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9 December 2011
U.S. Year Ahead 2012
A Year of Gradual Healing
PortfolioStrategy Thomas J Lee, CFA AC
(1-212) 622-6505 email@example.com
Director of U.S. Equity Research Noelle V. Grainger
(1-212) 622-6504 firstname.lastname@example.org J.P. Morgan Securities LLC
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North America Equity Research December 2011
US Year Ahead 2012
Table of Contents
Macro Portfolio Strategy ............................................................................. 5 Economics..................................................................................... 50 Equity Strategy – Small Cap........................................................... 52 Equity Technical Strategy............................................................... 55 Equity Quantitative Strategy ........................................................... 63 Accounting & Valuation .................................................................. 67 Equity Derivatives .......................................................................... 70 Delta One Strategy ........................................................................ 74 Capital Goods/Industrials Aerospace & Defense .................................................................... 81 Boeing Company (BA) Airfreight & Surface Transportation................................................. 82 Union Pacific (UNP) Electrical Equipment & Multi-Industry.............................................. 83 SPX Corp (SPW) Engineering & Construction............................................................ 84 Chicago Bridge & Iron (CBI) Environmental Services.................................................................. 85 Clean Harbors (CLH) Waste Connections (WCN) Machinery...................................................................................... 86 Deere & Co. (DE) Consumer Airlines .......................................................................................... 87 United Continental Holdings (UAL) Autos & Auto Parts......................................................................... 88 Visteon (VC) Beverages ..................................................................................... 89 PepsiCo (PEP) Food Manufacturing ....................................................................... 90 J.M. Smucker Co. (SJM) Food Retail .................................................................................... 91 The Fresh Market (TFM) Gaming.......................................................................................... 92 Las Vegas Sands (LVS) Homebuilding & Building Products.................................................. 93 Lennar (LEN) Owens Corning (OC) Household & Personal Care Products............................................. 94 Procter & Gamble (PG)
Consumer (Cont’d) Lodging.......................................................................................... 95 Wyndham Worldwide (WYN) Restaurants ................................................................................... 96 Brinker International (EAT) Retailing – Broadlines, Apparel & Footwear .................................... 97 Macy’s (M) Retailing – Hardlines/Discounters ................................................... 98 Costco (COST) Retailing – Specialty....................................................................... 99 Ulta Salon, Cosmetics & Fragrance, Inc. (ULTA) Tobacco....................................................................................... 100 Reynolds American (RAI) Energy Electric Utilities & Independent Power Producers .......................... 101 NRG Energy (NRG) Energy MLPs ............................................................................... 102 Buckeye Partners (BPL) North American Integrated Oils & Major Producers........................ 103 Nexen (NXY) Oil & Gas Exploration & Production............................................... 104 Denbury Resources (DNR) Pioneer Natural Resources (PXD) Oilfield Services & Equipment....................................................... 105 Halliburton (HAL) Financials Asset Managers, Brokers, and Exchanges .................................... 107 Invesco Ltd. (IVZ) Franklin Resources (BEN) – Avoid Banks – Large Cap....................................................................... 108 Citigroup (C) Banks – Mid- and Small Cap ........................................................ 109 First Horizon (FHN) Insurance – Life ........................................................................... 110 Prudential Financial (PRU) Insurance – Non-Life.................................................................... 111 Allstate Corp. (ALL) REITs/Real Estate Services.......................................................... 112 Public Storage (PSA) Specialty & Consumer Finance..................................................... 113 American Express (AXP)
North America Equity Research December 2011
US Year Ahead 2012
Health Care Biotechnology ...............................................................................115 Celgene (CELG) SMid Biotechnology ......................................................................116 Onyx Pharmaceuticals (ONXX) Healthcare Facilities......................................................................117 HCA Inc. (HCA) Healthcare Information Technology ...............................................118 Accretive Health (AH) Healthcare Technology & Distribution ............................................119 CVS Caremark (CVS) Life Sciences Tools & Diagnostics .................................................120 Agilent (A) Managed Care ..............................................................................121 UnitedHealth (UNH) Medical Supplies & Devices ..........................................................122 St. Jude Medical (STJ) Pharmaceuticals – Major...............................................................123 Pfizer (PFE) Pharmaceuticals – Specialty..........................................................124 Mylan (MYL) Materials Chemicals – Specialty, Commodity & Agricultural...........................125 DuPont (DD) Coal..............................................................................................126 Consol Energy (CNX) Gold & Precious Metals.................................................................127 Goldcorp Inc. (GG) Metals & Mining ............................................................................128 Freeport-McMoRan (FCX) Paper & Packaging .......................................................................129 Crown Holdings (CCK) Media & Telecom Information Services/Radio & TV Broadcasting..............................131 Verisk Analytics (VRSK) Internet.........................................................................................132 Google (GOOG) Media ...........................................................................................133 Viacom (VIAb) Telecom, Cable & Satellite ............................................................134 Comcast (CMCSA)
Technology Alternative Energy – LED ............................................................. 135 Cree (CREE) Alternative Energy – Solar PV....................................................... 136 First Solar (FSLR) – Avoid Applied & Emerging Technologies ................................................ 137 Zipcar (ZIP) Business & Education Services .................................................... 138 Robert Half International (RHI) Communications Equipment & Data Networking............................ 139 Riverbed (RVBD) Computer Services & IT Consulting .............................................. 140 MasterCard (MA) IT Hardware................................................................................. 141 Apple (AAPL) Semiconductor Capital Equipment ................................................ 142 Lam Research (LRCX) Semiconductors ........................................................................... 143 Texas Instruments (TXN) SMid Semiconductors................................................................... 144 Broadcom (BRCM) Software ...................................................................................... 145 Citrix Systems (CTXS) – Avoid Red Hat (RHT) – Avoid Software Technology.................................................................... 146 Equinix (EQIX) Technology Supply Chain............................................................. 147 Jabil Circuit (JBL) Disclosures .................................................................................. 152 Note: Unless otherwise noted, all stock prices and coverage lists in this report are as of the close on December 6, 2011, and target prices for December 2012.
North America Equity Research December 2011 US Year Ahead 2012 4 .
S. 2. corporates have represented 97% of the incremental inflows into equities. driven by expanding household formation rates. The J. 5 . fiscal tightening) and the outlook for equities is generally muted (see Figure 15) with only one strategist seeing equities in 2012 exceed the 1371 high of 3/11. For the past five years. bolstering net profit margins by 60-90bps to 10%. 8.S. U. High Yield. Vacancies are at five-year lows and other factors are also supportive. 4. Multiple events contributed to this: Japan floods.com Katherine C Khor (1-212) 622-0934 katherine. equities have bottomed 69 months ahead of a return to growth. CFA AC (1-212) 622-6505 thomas. Daniel M McElligott (1-212) 622-5598 daniel.S. economic resilience. housing should see a further advance in its recovery in 2012. equity markets are flat for the year. and CMBS. U. 3. election cycle should be positive for equities.lee@jpmorgan. despite this (Italian yields even broke above 8%). China entering selective easing cycle sets the stage for a Cyclical upturn in EPS. AAA downgrade.S. as shown below. However. surprisingly U. 6.com J. MBS. Consensus is cautious about 2012. Historically. EBIT margins should expand 100-150bps in 2012. 7. we have eight reasons to be constructive. Stocks have historically done well when an incumbent has had low approval ratings going into an election year (positive returns in seven of eight years).S. 1. Arab spring.North America Equity Research December 2011 US Year Ahead 2012 Portfolio Strategy Eight Reasons to Be Contrarian in 2012. and 3) severe relative undervaluation of equities (supporting prices). Peripheral Europe.S.khor@jpmorgan. the S&P 500 saw a 300-point range (a 9% rally followed by a 22% drop. setting a new high for profit margins and driving 2012E/2013E EPS of $105/$110.mcelligott@jpmorgan.P. Given equities are the junior piece of the capital structure. Even though equity markets are essentially flat year to date. Corporates are likely to ramp up total cash return by as much as $250bn in 2012.P. corporate financial strength and pricing power. We believe this is a testament to a combination of: 1) U. Morgan Fixed Income Strategists are constructive for 2012 on High Grade. 2) U. Morgan base case is for the Euro crisis to abate by 2H12 with Europe potentially exiting recession by mid-year. followed by a 20% rally). and U.m. However. Morgan Securities LLC Eight Reasons to Be Contrarian (Optimistic) in 2012 The consensus view is that visibility remains murky with significant tail risks (European systemic crisis. this is positive for equities (Figure 14). J. China hard landing. 5.com Macro Equities Rise Despite Uncertainty… 2011 is a year most investors would like to forget.S. YE Target 1430 Thomas J Lee.P. ABS. The 2012 U.
0x estimated 2013 EPS of $110. 6 . with Financials as our top pick for 2012. Morgan’s 65 best long and 4 avoid ideas (Figure 9). representing an earnings yield of 7. We see Cyclicals and Financials outperforming. This based on a target multiple of 13. 65 Analyst Best Ideas We have compiled J.P.4%).7% (compared to JULI HG yield of 4. From any historical lens. this P/E multiple appears conservative. Favor Cyclicals and Financials We believe the S&P 500 will reach 1430 by the end of 2012.North America Equity Research December 2011 US Year Ahead 2012 Establishing Year-End 2012 Target of 1430.
North America Equity Research December 2011 US Year Ahead 2012 Valuation: See S&P 500 Trading to 13.00X 2013 EPS $115 Target 1. Figure 1: J.430 Downside Source: J.0x estimated 2013 EPS of $110. P/E multiples could expand further towards 14x.0x 2013E EPS or 1430 2012 Price Target Reflects 13x 2013E EPS of $110 We believe the S&P 500 will reach 1430 by the end of 2012. top-down forecasts for 2011 EPS actually rose by $5. Similar to last year. For 2012. housing recovery.4%). we see greater variability in the P/E ratio.S.00X $95 1. we show our target P/E multiple and EPS forecast in Figure 1 below.150 7 . Morgan. but P/E ratios fell. We also highlight the upside and downside factors to the P/E multiple.09 in December 2010).9x in the fourth year of a bull market (Figure 2). This based on a target multiple of 13. compares to a typical multiple of 13.600 Europe recession ends ECB bazooka US housing recovers Congress compromises US govt ends attack on banks Base 13. Morgan Year-End 2012 Price Target Scenarios for S&P 500 $ per share YE '12 P/E Upside 14. Over the course of 2011. rather than in the EPS forecast. A P/E multiple of 14x. $92. As shown. and gain conviction in a strong U.7% (compared to JULI HG yield of 4. by the way.S. representing an earnings yield of 7.P.P. 12. if investors become comfortable with Europe and U. namely macro factors that could weigh on P/E multiples.38 now vs. this P/E multiple appears conservative. Congress.00X China hard landing Europe bank crisis US enters recession Obama gains in polls $110 1. From any historical lens.29 ($97.
5x -2.4x 2002 -1.0x 6. even those that have become bear markets.7x 15.P. or higher than our target P/E of 13. And for those that have remained bull markets.9x . Target P/E Is Consistent Our target multiple of 13.0x 0.9x 9.3x 13.3x 13.9x 1966 -0.1x 15.4x 5.3x 0.4x DELTA (avg P/E for months 40-46 less avg P/E for months 0-6 of a bull market) 12. the average P/E multiple has expanded by 2. Figure 2: P/E Ratios During Fourth Year of a Bull Market P/E ratio average for months 40-46 since 1900 Avg P/E: Months 40-46 19.1x 16.9x 13. Morgan and FactSet.4x 25.1x 11.2x 11.0x 8.0x represents no increase in multiple.9x 3.0x is in line with levels in prior bull markets. 8 Avg: if Bull intact 1903 1907 1914 1917 1921 1932 1933 1935 1938 1942 1949 1957 1962 1970 1974 1978 1982 1987 1990 Avg: all 2.0x In Line with Historical Average P/E 46 Months into a “Bull Market”…Thus. Take a look at the analysis in Figure 2 below which looks at P/E ratios 46 months into prior bull markets.1x 1.8x 1900 -1.0x 20.2x by month 46 if a bull market remained intact while multiple expansion was generally only 1.0x by month 46 across all bull markets examined.0x 0. since 1900.9x -4.North America Equity Research December 2011 US Year Ahead 2012 P/E Multiple of 13.2x -3.0x 14.8x 12. the P/E ratio was closer to 13.0x.6x -4.9x 8.0x Source: J.3x 5. In contrast.6x 16.0x 13.5x 14.5x 8.0x 5.0x -4.0x 8.9x 9.0x is in line with the historical average of 13.4x -2. the current bull market has not seen any P/E multiple expansion and our target P/E of 13.1x 19.2x Avg: if Bull intact 1900 1903 1907 1914 1917 1921 1932 1933 1935 1938 1942 1949 1957 1962 1966 1970 1974 1978 1982 1987 1990 2002 2009 Avg: all 13.1x 46 months into prior bull markets (even those that ended a long time before that).0x 4.7x 7.0x 13.0x 14.7x 15. Also.0x 10.1x -5.9x -2.0x -8.3x 15.8x 2009 0.4x 5.4x 10. Our target multiple of 13.4x 0.7x 2.5x 4.8x 1.9x 3.9x.
The equity risk premium is also virtually unchanged since the March 2009 low. The implication.27 Euro 10yr Avg 3. though. and 2009. The figure below shows the equity risk premium is at a 50-year high.0) '57 '59 '62 '64 '67 '69 '72 '74 10yr Avg Market low Market low Asia Crisis Subprime Crisis Market Crisis low 9/11 6. the margin of error is greater for equities when the equity risk premium is high. It is even higher than the levels seen at the heights of the Asia and subprime crises.0 1.55% and the ten-year average of 3.82 '77 '79 '82 '84 '87 '89 '92 '94 '97 '99 '02 '04 '07 '09 '12 Source: J.0 5.0 4. this relationship is likely to narrow. 9 .0 6.55%. well above the 50-year average of 2.27%.0 3. in our view. is the risk/reward for equities is attractive—that is. thus favoring stocks. despite substantial improvement in the economy. This indicates that investors currently show little trust in equities and reflects a general fear of capital investment. this again points to our argument that unless things worsen. We believe the most notable distortion is that the equity risk premium remains elevated. Morgan Global Asset Allocation Team. Figure 3: Equity Risk Premium Using a Dividend Discount Model to derive the real S&P 500 Equity Discount Rate implied by S&P 500 prices – This discount rate (EDR) is a risk-free rate.0 2. The current equity risk premium is also higher than at the major stock market lows of 1974.0 (1. The Equity Risk Premium is the difference between the Equity Discount Rate and the 10-yr real bond yield (10-yr nominal UST yield minus 10-yr Philly Fed inflation expectations) Equity Risk Premia 7. While some may argue this is a result of extreme risk aversion.P. both physical and financial. 1980.North America Equity Research December 2011 US Year Ahead 2012 …And Equity Risk Premium Points to Equities Being Undervalued Valuation for stocks continues to remain extremely attractive. The current equity risk premium is 6.0) (2.
650 +9% -17% +24% 1. Note: Composite is for bull markets that lasted at least 34 months. Figure 4: Price Performance of the S&P 500 in 2009-2012 2012 is a composite of Bull Markets that lasted at least 34 months 2009 1.250 1. 10 .300 1.000 900 800 700 600 12/08 2010 1. we think it makes sense to be long at the start of the year.200 1. which is slightly above the 1430 target we set for 2012. Consensus sees a tough 1H12 and rally in 2H (similar to composite) which we believe is less likely to happen. which saw major volatility in performance.200 1. Rather.600 1.700 1.150 1.050 12/11 Composite for Bull Markets that lasted at least 22 months 26% upside shown would be to reach 1350 YE target Composite for Bull Markets that lasted at least 34 months Assume 2012 starts the y ear at 1.200 1.100 1. Either way.150 51% Avg gain of 15% 4/12 6/12 8/12 10/12 12/12 +67% 1.050 1. Both 2010/2011 started with a 9% rally.400 1.550 1.100 +9% 1.450 Composite and High/Low range of Bull Mkts lasting at least 34 months -22% +17% (+26%) 2/11 4/11 6/11 8/11 10/11 12/11 1.North America Equity Research December 2011 US Year Ahead 2012 2012 Expected to Look More Like 2009… Fourth Year of Bull Markets Has Seen Less Variation in Performance… We compiled the composite return of the eight bull markets (which lasted at least 34 months) below to highlight the typical return in the fourth year of a bull market.000 12/09 2011 1.100 1.500 Actual S&P 500 Bull Mkt Composite 2012 1.P.350 1. The average was 15% and implies a YE level of 1448. This contrasts with 2010 and 2011. followed by a double-digit decline. we see either steady gains through 2012 or markets stronger in 1H.300 1.255 (current lev el) Source: J.250 1. Morgan and Bloomberg. and ended with a rally.750 1.000 900 800 -8% 2/12 2/09 4/09 6/09 8/09 10/09 12/09 2/10 4/10 6/10 8/10 10/10 12/10 700 12/10 1.
3x 2013E EPS.1 49. along with P/E of around 11.1 97. we expect returns to be stronger than single-digits.4x 12.8x of Bull Mkt of Bull Mkt 6/1924 6/1925 2/1945 4/1952 8/1960 4/1965 6/1985 8/1993 8/2005 2/1946 4/1953 8/1961 4/1966 6/1986 8/1994 8/2006 2 4/28/1942 5/29/1946 3 6/13/1949 7/12/1957 4 10/22/1957 12/12/1961 5 6/26/1962 2/9/1966 6 8/12/1982 8/25/1987 7 10/11/1990 3/24/2000 8 10/9/2002 10/9/2007 Average % Times Up 9 3/9/2009 12/31/2011 33.8x 18. and 2005-06) with 3-5% gains. 1960-61. Equity markets with modest gains (1952-53. and 1985-86).1 71.P. Note that the markets fall into two categories.3 Months 34-46 Date 34 Months after Start Date 46 Months after Start Perf months 3446 37% 26% 3% 21% 5% 26% 2% 3% 15% 100% 12/2011 1/2013 — P/E P/E (NTM) as of Month 34 7. 1993-94.6 60.4x 14.4 49.4x 16. Figure 5: Bull Markets Lasting at Least 34 Months Since 1900 Bull Market Length of Bull Start of Bull End of Bull Market 1 8/24/1921 Market Market (months) 9/3/1929 96. 11 .North America Equity Research December 2011 US Year Ahead 2012 No Fourth Year of a Bull Market Saw Declines…But Issue Today Is Risk of a Systemic Crisis… We have detailed below the eight bull markets (which were entering their 34th month).6x 15. 1945-46.9x 15. Given the tepid 2011 performance.6 60.0x Source: J. 1965-66.5 113.9x 13. Morgan and Bloomberg.8 12.2x 9. And those with strong gains (1924-25.7 43.
investors are reluctant to own them. election year). and Datastream. Materials (9%) Financials (1800bp underperformance in 2011). Discretionary.000bp). Technology/Materials/Staples (1. Financials (700bp) Best Sectors (12-Mo Relative Performance) Financials (7. intuitively. Industrials (300bp). Thus. Financials In our view. note that Financials have done well in most past scenarios (post-Lehman. If Europe’s crisis is resolved. In addition. Financials and Energy 200bp-700bp (100%/75%) Financials (700bp). Materials. housing bottoms. Technology (500bp). Cyclicals broadly have outperformed under most scenarios.North America Equity Research December 2011 US Year Ahead 2012 Sectors: Overweight Cyclicals.700bp). as shown in Figure 6 below. This is also intuitive.100bp). Energy (200bp) Current P/E below 40-yr average N/A N/A Technology (30% below LT trend)./ (Win Ratio) 1. Financials are arguably the most non-consensus call. the framework for 2012 may look a bit like 2009—emergence from a financial crisis and the potential for an acceleration of the business cycle (driven by Europe exiting recession and China easing).400-7.700bp (100%) 1. Figure 6: Sector Rationale – Cyclicals and Financials Look Attractive Cyclicals: Tech. And the prospect for Republican gains in the upcoming elections would likely also favor Financials. 12 .700bp) Financials/ Cyclicals Cyclicals/ Financials Macro-related Housing bottoms in 2012 2012 Election year with Presidential approval rating <50% Cyclicals. Housing is a major lever for Financials. Materials (970bp). the largest beneficiaries should be Financials. we see Cyclicals and Financials outperforming. given the plethora of risks. Near Cyclicals: Energy. Industrials (310bp) Other 2011 Underperformers (“buy the losers”) Source: Bloomberg. Industrials. Financials Cyclical or Driver for 2012 Post-financial crisis (a la ’08) Defensives? % Rel. Discretionary (3. and Industrials (2. After all.200bp (100%) Discretionary (2.300bp). However. Financials and Energy Cyclicals Cyclicals. FactSet. Chg.
50 48.20 3.79 45.80 28. vs.95 120.40 28.26 89. The group currently trades at a P/E multiple of 14x (124% relative P/E) and we look for that to reach 15.00 3.0x 11.3x 11.22 14.North America Equity Research December 2011 US Year Ahead 2012 Sector Earnings and Outlook We think a Cyclical bent makes sense in 2012 given the characteristics/catalysts outlined in Figure 6 above.11 16. As for anticipated upside.67 2. Not surprisingly.70 12.84 21.55 14.75 105.7x 13.4x 13. the next-fastest year-over-year EPS growth is expected for Basic Materials and Industrials.65 10.00 110. For 2012.30 12.55 2.05 88. we see most groups offering double-digit returns with the exception of Utilities and Telecom.7x 11.10 36.78 97.35 92.59 13.4x 11. For Utilities. Basically.079 552 317 375 178 Near Cyclicals Energy OW Financials OW Defensives Staples HealthCare Telecom Utilities S&P 500 S&P ex-Fin Cyclicals Near Cyclicals Defensives Cyclicals vs.2x 11.9x 11.25 4.0x -1.12 28.90 19.32 20.0x 11.78 9.30 2.30 22.0x by YE 2012.00 83. Industrials.90 19.1x 11.40 9.40 18% 10% 20% 8% 5% 3% 13% 7% Source: J.47 3.1x 16.6x -1. Point LongTerm Current Target Current Target Avg 7 17 17 46 21 30 16 24 3 3 185 154 87 51 46 41 13 .20 11. Discretionary.40 29.20 3.40 8.0x 10.0x 13. we see upside of around 8%—purely driven by P/E expansion.0x 14.26 4.40 3.25 10.35 41.95 10. and Datastream.89 52.70 10.2x 14. A summary of our sector views is shown in the following table. we recommend overweight positions in Cyclicals (Materials.5x 12.4x 11.40 10.9x 15.32 3.55 31.0x 9. Figure 7:2011/2012/2013 Estimated EPS and Target P/E Multiples by Sector $ per share B/U consensus JPM Strategy EPS JPM Strategy Rating Cyclicals Materials Industrials Discretionary Technology OW OW OW OW EPS % (JPM) 11E 12E 13E v s.30 14.5x 12.05 45. Technology) as well as Financials and Energy. We also continue to believe investors should overweight Health Care.75 16.47 11.67 3. we are slightly below consensus EPS for most sectors.3x 14. Defensives UW OW N UW 107.0x 13.30 10. respectively).P.00 12. Financials are projected to have the fastest EPS growth (13%) of the ten sectors.97 16.6x 14.50 15.02 10.37 20.05 17.2x 15.244 1.0x 13.15 2.50 14.70 21. vs.6x 13.30 32.73 12.55 99.55 9. We are looking for 2012/2013 EPS slightly below bottom-up consensus (about $2/$10.1x 15.00 27. Morgan.4x 9.15 17.58 2.72 18.3x 92% 101% 114% 97% 89% 83% 125% 99% 138% 124% — 103% 101% 85% 115% -14% 92% 100% 112% 100% 88% 85% 120% 101% 130% 115% — 103% 102% 86% 112% -10% 94% 95% 101% 132% 83% 75% 103% 115% 91% 71% — 98% 105% 79% 95% 10% 44 129 133 247 152 165 151 141 37 46 1.35 14. '10 '11E '12E 32% 11% 21% 11% 11% 9% 17% 10% 39% 3% 6% 13% 6% 3% 6% 1% 3% 10% 3% 2% 15% 16% 7% 6% 6% 9% 6% 5% 3% 6% 4% 2% 9% 0% 5% 5% 6% 4% 3% 3% 2013 P/E Relative 2013E P/E Point Contribution Current Upside % Upside 15% 13% 13% 19% 14% 18% 10% 17% 8% 7% 15% 14% 16% 16% 12% 353 bp 2012E 2013E 2011E 2012E 2013E 4.6x 13.86 33.65 10.13 24.84 31. FactSet.27 11.59 12.
North America Equity Research December 2011
US Year Ahead 2012
J.P. Morgan Industry Outlook by Analyst
We have summarized below the 2012 outlooks of J.P. Morgan’s U.S. fundamental equity analysts, based on our interpretation of their contributions to this report.
Figure 8: J.P. Morgan Fundamental Analyst Conviction Levels
HC = High Conviction, N = Neutral, LC = Low Conviction
CYCLICALS Materials — OW Gold & Precious Metals / Bridges Metals & Mining / Gambardella Chemicals / Zekauskas Coal / Bridges Paper & Packaging / Gresh Industrials — OW Business & Education Svcs / Steinerman Airlines / Baker Airfreight/Surface Transport / Wadewitz Machinery / Duignan Engineering & Construction / Levine Env ironmental Services / Levine Aerospace & Defense / Nadol Electrical Equip & Multi-Industry / Tusa Discretionary — OW Gaming / Greff HC Info Svcs/Radio/TV Broadcasting / Meltz HC Internet / Anmuth HC Lodging / Greff N Restaurants / Ivankoe N Autos & Auto Parts / Patel N Media / Quadrani N Homebuilders & Building Products / Rehaut C L Hardlines / Horvers LC Specialty Retail / Tunick LC Broadlines, Apparel & Footw ear / Boss LC T echnology — OW LED (Alt Energy) / Blansett SMid Semiconductors / Sur Semiconductors / Danely Technology Supply Chain / O'Brien Semiconductor Capital Equip / Blansett Software Technology / Auty Applied and Emerging Tech / Coster Computer Svcs & IT Consulting / Huang Communications Equipment / Hall Solar Alt Energy) / Blansett IT Hardware / Moskowitz Software / DiFucci
HC HC N LC LC
HC N N N N N LC LC
HC HC HC HC N N N N LC LC LC LC
NEAR-CYCLICALS Energy — OW Energy MLPs / Tonet Oil Services & Equipment / Anderson Integrated Oil & Gas / Minyard Oil & Gas E&P / Allman
HC N N N
Financials — OW Life Insurance / Bhullar HC REITs / Michael Mueller & Anthony Paolone HC Small/Mid Cap Banks / Alexopoulos HC Asset Managers / Worthington N Large Cap Banks / Juneja N Non-Life Insurance / Heimermann N Exchanges / Worthington LC Specialty & Consumer Finance / Shane LC
DEFENSIVES HealthCare — OW Healthcare Tech & Distribution / Gill SMid Biotechnology / Kasimov Pharmaceuticals (Major) / Schott Pharmaceuticals (Specialty) / Schott Managed Care / Rex Healthcare Information Tech / Rahim Biotechnology / Meacham Medical Supplies & Devices / Weinstein Life Sciences Tools / Peterson Healthcare Facilities / Rex
Source: J.P. Morgan.
HC HC HC HC N N N N LC LC
Telecom — N Telecom, Cable, & Satellite / Cusick
Staples — UW Tobacco / Maile HH & Personal Care Products / Faucher Bev erages / Faucher Food Manufacturing / Goldman Food Retail / Goldman
N LC LC LC LC
Utilities — UW Utilities / Smith
Note: Analyst conviction levels are based on our interpretation of the analysts’ sector contributions to this report.
North America Equity Research December 2011
US Year Ahead 2012
J.P. Morgan Analysts’ Best Ideas for 2012
65 Long and 4 Avoid Stock Ideas
J.P. Morgan’s fundamental equity analysts have also provided 65 long stock picks that represent each analyst’s best idea for 2012 (Figure 10 through Figure 12). J.P. Morgan’s analysts have also provided 4 avoid stock picks as their best ideas for 2012.
Figure 9: 65 LONG and 4 AVOID Stock Ideas from J.P. Morgan Fundamental Equity Analysts
Sorted alphabetically within each sector
LONG STOCK IDEAS CYCLICALS Materials 1 2 3 4 CCK DD FCX GG NEAR-CYCLICALS Energy 1 2 3 4 5 6 *NXY BPL CNX DNR HAL PXD DEFENSIVES Staples 1 2 3 4 5 6 COST CVS PEP PG RAI SJM
AVOID STOCK IDEAS CYCLICALS Technology 1 CTXS 2 FSLR 3 RHT NEAR-CYCLICALS Financials 1 BEN
Discretionary 1 2 3 4 5 6 CMCSA EAT LEN LVS M ULTA
7 VC 8 VIAb 9 WYN Industrials 1 BA 2 CBI 3 CLH 4 5 6 7 8 9 DE OC RHI SPW UAL UNP T echnology 1 AAPL 2 BRCM 3 4 5 6 7 8 CREE EQIX GOOG JBL LRCX MA
7 TFM Financials 1 ALL 2 AXP 3 C 4 FHN 5 IVZ 6 PRU 7 PSA HealthCare 1 A 2 AH 3 CELG 4 HCA 5 6 7 8 9 MYL ONXX PFE STJ UNH
10 VRSK 11 WCN 12 ZIP
9 RVBD 10 TXN
Utilities 1 NRG
Source: J.P. Morgan and FactSet.
North America Equity Research December 2011
US Year Ahead 2012
Figure 10: Top LONG Stock Ideas from J.P. Morgan Fundamental Analysts (1 of 3)
Priced as 12/6/2011; sorted by implied upside within each sector
JPM Coverage Current Name Industry Ticker Price CYCLICALS: Materials, Industrials, Discretionary, Technology Materials 1 2 3 4 Freeport-McMoRan CopperMetals &Inc. & Gold Mining Crown Holdings Inc. Goldcorp Inc. Containers & Packaging Metals & Mining FCX CCK GG DD $40.54 $33.14 $52.11 $47.94 $38,428 $5,010 $42,195 $44,293 OW Michael F. Gambardella $61.00 OW Phil Gresh, CFA $44.00 OW John Bridges CFA, ACSM $63.00 OW Jeffrey J. Zekauskas $57.00 50% 33% 21% 19% Market Cap JPM Rtg JPM Analyst Target Implied Price Upside
EPS and Valuation 2012E EPS P/E ('12E)
$4.77 $3.16 $3.16 $4.35
8.5x 10.5x 16.5x 11.0x
2.50x 2.02x 3.92x
E.I. DuPont de Nemours &Chemicals Co. Industrials
5 6 7 8 9
United Continental HoldingsAirlines Inc. Zipcar Inc. Owens Corning Deere & Co. Road & Rail Building Products Machinery Robert Half International Inc. rofessional Services P
UAL ZIP RHI OC DE
$20.13 $14.43 $27.48 $28.98 $78.38 $39.47 $32.83 $61.36 $62.82 $102.84 $70.87 $38.06
$6,660 $567 $3,929 $3,503 $32,443 $3,888 $3,673 $3,256 $3,205 $49,680 $52,673 $6,224
OW Jamie Baker OW Paul Coster, CFA
$45.00 124% $30.50 111% 46% 35% 28% 27% 22% 20% 19% 16% 13% 10%
$5.32 $1.44 $2.69 $7.78 $3.03 $1.65 $2.50 $5.24 $7.79 $4.95 $1.91
3.8x 19.1x 10.8x 10.1x 13.0x 19.9x 24.5x 12.0x 13.2x 14.3x 19.9x
2.88x 2.63x 4.96x 0.94x 4.77x 3.33x 2.63x 3.87x 1.42x 2.68x 8.82x
OW Andrew C. Steinerman $40.00 OW Michael Rehaut, CFA$39.00 OW Ann Duignan OW Scott Lev ine OW Scott Lev ine $100.00 $50.00 $40.00
10 Chicago Bridge & Iron Co. Construction & Engineering CBI N.V. 11 Waste Connections Inc. 12 Clean Harbors Inc. 13 SPX Corp. 14 Union Pacific Corp. 15 Boeing Co. Commercial Services & Supplies WCN Commercial Services & Supplies CLH Machinery Road & Rail Aerospace & Defense SPW UNP BA VRSK
OW Rodney C Clayton, CFA $73.50 OW C. Stephen Tusa, Jr CFA $75.00 OW Thomas R. Wadewitz 119.00 $ OW Joseph B. Nadol III $80.00 OW Michael A. Meltz, CFA $42.00
16 Verisk Analytics Inc. Cl A Professional Services Discretionary 17 Las Vegas Sands Corp. 18 Viacom Inc. Cl B 19 Brinker International Inc. 20 Comcast Corp. Cl A 22 Visteon Corp. 23 Macy's Inc. 24 Lennar Corp. Cl A
Source: J.P. Morgan and FactSet.
Hotels Restaurants & Leisure LVS Media Media Auto Components Multiline Retail Household Durables VIAb Hotels Restaurants & Leisure EAT
$45.58 $42.81 $23.78 $35.84 $56.30 $32.95 $19.27 $72.93
$33,397 $21,439 $1,914 $48,527 $5,520 $2,900 $13,833 $3,000 $4,514
OW Joseph Greff OW John Ivankoe OW Joseph Greff
$64.00 $31.00 $46.00
40% 31% 30% 29% 28% 21% 9% 9% 10%
$2.57 $4.29 $1.84 $1.86 $2.86 $4.94 $3.17 $0.81 $2.27
17.7x 10.0x 12.9x 12.5x 12.5x 11.4x 10.4x 23.9x 32.1x
4.43x 2.77x 5.04x 1.35x 2.28x 2.11x 2.37x 1.35x 8.51x
OW Alexia S. Quadrani $56.00 OW Philip Cusick, CFA $30.00 OW Himanshu Patel, CFA $68.00 OW Matthew R. Boss, CPA $36.00 OW Michael Rehaut, CFA$21.00 OW Brian J. Tunick $80.00
CMCSA $23.19 VC M LEN ULTA
21 Wyndham Worldwide Corp.H otels Restaurants & Leisure WYN
25 Ulta Salon Cosmetics & Fragrance Inc. Specialty Retail
86 $1.50 OW Richard Shane $55.68 Semiconductors & Semiconductor Equipment BRCM $30. 28 Apple Inc.40 $16.56 $86.38x 2.63x 4.322 $1.49 7.629 $5.686 Electronic Equipment Instruments & Components $4.7x 0. David Anderson.3x 23.84 6.75 $27.00 $525. Communications EquipmentRVBD $26.10 $3.00 $ OW Sterling Auty.P. 48 Public Storage Source: J.402 $22. $140.730 $5. 29 Lam Research Corp.74 $623.P.P.19x 2. 33 Google Inc.50 OW Jeremy Tonet $74. CFA 95% C$31.99x 2.00 OW Christopher Danely $35. CFA$167.57 $63.00 OW Jimmy S. CFA $120.00 Diversified Financial Services C Insurance Insurance Capital Markets Consumer Finance ALL PRU IVZ FHN AXP $29.449 OW Katherine Lucas Minyard. Cl A 31 Equinix Inc.00 32 Texas Instruments Incorporated Semiconductors & Semiconductor Equipment TXN $30.00x 2.00 OW Steven Alexopoulos. 43 Allstate Corp.404 $40.254 $11. O'Brien $705. 44 Prudential Financial Inc.40x 3.0x Name Technology 26 Cree Inc.North America Equity Research December 2011 US Year Ahead 2012 Figure 11: Top LONG Stock Ideas from J.705 $24. Morgan Fundamental Analysts (2 of 3) Priced as 12/6/2011.343 JBL $20.65x 2.3x 11.00 OW Joseph Allman. Industry Ticker P/B 1. CFA $66.3x 14.12 $51.68 $2.00 94% 77% 69% 17% C$2.49x 0.00 OW Doug Anmuth OW Rod Hall.66 $4.9x 20. ACSM $79.77 $159.087 OW Vivek Juneja $54.02 $3.15x 3.25x OW Matthew G Heimermann $40.00 82% 47% 28% 14% 13% 8% $4.3x 11.00 $22.48 Internet Software & Services QIX E Internet Software & Services OOG G OW Christopher Blansett $48.352 OW Christopher Blansett $56.00 $29.70x 2.808 $13.00 $390.00 OW Michael W. CFA 26% $26.30 $43.00 OW Harlan Sur OW Mark Moskowitz $45.00 OW John Bridges CFA.66x 1.13 $2.40 $9.17x 1.50 OW Joseph Allman.92 C$8.30 $102.67 $7. CFA $8.32x 38 Pioneer Natural Resources Oil Gas & Consumable Fuels Co.42 $3.00 $1. ommercial Banks C Real Estate Inv estment Trusts (REITs)$129.26 $4.977 $14. PE.00 OW Tien-tsin Huang.8x 11.2x 23.76x 0.68x 5.19x 7.7x 18. PXD OW J. CFA OW Steven J.60 P/E ('12E) 21.87 $21. 47 American Express Co.41 $20. 27 Broadcom Corp. 37 Consol Energy Inc. 40 Halliburton Co. CFA435. Financials 42 Citigroup Inc. Mueller.86 $35.6x 11.7x 33.959 $56. 30 MasterCard Inc.86 $371.7x 7.43 $48. Bhullar.1x 38.80 $94. Worthington. CFA 63% $58.80x 3.124 $45.00 46 First Horizon National Corp.14x 4.73 $4.163 $9. Oil Gas & Consumable Fuels *NXY Oil Gas & Consumable Fuels CNX Oil Gas & Consumable Fuels DNR Energy Equipment & Services HAL Oil Gas & Consumable Fuels BPL C$15.42 34 Riverbed Technology Inc.17x 0.68 $34.67 $1. Cl A 35 Jabil Circuit Inc.2x 11.3x 8.15 $3.2x 1.503 $6.70 $1. 45 INVESCO Ltd.4x 7. 41 Buckeye Partners L.2x 13.9x 10.67 $7.145 JPM Rtg JPM Analyst Target Implied Price Upside 87% 50% 34% 31% 17% 17% 15% 13% 8% 5% EPS and Valuation 2012E EPS $1.859 $34.759 $4.603 $32.69 $2.12 PSA 17 . Financials Energy 36 Nexen Inc. 39 Denbury Resources Inc.78 $0.00 CFA OW Kenneth B.74x 2. Morgan and FactSet.10 Computers & Peripherals AAPL IT Services MA Semiconductors & Semiconductor Equipment LRCX $42.86 NEAR-CYCLICALS: Energy. sorted by implied upside within each sector JPM Coverage Current Price Market Cap $2. CFA $28.0x 17.89x 2.27x Semiconductors & Semiconductor Equipment CREE $25.95 $363.18 $2.1x 13.062 $4.6x 8.
CFA OW Michael Weinstein OW John Rex OW Chris Schott.478 $27.98x 2. Health Care Providers & Services HCA Health Care Providers & Services AH Pharmaceuticals MYL $23.146 $2. 62 Pfizer Inc.32 $3.37 OW Andrew Smith $33.00 $72.87 $2. 51 Procter & Gamble Co.15x 1.8x 14.787 $51.66x 1.97 20.28x 3. Gill OW John Faucher OW Ken Goldman OW John Faucher OW Rae Maile $55.05 6.31 $4.57 $4.698 OW John Rex OW Atif Rahim OW Chris Schott.83x 2. Morgan and FactSet.3x 10.8x 14.55x 58 Agilent Technologies Inc.00 $75. 57 Accretive Health Inc. Smucker Co.074 54 Costco Wholesale Corp.North America Equity Research December 2011 US Year Ahead 2012 Figure 12: Top LONG Stock Ideas from J.4x 13.4x 10.6x 8.77 $2. 55 Reynolds American Inc.73x 1.46 $0.Biotechnology Utilities 65 NRG Energy Inc.P.21 $42.454 NRG $19.449 $11. $94.00 $28. 63 Celgene Corp.00 $35.20 $5. Telecom.98 $19.24 $23.1x 11.259 $12.617 $2.00 36% 31% 16% 12% 11% 7% Price Market Cap JPM Rtg JPM Analyst Target Implied Price Upside EPS and Valuation 2012E EPS P/E ('12E) P/B $1.65 $101. Peterson $53.00 CFA $3. Morgan Fundamental Analysts (3 of 3) Priced as 12/6/2011.21 $4.50 -$1. 61 UnitedHealth Group Inc.00 $75.396 $64. Life Sciences Tools & Services A Health Care Equipment & Supplies STJ Health Care Providers & Services UNH Pharmaceuticals Biotechnology PFE CELG ONXX OW Tycho W.19x 3.55 $4.83x 1.61x $64.64x 18 .73x 4. CFA OW Geoff Meacham OW Cory Kasimov $38.162 $24.94x 4.67 $88.63 $1.00 $50.81 $36.34x 2.1x 18.00 $48.P.507 64 Onyx Pharmaceuticals Inc.00 64% 52% 43% 41% 30% 24% 24% 21% 13% Food & Staples Retailing TFM Food & Staples Retailing CVS Household Products Food Products Beverages Tobacco PG SJM PEP RAI $40.27 $76.29 $62. 59 Mylan Inc.00 $36. Food & Staples Retailing COST OW Christopher Horvers.8x 10. Average Source: J.96 30.00 $48.0x 13.00 $60. HealthCare 56 HCA Holdings Inc.840 $8.8x 13.18 $2.0x 0. HealthCare.7x 11. 60 St. 50 CVS Caremark Corp.946 $49. Jude Medical Inc.00 $20.7x 33.728 $38.06 $41.00 70% 34% $0.55 $38.95 $48.63 $3.70 $3.0x 22.43x 2.M.84 $178.267 OW Ken Goldman OW Lisa C. Utilities Staples 49 Fresh Market Inc.64x 4.40 $10.59x 2.813 $8. sorted by implied upside within each sector JPM Coverage Current Name Industry Ticker DEFENSIVES: Staples. 52 J.37 $3.23 $155.00 $86.9x 15. Independent Power Producers & Energy Traders $4. 53 PepsiCo Inc.1x 8.00 $25.
Average Source: J. Semiconductors & Semiconductor Equipment FSLR $46.00 $32. Red Hat Inc. Industrials.23 $50.00 -17% 19 . Citrix Systems Inc. Morgan and FactSet.168 UW Kenneth B.748 UW Christopher Blansett $40.985 $13.11 Software Software CTXS RHT $73.55 $3.52 $22.00 UW John DiFucci UW John DiFucci $53. sorted by implied upside within each sector JPM Coverage Current Name Industry Ticker Price CYCLICALS: Materials. Discretionary.North America Equity Research December 2011 US Year Ahead 2012 Figure 13: Top AVOID Stock Ideas from J.P. CFA 10% $111. Morgan Fundamental Analysts Priced as 12/6/2011.657 $9. Financials Financials 4 Franklin Resources Inc. Capital Markets BEN $100.P.00 -13% -28% -37% Market Cap JPM Rtg JPM Analyst Target Implied Price Upside NEAR-CYCLICALS: Energy. Technology Technology 1 2 3 First Solar Inc. Worthington.
The catalyst for such a move in 2012 could follow any military action in the Middle East. as well as affordable housing programs. but of course the Middle East is the wildcard. subway projects. Colin Fentin. we do not see a hard landing in China in 2012. global banks are gaining market share as Euro banks delever.P. But our view would be altered if Europe’s crisis spread beyond European banks and became a systemic global crisis. After all.S. That is not the case. the surge in oil by itself was enough to cause a recession in the U. This partly stems from better inflation readings.8tr hydraulic resource investment. In 2008. China hard landing. Our China team does not see significant risk of a hard landing. if corporate profits continue to expand but labor remains weak. Lastly. a 20% rise in claims from a cycle low has been a good harbinger of a recession—the key level is 470k on the four-week average. if U.S.S.S. Morgan’s Global Commodity Strategist. Oil at $150 from Middle East tension. Europe entering a recession is built into our base case. trend of $110115). in fact. Jobless claims above 470k.North America Equity Research December 2011 US Year Ahead 2012 Risks: 4 Thesis Changers to Downside What Would Negate Our Positive Thesis Beyond Valuation? Swing Factors Fairly Straightforward Euro-area crisis morphs into a systemic bank crisis. signaling strengthening of labor markets. Historically. labor markets deteriorate. does not see the risk of a surge in oil to these levels (he does see a 10% rise in S&P GSCI) given higher production. 20 . this would undermine a U. recovery thesis. this would likely result in the U. A hard landing is a level of growth too slow to prevent a significant rise in unemployment rates and social unrest. and a reason we see $105 in 2012 EPS (vs. U. slipping back into recession. Fortunately. J. but also supported by the major government measures such as Rmb 1. While oil has been surprisingly stable. Similarly.S. four-week claims have been moving in the other direction.
how could equities necessarily rise? Notably. This bodes well for equities—think of it conversely.North America Equity Research December 2011 US Year Ahead 2012 #1: Risky Markets Expected to Rally in ’12 Risky Assets Generally Have a Positive Outlook.S. Every strategist sees positive returns in their markets with the exception of Treasuries (10-year expected to rise to 2. better fundamentals. if credit was to have a negative outlook. low financing risk Chang Fenton Matejka Mowat Attractive yields against tail risks from Eurozone crisis Darker near-term outlook Relative value Supportive policy 1017 969 1150 1150 13% 20% 21 .04 246 776 56 330 14 442 476 2. Morgan’s Fixed Income teams see meaningful positive returns in their markets in 2012. Morgan and Bloomberg.S.50 175 700 35 225 11 350 400 +0. We have highlighted 2012 Outlook for risky assets based on targets established by J. This is positive for equities. Surprisingly. and thus are bullish. U. Figure 14: 2012 Outlook for Risky Assets Spreads in Fixed Income. both new cycle lows. we view equities as the junior piece of the capital structure and the resulting value is based on the residual of macroeconomic and credit outlooks..5%). Jozoff Reardon Solid fundamentals and wildcard of QE3 for mortgages Cautiously optimistic due to cheap fundamental credit risk Sze Chang Fundamentals remain solid 5%-10% total return in 2012. High Grade strategist Eric Beinstein sees investment grade rallying to 175bp.P.P. Index Targets for Equities J.P.P. As a framework. High Yield strategist Peter Acciavatti sees HY spreads rallying to 700bp and U. Morgan Fixed Income and Equity Strategists and are summarized on Figure 14.. despite the Eurozone uncertainty.46 -71bp -76bp -19bp -105bp -3bp -98bp -76bp 10% Neutral VERY Positive VERY Positive Positive Positive Positive Positive Positive Mixed Positive Positive Wide divergence between strong corporate metrics and wide spreads lead to eventual rally High Yield Acciavatti Defaults remain historically low Fixed Income MBS (MBS L-OAS) 10Y AAA 30% CMBS (2007 Vintage) 3Y AAA Credit Cards Emerging Markets Index (Fixed Income) Corporate EM Index (Broad) Commodities (S&P GSCI) EMEA (MSCI Europe) Asia (MSCI EM) Source: J. Morgan Risky Asset Treasuries (10-year) Strategist Belton/ Ramaswamy JULI Investment Grade Beinstein Current Target Delta Rationale Flight-to-quality rally in 1Q and trend higher Equity implication 2. These are particularly correlated to equities. J.
