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Financial - Investing - Nutshell - HSBC
Financial - Investing - Nutshell - HSBC
Multi-sector
September 2010
HSBC Nutshell
David May*
Head of Equity Research. EMEA
HSBC Bank Plc
+44 20 7991 6781
david.may@hsbcib.com
David May is Head of Equity Research, EMEA (Europe and CEEMEA regions) at HSBC, a role he has been in since August 2007.
He was previously Global Head of Equity Product Management at HSBC. Prior to HSBC, David worked in an Equity Sales role
and an Equity Product Management role at a major American investment bank.
HSBC Nutshell
A guide to equity sectors
Tim Hammett*
Head of Research Marketing, EMEA
HSBC Bank Plc
+44 20 7991 1339
tim.hammett@hsbcib.com
Tim Hammett is Head of Research Marketing for EMEA, He joined HSBC in August 2009, bringing seven years experience of
research marketing and knowledge management with a major American investment bank and a previous 13 years of equity fund
management experience.
Nicholas Peal*
Research Marketing, EMEA
HSBC Bank Plc
+44 20 7991 5353
nicholas.peal@hsbcib.com
Nicholas joined HSBC in 2006. Prior to his current role within research marketing he gained experience in both foreign exchange
and interest rate derivative product areas.
Multi-sector Equity
This guide will help you gain a quick, but thorough understanding of 22 equity research sectors and
industry groups
It will help you to understand the organisation of the sector, the key drivers, indicators and themes,
historical context, and suitable valuation approaches
It is also an open offer to access HSBCs expertise in fundamental equity sector research
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations.
September 2010
Disclosures and Disclaimer This report must be read with the disclosures and analyst
certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it
abc
Dear Client
This HSBC Nutshell: A guide to equity sectors has been compiled by the EMEA Equity Research team at
HSBC to help you gain a quick, but thorough, understanding of the 22 sectors and industry groups we cover.
The guide assumes some basic working knowledge of the world economy, equity markets, financial
terminology and ratios, although it is designed to be used by new joiners or people who are looking at
industries with which they are not familiar.
As one of its business principles, HSBC Group is committed to providing outstanding customer service.
HSBCs Equity Research team reflects this principle in the way we work with you, our clients, on a daily basis.
We view working with our clients as a partnership. Within Equity Research, we aim to provide you with
best in class, financially robust, independent, insightful, actionable research on a global, regional and
local basis. We are making our resources, knowledge and expertise available to you.
Following the publication of this guide, we would like to remind you, our clients, that we are happy to
arrange one-on-one or group meetings with our senior analysts to help you build on your sector, industry
or stock knowledge from the nuts and bolts of the industry dynamics through to individual company
valuation and recommendation. Please get in touch with your HSBC representative to organise this, if
required, or come to me directly.
On the front page of each industry section within this guide, you will find the names and contact details of
our sector analysts and, where relevant, their specialist sales person/people. If you do not know these
analysts and sales people, we would be delighted to set up an initial meeting or call to discuss the HSBC
offering and how we can help you.
We hope you find this guide useful, and we look forward to working with you or to continuing to work
with you in future.
Regards
David May
Head of Equity Research, EMEA (Europe/CEEMEA)
david.may@hsbcib.com
+44 20 7991 6781
abc
abc
Contents
Aerospace and Defence
105
Autos
13
113
Banks
21
Real Estate
121
Beverages
27
Retail General
129
Business Services
35
Sporting Goods
137
Capital Goods
43
143
151
159
Utilities
165
173
Disclosure appendix
190
Disclaimer
192
Chemicals
Clean Energy and Climate
Change
Construction and Building
Materials
51
59
67
75
Food Retailing
83
Insurance
91
Luxury Goods
99
abc
abc
Aerospace and
Defence
Aerospace and Defence team
Harry Nourse*
Analyst
HSBC Bank Plc
+44 20 7992 3494
harry.nourse@hsbcib.com
Sector sales
Rod Turnbull*
Sector Sales
HSBC Bank Plc
+44 20 7991 5363
rod.turnbull@hsbcib.com
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations
6
EMEA Equity Research
Multi-sector
September 2010
Aerospace
Commercial jet
manufacturers
Defence
Business jet
manufacturers
Engine
manufacturers
Prime contractors
Boeing
Gulfstream
General Electric
BAE Systems
Bombardier
Honeywell
Boeing Defence
Dassault
EADS (Defence)
Embraer
General Dynamics
Cessna
Rolls-Royce (RR)
Lockheed Martin
Hawker Beechcraft
Safran
Northrop Grumman
Bombardier
Embraer
Superjet International
Tier 2/Primes
Tier 3/Systems
providers
Tier4/Sub-contractors
Tier 5/Component
suppliers
Finmeccanica
Cobham
Chemring
AAR
L3 Communications
Ultra Electronics
Goodrich
Chemring
Raytheon
Rockwell Collins
Meggitt
HEICO
Thales
Meggitt
Moog
Umeco
Safran
abc
Source: HSBC
140
120
Restocking recovery
100
120
100
80
80
The 1980s oil and economic crisis followed by a
period of strong growth in liberalised markets
Aerospace: Commercial aircraft orders versus stock price performance for Boeing
60
60
40
40
20
20
Jan-80
Jul-80
Jan-81
Jul-81
Jan-82
Jul-82
Jan-83
Jul-83
Jan-84
Jul-84
Jan-85
Jul-85
Jan-86
Jul-86
Jan-87
Jul-87
Jan-88
Jul-88
Jan-89
Jul-89
Jan-90
Jul-90
Jan-91
Jul-91
Jan-92
Jul-92
Jan-93
Jul-93
Jan-94
Jul-94
Jan-95
Jul-95
Jan-96
Jul-96
Jan-97
Jul-97
Jan-98
Jul-98
Jan-99
Jul-99
Jan-00
Jul-00
Jan-01
Jul-01
Jan-02
Jul-02
Jan-03
Jul-03
Jan-04
Jul-04
Jan-05
Jul-05
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
Defence: US DoD investment account spending vs PE relative to S&P 500 ( US defence primes)
130%
25%
20%
120%
15%
110%
10%
100%
5%
0%
90%
-5%
80%
-10%
60%
-20%
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010e
abc
70%
-15%
Sector description
The aerospace and defence (A&D) industry sits at the long end of the cyclical landscape, with peak-topeak durations in the region of 8-10 years for aerospace OE and 15-17 years for US defence spending.
Aerospace the sub-sector serves the aviation industry and manufactures commercial jets (>100 seat
aircraft), regional jets and business jets. The sub-sector also includes the commercial and institutional
satellite/related services business.
Defence the sub-sector serves the armed services and homeland security markets and its activities
relate primarily to the design and manufacture of defence equipment including military aircraft,
warships, submarines, land-based vehicles, surveillance and radar equipment, and related armaments.
While the drivers for each sub-sector are clearly different (air traffic versus threat and geopolitical
considerations), there are significant commonalities in terms of technological development, and
components, systems and products utilised. The overlap between the sub-sectors is especially significant
at the systems and component supplier level. As a result, most component suppliers in the industry
operate in both sub-sectors, thereby deriving benefits of economies of scale from common developments.
It is also the case that the major aerospace OEMs have significant defence operations, partly to diversify
their businesses and to mitigate cyclical pressures.
Players in the industry can be classified as:
Original equipment manufacturers (OEMs) in aerospace and prime contractors (tier 1) in
defence. These companies are at the forefront of most defence contracts or programmes, with
responsibility for designing, manufacturing and assembling the equipment, integration of electronic
systems and satisfactory delivery to the end customer; they bear most risk for the programme. There
are few competitors in this category due to the requirements of scale, breadth of products, execution
capabilities and political influence (in the case of defence).
Tier 2 suppliers. These are suppliers of major systems and are increasingly transitioning to
risk/revenue-sharing partners on commercial aerospace programmes. They do not have the product
breadth or execution capabilities to compete as prime contractors. They generally bear only some of
the risk on the programmes and therefore exhibit less earnings volatility than tier 1 players.
Sub-systems suppliers (tier 3). These have high value added technologies and focus on niches. They
are able to extract economies of scale, and risks are spread across programmes, which makes them
more profitable than tier 1 or 2 players.
Component suppliers (tier 4 and 5) produce high-volume but relatively low-tech components. They
often display high earnings volatility and do not boast long-term competitive technologies.
The industry structure also drives the industrys earnings volatility this is an M shaped graph with
earnings volatility being higher for tier 1 (due to programme risk) and tier 4/5 (volume driven) players
across the cycle.
abc
Harry Nourse*
Analyst
HSBC Bank Plc
+44 20 7992 3494
harry.nourse@hsbcib.com
*Employed by a non-US affiliate
of HSBC Securities (USA) Inc,
and is not registered/ qualified
pursuant to FINRA regulations
abc
Key themes
Aerospace
OE versus aftermarket
Like any capital-intensive industry, there are two phases to the end customers spend the purchase of
original equipment (OE, be it aircraft, engines or systems), followed by the stream of maintenance and
spares expenditure (aftermarket AM). What is unique to aerospace is that the airframers (aircraft
manufacturers like Boeing and Airbus) share OE revenues with suppliers, but the latter get the full benefit
of the AM revenues from a large installed base of equipment. A good example of this is the engine
manufacturer, Safran, which generates c35% of its aerospace revenues but more than 80% of its profit
from the aftermarket. Additionally, suppliers also benefit from the differential cyclicality of the two
revenue streams AM revenues tend to decline sooner and recover earlier than OE revenues during a
typical cycle.
Airframers versus suppliers
Both major airframers, Airbus and Boeing, engage in fierce product competition and, as a result, spend
significant amounts on R&D and face significant programme execution risk. This leads to relatively low
margins on a high fixed cost base. In contrast, suppliers of engines, components and systems are arguably
in a better position, due to a well-functioning oligopoly and lower programme risk and the ability to
diversify those risks somewhat across airframers. Suppliers tend, therefore, to be more profitable through
the cycle.
Airframers from oligopoly to competitive duopoly (and back again?)
Over the past four decades, the commercial OE industry has reduced to a highly competitive duopoly,
with Boeing and Airbus vying to capture a bigger share of the market. Currently the narrow-body market
is essentially in equilibrium, and the two firms have largely been competing for share in the wide-body
segment. As we move into the next decade, however, we anticipate increasing competition from new
entrants. For example, Bombardier (previously a regional jet manufacturer) is entering larger territory
with its new 130 seat CSeries, Russia with its Superjet 1000 and China with its C919. Although most of
this additional competition will be in the single-aisle aircraft segment (100-150 seats), that segment is a
key cash generator for Boeing and Airbus and funds large aircraft development: a risk to demand here
could have repercussions for other products.
Currency
Sales in the aerospace industry are dollar denominated, while costs are in local currency. This is a
particular structural problem for European firms, who typically hedge their dollar exposure over a
minimum three-year period. The depreciation of the US dollar versus the euro over 2001-08 led to a
structural competitive disadvantage for the European manufacturers, in particular EADS (given its
cUSD70bn hedgebook). This trend reversed in 2009-10, and resulted in most European aerospace names
being traded as proxy for the USD/EUR exchange rate.
Defence
Its all about the money affordability versus military superiority
Defence spending, as a proportion of GDP, has declined steadily across most of the Western world since
the end of the Cold War, thanks to a perceived peace dividend and a shift in government priorities. For
the US, which accounts for 46% of total global spend, this trend reversed after 9/11, although expenditure
now appears to be peaking, as the wars in Iraq and Afghanistan wind down. The current state of
government finances, particularly in Europe and the US, remains far from comfortable and there is
increasing pressure on governments to reduce defence spending (historically an early target for cuts),
without compromising effectiveness or military superiority. As a result, we believe affordability and not
just superiority of defence equipment will increasingly affect the industry landscape over the coming years.
Emerging market opportunity
While Western governments are facing pressures on their finances and defence budgets, some emerging
powers are raising budgets. As a result, exports to regions like Middle East, India and Asia ex-China are
increasingly becoming focus areas, with the added benefit to contractors of higher margins on export
sales. However, contract terms and technology transfer requirements can result in complex negotiations
(mostly government-to-government), leading to frequent delays.
Sector drivers
Aerospace
Passenger and freight traffic
Demand for aircraft is largely driven by increases in passenger and freight traffic (measured in revenue
passenger/freight mile RPM). Air traffic demand is driven by two trends; economic growth has a
particular impact on premium passenger traffic (business class), freight demand, tourism and leisure,
while flight demand is also affected by consumer confidence (air fares are a form of consumption
spending). Changes in traffic growth drive airline profitability and, consequently, new aircraft orders.
Yields and fuel prices
Yields (the amount of passenger revenue received for each RPM) and fuel prices affect the industry in
three ways: (1) they are a direct input for determining airline profitability and, hence, ability to buy new
aircraft; (2) increasing fuel prices drive replacement demand for more fuel-efficient aircraft; and (3) it
impacts the economic lives of aircraft, which is particularly important for lessors. Yields have been
trending lower over time, as low-cost carriers blossom, and increases in fuel prices have resulted in
pressure on airlines to replace old aircraft and in a reduction in the economic life of existing models.
Availability of finance
During the freezing of the credit markets, the availability of external financing declined significantly as,
for example, a number of lease firms suffered from their parents financial distress (for example
ILFC/AIG, CIT and RBS Aviation Capital). While the US Export-Import Bank and European export
credit agencies have stepped in as part of government efforts to protect industrial jobs, the return of
aircraft financing markets to normal levels is likely to be a major driver of future demand for aircraft. We
believe that heightened levels of government support are distorting the market at the expense of the health
of the secondary aircraft market, where debt financing remains hard to obtain for purchasing aircraft more
than 10 years old; this is potentially a serious problem in an industry where assets are assumed to have a
useful life of about 25 years.
10
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Defence
Defence spending is typically driven by threats, war, and politics and ideology. For export sales, rising
wealth (particularly in countries with abundant natural resources and high levels of economic growth) is a
major driver. Similarly, the actions of competitor nations can be important. There is an ongoing
requirement to replace existing, outdated equipment, and new threats can stimulate demand for responsive
technology, such as missile defence.
development over the life of the programme, rather than expensing them all up front. This permits a
smoothing of margins over the production period, but does not provide a particularly helpful measure of
current operational profitability (for which the cash-based, unit cost accounting methodology provides a
better snapshot). The level of R&D capitalisation is important to aerospace investors, as it can lead to
overstatement of EBIT. Airbus does not use programme accounting and this is one reason for its lower
(and more volatile) EBIT margins, which are also heavily influenced by hedge rates and other anomalies.
Pension: On the European side, pension deficit is a major issue for BAE, which has seen the deficit rise
nearly three-fold over the past two years and which has had to make substantial cash contributions to fund
the plans. Pensions is more a timing issue with the US defence players since pension costs are reimbursed
by the DoD as part of the contract billing. Aerospace OEMs like Boeing and Honeywell, however, face
the risk of having to fund large pension deficits for the non-defence businesses.
11
Notes
12
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Autos
Autos team
Horst Schneider*
Analyst
HSBC Trinkaus & Burkhardt AG, Germany
+49 211 910 3285
horst.schneider@hsbc.de
Niels Fehre*
Analyst
HSBC Trinkaus & Burkhardt AG, Germany
+49 211 910 3426
niels.fehre@hsbc.de
Sector sales
Rod Turnbull*
Sector sales
HSBC Bank Plc
+44 20 7991 5363
rod.turnbull@hsbcib.com
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations
13
14
Autos
Car makers
Auto Components
Tyre makers
Toyota
Audi (Volkswagen)
Denso
Michelin
Volkswagen brand
Bosch*
Goodyear/ Sumitomo
General Motors*
BMW
Continental AG
Bridgestone
HyundaiKia
Porsche (Volkswagen)
Aisin Seiki
Continental AG
Ford
Magna
Pirelli
Honda
Aston Martin*
Johnson Control
JaguarLandrover
(Tata Motors)
Faurecia
Yokohama
Delphi*
Hankook
Fiat + Chrysler
Valeo
Cooper
Renault
BorgWarner
Nissan
Suzuki
Changan Group
SAIC
First Auto Works (FAW)
Specialised suppliers
(Telematics, safety,
electricals, chassis etc.)
Autoliv
Leoni
Elringklinger
Rheinmetall
*Private companies
Source: HSBC
Harman*
abc
17
106
Car scrappage schemes
Bursting of dotcom bubble
Scrappage
schemes
expiry
16
102
104
Europe recession
100
14
98
13
96
12
94
92
11
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
abc
15
Sector description
The European automotive sector is very important to the European economy, supporting around 12m jobs
(2m directly) and contributing significantly to the EUs GDP with a net trade of cEUR40bn a year.
Developments in the auto sector influence and indicate the mood of the economy. Consequently, it is not
only tracked by financial analysts but also closely watched by the political community. The sector can
broadly be classified into mass-market car makers and premium car makers.
abc
Horst Schneider*
Analyst
HSBC Trinkaus & Burkhardt
AG, Germany
+49 211 910 3285
horst.schneider@hsbc.de
Mass-market manufacturers derive most of their sales from smaller and cheaper cars, with typically
Niels Fehre*
Analyst
HSBC Trinkaus & Burkhardt
AG, Germany
+49 211 910 3426
niels.fehre@hsbc.de
lower margins, and are exposed to a larger extent to cyclical demand. They rely on high production to
push asset turnover, which in turn is the key profitability driver. Besides being exposed to the fragmented
small-car segment, they are challenged by low capacity utilisation and constant pricing pressures.
Premium car makers, with exposure to larger-car and SUV segments, typically derive higher margins.
Added value from advanced technology, rich features and brand equity enable them to command higher
transaction prices. However, they face challenges from stricter CO2 regulations globally, which require
high investments to develop low-emission technologies. They also now face greater market fragmentation
and weakening product mix as they enter smaller car segments to cater to changing consumer preferences.
At the onset of the economic crisis, the highly cyclical nature of the sector caused new-car sales,
particularly in the Western markets, to collapse as consumer confidence plunged. Scrappage schemes
intended to boost short-term demand during the crisis have also created a strong pull-forward effect that is
creating additional medium-term challenges, especially for mass-market car makers, as issues of overcapacities in Europe are left unaddressed. Coupled with government austerity measures in Europe and
weakening US macro data, we believe that represents further risk for 2011 and beyond.
Key themes
Emerging-market growth compensating for weaker developed markets
Low car penetration and rising disposable incomes should lead to higher organic growth in emerging
markets, even as the outlook for developed markets remains uncertain. In China, for example, only 45 out
of 1,000 people own a car, compared with 40% to 50% of the population in Western Europe. Sales in
emerging markets are skewed towards small cars and most purchases are from first-time buyers. In
developed markets, sales are dominated by higher-priced large, premium cars and by replacement
demand. Beyond an uncertain 2011, we expect unit sales growth in all regions. But we do not expect
light-vehicle sales in Western Europe and the US to return to the pre-crisis levels of 2007 until after 2014.
We believe that globally, light-vehicle sales will continue to be led by emerging markets, particularly the
BRIC economies.
16
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we expect sales to decline c24% y-o-y in 2010 and to reach 2007 levels only by 2012e. Margins face
additional risks from consumers accustomed to the incentives now expecting discounts from car dealers.
17
Sector drivers
Volumes and macro data
As a capital-intensive business with rising costs for new model and technology development, car makers
must spread fixed costs across as many units as possible, underscoring the need for more economies of
scale and standardisation. Volumes are thus primary margin drivers for the sector, which in turn depends
on macroeconomic factors such as: consumer confidence, unemployment, disposable incomes and GDP.
The sector is extremely data-intensive. Some of the closely tracked statistics are: monthly sales numbers
from ACEA for Europe, US SAAR data, and for other key markets like Brazil, China and Japan; monthly
sales by car makers; incentives data in Europe and the US; residual value of used cars; and inventory at
dealer networks.
Pricing
Pricing is another closely monitored element of car makers margins. For the mass-market segment, price
elasticity is fairly high, which makes it difficult to pass on price increases to customers. Pricing is
influenced by a combination of factors, including segment/product mix shifts, new product launches and
competition. Scrappage incentives in Europe improved pricing for small cars because of the huge
demand, but with their expiry in 2010, the issue is back on the table. Aggressive volume targets in a
contracting market and efforts to increase capacity utilisation will leave car makers fighting on the pricing
front in 2010, especially in the mass-market segment.
predominantly an export-driven business, European and Japanese car makers are exposed to currency
risks. Although Japanese car makers benefited from a weak JPY in the past, and German companies have
been burdened with a stronger euro, the recent sovereign debt crisis has reversed this trend briefly.
Raw material prices: Steel is the most important input factor for car production and makes up around
60% of the total car weight on average. Having benefited from lower steel and other commodity prices in
18
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2009, higher raw material prices are expected in H2 2010 from contract re-pricing with steel makers.
Other commodities include aluminium, plastics, precious metals and rubber.
Interest rates: Financial services operations at auto makers are a capital-intensive business; any change
in refinancing costs can have a substantial impact on group P&L. Refinancing conditions determine the
net interest income and are one of the key profitability drivers. Those conditions are determined by
overall risk-free interest rates, the individual car makers credit rating and its credit default swap rates.
19
Notes
20
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Banks
Banking team
Sector sales
Carlo Digrandi*
Co-Global Sector Head
HSBC Bank Plc
+44 20 7991 6843
carlo.digrandi@hsbcib.com
Nigel Grinyer*
Sector Sales
HSBC Bank Plc
+44 20 7991 5386
nigel.grinyer@hsbcib.com
robin.down@hsbcib.com
Matt Charlton*
Sector Sales
HSBC Bank Plc
+44 20 7991 5392
matt.charlton@hsbcib.com
peter.toeman@hsbcib.com
James Rogers*
Sector Sales
HSBC Bank Plc
+44 20 7991 5077
james1.rogers@hsbcib.com
Robin Down*
Co-Global Sector Head
HSBC Bank Plc
+44 20 7991 6926
Peter Toeman*
Analyst
HSBC Bank Plc
+44 20 7991 6791
Johannes Thormann*
Analyst
HSBC Trinkaus & Burkhardt AG, Germany
+49 21 1910 3017
johannes.thormann@hsbc.de
Joanna Telioudi*
Head of Greek Equities Research
HSBC Pantelakis Securities SA
+30 210 6965 209
joanna.telioudi@hsbc.com
Dimitris Haralabopoulos*
Analyst
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations
21
22
European Banks
Austria
France
and Belgium
Germany
Greece
Italy
Spain
UK
KBC
Aareal Bank
Alpha Bank
Banco Popolare
Banco de Sabadell SA
Barclays
Raiffeisen
International
KBC Ancora
Commerzbank
Bank Of Cyprus
Deutsche Postbank
EFG Eurobank
Ergasias
Banca Popolare di
Milano
Banco Popular
BNP Paribas
Santander
Royal Bank of
Scotland
comdirect bank
Deutsche bank
National Bank of
Greece
Piraeus Bank SA
Intesasanpaolo
Monte dei Paschi
BBVA
Bankinter
Standard Chartered
UBI
Unicredit
abc
Northern Rock
600
Dotcom bubble
Lehman bankruptcy
09/11
400
300
AIG Fund infusion
"Black Monday"
200
100
European debt crisis
0
1987
1988
1990
1992
1993
1995
1997
1998
2000
2002
2003
2005
2007
2008
2010
abc
23
Sector description
The bank sector functions as an intermediary between sources of capital (investors and depositors) and
users of capital (individuals, corporations and governments). In providing this function banks take on
three major risks: credit risk (the risk that a borrower will not repay a loan), interest rate risk (changes in
the yield curve may change funding costs and asset yields) and liquidity risk (the risk, usually in a crisis,
that assets cannot be liquidated quickly enough to cover any short-term funding deficiency).
The bank sector includes institutions providing a comprehensive product offering to their clients, mostly
known as universal banks, as well as more specialised institutions focusing on a more limited business
segments such as corporate and investment banking activities (CIBM). With a few exceptions (Credit
Suisse, UBS) the majority of European banks are universal banks, although in some cases (Societe
Generale, BNP Paribas, Deutsche Bank) CIBM activities account for a large part of their profits.
The various lines of business for banks are classified below:
Net interest income, defined as the difference between the interest rate earned on assets and the
interest rate paid on liabilities: typically 65%+ of revenues.
Fee and commission income, includes account fees, overdraft fees, payments, arrangement fees,
guarantees as well as asset management and insurance: typically 25% of revenues.
Trading income: Banks derive trading income by transacting in securities/derivatives/forex. Also,
banks hold securities to manage their liquidity. Banks need to mark to market their securities, leading
to valuation gains/losses. Trading income is typically 10% of total revenue.
The banking sector remains a highly regulated sector globally, with multiple regulatory bodies keeping
close watch. There have also been efforts to evolve global standards in banking via the Basel norms,
developed by the Bank for International Settlements. In light of the recent financial crisis there has been
an increased focus on regulating banking activities and minimising the impact of future banking failures,
if any, on the economy.
Key themes
Key themes have changed rapidly in the past two years, but those detailed below are likely to
remain for some time.
Funding issues: Recent events have proven that the funding issue remains one of the key issues, risks or
themes in bank management. This relates to both internal (pertinent to a specific bank) and external
factors, such as perceived country risk, for example. In our view, the asset and liabilities structure is likely
to remain at the forefront of management focus over the next few years. The liquidity ratio, typically
calculated as the ratio of loans to deposits, is the key indicator: a ratio of 100% or less indicates that the
bank can count on a balanced structure with an optimum balance between loans and deposits. A higher
ratio would imply a need to procure liquidity in the wholesale market, with a consequent impact on
funding costs.
Fears on sovereign risk: The stress test of European banks by the Committee of European Banking
Supervisors (CEBS) proved to be a non-event as some of the assumptions it used were considered too
24
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Carlo Digrandi*
Co-Global Sector Head
HSBC Bank Plc
+44 20 7991 6843
carlo.digrandi@hsbcib.com
*Employed by a non-US affiliate
of HSBC Securities (USA) Inc,
and is not registered/ qualified
pursuant to FINRA regulations
abc
mild. Among others, it failed to consider sovereign default, envisaged only conservative credit losses and
used headline Tier I instead of core Tier I.
Sector profitability: The introduction of tougher regulation has raised some doubts about sector
profitability over the next cycle. Most would argue that this should be lower due to lower leverage and
declining margin.
Increased regulation (Basel III and related issues): The introduction of Basel III (currently still in
discussion) is expected to heavily affect capital requirements, obliging banks to raise additional funds to meet
new rules. It seems, however, that Basel III proposals will be subject to several changes, which may limit the
impact on the sector; nevertheless, this will remain an issue until the final proposal is approved.
Sector drivers
Banks earnings are very closely correlated to economic growth in the countries where they operate:
volume growth is a function of GDP growth, while growth in loan loss provisions is linked to
unemployment, for example. Hence banks could be considered a proxy for GDP growth. Other than GDP,
we would summarise the main, fundamental sector drivers as follows:
Lending and deposit volumes: These are mainly related to GDP, as lending demand is normally
positively correlated to expanding economic conditions and vice versa. Deposit growth is more a function
of market yield, alternative investment opportunities and gearing ratios but is, again, correlated to
economic conditions.
Interest rates: Cost of money is based on a spread banks apply to interest rates. Although spreads are
controlled to a large extent by banks, the level of interest rate is given by the market. For obvious reasons banks
tend to prosper in a high interest rate environment (when the spreads between assets and liabilities tend to be
wider) and vice versa. The steepness of the yield curve is also a key factor, as banks normally tend to spread
their financing according to the different rate levels along the curve for example making the spread the
differential between short rates (lending or borrowing) and long rates (borrowing or lending).
