTED AGGREGATES
10000
DISPOSA BLE INCOME
9500
9000
8500
INCOME EXCLUDING GOVERNMENT*
8000
2012
2011
2010
2009
2008
2007
2006
2005
2003
2002
2004
*NET OF BENEFITS, LESS SOCIAL INSURANCE CONTRIBUTIONS
7500
2001
Exhibit 3 shows what this meant for consumers. Total disposable income is now approaching its prior-cycle high, while
income excluding government transfers has recouped just over
one-third of its recession losses. The latter shortfall is largely
because compensation of employees has recouped less than
half of its recession losses (in real terms). The stimulus-fueled
income recovery underpinned the tepid consumer spending
recovery, and the moderate level of rehiring meant that most of
VARIABILITY OF US GDP AND PROFITS*
7
2000
The second factor leading to the outsized increase in earnings
was the extraordinary public-sector stimulus supporting the
recovery. In contrast, companies squeezed costs, as evidenced by reporting seasons in 2009/10 when earnings
handsomely beat consensus forecasts even as revenue growth
fell short. Put another way, to an unusual extent, this was a
recovery paid for by the public sector, not the corporate sector.
No ‘Great Moderation’ for Earnings
STANDARD DEVIATION
My biggest mistake over the past couple of years was to argue
that because the developed economies’ recovery would be
lackluster, the profit rebound also would be tepid. I was right on
the economy, badly wrong on earnings. Two factors contributed to the surprisingly strong rebound in earnings despite the
weak macro recovery: First, earnings have become increasingly sensitive to growth over the past decade. The so-called
‘great moderation’ – declining volatility for several important
macro variables – never applied to earnings (Exhibit 1).
Companies have operational leverage – profits rise and fall
proportionally more than sales – because they have fixed
costs, and operational leverage appears to have increased
over the past 10-15 years. Exhibit 2 shows the ratio of (absolute) growth in S&P 500 earnings and EPS to the (absolute)
growth in GDP. This ratio (or ‘beta’) has risen markedly
through the past decade. In other words, earnings now rise
faster than usual in recoveries, but fall further than usual in
downturns.
Exhibit 1
RATIO
Corporate earnings rebounded sharply from the Great
Recession low despite a weak macro recovery. This reflects the increased sensitivity of earnings to economic growth
apparent over the past decade. It was also, in my view, because aggressive government stimulus meant that the corporate sector did not have to “pay” for the recovery. These factors
could reverse in a downturn. In other words, even a mild recession could lead to an outsized decline in profits.
US$MN (REAL)
Morgan Stanley Australia
Limited+
the subsequent top-line improvement fell directly to the bottom
line.
Source: BEA, NBER; Morgan Stanley Research
13
November 2, 2011
the component going to domestic profits highlighted. In the
initial phase of the recovery, profits increased faster (in dollar
terms) than total income – implying that incomes excluding
profits were still falling. Over the first year of recovery (to June
quarter 2010), total income increased by $711 billion, while
domestic profits rose by $478 billion. In short, two-thirds of the
incremental growth went to domestic profits.
Adam Parker, our US equity strategist, has looked at bottom-up
incremental margins. One reason for his caution on the market
this year was that earnings forecasts implied ongoing high
incremental margin assumptions. Adam was right to be cautious: those forecasts are now falling (Exhibit 6).
Exhibit 6
Incremental Margin Forecasts Come Down
Exhibit 4
Never Before: Profits Take All the Initial Recovery
US GROSS DOMESTIC INC OME GROWTH
1000
GROSS DOMESTIC INCOME
4 QTR US$ CHANGE
800
576
600
400
200
0
-39
-200
-400
D O M E ST I C P RO FI T S
-600
I N C O M E E X P RO FI T S
2014
2012
2010
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
-800
Source: BEA, Morgan Stanley Research
Exhibit 5 shows the history of this ‘incremental margin’. In prior
recoveries, the incremental margin has typically peaked at
around 30%. It was higher in the recovery from the 2001 recession, and higher again this time (over 100% initially).
Exhibit 5
Source: Adam Parker, Dimensioning What We’ve Seen from Earnings Season, 23 October;
Morgan Stanley Research
The forward-looking point is that the higher operational leverage implies that earnings could fall significantly in even a mild
recession. To the extent that companies have maintained a
tight cost base, there would be less-than-usual scope to cut
costs in a downturn. I expect a US recession next year, although my macro colleagues do not agree. If there is a recession, even a mild one, I would expect a substantial set-back
to corporate earnings.
Incremental Margins Off the Scale
100
80
INC REMENTAL PROFIT MARGIN
FOUR QUARTER GROWTH IN PROFITS AS A PERCENT
OF FOUR QUARTER GROWTH IN NATIONAL INCOME
NBER RECESSIONS SHADED
60
AVERAGE MARGIN
% SHARE
40
20
0
-20
-40
INCREMENTAL MARGIN NOT CALCULATED FOR
PERIODS OF DECLINING NATIONAL INCOME
2012
2008
2004
2000
1996
1992
1988
1984
1980
1976
1972
1968
1964
1960
-60
Source: BEA, NBER; Morgan Stanley Research
14
November 2, 2011
November 1, 2011
Europe Equity Strategy
Latest EU Policy Initiatives Not
Enough to Change Our View
Morgan Stanley & Co.
International plc+
Graham Secker
Graham.Secker@morganstanley.com
We are sceptical on the new EU policy initiatives. The
outcome from last week’s EU summit was broadly consistent
with a base case scenario of modest progress, but no great
leap forward. While significant details still need to emerge, the
market appeared happy (at least initially) that policymakers
were travelling in the right direction. We are somewhat more
sceptical and do not believe enough progress was made to
warrant the equity markets’ optimistic response. For example:
1) Will the new restructuring of Greek bonds be seen as
credible by the market? The answer is complicated on a
number of levels and we encourage you to read Greece: Entering the PSI-2, October 28, 2011 by Daniele Antonucci and
Paolo Batori. They write: “Investors will likely focus on the
trade-off of holding out, and on whether debt sustainability can
be credibly restored. We argue that significant challenges
remain for both Greek debt sustainability and PSI implementation”. Since then, the situation has become even more
opaque given the call for a Greek referendum on the issue.
2) How much fresh capital will banks really raise? In their
report European banks: Some progress supports our national
champion call, October 28, 2011, our Banks analysts argue
that the €106bn headline capital requirement figure is, in reality, likely to be considerably lower. Factoring in retained earnings and other measures taken by banks over the next 8
months, our Banks team thinks the net figure of fresh equity
raised could be as low as €20-25bn (for the larger listed banks
it could be as low as €11 billion). In our opinion, these figures
are quite low and could stretch the credibility of the exercise. If
we do get a strong and credible sovereign backstop, a modest
capital raising, and national level guarantees for term funding
(as opposed to federal), this may be sufficient to satisfy the
market. However, excluding the former, this package may
ultimately not be enough to satisfy the market. Note also that
our Banks team believes that up to €2trn of bank deleveraging
could occur over the next 18 months, putting both bank earnings and the economic recovery at risk.
3) The commentary around closer fiscal integration was
really quite modest, with references to limited treaty changes
rather than anything more radical. It remains to be seen how
the new proposals stack up relative to the old Stability and
Growth Pact.
4) How will the proposed EFSF and SPV vehicles evolve?
Can they attract external capital (a significant positive) and can
they find buyers for their bonds at good prices? The IMF does
not traditionally invest unless it is senior to other bond holders –
this would likely rule out investing in the EFSF vehicle, which is
designed to take first losses above ordinary bond holders.
Investor positioning and performance dynamics likely
contributed to the initial rally. Given that the outcome of the
EU summit was broadly in line with the market’s ‘base case’,
the strong rally may have reflected other factors such as investor positioning. A combination of weak YTD fund performance and sizeable cash balances among investors can be
fertile ground for a performance-chasing rally. Our preferred
sentiment metrics illustrate that sentiment has bounced
strongly from its September lows, although in aggregate investor optimism is not overly high and does not provide a severe impediment to progress in the short term. For example:
1. European hedge fund gross exposure has risen sharply and
is now within a whisker of a 2-year high. Net exposure has risen
from 20% at its low to 32%, in line with its 5-year average.
2. The 14-day RSI on MSCI Europe has risen from 14 at the
beginning of August to 66 today, toward the upper end of its
5-year range. Morgan Stanley’s Global Risk Demand Index
(GRDI) has risen from -5 standard deviations in early August to
+2.3 standard deviations, implying a big increase in
cross-asset investor risk appetite.
3. The AAII net bulls reading has risen to +18, its highest
reading since the market hit its YTD peak in February. The
same measure was -22 at its low in September.
Rebound in sentiment and valuation does not provide a
severe headwind for stocks yet, but we think investors
should be wary of playing for a year-end rally unless they take a
more positive view on the wider macro outlook. As we highlight
below, we believe the longer-term fundamental outlook remains difficult and we remain happy with our assumption that a
12m forward P/E of 10 is a good proxy for fair value in this
cycle. Using this assumption we assume that markets are
pricing in 6% EPS growth over the next 12 months compared to
our top-down forecast of a 6% profit contraction.
Policy developments of the last week do little to alter our
longer-term framework for Europe at this stage. Even if the
authorities are able to execute comprehensively on their plans,
15
November 2, 2011
the tail risks associated with euro-zone sovereign debt are
likely to diminish rather than disappear (absent the ECB embarking on Fed style monetization) and the growth environment
is likely to remain weak. We continue to think the three factors
most important for European equity performance during 2H11
are likely to be: 1) Euro-zone growth and sovereign debt; 2) US
growth and fiscal policy; 3) Margins.
x
The earnings revisions ratio has been below the sales
revisions ratio all year – i.e., margin downgrades are
constant.
x
On a 12m trailing and 12m forward basis, our data
point to a meaningful pullback in margins over the last
6 months.
#1. European growth outlook continues to deteriorate
The European growth outlook remains difficult and is likely to
act as a drag on stocks. Our economists are not forecasting an
outright recession in Europe at this time, but they think occasional quarters of negative growth are possible. Part of this
weakness is expected to come from tighter fiscal policy (our
economists forecast every country in Europe will tighten fiscal
policy in 2012), and bank de-leveraging is also likely to create
some headwinds (for example, our Banks team thinks that as
much as €2trn of deleveraging is possible over the next 18
months). Further, some of the key economic lead indicators in
Europe are now in contraction territory and/or at levels that are
often consistent with recessions in the past.
x
Comparing sector price and earnings performance
over the last 3m and 6m, the main anomalies appear
to be Energy, which has been a good performer over
the last 3m despite reasonable downgrades, and IT
(excluding Software), which has outperformed in the
face of quite significant downgrades. Note that Financials continue to see the biggest downward
pressure on earnings estimates.
#2. US economic outlook is stable, but fiscal policy could
weigh in 2012. There has been a marked improvement in US
economic news in recent months as the much anticipated
pickup in GDP in 2H comes to fruition. In addition, leading
indicators such as the ISM and weekly initial claims have stabilized, and the year-on-year growth in retail sales and durable
goods compares favourably with the last 20 years. While the
current growth outlook is solid, if not spectacular, we would
expect to see some moderation in activity into 2012 if fiscal
policy starts to tighten. The conclusions from the budgetary
super committee toward the end of November (and any implications for short-term stimulus) could have a meaningful
influence on the direction of stocks.
#3. Margin deterioration is becoming significant. One of
our key themes for this year has been that margins are likely to
disappoint an optimistic consensus. If anything, the story on
margins this year actually looks likely to be worse than we were
anticipating, and much worse than what consensus was expecting. While the market has been primarily focusing on the
euro-zone debt crisis over the last three months, the deterioration seen in both earnings revisions and margins has been
significant. To summarise:
x
Note also that we have just published our first take on the
European 3Q11 reporting season (see Earnings Season
Monitor, October 28, 2011, and it shows that this results season is coming in worse than what we saw in 2Q11 (which itself
was poor). With most companies currently doing a bit better
than expected at the top line, all of the miss is due to margin
disappointment, with EBIT margins coming in around 31 bps
below expectations.
Summary – We’re Staying Defensive
At this time we do not believe that the latest set of EU policy
initiatives is sufficient to drive the year-end rally that most
equity investors are so keen to see. In addition, clouds appear
to be growing over the European economic growth outlook,
which should put further downward pressure on earnings (particularly given the meaningful deterioration in corporate margins we are now seeing), even if abating political uncertainty
can support the P/E ratio. The key upside risk is likely to come
from any further improvement in the global economic growth
outlook. Absent that, equities could be vulnerable to a pullback
given that investor sentiment indicators have recovered sharply
in the last few weeks. Because we remain somewhat sceptical
about Europe’s ability to execute on its latest initiatives, coupled with a deteriorating economic and profit growth outlook,
we are happy to remain overweight defensives (Telecoms and
Pharmaceuticals) and underweight cyclicals (Industrials and
Consumer Discretionary). We also have a modest underweight in Financials.
As per the FY2 net earnings revisions ratio, analyst
downgrades are currently occurring at a similar frequency to that seen in late 2008/early 2009.
16
November 2, 2011
Exhibit 1
October 28, 2011
Asia-Pacific Economics
Why China Needs Consumption
and India Needs Investment
Morgan Stanley Asia Limited
Chetan Ahya
China Needs to Boost Private Consumption
50%
48%
Sharp rise in
investments post
credit crisis
46%
44%
42%
Chetan.Ahya@morganstanley.com
40%
Derrick.Kam@morganstanley.com
38%
Jenny Zheng
36%
% of GDP
GCF
2010
2009
2008
2007
2006
2005
2004
2003
32%
2002
Past stimulus has brought with it the side effects of inflation and
questions over asset quality in the banking system. Given
downside risks to growth, policy makers in China and India will
need to focus on difficult structural reforms to put growth on a
sustainable path and accelerate the pace of policy action to
contain these risks.
Household Consumption
34%
2000
Jenny.L.Zheng@morganstanley.com
2001
Derrick Y. Kam
Source: CEIC, Morgan Stanley Research
Exhibit 2
India Needs to Boost Private Corporate Capex
18%
How to boost consumption in China? In China, demographic changes indicate that the rate of addition to the working
age population will decline significantly. In 2000-2009, when
the working age population was still growing substantially, it
was important to ensure the creation of sufficient employment
14%
12%
10%
Acceleration in private
investment activity from
F2004 to F2007
provided the platform for
an acceleration in GDP
growth
8%
Private Corporate
Capex (% of GDP)
6%
F2012E
F2011
F2010
F2009
F2008
F2007
F2006
F2005
F2004
F2003
F2002
4%
F2001
What could be the way out? To put growth on a productive
and sustainable path, policy makers need to focus on the difficult structural reforms in order to boost domestic demand.
The experience of the past two years has also highlighted that
the source of domestic demand growth matters as well. Policy
makers need to consider social objectives and demographic
trends in order to decide whether boosting consumption or
investment would lead to a sustained growth trend. In this
context, we believe China should tilt the balance towards
boosting consumption growth while India needs to focus on
lifting investment (Exhibits 1 and 2).
16%
F2000
More of the ‘same old’ policy response is unlikely. The
region is now again facing downside risks to growth due to a
global slowdown. Investors may be hoping for a repeat policy
response from China and India — a cut in policy rates, a boost
in bank credit or another round of aggressive fiscal stimulus to
revive growth. However, we believe this is no longer viable for
either country: High levels of inflation, banking sector asset
quality issues, and over-extended balance sheets mean that it
is not possible to employ the same aggressive stimulus to
tackle the impending slowdown.
Source: CEIC, CSO, Morgan Stanley Research
opportunities by lifting investment to GDP. However, according
to UN projections, the addition to working age population is
likely to be one-sixth of what it was in the last decade. Given
these demographic changes, we believe the social objectives
(economic welfare) that determine the policy response are
changing from employment creation in low value-added
manufacturing to moving employed workers up the value chain
(thereby giving them the opportunity to earn higher wages) and
enhance the social security of the households.
This would effectively involve economic restructuring
(re-orienting investment towards strategic high-value-added
activities — manufacturing and services) and an increase in the
provision of critical social services such as education, health
care and public housing. All these measures will help provide
sustainable growth in household incomes and improve consumer confidence, ultimately lifting consumption to GDP. The
17
November 2, 2011
resultant decline in national savings might mean a lower current account surplus. However, we believe it is more appropriate to boost domestic economic welfare than sustain the
current high savings rate, which is employed to buy government bonds in the developed world that have a lower incremental return on capital than if it were employed in China.
We believe that the government is aware of the required policy
changes. Hence, we believe that, in the current cycle, as G10
growth remains weak in line with our base case forecast of
1.5% for 2012, the government is likely to prioritize the acceleration in this strategic effort to boost domestic demand on a
sustainable basis.
How to boost investment in India? To support investment
growth, the government needs to focus on policy reforms to get
the productive dynamic back, in our view. A campaign-style
effort is needed soon from the government to revive corporate
investment sentiment.
In our view, a two-pronged strategy is required:
First, accelerate the implementation of the major policy
reforms, such as:
x
Strengthening of institutional capacity to allocate critical
national resources such as land and minerals to public and
private corporate sector in a transparent manner for rapid
industrialization. The aggressive industrialization from
2004-2007 meant that the scale at which the corporate
sector was acquiring land and mineral resources rose
significantly, increasing the risk of graft issues without
having a well-developed institutional capacity to manage
it.
x
Enacting the Goods and Services Tax — GST (value
added tax). This should greatly help improve the productivity in manufacturing business;
x
Strengthening institutional capacity to manage the
awarding of major infrastructure projects through the public-private route, which should increase transparency;
x
Building a comprehensive plan for energy security along
with a systematic program for energy pricing reform;
x
Initiating aggressive fiscal consolidation which aims to
reduce the national government deficit and improve the
mix of its expenditure towards development spending; and
x
Allowing FDI in multi-brand retail distribution, insurance
and other areas to build a sustainable source of capital
inflows.
Second, as policy reforms discussed above could take a while
to yield results, the government needs to identify 25-30 core
infrastructure and industrial projects which are either already
under way or can be taken up for execution quickly and
fast-track them to ensure that investment activity is revived in a
more timely fashion. These projects could be those that have a
limited call on land and mineral resources.
We believe the government should focus in particular on infrastructure investment, which can be taken up in a
counter-cyclical manner as weak global sentiment could weigh
on manufacturing investment.
We believe such measures could also serve as a strong boost
to foreign investor sentiment and will help revive capital inflows
as investors look for strong growth opportunities in an otherwise gloomy global environment. Among the large economies
in the world, India’s structural growth story remains the most
compelling, in our view. However, policy support would help to
keep faith in this growth opportunity intact.
The good news is that policy makers in China and India are
moving in the right direction, initiating structural changes to
boost domestic demand on a sustainable basis. However,
there is clearly a need to accelerate the pace of planning and
implementation of these reforms.
What if US and Europe face recession? Although, a recession in the US and Europe is not the base case for our global
economics team, they do highlight that the downside risk to
their base case growth estimates of 2.0% (US) and 0.5%
(Europe) in 2012 is high. Recent developments indicate that in
the context of increased concerns on sovereign debt issues,
there is a risk of fiscal tightening resulting in downside risks to
growth. We believe that, in the event of a recession in the US
and Europe, policy makers may be forced to supplement their
strategic responses with tactical responses again. If so, we do
concede that there is a possibility of policy rate cuts in both
China and India, while China also has the scope to provide
increase fiscal policy support. However, we do not foresee an
aggressive policy response along the lines seen in 2008.
18
November 2, 2011
October 25, 2011
Morgan Stanley Blue Paper:
The China Files
China’s Appetite for Protein
Turns Global
Hussein Allidina, CFA
Hussein.Allidina@morganstanley.com
tions inside China’s cities and higher incomes among urban
residents support a diet higher in protein and fat. Today, the
country’s urban residents spend a full 267% more per capita on
food than rural residents. While some of this difference can be
explained by higher prices in cities, the bulk of the difference
likely reflects higher income. As China’s cities expand, and
migration towards urban centers continues, the ability of average Chinese citizens to upgrade their diets will continue to
drive outsized growth in premium food items, including vegetable oil- and protein-intensive foods.
US, Latin Amer. & Asia Research Teams
Exhibit 1
A large population and rising income portend a disproportionately large boost in consumption, particularly for
agricultural commodities. China has a population of 1.3
billion, more than four times that of the US. As recently as
2004, 10% of this population lived in poverty, on less than $1 a
day at purchasing power parity (PPP). However, economic
growth continues to pave the way for China’s economic ascendency. Morgan Stanley’s house view is that China’s GDP
will grow at 9% in 2011 and 8.7% in 2012, compared with 3.9%
and 3.8% globally. Longer term, although Chinese growth is
likely to decelerate, we still expect average growth of 8% per
year through 2020. Indeed, relative to GDP, we expect that
overall consumption, service sector spending, and income will
continue to rise. It is estimated that the middle class will expand
from 12.4% of the population in 2005 to nearly 31% in 2015,
which translates to roughly 27 million people entering the
middle class each year. With an unprecedented number of
people leaving poverty, our economists believe that China is
entering a golden age for consumption, as incomes rise and
the poverty rate ratio falls. If their forecasts prove correct,
China’s total consumption will likely reach two-thirds of the
current US level by 2020.
A root cause of this growth in Chinese citizens’ spending
power is demographic shifts within the country. China’s
population has urbanized at an astonishingly rapid rate; in
1970, only 17% of the country’s population (or 144 million
people) lived in cities. Today, official data indicate that over 622
million people — nearly 50% of the population — live in an
urban environment, likely an understated figure owing to unregistered rural immigration. This push towards urbanization is
understandable, given the material benefits afforded to the
urban population. On average, per-capita income for the rural
population is only 39% that of the urban population.
Urbanization supporting a shift in the Chinese diet. A
further push towards urbanization in the coming years will
continue to drive outsized demand for agricultural commodities
as the combination of greater availability of western food op-
Urban Expenditures on Food Outstrip Rural Expenditures
Annual per capita food expenditure (RMB thousands)
5
4
3
2
1
0
1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009
Urban
Rural
Source: CEIC, Morgan Stanley Commodity Research.
China is becoming increasingly dependent on the global
market for food. Agriculture accounts for about 10% of
China’s GDP and the sector still employs an estimated 40% of
the population. Historically, the country has seen food
self-sufficiency as a matter of national security and has focused
significant energy on retaining that self-sufficiency. Yet incremental population growth, in concert with rising incomes
and a shifting diet, will create trends in Chinese food consumption that are likely to strain the limits of China’s ability to
increase domestic food production.
Chief among the constraints on food production is land availability: China’s cultivated land stands at around 122 million
hectares, or roughly 13% of the country’s total land (US cropland is around 164 million hectares, or 18% of its total land).
China’s ability to increase its cultivated land area is limited by
the outward expansion of cities, which continue to encroach on
farmland. Moreover, China’s agricultural productivity remains
constrained by resource availability, poor farmer education,
and challenges to domestic seed development.
19
November 2, 2011
In 2009, China became the second-largest importer of US
agricultural products such as soybeans, cotton, corn, and
poultry products. We expect this trend to continue for the next
five years at least before better technology and farming practices help to start narrowing the gap between consumption and
production growth.
Summary of Key Takeaways by Industry
US Agricultural Products
Vincent Andrews, Greg Van Winkle
ADM and Bunge are likely beneficiaries, while Sanderson
Farms is poorly positioned. ADM and Bunge benefit due to
their material exposure to US crop logistics. In addition, we
believe ADM’s Wilmar investment in offers upside to ADM that
Chinese consumption growth should highlight. While China
should also add to demand for US chicken, we believe that
domestic demand is more important than exports for US
chicken producers. Sanderson Farms looks poorly positioned.
Pork player Smithfield Foods is likely to see the bigger benefit
from export demand, and Tyson (which raises chicken but also
processes pork and beef) should fall in the middle.
US Fertilizer Industry
Vincent Andrews, Ted Drangula, Jeremy C. Chen
CF Industries and Potash Corp. look like beneficiaries.
China has implemented a protectionist fertilizer trade policy to
Chinese consumption should increase demand for Western Hemisphere grain and protein exports. GDP growth and
the “westernization” of China’s diet have dramatically increased Chinese protein consumption, and material growth
potential remains, as China’s average consumption is still
significantly less than is typical in developed markets. Constraints on China’s agricultural production will likely push China
to rely on imports in order to keep pace with growth in consumption. This is most bullish for corn and soybean meal from
the US and South America, as multiple pounds of feed are
required to produce one pound of meat.
address inflationary concerns; this should support a higher
floor for global nitrogen prices. Of North American fertilizer
companies, CF Industries is best positioned to benefit from
China’s nitrogen protectionist policy. Below-trend-line Chinese
potash purchases and applications in 2009-11 bode well for
near-term demand growth, and we see Potash Corp of Saskatchewan as best positioned to benefit from upside growth in
Chinese consumption.
Latin American Agricultural Products
Javier Martinez de Olcoz Cerdan, Wesley Brooks,
Rodrigo Mugaburu, Wendell Goncalves
LatAm is well-placed to capture global food demand
growth because it is a structurally low-cost producer in
many commodities and has plenty of available land and fresh
water. Best plays in Latin America, in our view, are Brasil
Foods SA, in animal proteins; Adecoagro in farming; Tereos
Internacional in sugar; and Soquimich in fertilizers.
Contributors to this Report
Hussein Allidina, CFA1 — Commodities
Bennett Meier1— Commodities
Tian Yu, PhD1— Commodities
Alan Lee1— Commodities
Lillian Lou2— Asia/Pacific Consumer Staples
Jeremy C. Chen3— Asia/Pacific Industrials
Vincent A. Andrews1— US Agricultural Products
Greg Van Winkle1— US Agricultural Products
Ted Drangula1— US Agricultural Chemicals
Javier Martinez de Olcoz Cerdan 1— Latam Agribus.
Wesley Brooks1— Latam Agribusiness
Rodrigo Mugaburu4— Latam Agribusiness
Wendell S. Goncalves4— Latam Agribusiness
Jonathan Garner2— Asia/GEMs Strategy
Ram Iyer1— US Institutional Securities
1 Morgan Stanley & Co. LLC
2 Morgan Stanley Asia Limited+
3 Morgan Stanley Taiwan Limited+
4 Morgan Stanley CTVM SA+
Stock prices: ADECOAGRO S.A. (AGRO.N, $9.33), Archer Daniels Midland (ADM.N, $28.94), Brasil Foods (BRFS3.SA, R$34.59), Bunge Ltd.
(BG.N, $58.94), CF Industries (CF.N, $159.14), Potash Corp of Saskatchewan (POT.N, $50.23), Sanderson Farms Inc. (SAFM.O, $50.45), Smithfield
Foods (SFD.N, $22.52), Soquimich (SQM.N, $58.01), Tereos Internacional SA (TERI3.SA, R$2.46), Tyson Foods (TSN.N, $18.96)
20
November 2, 2011
Opinion Changes
October 27, 2011
Bank of America
Earnings Pressure, Delayed
Catalysts — Equal-weight
Betsy L. Graseck, CFA
Betsy.Graseck@morganstanley.com
Michael J. Cyprys, CFA, CPA
Michael.Cyprys@morganstanley.com
Fragile global macro with rising risk of lower 10-year US
Treasury and RMBS yields pressure EPS outlook. Key $8.5b
RMBS settlement case moved to federal court, pushes out
certainty on reps/warranties, delaying positive catalysts for
BAC until 2H12 or 2013.
Stock Rating: Equal-weight
Price target
Shr price, close (Oct 26, 2011)
Mkt cap, curr(mm)
52-Week Range
Fiscal Year ending
ModelWare EPS($)
Prior ModelWare EPS($)
P/E
Consensus EPS($)§
Div yld(%)
Reuters: BAC.N Bloomberg: BAC US
$10.00
$6.59
$69,084
$15.31-5.13
12/10
0.98
13.6
0.86
0.3
12/11e
1.08
0.79
6.1
(0.03)
0.6
12/12e
0.97
1.07
6.8
1.03
0.6
12/13e
1.46
1.66
4.5
1.41
2.4
§ = Consensus data is provided by FactSet Estimates.
Price Performance
Bank of America Corp. (Left, U.S. Dollar)
Relativ e to S &P 500 (Right)
Relativ e to MSCI W orld Index /Div ersified Financials (Right)
$
%
BAC looks cheap at 0.3x P/B and 0.5x P/TB. But catalysts to
get to fair value have been pushed out to 2H12 or 2013 as risk
is rising that 10-year US Treasury and RMBS yields fall further
while the key residential mortgage-backed securities (RMBS)
settlement case has been moved to federal court. We expect
catalysts to reemerge as a settlement decision approaches,
rate pressure fades, and European deleveraging is further
along. The stock is likely to trade sideways until BAC can grow
earnings.
Downgrading BAC to Equal-weight
1. Heightened risk to rates. In the last 10 days, 5 Federal
Reserve vice chairs, governors, and regional presidents have
advocated for incremental support for the housing market,
including actions that could both flatten the curve and reduce
rates more at the front end of the curve.
We are lowering 2012e EPS by 9% (to $0.97 from $1.07) and
2013e by 12% (to $1.46 from $1.66) as we build in expectations
for the 10-year UST yield to decline to 1.5% over the next 3
quarters, and expectations of lower earning asset volumes,
partly offset by stronger credit. If the 10-year UST declines to
1.2%, we see EPS risk of $0.07, or 7%, to 2012e.
2. Global macro increasingly fragile. European banks likely
to delever, competing for investor dollars as BAC tries to shrink
its non-core portfolio (our colleagues Huw van Steenis et al.
expect European banks to deleverage €2 trillion in assets by
July 2012; see Euro-TARP – 10 things you need to know, Oct.
17, 2011). We expect deleveraging to be skewed to
non-Eurozone, a potential positive for some banks, though we
see BAC as unable to take share given its capital ratio goal.
The macro environment remains challenging, as European
banks need to delever over the next 12 months with rising
downside risk to the US and global economy.
100
50
90
80
40
70
60
30
50
20
40
30
10
20
10
07
08
09
10
11
Source: FactSet Research Systems Inc
Company Description
Bank of America is one of the world's largest financial institutions.