Today. given the myriad macro issues. this implies even greater relative underperformance of equities. the confidence in the 2012 outlook is low. thus.000 Broker 7 Broker 6 1.250 1. In some ways.325 1.375 1. but perhaps the simplest illustration is to look at top-down Strategists’ forecasts from Bloomberg (Figure 15.400 1. a Contrast to a Year Earlier. This also implies a YE 2012 P/E ratio of 11. Why? This is lower than the April 2011 high of 1363—given fixed income markets are forecasting spreads to be even tighter by YE 2012 vs.500 1.340 ’08 high ’10 high 1. that was a very obvious caution sign. in retrospect. When Consensus Was “Bullish” on 2011 Our takeaway is that the market is in a better position to be surprised on the upside given lowered expectations. The mean year-end target is 1351. Morgan Broker 5 Thomas Lee Avg Source: Bloomberg NI WGT <<GO>>.190 Broker 10 Broker 2 Broker 4 Broker 1 Broker 3 Broker 9 J. There are many ways to illustrate this. NI WGT <GO>). which would be the lowest P/E since 1950 for any market into its 46th month (the age of the bull market by December 2012) (see Figure 2). the YE 2012 target is actually lower than the year-ago 2011 forecast of 1377 (as of December 2010). the market is likely better positioned for an upside surprise.P. the Street was bullish on 2011 and perhaps. While not apparent from the figure below.North America Equity Research December 2011 US Year Ahead 2012 #2: Consensus Is Cautious About 2012 In general.349 1. And.200 1.600 ’07 high 1. 22 . Figure 15: Comparison of S&P 500 Targets for 2012 2012 based on those strategists that have established 2012 targets 1. April.300 1.400 1.330 1. A year ago.100 1.2x.430 1.350 S&P 500 Price Target 1. consensus is more cautious about 2012 compared to last year (when consensus was looking at 2011). Bottom Line—Consensus Is “Cautious” on 2012. this is a slightly bearish view.500 1.
the crisis is likely to worsen in 1H12. In the team’s words: “In our view. there is a lot of progress that needs to be made to get there. pushing spreads wider.P. it has the firepower to short circuit this feedback loop. to reluctance of core countries to support weaker countries for fear of “socializing debt. J.North America Equity Research December 2011 US Year Ahead 2012 #3: Euro Crisis to Abate by 2H12 J... 23 . and his team shows.” – Pavan Wadhwa. .” to Euro banks with excessive exposure to sovereign paper. Morgan Fixed Income Sees Euro-Crisis Abating by 2H12 Our Global Fixed Income team recently published its 2012 outlook. Among the known reasons for its reluctance: 1) playing a larger role is deemed “socializing” the debt and provides a disincentive for structural reform. Morgan’s Global Fixed Income team believes the crisis has spread so widely that the only institution that can end this crisis is the ECB—that is. IMF and EU will be on a scale sufficient to ultimately stabilise peripheral yields in 2H12. before the ECB feels compelled to step in and stabilize markets by monetizing debt . this is not the base case of our Fixed Income strategists. However. and 2) a larger role blurs the line between monetary and fiscal policy. The ECB Potentially the Cure: JPM Estimates €70Bn/Month Needed or Double Current Rate of Purchases. lagged responses by ECB. And as the feedback loop. We expect that the eventual response from the ECB. produced by Pavan Wadhwa. And a rally in spreads should be positive for equities. the ultimate response is not able to contain this. However.P. The fact is that cross-border capital allowed the weakness in the peripheral regions to quickly transmit through the rest of Europe.P. Morgan Global Fixed Income Strategist. followed by a coordinated response from ECB/EU/IMF that results in tightening of spreads. The obvious risk is that the crisis spreads to banks and beyond and. It sees 2012 as a bifurcated year—a worsening of the crisis in Europe. the outlook for Europe in 2012 starts with the crisis worsening and then taking a turn for the positive. a resolution of the crisis would be positive. As for equities. J. Granted. Global Fixed Income Strategist from “Global Fixed Income Markets 2012 Outlook” dated 11/24/11 Thus. But the Current Situation Is a Negative Feedback Loop… What had started as a “peripheral” debt crisis in Europe in early 2010 has spread and engulfed the entire region in a crisis that seems very difficult to extinguish. this has amplified the crisis (Figure 16). this pressure is working in favor of the core nations forcing change among the peripheral countries. arguably. thus. But consider that the pressure on markets today has resulted in the turnover of two governments (Greece and Italy) and. There is plenty of blame to spread around from slow reforms of policymakers. . there are multiple reasons it remains reluctant to intervene.
there is no actual capacity constraint. And Germany and other parties have not been supportive of broadening commitment. . The main risk. From an equity market perspective. this suggests that markets are likely to react very positively if the ECB finally succumbs to market pressure. This implies the ECB would need to double its current rate of purchases (from €35bn/month) to eliminate this imbalance. we do not think we are at that juncture. 24 . In other words. However.North America Equity Research December 2011 US Year Ahead 2012 For a variety of reasons. Figure 16: The Negative Feedback Loop in Europe . Doubling of Rate of Purchases Does Not Seem Unfathomable…But JPM Believes Markets Will Need to Force ECB’s Hand At the moment. if the situation worsens. there is no limit to how much the ECB would allow its balance to expand (beyond sterilization). based on self-imposed limits and the arguments noted above. And. Morgan. is if the situation deteriorates to the point that even the ECB cannot intervene. Wadhwa estimates there is about €1 trillion of funding (€350bn of primary plus €650-700bn of secondary selling less €135bn of private sector resources) or about €75bn per month of excess supply. Wadhwa believes that the current “official” resources (IMF. However. but it does increasingly take on peripheral credit risk as it does so. the view is that the ECB is not willing to commit to larger-scale purchases. EFSF. Negative Trifecta From 2012 Global Fixed Income Outlook by Pavan Wadhwa Source: J.) are not sufficient to fund both Italy and Spain if they both lose market access (see pages 13-14 of “Global Fixed Income Markets 2012 Outlook” dated 11/24/11) and therefore the ECB eventually needs to step in. in our view. . equity markets will drift up—the reason being that global economic momentum remains and there still exists the positive option of an ECB intervention. if the European situation stabilizes. it simply pushes us closer to ECB intervention. etc. However. in this view.P. what will markets do in the interim? It is our view that.
50% and a similar narrowing of its interest rate corridor to +/.25bp. . The weakening in the outlook is best seen in the downturn of the Euro-area PMIs. From “Global Data Watch” dated 11/25/11 Figure 18: . . J. a natural by-product of rising funding costs (both sovereign and corporate).P.North America Equity Research December 2011 US Year Ahead 2012 While certainly a possibility. Morgan. de-leveraging by banks. 25 . resulting in a deposit facility rate of 0. we believe those countries will see sufficient pressure from global policymakers to act prior to this. . J.P. While the region managed to post 0. and deteriorating business confidence. Morgan economists expect 4Q GDP to show contraction of at least -1% and negative growth until 4Q12. And Likely Further Cuts by ECB From “Global Data Watch” dated 11/25/11 Source: J. Source: J. The ECB is also likely to cut rates.8% growth in 3Q. the country area data show that France is really the only country with an upturn in PMI and the rest of the region is likely weakening. Figure 17: Euro-Area PMIs Point to Recession . .25%.P. Morgan. resulting in its main policy rate falling to 0. lagged policy response. following the downturn in the PMIs. Morgan forecasts a 25bp cut in December (2011) followed by moves in March 2012 and June 2012. But Europe’s Economy Is Slipping into Recession… Europe’s economy continues to contract. While the headline (Euro area) actually rose slightly in November.P.
Morgan and FactSet. 26 .1% Cyclicals and Near-Cyclicals underperformed sharply in 2011.0% 11.4% 7.4% -2.8% -2. and thus appear poised to outperform in 2012 once the European debt crisis is resolved.1% — 10.0% 4.2% -3.1% 2. On the downside.North America Equity Research December 2011 US Year Ahead 2012 What Outperformed After March 2009 Post-Lehman? We compiled a list of the groups that outperformed following the lows established in 2009 (post-Lehman). Fwd 12-mo Perf after Rank Sector S&P 500 Relative Perf Financials Discretionary Industrials Technology Materials HealthCare Staples Energy Utilities Telecom Cyclicals Near-Cyclicals Defensives Source: J. Figure 19: 2011 YTD Sector Performance % change YTD Figure 20: Sector Performance After 2009 Market Lows Forward 12-mo performance Rank Sector S&P 500 1 2 3 4 5 6 7 8 9 10 Utilities Staples HealthCare Discretionary Energy Technology Telecom Industrials Materials Financials Cyclicals Near-Cyclicals Defensives Absolute Relative Perf Perf -1. as it outperformed by 77% following the March 2009 low.1% -10.1% -9.9% -7. Morgan and FactSet. outperforming by 22% on average. 3/09 Low 69% 1 2 3 4 5 6 7 8 9 10 77% 31% 27% 15% 14% -23% -27% -30% -36% -49% 22% 24% -34% Source: J.7% -18.P. with Telecom leading to the downside with -49% underperformance.1% 3.P.4% 6. Defensives overall underperformed by -34% on average. Cyclicals overall performed strongly.7% -3.2% -4. as we think these groups should also be poised to outperform once the crisis in Europe reaches a resolution.0% 7.1% 8.7% -19.2% 5. Financials appears to be the sector with the most upside potential.2% 3.2% 4.0% -8.1% 6.0% 5. not surprisingly.3% -0.
00 $0.85 $23.28 $85. S&P 500 EBIT margins at 15% are still below prior peak of 18%. suggesting that S&P 500 companies are not over-earning.00 1992 $22.00 $88.80 2010 $85. The reason for this is that interest expense and taxes (as a percentage of sales) are well below levels in 2007.00 1996 $41. The question for investors is whether to be thinking about a downturn in earnings given EPS is already at prior highs. Granted.47 $51.44 $80.00 Source: J.00 $100.P.28 Prior peak EPS 2012E $105.68 1995 $38.02 $55. this should result from operating leverage as sales expand. We think such levels are somewhat sustainable given debt levels (as a percentage of sales) are lower than in 2007 and current low interest rates. EBIT Margins Have Room to Expand Further We realize the pushback is that net income margins already exceed their prior peak at 9.00 1990 1991 $18. there remains heightened risk of downside to earnings. On the other hand. S&P 500 EPS in 2011 is expected to surpass the prior high of $88 in 2007. S&P 500 profit recovery is tracking slightly below that in prior earnings recovery cycles (Figure 24).North America Equity Research December 2011 US Year Ahead 2012 #4: Corporate Profit Margin Expansion Still See Upside to Our 2012E/2013E EPS of $105/$110 We remain comfortable with our EPS forecast for 2012 EPS of $105.49 $40.00 .8% in 2007 (Figure 22).18 $67. But there are other reasons we see upside to profit margins. Figure 21: S&P 500 Annual EPS Since 1990 $97. Currently. Intuitively.07 1994 $32.77 1993 $28. Morgan and FactSet.2% compared 8.42 $20. Specifically: While net income margins are approaching the prior peak of 9% (Figure 22).16 2002 $47. we realize that with Europe in recession. EBIT margins still appear set to expand.02 1997 1998 $44.00 2004 2005 2006 2007 2008 2009 $60. Finally.74 $60.33 1999 2000 2001 $45.75 2011E $120.10 $76. only 78% of S&P 500 companies 27 2013E $110.12 $44.12 $65. As shown in Figure 21 below. which is above top-down consensus of $102 and below bottom-up consensus of $108.94 2003 $55. we believe quality of earnings is higher today as “inventory profits” are running at only 3% of overall earnings compared to 15% seen during the 1970s and 1980s. EBIT margins at 15% (as a percentage of sales) are still below the prior peak of 18% in 2007.
the prior peak is not a constraint.P.0% 10.0% 12/06 4/07 8/07 12/07 4/08 8/08 12/08 4/09 8/09 12/09 4/10 8/10 12/10 4/11 8/11 Source: J. Morgan and FactSet.2% Those Companies that Have Reached Prior EBIT Margin Peak Have Seen EBIT Margins Continue to Surge… Finally. 8.0% 16. We have plotted the composite EBIT margin of the 78% of companies that have exceeded prior peak EBIT margins.4% Prior Peak Net Income Margin. Net Income Margin Prior Peak Net Income Margin Prior Peak EBIT Margin. compared to only 78% of Cyclicals and 66% of Near Cyclicals. Figure 22: S&P 500 EBIT Margin and Net Income Margin Since 2006 EBIT Margin Prior Peak EBIT Margin 20.North America Equity Research December 2011 US Year Ahead 2012 have re-attained prior peak EBIT margins.0% 14. In other words. 17.0% 8.8% 9.0% 2.0% 4. 28 . 91% of Defensives are already operating at prior peak EBIT margins. As this figure shows.0% 12.0% 18.5% 15. the 22% that have not exceeded the prior peak have seen EBIT margins continue to expand as well and at a faster pace. consider Figure 23 below. we see no reason why EBIT margins cannot improve again in 2012. At the sector level. Thus.0% 6. In the meantime. pointing to EPS growing faster than sales.0% 0. And those 78% have already exceeded the prior peak by 6% (index 100 = prior peak). their EBIT margins are above the prior peak and are continuing to expand.
our 2012 EPS forecast of $105 puts 2012 EPS at 118% of 2007’s peak EPS (see Figure 24). The composite EPS recovery since the Great Depression has been for EPS to reach 123% of prior peak in 22 quarters (2012 equivalent). Morgan and FactSet.North America Equity Research December 2011 US Year Ahead 2012 Figure 23: Indexed S&P 500 EBIT Margin Since 2006 Indexed at 100 at Prior Peak for S&P 500 EBIT Margin in 2Q07 S&P 500 78% of cos that have Reattained Peak EBIT margin 22% of cos that have NOT Reattained Peak EBIT margin S&P 500 Pro-forma 106 19% 17% 91 LTM EBIT margin EBIT Margin (% Sales) S&P 500 78% of cos that have Reattained Peak EBIT margin 22% of cos that have NOT Reattained Peak EBIT margin S&P 500 Pro-forma 110 Indexed LTM EBIT margin 100 90 80 70 60 50 40 12/06 7/07 2/08 9/08 4/09 11/09 6/10 1/11 8/11 3/12 10/12 68 17% 15% 13% 15% 13% 11% 9% 7% 12/06 7/07 2/08 9/08 4/09 11/09 6/10 1/11 8/11 3/12 10/12 Source: J. Thus. This recovery in profits is actually below what has typically been seen in EPS recoveries following the Great Depression. YE 2012 YE 2013 YE 2014 29 .P. We indexed earnings so that 100 was the prior peak in EPS (prior cycle). FactSet. Current Profit Recovery In Line with Past Recoveries Currently. Figure 24: S&P 500 EPS vs. and Shiller.P. Prior Peak Indexed at 100 at prior peak EPS. while companies that had not re-attained peak EBIT margin by 3Q11 have re-attained peak EBIT margin by YE2012. the current recovery does not indicate an unprecedented surge in earnings. Note: S&P 500 pro forma assumes companies that had re-attained peak EBIT margin by 3Q11 have flat EBIT margin through YE2012. Morgan. since 1900 Peak in EPS 140 6/2007 Composite Composite (post-Great Depression) 134 123 117 118 106 141 BU Consensus Indexed S&P 500 EPS 120 100 80 60 40 126 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 Quarters since Peak EPS Source: J.
Profits are not forecast to peak until after 2013 (i. Our current EPS estimate for 2011 of $97.75 surpassing the prior record. buybacks would need to increase by 31% to $754bn. S&P 500 profits are at all-time highs. total cash return would need to increase by 28% to $1. corporate cash return is not anywhere close to prior highs. or $250Bn Upside in Total Cash Return…Looking at 2011 vs. 2007 We compared cash return statistics this year compared to 2007 (when S&P 500 profits were last near this level). 2007 vs.North America Equity Research December 2011 US Year Ahead 2012 #5: De-Equitization of Markets Taking Place Expect 28% Increase.060 $92 $305 $574 $880 2007 Source: FactSet. Figure 25: Dividends and Buybacks Likely Ramp Up .1 trillion in 2007 and only totals $880bn currently. or 6. 20142015). dividends would need to increase by 21% to $370bn. 2011(annualized).75 compares to profits of $92. with expected 2011 EPS of $97. But to true up to the 2007 implied level. But to true up to the 2007 implied level. Dividends totaled $349bn in 2007 and are only $305bn currently.1% higher.S. Corporate cash return as a percentage of profits (we used NIPA corporate profits for this exercise. We define corporate cash return as buybacks and dividends.e. Despite this record high. . We compiled all stock activity for all 15. Buybacks totaled $711bn in 2007 and are only $574bn currently. 30 .000 U. But to true up to the 2007 implied level.125 total return $1. and in our view the implication is that corporates are likely to vastly ramp up cash return activity. $bn where applicable EPS $98 Buybacks Implied level $754 $711 Dividends Implied level $370 $349 Total Cash Return $245b implied Implied level increase in $1. . Total cash return totaled $1..15 in 2007. which is a fairly comprehensive measure of corporate net income) is currently about 41% of profits—among the lowest levels since 1990 and well below the 20-year average of 51%. Below 51% Long-Term Average and 78% in 2007… As we are all aware. 2011 2007 2011 (annualized) 2007 2011 (annualized) 2007 2011 (annualized) YTD 41% of Income Has Been Returned to Shareholders.1 trillion. companies that are publicly traded (even those no longer trading) and plotted the data in Figure 26 below.
There are also incentives for companies to buy back stock versus paying dividends—namely. 31 . . An increase in corporate buybacks of $300-400bn is no different than a similar increase in the dollar amount of inflows from retail mutual funds. we compiled data on all companies since 1990 (~15. with a total of $880bn. The current figure is $880bn annualized with buybacks representing $574bn and dividends $305bn. In dollar terms. For % of profits. Note that the current ratio of buybacks as a percentage of cash return is 65%.2 trillion. this implies a buyback level in the range of $1. Source: FactSet..000 total securities). Corporate Cash Return Likely to Dramatically Increase Buybacks and Dividends in Coming Quarters Below we have compiled total cash return for the 15.000 companies since 1990 in Figure 27. Below 20-Year Average of 51% Since 1990 Recession 90% 80% 70% 60% 50% 40% 30% 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 37% 38% 32% 37% 33% 2009 2010 2011 annualized 48% 43% 43% 46% 57% 59% 52% 46% 47% 54% 65% 65% 63% 55% LT Avg 51% 41% Mature stages… Mature stages… LT Avg Cash Return as a % of CorpProfits 84% 78% Towards 70%80%. companies distributed 78% of profits via buybacks and dividends. this figure has tended to rise to 65-80%. and in 2000 distribution totaled 84%. the equity earnings yield is much higher than corporate bond yields. with a total of $1. As for composition.North America Equity Research December 2011 US Year Ahead 2012 As noted in Figure 26. For profits. On an annualized basis. we believe the delta in corporate cash return is likely to represent buybacks. we do not see why corporates would want to accelerate buybacks given their equity is so cheap relative to credit. Figure 26: Year to Date 41% of Corporate Profits Have Been Used to Buy Back Stock or Pay Dividends . The prior record year for total cash return was 2007.06 trillion returned to shareholders via buybacks and dividends.. up substantially from $880bn currently. we used NIPA data from BEA. This would be equal to the largest single year of inflows into equities by mutual funds. In 2007. during the later years of an expansion. In other words. .1-1. 2011 is tracking below that level.
shares outstanding have increased 3-4% annually. Figure 28: Share Count of S&P 500 Since 1991 Ex-Financials.000 $800 $600 $400 $349 $302 $299 $311 $587 $225 $190 $173 $186 $167 $157 $168 $153 $176 $143 $155 $365 $80$142 0% $29 $103 $37 $107 $43 $113 $45 $101 $49 $121 $266 10% $323 $145 $132 $144 $107 $148 $156 $170 $407 $450 $222 $160 $190 $556 $254 $196 $176 $574 -5.0 -4.9 25. thus. For profits. data are for 355 current constituents of S&P 500 with data available since 1991 220 210 S&P 500 shares outstanding (b) Figure 29: Five-Year % Change in S&P 500 Share Count Ex-Financials. we used NIPA data from BEA.3 14.North America Equity Research December 2011 US Year Ahead 2012 Figure 27: Buybacks and Dividends Are the Second Highest on Record .3 15.6 21. 32 5-year Delta in S&P 500 shares outstanding (b) 196 S&P Shares are back to 500 ex… levels not seen since 2001 203 208 213 216 217 218 218 213 209 213 212 212 . we compiled data on all companies since 1990 (~15.6 27.9 12/08 0.0 -10. highlighting the important role of corporates as the real incremental buyers of stocks (Figure 29).0 12/96 12/98 12/00 12/02 12/04 12/06 -6.0 25.3 12/10 $298 $711 $264 $287 $305 $761 $200 $0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 annualized Source: FactSet. Since 1990 Recession 70% 60% 50% 40% 30% 20% 36% 31% 22% 26% 27% 29% $363 $372 $353 $324 $329 $350 $491 48% 42% 52% 53% 53% 48% 47% 46% $706 54% 58% $858 Buybacks Dividends Buybacks as a % of Cash Return 65% 67% $1. Source: FactSet. For % of profits.6 15.8 27.0 0.0 20.2 20. Since 1990.1 23. the recent declines are a substantial change in trend.0 10. shares outstanding are currently at levels not seen since 2001. .060 59% 55% 56% $880 $652 65% $1. the first time this has occurred since 1990 (Figure 28). As noted below. The share count has declined by 3% since 2006.0 15. S&P 500 Shares Have Fallen to Levels Not Seen Since 2001… The share count of the S&P 500 (ex-Financials) has declined since 2008.0 5.0 -5. data are for 355 current constituents of S&P 500 with data available since 1991 30. .9 10. This is the first time since 1991 the share count is lower than it was a decade ago.4 15.1 S&P 500 ex Financials 200 190 180 170 160 150 166 170 173 176 179 182 186 189 12/91 12/93 12/95 12/97 12/99 12/01 12/03 12/05 12/07 12/09 9/11 Source: FactSet.200 $1.6 -6.000 total securities).
33 . 8 Gap Inc. 4 DIRECTV Ticker NVLS WLP AZO DTV TRV BIG CPWR GPS VRSN GICS 5yrs ago 45 35 25 25 40 25 45 25 45 30 35 40 25 35 40 35 25 40 35 45 124 621 71 1. 16 Aetna Inc. equities have outperformed European equities. corporates have been much more aggressive at buying back their shares than European companies. 2 WellPoint Inc. 20 Hewlett-Packard Co. Inc. 17 Sears Holdings Corp. take a look at Figure 32 and Figure 33. 13 AutoNation Inc. Figure 30: Distribution of Companies by Five-Year Change in Shares Outstanding % of companies in S&P 500 (ex-Financials) based on 5-year change in shares outstanding 33% of cos bought 35% 30% 25% % of companies 20% 15% 11% 10% 5% 0% <-10% <-20% -20% to -10% to -5% to 0% to 5% to >10% -10% -5% 0% 5% 10% % chg in Shares Outstanding (Now vs.7% of market cap and this level has been consistent for the past 15 years. 15 Torchmark Corp. 19 Biogen Idec Inc.S. with 33% of S&P 500 companies (ex-Financials) reducing share count by 10% since 2006 (Figure 30).219 690 109 352 822 244 478 589 412 208 393 147 522 154 556 337 2.S.002 Delta -57 -271 -31 -503 -277 -42 -134 -295 -85 -166 -202 -134 -66 -121 -45 -160 -47 -159 -94 -730 % chg -46% -44% -44% -41% -40% -38% -38% -36% -35% -35% -34% -32% -32% -31% -31% -31% -30% -29% -28% -27% -35% 33% back at least 10% of shares 22% 20% 15% 15% 11% 7% 5 Travelers Cos. In contrast.S. To get a better sense for this.S.732 Current 67 349 40 715 413 67 218 527 159 312 387 278 141 272 102 362 107 397 243 2. U. 6 Big Lots Inc. corporates have executed buybacks equal to about 4% of market cap. Over the past five years U. European corporates have bought back shares amounting to 0. 5 years ago) Source: FactSet.S. Thus. corporates have been buying shares at 6x the rate of European companies. This is obviously a significant difference and one reason we believe U. 9 VeriSign Inc. Corporate Buybacks 6x Larger than European Corporate Buybacks U. 18 Loews Corp. MHS 12 Chubb Corp. Total Source: FactSet. 7 Compuware Corp. 10 Coca-Cola Enterprises Inc. a trend that has been steadily accelerating since 1995 when the level was closer to 1.North America Equity Research December 2011 US Year Ahead 2012 33% of S&P 500 Companies Have Bought Back at Least 10% of Shares in Past Five Years… The reduction in shares outstanding for S&P 500 companies has also been widespread throughout the index. CB AN ABC TMK AET SHLD L BIIB HPQ U. Figure 31: 20 Largest Decline in Share Count (% Change) Since 2006 % change in shares Shares Outstanding Sector Name 1 Novellus Sy stems Inc. 14 AmerisourceBergen Corp. CCE 11 Medco Health Solutions Inc.5%. The companies with the top 20 reductions in share count have seen shares outstanding fall by an average of 35% (Figure 31). 3 AutoZone Inc.
0% 3.0x 1.0% 1.4x 0.6 trillion came from corporates. Europe data is based on the Datastream Europe Total Market Index. Corporate Buybacks vs. Look at how this has evolved in the past five years.5% 0. Take at look at the chart below.0% 0.1x 3.0x 1996-2000 2001-2005 2006-2011 all Periods Source: FactSet and Datastream. European Corporate Buybacks U.0% 2. this figure. as we noted in the previous section.528 $818 $705 $24 $1.0x 2. European Corporate Buybacks Buybacks as a % of Total Market Cap US Corporate Buybacks as a % of Wilshir 5000 Market Cap e Europe Corporate Buybacks as a % of EuropeTotal Market Index 4. 2011 data is annualized. 34 .5% 2.6% 0.S.9% 2. Corporate Buybacks vs. By the way. 2011 numbers are annualized Buybacks 95% 75% % of Flows 55% 35% 15% -5% -25% 1990-1994 1995-1999 2000-2004 2005-2009 2010-2011 Source: FactSet and Investment Company Institute (ICI). Figure 33: U.5 trillion of total incremental flows into equities since 1990.8x 2001-2005 2006-2011 5. 2011 data is annualized.5% 4. Thus.5x 2.5% 0. we see the upside bid to equities continuing. Morgan and DataStream.381 $127 $185 $489 $470 $5.6x all Periods 3.North America Equity Research December 2011 US Year Ahead 2012 Figure 32: U.7% 4. Corporate Buybacks/European Corporate Buybacks 1996-2000 6. Dividends 38% 33% 30% 33% $billions $484 $224 $75 $109 $41 $183 $159 $143 Mutual Fund Flows into Equities 3% 17% 26% 37% 42% 38% 37% 60% 67% -9% Total 45% 49% 18% 83% of inflows are Corporates 37% 1990-1994 1995-1999 2000-2004 2005-2009 2010-2011 Source: FactSet and Investment Company Institute (ICI).9 trillion while $9.0x 3. corporate buybacks represented 60% of the total.5x 3.0% 1996-2000 2001-2005 2006-2011 all Periods Source: J. In total.0x 5.5% 1. showing that since 1990 buybacks and dividends have been the largest incremental source of market demand. but it should be necessarily smaller.5% 3.P. We have not been able to obtain a similar figure for hedge funds. for instance.0% 1.6% 2.5x 4. 2011 numbers are annualized Buybacks $900 $750 $600 $450 $300 $150 $0 -$150 Dividends Mutual Fund Flows into Equities $11. Corporates really have been the incremental buyers of stocks. Figure 34: Corporates Have Been Incremental Buyers of Stocks Since 1990.0x 4. Europe data is based on the Datastream Europe Total Market Index. In 2005-2009.S. mutual fund inflows totaled $1.5% 0. Think about that: the real incremental buyers for stocks have been corporates.6% 2. there have been $11.S. Corporates the Incremental Buyers of Equities: 83% of All Inflows to Equities Have Been from “Corporates” This leads us to the next critical point.227 $184 -$61 Total Figure 35: Corporates Have Been Incremental Buyers of Stocks Since 1990.920 $305 $296 $496 $4.5x 1. Of this.5x 5. is likely to ramp up dramatically.
35 . NAHB Homebuilder sentiment hit a four-year high of 20 (November) (Figure 37). Mortgage delinquencies (MBA) at 7. .99% are the lowest since 3Q08 (Figure 39). Figure 38: Vacancy Rate of Homes HVRAHOME Index GP <GO> Figure 39: % Mortgages Delinquent MBA DLQTDLQT Index GP <GO> – MBA % mortgages delinquent Lowest since 2006 Fewest since 3Q08 Pre-Bubble Source: Bloomberg. Housing Affirms Recovery in 2012 Our thesis has been that U. NHSPATOT Index GP <GO> Figure 37: Homebuilder Sentiment Is the Best Since Early 2008 USHBMIDX Index GP <GO> Breakout to 3-yr high Distortion from homebuyer tax credit Distortion from homebuyer tax credit Breakout to 4-yr high 3-yr range 3-yr range Source: Bloomberg. the lowest since mid-2006 (Figure 38). Vacancy rate of homes fell to 2.S. housing markets would stabilize in 2011. with shortages developing given the extremely low level of starts (see “Positive on Housing Food Chain.” and “Housing Food Chain: Part III”).North America Equity Research December 2011 US Year Ahead 2012 #6: U. Figure 36: Building Permits Are Breaking Out of Prior Range .” “Positive on Housing Food Chain II.4%. . Source: Bloomberg.S. Source: Bloomberg. . While a bit slower to develop. evidence of a 2011 recovery is mounting: Building permits hit a three-year high at 653k (October) (Figure 36).
843 4. or a net increase in rented units of 1. of pricing supply/demand. We added another element of “vacancy” analysis called “vacant other. In 2010. as the latter are better measures. (c ) (d )=(b) * (c) (e) = (b) . in our view.190 9.083 (13) (13) (316) 36 .(d) = Target: 2005 Vacancy Rate Target rentals v acant Estimated excess rental units 37. The number of vacant homes declined slightly in the past year.1MM Recently We updated our analysis using current data (but using pre-2007 as target levels) and compared this to 3Q10.4MM to 1.40% 2. this is not an excess home from a fundamental supply/demand perspective—the occupant simply moves to another shelter.146 93 (224) 904 (132) 957 Others: Vacant for "other supply" (a) (b) (c ) = (a) . 2011 data are the latest available data.250 512 1. by 87k.4mm to 1. Morgan and US Census Bureau.511 539 1. 4.1MM 000s Excess housing. not shadow inventory.60% 2. Homeowner: Calculating excess supply + + (a) (b) + Owner occupied home Sold but awaiting occupancy Vacant y ear-round for sale only Total homeowner units Current vacancy rate Target: 2005 Vacancy Rate Target homes vacant = Estimated excess housing units 3Q10 75.625 2.000 2.00% 1. we calculated estimated excess homes using the notion of vacancy rates.North America Equity Research December 2011 US Year Ahead 2012 EXCESS HOUSING BASED ON VACANCY RATE.(d) (8) (80) Rentals: Calculating excess supply + (a) (b) + + Rental occuppied units Rented but awaiting occupancy Vacant y ear-round for rent only Total rental units Current vacancy rate (c ) (d )=(b) * (c) (e) = (b) .239 43. and thus worth including in our view. As shown. as these homes move through the foreclosure process.1mm.395 467 4.233 10.4MM to 1. What is notable in Figure 40 is that the total excess units have declined from 1.054 317 Large increase in occupied rentals 38.30% 9. creating supply from a price perspective.299 652 4.” Figure 40: Excess Inventory Has Declined from 1.863 77. NOT SHADOW INVENTORY Excess Home Supply Declined from 1.60% 4.00% 1. the occupant will need to find a new shelter. the occupant eventually needs to find shelter.371 42.80% 9. 71% or 224k is attributable to a drop in excess rental vacancies—in other words. this category is about 600k above the long-term trend. In other words.” This category of “other + temp occ by URE (Usual Residence Elsewhere)” could include homes held by banks and investors.553 311 Delta (261) (87) (375) Thus.560 390 3Q11 75. Why? The occupancy rate of homes that are delinquent today is close to 100% (primary residence).150 693 1.150 680 1. suggesting that the rise in rental demand was not all “migrations from homeowners to renters.2mm (rental formation). while the home will be liquidated.(b) = Other + Temp occ by URE Target: Other + Temp occ by URE Estimated excess rental units Total excess units of housing Source: J.60% 4. rather than fundamental demand.400 4. is best gauged by looking at vacancy rate. Of the 316k drop in excess homes. rather than “shadow inventory” or foreclosure data. therefore.P.950 78. We used vacancy rates. as of 4Q10. there was a 904k increase in occupied rental units and a 132k drop in “vacant” rental units. in our view.830 4.
but in any year this ratio varies and has plunged during recessions but recorded similar bounces during labor recoveries.65 0. there needs to be a recovery in household formation.86 — 0. a b Implied HHs formed Incr.69 0.71 0.70 0.27 0.262 Trending higher… Source: Bloomberg and Datastream.6mm 2. Morgan and Bloomberg.84 0.61.500 1.9mm 1.24 0. However.54 0.67 0.27 0.49 — 5 0.86 1. Adults HH/adult (see above) 2011e 2012e 2013e 2014e 2.50 0.90 0. Figure 42: Household Formation vs.42 0. A rise to the longterm average (Figure 41) would represent a doubling of household formation rates.54 0.55 1.22 0.500 2.19 1 0.71 0.70 0.69 0.43 0.000 1.2mm a*b Implied HHs Formed Source: J.P.1mm (and therefore establish a sustainable basis for a housing recovery).48 0.73 0. The long-term average of households formed per net adult is 0.10 0.500 YoY Household Formation LT avg ('59-'06) YoY Household Formation 2.000) 1/59 1/63 1/67 1/71 1/75 1/79 1/83 1/87 1/91 1/95 1/99 1/03 1/07 1/11 Source: J.000 0 (2.22 0.000 in Ratio 1962 1966 1974 1982 1989 1995 b Avg All Years 2009 (today) 0 0.North America Equity Research December 2011 US Year Ahead 2012 Household Formation Is Recovering as Well… In order to reduce excess housing inventory of 1.82 0.000 2.8mm 1.000 1.3mm 2.6mm 2.47 0. Figure 41: Household Formation Rates Are Slowly Recovering Are But Not at Normalized Levels YoY change in household formation 3.67 0. This ratio fell to cycle lows during the 2009 recession and has been slowly recovering. this is still below the long-term average of 1.50 0.42 2.60 0.69 0.55 0.60 0.35 0.41 3 1. This should bode well for household formation. 1.242mm (1959-2006) and reflects weak labor markets impairing household formation.000) (4. 37 .44 0.6mm 2.54 0.16 0.6mm 0.63 0.53 0.10 0.73 0.69 — 4 0.87 1. Morgan and Bloomberg.41 0. household formation varies with labor market conditions.30 0.000) Increase in Nonfarm Payrolls 1.23 0.67 0.14 0.92 0. HH Formation Households formed per net adult chg From trough HH Formed/ Net Adult chg Year of Trough 1. As one can see.16 2 0.P. Employment Growth Jobs and Households formed per net adult chg HH formation per Net Adult Chg Recession HH Formation per Net Adult chg Increase in Nonfarm Payrolls Figure 43: Following Labor.16 (6.16 0.36 0.47 0.000 500 0 (500) 1/01 3/02 5/03 7/04 9/05 11/06 1/08 3/09 5/10 7/11 9/12 9/11 330 LT avg ('59-'06).30 4.49 0.54 0.47 0.
As one can see.050 $950 $850 $750 $650 $550 12/90 8/93 4/96 12/98 8/01 4/04 12/06 8/09 4/12 1998 2000 2002 Cost of Renting. has pushed the cost of owning well below the cost of renting again. banks and mortgage lenders have been continuously tightening lending standards for the past few years. the sharp decline in home prices. 3Q11.004 Cost of Owning Cost of Renting 18% more expensive to rent Cost of Owning.250 $1.350 $1. this ratio has recovered to the long-term average The pace of that recovery is illustrated in Figure 43 on the right.North America Equity Research December 2011 US Year Ahead 2012 By the third year into a recovery. Figure 44: Cost of Owning vs.P. During the housing bubble of 2005-2007. bank mortgage loan standards have tightened in just about every quarter since the end of 2006. Morgan REITS Research. Cost of Renting Since 1990 $1. Rent/Own Affordability Ratio Shows Owning Is Cheaper Houses are inexpensive when comparing the cost of ownership vs. As shown in Figure 45. $1. 38 . In response to the lending practices that helped fuel the housing bubble. However. combined with lower mortgage rates.150 $1. households formed per net adult change accelerate meaningfully as labor market conditions improve. $858 Source: J. Lending Standards Have Finally Started to Ease One of the biggest obstacles to a housing recovery so far has been the difficulty for many households in obtaining a mortgage in order to purchase a home. However. the net percentage of bank officers tightening standards has fallen sharply since late 2008. 3Q11. suggesting households are better off owning than renting at this point. the cost of owning greatly exceeded the cost of renting as housing prices became extremely elevated (see Figure 44). the cost of renting. with renting now 18% more expensive than owning.
5 16.0 15. Figure 46: Household Total Financial Obligations Ratio Ratio of debt payments (payments on mortgage and consumer debt. bringing household debt leverage back to the best level since 4Q 1993.0% Tightening lending standards 40.9 in 3Q07 to 16. Federal Reserve Senior Loan Officer Opinion Survey Mortgage Loan Standards Prime Mortgage Loans Non-Traditional Mortgage Loans Net % of Respondents Tightening Standards 80.P. homeowner insurance. this ratio is comparable to levels seen during the early to mid-90s. Household Leverage Back to Level in Mid-1990s. Morgan and Bloomberg.2 6/11 16. Morgan and Bloomberg. reducing debt leverage significantly since the beginning of 2008.5 17.1 Source: J.0% 20.P.0 Debt Ratio 17. and property tax payments) to disposable personal income At 16%. Creating Room for Taking on Mortgage Debt U. rental payments on tenant-occupied property.0% 60.0 18.0% 0.1 as of 2Q11.North America Equity Research December 2011 US Year Ahead 2012 Figure 45: Bank Mortgage Loan Standards Easing % of respondents tightening standards. auto lease payments.9 5yr Avg 19.5 15.0% Easing lending standards -20.0 3/80 3/82 3/84 3/86 3/88 3/90 3/92 3/94 3/96 3/98 3/00 3/02 3/04 3/06 3/08 3/10 12/93 16. households have repaired their balance sheets substantially during this economic downturn. Lower Debt 39 . Figure 46 below shows the Household Total Financial Obligations Ratio. This ratio has fallen from 18.5 18. Households have made rapid progress in deleveraging over the last few years.1 Long-Term Avg 17.0% 9/90 9/91 9/92 9/93 9/94 9/95 9/96 9/97 9/98 9/99 9/00 9/01 9/02 9/03 9/04 9/05 9/06 9/07 9/08 9/09 9/10 9/11 Source: J.S.0 16. Household Total Financial Obligations Service Ratio Higher Debt Current Long-Term Avg 9/07 18.
Housing Starts Accelerated? Sector Strategy: Buy Cyclicals.500 1.000 500 0 1/59 1/62 1/65 1/68 1/71 1/74 1/77 1/80 1/83 1/86 1/89 1/92 1/95 1/98 1/01 1/04 1/07 1/10 10/66 843 2/75 904 11/81 837 1/91 798 628 Source: J. as indicated in Figure 47 above. In the table below we have highlighted those groups that have historically outperformed when U. as housing starts still remain near the lowest levels in the past 50 years. Morgan and Bloomberg.North America Equity Research December 2011 US Year Ahead 2012 What Groups Outperformed When U.500 Housing Starts Housing Starts Current Trough Energy has been the biggest laggard.S. These troughs marked turning points in construction activity for U. Morgan and Datastream.S. 2/1975 11/1981 1/1991 22% 10% 19% 17% -4% 29% -9% -10% 7% -22% -7% -11% -13% 12% -12% -12% 41% 39% -3% 23% 10% 10% 16% -1% -6% -34% 22% -12% 8% 11% -4% 3% 14% 22% -2% 19% -4% -15% -18% 2% 2% 3% % Times Avg Outperform 17% 100% 23% 10% 10% 10% 7% 5% 4% -4% -10% -22% 12% -7% 0% 100% 33% 67% 67% 67% 67% 67% 0% 0% 0% 100% 33% 67% 40 .S.000 1. In 000s Recession 3. Cyclicals in general have outperformed by 12%. housing activity picked up (since 1973).P. underperforming by -22% on average.P.S. along with it. housing starts have hit multi-decade troughs four times since 1959. Housing Starts Discretionary has outperformed by 23% on average with a 100% win ratio following a trough in housing starts. 2.S. housing and. U. particularly Discretionary Following the trend of declining demand for housing.S. Figure 47: Total U. the supply of new housing has also dropped off significantly. led by Discretionary which has outperformed by 23% with a 100% win ratio. U.000 2. economic activity. Figure 48: Sector Performance After Trough in Housing Starts Forward 12-month performance Rank Sector S&P 500 1 2 3 4 5 6 7 8 9 10 Relative Perf Discretionary Technology Materials Staples Financials Industrials H ealthCare U tilities Telecom Energy Cyclicals Near-Cyclicals Defensives Source: J.
with a good chance of change in the House and Senate and potentially in the White House. Moreover. 2012 creates the potential for electoral change. Bush Jr (R) — '08 Obama (D) — '12 Clinton (D) — '96 Clinton (D) — '00 Ford (R) — '76 41 . And. Historically equities have performed well when approval ratings leading into election year have been low. programs like Health Care Reform and Dodd-Frank. as contentiousness and indecision have weighed on the U. if the economy recovers with incumbents remaining in office. Why? Our logic is simple: Electoral change likely positive for equities. this would also help equities. and Gallup. Conversely.S. the failure of the Super Committee speaks to the environment in Washington. An improving economy would be good for equities. However. we see an election year as a likely net positive going forward. economy and equity markets.North America Equity Research December 2011 US Year Ahead 2012 #7: U. have added uncertainty to the outlook for certain sectors. Political Outlook Win-Win for Equities in Election Year… 2012 Likely to Be Win-Win: Either Electoral Change or Better Economy Keeping Incumbents in Office Investors have grown frustrated with Washington. Currently. Bloomberg. as we look to 2012.P. Figure 49: Presidential Approval Ratings into an Election Year: President Obama Below Long-Term Average Approval rating as of 12/31 of year prior to election Presidential Approving Rating at Start of Year 90% 80% President Approval Rating Avg 76% 64% 66% 53% 66% 77% 63% 56% 48% 49% 46% 52% 49% 46% 42% 32% 60% Avg 53% 43% 70% 60% 50% 40% 30% 20% 10% 0% 23% FDR (D) — '40 FDR (D) — '44 Eisenhower (R) — '56 Eisenhower (R) — '60 Truman (D) — '48 Truman (D) — '52 Nixon (R) — '72 Carter (D) — '80 Reagan (R) — '84 Reagan (R) — '88 Johnson (D) — '64 Johnson (D) — '68 Bush Sr (R) — '92 Bush Jr (R) — '04 Source: J. Given presidential and congressional approval ratings near historically low levels (see. of course. for example. President Obama’s approval rating of 43 is below the long-term average (since 1940) at the start of an election year. among others.S. Markets could embrace such change as it might be interpreted as likely to result in an era of “deregulation/deinterference”—this should be good for equities. Morgan. Figure 49).
8% 12. Bloomberg. We believe this reflects investor optimism that changes could take place in Washington during such an election year. And we would argue that 2008 was likely an exception as that was the only time when the U. 42 . Bloomberg. as shown. The other seven years are shown in Figure 51. Bottom line: The disappointment from the Super Committee.3% 19. in our view.North America Equity Research December 2011 US Year Ahead 2012 Markets Have Rallied in Election Years When Presidential Approval Rating Was Below 50 In Figure 50 we have plotted the presidential approval rating at the start of an electrion year and equity returns for that same year: There have been eight elections of 19 when approval ratings were below 50%. The sole exception was 2008. and Gallup. economy was in recession. and Gallup. is likely to solidify investor expectations that voter frustration could result in electoral changes.7% 4.P.8% 7. and. the average gain for the S&P 500 in the election year was 13%.1% 15. Figure 50: Presidential Approval Ratings and Election Year Stock Market Returns Approval rating as of 12/31 of year prior to election 30% 80 20% 96 52 92 0% -10% -20% -30% -40% 20% 30% 08 40% 50% 60% 70% 80% Presidential Approval Rat ng at Start of Year i Approval rating below 50 76 72 88 68 84 48 00 40 04 56 60 44 64 Figure 51: Expansion Years – Returns When Approval Rating Was Low in Election Year (<50%) Approval rating as of 12/31 of year prior to election Before Election After Election S&P 500 Perf S&P 500 Annual Perf 20. Morgan.1% 100% S&P 500 Perf in that year 10% Year 1 1996 2 1976 3 1972 4 1988 5 1952 6 1968 7 1992 President Clinton Ford Nixon Reagan Truman Johnson Bush Sr Party Democrat Republican Republican Republican Democrat Democrat Republican President Clinton Carter Nixon Party Democrat Democrat Republican Bush Sr Republican Eisenhower Republican Nixon Clinton Republican Democrat Sole exception Avg % times up Source: J.4% 11. Morgan.5% 13. stock market returns were positive seven times in the election year.S. Source: J.P. Of these eight instances.
underperforming by -4% on average with only a 25% win ratio. Financials was the clear beneficiary. Cyclicals overall outperformed by 2% and Near-Cyclicals outperformed by 5%. Morgan and Datastream. Defensives were big laggards. again likely due to improving investor optimism during Presidential election years. 1976 19% 1988 12% 1992 4% 1996 20% % Times Avg Outperform 14% 100% 4% 1% 6% 8% -5% -10% 6% -3% -17% -2% 0% 6% -6% 1% -13% -6% 4% 7% 2% 3% -6% 1% -4% -5% 2% 0% 15% 7% 4% -5% 14% -2% 8% 7% -10% -2% 8% 5% -2% 8% 23% 10% 3% -7% 4% -23% -4% 1% -20% 5% 5% -9% 7% 5% 3% 2% 2% -1% -2% -2% -7% -7% 2% 5% -4% 100% 75% 75% 75% 50% 50% 75% 25% 50% 0% 50% 100% 25% 43 . outperforming by 7% on average with a 100% win ratio. Cyclicals overall also outperformed by 2%. This is likely due to low expectations for the economy at the start of the year (signified by a low approval rating) combined with investor optimism regarding potential changes as a result of the upcoming election. Figure 52: Sector Performance During Non-Recession Presidential Election Years When Presidential Approval Rating Was Low at Start of Year (<50%) Since 1973 Financials outperformed by 7% on average with a 100% win ratio. The worst sectors on average were Utilities and HealthCare.North America Equity Research December 2011 US Year Ahead 2012 Financials Have Consistently Outperformed During Election Years Sector Strategy: Buy Financials We also looked at sector performance during Presidential election years in the midst of an expansion in which the President’s approval rating was low at the start of the year (<50%). both underperforming by 7%. however. Rank Sector S&P 500 Abs Perf Relative Perf 1 2 3 4 5 6 7 8 9 10 Financials Technology Industrials Energy Discretionary Staples Telecom Materials HealthCare Utilities Cyclicals Near-Cyclicals Defensives Source: J.P.
according to Frank Li. China. Providing Support for Easing Monetary Policy Inflation in China has begun to ease recently. construction boom).0 %point contribution to China GDP Growth Final Consumption Gross Capital Formation Net Exports 13. Source: J.North America Equity Research December 2011 US Year Ahead 2012 #8: China Entering Selective Easing Cycle Debate continues on whether China can avoid a hard landing given growing imbalances in the economy (e. J. 6. slide 2 from October 2011 by Jing Ulrich.5% yoy in October vs.0 -1.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 1Q11 2Q11 3Q11 Exports have become a much less significant driver of economic growth in China in recent years. 44 .P. Similarly. percentage points 15.0 -5.P.0 7. China’s economy becoming less dependent on exports The negative impact of external drags on China should be less severe than in past years.5% vs. Inflation Cooling Off. with exports contributing a much smaller amount to economic growth.5% in July. Morgan’s Chief China Strategist.0 3.1% the month prior and the cycle high of 6.0 9. 6. Chairman of Global Markets. as China’s economy has transformed over the past few years.0 11. property prices. Figure 53: China’s Economic Drivers China’s GDP growth by expenditure.. Pipeline inflation pressure has also benefitted recently from the moderation in global commodity prices. Instead.0 5.g.0 1. Consumption and Capital Formation have become more important drivers (Figure 53). from “China Amidst Softening Global Growth”. with CPI rising only 5.1% prior month). with headline inflation easing in China (5. however.0 -3. our China strategists believe China is in a better position to begin easing interest rates (via RRR). Morgan Research.