Asset quality and loan loss provisions (LLPs): Non-performing loans (NPLs) tend to increase in
periods of economic difficulty, thereby forcing banks to increase LLPs and write-offs. In several
European countries NPLs and unemployment growth are closely correlated. Empirical analysis also
suggests that LLPs and GDP growth are relatively well correlated.
In the past two years, following the subprime crisis, the role of regulators in the banking sector has
increased dramatically and it is expected to increase even more in the future. New compliance rules have
simultaneously increased costs, lowered margins and changed the sectors revenue base, thereby making
banks less profitable overall. As a result this is proving to be a key driver for the sector.
A second important element relates to market conditions and the interdependence of the banking system.
The recent liquidity crisis has shown the extreme importance of this factor and the weight that market
conditions (rates, interbank lending, the role of the central banks) can have on banking stocks. In our view
these are extremely important drivers, as they are mostly exogenous and affect the sector overall, making
it very difficult to differentiate between individual stocks.
25
26
abc
abc
Beverages
Beverages team
Lauren Torres
Analyst
HSBC Securities (USA) Inc
+1 212 525 6972
lauren.torres@us.hsbc.com
James Watson
Analyst
HSBC Securities (USA) Inc
+1 212 525 4905
james.c.watson@us.hsbc.com
Erwan Rambourg*
Analyst
HSBC Bank Plc
+44 20 7991 6793
erwan.rambourg@hsbcib.com
Antoine Belge*
Head of Consumer Brands and Retail Equity Research,
Europe
HSBC Bank Plc, Paris Branch
+33 1 56 52 43 47
antoine.belge@hsbc.com
Sophie Dargnies*
Analyst
HSBC Bank Plc, Paris Branch
+33 1 56 52 43 48
sophie.dargnies@hsbc.com
Sector sales
David Harrington*
Sector Sales
HSBC Bank Plc
+44 20 7991 5389
david.harrington@hsbcib.com
Lynn Raphael*
Sector Sales
HSBC Bank Plc
+44 20 7991 1331
lynn.raphael@hsbcib.com
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations
27
28
Beverages
Non-Alcoholic Beverages
Concentrate
companies
Alcoholic Beverages
Bottlers
Brewers
Latam Brewers
Other Alcoholic
companies
Coca-Cola Co.
Coca-Cola Enterprises
A-B InBev
Ambev
Diageo
PepsiCo
Coca-Cola FEMSA
SABMiller
FEMSA
Remy Cointreau
Coca-Cola Hellenic
Bost on Beer
Grupo Modelo
Pernod Ricard
Coca-Cola Icecek
Tsingtao
Brown-Forman
Constellation Brands
Source: HSBC
abc
40
August 1998
Valuation of Coca-Cola Co. (KO) peaked and
then began to be re-evaluated by investors
35
August 2007
Global consumer
slowdown began
30
August 2008
Investors looking for
safety in the
defensive consumer
staples sector
(valuations become
more normalised)
25
20
15
10
5
Aug-90
Aug-92
Aug-94
Aug-96
World
Aug-98
Consumer Non-durable
Aug-00
Aug-02
Beverages: Non-Alcoholic
Aug-04
Aug-06
Aug-08
Beverages: Alcoholic
abc
29
Sector description
The beverage sector includes companies that develop, produce, market, sell and distribute non-alcoholic
and alcoholic products, including soft drinks, beer, wine and spirits.
Soft drink concentrate companies such as Coca-Cola Co. and PepsiCo own and market nonalcoholic beverages. Both companies manufacture and sell concentrate/syrup to their bottling
partners. They are best known globally for their Coca-Cola and Pepsi trademark brands, but they also
have a diverse portfolio of water, juice, tea and sports drink brands.
Soft drink bottlers produce, sell and distribute soft drinks to retailers in designated regions. CocaCola Co. and PepsiCo have a global network of bottling partners, in some of which they hold an
equity interest. Recently, PepsiCo acquired its two largest bottlers, Pepsi Bottling Group and
PepsiAmericas, and in the fourth quarter of 2010, Coca-Cola Co. is scheduled to acquire the North
American bottling business from its largest bottler, Coca-Cola Enterprises.
Brewers produce, market, distribute and sell beer. Some are regional; others, like A-B InBev,
SABMiller and Heineken, are global. Brewers have undergone a fair amount of consolidation over
the past several years, creating an industry where scale matters.
Wine and spirits companies manufacture, bottle, import, export and market a wide variety of wine
and liquor brands. They tend to be more regional than the brewers but have been active in
acquisitions and have broadened their geographic and brand exposure. Price points vary widely from
super-premium to mainstream to value brands.
Key themes
Over the past couple of years, the beverage industry has experienced its fair share of challenges: a
deteriorating consumer environment as a result of the economic downturn; increasing costs of ingredients,
packaging and energy; and a competitive price environment. We believe beverage companies need to
revive struggling categories while focusing on potentially higher-growth categories, be proactive with
new-product introductions, rationalise costs and expand globally. On a positive note, the beverage sector
is as a defensive industry which is typically more resilient during challenging economic and market
conditions because it can offer affordable products to consumers.
Soft drinks
We believe that the key concerns/themes for the soft drink industry are:
Cost of doing business is going up: particularly sweetener (sugar and/or high fructose corn syrup) and
oil costs, but realising opportunities to offset these increases is necessary to operate more efficiently.
Revive the carbonated soft drink category: this is a longer-term solution, which is easier said than
done, but should be key to jump-start volume and profit growth.
Capitalise on energy drinks, sports drinks and enhanced water: this is a near-term solution,
which should support volume growth and cater to health and wellness trends.
30
abc
Lauren Torres
Analyst
HSBC Securities (USA) Inc
+1 212 525 6972
lauren.torres@us.hsbc.com
James Watson
Analyst
HSBC Securities (USA) Inc
+1 212 525 4905
james.c.watson@us.hsbc.com
abc
Beer
We believe that the key concerns/themes for the beer industry are:
Weakening economic conditions: a pullback in consumer spending, particularly on higher-margin
premium brands and on-premise purchases; beverage volume tends to closely track GDP growth
or decline.
Currency devaluation: depending on the companys reporting currency, a stronger US dollar may
hurt results because of higher local procurement costs and a translation hit to earnings.
Continued cost pressure: more expensive ingredients (barley, malt and hops) and packaging
(aluminium and glass) have been an issue that may not be resolved in the near future, since fixed-rate
contracts are in place.
Aggressive price promotions: the pricing environment has been favourable, but price promotions
could return to protect share and boost volume.
Intended marketing spend may not be enough: brewers may need to re-invest more in their brands
through greater and more effective marketing spend. Part of the industrys revival could depend on
improved beer brand equity.
Competitive/consolidating industry: many beverage companies are global, and the beer industry
has become more competitive as consolidation continues (SABMiller was surpassed as the largest
brewer by volume by Anheuser-Busch InBev).
31
Sector drivers
In difficult market conditions, we believe it is important to consider a companys product and geographic
portfolio and its ability to manage costs while still investing in growth opportunities.
Resilience of beverage sales during economic downturns: these categories offer consumers variety
at attractive price points, more so with non-alcoholic than with alcoholic brands. That allows
beverage companies to achieve volume and pricing growth despite a pullback in overall spending.
Geographic diversification: global companies have an advantage over smaller competitors,
particularly those not overly exposed to any one market; they have a more stable, developed market
presence in addition to good growth potential and emerging market presence.
Continued cost management/realisation of synergies: beverage companies have tightened their
belts, which could deliver significant cost savings, through realising bottling plant or brewery
efficiencies, streamlining organisation or leveraging global scale.
Continue to selectively invest: despite continued market and industry pressures, companies need to
take advantage of investment opportunities to emerge as stronger competitors when healthier
conditions return.
Conclusions
Shift in consumer preferences:
Necessary to have strong brands, stronger brand equity and the strongest distribution system
Right balance of volume and pricing growth, while running an efficient production and distribution system
Manage through a tough cost environment (rising energy and raw-material costs)
Global players should be better positioned to capture future growth
32
abc
abc
33
Notes
34
abc
abc
Business Services
Business Services team
Matthew Lloyd*
Analyst
HSBC Bank Plc
+44 20 7991 6799
matthew.lloyd@hsbcib.com
Alex Magni*
Analyst
HSBC Bank Plc
+44 20 7991 3508
alex.magni@hsbcib.com
Rajesh Kumar*
Analyst
HSBC Bank Plc
+44 20 7991 1629
rajesh4kumar@hsbcib.com
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations
35
36
Business Services
BPO / Consulting
Distributors
Staffing
Security firms
Rental companies
FM & Hygiene
Atkins
Bunzl
Adecco
G4S
Aggreko
Davis Services
Capital
Electrocom ponents
Hays
Securitas
Ashtead
Mears
Experian
Premier Farnell
Michael Page
Nort hgate
Mitie
Serco
Wolseley
Randstad
Regus
Rentokil
Xchanging
SThree
USG
Source: HSBC
abc
40.0%
80.0%
December 2007
Great recession in US
30.0%
60.0%
20.0%
40.0%
10.0%
20.0%
0.0%
Jan-91
0.0%
Jan-92
Jan-93
Jan-94
Jan-95
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
-10.0%
Jan-08
Jan-09
Jan-10
-20.0%
Lehman collapse
-20.0%
March 1991
End of recession
March-November 2001
US economic recession
October 2009
US unemployment rate at 10.1%, the
highest rate since 1983
-30.0%
-40.0%
-60.0%
US market proxy
abc
37
Sector description
Business services can be generally classified as enablers or intermediaries. It includes businesses such as
staffing, distributors, BPO and consulting firms.
BPO/consulting firms have a broad variety of business models. At one end of the spectrum we have pure
outsourcing firms, which work on a cost arbitrage model, and at the other end, there are consulting firms
providing engineering and design services to their clients.
Distributors purchase items, store them, and re-sell to a client base. The distributors sub-sector has a very
diverse client exposure, ranging from builders and grocery stores to janitors and research scientists.
Staffing includes firms which provide permanent and temporary workforce to organisations and is
primarily categorised as general staffing business, focusing on positions requiring general skills, and
professional staffing business, focusing on positions requiring professional skills.
Rental services is a heterogeneous sub-sector, where companies broadly work on renting a variety of
assets. The different rental companies are distinguished from one another by factors such as asset type,
geographical exposure, capital structure and economic sensitivity.
Security services provide a wide array of security services such as manned guarding, prison
management, alarm monitoring and security assessment. The industry is fragmented and services are
either offered directly to the client or through a facilities management contractor. The latter is more
common in the UK and the US, the former in Europe.
FM and hygiene offer a range of diverse services to the premises of their clients, ranging from facilities
management, pest control and reception services, to work-wear and linen, among others.
Key themes
BPO/consulting
Outsourcing companies, by and large, have less cyclical cash flow streams than much of the rest of the
business services sector. However, the most pertinent question is the extent to which individual companies
are less cyclical, or indeed whether they respond differently to different cycles. In order for valuations to be
attractive, the companies must demonstrate more defensive growth than is in the price. This will broadly
depend upon three questions: (a) whether non-public expenditure is non-cyclical; (b) whether business
revenues are affected by the tax receipt cycle; and (c) how margins are affected by the cycle.
Distributors
Distributors effectively suffer or benefit from the cyclicality of their clients. They have an arsenal of
efficiency measures to offset pricing and volume pressures. One option is to move towards using fewer,
larger and better-stocked centres which can reduce staff costs as well as freeing up property. This
process has been under way for some time and is now largely complete, although there are doubtless
additional options. Costs may also be reduced by managing the number of stock-keeping units (SKUs).
By focusing on a smaller list of SKUs, a distributor can focus its purchasing power on fewer suppliers and
reduce input costs. Another cost-reduction strategy is the use of private labels or own brands. This
enables a distributor to buy large quantities of a product from a supplier and offer them to clients at a
38
abc
Matthew Lloyd*
Analyst
HSBC Bank Plc
+44 20 7991 6799
matthew.lloyd@hsbcib.com
Alex Magni*
Analyst
HSBC Bank Plc
+44 20 7991 3508
alex.magni@hsbcib.com
Rajesh Kumar*
Analyst
HSBC Bank Plc
+44 20 7991 1629
rajesh4kumar@hsbcib.com
*Employed by a non-US affiliate
of HSBC Securities (USA) Inc,
and is not registered/ qualified
pursuant to FINRA regulations
abc
discounted rate, enhancing their gross margins. However, if distributors engage in cost-cutting measures
in a downturn that cut capacity, this can reduce the medium-term upside during recovery.
The distribution business lends itself to acquisitions because of the fragmented nature of the market.
Another increasing trend among distributors is to move towards web-based sales. Typically, web sales are
not only higher margin but also result in better inventory management and higher cash conversion.
Staffing
Staffing largely centres on the volume and price of services offered and the ability of companies to reduce
cost without damaging client relationships. Investors should be cautious of businesses that cut headcount
more aggressively than peers as staffing remains a relationship business and the elimination of too many
client-facing costs can materially reduce long-term growth during and following recovery.
The key distinction between staffers stems from the temp: perm mix, and geographical diversity. Bluecollar temps are largely low-margin business with limited operational gearing, but during economic
recovery they grow before white-collar temps. In the early stages of a recovery, temp tends to recover
earlier and more quickly than perm since permanent staff are expensive and carry more employment
risks. However, during initial phases there is frequently a spurt of catch-up hiring in the labour market.
When an early spurt in perm subsides, gross profit growth becomes subdued as temp constrains the value
per sale and the gross margins. However, growth in overheads tends to be correlated more to volumes.
Indeed, the effect particularly bedevilled the profit recovery during the early part of this decade, and in
the early 1990s. Evidence that operational gearing is a later-cycle phenomenon is powerful since wage
growth happens in the later stages. In previous recoveries, there has been emergent pricing pressure on
certain key sections of the market. The effect was significant in the blue-collar markets and the UK IT
market in 2001-04.
Rental companies
Despite the cyclical nature of its end-markets, the rental business model permits an unusual degree of
flexibility in controlling cash flows. The capital base in a rental business is not fixed and can be expanded
or shrunk relatively quickly in response to changing end-markets. Rental companies are also notorious for
their gearing, leading to exaggerated profit and share price behaviour at turning points in an economic
cycle. However, the nature of this gearing is more nuanced than it first appears. Consolidation remains a
long and ongoing structural trend in these highly fragmented markets, and rental companies ROIC
profiles are likely to approximate their cost of capital across a cycle.
Security firms
The business is widely perceived as being late cyclical, and has historically demonstrated margin pressure
late in the cycle. This is because the upward pressure to raise wages clashes with clients desire to reduce
costs. In developed markets, guarding is a reasonably mature market and outsourced service appears to be
a stable proportion of the market. Advances in technology have extended the scope of security to
electronic surveillance and monitoring. These services are normally a mark-up to labour charges. Security
firms nowadays provide integrated technology services, offering bundled services of access control,
alarms and monitoring services, for example.
39
FM and hygiene
The FM and hygiene businesses provide a host of diverse services and the businesses face different
markets and challenges. Given the diversity of business, some of the companies in the sector have
complex margin drivers. Spot-contract mix is one of the key determinant of margins. Historically, spot
sales have been c8-10% of sales at the peak of the cycle and have disappeared in recessions; however,
they held up in the latest downturn.
Sector drivers
Outsourcing
Government spending: Companies in this sub-sector have varying exposure to government contracts and
are directly exposed to local and central government spending, driven by government revenue, fiscal deficit
and tax receipt cycles. Government tax receipt cycles play a key role, and growth in the companies exposed
to the public sector has weakened in the wake of a fall in government tax receipts in previous cycles.
Contract mix: Margins of BPO and consultancy companies are largely determined by the contract and are
applicable for long periods. Although contracted revenues are indexed to inflation, the key driver of
margin is mix: the more complex the contract, the more margin variation is possible. Spot business
generally attracts higher margins while longer-term contracts usually have lower margins.
Distributors
Cyclicality of client: Distributors have a diverse client exposure, ranging from builders and grocery
stores to janitors and research scientists. These clients exhibit a degree of cyclicality, and distributors
effectively suffer or benefit from the cyclicality of their clients. The more cyclical the client base, the
more cyclical a distributors business.
Inflationary or deflationary environment: Distributors are beneficiaries of a mildly inflationary
environment as there is a lag of few weeks or months between their purchase and sale of a product.
Generally they are able to pass on most of the inflationary price rise to their clients, giving them holding
period gains. The effect is magnified lower down the P&L because much of the SG&A is volume related.
Ceteris paribus, in a period of accepted inflation, sales rise faster than volumes, gross margins may
nudge up, and SG&A costs grow with volume. In a deflationary period, the inverse is true.
Staffing
Temp/perm mix: Temporary staffing is a lower-margin business than permanent placement as the wages of
a temporary worker form part of the agents sales and cost of goods sold, whereas no such cost exists for a
permanent placement. A decline in the perm mix has a magnified impact on margins. Wage rate mix:
Broadly speaking, a lower wage rate implies a lower gross margin. The wages of candidates are a product of
the scarcity of their skills at any point in time. This same scarcity tends to drive the gross margin a staffing
agency can charge for sourcing candidates. A fall in the average wage rate reduces the value of sales more
than a fall in volume and also affects the gross margins or conversion of gross margin into operating profit.
Rental companies
Size is a key driver for rental companies given low entry barriers and service differentiation. Large,
diversified fleets help broaden the customer base, give negotiation power and help to achieve economies
40
abc
abc
of scale. Long-run returns are driven by: (1) rental rates; (2) utilisation; (3) cost of delivery (sales,
purchasing, maintenance, distribution and services); and (4) the cost of funds. Scale helps in all four.
Other businesses sector
The other businesses sector covers a host of largely blue-collar general services. These tend to be
contract-backed but volume-dependent. If a client wishes to clean its facilities less frequently or engages
less security, then sales and also margins are likely to come under some degree of pressure. Most such
services are cyclical and can be tracked through employment numbers. The core economics of the
security business is the mark-up over the cost of labour. Gross margin risk can frequently come from
rising wage rates, which cannot be passed on to customers in a recession.
Companies within the sector report their profits in a dissimilar fashion despite sharing nomenclature
categorised as trading profit, operating profit, EBIT and EBITA, for example. The key differences stem
from the classification of amortisation arising from acquisition intangibles, the share of profit from
associates and exceptionals. Hence, one needs to be careful when comparing multiples across companies,
to ensure that they convey the same economic content. For example, comparing staffing companies on
EV/EBITDA may be meaningful as these are not capex-intensive businesses.
It is also important to keep track of changes in regulation and the resulting impact on accounts. For
instance, a recent change in regulation requiring a reclassification of French business tax from COGS to
tax has boosted gross margins for staffing companies without affecting EPS/operating cash flow.
Discrepancies and/or changes arising from accounting adjustments need to be handled carefully when
comparing historical trends or different companies.
Leading indicators: The broad lead indicators for business services sector include the TCB leading
indicator, OECD leading indicators and ISM. Each of the sub sectors has a different lead indicator
specific to the dynamics of the business. For distributors, key leading indicators are industry shipments,
book-to-bill ratio, inventory-to-sales ratio. Also, lead indicators of the clients are important for analysing
distributors. As with building distributors, the key leading indicators are private housing starts, housing
price and inventory and plumber man-hours, for example. The US employment market has historically
been a leading indicator for the rest of the world. The best leading indicator for labour markets remains
US temp numbers. Job vacancies in the US, the UK and Europe are the best lead indicator for UK staffing
agencies. For the rest of the blue-collar general services, man-hours are among the key indicators, eg
security man-hours, alarms man-hours, uniform supply man-hours for security firms and pest control
man-hours, grocery man-hours and janitorial man-hours for FM and hygiene.
41
Notes
42
abc
abc
Capital Goods
Capital Goods team
Colin Gibson*
Global Sector Head, Industrials
HSBC Bank Plc
+44 20 7991 6592
colin.gibson@hsbcib.com
Matt Williams*
Analyst
HSBC Bank Plc
+44 20 7991 6750
matt.j.williams@hsbcib.com
Sector sales
Rod Turnbull*
Sector Sales
HSBC Bank Plc
+44 20 7991 5363
rod.turnbull@hsbcib.com
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations
43
44
Capital Goods
Diversified / multi-industry
conglomerates
Construction /
construction materials
Siemens
Philips
Honeywell
Smiths Group
Larsen & Toubro
Production technology
Power technology
Buildi ng technology
Commercial vehicles
ABB
BHEL
Schneider Electric
Volvo
Emerson Electric
Alstom
Schindler
Paccar
At las Copco
Kone
Scania
Sandvik
Doosan Heavy
Legrand
MAN
SKF
Shanghai Electric
Assa Abloy
Sinotruk
Rockwell Automation
Harbin Power
Geberit
Alfa Laval
Metso
Source: HSBC
abc
40%
1980s: poor start, but good
recovery as liberalised
markets promoted growth
30%
Lehman collapse
20%
10%
0%
-10%
-20%
1971
1976
1981
1986
Global
1991
Emerging
1996
2001
2006
Developed
Source: HSBC
abc
45
Sector description
The distinguishing characteristic of the capital goods sector is a profound heterogeneity, which extends through
technologies, applications and customer groups and shows up in growth rates, profitability levels and,
ultimately, valuation multiples. Diverse markets are inevitably niche markets, with relatively little in the way of
good third-party data (no Gartner, no JD Power). Much of the job of capital goods research is thus the
development of an understanding of the specific markets a supplier is active in, likely growth rates, and their
competitive environment.
Within capital goods, many sub-sectors have historically been, and continue to be, relatively cosy oligopolies.
Often, the rump of the market is highly fragmented and occupied by many smaller unlisted companies, whose
profitability and financial health are hard to ascertain.
There are normally positive economies of scale to be had, and consequently barriers to entry are high,
rewarding the incumbent leaders. These barriers to entry do not just refer to manufacturing efficiency but also
include input costs and, perhaps most importantly, aftersales provision. What differentiates capital goods from
consumer goods is the level of utilisation, as companies typically sweat assets far more than private individuals
do. Accordingly, aftersales or MRO (maintenance, repair and overhaul) accounts for a far larger proportion of
the total market opportunity than it typically would in consumer markets. Buyers typically expect reliable and
geographically extended MRO networks, which new entrants struggle to provide. The leading companies
within each sector have traditionally exploited this power and have faced relatively few pricing pressures; there
have been instances of price-fixing and collusion on occasion.
Key themes
Emerging versus developed markets
In emerging markets, dominated by the E3 of China, India and Brazil, demand has focused on the rapid
build-out of infrastructure and manufacturing capacity. In developed markets, demand focuses more on
replacement and MRO. EMs grew rapidly over the past decade and, if these growth rates are maintained,
could overtake DMs in total dollar value during or around 2013.
Providing a solution
The solution has become a buzzword within the capital goods sector, and represents a desired step away
from just supplying a tangible product. The classic example is the bundling together of a product with a
service component (aftermarket care, or energy efficiency consulting) in order to provide a more
comprehensive, higher-value-added product offering. This often has positive effects on margin expansion,
while the service element adds balance sheet lightness to the equation.
46
abc
Matt Williams*
Analyst
HSBC Bank Plc
+44 20 7991 6750
matt.j.williams@hsbcib.com
Colin Gibson*
Analyst
HSBC Bank Plc
+44 20 7991 6592
colin.gibson@hsbcib.com
*Employed by a non-US affiliate
of HSBC Securities (USA) Inc,
and is not registered/ qualified
pursuant to FINRA regulations
abc
Sector drivers
Capex cycle
Capital goods companies earnings are directly related to the capital expenditure activities of their end
customers, both private and public sector (the latter currently exposed to austerity budgets). Customer activity,
in turn, is linked to the broader economic cycle, and the likelihood that these capex investments will generate
positive-NPV projects. As such, the financing environment for such projects must also be borne in mind.
47
Another significant distinction can be made in the product destination. Assa Abloy, for example, stresses
that two-thirds of its products are sold to refit and refurbishment markets, and not new-build, reducing the
overall cyclicality of the business. At low points in the capex cycle, firms are universally keen to
emphasise these more defensive aspects of their product portfolio.
Input costs
Capital goods companies are big buyers of raw materials, including (but not limited to) industrial metals
such as iron, steel, nickel and copper, plus plastics and other miscellaneous item. Policies vary, but as a
general rule, the sector does not engage in overly long-term hedging, and consequently has an exposure to
rising input costs. That said, rising raw material prices usually correlate with rising end-user demand,
especially in EM. In addition, the leading companies enjoy strong pricing power, and can often pass on
price increases to end-customers.
Mix effects
Mix, namely the relative profitability of different products within the offering, also affects profitability. For
example, in some sub-sectors, the products required by EM are less sophisticated than those in DM, and
consequently margins are lower. In contrast, certain more complex high-end solutions sold to DM offer higher
profit margins.
48
abc
abc
is a valid argument, although the size of the targets is a complicating factor, as is a possible perception
that most of the fat has already been trimmed.
Leading indicators
The activities of capital goods companies are summarised at the macro level by the measurement of gross
fixed capital formation, ie the value quantity of the fixed assets ordered and subsequently manufactured.
Some (larger) products lend themselves better to the publication of order book statistics than others.
There is a huge array of data covering the sector, including such diverse data series as EMEA Regional
Gas & Steam Turbine Orders, Chinese Fixed Asset Investment in the Oil & Gas Sector, and Australian
mining capex to name but three.
49
Notes
50
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Chemicals
Chemicals team
Geoff Haire*
Head of Chemicals Europe, EMEA and Americas
HSBC Bank Plc
+44 20 7991 6892
geoff.haire@hsbcib.com
Jesko Mayer-Wegelin*
Analyst
HSBC Trinkaus & Burkhardt AG, Germany
+49 211 910 3719
jesko.mayer-wegelin@hsbcib.com
Sebstian Satz*
Analyst
HSBC Bank Plc
+44 20 7991 6894
sebastian.satz@hsbcib.com
Yonah Weisz*
Analyst
HSBC Bank Plc
+972 3710 1198
yonahweisz@hsbc.com
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations
51
52
Chemicals
Commodity
Speciality
AgroChemicals
Industrial Gases
Conglomerates
Arkema (EU)
K+S (EU)
BASF (EU)
Clariant (EU)
Croda (EU)
Syngenta (EU)
Linde (EU)
Lanxess (EU)
DSM (EU)
Yara (EU)
DuPont (US)
Rhodia (EU)
Givaudan (EU)
Solvay (EU)
Monsanto (US)
Symrise (EU)
Mosaic (US)
Celanese (US)
Umicore (EU)
Huntman (US)
Braskem (EM)
Praxair (US)
MA Industries (EM)
Uralkali (EM)
SABIC (EM)
Source: HSBC
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10
12.00%
Restocking recovery
Asian-led recovery
11.00%
10.00%
0
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
09
10
9.00%
-5
Rising oil prices
8.00%
Return on invested capital for chemicals stocks versus growth in industrial production
-10
7.00%
Recession
-15
6.00%
-20
5.00%
-25
4.00%
Growth in EU IP (% y-o-y)
ROIC (RHS)
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53
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Sector description
The Chemical sector, particularly in Europe and the US, comprises a wide range of companies serving
various end-markets. There are four sub-sectors commodities, industrial gases, speciality,
agrochemicals. There are several chemical conglomerates encompassing all of the sub-sectors.