Industry View: Attractive — Banking - Large Cap Banks
3. The case around the RMBS consortium settlement has
been moved from state to federal court. At a minimum, this
pushes out a decision as the legal teams need to refile with the
new court. In our worst-case outcome, the judge disagrees with
the settlement, enabling more investors to dissent and convene
separate action against BAC, but that was a risk in the state
court, too.
Thus, catalysts to get to fair value have been pushed out to
2H12 or 2013. BAC is trading at just 0.3x P/B and 0.5x P/TB,
but we do not expect it to outperform until a settlement decision
approaches and European deleveraging advances. Expect the
stock to trade sideways until BAC shows earnings growth.
Our price target falls to $10 from $13. Our target is a function of our 2012 ROE estimate of 4.7% and cost of equity declining to 10.5% by year-end 2012. This implies a 56% discount to book for a 0.44x forward BVPS multiple. We build in
$3.5 billion for reps/warranties over the next 5 quarters and
$800 million in 2013. We also build in $3.5 billion of litigation
expense over the next 5 quarters and $2 billion in 2013.
21
November 2, 2011
Opinion Changes
Investment Thesis
Key Value Drivers/Catalysts
x We are Equal-weight BAC as we see minimal
near-term catalysts, topline pressure from lower yields on
long-term assets as policy makers appear to be gearing up
for more housing stimulus, and elevated expense levels
through 2013 as BAC cleans up its mortgage and litigation
exposure
x RMBS consortium settlement approved. We think this
has been pushed out to 2H12 or 2013.
x
Eliminating reps/warranty payments.
x
Reducing credit-related expenses
x
Accelerating Q/Q decline in nonperforming loans
x This delays capital management and higher ROE potential as BAC focuses on shedding non-core assets, reducing tail risk and building capital levels to comply with
Basel 3 requirements. We see BAC reaching a common
Tier 1 capital ratio of 7.3% under Basel 3 by the end of 2012
and 8.3% by end of 2013.
x
Home Price Stabilize in 2H12
x
Net interest margin stabilization in 2H12
x
Loan growth
x We forecast BAC’s ROA slowly rising to 0.66% and
ROE to 6.7% by 2013, below its 10.5% normalized cost of
equity.
x Downside risks include higher cum losses, particularly
in residential mortgage; lower home prices than expected;
hard landing in Europe; US dips back into recession; higher
legal and reps/warranties costs; and adverse credit ratings.
BAC: Valuation Attractive, but Catalysts Delayed
Risks to Our Price Target
x Upside risks include eliminating reps/warranties costs,
higher home prices, lower consumer losses, realization of
any of several different investments such as China Construction Bank and Merrill Lynch’s securities processor.
$25
20
15
$15.00 (+128%)
10
$10.00 (+52%)
Collaborative Research with Strategy Team
$ 6.59
5
$2.50 (-62%)
0
Oct-09
Apr-10
Price Target (Oct-12)
Oct-10
Price Target $10
Bull
Case
$15.00
Base
Case
$10.00
Bear
Case
$2.50
Apr-11
Historical Stock Performance
Oct-11
Apr-12
Current Stock Price
WARNINGDONOTEDIT_RRS4RL~BAC.N
Based on blend of valuation methodologies including residual income, P/B, and P/E.
Residual
Sharper economic recovery. Economy accelIncome
erates in 2H11 and 2012 as world rebounds more
1.0x 2012
sharply from earlier supply constraints driving
Tangible BV
down cost of equity, and the market looks forward 2-yrs for expected ROEs. Valuation based
on residual income methodology against base
case earnings estimates.
Blended
Modest economic recovery. Housing values
valuation
fall modestly through late-2012 (down 7.5% from
methodologies here), mortgage losses rise during 2012,
0.69x 2012
non-mortgage credit improves during 2012. 2014
Tangible BV
ROEs at 8% and ROTEs at 12%+. Valuation
based on base case TBVPS.
0.19x 2012
Double dip recession. Consumer demand
Bear Case
fades, driving recession, with housing values
Tangible BV
declining 10% from here. Reps/warranties loss
rate rises to 6% vs. 2% implied by recent settlement. Valuation based on bear case TBVPS.
What’s working for bank stocks? Certainty. We
worked with our strategy team (Adam Parker) to see
what’s driving bank stock performance from a quantitative
perspective. Low EPS variability (small dispersion in estimates) appears to be the most important factor in driving
positive returns in bank stocks over the past 6 months,
something BAC ranks last in.
What’s not working? Valuation-related drivers such
as P/BV. BAC can reduce variability in EPS through
lower expenses and better earnings performance, but that
is unlikely to come in size until 2013.
Source: FactSet, Morgan Stanley Research
22
November 2, 2011
Opinion Changes
October 27, 2011
Dr Pepper Snapple
Downgrade to Underweight Ahead
of Expected Weak 2012 Outlook
Dara Mohsenian, CFA
Dara.Mohsenian@morganstanley.com
Kevin Grundy, CPA
Kevin.Grundy@morganstanley.com
Ruma Mukerji, CFA
Ruma.Mukerji@morganstanley.com
Alison M. Lin, CFA
Alison.Lin@morganstanley.com
We have downgraded DPS shares to Underweight from
Equal-weight. We see downside risk to 2012 consensus given
weak recent underlying profit trends, which dos not appear to
be fully reflected in valuation with DPS’s shares trading one
standard deviation above historical averages vs. peers. Weak
3Q results exacerbate our concern, and we are cutting 2012e
EPS by ~3% post-3Q EPS.
Risk to 2012 consensus. While we expect consensus estimates to come down slightly after weak 3Q results, we do not
believe the market fully appreciates the downside potential to
2012 consensus EPS. Consensus implies high-single-digit (%)
underlying profit growth in 2012 adjusted for non-operating
items, which would be a sharp reversal from a mid-single-digit
decline in 2011.
DPS’s market share momentum is slowing as Crush contribution eases. Strong DPS share gains in 2009/2010 are
dissipating as the benefit of putting the Crush brand into the
Pepsi system has slowed. Competitive industry dynamics with
a likely step-up in marketing spending from Coke/Pepsi in 2012
are also likely to pressure share, particularly if DPS pulls back
on marketing spending.
Limited organic growth prospects. We forecast 3% organic
sales growth over the next five years, below the ~5% average
of DPS’s large-cap beverage peers and at the low end of the
company’s 3-5% long-term target. We expect DPS’s leverage
to slow-growth developed markets (~93% mix) and mature
beverage categories (CSDs/juices ~90% mix) to limit forward
growth.
Valuation – ahead of historical averages: DPS is trading at
8.9x 2012e EV/EBITDA (including tax liability related to
KO/PEP licensing agreements) and 13.4x EPS. This represents a 16% premium to its global bottling peers, but a 14%
discount to its concentrate peer group of KO and PEP on a
2012e EV/EBITDA basis. Notably, DPS’s current multiples are
Stock Rating: Underweight
Price target
Mkt cap, curr(mm)
52-Week Range
Fiscal Year ending
ModelWare EPS($)
P/E
Consensus EPS($)§
Div yld(%)
Reuters: DPS.N Bloomberg: DPS US
$36.00
$37.91
$8,236
$43.13-33.68
12/10
2.40
14.6
2.40
2.3
12/11e
2.70
2.74
14.1
2.74
3.0
12/12e
2.82
2.93
13.4
2.96
3.5
12/13e
3.00
3.19
12.7
3.26
3.7
Price Performance
Dr Pepper Snapple Gr oup Inc. (Left, U.S. Dollar)
Relativ e to MSCI W orld Index /Food Bev erage & Tobacco (Right)
$
%
220
40
200
35
180
30
160
25
140
20
120
15
100
10
07
08
09
10
11
80
Company Description
Dr Pepper Snapple is the third largest player in the US liquid refreshment
beverages (LRB) category and leader in flavored carbonated soft drinks
(CSDs).
Industry View: In-Line — Beverages
one standard deviation above its historical averages vs. peers.
With downside risk to consensus, we see the potential for a
de-rating of DPS’s multiple closer to historical averages. Our
$36 price target is based on 12x our 2013e EPS, offering 5%
downside.
Risks to our price target:
x
Downside risks include a sales growth slowdown, competitive pressures affecting volume, higher industry promotion
driving pricing downside, and rising commodity costs.
x
Upside risks include (1) Rapid Continuous Improvement
(RCI) targets are announced in excess of the company’s targeted $150 million through 2013; (2) potential upside from Dr.
Pepper 10 launch; (3) “risk-off” environment emerges, where
developing markets slow, the US dollar strengthens, and investors seek US-centric companies with stable cash flows,
limited FX risk, and ample dividend yields; (4) the market values DPS’s strategic potential based on the industry’s and the
business’s history of proposed or consummated LBOs through
the 1980s and 1990s — though we have no knowledge of any
potential interest in DPS as a financial target (see our LBO
valuation model in our Aug. 24, 2011, report).
23
November 2, 2011
Opinion Changes
Exhibit 1
Exhibit 4
Consensus Implies Too Large an Improvement in DPS’s
FY12 Underlying Operating Profit Growth
Sum-of-Parts Implies Potential Downside
Est. DPS Underlying Operating Profit Growth*, 2010-12e
10%
7%
5%
5%
0%
-3%
-5%
-6%
-10%
-10%
-13%
-15%
2010
1Q11
2Q11
3Q11e
4Q11e
2012e
Est. DPS Underlying Operating Profit*
Source: Company data, Morgan Stanley Research estimates
*DPS underlying operating profit excludes our estimates for: (1) FX (2) impact of Coke/Pepsi
licensing agreements (non-cash deferred revenue recognition), (3) impact of repatriated
brands, and (4) one-time items associated with Victorville, CA, plant start-up costs (~$12
million) and employee strike costs (~$15 million) incurred in 2010 that were included in DPS’s
reported results.
est. $ amounts in millions
Business
Concentrate
Company Owned DSD
Warehouse Direct
Enterprise Value
2
Less: Net Debt
Equity Value
Shares O/S
Value per share
Current Share Price
Upside/(Downside)
C2012e
EBITDA1 Multiple
$592.4
$327.6
$290.5
8.8x
7.5x
8.9x
Enterprise
Value
$5,198.0
$2,467.6
$2,581.0
$10,246.6
($2,495.0)
$7,751.6
217.0
$35.73
$37.91
-6%
Source: Company data, Morgan Stanley Research estimates
Multiples are peer avgs.
1
Includes allocation of corporate costs
2
Includes $535M tax liability related to KO/PEP licensing agreements
Exhibit 5
Downside Bias to Consensus May Drive De-Rating
Exhibit 2
DPS’s Emerging Markets Exposure Is Among the Lowest
in Consumer Staples
0%
10%
20%
30%
40%
$42.00 (+11%)
40
Estimated Emerging Markets and Operating Profit Exposure
50%
$ 37.91
60%
$36.00 (-5%)
35
3%
DPS
$45
7%
22%
24%
Peer Avg.
$31.00 (-18%)
CL
30
51%
48%
35%
KO
42%
PG
31%
33%
PEP
24%
KFT
25
31%
20%
20
Oct-09
26%
CLX
13%
15%
15%
K
7%
3%
GIS
Apr-10
10%
HNZ
10%
Revenue
5%
Operating Profit
Bull
Case
$42
Source: Company data, Morgan Stanley Research
Exhibit 3
DPS Is More Than One Standard Deviation Above Its Historical EV/EBITDA Discount vs. KO and PEP
Base
Case
$36
DPS Historical EV/EBITDA vs. KO/PEP
90%
Bear
Case
$31
80%
Oct-10
Apr-11
Oct-11
Apr-12
Oct-12
Current Stock Price
WARNINGDONOTEDIT_RRS4RL~DPS.N
13x
Bull Case
2013e
EPS of
$3.23
Topline and productivity upside, commodity
costs pull back. Share gains drive 100 bps of volume upside, DPS realizes $25M of productivity upside versus our forecast, and commodity costs pull
back 5%, driving slight multiple expansion to 13x our
bull case 2013e EPS (implies 8.9x EV/EBITDA).
12x
DPS delivers mid-single-digit (%) EPS growth.
Base
We forecast +3% 2012-13e organic top line growth
Case
and MSD (%) EPS growth, slightly below DPS’s HSD
2013e
(%) guidance, and apply a 12x P/E multiple (implies
EPS
8.4x 2013e EV/EBITDA), slightly below its ~12.5x
of $3.00
NTM historical average.
11x
Sales growth slowdown. Competitive pressures
Bear Case drive 100 bps of volume downside, higher industry
2013e
promotion drive 25 bps of pricing downside, and
EPS
commodity costs increase 5%, compressing valuaof $2.80
tion to 11x 2012e P/E (implies 8.0x EV/EBITDA).
75%
70%
Jul-11
Sep-11
May-11
Jan-11
Mar-11
Nov-10
Jul-10
Sep-10
May-10
Jan-10
Mar-10
Nov-09
Jul-09
Sep-09
May-09
Jan-09
Mar-09
Nov-08
Jul-08
Sep-08
May-08
60%
Source: Company data, FactSet , Morgan Stanley Research Note: *MS includes DPS’s $535M
tax liability related to KO/PEP licensing agreements in enterprise value 1/11-10/11
24
November 2, 2011
Opinion Changes
October 28, 2011
Education Management Corp.
Move Back to Underweight;
Stock Price Appears Disconnected
from Fundamentals
Price target
Mkt cap, curr(mm)
52-Week Range
Reuters: EDMC.O Bloomberg: EDMC US
$15.00
$19.90
$2,556
$28.61-10.78
Suzanne.Stein@morganstanley.com
Fiscal Year ending
ModelWare EPS($)
P/E
Consensus EPS($)§
Thomas Allen
Thomas.Allen@morganstanley.com
Suzanne E. Stein
06/09
0.87
25.0
0.85
06/10
1.71
8.9
1.22
06/11
1.75
13.7
1.74
06/12e
1.35
1.52
14.8
1.54
Price Performance
EDMC currently trades at a major premium to peers despite
weaker fundamentals. We see downside risk as it cycles
through term-structure/comp changes and negative leverage
takes hold. Float/ regs will restrict buybacks and while limited
float will fuel volatility, we expect valuation will fall over time.
Education Management Cor p. (Left, U.S. Dollar)
Relativ e to MSCI W orld Index /Consumer Ser v ices (Right)
$
%
26
110
24
22
100
90
20
We have lowered our price target to $15: EDMC’s stock
price has increased 27% since the end of August, compared to
our for-profit coverage’s average return of -0.2%. Following
EDMC’s F1Q results and the earnings call, company fundamentals have deteriorated worse than management had anticipated.
EDMC is trading at 7x our new C2012E EV/EBITDA, a 45%
premium to the peer average. While management implied on
last quarter’s earnings call that it was more immune to industry
challenges, cuts to guidance and further commentary this
quarter reflect sizeable headwinds actually do exist. We’ve cut
F12 estimates to reflect enrollment growth declining on average 4%, but note this could be conservative given the vagueness of management comments and the negative comps we’ve
seen out of peers (who experienced this downdraft earlier).
Negative leverage a significant risk. This was the first Q
EDMC reported declining starts and declining total enrollment.
Given its high fixed cost base and levered B/S (2.7x debt/F12
EBITDA), we believe EDMC has more risk than others if things
do not go as planned.
We expect buybacks will slow, which will increase
downward pressure. We believe aggressive share repurchases have kept EDMC’s valuation high. EDMC has repurchased ~68% of shares issued in its 2009 IPO (incl. 2.5mm this
quarter), leaving just 7.6mm shares freely traded. Limited float
and minimum listing guidelines will make share-driven EPS
beats more difficult. We note limited float does create risk.
As the post-EPS move illustrated, the stock can rally despite
negative news.
80
18
70
16
60
14
12
50
10
40
8
07
08
09
10
11
Company Description
Education Management is a large provider of post-secondary education
with diverse academic offerings and degree programs. The company
owns four distinct brands (The Art Institutes, Argosy University, Brown
Mackie College, and South University) through which students receive
education in disciplines ranging from media arts, to health sciences, to
business administration and more. Education Management enrolls recent high school graduates and working adults alike, offering associate’s,
bachelor’s, master’s and doctoral programs through campus-based,
online, and blended instruction.
Industry View: In-Line — Business & IT Services
Exhibit 1
Start & Enrollment Growth for EDMC & Peers
Enrollment
APOL*
COCO
CECO
CPLA
DV**
EDMC
ESI
STRA
Starts
APOL*
COCO
CECO
CPLA
DV**
EDMC
ESI
STRA
1Q10
15%
33%
23%
32%
20%
22%
29%
22%
2Q10
13%
28%
20%
32%
19%
22%
23%
23%
3Q10
6%
22%
16%
26%
18%
23%
11%
12%
4Q10
-4%
13%
11%
16%
13%
16%
5%
5%
1Q11
-12%
-9%
2%
7%
8%
13%
-1%
0%
2Q11
-16%
-15%
-3%
-2%
4%
7%
-7%
-8%
3Q11E
-19%
-20%
-8%
-7%
-1%
1%
-10%
-9%
4Q11E
-18%
-14%
-10%
-5%
-7%
-4%
-12%
-6%
1Q12E
-17%
-7%
-10%
-5%
-8%
-6%
-12%
-4%
2Q12E
-16%
2%
-10%
-4%
-6%
-4%
-9%
-1%
9%
18%
32%
56%
18%
28%
22%
16%
8%
18%
18%
47%
13%
31%
10%
17%
-10%
12%
6%
20%
9%
22%
-4%
-2%
-42%
-8%
-2%
-11%
-2%
12%
-9%
-20%
-45%
-22%
-14%
-36%
-7%
8%
-6%
-19%
-40%
-27%
-14%
-42%
-13%
2%
-20%
-21%
-33%
-25%
-19%
-36%
-18%
-11%
-14%
N.M.
3%
-8%
-17%
-10%
-18%
N.M.
-13%
N.M.
2%
-1%
-12%
N.M.
-9%
N.M.
-8%
N.M.
3%
3%
-8%
N.M.
-3%
N.M.
0%
N.M.
Source: Company data, Morgan Stanley Research.
25
November 2, 2011
Opinion Changes
Exhibit 2
Limited Float Means Buybacks Must Slow Down
EDMC
% of IPO Shares O/S
Shares IPO'd
23.4
100.0%
Repurchased
(15.8)
-67.5%
Remaining (9/30/11)
7.6
32.5%
$49.7mm repurchased in F1Q12
Risks to the upside are:
Limited float. With just 7.6mm shares traded freely and limited
daily volumes, it can be difficult to predict which way the stock
will move in the short term. As the reaction to F1Q earnings
showed, with the stock up 14% at one point in response to
downward guidance revisions, movements can be volatile and
the stock can rally even on negative news. Though this limited
float does create risk, we believe that valuation will eventually
move back in line with peers.
Risks to Our Call
x Limited float– With public float representing less than 10% of
shares outstanding, significant cash, $51mm remaining on its
repurchase authorization, and private equity partners, predicting short-term moves in the stock is difficult
x Things turn around earlier than expected – Management
was purposefully vague in guidance given likely limited visibility. If trends improve earlier than expected, which would
likely be driven by EDMC’s strength in traditional students,
the stock could benefit
Exhibit 3
EDMC: We Believe the Stock Should Return to a Valuation
in Line With Peers
$ 30
25
$24 (+21%)
$ 19.90
EDMC’s Diverse Product Mix Could Continue to Lessen
Risk. EDMC operates four significant brands (Argosy, Brown
Mackie, South University, and The Art Institutes). Because of
this mix, no single course of study makes up more than 10% of
graduates, and if there’s weakness in demand for a program,
EDMC can shift resources. While this is a positive, different
Design, Media Arts & Culinary courses combined make up
~50% of EDMC’s enrollment. We expect these courses to have
weak outcomes in Gainful Employment regulations given the
low salaries associated with their related expected jobs.
Why Underweight?
xWe believe there are risks to EDMC’s lofty valuation given
limited ability to continue repurchasing shares given lack of
remaining float and listing guidelines
x With a ground-based focus (significant lease obligations),
EDMC is at risk of significant neg. op. leverage. Declining
enrollments that began in F1Q are likely to illustrate this issue
x Our $15 price target is 11x our C2012 EPS, which is more in
line with peers
x The DoJ False Claims Suit is also a risk
Key Catalysts
x Quarterly earnings – Focus on starts, total enrollment,
margins and guidance (which disappointed in F1Q)
x Update on DoJ False Claims suit
x Cuts to gov’t funding – Turmoil in DC has raised concerns
for the industry regarding gov’t funding for students
x Possible secondary offering – With 80+% of shares held by
sponsors, a secondary could drive the share price down
x Gainful Employment – While the transition period should
enable EDMC to spread changes over a longer period, it still
must adjust to adhere to the regs
x Legal/reg issues – EDMC is at risk of tripping 90/10 ratios in
F2012, which it must balance with GE compliance
20
15
$15.00 (-25%)
10
$9 (-55%)
5
0
Oct-09
Apr-10
Oct-10
Apr-11
Oct-11
Apr-12
Oct-12
Current Stock Price
Price Target $15 Based on NPV of future cash flows, at 11.5% cost of
equity; 11x P/E in line with peers
Bull 17x
Demand rebounds earlier than expected, with total
Case F2012
enrollment growth turning positive again in 1H of
$24 Bull Case F2013. Long-term enrollment growth of 8% (F2009 –
EPS of
2014E CAGR), and limited need to adjust to GE drive
$1.43
annual revenue growth of 9.5%. EDMC maintains
EBITDA margins above 19% through trough, rebounding
to hist. highs of 23% by F2015.
Base 11x
Market weakness drives enrollment and revenue deCase F2012
clines in F12 and F13; significant lease and other
$15 Base
fixed costs drives margin compression. F2009 –
Case
2014E enrollment CAGR of 7% drives annual rev growth
EPS of
+8%. EBITDA margins impacted in F2012-13 by in$1.35
creased student support, reg spend, increased marketing/acquisition costs; margin bottoms at 18% in F13 but
gets back to 20% by F2015.
Bear 9x F2012 Demand/conversions continue to deteriorate, exCase Bear
penses are more difficult to cut, GE limits certain
$9
Case
program eligibility. Quarterly enrollment declines conEPS of
tinue into F14 before rebounding, and revenue per stu$1.10
dent pressure brings revenues down 4% y/y in F12 & F13.
EBITDA margins decline to 16% during F2013 trough.
Source: FactSet, Morgan Stanley Research estimates
26
November 2, 2011
Opinion Changes
October 28, 2011
McDermott International
Lowering Estimates and Price
Target, Going to Underweight;
Heightened Execution Risk
Ole Slorer
Ole.Slorer@morganstanley.com
Igor Levi
Igor.Levi@morganstanley.com
Stock Rating: Overweight
Price target
Mkt cap, curr(mm)
52-Week Range
Fiscal Year ending
ModelWare EPS($)
Consensus EPS($)§
P/E
Reuters: MDR.N Bloomberg: MDR US
$12.00
$10.97
$2,610
$26.14-10.02
12/10
1.19
1.00
17.3
12/11e
0.78
1.99
1.16
14.1
12/12e
0.85
1.55
1.48
12.9
12/13e
1.00
1.80
1.72
11.0
Price Performance
Offshore construction is all about execution. In our view, it is
preferable to play a bullish cycle through the Services, Drilling
or Equipment space than through laggards in the offshore
construction space.
McDermott International Inc. (Left, U.S. Dollar)
Relative to S&P 500 Index (Reported Basis) (Right)
40
350
35
300
30
250
25
We have downgraded McDermott shares to Underweight
from Overweight. Headwinds from recent execution issues
are likely to linger beyond 12 months, resulting in limited earnings growth and multiple compression into what we see as an
otherwise robust construction market. As a result, we have
significantly reduced our earnings estimates and price target,
leaving less than 20% upside to our base case, relative to our
Overweight names with over 40% upside potential.
While MDR’s recent pullback on a profit warning sent the
shares sharply lower, we do not view it as overly compelling to
buy the dip compared to profit warnings or earnings miss related pullbacks in other segments of the oil service market. We
prefer Transocean (RIG, $59.29), Weatherford (WFT, $16.28),
and Nabors (NBR, $18.73), as our basket of seemingly “broken” stories that we believe could see a major turnaround into a
robust market.
McDermott’s growing ambitions in deepwater construction and
floating production, storage and offloading (FPSO) will, in our
view, dilute its exposure to lower-risk shallow-water Engineering, Procurement, Construction and Installation (EPCI)
activity in the Middle East and Asia, meaningfully increasing
the company’s risk profile.
Execution issues drive down earnings expectations.
Shipyard delays triggering liquidated damages on a deepwater
construction vessel on charter to Petrobras, a contract we
regarded as very low risk, resulted in a hit equal to half of the
$50 million of project losses in 3Q, with an incremental ~$250
million in zero profit revenue expected to be recognized over
the next five years. Another big item was poor execution on
preparation for a pipe lay job in Mexico. Beyond this the
200
20
150
15
100
10
50
5
0
0
07
08
09
10
11
Company Description
McDermott International is a leading offshore oil and gas construction
company providing services primarily to offshore oil and gas field developments worldwide, including the front-end design and detailed engineering, fabrication and installation of offshore drilling and production
facilities, and installation of marine pipelines and subsea production
systems. The company also provides project management and procurement services.
Industry View: Attractive — Oil Services, Drilling & Equipment
Exhibit 1
Execution Issues Typically Have Lingering Effects
Quarterly EBIT ($mm)
Our depressed 2012
estimate may be subject to
further negative surprises
150
100
50
0
-50
Execution issues have historically
had lasting impact on profitability
-100
1Q00
1Q02
1Q04
1Q06
1Q08
1Q10
1Q12E
E=Morgan Stanley Research Estimates
27
November 2, 2011
Opinion Changes
company has experienced execution issues on two smaller
jobs in Vietnam. McDermott expects to incur an increased
level of fixed costs and to recognize $50 million in zero-profit
revenue in 2012, depressing EBIT margins from their typical
10-12% range to 7-10%. The remaining ~$250 million of zero
profit revenue is expected to be recognized through 2016,
pressuring margins in the outer years. As a result, we lowered
our EPS estimates by ~40% in 2011, 2012, and 2013.
Exhibit 2
MDR: Lingering execution concerns
$ 30
25
20
$20.00 (+82%)
15
$ 10.97
$12.00 (+9% )
10
$6.00 (-45%)
5
0
Oct-09
Apr-10
Price Target: $12
Oct-10
Apr-11
Oct-11
Apr-12
Oct-12
Current Stock Price
WARNINGDONOTEDIT_RRS4RL~MDR.N~
Our price target is based on 12x 2013e EPS of $1.00,
a discount to its European peers, given significant
risk to ambitious growth plan in higher-risk segments
such as deepwater in the Atlantic segment.
Bull
Case
$20
15x 2013e Orders pick up in 2012, exceeding $4bn, while
EPS of
margins approach 10%. This sets the company up
$1.30
to earn over $1/sh in 2012 and more normalized
10-12% margins in 2013 driving earnings to $1.30/sh
Base
Case
$12
12x 2013e Flat revenues and orders in 2012 of ~$3.6bn, and
EPS of
EBIT margins of 8%. $50m of zero revenue pro$1.00
jects flow through the incomes statement in 2012,
with the remaining ~$250m negatively impact outer
years. Orders finally pick up in 2013 above $4bn,
while revenue is flat and margins expand by
~100bps.
Bear
Case
$6
0.9x Tan- Company sees another collapse in order intake
gible book and experiences losses on further execution
of $7/sh
hiccups. EBIT margins fall into the mid to low single
digits, while profitability meaningfully declines, as the
negative impact from recent execution hiccups is
larger than expected.
DRC and FTI Downgraded to Equal-weight
from Overweight
Dresser-Rand (DRC, $51.84): Due for a breather, following strong outperformance. We believe DRC’s
long-term growth story is intact as the company plays a
unique role in the fast growing upstream offshore infrastructure value chain. However, following strong outperformance and resiliency in the recent correction, we
see greater upside in more cyclical names within our
coverage universe on a 12-month view. DRC’s valuation
is currently in line to slightly above historical average
multiples. DRC is trading at a 15.5x 2012e EPS, in line
with its historical average, and an EV/EBITDA of 9x, or
10% above its 8x average. This compares to Cameron
International at less than 14x 2012e earnings (compared
to a similar 16x average multiple), while the service majors and offshore drillers are trading meaningfully below
their respective historical mean (P/E for service names
and P/NAV for drillers).
FMC Technologies (FTI, $47.17): Two years of outperformance, less attractive on relative valuation.
FTI has outperformed shares of its subsea equipment
peers Cameron and Dril-Quip by ~35% over the last two
years, while outperforming the broader PHLX Oil Services
Index (OSX) by 40%. Shares already discount FTI’s
dominant position in a fast growing subsea equipment
market, after two years of outperformance. FTI is now
trading at ~20x 2012e EPS (both our estimate and consensus). This represents a 40% premium to CAM and an
80% premium to the Big 4, despite our view that FTI will
experience a 20% earnings growth in 2013, vs. 30% for
Cameron and 40% for the Big 4.
Source: FactSet, Morgan Stanley Research; note: prior to NYSE listing price data is the USD
equivalent from Oslo exchange.
Risks to Our Price Target: Downside…
x Overpaying for an acquisition in order to expand its deepwater presence
x Ongoing losses on poor execution as McDermott enters
challenging areas like FPSO or Brazil related construction
projects at local yards.
…and Upside
x Accelerating orders next year could more than offset negative sentiment around earnings.
28
November 2, 2011
New Coverage
October 27, 2011
Retail, Hardlines
Initiating with Cautious View:
Still in The Hangover —
SPLS Added to Best Ideas
David Gober, CFA
to Morgan Stanley’s Best Ideas list, as the most stable player
and industry leader. Please see our report, “Fixed the Glitch:
Survey Suggests Office Supply Retailers Have Seen Bottom”
for a more detailed analysis.
Key Industry Debates:
1. Is every Hardlines retailer ultimately “a showroom for
Amazon”? Our take: eCommerce is clearly a threat, but not
terminal for all players.
David.Gober@morganstanley.com
Cynthia Rupeka
Cynthia.Rupeka@morganstanley.com
Shaun Kolnick, CFA, CPA
Shaun.Kolnick@morganstanley.com
We think muted discretionary spend over the next 1-3 years will
shrink the Hardlines’ 17.5% premium to the S&P 500. Our
work uncovers opportunity in office supply and auto parts, and
threats to housing exposed segments. Counter-consensus
calls: Overweight SPLS & RSH, Underweight BBBY & LOW.