0% 15. J. are: China’s massive Rmb1. China CPI YoY % chg 45 . from "China Strategy: A Powerful rebound ahead".0% 5. Morgan Economics. yet we see very little risk of hard landing. thanks to the economic housing projects and many 12th Five Year Plan related investment projects.0% 10. Li’s view is that “China’s economy has seen steady moderations in 2Q and 3Q.0% 10.0% 0. which has benefitted from a moderation in global commodity prices.P. especially in western and central China. The building of more subways in tier one cities such as Beijing and Shanghai. according to Frank Li. J.0% 25.North America Equity Research December 2011 US Year Ahead 2012 Figure 54: China Headline CPI.0% 10. Source: J. Food Prices.0% China CPI YoY % chg China Policy Rate China Policy Rate Figure 56: China One-Year Working Capital Rate Set to Be Flat/Up in 2012 Since 1986 China . Morgan Chief China Strategist. CPI YoY % chg 30.P.P. Morgan’s Chief China Strategist.0% 15.0% 6.0% 20. and Non-Food CPI Inflation %oya Inflation is cooling off. December 2011 by Frank Li. Morgan Economics.0% 0.1-year working capital rate 14.0% -5. Morgan Asia Pacific Equity Research.0% 0. On October 13.0% 20.0% JPM Forecast JPM Forecast 25.8 trillion hydraulic resource investments.P.0% Required Reserve Ratio CPI YoY % chg 30.0% 12.0% 4.0% 8.0% 2.0% 10. China Likely to Avoid a Hard Landing China will likely avoid a hard landing.0% 1/86 9/88 5/91 1/94 9/96 5/99 1/02 9/04 5/07 1/10 9/12 Source: J.0% 20. and the building of new subway projects in 30 provincial capital cities. China Development quoted the senior officials from China’s Ministry of Hydraulic Resources as saying that China has planned Rmb1.0% -5.0% 15. both in CPI and PPI. FAI projects from local governments.P. Figure 55: China RRR Set to Move Down in 2012 as Inflation Cools Since 1986 25.0% 5.0% 1/86 1/89 1/92 1/95 1/98 1/01 1/04 1/07 1/10 1/13 Source: J.8 trillion in investments for hydraulic resources.0% 0.” Some examples of the government’s supportive measures that are likely to help engineer a soft landing.0% 5. according to Frank Li.
P.8% 3.5% Cyclicals Near-Cyclicals Defensives 83. with Cyclicals outperforming by 33%. Financials have had a particularly rough year. this trend has sharply reversed.9% 60. Thus. led by Discretionary at 61% outperformance. Figure 57: Sector Relative Performance So far in 2011.1% 8.8% Utilities -29. however.9% HealthCare -31. we continue to recommend a Cyclical/Financials tilt.2% 4. as these groups look poised to outperform the overall market in 2012.1% -60%-40% -20% 0% 20% 40% 60% 80% 100% -0. outperforming by 23% since the March 2009 low. there was a sharp reversal of leadership between the groups that had outperformed since the start of the bull market in March 2009 and the groups that led in 2011.9% -7.7% S&P 500 Abs Perf YTD Relative Performance -1. but we expect this trend to reverse again to favor these groups in 2012.0% 5.1% 11. as the framework for 2012 is likely to look a bit like 2009—emergence from a financial crisis and the potential for an acceleration of the business cycle (driven by Europe exiting recession and China easing). 2011 Saw a Reversal of Outperformers of 2009-2010… As mentioned earlier. Cyclicals and Financials were the clear leaders. while Cyclicals and Near-Cyclicals have underperformed.1% -9. with Defensives the clear leaders.1% -15% -5% 5% 15% Source: J.8% 12. YTD performance and performance since 3/9/2009 relative to S&P 500 Relative Performance Since 3/9/2009 S&P 500 Abs Perf Discretionary Industrials Technology Financials Materials Energy -15.4% -31. 46 .7% Utilities Staples HealthCare Discretionary Energy Technology Telecom Industrials Materials Financials -18. At the sector level.3% Cyclicals Near-Cyclicals Defensives -25% 32.1% 6. we see Cyclicals and Financials outperforming again in 2012.1% 3.North America Equity Research December 2011 US Year Ahead 2012 Sector and Style Analysis Heading into 2012 with a bullish stance on equities overall. intuitively.9% 33.3% Telecom -42.4% 24. 2011 is a year most investors would like to forget. Financials also performed strongly. with Cyclicals and Financials moving from leaders to laggards.4% 7. Morgan and FactSet.8% -2. We expect this trend to reverse again in 2012. outperforming by 6%.2% 22. Since March 2009.9% Staples -20. underperforming by 18%. Sector leadership reversed sharply in 2011.2% -3.
North America Equity Research December 2011
US Year Ahead 2012
Materials, Technology, and HealthCare Attractive on Relative P/E
Stocks look very attractively valued overall, as mentioned earlier, but valuations at the sector level vary significantly. Technology is currently the most attractive sector on valuation, based on comparing the current relative P/E of the sector to the long-term average relative P/E. Materials and HealthCare are also attractively valued on this metric. Utilities and Telecom are currently the most overvalued on relative P/E compared against the long-term average relative P/E. This likely reflects investor rotation into Defensives in 2011 to avoid some of the market volatility, thus driving up the relative valuation of Defensives in general. Overall, valuation appears to favor Cyclical sectors, supporting our case for outperformance of Cyclicals in 2012.
Figure 58: Relative P/E Compared to Long-Term Average
Since 1973; P/E of each sector divided by S&P 500 P/E
Current and Long-Term Avg P/E
Current Materials 85% LT Avg 94% 95%
107% 101% 102% 132%
Delta of Current Minus Long-Term Avg P/E Delta Materials and Technology Materials -9% currently have Industrials 11% attractive valuations.
6% -30% Technology
83% 83% 79% 75%
109% 103% 112% 115% 91% 71% 70% 90% 107% 110% 130% 150% 126%
Staples HealthCare Telecom Utilities -40% -20% 0% -3%
HealthCare Telecom Utilities 50%
34% 36% 20% 40%
Source: J.P. Morgan and Datastream.
Valuation of Defensives overall, particularly Utilities and Telecom, is currently less attractive, as investors rotated into Defensives in 2011…
North America Equity Research December 2011
US Year Ahead 2012
Style Performance: Reversal of Style Leadership in 2011
Similar to the rotation in sector leadership in 2011 discussed earlier, 2011 also saw a sharp reversal in Style leadership. Riskier styles that have outperformed overall since the March 2009 low underperformed sharply in 2011. The top eight styles since March 2009 are highlighted in dark blue on the left side of Figure 59 below. In general, these styles are “riskier” as they typically have more volatility and are less consensus stocks. These styles that outperformed the S&P 500 have hit extreme levels since March 2009, with five of the eight outperforming by 100% or more. In 2011, however, these eight leading styles sharply underperformed. Only one of these eight styles (Citi Pure Growth) actually outperformed in 2011. Instead, less risky styles such as Defensives, Low Beta, High Quality, and Large Cap all outperformed. Similar to our sector outlook, we expect this trend of style leadership to reverse again in 2012, thus favoring “riskier” styles in 2012.
Style leadership reversed sharply in 2011, with “riskier” styles such as High Beta and Low Price changing from leaders to laggards, but we expect this trend to reverse again to favor these groups in 2012.
Figure 59: Style Relative Performance
YTD performance and performance since 3/9/2009 relative to S&P 500; Performance since 3/9/09 assumes rebalancing of styles at each year-end (12/31/09 and 12/31/10); Top 8 Styles since 3/9/09 are highlighted in dark blue on both charts below
Performance Since 3/9/2009
Market Cap Smaller Broken (low P/200d mavg) Beta — Higher Price Lower P/B — cheaper Citigroup Pure Growth Less Liked EV/EBITDA — cheaper P/E — cheaper Cyclical Citigroup Pure Value S&P Low Quality P/E — more expensive S&P High Quality EV/EBITDA — more expensive P/B — more expensive Price Higher Defensive -0.9% More Liked Market Cap Larger -0.9% Beta — Lower -13.8% Momentum (high P/200d mavg) -12.8% 151.6% 151.4% 136.8% 125.7% 111.8% 85.5% 92.7% 86.6% 85.0% 63.5% 58.7% 53.5% 42.6% 35.4% 28.9% 20.5% 2.0% 0.0%
Defensive Beta — Lower P/B — more expensive S&P High Quality Price Higher Citigroup Pure Growth More Liked Market Cap Larger P/E — more expensive -1.7% EV/EBITDA — cheaper -1.8% Citigroup Pure Value -1.9% Cyclical -2.2% Broken (low P/200d mavg) -2.2% Market Cap Smaller -2.5% P/E — cheaper -3.2% Less Liked -4.2% S&P Low Quality -5.3% EV/EBITDA — more expensive -5.7% Momentum (high P/200d mavg) -7.0% P/B — cheaper -7.1% Price Lower -7.3% Beta — Higher -10.7% -15% -10% -5% 0% 6.4% 5.8% 4.2% 3.7% 3.7% 2.0% 0.4% 0.3%
-50% 0% 50% 100% 150% 200%
Source: J.P. Morgan and FactSet.
North America Equity Research December 2011
US Year Ahead 2012
Valuation of Styles Suggests Cheap Stocks Even Cheaper than Usual
We also looked at the relative valuation of the Styles to identify those groups that have performed well since the March 2009 low but are still attractively valued. For valuation, we compared the current relative P/E of each style (vs. S&P 500) against the ten-year average relative P/E. Low Momentum (Low Price/200-Day Moving Avg), Low Price, Cheap EV/EBITDA, and Cheap P/E are all currently attractive based on relative valuation (vs. ten-year average) and have all outperformed sharply since March 2009. Smaller Market Cap and High Beta also look relatively attractively valued (only slightly more expensive on a relative basis than the ten-year average) and have been two of the top styles since March 2009. Thus, as the market sees a reversal again in 2012, these two groups, in particular, should be poised for outperformance, in our view.
Figure 60: Style Performance vs. Valuation
X-axis is performance relative to S&P 500 since 3/9/09; Y-axis is the # of standard deviations that current relative P/E (2013E) is from the ten-year avg. relative P/E
High Momentum 1.40 Low Beta Expensive P/E
# of Std Dev from 10yr Avg Relative P/E
Low Momentum, Cheap P/E, and Cheap EV/EBITDA are currently attractive on relative valuation despite having already outperformed the market strongly since March 2009.
Expensive P/B Defensive Expensive EV/EBITDA High Price S&P High Quality Less Liked
More Liked Mkt Cap Larger
Pure Value Cyclical S&P Low Quality
Pure Growth High Beta Cheap P/B Mkt Cap Smaller
Cheap EV/EBITDA -0.60 -15% Cheap P/E 5% 25% 45% 65% 85% 105% 125%
Low Price Low Momentum 145%
Relative Perf since 3/9/09
Source: J.P. Morgan and FactSet. Note: Ten-year average relative P/E is calculated using the stocks that currently fall into each style category and looking at those stocks’ relative P/E over the past ten years.
North America Equity Research December 2011
US Year Ahead 2012
2012 U.S. Outlook: A Year of Gradual Healing
(1-212) 834-5517 email@example.com
(1-212) 834-5523 firstname.lastname@example.org JPMorgan Chase Bank NA
The economic recovery which began in the middle of 2009 has now entered its third year, and so far GDP growth in the first nine quarters of this expansion has averaged 2.4%. In both 2010 and 2011, the summertime produced a growth scare, which subsequently faded as the data stabilized, but not before the Federal Reserve was prompted to take additional actions to support the recovery. As was the case in 2010, as we come to the end of the year concerns about another recession have diminshed. One important reason why the economy has been able to continue moving forward after the debt ceiling disruption of the summertime is the still-depressed levels of cyclically sensitive spending. The bouncback from low levels appears to be a central factor behind the strength in capital spending, which has been a major force behind the recovery thus far. While capital spending is now returning to more normal levels, investment in housing and other structures remains unsustainably low, and should be a ballast for growth going forward. Even so, two risks loom over the 2012 outlook. The first risk relates to spillovers from the economic and financial crisis in Europe. Around 20% of U.S. exports are destined for Europe, and the economic contraction will surely impact demand from that market. If that were the only transmission channel the risks would appear to be contained. However, the potential financial spillovers could be larger. Thus far, most measures show only a modest impact of the European crisis on domestic credit availability. Nonetheless, if conditions in Europe worsen the U.S. economy would not be immune from a seizing up of global financial markets. The second risk is tightening of domestic fiscal policy. The recession produced an unprecendented fiscal policy response, as the federal deficit increased to 10% of GDP. The political tolerance for such large deficits has lessened recently, and several temporary fiscal stimulus measures are set to fade in 2012, which could subtract one to two percentage points from GDP growth next year. There has been some talk about extending these measures, but so far nothing has been agreed upon. The anticipated drag from fiscal policy is the main reason behind our view that growth will be below potential in 2012, when we anticpate growth will average 1.75%. This expected tightening of fiscal policy is likely to hit the economy where it is weakest: the household sector. Slack conditions in labor markets have eroded labor’s bargaining position, resulting in very tepid wage gains. This outcome has been positive for corporate profits—which have received significant lift from restrained unit labor costs—but has held back consumers’ purchasing power. With wage inflation contained, the possibility of a wage-price spiral has been removed. The periodic episodes of higher headline inflation experienced in this expansion have not translated into lasting increases in underlying inflation. In the spring months of 2011, higher commodity prices, as well as temporarily higher prices of autos after the Japanese earthquake, gave a boost to core inflation. More recently, however, core inflation has eased back lower. With unemployment expected to remain elevated throughout 2012, we foresee more of the same on the inflation front: low wage inflation leading to low consumer price inflation.
the risk of this is high and rising (subjectively we’d put it at around 40%). Moreover. The two experiments this year were the giving a specific date—mid2013—for the zero rate funds guidance. particularly the unemployment rate. and Operation Twist. could be all that is required for QE3.North America Equity Research December 2011 US Year Ahead 2012 The low rate of inflation has given the Fed leeway to be creative in supporting the recovery. or an unwelcome fall in inflation expectations. Fed officials have shown an increasing openess to considering returning to MBS purchases. A significant setback in Europe. 51 . We think the most likely next step for the Fed is to replace the mid-2013 rate guidance with language that is more explicitly dependent on a limited number of observable economic variables. While we are not forecasting more asset purchases in 2012.
P. 2) Fundamentals encouraging with growth above investors’ grave expectations Based on consensus estimates.0% 2. Morgan Economists. Revenue growth coupled with productivity gains and limited wage inflation is likely to drive further margin expansion in 2012. yield curve steep. Morgan Securities LLC The market was completely bipolar this year with the Russell 2000 seeing doubledigit gains in 1H11 and a new record high. Morgan.b.S.com J. the median top-line growth for Russell 2000 is expected to be a healthy 7-9% in 2012 (Figure 61). -2.P.P.0% 6/03 12/04 6/06 6/09. This economic recovery never got a fair chance to air its wings due to the number of confidence crises and exogenous shocks.0% 3.0% -1.0% 5. which quickly reversed into losses by 2H11. lower equity risk premia. All told. 52 Margin (LTM) .0% -2. This growth is not aggressive if nominal GDP growth comes in above 3%. This means real rates should remain negative.P. 1) Negative real rates positive for the economy and risky assets With unemployment stubbornly high and inflation nowhere in the picture. As we head into 2012. Overall.email@example.com% 1. small-cap companies will muddle through given the following backdrop and are likely to reach new all-time highs in 2012. Figure 61: Russell 2000 Revenue Growth Actual and Estimated Y/Y Growth Figure 62: Incremental Net Income Margin Last Ten Years Estimates 20% Quarterly Revenue Grwoth (YoY) Russell 2000 R2K ex-Financials Incremental Net Income Margin (bp) 400bp 300bp S&P 600 Net Income Margin 4. we believe the dark clouds will begin to lift as policymakers around the world are forced to action.0% 15% 10% 5% 0% -5% -10% -15% 3/04 6/05 9/06 12/07 3/09 6/10 9/11 12/12 10% 8% 8% 7% 8% 9% Incremental Margin (bp) 200bp 100bp 0bp -100bp -200bp -300bp -400bp 12/01 Source: Factset and J. which is more characterized by yawnful up moves rather than recurring fears of a double dip. the persistent cyclical tailwinds were clearly evident in 3Q GDP growth and corporate earnings. but growth will be lower. the Fed should continue to keep policies favorable for the economy.0% 0. This period of high volatility is uncommon during the mid-cycle of an economic recovery.9% 6. as expected by J. however. and much higher equity prices. we remain constructive and believe U. Morgan.5% 12/07 6/09 12/10 -3.0% 6/11. and loan growth incrementally positive. 3. Source: Factset and J. Their actions are likely to inject hope and confidence that result in improving visibility. which should support risky assets. however. Russell 2000 EPS growth is likely to come in near 20%. This stop-and-go recovery means that this cycle will likely be longer.7% 4.North America Equity Research December 2011 US Year Ahead 2012 Equity Strategy – Small Cap A Year that Begins with Shattered Confidence Is Likely to End with Gains Bhupinder Singh AC (1-212) 622-6406 bhupinder.
S.000) ($15. we see: 1) M&A activity being more robust in 2012 with cash-rich U.3% 8. Buybacks. Source: Factset and J.000 ($5.0% 8.P.0% 7. 1/11 2/11 3/11 4/11 5/11 6/11 7/11 8/11 9/11 10/11 11/11 12/11 Source: Factset and J. In total.5% 9. ($12. 4) Technicals to become more favorable in 2012 The increasing volatility and record equity risk premium resulted in outflows from small caps totaling -$13bn year to date and M&A activity remained relatively subdued. 2) flows reversing or stabilizing. stocks likely to be seen as relative “safe havens. small caps have reduced credit risk substantially by extending maturities well into the future and/or paying off debt.5% 11.0% 9.000) ($25. Morgan.000) The rate of buyback activity is increasing.0% 10..0% 8.7% 7.5% 7. and 4) stock repurchase activity increasing with rising cash balances and high ROE.0% 27% Figure 64: Debt as % of Total Assets – S&P 600 Since 1996 27% 26% 25% 25% 25% 25% 24% 24% The 15-yr average is 8.8% 19% The 15-yr Average is 23.948) .. higher than the outflows seen from the asset class YTD.5% 8. In fact.1% 8.2% 1996 1997 1998 1999 2000 24% 9. Morgan.5% 7. the cash levels for small caps are near record level at around 10% of total assets while debt is near record low at 19% of total assets.949 Fund Flows.while Funds Flows remain negative.5% Current 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 17% 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Current Source: Factset and J.0% 8.S.5% 11. However.P. 53 . the increasing rate of stock repurchases was encouraging with a record number of companies participating in 3Q11. With improving visibility and declining volatility. Fund Flows YTD $25.6%7. Figure 65: Small-Cap Repurchases vs.6% 21% 21% 21% 20% 19% 19% 7.” especially with minimal international exposure by small caps.4% 7. Morgan. these strong metrics should help to keep default rates low.000 $5.7% 8.000 Cumulative ($'s in million) $15..4% Debt as % of Total Assets 25% 24% Cash as % of Total Assets 10.9% 7. corporates and underinvested PE firms.North America Equity Research December 2011 US Year Ahead 2012 3) Rich in cash and unlevered by historical standards Over the past two years.1% 7.P. 3) U.3% 10.. Russell 2000 companies bought back $22bn of stock. If a slowdown were to materialize in 2012. $21.9% 23% 23% 9. Figure 63: Cash as % of Total Assets – S&P 600 Since 1996 11.
0x 12.0x 2012E 12.4x 35.1x 7.1x 16.2x 15.1x 24.5x at beginning of the year and the ten-year average of 11.0x 19. 54 .0x 5. We prefer Cyclicals over Defensives due to superior growth and lower valuation.1x 8.9x 6. Large.1x 5.6x 10.7x 11. On a P/E basis. given our view that U. Morgan. Consumers.2x 12.7x 15.9x 18.4x 8. we recommend Industrials and Technology over Consumer.6x 17.3x 5.6x 12. Figure 66: Incremental EBITDA Margin – S&P 600 Last Ten Years EV/EBITDA 2011E Cyclicals: Technology Industrials Discretionary Materials Defensives: Healthcare Staples Utilities Telecom Other: Financials Energy Index 7.8x 9. especially after the sharp underperformance in 2011.8x 14.9x (see Figure 66).S. and Materials over Energy with China’s soft landing but both sectors should outperform the Russell 2000 in 2012.9x 1.6x at beginning of the year).8x 258.6x 7.9x 12.0x 7.2x 21.9x 12.6x 18.6x 13. At the sector level.4x 8.2x 15. we recommend investors overweight Small vs.0x on an EV/EBITDA basis (2011E) compared to 8.2x 5.5x 14.9x 54.2x P/E 2011E 16.8x NTM EPS (vs.1x 29.6x 8. In this environment.3x 9. Investment Strategy If the nominal GDP growth is at least 2% in 2012.P.0x 7.4x 6.4x -75.0x 5. we believe small caps are likely to deliver strong cash flow driven by revenue growth and continued margin expansion.9x 54. as we are in the growth phase with investors chasing emerging ideas in this low-growth environment.1x 7.S.0x 13. Value. as small caps are likely to outperform large caps given the stronger growth and declining volatility from improving visibility.9x 5. 15. and overweight Growth vs.2x Source: Factset and J.North America Equity Research December 2011 US Year Ahead 2012 5) Valuation more attractive both on an absolute and relative basis Russell 2000 now trades at only 8.0x 2012E 3.1x 14. Corporates are healthier than U.5x 4. the Russell 2000 trades at 14.8x 8.5x 21.8x 103. These positive fundamentals coupled with declining equity premium and improving technicals should push the Russell 2000 to all-time highs.
penalizing performance for many. facts are changing almost daily in nearly manic-depressive fashion. than to have made some subtle changes during March-April in our weekly U. That is not the case for this 2012 Outlook. Morgan Securities LLC S&P 500 Index Outlook 2011 Outlook Reviewed: S&P 500 Index While our S&P 500 forecast for this year turned out to be more accurate than our ten-year yield forecast.075 in October.350 around mid-year. 600-800 for the Russell 2000 Michael Krauss AC (1-212) 834-5103 michael.e. it would have been better to have kept our S&P 500 scenario for the year from the 2011 Outlook. Let us pray that we have the wisdom to choose correctly” – Woody Allen David Cohen. looking back. CFA (1-212) 622-5338 firstname.lastname@example.org. given the difficulty in anticipating global policy outcomes. Market whipsaws from “risk-on” to “risk-off” and back again have become commonplace from week to week. 55 . we suggested that the SPX would peak for the year at 1.S.com J. retaining fewer risk positions. Rather. forecasting outcomes has become increasingly uncertain.krauss@jpmorgan. One path leads to despair and utter hopelessness. Market participants in recent months have become increasingly neutral. As the financial markets are increasingly being driven by the gridlock of U.S. furthering the goal of getting to a safe harbor. Specifically. and then “see a substantial correction” down to a 1. The markets now are like ships caught in the treacherously stormy seas of headline risk. while avoiding a shipwreck against the rocks. Equity Technical Strategist report. and then the less likely bullish and bearish extremes.371 in May and bottomed at 1.130 yearly bottom in 2H (Figure 67).com Introduction Our goal with this 2012 Outlook is to present a most probable “base case” and less probable extreme bullish and bearish “tail risks.100-1. in the 2011 Outlook (written when the S&P 500 was at 1. Indeed. we will attempt to lay out our most confident targets/ranges. This “roadmap” was not far off. and European political and policy decisions. as the S&P 500 peaked for the year at 1. “More than any time in history mankind faces a crossroads. we have often provided singular annual “roadmaps. the other to total extinction.S.” combined with likely Treasury and U. We shall try our best to help navigate these difficult markets with flexible technical analysis views.P.North America Equity Research December 2011 US Year Ahead 2012 Equity Technical Strategy 2012 Outlook: 1100-1350 Trading Range for S&P 500.” when our confidence levels were high. Equity targets under each scenario.175). From the technical analysis side.
430 new highs by year-end. for a rally towards 1. it will be tough to move below strong 1.350 “Best Case” Mid-Year Peak and a Down 2H S&P 500 Index – Monthly Bars Source: CQG and J.340-1.220 key 2010 range highs.100 trading range into December 2012 (Figure 68). in our view. as long as the European sovereign debt crisis and recession lurk in the background. Morgan. That bottom and subsequent rally was accomplished in just three weeks. and eliminate the 1.360. we were forced to turn bearish below 1.200 in July. We suggested a 1.275 by yearend. leading to a more neutral bias into year-end.075-1.400s year-end target. as long as the U. with this year’s range defined at the 1.350-1. Indeed. then a May-September correction that would hold 1.300-1. We give this outcome a likelihood of 80%. On a positive note.400-1. we somewhat changed our preferred scenario in March-April.350 to 1. Similarly.S. it is reasonable for 2012 to form an inside range year. 56 .370 “Sell in May and Go Away” peak. It will be difficult for Equities to sustain back above the 1. we suggested buying in late September/mid-October amid 1.350 trendlines. earnings stay elevated. our base case assumption is for the S&P 500 to form a 1. which would be followed by 1.100 clustered support. avoids an economic recession.P.080 targets. After properly suggesting “summer rally sales” at 1.200-1. and investors remain defensively positioned.075 October 4 low. 2012 Outlook Targets: S&P 500 Index For this 2012 Outlook.North America Equity Research December 2011 US Year Ahead 2012 Figure 67: SPX Roadmap Used in 2011 Outlook Last Year: A 1.371 May 2 peak and 1.060-1. Unfortunately.
Source: CQG and J. 1. For next year. 57 .North America Equity Research December 2011 US Year Ahead 2012 Figure 68: We See a 1.100 Base Case Scenario for the S&P 500 in 2012 (80% Likelihood) S&P 500 Index – Monthly Bars Source: CQG and J.P.355 parallel internal channel high on the quarterly bar chart off the 4Q02 low.P.400 is the channel high off the July 2010 low/October 2011 low/May 2011 high (Figure 70). 1.353 March 2009-July 2010 0. 1Q09 low.300 right shoulder channel symmetry with the July 2010 low/October 2011 low/April 2010 high (Figure 69).350 2012 range high includes: 1.618 upside swing target. 1. resistance near our anticipated 1.325 May-July weekly downtrendline. 1. Morgan. Figure 69: S&P 500 Index Weekly Chart Parameters S&P 500 Index – Weekly Bars Figure 70: S&P 500 Index Monthly Momentum Gauges Are Currently in a Bearish Setup S&P 500 Index – Monthly Bars Source: CQG and J. Just above. 1.P. and 1Q00 high (Figure 71).371 is the May top. 1.350 to 1.348 violated March 2009-July 2010 monthly uptrendline (Figure 68). Morgan.342 October 2007May 2011 monthly downtrendline (Figure 68). and 1. Morgan.
1.618 swing parameter (Figure 72).371 May Top in the S&P 500 Stopped Exactly on This 1Q00 Internal Channel High S&P 500 Index – Quarterly Bars Source: CQG and J. and 1.6% retrace (Figure 69).511 is the parallel internal channel high on the quarterly bar chart off the 4Q02 low. fiscal policy stimulus. Fed QE3. Under the above global risk-on situation. Morgan. 1.2% retrace. 1.510 March 2009-October 2011 0. 1. U. Morgan U. S&P 500 Bullish versus Bearish Alternatives A more optimistic Equity case for 2012 would necessitate several of the following fundamental and policy outcomes: positive resolution of the European crisis.075 in October 2011 (Figure 70). Economic forecast. and 4Q07 top.907 is the March 2009-July 2010 1.618 downswing measure. Here: 1. and 1. key supports near our anticipated 1. 666 in March 2009. On the downside. We estimate a likelihood of only 8% for this outcome.P. 58 .564 March 2009-July 2010 equal upswing measure (Figure 72).121 is the October rally 78. the S&P 500 technically targets 1.100 is the May-October 0. 1. 1.113 is the rising 200 month MA (Figure 68).100 range low include: 1.North America Equity Research December 2011 US Year Ahead 2012 Figure 71: This Year’s 1.S.011 in July 2010. Longer term.500. 1Q09 low.P.S. and 1. and 1.473 is where the March 2009 bull market would equal the October 2002October 2007 bull market. ECB quantitative easing.106 is the declining 40-month MA (Figure 68). 1.780 is the March 2009-October 2011 equal upswing (Figure 72). We respect the fact that the S&P 500 has made higher annual lows in each of the past three years. and a China soft landing.101 is the March 2009 38. upward revisions to the J. 1. 1.600 is the trendline off the January 2000 and October 2007 peaks (Figure 72).618 upswing measure (Figure 72).075 is both the October low and January 2009-July 2010 weekly internal trendline (Figure 68).
The bear global risk-off case technically targets 950-1.8% retrace (Figure 73).” 59 .618 downswing collapse measure (Figure 73). and 785 is a downside projection from a potentially developing two-year Head and Shoulders top pattern (Figure 73). 956 is the June 2009 high breakout.S. zero U. Repeating the last sentence of both the 2010 and 2011 Outlooks. “We do not expect the 666 cycle low breaking.025 is the quarterly chart internal trendline with four points of contact since October 1998 (Figure 71). yet that is higher than the bull case.011 is the July 2010 bottom (Figure 72). 814 is the May-October 1.P. and a Chinese hard landing. a U.S. economic recession. absent a global depression.019 is the March 2009 50% retrace. We ascribe this outcome a likelihood of only 12%.500 in a “Global Risk-On” Scenario (Only 8% Likelihodd) S&P 500 Index – Monthly Bars Source: CQG and J. fiscal policy stimulus given continued partisan rancor from Congress and the President. A more pessimistic Equity case for 2012 would arguably necessitate global contagion from an unraveling of the European debt crisis.000. 1. 1. 936 is the March 2009 61. if not a dissolution of the EU itself. and possibly 800 (Figure 73): 1. 997 is the May-October equal downswing measure (Figure 73). Morgan.North America Equity Research December 2011 US Year Ahead 2012 Figure 72: We See Potential Upside for the S&P 500 Near 1.
100-1. and ebullient sentiment.S. rather than the upside barrier. another five-wave decline is needed to either complete 60 .North America Equity Research December 2011 US Year Ahead 2012 Figure 73: We See Downside to 950-1. Oppositely. Equity Technical Strategist). The Elliott Wave pattern interpretation is bearishly concerning.060-1. note that we did give slightly higher likelihood to the “bear case” than the “bull case. the slope of the line is more important than the level. Morgan. Under Elliott.080 in late September/mid-October. Equity seasonality typically sees a decline from May until October.371 to 1. and a market-friendly outcome to the November 2012 presidential election.350-1. To many technicians. To that end. like it did in 2011. The 1. If correct.000 (Maybe 800) in a “Global Risk-Off” Scenario (Only 12% Likelihood) S&P 500 Index – Weekly Bars Source: CQG and J. sentiment.075 was an impulsive five-wave decline. This year. A bull market would require the slope of the 200-day moving average to start rising. and for the market to sustain back above it. with distinct weekly momentum loss. the October seasonal bottom achieved our target low of 1. These signals have tended to last 7-9 months on average. and then a rally into May.P. and alarming pessimism.350 range proves incorrect. as the May-toOctober downtrend from 1. May peaked in our target zone of 1. If our favored 1. with diverging weekly momentum. it is technically more likely that the downside support breaks.371 S&P 500 peak during 2012. and changing the slope of the line can take months.370 by mid-year (U.293 has so far been a corrective three-step affair (Figure 73). which in this case would last into FebruaryApril 2012. To us.” There are four main factors for this defensive rationale: Monthly momentum retains a July sell signal (Figure 70). Seasonality only “works” when the underlying technical. then the typical Equity seasonality would not work in 2012. that is the definition of a bear market. Absent a resolution to the European debt crisis. we believe it will be extremely difficult to exceed this May’s 1. and momentum conditions are supportive of the seasonal influence. and the subsequent rally to 1.270 200-day moving average is falling with the major market averages trading below the moving average (Figure 69).
596 150-month moving average (Figure 75). Figure 74: Russell 2000 Is Likely to Complete an 868 2011 Bearish Reversal Year at the End of December Russell 2000 Index – Yearly Bars Source: CQG and J. Either way. The RTY risks a 2011 downside reversal year with a December close below 2010’s 783. 593 March 2000-April 2004 internal trendline (Figure 74). and substantially held major supports: 605 March 2009 50% retrace (Figure 75).North America Equity Research December 2011 US Year Ahead 2012 a large corrective ABC decline from May (ultimately macro bullish). the Russell 2000 is most likely to trade within this year’s range in 2012. touching the 1. equal downswings from the May and the October highs would measure in a large ABC decline (Figure 73). 61 .293 October 2011 peak (Figure 73).8% retrace (Figure 75). 588 July 2010 low (Figure 76).220 April 2010 high provides interesting symmetry with the 1.65 annual close (Figure 74).P. 547-553 August-November 2009 lows (Figure 76). sequences of five-wave declines and three-wave rallies are symptoms of bear markets that are incomplete. or start a very negative progression of a larger five-wave collapse (macro bearish). and 543 March 2009 61. which theoretically measures to 785 on a neckline breakdown (Figure 73).” the May 2011 top is the “head.” and the October 2011 rally is the “right shoulder” (Figure 73). Like the S&P 500. Russell 2000 Index Outlook The Russell 2000 small-cap index peaked at an 868 all-time high on May 2. There is a possibility that the S&P 500 has been forming a massive two-year “Head and Shoulders Top” pattern (Figure 73). Note that at 997.075 July 2010-October 2011 uptrendline would be the “neckline” (Figure 73).325-1. when subjectively interpreting Elliott Waves. The risk in this symmetrical pattern is that the April 2010 peak is the “left shoulder. Decisive weekly closes above 1. 596 May-August fifth-wave down target (Figure 76). The 1. Morgan. A parallel channel off the neckline. This would favor some additional weakness in 2012. after slightly exceeding the 856 July 2007 top (Figure 74). with a bearish key reversal day rejecting the top end of a 1998-2009 annual chart channel high. The 602 bottom on October 4 scored a bullish key reversal day.350 on superior advance-decline breadth would invalidate this foreboding pattern.
Increasingly.P. in 17 trading days. Source: CQG and J. if not score new all-time highs towards the 910 1990-2009 monthly channel high.North America Equity Research December 2011 US Year Ahead 2012 Figure 75: Russell 2000 Index Monthly Parameters Russell 2000 Index – Monthly Bars Figure 76: Russell Index Rejects 767-782 Key Resistance Russell 2000 Index – Weekly Bars Source: CQG and J. many investors feel the current Democratic administration has been regulatory heavy and unwilling to cut entitlements.P. At the margin. 776 March low. 767 March-June Head and Shoulders Top neckline. Finally. 773 June low. 778 falling 40week moving average. This “barrier” includes: 765 “right-shoulder symmetry” with the possible April 2010 “left shoulder and May 2011 “head.618 swing projection.9% to 769. the RTY lifted in a corrective ABC fashion. we can see the SPX index about 100 points higher on average through 2013 under a Republican victory than a President Obama reelection. Bulls need a weekly close above the 812 July 18 low breakdown/May 78. 62 . and failed squarely in the 767-782 major resistance band.6% retracement to garner sufficient momentum to retest the 868 May peak. Morgan. one would expect a shift to the Republicans to be welcomed by the Equity investor class.8% retrace. Despite this strong showing. and 782 April 2010 internal trendline (Figure 75 and Figure 76). and 991 March 2009-July 2010 equal upswings (Figure 75).” 766 May-October 61. The October 4-October 27 rally surged 27. the November 2012 Presidential election outcome should be a very important driver for the S&P 500 in the final two months of 2012. which shall be a major roadblock in 2012. Morgan. While we have no political aims in this Outlook. 927 March 2009-May 2011 0.
not surprisingly. The market has essentially been oscillating back and forth between a “risk-on” and “risk-off” stance and has been very sensitive to headline news.S.P. stocks—which can serve as a powerful barometer for style timing—does not seem to provide a strong case for value to outperform in the upcoming period.lakos-bujas@jpmorgan. on a relative basis Value has held up a lot better in the U. Value as a style has continued its sideways-moving trend that began back in 2009.P. especially in periods like the beginning of 2012 due to year-end/rebalancing effects. Dividend/Buyback Levels. it is equally compelling to say that the Value “pain” trade might be here to stay for some more time. 30-Day/14-Day Price-Reversal/RSI.S. and J. such as Earnings Dispersion. Going forward.North America Equity Research December 2011 US Year Ahead 2012 Quantitative Strategy The Current Landscape and the Year Ahead Dubravko Lakos-Bujas AC (1-212) 622-3601 dubravko. among the various popular investment styles in the U. Quality and Price Reversal have been leading the pack with stock selection factors. Compustat. being the dominant drivers of returns (see figure Figure 77). Interestingly. while there certainly may be room for bottom-fishing. While the level in valuation dispersions has been ticking up. than what we have seen in other global regions.com J. I/B/E/S. Figure 77: 2011 Cumulative L/S Factor Performance (Top Quintile – Bottom Quintile) – MSCI US Source: Bloomberg. it is still not significantly above historical levels and it is far off 2008 highs (see Figure 78). While it has yet again struggled to deliver this year. ROE. Morgan Securities LLC 2011 has been a year when risk aversion has been the recurring theme. such as Europe and Asia Pacific. Earnings Revisions. 63 . In fact. the level of dispersion in valuations across U.. Morgan. MSCI. Given these market conditions.S.
I/B/E/S.North America Equity Research December 2011 US Year Ahead 2012 Figure 78: Level of Dispersion in Equity Valuations (Based on Stocks’ Fwd P/E) – MSCI US Source: Bloomberg. The valuation spread between high. suggesting there is room for the spread to expand and thus for higher-Quality names to outperform (see Figure 79). and J. MSCI.P.and lowQuality names has remained steady.P. and J. MSCI. we think it is fair to say that a similar factor performance landscape to the one we saw this year may indeed continue to prevail. I/B/E/S. With a lot of macro/tail risks still prevailing. Quality is not expensive from a valuation point of view relative to history and previous market crisis periods. Morgan. Figure 79: Level of Dispersion in Equity Valuations (Based on Stocks’ Fwd P/E) Between Highand Low-ROE Names – MSCI US Source: Bloomberg. we might quite likely continue to face a sideways-moving market environment in the months and quarters ahead. 64 . Compustat. As a result. Compustat. Morgan. with Quality as a style likely to remain a dominant driver of future returns. Moreover.
in the current market environment where systemic risk has been the main driver of returns and stock-specific news has taken more of a back seat. has never been more important. MSCI. Figure 80: Stock Return Dispersion and Correlation Levels – MSCI US Source: Bloomberg.to lower-beta names—with Beta underperforming by more than 25% in that time period (see Figure 81). getting one’s systemic risk exposures right. and J. I/B/E/S. Figure 81: Cumulative L/S Performance for BETA (Top Quintile – Bottom Quintile) – MSCI US Source: Bloomberg.P. Compustat. whether quantitative or fundamental in nature. is because with stock return dispersions at historically low levels and stock return correlations simultaneously hitting record highs. A great example was the third quarter of this year which saw a relatively sharp unwinding of the beta trade—rotation from higher. and J. I/B/E/S. MSCI. The reason this matters to all stock pickers. Compustat. Morgan. In fact.P.North America Equity Research December 2011 US Year Ahead 2012 In addition. the investor community has been presented with a very challenging stock picker’s environment (see Figure 80). 65 . getting one’s systemic risk/style exposures wrong could be quite costly and could easily wipe out gains realized through pure stock selection and incur additional losses. such as Beta. Morgan.
North America Equity Research December 2011 US Year Ahead 2012 This has quite possibly been a painful ride for managers who did not have a tight grip on their portfolio’s Beta exposure (i. 66 .e. were long beta relative to market) and also possibly ones with a positive bias to value—thus implicitly capturing a positive Beta bias. as high-Beta names have been sold off and have become inexpensive on a relative basis. Unless one has strong skill in timing the market. we urge managers to be very careful with respect to managing their portfolio’s systemic risk/style exposures in the upcoming quarters and especially in an environment like the current one..
North America Equity Research December 2011
US Year Ahead 2012
Accounting & Valuation
Macro Uncertainty Takes Many Forms
Dane Mott, CFA, CPA AC
(1-415) 315-5905 email@example.com
(1-415) 315-6705 firstname.lastname@example.org J.P. Morgan Securities LLC
We expect the key theme of macro uncertainty to continue to be an overhang on the markets into 2012. The actions or inactions of Congress and the Obama Administration, the U.S. Securities and Exchange Commission (SEC), the Federal Reserve, U.S. Financial Accounting Standards Board (FASB), the International Accounting Standards Board (IASB), and other key decision makers in 2012 will substantially influence the pace with which the macro uncertainty begins to abate. Heightened tax policy uncertainty will continue through 2012 Partisanship was a key political theme in 2011, and we expect it to be a dominant theme in 2012 as Congress and the Obama Administration focus on the November 2012 elections. We assign a very low probability to the potential for any substantive tax changes being enacted until after the elections. Our expectation is that extender legislation maintaining the status quo will likely be enacted to carry forward most expiring 2011 tax policies to the end of 2012. Based on history, there is a potential that many of the expiring 2011 tax provisions may not get extended until the first quarter of 2012. Some of the high-profile tax code provisions that will expire at the end of 2011 unless they are extended are: The temporary 4.2% Social Security payroll tax for employees (rather than the traditional 6.2% rate); The research and development tax credit; The state and local tax deduction for federal tax purposes; The biodiesel and ethanol tax credits; The Subpart F active financing exemption. As we move further into 2012, the focus will shift to 2013 tax policy, and the November elections will have a lot of influence on defining the landscape of that environment. We are not likely to have clarity on the likelihood of the extension of the Bush-era tax cuts that expire in 2012 until the outcomes of the November elections are known. In addition, any hope for substantive legislative actions such as substantive tax system overhauls or economic stimulus in the form of special incentives for U.S. multinationals to repatriate foreign earnings will likely get pushed to 2013 at the earliest due to their controversial nature. In December 2010, the Simpson-Bowles Deficit Commission called for substantial overhauls to the U.S. federal tax system. The “Gang of Six” made similar appeals. The drama related to the debt ceiling resulted in the creation of the 12-member Congressional Joint Select Committee on Deficit Reduction (the Super Committee) which was ultimately unsuccessful at agreeing on $1.5 trillion in spending cuts by its November 23 deadline; thus, automated federal spending cuts of $1.2 trillion are triggered that are to begin in 2013 and are to be spread evenly across defense and non-defense accounts. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 provided companies with 100% bonus depreciation in 2011 and 50% bonus depreciation in 2012. There could be some consequences in 2012 of the reduced
North America Equity Research December 2011
US Year Ahead 2012
bonus depreciation relative to 2011 levels since some activity that would have otherwise occurred in 2012 could have been accelerated into 2011 to take advantage of the tax benefit. If we approach the end of 2012 and it becomes likely that the 50% bonus depreciation will not be extended into 2013, some 2013 capital spending may be accelerated into 2012. Another ramification of the eventual end of accelerated depreciation periods will be that U.S. corporations will systematically have a historically low depreciation tax shield available to them in the initial period of a return to the traditional depreciation tax policy since depreciation from prior years’ capital expenditures will be largely exhausted. Heightened accounting standard uncertainty will continue through 2012 The U.S. Securities and Exchange Commission (SEC) had previously indicated that it would provide more guidance by year-end 2011 on the potential for the U.S. to move from U.S. GAAP to IFRS, but our sense is that this decision will likely get pushed out until 2012. The process to converge U.S. GAAP standards issued by the FASB and IFRS issued by the IASB began during the early 2000s. While convergence initially appeared to be a “win-win” for all stakeholders when the process began in earnest, deeper investigation of the differences between U.S. GAAP and IFRS, two financial crises (one starting in the U.S. and one starting in Europe), and the inability for the boards to agree on some key areas of joint projects have all called into question the ambitiousness of the convergence plans. Based on our conversations with various U.S. stakeholders, our sense is that there is less support for a move to IFRS in the United States than there was prior to the financial crises of 2008 and 2011. At this point, we think full adoption of IFRS by the U.S. is unlikely within the next five to ten years. Our sense is that the most likely arrangement will be a more explicit set of rules of engagement between the U.S. Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB). In our view, the most viable proposal detailing how the future relationship between FASB and IASB could be structured is laid out in a comment letter from the Financial Accounting Foundation (FAF) to the SEC. The FAF is the organization with responsibility for the oversight, administration, and finances of the FASB. Currently, FASB and IASB are working on four key joint projects during 2012: 1) financial instruments, 2) insurance, 3) leases, and 4) revenue recognition. All four are controversial. We do not expect any of these proposals to be effective before 2015. The IASB and FASB recently released a joint exposure draft on revenue recognition that would result in all companies following one broad revenue recognition model if the standard is finalized. As we outlined in our joint note with Peter Elwin, J.P. Morgan’s European accounting analyst, these proposals could radically affect the way some companies account for revenues with serious implications on valuation multiples. Jointly issued exposure drafts for the insurance and leases projects are expected in the first half of 2012. The insurance proposal could dramatically change insurance accounting in the United States. The leases project looks to bring a portion of operating lease exposures onto companies’ balance sheets, thus making some balance sheets appear more leveraged. While financial instruments was identified as an urgent joint project in reaction to the 2008 financial crisis, we do not expect an exposure draft on this project during 2012. The boards have come to different conclusions on a number of key issues on this
North America Equity Research December 2011
US Year Ahead 2012
project, and the project takes on a multitude of complex issues. In addition, the boards must consider the effect of their decision on financial regulatory accounting since much of the regulatory accounting guidance references U.S. GAAP and IFRS measures. The success or failure of the boards to work together on the financial instrument project will likely have a large influence on the long-term viability of U.S. GAAP/IFRS convergence. The dark side of low interest rates: increased pension risk While in theory low interest rates can be a form of stimulus if they ultimately induce companies and consumers to borrow and spend, an unintended consequence of a long-term period of low interest rates is that it results in higher pension obligations and can result in an increase in the cash costs of running a pension plan. As shown in the following figure, the Moody’s Aa rate is down approximately 400 basis points relative to its 8.14 level as of the end of May 2000. To the extent rate policy is reducing interest rates below where equilibrium levels would have been absent intervention, the implication is that rate policy may be exerting additional stress on companies with elevated pension risk and resulting in the need for incremental cash contributions being made to close funding gaps that would not have existed if interest rates had been higher. Under pension funding rules in the United States, discount rates can be based off of a 24-month moving average of corporate rates. The risk-free rate has decreased substantially during 2011 and has taken U.S. corporate rates down with it. The smoothing in the funding discount rate mitigates temporary decreases in rates through its 24-month average; therefore, cash flow effects are not immediate. To the extent the decline in investment-grade corporate rates during 2011 persists into 2012 and beyond, material cash funding requirements could materialize and put liquidity strains on some companies beginning as early as 2013. To identify companies with material levels of pension risk, see our October report.