Summary of sub-sector characteristics
Sub-sector
Commodities
Lanxess
BASF
Rhodia
Braskem
SABIC
- tend to be price-takers
Dow Chemical
Solvay
Akzo Nobel
Johnson Matthey
Croda
Symrise
DSM
Umicore
DuPont
Specialities
Givaudan
Industrial Gases
Air Liquide
Linde
Air Products
Praxair
Agrochemicals
Israel Chemicals
Syngenta
K+S
Uralkali
MA Industries
Monsanto
Yara
Source: HSBC
Key themes
Emerging versus developed market economic growth
Historically the industrys end-markets have focused on the developed world, which has resulted in topline growth trailing that of other industrial sectors. However, with the growth of manufacturing,
upgrading of infrastructure and a growing middle class, emerging markets are of increasing importance to
the Chemicals sector. The sector average exposure to emerging markets is 27% of sales. However, a
54
Geoff Haire*
Head of Chemicals Europe,
EMEA and Americas
HSBC Bank Plc
+44 20 7991 6892
geoff.haire@hsbcib.com
Sebstian Satz*
Analyst
HSBC Bank Plc
+44 20 7991 6894
sebastian.satz@hsbcib.com
*Employed by a non-US affiliate
of HSBC Securities (USA) Inc,
and is not registered/ qualified
pursuant to FINRA regulations
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number of companies in the European sector already have a sizeable position in emerging markets,
including Rhodia (45% of sales), Givaudan (35%), Symrise (35%), Linde (35%), Syngenta (33%) and
Lanxess (33%).
Commoditisation
One of the inevitabilities in the chemical industry is commoditisation. There are two broad categories of
chemicals commodity and specialities.
Commodities chemicals prices tend to be set by public markets and are heavily correlated with input costs
and supply/demand balances. Raw material costs are more than 65% of the overall price. Customers can
easily switch suppliers. Products are defined by chemical entities and the barriers to entry are low if you
have unlimited capital. There are many competitors in this category.
In contrast, speciality chemical prices tend to be driven by the value the chemical adds to the customers
products/processes. Raw material costs represent less than 40% of the price. It is not easy for customers to
switch suppliers as this can involve changing manufacturing processes. There are few competitors in
this category.
However, history has shown that speciality chemicals can easily become commodities in the absence of
innovation, or as a result of end-market changes or new entrants chasing higher margins. We have seen
examples of this in plastic additives, engineering polymers and fine chemicals. In our opinion, the term
speciality has been misused by companies and should only apply to products that can sustain high
margins and growth such as crop protection, catalysts, fragrances and some engineering polymers.
M&A
Over the past 10 years we have seen significant M&A in the sector. There have been three types of
activity: consolidation within the sector (for example Akzo Nobel acquiring ICI), private equity activity
(the formation of Ineos, and Access Industries creating LyondellBasell from two acquisitions and, later,
Apollo acquiring LyondellBasell), and oil and healthcare companies spinning off their chemical
businesses (for example Novartis and Astra Zeneca forming Syngenta, and Total spinning out Arkema. its
vinyls chemical businesses). We expect M&A to continue in the sector as balance sheets are healthy,
currently Solvay and DSM are active buyers and BASF has just acquired Cognis for EUR3.1bn. We also
expect private equity to bring chemical companies back to the market as the economy and equity markets
recover; in the first half of 2010 two companies, Brenntag and Christian Hansen, had already come back
to the public market.
Substitution
The threat of external substitution to the chemical industry is limited but internal substitution is a constant
threat. Internal substitution is driven by other producers looking for new end-markets as well as
customers looking for lower-priced materials, for example polyethylene being substituted for
polypropylene in packaging. Currently there are many companies investigating new technologies, such as
biotechnology and nano-materials, which could result in new lower-cost or better-performing products, or
new low-cost manufacturing processes.
55
Sector drivers
Macroeconomics and pricing power
Top-line growth in the sector is driven by GDP and industrial production (IP). Over the last 20 years there
has been a high correlation between the performance of the European and US chemical sectors and IP in
the developed world. In the shorter term, Chinese and Asian industrial growth has become an important
driver of earnings and share price performance. Volume growth rates across sub-sectors vary
dramatically, with catalysts, industrial gases, engineering polymers and electronics growing at over 2x
GDP, but paper and textile chemicals volumes at less than GDP. We believe average volume growth rates
tend to be 1.4-2.5x GDP. Over the last 10 years, commodity chemicals volumes have grown at 2.3x
global GDP and 1.4x IP, specialty chemicals volumes at 1.4x global GDP and 0.8x IP and industrial gases
at 2.0x GDP and 1.3x IP.
Commodity players generally only have pricing power when input costs are rising and even then they
may not be able to recover all of the higher costs, so at the peak of the pricing cycle margins may already
be falling. However, speciality chemical, agrochemical and industrial gas producers will have varying
degrees of pricing power as they are providing a service that is essential to their customers products and
processes. It is worth noting that the industrial gas players tend to have prices linked to inflation and the
cost of energy for the large plants (tonnage) that they operate for customers.
Input costs
We estimate that 65% of the sectors input costs, if we include energy, are fossil-fuel based. Commodity
companies are more exposed to input costs than speciality producers, as these represent more than half of
the price of a product (as much as 65%). As commodity producers strive to reduce the cost base, they
have shifted a large amount of production to the Middle East, attracted by low gas prices. In 2001 Europe
and North America accounted for 54% of the worlds ethylene production; by the end of 2010 we expect
this to have fallen to approximately 40% and the Middle East to account for 19% by 2010 compared to
9% in 2001. The other sub-sectors are less exposed to input costs and potentially have more pricing
power. In times of fast-rising fossil fuel prices, the majority of the industry has struggled to pass on price
increases quickly, as customers are reluctant to take higher prices, resulting in margin compression for a
few quarters.
Restructuring
This is constant activity within the industry as companies look for ways to reduce the fixed cost base of
below-par businesses or integrate new acquisitions. There are at least two reasons for this. First, as
product portfolios become commoditised, management need to reduce costs or invest in new high-growth
businesses. Secondly, the movement in real long-term pricing (ie after inflation) is negative, therefore if
volume is growth just above global GDP, top-line growth is at best flat, so growth can only come from
cost reduction. However, as a rule of thumb, approximately 50% of any cost savings are given back
within five years of them being achieved.
Environment
One of the key long-term secular drivers in the sector is the environment, which is both a positive and a
negative. The positive aspects come from governments and regulators around the world being focused on
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reducing vehicle emissions. The main beneficiaries of tighter emissions have been the catalyst producers
BASF, Johnson Matthey and Umicore. We expect the focus on vehicle emissions to continue as the EU
and North America progressively reduce limits and the emerging markets (Brazil, China and India) start
to tackle the problem of emissions. Moreover, the engineering polymer producers (DSM, Solvay, BASF
and DuPont) also benefit as vehicle producers substitute plastics for metals. The holy grail is mass
production of zero emission vehicles (ZEVs), which can be achieved with either fuel cells or batteries.
Although the technology currently exists for this, it is not commercially attractive and a new
fuel/recharging infrastructure would need to be established.
The negative aspect of the environmental issue is regulations requiring the chemical industry to reduce
emissions in Europe. This includes REACH (Registration, Evaluation, Authorisation and Restriction of
Chemicals) and carbon emission limits to which they have to conform or be taxed on any emissions above
the limits.
57
Notes
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Christian Rath*
Analyst
HSBC Trinkaus & Burkhardt AG, Germany
+49 211 910 3049
christian.rath@hsbc.de
Nick Robins*
Head, Climate Change Centre of Excellence
HSBC Bank Plc
+44 20 7991 6778
nick.robins@hsbc.com
Murielle Andr-Pinard*
Analyst
HSBC Bank Plc, Paris Branch
+33 1 56 52 43 16
murielle.andre.pinard@hsbc.com
Zoe Knight*
Analyst
HSBC Bank Plc
+44 20 7991 6715
zoe.knight@hsbcib.com
Vangelis Karanikas*
Analyst
HSBC Pantelakis Securities (Greece)
+30 210 6965 211
vangelis.karanikas@hsbc.com
James Magness*
Analyst
HSBC Bank Plc
+44 20 7991 3464
james.magness@hsbcib.com
Sector sales
Charanjit Singh*
Analyst
HSBC Bank Plc
+91 80 3001 3776
charanjit2singh@hsbc.co.in
Burkhard Weiss*
Analyst
HSBC Trinkaus & Burkhardt AG, Germany
+49 211 910 3722
burkhard.weiss@hsbc.de
mark.van.lonkhuyzen@hsbcib.com
Billal Ismail*
Sector Sales
HSBC Bank Plc
+44 20 7991 5362
billal.ismail@hsbcib.com
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations
59
60
Bio-energy - OEM
Sao Martinho
Energy Efficiency
Building Efficiency
Aixtron
Philips
Water
American Water Works
Veolia Environnement
Industrial Efficiency
Krones
Rational
Waste
Geothermal - OEM
Daldrup & Soehne
Nuclear - OEM
Doosan Heavy Industry
Solar - OEM
Centrosolar
Wacker Chemie
Wind - OEM
Vestas Wind
Clipper Windpower
Renewable Power
Providers
Acciona
Iberdrola Renovables
Source: HSBC
Sch Environnement
Transport Efficiency
Delachaux SA
Vossloh
Multi-theme Efficiency
Alstom
Schneider Electric
Energy Storage
Saft Groupe
SFC Energy
Fuel cells
Ballard Power Systems
SFC Smart Fuel Cell
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New Environment
Energy
150
100
1988
1990
1992
1994
1996
1998
2000
200
2002
2004
2006
2008
WAVE II
Take Off
2010
2012
WAVE I
Laying the Foundations
2014
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250
UNFCCC signed
0
IPCC 1st Assessment
50
IPCC established
300
WAVE III
Transformation?
Sector description
Clean energy comprises a wide range of technologies intended to address climate change and energy
security by shifting from a high-carbon to a low-carbon economy. Those technologies include low-carbon
energy, energy efficiency for building, industry and transport, and efficient water and waste technologies.
Low-carbon energy includes power generation using no fuel or less fuel than conventional powergeneration technologies and producing no or fewer pollutants than conventional technologies. It uses
nuclear energy and renewable-energy sources that, unlike fossil fuels, are not depleted over time, such as
biomass and biofuels, solar power, wind power, geothermal and hydropower. Low-carbon power
producers like utilities are also included in the sector.
Energy efficiency involves replacing existing technologies and processes with new ones that provide
equivalent or better service but consume less energy. The sector includes energy-saving technologies to
reduce energy consumption in buildings, industries and transport. It also includes energy-storage
technologies such as batteries and alternative energy storage technologies such as fuel cells which can
store energy through storing reactants like compressed hydrogen.
Building efficiency includes: improved building materials that control the transfer of heat into and out of
buildings; more efficient lighting, which relies on the use of light-emitting diodes, compact fluorescent
lamps and sensors; energy-efficient chillers and directional lighting; and smart systems that control and
manage power consumption in buildings.
Industrial efficiency and multi-theme efficiency encompasses products or processes to conserve energy in
industrial sectors. These include process automation, control systems, instrumentation, smart grids and
energy-control and power-management systems.
Transport efficiency includes technologies that reduce the carbon emitted by conventional transport. Lowcarbon-intensive fuels like biodiesel and ethanol are also included. A shift from road to rail transport and
use of electric and hybrid-electric vehicles, which emit less carbon than fossil-fuel vehicles, falls under
transport efficiency. Mass transit buses, trains and trams are considered part of transport efficiency as
well, as are companies that supply efficient-engineering systems or parts that are supplied to cleaner
forms of transport.
The water sector includes companies providing efficient water supply, water conservation and recycling
and advanced water-treatment technologies. Waste management comprises mainly the collection,
transport and disposal of waste. Some support-services companies provide environmental consulting,
which also falls under this theme.
Key challenges
Clean energy is a growing industry in both developed and developing markets, but challenges remain to
the competitiveness of clean energy companies. One is regulatory uncertainty, since growth is driven to a
large extent by regulation, which tends to have been formulated in an effort both to reduce greenhousegas emissions and to provide secure sources of energy. Another is the need for innovation in low-carbonenergy technologies, which requires enough investment by governments and the private sector to offset
the economic advantage of conventional technologies. A third is the diversity of sub-sectors. Especially in
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Robert Clover*
Global Sector Head, Clean
Energy
HSBC Bank Plc
+44 20 7991 6741
robert.clover@hsbcib.com
Nick Robins*
Head, Climate Change Centre
of Excellence
HSBC Bank Plc
+44 20 7991 6778
nick.robins@hsbc.com
*Employed by a non-US affiliate
of HSBC Securities (USA) Inc,
and is not registered/ qualified
pursuant to FINRA regulations
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energy efficiency, they cover a wide range of technologies, resulting in a highly fragmented market
occupied by a large number of smaller, unlisted companies, whose profitability and financial health is
hard to determine.
Key themes
Emerging versus developed markets
The developed world has been the mainstay of the low-carbon economy over the past decade, primarily
because it has a larger base of installed nuclear and renewable generation capacity and more focus on
installation of energy efficient technologies. Investment in the industrialised world is likely to continue to
dominate over the next decade, but the share of emerging markets will increase. Looking at the three key
players from the industrialised world, the EU, the US and Japan, and the three leading emerging markets,
Brazil, China and India, we estimate the share of the former will decline from 60% in 2009 to 53% in
2020, while the share of the latter will grow from 25% to 34%.
In emerging markets, the spotlight will be on China. Its goals for low-carbon energy and energy
efficiency mean its demand for clean energy technologies is likely to outstrip that of its developingmarket peers. In the developed world, demand is expected to be more for replacement of existing lowcarbon energy production. Along with regulatory uncertainty, especially in the US, that is likely to see a
shift in demand to the developed world for new technologies.
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Credit crisis impact global new financial investment* in clean energy (USDbn)
45
40
35
30
25
20
15
10
5
0
Q1 10
Q3 09
Q1 09
Q3 08
Q1 08
Q3 07
Q1 07
Q3 06
Q1 06
Q3 05
Q1 05
Q3 04
Q1 04
Note: *Total new financial investment includes venture capital, private equity, public equity, asset finance (equity, debt, lease and other sorts), bonds and corporate debt. The quarterly figures
are not adjusted for reinvestment, for instance money raised on public markets later invested in projects.
Source: New Energy Finance, HSBC
Sector drivers
Climate change remains for many a distant and uncertain threat, notwithstanding the record-breaking
global temperatures and severe floods and droughts in 2010. The need to address climate change while
facilitating economic growth and social progress will be a challenge for governments worldwide.
Policy Drivers:
Climate Change /
Mex
Aus
Env ironmental /
Energy Efficiency
Itly
UK
Other
Ger
EU
India
Economic
Chin
Japn
Drivers:
Energy Security
Competitiv eness
Av ailability and
US
Cost of Tech/Jobs
Technological
Drivers:
Low Carbon
Economy
Fra
Innov ation
SKor
Brzl
Cand
Idsia
Resource
Drivers:
Renew able and
Energy Efficiency
Potential
Source: HSBC
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The response so far has come mainly in various cap and trade schemes and through international
regulations like the Kyoto Protocol. In the European Union, for example, the Emission Trading System
aims to reduce emissions 20% from 1990 levels by 2020.
But population growth and increasing industrialisation are likely to drive demand for energy up by more
than 50% by 2030, according to the International Energy Agency. Achieving energy security will become
increasingly important for many countries as demand rises and fossil fuel reserves are depleted. The high,
volatile energy prices of 2008 were a warning for many countries of their growing vulnerability,
prompting them to opt for renewable, inexhaustible energy sources.
Many factors come into play to encourage a business to invest in low-greenhouse-gas energy, and the
investment normally flows to where the highest and quickest returns can be made. Energy efficiency is
probably the preferred approach, because of its potential and its low cost. More important for a growing
number of decision-makers, however, is the way low-carbon strategies can stimulate industrial
innovation. In Japan and France, for example, early innovation has resulted in widespread deployment of
low-carbon technologies such as high-efficiency coal power plants and nuclear power, making them less
carbon-intensive than other countries.
65
Notes
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Construction and
Building Materials
Construction and Building Materials team
John Fraser-Andrews*
Head of European Construction and Building Materials
HSBC Bank Plc
+44 20 7991 6732
john.fraser-andrews@hsbcib.com
Jeff Davis*
Analyst
HSBC Bank Plc
+44 20 7991 6837
jeffrey1.davis@hsbcib.com
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations
67
68
Construction
Building Materials
Producers
CRH
HeidelbergCement
Holcim
Kingspan
Lafarge
Saint-Gobain
Residential builders
Barratt Developments
ACS
Bellway
Balfour Beatty
Berkeley Group
Carillion
Bovis Homes
FCC
Hochtief
Persimmon
Skanska
Nexity
Vinci
Redrow
Taylor Wimpey
Source: HSBC
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Spain
1200
Syria
Ireland
Saudi Arabia*
1000
Greece
Korea, Rep.
China
Italy
Portugal
800
Croatia
Slovenia
Turkey
Bulgaria
Algeria
Czech Republic
Egypt
Estonia
Morocco Thailand
Hungary
Russia
400
Poland
Romania Brazil
Serbia Ecuador*
Mexico
Lit huania
Ukraine South Africa
Argentina
200
India Sri Lanka* Colombia
Indonesia
Pakistan
Bangladesh*
Kenya
0
0
5,000
10,000
600
Austria
Belgium
Iran
France
Germany
USA
Netherlands
Finland
Denmark
Sweden
UK
15,000
20,000
25,000
30,000
35,000
40,000
Cement consumption and construction output growth versus real GDP growth in the UK (1956-2009)
0.25
0.20
0.15
0.10
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
1968
1966
1964
1962
1960
1958
1956
0.05
-0.05
-0.15
Construction is a highly
cyclical industry
-0.20
Real GDP growth
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-0.10
Sector description
The construction sector is a vertical chain of sub-sectors that begins with the building materials
companies, as shown in the sector organisation chart.
Building materials
Building materials companies produce the materials used to build homes (by residential developers) and
commercial real estate and infrastructure (by contractors). The companies can be divided into the heavyside materials majors, Holcim, Lafarge, Cemex and Heidelberg Cement, and the light-side materials
manufacturers, for example, Saint Gobain and CRH.
Heavy-side materials (cement, aggregates ready-mix concrete and asphalt) are consumed by infrastructure
projects like road expansion and utilities infrastructure, as well as the foundations stage of residential and
non-residential buildings. Light-side materials (concrete products, wallboard, insulation, bricks, tiles, pipe
and glass) are used predominantly in above-ground-level building construction. The heavy-side majors
have about two-thirds of their cement capacity in fast-growing emerging markets that are benefiting from
a structural expansion in infrastructure. Light-side producers are predominantly exposed to weak and
fragmented construction end-markets in debt-laden developed economies.
Housebuilders and contractors are the main customers for building materials companies.
Residential developers combine land (which must have residential planning approval in the UK) and
building materials to construct and sell houses. The UK is comfortably the most consolidated market in
Europe, where approximately 35% of production is undertaken by the seven listed builders. About 80% of
UK new-build homes are sold speculatively to individuals. The other 20% called social units are built
for and sold to government bodies at low margins, often as a necessary concession for residential
planning approval from the local planning authority (called Section 106 agreements).
The contractors deliver services essential to the creation and care of infrastructure and non-residential
buildings assets, including project design, engineering and construction and facilities management.
Key themes
Urbanisation cycle underpins decades of robust EM construction growth
Our statistical regression analysis suggests that cement consumption is determined by real GDP per capita
growth, as illustrated in the first graph above.
Typically, GDP per capita of around USD1,000 to USD3,000 triggers population growth and
urbanisation from a low base, underpinning cement-intensive mass infrastructure investment and real estate
development. Urbanisation further perpetuates population growth, which enhances absolute GDP and
growth thereof.
This urbanisation cycle (see chart The cement intensive urbanisation cycle below) supports cement
consumption/construction output growth in excess of real GDP growth, up to a saturation point, when
infrastructure and the housing stock have largely been provided.
This saturation point is at around GDP per capita of USD13,000 (the top of the hump in the graph
Cement consumption per capita versus GDP per capita on the previous page), after which the
cement-demand-to-real-GDP multiplier falls below unity.
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John Fraser-Andrews*
Head of European Construction
and Building Materials
HSBC Bank Plc
+44 20 7991 6732
john.fraserandrews@hsbcib.com
Jeff Davis*
Analyst
HSBC Bank Plc
+44 20 7991 6837
jeffrey1.davis@hsbcib.com
*Employed by a non-US affiliate
of HSBC Securities (USA) Inc,
and is not registered/ qualified
pursuant to FINRA regulations
abc
25
20
15
10
Infrastructure
investment
Population
growth,
urbanisation &
housing demand
0
U.S.*
France
Germany
U.K.
Russia
Turkey
Malaysia
Mexico
India
China
Iran
Korea, Rep.
Jordan
0.80
100%
0.60
80%
60%
0.40
40%
0.20
20%
0.00
UK
Brazil
US
France
Algeria
China
Egypt
India
U.S.
Russia
France
Germany
U.K.
Mexico
Turkey
Iran
Korea, Rep.
Malaysia
India
Jordan
China
0%
We expect emerging markets to deliver robust cement and construction growth for at least the next 30
years because:
Our Global Economics team expects emerging markets to generate the highest-trend GDP per capita
growth in the long term as these countries converge toward western levels.
Our regression analysis concludes that cement/construction-to-GDP-growth multipliers are higher
than unity in almost all EM.
High construction/cement-to-GDP-growth multipliers in emerging markets are explained by expectations
of high population growth coupled with low infrastructure provision (see road and rail provision charts
above) and urbanisation levels (see chart above).
Conversely, in developed countries like the UK, demographics are less favourable and urbanisation is
largely complete, so those countries have low long-term cement and construction growth potential (ie the
cement/construction-output-to-GDP-growth multipliers are near zero).
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High household indebtedness and constrained finance availability to weigh on developed market
construction growth for several years
In developed economies, we expect the availability of finance to remain constrained for at least the next
two years because:
Many western economies are suffering from record household indebtedness, high unemployment,
weak earnings growth and stretched long-term housing affordability. Unsurprisingly, banks are
unwilling to substantially increase the availability of cheap finance to households and businesses in
this fragile economic climate.
The banking industry continues to deleverage due to funding constraints and more stringent regulation.
Weak loan growth is likely to weigh on residential and non-residential construction because:
Most home-buyers need mortgage support, so we expect housing demand to remain weak for some time.
Private developers rely heavily on finance to fund their working capital requirements and for
financial leverage to amplify their returns on capital.
We expect UK housebuilders to suffer sluggish volume (and top-line growth) for several years, which
implies weak demand for building materials.
Fiscal austerity set to drive large cuts in European infrastructure construction
European governments are suffering from record indebtedness and unsustainable budget deficits. The
policy response has been austerity programmes to reduce fiscal deficits over the next four to five years.
The US government has increased infrastructure spending, relying on reserve currency status to maintain
a high budget deficit and indebtedness.
We expect European infrastructure budgets to suffer from public spending cuts as governments give
priority to spending on front-line services. We forecast public construction spending will decline by 25%
from the end of 2009 to 2013e in Spain and Ireland, and by 10% to 14% in other European countries.
European contractors face a challenging market in the medium term and we expect demand for building
materials from the European infrastructure end market to remain weak until 2013e.
Heavy-side producers offer a more defensive investment opportunity
Comparison of heavy-side and light-side
Cement
Substitutability
Finished goods
Consequences
Source: HSBC
The table above shows the heavy-side materials market benefits from several characteristics, such as high
concentration, barriers to entry and low import penetration, that underpins more disciplined pricing than
in light-side markets, which are generally fragmented and highly competitive.
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Sector drivers
Construction and building materials leading indicators
Affordability and mortgage availability are key long-term leading indicators for residential construction.
They determine the level of buyer enquiries and housing sales (proxies for short-term housing demand),
which can usually be tracked on a monthly basis. High housing demand drives growth in building-permit
applications and housing starts, which may lag if the housing inventory is high.
Vacancy rates show the demand/supply balance in commercial real estate markets. We track office
employment, retail sales and manufacturing output as proxies for commercial real estate space demand. A
combination of high space demand and low vacancy usually leads to rising rents, which should provide an
incentive for development.
We use governments infrastructure budgets to determine future public construction wherever possible.
Debt-to-GDP ratios and fiscal deficits also indicate the availability of future public finances.
73
Notes
74
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Sector sales
David Harrington*
Sector Sales
HSBC Bank Plc
+44 20 7991 5389
david.harrington@hsbc.com
Lynn Raphael*
Sector Sales
HSBC Bank Plc
+44 20 7991 1331
lynn.raphael@hsbc.com
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations
75
76
Food and
Staples Retailing
Beverages
Food Producers
Nestle
Danone
General Retail
Luxury and
Sporting Goods
Home
Personal Care
Henkel
LOreal
Beiersdorf
Reckitt Benckiser
Unilever
Source: HSBC
abc
+ 8.0%
December 2004-December 2007
Premiumisation era
700
+ 7.0%
December 2007-December 2008
Input costs inflation concern
600
+ 6.0%
500
+ 5.0%
400
+ 4.0%
300
+ 3.0%
Food and HPC historical share price index and organic sales growth
800
+ 2.0%
100
+ 1.0%
+ 0.0%
Jan-90
Dec-90
Dec-91
Dec-92
Dec-93
Dec-94
Dec-95
Dec-96
Dec-97
Dec-98
Index
Dec-99
Dec-00
Dec-01
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
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77
Sector description
Segments: The sector consists of two segments: food manufacturing and home and personal care, or
HPC. It is dominated by several large, international multi-brand groups. Some of them focus on food,
such as Nestl, others on HPC, such as LOral, and some combine both, such as Unilever.
Brands and categories: Food and HPC companies rely on brand awareness. Managing the distribution
channel, from hard discounters to department stores, through negotiations with retailers on price and also
in such areas as on-shelf availability, is key. Sector categories like dairy products and skin care are not
fixed entities. They are shaped by the leading brands and by innovation. Each category goes through a life
cycle from growth, driven by an increase in the penetration rate, to maturation, when concentration is
high, volume growth decelerates only offset by emerging markets and price elasticity is greater.
Sector characteristics: Food and HPC is historically a defensive sector. Cyclicality is limited by the
relatively small share of discretionary purchases in its sales in most categories. Pricing power is more
limited than it seems, so operating leverage mostly depends on volume growth to cover cost inflation.
Although the companies are huge, giving the impression the food industry is highly concentrated,
European big-cap companies tend to focus on a few categories, such as nutrition, confectionery and ice
cream, or water. Other parts of the industry, such as bakeries, are left to smaller players or private labels.
The home-care industry is much more concentrated. Procter, Unilever and Henkel dominate in European
laundry. Reckitt tends to focus on niche categories such as dishwashing and air and toilet care. Cosmetics,
despite limited private label presence, is also very competitive.
Key themes
Emerging markets
We estimate the industry has increased its exposure to emerging markets by at least 50% in 20 years.
Almost 40% of sales is derived from emerging economies, where category growth is driven by rising
income per capita, which implies a migration towards branded products, demographics and urbanisation.
These markets account for more than two-thirds of the sectors sales growth (sometimes 100%), and
represent the biggest growth driver in coming years, especially as saturated US and European categories
tend to become zero-sum games that are costly to expand. However, competition is also growing, and not
all categories benefit as much from emerging markets. The soap and laundry mass markets are already
decently penetrated in some emerging economies, for example, since companies have been targeting the
low end of the income ladder for years. Skin care and baby food are still taking off.
