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Equity Structured Products and Warrants

This material has been produced by RBS sales and trading staff and should not be considered independent.

The Round Up
20 January 2011
Issue No. 482

The Round Up is a comprehensive daily note produced by the RBS Warrants team providing an overview of market movements along with quality ideas for warrant traders and investors.

Global Market Action Aussie Market Action Equinox Minerals (EQNKZB) Qantas (QANKZL) S&P500 (SPFKZQ) Australian Strategy

Scoreboard, commentary SPI Comment, Events & Dividends MINI Trading Buy – Citadel not priced in MINI Trading Buy – ESG factors trending positively MINI Trading Short – US Market pullback Monthly Market Review - December 2010

Daily Monitor

Equity Structured Products and Warrants

Overnight Commentary United States Commentary
The US had its biggest decline in nearly 3 months as the financial sector, which has driven recent gains, collapsed as weaker than expected earnings from Amex and GS provided a harsh reality check about the state of the economy. Amex fell 2.4%, BOA fell 4.2%, JPMorgan fell 2.3% while on the big board MS and GS were off 3.5% and 4.7% respectively. IPL comps CF Industries and Monsanto fell 6.2% and 4.6% as Cargill continued its move to cash in on gains in Monsanto while Alcoa fell 1.3% as commodities fell against strength in the greenback. China data today will provide more insight into the health of the global economy.

United Kingdom and Europe Commentary
The FTSE was weaker overnight with banks removing a majority of point following weaker than expected earnings from GS. Risk was taken off the table as many market watchers pointed to the need for consolidation following the markets stellar run over the past 6 weeks. Marks & Spencer and Next fell as a raft of trading updates from their peers disappointed, while Morrison Supermarkets fell 2.3% with the added weight of a broker downgrade removing appeal. On the upside bargain hunters snapped up shares in GlaxoSmithKline an d RDSA managed to post a win if 0.5% despite a weaker crude price. Key Chinese economic data which will be released today will steer movements tonight.

Equity Structured Products and Warrants
Commodities Commentary


% Move


1370 90.87 1163 109 2390 9575

-0.2% -0.6% -1.7% -0.9% -1.9% -1.3% -0.1%

SPI Commentary
The SPI traded up 55pts to 4828. Open at 4773 with a high of 4829 and a low of 4769. Volume 30,423. Overnight the SPI traded down 49pts to 4779. SPI Intraday SPI Daily

*SPI report taken from the 9:50am open to the 4:30pm close on the previous trading day. Charts taken from IRESS

Upcoming Economic Events for the Week
Monday AUS US Tuesday AUS US Wednesday AUS US Thursday AUS US Friday AUS US
*Dates are indicative only and may change

New Motor Vehicle Sales (MoM)

NY Empire State Manufacturing Index , NAHB Housing Market Index Westpac Consumer Sentiment MBA Mortgage Applications , Housing Starts Initial Jobless Claims , Continuing Jobless Claims , Existing Home Sales , Philadelphia Fed Manufacturing Index , Crude Oil Inventories Import Price Index (QoQ)

Equity Structured Products and Warrants

MINI Trading Buy:
Equinox Minerals (EQNKZB) - Opportunity: Citadel not priced in
We have factored CGG into our estimates for EQN, which has materially lifted our NPV. In our view, the market has overlooked the value created by the deal, creating an opportunity for investors. The stock remains one of our key picks for 2011. Strike $3.51, Stop Loss $4.17.

Source: IRESS

A solid end to the year, 45Mtpa processing rates under review 4Q10 production of 34kt was slightly higher than our estimate of 32kt on the back of a significant jump in ore processing rates. Ore milled of 5.48kt (22Mtpa rate) was another record and comfortably above the 20Mtpa nameplate (EQN plans to be at a 24Mtpa rate by year end). Copper ore grades fell significantly from 0.87% in 3Q10 to 0.69% (lower grades were flagged, but slightly disappointing due to the read through to future years). Overall, it was a solid quarter, with full-year production of 147kt ahead of 2010 guidance of 140kt. 2011 production guidance of 145kt was provided, slightly lower than we were expecting (at a cash cost of US$1.45/lb). We note 2011 guidance could be conservative, as was the case for 2010. Further, expansion studies now include a 45Mtpa processing-rate scenario (previously 35Mtpa), which could provide further upside to our valuation. Factoring in CGG has lifted our EPS EQN now holds more than 93% of Citadel Resources (CGG) and is proceeding with the compulsory acquisition of the remaining stock. We believe the deal is a credit to management, which has secured a high-quality asset at a low premium relative to recent transactions. RBS Research EPS rises on average 9% over 2013-15 due to the CGG contribution. EQN one of our top picks for 2011 The overriding factor is the completion of the CGG transaction and NPV accretion. We continue to see upside potential at both Jabil Sayid, and Lumwana. Further, with copper remaining comfortably above US$4.00/lb, we see upside risk to consensus earnings as higher commodity prices are factored in, in our view. Our NPV and target price have risen from A$6.45ps to A$7.03ps after factoring in CGG, the end-of-year cash balance and other operational changes. EQN is one of our key picks in 2011. Buy.
Security EQNKZA EQNKZB ExPrc 2.2578 3.472 Stop Loss 2.71 4.17 CP Long Long ConvFac 1 1 Delta 1 1 Description Long MINI Long MINI