Figure 82: Moody’s Aa Corporate Bond Index, Month-End, December 1998-November 2011
8.50 8.00 7.50 7.00 6.50 6.00 5.50 5.00 4.50 4.00 3.50 Dec-98
Source: Moody's and J.P. Morgan estimates.
Dane Mott is a member of the FASB’s Investor Technical Advisory Committee and two IASB advisory committees: the Capital Markets Advisory Council and the Employee Benefit Working Group. Dane Mott is also a former member of the IASB’s IFRS Advisory Council. Amy Schmidt is a former Technical Manager at the IASB. JPMorgan Chase & Co. and its affiliates do not provide tax advice or advice on tax accounting matters. Accordingly, this material is not intended or written to be used, and cannot be used or relied upon, by any recipient in connection with promotion, marketing, or a recommendation for the purpose of avoiding U.S. tax-related penalties. Each client should consult his/her personal tax and/or legal advisor to learn about any potential tax or other implications that may result from acting on a particular recommendation.
11 Nov. 09 Nov. High correlations are the main driver of equity index volatility. 11 Jul.. and different duration of 2010 and 2011 volatility spikes both related to European debt crisis 50 45 40 35 40 Figure 84: Cross-asset and equity correlations recently reached all-time high levels. futures and ETFs).x.rudd@jpmorgan. In August. 01 May. Morgan Equity Derivatives Strategy.g. Source: J. 04 Nov. 10 Mar.S. equity volatility has been driven by risk on/off flows and the significantly reduced liquidity of equity index products.P. At the end of July. 10 25 ECB? FED? IMF? 20 H2 '08 H2 '10 15 H1 10 Jun. Given the positive macroeconomic sentiment and strong technicals (high liquidity. Morgan Equity Derivatives Strategy. giving rise to a record level of equity correlation (stock-to-stock correlation). As most equity flows have been implemented with index instruments (e. 10 Nov. growth and fears of another global recession caused rapid market deterioration. low correlation). even turmoil in the Middle East and the nuclear disaster in Japan in March did not result in a significant increase of equity volatility. It is interesting to note that the H2 changes in correlation (100% increase) and liquidity (70% decrease) were larger than changes in other equity risks. in our view. These macro risk on/off flows were transmitted to equities largely through index trading. the sustainability of U.P.25 index point). equities were in a low volatility regime with S&P 500 realized volatility reaching pre-Lehman low levels of ~12% (Figure 83).ch. 11 Source: J. renewed concerns about European sovereign debt.com Adam Rudd (1-212) 272-1215 adam. commodities.com Amyn Bharwani (1-212) 622-8030 amyn. liquidity dropped by more than 70% compared with the beginning of H1. market liquidity reached new highs. Large risk on/off flows between government bonds and risky assets such as equities. Over the same time period. The low volatility regime of H1 was caused by a strong market performance in H2 2010 that triggered a record decline in equity correlations (Figure 84). Figure 85 shows the liquidity of S&P 500 E-mini futures as measured by the number of contracts bid/offered within 5 futures ticks (1.bharwani@jpmorgan. Morgan Securities LLC During H1 2011.P. 1 See our H2 2011 Volatility Outlook for Discussion of Structural Pressure on Equity Volatility in H1 2011 due to long gamma positions. and derivative hedging activity put downward pressure on realized volatility1. 06 May. and currencies caused cross-asset correlations to reach all-time high levels (Figure 84).North America Equity Research December 2011 US Year Ahead 2012 Equity Derivatives 2012 Global Volatility Outlook Marko Kolanovic AC (1-212) 272-1438 mkolanovic@jpmorgan. and were the key drivers of equity volatility. Figure 83: S&P 500 Realized Volatility and the VIX – Note distinct regimes of volatility in H1 and H2 2011. 70% 60% Euro Debt EFSF QE2 Japan Libya Egypt H2 Euro Debt 35 1Y Average Correlation of Risky Assets at All-Time High H2 '11 30 3M Realized Volatility 50% 40% 30% 20% Equity Correlations at All-Time Highs VIX 30 25 20 15 10 Feb. 11 10% Nov. 70 .com J.
North America Equity Research December 2011 US Year Ahead 2012 The drop in equity liquidity in H2 suggests that the current system has significantly reduced capacity to store equity risk. Figure 85: Cumulative US mutual fund flows in 2011 (left axis). such as during the flash crash in May 2010.e. Figure 87 shows an extreme example of the gamma hedging impact during the second week of August. 02 Nov. Morgan Equity Derivatives Strategy. when the market rallied on the coordinated action of central banks. resulting in persistent outflows from U.P. In addition to liquidity and correlations. the gamma exposure of outstanding protection became significantly short. 05 $(25) Mar. Hedging of levered ETFs and other volatility products such as variance swaps and CPPI structures can also have an impact on market volatility. 30d MAvg.S. and liquidity fell to the lowest point for the year (Figure 85 and Figure 86). equity mutual funds during H2 (Figure 85). High levels of correlation and low liquidity further discouraged fundamental equity investors from trading stocks. This may be related to regulations (e.P. Based on dealers’ exposure. Source: J. market liquidity as measured by the depth of S&P 500 futures (right axis) $75 US Equity Mutual Fund Flows ($Bn) 12 Market Depth (1000s SPX E-mini Cts) S&P 500 Hedged Gamma ($Bn) $5 $Oct 10 $(5) $(20) $(10) $(15) $(20) S&P 500 Hedged Gamma (Estimate. pension funds. putting upward pressure of ~3-4 points on short-term realized volatility (Figure 86).” as well as a series of Market commentaries from August and September 2011.. i. After the sharp drop in the market in August. hedging activity can increase market volatility (hedging of short gamma positions) or decrease market volatility (hedging of long gamma positions)4. 14 Sep. and hedge funds to reduce their equity risk exposure. 4 See our report “Impact of Derivatives Hedging. For that reason. The other side of these hedging transactions is taken by dealers who replicate their liability by daily delta hedging. net futures speculative open interest (right axis) $10 Futures Speculative OI $Futures Spec. a significant amount of stock trading in H2 was the result of index and statistical arbitrage programs putting further upward pressure on correlations. gamma hedging flows caused a significant portion of market volatility that week. 3 71 . 26 Jun. Short Interest ($Bn) $10 10 $25 8 Jan. increased capital requirements) and changes in the structure of equity liquidity. As the amount of gamma exposure reached record levels. the impact of index options hedging was another driver of equity volatility3.) $(30) Dec 10 Mar 11 May 11 Aug 11 Oct 11 $(10) Figure 86: Estimated S&P 500 options gamma exposure (left axis).g. elimination of proprietary desks. 21 6 4 $(75) 2 0 $(40) $(125) Source: J.. A ~3% overnight move caused additional hedging flows that pushed the market another ~1% in the last hour of the trading day. thus reducing market volatility by ~2 points. This hostile risk on/off environment started undermining confidence in equities as an asset class. Our estimates show that dealers were net long gamma in H1 2011. Morgan Equity Derivatives Strategy. Figure 88 shows a more recent example from November 30th. These products are used by asset managers. the increased role of computerized trading in liquidity provision2. 2 This liquidity can quickly disappear.
as well as changes in the outlook for global growth. Figure 86 shows record levels of speculative short interest in S&P 500 futures built up during the month of August. we build our forecast based on historical trends. In addition to poor liquidity and gamma hedging flows. Bloomberg. and credit. Morgan Equity Derivatives Strategy. or will gradually wear off from the current extreme levels. This is also true when comparing the current outburst of volatility with volatility patterns over the past 20 years. Comparing the current pattern of the VIX with the market crisis last summer (shown in Figure 83). The current record levels of cross-asset correlations and equity correlations are not sustainable in our view. 7 See our report on the seasonality of equity correlations. large short interest in index products also contributed to market instability and higher volatility. in either case contributing to a decline in volatility during 20127. 5 6 More accurately.P. we believe a stabilizing solution in Europe will be agreed upon. Volatility in 2012 will largely depend on the pace with which the European sovereign debt crisis is addressed by policymakers. cyclical or seasonal effects). This can be directly attributed to the lack of progress made by European policymakers. rather than linear. While many of the structural drivers should persist.P.North America Equity Research December 2011 US Year Ahead 2012 Figure 87: Impact of S&P 500 Gamma Hedging in Early August Figure 88: Impact of S&P 500 Gamma Hedging on November 30th Source: J. equities. volatility tends to decay in an exponential. eventually causing volatility to decline from current high levels. Source: J. Morgan Equity Derivatives Strategy. Stop-loss covering of shorts caused several market squeezes and contributed to end-of-the-day moves such as the one illustrated in Figure 88. and J. As it is not possible to forecast these developments with certainty. our views on the structural drivers of correlation and volatility. and in particular the reluctance of Germany to endorse employing ECB resources in removing the tail risk. A prolonged period of risk on/off trading in illiquid markets is likely to cause significant underperformance for proponents of this approach and create divergences in valuations that will invite relative value investors. While one could argue that volatility may persist and equities are entering a secular bear market. Larger market crises and outbursts of equity volatility usually take a longer time to resolve. one can notice that the current market crisis is taking a significantly longer time to abate6. fashion. Morgan’s 2012 fundamental projections for the macroeconomy. we believe that the correlations will either collapse (with removal of tail risk.P. Bloomberg. 72 . This gives rise to the familiar “triangular shape” of VIX spike patterns5.
75 Neutral US Unemployment 8.68 1. our credit and equity strategists argue for a significant reduction of credit risk and higher equity valuations in 2012.P. thus supporting our view of declining volatility (Figure 89). unemployment) points to the same level of volatility that we saw this year (12-month volatility of 23%).5 Source: J. Figure 89: S&P 500 Realized Volatility and Average VIX Forecast Volatility Asset Current Target Impact CDX Investment Grade 140 100 Lower CDX High Yield 800 550 Lower S&P 500 1245 1450 Lower US GDP 1. Another consideration in forecasting volatility is J.5 points.5% target volatility would still be higher than about 75% of observations and could be classified as a high volatility regime. Over the past 100 years. 8 Here we define medium volatility regime relative to the past 5 years.g. Morgan’s fundamental projections.5 18. This represents a decline from the current high volatility regime (6-month realized volatility at 30%) into a medium volatility regime8.5% with a most likely range of ~15-20%. an 18.2% 27.P. GDP.North America Equity Research December 2011 US Year Ahead 2012 Our forecast is that the average realized volatility of the S&P 500 in 2012 will decline to ~18. Our forecast for the average spread of the VIX to realized volatility is 4. We believe that the premium of implied to realized volatility will stay elevated.6% 9. While the outlook for the US economy (e. 73 . Morgan Equity Derivatives Strategy.7% -4.. due to reduced capacity of the system to store risk and high demand for downside and tail risk protection.0% Neutral S&P 500 Realized Volatility VIX 23.5% 23 -4.
By selling a covered call spread. and investors risk losing 100% of the premium paid if the stock is above the strike price of the put option. When overlaid onto a long stock position. Investors who own the underlying stock will have downside protection between the higher strike put and the lower strike put.North America Equity Research December 2011 US Year Ahead 2012 Risks of Common Option Strategies Risks to Strategies: Not all option strategies are suitable for investors. Straddle or Strangle. Covered writers are exposed to declines in the long stock position as well as any additional shares put to them should the stock decline below the strike price of the put option. Butterfly spreads are established at a net debit. Booster. Butterfly Spread. investors regain exposure to the underlying stock. that is. In a sell-off. Call Spread. A butterfly spread consists of two spreads established simultaneously. Put Purchase. One a bull spread and the other a bear spread. The buyer of a put spread risks losing 100% of the premium paid. Put Spread. Options are a decaying asset. The seller of a call spread risks losing an amount equal to the spread between the two call strikes less the net premium received. Options are a decaying asset. If the collar is not costless.” We advise investors to consult their tax advisors and legal counsel about the tax implications of these strategies. Put Sale. The resulting position is neutral. and they remain exposed to the downside of the underlying stock in the return for the receipt of the option premium. will be exposed to any decline in the stock price below the strike potentially to zero. In a rally. Collar. The maximum profit will occur at the middle strike price. please call your sales representative for a copy of “Characteristics and Risks of Standardized Options. option losses are potentially unlimited as the investor is net short a call. Since exposure on the upside is theoretically unlimited. The buyer risks losing 100% of the premium paid. the maximum loss is the net debit. investors who also own the stock would have limited losses should the stock rally. We have summarized the risks of selected derivative strategies. the investor gives up all appreciation in the stock above the strike price of the call option. Call Overwrite or Buywrite. dependent on the number of lower struck puts sold. 74 . but downside losses are not. Call Sale. For additional risk information. Since investors are selling a call option. and investors risk losing 100% of the premium paid if the stock is below the strike price of the call option. and this exposure is multiplied by the number of puts sold. they give up any stock appreciation above the strike price of the call option. However. when the underlying is at the lower strike. The buyer of higher ratio put spread has unlimited downside below the lower strike (down to zero). Having sold a covered call option. The gain is limited to the spread between the two strike prices. and are not indicative trading levels. Investors who sell call options against a long position in the underlying stock give up any appreciation in the stock price above the strike price of the call option. certain strategies may expose investors to significant potential losses. therefore. The maximum gain is limited to the spread between the two put strikes. should the stock price fall below the strike price of the lower strike put. Investors who sell uncovered call options have exposure on the upside that is theoretically unlimited. Locks in the amount that can be realized at maturity to a range defined by the put and call strike. The seller of a straddle or strangle is exposed to stock increases above the call strike and stock price declines below the put strike. Investors. Call Purchase. Investors who sell put options will own the underlying stock if the stock price falls below the strike price of the put option. the investor remains exposed to the downside of the stock and gives up the spread between the two call strikes should the stock rally. Please also refer to option risk disclosure documents. Pricing Is Illustrative Only: Prices quoted in the above trade ideas are our estimate of current market levels. investors risk losing 100% of the premium paid. the investor will profit if the underlying is stable. and they will not participate in any stock appreciation if the option expires unexercised. the maximum realised downside potential of a double-up booster is the net premium paid. upside losses are capped (as for a covered call).
Industrials 17% Consumer Staples 10% Health Care 14% Consumer Discretionary 14% Consumer Durables & Apparel 2% Automobiles & Components 2% Financials 11% Banks 2% Software & Services Household & 5% Personal Products 2% Pharmaceuticals.P. with stocks selected by analysts covering a range of different industry groups. Top Picks for 2012 Basket. The constituents and their weights are shown in the table on the following page. because of differences in methodology.S.com Introduction The J. Marko Kolanovic (1-212) 272-1438 mkolanovic@jpmorgan. the performance of JPUS2012 could diverge from returns quoted in this report.P. Morgan Securities LLC Basket Methodology and Composition Each of the stocks in the basket has been selected as a key stock to own in 2012 that should outperform its sector.P. S&P. The basket is well diversified across sectors. We have weighted the basket equally for all large-cap (>$5 billion market capitalization) and liquid (>$50 million average daily value traded) stocks. Morgan U. Bloomberg. we have used a sliding scale so that the amount of stock traded to enter the position should not be a substantial proportion of average daily volume. Morgan U. Morgan Delta One desk to leverage the theme discussed in this report.com Adam Rudd (1-212) 272-1215 adam.P. Biotechnology 8% Food Beverage & Tobacco 5% Diversified Financials 5% Media 3% Capital Goods 8% Health Care Equipment & Servic 5% Food & Staples Transportation Retailing 4% 4% Technology Hardware & Equipmen 5% Utilities 2% Commercial & Professional Serv 6% Retailing 3% Real Estate 2% Insurance 3% Energy 9% Semiconductors & Semiconductor 7% Consumer Services 5% Materials 7% Source: J. Morgan Equity Research Analysts have selected as their top ideas for 2012. For smaller stocks with lower liquidity.P. according to our analysts. Top Picks for 2012 Basket Energy 9% Materials 7% Utilities 2% Information Technology 16% Basket Details Bloomberg Ticker Benchmark Number of Components Weighting Scheme Source: J.S.rudd@jpmorgan.S.com J.ch. Over time.P. 75 . Morgan Research does not provide research coverage of this basket and investors should not expect continuous analysis or additional reports relating to it. The charts below show the sector and industry group composition of the J. stocks that J. Morgan Derivatives & Delta One Strategy.North America Equity Research December 2011 US Year Ahead 2012 Delta One Strategy J.P. Morgan salesperson or the Delta One Desk.dhingra@jpmorgan.P. Figure 90: Sector and Industry Composition of the J. Morgan U. The rationale for each stock’s selection is provided by the analysts in their individual sector notes. Morgan U. Top Picks for 2012 Basket <JPUS2012> Kapil Dhingra AC (1-212) 272-7823 kapil.S. Morgan.P.S.P. J. JPUS2012 <Index> SPX Index 65 Proprietary Bloomberg subscribers can use the ticker JPUS2012 to access tracking information on a basket created by the J. For information on JPUS2012.P. please contact your J. Top Picks for 2012 Basket (<JPUS2012> Index on Bloomberg) represents the portfolio of U.
625% 1.55 $ 2. Biotechnology Insurance Food Beverage & Tobacco Media Real Estate Semiconductors & Semiconductor Retailing Insurance Pharmaceuticals.250% 1.34 $ 49.625% 1.500% 0.10 $ 8.625% 1.500% 0.625% 1.625% 1.82 $ 27.20 $ 100.99 $ 4.53 $ 177.56 ADV ($M) $ 7.26 $ 7.28 $ 6.625% 1. Biotechnology Health Care Equipment & Servic Energy Health Care Equipment & Servic Diversified Financials Energy Food Beverage & Tobacco Pharmaceuticals. Biotechnology Energy Energy Transportation Commercial & Professional Serv Consumer Services Energy Semiconductors & Semiconductor Materials Software & Services Retailing Utilities Technology Hardware & Equipmen Technology Hardware & Equipmen Commercial & Professional Serv Capital Goods Commercial & Professional Serv Capital Goods Consumer Durables & Apparel Commercial & Professional Serv Capital Goods Semiconductors & Semiconductor Automobiles & Components Pharmaceuticals.43 $ 11.36 $ 9.625% 1.12 $ 3.83 $ 16.52 $ 6.625% 1.95 $ 11.625% 1.625% 1.P. Bloomberg.46 $ 4.37 $ 42.625% 1.625% 1.625% 1.42 $ 3.500% 1.21 $ 24.North America Equity Research December 2011 US Year Ahead 2012 Figure 91: Composition of the J.01 $ 3.98 $ 42.67 $ 8.52 $ 24.I.625% 1.625% 1.72 $ 6.625% 1.92 $ 3.625% 1.625% 1.08 $ 199.625% 1.625% 1.625% 1.07 $ 48.625% 1.94 $ 4. 76 .625% 1.625% 0.58 $ 3. Morgan Top Picks for 2012 Basket – JPUS2012 <Index> Ticker AAPL GOOG PG PFE PEP C CMCSA AXP BA UNH CVS UNP MA DD GG FCX COST LVS TXN HAL DE CELG PRU RAI VIAb PSA BRCM M ALL A STJ PXD HCA IVZ CNX SJM MYL NXY DNR UAL VRSK WYN BPL LRCX CCK EQIX ULTA NRG JBL RVBD RHI CBI WCN OC LEN CLH SPW CREE VC ONXX AH TFM FHN EAT ZIP Name Apple Inc Google Inc-Cl A Procter & Gamble Co/The Pfizer Inc Pepsico Inc Citigroup Inc Comcast Corp-Class A American Express Co Boeing Co/The Unitedhealth Group Inc Cvs Caremark Corp Union Pacific Corp Mastercard Inc-Class A Du Pont (E.625% 1.49 $ 31.46 $ 34.82 $ 2.625% 1.53 $ 52.33 $ 3.49 $ 47.461 $ 459 $ 399 $ 432 $ 397 $ 379 $ 329 $ 508 $ 380 $ 336 $ 805 $ 226 $ 734 $ 380 $ 562 $ 420 $ 217 $ 261 $ 129 $ 219 $ 130 $ 253 $ 284 $ 141 $ 173 $ 136 $ 171 $ 75 $ 118 $ 154 $ 62 $ 136 $ 48 $ 94 $ 133 $ 33 $ 96 $ 16 $ 113 $ 47 $ 74 $ 73 $ 55 $ 89 $ 129 $ 53 $ 51 $ 27 $ 49 $ 100 $ 28 $ 40 $ 92 $ 34 $ 45 $ 13 $ 18 $ 37 $ 43 $ 6 Source: J.13 $ 61.625% 1.625% 1.625% 1.89 $ 1.19 $ 30.625% 1.625% 1.56 $ 13.08 $ 22.625% 1. Biotechnology Health Care Equipment & Servic Food & Staples Retailing Banks Consumer Services Transportation Analyst Mark A Moskowitz Douglas Anmuth John A Faucher Christopher T Schott John A Faucher Vivek Juneja Philip Cusick Richard Shane Jr Joseph B Nadol Iii John F Rex Lisa C Gill Thomas R Wadewitz Tien-Tsin Huang Jeffrey J Zekauskas John Bridges Michael F Gambardella Christopher Horvers Joseph R Greff Christopher Danely J David Anderson Ann Duignan Geoffrey Meacham Jimmy S Bhullar Rae Maile Alexia S Quadrani Michael W Mueller Harlan Sur Matthew Boss Matthew G Heimermann Tycho W Peterson Michael N Weinstein Joseph D Allman John F Rex Kenneth B Worthington John Bridges Kenneth Goldman Christopher T Schott Katherine Lucas Minyard Joseph D Allman Jamie N Baker Michael A Meltz Joseph R Greff Jeremy Tonet Christopher Blansett Phil M Gresh P Sterling Auty Brian J Tunick Andrew L Smith Steven J O'Brien Rod Hall Andrew C Steinerman Scott Levine Scott Levine Michael Rehaut Michael Rehaut Rodney C Clayton Charles Stephen Tusa Christopher Blansett Himanshu A Patel Cory William Kasimov Atif Rahim Kenneth Goldman Steven Alexopoulos John W Ivankoe Paul T Coster Wgt (% ) 1.625% 1.P.625% 1.05 $ 13.78 $ 4.625% 1.82 $ 3.28 $ 4.147 $ 698 $ 997 $ 591 $ 1.625% 1.625% 1.625% 1.16 $ 1.625% 1.625% 1.47 $ 4.250% Mkt Cap ($Bn) $ 363.99 $ 1.34 $ 37. Morgan Derivatives & Delta One Strategy.625% 1.625% 1.07 $ 2.250% 1.592 $ 2.625% 1.43 $ 10.625% 1.625% 1.625% 1.73 $ 8.625% 1.625% 0.625% 1.00 $ 23.625% 1.500% 1.625% 1.78 $ 9.42 $ 36.72 $ 2.625% 1.625% 1.10 $ 55.38 $ 5.18 $ 4.91 $ 0.625% 1.625% 1.15 $ 51.) De Nemours Goldcorp Inc Freeport-Mcmoran Copper Costco Wholesale Corp Las Vegas Sands Corp Texas Instruments Inc Halliburton Co Deere & Co Celgene Corp Prudential Financial Inc Reynolds American Inc Viacom Inc-Class B Public Storage Broadcom Corp-Cl A Macy'S Inc Allstate Corp Agilent Technologies Inc St Jude Medical Inc Pioneer Natural Resources Co Hca Holdings Inc Invesco Ltd Consol Energy Inc Jm Smucker Co/The Mylan Inc Nexen Inc Denbury Resources Inc United Continental Holdings Verisk Analytics Inc-Class A Wyndham Worldwide Corp Buckeye Partners Lp Lam Research Corp Crown Holdings Inc Equinix Inc Ulta Salon Cosmetics & Fragr Nrg Energy Inc Jabil Circuit Inc Riverbed Technology Inc Robert Half Intl Inc Chicago Bridge & Iron-Ny Shr Waste Connections Inc Owens Corning Lennar Corp-A Clean Harbors Inc Spx Corp Cree Inc Visteon Corp Onyx Pharmaceuticals Inc Accretive Health Inc Fresh Market Inc/The First Horizon National Corp Brinker International Inc Zipcar Inc Industry Group Technology Hardware & Equipmen Software & Services Household & Personal Products Pharmaceuticals.38 $ 155.26 $ 5.17 $ 35. Biotechnology Food Beverage & Tobacco Diversified Financials Media Diversified Financials Capital Goods Health Care Equipment & Servic Food & Staples Retailing Transportation Software & Services Materials Materials Materials Food & Staples Retailing Consumer Services Semiconductors & Semiconductor Energy Capital Goods Pharmaceuticals.625% 1.57 $ 81.625% 1.625% 1.
Top Picks for 2012 Basket 120 110 100 90 80 70 60 50 Dec-10 S&P 500 Index J.P.P. The basket would have outperformed the S&P 500 since the beginning of 2009 by an annualized return of ~4%.S. 2010) by an annualized return of ~5. 77 .P. Note: All price performance excludes commissions and fees. Morgan U. Source: J. Bloomberg. Top Picks for 2012 Basket and those of the S&P 500 Index. In addition. 9 Not all stocks in the basket have three years of price history (HCA. Morgan Derivatives & Delta One Strategy. AH.P.North America Equity Research December 2011 US Year Ahead 2012 Basket Performance Statistics The daily returns of the J. Figure 92: Performance of the J. The basket has a beta of ~1. We also show the 3M rolling beta and the 3M rolling correlation for the basket against the S&P 500 Index. Top Picks for 2012 Basket Since the Beginning of 2008 190 170 150 130 110 90 70 50 Dec-08 S&P 500 Index J. Morgan U. VC.S. Morgan U.P.S.S.9%. Top Picks for 2012 Basket as well as that of the S&P 500 Index since beginning of 2009 and the beginning of 2011.S. Bloomberg. The J. In such cases. Morgan Derivatives & Delta One Strategy. TFM.S. ZIP).2 versus the S&P 500.P.P.P. and it would have underperformed the S&P 500 this year (since December 31. Morgan U. Top Picks for 2012 Basket would have been closely correlated to those of the S&P 500 Index9 (~98% correlation over the last year). we have substituted the basket with an equivalent quantity of cash for the purpose of the back test. Note: All price performance excludes commissions and fees.Morgan U.P. Morgan U. the charts below show a scatter plot of daily returns of the J. Top Picks for 2012 Basket Figure 93: YTD Performance of the J. The realized volatility of the basket would have been ~28% since the beginning of 2011.P.S. The figures below show the hypothetical performance of the J. Morgan U. Morgan U. compared to ~23% for the S&P 500. VRSK. Top Picks for 2012 Basket Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11 Source: J. given the relatively high weighting of lower-yielding stocks.S. Top Picks for 2012 Basket has a dividend yield well below that of the S&P 500. Past performance is not indicative of future returns. Past performance is not indicative of future returns.
0% 0.3 1.0% Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Source: J. Daily Returns of the S&P 500 Index 10% 8% Basket Daily Return (%) 6% 4% 2% 0% -2% -4% -6% -8% -10% -10% -5% 0% 5% 10% R² = 96% Figure 97: 3M Beta and 3M Correlation of the J.6 96% 92% S&P 500 Daily Return (%) Source: J. Top Picks for 2012 Basket 4.0% 2. Morgan U.0% 3. Morgan Derivatives & Delta One Strategy.P. Past performance is not indicative of future returns.S.7 0. Source: J. Note: All price performance excludes commissions and fees. Morgan U.P.P.P. Bloomberg.8 3M Correlation (Left) 90% Mar-09 Aug-09 Jan-10 Jun-10 3M Beta (Right) Nov-10 Apr-11 Sep-11 0. Top Picks for Figure 95: 1Y Realized Dividend Yield of the J.4 1. Past performance is not indicative of future returns. Note: All price performance excludes commissions and fees.0% 1. Past performance is not indicative of future returns.P.S.0 94% 0. Morgan Derivatives & Delta One Strategy.P. Morgan Derivatives & Delta One Strategy. Note: All price performance excludes commissions and fees.1 1. S&P 500 Index 100% 98% 1.S. Morgan U.5% 1.2 1.P. Past performance is not indicative of future returns. Bloomberg.S.9 0. Morgan Derivatives & Delta One Strategy. Bloomberg. Morgan U.5% Top Picks for 2012 Basket Dividend Yield S&P 500 Dividend Yield Jan-10 Jun-10 Nov-10 Apr-11 Sep-11 0.5% 2.5% 4.P. Morgan U. Top 2012 Basket and the S&P 500 Index Picks for 2012 Basket and the S&P 500 Index 60% 50% 40% 30% 20% 10% 0% Mar-09 Aug-09 S&P 500 3M Volatility 3M Volatility of J. Top Picks for 2012 Basket vs.5% 3.P. Source: J. 78 . Top Picks for 2012 Basket vs.North America Equity Research December 2011 US Year Ahead 2012 Figure 94: 3M Realized Volatility of the J.S. Bloomberg. Note: All price performance excludes commissions and fees. Figure 96: Daily Returns of the J.
P. This may include ensuring that the sector exposure of the basket remains broadly consistent with the investment theme. The composition of a custom basket is typically adjusted in the following manner: Cash merger. If the acquirer is not a part of the basket. then the weight allocated to the acquired will transfer to the surviving entity on the close of the last day it trades.S. then proceeds (losses) from the acquired company will be redistributed to the surviving basket constituents based on the recalculated weighting on the close of its last trading day.P. Tender offers and share buybacks.North America Equity Research December 2011 US Year Ahead 2012 Additional Basket Methodology In order to keep the basket relevant to the investment theme.P. This is to ensure the rules of the basket remain relevant following any structural changes to the theme. Delisting/insolvency/bankruptcy. Morgan reserves the right to review the following at any time: Basket methodology. If a stock trades on “pink sheets” it will not be included in the basket. Spinoffs. If the acquirer is a member of the basket. Top Picks for 2012 Basket. Stock merger. J. Basket change implementation. and both the spinoff and parent company weights will be readjusted according to new market capitalizations after the spinoff date. Corporate actions may affect the J. J. The company remains in the basket and its weight is adjusted according to the impact the tender/buyback has on the stock’s market value. The company is removed from the basket as of the close of the last trading day. and the proceeds (losses) will be redistributed into remaining companies according to re-calculated weights of remaining companies in the basket. Morgan will consider extending the implementation of changes to the basket composition from one trading session to any period up to five trading sessions in the event that a material increase in the liquidity or capacity of the basket is required to minimize market impact. The divisor is adjusted. and we remove the merging company from the basket on the day of merger and redistribute gains into remaining companies according to recalculated market cap weights of surviving constituents in the basket. Morgan U. The spinoff company and parent will be included in the basket. 79 .
North America Equity Research December 2011 US Year Ahead 2012 80 .
and we see this as most likely at least a year away. Nadol Alliant Techsystems Inc. Boeing Company (BA) – Overweight – Dec 12 Price Target: $80 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. We see two keys to performance: sustainment of aircraft demand despite the global economic turmoil and execution on the 787 program. Morgan Securities LLC Joseph B.S. 81 . respectively. Boeing Company Bombardier CACI International Inc Comtech Telecommunications Embraer SA Exelis Inc. Defense fundamentals remain highly challenging. perhaps $300-400 billion. in line with commercial aero stocks historically.m. Risks: Incremental problems with 787 production ramp. higher-than-expected R&D.com J. and replacement looks like it should support these production levels.seifman@jpmorgan. and demand driven by both air traffic growth.b. Nonetheless. which we think will take some time yet.sands@jpmorgan. Defense Down-Cycle Just Starting Joseph B. as large-jet demand is recovering nicely. Regardless of the outcome.45 $4. we see potential for continued double-digit growth in 2012 following the strong rebound in 2011. as aftermarket sales are just now surpassing the 2008 peak despite 10% higher airline capacity. Seifman. CFA (1-212) 622-5597 seth. which should support stocks in 2012. we expect 2012 sales to decline in line with a 4-5% decrease in the addressable market. In the aftermarket. and the best hope for outperformance in 2012 appears to be poor market performance overall. General Dynamics Corp.6 $52. We see potential for a major cash flow turnaround as 787 cash burn abates.com Seth M. Our average defense EPS forecasts are 4% and 6% below Consensus for 2012 and 2013. ATK BA BBDb. but the timing and substance of any resolution are unclear. Aircraft finance is another risk due to turmoil in the banking system. and a resurgence of 777 demand driven by delays and customer concerns on the A350. the launch of the 787-10. particularly in China.7 14. driven by conversion of commitments for the 737 MAX into firm orders. While defense stocks could outperform in 2012 in a poor market environment.85 15. Improving cash flows increase financial flexibility as well.87 $80. but we believe it would have to be especially severe and include the emerging markets. and we could see ~2-3% upside or downside to that depending on the outcome of the effort to reverse or reduce the automatic cuts. but we also see this as manageable. we don’t believe the stocks will really start to work until the market gains confidence that the ~$1 trillion fiscal deficit will be cut to a more sustainable level.com Christopher Sands (1-212) 622-9224 christopher. although the stocks appear to be heavily discounting a continued flow of bad news given their relatively strong performance in the wake of the Congressional Super Committee’s inability to reach an agreement.01 Dec $4. particularly in Europe.673 Valuation: Target reflects ~14x 2013E EPS. renewed recession or macro shock lowering production rates. Inc. we again expect a 5% decline in the addressable market and organic growth in line with that. through entitlement reform and/or tax increases.65 $56. and earnings to further suffer from ~60bps on average of margin pressure (excluding pension). Nadol AC (1-212) 622-6548 joseph. Looking into 2013. which has held up well amid the macro turmoil of recent years.nadol@jpmorgan. A global economic downturn is a key risk. while light-jet demand remains anemic and will probably require more activity from U. we believe the stocks will be stagnant as earnings estimates sag.TO CACI CMTL ERJ XLS GD GR HRS LLL LMT NOC PCP RTN COL SAI SPR TDG UTX WAIR N OW OW N OW OW N N (rs) N N OW N OW OW OW N N N (rs) OW Commercial aerospace fundamentals remain attractive. Best Idea – Boeing Company (BA) Boeing (BA) is our top pick for 2012. Rate increases are scheduled to boost Boeing and Airbus deliveries by ~40% from 2011 to 2015. aided by emerging market customers. The business jet market remains bifurcated. Goodrich Harris Corporation L-3 Communications Lockheed Martin Northrop Grumman Precision Castparts Raytheon Rockwell Collins SAIC Spirit AeroSystems TransDigm Group Inc United Technologies Wesco Aircraft Holdings.P.North America Equity Research December 2011 US Year Ahead 2012 Aerospace & Defense Capital Goods/Industrials Commercial Aero Looks Solid Despite Uncertainty.) $70. to derail planned rate increases. Efforts to amend the automatic defense cuts are under way. and we believe 2012 could see Boeing’s first dividend increase since 2008. customers in order to bounce. Commercial aircraft orders should remain strong. which account for 55-60% of traffic growth.50 $4.
we believe that the small package names FDX and UPS are attractive given a favorable domestic pricing story and operating costs that should remain muted. economy would be another risk to our volume and EPS growth forecasts and to our Overweight rating.H. Robinson Worldwide Canadian National Railway Canadian Pacific Railway Con-way CSX Expeditors FedEx Corp Genesee & Wyoming Heartland Express J. In our view.5 $49. Weinz.P.wadewitz@jpmorgan. We estimate that the combined revenue increase resulting from repricing the legacy contracts is ~$490mm in 2012 or ~$0.North America Equity Research December 2011 US Year Ahead 2012 Airfreight & Surface Transportation Rail EPS Growth Should Persist Amid Modest Economy. N UW N UW UW OW N OW OW N OW OW N OW OW N OW OW OW OW N OW N ABFS CHRW CNI CP CNW CSX EXPD FDX GWR HTLD JBHT KSU KNX LSTR NSC ODFL RA SWFT UNP UPS UTIW WERN YRCWD While we can identify a few truckload names with attractive company-specific stories such as WERN (cost side) and SWFT (valuation).r. Union Pacific (UNP) – Overweight – Dec 12 Price Target: $119 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. A sharp slowing in the U. UNP’s exposure to PRB coal is likely to be more stable than the eastern rails’ due to moderate utility stockpile levels and little exposure to export coal demand. In our view. UNP’s revenue mix is the most defensive of the rail group as 38% of the company’s revenues come from the less economically sensitive agriculture and coal segments. we expect solid performance from the major railroad stocks as cost-side pressures from 2011 ease and solid pricing momentum continues.r. 82 . and intermodal names (JBHT.52 $7. which contributes about ten percentage points to earnings growth.S. compared to long-term historical range of 11-15x and stronger range of 13-17x during the positive rail price story of 2004-2008.680 Valuation: Target reflects 14x 2013E EPS.84 $107. Unfavorable regulatory and court rulings are also a risk to our positive view on UNP stock. Best Idea – Union Pacific (UNP) Union Pacific (UNP) should realize a significant tailwind in 2012 from repricing ~$1. Among the other transports.weinz@jpmorgan. Landstar Norfolk Southern Old Dominion RailAmerica Swift Transportation Union Pacific United Parcel Service UTi Worldwide Werner Enterprises YRC Worldwide Michael R.61 $6. NSC) is attractive relative to a normal historical range of 11-15x and in light of our positive outlook for rail EPS performance in 2012.63/share. UNP Story the Most Resilient Thomas R. railroads (UNP.johnson@jpmorgan. Wadewitz AC (1-212) 622-6461 thomas. In our view.S.60 15. CSX. Wadewitz Arkansas Best C. which we believe is unlikely.73 Dec $5.89 $77.com J. sluggish economic growth in 2012 is a source of greater risk to the pricing stories in these less consolidated and more cyclical transport groups. P/E valuation on our 2012 EPS estimates of 11. Morgan Securities LLC Thomas R.com Alexander K. Risks to our earnings expectations and Overweight rating on UNP include increased price competition between the Western rails.com Michael R.3-13. The small package names would likely be more interesting versus the railroads if economic growth surprises to the upside. CFA Hub Group Pacer International Against a backdrop of modest economic growth in 2012.B. Hunt Transport Services Kansas City Southern Knight Transportation. Johnson (1-212) 622-6513 alexander. we are generally cautious on the more cyclical industry groups within transportation including the less-than-truckload and truckload segments.5x for the three major U.8 13.05bn in revenue of old contracts (legacy intermodal and coal) for which pricing is likely to rise sharply. Weinz.k. HUBG) with attractive growth.) HUBG PACR OW N $102. CFA (1-212) 622-6383 michael. We anticipate only limited support for EPS performance from volume growth given a muted outlook for the economy. Inc.
Outside of transformers. which is at trough. the company’s transformer business.com Paul Mammola. and the book-to-bill in 3Q11 was over 2x. Drew Pierson (1-212) 622-6627 drew.13 $40. or are being unfairly punished for what we believe to be universal macro uncertainty.205 Valuation: Target reflects ~13x 2013E EPS EPS. Jr CFA AC (1-212) 622-6623 stephen. Textron Tyco International WABCO Watsco Watts Water Technologies Wesco MMM DHR DOV EMR GNRC GE HON HUBB IR ITT LII MSI ROK ROP ST SPW TXT TYC WBC WSO WTS WCC N OW UW N N OW OW OW OW OW N N N OW OW OW OW N OW N OW Best Idea – SPX Corp.P. which is reflected in our below-consensus estimates. but is still expected to be accretive next year. Despite cyclical upside. Morgan Securities LLC C.North America Equity Research December 2011 US Year Ahead 2012 Electrical Equipment & Multi-Industry Handoff to Late-Cycle Growth in Progress C. group -9%) as the recovery for power and T&D end markets (~50% of sales) remained tenuous for most of 2011. muted recovery in short-cycle businesses like Flow. weak electricity demand leading a muted spending recovery on power transformers by utility customers. The associated Clydeunion deal has moving parts (financing. in our view. (SPW) SPX Corp. setting up a ramp for the business in mid-2012. and mix is likely to act as a partial offset to sales pressure. down 9% compared to a 5% decline for the S&P 500. and demand from process end markets should help show mid-cycle profit levels for Flow. Risks: Prolonged recovery in global infrastructure negatively affecting Thermal.80 14.3 13. pricing has been up for two straight quarters. Jr CFA 3M Danaher Dover Emerson Electric Co. a 5% premium to the group vs. we believe the turn in key end markets coupled with execution on Clydeunion/Thermal will help the shares’ multiple firm from what we view as an unwarranted 5% discount today. but management has ring-fenced the issue.com J. as we see structural issues as a relevant drag on valuation. SPX Corp. now the company’s biggest business. Ingersoll Rand ITT Corp. we remain cautious.1 $3. revenue outlook). While the current 11x group multiple looks inexpensive on consensus (15x heading into 2011). Lennox International Motorola Solutions Rockwell Automation Roper Industries Sensata SPX Corp.mammola@jpmorgan. We continue to favor later-cycle stocks for which sales/earnings should begin to outperform in 2012. restructuring efforts.82 $87.40 $4. Within this dynamic. with uncertainties around developed market fiscal policy and a broader sovereign debt crisis leading to a lower-growth environment. Coincidentally. Stephen Tusa.62 $4. Timing the improvement here has been delicate. with this backdrop of uncertainty. a ~10% discount historically.) $62. Stephen Tusa. making this one of the last to fully recover on our coverage list. First. The company’s sales should end 2011 about 10% below the 2008 peak. weaker performance has been slanted towards later-cycle stocks as the recovery for certain end markets was pushed to the right.pierson@jpmorgan. Specifically. we see several factors working in SPW’s favor in 2012 as end-market growth accelerates.tusa@jpmorgan. to account for a later-cycle business mix. and leaving the whole earnings cycle ahead. (SPW) – Overweight – Dec 12 Price Target: $75 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. Honeywell Hubbell Inc.66 Dec $3. valuation disparity in a shifting growth landscape presents opportunities heading into next year. CFA (1-212) 622-6382 paul. The stock has unperformed this year (-17% vs. but order data from SPX and commentary from peer ABB (each ~34% NA market share) solidify that the turn is here. (SPW) is one of the best ways to leverage the handoff from early. is starting to turn: lead times have stretched to peak levels (8-12 months). 83 . Thermal has been a risk given backlog degradation. padding EPS. but we continue to get clarity on endmarket and earnings momentum heading into 2012. and represents a $2. In sum.00 swing in EPS through the peak. recent pricing action. most of these names trade a discount. The macro is still mixed.a. Generac General Electric Co.to late-cycle growth.com The EE/MI group has underperformed in 2011. providing an entry point. Lastly.
we think the company should be able to remain toward the top of the peer group (including high-single-digit EBIT margins).2x in Q3. Inc TMS International URS Corporation Vulcan Materials BWC CBI EXP FLR JEC MLM MG PIKE PWR SHAW TMS URS VMC N OW N OW OW OW OW N OW N OW N N Expecting an uneven global recovery. NV Eagle Materials Fluor Corp Jacobs Engineering Martin Marietta Materials Mistras Group Pike Electric Quanta Services.52 $3.7 13.c. as the company’s Lummus Technology and Steel Plate segments complement its more traditional EPC segment.com Ankit Varmani (1-212) 622-5654 ankit. BtB and backlog have traditionally been important drivers of E&C stock performance.88 Dec $2. We consider CBI’s business model as uniquely attractive. enabling it to participate in projects in a greater variety of roles than many of its E&C peers. While the group indeed has cyclical qualities. we favor E&Cs exposed to investment themes that we consider to be secular (i. Within public-sector markets. Although a competitive environment for contractors could limit further improvement in CBI’s margins. regional) may be unique to individual end markets (or E&Cs). but above peer group average. End-market variations could become more pronounced. slightly below historical average. we maintain a cautious outlook for most Federal markets (including work for the DoD and DOE).. as well as the Materials companies (particularly aggregates-focused MLM and VMC). Q3 results suggested that the E&Cs experienced little (if any) disruption to bookings due to any recent slowing in global economic conditions. as new Highway legislation could benefit E&Cs. The Shaw Group. execution issues resulting in cost overruns on key projects.) $39. assuming execution remains strong. Morgan Securities LLC Babcock & Wilcox Co. share issuance to support growth initiatives. many of which (regulatory. The outlook for the global economy remains uneven and uncertain (with emerging markets expected to outgrow developed economies by 300-500bps).levine@jpmorgan. 84 .P. Risks: Slowdown in project flow.varmani@jpmorgan. reflecting continued improvement in order trends. We continue to favor E&Cs with exposure to private-sector markets.com Rodney C Clayton. reflecting exposure to fastgrowing international energy markets and improving execution. Given this context.e. Inc.2 $3.00 15. including high exposure to attractive international energy markets (particularly global LNG) and limited exposure to domestic public-sector markets we view less favorably (given formidable budget and regulatory concerns). Q3 results signaled no disruption in industry bookings momentum. Composite E&C book-to-bill (BtB) was ~1. margin pressure in a more competitive environment. consistent with recent quarters. budget.04 $2.12 $23. such as Natural Gas (particularly LNG) and Transmission & Distribution (T&D).x. given a stillfavorable hydrocarbon market backdrop and expectations of continued recovery in global demand (supporting a favorable bias toward CBI. though we’re more optimistic on the Infrastructure market.5x 2013E EPS. look for secular stories. though execution has been a greater factor in recent quarters.North America Equity Research December 2011 US Year Ahead 2012 Engineering & Construction An Unconventional Road to Recovery Scott Levine AC (1-212) 622-5609 scott.com J. suggesting cyclical E&C stocks may not be viewed as particularly attractive in this environment. several other factors influence spending on construction services. as E&Cs ramp up on projects booked during the early phases of the cycle. Best Idea – Chicago Bridge & Iron (CBI) Chicago Bridge & Iron (CBI) is our favorite name in E&C.47 $45. non-cyclical) in nature. Chicago Bridge & Iron (CBI) – Overweight – Dec 12 Price Target: $50 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. and JEC). and may remain a focus for investors in 2012.j. including commodity verticals such as Oil & Gas (particularly Upstream & Midstream) and Mining. CFA (1-212) 622-2873 rodney. FLR. due to its favorable business mix.clayton@jpmorgan. and suggesting that the recovery in activity levels remains intact.888 Valuation: Target reflects 14. Chicago Bridge & Iron Co.