Raw materials
Raw materials are a key part of manufacturing cost, from milk to petrochemicals or vegetable oils. Raw
material and packaging costs represent about 15% to 25% of sales for cosmetics players higher product
prices imply raw materials and packaging represent a lower share of the product value but around 30%
to 35% of sales for food and home care. That means input-cost price volatility is a key issue. It can
quickly inflate the cost base and require risky price increases to offset it. The main commodities are milk
(Danone being the most exposed for its yoghurt business), oil-related/PET/plastics (everybody, but
mostly Henkel, Reckitt, Unilever), tea (Unilever), cocoa (Nestl) coffee (Nestl), vegetable oils/palm oil
(Unilever), sugar, fruit and vegetables. These companies usually hedge by three to six months for most of
78
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Cedric Besnard*
Analyst
HSBC Bank Plc, Paris
Branch
+33 1 56 52 43 26
cedric.besnard@hsbc.com
abc
these commodities, implying that price variations tend to have an impact on gross margin with a time lag.
Some of these commodities are either regulated (EU sugar) or quoted (cocoa). A commodity like milk is
less visible, since its not quoted and needs to be purchased locally. When input costs start to bite, the
debate is on whether the company can offset them with price increases (or emergency cost savings).
Pricing power (or the lack of) and the rise of the trading down concept
In a context of growing demand and low price elasticity, input cost inflation would be a structural issue to
bear in mind, but the short-term implications would be mitigated by easy price increases passed on to a
more willing customer. However, when price increases are implemented in the context of the consumers
falling available income, the risk of a volume backlash is high. This risk is reinforced by a dreaded
consumption pattern: down-trading. In a sector focused on premiumising brands and creating new needs,
a return to non-branded, low price, more basic substitution products (usually private labels) is a setback
that is sometimes hard to survive. We believe that down-trading is a risk in categories where brands have
difficulty claiming specific health benefits (chocolate, frozen/chilled) or where the perceived needs can
easily be ignored in favour of the benefits of more vital needs (make-up, specialty household).
However, down-trading is not as new as in the 1990s, and input cost inflation is far worse news for
private labels, as raw materials and packaging account for a higher share in the profit and loss of these
low-priced/low-marketed products, thus making their life more difficult in inflationary times.
Sector drivers
The cubic matrix
Most of the companies are exposed to the same consumption trends, but organic sales growth, excluding
FX and M&A, can range from high-single-digit to low-single-digit. Each company can be seen as a cubic
matrix, with its organic growth potential the sum of three drivers: category mix, geographical mix and
execution the capacity to gain market share and roll out innovation. A combination of growing
categories those that arent too mature or competitive and provide pricing power, for example and a
good execution track record seem most important. A category can always be rolled out in new countries,
although being in growing countries but with mature or competitive segments, or with execution issues,
may offer less visibility. The end game for all companies is to find the right balance inside the cubic
matrix to generate sustainable organic sales growth, the clear earnings growth driver over the long term,
in an industry not over-reliant on cost-cutting.
2009 was below 2% a year in the food industry, implying low pricing net of inflation. Furthermore, in
some categories, price elasticity can cap the companies ability to raise prices for more than a year (in the
case of external shocks like input-cost inflation).
(2) Mix: Basically introducing a new product but with a higher price, usually driven by the more benefits
argument, which companies fuel with R&D (to create the claim) and advertising and promotions (to
justify it). We believe the return on mix, when successful, is quite high a significant part of the fixed
79
cost remains the same as the product thats replaced, but with a higher price. That said, mix is a tool with
little visibility (trading down is a common pattern in the industry) and requires strong innovations to be a
sustainable driver.
(3) Volume growth: As a result, putting aside the profitable but cyclical mix element, volume growth is
the driver offering the most visibility and thus the most looked at. There are various ways to generate
volume growth, some cheaper than others. We believe there are three main drivers to volume growth.
An increase in the number of consumers, primarily driven by categories increasing their penetration in a
country, provides a rather cheap volume driver, once the cost of creating the category has been passed on.
Most of the growth comes from a natural flow of consumers to the product. Companies entering new
emerging markets, for example, can increase volumes, since the rising number of users is driven by rising
income per capita, making consumers migrate towards branded goods.
Increasing the frequency of usage is usually more important when increasing the number of consumers
becomes harder. Shampoo would be a good example: adding conditioner to regular shampoo. So are
biscuits: 10am, then noon, then mid-afternoon.
A greater focus on market share would be the last step in a category life cycle. It occurs when a category
is fully penetrated, private labels have appeared in mature regions as credible alternatives and roll-out in
new regions has been completed or has become a necessity. Excluding innovations, market-share gains
are the only driver of volume growth. They need to be generated by advertising and promotions,
execution or price cuts. This is clearly when the cost of growth becomes very high and requires costcutting or M&A.
80
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81
Notes
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Food Retailing
Food Retailing team
Jrme Samuel*
Analyst
HSBC Bank Plc, Paris Branch
+33 1 56 52 44 23
jerome.samuel@hsbc.com
Sector sales
David Harrington*
Sector sales
HSBC Bank Plc
+44 20 7991 5389
david.harringon@hsbc.com
Lynn Raphael*
Sector sales
HSBC Bank Plc
+44 20 7991 1331
lynn.raphael@hsbc.com
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations
83
84
Food
and HPC
Beverages
General Retail
Luxury and
Sporting Goods
Online
Ocado
UK
Europe
Morrison
Casino
Tesco
Carrefour
Sainsbury
Jeronimo Martins
Metro
Ahold
Delhaize
Source: HSBC
abc
600
Delhaize buys
Hannaford (2000)
500
Morrison buys
Safeway (2004)
Promods launches
unfriendly takeover
on Casino (1997)
400
300
200
Sector boosted by
property valuation
(2007)
Wal-Mart buys Asda
(1999)
100
0
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
09
10
Stock performance
Source: Factset, HSBC
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Sector description
Food retailing is the largest consumer sector, at least by sales, with EUR146bn of revenues in 2009 in the
UK, according to the Institute of Grocery Distribution (IGD). It has always been seen by investors as a
defensive sector, but we believe this is no longer the case. In the 1980s, food retailers with negative
working capital benefited from high inflation and high interest rates. In the 1990s, sector performance
was driven by international expansion and consolidation in mature markets. The top five market shares
now exceed 50% in the main European countries.
There are several reasons why the sector is not as defensive as it was. Food spending has shrunk as a
percentage of total spending, few listed players are pure food retailers and even discounters are exposed
to economic slowdowns.
In mature markets, spending on food as a percentage of total household spending has continued to
shrink and now accounts for an average 14% of consumer spending in mature European markets, a
third of its level in the 1960s.
Few listed food retailers are pure food retailers and therefore largely immune to a slowdown in
discretionary spending. Metro and Carrefour are the most exposed to non-food; Jeronimo Martins,
Morrison, Ahold and Delhaize still sell mainly food.
Discount stores enjoyed faster organic growth than other formats in the past decade, taking market
share from hypermarkets and supermarkets in Germany and France and even in the UK. That trend
has since reversed in France and Germany as hypermarkets started to compete more on price and as
the economic crisis curbed spending by lower-income households.
The industry operates in various store formats: hypermarkets, supermarkets, discounters, convenience
stores, cash and carry and department stores, which often reflect market positioning: premium, mass or
value-orientated.
Hypermarkets are large stores (above 5,000 square metres per store) that focus on volumes; they sell
groceries and general merchandise, offering up to 50,000 stock-keeping units (SKUs).
Supermarkets (around 2,500 square metres per store) are medium-sized stores focusing on groceries,
with a limited non-food range and about 13,000 SKUs in grocery.
Discounters have smaller stores, fewer SKUs and aggressively promote non-food items.
Convenience stores offer a variety of food and are generally located near their target customers,
who are prepared to pay higher prices than in hypermarkets or discount stores as a result.
Cash and carry stores offer low prices but only sell groceries and general merchandises in bulk to
hotel, restaurant, catering customers and small retailers.
Department stores have multiple categories functioning as different business units under one roof.
They are sometimes national chains and often carry the largest number of SKUs.
86
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Jrme Samuel*
Analyst
HSBC Bank Plc, Paris
Branch
+33 1 56 52 44 23
jerome.samuel@hsbc.com
abc
Online grocery retailing: Among other formats, it is worth highlighting the emergence of online
grocery retailing, which has two types of players: conventional retailers that have added online
retailing and pure online retailers such as Ocado.
A typical discount store will have a leaner cost structure than a hypermarket, with lower gross margin but
also much lower SG&A. A supermarket enjoys a higher gross margin but provides a higher level of
service in store. We estimate hypermarkets have an operating margin of 4.5%, supermarkets and discount
stores about 5.5% and convenience stores higher.
Brand awareness and private labels are key success factors in food retailing, along with location. They
attract customers and help build their loyalty. Private labels ensure higher margins for the retailers, not
necessarily in terms of cash but in percentage terms, since although private labels are sold at lower prices
than national brands (c25% on average) their costs are discounted to an even greater degree. In all mature
markets, private labels are growing much faster than national brands. The UK is the leader, with private
labels representing more than 40% of retailers sales, but French, German and the other European retailers
are catching up; private labels now account for more than 25% of their sales.
Key themes
Top line: Organic sales
An important metric is like-for-like (same-store, identical) sales growth: the constant currency sales
growth in stores that have been open more than a year (the duration may differ slightly from company to
company). Like-for-like gives an indication of how the retailer has performed in attracting more
customers and increasing sales per customer, through such techniques as better branding, pricing,
offerings and loyalty programmes. It gives a fair representation of actual sales growth, excluding forex,
new stores and acquired/disposed of stores.
Historically, the top line has helped drive returns for investors, since margins tend not to change much.
With top-line growth opportunities drying up in existing stores, retailers keep opening new stores and
increasing store sizes. Organic growth represents increases in sales ex-currency effects and ex-M&A.
Besides company-specific factors (eg brand awareness, loyalty programmes, promotional activity), there
are structural differences explaining why some retailers enjoy faster sales growth than others:
Maturity of the domestic market: As a general rule, the higher the retail density, or retail space per
capita, the lower the growth potential.
Extent of opening programmes: Retailers plan store openings to improve coverage, complementing
the coverage of existing stores and adding new space that will later contribute to like-for-like growth.
Exposure to growth markets: Although currency fluctuations and shorter economic cycles may increase
earnings volatility, emerging markets offer a good opportunity for top-line growth. Modern retailing is
still at an early stage of development in emerging markets. A weak currency may have a positive impact
on financial interests by lowering net debt. Most food retailers try to have their international activities
self-financed in local currencies and are not hedged. Large food retailers are present in multiple countries,
thereby bearing significant forex risk. Although most of the sourcing is done locally, the currency
exposure still brings volatility to the top line and the bottom line, if not the margins.
87
Exposure to different formats: Different formats have different dynamics and may grow at widely
differing levels even in the same region. For example, discounters lost market share in 2009 as a
consequence of greater price competitiveness from hypermarkets in France.
Cost savings
Of late, the focus for large retailers has turned more towards cost savings (mainly Carrefour and Metro) and
subsequent margin improvement. Economies of scale provide an opportunity for significant cost savings, for
example the ability to harness synergies in purchasing and distribution for different banners within the same
company. Building efficiency in logistics and optimising store size also helps improve margins.
Since 2009, most of the major food retailers have been executing cost-saving plans. Asda, for example,
describes the virtuous circle of its trading model as buying better, lowering prices, improving quality,
getting the offer right, driving volume and finally improving operational profitability. In other words, low
prices help to drive higher volumes through gains in market share, which in turn lead to better buying
conditions and hence the ability to offer even better prices to customers.
M&A
Big mergers like Carrefour-Promods in 1999 and Morrison-Safeway in 2004 had problems with
integration and value creation. Most synergies announced at the time of the deals have not been delivered,
especially in the case of cross-borders deals where buying synergies have been made on a national basis.
As the top players enjoy major market shares in mature markets, few developed countries offer
opportunities for consolidation. However, emerging markets are a source of growth, and many players
enter them through acquisitions. Sometimes retailers also swap assets, which may make sense if each
lacks critical size. For example, in 2005, Carrefour and Tesco agreed to swap some Tesco stores in
Taiwan for Carrefour stores in the Czech Republic and Slovakia.
Sector drivers
Consumer confidence
In mature economies, consumer confidence is one of the main drivers of the top line. Although the sector
withstands shocks well, consumers do tend to trade up in confident times and vice versa. Emerging
markets are structurally different. Their low per-capita incomes and lower retail penetration provide room
for significant long-term structural growth.
Economy/inflation
Moderate inflation is good for the sector; it helps both the top line and the bottom line for those who have
pricing power. The worst scenario for food retailers is deflation. In general, macroeconomic factors such
as rising per-capita income and expenditure levels help sales growth.
88
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higher margins for food retailers with lower prices for consumers. Obviously, food retailers focus on
increasing the share of private labels in total sales.
Over the long term, the food retailers that have performed best have been mono-format retailers with a
strong concept and brand awareness and the ones that have managed to secure loyal customers.
Distribution costs
Distribution costs are not entirely comparable because retailers do not all account for their costs in the
same way. Formats, assortment, exposure to non-food and the level of service in stores have a direct
impact on distribution costs and margins.
Property
The level of property ownership is different for different companies, making EBITDA comparisons
difficult. However, EBIT is generally comparable as it includes both rental costs (for leased property) and
depreciation (for freehold property).
Valuation
Most of the major international food retailers provide good revenue and earnings visibility. Hence, a
discounted cash flow model may be used to value them. The presence of comparable peers means relative
valuation can also be used. We estimate the food retail sector in Europe now trades at EV/sales of 44%
and EV/EBITDA of 6.5x in 2011e and on a 2011e PE of 11.9x, compared with the 16.3x at which it
traded on average between July 1999 and August 2010. During the same period, the average PE relative
to the DJ Stoxx 600 for European food retailers was c103.
89
Notes
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Insurance
Insurance team
Kailesh Mistry*
Analyst, Head of European Insurance
HSBC Bank plc
+44 20 7991 6756
kailesh.mistry@hsbcib.com
Thomas Fossard*
Analyst
HSBC Bank plc, Paris branch
+33 1 5652 4340
thomas.fossard@hsbc.com
Dhruv Gahlaut*
Analyst
HSBC Bank plc
+44 20 7991 6728
dhruv.gahlaut@hsbcib.com
Sector sales
Martin Williams*
Sector Sales
HSBC Bank plc
+44 20 7991 5381
martin.williams@hsbcib.com
Juergen Werner *
Sector Sales
HSBC Trinkaus & Burkhardt AG, Germany
+49 211 910 4461
juergen.werner@hsbc.de
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations
91
92
Insurance
Primary insurance
Reinsurance
Hannover Re
Korean Re
Life insurance
Non-life insurance
Composites
Lloyds
Aegon
China Life
Admiral
Euler Hermes
Allianz
Aviva
Amlin
Brit Insurance
CNP
Fondiaria-Sai
Axa
Catlin
Korea Life
PICC
Baloise
Hiscox
RSA Insurance
China Pacific
China Taiping
Lancashire
Prudential plc
Dongbu
Standard Life
Swiss Life
Generali
Hyundai
T&D Holdings
ING
Munich Re
Scor
Swiss Re
LIG
Meritz
MS&AD Insurance Group
NKSJ Holdings
Ping An
Samsung Fire & Marine
Sony Financial
Tokio Marine
Vienna Insurance Group
Zurich Financial Services
Source: HSBC
abc
500
12%
450
Market crash:
Dotcom bubble
400
Axa buys Sun Life
350
Converium
IPO
Winterthur acquisition
by Axa (EUR7.9bn) and
Axa rights issue
(EUR4.1bn); Generali
acquires Toro
(EUR3.85bn)
Scor acquires
Converium; Allianz buys
out minority in AGF
Lehman collapse &
problems at AIG
8%
Allianz sells
Dresdner
bank; VIG
rights is sue
6%
300
9/11 attacks
in US
250
200
150
Norwich Union
IPO
100
50
10%
Aegon buys
Transamerica
Corp
Swiss Life
rights issue
4%
Swiss Re raises
capital
Aegon, Axa & ING
rights issue
Sale of Alico
announced by AIG
(USD 15.5bn)
0%
01/1990 01/1991 01/1992 01/1993 01/1994 01/1995 01/1996 01/1997 01/1998 01/1999 01/2000 01/2001 01/2002 01/2003 01/2004 01/2005 01/2006 01/2007 01/2008 01/2009 01/2010
DJ Ins abso lute
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Sector description
Insurance companies provide protection to individuals and businesses against uncertain events by
transferring risk to an underwriter, which promises to pay the insured an amount, usually unknown, if
those events occur. The unknowns make estimating profits difficult and give rise to accounting that has
been a topic of debate for investors and insurance companies for some time now. Insurance companies
have also expanded into accumulation products where there may or may not be an insurance element.
The global insurance industry generated USD4,066bn of premiums, or about 7% of global GDP, in 2009. Life
insurance accounted for 57% of premiums, and non-life for 43%. The US is the largest insurance market, with
around 28% of the global premiums, followed by Japan and the UK. The chart below illustrates the widely
referenced S-curve in the industry, which highlights the level of maturity of the insurance market and per capita
GDP, and may be used as an indication of potentially high-growth markets as GDP per capita increases.
Proportion of GDP spent on insurance versus per capita GDP in 2009 (USD)
TW
16%
14%
UK
SA
12%
SK
10%
8%
6%
IN
4%
CH
2%
PH
0%
100
1,000
ID
TH MY
BZ
CL
PL
HN
HK
F ra
J ap
C
US
I
SP G
AUS
SW
CZ
RN
10,000
100,000
C ountry legend: A us - Aus tralia, C - C anada, F ra - France, G - Germany, H K - H ong Ko ng, I - Italy, ID - Indonesia, Jap - J apan,
M Y- M alays ia, N - Netherlands , P H-P hilippines, SA - South A fric a, SK - So uth Ko rea, SP - Singapo re, SW - Switzerland , T H -T hailand,
C Z - C zec h R epublic , RN - Ro mania, P L - Po land, HN - H ungary, IN - India, CH - C hina, TW - T aiwan, C L - C hile, BZ - B razil
Source: Sigma, HSBC estimates
The sector has a mix of mutual and listed companies, whose total market capitalisation equates to about 6%
of that of the DJ Stoxx 600. The sector is divided into primary insurance and reinsurance, depending on the
nature of the risk underwritten. Primary insurance, which underwrites risk directly from households and
businesses, is further split between life and property and casualty, or non-life. Reinsurance refers to the
way primary insurers insure themselves against the risk. Some insurers also have banking and asset
management operations alongside the typical life and non-life underwriting segments.
Life insurance comprises two main classes of products: savings products, for which margins are tied to
investment returns or fees linked to asset values as well as insurance protections offered, and personal risk
products, which cover death and disability and whose margins are linked to underwriting and technical
factors such as mortality and morbidity. Health insurance covers medical expenses and often belongs to
the primary life segment.
Key themes
Regulatory and accounting changes: Introduction of new regulatory solvency and accounting standards
are a key theme in the sector. The current solvency calculation, referred to as Solvency I in Europe, is a nonrisk-based measure which is inconsistent across different countries, making comparisons difficult. The
94
Kailesh Mistry*
Analyst, Head of European
Insurance
HSBC Bank plc
+44 20 7991 6756
kailesh.mistry@hsbcib.com
Thomas Fossard*
Analyst
HSBC Bank plc, Paris branch
+33 1 5652 4340
thomas.fossard@hsbc.com
Dhruv Gahlaut*
Analyst
HSBC Bank plc
+44 20 7991 6728
dhruv.gahlaut@hsbcib.com
abc
inconsistency primarily relates to allowable capital resources, which varies by country, although the
approach to the calculation of capital requirements appears to be more consistent. The European Union
plans to introduce risk-based Solvency II by 1 January 2013, and the US is reviewing its capital adequacy
requirements; China is also moving towards a risk-based system. In theory, this should increase consistency.
There is a similar debate on accounting standards, which diverge between regions. New standards are
being considered and will be introduced over time. For example, IFRS Phase II is due to be implemented
in 2013. The life insurance industry is also seeing a transition to embedded value accounting to market
consistent embedded value (MCEV) from European embedded value or traditional embedded value.
There is also greater demand for insurance company cash flow disclosure.
Focus on efficiency: Insurance companies have increasingly focused on efficiency and cost reduction
over the past few years. In our view, this theme has been driven by pressure on underwriting and
investment margins, the increasing maturity of the industry and the consequences of shareholder
ownership rather than mutuality, as in the past. The industry has tried to reduce costs through integrating
back offices, centralising group functions, off-shoring jobs to low-cost-centre territories, cutting
headcount, reducing policy administration costs and moving to lower-cost distribution channels. In a
report on cost-cutting potential, we analysed 49 insurers across Europe and estimated cost-restructuring
potential of EUR24bn in our base case, some of which has already been executed or announced.
Primary life segment: Life insurers have emerged from the financial crisis with an improved capital position,
while avoiding forced capital raising. Increasingly life insurers have been focusing on improving underwriting
profitability through action on prices, guarantee rates and charging for specific features. In addition, the trend
to move away from high upfront commissions paid to distributors to level-loaded structures is helping to
improve the cash flow credentials of the sector. There has also been a focus on lowering administration costs
and reducing dependence on investment markets by moving to fee-based products.
Primary non-life segment: Premium growth, evolution of pricing, prior-year reserve development, claims
inflation, investment returns and changes in distribution are the key themes for this segment. The balance
of these factors will differ over time and affect the underwriting cycle, which varies by product and
region. For example in the UK personal motor insurance market we see a hardening or increase of
insurance rates as a result of significant deterioration in underwriting profitability. Prior-year reserve
releases have declined across Europe while investment returns remain under pressure, forcing insurers to
improve underwriting profitability rather than subsidising present-year losses through positive prior-year
development and strong investment results. We are also seeing a shift away from the usual broker/agent
distribution channel towards greater use of internet, phone and affinity tie-ups to sell non-life insurance,
especially in the personal motor and property segment with the aim of reducing distribution costs.
Reinsurance segment: The industry is similar to the primary non-life segment in terms of having an
underwriting cycle and a conservative investment portfolio relative to the rest of industry. However, the
catalyst for the reinsurance industry remains large claims events, which forces an increase in insurance
rates. Despite a high claims burden in H1 2010, reinsurance capacity still exceeds demand, which is
putting prices under pressure. That said, the reinsurance segment could be a key beneficiary of the
Solvency II regime, which is expected to generate additional demand for reinsurance from smaller and
less-diversified insurers as well as mutuals. We expect a reduction in the retention rates by primary
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insurers, which have reached their highest points since 2002, to increase the demand for reinsurance as
the primary segment continues to de-risk its business models.
Increase in GDP and per capita income: Growth in the economy and per capita income boosts demand
for insurance. As income rises, demand expands from compulsory products (motor insurance) to more
sophisticated products such as saving products, asset protection such as household insurance and
retirement products.
Importance of emerging markets: Emerging markets have lower insurance penetration than developed
economies and offer significant opportunities for expansion. The growth story is well supported by the
recovery in their GDP growth, high rates of household savings and lack of social security structures in some
of these countries. Insurance companies based in developed markets have shown their desire and willingness
to expand in these regions and we expect the trend to continue. Regions such as LatAm, Asia ex Japan, and
Taiwan and Central and Eastern Europe remain attractive regions for insurance companies to expand into.
Premium growth was significantly higher in emerging markets than the developed market during the period 1999-2009
Wo rld
5.7%
5.2%
Em erging m arkets
10.1%
Japan
0.1%
3.9%
Oceania
5.1%
7.4%
8.3%
LATA M
11.8%
11.9%
Ot her Euro pe
18.8%
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
P re miu ms gr o wt h ( 10 ye ar C A GR )
Source: Sigma, HSBC estimates
Sector drivers
Capital adequacy: The insurance sector, like banks, needs to maintain a minimum level of solvency to be
able to underwrite new products and honour its future liabilities. Investors screen companies using
regulatory and rating-agency models to measure the groups solvency position and gauge its financial and
operational flexibility. The adoption of a risk-based approach to the calculation of capital adequacy and
quality of capital are the next steps in the debate on capital adequacy. A minimum rating is required to
underwrite business in reinsurance as well as certain lines of businesses in the non-life segment and life
segment. As already highlighted, life insurers continue to move away from higher capital-intensive
products and have emerged in a much better state from the crisis as a result of management actions
implemented since the 2003 crisis. Management teams have taken action to improve the capital position
by reducing risk, disposing of assets, saving on costs and focusing on underlying profitability.
Underlying profitability: Underwriting profitability and investment returns are key elements of operating
profits. Underwriting profitability depends on the pricing of products, fee structure, claims experience and
expenses, and is relevant to both primary and reinsurance segments. Underlying profitability at life
96
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companies is dependent on the type of product and can be broadly broken into risk result and investment
spread for the traditional product which are generally split between policyholder and shareholder in a
defined proportion and fee income for the unit-linked product. Surrender and lapses of policies also affect
profitability at life insurers and have to be considered for calculations along with expenses. Primary non-life
and reinsurance companies measure technical profitability based on the combined ratio, the total of claims
paid and losses incurred versus the premiums collected. We have already mentioned the increasing focus on
efficiency and changes in distribution cost structures for both the primary life and non-life segments.
Investment exposure: Investment exposures have changed over time as insurance companies have
lowered their gearing to equity markets from the levels seen at the start of the decade, and instead
increased their exposure to corporate bonds and alternative investments. Currently life insurers have a
higher exposure to riskier assets like equity and corporate bonds, while reinsurers and primary non-life
insurers are mainly invested in shorter-duration bonds and cash. Shareholders are fully exposed to assetquality risks in the non-life segment, but the risks are shared with policyholders in the life segment
assets are largely managed on behalf of policyholders. Bond duration also varies, with life insurers having
a longer duration as a result of the longer maturity of liabilities.
Adequate reserving: Prudent reserving is critical for insurance companies. Premiums are paid in the short
term, but liabilities are paid over a long period. Inadequate reserves will need to be replenished, possibly
funded by shareholders, although surplus reserves, if any, may be released to improve or smoothen profits.
Premium growth: This vital aspect depends on factors ranging from economic activity and development of
the insurance market to government policies and social security systems. In the past 10 years, premiums
have grown twice as fast in emerging as in developed markets, and we expect EM growth to remain higher.
97
Notes
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Luxury Goods
Luxury Goods team
Antoine Belge*
Head of Consumer Brands and Retail Equity Research, Europe
HSBC Bank Plc, Paris Branch
+33 1 56 52 43 47
antoine.belge@hsbc.com
Erwan Rambourg*
Analyst
HSBC Bank Plc
+44 20 7991 6793
erwan.rambourg@hsbcib.com
Sophie Dargnies*
Analyst
HSBC Bank Plc, Paris Branch
+33 1 56 52 43 48
sophie.dargnies@hsbc.com
Sector sales
David Harrington*
Sector Sales
HSBC Bank Plc
+44 20 7991 5389
david.harrington@hsbcib.com
Lynn Raphael*
Sector Sales
HSBC Bank Plc
+44 20 7991 1331
lynn.raphael@hsbcib.com
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations
99
100
Luxury Goods
Diversified Groups
or Holdings
LVMH
Hard luxury
companies
Christian Dior
PPR
Richemont
Soft luxury
companies
Swatch Group
Louis Vuitton
Gucci
Cartier
Omega
Hennessy
Dior Couture
Brand
Puma
Montblanc
Breguet
Retail assets
IWC
Calvin Klein
Panerai
Swatch
Sephora
Tiffany
Bulgari
Coach
Burberry
Tods
Herms
Source: HSBC
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40.0 x
35.0 x
2000 bubble
30.0 x
SARS epidemic
China starts
to matter
25.0 x
20.0 x
15.0 x
10.0 x
Post-Lehman
collapse
5.0 x
Asian financial
crisis
09/11 attacks
0.0 x
Mar-97
Mar-99
Mar-01
Mar-03
Mar-05
Mar-07
Mar-09
Note: *Non-weighted average of LVMH, Richemont, Swatch, Tiffany (other companies do not have the necessary history, own non-luxury assets or their valuations have been distorted by speculation).