Challenging fundamentals: Cyclical and secular headwinds
will restrain the US consumer, based on Morgan Stanley’s
economists’ forecasts. Despite improved productivity through
the recession, we believe future margin gains will be increasingly difficult given top-line pressures and Street incremental
margin assumptions appear high. We initiate coverage of the
Hardlines Retail industry with a Cautious view.
2. Where are the opportunities for consolidation of share
and/or concept growth? Our take: Auto parts is the best way
to play further consolidation.
3. Is a challenged consumer priced in? Our take: Not entirely, downside risk still exists.
4. Which Hardlines retailers have the most flexible cost
structures? Our take: Smaller-store players (autos and RadioShack) with stable growth have most margin potential.
Exhibit 1
Morgan Stanley’s Bull-Base-Bear Valuations
200%
150%
100%
50%
BULL
37%
37%
17%
Group looks overvalued: Our universe trades at a 17.5%
premium to the S&P 500 despite our expectation of slower
relative EPS growth. In addition, we see Hardlines’ share of
wallet shrinking as wages grow slowly and essential goods
inflate. Thus, we expect the group’s relative valuation to shrink.
We see homeownership rates declining towards low 60%s.
Coupled with spending pressures, these trends remain challenging to home improvement and furnishings.
19%
11%
5%
4%
1%
current
price
BASE
-1%
-5%
-8%
PT
-50%
BEAR
-100%
SPLS
OW
RSH
OW
ORLY
OW
ODP
EW
AZO
EW
BBY
EW
AAP
EW
HD
EW
WSM
EW
BBBY
UW
LOW
UW
Source: FactSet, Morgan Stanley Research estimates
For valuation methodology and risks associated with any price targets above, please email
morganstanley.research@morganstanley.com with a request for valuation methodology and
risks on a particular stock.
Exhibit 2
Safe haven in auto parts retail: This sub-industry offers a
stable 2-4% sales CAGR, and the three national players have
grown throughout the cycle. Share gains through store expansion and focus on commercial sales should drive 5-7%
sales growth for O’Reilly, AutoZone, and Advance Auto Parts.
We see O’Reilly (rated Overweight) as the industry leader in
commercial, which will likely be a key driver.
Generally Below Sell-Side Consensus for 2012
10.0%
5.0%
0.0%
-5.0%
-10.0%
-15.0%
LOW
Morgan Stanley AlphaWise survey suggests upside to
office supply; SPLS added to Best Ideas: Our August 2011
survey of purchasing managers implies 0-1% growth in office
supplies in 2012. Results also suggest a 2-3% tailwind from
adjacent businesses like tech services & facilities and breakroom. We rate SPLS Overweight — the stock has been added
AAP
BBY
RSH
BBBY
SPLS
AZO
WSM
HD
ORLY Mkt Cap
Weighted
Source: Company Data, Morgan Stanley Research
Industry View : Cautious
Retail, Hardlines
29
November 2, 2011
New Coverage
Exhibit 3
1.0
120.00%
0.8
100.00%
80.00%
60.00%
0.3
40.00%
Mar-11
Mar-10
Mar-09
Mar-08
Mar-07
Mar-06
Mar-05
Mar-04
Mar-03
Mar-02
Mar-01
Mar-00
Mar-99
Mar-98
Mar-97
Mar-96
Mar-95
Mar-94
Mar-93
-0.3
Mar-92
0.0
Mar-91
NBER Economic Cycle
0.5
20.00%
0.00%
-0.5
-20.00%
-0.8
-40.00%
Late
Contraction
-1.0
Late
Contraction
Consumer Discretionary Price Performance
vs. S&P500
Hardlines Group Tends to Outperform in Late Contraction
and Early Expansion Phases of Cycle
Key controversy: Is the office supply industry in secular decline due to declining paper consumption?
Exhibit 4
Hardlines at a Premium to S&P 500 on Price-To-Forward
EPS Relative to Historical Averages…
Hardlines Composite
S&P 500
22x
Hardlines Avg = 15.6x
20x
Forward P/E Multiple
Staples, Inc. (SPLS): Added to Best Ideas List
Top-quality office supply retailer at an inflection point of growth
due to adjacent categories with a 10% payout yield
-60.00%
Source: FactSet, NBER, Morgan Stanley Research
24x
Valuation Framework. We use two primary methodologies to
arrive at our base case valuations: DCF analysis and P/E
multiple analysis. Our P/E analysis is based on long-term
estimates and assumes a forward earnings multiple in 2015
discounted back. This analysis assumes that 5% long-term
EPS growth merits a 12x baseline P/E multiple. We based this
12x multiple on a 1.5x discount to today’s group average. We
adjust the long-term multiple by one turn per 5% of EPS growth
and one turn per 0.2 of expected beta away from 1.0.
Hardlines
composite
trades at 87%
of historic
average
18x
16x
14x
12x
Our insight: Our long-term office supply model suggests 1-3%
growth as technology has a modest impact, offset by expansion in adjacent categories like facilities and breakroom supplies and tech services. Our AlphaWise survey suggests a
200-300 bps tailwind from these products for Staples over the
next few years and core office supply spending growth of 0-1%
in 2012, an improvement from recent declines. Over the past
few years, businesses have cut per-employee spending on
office supplies as well as lowering employee counts. Many
businesses may have cut spend to minimal levels, which
should make revenues more resilient from here than in the
2008-09 recession.
10x
S&P 500 Avg = 14.4x
S&P 500 trades at 80%
of historic average
M
Ja
n03
ay
-0
3
Se
p03
Ja
n0
M 4
ay
-0
4
Se
p04
Ja
n0
M 5
ay
-0
5
S
ep
-0
5
Ja
n06
M
ay
-0
6
S
ep
-0
6
Ja
n07
M
ay
-0
7
Se
p07
Ja
n0
M 8
ay
-0
8
Se
p08
Ja
n0
M 9
ay
-0
9
Se
p09
Ja
n1
M 0
ay
-1
0
Se
p10
Ja
n1
M 1
ay
-1
1
Se
p11
8x
Exhibit 5
…Though Roughly In Line on EV/EBITDA Basis
14.0x
Hardlines Composite
S&P 500
13.0x
12.0x
S&P 500 Avg = 9.4x
11.0x
Risks to the call: Macro weakness could drive retail trends
and business spending lower. A more rapid adoption of new
technologies by businesses than we have assumed could also
speed the decline in office supply consumption.
S&P 500
trades at 86%
of historic
average
10.0x
EV/EBITDA
Expected catalysts: While we expect employment gains to be
modest over the next year, a continuation of even slow growth
in employment (particularly white-collar) should be a positive
for SPLS. Further evidence of traction in adjacent categories
would be a positive for shares. We also expect Staples to
continue its recent 10%-plus dividend increases and share
repurchase program, which could provide catalysts.
9.0x
8.0x
Companies mentioned: Advance Auto Parts (AAP, $63.34,
7.0x
Equal-weight); AutoZone (AZO, $327.79, Equal-weight); Bed Bath &
6.0x
Hardlines
composite
Hardlines Avg = 8.8x trades at 87%
of historic
average
5.0x
Beyond (BBBY, $60.94, Underweight); Best Buy (BBY, $26.65,
Equal-weight); Home Depot (HD, $36.55, Equal-weight); Lowe’s
9/8/2011
5/8/2011
1/8/2011
9/8/2010
5/8/2010
1/8/2010
9/8/2009
5/8/2009
1/8/2009
9/8/2008
5/8/2008
1/8/2008
9/8/2007
5/8/2007
1/8/2007
9/8/2006
5/8/2006
1/8/2006
9/8/2005
5/8/2005
1/8/2005
9/8/2004
5/8/2004
1/8/2004
9/8/2003
5/8/2003
1/8/2003
4.0x
(LOW, $21.64, Underweight); Office Depot (ODP, $2.32,
Equal-weight); O’Reilly Automotive (ORLY, $70.20, Overweight);
RadioShack (RSH, $11.70, Overweight); Staples (SPLS, $14.65,
Overweight); Williams-Sonoma (WSM, $38.42, Equal-weight.
30
November 2, 2011
Industry Analysis
October 31, 2011
Autos & Auto-Related
DoJ Investigations Are a Clear and
Present Overhang for Suppliers
Ravi Shanker
Ravi.Shanker@morganstanley.com
Adam Jonas, CFA
Adam.Jonas@morganstanley.com
How to Play This
We believe suppliers associated with these investigations
could trade at a depressed multiple until final resolution
given the potential for an 18- to 24-month overhang and a
potentially material financial and criminal penalty.
We prefer the OEMs (GM, F) who stand to benefit from
these investigations, both directly (potential lawsuits to recover past pricing) and indirectly (more pricing power over
suppliers in future negotiations).
Yejay Ying
Yejay.Ying@morganstanley.com
Recent antitrust investigations of several suppliers have until
now been seen as merely a distraction to companies involved.
We believe investors should pay attention to this issue, which
could carry a significant overhang in the medium term and/or
result in a material financial impact.
The investigations are real and are not going away
anytime soon. Our contacts in Washington lead us to believe
that the United States Department of Justice (as well as authorities in Europe and Japan) are keenly focused on targeting
anti-competitive behavior in the auto parts industry, similar to
recent investigations of the air cargo and LCD industries that
resulted in material fines. What set off these investigations is
still unclear, but a recent guilty plea by Furukawa in the US that
resulted in a $200 million fine and jail time for executives indicates that the stakes are potentially high.
Our Main Takeaways
This is a clear distraction for the companies being investigated: While being the target of a DoJ investigation does not
mean that you are guilty (or even that you are being investigated; see our full note for details), it could involve compliance
costs, management time, and even indirectly affect current
bidding for contracts.
This could be a positive for OEMs vs. suppliers: After
having surrendered some pricing power to suppliers in the
recent downturn, OEMs could find in this a new way to exert
price leverage. OEMs could also pursue guilty suppliers
through civil lawsuits for further restitution.
This could stall M&A: OEMs and government authorities are
unlikely to look favorably on combinations of T-1 suppliers at a
time when the entire industry is being investigated for
anti-competitive behavior.
We also prefer OW-suppliers who have not yet been associated with these investigations (BWA, JCI, DAN) as well
as non OE-suppliers (CTB, PAG).
We are not modeling any negative outcomes for suppliers
involved at this time.
Recent Precedents
Air cargo: Starting in 2000, different airlines were found to be
involved in price fixing for different time periods and routes
involving the United States.
The DoJ investigation of air cargo and passenger companies
resulted in charges against 22 airlines and 21 executives as
well as more than $1.8 billion in fines and jail sentences for four
individuals.
British Airways and Korean Air Lines were among the first to
plead guilty with a fine of $300 million in August 2007. EVA
airlines was the latest with a charge of $13.2 million in May
2011.
TFT-LCD: A DoJ investigation of TFT-LCD panel companies
has led to charges against at least 8 companies and 22 executives. The investigation, led by the DoJ Antitrust Division’s
San Francisco Field Office and the FBI in San Francisco, has
resulted in more than $980 million in fines and jail sentences for
executives based on violations of the Sherman Antitrust Act.
Companies mentioned: BorgWarner (BWA, $76.33), Cooper Tire &
Rubber (CTB, $14.33), Dana Holding Corp. (DAN, $15.08), Ford Motor
Company (F, $12), General Motors (GM, $26.45), Johnson Controls
(JCI, $33.62), and Penske Automotive Group, Inc. (PAG, $21.03), all
rated Overweight.
Industry View : Attractive
31
November 2, 2011
Industry Analysis
Exhibit 1
Overview of investigations announced thus far
Segment
Wire Harnesses and
Related
Tooling
Safety
Companies
Involved
Investigation
Geography
Company Segment
2010 Segment Financials (as
% of Total)
Revenue
Op. income
Furukawa Electric
US, EU
Electrical Equipment & Electronics
$2.4 bn (22%) $94 mm (22%)
Delphi Automotive
US, EU
Electrical/Electronic Architecture
Lear Corp
US, EU
Electrical Power Management
Leoni AG
US, EU
Wiring Systems
Sumitomo Electric
US, EU
Electric Wire Equipment
S-Y Systems
Status/Comments
Pled guilty. Fined $200 mm. Class
action lawsuit filed
$5.6 bn (41%) $54 mm (58%) Class action lawsuit filed
$2.6 bn (21%)
$120 mm
(19%)
Denied wrongdoing in a recent press
release. Class action lawsuit filed
€1.6 bn (55%) €87 mm (56%) Class action lawsuit filed
$5.4 bn (22%)
$162 mm
(13%)
Class action lawsuit filed
US, EU
Private
Private
Yazaki Corp
US, EU
Private
Private
Magna (Cosma)
US
Tooling, Engineering & Other
$1.96 bn
(8%)
NA
TRW
US, EU
Occupant Safety
$3.5 bn (23%)
$373 mm
(30%)
TRW provide an update in a press
release saying it currently cannot
estimate the financial impact resulting
from this investigation but will evaluate
developments on a regular basis and
record an accrual as and when
appropriate
Autoliv
US, EU
Airbags
€4.8 bn (67%)
NA
Seatbelts
€2.4 bn (33%)
NA
The company stated in a press release
that for the reporting periods in which
the related liabilities become estimable
or the investigations are resolved, the
Company’s operating results and cash
flows will be materially impactedbut it is
unable to estimate such impact or
predict the reporting periods in which it
may be recorded.
Magna announced it is co-operating
with DoJ in a press release
Valeo announced in a press release
that it has received a subpoena from
the DoJ requesting documents and
information and that the scope of the
inquiry covers many products
manufactured or supplied by Valeo
Thermal
Valeo
US
Thermal
€2.9 bn (30%)
NA
Multiple Segments
Denso
Japan
Total
Thermal
Powertrain Control
Information & Safety
Electric
Electronic
Small Motors
$36.6 bn
31%
25%
17%
9%
9%
7%
$2.2 bn
NA
NA
NA
NA
NA
NA
Denso acknowledged in a press release
that it was investigated by Japan Fair
Trade Commission in relation to
antimonopoly act regarding sales of
certain automotive compoenents and
that it is fully co-operating with the
investigations
Mitsubishi Electric
US, Japan
Total
Energy & Electric
Industrial Automation
Electronic
$43 bn
28%
25%
5%
$2.7 bn
NA
NA
NA
Mitsubishi, like Denso, said in a press
release that its co-operating with the
investigations by JFTC in Japan and
also the FBI in Michigan, US
Calsonic Kansei*
Japan
Total
$8.7 bn
$227 mm
Mitsuba Corp.*
Japan
Total
Transportation
$2.4 bn
96%
$122 mm
97%
Hitachi Automotive*
Japan
T.RAD*
Japan
Total
$109 bn
$5.2 bn
Automotive Systems
7%
5%
Total
$974 mm
$56 mm
Heat Exchangers - Automobiles
47%
NA
Source: US Department of Justice, FactSet, Automotive News, Company data, Morgan Stanley Research *Companies reported to be involved by Kyodo News Agency
32
November 2, 2011
Industry Analysis
October 25, 2011
Integrated Oil and
Refining & Marketing
WTI-LLS Spread Should Find
Support in November
Evan Calio
Evan.Calio@morganstanley.com
Low inventories have been driven by the higher light sweet
crude prices, keeping European and Northeast US refining
runs lower and US exports higher, and supporting a wider
WTI-LLS.
Stocks following second derivative. Regardless of valuations, shares of refiners — the best-performing Energy segment over the last 2 years — are following the change in
WTI-LLS. In 4Q11, we expect base cracks to expand, Brent
spread to stabilize, 311Q beats, and 4Q11e raises.
Hussein.Allidina@morganstanley.com
Ben Hur
Ben.Hur@morganstanley.com
Jacob Dweck
Jacob.Dweck@morganstanley.com
WTI-LLS* has narrowed by $7, to $21/bbl, in the last 2 days,
pulling Mid-Con refiners down ~12%. We believe Cushing will
resume filling for the entire month of November and crack
spreads will expand in 4Q (due to critically low inventories). 3Q
EPS beats and 4Q estimate raises should drive the group
higher.
Fundamentals should improve, supporting a $15-20/bbl
WTI-LLS differential in November. Our preferred names to
buy on weakness: MPC and HFC. We believe that Cushing
storage will fill for the 4-5 weeks into December, supporting a
$15-20 WTI-LLS differential.
WTI forward curve went from contango to backwardation
in 2 days. While more barrels are being railed out of the
Bakken, we believe the market has been generally short WTI
futures contracts and the recent compression in the spread and
inversion of the curve is related to market positioning. We
believe the quick movement of the front end of the curve will be
mitigated by increased crude flows from higher production and
heavy turnarounds in the next month. In our opinion, WTI LLS
will remain at $15-20/bbl since rail economics are $2/bbl per
transload, or $11-13/bbl to rail including trucking & storage.
Exhibit 1
Major 4 Day Change in WTI Structure:
Contango to Backwardation
92.00
Oct-24
Oct-20
91.00
90.00
Two major events should drive increased Cushing storage:
89.00
x
Syncrude’s Mildred Lake Upgrader (re-starting October
25) will provide 80kbpd of increased Canadian production into
the Mid-Con, and
87.00
x
BP’s Whiting refinery in Mid-Con PADD 2 (offline for a
30-day planned outage from October 27 until December 1)
removes ~260kbpd of refining capacity.
We further expect Cushing storage to fill based on October 25
API data marking the near-term low in the differential. We
believe rail transport at $15+ per barrel cost will support
downside to the spread.
88.00
86.00
85.00
2
12
22
32
months
42
52
62
Companies mentioned: HollyFrontier (HFC, $29, Overweight) and
Marathon Petroleum (MPC, $33, Overweight).
Oil markets are tight, product markets tighter. Crude
product balances are below 5-year averages with simple US
and European refining capacity out of the money. Given low
product inventory levels globally, absent a GDP collapse, we
expect counter-seasonal strength in crack spreads in 4Q11.
* WTI=West Texas intermediate crude; LLS=Light Louisiana Sweet crude
Industry Views
Integrated Oil : Attractive
Refining & Marketing : Attractive
33
November 2, 2011
Industry Analysis
Exhibit 2
Exhibit 4
Cushing Storage Directionally Likely to Increase in November with Syncrude and Whiting (mmbbls)
Fwd WTI/Brent Diffs Lower, Refiners Follow ($/bbl)
Oct-24
26
Last Week
Last Month
24
22
$/bbl
30612
2011
29902
29969
30600
29919
30453
30936
31164
32257
34111
34565
36244
37028
37945
37621
37889
37416
37610
36784
35989
35805
Dec
Nov
Oct
34916 2/12/2010
34864 2010
2/19/2010
34506 2/26/2010
33953
3/5/2010
33552 3/12/2010
33920 3/19/2010
31709 3/26/2010
30853
4/2/2010
29975
4/9/2010
29233 4/16/2010
29542 4/23/2010
29763 4/30/2010
29819
5/7/2010
28826 5/14/2010
29620 5/21/2010
30684 5/28/2010
29918
6/4/2010
28976 6/11/2010
28971 6/18/2010
28238 6/25/2010
28601
7/2/2010
Sep
Aug
2/6/2009
5 Yr Avg
2/13/2009
2/20/2009
2/27/2009
3/6/2009
3/13/2009
3/20/2009
3/27/2009
4/3/2009
4/10/2009
4/17/2009
4/24/2009
5/1/2009
5/8/2009
5/15/2009
5/22/2009
5/29/2009
6/5/2009
6/12/2009
6/19/2009
6/26/2009
Jul
Jun
May
2/8/2008
17156
2/15/20085 Yr Min
16678
2/22/2008
16918
2/29/2008
16094
3/7/2008
18877
3/14/2008
17481
3/21/2008
17192
3/28/2008
17456
4/4/2008
17523
4/11/2008
18383
4/18/2008
19149
4/25/2008
19297
5/2/2008
20212
5/9/2008
20412
5/16/2008
20587
5/23/2008
21333
5/30/2008
21777
6/6/2008
21251
6/13/2008
20638
6/20/2008
20697
6/27/2008
20870
Apr
21234
5 Yr
Max
22999
22065
21728
22311
24071
23859
26739
26986
28015
26838
27114
27722
26458
27357
26727
26157
26026
25542
24085
23695
Mar
Feb
22439
22244
23528
24022
38,000
23899
25300
33,000
24943
24472
28,000
25147
25055
23,000
24999
25121
24429
18,000
23157
22569
13,000
23236
22527
8,000
23642
24127
24920
43,000
2/9/2007
2/16/2007
2/23/2007
3/2/2007
3/9/2007
3/16/2007
3/23/2007
3/30/2007
4/6/2007
4/13/2007
4/20/2007
4/27/2007
5/4/2007
5/11/2007
5/18/2007
5/25/2007
6/1/2007
6/8/2007
6/15/2007
6/22/2007
6/29/2007
Jan
21267
48,000
20
18
16
14
12
0
5
10
Months
15
20
Source: EIA, Morgan Stanley Research
Exhibit 3
Product Markets Tight: US Gasoline & Distillate
Exports Highest in 15 months (kbpd)
1700
Distillate Exports
Gasoline Exports
1500
1300
1100
900
700
500
300
Sep-11
Jul-11
May-11
Mar-11
Jan-11
Nov-10
Sep-10
Jul-10
100
Source: EIA, Morgan Stanley Research
34
November 2, 2011
Industry Analysis
November 1, 2011
Midcap Banks
NIM Compression in 3Q11 Offset
by Earning Asset Growth —
Group Still Looks Attractive
Ken A. Zerbe, CFA
Ken.Zerbe@morganstanley.com
Josh Wheeler, CFA
Lower NIM is not the end of the world for the banks. It’s
well understood the impact that lower loan and reinvestment
rates are having on the margin, but we think the market might
be overly discounting the value of deposit growth (and the
corresponding increase in earning assets). Zions Bancorp and
City National, for example, grew core deposits by $0.7–1.0
billion this quarter (positive from a franchise perspective), funds
which were largely invested in short-duration securities. We
estimate NIM declined by 6 and 17 bps, respectively, as a
result, given a higher denominator (assets) while NII remained
largely unchanged.
Joshua.Wheeler@morganstanley.com
Jonathan Katz
Jonathan.Katz@morganstanley.com
Giselle Cheung
Giselle.Cheung@morganstanley.com
3Q11 earnings were better than the stock reactions might
suggest, with 19 of 31 banks we cover coming in either in line
or above EPS estimates. NIM compression was a sizable
headwind, but was offset by higher earning assets growth,
driving in line NII. We have reduced 2012 EPS estimates by an
average of 4%, but our industry view remains Attractive.
Third quarter earnings were not nearly as bad as the
market reaction would imply, in our view. Net interest margin (NIM) compression was clearly the biggest issue in the
quarter, with NIM coming in well below expectations for most
banks we cover. This is a negative for the group, but from an
earnings perspective, net interest income (NII) matched expectations due to stronger-than-expected earning asset growth
(due in part to stronger loan growth and deposit inflows). This
was not a bad quarter for the banks, in our view: EPS, for the
group, matched our estimates overall, an increasing number of
banks either bought back shares or raised their dividends, and
credit is still showing improvement even if managements are
sounding slightly more cautious given the economy.
Upside/Downside Earnings Surprises
Negative
Net Interest Margin
Loan Growth
Credit Improvement
Capital Management
Source: Morgan Stanley Research, Company data
Deposit growth by itself is not hurting EPS — it is just damaging
the perception of what the banks can earn on assets over a
prolonged period by depressing NIM. Our view is that the
market is being too pessimistic regarding the value of these
deposits, although the true value will likely be realized only as
the economy improves and rates rise.
Attractive industry view: Loan growth is accelerating,
credit improving, and capital deployment ramping up. Our
long-term Attractive industry view is based on the view that the
improving fundamentals of the Midcap Banks are not being
reflected in current valuations, particularly given the sell-off for
most of this year. Loan balances are rising with the pace of
growth surprising to the upside, capital deployment is slowly
starting to become more relevant for an increasing number of
banks, and credit continues to improve. NIM compression is
the most severe headwind, but given stronger security balances, the impact on NII is much less than feared. As the
strongly negative sentiment on the group ebbs, and banks
become more aggressive with capital deployment, we expect
multiple expansion across the group.
Our top picks are FITB and ZION on significant credit leverage, and EWBC on loan growth and capital deployment.
Conversely, high-quality but expensive bank shares, including
BOH, CFR, VLY, and WABC, could lag the group as their
revenue growth outlook remains challenged.
Positive
As for the actual earnings, results were surprisingly in line
with expectations overall, with both the average and median
difference versus expectations of zero. Make no mistake, there
were plenty of banks that did rather well (BOK Financial, SVB
Financial, Fifth Third, and East West Bancorp, among others),
beating expectations by a wide margin — but we saw a similar
handful of banks that disappointed (M&T, City National,
Commerce Bancshares, Westamerica, and even some of our
Overweights, including Popular and First Horizon).
Industry View : Attractive
Midcap Banks
35
November 2, 2011
Industry Analysis
While the market appeared almost singularly focused on NIM
compression, banks were able to offset much of the negative
impact on NII through stronger than expected earning asset
growth. On an aggregate basis, NII matched our estimate, the
banks just took a different path to get there (lower NIM but
higher earning assets). Banks benefited from stronger mortgage banking and modest security gains, although this was
partially offset by higher operating costs and slightly higher
provisions. Overall earnings were in line.
Margin declines worse than expected… NIM compression
was the primary issue in 3Q; it remains the banks’ biggest
headwind. The median NIM decline was 3 bps worse than we
expected, driven by stronger deposit inflows (good in the long
term), lower asset yields, and accelerated MBS prepayments.
Some banks (Commerce Bancshares, Cullen/Frost, Comerica,
and Hudson City) posted margins 12-32 bps below our forecasts. We have lowered our NIM estimates, but expect the
declines to be gradual for most banks (roughly 3-5 bps per
quarter).
...but offset by earning asset growth. Earning assets grew
2.0% Q/Q, offsetting the negative impact on NII from lower NIM
— an important point, in our view. Average loans increased
1.6% Q/Q, or 20 bps more than we expected, driven by commercial & industrial (C&I) loans (up 2.7%) and
residential mortgage (up 2.4%). Securities growth was also
robust, driven by strong deposit inflows. The banks that beat
our loan growth estimates by the most were SVB, East West,
and First Republic Bank.
Capital deployment increases. Seven banks bought back
shares (up from four last quarter) and three increased their
dividend.
Credit is also showing improvement, with nonperforming
assets down 4% Q/Q and the net charge-off ratio down 2 bps.
the ability of banks to benefit from material credit leverage (i.e.,
lower sequential provision expenses) is minimal overall. For
some banks (Zions, Fifth Third, First Horizon — those with
large reserve ratios), reserve release will continue to benefit
earnings for several more quarters at least, but they are more
the exception at this point, than the rule. From what we can tell,
investors have completely stopped caring about credit and are
much more focused on estimating the all-important, but entirely
elusive level of “normalized earnings.”
Companies mentioned: Bank of Hawaii (BOH, $42.23, Underweight),
Cullen/Frost (CFR, $49.04, Underweight), East West Bancorp (EWBC,
$19.47, Overweight), Fifth Third Bancorp (FITB, $12.01, Overweight),
First Horizon National (FHN, $6.99, Overweight), Popular (BPOP,
$1.86, Overweight), Valley National (VLY, $12, Underweight),
Westamerica Bancorp (WABC, $44.82, Underweight), and Zions
Bancorp (ZION, $17.36, Overweight).
36
November 2, 2011
Company Analysis
October 31, 2011
Ann Inc.
Management Meeting:
We See Compelling EPS Growth
Kimberly C. Greenberger
Kimberly.Greenberger@morganstanley.com
Laura O. Ross
Price target
Mkt cap, curr(mm)
52-Week Range
Reuters: ANN.N Bloomberg: ANN US
$33.00
$27.75
$1,577
$32.47-19.00
Fiscal Year ending
EPS($)**
Consensus EPS($)§
ModelWare EPS($)
01/11
1.33
1.30
1.82
Laura.Ross@morganstanley.com
Jay Sole
** = Based on consensus methodology
Jay.Sole@morganstanley.com
Sharyn M. Uy
01/13e
2.35
2.21
2.71
01/14e
2.75
2.58
3.13
Price Performance
Sharyn.Uy@morganstanley.com
Trading at 12x C2012e EPS and 4.4x EV/EBITDA, ANN is the
most attractively valued stock we cover. We see stable
15–25% EPS growth over the next several years driven by
sales productivity improvements, supply chain efficiencies and
laser-focused expense controls. Reiterate Overweight.
01/12e
1.90
1.87
2.28
Ann Inc. (Left, U.S. Dollar)
Relativ e to MSCI W orld Index /Retailing (Right)
$
%
40
100
35
90
30
80
70
25
60
20
50
15
Positive takeaways from meetings with top management:
CEO & President Kay Krill; EVP, CFO & Treasurer Mike
Nicholson; Ann Taylor brand President Christine Beauchamp;
Loft brand President Gary Muto; Chief Supply Chain Officer
Paula Zusi; EVP, Enterprise Transformation and Technology
Michael Kingston, and VP Investor Relations Judy Lord.
We think ANN’s double-digits operating margin goal is
achievable and within reach driven by (1) sales productivity
improvements primarily (we think ANN can return to pre-2008
sales productivity (~$450-470 psf) over the next 3-4 years
driving 50-100bps SG&A leverage/year); (2) expense controls;
and (3) some gross margin improvement. We have raised our
C2013e EPS to $2.75 from $2.70 driven by our increased
50-100 bps/year SG&A leverage assumption.
Ann Taylor store remodels continue to meet or exceed
expectations. By reducing square footage 30-40% while
maintaining sales volume, we calculate ~50% higher sales
productivity in the remodeled stores. ATS has completed 45
remodels, with another 100 stores designated to refresh. New
format build-out costs remain 15-20% below prior.
40
10
30
5
20
07
08
09
10
11
Company Description
Ann Inc. is one of the leading women's specialty retailers for fashionable
clothing in the United States, operating 894 Ann Taylor, Ann Taylor
Factory, LOFT and LOFT Outlet stores in 46 states, the District of Columbia and Puerto Rico as of July 31, 2010, as well as online at
AnnTaylor.com and LOFTonline.com.