Signs of pricing pressure have become more evident in recent quarters (particularly in the municipal business). suggesting this could be an appealing attribute if the recovery stalls.14 $2.08 Dec $2. recycled fiber prices (OCC. Risks: Rising cost headwinds. Furthermore.3% and 3.24 $1. Morgan Securities LLC Scott Levine Casella Waste Systems Inc. WCN.j. suggesting a likely good fit for the low-growth environment our strategists/economists envision for 2012.83 $35. Our forecast assumes stable volumes.) $32.36 $61. acquisition and integration risk. M&A is another lever for waste companies to supplement organic email@example.com $25.com Rodney C Clayton. while WCN. as it insulates the company from any competitive headwinds that may emerge until volumes recover. Cash Flows in a Low-Growth Environment Scott Levine AC (1-212) 622-5609 scott. CLH. Solid waste pricing is a risk worth monitoring. ONP) have fallen 25%+ in early Q4.45 28. CWST ES BIN RSG SRCL WCN WM N N OW OW N OW N CLH OW Best Idea – Waste Connections (WCN)/Clean Harbors (CLH) Solid Waste: We view Waste Connections (WCN) as an attractive stock for firstname.lastname@example.org J. as competition could intensify given the sluggish volume recovery. lower oil and gas prices. Waste stocks have traditionally performed well during periods of uncertainty. cash flows tend to be resilient (often holding up better than earnings in downturns). including share buybacks (BIN and RSG increased their authorizations over the past summer. respectively).43 $2. We view pricing as a risk for the group in 2012.256 Valuation: Target reflects 9x 2013E EBITDA.P. WM.96 Dec $1. CFA (1-212) 622-2873 rodney. Although WCN’s premium valuation could limit potential upside relative to other solid waste names. 85 . and SRCL among the more active acquirors in the group. and we don’t foresee much downside even in a recession. above historical average. CFA Clean Harbors Defensiveness appealing in a low-growth environment.varmani@jpmorgan. as its business model (which focuses on exclusive and secondary markets) provides comfort. Also.48 $1. given strong balance sheet and increasing scale in higher-growth acquired businesses. Furthermore. EnergySolutions Progressive Waste Solutions Republic Services Inc Stericycle Inc.84 $38.) $61. cash flows remain supportive (FCF margins are toward the top of the peer group).67 22. Waste companies can utilize their cash flows to increase shareholder value in a number of different ways. with BIN. Cash flow deployment initiatives could enhance shareholder returns.0 $3.50 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil.x.2%. which offers potential upside to our estimates (we do not forecast future acquisitions).2 19. weak macro conditions in Western and Southern markets. above historical avg.7 25. unless trends reverse course. Waste Connections Waste Management Rodney C Clayton. as the cyclical construction business is already at very low levels. decline in pace of acquisitions. Risks: Increased competition and pricing erosion.7 $3. Waste Connections (WCN) – Overweight – Dec 12 Price Target: $40 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. and new acquisitions (not included in our estimates) offer potential upside to our forecasts.c. supported by its market-leadership position in hazardous waste and accelerating secular growth profile in energy and industrial services.North America Equity Research December 2011 US Year Ahead 2012 Environmental Services Focus on Fundamentals. the company has demonstrated the ability to augment organic growth with an aggressive but disciplined and accretive acquisition program. suggesting the recycling business could turn from a tailwind to a headwind in 2012. and SRCL are also active in this area) and dividends (WM and RSG sport yields of 4.673 Valuation: Target reflects 10x 2013E EBITDA. and easing inflation rates could limit index-based growth in 2012 (declines in diesel could also limit surcharge revenue). reflecting potential for above-average M&A and defensive growth profile.com Ankit Varmani (1-212) 622-5654 ankit. Clean Harbors (CLH) – Overweight – Dec 12 Price Target: $73. Specialty Waste: We believe Clean Harbors (CLH) offers attractive long-term growth prospects.
38 $99.443 Risks: Market share risk from aggressive competition.com J.2bn.92 Oct $6.9 $32. Management’s FY12 outlook included an expectation for equipment sales to be up 15% (implied sales of $33.) $78. prior consensus of $7.96bn. Morgan Securities LLC Actuant Corp AGCO Corp.63 $7. total cash receipts for 2012 are expected to be $374. This is also higher than those of other ag equipment companies. strong dairy and livestock prices in Western Europe.9bn) vs.90. prior consensus of $2. Manitowoc Co. equipment demand remains very strong—recovering after a significant decline in 2009 and 2010.9 8. (DE) recently posted an upside earnings report for F4Q11 and introduced an outlook for FY12 that was well above consensus expectations. PACCAR Inc. as agriculture commodity prices are less impacted by general macro trends and more influenced by strong global demand as well as supply-side volatility.5 reached in 2008.shlisky@jpmorgan. Deere & Co. and this should result in lower price inflation in 2012. but still at historically high levels. Net income is expected to be $3. Strong demand fundamentals are evidenced by the global food price index produced by the UN Food and Agriculture Organization (FAO) which reached a historic peak of 238 in February 2011. (DE) – Overweight – Dec 12 Price Target: $100 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil.c. on solid endmarket fundamentals as well as compelling valuation.North America Equity Research December 2011 US Year Ahead 2012 Machinery Agriculture Fundamentals Remain Strong. this is still 16% higher than in October 2010. Deere & Co. Modine Manufacturing Co. we expect North American farm equipment sales to remain elevated. in Europe weather negatively impacting equipment spending and higher crop prices continuing to pressure the protein sector. Our $100 price target represents a ~13x multiple on our FY12 EPS estimate of $7. prior consensus of $31. though perhaps down slightly y/y.20bn vs. given DE’s strong execution and share gains in key markets such as Brazil and Germany.80 $59. According to FAO. equipment demand may be under some pressure due to the saturation of a program to support the sale of small-HP tractors to small farmers.d. In Western Europe.com Ingrid Aja. Navistar Int'l Oshkosh Corp. with the strong correlation between cash receipts and equipment sales. Illinois Tool Works Joy Global Kennametal Inc.70 vs. we anticipate a high probability of continued upside to earnings as we go through 2012. Best Idea – Deere & Co. should remain solid. We rate Deere Overweight and have a Dec-12 price target of $100.13—as a result. Eaton Corp.duignan@jpmorgan. CFA (1-212) 622-3730 ingrid.90 $8. farmers around the world are benefiting from the current balanced supply and demand conditions—a positive for equipment demand.P.com Michael Shlisky (1-212) 622-6656 michael. well above the peak of 213. we believe that mix in Brazil will be positive as demand for large crop equipment. Supply-side fundamentals have improved in recent months on the back of decent harvests around the world. CNH Global Commercial Vehicle Group Cummins Inc Deere & Co. however. ATU AGCO CAT CNH CVGI CMI DE ETN ITW JOY KMT MTW MOD NAV OSK PCAR PH TEX WPRT N N OW N N N OW OW N N N N N N N OW N N N The agriculture sector represents a decently defensive space. and strong wheat prices in Eastern Europe.6bn.aja@jpmorgan. the fundamentals for farm cash receipts and thus farmer sentiment remain strong on the back of strong crop prices in North America. Overweight DE Ann Duignan AC (1-212) 622-0381 ann. down 2% y/y. Caterpillar Inc. That said. Implied EPS for FY12 is $7. That said. as the multiple compresses toward cycle peak. 86 . strong sugar and soybean prices in South America. prices have since eased and in October the index registered 216.79 9. Parker Hannifin Terex Corp Westport Innovations Inc. In North America. (DE) Globally. in Brazil. including sugarcane harvesting equipment.
airline industry. variations in energy prices and labor-related job actions. Best Idea – United Continental Holdings (UAL) United Continental Holdings (UAL) continues to offer a compelling valuation. Copa Holdings. we are running out of plausible explanations.P. and should reduce the historical operating margin range of -9% to +11% toward something closer to +6 to +9%. We are maintaining our 2012 price target of $45. Delta Air Lines.S. in our view.S.1x. Unfortunately. in addition to 50% EV/EBITDAR weight using 4. Southwest Airlines Co. It’s different this time. Air Lease Corp.” U. UAL’s liquidity profile is above average for similar airlines. we believe the benefits to UAL will prove most pronounced given UAL’s network overlap and a more favorable labor cost outcome.13 $27. Lastly.com J. and remains one of our best ideas. a period in which the lights were quickly being dimmed on the U. GOL Linhas Aereas Inteligentes S.4x. Ultimately. TAM S. whenever U. then upside equity potential in a firmer economic scenario should only bolster our thesis.V.tan@jpmorgan. structural improvement. Inc.97 5.6 2. JetBlue Airways Corp. in the post-war period. 87 . For starters.8x compared with the peer average of 5. Airline enterprise values continue to flirt with levels last seen in 1H09.g. Current profits. and two recent acts of consolidation stand in stark contrast to what the industry then faced. Inc.com Consumer Scott Tan. UAL/CAL merger proving more costly than expected. While it may appear unusual to stick with a recessionary outlook that differs from consensus GDP expectations. GDP growth has been 1% or less for two consecutive quarters the economy was on the verge of entering a recession or already in one. Call us stubborn.S.S. one differentiating facet is that not many seem to care—at least until AMR’s recent bankruptcy filing. We view AMR’s filing as a positive for the industry and believe continued profit production during a domestic downturn can help lift equities from their current funk. In addition. we boosted our 2012 UAL estimates with additional revenue upside of ~$500mm and cost savings of $100mm leading to an EV/EBITDAR multiple valuation of 3. strong liquidity.31 $3. Inc. recession. S. Risks: Fluctuations in demand for air travel. We have opined for some time that the industry has undergone significant. AMR Corp. in our view. in our view.com Joseph Abboud (1-212) 622-7059 joseph.A. With AMR’s recent bankruptcy filing. United Continental Holdings (UAL) – Overweight – Dec 12 Price Target: $45 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil.61 $6.72 $15. Aircastle Limited Alaska Air Group. The market appears to be modeling for something much worse. airlines have never produced profits in a U. CFA (1-212) 622-5541 email@example.com Dec $4.b. but we continue to model for just such an outcome in 2012. however. reflecting historical multiple associated with our level of forecast profitability. AER AL AYR ALK AMR CPA DAL FLY GOL JBLU LUV TAM UAL LCC OW N OW N N OW N N OW N (rs) OW OW We continue to model for the unprecedented “profitable recession. Frankly.660 Valuation: Target reflects 50% weighting toward a P/E methodology using 7x multiple. we believe there are good reasons to approach our modeling this way.A. we believe if a strong value case can be made for airline equities when modeling for recessionary inputs. UAL is expected to generate roughly $10bn in unrestricted cash by year-end 2012 with forecasted net debt/LTM EBITDAR of 1. lower-than-expected capacity reduction. functioning markets. As such.) $20. at low end of United’s and Continental’s historical average range of 8-10x. More importantly.baker@jpmorgan. We also believe that the correlation between oil prices and GDP represents a “natural” hedge for airlines. Morgan Securities LLC AerCap Holdings N. United Continental Holdings US Airways Group. while not immune to any unanticipated fuel or demand shocks. FLY Leasing Ltd. the lowest leverage ratio among the legacies excluding Alaska. more stable and predictable profit streams should attract the types of longer-term investors that have shunned the space in the past. which lies at the root of our investment thesis.5x.A.North America Equity Research December 2011 US Year Ahead 2012 Airlines 2012: Modeling for a “Profitable Recession” with Opportunities Ahead Jamie Baker AC (1-212) 622-6713 jamie.9 $6.
to fear a cliff-type event for European auto sales in the coming quarters. Best Idea – Visteon Corp (VC) We think Visteon’s timing on value-unlocking corporate actions may be accelerating. KAR Auction Services. Risks: High customer concentration. the appointment of Harry Wilson (former U.5x EV/EBITDA multiple on pure (before equity income) 2013E EBITDA.x.6mm vs. Inc.com Vivek Aalok (1-212) 622-0798 vivek..52 $3. We continue to favor stories that are largely non-SAAR dependent (i. Avis Budget Group. and Brazil has shown some signs of slowdown in recent months. despite steep regional confidence survey declines. Auto Task Force member with a workout/PE background) to the Board and Finance committee seems to suggest a similar theme on potential ways to unlock value and encourage management to accelerate portfolio optimization actions. Inc. We also think GM and particularly Ford have neared a bottom. higher commodity costs.30 $76.1mm) and is broadly consistent with better-than-expected U. strategic actions. Further. but increasingly think 2012 expectations are near bottom. raising the question of why such an advisory assignment was disclosed at such a time. Also.7mm). though these stocks cannot escape a high degree of capital market sensitivity given their large pension plans. Borg Warner Inc. The Western Europe PV SAAR.3mm and September’s 13.com J. Meritor.patel@jpmorgan.S.900 Valuation: Target reflects 3. Visteon disclosed that it had retained Rothschild and Goldman as financial advisors. 88 . Sonic Automotive.carroll@jpmorgan. We also like the global tire space (Cooper Tire and Goodyear) going into 2012 as volumes have fallen but stabilized sequentially in many critical tire sub-segments (e. We believe the most likely outcome of events could encompass two main transactions and one minor transaction (though potential sequence is unclear): 1) divestiture of Lighting (small deal).2mm vs. Inc.S. 2011 estimated SAAR of 12. We expect to hear of at least some actions in next six months.3 12. FX transaction risk. Inc.32 Dec $0. specifically for Europe-heavy players.. Morgan Securities LLC American Axle Autoliv AutoNation.com Amy Carroll (1-212) 622-1206 amy. Inc Harley-Davidson Harman International Hertz Global Holdings. 2) purchase of remaining 30% stake in Halla Climate Control.) $56. We believe VC made this disclosure primarily to signal to investors that it is serious about looking at portfolio restructuring actions. but the data flow in the past three months simply does not suggest such an event so far.g. economic data points (we note JPM estimated 2012 SAAR is 13. with equity and minority stakes at 10x P/E. SAAR has generally trended up in recent months (November SAAR came in at 13. Visteon Corp (VC) – Overweight – Dec 12 Price Target: $68 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil.com Michael Kimlat (1-212) 622-0458 michael. Tenneco Automotive Tesla Motors Tower International TRW Automotive Visteon Corp.l. Inc. CarMax Inc. AXL ALV AN CAR BWA KMX CTB DAN DTG F GM GNTX GT GPI HOG HAR HTZ JCI KAR LEA LAD MGA MTOR PAG SAH TEN TSLA TOWR TRW VC OW OW N OW N OW N (rs) N OW N OW OW N OW (rs) OW N N N OW N N N N OW N OW OW We believe the global auto sector continues to send mixed signals. commodities are likely to be guided flattish as relief in base metals is offset by resins/rare earths. Cooper Tire & Rubber Dana Holding Corporation Dollar Thrifty Automotive Ford Motor Company General Motors Gentex Corporation Goodyear Tire & Rubber Group 1 Automotive.x. Our conversations with a handful of suppliers/OEMs suggest 2012 guidance commentary is likely to be more conservative than current consensus estimates. in our view.5 $2.S. Inc. consumer replacement).P. has been resilient (flattish in August through October) during the recent market swoon. CFA AC (1-212) 622-3906 himanshu. HAR.aalok@jpmorgan. VC. U.S. It is not particularly farfetched. TSLA) though the prospect of a plunge in Europe SAAR would suggest all could potentially be had for less.e.72 $38. October’s 13. European auto production guidance may be down 8% at the more prudent suppliers (versus IHS’s -4% and JPM -5%). Johnson Controls.kimlat@jpmorgan. Lear Corporation Lithia Motors Magna International.93 $4. however. U. Inc.50 14. and 3) divestiture of both interior trim assets (50% Yanfeng joint venture and consolidated Interiors).North America Equity Research December 2011 US Year Ahead 2012 Autos & Auto Parts Global SAAR Signals Mixed as US-Europe Decoupling Evidence Builds Himanshu Patel. Penske Automotive Group. and pricing is not likely to fall fast despite the recent lurch down in raw materials. without any reference to their specific assignment. Inc. Inc. atypical shareholder base.
we continue to be concerned about the overall raw material environment given very favorable hedges that most of these companies had in place for 2011. as our economic/strategy teams believe. PepsiCo (PEP) is our top pick.k. although our enthusiasm for HPC is only slightly greater.s. For beer. beverages sector.48 versus consensus of $4. more profound weakness in NA beverages. In particular. we think the sustained high unemployment rate for young men (2x the rate before the recession) is the biggest negative impact. we recommend that investors underweight the sector. Recent reductions in corn futures prices leave us more optimistic that PEP will be able to continue to raise advertising/ marketing support which should help keep top-line growth in the 4-5% range. we expect low-single-digit volume growth along with muted pricing and a slight mix benefit as discounting continues at the higher end.com Sofya Tsinis (1-212) 622-6391 sofya. As we have stated all year.7 14. Risks: Slowdown in international or Frito business. The biggest problem for this group over the past several years has been the persistent weakness in the low-end U.39 $4. While we are below consensus for 2012 ($4. as they have never truly seen a rebound following the recession.North America Equity Research December 2011 US Year Ahead 2012 Beverages Another Tough Year Expected for Beverages John Faucher AC (1-212) 622-6443 john. potential stabilization of demand could provide a catalyst for the group. Peter K Grom (1-212) 622-4876 peter. as valuations have come down across the board. yet still outperforming the market. Raw materials are also likely worse than most think. we think the buy-side is mostly aware that numbers need to come down.13 $4. multiple of 17x.63).com J.50 Dec $4. PepsiCo (PEP) – Overweight – Dec 12 Price Target: $72 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. We expect juice costs to be flattish and PET costs are forecasted to also remain flattish with some potential relief in 2H.S. Demand is likely to remain weak.8%). and we are looking for that discount to close as investors regain some confidence in PEP management if they can finally deliver on (lowered) numbers for firstname.lastname@example.org@jpmorgan. Morgan Securities LLC John Faucher Coca-Cola Co. and pricing has dampened volume growth as well. The stock has underperformed the group YTD (-0. We look for non-alcoholic volumes to be flat in 2012.) $64. 89 . along with heightened competition from spirits and wine.com Neal Rudowitz (1-212) 622-0094 neal. top-line growth remains fairly muted. In nonalcoholic beverages. this group should benefit. KO is trading at a 15% premium to PEP. and the profit outlook is even worse. just under the five-year historical avg.89 $58.P. after several rounds of negative revisions. For the wine and spirits categories.65 $71. with beer down slightly. we think the CSD companies are likely to see strong inflation in corn costs. sentiment is weak.tsinis@jpmorgan. we think consumers have continued to move away from bottled water and CSDs.S. With the group up a little over 2% YTD. Coca-Cola Enterprises Dr Pepper Snapple Group Hansen Natural Corp. Both the non-alcoholic and beer segments have been steady decliners over the past several years. We are below consensus for pretty much every name we cover. and would prefer HPC to beverages. namely energy and agricultural.rudowitz@jpmorgan. When we see reductions in consensus. further increase in raw materials prices. Molson Coors Brewing Company PepsiCo Neal Rudowitz Brown-Forman Corp Constellation Brands Cott Corp KO CCE DPS HANS TAP PEP N N N N N OW BFb STZ COT N N OW Best Idea – PepsiCo (PEP) With a lack of Overweight-rated stocks (only three in beverages).com We remain unimpressed with the U. While resins and aluminum may end up being favorable. If the economy does continue to improve. as we believe that raw materials and foreign exchange are not appropriately reflected. but likely not enough to meaningfully outperform.075 Valuation: Target reflects 15x 2013E EPS. consumer.4 $101.m.48 14. Consistent with our market strategist’s view.
00 $5. and continued share repurchases. including in the United States. we would expect currency to be a headwind to sales and earnings growth for most international food companies we cover.M. much less than the ~10% some companies have cited lately. clean balance sheet. Smucker appears well positioned for strong growth in 2012. accelerating savings from its restructuring program.3 13. which could be another headwind for the group. After navigating one of the food industry’s most challenging cost-inflation periods in 2011.M. Smucker Co. With the stock currently trading at a P/E discount of 0.728 Valuation: Target reflects 14.com We hold a mixed outlook for food manufacturing stocks in 2012. in line with group. We also believe that.tsai@jpmorgan. greater-than-feared peanut butter elasticity.69 $5. Inc. benefits from the SLE coffee deal. companies have announced their intention to split in two—Kraft.com J. trends we believe should continue. Inc. Jessica Schmidt (1-212) 622-1205 jessica. hogs. Three U.S. less ability to take pricing. Morgan Securities LLC Ken Goldman Campbell Soup Company ConAgra Foods Dean Foods General Mills H. we expect spot prices to be up ~2-3% y/y on average. 90 ..l. Government austerity programs will not help in this regard. The company remains well positioned strategically as the branded leader in its categories and has proven its dedication to innovation and marketing. Although food is a staple.com Priscilla Tsai (1-212) 622-5331 priscilla.3x to the group median. while not fundamental in nature.4x CY2013E EPS. Tailwinds may include a less onerous level of cost inflation and corporate actions that could create a higher level of interest than normal in the group. Sara Lee Smithfield Foods.M. The company has a number of tailwinds next year. consumer will not improve much next year. we think the risk/reward profile is attractive given the company’s strong market share. We also assume that conditions for the average U. it can be victimized by trading down and/or less pantry loading. we see this margin tailwind outweighing continued challenges from rising peanut prices.67 $80. soybeans. (SJM) – Overweight – Dec 12 Price Target: $86 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. Risks: Rising coffee costs pressuring margins. Lastly. Headwinds may include foreign exchange rates. (SJM) J. Heinz Co.16 Apr $4. Headwinds Assuming that foreign exchange rates remain flat between now and the end of next year. Hershey J.61 15.P. TreeHouse Foods Inc. Tyson Foods Jessica Schmidt Dole Food Co.S. Hain Celestial Group CPB CAG DF GIS HNZ HSY SJM K KFT MKC MJN PPC SAFM SLE SFD THS TSN N N N OW OW OW OW OW N N OW N N OW N OW OW DOLE HAIN OW OW Best Idea – J.) $76. including decelerating raw material costs (vs. Smucker Co. Smucker Co. where retail comps may soften. Inc. Tailwinds We believe that cost inflation should be significantly lower in 2012 than in 2011 for most food manufacturers.goldman@jpmorgan. we remain concerned about the global retail environment— competitors in nations such as Australia are “playing hardball” with manufacturers on price and driving sales lower. some corporate actions may generate interest in the group.J. Smucker Co. Kellogg Kraft Foods McCormick & Co.. etc. Mead Johnson Nutrition Pilgrim's Pride Sanderson Farms. and long list of tailwinds heading into next year.North America Equity Research December 2011 US Year Ahead 2012 Food Manufacturing Cost Inflation May Decelerate But Consumer Confidence Still Not Strong Ken Goldman AC (1-212) 622-0359 ken.schmidt@jpmorgan. a COGS increase of 19% this year). Based on current futures prices for corn. With over 60% of EBIT coming from SJM’s coffee business and our expectations for lower coffee costs next year.M.7 $8. Sara Lee. and consumers that are still cash strapped. and Ralcorp—and all three splits could possibly occur in 2012. (SJM) is our top pick for 2012. SLE deal not as accretive as forecast. We believe that the global retail environment will become even tougher in 2012.26 $61. J.
widening gap with TFM. certain large supermarkets may accelerate their price investments. We believe the company is likely to experience an EPS CAGR of ~28% over the next two years (FY12-13E).86 $1. We believe the food retail industry is likely to experience a revenue slowdown next year. We think traditional grocers will continue to lose share to alternative grocers.07 $1. still have significant room for new store growth in the U. but we note that the stores are rather different.55 $46. More importantly. The Fresh Market (TFM) – Overweight – Dec 12 Price Target: $55 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. supported by its long runway for new store growth and margin expansion. we believe.40 37. Historically. in line with WFM’s average over last ten years. we think TFM is poised for significant growth and has found a niche—the higher-income consumer who is not as price sensitive and wants a quality shopping experience. While there is an argument to be made that lower prices could lead to better volumes. offer better ID email@example.com@jpmorgan. The competitive environment remains a structural challenge for traditional grocers. partially due to our expectations for a significantly weaker pricing tailwind vs. namely Whole Foods (WFM – Neutral). and continue to add more food to their mix.) $40.com J. Over the last 60 years.com Priscilla Tsai (1-212) 622-5331 priscilla.85 $30. Risks: Worsening economy. we do not see it as inflated given the compelling case for continued earnings expansion.S. pricing deceleration should hurt ID sales. history shows that the relationship has not been 1:1. meaning that volumes generally do not rise as much as prices fall.goldman@jpmorgan. which could potentially pressure traffic at competitors. Based on our JPM Raw Foodstuffs Index. price deceleration should help the bottom line.86 Jan $0. which should create a favorable environment for margin expansion. Fundamentally. However. KR SWY SVU TFM WTW WFM N N OW OW N N Best Idea – The Fresh Market (TFM) The Fresh Market (TFM) is a true growth stock with strong fundamentals. other grocers lowering prices. In addition. In our opinion. food retailers’ penny profits have been highest when inflation was in the low-single-digit range. leaving consumers with less discretionary cash. and vice versa. we estimate food retailers may hit the “sweet spot” of lowsingle-digit cost inflation. While we are not making an argument for significant multiple expansion (with TFM currently trading around 29x FY12E on a consensus basis and 1x below WFM’s ten-year average).7% m/m.com Jessica Schmidt (1-212) 622-1205 jessica. eventual venture into California proving unsuccessful. we see alternative retailers generally as better plays next year.P. Club stores. dollar stores.946 Valuation: Target reflects 30x F2013E EPS.l. Morgan Securities LLC Ken Goldman Kroger Safeway SUPERVALU The Fresh Market Weight Watchers International Whole Foods Market We expect input costs to come down significantly next year.0 $1. 91 . By next year.9 29.North America Equity Research December 2011 US Year Ahead 2012 Food Retail Beware the Comps Ken Goldman AC (1-212) 622-0359 ken. we believe the worst of inflationary pressure is behind the grocers.. 2011. discounters. We appreciate that other food retailers. etc. The Fresh Market remains one of the best growth stories in the entire consumer space. So on a relative basis. niche grocers. with WFM more focused on health and wellness and TFM more committed to a pleasurable shopping experience. when the Food PPI declined month on month. the average food retail margin improved by 0.
15. and no exposure to Europe. as well as increases in hotel and retail spend trends. as well as an increase in leisure travel. 15. which should help to accelerate market-wide growth. Furthermore. N N N N OW N OW OW OW N N OW ASCA BYI BYD IGT LVS MPEL MGM PENN PNK SHFL WMS WYNN SGMS N The expected growth rate in Macau is significantly stronger than any gaming market in the U.0x 2013E Macau EBITDAR (adjusted for 70. 92 .S. for which we believe there are relatively low investor expectations. and 90% of 9.62 22.386 Valuation: Target reflects multiples of 10. Risks: Additional regulatory investigations related to FCPA compliance. Given the solid trends in the mass and VIP gaming segments.05 $36.4x 2012E EPS). CFA (1-212) 622-1306 james.0x our 2013E PA EBITDAR.com J.0x 2013E LV EBITDAR. as well as a staggered 2012 (beginning in late 1Q12) Sands Cotai Central opening. Inc.00 $2. The initial growth of the Singapore market can be described as robust and going forward we believe the market-wide growth will remain solid given the depth of the Asian gaming customer base and limited capacity within the region.P. one of which is owned by LVS.3 17. Bally Technologies. 15.58 $51. That being said.0x 2013E Singapore EBITDAR.S. in our view. despite a staunch +57% growth comparison.04 $2. given solid convention and group business demand. Year to date through November. low exposure to the U. which opened less than two years ago and consists of just two integrated resort casinos. we believe the most attractive fundamentals continue to be in Macau and Singapore. as well as the opening of Sands Cotai Central (sites 5 and 6) in late 1Q12. gaming revenue growth in Macau is up 44% over prior-year levels.) $45. LVS’s growth prospects are superior to those of any other company in our coverage universe.com Jonathan Mohraz (1-212) 622-1111 jonathan. consistent with LV/Macau-centric peers. Inc.omstrom@jpmorgan. Melco Crown Entertainment MGM Resorts International Penn National Pinnacle Entertainment Shuffle Master WMS Industries Wynn Resorts James Omstrom.com James Omstrom. executing Singapore VIP ramp. slightly higher than buy-side expectations. In our view. we remain very excited about the Singapore gaming market. while near.mohraz@jpmorgan. CFA Scientific Games Corporation Within the Gaming sector.to mid-term competitive supply remains relatively low. and reasonable valuation (17. we believe there is potential for upside to estimates given Macau junket (VIP)–related market shares gains beginning in 4Q11. In addition. Recent trends point to continued strength in the mass and VIP gaming customer base. Las Vegas Sands (LVS) – Overweight – Dec 12 Price Target: $64 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil.. Morgan Securities LLC Joseph Greff Ameristar Casinos.North America Equity Research December 2011 US Year Ahead 2012 Gaming Asia Outlook Remains Solid ─ LVS Positioned to Outperform in 2012 Joseph Greff AC (1-212) 622-0548 joseph.3% interest). potential restrictions relating to Macau travel. volatility related to investor expectations on monthly Macau results. we believe the market can still grow 30-35%.05 Dec $1. We believe LVS is a solid risk-reward proposition at current levels. we expect Macau GGR growth to trend in the 15-20% range in 2012. where gaming growth continues to remain robust.4 $37. less 2013E year-end net debt. given its strong positioning in the growth markets of Macau (~47% of 2012E EBITDA) and Singapore (~42% of 2012E EBITDA). where the mature nature of the business combined with high unemployment and a slow economic recovery continue to keep results muted.greff@jpmorgan. market (~11% of 2012E EBITDA). free cash flow generation (9% yield on 2013E). Boyd Gaming Group International Game Technology Las Vegas Sands Corp.0x Sands China royalty fees. While market-wide gaming revenue growth is expected to show signs of deceleration in December due to a difficult yearover-year comparison. offering an attractive combination of EBITDA and earnings growth. trends on the Las Vegas Strip continued to strengthen throughout 2011 and we believe this strength will accelerate in 2012. Best Idea – Las Vegas Sands (LVS) We continue to maintain our Overweight rating on Las Vegas Sands (LVS) and view it as one of the best ideas within the gaming space for the year ahead.
69. as well as further positive results from Rialto. an 8% discount to its ten-year average and a 15% discount to peer levels. Wong (1-212) 622-1442 william.93 37. at the low end of their historical 1. there is upside potential. which we believe is appropriate and reflects the recently more challenged visibility surrounding economic growth in both the U.North America Equity Research December 2011 US Year Ahead 2012 Homebuilding & Building Products Selective Approach on Both Homebuilders and Building Products. higher raw materials costs.5x. Building Products Our more selective approach to the Building Products sector is based on two factors. as our estimate of $2.1 20. Owens Corning PulteGroup Inc.com Jason A. LEN is currently trading at a 12% premium to its larger-cap peers.50 $0. as well as additional accretion coming from its Rialto segment. given our outlook for the more challenged macro environment to persist at least over the next 6-9 months.6x EV/EBITDA multiple to our 2012E EBITDA.00. given the more challenged macro and demand environments. and accretive Rialto segment should drive further multiple expansion relative to its peers. leaving little room for upside. OC’s valuation as attractive.503 Risks: Greater-than-expected demand decline for composites. weaker-than-expected U. Best Idea – Lennar (LEN) We continue to highlight Overweight-rated LEN as our top pick.6x multiple represents a 4% discount to its five-year average. CFA AC (1-212) 622-6696 michael. while we believe the Roofing segment’s margins can remain well above normalized levels at least through 2012.S. is not compelling either. Regarding our price target.) $3.5x and 14.2 10.94 $18.P. given our outlook for continued outperformance by LEN’s homebuilding operations.20 $2. MDC Holdings Meritage Homes Mohawk Industries NVR.18x book value (ex-adj.a. Ryland Group Standard Pacific Stanley Black & Decker Toll Brothers USG Corporation Whirlpool BECN BZH DHI HOV KBH LEN MAS MDC MTH MHK NVR OC PHM RYL SPF SWK TOL USG WHR N UW N UW N OW UW UW N OW OW OW N N N N OW N N Homebuilders While we estimate the builders are currently trading at 1. in our view. We note that margins for one of its three main segments—Insulation—remain near trough levels and therefore represent a compelling upside opportunity.54 $12.85 is above the Street’s $2. OC’s third main segment.2 $3.wong@jpmorgan. In addition. to the Street consensus for 2012. Composites. the Street is largely in line or ahead of our 2012E.0x range. we believe investors should use a fairly selective approach in terms of individual stock selection.07x on an adjusted P/B basis. as we believe the company’s near industry-leading margins. Best Idea – Owens Corning (OC) At only 6. in our view.98 $38.85 13.52 $0.67 Dec $1. At 1. resulting in a price target of $39.27 $21. Top Picks LEN and OC Michael Rehaut. the group’s P/E of 13. FAS 109). Inc. 93 . and current EV/EBITDA at 7. Morgan Securities LLC Beacon Roofing Supply Beazer Homes D.57 $2. we believe valuations will likely remain depressed relative to historical averages over this period. Moreover. Our 6.rehaut@jpmorgan. lower-than-expected Rialto earnings. As a result.54 (ex-adj.23x P/B multiple to our end-2012 book value estimate of $17. we believe further multiple expansion relative to peers is likely. should show further margin expansion in 2012.com J.S. we apply a 6. Lastly. while not expensive. Lennar (LEN) – Overweight – Dec 2012 Price Target: $21 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil.marcus@jpmorgan. weaker-than-expected growth.) $28. First. which we believe is reflective of LEN’s higher margins and profitability. Marcus (1-212) 622-4906 jason.6x for 2011E and 2012E. in our view. We apply a 1.3x 2011E EBITDA. as well as our more muted industry demand outlook for 2012. and Europe. FAS 109) to reach a December 2012 price target of $21.00. solidly positive EPS.14 Nov $0. Second. Horton Hovnanian Enterprises KB Home Lennar Masco Corp.w. Owens Corning (OC) – Overweight – Dec 2012 Price Target: $39 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil.0-2.7 Risks: Larger-than-expected impairment charges.com William W.464 $19.R. residential demand.
com Peter K Grom (1-212) 622-4876 peter. We expect PG to accelerate core earnings growth from 4% in calendar 2011 to 14% in calendar 2012 through more pricing. as our large-cap names (ex EL) will fail to deliver their long-term. The turn in foreign exchange to negative for 2012 should lead to a slowdown in reported EPS growth.95 $4. as organic top line is likely to remain sluggish as developed markets remain below our longer-term targets due to continued weakness with the low-end consumer. At this point. as many of the individual stories are less reliant on macro factors. Procter & Gamble (PG) – Overweight – Dec 12 Price Target: $75 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. beverages sector. deterioration in innovation pipeline.m. only partially offset by strong emerging market growth. which should lead to organic top-line growth at the high end of the group.84 $67. On the pricing side.com Sofya Tsinis (1-212) 622-6391 sofya.rudowitz@jpmorgan. While not positive.49 15. On the SMid-cap side we are generally more positive. in our view. We continue to believe that 2011 was a tougher year than investors realize. Pricing has turned positive on a reported basis for these companies.15 $4. better productivity. We expect 2012 to be another difficult year. inability to take pricing. In the context of JPM’s macro call. and should improve slightly on a sequential basis heading into calendar 2012.s.396 Valuation: Target reflects approx.72 $57. Raw materials should also be less of a drag as many oil-based raw materials are now projected to be just up slightly y/y.56 Jun $3.com J.grom@jpmorgan. we think the underperformance in 2011 (-16% vs. and could even be down in calendar Q2. we are seeing pricing move up in the HPC categories. providing greater comfort surrounding the ability to drive some margin expansion. as PG delivers four straight quarters of operating profit growth for the first time in four years. names like Tupperware and NuSkin have greater-than-average exposure to emerging markets. Top line has generally been at the low end of expectations given continued weakness in developed markets. with most of the companies using foreign exchange to substitute for pricing. we think there is room for the multiple to move up as well. While the more defensive nature of PG would seem to make it ill suited for this type of market. we generally see less risk despite some very competitive behavior on the part of most players. Nu Skin Enterprises Procter & Gamble SodaStream International Sofya Tsinis Tupperware Brands As with the U. We also would point out that productivity levels for HPC companies are generally higher.tsinis@jpmorgan. 94 . Morgan Securities LLC John Faucher Church & Dwight Clorox Colgate-Palmolive Energizer Holdings Estee Lauder Kimberly-Clark Newell Rubbermaid Inc.k. With the stock now trading at a 17% discount to the large-cap HPC group. similar to levels over past five years. 16x CY13E EPS. and SG&A leverage. as the U. the large-cap HPC group) leaves it well positioned to outperform its peers.com Neal Rudowitz (1-212) 622-0094 neal.6 14. as the ad-to-sales ratio has already been increased to above 11%. input costs.North America Equity Research December 2011 US Year Ahead 2012 Household & Personal Care Products Stay Picky as Numbers Come Down John Faucher AC (1-212) 622-6443 john.S. In particular.S. larger-than-anticipated hit from mix. Raw materials have also been a big drag on results. Fx-neutral EPS algorithms. the pricing and cost inflation outlooks are better for HPC than for beverages. Risks: Lower-than-anticipated benefit from costsaving initiatives and/or investment levels. In general. Household & Personal Care space. soft drink category still has more competitive pressure. we advise investors to underweight the group.S. although with a slight preference to HPC.P. N N N OW N N OW OW OW OW CHD CLX CL ENR EL KMB NWL NUS PG SODA TUP OW Our preference for HPC over beverages is due to pricing and raw materials. although this will obviously come with greater foreign exchange risk. we are below consensus on most of our large-cap and SMid-cap names.faucher@jpmorgan. slowdown in top-line growth. Best Idea – Procter & Gamble (PG) Our top pick for 2012 in HPC is Procter & Gamble (PG).4 $178.) $64. we remain unenthused with the state of the U.
or increased attrition over the past month—things that lodging operators likely would experience at the beginning of a slowdown. (3) its solid balance sheet. for the next few years.com Kevin Milota (1-212) 622-0987 kevin. We are generally positive on the longer-term demand-supply equation. We keep hearing words like “yet” when asked if the group has slowed or that it is still early (this is true.60 $24.greff@jpmorgan. lodging. Recent 3Q11 earnings conference calls suggest approximately mid-single-digit RevPAR growth in 2012. (2) its (still) underappreciated and improving free cash flow generation. no-show increases. over time.76 Dec $2.0x Property Management Fee EBITDA less corporate net debt plus value related to its timeshare receivables (100% of book value) and timeshare inventory value (100% of book value) less securitized timeshare debt (100% of book value).S.46 $2. and secular growth internationally (emerging markets like China. Hyatt Hotels Corporation LaSalle Hotel Properties Marriott International Orient-Express Hotels Starwood Hotels & Resorts Worldwide Strategic Hotels & Resorts Sunstone Hotel Investors Inc. if any.P.S.84 $36. there has been to business travel from potentially eroding business confidence.) CCL GET RCL OW OW N $35. India. Risks: Greater-than-expected impact from slowing economy. 11. and leisure coverage universe. timeshare financing issues.mohraz@jpmorgan. and Europe.firstname.lastname@example.org multiple points on an EV/EBITDA basis to its C-Corp peers on our 2012 estimates). no lodging operator that we know of has experienced cancellation increases.8 $5.com Jonathan Mohraz (1-212) 622-1111 jonathan. 95 .com J. We believe WYN’s valuation discount to its lodging peers is undeserved and. That said. consistent with our estimates. and (4) not a lot of execution risk and high level of resiliency within its hospitality business model. 10. Morgan Securities LLC Joseph Greff Chesapeake Lodging Trust Choice Hotels International FelCor Lodging Trust Host Hotels & Resorts Inc. Hong Kong. in our view) and that Fall will be a telling period on what impact. timeshare development timing risk. room rate upside relative to rates in the prior cycle’s peak. Wyndham Worldwide Kevin Milota Carnival Corporation Gaylord Entertainment Royal Caribbean Cruises Current fundamentals in the lodging sector remain sound and in our view do not imply a slowdown despite recent soft macroeconomic data in the U. we believe WYN possesses a very resilient and underappreciated set of hospitiality businesses with fairly low capital intensity that generate meaningful free cash flow ($600-700mm annually) which can be harvested to meaningfully shrink the share count (in a manner highly accretive to EPS given the shares’ low valuation) while maintaining investment-grade credit statistics.00 $2. greater-than-expected competition.520 Valuation: Target reflects 11. the discount will narrow (current discount of ~4. So far. given low supply growth in the U. among others). Singapore. though it is still early in the negotiations and we think that a mid-single-digit rate increase would be positive and better than what’s priced in the stocks currently. and Brazil. and London).0x 2012E Lodging EBITDA. Wyndham Worldwide (WYN) – Overweight – Dec 12 Price Target: $46 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. We believe the WYN investment story is one of the least appreciated in our gaming.North America Equity Research December 2011 US Year Ahead 2012 Lodging No Slowdown in Sight ─ WYN Positioned to Outperform in 2012 Joseph Greff AC (1-212) 622-0548 joseph. it is early for any impact given that lodging fundamentals have historically lagged economic cycles.80 14.6 12. In short. Our checks indicate that 2012 corporate rates should reflect mid-single-digit increases (likely slightly higher for markets like NYC.0x 2012E Vacation Exchange and Rentals EBITDA. CHSP CHH FCH HST H LHO MAR OEH HOT BEE SHO WYN N N N N OW N OW OW OW N N OW Best Idea – Wyndham Worldwide (WYN) Wyndham Worldwide (WYN) remains our top lodging pick given: (1) its substantial valuation discount to its peers.
Inc.email@example.com. In addition. Darden Restaurants DineEquity Inc. Yum Brands ARCO EAT CMG DRI DIN DPZ DNKN MCD PFCB SBUX SYY TXRH CAKE WEN THI. a 6%+ FCF yield in F12E and 10%+ in F13E should provide EPS support and potential for solid shareholder return. For the full year F12. The Cheesecake Factory.5% commodity price increase offset by only 1-2 points of price. particularly in emerging markets. margin. We expect the company to remodel 200 out of 800 units in F12 at a per-unit cost of $200-250k at an average 3-4%.914 Risks: Reversal in SSS improvement at Chili’s.6mm shares outstanding in 1Q12 vs. In such a period. Brinker International (EAT) – Overweight – Dec 12 Price Target: $31 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. 300bps in 1H13 for a 100bp+ impact) to allow margin gains of 60bps for the year with further gains offset by a 3. the casual dining group low. Further. Valuation is also attractive—stock too inexpensive for 20%+ earnings growth in each of F12E and F13E and 12% thereafter. Morgan Securities LLC Arcos Dorados Holdings. Inc.9 10. has considerable opportunity for upside. we expect F12 earnings to be driven by previously bought-back stock. reflective of average earnings growth of ~20-25% over F12/13 and low-double-digit growth thereafter. we believe the story in the restaurant sector will be “much of the same” compared to 2011. and remodels. in our view.P. an 11% reduction from the F11 level. and FCF generation which should allow for 10%+ EPS growth in F12 and beyond. sales lift.ray@jpmorgan. a lapping of negative lunchdriven menu mix in January.S.F.78 $26.gautam@jpmorgan. Best Idea – Brinker International (EAT) Our top pick for 2012 is Brinker International (EAT). we recommend that investors own a combination of defensiveness with respect to volatile sales/margins with opportunity for cyclical-driven upside resulting either from a forward-looking stock market or actually improved near-term results.) $23.TO YUM N OW N OW OW OW OW OW N OW N OW N N N OW In 2012. we expect an average of 82. or $100k. Domino's Pizza Inc Dunkin' Brands McDonald's P. We also believe investors looking for U. In addition. 96 . We visited management at an onsite visit at a Chili’s in Raleigh in mid-November to showcase the new remodel package but more importantly Phase 2 of the “kitchen of the future. Inc.84 $2. We expect initiatives related to kitchen systems (to be completed by end-F12 for a 50bp impact) and kitchen equipment (500bps in F12. Brinker International Chipotle Mexican Grill. margin initiatives that fail to provide anticipated benefits. Slow employment and wage growth should continue to limit traffic growth while 4-5% commodity inflation should test restaurant operators’ ability to manage margins as effective pass-through pricing power is limited. consumer acceleration should participate in casual dining’s cyclical upside potential but own Brinker specifically as the company provides highly visible costsavings opportunity which we expect will enhance margins by 60bps in F12 (June) and 130bps in F13. Our $31 price target assumes EAT can trade at 14x F13E EPS.” We came away impressed with the company’s “better not bigger” focus with all operational initiatives geared toward—and succeeding in—driving improved employee/ customer satisfaction to improve shareholder returns. we believe investors should own Yum Brands for solid global development. a F11 average of 92. Chang's China Bistro Starbucks Sysco Corporation Texas Roadhouse Inc.3mm.80 $19.8x.North America Equity Research December 2011 US Year Ahead 2012 Restaurants Cost-Saving Initiatives and FCF Opportunity Make Brinker Our Top Pick in 2012 John Ivankoe AC (1-212) 622-6487 john.25 12. and overall EPS visibility has increased and that the company’s C12E P/E multiple of 11.52 $1.com J. The Wendy's Company Tim Hortons Inc.com Shaurja Ray (1-212) 622-2039 shaurja.50 Jun $1. The company had an average 83. Specifically.6mm shares.com Amod Gautam (1-212) 622-6417 amod. We believe sales.6 $1. higher-than-expected commodity costs. comps of 2% in F12 should be driven by aforementioned pricing.