Source: HSBC
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Sector description
The luxury goods sector includes companies that develop, produce, market, distribute and sell high-end
apparel, jewellery, watches, leather goods and accessories. Some luxury goods companies are also
involved in other premium-priced goods, such as LVMH, with its fragrances and wines and spirits, or in
businesses that are part of a vertical integration drive, such as the watch-component division of the
Swatch Group. Many listed companies are family-controlled, although some have a 100% free float, such
as Burberry and Tiffany. The sector is characterised by high operating margins, substantial emergingmarket exposure and strong cash generation. M&A has been a driver in the past, but with a few
exceptions Luxottica, for example synergies are scarce, making it hard to return cash to investors in
an efficient manner.
Diversified groups/holdings: Some of the listed companies in the space have grown by acquisitions
that gave them large, diversified brand portfolios. The proxy for the sector and the largest group is the
French company LVMH, which now has more than 50 brands in five different product categories:
fashion and leather, fragrance and cosmetics, wines and spirits, watches and jewellery and selective
distribution. Christian Dior is a listed holding company of LVMH. PPR is more of a conglomerate
than a diversified luxury group, since it holds retail assets, a stake in sports brand Puma and a luxury
portfolio. Richemont and the Swatch Group also have diversified portfolios, although they focus on
so-called hard luxury.
Hard-luxury companies: Hard luxury describes products such as watches, jewellery and pens,
although pens no longer contribute much to sales. Watches and jewellery are often considered
together, but their distribution structures vary considerably. Watches are wholesale-driven, because
consumers want to compare designs, brands, prices and functionality. Jewellery is often retail-driven
companies sell their own jewellery in their own stores. The largest hard-luxury companies are
Richemont, with its star brand Cartier, and the Swatch Group, with the star brand Omega. Monobrand
companies include Tiffany, which sells mostly jewellery, and Bulgari, which sells jewellery, watches
and fragrances.
Soft-luxury companies: Soft luxury describes high-end apparel and leather goods. Soft-luxury
goods are mostly sold in directly operated stores. Monobrand listed companies include Burberry,
Herms, Tods and Coach.
Key themes
Luxury goods stocks historically have been strong growth stocks trading at a premium valuation to the market.
The key concern is the sustainability of their growth, and the key question for the bigger brands like Louis Vuitton
and Cartier is how close the brand is to being mature. It seems paradoxical to try to sell more of what theoretically
should be exclusive, but the leaders of the industry have walked a fine line between selling in volume but holding
on to their identity (and the consumer). Most of the key themes in the sector will revolve around image
management, pricing power and the concept of maturity.
We believe that the key concerns and themes are:
High-end consumer behaviour: Most investors consider luxury goods demand to be directly linked to
GDP growth. To a certain extent, that has been the case in some countries. But consumption of luxury is
102
Antoine Belge*
Head of Consumer Brands
and Retail Equity Research,
Europe
HSBC Bank Plc, Paris
Branch
+33 1 56 52 43 47
antoine.belge@hsbc.com
Erwan Rambourg*
Analyst
HSBC Bank Plc
+44 20 7991 6793
erwan.rambourg@hsbcib.com
Sophie Dargnies*
Analyst
HSBC Bank Plc, Paris
Branch
+33 1 56 52 43 48
sophie.dargnies@hsbc.com
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driven by social, cultural and psychological factors as well as financial issues. Luxury boomed in Japan
during one of the countrys deepest recessions. Similarly, consumer confidence seemed sluggish in the first
half of 2010, but luxury demand soared as wealthy consumers un-tightened their belts after almost two years
of austerity.
Pricing power: Luxury brands do not really compete on price but rather on design and desirability. During
the downturn, prices generally held up. In recovery phases, brands tend to launch higher-priced, highermargin products, and raise prices again.
Trading up or down, more or less: Linked to this pricing power and the social status that is associated
with luxury, there is a big debate around trading up or down and trading more or less. In spirits, trading
down is common; customers buy cheaper vodka in the US during a recession, for example. We think in
luxury goods, high-end consumers tend to trade less when times get tough. A consumer interested in the
latest Patek Philippe watch would probably postpone buying it during an economic crunch rather than
trade down to a Casio or Swatch. Since the October 2008 slowdown, the industry has suffered from much
lower volumes.
Market share/polarisation: Trading less implies that some brands have a reference status and will both
grow when times are good and expand their market share when times are tougher. Louis Vuitton is usually
the reference in leather and accessories; Cartier in watches and jewellery.
Market maturity/saturation: If Louis Vuitton, for example, increases sales by a high single-digit to low
double-digit rate every year, how long can this last? When will its market be saturated? This is a theoretical
debate that has gone on for years. Japan and possibly a few other countries may be treated as cash cows
now, but we believe companies still have considerable capacity to recruit customers and trade them up.
Image control: It is hard to trade consumers up if the distribution network is not up to speed in product
assortment, merchandising and in-store service. Most brands try to control their image as much as they
can. That often means taking back licences or transferring sales from wholesalers to directly operated
stores, which is harder for wholesale-driven businesses such as watches or fragrances. And if the product
category is a profitable diversification in which the company has not developed know-how or a production
base, such as fragrances and eyewear at Burberry or Gucci, a licence makes sense. Another recurring
subtheme here is counterfeit products in luxury.
Sector drivers
Luxury goods have been driven by emerging-market exposure, both within developing countries and through
customers from those countries buying goods in Europe. We expect access to higher-growth countries and
developing leadership positions there, where margins are already currently higher than in the developed world
outside Japan, will continue to be a key factor for the sector. Historically, currency and M&A have also had an
impact on stock prices.
Currency: Most European luxury goods manufacturers produce in euros, generally in France and
Italy, and sell throughout the world. They have important exposure to the US dollar and dollar-linked
currencies such as the renminbi and the Hong Kong dollar and, in some cases, such as Bulgari and
Hermes, to the yen. After a decade of negative FX impacts from a stronger euro, we believe the
103
sector should now benefit from currency effects at least until the end of 2011 hedging policies are
in place if the current spot rates prevail.
M&A and cash management: Few acquisitions have occurred since an LVMH buying spree in 19992000. But with cash piling up, talk about deals has resurfaced. We do not believe the interesting assets
have suffered in the downturn (and many theoretical targets are privately held), but cash generation could
become an issue if buy-back programmes or dividend hikes do not occur. The issue with acquisitions in
the sector is that they do not produce many synergies if LVMH were to acquire a leather goods brand, it
would not be distributed in existing Louis Vuitton stores.
Geographic diversification: The US remains an underdeveloped market in our view, and countries like
India, Russia and Brazil could represent growth opportunities in the future. But the investment case for the
sector now relies greatly on Asia outside Japan. Although there are theoretical risks when operating in
China, we believe they are outweighed by the many reasons to remain excited by the countrys potential.
104
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thorsten.zimmermann@hsbcib.com
Sabrina M Grandchamps
Analyst
HSBC Securities (USA) Inc.
+1 212 525 5150
sabrina.m.grandchamps@us.hsbc.com
Sector sales
Jacques Vaillancourt*
Sector Sales
HSBC Bank Plc
+44 20 7991 5210
jacques.vaillancourt@hsbcib.com
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations
105
106
Mining
Base Metals
Bulks
Aluminium
Alcoa
A lumina
Ru sal
Nalco
Rio
Steel
Iron ore
Rio
P latinum/ Pa lladium
Ferre xpo
BHP
S esa Goa
Va le
Fortescue
Ku mba
Copper
Lonmin
Cliffs
Barrick
Go ldco rp
Kinross
Polyus
Buenaventura
Teck
Yaman a
Goldfields
Randgold
Polymetal
AngloGold
IAMGo ld
Harmony
Cen terra
Th ysse nKrupp
Outokumpu
Ar celo rMittal
US Steel
Tata
Posco
Ge rdau
JFE
Voestalpine
AK Ste el
CS N
Newmo nt
Xstrata
Terniu m
Baoste el
BHP
BHP
China ste el
SS AB
Gold / Silver
NWR
Southern
Copper
Sa lzgitter
Acerino x
No rilsk
Aurubis
KGHM
Blast Furnace
Nucor
Amplats
Antofagasta Xstra ta
Fre eport
Electric Arc
P re cious Metals
IFM
Merafe
Zinc / Lead
Usiminas
Long steel
EZZ
Flat s teel
S tainless
Nucor
ArcelorMittal
ThyssenKr upp
Acerinox
E rdemir
Salzgitter
SS AB
Outokumpu
Tata
US Steel
Posco
Rautarru kki
Voestalpine
Nippon
S AIL
China steel
JFE
Ge rdau
Ternium
Bao steel
Nyrstar
Boliden
AK Steel
Korea Zinc
Terramin
Usiminas
CSN
Nickel
No rilsk
Vale
Tin
Source: HSBC
Ma jors:
Rio Tinto
Others
Boliden
Vedanta
ENRC
Xstrata
Vale
A rcelorMittal
MMK
Krup p
Thyssen
Evraz
US Steel
NLMK
S SAB
S ail
P osco
Nucor
Tata
G erdau
A K S teel
CSN
V oestalpine
S alzgitter
abc
Diversified companie s
Severstal
1200
1000
800
600
400
200
0
0
5000
10000
15000
20000
25000
30000
35000
40000
45000
real GDP/capita
US from 1900
China
Korea
Japan
India
Source: HSBC
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Sector description
The metals and mining sector falls broadly into two areas, mining and steel, although these sub-sectors
are closely interrelated. Miners encompass many independent industries, each focused on the extraction
and refining of metals, including base metals copper, aluminium, zinc, nickel, and precious metals
platinum and gold. Mining companies also produce bulk commodities such as thermal coal, coking coal
and iron ore (the latter two are the raw materials for much of the steel industry). The steel industry is
largely a processor of raw materials into downstream products (grouped broadly as flat-rolled, stainless
and long steel), although some steelmakers are also backward integrated and own upstream assets.
Steel and base metals are key materials for construction, infrastructure and consumer goods. Major
consumers include construction and automotive firms, capital goods producers, wire and cable
manufactures and food packaging companies. Metals and mining is arguably the oldest truly global
sector, as all producers are subject to global commodity prices and the sector has long been characterised
by cross-border investment.
Mining industry
The mining industry has undergone significant consolidation over the past decade, and is now dominated
by five large companies (BHP Billiton, Rio Tinto, Anglo American, Xstrata and Vale the first four of
which are listed in London). This consolidation has been driven by the desire to secure production growth
more quickly than through the commissioning of new projects. The industry has produced significant
excess cash flows over the past decade, but still struggles to accelerate production growth through
greenfield projects, which can take 10 years or longer to bring on stream. Hence, it has been quicker and
more profitable to buy than build. Consolidation has also produced some scale benefits, (although SG&A
costs for global mining firms are relatively low in absolute terms).
Steel industry
The steel industry has also undergone significant consolidation over the past decade, led by the largest
firm in the industry, ArcelorMittal. As a result, the industry is no longer predominantly made up of
national-based steelmakers (particularly in Europe) as intra-regional and global steelmakers are becoming
more common. There is emerging evidence that this higher level of consolidation in developed countries
has changed the industry from being one that traditionally competed aggressively for market share (and
frequently looked to governments for support), to one that is producing returns above its cost of capital
through the cycle. In the 2008/09 downturn (which represented the worst capacity utilisation cycle for a
generation) major steelmakers did not seek bankruptcy protection or assistance from governments, a
significant break from past cycles.
Key themes
Emerging market growth
Around one-third of metals are consumed in China, and China is now about three times the size of the US
as a metal consumer. The acceleration of China as a metal consumer has led to a rise in global metals
demand growth from 2-3% pa for much of the 1980s and 1990s to 5-7% pa over the past decade. This has
changed the investment cycle in the industry, and once growth was easily satisfied with brownfield
expansion and the occasional new mine, now fresh capital needs to be constantly invested in new
108
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Andrew Keen*
Head of Metals and Mining
Research, EMEA
HSBC Bank Plc
+44 20 7991 6764
andrew.keen@hsbcib.com
Thorsten Zimmermann*
Analyst
HSBC Bank Plc
+44 20 7991 6835
thorsten.zimmermann@
hsbcib.com
*Employed by a non-US affiliate
of HSBC Securities (USA) Inc,
and is not registered/ qualified
pursuant to FINRA regulations
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projects. Consequently, commodities are more dependent on incentive pricing, or commodity prices that
are required to justify investment in projects that have traditionally been seen as marginal.
This structural change in global demand has been driven by economic growth in China, which has led to
15-20 million people being urbanised each year. Although this trend is difficult to define and measure, a
significant proportion of Chinas population has reached the personal income band where demand for
metal-intensive goods accelerates significantly. This is due to the movement from rural housing and
employment to urban manufacturing jobs (which require plant and infrastructure) and urban
accommodation (which drives demand for materials such as steel-reinforced concrete and copper wiring).
On our estimates, 75-90% of the metal consumed in China stays in China, with the balance exported in
the form of manufactured goods.
Deteriorating resources
A common theme in the sector (although one that we do not entirely subscribe to) is the deterioration in
the quality of natural resources and the impact on commodity prices. Many commentators and some in the
industry claim that the quality and quantity of ore for the next generation of mines is significantly
degraded from the last generation, which will require higher incentive pricing and lead to further delays
and disruptions. Most mining companies will also claim to have growth pipelines that are in the lower
half of the cost curve and relatively easy to deliver, which is incompatible with the claims made on an
industry-wide basis. It is becoming more challenging to extract some metals but there is no evidence of
reaching absolute depletion levels of minerals (the predictions made in the 1970s Club of Rome have
proved false reserves and resources have continued to rise over time as technological advancements in
exploration, processing and extraction have led to continued upgrading of known resources and a
containment of structural cost increases).
109
Sector drivers
Commodity prices undoubtedly drive movements for all types of metals stocks. For miners, this is not
surprising given that their costs and output levels are broadly stable, so the fluctuating prices of metals
drive margins and cash flows. There are few ways to invest in the sector without taking a view of the
underlying commodity markets for a stock (such as spotting excess cash generation, buybacks and
M&A). In the case of steel, the difference between input (iron ore, scrap and coking coal) and output
(finished steel) prices, as well as operating rates, are critical for forecasting margins.
Due to its dependence on commodity markets, global economic growth is a major driver of stock
performance, and the metals and mining sector is high beta versus the broader market. Given the sectors
size and volatility, it has also attracted significant interest from hedge funds, and this faster money has
tended to amplify the sectors beta. The risk trade of buying or selling a high-beta sector on economic
data points (particularly those associated with Chinese economic growth or trade) is growing as a trend,
and this has made the timing of entering and exiting stock investments increasingly important.
Although commodity prices have a long history of mean reversion and asset lives of mines can stretch to
many decades (both implying that equity prices should not follow short-term commodity prices), mining
equities do tend to be volatile and closely correlated to near-term metal price movements. In simple
terms, when commodity markets are good, the market expects them to stay good forever, and when they
are bad, the market expects them to stay bad forever. Remembering this simple principle (and trying to
spot key inflection points) is the key to moving beyond simple momentum investing in the sector.
Commodity markets are relatively straightforward in principle, but often complex in detail. Metals
markets typically work between two dynamics. In periods of poor demand, inventories in the industry (or
on exchanges for some commodities) rise and prices tend to fall to marginal cost (typically a price at
which 10-25% of producers experience cash operating losses). This leads to an inevitable supply response
and returns a market to equilibrium. At the other extreme, in tight markets (as a result of demand growth
or supply interruptions) prices will explore an upper limit, which is usually defined by demand
destruction through substitution or the availability of new sources of supply.
110
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Steel companies
For steel companies, as industrial companies with defined plant and equipment, book values are more
relevant and the sector historically traded at 1.1x P/book. Although earnings multiples are very volatile
through the cycle, a 10x forward PE seems to work well as a rule of thumb. It is still up for debate if the
higher consolidation that occurred in 2002 and 2006 will transform into structurally higher margins for
the industry and allow higher valuation multiples going forward.
Steel companies tend to report much less information than miners, with EBITDA broken down into broad
regional or product groupings. Stated earnings are not readily comparable, as one-off items can be
significant (inventory write-downs, restructuring costs, hedging gains/losses) but the assessment across
companies differs significantly about what should be regarded as non-recurring items. Steel mills tend to
generate a fair amount of cash flow during upcycles; however, as this is frequently spent on acquisitions
and very costly greenfield plants (capex cUSD1,000/t of steel), steel mills tend to be more highly
leveraged than the miners. Steel company earnings tend to be more difficult to model than for miners as
a processing business on top of volatility for product prices, they are also more vulnerable to fluctuations
in the prices of key raw materials and variances in capacity utilisation. As a result, and unlike miners,
steel companies do tend to react to earnings releases, particularly guidance for the quarter ahead. Picking
entry points around earnings releases is therefore a key consideration for investing in steel stocks.
111
Notes
112
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anisa.redman@hsbcib.com
Sector sales
Annabelle O'Connor*
Sector Sales
HSBC Bank Plc
+44 20 7991 5040
annabelle.oconnor@hsbcib.com
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations
113
114
Independent
Players
Independent
Players
(Upstream,
Downstream,
Transportation,
Petrochemicals)
Upstream
(E&P)
Downstream
(R&M)
Seismic
Drilling
Subsea &
Offshore
Equipment
E&C
Europe
Europe
Europe
CGGVeritas
Transocean
Technip
FMC
BP
BG
Neste
WesternGeco
Noble
Saipem
Cameron
RD Shell
Total
Statoil
Tullow
ERG
Saras
- (Schlumberger)
PGS
Diamond
Pride
KBR
Fluor
Aker Solutions
DrilQuip
ENI
Cairn Energy
Repsol
OMV
Dana Petroleum
JKX
Emerging markets
Emerging markets
Petrobras
Lukoil
TGS Nopec
Seadrill
CB&I
Wellstream
Emerging markets
MOL
Ion
Polarcus
Ensco
Rowan
Petrofac
Kentz
Technip
Nkt Flexibles
PKN
EMGS
COSL
Lamprell
Hellenic Petroleum
Fugro
Nabors
Amec
National Oilwell
Varco
OGX
BGP/CNPC
Hercules
Seahawk
Marie Technimont
Aker Solutions
Rosneft
Asia
Oil refineries
Saipem
Acergy/Subsea 7
Nexans
Prysmian
Gazprom
Novatek
CNOOC
ONGC
Petrol Ofisi
Ayagaz
McDermott
Oceaneering
Cairn India
Turcus
Asia
PTT E&P
Petrochina
Sinopec
Santos
Woodside Petroleum
Reliance Industries
Asia
S Oil
Floating
Production
Supply
Vessels
GEVetco
Well
Services
SK Energy
SBM Offshore
Bourbon
Schlum berger
Anadarko
Apache
Formosa Petrochem
BPCL
BW Offshore
Tidewater
Halliburton
HPCL
Farstad
Solstad
Weatherford
Baker Hughes
ConocoPhillips
Cheasapeake
Energy
Prosafe Production
Modec
Thai oil
Bluewater
Edison Chouest
ChevronTexaco
Marathon Oil
Devon Energy
Encana
US
Sevan Marine
OSX
Swire
Ezra
EOG resources
Valero
Superior Offshore
Newfield Exploration
Sunoco
Trico Marine
Nexen
Talisman Energy
Tesoro
US
ExxonMobil
Source: HSBC
US
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Sinopec Sanghai
PTT
1991-94
Following the Gulf War to liberate
Kuwait, crude price steadily declined and
reached it s lowest level in 21 years
1994-98
Sustained low oil
prices dampened
new investments
2001 9/11
Increase in Russian production,
decline in US economy resulted
in lower oil price
5
4
2005/8
Sharp increase in
demand from Asia
2008 (end)
Onset of recession
120
100
Oil demand supply balance, oil price, oil sector PE and PE relative
80
3
2
60
1
40
0
2006 Lebanon war
After Israel launched
attacks on Lebanon, oil
pric e reached a new
high of USD78/bbl
-1
-2
1999
Serie s of OPEC cuts (4.2Mbbl/d) supported oil price rise
-3
1991
1992
1993
1994
1995
OECD
1996
1997
1998
Non-OECD
1999
2000
2001
2002
2003
2004
2005
2006
2007
20
0
2008
2009
Brent (RHS)
120%
25
23
110%
21
19
100%
17
90%
15
13
80%
11
9
70%
7
60%
Jan-93
Jan-95
Jan-97
Jan-99
Europe Oils PE2
Jan-01
Jan-03
PE2 relative (RHS)
Jan-05
Jan-07
Jan-09
115
abc
5
Jan-91
Sector description
The value chain of the oil and gas sector includes the extraction of oil and gas, transportation of
feedstocks, the refining of oil to produce gasoline, diesel and other petroleum products, and the marketing
of oil and gas products to consumers. It can also include a gas and power division. This can involve power
generation and distribution, gas transportation (both by pipe and as liquefied natural gas LNG).
Integrated players operate across the entire value chain. Independents normally focus on a part of the chain.
demand is 1% to 2% for oil and 2% to 3% for gas. Growth tends to be higher in non-OECD regions and
can be flat or even negative in parts of the OECD. The industry still needs to add new productive capacity
equivalent to 5% to 7% of existing production to achieve growth in net capacity of 1% to 2% annually,
since existing fields have decline rates of around 3% to 5% annually. Development of this new capacity
involves long lead times, typically five to ten years from discovery to monetisation, and possibly more for
large projects. The industry is also capital intensive with most material projects involving multi-billion
dollar spending. Oil companies also face tightening fiscal regimes and resource nationalism as host
governments seek to maximise their return from oil and gas discoveries.
Oil services
Oilfield services are diverse; some are asset heavy, some asset light. The main sub-sectors are seismic,
drilling, engineering and construction, subsea/offshore equipment and construction, supply vessels,
floating production and well services. One distinction among different parts of the sector is cyclicality.
All areas are cyclical, but some are longer cycle (related to capex), others shorter cycle (related to
operating expenditure and exploration activity).
The equity-listed structure of the global oilfields services sector is, unsurprisingly, more developed in the
Western world, but it is likely to become increasingly important (as a traded sector) in emerging markets,
particularly Latin America and Asia. The oil-service industry is a large-cap sector in the US and a midcap sector in Europe. The European sector has high exposure to capex trends (long cycle) and to offshore
activities, which drive 75% to 80% of earnings. The US sector is weighted more towards well services,
both onshore and offshore, and drilling.
Key themes
Access to resources
With growing resource nationalism, companies that have secured acreage in prospective, accessible areas
of the world (Brazil, West Africa, the US Gulf and East Siberia, for example) are likely to have the
116
abc
Paul Spedding*
Global Co-Head of Oil and
Gas
HSBC Bank Plc
+44 20 7991 6787
paul.spedding@hsbcib.com
David Phillips*
Global Co-Head of Oil and
Gas
HSBC Bank Plc
+44 20 7991 2344
david1.phillips@hsbcib.com
*Employed by a non-US affiliate
of HSBC Securities (USA) Inc,
and is not registered/ qualified
pursuant to FINRA regulations
abc
potential for above-sector average growth. This tends to favour national energy champions, many of
them partly or wholly government-owned, which often get preferential access to exploration acreage.
Some governments also give their national companies automatic participation in discoveries made by
other companies.
Long-term cyclicality
The long lead times in the oil industry mean most of its businesses are at risk of cyclical behaviour. Those
are more pronounced in the downstream than in the upstream. OPECs policy of managing production at
a level sufficient to support oil prices dampens some of the cyclicality in the upstream.
Sector drivers
Realisation and margin are key drivers
For most companies, realisation and margins are more important drivers of earnings than growth. The
three key levers are oil price, natural gas price and refining margins. The dollar is also a key driver. For
most companies, short-term movements in their share prices are correlated with the oil price. The degree
of sensitivity to the oil price varies depending on the type of company. For example, the shorter-cycle
service companies and independent exploration companies are more sensitive than the majors.
117
Refining oversupply
We do not expect the current overcapacity to disappear in the next five to 10 years unless large-scale
closures take place. For the balance of the decade, we believe, increases in demand will be met from new
capacity being added, mainly in Asia and the Middle East. We expect OECD refining profitability to
remain weak, with Asian and Middle East refiners benefiting most from non-OECD demand growth.
Valuation approaches
There are significant differences in the approaches followed to value integrated large players and small
independent players.
118
abc
abc
currently.) The most common valuation approach used is PE-based, in our view. The long-run PE for the
sector is around 80% relative to the market. The price-to-book (P/B) ratio also serves as a useful check to
valuation, particularly for companies with significant capital under construction.
For some of the smaller companies or for those where a restructuring is possible, analysts can use a sumof-the-parts approach. Upstream assets tend to be valued using discounted cash flow (DCF) analysis or by
using comparable transaction values. Downstream assets are valued using per barrel approaches based
on market transaction with adjustments for complexity, size and location. Other assets can be valued on a
multiple basis either earnings or cash-flow based using comparable companies as a reference point.
119
Notes
120
abc
abc
Real Estate
Real Estate team
Nicolas Lyle*
Analyst
HSBC Bank Plc
+44 20 7992 1823
nicolas.lyle@hsbcib.com
Stephanie Dossmann*
Analyst
HSBC Bank Plc, Paris Branch
+33 1 56 52 4301
stephanie.dossmann@hsbc.com
Thomas Martin*
Analyst
HSBC Trinkaus & Burkhardt AG, Germany
+49 211 910 3276
thomas.martin@hsbc.de
Sector sales
Martin Williams*
Sector Sales
HSBC Bank plc
+44 20 7991 5381
martin.williams@hsbcib.com
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations
121
122
Indirect
Direct
Property assets
UK
Land Securities
France
Unibail-Rodamco
Germany
Deutsche Euroshop
Netherlands
Corio
Belgium
Wereldhave
British Land
Klepierre
Alstria
Eurocommercial
Confimmo
Hammerson
Gecina
Gagfah
SEGRO
Capital Shopping
Centres
Mercialys
Silic
DIC Asset
Deutsche Wohnen
ICADE
IVG Immobilien
ANF
VIB Vermoegen
Derwent London
Great Port land
Estates
Fonciere des
Regions
Holding company
Property asset
Property asset
Shaftesbury
Workspace
Others - See EPRA Index
Source: HSBC
abc
7000
First sign of credit
defaults emerge in
US. LIBOR spikes,
liquidity dries up
12.00
10.00
6000
Lehman collapse
5000
8.00
4000
6.00
3000
Sector rebound as UK exits
ERM and base rates and
LIBOR halve
4.00
2000
Jun-10
Jun -09
Jun-08
Jun -07
Jun-06
Jun-05
Jun -04
Jun-03
Jun -02
Jun-01
Jun -00
Jun-99
Jun-98
Jun-97
Jun-96
Jun-95
Jun-94
Jun-93
Jun-92
Jun-91
0
Jun-90
0.00
Jun-89
1000
Jun-88
2.00
123
abc
All property equivalent yield, 10-year gilts yield and quoted sector performance 1988-2010 y-t-d
14.00
abc
Sector description
Propertys place in the economy
The primary purpose of property companies is to provide accommodation to businesses and households.
The key driver of asset pricing in the industry is rental growth expectations, which are derived from
imbalances between tenant demand and property supply, reflecting the cyclicality of the economy.
Property yields represent the ratio of a propertys annual rental value to its real estate value.