Equity Structured Products and Warrants

MINI Trading Buy:
Qantas (QANKZL): ESG factors trending positively
QAN has embraced ESG reporting, which in our view is important in such a challenging industry. In this note we update QAN's FY10 sustainability performance in detail, noting it was generally positive across most measures. With QAN trading below 1.0x P/B, we maintain our Buy recommendation. Get long QANKZL

Source: IRESS

2010 ESG data points largely trended well On a majority of the ESG data points we track, QAN trended positively in FY10. Positively, fuel efficiency continued to improve as new aircraft were brought into the fleet (ASK/bbl increased by a solid 2.7% on the pcp), governance measures strengthened, and operational performance (on-time arrivals and load factor) improved. On the negative side, the lost time injury frequency rate (LTIFR) increased marginally (from 4.2 to 4.3), while the workforce is aging, suggesting QAN may be having more difficulty attracting new employees. Valuation upside potential dominated by fuel efficiencies Our long-term DCF valuation is most influenced by potential fuel efficiency improvements (+54%), offset by carbon pollution reduction scheme imposts (-25%). Operational measures such as passenger yields and load factors are also influential, and are affected by QAN's performance in relation to customer satisfaction and brand. Risks are ever-present in the airline industry, but we believe QAN has well defined risk management policies to react to and minimise these risks as much as possible. QAN compares well on ESG metrics to peers and the broader S&P/ASX 200 The aviation industry generally is focused on ESG issues given impending emission trading schemes globally. In our view, QAN shows particularly strong engagement on ESG issues, with many initiatives integrated into business operations. Not surprisingly, therefore, comparative data shows QAN generally ranking in the top half on ESG metrics against peers and strongly against the broader S&P/ASX 200 on ESG related disclosure. QAN good value at <1.0x P/B, reiterate Buy recommendation We believe that QAN's positive ESG metrics should have a positive influence on its trading multiples. However, QAN is currently trading at both a P/E and P/B discount to its global peers due in large part to the recent A380 issues. With the fleet now returning to normal operations, we expect QAN to rerate and maintain our Buy recommendation. RBS MINIs over QAN
Security QANKZL QANKZM ExPrc 1.6607 2.02 Stop Loss 1.83 2.23 CP Long Long ConvFac 1 1 Delta 1 1 Description MINI Long MINI Long

Equity Structured Products and Warrants

MINI Trading Short:
S&P 500 – US Market pullback
The US S&P 500 has rallied significantly over the festive season on reasonably light volumes. From the end of August 2010 to 17th January 2011 the S&P500 has jumped 24% compared to a relately weak 11% gain in the Australian XJO over the same 4.5 month period. We expect to see a modest pullback in the S&P500 as the large mutual funds return from holidays and look to take profits in many of their positions. SPFKZQ (Stop Loss at 1,313) is the instrument to play a pullback (Or SPFKZR higher Stop Loss of 1,396) and we believe the S&P500 futures could easily fall from 1,262 to 1,220 and even below 1,200 before the end of January. Alternatively, some traders will prefer a pairs trade to take advantage of the US outperformance and therefore mitigate the market risk of global economic news. Traders wishing to use this strategy can therefore Buy 1 Long MINI XJOKZL for every 4 SPFKZQ shorts (market exposure of 1 XJOKZL is $47 and 1 SPFKZQ is $12.60). We would look to close out this trade at around 1,220 in the S&P 500 and this would return ~65% purely in the SPFKZQ MINI.