.boss@jpmorgan. DDS JCP KSS M JWN SKS N OW UW OW N N Best Idea – Macy’s (M) At 10. Inc. with specific commentary related to need-based/event shopping and highly competitive/promotional backdrop. Kohl's Corp. 2) gross margin pressure greater than expected with five of six department stores missing JPM projections (SKS the sole upside surprise). Saks. 97 .com In the midst of today’s volatile macroeconomic backdrop. On the margin side. Boss.North America Equity Research December 2011 US Year Ahead 2012 Retailing – Broadlines.25 and 5.833 Valuation: Target reflects 11x 2012E EPS. wage inflation in China could offset a portion of the upside opportunity. Eye on margins: On the cost side. excess clearance markdowns impacting gross margin more than expected. 4) tougher compares at high end to result in likely moderation—SKS and JWN cited tougher upcoming compares leading to likely top-line and gross margin moderation. Four notable themes out of 3Q EPS: 1) credit the primary upside P&L driver—all six retailers spoke to 3Q favorability (lower write-offs/bad debt). the silver lining may be easing top-line compares as the year progresses with 2H12 ~270bps easier than 1H (two-year stack).com J. 3) conservative Holiday/4Q tone with December (extra shopping day) expected to outpace November. 50bps above three-year average.1 $13. Europe’s financial turmoil (JPM Eurozone base case is mild recession ending mid-2012) could negatively impact high-end spending (i.11 $2. while product cost inflation is expected to ease in 2H12. particularly given a potential slowdown in tourism (accounts for 25% of Saks’ New York Flagship store). change in competitive promotional landscape. and 3) Magic selling also in first inning.8 10. Macy's. J.1x our 2012E EPS of $3. Balanced approach: Heading into 2012 we like OW-rated Macy’s (long-term core holding) and JCPenney (turnaround opportunity) on the long side and would use UW-rated Kohl’s (top-line inconsistency/peak gross margins) as a source of funds. 2) My Macy’s in third inning.80 $3.) $32. CPA AC (1-212) 622-2630 matthew.C.firstname.lastname@example.org $21. Inc. valuation. Risks: Greater-than-expected downturn in household spending. price.5x EBITDA. Department stores 2012 puts and takes Focus on top-line: We expect 2012 to remain promotional for the moderate department stores.e. From a macro perspective. quality trio). with headwinds including free shipping and increased promotions. Apparel & Footwear Balanced Approach to 2012 with Macy’s Our Top Idea Matthew R. we anticipate continued spending around multi-channel online growth and believe the level of 2011 credit upside will be a tough act to follow. We believe top-line momentum is sustainable for the next 3-5 years given the following drivers: 1) Omni-channel initiative in first inning.P. Anne McCormick (1-212) 622-4163 anne. With annual free cash flow generation in excess of $1. we believe Macy’s can and will continue to win through focusing on its own strategy (brand.95 $33. Saks). particularly in the fourth quarter. Macy’s (M) – Overweight – Dec 12 Price Target: $36 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. Nordstrom.7 billion. Morgan Securities LLC Dillard's. as the battle for market share is likely to heat up given the reemergence of JCPenney under the direction of new management. Inc. we recommend a balanced approach focusing on company-specific fundamentals. That said. the prospect of an increased share repurchase plan post December represents another upside catalyst.e. Inc.25 11.. Penney Co. elevated unemployment levels in 2012 should continue to pressure spending at the middle/low end. competitive forces. and investor sentiment. Macy’s (M) trades at some of the cheapest multiples in retail today. On the SG&A front.69 Jan $2. While the promotional environment continues to heat up. the roll-out of Omni-channel functionality and price optimization in 2012 should begin to bear P&L fruit in 2H12. Inc.
decreased SG&A leverage. the uncertainties weighing on economic growth globally temper our outlook and we prefer to begin the year with a relatively defensive posture.) CAB HGG UW N $88. Net-net.68 $68. Inc. hhgregg AAP AZO BBBY BBY COST DKS GPC GNC LOW ORLY ODP OMX PETM RSH SPLS TGT HD TSCO VSI WMT WSM UW N N N OW OW N OW N UW OW N N N OW N OW N OW OW N Years of aggressive store expansion drove outperformance for many retailers.com Rachel Stubins (1-212) 622-4245 rachel. In addition to sales growth driving earnings. particularly for the low-end consumer. a stretched savings rate. Inc. now only a handful of retailers are expanding significantly (and are generally crowded stocks). Inc. Morgan Securities LLC Christopher Horvers.17 in FY13E or 3% and 4-5% incremental earnings growth. we believe these factors should support a high multiple and a “buy the dips” philosophy.com Aaron Goldstein (1-212) 622-1336 aaron. while the recently announced membership fee increase provides visibility into incremental earnings growth over the next eight quarters (~$0.stubins@jpmorgan. rising product cost inflation and increased competitive pricing. hardlines/big-box retailers fall into the mature/macro-driven bucket with low domestic footage growth (which increases dependence on the economy for their success).North America Equity Research December 2011 US Year Ahead 2012 Retailing – Hardlines/Discounters COST: Strong Port in the Storm Christopher Horvers.to mid-single-digit core comp growth expected for the foreseeable future.86 $4. AutoZone. Inc. CFA Advance Auto Parts. high exposure to California. We believe the consumer is likely to remain conservative (and retrench after Christmas) given little need to shop (particularly in 1Q). Inc. until more jobs are created. From a lifecycle perspective. a value-oriented consumer. We particularly favor COST in early 2012 when the consumer is likely to pause after what we expect to be a strong holiday period (when retail industry sales are expected to be up nearly 4%). two of the most highly sought-after attributes a company can have include the ability to drive sales and visibility into earnings. RadioShack Staples Target Corporation The Home Depot Tractor Supply Vitamin Shoppe. Best Idea – Costo (COST) Given this backdrop.a. job creation remains lackluster with nonfarm payrolls posting an anemic 1% y/y growth rate since early 2011.44 (equating to ~9x on an EV/EBITDA basis). Costco Wholesale Corporation (COST) – Overweight – Dec 12 Price Target: $94 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. COST continues to have strong sales momentum due to 3-4% store growth and ~4% traffic growth driving market share gains. The latter is a function of impressive merchandising.8 $38. O'Reilly Automotive Office Depot OfficeMax Inc. deterioration in membership renewal rates. 98 .P. and a higherend customer base (household income of $96k per year).44 22. Overall. Our Dec-12 price target of $94 is based on a multiple of ~21x our fiscal 2013 EPS forecast of $4. and likely mounting credit card bills.com J. Aaron Goldstein Cabela's Inc.53 Aug $3. Furthermore. In contrast.162 Risks: Consumers limiting spending on more discretionary product categories. We forecast continued solid results with low.30 $3. Williams-Sonoma. our outlook for discretionary retail is challenged with the dominant bull or bear points being either 1) macro-related or 2) related to Congress and the EU. Bed Bath & Beyond Best Buy Costco Wholesale Corporation Dick's Sporting Goods Genuine Parts Company GNC Holdings Lowe's Companies.8 19.com Mark Becks (1-212) 622-5265 mark. CFA AC (1-212) 622-1316 christopher. missed or poorly executed store opening plans. Inc Wal-Mart Stores.06 $88.08 in FY12E and ~$0. Inc. membership fees provide both stability and long-term visibility to EBIT margins. it isn’t over and we don’t expect acceleration in spending trends. Looking into 2012. roughly half of the mix being consumable. PetSmart.email@example.com@jpmorgan. respectively). While the worst of the deleveraging process is likely past.becks@jpmorgan.
specialty retailers that cater to the underserved men’s/young men’s market.) FOSL SIG VRA OW OW N $72. Inc.01 Jan $1.com J. As a result. Inc.30 40. but the fabric side of the equation could lead to high-single-digit declines in product costs versus 2H11. Labor costs are likely to remain elevated and freight costs are also unknown.514 Valuation: Target reflects 35x 2012E EPS.S. The Buckle Inc. junior. As U. This backdrop continues to set up a highly promotional environment in which softline apparel retailers in the missy.17 $1. Asia. Fossil. Men's Wearhouse Ross Stores rue21. Beyond sourcing relief.com Ike Boruchow. industry-wide level of promotions. The Children's Place The Gap. an improved loyalty program. Cosmetics & Fragrance.7 $4. Morgan Securities LLC Brian J. and uncertainty around fashion newness. Among our coverage universe. growth continues to slow. the sector continues to look for growth to come from expansion into Europe. Tunick Abercrombie & Fitch Aeropostale American Eagle Outfitters Ann Taylor Stores Ascena Retail Group Inc Chico's FAS. Another positive in the ULTA story is the fact that new stores open at 30% lower volume than mature stores. ULTA remains one of the most compelling growth stories in retail. Jr.North America Equity Research December 2011 US Year Ahead 2012 Retailing – Specialty Cotton May Offer Some Relief in 2H12.boruchow@jpmorgan. Inc. A. Inc.S. Best Idea – Ulta Salon. Risks: Ability to open new stores on timely basis.5 31.P. Cosmetics & Fragrance (ULTA) We believe Ulta Salon. Coach. inc. and those that sell accessories and handbags or other categories like cosmetics and intimates should be better positioned. a continuation of shopping closer to need. giving the store base a natural “maturation curve” to help support 3-5% annual comp growth. Bank Clothiers Inc Limited Brands. Inc.80 $2.tunick@jpmorgan. The Wet Seal. and Canada as those markets have so far shown to be higher-margin projects than additional openings in the saturated U. market. We also expect channel mix—growth of ecommerce and factory outlet—combined with the closing of some underperforming mall-based stores—to be another potential way for retailers to improve returns. Cosmetics & Fragrance (ULTA) remains one of the few retailers that can more than double its 450-store base given favorable industry trends and a strong competitive position. in our view—alongside its salon service offerings.00 in EPS power over the next 3-4 years (~30% CAGR). the competitive landscape hasn’t seen much relief in the past year and there has actually been some new store growth from select international retailers looking for growth in the United States. Inc. Urban Outfitters Ike Boruchow. Tunick AC (1-212) 622-6449 brian.com Simeon Siegel. For the softline retailers as a group. and kids’ space could continue to be challenged to improve returns.70 $32. ULTA should continue to benefit from market share shifts in the beauty industry away from traditional players and toward specialty stores. Inc Tiffany & Co TJX Companies Ulta Salon.00-5. Citi Trends. On the supply side. But Generally Expect More of the Same Trends Brian J. traffic levels. Signet Jewelers Vera Bradley ANF ARO AEO ANN ASNA CHS CTRN COH FRAN JOSB LTD MW ROST RUE BKE PLCE GPS WTSLA TIF TJX ULTA URBN N N N N N OW N OW N N OW OW N OW N N N OW N N OW OW We believe that many of the same issues that impacted 2011 are set to continue to affect our coverage universe again in 2012. Jr.siegel@jpmorgan. in our view.93 $75. given company’s potential to generate 25-35% bottom-line growth for next several years. we still see a weak consumer confidence/employment backdrop for the lower-income demographics. the retailers are faced with the increasing burden of putting their volatile free cash flow to use. Ulta Salon. On the demand side. The continued additions of new prestige brands. 8. The company had stated that its long-term target is to achieve mid-teen operating margins over the next 3-4 years (vs. as the company offers one of the broadest product selections in beauty retail— a major competitive advantage.0% in 2010) with the potential for $4. some benefit should come in 2H12 as they start to feel the relief of lower cotton costs begin to hit their P&L. 99 . and increased recognition of ULTA as a beauty destination (continued rollout of marketing events) should support comp growth going forward. (1-212) 622-9758 ike. Inc Francesca's Holdings Corp JoS. Cosmetics & Fragrance (ULTA) – OW – Dec 12 Price Target: $80 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. CFA (1-212) 622-0149 simeon. departure of CEO having an impact on supply chain and relationships withspecific brand-name vendors.
to high-single-digit EPS growth over the medium term. with the industry benefiting from higher rates of tax and duty which mask underlying manufacturers’ pricing decisions. the industry is dominated by just three players. filters.18 $31. offering further upside to estimates. driven by a focus on value growth rather than volume growth. etc. With duty approximating 65% of retail prices. Reynolds American (RAI) – Overweight Price 12/6/2011 $41.—price has become a much reduced source of competition.maile@jpmorgan. the company stands to benefit more than peers from a resolution to ongoing negotiations with respect to overpaid Master Settlement Agreement sums.) $24. superslims. and repurchase its equity (having announced a $2. Best Idea – Reynolds American (RAI) Reynolds American (RAI) remains our top pick in the sector given the expectation of mid. Philip Morris International (PM) should continue to deliver its stated target for constant-currency EPS growth of 10-12% in 2012.S. leverage and reduce its cost base. consistent profit growth over the medium term.5bn program in November 2011 to run over the next two and a half years).49 FY EPS Cur (E) $2. helped by its continuing share repurchase program but mainly as a result of the favorable industry dynamics discussed above.54 FY End Dec Last (A) $2.7 Next 14. This expectation is driven by our view that the company can deliver modest revenue growth from its portfolio of brands.63 52-Wk Range High Low $42. Each of these companies has a stated target of consistently delivering medium-term profit growth to shareholders. each of the industry majors has an active share repurchase program.North America Equity Research December 2011 US Year Ahead 2012 Tobacco Continuing to Deliver Rae Maile AC (44-20) 7155 6102 rae.7 Mkt Cap (mil. For 2011 we estimate underlying tobacco consumption will have declined by only 2%. In the U. we believe. Altria Group Lorillard Inc Philip Morris International Reynolds American MO LO PM RAI OW N N OW The tobacco sector continues to offer scope for material. Morgan Securities Ltd. As conditions improve we expect to see a lessening of downtrading pressures in developed markets and a stronger trend of uptrading in developing markets.84 Cur 15. a manufacturer’s price increase of 5% implies a retail price increase of only around 2%. Pricing remains the key driver of industry profitability. blends.S. In addition. domestic market we expect to see further evidence of a firm pricing agenda from the industry. and with the benefit of share repurchases (roughly $1bn per company) midto high-single-digit EPS growth. In addition.com J.66 P/E Next (E) $2. the industry should be able to deliver mid-single-digit operating profit growth. with a similar decline likely in 2012. delivering further value to shareholders in addition to already generous dividends and ensuring that balance sheets do not strengthen further. With the major manufacturers focusing on product innovation—in packaging.267 100 . while in the U. we believe. Although the sector has proven recession resilient it has not been wholly recession proof. As a result of consolidation in the global market there are just four major players.P. With the benefit of pricing. slims.
Pepco Holdings PG&E Corp. equity sectors as a percentage of starting assets this year.3% through 12/6/11 versus flat performance for the S&P 500 index.) $19. equities would also pressure utility stocks J.66 $18. Portland General Electric Co. Progress Energy Sempra Energy Southern Company UIL Holdings Corporation Vectren Corp Westar Energy Inc Wisconsin Energy Corp Xcel Energy AGL AEE AEP BKH CNP CMS ED CEG CVA D DUK DYN EIX ETR EXC GXP TEG ITC NEE NU NRG NVE POM PCG POR PGN SRE SO UIL VVC WR WEC XEL (rs) UW N N OW OW N (rs) OW N (rs) N N (rs) (rs) N (rs) OW N OW OW N N N (rs) N N N UW N N N Growing economy likely pressures utility stocks Electric utility stocks were one of the best-performing sectors in 2011 as the UTY index gained 10. We project this drives stable EBITDA and FCF. equities likely signifies investor interest in stocks leveraged to an improving economic climate. Morgan Securities LLC AGL Resources Ameren Corp American Electric Power Black Hills Corp. trading at ~125% of the S&P 500 P/E multiple (the average is ~85%). We believe that the attractiveness of the yield spread may moderate some utility underperformance as declines in utility stock prices only amplify the attractiveness of the yield spread. However. Best Idea – NRG Energy (NRG) NRG Energy (NRG) matches a naturally short retail supply position with a naturally long power plant fleet.S. The company should complete a balance sheet restructuring in 1Q12 that likely frees the company to buy back 20% or more of its shares outstanding. Dominion Resources Duke Energy Corp.75 15. failure to redeploy FCF in attractive investments or spending significant capital on pursuing construction of nuclear plant expansion.North America Equity Research December 2011 US Year Ahead 2012 Electric Utilities & Independent Power Producers Energy Electric Utilities Likely Underperform if Macro Call for Growth and Return to Equities Is Right Andrew Smith AC (1-713) 216-7681 andrew. CenterPoint Energy CMS Energy Corp Consolidated Edison Constellation Energy Group Covanta Holding Corp.S. Morgan expects GDP growth to accelerate as 2012 progresses.22 Dec $1. Fund flows may be slow to reverse Electric utilities have the second-highest fund inflows of U. Inc.454 Valuation: Target reflects comparable asset transactions. Dynegy.S. Great Plains Energy Integrys Energy Group ITC Holdings NextEra Energy Inc. Return to U. Electric utility stocks have the second-highest fund flows of U.S.P.S. 101 .S. If this firstname.lastname@example.org@jpmorgan. Morgan’s economic outlook is accurate.l. 10-year Treasury is at historically attractive levels.P.25 $1.com J.P. equities in 2012.P. Based on our conversations with dedicated utility fund managers.37 $25.j. Valuations and fund flows might offset some pressure We believe two factors might offset some of the pressure on utility stocks if J. Equity Strategist expects investors to return to U. we expect investors to seek out stocks with greater leverage to the economic cycle. We also expect the stock to offer some upside if the macro environment discussed above occurs as NRG would benefit from higher power sales volumes. Northeast Utilities NRG Energy NV Energy Inc. NRG Energy (NRG) – Overweight – Dec 12 Price Target: $33 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil.com Michael Dandurand (1-212) 622-6432 michael. Edison International Entergy Corp. We believe these investors may be slower to rotate out of utility funds. We believe utility stocks will also underperform if this occurs. J. However.84 $1. the yield spread versus the U. Morgan’s U. which represents a FCF yield of ~20% today.1 $4.smith@jpmorgan.S. We expect this trend to reverse if investors revisit U.5 11. currently suspended. 10-year Treasury is attractive Electric utility shares are near all-time-high valuations on a relative P/E multiple versus the S&P 500. We believe the strong utility stock performance was driven by investors’ flight to the stable EPS profile of the regulated utility model along with attractive dividend yields. it appears that much of the fund flows are driven by retail investors seeking relative security and yield.S. Risks: Collapse in commodity costs or spike in fuel costs. Exelon Corp. resulting in utility stocks underperforming.S. equities more broadly as a return to U. and thus moderate some of the pressure on utility stocks in the event that utility stocks start to come under pressure. Yield spread versus the U. equities as a percentage of starting assets through November.com Christopher Turnure (1-212) 622-5696 christopher.
S.) $63. In this low interest rate environment. With supportive capital markets and continued low interest rates.P. MLPs appear well positioned to capitalize on such opportunities. capital indigestion weighing on near-term performance. we expect to see elevated M&A activity in the midstream space next year. BPL EPB EEP ETP EPD GEI.7 18. Energy Transfer Partners. allowing accelerating distribution growth in 2012. we believe the MLP space is ripe for consolidation as larger players acquire MLPs without a GP.North America Equity Research December 2011 US Year Ahead 2012 Energy MLPs Low Interest Rates and Potential Market Turbulence Enhance MLP Value Proposition Jeremy Tonet AC (1-212) 622-4915 jeremy. L. L. one of the two MLPs under coverage without a GP.email@example.com. Marcellus.TO KMP MMP NS OILT OKS PAA WPZ OW OW OW N OW N N N UW OW N OW N The quest for yield is supporting MLP valuations. 102 . which we expect the market to reward with a higher valuation (lower yield).449 Valuation: Target reflects DCF using 1. After multiple LP/GP mergers over the past few years. Bakken.5 $5. Morgan’s U.P.meadows@jpmorgan. we believe current yields of 6-7% combined with median distribution growth of ~6% could lead to low-double-digit total returns without any revaluation required.75%. Michael Feroli (J. L. L.P. Enterprise Products Partners. Risks: Execution risk at BORCO.P.25% terminal growth rate and required rate of return of 8. and entering new complementary growth markets (BORCO acquisition). L. we think consolidation among MLPs is more likely. we view these returns as particularly attractive in a choppy market.P.P. Oiltanking Partners. Kinder Morgan Energy Partners L. Secular trends in upstream development driving demand for new energy infrastructure.79 $3. Midstream consolidation is fueling distribution growth. as BORCO expansions come online. While rising interest rates will be an issue at some point in the future. Best Idea – Buckeye Partners (BPL) Our top pick is Buckeye Partners (BPL). lowering BPL’s cost of equity (acquiring the GP). Gibson Energy Inc.P.0% yield. While we would not rule out more transactions whereby MLPs acquire C-Corp brethren in the quest for growth (KMP/EP and ETE/SUG). We believe that the market does not fully appreciate BPL’s transformation and that management is actively looking to capitalize on Buckeye’s lower cost of capital and new organic growth opportunity set.P. new production likely will overwhelm existing infrastructure capacity and require new midstream buildout. thereby driving attractive price appreciation. The secular trend towards liquids-rich production should continue to drive significant demand for new energy infrastructure. ONEOK Partners.P. we believe MLPs offer an attractive value proposition on a relative basis. L. Economist) does not expect the Fed to increase rates during 2012 and Terry Belton (J. Magellan Midstream Partners L. MLPs have historically traded at an average spread to the 10-year Treasury of ~300bps. Buckeye Partners L. Buckeye Partners.com J.P. and other emerging plays. Morgan’s U. As we view energy infrastructure MLPs as a play on energy demand (which exhibits low elasticity). Though we do not expect MLPs to fully converge towards the historical spread (which would drive ~22% price appreciation). Plains All American Pipeline.P.com Tim Fisher (1-212) 622-5403 tim.5%). acquisition risk. We expect projects coming on line will drive increasing distribution growth rates during 2H12. Enbridge Energy Partners. Nustar Energy L. Williams Partners. screens cheaper than peers on 2013E metrics.92 $54.43 22. the current 6. (BPL) – Overweight – Dec 12 Price Target: $74 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. Fixed Income Strategist) forecasts a modest increase in the 10-year (exiting 2012 at 2.40 $68. As producers focus on oil and liquids-rich production in the Eagle Ford.j.3% yield on the Alerian MLP Index represents a ~430bp spread over the 10-year Treasury’s 2.P.51 Dec $2.com Alistair J Meadows (1-212) 622-6442 alistair.46 $2. Buckeye has undertaken several key initiatives to transform the partnership.S. such as increasing asset utilization (Farm and Home acquisition).P.P.P. Morgan Securities LLC Buckeye Partners L. L.P. and could provide asset diversification and strategic foothold in the northeast.tonet@jpmorgan. El Paso Pipeline Partners L.
exploration and appraisal activity continues.75 Dec C$1.com J. catalysts. and more volatile names within our coverage.7 C$8. then an improving economic outlook that reduces uncertainty and encourages investment may well do so at the expense of future buybacks. an equity market outlook that suggests a wide range of potential outcomes.3%) is unlikely to attract capital alone. if repurchases are a symptom of corporates’ reluctance to embark on large-scale capital investments in a period of economic uncertainty. production reliability improves at Long Lake and Buzzard.79 8. We believe NXY offers a rich catalyst slate as new volumes from the Usan project come online in 1H12. removing one of the elements of share price support. Nexen (NXY) – Overweight – Dec 12 Price Target: C$31 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. oil price retreat. based on our estimate of segment-level cash flows discounted at a WACC of 7. we are again selecting Overweightrated NXY as our top pick for the year ahead. with $3 of buybacks for every $1 of mutual fund flows.11 C$14.396 Valuation: Target reflects DCF. unsuccessful exploration. In our view.grinman@jpmorgan. the highest in its peer group. and a commodity outlook calling for near-term weakness in the energy and broader commodity space. corporates themselves have been the incremental buyers of stocks. we believe investors putting capital back to work in the sector will be more inclined to return to names offering a combination of attractive upside. riskier. portfolio growth. outside-operated project slate. we take a relatively longer view on investing in the sector. we believe NXY is well positioned to outperform peers.16 C$1.8%.TO TLM. the shares that have performed courtesy of a large boost from share repurchases may well be on an unsustainable share price trajectory. S&P 500 +3% and WTI +13%). and catalysts.minyard@jpmorgan.TO N N UW (rs) UW OW UW OW N N OW OW N OW As we look ahead to 2012. Although NXY’s below-market dividend yield (1. and we acknowledge a macroeconomic outlook shadowed by external (Europe) and internal (domestic fiscal policy) risks. Risks: Continued challenges at Long Lake.com Igor Grinman (1-212) 622-6596 igor. Where to go when the defensive positioning has overstayed its welcome? As we have stated in recent research. Best Idea – Nexen (NXY) We are again selecting Overweight-rated Nexen (NXY) as our top pick for the year ahead.TO CVE.83 C$2. At the risk of being repetitive.TO CVX COP XOM HES HSE. and maintain our stance that the better value lies in the higher-beta. expanding returns. especially in the Gulf of Mexico and West Africa. Morgan Securities LLC Canadian Natural Resources Cenovus Energy Chevron Corp ConocoPhillips Exxon Mobil Corp Hess Husky Energy Lone Pine Resources Marathon Oil Murphy Oil Nexen Occidental Petroleum Suncor Energy Talisman Energy CNQ. and growing portfolios. What happens when the buybacks stop? According to our Equity Strategy team.92 C$27. and potentially changing investor sentiment underpin the outlook for 2012.P. we believe capital is best put to work over the course of 2012 in names offering a combination of strong potential upside. and a handful of potentially favorable catalysts to focus investor attention on the underlying portfolios. and investors move past the overhangs that have plagued NXY’s share price performance in the last 12 months (down 29% vs.) C$15. we believe the combination of upside. currency exchange rate risk. Although uncertainty seems to dominate the overall investment mood.North America Equity Research December 2011 US Year Ahead 2012 North American Integrated Oils & Major Producers Will Value Work in 2012? Recommending OW-Rated Nexen as Top Pick (Again) Katherine Lucas Minyard.TO OXY SU. oil price leverage. that is. but with some level of defensiveness and attractive dividend yield. With NXY shares offering >90% potential upside to our C$31/share price target.7 5. delivering higher margins and loftier cash flows.l. 103 .TO LPR MRO MUR NXY. especially given our view that crude oil will hold between $110/bbl and $120/bbl in 2H12. CFA AC (1-212) 622-6402 katherine.
com Jessica Lee (1-212) 622-9812 jessica. leverage to crude. and global economy and.S. One operational catalyst stands out: drilling results from its new Horizontal Wolfcamp Shale play. During the 2008-2009 financial crisis and the economic stresses of 2H11. Risks: Commodity price volatility. In recent years. Therefore. PXD has been one of the most disciplined companies (i..98 $5.wai@jpmorgan. it recently instituted a share repurchase program and budgets around $250mm of buybacks for 2012. oilfield leverage to crude. Inc. which we calculate using a DCF model. we highlight those names as our favorite stocks for 2012. SM Energy Southwestern Energy Company Swift Energy Company Ultra Petroleum Corp Venoco. Inc. Cobalt International Energy Concho Resources. results from plays. Operational catalysts include production response from its Hastings and Oyster Bayou EOR fields (commencing production in the next few months) and the performance of its other EOR fields.) $16. the data suggest that DNR generally is on track in the development of its EOR projects. If Pioneer can deliver strong well results.80 $3. which we calculate using a DCF model.50).503 Note: Target based on our estimate of NAV.e. Best Idea – Pioneer Natural Resources (PXD) Pioneer Natural Resources (PXD) is one of our best ideas for 2012. therefore. which outperformed the small caps. the large-cap E&Ps outperformed the mid-caps. DNR is up only 52% versus the EPX which is up 151% (WTI oil was close to $40/Bbl in March 2009 vs. Goodrich Petroleum McMoRan Exploration Company Newfield Exploration Company Noble Energy PDC Energy Penn Virginia Corporation PetroQuest Energy. the stock offers some of the best upside to NAV among all E&Ps.10 23.d. Using NYMEX futures. The company is among the oiliest in our coverage group (93% of current production is oil). we are cautious on the U. the company offers over 70% upside from the current stock price.s.61 $1. but two mid-caps appear to offer much more stock price upside potential and also have good balance sheets and efficient cost structures. 104 .) $94.50 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil.86 $26. Inc.7 18. the stock likely will perform well. EQT Corporation EXCO Resources.40 $106. Denbury Resources (DNR) – Overweight – Dec 12 Price Target: $28.2 12. Inc. Risks: Commodity price volatility. Overall. Our favorite large cap is EOG Resources (Overweight rating. Continental Resources. Inc.50 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. oilfield service cost inflation. Best Idea – Denbury Resources (DNR) Denbury Resources (DNR) is one of our best ideas for 2012.20 Dec $0. Chesapeake Energy Cimarex Energy Co.P.lee@jpmorgan. shutting down operations when costs got out of hand) and the company’s balance sheet is strong. $100 today).5 $11. performance of CO2 fields and EOR fields.63 Dec $1. Pioneer Natural Resources Plains Exploration & Production QEP Resources Quicksilver Resources Inc Range Resources Corp SandRidge Energy Inc. Whiting Petroleum Corporation Williams Companies APC APA AREX ATPG BRY BEXP COG CRZO CHK XEC CIE CXO CLR DPTR DNR DVN EP EOG EQT XCO GDP MMR NFX NBL PETD PVA PQ PXD PXP QEP KWK RRC SD SM SWN SFY UPL VQ WLL WMB OW OW N UW OW N N N N OW OW N N UW OW OW OW OW OW N OW OW OW OW OW OW OW OW OW N N OW N N OW N N UW N (rs) Consistent with our economics team. oilfield service cost inflation. As the company also thinks it is undervalued.03 $10.33 13. Devon Energy El Paso Corp. CFA AC (1-212) 622-4864 joseph. Morgan Securities LLC Anadarko Petroleum Apache Corporation Approach Resources ATP Oil & Gas Berry Petroleum Brigham Exploration Company Cabot Oil & Gas Carrizo Oil & Gas Inc.07 $58. On a NYMEX NAV basis.allman@jpmorgan. PXD is growing at ~20%. We think investors generally should orient their E&P investing towards the more defensive names: larger cap with good balance sheets and efficient cost structures. Despite revisions to the timing and/or the magnitude of production ramp at two of its EOR fields. would recommend investors position themselves conservatively.com J. Delta Petroleum Corporation Denbury Resources Inc. Dec 12 PT of $144.603 Note: Target based on our estimate of NAV.North America Equity Research December 2011 US Year Ahead 2012 Oil & Gas Exploration & Production Cautious Economic View Leads to Conservative E&P Investing Joseph Allman.com Jeanine Wai (1-212) 622-6489 jeanine. Inc. Since trough E&P stock prices in March 2009.7 $6.28 $1. EOG Resources. Pioneer Natural Resources (PXD) – Overweight – Dec 12 Price Target: $167.
Rowan Companies Schlumberger Transocean Weatherford International BHI CJES CAM CPX DO DRC DRQ ESV EXH FTI HAL NOV NE RDC SLB RIG WFT OW OW OW (rs) UW OW N N N OW OW OW OW OW OW N N The Oilfield Services & Equipment sector is unlikely to outperform the broader market until two things occur: global macro issues abate and international upstream markets start growing again . CFA AC (1-212) 622-6684 jdavid. viewing large-cap services.57 $57.North America Equity Research December 2011 US Year Ahead 2012 Oilfield Services & Equipment North America Is Stronger Than You Think J.34 $4. Morgan Securities LLC Baker Hughes C&J Energy Services Cameron Int'l Complete Production Services Diamond Offshore Dresser-Rand Dril-Quip Ensco plc Exterran Holdings FMC Technologies Halliburton National Oilwell Varco Noble Corp. .P.e. heavily discounted because of its high exposure to North America (60% of ’12E revenue). . David Anderson. with service intensity considerably higher than in 2008 (monthly revenue/rig). steady spenders). market consolidation putting HAL’s advantage in unconventional resources at risk. Global oil production is becoming increasingly service intensive. we remain incredibly bullish on the fundamentals of the group.45 10. and capital equipment companies separately. but is by no means poised to turn down. Risks: Potential and uncertain liability from involvement in Macondo blowout. which has once again been left for dead . requiring ever-greater scale and the latest technology. this market is more cyclical than the others.) $35. trading about 40% below estimated fair value on normalized EPS and about $20/bbl below WTI oil prices using historical regressions.k. Best Idea – Halliburton (HAL) Halliburton (HAL) is our top pick within the large-cap service sector..730 Valuation: Target reflects 13x 2012E EPS and assumes stock trades at a smaller discount to the group average due to its commanding position in North America and progress in its international operations. and continue to believe this group will outperform through the cycle based on a simple premise: each barrel of oil produced in the foreseeable future will cost more than the last.21 Dec $2. land rig count to grow 10% in 2012. We take a portfolio approach to our sector. compared to 83% drilling for natural gas at the last peak in 2008.0 $32. service companies should reap the benefits of increased spending with improving pricing. Halliburton (HAL) – Overweight – Dec 12 Price Target: $58 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. in our view.hoh@jpmorgan. We believe large-cap service companies are most attractive on valuation.6 8. .com J. North America is an oil market now. biggest consensus long on Street.com William S Thompson (1-212) 622-9978 william.s. Whether exploring and developing from oil and gas fields in firstname.lastname@example.org $27. Beyond the next few quarters. We expect 2012 EPS estimates to have upside risk as the Street becomes convinced in the strength of the North American market. Yes. CFA (1-212) 622-5248 samantha. . PE. often applied in harsh environments.06 $3. That leads us to the North American land market. along with multiple expansion as the offshore and international land markets contribute more materially as the year progresses. sustainability of North American onshore recovery.S. while 50% of operators are major oil companies or large-cap E&Ps (i.com Samantha Hoh. possibility of a large acquisition pressuring shares. for which 60% of rigs are now drilling. 105 . offshore drillers. We don’t think so.000ft of water or unlocking the potential of unconventional resources in shales. All the growth will be coming from horizontal oil and liquids plays that should be largely insensitive to oil prices above $70/bbl. as each has its own set of drivers and trades distinctly.thompson@jpmorgan. instead favoring those names with the greatest potential for upside to earnings. Our concern is whether this valuation gap can close with the overriding macro issues and the persistently weak international markets. We are forecasting the U. we couldn’t disagree more. both of which should happen by mid-2012.
North America Equity Research December 2011 US Year Ahead 2012 106 .
322 Valuation: Target reflects 13x 2013E EPS. asset managers experienced meaningful multiple contraction in 2011. Franklin Resources FXCM Invesco Ltd. CFA AC (1-212) 622-6613 kenneth. With its relatively inexpensive valuation.67 $27. 2011 saw a number of macro events that are not expected to repeat in 2012 and. While exchanges still act as defensive stocks in an uncertain market.64 $8. the relative value pair Invesco Ltd.38 $1. Franklin Resources (BEN) – Underweight – Dec 12 Price Target: $111 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. as its flagship Templeton Global Bond fund goes out of favor due to poor currency investments and negative returns. (IVZ) – Overweight – Dec 12 Price Target: $26 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. as a result. improvement in fund performance. we recommend being positioned in asset managers that are especially inexpensive and are generating positive sales and good relative performance. We are concerned that the Global Bond fund will experience flat sales or redemptions as the one-year Lipper performance has now dipped to bottom quartile.52 $137. Best Ideas – Invesco Ltd. a continued discount as sales continue to slow down.76 12.50 $14. outstanding performance of its UK. tax repatriation legislation. As an investor.92 $9. (IVZ)/Franklin Resources (BEN) For the short to medium term. Record volume levels and consolidation among the exchanges helped them outperform their financial sector peers in 2011. continue to meaningfully underperform peers as currency investments (both long and short) are working against the funds.6 11.64 $1. Our top picks for 2012 are Intercontinental Exchange (ICE) and FXCM. Risks: Aggressive deployment of cash on balance sheet. Inc. Worthington.30 11.7 $9. and potential for added distribution to drive incremental sales in the coming quarters. (IVZ) and Franklin Resources (BEN) is our favorite idea. as valuation should recover as asset managers recuperate after a particularly weak 3Q. we continue to see the stock as attractive. as uncertainty continues to plague the equity markets. Franklin’s leading asset-gathering funds. something that was not expected when Global Bond fund was gathering about $10bn of sales per quarter over the last few quarters. Federated Investors. Invesco Ltd.com Rahul Nevatia (1-212) 622-6454 rahul. Exchanges Could Underperform in 2012 Kenneth B. Eaton Vance Corp Evercore Partners Inc. Even if the Global Bond fund does not wind up posting significant redemptions.and Canada-based funds. However. As a result. Weak markets in 2H11 depressed asset levels and volatility acted as a deterrent to retail and institutional sales.853 Valuation: Target reflects 12x C2013E EPS.71 Sep $8. in our view.) $20.8 $21. Investment Technology Group Janus Capital Group Knight Capital Group LPL Investment Holdings NASDAQ Stock Market NYSE Euronext Och-Ziff Capital Management Penson Worldwide Pzena Investment Management T. 107 . a slowdown in global fixedincome fund sales could result in overall net outflows for Franklin.P.) $100. we believe that valuations are especially inexpensive and are poised to bounce back if fundamentals improve slightly. led by the Templeton Global Bond fund. we believe they will underperform the financial sector in 2012.nevatia@jpmorgan. However. Morgan Securities LLC Apollo Global Management Artio Global Investors BM&F Bovespa CBOE Holdings Charles Schwab CME Group Inc. Rowe Price Group.3 10. Exchanges: Exchanges posted record volume levels and earnings in 3Q and are expected to report better-than-usual earnings in 4Q. Risks: Market downturn. Brokers & Exchanges Financials Asset Managers Offer Opportunities. Invesco (IVZ) fits these criteria. positive turn in sales of global equity funds and global fixed income funds.North America Equity Research December 2011 US Year Ahead 2012 Asset Managers. Franklin Resources (BEN) is the one to avoid.56 $87. Inc The Intercontinental Exchange APO ART BVMF3. meaningful appreciation of USD.b.52 Dec $1. fee rate falling. Invesco remains on the road to a sales recovery after acquiring and merging Van Kampen funds.SA CBOE SCHW CME EV EVR FII BEN FXCM IVZ ITG JNS KCG LPLA NDAQ NYX OZM PNSN PZN TROW ICE OW N OW N OW OW N N UW UW OW OW OW UW N N (rs) OW N N OW OW Asset Managers: The 2012 outlook is for modestly increasing earnings on what are still uncertain equity market conditions.com J. On the other hand.worthington@jpmorgan. volumes are likely headed lower in 2012.
S.com John P Grassano (1-212) 622-5605 john. changes in capital structure/adequacy. In addition.P.75 $51. Near term. Consolidation activity remains sluggish and large deals are unlikely in this environment. with Asia consumer business reporting positive operating leverage in 3Q11 and Latin America business expected to do so in 4Q11. Eurozone.) $29. We expect trust bank stocks to remain under pressure near term due to pressure on revenues from weak markets and still-high expenses.S. However. the sector remains underowned. C has improved its risk management over the last few years and we believe losses should be manageable. Absolute low interest rates and legal/ regulatory challenges are added headwinds and expense savings are further out. we remain defensively positioned near term and recommend names such as US Bancorp and Wells Fargo due to relatively lower risk. combined with attractive valuations should provide a lift to bank stocks later in the year.juneja@jpmorgan. C continues to grow revenues and improve profitability of international revenues.com Chris K Baydar (1-212) 622-8115 christopher. we expect C to begin returning capital via share repurchases in 2012 due to its strong capital position.6x tangible book (near low of 0. Capital Return.p. deterioration in credit risk profile. continued slow recovery in the U.S. continued but slower-paced improvement in credit costs. Inc. Morgan Securities LLC Bank of America Bank of New York Mellon Corp. C stock may remain under some pressure especially due to Eurozone issues.4x 2012E EPS. positive results under a very harsh stress test and continued recovery in the U. Best Idea – Citigroup (C) On a full-year 2012 basis. However. We also expect Citigroup to recover in 2012 as it gets approval to return some capital despite the harsh stress tests. good capital including continued capital return.5x. However.58 $4. emerging markets are expected to recover sooner which should be a positive for Citigroup. BB&T Corporation Citigroup Inc. Given the uncertainty in the environment. performance of equity and fixed income markets. As a result. Even under the Fed’s harsh stress test. U.grassano@jpmorgan.S.email@example.com 7.50 $21. We expect bank earnings to be driven by continued recovery in loan growth. 108 . risks from government interference. While growth in emerging markets will lead to higher credit losses.40 Dec $3. we recommend Citigroup (C) because it has been overly beaten down due to concerns about weak markets and fallout from the Eurozone including in the emerging markets. Trust and processors: attractive valuations. and regulatory/political risk. We also expect benefit to some U. the biggest headwind to banks. rating agency actions. Citigroup (C) – Overweight – Dec 12 Price Target: $54 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. Fifth Third Bancorp Northern Trust PNC Financial Regions Financial State Street SunTrust Banks.k. in our view. could drive some small bank deals. Regulatory/political risk will likely remain high because it is an election year. economy. and some expense reduction plus benefit to EPS for some banks from share repurchases.com J. but some headwinds. a discount to expected peer group multiple of 1.980 Valuation: Target reflects 1x YE12E TBV. Continued Recovery to Help Later in 2012 Vivek Juneja AC (1-212) 622-6465 vivek.North America Equity Research December 2011 US Year Ahead 2012 Banks – Large Cap Several Headwinds Near Term.1 6. assets by European banks and de novo growth of business lines. Bancorp Wells Fargo BAC BK BBT C FITB NTRS PNC RF STT STI USB WFC OW N N OW N N (rs) N N N OW OW We expect a slow recovery in the United States and continued economic slowdown in Europe to create some headwinds for bank stocks early in 2012. The bank sector has lagged recently due to fears about multiple headwinds—U. despite the harsh stress test scenario. emerging markets should have a lesser impact and likely quicker recovery from a slowdown. banks from divestitures of U.4 $86. slowdown in global economic growth. These should offset net interest margin pressure.S. Risks: Regulatory risk. Citi has among the highest capital ratios in our universe. Valuation remains attractive with C trading at 0. and some drivers for revenue growth (portfolio acquisitions and growth/expansion of relatively newer businesses).S.3x during last recession) and 6.17 $4.
Although the fiscal drag is expected to meaningfully detract from U.com J. permanently diluting shareholders. while the stock is inexpensive on “normalized” 2015E EPS of $1. FHN. and SIVB.firstname.lastname@example.org TBV. many mid. we see many attractive values and point o a portfolio of CMA. with our average stock down 19% YTD.5% yield. resulting in a flattening of the yield curve. we needed to get comfortable on the risk profile at the bank given a sizeable home equity portfolio as well as mortgage putback risk. In this group.S. mid. PVTB. We believe this will open a window for investors to reduce underweight positions in mid. GDP growth in 2012 (could be -150 bps should current benefits expire). For income funds. we suggest FMER given the 4. using excess capital to pay a sharp premium on an acquisition. and ZION. Inc. for the first time. a global risk-off trade has resulted in a flight to U.6 $1.North America Equity Research December 2011 US Year Ahead 2012 Banks – Mid. through 2012 we see a tremendous amount of uncertainty being lessened in regards to both the Euro debt crisis as well as the U.and Small Cap Risk/Reward Favors Going Long This Crisis. Global markets have seen considerable selling pressure since mid-July largely in response to the Euro debt crisis. economic outlook.38 Dec $(0.959 Valuation: Target reflects 0. we believe the coming NIM storm is largely captured in valuations. 15% Sector Upside with Many Attractive Plays Steven Alexopoulos.alexopoulos@jpmorgan. with FHN’s stock trading below TBV at 0. First Horizon National First Republic FirstMerit Corporation KeyCorp M&T Bank MB Financial New York Community Bank People's United Financial PrivateBancorp.35 (puts stock at 5.2 18. we believe the $100mm buyback plan announced in tandem with 3Q earnings was a milestone. Given the anticipated fiscal drag in 2012. Risks: Failure to deliver on previously outlined results. Best Idea – First Horizon (FHN) Although we see many attractive values within the mid. we suggest FRC. maintaining current discount to peers. we suggest a portfolio of niche banks that can capture growth despite tepid macro conditions. Coupled with absent loan growth and more banks investing free cash flow into securities. With regional bank stocks trading off recent lows. Contrasted to the financial crisis of 2008/2009 when many banks were forced to issue stock at historical lows. In the value bucket. First Horizon (FHN) – Overweight – Dec 12 Price Target: $8.67 $5. Consequently. Morgan Securities LLC Astoria Financial BancorpSouth CapitalSource City National Corp Comerica Incorporated Cullen/Frost Bankers Inc. excluding mortgage repurchase provisions for 2015E. Inc. First Horizon (FHN) moves to the top of our list of attractive bank stocks. 109 . While most U.50 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil.and small-cap banks don’t have direct exposure to either Eurozone countries or companies. normalized EPS move to $1. With that said. TCF Financial Corporation Trustmark Corporation Umpqua Holdings Corporation Valley National Bancorp Washington Federal. we like the multiple earnings levers. CFA AC (1-212) 622-6041 steven.40 15. in terms of the risk of mortgage putback.85x. given a conservative management team that feels comfortable reducing its strong capital position.and small-cap banks are now actually buying back small amounts of stock at historical lows—even a small buyback has the potential to materially reduce the share count.14) $0.7x). adverse scenario for private label.and small-cap bank sector.and small-cap banks through 2012. we believe investors will now need to tolerate increased downside risk to position for this longer-term upside potential.43 $12. In addition to an inexpensive valuation. SBNY.0x range.S. Treasuries. with FHN our top pick owing to a very inexpensive valuation and multiple earnings levers.9x TBV. While credit has now improved for several quarters. we see 15% upside through 2012.com Preeti S Dixit (1-212) 622-9864 preeti. we believe investors should consider utilizing a buy-on-dips strategy. Webster Financial Corporation Zions Bancorporation AF BXS CSE CYN CMA CFR FHN FRC FMER KEY MTB MBFI NYB PBCT PVTB SBNY SUSQ SIVB SNV TCB TRMK UMPQ VLY WFSL WBS ZION N UW N OW OW N OW OW OW OW N N N N OW OW (rs) OW N N OW N N N OW With mostly indirect risk from Eurozone.P.s. particularly with the group trading at only 1. Signature Bank Susquehanna Bancshares SVB Financial Synovus Financial Corp. the flattened curve is having a pronounced negative effect on net interest margins. KEY. A shopping list of buying opportunities.) $7.05. and looking to long-term profitability targets could put the stock in the 3. While we’ve known about these for some time.S. given the indirect risk of the current crisis at hand.S. however. In terms of earnings levers.5-4.49 $0.