Industry View: In-Line — Retail, Softlines
Exhibit 1
In Our Base Case We Project ANN Will Reach Its Double-Digits Operating Margin Goal in 2014…
ANN Operating Margin vs. SG&A rate
11.3% 54%
10.4%
52%
9.4%
12%
10%
9.6%
8.5%
7.8%
8%
7.6%
6.3%
50%
48%
6%
2H12 cotton and polyester costs stable, no need for
pre-positioning, wool and silk higher Y/Y… Ms. Zusi reiterated that ANN is not seeing product cost pressure in 1H12
and is working with designers to mitigate higher wool and silk
costs (which affects ATS more than Loft) through product
re-engineering and adapting materials (e.g. wool blends) while
maintaining quality and fit.
46%
4%
44%
1.5%
2%
42%
0.1%
40%
0%
2006
2007
2008
2009
2010 2011e 2012e 2013e 2014e 2015e
37
November 2, 2011
Company Analysis
Exhibit 2
Exhibit 4
…but We See Upside to Reaching That Goal a Year Earlier
in 2013 in Our Bull Case
…and in Our Bull Case a Return to Peak Sales
Productivity (~$500 spsf) Could Drive 20%-Plus
EPS Growth Through 2015e
ANN Operating Margin vs. SG&A rate
13%
12.4%
12%
48%
11.2%
11%
47%
10.2%
10%
46%
9.0%
9%
8%
49%
45%
7.6%
44%
7%
43%
6%
42%
2011e
2012e
2013e
2014e
2015e
…wage rates structurally higher, but excess capacity due
to fewer orders from retailers offsets the higher costs. In
addition, IT investment, automation and location changes
should help offset future costs.
We see operating margin expansion driven primarily by
sales productivity improvements. We think smaller-format
Ann Taylor stores’ productivity could reach ~50%-plus.
Forty-five stores have already been remodeled with another
100 stores identified. In addition, ANN aims to open new AT
stores in the smaller, more productive format. The new store
prototypes are driving more traffic and customers are spending
more per transaction, while conversion is flattish vs. legacy
stores. We forecast sales per square foot of $356 and $338 for
Ann Taylor and Loft in 2011, with upside likely as productivity
remains well below 5-year averages of $385 and $370.
Exhibit 3
Improved Sales Productivity Should Drive 15%-Plus EPS
Growth In Our Base Case…
EPS
EPS Growth (%)
Comp. Grow th (%)
Sales per Sq. Ft.
2010
$1.33
393%
11%
$372
2011e
$1.90
42%
7%
$411
2012e
$2.35
24%
5%
$427
2013e
$2.75
17%
4%
$446
2014e
$3.25
18%
4%
$463
2015e
$3.75
15%
4%
$480
ANN has improved its supply chain, resulting in more
flexibility than in the past. ANN has been able to chase into
product and change orders mid-season based on sales trends,
driving more full-price selling and taking some of the volatility
out of the business.
EPS
EPS Growth (%)
Comp. Grow th (%)
Sales per Sq. Ft.
2011e
$1.90
42%
7%
$411
2012e
$2.50
32%
6%
$433
2013e
$3.10
24%
6%
$461
2014e
$3.70
19%
6%
$488
2015e
$4.45
20%
6%
$517
Ann Taylor Stores’ promotional cadence is higher than
last year, but within management’s plan and guidance.
We do not see 3Q EPS risk. In addition, we think investors
disproportionately factor in their view of ATS division – it
represents ~25% of sales, while Loft represents ~50% of sales.
ANN has just begun to develop an integrated inventory
management system which should also benefit gross
margin over time. ANN is implementing a single view of
inventory across channels, eliminating “stranded inventory”
(inventory in a store or an eCommmerce distribution center that
cannot be sold to a customer in the other channel). We expect
ANN to start testing this system in 2012, with a rollout in late
2012 or early 2013.
ANN currently trades at 12x 2012e EPS and 4.4x 2012e
EV/EBITDA, the cheapest stock in our coverage universe.
Our base case assumes 15%-plus stable EPS growth over the
next 3-5 years. Our $33 price target is based on ~14x our
C2012 EPS estimate of $2.35. We expect ANN to trade at the
high end of the 13-14x industry average as earnings exceed
expectations and margins expand.
Risks to our thesis: (1) Fashion risk. ANN’s customer is very
discriminating on fashion newness and any misstep in fashion
execution could hurt sales and margins.
(2) Real estate hurdles. Our EPS estimates assume the
company will be able to open new stores in profitable locations.
Any change in real estate availability could pressure sales
growth and therefore margin leverage.
(3) Operational execution. Sales and EPS growth have been
relatively inconsistent historically. We think investors are looking for consistency under this new management team. If the
company misses sales or EPS estimates, we think the stock
would likely suffer perhaps more so than others we follow given
the company’s history.
38
November 2, 2011
Company Analysis
October 25, 2011
Amazon.com
Conservative Revenue Guide,
Scott Devitt
Scott.Devitt@morganstanley.com
Andrew Ruud
Price target
Mkt cap, curr(mm)
52-Week Range
Reuters: AMZN.O Bloomberg: AMZN US
$260.00
$227.15
$104,720
$246.71-156.77
Fiscal Year ending
Revenue, net($mm)
EBITDA, adj($mm)**
ModelWare EPS($)
12/10
34,205
2,504
2.53
Andrew.Ruud@morganstanley.com
Zachary Arrick
Zachary.Arrick@morganstanley.com
Price Performance
Key takeaways from CQ3:11 earnings are that global macro
and consumer spending pressures could make CQ4 tough.
Amazon.com continues to invest in its business with 17 new
fulfillment centers next quarter, and we believe now is a good
time to buy.
12/11e
48,488
2,358
1.07
12/12e
64,718
3,845
2.98
12/13e
83,938
5,197
4.63
Amaz on.com Inc. (Left, U.S. Dollar)
Relativ e to MSCI W orld Index /Retailing (Right)
$
%
250
800
700
200
600
500
150
400
Amazon.com continues to be our preferred way to play the
global, secular transition from offline retail to online
eCommerce. The company continues to innovate with a focus
on future profit pools, not yesterday’s. We believe continued
investment in fulfillment centers and Amazon Prime penetration will payoff in sustainable, profitable growth for years to
come. We firmly remain Overweight with a $260 price target,
down from $275 previously. Amazon.com is a Morgan Stanley
Best Idea. Our price target of $260 is derived via a DCF
analysis, assuming an 11.5% hurdle rate and 5.75% perpetual
growth post-2013.
Focus needs to stay on increasing lifetime value of the
customer: Amazon.com seems to be living the mantra of the
3-step plan:
x
Invest in high levels of customer service (low prices, more
fulfillment centers to shorten shipping times);
x
Increase penetration of Amazon Prime; and
x
Reinvest profits to allow the plan to be self-fulfilling. The
end game is more valuable, more loyal customers.
EGM Sales Should Drive CQ4:11 Earnings. We are looking
for $17.8B of sales in CQ4, primarily driven by strength in EGM
sales in North America and International. Sales of Kindle Fire
drive year-over-year and sequential degradation in gross profit
margin to 18.8% on a clean basis, down 150 bps from CQ4:10.
Amazon’s investment in fulfillment centers and our assumed
pick-up in marketing spend also contribute to our estimated
operating income of $290MM. We are modeling GAAP EPS of
$0.08 and Adj. Non-GAAP EPS of $0.36.
100
300
200
50
100
07
08
09
10
11
Company Description
Amazon.com operates eight global websites where users can search,
find and obtain millions of products to buy online. Amazon.com also
enables third parties to sell to its customers — for which it earns fixed
fees, sales commissions, per-unit activity fees, or a combination thereof.
Amazon.com also provides marketing and promotional services, such as
sponsored search, and has a co-branded credit card agreement.
Industry View: Attractive — Internet & Consumer Software
Exhibit 1
SWOT Analysis – Amazon.com
Strengths
Weaknesses
1. Market / brand leadership in
growing eCommerce
1. Low prices / free shipping / product
mix pressure near-term margins
2. Best-in-class user experience
defined by selection / convenience
/ reliability / low prices / free shipping / powerful recommendation
engine
2. High exposure to foreign exchange fluctuations
3. Seasonality + inventory risk
3. Leader in Internet innovation +
logistics
Opportunities
Threats
1. Continued share gains in overall
retail market, in which eCommerce
penetration is still low.
1. Apple and others present threat as
media products transition to digital
distribution
2. Continued expansion into international markets (both mature +
emerging)
2. Execution risk in new markets /
categories
3. Monetization of nascent-stage
initiatives gaining traction, such as
Kindle, Amazon.com Web Services + digital downloads (VoD +
Amazon.comMP3)
3. Intense competition in both core
(retail) + new markets (digital
downloads, eCommerce solutions,
web services, etc.)
4. Legal (e.g., state sales tax issues,
international sales tax possibility)
Source: Morgan Stanley Research, Format based on Michael Porter’s Competitive Strategy
39
November 2, 2011
Company Analysis
Exhibit 2
AMZN: Several Channels for Long-Term Growth
$350
$330.00 (+45%)
300
$260.00 (+14%)
250
$ 227.15
200
$152.00 (-33%)
150
100
50
0
Oct-09
Apr-10
Base Case (Oct-12)
Oct-10
Apr-11
Oct-11
Apr-12
Oct-12
Current Stock Price
WARNINGDONOTEDIT_RRS4RL~AMZN.O
Bull
Case
$330
25x Bull
Case '13E
EV /
EBITDA
Amazon.com actively participates in digital distribution of video, music, and
books; leverages a strong product cycle that is hardware driven, allowing the
company to grow accounts and average spend per account. Assumes a 5-yr
revenue CAGR (C'10-C'15E) of 34% and Adj. Operating Income margins
expanding to 6% in C'15E.
Base
Case
$260
22x Base
Case '13E
EV /
EBITDA
Amazon.com invests in its business (FCs and Technology), but margins
begin to rebound in C2012E. Broad selection and low prices drive continued
customer momentum, which allows Amazon.com to significantly outperform
overall eCommerce. Tablet sales increase Prime accounts and generate
positive returns for the company. Tablet begins to cannibalize Kindle, but
Amazon continues as the dominant eBook seller. Assumes a 5-yr revenue
CAGR (C'10-C'15E) of 31% and Adj. Operating Income margins expanding to
5% in C'15E.
Bear
Case
$152
17x Bear
Case '13E
EV /
EBITDA
Amazon.com is forced to invest in its business and cut margins to maintain
low prices as competition intensifies. Competition around digital distribution
negatively affects Media segment (Music, Video, Books). Assumes a 5-yr
revenue CAGR (C'10-C'15E) of 27% and Adj. Operating Income margins
settle at 3% in C'15E.
Why Overweight?
x Long-term, sustainable revenue growth opportunities
x eCommerce leader that continues to take market share from
offline and online channels
x Broad selection / superior customer experience / ease of use
creates superior user experience, drives loyalty
x Focus on customer has led to double-digit y/y active customer
/ seller growth
Key Value Drivers
x International sales should achieve higher eCommerce penetration than domestic sales due to demographics
x Account and spend per account growth
x Increased revenue per customer owing to greater selection
and convenience drive increased value
Potential Catalysts
x Accelerating mobile commerce business / mobile commerce
market share could be higher than its eCommerce share
x Faster-than-expected shift from offline to online commerce
x Retail bankruptcies could continue to shift sales online
Potential Risks
x Amazon.com faces competitive threats from Apple / others as
Media sales (38% of total revenue in CQ3) transition to digital
distribution
x Investors capitalize working capital free cash at the same rate
as operating free cash; if growth slows, this could have a
meaningful impact on the stock
x Sales tax collection laws could be challenged as eCommerce
grows
x Investment spending needs could be greater than expected
40
November 2, 2011
Company Analysis
October 26, 2011
Apple
China Handset Survey Points to
Surge in iPhone Growth
Katy L. Huberty, CFA
Kathryn.Huberty@morganstanley.com
Jerry Liu
Jerry.Y.Liu@morganstanley.com
China is a key driver of our $50 bull case EPS in CY12. Our
AlphaWise survey indicates over a third of Chinese respondents plan to purchase an iPhone as their next 3G handset, far
higher than Apple's current share. A lower-priced iPhone would
generate 2-3x incremental demand.
Price target
Mkt cap, curr(mm)
52-Week Range
Reuters: AAPL.O Bloomberg: AAPL US
$480.00
$397.77
$375,274
$426.70-297.76
Fiscal Year ending
ModelWare EPS($)
Consensus EPS($)§
P/E
P/FCFfY
EV/rev
ROE(%)
09/11
27.68
27.68
13.8
11.1
2.6
54.2
09/12e
37.23
34.51
10.7
9.3
1.7
46.0
09/13e
46.08
38.90
8.6
7.5
1.1
38.9
09/14e
49.27
8.1
7.6
0.8
29.5
Price Performance
Apple Inc. (Left, U.S. Dollar)
Relativ e to MSCI W orld Index /Technology Hardware & Equipment (Right)
$
%
Survey results suggest large pent-up demand for Apple
iPhone in China. Apple just overtook Nokia as the leading
smartphone brand in China, indicating a shift in mind share. In
the last three months, iPhone share declined from 12% to 7%
as respondents waited for the new iPhone. Going forward, a
large portion of handset owners are choosing iPhone as their
next device. Among higher-income households, demand is
double iPhone’s current share (52% vs. 25%). See China
Handset AlphaWise: 3G Plows Full Steam Ahead by our Asia
Tech team, also published today, for more details.
A lower-priced iPhone in CY12 will be the next major
catalyst in China, in our view. Price remains the top reason for
not buying the iPhone, cited by 85% of respondents, far above
55% for the number two reason battery life. We estimate
Apple can almost double demand by introducing a cheaper
phone at $400 pre-paid or 2.6x demand at $300 pre-paid.
CY12 is also the right timing, in our view, as more respondents
are willing to pay for a $400 iPhone than just six months ago.
They are also willing to pay a premium over other 3G phones,
allowing Apple to maintain its premium branding and take
outsized profit share (see Exhibits 5-8 in our full note.)
China is a key driver of our $50 Bull case EPS in CY12, and
it has already become Apple’s second largest market. This
survey increases our conviction that iPhone 4S will fuel further
growth in the country, which the iPhone 4 ignited a year ago.
We are also seeing signs of an iPhone halo effect, as the device introduces Chinese consumers to Macs, iPods and likely
iPads, similar to the iPod halo effect that started 10 years ago
in the developed markets (Exhibits 9-10 in our full report).
400
600
350
500
300
400
250
200
300
150
200
100
100
07
08
09
10
11
Company Description
Apple designs and sells electronic devices, software and services for
personal computing, mobile communications, and media and entertainment.
Industry View: In-Line — Systems and PC Hardware
Exhibit 1
Purchase Intentions for Apple iPhone is 4.5 Times its
Current Share with Respondents
First Choice for Next Handset
Apple iPhone
+30 pts
Nokia
-22 pts
HTC
Samsung
Motorola
Blackberry
Sony Ericsson
Dopod
First choice for next 3G handset
Lenovo
Current handset
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
Source: AlphaWise, Morgan Stanley Research
41
November 2, 2011
Company Analysis
Survey Points to Surge in iPhone Growth in China
Exhibit 2
x
Growth in China and lower-priced iPhones are two of
the main drivers of our Bull case.
We Think AAPL Shares Discount Unjustified Growth Deceleration
x
We believe China could surpass the US as Apple’s
largest market in about three years, adding nearly $30
billion more per year to the top-line along the way. China,
already Apple’s second largest market, grew revenue from
$3 billion in FY10 to $13 billion in FY11, fueled by iPhone 4
distribution at China Unicom starting in C3Q10.
x
x
Our AlphaWise survey increases our conviction that there
is strong, pent-up demand for iPhone 4S and even stronger
demand for a lower-priced iPhone in China over the next year.
Key upcoming catalysts include pent-up demand
unleashed by the launch of iPhone 4S, and potentially a
new lower-priced iPhone and/or carrier distribution relationships with China Telecom and China Mobile.
Core Questions for Evidence Research
How fast are Chinese consumers adopting 3G handsets?
Quantify Apple iPhone’s growth opportunities in China.
The Evidence
Chinese consumers show growing interest in 3G
handsets or smartphone
90% and 91% of the total respondents indicated that they
are likely to buy a 3G handset or smartphone as their
next phone, up from 87% and 88% in 1H11.
Apple iPhone is the strongest smartphone brand
and is likely to gain market share at the expense of
Nokia
The proportion of respondents selecting Apple iPhone as
the leading smartphone brand surpassed those who
select Nokia the first time (78% vs. 70%).
The percentage of respondents planning to purchase
Apple iPhone increased to 34% in 2H11 from 30% in the
1H11 survey, while 16% planned to purchase Nokia,
down 9%.
What Gives Us Confidence
We surveyed a sample of 2,050 Chinese mobile phone
owners via online interviews across Tier 1 to 3 cities
during September 2011.
The maximum margin of error for conclusions based on
the total sample is +/-1.7% at a 90% confidence level
and higher for conclusions between sub-groups.
This is our second China Handset Survey. The first survey was conducted in February-March 2011.
$700
600
$600.00 (+42%)
500
$ 422.24
$480.00 (+14%)
400
$350.00 (-17%)
300
200
100
0
Oct-09
Apr-10
Bull
Case
Case
$600
Price
Target /
Base
Case
$480
Bear
Case
$350
Oct-10
Apr-11
Oct-11
Apr-12
Oct-12
Current Stock Price
WARNINGDONOTEDIT_RRS4RL~AAPL.O
12x CY12 Apple maintains its market dominance with
EPS of
lower-priced iPhone, iPad shipment upside, and
$50
growth acceleration in China. iPhone and iPad
shipments reach 175 million and 75 million in CY12.
Gross margins remain near 40% with mix shift to
more profitable mobile devices offsetting pricing
declines. Apple’s one-year historical forward P/E
averaged 19x and troughed at 13x. We assume
slight discounts to consider the company’s larger
market cap.
12x CY12 iPhone and iPad momentum continues. iPhone
EPS of
and iPad shipments reach 134 million and 52 million
$40
in CY12 as Apple maintains 60%+ tablet market
share, and Mac units grow 19%. Gross margin rises
to 41.3% and EPS to $40 in CY12. Apple’s one-year
historical forward P/E averaged 19x and troughed at
13x. We assume slight discounts to consider the
company’s larger market cap.
10x CY12 iOS unit growth offset by Mac and iPod decelEPS of
eration and lower price points limit margin ex$35
pansion. iPhone and iPad shipments of 110M and
44M in CY12. Gross margin declines from 40.9% in
CY11 due to lower than expected iPhone and iPad
profitability. EPS is $35. P/E multiple is depressed at
10x due to CEO transition and growth concerns.
Source: FactSet, Company Data, Morgan Stanley Research
Near-term Catalysts
Bifurcation of iPhone pricing to capture EM demand
Improved iPhone and iPad shipment momentum
Rising gross margins driven by iPhone and iPad scale
Long-term Catalysts
Expanding store, online and carrier distribution in China or
other developing markets
Returning cash to shareholders through buybacks or dividends
Shipment upside and continued evolution of iPad line
Potential Smart TV launch in 2012-13
Investment Risks
CEO transition
Android competition in smartphones and Android and Windows competition in tablets
Regulatory and legal risk as Apple gains profit share momentum in mobile devices.
42
November 2, 2011
Company Analysis
October 31, 2011
Cavium Networks
2008 Redux?
Sanjay Devgan
Sanjay.Devgan@morganstanley.com
Sean Hazlett, CFA
Sean.Hazlett@morganstanley.com
Michael Kim
Michael.K.Kim@morganstanley.com
Price target
Mkt cap, curr(mm)
52-Week Range
Fiscal Year ending
EPS($)**
Consensus EPS($)§
ModelWare EPS($)
P/E
Reuters: CAVM.O Bloomberg: CAVM US
$44.00
$32.69
$1,794
$48.30-24.20
12/09
0.04
0.03
(0.25)
NM
12/10
0.89
0.88
0.43
87.8
12/11e
1.12
1.19
0.51
63.5
12/12e
1.40
1.32
0.68
48.1
We continue to view Cavium as a long-term beneficiary of the
transition to L4-L7 routing and switching, and view the company as favorably tied to secular growth opportunities across
the wireless infrastructure, data center, and the digital home.
Price Performance
Cav ium Inc. (Left, U.S. Dollar)
Relativ e to MSCI W orld Index /Semiconductors & Semiconductor Equipment (Right)
$
Reiterate Overweight. We believe that Cavium’s growth will
pick up again in 1Q12 as it starts to benefit from several new
product cycles in wireless infrastructure, the data center, and
the digital home. Furthermore, we believe Cavium’s muted
4Q11 outlook is temporary, as it includes completion of the hub
transition at Cisco, and a near-term demand trough. We view
CAVM as one of the best secular stories in our coverage
space, and would aggressively buy the name on weakness.
Estimates adjusted post-3Q. Cavium reported revenue of
$67.7 million (down 5% Q/Q), which was in line with guidance
of $67–69 million, and EPS of $0.27 (versus our estimate of
$0.26). A tax benefit drove most of the upside. The Enterprise,
Data Center, and Service Provider segment was down ~6%
Q/Q, primarily due to an 18% Q/Q decrease in sales to Cisco
Systems.
While Cavium guided to an 8-10% Q/Q decline on the continued hub transition, and a softening macroeconomic environment, we believe 4Q11 will likely mark a trough, and Cavium
will benefit from new design ramps beginning in 1Q12. Our
EPS estimates for C2011 and C2012 go to $1.12 and $1.40
from $1.17 and $1.60.
2008 redux? We remind investors that the last time Cavium
experienced a weak demand outlook in 2008, its stock price
reached a low of ~$8, but it ultimately bounced back to a high of
$48 earlier this year. While Cavium is a larger company today,
we still believe that the stock has the potential to outperform
coming out of a weak demand environment as long-term
secular tailwinds bolster the name.
$400–500 million ternary content addressable memory
(TCAM) market opportunity. Cavium highlighted strong traction for its NEURON processor products citing evaluation at
%
50
45
300
40
250
35
30
200
25
20
150
15
100
10
07
08
09
10
11
Company Description
Cavium is a leading developer of integrated circuits (ICs) for the networking market. Cavium's product offering include both security and
network services processors. The company's network processors enable next generation intelligent networks as they provide for L4-L7 deep
packet inspection capabilities.
Industry View: In-Line — Semiconductors
multiple Tier 1 OEMs, and announced a new customer win at
Radisys. While Cavium expects its NEURON product to have
a faster design cycle than many of its other products, it also
expects to integrate the new products into its existing product
suite over time. As such, we believe Cavium will be able to
realize a greater share of its customers’ bill of materials from
this new category over time.
Cavium reiterated the migration to 2048 bit encryption
fueling growth within the data center and enterprise. We
believe this transition increases Cavium’s addressable market
by $100 million as the shift to 2048-bit keys requires a 10x
increase in compute power likely forcing data center architects
to off-load encryption functionality to separate co-processors or
network interface cards (NICs). Consequently, we view this is
a positive for Cavium due to Cavium’s leadership position
within the encryption/decryption security space. We also note
the company started shipping prototype quantities for the data
center to a Tier 1 customer in 4Q11. Please see our March 16,
43
November 2, 2011
Company Analysis
2011 note Data Center Opportunity is Underappreciated for
more details.
Exhibit 3
CAVM: Enterprise Recovery Drives Upside Bias
$60
We expect Cavium’s Software and Services segment to
grow in 1H12, despite being historically lumpy (Exhibit 1).
While Cavium is guiding 4Q Software and Services revenue
sequentially flat, management noted push-outs at a large federal customer due revenue recognition, and also cited a new
contract starting in 1Q12.
$56.00 (+65%)
50
$44.00 (+29%)
40
$ 32.69
30
$21.00 (-38%)
20
Exhibit 1
10
Software and Services Business
$16
80%
0
Oct-09
Apr-10
Oct-10
Apr-11
Oct-11
Apr-12
Current Stock Price
WARNINGDONOTEDIT_RRS4RL~CAVM.O~
60%
$12
40%
$8
20%
0%
$4
-20%
Bull
Case
$56
-40%
C
1Q
10
A
C
2Q
10
A
C
3Q
10
A
C
4Q
10
A
C
1Q
11
A
C
2Q
11
A
C
3Q
11
A
C
4Q
11
E
$0
Revenue
E = Morgan Stanley Research Estimates
Q/Q Growth
End Market Summary
Product Segment
Enterprise, data center and
service provider
C3Q11 Result
• Down 6% Q/Q, driven primarily by
C4Q11 Guidance
• Down Q/Q, driven by the hub
transition at Cisco for the enterprise
business, and softness in the wireless
infrastructure segment in the service
provider business
Broadband and consumer
• Up 7% Q/Q, driven by the broadband
business and the Wi-Fi display
segment, where several customers
started initial pre-production and
production builds
• Down 21% Q/Q, driven by lower
revenue in the services business
• Down Q/Q
Source: Morgan Stanley, Company data
Base
Case
$44
Source: Morgan Stanley, Company Data
Exhibit 2
Software and services
Price Target $44
Bear
Case
$21
Our $44 price target represents a ~25x multiple on
our annualized C2H12 estimate, which is roughly in
line with multiples for peer high-growth semiconductor names
25x
Rapid growth in enterprise: Five-year revenue
AnnualCAGR (2008–13) of 43% driven by the rapid prolifized 2H12 eration in new and existing enterprise customers as
Bull Case well as successful initial penetration into the cliEPS of
ent-side/consumer market.
$2.24
25x
Steady growth continues: Five-year revenue
AnnualCAGR (2008–13) of 42% with continued strong
ized 2H12 proliferation in the enterprise market and early
Base Case penetration into the client-side/ consumer market.
EPS of
Video processing applications such as video sur$1.74
veillance and video distribution within the home
represent likely secular drivers.
20x Annu- Slow ramp, slow up-take, and stagnant product
alized
cycles: An unlikely scenario, in our opinion, in
2H12 Bear which revenue declines over time with delays in the
Case EPS ramp of key programs and low proliferation in the
of $1.07
enterprise market due to the slow adoption of intelligent networking hardware caused by a global recession. Net income margins peak at high single
digits as product cycles stagnate, leading to more
significant competitive forces.
• Flat Q/Q
Potential Catalysts
x Entry into new markets.
x Additional design win announcements, especially for the
higher priced, higher volume Octeon network processor would
serve as a positive dynamic.
Risks to Achieving Our Price Target
x In addition to the risks built into our scenarios outlined
above, design wins could be slower than anticipated because
of customer pushouts.
44
November 2, 2011
Company Analysis
October 31, 2011
Freeport-McMoRan
Copper Fundamentals Still Strong;
Reiterate Overweight
Paretosh Misra, Ph.D.
Paretosh.Misra@morganstanley.com
Evan L. Kurtz, CFA
Evan.Kurtz@morganstanley.com
Wes Sconce
Price target
Mkt cap, curr(mm)
52-Week Range
Reuters: FCX.N Bloomberg: FCX US
$43.00
$42.80
$40,930
$61.35-28.85
Fiscal Year ending
ModelWare EPS($)
P/E
Consensus EPS($)§
Div yld(%)
12/10
4.64
12.9
4.64
1.9
12/11e
4.94
8.7
5.12
3.5
Wes.Sconce@morganstanley.com
Piyush Sood
Piyush.Sood@morganstanley.com
Price Performance
Earnings expectations (down 21% from peak) look more reasonable. Freeport has minimized the earnings impact of strikes
by increasing mining from high-grade zones. Recent strength
in copper data supports our $3.80 forecast for 2012. We estimate FCX prices in $3.30 copper vs. $3.70 spot.
FCX shares appear to be pricing $3.30 copper (vs. spot at
$3.70), but we see support for copper. Our base case
valuation at $3.80 copper suggests $50 per share.
FCX minimized earnings impact of strike. At its Grasberg
mine, the company optimized the mine sequence to access
higher grades earlier.
We are above consensus again. On October 2, we cut
2012e EPS by 21%, to 9% below consensus; the Street has
fallen to below our number.
Recent trends suggest a copper floor price near $3:
x
There is price-sensitive Chinese buying. LME copper fell
below $3.10 twice in October and twice saw a surge in
canceled warrants in Asia, suggesting Chinese buyers are
keen to capitalize on price dips.
x
Supply shortfalls have raised concerns; these include
force majeure at Grasberg and YTD production declines of
~5% in Chile and ~1% in Zambia. At spot copper, we estimate
FCX generates $5.5 billion in annual excess cash before capex
and $1 billion regular dividend.
12/12e
5.20
8.2
5.06
2.3
12/13e
7.15
6.0
5.79
2.3
Freepor t-McMoRan Copper & Gold Inc. (Left, U.S. Dollar )
Relativ e to MSCI W orld Index /Materials (Right)
$
%
220
60
200
180
50
160
40
140
30
120
100
20
80
60
10
40
07
08
09
10
11
Company Description
Freeport-McMoRan Copper & Gold Inc. explores for, develops, mines
and processes ore containing copper, molybdenum, gold, and silver in
Indonesia, the United States, Peru, and Chile, and smelts and refines
copper concentrates in the United States, Spain and Indonesia.
Industry View: In-Line — Nonferrous Metals & Mining
Exhibit 1
We Estimate FCX Shares Discount ~$3.30 Copper
$5.00
Copper Price, Implied by FCX shares
$4.50
Actual Copper Price
$4.00
$3.50
$3.00
$2.50
$2.00
$1.50
Jul-11
Sep-11
May-11
Jan-11
Mar-11
Nov-10
Jul-10
Sep-10
May-10
Jan-10
Mar-10
Nov-09
Jul-09
Sep-09
May-09
Jan-09
Mar-09
Nov-08
Jul-08
$1.00
Sep-08
Shares pricing risk to copper, but we see fundamental
support. LME canceled warrants for copper are at 13% of
inventory. This lead indicator of inventory decline is now double the average since 1997. Further, the rate of decline of LME
inventories in Asia in October has thus far been 7x the 3Q
average; Shanghai premiums at $145/T remain well above the
May trough of $20/T; Shanghai inventories are lowest since
August 2009. Declining treatment/refining charges (down
~65% since March) in China suggest tight concentrate supply.