The industry can be viewed in the context of ownership, ie the kind of entity that owns the real estate. The
amount of money invested in commercial property globally was USD10.9 trillion at the end of 2009 with a
total EUR2,998bn in Europe. Of that, EUR629bn was in the UK, EUR410bn in France and EUR451bn in
Germany, according to DTZ in its Money into Property report (May 2010). The breakdown of investment
by source of capital (see chart) shows that the proportion of public equity (which includes REITs real
estate investment trusts in the UK) was only 4% of the total or GBP24bn, which is representative of the
market capitalisation of the FTSE 350 real estate index. The European public equity market (excluding
Nordics and Switzerland) is approximately EUR58bn according to EPRA (European Public Real estate
Association) with the key difference being less liquidity due to lower levels of free float.
Insurance companies and banks are the largest owners of private debt and private equity invested in the
sector as commercial property has traditionally met their need for asset diversification. REITs (and their
European equivalents) were invented to enable investment in property via a vehicle offering much greater
liquidity than direct property (real estate itself), but the same effective tax treatment with the added
possibility, therefore, of attracting new sources of capital into the sector.
REITs in the UK have adopted a total return strategy, which aims to deliver income returns (through asset
management strategies) and capital growth (via development projects). At various points in the cycle, the
emphasis on the different parts of the strategy will vary, and the attraction for investors also depends on
the tax treatment of capital gains and income. In the UK, current personal taxation favours capital gains
over income. In Europe, lower liquidity and a less transparent valuation network are reflected in lower
volatility of capitalisation rates, and therefore market pricing is more focused on income returns.
32%
48%
27%
52%
Public equity
4%
Public equity
4%
Public debt
Public debt
17%
16%
Source: DTZ
124
Source: DTZ
Nicolas Lyle*
Analyst
HSBC Bank Plc
+44 20 7992 1823
nicolas.lyle@hsbcib.com
*Employed by a non-US affiliate
of HSBC Securities (USA) Inc,
and is not registered/ qualified
pursuant to FINRA regulations
abc
Key themes
Late in the cycle returns
The availability and cost of debt capital determine the size of the investment pool. This was the key driver
of the listed sectors tripling in value between 2003 and 2007. The all property equivalent yield (as
measured by the UK investment property databank) fell by 250bps to a trough value of just under 5.40%
at the height of the boom, as can be seen in the chart above. Conversely, the near freezing of debt capital
in the months around the Lehman Brothers bank collapse in September 2008 caused the greatest fall in
property prices in the post-war period with the all property equivalent yield rising just under 400bps to a
peak value of 9.30%, causing a 45% fall in capital values over the two years to June 2009. The
investment boom left over-leveraged bank balance sheets over-exposed to the sector. As a result, REITs
also over-leveraged themselves in this period and the majority had to resort to rescue rights issues in 2009
as property prices fell beyond expectations and threatened breaches of loan covenants.
Bank de-leveraging
The property boom of 2003-2007 has led to a record level of bank debt secured against UK commercial
property. The Bank of England reports just under GBP250bn of outstanding debt, representing just over
11% of participating banks total lending at the end of 2009 compared with 10% at the height of the last
credit crisis in the UK in the early 1990s. As in the 1990s credit crisis, significant numbers of loans are in
breach of covenants, with industry estimates of GBP50bn in negative equity. In the UK, RBS and Lloyds
Banking Group together represent approximately 38% of the GBP250bn market and both have publicly
committed to reducing their exposure to non-core property loans. This gradual reduction in exposure to
loans secured by commercial property assets is likely to restrict the availability of (debt) capital to the
sector for many years to come.
Retail consolidation
The internet has been a key driver of the reduction in retailers need for physical space in the UK, with an
increasing trend among national retailers to open flagship stores in fewer but higher-footfall locations. This has
been accompanied by a gradual shift from high streets to edge of town retail parks, where occupancy costs are
lower and access is more convenient for car users. As a result, vacancy rates across town centres and in
secondary quality shopping centres rose to historic highs in the last three years, sending rental values into
freefall. The corollary is that inadequately financed retailers with declining brands have been forced into
liquidation, leading to market share gains for the national retailers but reducing overall demand for retail space.
125
Over-renting
In the UK, many property companies and some REITs are likely to see underlying net rental income falter
between 2010 and 2012, as leases expire on over-rented property (where the passing rent exceeds the value
of the market rent). A strong global and domestic economy fuelled five years of continuous rental growth to
2008 which was a key driver behind the surge in property company NAVs. However, prime rents have
fallen 20-50% on a net effective basis since the onset of the crisis. As a result, current lease income on many
property portfolios is above market values, and so they face a significant reduction of rental income when
the current leases expire and new leases are negotiated, exacerbated by historically high levels of available
space in secondary locations. This reduction in income will take time to unwind, and will reduce free cash
flow growth and constrain commercial property landlords ability to grow earnings.
Sector drivers
The listed vs the direct market
REITs share prices (and those of listed property companies) are sensitive to global capital flow imbalances
and macroeconomic conditions. Rental growth is the principal driver of property returns over the long
term, and as a result the sector is late cycle (owing to the time it takes to renew the rent roll as leases
expire). The listed sector is also more affected by wider market sentiment, implying greater volatility of
returns, although this is compensated in part by the greater liquidity and transparency of share trading.
Rental growth
Rental value growth is a fundamental driver of property prices as investors determine an acceptable
capitalisation rate for rental income projections. Occupier demand is the key driver of portfolio vacancy
rates and therefore rental growth potential. In times of economic expansion, tenants space requirements
increase and drive up occupancy rates to high levels, limiting the choice and availability of
accommodation. Consequently, when a tenant needs to move or to expand and property supply does not
increase to match these needs, rents rise and capitalisation rates (yields) fall, and if supply exceeds
demand the reverse is true. Further, the REIT regime (which requires the payout of 90% of eligible rental
income) limits the retention and re-investment of capital. An absence of economies of scale and low
barriers to entry compounds the weakness of a capital-intensive industry, placing the sector squarely in
the value category (rather than in growth). Sustainable income returns and the potential for rental
growth are therefore very important to overall returns, especially in a capital-constrained economy.
126
abc
abc
Leading indicators
Investment market
Employment indicators
Vacancy rates
Development pipelines and space absorption rates
Tenant incentive levels
Income spreading
The main accounting adjustment that REITs have to make under IAS 17 (SIC 15) is to account for lease
incentives (mostly rent-free periods and capital contributions) as an integral part of the consideration for a
leased asset. As a result, these are capitalised and accounted for as a deduction of cash rents, amortising
on a straight-line basis, over the life of the lease in line with accounting for net rental income. As a result,
timing differences exist between the income and cash rents receivable in any given year, with the income
account notably higher than the cash account in the early years of a lease (especially in recession when
rent-free periods comprise a greater portion of net rental income). As rent-free periods come to an end,
the cash rent roll begins to overtake the income account, reflecting the headline rental value achieved on
leasing. In a benign economic environment, rent-free periods are minimal and therefore the gap between
the income and cash accounts is minimal.
127
Notes
128
abc
abc
Retail General
General Retail team
Paul Rossington*
Analyst
HSBC Bank Plc
+44 20 7991 6734
paul.rossington@hsbcib.com
Sector sales
Lynn Raphael*
Sector Sales
HSBC Bank Plc
+44 20 7991 1331
lynn.raphael@hsbcib.com
David Harrington*
Sector Sales
HSBC Bank Plc
+44 20 7991 5389
david.harrington@hsbcib.com
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations
129
130
Food and
staples retailing
Beverages
General Retail
Hardlines
Specialty
DSGI (FTSE250)
Kesa Electricals (FTSE250)
Kingfisher (FTSE 100)
Luxury and
sporting goods
Softlines
Multiline
Home Retail Group
(FTSE100)
Multiline
Specialty
Debenhams (FTSE250)
Carpetright (FTSE250)
Mothercare (FTSE250)
Next (FTSE100)
Source: HSBC
abc
21
525
UK leaves ERM in
Sept 1992, resulting
in sharp fall in interest
rates and economic
recovery
450
Collapse in UK
GDP as credit
crunch bites
13
375
300
-3
225
-11
150
75
-19
-27
-35
1990
1990
1991
1992
1993
1993
1994
1995
1996
1996
1997
1998
1999
1999
2000
2001
2002
2002
2003
2004
2005
2005
2006
2007
2008
2008
2009
2010
abc
131
Sector description
General retail
The UK general retail sector is highly cyclical and a largely mature industry (70% organised retail
penetration) with few genuine defensive propositions and limited international revenue exposure.
Furthermore, owing to substantial private equity investment between 2002 and 2007, attracted by strong
cash generation, and premised on the availability of cheap debt finance and sale-and-leaseback freehold
property assets, a significant proportion of the industry is now in private hands. Accordingly, the listed
component is typically asset-light, is varied in nature with no two companies the same, and has a
combined market capitalisation of just cGBP24bn. The four FTSE 100 companies account for c65% of
this total, limiting investment opportunities. This compares with the cGBP62bn combined market
capitalisation of Inditex and H&M, the two major European stocks.
Where growth propositions do exist in this sector they are typically small/midcap companies, with one or
more of the following characteristics:
Specialist proposition with limited exposure to supermarket competition
Percentage of revenues from international and emerging markets
Exposure to, or the ability to adapt to, the internet and online consumer spending patterns, which, except
perhaps for the value-based propositions (eg fashion), is arguably the only area of structural growth
Key themes
Sector drivers and sales indicators
Macro drivers: unemployment, savings ratio, interest rates and inflation
In most consumption-driven economies (like the UK) the unemployment rate has a very strong
correlation with the GDP growth rate. Thereafter the savings rate (the percentage of disposable income
that is not spent) is the single largest determinant of future household disposable income, an increase in
the savings rate means less consumer spending with a knock-on effect on GDP and household income.
Base rates have a strong positive correlation with retail sector performance. Although lower interest rates
help support or encourage consumer spending and confidence, it is rising interest rates and by implication
the improving outlook for GDP growth that drives longer-term sector performance. Inflation is good for
the sector as it helps the top line and the bottom line for those who have pricing power.
Consumer confidence
In the short term, consumer confidence is a key lead indicator of the retail sectors performance. Although
consumer confidence has staged a marked recovery since the beginning of 2009 (from historically low
levels), the recent problems in Greece and Eurozone debt worries and, specifically for the UK, the general
election and emergency budget, have reduced consumer confidence. We note UK consumer confidence is
also closely correlated with that of the US.
Company sales indicators
Although the vast majority of companies in the sector are cyclical by nature, no two companies are the
same, and so the key lead indicators for sales and earnings growth performance can differ markedly
between companies. We give some examples on the next page.
132
abc
Paul Rossington*
Analyst
HSBC Bank Plc
+44 20 7991 6734
paul.rossington@hsbcib.com
*Employed by a non-US affiliate
of HSBC Securities (USA) Inc,
and is not registered/ qualified
pursuant to FINRA regulations
abc
10%
8%
23%
20%
5%
6%
15%
12%
4%
8%
4%
0%
-4%
-8%
-12%
-15%
-20%
0%
2%
-5%
Jul-10
-5%
-50%
-6%
-9%
-120%
Apr-08
Aug-10
-3%
Apr-10
20%
Dec-09
-1%
Aug-09
0%
Apr-09
90%
Dec-08
3%
Aug-08
3%
Aug-10
Jun-10
Apr-10
Feb-10
Dec-09
Oct-09
0%
160%
Dec-07
10%
7%
Aug-07
20%
6%
Apr-07
30%
Aug-09
Apr-10
Jun-09
Jan-10
Jul-09
Apr-09
Oct-09
Apr-09
Jan-09
Jul-08
Oct-08
Apr-08
Jan-08
Jul-07
Apr-07
Jun-10
Mar-10
Dec-09
Jun-09
Sep-09
Mar-09
Dec-08
Jun-08
Sep-08
Mar-08
Sep-07
Dec-07
-4%
Jun-07
-2%
-15%
Mar-07
-10%
Oct-07
0%
Argos and Homebase lfl sales growth vs John Lewis Elec &
Home category sales growth
MKS GM lfl sales growth and John Lewis Fashion sales growth,
MKS Food lfl sales growth and Waitrose sales growth
8%
-2%
-15%
0%
-5%
Aug-10
Jun-10
Apr-10
Feb-10
Dec-09
Oct-09
Aug-09
Jun-09
Apr-09
John Lew is- Elec & Home Tech (4 w eek rolling av g) (LHS)
John Lew is- Home (4 w eek rolling av g) (LHS)
Argos lfl sales (RHS)
Homebase lfl sales (RHS)
Aug-10
-10%
-20%
Jun-10
-10%
Apr-10
1%
Feb-10
16%
0%
Dec-09
-5%
10%
Oct-09
4%
0%
Aug-09
24%
20%
Jun-09
7%
5%
Apr-09
32%
30%
133
abc
EUR/GBP revenues
35%
65%
35%
100%
85%
60%
Company
EUR/GBP revenues
20%
50%
80%
80%
100%
100%
Kingfisher
Marks & Spencer**
Next
Note: *Home Retail Group derives >50% of revenues from electrical goods, a large proportion of which are sourced via the local agents of major branded manufacturers based in the Far East thus underlying exposure to rising input
cost pressures is greater than the directly sourced Far East CoGS would suggest. **Refers to Marks and Spencer General Merchandise sales only.
Source: HSBC, company data, all numbers are approximate
VAT
The increase in UK VAT to 20% from 17.5% not coming into effect until 4 January 2011, six months
after the rise was announced, was as good a result as UK general retailers could have hoped for. It
minimises implementation costs, as companies can re-price on the introduction of their Spring ranges
after Christmas, while providing a six-month window in which to identify the best way to pass on the
increase through higher prices and also to switch or renegotiate supply contracts.
134
abc
Classification
Cyclical vs defensive: Stocks can be classified as cyclical and defensive names as well as those offering
international diversification or genuine growth potential. Cyclical stocks typically trade at a premium to the
sector and can often deliver high or super-normal earnings growth, supported by a structural growth dynamic
(eg the internet) or cyclical recovery. Defensive stocks typically trade at a discount to the sector but are often
characterised by higher FCF/dividend yields supported by consistent and sustainable cash generation.
UK-centric vs international: Those stocks which offer international diversification (Kingfisher, Inditex,
Hennes & Mauritz, Mothercare) typically trade at a premium to UK-centric business models, with
exposure to emerging markets and BRIC territories highly valued by the investor.
FTSE100 vs FTSE350: FTSE100 stocks, because of their largely mature status, UK-centric business models
and thus low earnings growth rates, typically trade at a discount to other UK FTSE350 General retailers, often
characterised by companies with emerging competitive advantages via scale in specialist retail categories.
Accounting dilemmas
The proposed inclusion of off-balance sheet operating leases (essentially future rent liabilities attached to
retail stores) under IFRS accounting rules could negatively impact the perceived valuations of those
companies that do not screen well under this metric.
135
Notes
136
abc
abc
Sporting Goods
Sporting Goods team
Erwan Rambourg*
Analyst
HSBC Bank Plc
+44 20 7991 6793
erwan.rambourg@hsbcib.com
Antoine Belge*
Head of Consumer Brands and Retail Equity Research,
Europe
HSBC Bank Plc, Paris branch
+33 1 56 52 43 47
antoine.belge@hsbc.com
Sophie Dargnies*
Analyst
HSBC Bank Plc, Paris branch
+33 1 56 52 43 48
sophie.dargnies@hsbc.com
Sector sales
David Harrington*
Sector Sales
HSBC Bank Plc
+44 20 7991 5389
david.harrington@hsbcib.com
Lynn Raphael*
Sector Sales
HSBC Bank Plc
+44 20 7991 1331
lynn.raphael@hsbcib.com
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations
137
138
Sporting Goods
Global Players
Nike
Local Players
US
Lifestyle Companies
China
Europe
Casual
adidas
Puma
Under Armour
LiNing
Umbro
Lac oste
ASICS
Lululemon
Anta
Dcathlon
private label
Diesel
Converse
Xtep
Reebok
Kappa
Vertical
Retailers
Uniqlo
Luxury
Louis Vuitton
Christian Dior
Tods
New Balance
Action
Sports
Golf
Racquet
Sports
Billabong
Titleist
Babolat
Quiksilver
Callaway
Head
Hurley
Mizuno
Prince
Ping
Source: HSBC
abc
Nex t 12 months P/E for adidas AG (DE Listing) (DE) in EUR as of 20/08/10
35
35
December 1997
Salomon acquired by
adidas
June 2003
Converse acquired by
by Nike
October 2005
Sale of Salomon by
adidas
January 2006
Reebok
acquired by
adidas
July 2007
PPR bid on Puma
30
30
Historical PE valuation of the Sporting Goods industry: adidas, Nike and Puma forward PE since 1996
October 2007
Umbro acquired
by Nike
25
25
20
20
15
15
10
10
5
95
96
97
98
99
00
01
02
03
04
05
06
07
08
09
10
Source: FactSet
abc
139
abc
Sector description
The sporting goods sector includes companies that develop, produce, market, distribute and sell athletic
apparel, footwear and/or accessories (hardware such as golf clubs, skis and training machines but also watches,
footballs and fragrances). Although most apparel and footwear developed by these companies was initially
designed to actually practise a given sport, the consumer trend of wearing sporting goods products on evenings
or weekends just for the look has gradually blurred the boundaries between athletic and lifestyle products.
Global players: a few companies (such as adidas, Puma, Nike, ASICS and New Balance) have a
global footprint and a highly diversified portfolio of products. Nike, the world leader in the sector,
sells from California to Tokyo and caters to athletes in most sports, from the very broad football
(soccer), running, basketball and tennis product categories to the more regional or specialised
categories like baseball, cricket, American football and action sports.
Local players: some sporting goods companies have a more local reach. Although Under Armour
(originally grassroots American Football) and lululemon, for instance, have diversified their reach,
their main focus is still their domestic market in the US. Private-label brands, such as those
developed by French distributor Dcathlon, for instance, are limited in reach by the distributors
regional exposure. In China, where much of the production for sporting goods is done locally and
some consumers may not be able to afford or be willing to purchase the higher-priced Western goods,
many local companies, such as LiNing and Anta, have become big successes.
Niche/specialised players: some companies have developed an edge/specialty in a given subsector
of the industry. In racquet sports, for instance, companies like Babolat and Head have dedicated much
of their development to hardware (the actual racquets). Some companies are invested almost
exclusively in golf for example Titleist, Callaway, Mizuno.
Lifestyle companies: one of the problems when defining the sector is that consumers are much more
volatile than before and open to buying sporting goods as a lifestyle statement. Consequently, the
sector is broadly challenged by any company that manufactures sneakers or casual apparel, be it in
luxury (eg Christian Dior and Louis Vuitton), casual wear (Lacoste and Diesel) or vertically
integrated retailers (eg Uniqlo).
US athletic footwear market shares (total: cUSD12bn) 2009
Other
Other
22%
ASICS
Reebok
Reebok
4%
New Balance
4%
4%
Skechers
VF Corp
5%
adidas
6%
140
30%
34%
4%
Source: SGI
Nike
24%
Nike
Skechers
New Balance
Conv erse
7%
9%
adidas
4%
9%
Source: SGI
Puma
ASICS
Conv erse
6%
6%
7%
15%
Erwan Rambourg*
Analyst
HSBC Bank Plc
+44 20 7991 6793
erwan.rambourg@hsbcib.com
Antoine Belge*
Head of Consumer Brands
and Retail Equity Research,
Europe
HSBC Bank Plc, Paris branch
+33 1 56 52 43 47
antoine.belge@hsbc.com
Sophie Dargnies*
Analyst
HSBC Bank Plc, Paris branch
+33 1 56 52 43 48
sophie.dargnies@hsbc.com
*Employed by a non-US affiliate
of HSBC Securities (USA) Inc,
and is not registered/ qualified
pursuant to FINRA regulations
abc
Key themes
The difficulty of defining the boundaries of the sector itself means that the issue of barriers to entry is of
key importance for the companies that operate in sporting goods. On the performance side alone, barriers
to entry are high, as the major players (Nike, adidas) have considerable marketing and advertising clout,
ensuring that they can lock in the key sponsorship deals with high-profile teams (football clubs and
national Olympics teams) and athletes (NBA, ATP Tennis, golf stars and football stars). In the lifestyle
part of the business, barriers to entry appear more limited, although there too a brands capacity to
outspend its competitors is a key sales driver.
To make sure that inflation in ad spend and sponsorship costs does not hamper the long-term margin
profile of these companies, it is key for them to find ways of expanding/maintaining their gross margin
and containing operating expenses other than advertising and sponsorship costs.
We believe that the key concerns/themes for the sporting goods industry are:
Production cost pressures: an important part of production for sporting goods takes places in South-East
Asia most notably mainland China. Although the macro environments may influence the cost of goods sold
(via the prices of oil and oil derivatives, leather and fabric), we nonetheless believe Chinese wages are likely
to increase structurally over the long term, obliging companies in the sector to find ways of offsetting the
resulting pressures.
Commoditisation risk: with new entrants every year and the increasing credibility of private label, even on
technology-driven products, pricing power in the sector may turn out to be a long-term issue.
Currency fluctuations: since much is produced in countries with USD-related currencies (and often
negotiated in US dollars), any weakness in the dollar against a basket of currencies (notably the euro) is a
positive for the sector, and any strength of the dollar is a negative for both European players and Nike.
Increasing retail exposure: as a way of controlling their brand image (avoiding tough discounting from
distributors) and enhancing their gross margins, many brands have entered into comprehensive own retail
strategies. Although we believe the space for performance products should still be dominated by wholesale
(eg consumers will want to compare technology, looks, price and brands), we believe own retail makes sense
for the more lifestyle-driven products.
Advertising and sponsorship deals: one approach to the sector is to look at the inflation in advertising and
sponsorship deals, whose costs appear to be consistently rising as a percentage of sales, possibly creating a
perception that the value is going to athletes, not investors. This pressure on costs could lead to the belief that
big is beautiful within sporting goods or at least oblige small brands to be nimble if they are to establish a
worthwhile business model.
Sector drivers
The sporting goods sector has been driven by sector-specific events: big events like the FIFA World Cup or
Olympic Games that can drive sales while increasing marketing spend and also M&A events that have gradually
reshaped the competitive landscape. In future, we expect that one of the key drivers beyond these two will be
gaining access to higher-growth countries and developing leadership positions there, where margins are already
currently higher than in the US still the leading market for the sector.
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Sports events: sporting goods is characterised by on years and off years. The on years are all the even
years when the sector is moved either by the FIFA World Cup (eg 2006, 2010 and 2014) or by both the
UEFA Football Euro and the Olympic Games (eg 2008, 2012). Although some events both bring a strong
boost on sales and imply large advertising investments (World Cup), others (typically the Olympics) are
more akin to a PR event, entailing high costs but fairly limited event-related sales.
M&A and cash management: as advertising/sponsorship costs inflate, the sector has been very active in
terms of consolidation. Nike Inc (Nike, Converse, Umbro and Hurley) and the adidas group (adidas, Reebok
and TaylorMade) have been among the bigger players in this respect.
Geographic diversification: although the US remains the largest market by far, it is also structurally less
profitable than others (at least in terms of gross margin) as the products have, to a certain extent, been
commoditised there. Market share battles should now focus on higher-growth, higher-margin regions
including China.
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Antonin Baudry*
Analyst
HSBC Bank Plc, Paris branch
+33 156 524 325
antonin.baudry@hsbc.com
Nicolas Cote-Colisson*
Analyst
HSBC Bank Plc
+44 20 7991 6826
nicolas.cote-colisson@hsbcib.com
Amit Sachdeva*
Analyst
HSBC Bank Plc
+91 803001 3795
Dominic Klarmann*
Analyst
HSBC Bank Plc
+44 20 7991 6819
dominik.klarmann@hsbcib.com
Sector sales
Luigi Minerva*
Analyst
HSBC Bank plc
+44 20 7991 6928
luigi.minerva@hsbcib.com
Tim Maunder-Taylor*
Sector Sales
HSBC Bank Plc
+44 20 7991 5006
Richard Dineen
Analyst
HSBC Securities (USA) Inc
+1 212 525 6707
richard.dineen@us.hsbc.com
amit1sachdeva@hsbc.co.in
tim.maunder-taylor@hsbcib.com
Olivier Moral*
Anaylst
HSBC Bank Plc, Paris Branch
+33 1 5652 4322
olivier.moral@hsbc.com
Dan Graham*
Analyst
HSBC Bank Plc
+44 20 7991 6326
dan.graham@hsbcib.com
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations
143
144
Telecom
Media
Technology
Diversified telcos
Pay-TV operators
Telecom equipment
vendors
Deutsche Telecom
BSkyB
Free-to-air-TV operators
SAP, Capgemini
Advertising agencies
Original equipment
manufacturers
Nokia, Samsung
Professional publishers
Foundries
Reed Elsevier
TSMC, UMC
Portugal Telecom
Telefonica
France Telecom
Telenor
TeliaSonera
Tele2
JCDecaux (Outdoor),
Pages Jaunes (Internet)
Vodafone
Satellite operators
Inmarsat
Cable operators
Source: HSBC
abc
Telecoms, media and technology 1990-2003: growth, bubble and burst phases
9.0x
Macro
improvement
Signs of slowdown
in economy
8.0x
7.0x
6.0x
5.0x
10.0x
4.0x
3.0x
2.0x
Recess io nary
environment
1.0x
0.0x
J an 04
Jan 05
Jan 06
J an 07
J an 08
J an 09
Jan 10
Telecoms, media and technology 2004-2010: emerging market-led growth, economic slowdown, stabilisation and re-growth
30.0x
Peak of
dotcom bubble
20.0x
Burs ting of
dotcom bubble
3G licences
Pick up
of mobile
services
10.0x
0.0x
J an-90
J an-91
J an-92
Jan-93
Jan-94
J an-96
J an-97
Jan-98
J an-99
J an-00
Jan-01
Jan-02
Jan-03
145
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Jan-95
Sector description
The Telecoms, Media and Technology (TMT) sector encompasses a wide range of sub-sectors.
Telecom sector: The telecoms operators work on two different platforms, fixed line and mobile, and sell raw
connectivity (eg line rental and broadband) and services (eg voice and IPTV).
Media sector: The media sector brings together a large range of business models; some are advertising-related,
others not; some mostly local, others global; some suffer and some benefit from the audience fragmentation
due to digital media; and some are more capital-intensive than others. Traditional sub-segments are pay-TV
and free-TV, communication agencies (together with market research), publishers and internet-related players.
Satellite operators (fixed and mobile satellite service) and cable operators are linked to both media and telecom.
Technology sector: The technology sector is also fragmented and diverse. However, for ease of
understanding, we have divided the sector into four sub-sectors: telecom network equipment vendors, software
and services, original equipment manufacturers and foundries.
The entry barrier in the telecoms space is intrinsically very high, given that each market is dominated by three
to four key players and scale is the key determinant of success. However, regulators have attempted to
undermine these natural barriers to entry by intervening with remedies like unbundling the local loop so as to
promote market entry. In the media space, the need to have the use of a distribution platform (like satellite) has
been a powerful barrier to entry, but in future we believe that viewers will increasingly turn to broadband
internet links to receive their video content (eg via the BBCs iPlayer or Googles YouTube). This will open up
the media market to a broader range of names, in particular to internet and telephony brands.
Telecom and media are coming together converging in some instances and colliding in others. Telecom
service providers have entered not only the media sector with TV offerings, but also the technology sector, with
a host of applications. On the media side, cable/satellite TV operators are vying for telecom customers through
converged service offerings of voice and broadband along with TV. Standalone satellite operators, which have
traditionally relied on capacity leasing for revenues, are now becoming more ambitious, and are entering the
telecom space, aiming to offer broadband services using the terrestrial and satellite networks. In the technology
sector, device/hardware manufacturers, such as Apple have had some success in software. Mobile device/chip
manufacturers, such as Qualcomm, have also displayed interest in the mobile services business.