370% at YE07). Prudential Financial (PRU) – Overweight – Dec 12 Price Target: $66 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil.1x YE2012E BV ex. Genworth Financial.90 $6.s. Competition in most products appears rational.41 $67.) $51. Even if the current rate environment persists. CFA (1-212) 622-2295 erik. we expect the group to generate a 10%+ ROE for the foreseeable future. although prevalence of equity market and interest rate guarantees remains a concern. American International Group Assurant.9x YE2012E total BV (25% weight). further deterioration in disability margins.bass@jpmorgan. PRU is generating robust sales and flows in its international insurance.52 $42. CFA AC (1-212) 622-6397 jimmy.com Erik J. the group should trade close to book value. above-average EPS growth. helped by new products and stable pricing.com Matthew P. 8. capital deployment. top-line growth in group benefits (group life and disability) and retirement plans remains pressured by tepid employment growth. Capital levels have steadily risen over the past few years (RBC 422% at YE10 vs.1% in 2011 to 11. and sales and net flows in most products are recovering. Investment portfolio risk seems manageable with reduced exposure to structured securities and minimal European holdings. In addition. In our view.North America Equity Research December 2011 US Year Ahead 2012 Insurance – Life Macro Factors to Drive Near-Term Performance. AFL AIG AIZ GNW HIG LNC MET NFP PNX PFG PL PRU RGA SYA TMK UNM OW N N N OW N OW N UW UW N OW OW N N N AEL CNO OW N Best Idea – Prudential Financial (PRU) PRU is our top pick as we project an improving ROE. Inc. Inc. Fixed annuity sales are also likely to be pressured by low interest rates. AOCI (50% weight).P. CFA American Equity Investment Life CNO Financial Group Our outlook for the life insurance sector is positive. we expect multiples to expand as fears about insurers’ ability to withstand low interest rates dissipate. most companies have excess capital. Risks: Accretion from Star/Edison below guidance. operating fundamentals are relatively healthy. While declining yields will pressure investment income.45 Dec $6. and we expect management teams to continue repurchasing shares and raising dividends despite the macro uncertainty. National Financial Partners Phoenix Companies Principal Financial Group Protective Life Prudential Financial Reinsurance Group of America Symetra Financial Torchmark Corp Unum Group Erik J Bass.email@example.com BV (ex. On the other hand. including raising prices and reducing crediting rates. Risk-reward appears attractive given current valuations. well below what we consider to be fair value based on our projected returns. Sustained low interest rates are our primary fundamental concern.com J. annuities. sizable variable annuity heding loss. Bhullar.95 8. which should enable the company to generate double-digit EPS growth for the next few years. Inc. As a result. Morgan Securities LLC Jimmy S. we do not anticipate significant near-term balance sheet charges (reserve increases or DAC and goodwill impairments) for most insurers related to low rates. and asset management businesses.0x 2013E EPS (25% weight). Sales outlook mixed by product.5% in 2012 and 12.4 $24. Insurers also have more extensive hedging programs. Hartford Financial Services Lincoln National MetLife. 110 .3 7. We project returns to improve from 10.bhullar@jpmorgan. but pricing trends are generally improving. Byrnes. AOCI).4% in 2013 as a result of organic growth. and healthy operating trends will drive upside in the stock. Bhullar. and we believe insurers should be able to raise rates to help offset lower investment portfolio yields.p.20 $6.985 Valuation: Target reflects 1. CFA AFLAC. insurers have several levers to offset the drag on earnings. Sales of variable and indexed annuities should also rise at a healthy rate despite the weak market. 0. Insurers’ balance sheets are better positioned to withstand poor equity and credit markets than in 2008-2009. The life group is currently trading at roughly 0. Also. and accretion from the Star/Edison acquisition. But Long-Term Risk-Reward Is Favorable Jimmy S. Inc. While near-term stock performance is likely to be heavily dependent on moves in interest rates and the equity market. insurers have increased holding company cash and reduced reliance on short-term funding. if the sector can earn a 10% ROE. In addition. We expect individual life sales to continue recovering. Bass. In addition. CFA (1-212) 622-0695 matthew.
in our view. Aon Corporation Arch Capital Group. excluding catastrophes.P. catastrophe losses. which were bottoming at mid-year 2011.40 $22. increased period of highfrequency/low-severity events continuing to pressure earnings.h.2 6.27 Dec $2. rates need to rise further over a sustained period of time to significantly improve earnings prospects across the group. etc.com Mei Feng A. Axis Capital Holdings. We believe the implications of this incrementalism are much less positive than past periods of commercial pricing power. It is one of the only stocks we cover that is likely to generate significant bottom-line growth over the next few years given current pricing fundamentals. while holding margins stable in the rest of the country. Allstate Corp. The market also seems to be lacking one of the convincing catalysts that has marked other periods of material pricing power—reserve inadequacies. Marsh & McLennan Cos. especially for those with medium time horizons. Brown & Brown. (ALL) offers investors the best risk-reward opportunity in our sector. The Progressive Corp. normalizing loss cost trends—have finally resulted in underwriters pushing through small price increases.heimermann@jpmorgan. the industry appears to be in an environment in which incremental pressures—falling investment yields. we believe it is premature to move from neutral to overweight the group. Platinum Underwriter Holdings. Morgan Securities LLC ACE Limited Allied World Assurance Company Holdings. we are skeptical that we are witnessing a traditional cycle turn. 2) achieving underwriting profitability in Florida and New York auto.96 36. and normalized ROE levels. Risks: Expectations for stabilizing to improving EPS and capital levels prove optimistic. Inc Chubb Corp.com J.8x 2012E EPS (versus its long-run average of 10.8 $13.705 Valuation: Target reflects residual income analysis based on prospective ROE (as defined by book value change adding back dividends) adjusted for operating and financial risks as well as historical valuation multiples and historical risk-adjusted returns. Inc. But Need More to Expect Outperformance Matthew G. pricing trends in personal lines remain positive as do trends in a number of property reinsurance markets. we believe that EPS could reach a run rate of $5. 2) growth prospects. pressure on investment yields.zhang@jpmorgan. and 3) growing life earnings in areas with high margins and low capital intensity. asset pressures. Endurance Specialty Holdings Everest Re Group.84 $0. Ltd. PartnerRe Ltd. to the levels of 2003-2007. In addition. low executive compensation. whether organic or via M&A given weak organic prospects. and 5) valuation relative to current. Ltd. including 1) returning homeowners’ margins. Despite more constructive pricing trends. Meanwhile.) $27.chen@jpmorgan. and. 3) capital flexibility for either capital management or acquisitions. now appear to be improving with positive rate gains being reported in a number of product and market segments. The risk to our call is that commercial pricing trends accelerate creating margin expansion opportunities in other parts of the sector.5x) and 0. (ALL) – Overweight – Dec 12 Price Target: $40 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil.12 $34. We believe the stock and valuation can expand with earnings over time. we see limited downside given the stock is trading at 6. more recently. Ltd. Ltd. Heimermann AC (1-212) 622-6545 matthew. Chen (1-212) 622-2875 donald. We believe the following factors are important to consider in the group today: 1) relative earnings prospects given continued ROE headwinds from low interest rates. We have identified three areas that should help ALL achieve this normalized EPS goal.77x tangible book (excluding AOCI) despite a 2012E ROE of close to 11%. While the stock is still a show-me story.com Donald H.North America Equity Research December 2011 US Year Ahead 2012 Insurance – Non-Life Pricing Showing Signs of Life. Rather. intermediate.a.00-plus exiting 2013 assuming normal catastrophes.. In terms of EPS. While this is clearly a positive development. Zhang (1-212) 622-6445 meifeng. Allstate Corp. Transatlantic Holdings Travelers Validus Holdings Willis Group Holdings plc XL Group PLC ACE AWH ALL AON ACGL AXS BRO CB ENH RE MMC PRE PTP PGR TRH TRV VR WSH XL OW OW OW OW UW N N UW OW N N N N N (rs) N (rs) N N Commercial insurance prices in the United States. (ALL) We believe Allstate Corp.g.75 $3. As a result. weak economic growth. Ltd. valuation appears to be discounting further EPS deterioration rather than improvement. improved industry pricing may not continue. Best Idea – Allstate Corp. 4) ROE leverage to the extent that pricing fundamentals improve further. 111 .
From a valuation perspective.51 is $firstname.lastname@example.org Dec $4. However.81 $6. there could be upside to our core growth estimates. CFA AC (1-212) 622-6682 anthony.118 Valuation: Target reflects DCF model based on our normalized dividends driven by our AFFO estimates. Inc.mccartin@jpmorgan. High Yields. Vornado Realty Trust Washington Real Estate Investment Trust 112 AKR CBL DCT DDR EQY FRT FR GGP HCP HCN HR JLL KIM MAC MPW PEI PLD PSB PSA RPT REG SPG STAG SKT TCO WRI AIV ARE ACC AVB BXP BDN BPO CPT CBG OFC CUZ DEI DRE EDR EPR EQR ESS GTY KRC LXP LRY CLI MSW PDM PPS O SLG UDR VNO WRE From a capital flows point of view. Duke Realty Education Realty Trust Entertainment Properties Trust Equity Residential Essex Property Trust Getty Realty Kilroy Realty Lexington Realty Trust Liberty Property Trust Mack-Cali Realty Mission West Properties Piedmont Office Realty Trust Post Properties Realty Income SL Green Realty Corp.P.12 $132. and Good Total Return Prospects Michael W. . CFA AIMCO Alexandria Real Estate Equities American Campus Communities AvalonBay Communities Boston Properties Brandywine Realty Trust Brookfield Office Properties Camden Property Trust CBRE Group. Best Idea – Public Storage (PSA) Public Storage (PSA) continues to be one of our top ideas in the REIT sector based on both our fundamental outlook for the company and its relative valuation.S.com Molly McCartin (1-212) 622-6615 molly. Some key risks we see to the group are: 1) capital rotation out of REIT stocks if the economy and financial uncertainties surprise on the upside.com Anthony Paolone. the stock trades at 22x our 2012 AFFO estimate which is less than a 10% premium despite being a blue chip with financial leverage that is just one-third of the overall REIT sector average. and 3) commercial real estate debt markets widening out.2 19.19 higher than the Bloomberg consensus as we believe that the combination of stronger-than-expected comp NOI growth and the deployment of retained cash flow should drive bottom-line earnings growth.l. UDR. Our 2012 FFO estimate of $6. assuming 8. Health Care REIT Healthcare Realty Trust Jones Lang LaSalle Inc Kimco Realty Corporation Macerich Medical Properties Trust Pennsylvania REIT ProLogis PS Business Parks Public Storage Ramco-Gershenson Properties Trust Regency Centers Simon Property Group STAG Industrial. Mueller.8 $23.5% discount rate and long-term growth rate of about 5%. To the extent job growth picks up in 2H or trends higher than 100-150k/month. higher than what the Street currently expects. PSA offers a competitive dividend yield today (just 90bps below the group average) due to three dividend increases over the past 24 months that were driven by a rebound in earnings. Fundamentally. Inc. 7% earnings growth in 2013.) $129.72 $5. we expect REITs to be active buyers as they continue to have better balance sheets than most private market counterparts. and 3) the RMZ sits about 3% below our shorter-term tactical fair value of 790. Inc.c. On the transaction side. 2) Japanese investors reverse course and redeem massive investments in REIT stocks made over the last 12-18 months.North America Equity Research December 2011 US Year Ahead 2012 REITs/Real Estate Services Earnings Visibility.com We think REIT stocks should deliver mid-teens total returns in 2012 with a combination of 4% dividend yields. Public Storage (PSA) – Overweight – Dec 12 Price Target: $140 Price 12/6/2011 52-Wk Range High Low FY End 2010 (A) FY FFO 2011 (E) P/FFO 2012 (E) Cur Next Mkt Cap (mil. two things stand out to us. inability to deploy capital into new investments. and about 3% valuation expansion from current levels. We believe there is some room for valuations to expand since 1) the pullback in stocks starting in July has been greater than the roughly 1% decline in 2012 FFO estimates stemming mostly from a weaker macro backdrop. Mueller. REIT portfolios should see occupancy increase at a slow clip (up 0100bps) and market rents should move up modestly (3-5%) in 2012.mueller@jpmorgan. Federal Realty Investment Trust First Industrial Realty Trust General Growth Properties HCP. First. Inc Corporate Office Properties Cousins Properties Douglas Emmett. Second.51 22. Morgan Securities LLC Michael W. 2) REIT stocks now trade at a slight NAV discount. economy continues to face drags on growth and financial markets face global uncertainty. CFA (1-212) 622-6416 joseph.w. in contrast to prior to the downturn. N N N N N OW UW N N OW N N N OW UW UW N N OW UW N OW N N OW OW UW OW N N OW N N N OW UW N OW N N OW OW OW UW OW OW N N N OW N N OW OW N N Cindy True (1-212) 622-6748 cindy. CFA Acadia Realty Trust CBL & Associates Properties DCT Industrial Trust DDR Corp Equity One Inc. if equity prices remain under pressure.paolone@jpmorgan. it will be more difficult for REITs to drive external growth initiatives as most will not want to increase leverage to do deals.dazio@jpmorgan. REIT stocks should benefit from capital seeking relatively visible earnings streams and high cash dividends while the U.20 $97.com Joseph Dazio. Tanger Factory Outlet Centers Taubman Centers Weingarten Realty Investors Anthony Paolone.com J. Risks: Continued economic weakness taking a toll on occupancy or pricing power. Inc. CFA AC (1-212) 622-6689 michael.
commercial. respectively. Over the past email@example.com 11.38 $4.12 12. We believe the company is well positioned for an environment of normalizing credit and slow portfolio growth. We note that current loss levels are approximately 220bps below the company’s historical average. a discount to historical multiple of 17. As the credit tailwind begins to subside.b. and unsecured.kim@jpmorgan. Department of Justice lawsuit.8 $56. we expect our coverage universe will encounter periods of data point–driven volatility. secured. in light of increased economic uncertainty. with the possible exception of residential mortgage). We believe this will occur across asset classes (consumer. We also note that loan growth is likely to remain below historical norms as the supply/demand equilibrium for credit remains constrained. 113 .com Daniel Kim (1-212) 622-6557 daniel. Finally. we note that in 2012.P.56 $53. we expect the company to demonstrate additional operating leverage as credit tailwinds subside and Visa/MasterCard settlement payments expire. Morgan Securities LLC American Capital American Express Annaly Capital Apollo Investment Apollo Residential Mortgage Ares Capital BlackRock Kelso Capital Capital One Discover Financial MFA Financial PennantPark Investment SeaCube Container Leasing Solar Capital TAL International ACAS AXP NLY AINV AMTG ARCC BKCC COF DFS MFA PNNT BOX SLRC TAL OW OW OW N N OW N (rs) N N N OW N N A new normal for credit quality and growth Following two years of improvement.com Jonathan Philpot (1-415) 315-6725 jonathan. investors will need to be willing to embrace tactical entry points created by credit data. This is based upon our thesis that high-end consumers are generally less sensitive to cyclical trends in terms of credit and spending.9x our 2013 EPS estimate of $4.com J.80 $41. American Express (AXP) – Overweight – Dec 12 Price Target: $55 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil.shane@jpmorgan. versus the industry average of approximately 9%.) $48. On the credit side. we believe credit performance has reached a cyclical peak (DQs and NCOs are likely to increase in 2012). Best Idea – American Express (AXP) Our best idea for 2012 is American Express (AXP).25 Dec $3.402 Valuation: Target reflects 11. domestic billed business has grown approximately 13% y/y. losses and delinquencies on the company’s portfolio are 200bps and 140bps below the industry averages.5x (excluding 2009).x.63. In order to maximize returns over the next 12 months.North America Equity Research December 2011 US Year Ahead 2012 Specialty & Consumer Finance The New Normal Richard Shane AC (1-415) 315-6701 richard. sluggish growth outlook for credit card portfolio. Risks: Economic backdrop remains fragile.04 $4. We are modeling operating expenses to fall to 71% of net revenues (versus 74% in 2011). we see long-term value in the group as normalized loss rates are likely to remain below historical levels. Ultimately.
North America Equity Research December 2011 US Year Ahead 2012 114 .
Given this.80 $3. We do expect ultimate approval. Inc. with potential meaningful clinical/regulatory catalysts (Alexion. In 2012. Celgene (CELG). Our focus in early 2012 will be on the first-line maintenance filing in the EU. The demand trends for flagship drug Revlimid were impressive in 2011. our top pick for 2012. Best Idea – Celgene (CELG) Our favored names in biotech are ones with solid underlying fundamentals and/or ones with meaningful potential catalysts. but 2012 will be different. Morgan Securities LLC Acorda Therapeutics Inc. Alexion Pharmaceuticals Allos Therapeutics AMAG Pharmaceuticals Amgen Inc Amicus Therapeutics AVEO Pharmaceuticals.20 16.8 $27. any negative developments with the IP for Revlimid. Celgene (CELG) – Overweight – Dec 12 Price Target: $75 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil.ulz@jpmorgan. biosimilars legislation. Regarding clinical/regulatory catalysts. 115 .92 Dec $2. we expect increased market penetration and share duration gains to continue to fuel Revlimid growth.c. a substantial market opportunity.4 14.com Michael E Ulz (1-212) 622-0900 firstname.lastname@example.org Anupam Rama (1-212) 622-0105 anupam. additional data from clinical trials could come in below expectations. above large-cap group average of 13x. Risks: Vidaza or Abraxane sales fluctuating from quarter to quarter.com J. Gilead.S. and Viropharma). U.North America Equity Research December 2011 US Year Ahead 2012 Biotechnology Health Care Fundamentals Intact.meacham@jpmorgan. But Volatile Times Call for Selective Measures: Celgene Top Pick Geoff Meacham AC (1-212) 622-6531 geoffrey. generalist interest overall in the sector is quite low.79 $4. 2011 was a quiet year. We do believe there are names in biotech that retain the sector’s inherent defensive nature—which should garner interest from both generalists and specialists alike.21 $68. has both. Other meaningful potential catalysts for Celgene to monitor will be potential accelerated approval of pomalidomide in relapse/refractory multiple myeloma and Phase 3 data from apremilast in psoriasis/psoriatic arthritis. Despite this performance.617 Valuation: Target reflects 18x 2012E EPS. our overall view on the sector is to take a selective approach. Indeed.) $62. Biogen Idec Celgene Gilead Sciences Idenix Pharmaceuticals InterMune Ironwood Pharmaceuticals Medivation PDL BioPharma Pharmasset Regeneron Pharmaceuticals United Therapeutics Vertex Pharmaceuticals ViroPharma Incorporated ACOR ALXN ALTH AMAG AMGN FOLD AVEO BIIB CELG GILD IDIX ITMN IRWD MDVN PDLI VRUS REGN UTHR VRTX VPHM OW OW OW N OW N OW N OW OW OW OW OW OW N N N N N OW Biotech fundamentals are intact. We do not currently include either of these opportunities in our model.P. as we expect Celgene to continue to outperform its biotech peers.e. Looking to 2012. headlines regarding macro and biotech industry–specific concerns (EU sales exposure. in our view. and pricing pressure on Medicare/Medicaid duel-eligible patients) could keep generalists on the sidelines. which is underscored by solid top-line performance in 2011 despite a challenging macro environment.25 $48. These names have good underlying fundamentals. particularly in the face of concerns regarding second primary malignancies (SPMs) associated with the drug in 1H11 (concerns that we had always felt were overdone). Celgene.
40 $46. boosting its value to ONXX. persistent investor skepticism surrounding “launch stories” could continue to be a theme next year. Ultimately.6% vs.13 $0. regulatory and/or commercial failure of carfilzomib in multiple myeloma. faster. However. Ph.com J.P. failure of label expansion trials.jay@jpmorgan.) $42.5%) but 2012 could be a transformative year with the potential approval of wholly owned asset carfilzomib (CFZ) for multiple myeloma. attractive valuations and a potentially more robust IPO market could also facilitate increased investor interest.” ONXX shares have posted solid performance YTD in 2011 (up 12.com Karen E Jay.w. and we would note that SMid biotechs are not as reliant as most industries on the performance of the overall economy so long as they have access to capital. the Nasdaq Biotechnology Index (NBI) has outperformed the broader market (NBI +8. With that backdrop.72 $(0. Ariad Pharmaceuticals Array BioPharma Biodel Inc.e.and lower-thanprojected uptake of Nexavar in HCC setting. Key to this view are the eight ongoing or recently completed studies evaluating Nexavar and regorafenib in six different tumor types.17 Dec $0. Potential approval in 1H12 would be the major positive catalyst though we also believe that any regulatory setbacks could be met with money coming in from the sidelines (given long-term optimism).34) 58.07 $27.com Matthew J Lowe.D. Beyond a possible acceleration in M&A. S&P 500 +0.j. key launches to monitor include DNDN’s Provenge. we still expect investor risk appetite for the SMid biotechs to continue to be driven by high-profile clinical and regulatory catalysts.9 N/M $2. we lean towards ONXX at this point as it is the more controversial name (at least in the near term) while BMRN has become more of a “consensus long.North America Equity Research December 2011 US Year Ahead 2012 SMid Biotechnology Will 2012 Finally Be the Year for Resurgence in M&A Activity? ONXX Remains Top Pick Cory W Kasimov AC (1-212) 622-5266 cory. and risk-adjusted NPV analysis.698 Valuation: Target reflects P/E analysis. Ph. Inc ALKS AMLN ARNA ARIA ARRY BIOD BMRN DNDN EBS EXEL GERN HGSI IMGN INCY LXRX MNKD NKTR ONXX OREX RIGL SVNT SGEN MDCO VVUS OW N N OW OW N OW OW OW N N OW N OW OW UW OW OW N OW N N N OW We have a generally optimistic outlook for the small/mid-cap biotech group going into 2012. real options scenario analysis. Within our universe alone. BioMarin Pharmaceuticals Dendreon Emergent BioSolutions Exelixis. Inc Geron Corp Human Genome Sciences ImmunoGen Incyte Corporation Lexicon Pharmaceuticals MannKind Corporation Nektar Therapeutics Onyx Pharmaceuticals Orexigen Therapeutics Rigel Pharmaceuticals Savient Pharmaceuticals Seattle Genetics The Medicines Company VIVUS. INCY’s Jakafi. Onyx Pharmaceuticals (ONXX) – Overweight – Dec 12 Price Target: $48 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. Risks: Slower. we do believe there’s a reasonable chance that biotech M&A activity could pick up in 2012 for the same reasons that have been tossed around for the last couple of years (patent cliffs for large pharma combined with plush pharma balance sheets and more mature biotech pipelines).and greater-than-expected erosion in RCC. To date in 2011. 116 . Inc. Inc. on the negative side.D. and the potential for M&A activity. Morgan Securities LLC Alkermes. We’ve also stressed that ONXX is about much more than just CFZ despite investors’ overwhelming focus on that product. CFZ’s efficacy and safety profile has resonated well with doctors and we believe. However. based on early data. (1-212) 622-0848 email@example.com%). SGEN’s Adcetris. Amylin Pharmaceuticals Arena Pharmaceuticals. HGSI’s Benlysta. that there is a good chance the drug will be eventually be used across the entire spectrum of disease. We expect the next updates will be in 1Q for Nexavar in lung cancer (see our MISSION preview) and rego in GIST with the remaining four studies reporting out at varying times over the subsequent 12 months. (1-212) 622-4668 karen. commercial performance. We believe it will be important for the overall performance of the sector that at least some of these commercial companies make strides in 2012. So far ONXX is 2-for-2 (positive Nexavar SPACE data and positive rego CRC data). The anticipated uptick in M&A once again failed to live up to expectations in 2011. although the recent proposed acquisition of Pharmasset (VRUS) by Gilead Sciences (GILD) could reignite investor optimism. and potentially AMLN’s Bydureon (late January PDUFA date). greater-thanexpected competition in RCC and HCC markets.kasimov@jpmorgan. we continue to prefer ONXX and BMRN. Best Idea – Onyx Pharmaceuticals (ONXX) Among our mid-cap companies. when choosing between the two.
Inc. Beyond mix improvement. facilities will ultimately be among those most levered to economic stabilization/recovery. we believe it will ultimately be difficult to enact anything much more significant than 2%. Broadly.03 Dec $2. and that potentially a nearer-term constraint on the stocks. while the reality is probably more biased to the fact that Congress and the Administration will have to restart the discussion in 2012.60 8. Health Management Associates Inc. an element that that we believe could factor again as a renewed visibility constraint. to swap some of the current disproportionate mix of (low-paying) self-pay and/or government-support program business out for (much higher-paying) commercial. Morgan Securities LLC Community Health Systems Inc. and while economic recovery is likely not viewed by most as a near-term event. (HCA) We currently rate HCA Inc. coverage expansion extends longer-term view. the Super Committee announced that it had not found a compromise in the deficit reduction talks and technically (under sequestration at least) for now this means Medicare will take just a 2% cut beginning in 2013 and Medicaid will see no reductions at the federal level. (HCA) Overweight. That is the potential.com J.rex@jpmorgan. Best Idea – HCA Inc. replaying the deficit talks is a potential headwind. while that not the nearest-term event. and even if this trimmed somewhat. and especially as we consider acute care. Risks: Pressures on operating margins as currently running well above peer group.67 $3. HCA Inc. in part as the group has been under pressure with still persistently weak payor mix. While likely to be much in focus in 1H12 as the Supreme Court takes up its review. the benefit to lowering uncompensated care costs will be meaningful. It’s the longerterm play in acute care. light medical consumption patterns. with a year-end 2012 price target of $38.) $23.S. HCA is the largest U. health reform coverage expansion getting derailed or scaled back. our hospital volume work does show stabilization in mix. the leverage to earnings from such a shift is meaningful. (HCA) – Overweight – Dec 12 Price Target: $38 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. Nearer term though. and often have one of the leading shares in those regions. Recall that 34 million individuals are expected to gain coverage. particularly as we look further ahead and consider leverage to a recovering job market and.93 $2. HCA Inc. potential supply of shares from private equity investors.5 $10. With the largely nonprofit acute-care sector running extremely slim margins. we believe that ultimately most of the 2014 coverage expansion envisioned under the health reform law will occur. Universal Health Services Inc. Vanguard Health Systems CYH HCA HMA HLS KND LPNT SEM SKH THC UHS VHS N OW N N OW N N N OW N OW Among the most levered in healthcare to economic stability/recovery. in line with our group average objective. hospital system by a considerable margin. Select Medical Corp. but we see how the entire story may have to be revisited. With virtually no cost-of-care differential. The company’s facilities—with a portfolio biased toward higher quality-ranked properties—are mostly situated in urban markets with faster population growth. HealthSouth Corp Kindred Healthcare. Here in particular. At the end of November.24 $35. it is about payor mix. 117 .37 $17.P. we favor such scale and urban market positioning.North America Equity Research December 2011 US Year Ahead 2012 Healthcare Facilities Economic Stability and Expansion Assist Long Term. While Budget Issues First John Rex AC (1-212) 622 6600 john. out in 2014. operating over 160 hospitals with nearly 39. with a cost structure much more heavily biased to semi-fixed costs than most of healthcare. Of course that’s the technical prognosis. LifePoint Hospitals Inc. coverage expansion. as more individuals gain employer-based coverage. However. Healthcare facilities stocks have been challenged this year. Skilled Healthcare Group Tenet Healthcare Corp.146 Valuation: Target reflects 7x EV/EBITDA using our 2013E EBITDA. and the threat (and reality) of budget cuts for government program business. about 5% of the market.000 beds.7 6.
competitive pressure from new entrants.5 31.24 $0.rahim@jpmorgan. as we expect the company’s steady-state EPS growth in the 2014-2017 timeframe to be around 30-40%. delays in signing on new customers. as well as revenue cycle management (to offset reimbursement pressure) are the products and services that will experience increased demand. MDRX.a. and QSII) have benefitted from the 2009 Stimulus Bill. regulatory changes.00 $32. titled “Stage 2 Criteria Point to Sustained Demand.com J. However.20 Dec $0. 2011. Specifically. we like Accretive for its unique business model which requires no upfront or incremental investment from a hospital and yet delivers revenue gains to the hospital by bringing efficiency to the collection process. but we continue to believe there is upside to the names because Stage 2 requirements which are due to be finalized by mid-2012 point to sustained demand for the next 2-4 years.) $23.73 53. which incentivizes healthcare providers to purchase EHRs and demonstrate “meaningful use. we believe initiatives under the Patient Protection and Affordable Care Act (aka Health Reform) will provide the next growth driver.5 $2. 118 .43 $0. Accretive Health (AH) – OW – Dec 12 Price Target: $35 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. The recently announced Intermountain Healthcare deal is likely to go a long way in terms of generating brand recognition for the company. we intend to focus on this in the coming year as that is where the puck is moving. Risks: Loss of key customers. Also. longer than many investors believe to be the case (we published a detailed report on this on June 16.P. Best Idea – Accretive Health (AH) Accretive Health (AH) is the best long idea in our coverage universe. we believe health information exchanges (HIEs) and technology to allow development of accountable care models. Accretive has the best topand bottom-line growth prospects in our coverage universe and trades at a 43% discount to our projected 55% earnings growth rate for the company through 2013.82 $13. multiple contraction from execution missteps. we believe Accretive is an attractive option as the company has not experienced any material benefit from the Stimulus. Morgan Securities LLC Accretive Health Allscripts Healthcare Solutions athenahealth Cerner Corp Epocrates MedAssets Quality Systems AH MDRX ATHN CERN EPOC MDAS QSII OW OW UW OW N N OW The electronic health record (EHR) companies in our coverage universe (ATHN. At a high level.” Investors generally view stimulus-driven demand as priced into the shares at current levels. For investors that are looking for the next driver of growth. From a numbers standpoint. It is still early to quantify precisely how much demand will be generated given the dynamic nature of Health Reform and the fact that a number of rules have yet to be published.259 Valuation: Target reflects 34x 2013E EPS. for investors wary of the risk of multiple compression as the effect of the Stimulus wanes.North America Equity Research December 2011 US Year Ahead 2012 Healthcare Information Technology What’s the Next Growth Driver Beyond Stimulus? Atif Rahim AC (1-212) 622-6671 atif. CERN. EHR Market Update”).
based on a robust biotech pipeline and ongoing demand from plan sponsors looking to rein in rising specialty drug costs. acquisition integration. we note that the weak economy has created consolidation opportunities for the large chains. which should lead to improved investor sentiment and multiple expansion. which could provide a cushion to earnings should a weak economy persist. Finally. slowdown in front-end sales.s. CHSI SXCI OW OW Best Idea – CVS Caremark (CVS) Our best idea for 2012 is CVS Caremark.1x our 2012 EPS estimate of $3. valuation remains attractive. Owens & Minor. and retail pharmacies to continue to use strong free cash flows to repurchase shares.16.27 $39. increasing prescription utilization and consumer spending driven by a cyclical recovery could drive near-term upside. based on favorable demographic trends and the near-term generics opportunity. For the retail pharmacies. In our view. Gill AmerisourceBergen Cardinal Health CVS Caremark Corp. based on marketplace developments. Finally.com Michael Minchak. Morgan Securities LLC Lisa C. we believe the company is well positioned for share gains on the retail side and also a strong 2013 PBM selling season. In addition.50 $31. Weiss (1-212) 622-5451 gavin. The aging population should continue to help drive prescription utilization as the elderly utilize a significantly higher number of scripts per year than the overall average. we expect the PBMs. Risks: Weak core productivity. The drug distributors have highly fixed cost bases and incremental scripts are very accretive to the model. Inc. The PBMs continue to be our favorite subsector. generic launches are expected to ramp significantly in 2012.c. Inc. while top-line growth slowed with the economy. We believe healthy PBM operating income growth (driven by generic launches. retail pharmacy reimbursement pressure. Further. 119 .P. Further. based on two key drivers: generics and specialty pharmacy. with shares currently trading at 12. SXC Health Solutions ABC CAH CVS ESRX HSIC LH MCK MHS OCR OMI PDCO PSSI DGX RAD WAG N OW OW (rs) N N OW (rs) OW N N N N N N Underlying earnings visibility remains strong. and we note that generics are generally more profitable across the pharmaceutical supply channel. the number of new generic launches will ramp over 2012. While the weak economy and high unemployment rate have contributed to slower prescription growth over the past few years. CFA Catalyst Health Solutions. Omnicare Inc. as small chains and independents find it increasingly difficult to compete. Henry Schein Inc LabCorp McKesson Corporation Medco Health Solutions. CVS Caremark (CVS) – Overweight – Dec 12 Price Target: $50 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil.North America Equity Research December 2011 US Year Ahead 2012 Healthcare Technology & Distribution The Generics Wave Is Here: Expect Positive Benefit Across the Pharma Supply Channel Lisa C. much of the benefit will be felt in 2H12. Gill AC (1-212) 622-6466 lisa. which are more profitable for PBMs.16 13. Finally.813 Valuation: Target reflects 14x blended multiple on 2013E EPS. although due to the timing of launches and exclusivity periods. new business. In addition.7 12. based on a sizeable expected benefit from the generics wave. especially if there is incremental prescription growth from a gradual recovery in the labor market. and also below our longer-term EPS growth forecast. slowdown in prescription drug utilization.80 $3.30 Dec $2. competitive pressure on PBM profitability.com J.firstname.lastname@example.org@jpmorgan. a cyclical recovery could provide a potential source of upside to the companies across the pharmaceutical channel.1 $49. Inc. CFA (1-212) 622-6506 michael.com Gavin S. while a cyclical lift could drive incremental prescription usage and earnings upside.weiss@jpmorgan.) $38. Patterson Companies PSS World Medical. below the average historical forward P/E multiple. and streamlining benefits) coupled with stability in the retail pharmacy and ongoing share buybacks should lead to accelerating earnings growth in 2012. For pharmaceutical distributors. distributors. generic utilization (based on new launches expected in 2012) and private-label sales should continue to benefit margins. the longer-term trend remains favorable as well. We remain positive on the pharmaceutical supply channel in general. Quest Diagnostics Rite Aid Walgreen Company Michael Minchak. Express Scripts. The outlook for the PBMs remains strong. the specialty pharmacy opportunity remains strong. while the upcoming generics wave will also be an incremental positive. Inc.68 $2. We believe the weak economy has led to plan designs that promote utilization of mail and generics. Inc.
Inc. Varian email@example.com. including a further restructuring during the 2008/2009 financial crisis.) $36. Sigma Aldrich Sirona Dental Systems Inc SonoSite Thermo Fisher Scientific Varian Medical Waters WuXi PharmaTech ARAY AFFX A BRKR CRL CVD GPRO GHDX HOLX ICLR ILMN ISRG LIFE LMNX MTD MYGN PACB QGEN QDEL SHP SIAL SIRO SONO TMO VAR WAT WX N UW OW OW N OW N N OW N OW N OW N N N UW N N OW OW OW OW N N N OW With two of the three core growth drivers (academic. operational excellence. 14% and 15% organic growth in FY2010 and FY2011.. we are taking a more cautious stance for our 2012 outlook.67 Oct $2. While we see opportunities to selectively own names in the group based on valuation and exposure to emerging markets.donthamsetty@jpmorgan. Given management’s history of disciplined capital deployment. secular trends in electronic test and LS/CA instrumentation.8 10.44 11. Agilent (A) – Overweight – Dec 12 Price Target: $53 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil.4bn net cash.North America Equity Research December 2011 US Year Ahead 2012 Life Sciences Tools & Diagnostics Seeking Favorable Risk-Reward After the Storm Tycho Peterson AC (1-212) 622-6568 tycho. Inc. Spun out of Hewlett-Packard in 1999. Quidel ShangPharma Corp. Intuitive Surgical. We continue to selectively favor stocks that appear to be discounting severe macro scenarios in the near term.com Evan Lodes (1-212) 622-5650 evan. Risks: Macro conditions. though the vast majority trapped overseas) and robust cash flow toward favorable long-term opportunities in 2012.33 $28. although this is still above our expectations for peer growth next year. After a strong FY2011 and given the difficult and highly uncertain macro environment. credible management.95 $3.98 $55.13 $3. pharma) for life science tool companies facing a secular shift to lower growth in the next several years. We believe the company is now more profitable and less cyclical.V.com Ramesh C Donthamsetty (1-212) 622-6580 ramesh. we think the stock is fully discounting a serious downturn and believe risk/reward is favorable.840 Valuation: Target reflects DCF analysis. assuming 2% terminal growth and WACC of 13. which led to restructuring and divestitures over the subsequent decade. Best Idea – Agilent (A) We are Overweight on Agilent (A) due to the company’s above-peer organic growth (e. respectively). Pacific Biosciences Inc.g. Importantly. Agilent endured significant challenges during the 2000 tech bust. Qiagen N. operational excellence (targeting >30% incremental operating margins. favorable geographic exposure (~30% exposure to Asia/ROW (ex-Japan)).com J.P. >20% ROIC). 120 . and disciplined capital deployment. and the industrial market set for a mid-cycle slowdown (at best).5%. we expect the company to utilize its strong balance sheet (now ~$1. Morgan Securities LLC Accuray Affymetrix Agilent Technologies Bruker Corporation Charles River Laboratories Covance Gen-Probe Genomic Health Hologic ICON Plc Illumina. the life science tools industry is undergoing a secular change that could have meaningful impacts to sector multiples longer term.peterson@jpmorgan. and prudent capital deployment. the company expects a more challenging FY2012 (~6% organic growth). Life Technologies Corporation Luminex Mettler-Toledo Myriad Genetics Inc. despite company fundamentals remaining well positioned to benefit longer term from emerging market growth.8 $12. competitive dynamics.
The first-half 2012 Supreme Court review of the health reform law. Ultimately. On the latter. WellPoint Inc. Taking a look at government program books. As a result. For managed care. with not-for-profit insurers (40%+ of the market) continuing to have record surplus capital levels and.4 $51. now approaching 20% of earnings and with a target 30-40% composition.com J. Best Idea – UnitedHealth (UNH) We rate UnitedHealth (UNH) Overweight. similar to the 2010 overhang as the regulations were being written. neither of these looks particularly prone to surge in the coming year and. we look for more of the same on the operating front (earnings upside). this against the highly constrained current level. while regulatory considerations persist. As we write this. the company has a large and rapidly growing business in less regulated health-related services (non-insurance) business.10 $4.94 Dec $4. while for the stocks the first half 2012 will be somewhat crowded with regulatory events that could temper the response. while there was resurgence in cost ratios in the first half across the industry. on slack medical consumption against a stable commercial pricing environment. however. at current consumption levels. In addition. in line with group average objective. operating themes are familiar.rex@jpmorgan. we do not see a significant negative outcome for managed care. As a result. the pricing actions are far more contained than one would normally expect and we credit continued uncertainty around 2014 health reform changes as having inserted a high degree of caution among such operators. and the stocks unable to react to even quite meaningful earnings upside until that outcome was 100% assured. Health Net Inc. AET AGP CNC CI CVH HNT HUM MOH SUNH UNH WCG WLP OW N N OW N N N N N OW N OW For 2012.P.5x 2013E EPS. Sun Healthcare Group. UnitedHealth (UNH) – Overweight – Dec 12 Price Target: $60 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. On earnings. greater exposure to Medicare Advantage. the underwriting margin outlook often dominates the stocks. Coventry Health Care Inc. with a year-end 2012 price target of $60. Centene Corp. the most recent reports exhibited more stability. pricing yields in some markets have moderated. having the potential to act as a stalling factor. UnitedHealth Group WellCare Health Plans Inc. while for the past couple of years this component has been quite favorable. market-dominant positions that span both employer/commercial and higher-growth government program lines. and we believe heavily tied to the economy and consumer confidence.65 10. First half of 2012 about the Supreme Court and the deficit. UNH is the most diversified name within the benefits business having wellestablished.6 10. as a result. we expect this to be in focus for much of 2012. we see an incremental mitigating element as employers once again adapt even greater levels of high-engagement offerings. the question of competitive pricing pressures remains. 121 .North America Equity Research December 2011 US Year Ahead 2012 Managed Care Operating Themes Familiar. earnings upside for the group was significant again in 2011 and. moreover. though. mostly about medical consumption. even with the failed Super Committee efforts. could appear somewhat binary.) $48. in the context of these high surplus levels.56 $4. while such considerations seem to at least insert some overhang across healthcare stocks broadly. potential for medical utilization to reaccelerate ahead of pricing yields. Inc.50 $34.478 Valuation: Target reflects 11.29 $53. So while the commercial pricing environment is a bit softer. these featuring increased out-of-pocket exposure for employees. However. Risks: Implementation of regulations that will govern health reform law. Regulatory Backdrop Likely Gets Some Focus John Rex AC (1-212) 622 6600 john. it’s still holding up comparably well and the focus for the 2012 margin outlook should really be mostly about medical consumption. Molina Healthcare Inc. we would expect favorable spread and resulting earnings upside again for 2012. Morgan Securities LLC Aetna Inc. To be sure. Humana Inc. a factor we expect to persist as a braking factor. AmeriGroup Corp. Cigna Corp.
one of the best pipelines in large-cap MedTech. 2012 is likely to bring incremental pricing pressure and make Europe the incremental risk to the industry’s 2012 outlook.1% FCF yield. The Cooper Companies. returning that cash to shareholders. Europe has been weak. causing nearterm share loss. Jude’s ICD leads are undergoing increasing scrutiny. or there will need to be an increased level of interest from strategic or financial sponsors.pasquale@jpmorgan. In 2012. St.27 $3. Jude is looking more and more like a 2013 growth acceleration story. Downside demand risk from new austerity measures and a weaker Euro are both worth watching. Inc.18 $33.and bottom-line growth prospects. 122 . Risks: Further weakening in the U. Near-term risks remain: 1) the ICD market has yet to bottom.to mid-singledigit industry revenue growth and mid. resulting in low. in many cases.com MedTech stocks struggled in 2011. and 3) the St. including deep brain stimulation for Parkinsons and occipital nerve stimulation for chronic migraines.North America Equity Research December 2011 US Year Ahead 2012 Medical Supplies & Devices Outlook for 2012 Michael Weinstein AC (1-212) 622-6635 mike. Dickinson & Co BioMimetic Therapeutics Boston Scientific Corporation C. Because of the ongoing contraction of the ICD market and the timing of key approvals. Wright Medical Group Christopher Pasquale Hansen Medical Integra LifeSciences NuVasive. A combination of structural and cyclical pressures has resulted in weakening end markets and a slowing of industry growth rates. of course. with two-thirds of S&P healthcare stocks trading at less than 12x anticipated 2012 earnings. with the stock trading at 10x 2012 estimates. Inc.S. Jude’s entry into two major new markets: transcatheter aortic valve replacement and renal denervation for drugresistant hypertension. Inc. Valuation: Target reflects 13x 2013E EPS. by our estimation.w. but relatively stable. 2011. Morgan Securities LLC Michael Weinstein Abbott Laboratories Baxter Intl Becton. St. particularly on the heels of the unfavorable CardioMEMS panel.P. Jude struggled in 2011 from a >10% contraction in the U. Jude Medical (STJ) – Overweight – Dec 12 Price Target: $48* Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. with the potential to pressure 2012 earnings across the space.to high-single-digit EPS growth. inexpensive. as visibility on new products increases.95 $54. Yet. Jude story is dependent upon EU and FDA approvals. demand. Jude is also at the front of entering or developing several other markets.5x 2012E EPS and a 10. ICD market.45 11. Yet. either fundamentals will need to improve. increased pricing and reimbursement pressures in the U.S. In our view. Jude still has. ICD market. Yet.S.w. which as we approach 2012 is still playing out. Jude Medical (STJ). Thoratec Corp.com J. Over the next 12 months new product approvals should pave St. CareFusion Covidien Edwards Lifesciences Heartware International Johnson & Johnson Medtronic St Jude Medical Stryker Corp Tornier Zimmer Holdings Kimberly Gailun Insulet Corp Mako Surgical NxStage Medical. the potential for a 2013 acceleration is far from reflected in the name.787 * Target and estimates as of December 9.com Christopher Pasquale (1-212) 622-6590 christopher. St. Bard Inc. To date. MedTech stocks are. valuation and capital allocation alone aren’t likely to be enough to improve sector performance. St. Jude Medical (STJ) Our top pick as we enter 2012 is St.firstname.lastname@example.org@jpmorgan. and Europe.R. is likely to get increasing Street attention over the course of 2012.54 Dec $3. the companies are generating ample cash and.7 $11. we expect these pressures to continue. which.S. Kimberly Gailun (1-617) 310-0740 kimberly. pipeline delays for Portico or renal denervation program. St.t.com Ross Comeaux (1-212) 622-1895 ross. making the 12-month risk/reward in our view meaningfully skewed to the upside. Moreover. This led to a series of downward revisions to Street estimates. Absent a pickup in U. trading at 10. 2) St.) PODD MAKO NXTM COO WMGI OW N OW N N HNSN IART NUVA THOR VOLC N N N N OW $36. a premium to the large-cap MedTech average due to STJ’s superior top. Volcano Corporation ABT BAX BDX BMTI BSX BCR CFN COV EW HTWR JNJ MDT STJ SYK TRNX ZMH N OW N N N N OW OW UW OW N N OW OW N N Best Idea – St.3 10.02 $3.gailun@jpmorgan.
potential for pipeline setbacks to put pressure on margins. Singulair) as well as increased visibility on post– patent cliff earnings growth based on continued pipeline newsflow/business development activity.com J. share repurchase.507 Valuation: Target reflects DCF assuming 0% sector terminal growth and WACC of 9%.d.com Jessica Fye (1-212) 622-4165 jessica.North America Equity Research December 2011 US Year Ahead 2012 Pharmaceuticals – Major Increasing Clarity on Trough Earnings Positive for Pharma in 2012 Chris Schott. and 4) limited earnings risk.. by our estimates.59 Dec $2.8x ’12E EPS). major pipeline data releases or new product launches across the group should increase the Street’s confidence in the longer-term earnings power for the sector. Strong new launch cycle ahead. we anticipate approval of Prevnar 13 in adults (January 2012) will represent an incremental positive catalyst for the shares. Best Idea – Pfizer (PFE) Pfizer (PFE) offers an attractive mix of 1) inexpensive valuation (8. Pfizer (PFE) – Overweight – Dec 12 Price Target: $25 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. CFA (1-212) 622-5350 dewey.m.) $20. 123 .9 8. in our view. Along these lines.23 $21.28 $2. Lipitor.7 $155. With valuation (particularly for Pfizer and Merck) continuing to reflect ongoing earnings erosion for the sector. we see capital deployment as an underappreciated catalyst with a notable increasing focus on returning cash to shareholders following a period of M&A digestion. we now expect the sector to maintain operating margins through its patent cycle.23 $2.com Dewey Steadman.t. 2) an approaching near-term new product cycle.P. challenges PFE’s size presents to longer-term growth/management. we continue to see an attractive entry point in PFE shares and reiterate our Overweight rating. Beyond pipeline catalysts.32 8. we see the company’s business unit divestitures as unlocking significant value and believe a December 2011 dividend increase represents another potential catalyst on the horizon. Pfizer Inc. Risks: Failure to effectively integrate the Wyeth acquisition. This core portfolio of pipeline assets will enable Pfizer to return to modest top-line growth beyond the company’s 2012 patent expiration cycle. Inc. we see an opportunity for multiple expansion across the sector. dividend increases) as more attractive than the scenario that we (and the Street) currently have modeled—namely significant growth of cash on the balance sheet. Beyond these assets. Following several rounds of cost-cutting. BMY LLY MRK PFE N UW OW OW We see the major pharma group as well positioned in 2012 based on what we expect will be increasing clarity on trough EPS as we move through a wave of significant patent expirations (Zyprexa. We continue to see nearly all capital redeployment options (business development. We believe the positive results from the ARISTOTLE study for Eliquis (atrial fibrillation) coupled with the recent approval of Xalkori (ALK-positive lung cancer) and positive Phase III data for tofacitinib (RA) at ACR represent the start of a significant new product cycle for Pfizer including four $1bn-plus product opportunities. 3) a high FCF/dividend email@example.com@jpmorgan. CFA AC (1-212) 622-5676 christopher. Morgan Securities LLC Bristol-Myers Squibb Company Eli Lilly & Company Merck & Co. Finally. In firstname.lastname@example.org $16.