Source: Bloomberg, FactSet, Morgan Stanley Research
45
November 2, 2011
Company Analysis
Exhibit 2
Exhibit 5
LME Copper Canceled Warrants Recently Climbed to a
2-Year High to ~13% of Inventory
LME Inventory Decline Accelerates amid Supply Concerns
and Price-Sensitive Chinese Buying
4.50
140
80
2.50
60
2.00
40
1.50
3.90
120
Copper Price
Copper Inventory
Cerro Verde Strike
100
Jun-11
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
2.90
Jan-05
Jan-04
0.50
Jan-03
140
3.30
3.10
Jan-02
Grasberg
Strike
3.50
1.00
Jan-01
160
3.70
20
Jan-00
180
Oct-11
100
3.00
Sep-11
3.50
200
4.10
Aug-11
120
Copper Price, $/lb
LME Copper Price, $/lb
4.00
Asian Inventory
Drawdown
Accelerates
4.30
LME Canceled Warrants, kt
LME Copper Price
LME Asia Copper Inventory, kt
160
LME Canceled Warrants, Global
4.50
Jul-11
5.00
Source: Bloomberg, LME, Morgan Stanley Research
Exhibit 3
A Surge in Canceled Warrants (CW) Has Historically Come
Ahead of a Copper Price Rally
Year
CW Peak Inventory
CW/
(kt)
(kt)
Inventory
2000
2003-2004
2007-2008
2009
2010-2011
2011
104.3
146.0
39.4
84.0
38.6
60.0
570
341
169
406
417
472
Inventory,
Weeks of
Consumption
Trough
Copper
($/lb)
2.0
1.0
0.5
1.2
1.1
1.2
0.74
0.90
2.87
1.41
2.75
3.08
18%
43%
23%
21%
9%
13%
Peak
%
Copper
Change
($/lb)
0.91
1.43
4.03
2.43
4.62
3.70
23%
59%
40%
72%
68%
20%
Valuation and risks. Our base case valuation of $50 is based
on 4.7x 2012e EBITDA at $3.80 copper, in line with FCX’s last
8-year average EV/EBITDA multiple of 5.5x. Our $43 price
target is derived from probabilities assigned to our scenario
values: 30% to our bear case (DM recession), 60% to our base
case, and 10% to our bull case (strong copper prices and
growth above 5 billion/lbs of copper production). These
probabilities are subjective and illustrative only.
Source: Bloomberg, LME, Morgan Stanley Research
Exhibit 4
Shanghai Spot Premiums at Highest Since May-09; We
Expect Strong Oct. Chinese Copper Imports
500
250
Imports
450
400
350
150
300
100
250
200
50
150
100
Sep-11
Jul-11
May-11
Jan-11
Mar-11
Nov-10
Sep-10
Jul-10
May-10
Mar-10
Jan-10
Nov-09
Jul-09
Sep-09
Mar-09
May-09
-
Chinese Copper Imports, kT
Shanghai Copper Premium, $/T
Copper Premium
200
Risks to our FCX rating and price target include an earlier
and sharper correction in the copper price than we forecast, weaker-than-expected gold and/or molybdenum pricing,
higher-than-expected capital costs associated with growth
projects, delays in completion, and/or less impact on costs than
expected from new operations. Larger copper surpluses than
we forecast could result from economic weakness related to
the US, Europe, and/or China.
Exhibit 6
FCX: EV/EBITDA Valuation
In $ mn, except per share data
Total number of FD shares
Share price
Equity Value (FD basis)
Cash
Total debt
Net debt
Minority Interest
Pensions/OPEB
ARO
EV (ex Pension/OPEB)
956.3
$42.80
40,930
5,128
3,535
(1,593)
2,694
528
856
42,887
EV (incl Pension/OPEB)
43,415
46
November 2, 2011
Company Analysis
October 30, 2011
Interpublic Group
Late Cycle, Margin Upside
Benjamin Swinburne, CFA
Benjamin.Swinburne@morganstanley.com
Micah Nance
Micah.Nance@morganstanley.com
Hersh S. Khadilkar
Hersh.Khadilkar@morganstanley.com
We remain Overweight following strong 3Q results. IPG’s
risk-reward profile remains compelling at current levels. Our
$12 price target reflects a partial closing of the margin gap with
peers. Reaching peer margins by 2013 helps drive our $16 bull
case.
Price target
Mkt cap, curr(mm)
52-Week Range
Fiscal Year ending
ModelWare EPS($)
P/E
Consensus EPS($)§
Div yld(%)
Reuters: IPG.N Bloomberg: IPG US
$12.00
$9.92
$5,385
$13.34-6.75
12/10
0.44
23.9
0.47
0.0
12/11e
0.63
0.59
15.7
0.63
2.4
12/12e
0.77
0.73
13.0
0.74
2.7
12/13e
0.97
0.93
10.2
0.91
2.9
Price Performance
Interpublic Group Of Cos. (Left, U.S. Dollar )
Relativ e to MSCI W orld Index /Media (Right)
$
%
130
14
A late-cycle media play with additional upside from margin discount: We continue to be in the camp of low, but still
growing, advertising in the US in 2012. However, we recently
lowered our outlook for measured media spending growth and
do not see significant upside potential from advertising spend
given the macro outlook. With a more flexible cost structure
than media companies, exposure to high-growth emerging
markets and marketing platforms (TV, digital, etc.), agencies
offer attractive later cycle exposure and at historically low
valuation levels. In addition, IPG offers the potential for
meaningful outsized growth from closing the margin gap versus
peers and utilizing its balance sheet to pay a healthy dividend
and shrink its equity base.
120
12
110
10
100
8
90
80
6
70
4
60
50
2
07
08
09
10
11
Company Description
The Interpublic Group of Companies is one of the largest advertising and
marketing services companies in the world, providing integrated, large
scale global solutions through three major global brands: McCann
Worldgroup, Draftfcb, and Lowe Worldwide, along with domestic integrated and media agencies.
Industry View: Attractive — Media
Our $12 price target represents 10.5x 2013 fully taxed
FCF/share of $1.06 (ex-working capital) + $0.68 NPV of NOLs,
in line with the current multiple and below historical levels of
12–14x. Opportunity for multiple expansion remains, given
IPG’s FCF growth profile relative to peers.
Exhibit 1
IPG’s FCF Growth Attractive Relative to Media Peers
30%
YoY FCF / Share Growth %
Risk-reward remains attractive – $16 bull case (60% upside), $7 bear (30% down). Our bull case assumes:
(1) ~5% average organic revenue growth annually 2012-2013
(similar to annual organic growth for marketing services industry globally from 2003-2007); (2) peer margins by 2013; and
(3) multiple expands from ~11x today to 12x forward FCF (fully
taxed, excluding working cap plus NPV of the tax benefit of net
operating loss carryforwards (NOL) by year-end 2012. Bear
case of $7 assumes organic revenue declines ~2% in 2012 and
margins compress with the stock trading at 8x forward FCF.
25%
20%
15%
10%
5%
0%
2012E
2013E
IPG
FCF metric fully taxed and excludes working capital
Source: Morgan Stanley Research
2014E
Media Peers
E = Morgan Stanley Research Ests.
47
November 2, 2011
Company Analysis
Exhibit 2
Exhibit 3
IPG: Our $12 Price Target Implies ~20% Upside
IPG’s 2012 Equity Shrink at High End of Peers
$18
12%
$16.00 (+61%)
16
12
$12.00 (+21%)
$ 9.92
10
8
$7.00 (-29%)
6
% of YE11 FD shares
14
10%
8%
6%
4%
2%
4
0%
2
DIS
Apr-10
Base Case (Oct-12)
Bull
Case
$16
Base
Case/
Price
Target
$12
Bear
Case
$7
12.0x Bull
Case fwd
FCF of
$1.27(excl.
WC) + $0.71
NPVs of
NOLs
10.5x Base
Case fwd
fully-taxed
2013 FCF /
share of
$1.06 (excludes working capital) +
$0.68 NPV of
NOLs
8.0x Bear
Case fwd
FCF of $0.79
(ex-WC) +
$0.51 NPV of
NOLs
Oct-10
Apr-11
Oct-11
Apr-12
Oct-12
Current Stock Price
CBS
DISCA
SNI
OMC
TWX
VIA.B
IPG
NWSA
IPG share reduction assumes $400mm of convertible debt put to the company in Mar. 2012
WARNINGDONOTEDIT_RRS4RL~IPG.N~
~5% organic revenue growth through 2014,
EBIT margins of 13% by 2014. Organic growth of
~5% in 2012 through 2014. We assume outsized
growth on the top line vs. operating and G&A costs
driving better than expected margin expansion.
The company repurchases $800mm worth of
shares in 2011/2012 and retires convertible note,
achieving $1.17 EPS in 2013 (~20% upside to base
case) and $1.27 fully taxed FCF / share (excl.
working capital).
2012 organic growth of ~3%, 12% reduction in
fully diluted shares by year-end 2012. We assume ~3% organic revenue growth in 2012, which
we see as achievable given our US marketing services growth forecast of 3.4% in 2012 and the
company’s EM footprint. Revenue in 2011 heavily
weighted to 4Q (30% of full year) and steady costs
drive incremental margins of ~50% in 2H11. 12%
reduction in share count by year-end 2012 as
company repurchases $130mm worth of shares in
4Q11 and $200mm in 2012, and repays $400mm of
convertible notes in Mar-12 (reducing fully diluted
share count by ~33mm shares).
Exhibit 4
IPG’s Revenue More Weighted to Asia and LatAm Compared to Agency Peers
100%
90%
80%
70%
% of Revenue
0
Oct-09
60%
50%
40%
30%
20%
10%
0%
Aegis
WPP
ROW
Publicis
Euro + UK
Havas
Omnicom
IPG
N. America
Source: Morgan Stanley Research, Company Data
Macro deterioration coupled with market share
losses. Our bear case assumes organic revenues
decline 1.4% in 2012 along with EBIT margin compression of ~100bps to 8.5%. SC Johnson losses
and additional account losses lead to share loss vs
peers. Company repays $400mm of convertible
notes at the put date, but does not repurchase any
shares in 2012.
Key downside risks include. (1) Further account losses; 2)
Inability to meet margin expansion expectations.
48
November 2, 2011
Company Analysis
October 28, 2011
NuStar (NS/NSH)
Modest Growth Ahead
Stephen J. Maresca, CFA
Stephen.Maresca@morganstanley.com
Robert S. Kad
Robert.Kad@morganstanley.com
Abdiel Santiago
Abdiel.Santiago@morganstanley.com
Shaan Sheikh
Shaan.Sheikh@morganstanley.com
Brian Lasky
Brian.Lasky@morganstanley.com
Despite a discounted valuation (14.8x/11.5x 2012e P/CF and
6.5%/8.1% current yield for NSH/NS respectively), NuStar has
a more modest and less visible growth profile relative to peers.
We prefer NSH to NS given growth outlook (5% vs. 3% in 2012)
NS posted 3Q11 earnings of $0.92, above our $0.59 estimate and consensus at $0.61 (includes 6 million contract
adjustment in Asphalt Segment). NS will pay a quarterly distribution of $1.095/unit, flat q/q and up 1.9% y/y. Total distribution coverage was 1.13x for the quarter.
NSH posted earnings of $0.43, above our (and the consensus) estimate of $0.36. NSH will pay a distribution of
$0.495/unit, flat q/q and up 7.6% y/y; coverage was 1.0x.
We remain Underweight NS and Equal-weight NSH. We
are lowering our price target on NS to $65 from $67, implying a
7% yield on our 3Q12e distribution. We await further execution
on storage and pipeline build out and improvement in fundamentals for asphalt business.
Storage & Transportation segment drives results. Asphalt
& Fuels Marketing EBITDA fell 22% y/y to $31.5 million from
$40.6 million a year ago. Storage EBITDA rose 8% y/y to $70.5
million while Transportation EBITDA rose 2.0% y/y to $51.1
million. Storage benefited from the St. Eustatius terminal reconfiguration while transportation results were driven by increased tariffs and growth projects.
Storage and Transportation key to 4Q11 and 2012 guidance. Management maintained 2011 EBITDA guidance flat vs.
2010, with Storage growth offsetting Transportation and Asphalt & Fuels Marketing. NS issued 4Q11 EBITDA guidance of
$90-100 million and EPS guidance of $0.20-0.30. NS expects
2012 EBITDA growth of $40-60 million on $350-400 million of
capex. Management sees a run rate of $300+ million of strategic capex for the next three years with distribution growth
Price target
Mkt cap, curr(mm)
52-Week Range
Fiscal Year ending
ModelWare EPS($)
P/E
Consensus EPS($)§
Div yld (%)
Div per shr ($)
EBITDA ($mm)
EV/EBITDA
Shares out, diluted, avg (mm)
Distrib. Cash Flow ($mm)
Distrib. Coverage Ratio
Price target
Mkt cap, curr(mm)
52-Week Range
Fiscal Year ending
ModelWare EPS($)
P/E
Consensus EPS($)§
Div yld (%)
Div per shr ($)
P/DCF
Shares out, diluted, avg (mm)
Distrib. Cash Flow ($mm)
Distrib. Coverage Ratio
Reuters: NS.N Bloomberg: NS US
$65.00
$55.60
$3,556
$71.69-49.02
12/10
2.90
24.0
6
4.3
467
13.81
63
320
1.04x
12/11e
2.77
2.72
19.9
2.76
8
4.4
493
12.48
65
329
1.01x
12/12e
3.08
3.06
17.9
3.29
8
4.5
540
12.07
67
367
1.06x
12/13e
3.44
3.19
16.0
3.63
8
4.6
586
11.58
69
405
1.08x
Reuters: NSH.N Bloomberg: NSH US
$40.00
$31.80
$1,346
$39.98-27.94
12/10
1.70
21.3
5.1
1.87
17.0x
43
80
1.00x
12/11e
1.45
1.46
21.8
1.49
6.2
1.97
16.2x
43
84
1.00x
12/12e
1.70
1.72
18.6
1.78
6.5
2.06
15.2x
43
89
1.02x
12/13e
1.91
1.86
16.5
1.97
6.9
2.18
14.1x
43
96
1.03x
Company Description
NuStar Energy (NS) transports, distributes and storages crude oil and
refined products in the US.
NuStar GP (NSH) is involved in the transportation, storage, terminalling,
and marketing of crude oil and refined products.
Industry View: In-Line — Midstream Energy MLPs
acceleration possible in 2013. Key drivers of growth include
the Eagle Ford and expansions at St. James and St. Eustatius.
We expect distribution growth of 3% at NS and 5% at NSH in
2012.
49
November 2, 2011
Company Analysis
Exhibit 1
Exhibit 2
NuStar Energy (NS, Underweight)
Volatile Asphalt Business Leaves CF at More Risk
NuStar GP Holdings (NSH, Equal-weight)
Scarcity Value as a GP Stock with Growth Upside
$50
$80
$70.00 (+26%)
70
$65.00 (+17%)
60
45
$44.00 (+38%)
40
$40.00 (+25%)
$ 55.60
35
$ 31.88
$52.00 (-6%)
50
30
$30.00 (-6%)
25
40
20
30
15
20
10
10
5
0
Oct-09
Apr-10
Price Target $65
Bull
Case
$70
6.5% yield /
6% distr
growth
Base
Case
$65
7% yield /
3.5% distr
growth
Bear
Case
$52
8.5% yield /
0% distr
growth
Oct-10
Apr-11
Oct-11
0
Oct-09
Apr-12
Current Stock Price
Derived from our base case (assumes stable
yield in line with historical range and modest
growth given expansion projects).
Strong economic recovery. NS benefits from
asphalt margins that recover strongly due to
supply constraints and improving economic
conditions. Refined product storage growth
opportunities exist, reassuring investors that the
midstream side of the business will grow
alongside the asphalt operations.
Modest y/y improvement for asphalt. Distribution growth rate is minimal as weaker demand
persists in asphalt and refined products businesses.
Back to square one. Refined product volumes
and/or asphalt margin weakness persists.
Storage projects make up for cash flow shortfall
in existing segments; distribution growth is
non-existent. This scenario represents risks to
our price target.
Apr-10
WARNINGDONOTEDIT_RRS4RL~NS.N~
Oct-10
Apr-11
Oct-11
Apr-12
Current Stock Price
W ARNINGDONOTEDIT_RRS4RL~NSH.N~
Price Target $40
Bull
Case
$44
Base
Case
$40
Bear
Case
$30
Derived from our base case (assumes stable
yield in line with historical range and modest
growth given expansion projects).
5% yield / 10% Asphalt kicks into gear. Asphalt benefits from
distr growth
infrastructure spending. Long-term fundamentals remain intact. Demand for new terminal
projects completed position NSH well for upturn.
New organic projects are identified.
5.25% yield /
Core storage business picks up. Higher re6% distr
finery utilization drives improved pipeline results
growth
and storage projects boost cash flow. Asphalt
margins recover following seasonal weakness.
Growth remains steady from tariff increases at
NS.
6.5% yield /
No economic recovery in sight. Refined
3% distr
product demand declines and asphalt activity
growth
wanes. Investors worry that the stimulus package will have limited effect on asphalt pricing. NS
struggles to cover its distribution and growth
suffers. This scenario represents risks to our
price target.
Why Underweight: Asphalt fundamentals are mixed and
contribute to a weaker distribution growth outlook relative to
peers; business mix has shifted to more variable cash flow.
Why Equal-weight: Will benefit from growth spending at NS.
NSH receives 25% of increased cash distribution payouts at
NS on its general partner stake.
Seasonal and variable asphalt business adds more risk to
profile, company is not adequately reserving cash flow to reduce this risk.
Valuation support and scarcity value for general partners.
NS is exposed to refined products volumes (declining due to
weak demand); however, they are regulated under a producer
price index (PPI) tariff-based system providing inflation protection.
Key value drivers: Favorable PPI adjustments result in
higher allowed regulated tariff charged on its refined products
pipelines. Adjustments occur every July, and are based on PPI
+ 2.65%. Organic and third party acquisitions at attractive
multiples. Crude oil storage projects in high growth areas (e.g.,
Bakken, Eagle Ford). Announcements of crude oil pipeline
expansions in emerging oily shale plays. Lower GP incentive
sharing agreement of 25% (versus many peers at 50%) provides more cash in NS for growth and distributions.
Tariff boost every year; should have big impact July 1, 2011.
PPI + 2.65% tariff adjuster should have material increase to
rates and will boost 2H11 cash flows (and NSH distribution
payout).
x Key value drivers: Storage and pipeline infrastructure
spending at attractive returns. Contango market increases
demand for storage; the approximately 25% of contracts up
for renewal per year could be recontracted at higher rates.
Equity issuance at NS boosts growth multiplier at NSH.
Acquisition at NS that materially grows cash flows to NSH.
50
November 2, 2011
Company Analysis
October 26, 2011
Red Hat
RHEV-ing Up the Engine with
Upcoming 3.0 Release
Adam Holt
Adam.Holt@morganstanley.com
Keith Weiss, CFA
Keith.Weiss@morganstanley.com
Jonathan Parker
Jonathan.Parker@morganstanley.com
Price target
Mkt cap, curr(mm)
52-Week Range
Fiscal Year ending
Revenue, net($mm)
Sales, consensus($mm)
EPS($)**
Consensus EPS($)§
P/E**
ModelWare EPS($)
Reuters: RHT.N Bloomberg: RHT US
$54.00
$46.46
$9,105
$48.99-31.77
02/10
748
748
0.71
0.71
39.3
0.48
02/11
909
909
0.83
0.83
49.5
0.55
02/12e
1,125
1,128
1.05
1.05
44.2
0.69
02/13e
1,306
1,294
1.14
1.16
40.7
0.71
Red Hat’s pending release of RHEV 3 represents a potentially
significant top-line driver. We have raised our Bull/Base/Bear
to reflect recent customer momentum and new product opportunities. While EPS moves slightly lower on Gluster, Red
Hat has now derisked F2013 margins and estimates look low.
Price Performance
Red Hat Inc. (Left, U.S. Dollar)
Relativ e to MSCI W orld Index /Software & Serv ices (Right)
$
%
50
RHEV represents a ‘call option’ on F2013, in our view. Red
Hat has slowly gained virtualization traction, but the general
availability release of Red Hat Enterprise Virtualization 3.0
(RHEV 3) is a meaningful upgrade (available in coming weeks)
and RHEV is moving to an open stack and away from Windows
which was a key problem, while a more powerful back-end
should drive Tier 1/2 app penetration and intuitive toolkits ease
adoption. Given its strong RHEL installed base, which is
growing ~20%-plus Y/Y and low penetration, Red Hat has a
significant opportunity to cross-sell RHEV 3.0 into the base.
Each point of attach could drive $12–23 million per year of
revenue or 1–2 points of revenue growth, and we have raised
our F2013 new billings target to 10% growth (from 6%) to
reflect more confidence in RHEV and other new products.
350
45
40
300
35
250
30
25
200
20
150
15
100
10
07
08
09
10
11
Company Description
Red Hat is the leading distributor of open source software. Red Hat’s
core offering is a server operating system named Red Hat Enterprise
Linux, which is based on the Linux OS. Red Hat has expanded into
middleware, virtualization, systems management, and security.
Industry View: In-Line — Software
Exhibit 1
RHEV Addresses Potential $1.2–2.3bn Annual
Opportunity and $12–23mn per Point of Attach
RHEV ASP (per
socket)
Bull//Bear move higher. We had been underestimating the
strength of up-sells and large deal momentum, the durability of
JBoss, the potential for Red Hat Enterprise Virtualization
(RHEV), and the value of the installed base. We have updated
our “value of the installed base” analysis, which raises the
notional floor in the stock and our bear case to $30, while the
potential for better renewals, Gluster and RHEV 3 raises the
ceiling and our bull case to $69. Our base case and target
move to $54 from $50, on what we still regard as conservative
ramp assumptions, but our target still reflects 16% upside from
here.
$300
$350
$400
$450
$500
$550
$600
Assumed RHEL Phyiscal Installed Base (MM Units)
2.7
1.1
1.5
1.9
2.3
$660
$900
$1,140
$1,380
$1,620
$770
$1,050
$1,330
$1,610
$1,890
$880
$1,200
$1,520
$1,840
$2,160
$990
$1,350
$1,710
$2,070
$2,430
$1,100
$1,500
$1,900
$2,300
$2,700
$1,210
$1,650
$2,090
$2,530
$2,970
$1,320
$1,800
$2,280
$2,760
$3,240
Revenue per 1% Incremental Penetration ($MM)
$6.6
$9.0
$11.4
$13.8
$7.7
$10.5
$13.3
$16.1
$8.8
$12.0
$15.2
$18.4
$9.9
$13.5
$17.1
$20.7
$11.0
$15.0
$19.0
$23.0
$12.1
$16.5
$20.9
$25.3
$13.2
$18.0
$22.8
$27.6
$16.2
$18.9
$21.6
$24.3
$27.0
$29.7
$32.4
Source: IDC, Company data, Morgan Stanley Research. Assumes avg. server is two-socket.
51
November 2, 2011
Company Analysis
Numbers look increasingly conservative: With the Gluster
deal closed, we have lowered our F2013 margin estimate by
190bps, in line with Red Hat’s guided expenses, which requires
loading the model much more than is likely. On that front, Red
Hat outperformed original margin guides by 330 and 150bps
post Qumranet and JBoss, respectively. Combined with our
model which reflects sub-seasonal Q/Q growth in the next six
Qs, and an unlikely billings deceleration, there is upside ahead.
Exhibit 2
RHT: Secular Growth Story Should Drive FCF Growth and
Shares Higher
$80
70
$69.00 (+49%)
60
$54.00 (+16%)
$ 46.46
50
40
Investment Thesis
x Red Hat’s low cost open source technology platform,
broadening product portfolio and subscription model should
enable billings growth to sustain levels ahead of consensus
expectations. Along with continued margin improvements, we
look for FCF growth to accelerate in F2012, buttressing multiples and driving shares higher.
x While the new RHEL business could be hindered by slowing
server growth, we see several potentially offsetting factors
including: a fast growing renewal base, ASP increases,
strength in the JBoss business, new cloud and virtualization
offerings, and improving renewals.
x Recently released virtualization technology is still not a
material contributor today, but represents a compelling call
option to our current estimates and could drive RHT shares
toward our $69 bull case.
Key Drivers
x Share gains by Linux within the overall OS base, increasing
conversion of free users to paid subscription, and adoption of
higher priced SKUs.
x Traction of product segments outside the core Linux business, such as JBoss and virtualization.
Key Concerns/Risks to Our Price Target
x Execution risk on virtualization, in a market dominated by
VMware.
x Microsoft Windows 2008 Server product cycle.
30
$30.00 (-35%)
20
10
0
Oct-09
Apr-10
PT = $54
Bull: $69
EV/FCF =
29x F2013
Adjusted
FCF of
$2.11 +
$7/sh cash
Base: $54
EV/FCF =
26x F2013
Adjusted
FCF of
$1.79 +
$7/sh cash
Bear: $30
EV/FCF =
14x F2013
Adjusted
FCF of
$1.57 +
$7/sh cash
Oct-10
Apr-11
Oct-11
Apr-12
Oct-12
Current Stock Price
WARNINGDONOTEDIT_RRS4RL~RHT.N
Price Target equals our base case scenario.
Emergence as a Cloud Player: Red Hat continues to gain
share in the OS and middleware markets, while new virtualization technologies gain traction, significantly raising ASPs
and opening new market opportunities. This drives a new
billings CAGR of ~25% thru F2013, enabling total billings
growth of 23% Y/Y. Billings strength helps offset recent investments and fuels 50-100 bps of margin expansion annually, sustaining mid-twenties FCF growth. Stock trades at 29x
our F2013 adjusted FCF estimate of $2.11 per share, plus $7
in cash.
Broadening Product Portfolio Sustains Growth. The low
cost/ high performance value proposition of open source and
continued traction with JBoss, combined with continued operational improvements, sustains 18% total billings growth
thru F2013. We forecast 60-90 bps of core operating margin
improvements annually as RHEV starts yielding returns,
though investment in Gluster weighs on short-term overall
margins. RHEL ASPs continue to improve and the renewal
business grows as a percentage of overall billings, yielding
20%+ FCF growth in F2012. This growth sustains an EV
multiple at 26x our F2013 adj. FCF, in line with other
high-growth software companies, plus $7 in cash.
Open Source Yields No Defense Against Weak Server
Sales. Slowing server growth in F2012 has a significant
impact on Red Hat’s core business. The middleware and
virtualization segments fail to boost new billings, which are
close to flat Y/Y, yielding a total billings CAGR of 15% Y/Y thru
F2013, and muting any potential margin expansion as the
Gluster investments move margins lower. The stock trades at
14x our F2013 adjusted FCF of $1.57, in line with the value of
the installed subscription base, plus $7 in cash.
52
November 2, 2011
Company Analysis
November 1, 2011
Salesforce.com
Strong Transaction Growth,
Large Deals Should Pace Q3
Adam Holt
Jennifer Swanson, CFA
Jennifer.Swanson@morganstanley.com
Jonathan Parker
Jonathan.Parker@morganstanley.com
Our proprietary transaction and jobs data suggest sustained
momentum in Q3, while early checks indicate continued large
deal strength in Q3. We also believe early commentary on
F2013 revenue will be constructive vs. consensus and we
remain buyers.
Price target
Mkt cap, curr(mm)
52-Week Range
Fiscal Year ending
Revenue, net($mm)
Sales, consensus($mm)
EPS($)**
Consensus EPS($)§
ModelWare EPS($)
Reuters: CRM.N Bloomberg: CRM US
$180.00
$133.17
$19,104
$160.12-109.21
01/11
1,657
1,657
1.22
1.22
0.62
01/12e
2,227
2,230
1.29
1.30
0.35
01/13e
2,805
2,766
1.76
1.79
0.66
Price Performance
Salesforce.com Inc. (Left, U.S. Dollar )
Relativ e to MSCI W orld Index /Software & Serv ices (Right)
$
%
160
400
140
Positive early read on the quarter. Transaction growth,
which has tracked billings growth over the past 15 quarters,
was steady in Q3 at +62% Y/Y, the fourth straight quarter of
60%-plus growth. At the same time, CRM is being viewed
more strategically within organizations and its broader product
portfolio has driven an increase in 8-figure deals, which our
checks suggest continued in Q3, while the Q4 pipeline remains
strong. The larger deals tend to be multi year and are not all
billed up front, but should be a positive lever in Q3/Q4. Our
“new billings” estimates reflect deceleration from +53% in 1H12
to +16% in 2H12 which likely sets up for billings upside in Q3
given recent momentum.
Strong transaction growth in Q3 bodes well for billings.
Transaction growth of +62% Y/Y in Q3 remains strong vs. more
difficult comps and is in line with the +63% seen in Q2. Historical correlations of billings to transactions would point to a
Q3 billings growth rate at least in the low-to-mid 30s, and our
estimate of +30% Y/Y in Q3 is likely to prove low if renewal
rates continue to improve and new billings display normal
seasonality (0–10% Q/Q vs. our –7%). The Y/Y currency tailwind will moderate in Q3 to about +2% to reported billings
growth (from 5% in Q2), but euro strength since early October
should result in minimal impacts vs. guidance and constant-currency billings should show upside.
Hiring continues. We have adjusted our F2013 operating
margin estimate to reflect added expenses from Assistly and
commentary at DreamForce on further investment to sustain
growth. Along this line, our proprietary job data indicates a
steady ramp of postings through Q3 and likely implies the
company adding 400-500 heads in the quarter, and 35% YTD
01/14e
3,463
3,352
2.25
2.30
0.98
350
120
300
100
250
80
200
60
150
40
100
20
07
08
09
10
11
Company Description
Salesforce.com provides hosted applications that manage customer information for sales, marketing, and customer support. Its applications
are used for generating sales leads, maintaining customer information
and tracking customer interactions.
Industry View: In-Line — Software
organic growth in headcount (much in sales) — which should
put upward pressure on F2013 consensus revenue of +24%
Y/Y growth, and we believe that billings growth of 25-30% is
sustainable.