Overall, we believe the collision between the sectors will favour multi-play providers over single-play
competitors, not only from a customer perspective (bundling, cross-selling and churn prevention), but also from
a network cost perspective, as backbone and backhaul capacities can be shared. We therefore expect mobileonly players to increasingly seek to add fixed-line capabilities as Vodafone attempted to do in 2007 by
acquiring Tele2s operations in Italy and Spain. We also expect integrated telcos to look to expand their content
provision capabilities by, say, acquiring football tournament rights or even small content/application
companies. Consequently, we expect the purpose of M&A in TMT to shift towards building a cross-sector
presence in an individual market from creating a cross-country presence (although the appeal of adding
exposure to emerging market growth will continue to drive acquisitions).
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Stephen Howard*
Head, Global TMT Research
HSBC Bank plc
+44 20 7991 6820
stephen.howard@hsbcib.com
Olivier Moral*
Analyst
HSBC Bank Plc, Paris
Branch
+33 1 5652 4322
olivier.moral@hsbc.com
Dan Graham*
Analyst
HSBC Bank Plc
+44 20 7991 6326
dan.graham@hsbcib.com
abc
Key themes
Scale and capex important; multi-play and NGA likely drivers
As the TMT sectors converge, the service providers are expanding their capabilities (organically or via
acquisition) to market themselves as one-stop destinations for all telecom, media and software services for
residential and business customers. We believe this shift provides new growth opportunities for service
providers while cutting the overall cost of services for consumers. We expect the multi-play phenomenon to
continue, and forecast that operators pursuing the strategy of investing and expanding their portfolios stand to
benefit. Cable companies (eg Virgin Media) have so far been the main beneficiaries of the multi-play trend, as
their network upgrades were easier to achieve.
For fixed-line telecoms operators (usually the incumbents), we believe the pace of next-generation access
(NGA) fibre network deployment (with FTTN/VDSL or FTTP) is the key to success, as this upgrade greatly
enhances the bandwidth and range of services it is possible to offer. One key result of the upgrade is that it is
likely to change the competitive landscape. At present many incumbents find themselves out-competed by
unbundlers that have bought the use of the incumbents existing copper infrastructure to offer their broadband
ADSL services. Although we would expect regulators to insist on unbundling being extended to NGA
platforms as well, the fact is that it is intrinsically very expensive (as the unbundler has to install its equipment
in many more locations for it to work, and this necessitates very much higher capex). As a consequence, we
think that most competitors will have to purchase a wholesale service from the incumbent (which they will then
resell to their customers); and the returns on providing a wholesale fibre service will be much more attractive to
the incumbent than the returns it generates on unbundled copper.
New media
As the reach of the internet widens with increasing fixed-line and mobile broadband penetration, digital is
being hailed as the new growth frontier for advertising agencies. The emergence of online advertising, which
creates new advertising space without incremental demand, is causing fears of deflation in media prices. Media
owners (such as television channel owners and newspaper publishers) are already beginning to feel the
147
pressure. The increasing number of TV channels and websites has caused audiences to fragment, making them
harder for advertisers to reach and introducing more competition for media owners.
Sector drivers
Telecoms
The telecoms industry is subject to many drivers, including the affordability and availability of services, the
rate of technological innovation (Moores Law exerts a particularly powerful influence) and the extent of
regulatory intervention. And note that, although the sector is not highly geared to the economy, it is clearly
influenced by economic and business cycles.
The level of penetration (fixed, mobile and broadband) is a basic driver for telecom services and is, in turn,
driven by the availability and affordability of services. Although penetration levels have generally reached very
high levels in the developed markets, much demand in emerging markets remains untapped. Developed market
operators often, therefore, look to buy exposure to emerging markets, as they must otherwise rely on growth in
new services (eg IPTV or mobile broadband) to drive revenues.
Data services have recently been the key growth driver for mobile revenues, and we expect this trend to
continue. The three main enablers that we think are underpinning the demand for data services are: (1) better
network speed and coverage; (2) increased penetration of data-optimised devices, like smartphones; and (3)
improved packaging and marketing of data offerings. The penetration of smartphones is still quite low (c15%
in Europe at the end of Q1 2010), so we see considerable potential.
Regulation also plays a very important role. It is one of the main drivers in determining competitive intensity,
as the regulators decide the number of licences to be issued and set the level of many tariffs (in particular, those
relating to unbundling). On the mobile side, the regulators set mobile termination rates (MTR) and roaming
tariffs, which have a material impact on mobile revenues and EBITDA.
Technology cycles (and upgrades) influence the capex intensity of the industry, and operators that upgrade to
the new technology early can enjoy competitive advantages over the laggards (but are also often exposed to the
practical problems that inevitably accompany new technologies).
The economic environment also has an impact on the telecom sector. Consumer spending is usually less
cyclical, while enterprise revenues (eg roaming and IT contracts) exhibit greater cyclicality. However, we
stress that the relatively high margins seen in the telecom sector mean that, while revenues are tightly linked to
the economy, profits and cash flows are relatively defensive in nature.
Media
Media is a heterogeneous sector which lends itself more to stock-picking than to top-down sector-based
analysis; on the one hand, there are pay-TV operators, satellite operators and professional publishers whose
growth is mainly driven by consumer and service take-up and who generate the majority of their revenues from
subscriptions, whereas free-to-air TV operators, consumer publishers, communication agencies, market
research and outdoor rely predominantly upon marketing expenditure (mostly advertising).
The professional publishers are typically conglomerates with multiple areas of business, eg trade shows,
conferences, newswires, academic publications, specialist trade publications, only a few of which overlap,
which hinders sector generalisations.
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All pay-TV operators are more defensive in terms of their revenue-generating abilities during a downturn than
are free-to-air-TV operators or advertising agencies. Among the purely advertising-driven groups, the
communications agencies and market research are global businesses with high exposure to emerging markets
(typically 25% of revenues) whereas the media owners (eg TV, radio, directories and newspapers) are typically
local businesses, usually wholly exposed to their domestic economies. Only outdoor players are developing a
media that is fully advertising-related with a business model that can be duplicated everywhere in the world
(and catching growth opportunities in emerging areas).
Revenue growth is driven by market share gains from competitors, as well as from other types of media (eg if
advertisers shift money from radio to TV), and GDP growth. Top-line momentum, EBITDA margins and FCF
generation ability each play a critical role in driving the stocks. Media groups are mostly asset-light, and capital
intensity varies according to the platform (eg cable TV is much more capital-intensive than satellite TV).
Technology
The technology sector is highly heterogeneous. For the telecoms equipment vendors, we focus on the factors
driving the operators capex lines, while for the foundries, we focus on the capacity utilisation rate, ASPs
(determined by technological advance and the level of competition) and shipments to assess the likely
trajectory of the top line. Given the cyclical nature of the foundries business, we are cautious about
inventory/capacity build-ups and/or slowdowns in the order book.
149
Notes
150
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robin.byde@hsbcib.com
Joe Thomas*
Analyst
HSBC Bank Plc
+44 20 7992 3618
joe.thomas@hsbcib.com
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations
151
152
Transport sector
Airlines
Network
carriers
Airports/Toll Roads
Low-cost
carrier s
easyJet
British Airways
Ryanair
Lufthans a
Airports
Aeroports de
Paris
Fraport
Toll roads
Abertis
Atlantia
Brisa
Groupe
Eurotunnel
Logistics/ Shipping
Integrators
Deutsche postDHL
Freight
forwarders
DSV
FedEx
Kuehne &
Nagel
TNT
Panalpina
UPS
UK B us and Rail
Shipping
AP MollerMaersk
Rail
operators
Transport
Bus
operators
Firs tGroup
Go-Ahead
National
Express
Stagecoac h
Vinc i
Source: HSBC
abc
Relative stock performance: 10-year performance of MSCI European transport index, MSCI European equity, MSCI World transport index and MSCI World equity index
EMEA Equity Research
Multi-sector
September 2010
200
180
Financial crisis due to over
securitisation of risk
160
140
9/11 WTC, NY attack
120
100
80
60
January 2003
End of Bear Market (2000-02)
40
Aug-00
Aug-01
Aug-02
Aug-03
Aug-04
Aug-05
Aug-06
Aug-07
Aug-08
Aug-09
Aug-10
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153
Sector description
The global transport sector comprises a number of sub-sectors, which often have different economic
characteristics, earnings drivers and valuation references. These sub-sectors are airlines, logistics and
shipping, airports and toll roads, and land passenger transport (in Europe HSBC covers the UK bus and
rail sector).
Airlines
Airlines is a highly cyclical global sector, whose volumes correlate with GDP with a multiplier acrossthe-cycle of c1.5x. Airlines generally operate two business models full-service network carriers, which
combine regional feeder and intercontinental networks, and low-cost carriers, which generally operate
intra-regional networks, point-to-point.
The network carriers also often have large cargo operations, with revenue correlated with industrial
production. In addition, network airlines such as Lufthansa and Air France-KLM have other operations,
which include MRO (Maintenance, Repair and Overhauling), IT services and catering services. Low-cost
airlines operate on a low cost-low fare model. Primarily, they operate a young and smaller fleet, use a
single-type aircraft and secondary airports, and provide one class of service and sell unbundled services.
154
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Robin Byde*
Global Sector Head
HSBC Bank Plc
+44 20 7991 6816
robin.byde@hsbcib.com
Joe Thomas*
Analyst
HSBC Bank Plc
+44 20 7992 3618
joe.thomas@hsbcib.com
abc
FirstGroup and Arriva also operate in London, where operators are funded by the public sector for
providing contracted services to Transport for London. The UK rail operation is a largely franchised
process with operators winning the right to operate a franchise for a period of around seven years. The
sector has a high correlation with UK GDP, unemployment rates and consumer spending. Operators are
not responsible for rail infrastructure but instead they pay access fees to Network Rail. The rail industry is
highly regulated, and heavily funded by government subsidy and a revenue support system.
Key themes
Airlines
Global and regional recovery in demand and yields: Airlines have reported a recovery in traffic, yields
and earnings after a big dip in 2008-09. Cargo traffic recovered sharply but passenger traffic recovery is
slow, particularly in Europe. Premium traffic recovery has pulled the yields up. Passenger and cargo
yields recovered sharply in Q2 2010, but airlines are expecting yield growth to slow down during the
winter (September 2010 to March 2011). Structural cost cuts have also supported the earnings lift.
Capacity overhang: 2008-09 recession led to overcapacity. In response to this situation most of the
deliveries of new aircraft were postponed and older aircraft from running fleets were parked in deserts to
reduce the capacity. Now, with the slow recovery, European airlines are bringing the capacity back
slowly. However, the expansion of Middle-East-based carriers (capacity to grow at 14-15% CAGR 201015) is a worry as this capacity will be deployed on all the routes globally.
Fuel prices, emissions controls and departure taxes: Higher and volatile fuel prices remain a concern
for airlines; fuel expenses for global airlines increased by USD55bn in 2008 versus 2007 (IATA).
Departure tax (APD) came as extra burden for European airlines as airports in Europe are charging (or
planning to charge) a departure tax per passenger. If this tax is fully passed onto the passengers, traffic
growth may be hampered, but if it is (or a part of it) absorbed by airlines, it will burden their earnings.
Also, the European Union plans to start charging for carbon emissions from 2012 when each airline in
Europe (other regional airlines flying into Europe) will be charged for carbon emissions above a set limit.
Others: includes restructuring of the network/flag carriers and the ongoing threat of other modes of
transport such as high-speed rail, M&A, alliance growth and cross-border JVs.
factors such as near sourcing and a high basis of comparison. The trade multiplier in 1995-2007 averaged
2.6x global GDP, with an expanding supply chain. We forecast this could contract to 1.5x GDP for the next
few years due to the fragility of the global recovery, impact of withdrawal of stimulus and near sourcing.
Mid-cycle earnings growth: Clearly 2010 is the bounce-back year for earnings, showing significant
growth on soft comparables, with a focus now on trend growth through the mid-cycle. Currently we
forecast a fairly healthy 2011-2012 CAGR of 10-11% in operating profits versus c16% 2004-06.
Slowing of off-shoring: We believe that global freight is at a pivotal point. The rapid growth of the past
20 years with the expanding economy and off-shoring has slowed and even reversed, with a gathering
155
trend for production and assembly to be located nearer to end markets. Peak oil and supply chain security
are persuading many production managers to choose Mexico and Eastern Europe over China.
Supply overhang in container and dry bulk shipping: There is over-supply of container and dry bulk
ships. Companies have reduced the supply by laying up some ships and slow streaming (reducing the
speed of the ship). But with the recovery in demand, laid-up ships are coming back into service.
Fuel prices: Earnings of logistic companies are inversely correlated with increase in fuel prices.
Sector consolidation with healthy balance sheets: Gearing is generally low in the sector and companies
either have strong net cash or neutral positions. Many large projects have been completed and we expect
capex to remain comparatively subdued in the next two years. M&A will rise, particularly if trend organic
growth, as we believe, is slower, and also assuming assets prices remain comparatively subdued.
2008-09. Companies with dense networks (like Italian toll roads) or good hub characteristics (Frankfurt or
CDG airport) are in the best position to show good growth. Eurotunnel has more catalysts here (HS1, new
direct destinations from London, 2012 London Olympics) and better service than its ferry competitors.
Expansion in developing markets (Asia and Latin America): These high growth markets, are just exploring
the PPP model to develop their infrastructure and will provide the value accretion to shareholders as returns are
higher than in developed markets. Regulation and user demand could be a risk if not analysed properly.
Free cash generation with large capital expenditure programmes: Regulatory requirements (Atlantia) and
capacity constraints (Frankfurt airport) require large capital expenditure programmes. The revenues realised
from the resulting tariff structure and capacity increase (and traffic) should exceed the expenditure incurred.
(c40-45% of revenue from taxpayers). The sector has ridden the expansion of public spending but now
spending cuts are looming. Since 1997, subsidy increases due to the expansion of the London bus
network, maintenance of commercially unviable routes and people over 60 being given right to free offpeak travel. HSBC economists expect cumulative real declines in spending of c25% over four years. We
expect subsidies to come under pressure, eroding margins. Political will against operators seems to be
growing and investigation by the Competition Commission into non-London bus operations is ongoing.
Rail franchise opportunities ahead: Rail passenger revenue trends are strengthening after a stuttering
performance in 2009. Volumes are recovering and fares outlook is strong with an expected regulated fare
increase of 5.8% in 2010 based on July RPI of 4.8%. However, upside to earnings will be limited by the
revenue support mechanism, which de-risks rail franchises four years after they have begun. Up to three
new franchises were due to be awarded by next year a clear positive for the sector but government
consultation on changes to the franchising system has delayed the process.
Changing competitive landscape: Facing liberalisation in their home markets, European operators are
looking for growth abroad. Deutsche Bahn (German railway operator) recently acquired Arriva. The deal
reinforces the threat posed by major European operators. The UK is attractive because of its large,
156
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privately-owned market and high margins, especially in bus. This could lead to major M&A activities, but
expansion could also come organically through rail franchise wins or smaller acquisition in bus. So
competition could intensify and margins may take a hit.
Sector drivers
Airlines
(1) Passenger and cargo capacity (measured in available seat kilometres and available cargo tonne
kilometres); (2) passenger and cargo traffic (measured in revenue passenger kilometres and freight tonne
kilometres); (3) passenger and cargo load factor; (4) passenger and cargo yields (measured in revenue per
RPK/per passenger and revenue per FTKs; (5) fuel costs; and (6) gearing.
157
Notes
158
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ben.otoole@hsbcib.com
Emmanuelle Vigneron*
Analyst
HSBC Bank Plc, Paris branch
+33 1 56 52 4319
emmanuelle.vigneron@hsbc.com
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations
159
160
Travel*
Hotels
Tour Operators
Le isure
Bookmakers/
Online Gaming
Cruise Companies
Caterers/
Vouchers
IHG
Thomas Cook
Carnival
PartyGaming
Greene King
Compass
Accor Hotels
Tui Travel
Royal Caribbean
bwin
Enterprise Inns
Sodexo
Whitbread
Kuoni
888
Punc h Taverns
Edenred
M&C
Holidaybreak
Sportingbet
Marston's
Playtec h
JD Wetherspoon
William Hill
Paddy Power
Ladbrokes
Rank
abc
2
50%
1
0%
100%
0
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
-1
-50%
-2
-100%
-3
y-o-y % change in FTSE350 Travel and Leisure Index
100%
50
The sector also tends to track consumer confidence
50%
25
0%
0.0
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
-50%
-25
-100%
-50
UK c onsumer confidence in dicator- UK SADJ (RHS)
161
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Sector description
The travel and leisure sector comprises numerous diverse sub-sectors including pubs and restaurants,
hotels, cruise and tour operators, bookmakers and gaming companies, and catering companies. In
addition, there are a several smaller esoteric businesses that do not fit neatly into a specific sub-sector,
such as the fast food delivery company Dominos Pizza and cinema operator Cineworld. One should note
that airlines and bus and rail operators also fall under the travel and leisure umbrella, but in this report are
categorised under transport.
Key themes
Discretionary spend
Unlike other sectors, such as banks or oil and gas, where there is a common denominator for all sector
constituents, in the travel and leisure sector similarities between companies are more subtle. For example
what connects a pub company to a tour operator, or indeed a hotel to an online gaming company? Broadly
the connection is that each company depends on some form of discretionary expenditure. As an
example, consumers are unlikely to view expenditure on eating out, going on holiday or gambling as
essential, even if it is enjoyable. Moreover, when confidence and incomes are high, spending on
discretionary items is also likely to be strong. Alternatively, if economies weaken, confidence falls and
individuals and firms cut discretionary spending to ensure sufficient income is available to cover more
important expenses such as staples, rents and utilities. It is the dependence on discretionary spending that
makes the sector more cyclical than many others.
Long-term growth
Despite this cyclicality, all sub-sectors have in the past, and most likely will over the long term, exhibit
real structural growth. Travel-related companies such as hotels, tour operators and airlines benefit from
GDP growth, while increased globalisation means more people travelling and political change can allow
freer movement of people. Meanwhile, as disposable incomes increase in both developed and emerging
markets, there is greater demand for leisure activities such as eating out, holidays, sporting events and
gambling. Part of the art of investing in the travel and leisure sector is to determine which factors
influencing demand and supply are cyclical and which are structural.
Sub-sector drivers
Considering the diversity of the sector, we think it is best to analyse each sub-sector independently,
knowing that each one has its own unique structure and is subject to different macro and micro drivers. For
example, the barriers to entry in the cruising industry are high since large sums of capital are required to
acquire a new cruise ship. In contrast, opening a new restaurant is much easier as there are relatively few
barriers in the restaurant industry. At the same time, average spending is high in the cruise industry but
volumes are low, while average spending per head in restaurants is low but volumes are high.
Although clearly not exhaustive, we have highlighted below some of the key themes to be aware of
within each sub-sector:
Pubs and restaurants: growth of the eating-out market versus the decline of the drinking-out market;
changes in taste and preferences, such as for locally sourced produced and healthier menus; freehold
versus leasehold sites and property values; managed, leased, tenanted or franchise-based operating
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Ben OToole*
Analyst
HSBC Bank Plc
+44 20 7991 3448
ben.otoole@hsbcib.com
abc
models; a fragmented industry with consolidation potential; input cost inflation; competition from
supermarkets and the off-trade; changes in duty and taxes; and changes in regulation.
Hotels: penetration of branded hotels versus non-branded hotels; low growth in developed markets
versus growth in emerging markets; asset-light versus owner-operated business models; recovering
demand and limited new hotel capacity; changes in corporate travel budgets; loyalty schemes; and
asset values.
Cruise and tour operators: changes in aircraft and ship capacity; growth of independent travel,
disintermediation caused by the internet; changes in booking patterns; growth of low-cost carriers;
exchange rates; geo-political risk and climate change; fuel costs; and changes to excise and duty rates.
Bookmakers and gambling: high growth in online versus subdued growth in land-based gambling;
changes in tastes and preference, such as growth in football betting and the decline in horse racing
betting; changes to global regulation, taxes and duties; social acceptance and awareness of gambling.
Caterers: size of overall market and potential growth of outsourcing; penetration levels vary across
industry sectors and regions; cyclical or defensive; types of contract; input costs (food and labour);
Sector drivers
Consumer and business confidence
Quite simply, increasing confidence means greater discretionary spend. We have outlined that relationship
for consumers above, but it is also worth considering business confidence. Corporate spending on airlines
and hotels usually fluctuates with the economy, with flights and rooms being upgraded to premium
categories in the good times, but travel restrictions quickly being enforced in tougher economies.
Input costs
Yet again input costs differ between sub-sectors. However, labour is more often than not one of the
highest costs. Other key costs are food and beverage costs for hoteliers, pubs and restaurants, and fuel
costs for cruise and tour operators, and airlines. These costs ultimately depend on commodity markets,
although businesses tend to have long-term contracts with suppliers in order to reduce volatility.
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places in the UK in 2007 (which includes public places such as bars and restaurants), wet-led pub
operators quickly had to substitute declining alcohol sales, due to the change in customer mix, with food
sales. Since expenditure in the sector is discretionary, it is often an easy target for governments to tax;
duties on alcohol, gambling and air travel are obvious examples.
Accounting issues
Most operators have fairly predictable cash flows since customers pay for their goods and services when
they receive them. Therefore the conversion ratio of operating profit into free cash flows tend to be high,
and this, in most cases, means accounting standards are fairly straightforward.
One issue to be aware of is operating leases, which can be used for property assets such as real estate and
aircrafts. Since these assets are simply leased, the potential full liabilities are not capitalised on the balance
sheet. Investors need to be aware that, as these liabilities are often spread over a long period of time, the
actual level of gearing can be understated. To compensate for this, a calculation is made to determine
adjusted net debt/EBITDAR, and capitalising the annual lease cost at 8x is often used. Alternatively
investors can focus on the fixed cover charge, which takes into consideration both interest costs and rent.
Another area to focus on is working capital. Assuming the top line is growing, then working capital tends
to be positive, since cash is paid when goods and services are acquired, but suppliers are often paid 90
days later. However, if sales fall, then less cash comes in but suppliers still need to be paid, and there is a
working cash outflow. This is particularly important for tour operators as, due to the seasonal nature of
their businesses, they can see a large swing in working capital from the time cash comes in over the
summer months from customers paying the balance of their holidays, to the low point, usually at the start
of the calendar year, when they pay hoteliers for their allocation of rooms for the prior year.
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Utilities
Utilities team
Adam Dickens*
Analyst
HSBC Bank Plc
+44 20 7991 6798
adam.dickens@hsbcib.com
Jos A Lpez*
Analyst
HSBC Bank Plc
+44 20 7991 6710
jose1.lopez@hsbcib.com
Verity Mitchell*
Analyst
HSBC Bank Plc
+44 20 7991 6840
verity.mitchell@hsbcib.com
Sector sales
Mark van Lonkhuysen*
Sector Sales
HSBC Bank Plc
+44 20 7991 1329
mark.van.lonkhuysen@hsbcib.com
Billal Ismail*
Sector Sales
HSBC Bank Plc
+44 20 7991 5362
billal.ismail@hsbcib.com
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations
165
166
Power/Gas
Water/Waste
Regulated
Non-Regulated
Regulated
Non-Regulated
National Grid
Veolia Environnement
Centrica
Pennon Group
Suez Environnement
Enagas
International Power
Severn T rent
Seche Environnement
Red Electrica
United Utilities
Utilities
E.ON
RWE
EDF
GDF Suez
Enel
Iberdrola
Gas Natural
Energias de Portugal
Fortum OYJ
Verbund
CEZ a.s.
Source: HSBC
abc
7
2. But the y ie ld premium narrowed during 2004-2008 when the sector
traded at a higher PE - valu ations underpin ned by a strong upturn in
3
3. However, in wake of the recent global financia l crisis and the
consequent decline in commodity prices, the sector has regained its
0
Jan-95
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
abc
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Sector description
Traditionally seen as a defensive sector but earnings volatility increasing
The European utilities sector encompasses companies operating across the value chain in electricity, gas,
water and environment services. For electricity and gas, upstream activities include: power generation,
and oil and gas exploration and production, while downstream activities are related to retail sales and
services. These activities are lightly regulated in Europe. However, infrastructure activities (transmission
and distribution networks and pipes) are subject to regulated returns. Environmental and waste services
are competitive activities, water supply activities in England and Wales are subject to regulated returns in
contrast, but are unregulated in France. Operating profit margins are higher in more asset-intensive and
regulated activities, but lower in retail supply (single digits) owing to competitive pressures.
As regulated networks are relatively immune to economic cycles, the sector is traditionally seen as a
defensive sector or yield play. However, unregulated activities have become less defensive as political
pressure (the threat of re-regulation), environmental legislation (Kyoto targets), competition and volatility
in commodity prices have contributed to eroding margins.
Key themes
Power
EU energy policy and regulation competitive pressure
Given the challenges of rising energy demand, finite fossil fuel resources and the need to protect the
environment, energy policy and regulation in Europe are being centred on three overarching objectives:
energy security, environmental protection and affordability. Regulation in individual member countries is
being shaped by the broader EU objectives of an internal energy market and the 20-20-20 initiative for
2020 aimed at energy efficiency. Members are targeting the establishment of an EU-wide internal energy
market as a means of promoting competition and giving consumers a choice of suppliers. However, lack
of interconnection among networks and barriers to cross-border M&A activity have put a brake on this
aspiration. Although network activities have been legally unbundled from generation and supply activities
in most countries, competition is still weak and there are high barriers to entry owing to high capital costs.
In several of the EUs major markets (France and Germany) the former monopolies still control the
transmission and distribution networks.
Climate change energy policy subsidy pressure
The 20-20-20 EU goal aims for a 20% reduction in primary energy consumption and carbon emissions,
and for 20% of energy needs in the EU to be met by renewables by 2020. The impact of climate-changerelated policy will continue to affect the utilities sector. The regulated companies will potentially benefit
from the need to build new grid to connect renewable energy installations, and to reinforce the existing
grid to withstand huge fluctuations in renewable output. The non-regulated companies will suffer as a
result of the reduced load factor from existing plants and the limited load factor from new flexible plants
(CCGT, for the most part) caused by the construction of renewable plant particularly wind. These
companies hope to take advantage of renewable subsidies to offset the lower profitability of their
conventional plant by involving themselves in renewable activities, usually via listed subsidiaries. Owing
to the fall in load factors of conventional thermal plant, there have been calls from within the industry
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abc
Verity Mitchell*
Analyst
HSBC Bank Plc
+44 20 7991 6840
verity.mitchell@hsbcib.com
*Employed by a non-US affiliate
of HSBC Securities (USA) Inc,
and is not registered/ qualified
pursuant to FINRA regulations
abc
(E.ON for example) for capacity payments to be paid to generators for running conventional flexible plant
as a means of guaranteeing security of supply when renewable generation output fails (wind and hydro).
The EU cap-and-trade system the European Union Emissions Trading Scheme (EU-ETS) is a mechanism
for encouraging companies to reduce carbon emissions by requiring them to purchase carbon certificates to
cover amounts that exceed their free allocations. Under the current EU-ETS, generators receive a varying
amount of carbon emission certificates free of charge and will do so until 2012. By 2013 most Western
European countries will have to purchase 100% of their requirements. Central and Eastern European (CEE)
countries will have to do likewise by 2020.