Source: IRESS

Pure S&P500 Short play
Security SPFKZQ SPFKZR ExPrc 1382 1469.8 Stop Loss 1313 1396 CP Short Short ConvFac .01 .01 Delta 1 1 Description MINI Short MINI Short

Pairs trade
Buy 1 Long MINI XJOKZL for every 4 SPFKZQ shorts
Security XJOKZL SPFKZQ ExPrc 4088.4 1382 Stop Loss 4293 1313 Type Long Short ConvFac .01 .01 Delta 1 1 Description MINI Long MINI Short

Equity Structured Products and Warrants

RBS Round Up Corner:

Monthly Market Review - December 2010
Global equities staged a late rally into the close of the year and Australian equities rebounded by 3.5% in December. RBS forecasts 20% returns for the S&P/ASX 200 in 2011, up to 5700 by year end, supported by growing confidence in the global economic outlook.

Australia's performance vs the world In local currency, the All Ordinaries (+3.6%) underperformed the US S&P 500 (+6.5%), the World MSCI ex Australia Index (+7.1%) and the regional MSCI ex Japan Index (+6.7%). The best- and worst-performing sectors The best performers for the month were Information Technology (+6.9%), Materials (+6.5%) and Energy (+4.6%). The worst performers were Telecommunication Services (-0.8%), Property (-0.2%) and Consumer Discretionary (+0.6%). The top-five and bottom-five performing S&P/ASX 200 stocks The top-five performers from the S&P/ASX 200 (price) Index for the month were Sundance Resources (+59.7%), Energy World Corporation (+50.0%), Aurora Oil & Gas (+47.9%), Tower Australia (+46.0%) and Mirabela Nickel (+37.8%). The bottom-five performers were St Barbara (-20.0%), The Reject Shop (-18.8%), Sigma Pharmaceuticals (-14.0%), Hastie Group (-13.2%) and Perpetual (-12.1%). Consensus earnings revisions The top-five upgrades were Boart Longyear (+12.2%), Lend Lease (+10.7%), OZ Minerals (+5.6%), Ramsay Health Care (+5.5%) and Origin Energy (+3.7%). The top-five downgrades were MAp Group (-90.3%), Westfield Group (-12.7%), Billabong (-9.1%), Riversdale Mining (-8.6%) and Aristocrat Leisure (-8.5%).