As a result, our operating margin estimates move from 14.2%
to 12.7% for F2013 and our EPS from $1.82 to $1.76. The
acquisition adds Assistly’s SMB-oriented, instant-onboarding
service desk apps into the Service Cloud and because of the
deal, CRM guided to a $0.02 impact in Q3 and Q4 from added
expenses — though maintained Q3 guidance as CRM will
recognize an offsetting investment gain. The impact on operating margins in our model is roughly 80 bps in 2H12 and we
expect continued investments related to the acquisition to carry
into next year as well.
Given our current expectation for 26% revenue growth in
F2013, we believe margin expansion is likely to be more limited
than we were previously modeling (+270bps); and we have
53
November 2, 2011
Company Analysis
lowered our expectations by ~100bps for added investments
outside of the Assistly deal. However, we would note that we
are not assuming any incremental impact on the top line or
billings from added sales capacity or Assistly, which we think is
likely conservative — and we think 25-30% billings growth is
sustainable.
Our $180 price target is based on DCF that assumes a
10.3% WACC, 16% 2011–26e revenue and FCF CAGRs, and
a 3.5% terminal growth rate.
Risks to achieving our target include: High Street expectations increase downside risk if Salesforce misses; investments may pressure cash flow near term, while the company may be reluctant to scale back costs over time if growth
slows; new billings can be lumpy Q/Q; competition from apps
vendors and emerging Internet platforms (Oracle, SAP, Microsoft, Google, Amazon.com); potential for further M&A and
acquisition execution.
Exhibit 1
Exhibit 3
Y/Y Transaction Growth Stayed Above 60% in Q3
Job Openings Have Continued Steadily Increase Over the
Past Three Months to 720 from 540 in Q2
80%
20%
10%
20%
800
10%
600
0%
400
-10%
0%
-20%
-30%
1Q
09
2Q
09
3Q
09
4Q
09
1Q
10
2Q
10
3Q
10
4Q
10
1Q
11
2Q
11
3Q
11
4Q
11
1Q
12
2Q
12
3Q
12
7/22/09
8/17/09
9/7/09
9/28/09
10/19/09
11/9/09
11/30/09
12/21/09
1/11/10
2/1/10
2/22/10
3/15/10
4/5/10
4/26/10
5/17/10
6/7/10
6/28/10
7/19/10
8/9/10
8/30/10
9/20/10
10/11/10
11/1/10
11/22/10
12/13/10
1/3/11
1/31/11
2/21/11
3/14/11
4/4/11
4/25/11
5/16/11
6/6/11
6/27/11
7/18/11
8/8/11
8/29/11
9/19/11
10/10/11
10/31/11
0
Source: trust.salesforce.com, Company data, Morgan Stanley Research
Actual CRM Postings
Exhibit 2
70%
100%
90%
60%
20%
10%
Headcount Growth
4/11
10/11e
4/10
0%
10/10
0%
30%
4/09
O
ct
0
Ja 7
n
Ap 08
ri l
Ju 08
ly
0
O 8
ct
0
Ja 8
n
09
Ap
r
Ju 09
ly
0
O 9
ct
0
Ja 9
n
10
Ap
r1
Ju 0
l-1
O 0
ct
1
Ja 0
n
11
Ap
r
Ju 11
ly
O 11
ct
11
e
0%
10%
40%
10/09
20%
50%
4/08
20%
60%
10/08
30%
70%
4/07
40%
40%
4/04
60%
80%
50%
Billing Growth YoY
80%
10/07
Billings Y/Y
Billings Growth Typically Tracks Headcount Growth
4/06
Transactions Y/Y
Adjusted CRM Postings
Exhibit 4
80%
120%
Actual MoM%
Billings Growth Trends Have Tracked Closely to the
Transaction Trend We’ve Tracked
100%
Website Re-Configuration
Resulting in One-Time
Decrease
200
10/06
30%
30%
4/05
40%
40%
1,000
10/05
50%
+12% +1% +3% -1%
Q/Q Q/Q Q/Q Q/Q
+10%
+14% Q/Q
+38% Q/Q
-28%
+2%
Q/Q
Q/Q -20%
+14%
Q/Q
Q/Q
-21% Q/Q
Q/Q
10/04
Y/Y Growth
60%
Re-Based Posting #
1,200
-28%
Q/Q -2%
Q/Q
# of Total Open Positions
70%
Growth, MoM
90%
Billings Growth
Source: trust.salesforce.com, Company Data, Morgan Stanley Research
54
November 2, 2011
Company Analysis
October 26, 2011
Walker & Dunlop
Protection in a Downturn;
Head Start in a Recovery
Cheryl M. Pate, CFA
Cheryl.Pate@morganstanley.com
Vincent Caintic, CFA
Vincent.Caintic@morganstanley.com
Price target
Mkt cap, curr(mm)
52-Week Range
Fiscal Year ending
ModelWare EPS($)
P/E
Consensus EPS($)§
Reuters: WD.N Bloomberg: WD US
$16.00
$13.06
$280
$14.05-9.61
12/10
1.16
8.7
1.64
12/11e
1.57
1.64
8.3
1.60
12/12e
1.78
1.70
7.3
1.76
12/13e
1.97
1.87
6.6
1.87
WD should benefit from strong tailwinds in multifamily refinancings, steady servicing fees, and diversification into other
CRE products.
Price Performance
W alker & Dunlop Inc. (Left, U.S . Dollar)
Relativ e to MSCI W orld Index /Banks (Right)
$
We are assuming coverage of WD at Overweight. Our $16
price target is based on our discounted cash flow model and
implies 9.1x our 2012 EPS estimate of $1.78. We believe that
WD offers a compelling top-line growth story, with limited
downside risk.
Relatively immune from downturn. Multifamily lending,
WD’s core market, has a well-defined $307 billion pipeline of
maturing loans that need to be refinanced over the next decade. Non-bank multifamily refinancings are poised to grow from
$25 billion in 2011 to $53 billion in 2016e, a 16% CAGR. The
current lack of competitive capital in multifamily lending is a
near-term positive for WD.
A growth story. We forecast a 15% origination CAGR in
2010-15. WD has taken substantial share in multifamily originations in the past 2.5 years. We expect it will continue to
benefit from weak competition near term and will expand its
product capabilities long term.
Value in servicing. The servicing portfolio adds stability to
earnings, with higher originations share driving expansion in the
servicing base. We think WD can maintain servicing fee margins
at 20-21bps through 2015, even under our bear scenario of new
servicing margins returning to trough levels at 17bps.
What will move the stock:
x
Improved sentiment on WD’s growth in a recovering
economy. We agree with most observers that competition will
return to multifamily lending in a recovery. However, we think
that WD will benefit from platform expansion and growth in the
servicing portfolio to a greater extent than consensus implies.
x
Clarity on GSE reform risk. The stock is subject to headline
risk on GSE reform, but we think a bearish GSE scenario is
being priced in. Our base case is that GSE reform is not a
near-term event. Product and channel diversification help ease
WD’s risk.
%
140
13.5
135
13
130
12.5
125
12
120
11.5
115
11
110
10.5
105
100
10
07
08
09
10
11
Company Description
Walker & Dunlop is primarily a multifamily originator and servicer, operating an “originate and sell” business model. WD lends in several multifamily asset classes including market-rate apartments, affordable
apartments, manufactured housing developments, senior housing, and
student housing.
Industry View: In-Line — Specialty & Consumer Finance
Key Debates
Debate 1: How fast can WD grow in a recovering economic
environment?
x
Market View: Expect competition to return to the multifamily market and pressure market share gains and margins.
x
Our View: We look for origination market share to decline
from 2011 levels as competition returns to the market over
time. The significant growth in the servicing portfolio over the
last 2.5 years adds stability to earnings.
Debate 2: How big of a risk is GSE reform to WD’s business
model?
x
Market View: Bearish GSE scenario is being priced in,
shares are subject to headline risk on GSE reform.
x
Our View: GSE reform is not a near-term event in our view.
Product and channel diversification help alleviate WD’s risk.
55
November 2, 2011
Company Analysis
Exhibit 1
Exhibit 3
Well Defined Non-Bank Multifamily Refi Pipeline: $307B
Through 2020
WD: Positive Skew, with Downside Protection
$25
NonBankMultifamilyLoanMaturitiesbyInvestorType
20
60
$20.00 (+61%)
53
49
50
$16.00 (+29%)
15
42
$ 12.39
40
37
34
30
31
10
25
21
22
14
16
16
2018
2019
2020
18
20
$10.00 (-19%)
5
10
16
20
17
21
2013
2014
2015
24
21
7
0
2011
2012
2016
2017
0
Oct-09
Price Target $16
Fannie,Freddie,FHA,Ginnie
LifeInsuranceCo's
CMBS,CDO,otherABS
CreditCo's,Warehouse,Other
Source: Mortgage Bankers Association, Morgan Stanley Research estimates
Exhibit 2
Avg. Multifamily Housing Starts Up 44% ’11 vs. ‘10
Bull
Case
$20
Starts - Multifamily
400
350
Base
Case
$16
300
250
200
MF starts are about 30-35%
of the total starts - and this
share is set to increase
150
100
0
1990
Bear
Case
$10
Starts - Multifamily
50
1992
1994
1996
1998
2000
2002
2004
Apr-10
Base Case (Oct-12)
2006
2008
2010
Risks to our price target:
Oct-10
Apr-11
Oct-11
Apr-12
Oct-12
Current Stock Price
WARNINGDONOTEDIT_RRS4RL~WD.N
Based on our discounted cash flow model, using
a risk free rate of 5.0%, an equity risk premium of
4.5%, and a beta of 1.6.
9.4x
Pretax operating margins (2012):
37.0%
Bull Case
20.3%
2012e EPS of Revenue CAGR (2010-15):
$2.19
Origination volume CAGR (2010-15): 18.2%
Average origination fees (2012):
1.30%
Average servicing fees (2012):
21 bps
Provisions/At-Risk Portfolio (2012):
8 bps
9.1x
35.2%
Base Case
15.1%
$1.78
1.12%
20 bps
Provisions/At-Risk Portfolio (2012):
9 bps
7.3x
33.6%
Bear Case
8.2%
$1.38
1.00%
20 bps
Provisions/At-Risk Portfolio (2012): 12 bps
x
Downside risks to our price target and thesis, earnings
estimates and valuation target include a faster than anticipated
return of competitive capital, and significant GSE reform.
x
Upside risks include higher multifamily new origination
volumes (in addition to expected refis), a slower return of
competitive capital and faster-than-expected rollout of products
that expand WD’s capabilities.
56
November 2, 2011
International
October 31, 2011
Asia IC Manufacturing
Asia Insight: Foundries –
Samsung vs TSMC
Morgan Stanley Asia
Limited+
Bill Lu
International plc, Seoul
Branch+
Keon Han
Bill.Lu@morganstanley.com
Keon.Han@morganstanley.com
This is a follow-up to our Foundry Global Competitive Report,
published on October 7, 2010. We see a structural shift in the
industry as new players such as Samsung and GlobalFoundries enter or provide foundry-like services.
What is different now?
Mobile Internet applications continue to surprise on upside. We believe smartphones and tablets add an incremental
US$3.3 billion in revenues to the foundry opportunity in 2012
and another US$2.1 billion in 2013. This is driven not only by
higher units but also the shift towards 28nm, LTE, and
multi-core processors.
The consensus view is that Samsung’s entry into logic manufacturing is a negative for TSMC, but we believe the pie is
clearly growing. Samsung is clearly a long-term threat, but for
now, both companies are benefiting.
We believe the end markets could now be more important
than the industry call. Companies in the group have historically traded together over the past twenty years and displayed similar revenue progressions. However, we think that is
likely to change as smartphones/tablets and 28nm are clearly
outgrowing other segments.
Samsung, already a proven Application Processor Specialist. Apple sourced 100% of its A/P from Samsung starting
with A4, and now A5, the next generation product. We currently believe Samsung will retain all production of Apple’s
future generation A/P, the A6, at least for the next 12 months,
currently designed on Samsung’s 32 nm node. Adding Samsung’s own Hummingbird and now Exynos, A/Ps produced at
Samsung already run the best-selling smartphones and tablet
PC brands globally. We see a high probability that Samsung
will also take on some production of TI’s OMAP, and there is
also an outside chance of producing for NVDA and QCOM in
the future.
For GlobalFoundries, more time is needed. Recent checks
suggest that GlobalFoundries remains aggressive on capex
and capacity expansion – but poor yields, lack of new customers, and management turnover likely imply that more time
is needed before it can compete with the leaders. We would
expect it to lose some market share to TSMC, and recent yield
issues with AMD would suggest to us that AMD could move its
Fusion products to TSMC.
Likely another big capex year in 2012: Although the macro
environment remains uncertain, we would expect another big
foundry capex year in 2012.
x
The new entrants such as Samsung and GF will likely
forge ahead in their quests to gain share,
x
We see TSMC spending up to US$6 billion to build out its
28nm capacity,
x
Other, small foundries are likely to maintain or slightly
reduce capex.
Overall, we project that foundry capex will decrease just 5%
Y/Y off of the record level in 2011.
Key Stock Implications
TSMC (2330.TW: NT$73.10,
Overweight/In-Line industry View)
We maintain our Street-high estimates for 2012 – this is based
on the analysis in this report on smartphone/tablet-related
opportunities and overall growth at 40nm and 28nm. We believe 28nm business could exit 2012 at 15% of TSMC’s total
revenues. Even if we assume the macro environment does not
pick up and the semiconductor industry remains flat Y/Y, the
growth for TSMC’s 28nm and 40nm business is enough to
allow TSMC to significantly outperform the industry. Our new
2012e EPS is NT$6.11, ~10% above consensus.
Samsung Electronics (005930.KS; W945,000,
Overweight/Attractive industry View)
We have raised our EPS estimate for 2012 by 14%. As a result
of much faster expansion of its System LSI business, we believe that by 2012, System LSI products, with estimated
revenue of W16 trn, will displace both DRAM and NAND as the
largest semiconductor product revenue and profit generator.
As a comparison, System LSI revenues in 2008 were roughly
on-half the size of DRAM.
We have also raised our 2013 earnings estimate by 17% to
reflect greater product successes in its handsets, System LSI
and OLED products.
57
November 2, 2011
International
UMC (2303.TW, NT$13.20,
Equal-weight/In-Line industry View)
We have lowered our 2012 forecast significantly – our new
2012e EPS is NT$0.84: That now represents 5% Y/Y growth
versus our previous estimate of 12% growth.
However, our main issue is structural. We believe UMC is
exposed to too many of the Taiwanese fabless companies that
are mainly leveraged to the PC foodchain, whereas its
smartphone/tablet exposure is limited. In our view, this is likely
to lead to additional underperformance in 2012.
As stated in previous reports, we have seen the company
executing much more efficiently over the past two years and it
has done well in its cost cuts and ability to ramp.
Key Debates
DEBATE
MARKET’S VIEW
OUR VIEW
Samsung is increasingly competing against TSMC in the foundry business. Who will win?
Split: Some believe that
Samsung’s bundling strategy will lead to share gains.
Others view TSMC’s experience and independence
as keys.
Not a zero-sum game: We think the industry is likely to
generate significant growth over the next few years based
on the proliferation of smartphones and tablets. TSMC and
Samsung are both key beneficiaries of this trend. We believe some of the smaller foundries without exposure could
show slower growth.
While both Samsung and TSMC benefit, we see them
benefiting differently. TSMC remains dominant at the most
advanced nodes, i.e., 28nm. We see this as a large driver
in 2012. Samsung is rapidly becoming an Application
Processor specialist, especially at 45nm.
How big is the smartphone/tablet
opportunity?
Growing, but diversification muffles impact on
foundries: The market
understands that smartphones and tablets are
growing, but consensus
view is foundries and TSMC
specifically is too diversified
to benefit from the trend.
Conservatively, roughly $3.3 billion in industry revenue in 2012 and another $2.1 billion in 2013. We estimate global foundry industry revenue is around $30-40
billion annually – thus, this is significant.
Where are the share shifts? What
will Apple do with its foundry
supplier?
Split: Unconfirmed speculation about Apple’s supplier choices is rampant, as
well as several other customers.
We see several significant shifts happening: 1.) TSMC
continues to take share at 28nm. We would not be surprised if AMD shifts some of its “Fusion” chips to TSMC and
the win with Xilinx is well documented. 2.) We see TI
moving some production from UMC to Samsung.
While Apple remains 100% Samsung today, at 20nm we
believe vendor diversification makes sense and TSMC is
likely to become a second source.
Where is foundry capex headed?
Split: The overall macro
environment is challenging,
but 28nm demand remains
robust and newcomers are
spending aggressively.
2012 foundry capex should be down Y/Y, but only by
around 5% Y/Y off 2011’s record levels: Leading edge
demand likely remains robust, but older fabs could see
overcapacity. We therefore advise leaning towards those
with leading edge exposure.
58
November 2, 2011
International
What’s changed?
October 31, 2011
Europe Reinsurers
Falling Yields Weigh on Industry;
Munich Re Is Key Pick
International plc+
Old rating
New Rating
Old PT
Hannover Re
OW
ÐEW
47.0
New PT
45.4
Munich Re
OW
OW
143.0
129.0
Swiss Re
EW
EW
52.8
57.5
Maciej Wasilewicz
2010
2011e
2012e
Hannover Re
37
41
45
Swiss Re (SFr)
60
65
69
126
125
129
Hannover Re
6.2
4.6
5.9
Swiss Re (US$)
2.5
3.9
6.4
13.1
5.3
15.3
Maciej.Wasilewicz@morganstanley.com
BV per share
The most material change in 3Q for reinsurers was the
large fall in sovereign yields, which cuts our stock valuations by ~10%. This fall, together with stock outperformance, reduces the upside for Hannover Re so we downgrade the stock to Equal-weight. Munich Re is now our top
pick with ~30% upside.
3Q profits hard to predict, but equity should grow. European reinsurer underwriting profits should be close to the
long-term average as lower than expected US wind losses
counter-balance further loss revisions. Asset impairments are
hard to forecast but book values should rise 5-10% as falling
yields and FX more than offset GIIPS sovereign losses and a
fall in equities.
Munich Re
EPS
Munich Re
P/BV
Hannover Re
0.99
0.91
0.82
Swiss Re
0.81
0.75
0.71
Munich Re
0.78
0.79
0.76
20.2
12.2
14.4
3.9
6.0
8.0
11.0
4.2
12.2
Hannover Re (%)
6.2
4.3
6.2
Swiss Re (%)
6.6
7.2
8.0
Munich Re (%)
6.3
6.3
6.4
ROE
Hannover Re (%)
Swiss Re (%)
Munich Re (%)
Div yield
Falling yields reduce our valuations. We think the biggest
3Q11 impact on reinsurers is the acceleration in the decline of
sovereign bond yields. This reduces our valuation of reinsurer
price targets by 10% on average (offset by FX for Swiss Re).
Reinsurers could re-price for lower yields, but, historically,
combined ratios lag yields, so we are not changing our combined ratio estimates.
1/1 renewals – discipline, if not price rises. Newsflow on
prices from the Baden-Baden conference is tepid as sufficient
capacity is preventing rises in lines other than catastrophe
lines. Yet we think capital discipline is improving, and that if 1/1
renewals are weak, buybacks will rise.
e = Morgan Stanley Research estimates Source: Company data, Morgan Stanley Research
Exhibit 1
Impact of low yields on reinsurer valuations
Leverage
% investBlended ments in
Govt.
yield
change
bonds
Impact
on
sustainable
RoE
Impact
on valuation
-8.50%
Hannover Re
368%
-59.3
44.00%
-0.96%
Swiss Re
395%
-66.3
37.00%
-0.97%
-8.92%
Munich Re
435%
-59.0
39.19%
-1.01%
-9.78%
Source: Morgan Stanley Research estimates
Downgrading Hannover Re to EW for two key reasons:
1) the stock has outperformed its peers over the past two
months, and 2) with the reduced upside from lower yields, we
now think it is trading close to its historical discount to the
insurance sector (20%).
Exhibit 2
Upside remains high, despite falling yields
Hannover Re
Swiss Re
Munich Re is our key pick. Munich Re stock is down 4.6%
since 30 June versus +2.1% for Swiss Re (adjusted for FX) and
+6% for Hannover Re. Yet, in our view, the fall in yields since
that date will impact reinsurer valuations by a similar amount
(~10%). In Munich Re’s case, this means 30% upside – high
relative to peers.
Munich Re
RoE 12e
Adj.
RoE
CoE
Implied
P/BV
Upside
14.4%
13.5%
11.3%
1.19
28.4%
9.3%
8.3%
10.9%
0.77
4.4%
12.2%
11.2%
10.3%
1.09
38.1%
Note, this is similar to but not the same as our SOTP valuation because we use EV for Munich
Re and Hannover Re, not book value. Source: Morgan Stanley Research estimates.
59
November 2, 2011
International
Exhibit 3
5-7y sovereign yields: although yields have rebounded since 30 Sept, they are still well below 30 June levels, let alone the
levels they were at on 1 Jan 2010. The exception to this rule is aggregate Eurozone sovereigns
1 Jan 10
3.5%
30 Jun 11
30 Sep 11
26 Oct 11
3.46%
3.15%
3.06%
3.0%
3.24%
3.13%
2.83%
2.72%
2.45%
2.5%
2.44%
2.09%
2.0%
1.76%
1.55%
1.47%
1.5%
1.19%
1.55%
1.34%
1.0%
0.5%
0.0%
Euro
UK
US
Bund
Valuation methodology
Our valuation methodology for the three stocks is based on a
sum-of-the-parts approach with capital multiples reflecting our
views about the sustainability of returns by business line. We
then weight our bear/base/bull scenarios 20%, 60% and 20%.
Price target risks
Hannover Re
Hannover Re is exposed to claims event risk, including
man-made and natural catastrophes across the globe. As a
large holder of investments, asset market shocks or changes in
interest rates can impact the market value of holdings, potentially reducing IFRS equity. A sudden shift in claims inflation,
potentially due to an environmental or legal trend, could cause
reserves to prove inadequate.
pressure the primary life business, in particular, where policyholders often have guaranteed returns.
Swiss Re
Swiss Re is exposed to claims event risk, including man-made
and natural catastrophes across the globe. As a large holder of
investments, asset market shocks or changes in interest rates
can impact the market value of holdings, potentially reducing
IFRS equity. A sudden shift in claims inflation, potentially due to
an environmental or legal trend, could cause reserves to prove
inadequate. Changes in CHF relative to USD affect the share
price as the company reports in USD.
Munich Re
Munich Re is exposed to claims event risk, including
man-made and natural catastrophes across the globe. As a
large holder of investments, asset market shocks or changes in
interest rates can impact the market value of holdings, potentially reducing IFRS equity. In particular, Munich Re has above
average exposure to periphery sovereigns and a deterioration
of the macro environment could threaten near-term earnings. A
sudden shift in claims inflation, potentially due to an environmental or legal trend, could cause reserves to prove inadequate. A sustained low yield environment would significantly
60
November 2, 2011
International
October 27, 2011
Global Hardware Technology
China Handset AlphaWise:
3G Plows Full Steam Ahead
Morgan Stanley Asia Limited+
Jasmine Lu
Jasmine.Lu@morganstanley.com
Tim Hsiao
Pricing remains a key consideration, but pricing pressure
might not be as severe as we previously worried: China 3G
handsets and smartphones remain price-driven markets.
Nonetheless, respondents increasingly stress faster Internet
services when buying 3G phones, suggesting more frequent
mobile data-usage/Internet browsing outweigh pricing.
Notably, the maximum average price that potential 3G phone
buyers are willing to spend rose 6% (to Rmb2,716) over the
1H11 survey result.
Tim.Hsiao@morganstanley.com
Bill Lu
Our Investment Thesis
Bill.Lu@morganstanley.com
Navin Killa
Navin.Killa@morganstanley.com
Gary Yu
Gary.H.Yu@morganstanley.com
Katy L. Huberty, CFA
Kathryn.Huberty@morganstanley.com
Adam Holt
Higher-than-expected purchase interest for 3G handsets/Smartphones in 2H11 leads us to raise our Smartphone
volume forecasts in China as industry reshuffles faster than
projected, giving China a more fragmented market than DM.
Pricing pressure, surprisingly, might not be as bad as feared.
Key Findings & Messages
Purchase interest for China 3G handset/smartphone is
higher than anticipated in 2H11 vs. 1H11; we have thus
raised our China 2011/12 smartphone forecasts by 30%
and 23%, to 51mn/92mn units, respectively, on top of total 3G
handset estimates of 102mn/167mn units, to reflect consumers’ strong upgrade intentions. Smartphone mix of total
handsets likely reaches 24% in 2012e, up from 14% in 2011
and higher than our prior estimate of 20%.
3G upgrade sparks industry reshuffle to move faster than
expected, giving China a more fragmented market than
DM: Android plays and iPhone have been gaining share at
Nokia’s expense in China. Unlike developed markets (DM),
where leading brands dominate, several local brands in China
have also been gaining traction during the past nine months on
more competitive marketing strategies (e.g., Xiaomi) and / or
entry-level 3G smartphone offerings introduced by ZTE and
Huawei.
A/P Hardware Technology: We prefer AAC (HK$18.70) and
Largan (NT$670) as the best proxies to play Apple gains in
China. For handset OEMs, HTC is gaining traction rapidly in
China, though its share opportunity might be counterbalanced
by deceleration in US/Euro growth. We believe ZTE’s gearing
to China entry-level 3G smartphones is a net positive to its
bottom-line growth. (Covered by Jasmine Lu, Tim Hsiao).
A/P Semiconductors: We remain EW on MediaTek
(NT$319.50, covered by Bill Lu). Our view is that 2G competition could intensify going into 2012. The 3G market remains
operator-driven; thus the white brands will have a smaller
presence than in the 2G era. Consequently, we believe expectations for 2012 may be aggressive, even though we do see
MediaTek's smartphone business ramping from a small base.
A/P Telecom operators: The survey supports our thesis of a
steady market share shift from CM to CU /CT given the former’s
3G technology disadvantage. It also shows that CU continues to
generate higher ARPU from its 3G subscribers on higher data
usage. We retain our preference for CU (HK$15.74) in the
Chinese telecom sector. (Covered by Navin Killa, Gary Yu).
Global Technology: We see China as a key driver for Apple
(US$396.51, covered by Katy Huberty, Jerry Liu) to achieve $50
of bull case earnings in CY12. This survey increases our conviction, as over one-third of respondents intend to purchase an
Apple iPhone as their next handset, about six times its current
share among respondents. The company has by far the most
purchase-intention share, more than double Nokia or the major
Android vendors. Additionally, Apple just overtook Nokia as the
leading smartphone brand in C2H11, indicating a shift in
mindshare. We expect a lower-priced iPhone in CY12 to be the
next major catalyst in China. MSFT (covered by Adam Holt)
likely becomes the third key OS player with Nokia partnership.
61
November 2, 2011
International
Exhibit 1
x
Which handset manufacturer and network provider is the best positioned to gain market share
in the 3G transition?
The Evidence
Chinese consumers display growing interest in
3G handsets or smartphone
x
x
The proportion of respondents electing Apple
iPhone as the leading smartphone brand surpasses those who select Nokia the first time
(78% vs. 70%).
91%
7%
1H11
88%
9%
2H11
90%
8%
87%
1H11
0%
China Unicom remains as the main beneficiary
on the back of switching movement upon current
contract expiry, recording an estimated 8% gain
in market share, higher than China Telecom
(+3%) and China Mobile (-13%).
x
40%
Likely
60%
Neut ral
The maximum margin of error for conclusions
based on the total sample is +/-1.7% at a 90%
confidence level and higher for conclusions between sub-groups.
80%
100%
Unlikely
Exhibit 2
Leading Smartphone Brands (% of Respondents)
+6ppt
iPhone
- 8ppt
Nokia
+7ppt
+0ppt
Motorola
+14ppt
HTC
- 3ppt
Blackberry
- 4ppt
SEMC
- 10ppt
Dopod
+14ppt
Xiaomi
- 1ppt
Lenovo
- 1 ppt
Meizu
- 1ppt
LG
What Gives Us Confidence
x
We surveyed a sample of 2,050 Chinese mobile
phone owners across Tier 1 to 3 cities during
September 2011.
x
20%
10%
Samsung
The percentage of respondents saying to purchase Apple iPhone climbs to 34% in 2H11, up
4% since the 1H11 survey, while Nokia sees
deterioration with 16% only claiming to purchase
it, down 9%.
China Unicom may continue to benefit from
churning activities
x
2H11
90% and 91% of the total respondents indicated
that they are likely to buy a 3G handset or
smartphone as their next phone, up from 87%
and 88% in 1H11.
Apple iPhone is identified as the strongest
smartphone brand and is likely to gain market
share at the expense of Nokia
x
Smartphone
Core Questions for Evidence Research
x
How rapidly are Chinese consumers adopting 3G
handsets?
3G Phone
Potential 3G/Smartphone Purchase (% of Respondents)
+3ppt
Huawei
+0ppt
Coolpad
+ 3ppt
ZTE
1H11
+1ppt
Oppo
0%
10%
20%
30%
40%
50%
60%
70%
80%
2H11
90%
This is our second China Handset Survey. The
first survey was conducted in February-March
2011.
62
November 2, 2011
International
Exhibit 1
October 27, 2011
Greater China Consumer
Asia Insight:
Top Picks amid Uncertainty
Morgan Stanley Asia Limited+
Angela Moh
Retail Sales Leading Indicator: General Deceleration
35%
R-square = 0.83
30%
25%
20%
Angela.Moh@morganstanley.com
Lillian Lou
15%
Lillian.Lou@morganstanley.com
10%
Mar-12E
16.4.0%
Rob.Lin@morganstanley.com
5%
Leading Indicator
China Retail Sales YoY Growth
+1 Stdev
Jul-11
Jan-12
Jul-10
Jul-09
Jan-10
Jul-08
Jan-09
Jul-07
Jan-08
Jul-06
Jan-07
Jul-05
Jan-06
Jul-04
Jan-05
Jul-03
Jan-04
Jul-02
Jan-03
Jul-01
Jan-02
Jul-00
Jan-01
Jul-99
Jan-00
0%
Jan-99
Staples and food retail traditionally offer greater defensiveness,
but we view this as priced in. We prefer discretionary names
with greater levels of variable costs in an economic slowdown.
Considering valuation levels, our top picks are Belle, China
Agri, Intime, Mengniu, and Springland.