Energy security and an ageing European fleet medium-term profit outlook improving
The economic crisis led to an increase in the capacity reserve margin (unallocated power available to the
grid) and has reduced the need for new investments. It has also reduced spreads (the profit margins
achieved by generators). However, new build will be increasingly required in the second half of the next
decade irrespective of the degree of demand recovery. Europe has a plant ageing problem, as close to
60% of its conventional plants are in the second half of their lifecycle. Also, under the EU Large
Combustion Plant directive (LCPD), a significant number of non-compatible plants are expected to close
in 2015. These supply-side constraints call for significant investments, and in clean technologies. There
will also be a need to invest in network reinforcements. We believe these pressures could lead to a
recovery in spreads and profitability for the sector.
Political risk increasing
Political and regulatory risk increased with the economic downturn, as EU governments again recognised
the possibility of using utilities profits and/or driving down regulated utility returns to reduce customers
bills. Germany intends to raise EUR2.3bn annually from the nuclear power generators as part of its 201114 austerity plan. In the wake of the German nuclear tax, the prospect of regulatory risk has now moved
on to Spain, Italy, Belgium and Finland. Belgium and Sweden already tax nuclear power, and Finland
now intends to do so as well. Belgium imposed a levy of EUR250m on its nuclear industry in 2008 and
2009, and Sweden already levies EUR6.7/MWh of nuclear output (revised in 2008). In late March 2009
Finland said it intended to levy EUR30m-330m starting from 2011. The UK power companies contribute
to a poverty package for consumers but, given the need for investment especially in new nuclear, we
view heavy taxes on generation as less likely in the UK.
Growth areas: emerging markets and renewables
Faced with low growth in mature western European markets, utilities have expanded their investment in
renewables and their presence in emerging markets (CEE, Russia, Latin America and the Middle East) in
search of growth. Major companies with a sizeable presence in renewables and exposure to high-growth
markets include Iberdrola, EDP and Enel. Markets include: (1) Latin America GDF Suez, Gas Natural,
Iberdrola, EDP and Enel (through Endesa); (2) Russia Fortum (TGK-1, TGK-10), E.ON (OGK-4), and Enel
(OGK-5); and (3) Middle East and Asia GDF Suez, International Power.
Water
Investment in growing asset bases
Water companies continue to invest in the water network, rehabilitating ageing pipes and enhancing waste
water treatment, to comply with EU directives most notably those covered by the EU Water Framework
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Directive (2013). For UK water companies, the RAB (regulated asset base) or RCV (regulatory capital
value) is the asset value (calculated by the regulator in every five-year period) on which companies earn a
return based on an approved WACC that is revised in every regulatory period. For equity investors, the
RCV provides a spot reference point as to whether the stock is trading at a premium or a discount, while
stable regulated returns provide visibility on dividends. Moreover, because of the regulated nature and
high visibility of returns, the proportion of debt to RCV tends to be high, in the range of 55% to 65%. The
UK water companies are allowed to increase their prices each year using the RPI x + K formula,
where x denotes the efficiency savings factor and K is the factor used to raise prices to cover the
financing of new capital expenditure and other expense items related to the improvement of its assets.
Global scarcity
For the French water companies, the scarcity of project finance and the austerity measures by many
governments and municipalities led to fewer water treatment and desalination project awards over 200910. We believe contracts will be awarded and growth will resume, especially in areas of acute water
shortage Middle East, Australia, China and some parts of the US.
Sector drivers
For utilities, earnings drivers differ depending on whether the operations are regulated or unregulated.
Regulated stocks
Regulated network activities are remunerated through an approved return (WACC) on a RAB. Companies
may extract a return higher than the allowed/approved return through operational and/or financial
efficiencies. Thus, profits for regulated activities are a function of: (1) investment/RAB growth; (2) the
level of allowed returns/WACC; and (3) operational, financial efficiencies.
Unregulated stocks
The profitability drivers of unregulated activities are explained below:
Demand growth: Overall, energy demand is directly linked to the pace of economic growth,
industrial demand being more cyclical and residential demand being stable. Other factors affecting
energy demand are demographic changes and advances in energy efficiency methods. Demand
growth also affects environmental services. Reduced demand caused by the economic recession has
been a negative influence on the waste management activities of the water companies.
Commodity prices and power activities: Higher economic growth and consequently higher fuel prices
(oil, gas, coal) result in higher power prices a trend that benefits upstream power generation companies
but hurts downstream suppliers. The profitability of power generators also depends on the nature of their
assets. For power generators with baseload assets (hydro, nuclear and lignite), earnings tend to be highly
geared to commodity prices, and their key profit metric is the achieved power price, as variable costs for
such technologies are very low. For mid-merit (coal and gas) plant operators, the key profit driver is the
spread between power prices and associated fuel and carbon costs. Finally, for peaking (gas, oil and
pumped storage) plant operators, short-term volatility is a key profit driver. In addition to engaging in
downstream retail activities that act as a natural hedge to upstream generation, utilities typically sell power
forward up to three years in advance to mitigate the impact of commodity price volatility.
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Commodity prices and gas activities: The profitability of upstream E&P operations is a direct
function of the trend in oil and gas prices, which, in turn, is linked to the level of economic activity
and the structural demand-supply balance in a market. Downstream gas suppliers in Europe mostly
secure gas on long-term contracts (indexed to oil prices), so movements in spot gas prices versus
long-term contracted gas price determine the profitability of gas suppliers.
Demand-supply mismatch and level of integration: Power prices and pressure on spreads tend to
be lower where reserve margins are comfortable (ie supply exceeds peak demand). Also, the level of
interconnection between countries can influence the level of prices through the import/export of
energy. However, for the time being, the level of interconnection in Europe remains relatively low.
Weather: The weather affects the sector on both the demand and supply sides. On the demand side, for
example, a cold winter can increase energy demand, while on the supply side, wind conditions and
water/hydro reservoir levels affect the level of electricity production from renewable energy sources.
relatively stable returns, the preferred valuation techniques are: (1) DDM higher dividend visibility
given stable regulated earnings and a defined dividend payout range; (2) DCF the source of value is the
companys ability to generate free cash flows and long-term growth; (3) residual income method the
technique focuses on value creation through a companys ability to earn returns above the level allowed
by the regulator, and captures long-term growth; and (4) asset valuation application of a premium or
discount to the RAB depending on the quality of assets.
Upstream activities: Unlike regulated stocks, utilities whose business model is dominated by upstream
power generation, or upstream oil and gas, have volatile earnings that are geared to trends in commodity
prices (oil, gas, coal and carbon). Consequently, such stocks tend to trade at higher market multiples
during an upturn in commodities, and lower multiples during a downturn. Power generation assets are
typically valued by the DCF/MW of a particular technology, with baseload technologies (renewables,
hydro, nuclear and lignite) deserving a higher valuation than the mid-merit to peaking technologies (coal,
gas, oil-fired plant and pumped storage plants).
Downstream activities: Although profit margins are high in upstream activities, they are low in the
downstream or retail supply of power or gas owing to intense competition. Retail activities are typically
valued by ascribing a DCF/customer value to the number of customers, with more value being assigned to
customers with combined power and gas supply.
a recurring or EBITDA or EPS. Most utilities report a recurring operating metric that excludes one-off
items. Dividend, which is among the sectors principal attractions, is often linked to recurring EPS. Given
investors preference for consistent dividends, most utilities try to maintain a stable growth rate in
dividends and offer visibility on payout (the typical range for large utilities is 50% to 60%).
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Notes
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Basic Accounting
Guide
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations
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Power of suppliers
New entrants
Rivalry
High rivalry will result from the extent to which players
are in balance, growth is slowing, customers are
global, fixed costs are high, capacity increases require
major incremental steps, switching costs are low,
there is a liquid market for corporate control and exit
barriers are high.
Substitute products
Power of customers
COMPANY
Strengths
Patents
Strong brand and/or reputation
Location of the business
The products, are they new and innovative?
Quality process and procedures
Specialist marketing expertise
Opportunities
Threats
New competitor
Price war
Competitor has a new, innovative substitute product or service
Rivals have superior access to channels of supply and distribution
Increased trade barrier
Taxation and/or new regulations on a product or service
Source: HSBC Note: The upper score represents an assessment of the balance of strengths and weaknesses. Similarly the bottom number scores the balance of opportunities and risks.
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abc
The figure above combines a diagram of a Five Forces model used to analyse an industry, with an outline
of a SWOT analysis for evaluating a company.
Porters Five Forces is an analytical approach that assesses industries or a company by five strategic
forces; it helps to indicate the relationship between the different competitive forces within the industry.
Five Forces can be used by a business manager trying to develop an edge over a rival firm or by analysts
trying to evaluate a business idea.
Porters Five Forces has a scoring system in which positive, negative or neutral results are combined to give a
final score for each force. The higher the score, the more sound the industry, or business is.
SWOT analysis is routinely used to help the strategic planning of a firm in the business world. Strengths
and weakness (SW) apply to any internal factors within the firm, while the opportunities and threats (OT)
are the many external factors that a firm must account for.
Valuation
The following sections give a brief introduction to the main accounting issues and valuations techniques,
their definitions and ratio analysis. It is structured by addressing what is valued, how it is valued, and the
inputs of the valuation. This accounting guide can be used to gain a better understanding of a companys
financial statements. We include a brief introduction to balance sheet items. The valuation measures and
methods described below apply only to listed companies.
Valuing what?
Enterprise value (EV)
An enterprise is a company and therefore the enterprise value is a measure of the whole companys value.
It is believed by many to have more uses than market capitalisation, because it takes into account the
value of debt for a company (and also adjusts for minorities and associates) to make it suitable for ratios
above the P&L interest line such as EV/sales, EV/EBITDA and EV/EBIT.
Calculate by: market capitalisation (all share classes) + net debt (and other liabilities, such as pension
deficits) + minority interests associates (both fair value).
There are three types of enterprise value: total, core and operating.
Enterprise value
Source: HSBC
175
Net debt
This is the total amount of debt and liabilities a company has after subtracting the value of its cash and
cash equivalents. A company with more cash than debt would be said to have Net Cash.
100% of the assets and liabilities (in the balance sheet) and 100% of the cash flows of a subsidiary,
but also deduct the minorities shares of profits in a separate minorities P&L line, their share of net
assets in a minorities balance sheet line and any dividends paid to them in the cash flow. For
example, if Company A owns 80% of Company B, where Company B is a GBP100m company.
Company A will have a GBP20m liability, on its balance sheets, to represent the 20% of Company B
that it does not own, this being the minority interest.
As an adjustment in an EV, DCF valuation, etc, at fair value (rather than the book value used in the
balance sheet). For example, if fair value was GBP30m, this would be added to EV and deducted as
part of the DCF.
Pension obligations
This is a projected sum of total benefits that an employer has agreed to pay to retirees and current
employees entitled to benefits. There are two main types of pension scheme:
Defined Benefit, where payment is linked to employees salary level and years of service. The
benefits are fixed but, as the actuarial assessment of the liability depends on changing factors (such as
life expectancy and discount rates), the companys liabilities (and contributions) are variable. The
company has an obligation to pay out the determined benefit and, if there is a shortfall in the fund,
must draw on the companys profits to subsidise the discrepancy.
Defined Contribution, where the employers contributions are fixed but the benefits are variable.
The pension in retirement depends on the cumulative contributions to the fund, returns from its
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An estimate of liability if the pension plan assumes immediate discontinuation; it does not take into
account any future salary increases.
Discount Rate
The rate used to establish the present value of future cash flows.
Retrospective benefit costs for services prior to pension plan commencement or after plan
amendments.
This assumes the pension plan is ongoing, as the employee continues to work, and therefore it
projects future salary increases.
Service Cost
Most plans require a certain number of years service before benefits can be collected, and this is
Vested. The VBO represents the actuarial present value of vested benefits.
Source: HSBC
Valuing how?
Cash flow
This indicates the amount of cash generated and used by a company over a given period. There are
several different measures, used for different purposes, plus a cash flow statement in the reports and
accounts.
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For a business lasting beyond the n years for which you have estimated cash flow, add a terminal value,
being the value at year n discounted to the present day. The value at year n+1, if thought to be a
perpetuity growing at rate g per annum, would have a value in year n of CFn (1+g)/(r-g) and a present
value of CFn(1+g)/(r-g)/(1+r)n.
Multiples
Multiple
Calculation
PE ratio
Price of a stock
Earnings per share
Definition/Interpretation
Helps to give investors an overview of how much they are paying for a stock; the ratio states
how many years it would take for the investors to recoup their investment, with the company
keeping profits steady (if fully distributed as dividends).
Generally companies with high PE (over 20) are faster growing, while a low PE may be
an indication that the companies are low-growth or mature industries.
PEG ratios
EV/Sales
EV/EBITDA
Price/Earnings Ratio
Annual EPS Growth
Market capitalisation
Total assets - Intangible assets
- Liabilities
(equal to price / book value per share)
EV (see above to calculate)
Annual Sales
This ratio is used to determine a stocks value taking into account earnings growth,
especially if growth is very high. A low PEG company may reflect high risk.
This ratio compares stock market value with book value; it can be compared throughout
the same industry sector. It can be based on net assets or after deducting intangibles.
As sales are above the interest, associates and minorities lines in the P&L, it is more
consistent and popular to compare EV (including net debt and adjusted for minorities and
associates) with sales than, say, price/sales.
EBITDA (earnings before interest, tax, depreciation and amortisation) is also above the
interest, associates and minorities lines, so comparing with EV is consistent and popular.
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This calculates the firms cost of capital, with each category of capital proportionally weighted. It is used
with pre-interest cash flows (eg DCF) or profits (eg Economic Profit).
Calculate by:
Cost of debt
This is the effective rate that a corporation pays on its current debt; it can be measured either pre- or posttax. It is usually higher than the risk-free rate (eg 10-year government bond yields) because of the spread
over such bonds that corporate bond holders tend to demand.
Cost of equity
This is in theory the return a stockholder requires for holding shares in a company; representing the
compensation that the market demands in exchange for owning the asset and bearing the risk of ownership.
Calculate by: Risk-free rate + equity beta x equity risk premium
Equity beta
The correlation between a share and the general stock market. It is useful to estimate the cost of equity for
a stock as an investor can, in principle, diversify away uncorrelated risks, but not correlated sensitivity to
the market.
Equity risk premium
This is the premium investors would expect for investing in equities because of the higher risk. It is a
measure for the general stock market rather than individual stocks.
MACC inputs
Invested capital (IC)
This is capital that the company can invest within itself or has already invested internally.
Calculate by: Long-term debt +stock + retained earnings
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This evaluates a companys cash return to its equity: it measures the cash profits of a company and
compares this with the proportion of the funding required to generate it.
Calculate by:
Where,
Gross cash flow is operating cash flow plus post-tax gross interest expense
GCI: Gross fixed assets plus gross intangible assets plus net working capital plus cash
Multiple inputs
Earnings per share
Net profit per share, which may be headline or adjusted (for example, to exclude the impact of nonrecurring items). Shares are normally those in issue (excluding treasury shares owned by the company).
Calculate by:
Book value
The value at which an asset is carried on the balance sheet, taking into account depreciation that may have
occurred each year after the asset was brought. Each asset, from the smallest piece of equipment to the
whole business, has a book value. The fair value of an asset may be higher than its book value, and often
is. However, if the fair value is lower then the book value, it should be written down to fair value.
Sales
Total amount of goods sold over a given period, usually reported net of any sales taxes (eg value added tax).
Dividend
This is the distribution of earnings to shareholders. It can be paid in money, stock or, very rarely,
company property. The occurrence of the dividend payment depends on the company; it can either be
paid quarterly, half yearly or once a year, and may be ordinary (usually expected to recur) or
special/extraordinary (often non-recurring).
EVA inputs
Net Sales
This is the sales figure with deductions for any discounts, returns, and damaged or missing goods or sales
taxes (eg value added tax).
Operating expenses (OPEX)
Any expenses brought about by the operations of the company, eg cost of goods sold, SG&A (selling,
general and administrative expenses). It does not include non-operating costs (such as interest or tax).
Net operating profit less adjusted taxes (NOPLAT)
This is operating profit (net sales less opex) minus the tax that would be paid if there were no other
factors (such as tax-deductible interest).
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Quick ratio
Debt/equity ratio
Calculation
Definition/Interpretation
Current assets
Current liabilities
Financial liabilities
Shareholder funds
EBIT
Interest
Net Income
Shareholders Equity
* 100
* 100
Return on invested
capital (ROIC)
NOPLAT
Total Capital
Sales
Assets
Sales
Inventory
Sales
Average Debtors
Credit purchase
Average creditors
This indicates the credit period that firms benefit from before
they pay off their creditors. A high ratio indicates that the
creditors are being paid promptly, while a low ratio is good for
working capital.
Dividend yield
Gross margin
Gross Profit (sales less COGS) as a percentage of sales.
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Depreciation
The reduction in value of an asset through time, use, etc. EBITDA less depreciation and amortisation is
EBIT. It is non-cash (the cash already having been paid to acquire the asset) but a part of the P&L and an
annual reduction in balance sheet asset value. If an asset is depreciated over its useful life, it may well
need replacing when fully depreciated at end-of-life.
Amortisation
This is a reduction in the cost of an intangible asset through changes in income. If Company A buys a
piece of equipment with a patent for GBP25m and the patent lasts for 10 years, GBP2.5m each year
would be recorded as amortisation. (Depreciation, by contrast, is for tangible assets such as land,
building, plant and equipment.)
Interest
Financial income (on cash, etc) less expense (on bonds, bank debt, etc). Some companies include their
share of profits from associates, dividends from investments and various other factors (eg FX gains and
losses) in a Financial Items line along with interest.
Tax
Taxes on company profit, as opposed to sales taxes (usually deducted directly from sales) or operating
taxes (usually added to staff costs, property costs, etc, in opex).
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Provision
Costs are provided for if they are expected but have not yet been paid. For example, banks unlikely to
collect all the money lent provide for the proportion they expect not to collect, damages for a law suit
expected to be lost, etc. Provisions are often included within COGS or SG&A.
Clean profit
Restructuring and other non-recurring costs (or income) are often separately identified by companies to help
understand and predict future profits and often adjusted for in clean profit measures, eg clean EBIT.
Continuing operations
These are the segments within a business expected to continue functioning for the foreseeable future.
For investors it indicates what the business could rationally be expected to replicate in future.
Discontinued operations
These are any segments of a business that have been sold, disposed of or abandoned. This is reported
separately in the accounts to continuing operations.
Non-current assets
Assets not easily convertible to cash, or not expected to become cash within the next year. Also known as
long-life assets.
Fixed assets
Assets that a company uses over a long period of time; they are not expected to be sold on.
Intangible assets
An asset that is not physical in nature, such as corporate intellectual property rights, goodwill, brand
recognition.
Investment assets
An asset not used within the companys operations.
Receivables
All accounts receivable and debt owed to a company, whether they are due in the short or long term.
Current assets
Assets expected to be turned into cash within the coming year, or assets that are expected to be sold.
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Inventories
The value of the firms raw materials, work in process, supplies used in operations and finished goods.
Liabilities
Money, services and goods that are owed by a company.
Non-current liabilities
Liabilities not expected to be paid with a year.
Current liabilities
Liabilities expected to be paid throughout the coming year. They include short-term debt, payable
accounts, unpaid wages, tax due, etc.
Share capital
The original value of the shares issued by a company; therefore, even if there is a rise in the share price,
this is not taken into account. Shares may be issued at the creation of the company or later and may be at
nominal value or with a share premium on top.
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Retained earnings
Cumulative total earnings minus that which has been distributed to the shareholders as dividends.
Calculate by: Closing retained earnings = opening retained earnings plus earnings in the period less
dividends declared in the period
These include cash receipts from sale of goods and services and cash payments to suppliers for goods and
services.
Other income
These include interest received on loans, dividends received on equity securities, payment to employees, etc.
Non-cash items
These include depreciation, amortisation, deferred taxes, etc, which are added back to/subtracted from the
net income figure.
Any buying or selling of fixed assets that allow the running of the company to take place.
Expenditure on intangible assets
Any profits or losses occurred from discarding concrete material of the companies, such as land and machinery.
Investment in financial assets
This is profit gained from investing in an asset that does not have a physical worth, such as stocks, bonds,
and bank deposits.
Proceeds from sale of financial assets
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Companies raise capital by issuing new shares either in the initial market (first-time equity issue) or in the
secondary market (subsequent issues of equity).
Proceeds from exercise of share options
The exercise of share options is the purchasing of an issuers common stock at the price set by the option,
regardless of the price of the stock at the time the option is exercised. Proceeds can thus be obtained if the
price set by the option initially is less than the current stock price.
Purchase of own shares
This occurs when a company purchases its own shares. A number of restrictions and conditions must be
met for this to occur. The company must pay for the shares out of distributable profits or out of the
proceeds of a fresh share issue to finance the purchase. Following the company share repurchase, the
shares are treated as cancelled.
Dividends paid to equity shareholders
The cash interests, which are the amounts that accrue periodically on an account that can be paid out
eventually to the account holder, payable to the company.
Further multiples
Multiple
Calculation
EV/EBIT
EV
EBIT
EV
NOPLAT
EV
IC
ROIC
WACC
EV/NOPLAT
EV/IC
ROIC/WACC
Definition/Interpretation
Can be used to value a company, regardless of its capital
structure. Takes into account D&A.
This is another profit multiple, and can be used as a substitute
for EV/EBIT. Takes into account tax.
This is an unlevered price-to-book ratio.
Dividing ROIC by WACC helps to compare returns between
markets (or companies) with different WACC, and may help in
judging what EV/IC is reasonable.
This section was prepared by Uktarsh Majmudar and Ruzbeh Bodhanwala, Global Research Best
Practise, HSBC EDP (India) Private Ltd
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Notes
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Notes
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Notes
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Disclosure appendix
Analyst Certification
Each analyst whose name appears as author of an individual chapter or individual chapters of this report certifies that the views
about the subject security(ies) or issuer(s) or any other views or forecasts expressed in the chapter(s) of which (s)he is author
accurately reflect his/her personal views and that no part of his/her compensation was, is or will be directly or indirectly related
to the specific recommendation(s) or view(s) contained therein.
Important disclosures
Stock ratings and basis for financial analysis
HSBC believes that investors utilise various disciplines and investment horizons when making investment decisions, which
depend largely on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations.
Given these differences, HSBC has two principal aims in its equity research: 1) to identify long-term investment opportunities
based on particular themes or ideas that may affect the future earnings or cash flows of companies on a 12 month time horizon;
and 2) from time to time to identify short-term investment opportunities that are derived from fundamental, quantitative,
technical or event-driven techniques on a 0-3 month time horizon and which may differ from our long-term investment rating.
HSBC has assigned ratings for its long-term investment opportunities as described below.
This report addresses only the long-term investment opportunities of the companies referred to in the report. As and when HSBC
publishes a short-term trading idea the stocks to which these relate are identified on the website at www.hsbcnet.com/research.
Details of these short-term investment opportunities can be found under the Reports section of this website.
HSBC believes 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. Different securities firms use a variety of ratings terms as well as different rating
systems to describe their recommendations. Investors should carefully read the definitions of the ratings used in each research
report. In addition, because research reports contain more complete information concerning the analysts' views, investors
should carefully read the entire research report and should not infer its contents from the rating. In any case, ratings should not
be used or relied on in isolation as investment advice.
HSBC assigns ratings to its stocks in this sector on the following basis:
For each stock we set a required rate of return calculated from the risk free rate for that stock's domestic, or as appropriate,
regional market and the relevant equity risk premium established by our strategy team. The price target for a stock represents
the value the analyst expects the stock to reach over our performance horizon. The performance horizon is 12 months. For a
stock to be classified as Overweight, the implied return must exceed the required return by at least 5 percentage points over the
next 12 months (or 10 percentage points for a stock classified as Volatile*). For a stock to be classified as Underweight, the
stock must be expected to underperform its required return by at least 5 percentage points over the next 12 months (or 10
percentage points for a stock classified as Volatile*). Stocks between these bands are classified as Neutral.
Our ratings are re-calibrated against these bands at the time of any 'material change' (initiation of coverage, change of volatility
status or change in price target). Notwithstanding this, and although ratings are subject to ongoing management review,
expected returns will be permitted to move outside the bands as a result of normal share price fluctuations without necessarily
triggering a rating change.
*A stock will be classified as volatile if its historical volatility has exceeded 40%, if the stock has been listed for less than 12
months (unless it is in an industry or sector where volatility is low) or if the analyst expects significant volatility. However,
stocks which we do not consider volatile may in fact also behave in such a way. Historical volatility is defined as the past
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month's average of the daily 365-day moving average volatilities. In order to avoid misleadingly frequent changes in rating,
however, volatility has to move 2.5 percentage points past the 40% benchmark in either direction for a stock's status to change.
36%
Underweight (Sell)
13%
Analysts, economists, and strategists are paid in part by reference to the profitability of HSBC which includes investment
banking revenues.
For disclosures in respect of any company mentioned in this report, please see the most recently published report on that
company available at www.hsbcnet.com/research.
* HSBC Legal Entities are listed in the Disclaimer below.
Additional disclosures
1
2
3
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Disclaimer
* Legal entities as at 31 January 2010
Issuer of report
'UAE' HSBC Bank Middle East Limited, Dubai; 'HK' The Hongkong and Shanghai Banking
HSBC Bank plc
Corporation Limited, Hong Kong; 'TW' HSBC Securities (Taiwan) Corporation Limited; 'CA' HSBC
8 Canada Square
Securities (Canada) Inc, Toronto; HSBC Bank, Paris branch; HSBC France; 'DE' HSBC Trinkaus &
London, E14 5HQ, United Kingdom
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(India) Private Limited, Mumbai; 'JP' HSBC Securities (Japan) Limited, Tokyo; 'EG' HSBC Securities
Telephone: +44 20 7991 8888
Egypt S.A.E., Cairo; 'CN' HSBC Investment Bank Asia Limited, Beijing Representative Office; The
Fax: +44 20 7992 4880
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Website: www.research.hsbc.com
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Corporation Limited, Seoul Branch; HSBC Securities (South Africa) (Pty) Ltd, Johannesburg; 'GR'
HSBC Pantelakis Securities S.A., Athens; HSBC Bank plc, London, Madrid, Milan, Stockholm, Tel Aviv,
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HSBC Nutshell
David May*
Head of Equity Research. EMEA
HSBC Bank Plc
+44 20 7991 6781
david.may@hsbcib.com
David May is Head of Equity Research, EMEA (Europe and CEEMEA regions) at HSBC, a role he has been in since August 2007.
He was previously Global Head of Equity Product Management at HSBC. Prior to HSBC, David worked in an Equity Sales role
and an Equity Product Management role at a major American investment bank.
HSBC Nutshell
A guide to equity sectors
Tim Hammett*
Head of Research Marketing, EMEA
HSBC Bank Plc
+44 20 7991 1339
tim.hammett@hsbcib.com
Tim Hammett is Head of Research Marketing for EMEA, He joined HSBC in August 2009, bringing seven years experience of
research marketing and knowledge management with a major American investment bank and a previous 13 years of equity fund
management experience.
Nicholas Peal*
Research Marketing, EMEA
HSBC Bank Plc
+44 20 7991 5353
nicholas.peal@hsbcib.com
Nicholas joined HSBC in 2006. Prior to his current role within research marketing he gained experience in both foreign exchange
and interest rate derivative product areas.
Multi-sector Equity
This guide will help you gain a quick, but thorough understanding of 22 equity research sectors and
industry groups
It will help you to understand the organisation of the sector, the key drivers, indicators and themes,
historical context, and suitable valuation approaches
It is also an open offer to access HSBCs expertise in fundamental equity sector research
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations.
September 2010
Disclosures and Disclaimer This report must be read with the disclosures and analyst
certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it