Equity Structured Products and Warrants
Looking back and looking forward As we moved towards the close of the year, equity markets have staged a late rally back towards pre-Lehman levels. Equity and currency markets are less concerned about periphery Europe than bond markets, and equities are slowly rerating, a trend we expect to continue in 1H11. In local terms, in December the S&P 500 was up 6.5%, the Stoxx 600 was up 5.3% and the S&P/ASX 200 was up 3.5%. We note the rally has been broad-based as equities in Spain, Italy, Portugal and Ireland have also participated. The sovereign bond markets are not so relaxed, and European peripheral bond yields and CDS spreads are close to their highs, highlighting to us that sovereign risk in Europe will be an ongoing concern. The catalysts for this late stage rally are a combination of reduced US recession risk and reduced concerns about European contagion risk. Investors are retreating from bond funds following signs of a US economic recovery and the stock market rally has increased speculation that interest rates may rise. US economic growth gaining momentum – Alongside continued monetary accommodation in the US, the economic recovery looks to be picking up momentum, providing a firmer macro backdrop as we move into 2011. The December Philly Fed highlighted the trend, with forwardlooking components returning to the stronger March-April levels that were interrupted by the European sovereign crisis from May. In particular, the expected capex component is at its strongest level since mid-2005, and the prices paid component suggests inflation should normalise. This is particularly important, given monetary policy must now give way to the private sector to drive economic growth. We highlight US capex as a significant equity market theme as we move into 2011. In addition, small to medium-sized enterprises are beginning to rehire and income growth is driving consumer spending. European stability – While improving economically, Europe remains vulnerable to pockets of deflation and a resurgence of European sovereign debt woes as this structural issue takes time to repair. From an economic perspective, the manufacturing PMIs in core Europe have remained resilient as demand in foreign markets has benefitted the region. The latest survey data continue to point to ongoing recovery in the euro area business cycle, albeit at muted levels. It will likely take time for a sustained domestic demand recovery to emerge in Europe, while real income growth remains moderate in an environment of modest employment and wage growth. We expect peripheral sovereign debt to weigh on markets from time to time, but we note investors appear less concerned that this will cause outright financial markets seizure, as was feared in May this year. Also, at the latest ECB press conference there was a clear desire to ensure the stability of the Eurozone and a greater willingness to use the bond purchase programme (SMP). Chinese officials have also offered to step up their support of European stabilisation efforts. What form this might take is unclear, but at the very least should be successful in lifting sentiment. Chinese property – We highlighted Chinese residential construction as a linch-pin for our investment strategy going forward, as this sector is 33% of steel demand. The IMF’s new report on Chinese property highlights some interesting conclusions, notably that house prices do not appear to be significantly higher than justified by fundamentals. While there may be overvaluation in some coastal cities, developments are still ‘early stage’. Moreover, there are powerful structural drivers underpinning the housing market, namely low real interest rates, strong income growth and a low mortgage-to-GDP ratio. We believe these drivers will result in a wider economic rebalancing, providing the global economy with an invaluable growth engine for the foreseeable future. Australian economic growth on a rising trend – RBS economist Kieran Davies expects 3.7% growth yoy for 2011, and we expect Australia to remain in the fortunate position of enjoying buoyant terms of trade while also generating significant export volume growth through the expansion of iron ore, coal and LNG operations. Australia’s increasing dependence on China, however, does give rise to risks of greater volatility. RBS expects the RBA to take the cash rate to 6% by the end of 2011. The RBA responded recently to the risks to mediumterm inflation, given the strong growth outlook and limited spare capacity in the economy. The market is currently pricing in 25bp to end 2011 and we expect this to change as the outlook for growth in advanced economies firms. On our forecast cash rate of 6% by the end of 2011, we expect rates to take 2ppt off income, as the RBA’s actions would be magnified by higher household debt. However, on the positive side, our banks team does not forecast further increases in the standard variable rate above the cash rate from here. The tight labour market (unemployment now at 5.2%) is now feeding through to wages growth; this month we saw the wage price index up 1.1% in the quarter, a sharp increase from 0.8% in 2Q10 and showing the fastest growth since 4Q08. This gain lifts annual growth in this key measure of wages from 3.0% to 3.5%, although it is still well short of the peak of 4.3% reached in 4Q08. Also, given hours worked are rising at a rate of 3.1% yoy combined with wages growing at about 3% (and, given previous experience, that wages could grow at 4% or

Equity Structured Products and Warrants
above), we estimate household income could grow into the high single digits. Indeed, the six-month annualised growth in the national accounts measure of compensation of employees was 9.6%. Even detracting an additional 2ppt of debt service given our profile of the RBA cash rate would leave mid-single-digit household income growth available for consumption growth.

Continued sovereign risk a possibility – Let us not forget the discount applied to Australian equities for sovereign risk post the Henry Tax Review and, specifically, the handling of the MRRT, a topic international investors are reluctant to dismiss going forward. Australian sovereign risk will remain topical as 2011 is unlikely to be quiet on this front, in our view. RBS targets for 2011 – The continued rebound of corporate earnings means current valuations continue to look cheap, reinforcing our constructive view on equities. With near-term earnings risk modest and the outlook for continued earnings growth of 18.8% (IBES) on a 12-month-forward basis relatively assured, in our view, we project market growth in line with 12-month-forward earnings to reach 5657. If we then apply a modest 5% PE rating from 12.8x 12-month-forward currently to 13.5x (still at a 5% discount to long-run average of 14.2x), this indicates the market has potential upside of 20% to 5700.

Equity Structured Products and Warrants

For further information please do not hesitate to contact us on the details below

Equities Structured Products & Warrants Toll free Trading Products Team Ben Smoker Ryan Corrigan Investment Products Team Elizabeth Tian Tania Smyth Robert Deutsch Mark Tisdell 02 8259 2017 02 8259 2023 02 8259 2065 02 8259 6951 02 8259 2085 02 8259 2425 1800 450 005

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Explanation of Warrant Tables
Security – refers to the code ascribed to the warrant, ExDate – refers to the date on which the warrant expires or is reset, ExPrc – refers to the exercise price, or second instalment payment, CP – tells you whether the warrant is a call or a put, ConvFac – the conversion factor of the warrant which tells you how many warrants you need to exercise in order to take possession of 1 share, Delta – tells you how much the warrant will move for a 1c move in the underlying security, Description – Tells you the type of warrant.
All charts taken from IRESS unless indicated otherwise