Sep-11 A
17.2%
Jan-11
Robert Lin
-1 Stdev
Source: Company data, Morgan Stanley Research. E = Morgan Stanley Research estimates.
Exhibit 2
50
35%
RSLI Feb 12E 17.0%
RSLI Mar 12E 16.4%
30%
45
40
25%
35
30
20%
25
15%
20
15
10%
10
MS Retail Sales Lead Indicator
MS Staple PE
5%
5
Jan-12
May-11
Sep-10
Jan-10
May-09
Sep-08
Jan-08
May-07
Sep-06
Jan-06
May-05
Sep-04
Jan-04
May-03
Sep-02
Jan-02
May-01
0%
Jan-00
Some deceleration, but anecdotal evidence still points to
healthy sales trend in China. There has been a lot of concern
about a potential hard landing in China. While there is some
deceleration, trends from the key retail operators continued to
show solid growth momentum in 3Q, with most reporting continued robust sales growth during the October holiday. Nevertheless, we would not be surprised by some deceleration
given a higher base effect. The exception is in the sports
sector, where industry-specific issues (e.g., near-term excess
retail capacity and inventory) are holding back most of the
operators.
MS RSLI vs. Staple P/E
Sep-00
Given recent market volatility, we have examined our coverage
universe to see how the stocks are trading, determine factors
that may be different this time should a severe downturn kick in
compared to the 2008/09 downcycle, and gauge potential risk
factors going into 2012.
Exhibit 3
MS RSLI vs. Discretionary P/E
35%
40
30%
35
RSLI Feb 12E 17.0%
RSLI Mar 12E 16.4%
30
25%
25
20%
20
15%
15
10%
10
MS Retail Sales Lead Indicator
MS Discretionary PE
5%
5
Jan-12
May-11
Sep-10
Jan-10
May-09
Sep-08
Jan-08
May-07
Sep-06
Jan-06
May-05
Sep-04
Jan-04
May-03
Sep-02
Jan-02
May-01
Sep-00
0%
Jan-00
We have seen overall retail sales growth decelerate from 20%
in March 2011 to 17.2% in September. After a few months of
stabilization around 17%, our retail sales leading indicator is
forecasting a dip to 16.4% by March 2012. We note that in the
past, there has been some relationship between stocks’
valuation multiples and the retail sales growth trend – valuations tend to peak/trough 6-8 months before retail sales growth
peak/trough (Exhibit 2-3), though, this year, there has been a
lot more volatility. From a top-down perspective, we continue
to look for an inflection point upward as a signal for rerating in
retail stock valuations.
63
November 2, 2011
International
Staples more defensive, but somewhat priced in. Prefer
discretionary names with more variable cost structure.
Going into a potential slowdown, the staples and food retail
spaces are traditionally more defensive operationally. However,
we feel this is somewhat priced in for most of the downstream
staple operators, such as Tingyi and Want Want, and retailers
such as Sun Art. For food retailers, we also note a potential
derating risk, given some correlation between food retailers’ P/E
multiples and CPI. Our economics team is expecting CPI to fall
from 6.3% in 3Q11 to 3.6% for full-year 2012. For the discretionary space, we would prefer names with a more variable cost
structure, as the risk to operating deleverage from some slowdown in sales would be lower. We would also prefer those
names with multi-category/multi-brand exposure.
Our top picks are Belle, China Agri, Intime, Mengniu, and
Springland.
Mengniu: We continue to expect solid earnings growth in 2011
and 2012, driven by mid- to high-teens sales growth and some
operating leverage. The stock is trading at 19x 2012e P/E, or
15x ex-cash.
China Agri: The stock has underperformed the Hang Seng
Index by 16% since the beginning of September, on concerns
about a high gearing ratio and reduced industry crushing
margin on recent weakness in commodity prices. We believe
these concerns are overdone, given that the company’s
crushing margin has been relatively stable (thanks to an effective hedging policy), and balance sheet risk is actually very low
(80% of its debt is working capital loans with easy access to
credit facilities backed back its parent company, COFCO). The
stock is trading at 6.0x 2012e P/E (vs. average P/E at 12.0x
and trough P/E at 4.5x).
Belle: Given Belle’s scale, higher variable costs (variable
rental), greater “younger” brand portfolio, and wider geographical reach than in 2008/09 that potentially translates into
less volatile SSSG swings, the company is our preferred pick in
the discretionary branded retail space.
Intime and Springland: We cite their relatively more attractive
valuations coupled with operational fundamentals that remain
sound.
Exhibit 4
Top Picks
Company
China Agri (0606.HK)
Mengniu (2319.HK)
Belle (1880.HK)
Intime (1833.HK)
Springland (1700.HK)
2011e
P/E
2012e
P/E
11-13e Earnings
CAGR
7.9
22.4
23.0
23.6
17.6
6.0
18.2
19.1
16.6
14.1
18.4%
19.9%
21.0%
43.5%
22.5%
Source: Morgan Stanley Research. e = Morgan Stanley Research estimates
Exhibit 5
Other Candidates with Positive Fundamentals
Company
Tingyi (0322.HK)
Want Want (0151.HK)
Sun Art (6808.HK)
Giordano (0709.HK)
Golden Eagle (3308.HK)
Li & Fung (0494.HK)
Samsonite (1910.HK)
Yue Yuen (0551.HK)
2011e
P/E
2012e
P/E
11-13e Earnings
CAGR
32.1
29.4
37.2
11.7
24.5
20.5
15.7
9.1
26.9
23.4
29.1
10.1
19.7
16.3
12.7
8.1
19.2%
21.9%
26.2%
12.7%
27.7%
23.8%
22.4%
15.0%
Source: Morgan Stanley Research. e = Morgan Stanley Research estimates.
We also like Bosideng (which we have upgraded to Overweight) for its high dividend yield. On corrections, companies
that we would look to pick up, given their long-term competitiveness, include Golden Eagle, Sun Art, Tingyi, and Want
Want. Among the export/internationally exposed companies,
barring a significant macro downturn, we like Samsonite for its
near-term earnings momentum, Giordano for its good margin
trend and dividend yield, and Li & Fung and Yue Yuen for their
long-term positioning in the industry.
Valuations for most names have seen some rebound in the
past week on some signs of resolution of the EU debt crisis. In
general, the staples had seen less of a sell-off compared to the
discretionary names and export plays, and many have rebounded to close to the levels prior to the sharp 21% correction
in September.
Most of the downstream staples are at around 80%+ of their
52-week highs, and, within the discretionary space, department
stores are at around 65% and sportswear names at well under
50%, given industry-specific issues. Unsurprisingly, strong
retail operators, such as Belle and Sun Art, are at 81% and
89% of their 52-week highs, respectively.
Prices of stocks mentioned: China Agri (HK$5.73), Mengniu (HK$25.10), Belle (HK$14.50),
Intime (HK$10.60), Springland (HK$4.99), Bosideng (HK$1.95), Tingyi (HK$22.40), Want
Want (HK$7.09), Sun Art (HK$9.72), Giordano (HK$5.94), Golden Eagle (HK$18.48), Li &
Fung (HK$13.96), Samsonite (HK$12.32), Yue Yuen (HK$22.05)
64
November 2, 2011
International
October 30, 2011
Lojas Renner
Downgrading to Equal-weight on
Credit Concerns
Lore Serra
Lore.Serra@morganstanley.com
Jeronimo De Guzman
Jeronimo.De.Guzman@morganstanley.com
Morgan Stanley C.T.V.M.
S.A.+
Franco T. Abelardo
Franco.Abelardo@morganstanley.com
Renner’s past dues rose markedly in 3Q11. We analyze
Renner’s credit history and cannot explain the change solely
from temporary factors. We prefer to move to the sidelines until
we get more clarity, given the importance of the credit business
to Renner.
Mkt cap, curr(mm)
52-Week Range
Reuters: LREN3.SA Bloomberg: LREN3 BZ
R$52.80
R$6,465
R$65.80-43.73
Fiscal Year ending
ModelWare EPS(R$)
Prior ModelWare EPS(R$)
P/E**
EPS(R$)**
Consensus EPS(R$)§
Div yld(%)
12/10
2.51
21.7
2.52
2.50
2.2
12/11e
2.60
2.74
19.7
2.68
2.87
3.6
12/12e
2.97
3.23
17.6
3.01
3.44
3.8
12/13e
3.47
3.76
15.2
3.47
4.07
4.3
Price Performance
Loj as Renner S/A (Left, Braz ilian Real)
Relativ e to MSCI EM INDEX (Right)
Relativ e to MSCI W orld Index /Braz il (Right)
BRL
%
70
350
60
Renner’s 3Q11 results showed credit quality deterioration
and slower organic retail sales growth. Same-store sales
growth of 3.8% for Renner stores was well below 1H11’s
10.4%, but this was somewhat anticipated since a few of the
retailers in Brazil were commenting that colder-than-expected
weather was hurting sales trends. Despite this and higher
cotton prices Y/Y, Renner reported a stable retail margin, which
is impressive. However, past due loans on the card portfolio
rose a surprising 240 bps Y/Y – a large change for Renner
based on the historical patterns – which wasn’t fully reflected in
the Renner Card provisions.
Though it is possible that some of the credit deterioration came
from one-off factors (e.g., a one-month postal strike and/or
weather), our analysis suggests that the change started at the
beginning of this year, and has been building. What’s more,
though we believe that weather and merchandising decisions
hurt 3Q11’s same-store sales (SSS), Renner’s retail operations
have shown above-average cyclicality to macro trends in the
past.
300
50
250
40
200
30
150
20
100
10
07
08
09
10
11
50
Company Description
Lojas Renner has retail revenues of R$2.9 billion annually, and currently
operates 146 stores throughout Brazil. It began operations in 1912 in Rio
Grande do Sul, Brazil, as a branch of a textile company operated by the
Renner family. In 1940, the company expanded its merchandise offering
and became a department store. After an extensive restructuring in the
early 1990's, it was transformed into a department store specializing in
fashion apparel, and had its IPO in mid-2005.
Industry View: In-Line — Brazil Consumer
Exhibit 1
Past Dues as a % of Portfolio – Seasonally Adjusted
12%
1-30 days
31-180 days
11%
10%
9%
8%
7%
1Q
07
2Q
07
3Q
07
4Q
07
1Q
08
2Q
08
3Q
08
4Q
08
1Q
09
2Q
09
3Q
09
4Q
09
1Q
10
2Q
10
3Q
10
4Q
10
1Q
11
2Q
11
3Q
11
We have downgraded our recommendation on Renner’s
shares to Equal-weight from Overweight because we are
concerned about the recent trends in credit quality and, to a
lesser extent, the slower pace of organic growth currently.
Both trends could be temporary but, given the importance of
the credit business to Renner as well as the more cyclical
nature of Renner’s profitability to organic sales growth, we
prefer to move to a neutral position until we understand better
what drove 3Q’s deterioration. With the macro risks skewed to
the downside in the near-to-medium term, we do not see room
for the shares to outperform until credit trends revert.
65
November 2, 2011
International
We have lowered our earnings estimates mostly because
of more conservative credit income assumptions, though
our revisions could prove to be either too little or too much.
More importantly, we outline the trends in past dues, allowances, and write-offs for Renner’s credit business to benchmark 3Q to historical figures. We expect that retail sales will
stagnate/slow with employment as the pivotal variable to
watch. Net, we are not trimming our SSS estimates that call for
7% growth next year.
Trading at 17.6x our 2012 our revised 2012 earnings estimate,
Renner’s valuation does not appear overly demanding, but our
confidence in our projections has diminished. We view our
bear case as conservative for the medium term, but it could be
plausible in a globally adverse event. Renner trades at 23x
times our 2012 bear case estimate.
Where we could be wrong: Renner reports before many
retailers. The credit and sales trends of other retailers in the
coming weeks will give an indication of how much of Renner’s
deterioration was company-specific.
Valuation Methodology and Risks
Our valuation work is based on DCF using a cost of capital of
10.8% in our model and terminal value growth 4.5%. Investment risks include slower-than-expected economic growth,
further deterioration in the credit portfolio, and/or an inability to
execute Renner’s expansion program.
Exhibit 2
LREN3.SA: Risk-Reward View
R$90
80
R$80 (+52%)
70
Credit Review
Income from financial services accounted for 25% of
Renner’s EBITDA in 2010. Renner has two credit portfolios:
a ~R$700 million one from sales made through the Renner
Card (two-thirds of Renner’s financial services income) and a
~R$100 million one from personal loans. We focus on the card
portfolio, because of its size and importance.
60
40
30
R$30 (-43%)
20
10
0
Oct-09
Past dues for the card portfolio jumped by a surprising
240 bps Y/Y in 3Q11, a rate of deterioration that resembles the
2008-09 crisis. Renner has two products within its card portfolio – interest-free for up to five months, and up to 8 months
with interest. We have the provisions broken down between
the two, but not the past dues. However, the higher-risk, financed sales have been stable at 21-22% of the Renner card
sales, so we don’t think a change in the duration of the portfolio
explains the rise in past dues. Putting the two together,
Renner’s level of bad debt creation jumped materially in 3Q,
after rising more moderately in 2Q. We define bad debt creation as the change in past dues plus the write-offs.
Renner has the high fixed costs among retailers we cover.
Given this and rising macro uncertainty, we reviewed our bear
case assumptions for 2012 and lowered our SSS estimate for
2012 to 0% from 4%, as well as our financial services income.
(Post-2012, our bear case model assumes SSS of 4%.)
Weather aside, we think this is very conservative and is only
relevant in a global-type event. (Renner’s SSS fell 2.5% during
the peak of the 2008-09 crisis, but rebounded quickly, growing
1.4% in 2009 and 10.3% in 2010). However, under this assumption, our retail margin for 2012 falls 180 bps Y/Y. To put
this in perspective, Renner’s retail margin dropped 280 bps
Y/Y, but then doubled in the subsequent four quarters.
R$60 (+14%)
R$ 52.80
50
Apr-10
Base Case (Oct-12)
Bull
Case
R$80
~22x Bull
Case
2012e
EPS of
R$3.73
Base
Case
R$60
20x Base
Case
2012e
EPS of
R$3.00
Bear
Case
R$30
13x Bear
Case
2012e
EPS of
R$2.27
Oct-10
Apr-11
Oct-11
Apr-12
Current Stock Price
Stronger SSS/ margins. SSS growth of 10% in
2012, 8% for 2013-2016 and 6% in the long term.
Renner grows its selling area by an average rate of
12.5% over 2011-2014. Store operating margin
reaches 13.2% in 2011 and improves steadily to
reach 15.4% by 2014. Financial services revenue
averages 4.0% of retail sales over the medium term.
EBITDA, with financial services, grows 26% per year,
on average, over 2011-2013.
Solid retail sales/profitability. SSS growth of 7.6%
in 2011 and ~7% in 2012-2014. Renner grows its
selling area by an average rate of 12.5% over
2011-2014. Store operating margin of 12.2% in 2011
improves modestly to 12.4% by 2014. Financial
services result averages 3.7% of retail sales over the
medium term. EBITDA, with financial services,
grows 15% per year, on average, over 2011-2013.
Slower top line/margins. SSS growth of 0% in
2012 and 4% thereafter. Renner grows its selling
area by 9% per year from 2011-2014. Store operating margin falls from 12.2% in 2011 to 9.7% in 2013
and 9.5% for the long term. Financial services
revenue averages 3% of retail sales over the medium
term. EBITDA, with financial services, grows 0.5%
per year, on average, over 2011-2013.
66
November 2, 2011
International
October 31, 2011
Reuters: 005930.KS Bloomberg: 005930 KS
Price target
W1,220,000
Up/downside to price target(%)
29
W945,000
52-Week Range
W1,014,000-672,000
Sh out, dil, curr(mn)
147
Mkt cap, curr(bn)
W139,198
EV, curr(bn)
W116,117
Avg daily trading value(bn)
W345
Samsung Electronics
The Anatomy of the
System LSI Strength
International plc, Seoul
Branch+
Keon Han
Keon.Han@morganstanley.com
Young Suk Shin
Young.Shin@morganstanley.com
Mike Chung
Mike.Chung@morganstanley.com
What's Changed
Price Target
2011e, 2012e, 2013e ModelWare EPS
W970,000 to W1,220,000
Up 10%, 14%, 17%
We reiterate our Overweight rating on Samsung Electronics. We have raised our F2011e, F2012e, and F2013e
earnings by 10%, 14%, and 17%, respectively, and lifted our
price target to W1.22mn. The System LSI business, just an
infant business a few years ago, is now growing at a much
faster rate and is poised to overtake DRAM and NAND in terms
of both revenue and profits by 2012.
Fiscal Year ending
ModelWare EPS(W)
Prior ModelWare EPS(W)
Revenue, net(Wbn)
EBITDA(Wbn)
ModelWare net inc(Wbn)
P/E
P/BV
12/10
108,765
154,630
28,690
16,021
8.7
1.6
12/11e
93,835
85,434
162,729
30,108
13,822
10.1
1.4
12/12e
108,045
94,734
191,590
35,316
15,915
8.7
1.2
12/13e
119,397
102,041
210,301
40,131
17,587
7.9
1.1
Company Description
Samsung Electronics (SEC), the flagship of the Samsung Group, is the
largest diversified electronics company in Asia, ex-Japan. Valued at
W140 trillion in market capitalization, SEC is the largest company on the
Korea Stock Exchange and represents over 10% of the total KOSPI index. The company's core products include semiconductors, TFT-LCDs,
and telecommunications equipment and consumer electronics.
S. Korea Semiconductors
Industry View: Attractive
Our investment thesis for Samsung for the past 18 months had
been:
1)
Transition of component business from PC-centric to more
profitable and growth-oriented mobile-centric products
(smartphones, tablet PCs, etc.);
2)
Potential for the new growth products emerging out of
System LSI and OLED;
3)
Samsung finally hitting its stride in developing strong mobile devices on its own.
We think 3Q11 offered a glimpse of these themes and set a
strong platform for brisk earnings growth well into 2012.
As key earnings driver, handsets still lead the way: We cite
the vast scale of the products and the upward shift in their
profitability. Smartphone mix has improved and the new,
competitive product lineup well into 2012 looks very strong.
This is fueling revenue growth based on both stronger unit
volumes and rise in blended ASP. We continue to believe that
handsets will provide a stable and solid base for earnings
growth, continuing to contribute over one-half of core profits.
Systems LSI’s growth profile has also changed: Due to the
capacity tightness in logic wafers, some of the older 8-inch
specialty memory fabs, and even relatively newer 12-inch
NAND fabs, are being converted in order to add capacity faster
than otherwise possible. We believe these types of fab conversion underscore the strength of demand, particularly in
Application Processors (A/P) and high-density camera sensors
(CMOS Image Sensors).
Focusing on these two products, development of leading-edge
process technology (32 nano for next generation A/P and 28
nano HKMG for foundry services), and much faster capacity
addition changes the revenue growth profile and profitability
assumption of the System LSI business.
We think that by 2012, the logic product will surpass DRAM and
NAND in terms of revenue size and profit contribution.
OLED is also hitting its stride. More importantly, it allows
Samsung to design a differentiated mobile device on a much
lighter and more battery-efficient display device. The size
migration will shift upward from 4-inch products, mostly focused on smartphone display applications, to usage in tablet
67
November 2, 2011
International
PCs by early 2012. The company has already showcased a
7.7-inch OLED device on its tablet PC, expected to be released
soon. Application on larger tablet devices is expected to follow.
The profit contribution from SMD, its OLED JV, surged in 3Q11
to W320 bn. We believe almost all of the profit is being derived
from OLED. The OLED capacity has been increasing rapidly
during the course of 2011 and the profit margins are also rising
sharply on better yields.
Another look at these three products leads us to raise our
estimates to reflect the better profitability outlook for handsets
and faster than anticipated growth of the System LSI business.
Improvements of product mix on both businesses are expanding OPM faster than anticipated. OLED profitability has
also improved on better yields and migrating to bigger size
panels.
To derive our price target, we continue to use a combination of P/B multiple and RI valuation. Key parameters in our
residual income model include cost of equity of 11.5%, a terminal growth rate of 5%, and a beta of 1.00. We then round up
our base case value.
Downside risks to our price target include weakening global
consumer electronic goods demand; ongoing legal disputes
with Apple; while sudden changes in USD and EUR versus
KRW would affect overall profitability.
Exhibit 1
SEC: System LSI to Grow Larger than DRAM/NAND
2012E
Samsung
OP
Unit: KRW bn Revenue
System LSI
15,847
2,695
DRAM
13,026
1,251
NAND
11,430
2,213
2013E
Revenue
OP
17,398
3,140
12,801
1,267
13,059
2,291
Exhibit 2
SEC: Price Target Methodology
Method
Intrinsic Value 2012E
Multiple
Price (Won)
1,260,183
Base Case
Mid Cycle P/BV
Mid Cycle P/BV
Residual Income
1.5x
2012E
Average
1,177,485
1,260,183
1,218,834
Samsung Electronics (005930.KS) Risk-Reward View: Mobile Strength to Lead Earnings Growth in 2012
1,600,000
1,460,000 (+54%)
1,400,000
1,220,000 (+29%)
1,200,000
945,000
1,000,000
800,000
770,000 (-19%)
600,000
400,000
200,000
0
Oct-09
Bull
Macro environment rapidly recovers while
Case
handset division sees further upside: DeW1,460K mand for consumer electronic goods recovers
quickly with stabilization of macro environment.
Company’s smartphone shipments grow at a
faster rate while capacity ramp-up at System
LSI is further accelerated. Also, sharp production cuts and capex reductions at second-tier
players in DRAM and TFT-LCD industry continue improving overall supply/demand dynamics.
Apr-10
Base Case (Oct-12)
Oct-10
Apr-11
Oct-11
Apr-12
Current Stock Price
WARNINGDONOTEDIT_RRS4RL~005930.KS~
Base
Mobile strength drives strong earnings
Case
growth: Continued success at its handset
W1,220K business via improving smartphone mix leads
earnings growth. Handset division generates
over 50% of core profits. Meanwhile, System
LSI business surpasses DRAM and NAND to
become the largest semi business in terms of
revenue and profits on the ongoing capacity
additions. OLED remains profitable on yield
improvement and adoption into larger size
panels such as tablet PCs. In other businesses,
NAND is resilient thanks to stable demand from
mobile products while DRAM and TFT-LCD
remain as the weaker link.
Bear
Case
W770K
Prolonged consumption slowdown into
2012: Further deterioration in macro conditions
stalls global consumption of IT products into
2012. Negative outcome of any potential
product ban impairs company’s profitability.
68
November 2, 2011
Morgan Stanley ModelWare is a proprietary analytic framework that helps clients uncover value, adjusting for distortions and ambiguities created by local accounting
regulations. For example, ModelWare EPS adjusts for one-time events, capitalizes operating
leases (where their use is significant), and converts inventory from LIFO costing to a FIFO
basis. ModelWare also emphasizes the separation of operating performance of a company
from its financing for a more complete view of how a company generates earnings.
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As to each company mentioned in this report, the respective primary research analyst or analysts covering that company hereby certify that their
views about the companies and their securities discussed in this report are accurately expressed and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report. Unless otherwise stated, the
individuals listed on the cover page of this report are research analysts.
Global Research Conflict Management Policy
Morgan Stanley Research has been published in accordance with our conflict management policy, which is available at
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Important US Regulatory Disclosures on Subject Companies
The following analyst or strategist (or a household member) owns securities (or related derivatives) in a company that he or she covers or recommends in Morgan Stanley Research: Michael Cyprys - Bank of America (common or preferred stock); Franco Abelardo - Lojas Americanas (common or preferred stock). Morgan Stanley policy prohibits research analysts, strategists and research associates from investing in securities in their
sub industry as defined by the Global Industry Classification Standard ("GICS," which was developed by and is the exclusive property of MSCI and
S&P). Analysts may nevertheless own such securities to the extent acquired under a prior policy or in a merger, fund distribution or other involuntary acquisition.
A household member of the following analyst or strategist is an employee, officer, director or has another position at a company named within the
research: Micah Nance; Interpublic Group.
As of September 30, 2011, Morgan Stanley beneficially owned 1% or more of a class of common equity securities of the following companies covered in Morgan Stanley Research: Alcoa Inc., Amazon.com, Apple, Inc., Belle International, BorgWarner Inc., Brasil Foods, CBS Corporation, CenturyLink, Inc., China Mengniu Dairy, Dr Pepper Snapple Group Inc, Freeport-McMoRan, Halliburton Co., Hecla Mining Co., Li & Fung Ltd, Lojas
Renner, MediaTek, Munich Re, NuStar GP Holdings, LLC, Office Depot Inc., Red Hat, Inc., Salesforce.com, Samsonite International, Scotts Miracle-Gro Company, Stillwater Mining Co., Sun Art Retail Group Limited, UMC, Want Want China Holdings Ltd.
Within the last 12 months, Morgan Stanley managed or co-managed a public offering (or 144A offering) of securities of ADECOAGRO S.A., Alcoa
Inc., Bank of America, Belle International, Best Buy Co. Inc, CenturyLink, Inc., Fifth Third Bancorp, First Horizon National, Ford Motor Company,
General Motors Company, Intime Department Store (Group), Marathon Petroleum Corporation, Munich Re, Potash Corp of Saskatchewan Inc, PPG
Industries, Inc., Samsonite International, Samsung Electronics, Schlumberger, Sun Art Retail Group Limited, The Home Depot, Inc., UMC, Union
Pacific Corp., Walker & Dunlop Inc.
Within the last 12 months, Morgan Stanley has received compensation for investment banking services from ADECOAGRO S.A., Alcoa Inc., Amazon.com, Arch Chemicals Inc., Archer Daniels Midland, AutoZone Inc., Bank of America, Belle International, Best Buy Co. Inc, BorgWarner Inc.,
Brasil Foods, Bunge Ltd., Calgon Carbon Corporation, CBS Corporation, CenturyLink, Inc., CF Industries, Cooper Tire & Rubber Company, Domtar
Corporation, Dr Pepper Snapple Group Inc, Dresser-Rand, Education Management Corp., Fifth Third Bancorp, First Horizon National, FMC Technologies, Ford Motor Company, Freeport-McMoRan, General Motors Company, H.B. Fuller Co., Halliburton Co., HollyFrontier Corporation, Huntsman Corporation, Interpublic Group, Intime Department Store (Group), Li & Fung Ltd, Lowe's Companies, Inc., LyondellBasell Industries N.V., Munich Re, NuStar Energy LP, Office Depot Inc., Potash Corp of Saskatchewan Inc, PPG Industries, Inc., Praxair, Inc., RadioShack Corporation, Red
Hat, Inc., RenaissanceRe Holdings Ltd., Samsung Electronics, Schlumberger, Smithfield Foods, Sociedad Quimica y Minera de Chile S.A., Solutia
Inc., Springland International Holdings, Staples, Inc., Swiss Re, Target Corp., The Dow Chemical Co., The Home Depot, Inc., Tyson Foods, UMC,
Union Pacific Corp., Walker & Dunlop Inc., Westlake Chemical Corp.
In the next 3 months, Morgan Stanley expects to receive or intends to seek compensation for investment banking services from AAC Technologies
Holdings, Advance Auto Parts, Albemarle Corp., Alcoa Inc., Amazon.com, Apple, Inc., Arch Chemicals Inc., Archer Daniels Midland, AutoZone Inc.,
Balchem Corp., Ball Corporation, Bank of America, Bed Bath & Beyond Inc., Belle International, Best Buy Co. Inc, BorgWarner Inc., Brasil Foods, Bunge
Ltd., Calgon Carbon Corporation, Cavium Networks Inc., CBS Corporation, CenturyLink, Inc., CF Industries, China Agri-Industries, China Mengniu
Dairy, Cullen/Frost Bankers, Cytec Industries Inc., Domtar Corporation, Dr Pepper Snapple Group Inc, Dresser-Rand, Education Management Corp.,
Fifth Third Bancorp, First Horizon National, FMC Technologies, Ford Motor Company, Freeport-McMoRan, General Motors Company, Golden Eagle
Retail Group Limited, H.B. Fuller Co., Halliburton Co., Hannover Re, HollyFrontier Corporation, Interpublic Group, Intime Department Store (Group),
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Johnson Controls, Inc., Li & Fung Ltd, Lojas Renner, Lowe's Companies, Inc., LyondellBasell Industries N.V., McDermott International Inc., MediaTek,
Munich Re, NuStar Energy LP, O'Reilly Automotive Inc., Office Depot Inc., OM Group Inc., Packaging Corp. of America, Popular, Inc., Potash Corp of
Saskatchewan Inc, PPG Industries, Inc., Praxair, Inc., Red Hat, Inc., RenaissanceRe Holdings Ltd., Salesforce.com, Samsonite International, Samsung
Electronics, Schlumberger, Smithfield Foods, Sociedad Quimica y Minera de Chile S.A., Solutia Inc., Springland International Holdings, Staples, Inc.,
Sun Art Retail Group Limited, Swiss Re, Teradata, The Dow Chemical Co., The Home Depot, Inc., Tingyi (Cayman Islands), Tyson Foods, UMC, Union
Pacific Corp., Walker & Dunlop Inc., Want Want China Holdings Ltd, Westlake Chemical Corp, Yue Yuen Industrial.
Within the last 12 months, Morgan Stanley has received compensation for products and services other than investment banking services from AAC
Technologies Holdings, Advance Auto Parts, Alcoa Inc., Amazon.com, Apple, Inc., Archer Daniels Midland, Ashland Inc., AutoZone Inc., Bank of
America, Bank of Hawaii Corp., Belle International, Best Buy Co. Inc, BorgWarner Inc., Bosideng International Holdings Limited, Brasil Foods,
Bunge Ltd., Calgon Carbon Corporation, CBS Corporation, CenturyLink, Inc., CF Industries, China Unicom, Cullen/Frost Bankers, Dana Holding
Corp., Domtar Corporation, Dr Pepper Snapple Group Inc, Dresser-Rand, East West Bancorp, Inc., Education Management Corp., Fifth Third Bancorp, First Horizon National, FMC Technologies, Ford Motor Company, Freeport-McMoRan, General Motors Company, Golden Eagle Retail Group
Limited, Greif Inc. (Cl A), H.B. Fuller Co., Halliburton Co., Hannover Re, HollyFrontier Corporation, Huntsman Corporation, Innophos Holdings Inc.,
Interpublic Group, Intime Department Store (Group), Lowe's Companies, Inc., LyondellBasell Industries N.V., Marathon Petroleum Corporation,
McDermott International Inc., MediaTek, Munich Re, NuStar Energy LP, O'Reilly Automotive Inc., Office Depot Inc., OM Group Inc., Packaging
Corp. of America, Popular, Inc., Potash Corp of Saskatchewan Inc, PPG Industries, Inc., Red Hat, Inc., RenaissanceRe Holdings Ltd., Schlumberger, Scotts Miracle-Gro Company, Smithfield Foods, Solutia Inc., Staples, Inc., Swiss Re, The Dow Chemical Co., The Home Depot, Inc., Tyson
Foods, UMC, Union Pacific Corp., Westlake Chemical Corp, Yue Yuen Industrial, Zions Bancorp.
Within the last 12 months, Morgan Stanley has provided or is providing investment banking services to, or has an investment banking client relationship with, the following company: AAC Technologies Holdings, ADECOAGRO S.A., Advance Auto Parts, Albemarle Corp., Alcoa Inc., Amazon.com,
Apple, Inc., Arch Chemicals Inc., Archer Daniels Midland, AutoZone Inc., Balchem Corp., Ball Corporation, Bank of America, Bed Bath & Beyond Inc.,
Belle International, Best Buy Co. Inc, BorgWarner Inc., Brasil Foods, Bunge Ltd., Calgon Carbon Corporation, Cavium Networks Inc., CBS Corporation, CenturyLink, Inc., CF Industries, China Agri-Industries, China Mengniu Dairy, Cooper Tire & Rubber Company, Cullen/Frost Bankers, Cytec Industries Inc., Domtar Corporation, Dr Pepper Snapple Group Inc, Dresser-Rand, Education Management Corp., Fifth Third Bancorp, First Horizon
National, FMC Technologies, Ford Motor Company, Freeport-McMoRan, General Motors Company, Golden Eagle Retail Group Limited, H.B. Fuller
Co., Halliburton Co., Hannover Re, HollyFrontier Corporation, Huntsman Corporation, Interpublic Group, Intime Department Store (Group), Johnson
Controls, Inc., Li & Fung Ltd, Lojas Renner, Lowe's Companies, Inc., LyondellBasell Industries N.V., Marathon Petroleum Corporation, McDermott
International Inc., MediaTek, Munich Re, NuStar Energy LP, O'Reilly Automotive Inc., Office Depot Inc., OM Group Inc., Packaging Corp. of America,
Popular, Inc., Potash Corp of Saskatchewan Inc, PPG Industries, Inc., Praxair, Inc., RadioShack Corporation, Red Hat, Inc., RenaissanceRe Holdings
Ltd., Salesforce.com, Samsonite International, Samsung Electronics, Schlumberger, Smithfield Foods, Sociedad Quimica y Minera de Chile S.A.,
Solutia Inc., Springland International Holdings, Staples, Inc., Sun Art Retail Group Limited, Swiss Re, Target Corp., Teradata, The Dow Chemical Co.,
The Home Depot, Inc., Tingyi (Cayman Islands), Tyson Foods, UMC, Union Pacific Corp., Walker & Dunlop Inc., Want Want China Holdings Ltd,
Westlake Chemical Corp, Yue Yuen Industrial.
Within the last 12 months, Morgan Stanley has either provided or is providing non-investment banking, securities-related services to and/or in the
past has entered into an agreement to provide services or has a client relationship with the following company: AAC Technologies Holdings, Advance Auto Parts, Alcoa Inc., Amazon.com, Apple, Inc., Archer Daniels Midland, Ashland Inc., AutoZone Inc., Ball Corporation, Bank of America,
Bank of Hawaii Corp., Belle International, Best Buy Co. Inc, BorgWarner Inc., Bosideng International Holdings Limited, Brasil Foods, Bunge Ltd.,
Cabot Corp., Calgon Carbon Corporation, Carpenter Technology Corp., CBS Corporation, CenturyLink, Inc., CF Industries, China Unicom, Coeur
d'Alene Mines Corp., Cullen/Frost Bankers, Dana Holding Corp., Domtar Corporation, Dr Pepper Snapple Group Inc, Dresser-Rand, East West
Bancorp, Inc., Education Management Corp., Fifth Third Bancorp, First Horizon National, FMC Technologies, Ford Motor Company, FreeportMcMoRan, General Motors Company, Golden Eagle Retail Group Limited, Greif Inc. (Cl A), H.B. Fuller Co., Halliburton Co., Hannover Re, Hecla
Mining Co., HollyFrontier Corporation, Huntsman Corporation, Innophos Holdings Inc., Interpublic Group, Intime Department Store (Group), Johnson Controls, Inc., Lowe's Companies, Inc., LyondellBasell Industries N.V., Marathon Petroleum Corporation, McDermott International Inc., MediaTek, Munich Re, NuStar Energy LP, O'Reilly Automotive Inc., Office Depot Inc., OM Group Inc., Packaging Corp. of America, Popular, Inc., Potash
Corp of Saskatchewan Inc, PPG Industries, Inc., Praxair, Inc., RadioShack Corporation, Red Hat, Inc., RenaissanceRe Holdings Ltd., Schlumberger, Scotts Miracle-Gro Company, Smithfield Foods, Solutia Inc., Staples, Inc., Stillwater Mining Co., Swiss Re, Tereos Internacional SA, The Dow
Chemical Co., The Home Depot, Inc., Tyson Foods, UMC, Union Pacific Corp., Westlake Chemical Corp, Yue Yuen Industrial, Zions Bancorp.
An employee, director or consultant of Morgan Stanley (not a research analyst or a member of a research analyst's household) is a director of Alcoa
Inc., Belle International, Ford Motor Company.
Morgan Stanley & Co. LLC makes a market in the securities of ADECOAGRO S.A., Advance Auto Parts, Albemarle Corp., Alcoa Inc., Allied Nevada
Gold Corp., Amazon.com, AnnTaylor Stores Corp, Apple, Inc., Archer Daniels Midland, Ashland Inc., AutoZone Inc., Balchem Corp., Ball Corporation, Bank of America, Bank of Hawaii Corp., Bed Bath & Beyond Inc., Best Buy Co. Inc, BorgWarner Inc., Brasil Foods, Bunge Ltd., Cabot Corp.,
Calgon Carbon Corporation, Carpenter Technology Corp., Cavium Networks Inc., CBS Corporation, CenturyLink, Inc., CF Industries, China Unicom,
Clearwater Paper Corporation, Coeur d'Alene Mines Corp., Cooper Tire & Rubber Company, Cullen/Frost Bankers, Cytec Industries Inc., Dana
Holding Corp., Domtar Corporation, Dr Pepper Snapple Group Inc, Dresser-Rand, East West Bancorp, Inc., Education Management Corp., Fifth
Third Bancorp, First Horizon National, FMC Technologies, Ford Motor Company, Freeport-McMoRan, General Motors Company, Globe Specialty
Metals Inc., Greif Inc. (Cl A), H.B. Fuller Co., Halliburton Co., Hecla Mining Co., HollyFrontier Corporation, Huntsman Corporation, Innophos Holdings Inc., Interpublic Group, Johnson Controls, Inc., Li & Fung Ltd, Lowe's Companies, Inc., LyondellBasell Industries N.V., McDermott International
Inc., Minerals Technologies Inc., NuStar Energy LP, NuStar GP Holdings, LLC, O'Reilly Automotive Inc., Office Depot Inc., OM Group Inc., Packaging Corp. of America, Penske Automotive Group, Inc, Popular, Inc., Potash Corp of Saskatchewan Inc, PPG Industries, Inc., Praxair, Inc., RadioShack Corporation, Red Hat, Inc., RenaissanceRe Holdings Ltd., Royal Gold Inc., Salesforce.com, Sanderson Farms Inc., Schlumberger,
Schweitzer-Mauduit International, Inc., Scotts Miracle-Gro Company, Smithfield Foods, Sociedad Quimica y Minera de Chile S.A., Solutia Inc., Sonoco Products, Staples, Inc., Stillwater Mining Co., Target Corp., Teradata, The Dow Chemical Co., The Home Depot, Inc., Titanium Metals Corp.,
TSMC, Tyson Foods, UMC, Union Pacific Corp., Valley National Bancorp, Vulcan Materials Company, Walker & Dunlop Inc., Westamerica Bancorp., Westlake Chemical Corp, Williams-Sonoma Inc., Zions Bancorp.
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The equity research analysts or strategists principally responsible for the preparation of Morgan Stanley Research have received compensation
based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overall investment banking revenues.
Morgan Stanley and its affiliates do business that relates to companies/instruments covered in Morgan Stanley Research, including market making,
providing liquidity and specialized trading, risk arbitrage and other proprietary trading, fund management, commercial banking, extension of credit, investment services and investment banking. Morgan Stanley sells to and buys from customers the securities/instruments of companies covered in Morgan Stanley Research on a principal basis. Morgan Stanley may have a position in the debt of the Company or instruments discussed in this report.
Certain disclosures listed above are also for compliance with applicable regulations in non-US jurisdictions.
STOCK RATINGS
Morgan Stanley uses a relative rating system using terms such as Overweight, Equal-weight, Not-Rated or Underweight (see definitions below). Morgan
Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, Not-Rated and Underweight are not the equivalent of buy, hold and sell. Investors should carefully read the definitions of all ratings used in Morgan Stanley Research. In addition, since Morgan
Stanley Research contains more complete information concerning the analyst's views, investors should carefully read Morgan Stanley Research, in its
entirety, and not infer the contents from the rating alone. In any case, ratings (or research) should not be used or relied upon as investment advice. An
investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations.
Global Stock Ratings Distribution
(as of October 31, 2011)
For disclosure purposes only (in accordance with NASD and NYSE requirements), we include the category headings of Buy, Hold, and Sell alongside our ratings of Overweight, Equal-weight, Not-Rated and Underweight. Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks
we cover. Overweight, Equal-weight, Not-Rated and Underweight are not the equivalent of buy, hold, and sell but represent recommended relative
weightings (see definitions below). To satisfy regulatory requirements, we correspond Overweight, our most positive stock rating, with a buy recommendation; we correspond Equal-weight and Not-Rated to hold and Underweight to sell recommendations, respectively.
Stock Rating Category
Overweight/Buy
Equal-weight/Hold
Not-Rated/Hold
Underweight/Sell
Total
Coverage Universe
Investment Banking Clients (IBC)
% of
% of % of Rating
Count
Total
Count Total IBC Category
1126
1176
108
418
2,828
40%
42%
4%
15%
449
431
23
115
1018
44%
42%
2%
11%
40%
37%
21%
28%
Data include common stock and ADRs currently assigned ratings. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations. Investment Banking Clients are companies from whom Morgan Stanley
received investment banking compensation in the last 12 months.
Analyst Stock Ratings
Overweight (O). The stock's total return is expected to exceed the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months.
Equal-weight (E). The stock's total return is expected to be in line with the average total return of the analyst's industry (or industry team's) coverage
universe, on a risk-adjusted basis, over the next 12-18 months.
Not-Rated (NR). Currently the analyst does not have adequate conviction about the stock’s total return relative to the average total return of the
analyst’s industry (or industry team’s) coverage universe, on a risk-adjusted basis, over the next 12-18 months.
Underweight (U). The stock's total return is expected to be below the average total return of the analyst's industry (or industry team's) coverage
universe, on a risk-adjusted basis, over the next 12-18 months.
Unless otherwise specified, the time frame for price targets included in Morgan Stanley Research is 12 to 18 months.
Analyst Industry Views
Attractive (A): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be attractive vs. the
relevant broad market benchmark, as indicated below.
In-Line (I): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be in line with the relevant
broad market benchmark, as indicated below.
Cautious (C): The analyst views the performance of his or her industry coverage universe over the next 12-18 months with caution vs. the relevant
broad market benchmark, as indicated below.
Benchmarks for each region are as follows: North America - S&P 500; Latin America - relevant MSCI country index; Europe - MSCI Europe; Japan TOPIX; Asia - relevant MSCI country index.
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November 2, 2011
Stock Price, Price Target and Rating History (See Rating Definitions)
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Other Important Disclosures
Morgan Stanley & Co. International PLC and its affiliates have a significant financial interest in the debt securities of Morgan Stanley & Co. International PLC and its affiliates have a significant financial interest in the debt securities of Alcoa Inc., Archer Daniels Midland, Ashland Inc., AutoZone
Inc., Ball Corporation, Bank of America, Best Buy Co. Inc, BorgWarner Inc., CBS Corporation, CenturyLink, Inc., Cooper Tire & Rubber Company,
Cytec Industries Inc., Dana Holding Corp., Domtar Corporation, Dr Pepper Snapple Group Inc, Dresser-Rand, Fifth Third Bancorp, FMC Technologies, Ford Motor Company, Freeport-McMoRan, General Motors Company, Halliburton Co., Hannover Re, HollyFrontier Corporation, Interpublic
Group, Intime Department Store (Group), Johnson Controls, Inc., Li & Fung Ltd, Lowe's Companies, Inc., Marathon Petroleum Corporation, Munich
Re, Office Depot Inc., Packaging Corp. of America, Popular, Inc., Potash Corp of Saskatchewan Inc, PPG Industries, Inc., Praxair, Inc., RadioShack
Corporation, RenaissanceRe Holdings Ltd., Samsung Electronics, Schlumberger, Smithfield Foods, Sociedad Quimica y Minera de Chile S.A., Sonoco Products, Staples, Inc., Swiss Re, Target Corp., The Dow Chemical Co., The Home Depot, Inc., Tyson Foods, UMC, Union Pacific Corp., Vulcan Materials Company, Westlake Chemical Corp, Zions Bancorp.
Morgan Stanley is not acting as a municipal advisor and the opinions or views contained herein are not intended to be, and do not constitute, advice
within the meaning of Section 975 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Morgan Stanley produces an equity research product called a "Tactical Idea." Views contained in a "Tactical Idea" on a particular stock may be
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The recommendations of Franco Abelardo in Morgan Stanley Research reflect solely and exclusively the analyst's personal views and have been
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November 2, 2011
North America
Director of Research
Stephen Penwell
Softlines
1+212-761-1466
Associate Director of Research
Sharon Pearson
Michael Eastwood
1+212-761-3159
1+212-761-8015
Director of Associates
Michelle Teitsch
1+212 761-4192
Management
Gail Alvarez
Aaron Finnerty
Kimberly Greenberger
Jay Sole
Laura Ross
Sharyn Uy
REITs Strategy
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1+212-761-5866
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1+212-761-5156
CONSUMER STAPLES
MACRO
David J. Adelman
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1+212-761-6382
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Agricultural Products
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Gregory Jonas
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Vincent Reinhart
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Derivatives
Sivan Mahadevan
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Commodities
Hussein Allidina
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1+212-761-4150
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Sectors
CONSUMER DISCRETIONARY/RETAIL
RETAIL
Adam Jonas
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Yejay Ying
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Department Stores
Michelle Clark
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Mark Wiltamuth
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Gaming & Lodging
Mark Strawn
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Hardlines
David Gober
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Restaurants
John S. Glass
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Integrated Oil
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MLPs
Stephen J. Maresca
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Oil Services & Equipment
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Banks/Canadian
Cheryl Pate
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Timothy Skiendzielewski
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Brokers & Exchanges
Matthew Kelley
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Entertainment & Broadcasting
Biotechnology
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Doug Simpson
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Pharmaceuticals
David Risinger
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INDUSTRIALS
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Heidi Wood
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TECHNOLOGY
Communications Equipment
Ehud Gelblum
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1+212-761-8564
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Enterprise Software
Adam Holt
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Enterprise Systems & PC Hardware
Kathryn Huberty
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Scott Devitt
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1+212-761-3365
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Semi Capital Equipment
Atif Malik
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1+415-576-2607
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Semiconductors
Sanjay Devgan
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1+415-576-2382
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TELECOM
Wireline & Wireless Telecom Services
1+212-761-3293
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Chemicals
1+212-761-3293
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1+212-761-6432
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Nonferrous Metals, Gold
TRANSPORTATION
Paretosh Misra
Alexander Levy
Airlines & Freight Transportation
1+212-761-3590
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Steel
Insurance/Life & Annuity
Evan Kurtz
Nigel Dally
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1+212-761-4132
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Agricultural Chemicals
Vincent Andrews
Charles Dan
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1+212-761-7527
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Payment/Processing Technology
MATERIALS
Vincent Andrews
Ted Drangula
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1+212-761-7527
1+212-761-3005
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Industrial Conglomerates
Nigel Coe
Nicole DeBlase
Claire Diesen
Jiayan Zhou
Benjamin Swinburne
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Hersh Khadilkar
Bernard McTernan
Emmy Mathews
Internet & PC Application Software
Business & IT Services
Suzanne Stein
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Thomas Allen
Cable & Satellite
1+212-761-4407
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Machinery
Banks/Large/Mid Cap Banks
Betsy Graseck, CFA
Peter Newman
Michael Cyprys
Ken Zerbe
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Giselle Cheung
Jonathan Katz
MEDIA
Managed Care
FINANCIALS
Branded Apparel
Joseph Parkhill
Jane Zhao
Joseph Wyatt
1+212-761-3293
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Clean Tech
U.S. Strategy
Adam Parker
Brian Hayes
Antonio Ortega
Adam Gould
Phillip Neuhart
Yaye Aida Ba
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Greg Van Winkle
Beverages/HPC
Dara Mohsenian
Ruma Mukerji
Kevin Grundy
Alison Lin
Vinay Ayala
1+415-576-2627
1+415-576-2637
1+415-576-2361
1+415 576-2631
1+415-576-8913
HEALTHCARE
Tobacco
1+212-761-7650
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Paul Morgan
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Jorel Guilloty
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1+212-761-7583
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Bill Greene
John Godyn
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Matthew Parker
1+212-761-8017
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Insurance/Property & Casualty
Gregory W. Locraft Jr.
Kai Pan
Scott Thomas
Quentin McMillan
1+212-761-0040
1+212-761-8711
1+212-761-6586
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75
November 2, 2011
Asia/Pacific
Director of Asian Research
Neil Perry
S. Korea
+852 2848 8877
Deputy Director of Asian Research
Marcus Walsh
+852 2848-5912
Associate Director of ASEAN Research
Hozefa Topiwalla
+65 6834-6439
Associate Director of Australia Research
Lou Pirenc
+61 2 9770-1569
Head of Australia Research and Distribution
Will McKenzie
+61 2 9770 1161
Associate Director of Greater China
Research
Dickson Ho
+852 2848-5020
Associate Director of India Research
Ridham Desai
+91 22 6118-2222
Associate Director of South Korea
Research
Shawn Kim
+82 2 399-4940
MACRO
Strategy
Asia/Pacific ex. Japan / GEMs
Jonathan Garner
+852 2848-7288
Pankaj Mataney
+852 2239-7830
Pauline Yeung
+852 2848-6853
ASEAN
Hozefa Topiwalla
+65 6834-6439
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+65 6834-6317
Australia
Antony Conte
+61 2 9770-1544
China / Hong Kong
Corey Ng
+852 2848-5523
Allen Gui
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+86 10 8356 3948
India
Ridham Desai
+91 22 6118-2222
Amruta Pabalkar
+91 22 6118-2225
Utkarsh Khandelwal
+91 22 6118-2226
S. Korea
Shawn Kim
+82 2 399-4940
HyunTaek Lee
+82 2 399-9854
Economics
Asia/Pacific
Chetan Ahya
Derrick Kam
Jenny Zheng
ASEAN
Chetan Ahya
Deyi Tan
Seen Meng Chew
Australia
Gerard Minack
Katie Hill
China / Hong Kong
Helen Qiao
Denise Yam
Ernest Ho
India
Chetan Ahya
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Sharon Lam
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+852 2239-7812
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Commodities
Peter Richardson
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+61 3 9256-8943
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CONSUMER DISCRETIONARY
Automobiles
China
Kate Zhu
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India
Binay Singh
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S. Korea
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Consumer / Retail
ASEAN
Divya Gangahar Kothiyal
Australia
Thomas Kierath
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Mark Christensen
Ben Tedder
India
Nillai Shah
Girish Achhipalia
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Greater China
Angela Moh†
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+852 2848-6843
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Kelly Kim
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Leisure & Lodging
China
Lin He
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India
Parag Gupta
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+82 2 399-4837
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ENERGY
Clean Tech / Solar Devices
S. Korea
Sung Hee Lim
+82 2 399-4937
Fertilizer
Taiwan
Jeremy Chen
+886 2 2730-2876
Lily Chen
+886 2 2730-2871
Oil & Gas
Australia
Stuart Baker†
+61 3 9256-8929
Cameron O’Neill
+61 3 9256-8936
China
Wee-Kiat Tan
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+852 2848-5292
Josh Du
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India
Vinay Jaising†
+91 22 6118-2252
Rakesh Sethia
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Thailand
Mayank Maheshwari
+65 6834-6719
FINANCIALS
Banks
ASEAN
Nick Lord
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Australia
Richard Wiles
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Minyan Liu
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Hong Kong
Anil Agarwal†
Isabella He
India
Anil Agarwal
Mihir Sheth
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S. Korea
Joon Seok
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Taiwan
Lily Choi
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Insurance
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Daniel Toohey
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China
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Sara Lee
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Lily Choi
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+65 6834-6746
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+852 2848-5830
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HEALTH CARE
Australia
Sean Laaman
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Bin Li
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India
Sameer Baisiwala
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+61 2 9770-1559
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INDUSTRIALS
Capital Goods / Shipbuilding
China / Hong Kong
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S. Korea
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Capital Goods
India
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+91 22 6118-2211
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+91 22 6118-2213
Cement / Glass / Auto Components
/ Property / Steel
India
Akshay Soni
+91 22 6118-2212
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+91 22 6118-2240
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+91 22 6118-2211
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Taiwan
Jeremy Chen
+886 2 2730-2876
Lily Chen
+886 2 2730-2871
Developers & Contractors
Australia
Nick Robison
+61 2 9770-1536
Gaming / Multi-Industry
ASEAN
Xin Jing Lin
+65 6834-6295
China / Hong Kong
Praveen Choudhary
+852 2848-5068
Corey Chan
+852 2848-5911
Calvin Ho
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+852 2239-7832
India
Akshay Soni
+91 22 6118-2212
Aarti Shah
+91 22 6118-2211
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+91 22 6118-2213
Transportation & Infrastructure
Regional
Chin Y. Lim†
+65 6834-6858
Sophie Loh
+65 6834-6823
Chin Ser Lee
+65 6834-6735
Australia
Scott Kelly
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Celine Parle
+61 2 9770-1136
Julia Weng
+61 2 9770-1197
China
Edward Xu
+852 2239-1521
Andy Meng
+852 2239-7689
Li Mao
+852 2239-1523
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+852 2239-7817
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+852 2239-1527
Cedric Shi
+86 21 2033-6653
India
Parag Gupta
+91 22 6118-2230
Satyam Thakur
+91 22 6118-2231
INFORMATION TECHNOLOGY
Hardware Components
China / Hong Kong
Jasmine Lu
Tim Hsiao
Grace Chen
Terence Cheng
Bill Lu
Charlie Chan
S. Korea
Keon Han
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Taiwan
Jasmine Lu
Tim Hsiao
Po-Ling Chen
Sharon Shih
Brad Lin
Grace Chen
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Internet / Media
Australia
Andrew McLeod
Mark Goodridge
China
Richard Ji
Philip Wan
Gillian Chung
Timothy Chan
Yu-Heng Fan
Carol Wang
Alvin Jiang
India
Vipul Prasad
Ritish Rangwalla
South Korea
Shawn Kim
HyunTaek Lee
Semiconductors
S. Korea
Keon Han
Young Suk Shin
Mike Chung
Taiwan
Bill Lu
Charlie Chan
Software & Services
China
Carol Wang
Alvin Jiang
India
Vipin Khare
Gaurav Rateria
+852 2239-1348
+852 2848-1975
+886 2 2730-2890
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+852 2848-5214
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+82 2 399-4933
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+852 2239-1348
+852 2848-1975
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+886 2 2730-2865
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+852 2848-6926
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+852 2239-7107
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+86 21 2033-6669
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+91 22 6118-2238
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+82 2 399-4940
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+82 21 2326-0026
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+91 22 6118-2236
+91 22 6118-2237
MATERIALS
Building Materials
Australia
Phil Bare
India
Akshay Soni
Aarti Shah
Pratima Swaminathan
Chemicals
India
Vinay Jaising†
Anirban Roy
Rakesh Sethia
S. Korea
Harrison Hwang
Kyle Kim
Materials
ASEAN, China
Charles Spencer†
Mean Phil Chong
Rachel Zhang
John Lam
Aishwarya Narayanan
India
Nillai Shah
S. Korea
Charles Spencer
Metals & Mining
Australia
Brendan Fitzpatrick
Stefan Hansen
Sarah Lester
India
Vipul Prasad
Ritish Rangwalla
+61 3 9256 8932
+91 22 6118-2212
+91 22 6118-2211
+91 22 6118-2213
+91 22 6118-2252
+91 22 6118-2254
+91 22 6118-2253
+82 2 399-4916
+82 2 399-4994
+65 6834-6825
+65 6834-6194
+852 2239-1520
+852 2848-5412
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+91 22 6118-2244
+65 6834-6825
+61 2 9770-1148
+61 2 9770-1390
+61 3 9256-8436
+91 22 6118-2238
+91 22 6118-2258
PROPERTY
Australia
Lou Pirenc
Todd McFarlane
John Meredith
ASEAN
Wilson Ng
China
Brian Leung
Angus Chan
Jacky Chan
Hong Kong
Praveen Choudhary
Angus Chan
Jacky Chan
India
Sameer Baisiwala
Arunabh Chaudhari
Harshal Pandya
+61 2 9770-1569
+61 2 9770-1316
+61 2 9770-1317
+65 6834-6345
+852 2848-5220
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+852 2848 5973
+852 2848-5068
+852 2848-5259
+852 2848 5973
+91 22 6118-2214
+91 22 6118-2216
+91 22 6118-2217
SMALL AND MID CAP
Emerging Companies
Australia
Christopher Nicol
David Evans
James Bales
Mid Cap
China
Lin He
Ying Guo
Taiwan
Jeremy Chen
Lily Chen
+61 3 9256-8909
+61 2 9770-1504
+61 2 9770-1603
+86 21 2326-0016
+86 21 2326-0018
+886 2 2730-2876
+886 2 2730-2871
TELECOMMUNICATIONS
Australia
Mark Blackwell
John Burns
+61 3 9256-8959
+61 2 9770-1395
Greater China / Malaysia / Thailand
Navin Killa†
Gary Yu
Surabhi Chandna
Andri Ngaserin
India
Vinay Jaising
Vanessa D’Souza
S. Korea
Sam Min
Jessica Bang
+852 2848-5422
+852 2848-6918
+65 6834-6517
+852 2848-7221
+91 22 6118-2252
+91 22 6118-2245
+82 2 399-4936
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UTILITIES
Australia
Mark Blackwell
John Burns
China / Hong Kong
Simon Lee
Vincent Chow
Eva Hou
Jacky Pang
Helen Wen
Ivy Lu
India
Parag Gupta
Satyam Thakur
+61 3 9256-8959
+61 2 9770-1395
+852 2848-1985
+852 2239-1588
+86 21 2326-0031
+852 2848-5289
+852 2848-5438
+852 2239-7814
+91 22 6118-2230
+91 22 6118-2231
76
November 2, 2011
Europe
Tobacco
Rupert Jones
Toby McCullagh
+44 (0)20 7425 4271
Juliet Estridge
Matthew Ostrower
Mitzi Frank
+44 (0)20 7425 8160
+44 (0)20 7425 8560
+44 (0)20 7425 8022
+44 (0)20 7425 8154
+44 (0)20 7677 6101
Oil Services
Media Relations
Sebastian Howell
+44 (0)20 7425 5324
Equity Strategy
+44 (0)20 7425 4944
+44 (0)20 7425 3595
+44 (0)20 7425 6188
+44 (0)20 7425-1437
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Economics
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Dan Cowan
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EMERGING MARKETS
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SOUTH AFRICA RMB MORGAN STANLEY
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77
November 2, 2011
Japan
Director of Asian Research
Machinery and Capital Goods
Neil Perry
Yoshinao Ibara
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+813-5424-5305
Economic Research
Director of Economic Research
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Takehiro Sato
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CONSUMER STAPLES
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+813-5424-5689
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+813-5424-5397
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ENERGY/UTILITIES
Oil & Coal Products
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Yohei Yamada
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+813-5424-5923
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TECHNOLOGY
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Sectors
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Utilities
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TRANSPORTATION &
INFRASTRUCTURE
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78
November 2, 2011
Fixed Income Research - Global
Currency Strategy
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Gregory Peters
Jason Draho
Jerry Chen
Liz Golden
1+212 761-1488
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North America
Gregory Peters
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North America
Gabriel de Kock
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1+212 761-1488
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Europe
Hans Redeker
Ian Stannard
Tim Davis
Calvin Tse
Dara Blume
North America
Jim Caron
Subadra Rajappa
Janaki Rao
Zofia Koscielniak
Jonathan Marymor
Ankur Shah
Tiffany Wilding
Europe
Andrew Sheets
Phanikiran Naraparaju
Serena Tang
Jonathan Graber
44+20 7677-2905
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Credit Strategy
Japan
Hidetoshi Ohashi
Tomoyuki Hirose
81+3 5424-7908
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Asia Pacific
Viktor Hjort
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Nishant Sood
+852 2848-7479
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Structured Credit Strategy
Sivan Mahadevan
Ashley Musfeldt
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James Egan
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1+212 761-1349
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Asia Pacific
Stewart Newnham
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Economics
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David Greenlaw
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Joachim Fels
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Europe
Laurence Mutkin
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Asia Pacific
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+852 3963-0550
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EM Fixed Income and Foreign
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Rogerio Oliveira
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Europe
Rashique Rahman
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Vanessa Barrett
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James Lord
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Credit Research
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Jackie Ineke
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Lee Street
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79
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U.S. and the Americas Investment Perspectives

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