Mylan (MYL) – Overweight – Dec 12 Price Target: $28 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. expectations have generally moderated and we believe the impact from a downside scenario in Europe would have only a muted impact on Mylan’s bottom line. Impax Laboratories Medicis Pharmaceutical Corp. greater-than-expected European price erosion.46 10. While we anticipate strong results across the generic group. Mylan Inc. 124 .North America Equity Research December 2011 US Year Ahead 2012 Pharmaceuticals – Specialty Generics Offering an Increasingly Favorable Risk/Reward Chris Schott.com Jessica Fye (1-212) 622-4165 jessica. and Hospira (HSP). which is poised for an extremely strong new product cycle next year.46 $15. Perrigo Company Sagent Pharmaceuticals Teva Pharmaceuticals Valeant Pharmaceuticals Warner Chilcott Watson Pharmaceuticals Jessica Fye MAP Pharmaceuticals AGN ENDP FRX HSP IPXL MRX MYL PRGO SGNT TEVA VRX WCRX WPI N OW OW OW N OW OW N N OW OW OW OW Generics: Heading into a record year of new product launches and with valuations near an all-time low. aclidinium) represent potential catalysts within the sector.) MAPP OW $19. as was seen in 2011. new product launches from Endo (Opana TR) and Forest (linaclotide. With a highly diversified business that we believe is capable of delivering mid-teens EPS growth over the next several email@example.com J. In addition.81 $25.99 $2. for which we see broadly improving news flow throughout the year.0 8. Morgan Securities LLC Allergan Endo Pharmaceuticals Forest Laboratories. we see a number of opportunities in the generics group in 2012.P. as well as Valeant (VRX). Best Idea – Mylan (MYL) We see a very strong 2012 ahead for Mylan (MYL) driven primarily by the company’s core U. In addition. we see Europe as less of an overhang on the sector as expectations have reset and volume growth is expected to accelerate as major products such as Lipitor. generic competition for Epipen.S. While we acknowledge that Mylan’s European business has been an ongoing overhang for the stock.49 Dec $1. Teva (TEVA).schott@jpmorgan. growth for the group in 2012 driven by a combination of significant new product introductions and ongoing favorable pricing. reflecting ongoing core business strength and solid execution on cost-synergy objectives from the Merck KgaA/Matrix integration.5x 2012E EPS. Specialty Pharmaceuticals: Merger activity represented a significant catalyst for the group over the past two years and we anticipate the same to be true in 2012 as the sector continues to consolidate in-market assets. CFA (1-212) 622-5350 dewey. our Overweight-rated names in the sector include Mylan (MYL).S. Medicis (MRX). CFA AC (1-212) 622-5676 christopher. Zyprexa.449 Valuation: Target reflects 11. we remain Overweight MYL shares heading into firstname.lastname@example.org 2012E EPS.1 $8. Risks: Greater-than-expected generic competition for Mylan’s core base products. Inc Hospira. and Diovan lose patent protection. Watson (WPI). We are anticipating accelerating U. business.com Dewey Steadman.m.t. We expect names such as Valeant (VRX) and Warner Chilcott (WCRX) to remain active on this front while merger integration will be a focus for Endo (ENDP).d.62 $1. Inc. closer to our target sector multiple of roughly 12.
10 Dec $3. and IFF Overweight. to 94 million versus 91.S.B.) ROC OW $47.7-20. inventory destocking.richardson@jpmorgan. The company trades at an 11.yan@jpmorgan. 125 . Ferro Corp Georgia Gulf H. AGU APD ALB AMRS ASH AVY CBT CF CMP DOW DD EMN ECL FOE GGC FUL HUN IFF LYB MTX MON NZYMb. This regional raw material advantage may become more apparent later in 2012 and beyond. LYB.4x.x. Risks: Cyclical company. Current drivers of domestic agriculture are low stocks-to-use ratios. DuPont currently trades at 7.4%.com 2012 Outlook: The agricultural markets are likely to be strong in the year-ahead period. Commodity & Agricultural Materials Gathering Strength Jeffrey J. We do not expect a robust earnings year for these companies generally in 2012 given contracting European export markets.2x 2012E EBITDA. We believe a $130mn cost saving target (2013) from the acquisition of Danisco could prove conservative.291 Valuation: Target relects email@example.com 11.9 million in 2011. Morgan Securities LLC Jeffrey J. We expect a healthy and improving multi-year earnings profile for Dow Chemical.2-10.7 $45. Inc. should perform well in an economic environment of little growth. We believe that 2012 is likely to be a year of rebuilding profitability for North American chemical producers (commodity and specialty). The dividend yield is 3. Ashland Inc.zekauskas@jpmorgan. consistent with Specialty Chemicals peers. APD. and is purchasing regional seed companies.com J.7x P/E multiple for 2012E compared to the peer group at 11. and excellent farmer profitability. India. lower export demand. We expect commodity chemical margins to recover gradually in 2012 as supply and demand rebalance.guteneva@jpmorgan.P. which account for about 70% of consolidated operating income. OW OW OW N OW N (rs) N N OW OW N OW N OW N N OW OW OW OW N N N OW N N N N OW N N OW Olga Guteneva (1-212) 622-6488 olga.94 $57. Silke Kueck Rockwood Holdings. and falling product prices.9x EBITDA for 2012E. Fuller Huntsman Corporation International Flavors & Fragrances LyondellBasell Industries Minerals Technologies Monsanto Novozymes Pall Corporation Polypore International Potash Corp. Praxair RPM International Inc. and WLK Overweight. customer inventory rebalancing. Inc. Inc.com Silke Kueck (1-212) 622-6503 silke.30 $4.00 $37. ECL.v. DuPont forecasts seed prices to grow ~5% in 2012 with additional benefits from a better product mix. ethanol consumption absorbs 40% of the domestic corn market. implying 14x EPS. a slower rate of domestic volume growth.North America Equity Research December 2011 US Year Ahead 2012 Chemicals – Specialty. pension expense. which compares to its Specialty Chemical peer range of 7.10 12. DuPont (DD) – Overweight – Dec 12 Price Target: $57 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. and a slower rate of emerging market demand expansion. and Brazil and is executing well. and Westlake Chemical given the advantaged feedstock position of North American producers. Zekauskas Agrium Air Products and Chemicals Albemarle Corporation Amyris. DuPont’s construction and auto-related operations in 2012 should compare well versus 2011 performance. which has an enhanced technology and operational focus. Volume growth for agricultural seeds in 2012 is supported by a likely corn planting acre increase in the U.com Youyou Yan (1-212) 622-4951 youyou.00 $4.5x EV/EBITDA on 2012E. Broader commodity chemicals demand is currently weak due to seasonal factors. Commodity chemical margins sharply weakened late in 2011 from peak-like levels in 2Q and 3Q. We believe that year-ahead agricultural fundamentals are likely to be more resilient when encountering economic volatility due to the long-cycled nature of agricultural balances. Zekauskas AC (1-212) 622-6644 jeffrey. Moreover. DD has increased its exposure to growth markets in China. Avery Dennison Cabot Corporation CF Industries Holdings. LyondellBasell. as advantages accrue from the development of North American shale gas. Scotts Miracle-Gro Co. DuPont has made a successful transition to a new CEO and her team. DuPont is reinvesting with free cash from TiO2 and Agriculture. DuPont should generate 7-8% of its share price in free cash flow in 2011 and about 6-7% in 2012.CO PLL PPO POT PX RPM SMG SHW MOS VAL WDFC WLK Specialty chemical volume growth has stepped down with the economy since the end of August. We rate ASH. Inc. Dow Chemical DuPont Eastman Chemical Company Ecolab Inc. Compass Minerals International.com Ben Richardson (1-212) 622-6455 ben. We rate DOW. Best Idea – DuPont (DD) DuPont’s large Agricultural and Performance Chemical (TiO2 and Refrigerants) segments. Sherwin-Williams The Mosaic Company Valspar Corp WD-40 Company Westlake Chemical Corp. high crop prices.
It has been doing deals to monetize these assets. We believe the market has still not been able to value the coal/gas hybrid correctly and the company is trading at a discount to its actual value. With its low-cost coal operations. Reduced crossover coal demand will affect CAPP producers’ margins significantly and.1 10. in our view.S. but the demand from China and India remains a wildcard.bridges@jpmorgan. Best Idea – CONSOL Energy (CNX) We believe CONSOL Energy (CNX) is a special situation within the coal sector with some of the best remaining coal assets in Appalachia and a rapidly growing gas business. and other shales. Inc. high medical inflation or lower forecast rate of return on pension plan assets. The thermal coal prices have also come under pressure.32 $30.08 14. On a positive note. 126 . we feel the better-quality names will gain market share.P. We could see some pressure on coal prices in the near term unless Australian floods again interrupt supplies.90 $4. the company is better placed than other miners in the region to take market share in a weaker market.) $40. The accelerated development of the gas properties helped by its JV partners is de-risking these properties. coal sector has been lifted by the international coking coal markets. CNX has completed joint ventures with Noble Energy to develop its Marcellus acreage and with Hess Corporation to develop its Utica acreage. With international coal prices trading below Chinese domestic coal prices.North America Equity Research December 2011 US Year Ahead 2012 Coal Sector to Remain Choppy .bindal@jpmorgan. this could create a difficult situation for some of the miners. J. continued oversupply of natural gas. Our economists highlight two major risks: 1) spillovers from the economic and financial crisis in Europe and 2) tightening of domestic fiscal policy. We Like the Quality Names John Bridges CFA.P.0 $9. ACSM AC (1-212) 622-6430 john. we believe there could be some lift in China’s imports once colder weather increases demand. CONSOL Energy Peabody Energy ARLP ANR ACI CNX BTU OW N OW OW The U. The company also has large gas reserves in the Marcellus.S.56 Dec $1.com Sadhak Bindal (1-212) 622-2684 sadhak. Consol Energy (CNX) – Overweight – Dec 12 Price Target: $79 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. However. with the region already facing regulatory pressures and high inflation.x. Utica. We believe under the prolonged negative sentiment scenario the coal sector could remain under pressure for longer. Morgan’s commodity group recognizes the pullback in steel prices as a worry and something that must be watched.com J.80 $56. . recovery. . Morgan Securities LLC Alliance Resource Partners Alpha Natural Resources Arch Coal.254 Valuation: Target reflects sum-of-the-parts analysis using DCF values for coal and gas assets. coking coal hasn’t fallen as much as the scrap steel and iron ore prices.98 $2. Risks: Delay in expected global and U.
729/oz).) $52. sharp fall in silver and base metals prices that affects economics of Penasquito.com J.0 18.1 0 Jan-00 Source: Bloomberg.x. it touched the $1. could be all that is required for QE3. While the absolute value of gold could be depressed by money flows into the U.2 0.17 $2. (GG) Goldcorp (GG) offers our favorite mix of solid production growth and lower-thanaverage geopolitical risk.04 Dec $1. significant capital or cost overruns at joint development project (Pueblo Viejo). 127 . Risks: Further difficulties with high-pressure rolls at Penasquito.31 $39. Best Idea – Goldcorp Inc. Goldcorp Inc.75 24.355 Valuation: Target reflects Black-Scholes call option value based on aplying a probability-weighted average gold price of $1. Penasquito. We believe the precious metal will remain attractive relative to most other assets in the current uncertain environment and expect the metal to outperform other industrial metals and its “basier” sister metal.11 $56. The company has apparently resolved the issues at its flagship mine. silver. and expects to ramp up to nameplate throughput in early 2012. (GG) – Overweight – Dec 12 Price Target: $63 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. Figure 98: HUI/SPX – A Decade of Outperformance 0. We believe the company is well positioned to grow ounces per share and we continue to see value in the stock.P.6 0.900/oz level during September.300/oz to the gold forward curve and our estimates of gold sales over the life of the known assets and the forecast cost structure.9 $42. dollar. and Éléonore projects.” If there is a QE3.4 0.bridges@jpmorgan.North America Equity Research December 2011 US Year Ahead 2012 Gold & Precious Metals We Continue to Recommend “Golden Insurance” John Bridges CFA.com Sadhak Bindal (1-212) 622-2684 firstname.lastname@example.org 0. ACSM AC (1-212) 622-6430 john. Pueblo Viejo.5 0. GG is forecasting 60% growth in its production profile by 2015. Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 European problems could also prompt more stimulus. gold prices and gold equities could benefit from the new money supply as the risk of inflation increases. Morgan Securities LLC Agnico-Eagle Mines Barrick Gold Coeur d'Alene Compania de Minas Buenaventura Gold Reserve Hecla Mining Jaguar Mining Kinross Gold Newmont Mining NovaGold Resources Pan American Silver Silver Wheaton Stillwater Mining AEM ABX CDE BVN GRZ HL JAG KGC NEM NG PAAS SLW SWC N OW N N N N N OW OW (rs) UW OW N The gold price is up roughly 30% since the start of 2011 (currently $1.S. The company has one of the best growth profiles with new ounces coming from the Cerro Negro. we see no change in the positive trend shown by the gold equities’ outperformance of the S&P 500 in the relative chart shown below. or an unwelcome fall in inflation expectations. Our economists say “a significant setback in Europe.36 $2.
FCX’s dividend yield would increase to 4.5%.0 $38.S.01 $5. However. if we were to include the supplemental dividend of $0. increased copper supply.6bn. dollar.TO OW $40. forward multiple. On the steel side. and a slowdown in Chinese growth. we would expect integrated producers (such as X.7bn by the end of 2012 if current metal prices hold flat for the remainder of this year and next.S. 2010 and June 1. We also don’t believe FCX’s current stock price is fully reflecting the company’s strong balance sheet.85 Dec $4.com Brian P. In contrast to what equities are discounting. the company’s net cash position stood at $1. the LME copper price is down 19% to $3. If the growth follows J. inability of company to cut costs quickly enough to preserve cash.langton@jpmorgan.S.50/share that FCX paid on both December 30. further deterioration in global economy.5x EV/EBITDA using 2012E. respectively) would have the stock trading at its historical forward EV/EBITDA multiple of 5. In addition.. we would expect our stocks to rally strongly on the stronger-than-expected demand.40/lb. that FCX’s stock price is pricing in too negative an outlook for copper prices and not fully valuing the financial strength and flexibility of the company. MT.TO TC X WOR OW OW OW OW (rs) N OW N N OW OW OW OW OW N OW OW OW OW N OW N Best Idea – Freeport-McMoRan (FCX) Since July 15th.54. in line with FCX’s long-term avg. Finally.9%. a stall/mild recession in the U. and share repurchases).North America Equity Research December 2011 US Year Ahead 2012 Metals & Mining Stocks Discounting Significant Further Deterioration in Macro Fundamentals Michael F. AKS AA ATI MT CRS CENX CLF CMC BOOM FCX GSM GTI HAYN MUSA MCP NUE RS STLD TCKb.54/lb.428 Valuation: Target reflects 5. by our estimates. which (excluding the potential impact of the strike in Indonesia) we estimate would grow to roughly $2. Reliance Steel & Aluminum Steel Dynamics. miners with low (and more fixed) costs such as FCX in copper should do better than aluminum producers as their cost profiles also adjust to a greater extent with underlying commodity prices.com J. companies with high levels of fixed costs should outperform those with more variable cost structures.10/lb.728/oz and $13. FCX’s stock now appears to be pricing in a copper price for 2012 of $3. Morgan’s forecasts rather than the signals from equities. Teck Resources Thompson Creek Metals U.p.com Tyler J.email@example.com. As of 3Q11. CFA (1-212) 622-1023 brian.S. FCX has a dividend yield of 2.25/share.08 8. 2011 as regular payments going forward. More specifically. Langton (1-212) 622-5234 tyler. and easing inflation in China should allow for a more accommodative monetary policy. rise in U.1 8. Risks: Pullback in copper purchases by China. With its regular quarterly dividend of $0.5x and a FCF yield of 8%.S. while FCX is down 27% to $40.) IMN. Europe should start to grow again by mid-2012. Morgan Securities LLC Michael F. most stocks in our coverage universe appear to be pricing in a recession for Europe.j. GDP growth is expected to remain positive.P.P. Freeport-McMoRan (FCX) – Overweight – Dec 12 Price Target: $61 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. especially as the lessening in uncertainty would likely cause purchasers to move away from their current cautious buying patterns.54 $60. Gambardella AC (1-212) 622-6446 michael. 128 . Steel Corp Worthington Industries Tyler J. Inc. U.75 $28.gambardella@jpmorgan. we would not be surprised to see the company take additional actions if the stock remains near these levels. our economists and strategists are looking for a more positive scenario for 2012. Gambardella AK Steel Alcoa Allegheny Technologies Arcelor Mittal Carpenter Technology Century Aluminum Company Cliffs Natural Resources Commercial Metals Dynamic Materials Freeport-McMoRan Copper & Gold Globe Specialty Metals GrafTech International Haynes International Metals USA Molycorp Nucor Corp. as this number (assuming current gold and moly prices of $1. growth.65 $5. and AKS) to outperform the more variable-cost minimills and distributors. special dividends. For the metal producers. We believe. with the metal/mining stocks more levered to China/global growth and the steel stocks to U. given the company’s track record of shareholder-friendly actions (dividend increases. Langton Inmet Mining In general. however. Ossenbeck. assuming current metal prices for all of 2012 would have FCX trading at a 2012E EV/EBITDA multiple of 4.
80 $3. overcapacity resulting from weaker CSD trends and the end of can exports from North America to Brazil leading to pricing compression. While CCK is a consensus long (91% buys).P. we would recommend investing in these higher-quality stocks that are likely to show lower earnings volatility.1x multiple on 2013E EBITDA.8x 2012E EBITDA. a discount to its recent average of closer to 7. with some declines in pulp and paper). Morgan Securities LLC Ball Boise Crown Holdings Domtar Graphic Packaging Greif International Paper Co. particularly since it has some exposure to faster-growing emerging markets with opportunities to improve penetration rates in beverage cans that could lead to end-market outperformance.gresh@jpmorgan. On the paper side.com Ariel Avila (1-212) 622-8021 ariel. Best Idea – Crown Holdings (CCK) Crown Holdings (CCK) is our top pick in the paper & packaging sector. Crown Holdings (CCK) – Overweight – Dec 12 Price Target: $44 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. From a valuation perspective. CFA AC (1-212) 622-4861 phil.10 11. CCK shares currently trade at 6. our overall view on the paper and packaging space is fairly cautious.x. on the other hand. even in containerboard.24 $2.7 $5. pricing risks in Western Europe. Therefore. group 20% upside) represents a ~7. MeadWestvaco O-I Packaging Corp of America Rock-Tenn Silgan Holdings Sonoco Temple-Inland BLL BZ CCK UFS GPK GEF IP MWV OI PKG RKT SLGN SON TIN N N OW N N N N OW N OW OW N N N In a macro environment in which our economists are forecasting <2% GDP growth in 2012.com J. given that we see synergy upside over the next several quarters from its acquisition of SSCC. therefore we do not expect much in the way of pricing in 2012 (we currently assume flat pricing for containerboard. it is hard to ignore the combination of its potential mid. Packaging. or an 8% premium to the group’s 6. shift from can to glass packaging in North America and Brazil as brewers focus on price over volume. particularly if global economy slows. Gresh. in particular CCK.6x target multiple (discount to more recent group average multiple of 7x). tends to hold up better in a slow-growth environment.North America Equity Research December 2011 US Year Ahead 2012 Paper & Packaging Stick with Relative Security at a Discount in a Volatile Market: CCK Top Pick Phil M. Our December 2012 price target of $44 (33% upside.) $33. As a reminder. if one wanted to invest here around the theme of potential consolidation in containerboard. While some of this reflects the overall discount in the market today.m.8 10. By 2013. all of which should drive higher long-term earnings power and FCF generation once volumes are fully ramped.68 Dec $2.to high-single-digit organic growth through 2013 and shareholderfriendly capital allocation. along with its dominant share in the Middle East and SE Asia. CCK should be on track to gain 5-10 points of market share in key emerging markets such as Brazil and China.010 Risks: Overexpansion into emerging markets could lead to overcapacity. 129 . we think CCK shares look fairly inexpensive on a relative basis to the packaging group overall as well.5x forward EBITDA.14 $41. the paper sector tends to exhibit “GDP minus” firstname.lastname@example.org $28. a function of increased competition due to Can-Pack’s entry into the United Kingdom. we would recommend RKT.
North America Equity Research December 2011 US Year Ahead 2012 130 .
secular trends remain challenging and we expect modest advertising growth industrywide. P&C customers (~58% of revenues).com David Lewis. healthcare (~15% of revenues). CFA Arbitron Belo Corp. A few educational/book publishers (e. We remain positive on the credit bureaus (Experian. and prevent and detect fraud. We’re keeping a close eye on Washington newsflow regarding spectrum incentive auctions.7x net debt/EBITDA). We find valuation attractive (17. and also like a handful of esoteric research/database/analytics providers (Verisk. Meltz. depending on the duration. nice operating leverage. insurance companies could trim business relationships with VRSK. McGraw-Hill.4 20. retransmission consent. The company’s ISO brand dominates in its email@example.com $30. the S&P 500’s -5%) and we see more room for upside in 2012. For Magazines. a modest improvement in housing investment could imply estimate upside for many of these stocks (VRSK. We expect most operators to benefit from a rebound in auto advertising and strong political spending.L IHS MDP MCO NLSN SBGI MHP TRI VRSK OW N OW N OW OW N N OW OW N OW N OW Information Services stocks should outperform in a sluggish economic recovery given rising secular demand.273 Valuation: Target reflects 19-20x 2013E adj.8x 2013E EPS and 10.P.06 $39. Gartner).V. Verisk Analytics (VRSK) – Overweight – Dec 12 Price Target: $42 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. XO Group Inc ARB BLC CBS DNB EFX EXPN. we expect industry ad revenues to jump >10% due to Olympics and heavy political spending—with a boost from the Presidential Election and the Supreme Court Citizen’s United campaign finance ruling.com Nadia Lovell (1-212) 622-4885 nadia. For TV.) CCO LAMR XOXO N N N $38. In a financial spillover. On the positive side. predict losses. Sinclair Broadcast Group The McGraw-Hill Companies Thomson Reuters Verisk Analytics David Lewis. acquisitions remain major part of growth strategy.76 Dec $1.s.70 $1. supply chain.lovell@jpmorgan. Auto & Political Ads Could Lift TV Names Michael A. and the FCC 2010 quadrennial review of media ownership laws. EPS. EFX)—with improving revenue growth bolstered by highly fixed cost bases. Nielsen Holdings N. The group has limited exposure to the anticipated fiscal drag on households in 2012. with “need-to-have” databases. and healthcare industries. 131 . VRSK has performed well year to date (+9% v. We assume 2-3% growth in underlying core TV advertising.com J. FDS IT JWa SLH N OW OW OW Best Idea – Verisk Analytics (VRSK) Verisk is a leading provider of risk management solutions and analytics to the insurance. Its databases and tools are used by customers to measure risk.90 22.0 $6. The company drives strong cash flow and maintains a healthy balance sheet (1.North America Equity Research December 2011 US Year Ahead 2012 Information Services/TV & Radio Broadcasting Media & Telecom Remain Positive on Info Services Names in 2012. software. Morgan Securities LLC Michael A. is steadily recovering. These companies provide “need-to-have” information for professionals. Risks: Subscription-oriented revenue mix is late cycle and weighted to P&C insurance sector.. the rating agencies would likely see the most estimate downside. Meltz. High diesel gas prices and European unemployment could limit Solera’s near-term upside. and market expansion opportunities. and tools for P&C insurers. Analytics (59% of revenues) lifted 12% in Q3. A clearinghouse model results in high barriers to entry and above-average pricing power.9x 2013E EBITDA). Verisk’s key vertical. CBS Corporation D&B Equifax Experian plc IHS Inc. CPA FactSet Research Systems Gartner Inc. thus typically enjoy good pricing flexibility and high renewal rates. John Wiley) are exposed to state budget pressures—although both operators are diversified and benefiting from share gains.40 $1. Comparison for TV & Radio Broadcasters and Magazines will ease in 2012.lewis@jpmorgan. John Wiley & Sons Solera Holdings Nadia Lovell Clear Channel Outdoor Lamar Advertising Co. Verisk generates nearly 70% of revenues from a subscription model—this could limit downside if market volatility persists. mortgage. and supply chain.m. Verisk is rapidly expanding its addressable market into data solutions and analytics for emerging verticals including mortgage (~17% of revenues). Meredith Corporation Moody's Corp. CPA (1-212) 622-6435 david. Subscription nature of business implies relatively less inherent leverage to an economic slowdown.g. Diversifying with acquisitions of faster-growing Decision Analytics properties. Equifax). CFA AC (1-212) 622-0416 michael.
advertising.02 Dec $29. applications.com J. Google. strong network effects. and strong mobile revenue numbers highlight the importance of Android and support the rationale for the MMI deal.65 $42.com Bo Nam (1-212) 622-5032 bo. The Internet economy will also likely be bolstered by monetization of online video content. large and developing ecosystems.com Bankrate Inc eBay. We believe smartphone and tablet adoption has played a critical role in accelerating key industry trends including social.com QuinStreet. Google (GOOG) – Overweight – Dec 12 Price Target: $705 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (firstname.lastname@example.org PEG on 2010-13E EPS CAGR of 19%. and cloud-based services. Morgan Securities LLC Amazon.96 $473.) $623. increased regulatory scrutiny.P.S. Apple. and revenue-generating. increased online accessibility via mobile devices and tablets. we expect these platforms to continue to grow stronger as the rest of the Internet increasingly relies on them.). virtual goods. CFA (1-212) 622-6436 kaizad.North America Equity Research December 2011 US Year Ahead 2012 Internet Positive Outlook Given Strong Secular Growth and Emerging Trends Doug Anmuth AC (1-212) 622-6571 douglas.com Our positive view on the U. As smartphone penetration moves beyond the current ~30% global penetration rate and tablets approach mainstream adoption. continued competition for engineering talent. we believe the Internet economy is quite healthy and supported by the shift to online channels in both advertising and eCommerce.20 17. we believe these segments should continue to have many years of double-digit growth ahead on a global basis. Inc Google HomeAway Inc LinkedIn Corp Netflix Inc Pandora Media Inc Priceline.com Kaizad Gotla. Looking ahead. local.8 $202. toll-booth capabilities. and commerce are likely to be conducted. We believe core search growth remains healthy—in the high teens in 2012—while Google’s mobile and display businesses are taking significant share in higher-growth segments. Mobile devices leading confluence of key email@example.com Valuation: Target reflects 14x 2013E PF EPS. OW N N OW OW OW N OW OW N OW N Shelby Taffer (1-212) 622-6518 shelby.nam@jpmorgan. and video.x. We continue to believe Google shares represent strong large-cap growth at a compelling valuation. We believe Amazon. However. Notable characteristics of these major platforms include global reach. While most Internet names in our coverage universe have high levels of exposure to discretionary consumer spending and are subject to the broader macro pullback. and mobile search. Internet sector into 2012 is driven by strong secular growth. “appification” of mobile Internet.77 $642.S.61 $36.gotla@jpmorgan. and strengthening of key trends including social. we think the spending is appropriate given new management’s focus on product and innovation. ReachLocal Yahoo Inc AMZN RATE EBAY GOOG AWAY LNKD NFLX P PCLN QNST RLOC YHOO Platform/ecosystem competition to intensify. Margin concerns and the MMI acquisition have been recent overhangs on the stock. 132 . we expect mobile devices to have an even bigger impact on Internet business models and eCommerce trends.0 14. or 0. Inc. Best Idea – Google (GOOG) Google is our top pick on the strength of its core business fundamentals. Risks: Potential for continued heavy investment spending. Strong secular growth to continue. and Facebook are emerging as primary platforms on which increasing amounts of online/mobile communications. With online advertising at ~18% of total ad spending and eCommerce at ~9% of total retail (in the U. increasing competition from Facebook as source of traffic across Internet. local.
Risks: Weaker-than-expected advertising revenue. and improved ratings as catalysts to shares ahead. we favor those stocks in our universe with greater national ad exposure and particularly like cable assets given their growing share of ad spend and additional revenue stream of steady affiliate fees.com Townsend Buckles.North America Equity Research December 2011 US Year Ahead 2012 Media Economic Uncertainty Continues. industry trends remain healthy heading into 2012 and while scatter has softened a bit recently. down slightly from 5% growth anticipated in 2011. Inc Interpublic Group of Companies National CineMedia. core national advertising levels appear to be much healthier.5bn in shares during F2012 (we estimate $2. concentration of ownership.4 $24.3%. Management has guided to high-single.8 8. CFA.buckles@jpmorgan. and substantial share buyback.13 Sep $3.dicenso@jpmorgan. Viacom plans to buy back at least $2.quadrani@jpmorgan. change in cable provider structure to tiering or a la carte. so a modest deceleration in growth is expected heading into 2012. Inc. Scripps Company The McClatchy Company Time Warner Valassis Communications Viacom WPP Group CNK DISCA DIS GCI HHS IPG NCMI NYT OMC RGC SNI SSP MNI TWX VCI VIAb WPP. But Advertising Holding In and Valuations Appear Attractive Alexia Quadrani AC (1-212) 622-1896 alexia. Viacom’s leading cable assets—including Nickelodeon and MTV—represent more than 90% of the company’s earnings vs.81 $52.013 Valuation: Target reflects VIAb’s three-year historical forward P/E of 11x applied to forward EPS.com Monica DiCenso. On the advertising side. 133 . more than $1bn of cash. its Filmed Entertainment division.35 $5.anastasi@jpmorgan. representing over 10% of shares outstanding—the highest among its peers. SNI.com J. Morgan Securities LLC Cinemark Discovery Communications Disney Gannett Company Harte-Hanks.W. Viacom’s network ratings have been weak which may put a lid on near-term ad growth but we believe this fact is well digested and anticipated. In a healthy but sensitive macro environment. Recent comments from top executives at some of the largest ad agencies indicate that budgets for 2012 look relatively healthy so far and advertisers are not meaningfully changing spending patterns heading into next year. and a planned increase in leverage through debt issuance. studio business tends to be volatile.to double-digit affiliate fee growth driven in part by meaningful digital content deals.L OW N OW N N OW N N OW OW N OW N OW OW OW N Economic concerns continue to weigh on the Media sector as investors remain skittish and look for any signs of an advertising slowdown. CPA (1-212) 622-0461 townsend. CPA (1-212) 622-0473 monica. While local will benefit from a boost in political spending in 2012 (possibly upwards of $4bn).5bn in F2012E. for a high-teens EPS growth profile. As such.com Caroline Anastasi (1-212) 622-0138 caroline.67 $35. Viacom (VIAb) – Overweight – Dec 12 Price Target: $56 Price 12/6/2011 52-wk range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. Ad spending is highly correlated to GDP and generally lags movements in economic data by a quarter or two.) $42. and DISCA) and well below its own historical averages. Viacom also pays a nice dividend. Repurchases will be funded by robust free cash flow at over $2. cable networks stand out as attractive earnings generators given their dual revenue streams of advertising and highvisibility affiliate fees. New York Times Company Omnicom Group Regal Entertainment Scripps Networks Interactive The E. yielding 2.11 9. Best Idea – Viacom (VIAb) We find Viacom (VIAb) shares compelling heading into 2012 given the company’s leading cable assets.61 $4. Finally.P. We currently expect global ad growth to approximate 4% in 2012. discounted valuation.e. we expect profitability in the Cable business to expand nicely in the year ahead. We look to a healthy ad market into 2012.8bn). TWX. We believe VIAb shares offer great value at just 10x our F2012E EPS. more than a 20% discount to its peers (DIS. CBS. it continues to sell at nice premiums to a strong Upfront base. boosted by the strong affiliate revenue growth and ongoing structural improvements internationally. continued aggressive buybacks.
and higher ARPU driven by data.16 $19. sales of tablets.com J. Smartphone penetration could exceed 75% at some carriers.5% and perpetual growth rate of 0.P. CFA AC (1-212) 622-1444 philip. NBC requires investment for further improvements. Best Idea – Comcast (CMCSA) Comcast is our top pick in the telecom.erdemli@jpmorgan. AT&T and Verizon continue to rapidly build out LTE.2% dividend yield.045 Valuation: Target reflects DCF analysis assuming WACC of 7. which should drive growth in ARPU.1 $63.2% dividend yield and 3.41 $1.com Richard Choe (1-212) 622-6708 richard. Cash generation in the space is high. Sprint has become more active after years of minimal leasing activity. and doesn’t give CMCSA any credit for value of its 50% carried interest in NBCU.5x. 134 .5% buyback. the company’s solid cable segment growth combined with steady improvements at NBCU make for a strong and well-diversified cash flow stream. but new Android and Windows tablets gaining some traction. cable.cusick@jpmorgan.S. Roberts family voting control. We expect that most of 2012E cash flow—an 10.64 16. CFA (1-212) 622-8529 derya. Towers We expect tower companies to continue to benefit from the 4G network buildout by wireless carriers in 2012.choe@jpmorgan. the slowing residential business. and satellite space with an Overweight rating and year-end 2012 price target of $30. LTE data cards and MiFi devices could also drive 2012 growth mainly from Verizon. Cable & Satellite Slowing Growth But Strong Capital Return Potential: Top Pick CMCSA Philip Cusick.9% to 20.2% in 2012E and aggregate U. government-related revenue could be at risk. up from 40-60% today. we believe the biggest upside could come from a continued recovery in enterprise telecom spending. Comcast (CMCSA) – Overweight – Dec 12 Price Target: $30 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. 2011 business trends were strong and we expect that 2012 could be even better. there could be incremental wireless data growth from tablets with the iPad continuing to be the dominant tablet. as expected. We also expect cell tower backhaul revenues to continue to increase as wireless carriers ramp up their 4G network build and require higher throughput for handling the increase in data usage.com Derya Erdemli.5%. currently 2. and cloud services and slower declines in legacy services. NBCU increases ad exposure.19 $27. We also think the commercial business offers incremental growth potential vs.18 $1. IP. over-the-top video creates potential for customers to cut basic video packages. Cable and Satellite We maintain a positive view on the cable and satellite sector.) $23.North America Equity Research December 2011 US Year Ahead 2012 Telecom. revenue and EBITDA growth of 4. While we do not reflect a significant macroeconomic recovery in our estimates. Risks: Heavy telecom video competition continues to increase. we are seeing increased activity from enterprises for data.19 Dec $1.4 14. while maintaining leverage. respectively. we expect to see slower subscriber growth but continued strength in wireless data revenue growth from increased penetration of smartphones. as we find the over-thetop threat limited and believe that broadband growth will offset softness in the video market. Wireline On the wireline side. However.4% upside from current levels including an estimated 2. implying 33. In our view. In addition. but also from AT&T as it launches markets. and applications for amendments are rolling out for Network Vision upgrades.9% yield at current levels—will be available to capital-return projects including ramping the company’s 2.5%. Morgan Securities LLC American Tower AT&T Cablevision CenturyLink Charter Clearwire Comcast Crown Castle DIRECTV DISH Network Frontier Leap Wireless MetroPCS NTELOS SBA Communications Sprint Nextel Telephone & Data Systems Time Warner Cable US Cellular Verizon Communications Windstream AMT T CVC CTL CHTR CLWR CMCSA CCI DTV DISH FTR LEAP PCS NTLS SBAC S TDS TWC USM VZ WIN OW (rs) N OW OW N OW OW OW N N OW OW OW OW N N N UW N Wireless For 2012.1x versus Comcast’s target range of 2-2. with free cash flow yields of 6.1% and 2.
We expect the combination of Ruud Lighting and Cree’s internally developed. However. which will help to reduce its product cost basis at an accelerated rate. In general. Morgan Securities LLC Cree Rubicon Technology Veeco Instruments CREE RBCN VECO OW OW OW We believe the LED industry will trough in C4Q11/C1Q12 and improve throughout 2012. Best Idea – Cree (CREE) Cree is our top pick in the LED sector as roughly 75% of its revenue already comes directly from sales related to LED-based lighting.68 $72. Lighting-Related Demand Growth to Lead the Way in 2012 Christopher Blansett AC (1-415) 315-6708 christopher. Cree (CREE) – Overweight – Dec 12 Price Target: $48 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. We believe there is significant GM leverage in Cree’s business model due to a very high level of fixed costs in both COGS and Opex. we recommend investors invest as far downstream toward LED-based lighting as possible as we believe LED-related companies with higher exposure to lighting will outperform LED companies that are more CE-centric. Unsubsidized payback periods for third-gen LED lights vs.977 Valuation: Target reflects 29x C12E EPS. given expected revenue growth opp.P.com J. 135 . we expect demand for Cree’s LED components to accelerate significantly through 2012. slower-than-expected penetration of LED-based lighting. and legislative mandates for conventional lighting technologies in various countries should drive the long-awaited inflection in demand for LED-based lighting in 2012. prior product generations. we believe demand for LEDs for consumer electronics (CE) will recover slowly due to a significant structural oversupply and weak macro outlook for CE product demand while demand for LEDs for lighting will accelerate aggressively throughout the year as third-generation LED lighting products come to market. we expect less pricing pressure for LEDs sold into LED lighting vs.85 $23. legislative drivers in numerous countries are limiting the availability of incandescent bulbs. In addition.r. especially if there is an energy efficiency subsidy available. We do not believe the Street understands the strong correlation between Cree’s utilization rates and its margins and.37 $0. as a result. a lighting product manufacturer which we believe has the largest share of North America’s LED-based outdoor lighting market with its Beta LED product line. Risks: Weaker-than-expected demand for high-brightness LEDs. believe the Street is underestimating the improvement in margins and earnings that is likely to occur should Cree return to 90%+ utililization rates. Thus. a greater number of utility-based energy efficiency subsidies.peterson@jpmorgan. We expect this to increase further in 2012. Cree is a leading supplier of high-performance LED components used extensively by LED lighting product manufacturers. indoor LED-based lights will be the fastest-growing business for the company with a 50%+ CAGR over the next five years. those that are sold into traditional consumer electronics applications. In addition. In addition.) $25. which should only help to drive increased adoption of LED-based lighting products.9 N/A $2.North America Equity Research December 2011 US Year Ahead 2012 Alternative Energy – LED Technology LED Fundamentals Troughing.86 N/A 29.03 Jun $1.c. the combination of third-gen LED lighting products. We also believe the need for very high performance LEDs to provide LED-based lighting products with a short payback period will limit competition for the next few years.blansett@jpmorgan. of >30% over next few years. As these companies bring to market their own third-gen LED lighting products over the next six months. Cree will begin to ramp production on 6” wafers at the beginning of C12. Cree recently acquired Ruud Lighting. stronger-than-expected competitive environment. conventional incandescent and outdoor lighting technologies are very attractive and we think associated usage of these products will greatly increase. which further reduce product cost and have lower relative payback periods vs. In general.com William Peterson (1-415) 315-6711 william.
a large percentage of its revenue comes from the sale of modules. Although the company has a strong U. The solar industry continues to be driven by subsidies and its outlook has little to do with the outlook for the global economy. Risks: Faster-than-expected reduction in product cost. will all reduce their solar subsidies at the beginning of 2012.com J. 136 . resulting in less demand in 2012 vs. We believe First Solar will see significant margin compression in its module business in 2012 as subsidies are reduced and as silicon wafer–based peers see significantly lower polysilicon prices. 2011.985 Valuation: Target reflects 0.9x C12E revenue. Unfortunately. is likely to be the primary reason for stock price underperformance.r. a weaning out of weak players is not likely to resolve the industry’s woes as the problems are not simply due to overcapacity. which represent more than 50% of global solar demand. 2012 Will Be Even More Difficult Than 2011 Christopher Blansett AC (1-415) 315-6708 christopher. in line with subsidy cuts.24 $5. We also believe 2012 will be a year known for significant consolidation of the solar PV industry with companies with high product costs and/or poor balance sheets likely to disappear through bankruptcy or through acquisition by stronger players. is no longer a factor to help maintain the political willpower to keep them intact.05 Dec $7. in conjunction with significantly lower module margins.S. pipeline of projects. Italy.P.com William Peterson (1-415) 315-6711 william. the growing realization that we are at the beginning of a new era in global natural gas production enabled by the combination of horizontal drilling/fracking is likely to be a negative factor toward the subsidization of solar and all forms of renewable energy. Morgan Securities LLC Broadwind Energy First Solar. Given the already poor financials of most solar PV companies which are in the red or operating near breakeven. We think multiple contraction. Thus. MEMC Electronic Materials SunPower BWEN FSLR WFR SPWR N UW UW UW We continue to recommend long investors avoid the solar sector heading into 2012 as further subsidy reductions in major markets will continue to drive down returns on solar project investments. strong B/S assists project financing. Inc. and the U.11 $175. In addition.13 6. In fact. Best Idea – First Solar (FSLR) We rate First Solar Underweight and continue to believe the stock will remain under pressure as pricing conditions in the solar sector become even more difficult in firstname.lastname@example.org. We also believe First Solar will need to structurally raise its R&D spend in order to try and accelerate product improvement to keep pace with falling subsidies.4 9.71 $7. but primarily due to the structural lowering of subsidy levels. as the subsidies go. causing meaningful demand destruction in our view. rising electricity prices due to rising natural gas email@example.com $3. so does the solar sector. Germany. due to a deteriorating growth outlook for the company. We think long-only investors will continue to avoid FSLR and other solar stocks until uncertainty on subsidies and overcapacity is resolved. we do not believe the industry is in a position to reduce pricing further.. prior years. We also believe financing costs will be higher in 2012 vs. (FSLR) – Underweight – Dec 12 Price Target: $40 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. is likely to reset operating margins lower than most investors currently expect. also placing additional downward pressure on solar system returns and further inhibiting demand. the force behind the creation of the subsidies in the first place.) $46. These subsidy cuts will cause a significant impairment in solar economics requiring a reduced capital cost to offset the lower subsidy levels.North America Equity Research December 2011 US Year Ahead 2012 Alternative Energy – Solar PV Long Investors Should Stay Away. as many governments around the world are now looking at the potential to produce significant amounts of natural gas domestically at rates significantly lower than current market prices. This. First Solar Inc.S.45 $40.
Inc. While it is certainly not completely immune from another downturn. calls for pro forma EBITDA and revenue growth of ~125% and ~30%. ZIP should reach sustainable profitability in 2012. ZIP was able to add members. DTS. we believe ZIP’s experience during the last downturn compares favorably to those of traditional rental car companies.com Best Idea – Zipcar (ZIP) Auto-sharing is a secular growth market. Synaptics Inc. Inc. FLIR Systems Inc Garmin Ltd. TASER International Inc. Sierra Wireless Inc.P. Inc. Morgan Securities LLC Acacia Research Corp.com J. Avid Technology Coinstar Inc. Inc. Frost & Sullivan forecasts tenfold growth in car-sharing members through 2016 and a revenue CAGR of 44% to $3. deteriorating unit economics as company enters new markets or existing markets approach saturation. unrivaled transactional and customer data.05 $0.krgovic@jpmorgan. ESCO Technologies Inc.43 $31. Zipcar plans to deploy in two new U. Inc.00 Dec $(0.S. execution challenges. continuing the positive trajectory from FY11E which. and engenders sustainable consumption in an urbanized. We also expect ZIP to record net income of ~$5mm.w. Inc.strouse@jpmorgan. Zipcar is the global leader in auto-sharing. which experienced revenue declines on average during that timeframe.50 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY PF EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. respecitvely. grow revenue.34 N/M 42. TeleCommunication Systems. size of balance sheet.3 billion in the United States alone. 137 .North America Equity Research December 2011 US Year Ahead 2012 Applied & Emerging Technologies Hip to Be Zip Paul Coster. cities each year. resource-constrained world. compared to an estimated loss of ~$11mm in FY11. TeleNav.4 $567 Valuation: Target reflects 30x multiple assigned to 2014E PF EPS discounted back one year at WACC of 12%. Cubic Corp Diebold. CFA AC (1-212) 622-6425 paul. Trimble Navigation Verint Systems.9%. Echelon Corporation Elster Group SE EnerNOC Inc.68) $0.) Mark Strouse. The flexibility of auto-sharing yields consumers the benefits of auto ownership without the high cost and hassle. CFA (1-212) 622-8244 mark.com Marija Krgovic (1-212) 622-5552 marija.coster@jpmorgan. and through the recent Streetcar acquisition has a beachhead to pursue the European market in 2012. auto-resale value introducing profit risk. differentiated technology infrastructure. at the midpoint of guidance.50 $14. RealD Inc. GeoEye. Zipcar (ZIP) – Overweight – Dec 12 Price Target: $30. Dolby Laboratories.We expect this favorable trend in ZIP’s established markets to continue with additional growth and leverage experienced as other existing markets mature. Macro resistant. with over 75% share of the market and competitive advantages through scale and reach. Risks: Probable price-based competition from rental car companies. ZIP’s established markets have grown ~23% year to date and pre-tax margins have increased by ~80bps to 20. Zebra Technologies Zipcar ACTG AVID CSTR COMV CUB DBD DGI DLB DTSI ELON ELT ENOC ESE FLIR GRMN GEOY IRBT ITRI ITRN LOGI LOJN NCR NICE NVTL OVTI PLT RMBS RLD SWIR SYNA TASR TSYS TNAV TRMB VRNT ZBRA ZIP OW N OW N N UW OW OW UW N OW N N UW UW N N OW UW N N OW OW N OW N N OW UW N UW N N OW OW OW OW $14. Inc Ituran Location and Control Logitech International LoJack Corp NCR Corporation Nice Systems Novatel Wireless OmniVision Technologies Plantronics Inc Rambus Inc. Comverge. and branded self-service experience. and lower acquisition cost per new member during the 2008/2009 downturn. Inc. Incorporated DigitalGlobe. Inc. We expect ZIP to grow pro forma EBITDA ~90% in FY12E on revenue growth of ~24%. iRobot Corporation Itron.
For example. We sense margins of many staffing firms (e. despite rather lackluster GDP. better margins. but is still modestly growing. New enrollments (starts) are the leading indicator of the sector and have been pulled down by the exhausted consumer and negative media during 2011. RHI should see expanding multiples.) $27. We note that Education stocks now trade at 11x NTM EPS. RHI is still trading at a normal recessionary multiple.com Jeffrey Y. Cintas DeVry Education Management G&K Services Iron Mountain ITT Educational Services Inc ManpowerGroup Resources Global Professionals Robert Half International Strayer Education UniFirst Jeffrey Y. We also see operating leverage prospects tied to revenue growth. better margins. enabling it to command better pricing power.steinerman@jpmorgan. We expect sector starts to rebound by mid-year 2012 and total enrollments to follow with a lag. RHI) could be 50%+ higher over the next couple of years. assuming a permissive economy. Education Finding Traction Andrew C.48 26. flex staffing growth has remained healthy throughout 2011. Risks: Economic slowdowns and accounting staffing volatility. and revenue growth. We have long maintained that flex staffing is concurrent with the economy and a leading read on the labor market.929 Valuation: Target reflects 1.S.S. Assuming a permissive economy. Volshteyn (1-212) 622-2940 jvolshteyn@jpmorgan. Steinerman American Reprographics Company Apollo Group Bridgepoint Education Capella Education CDI Corp.7x. In addition. the key is the trajectory of new enrollments. Eurozone real GDP is more of a risk in those geographies. We maintain that for-profit education institutions will reachieve healthy mid-term growth due in part to public sector supply constraints. Encouragingly. U. Domestic demand continues to be strong in IT and other professional staffing. ARC APOL BPI CPLA CDI CTAS DV EDMC GKSR IRM ESI MAN RECN RHI STRA UNF N OW N N N N N N N OW N OW N OW OW N TW OW Best Idea – Robert Half International (RHI) Robert Half International (RHI) is the King Kong of accounting staffing with ~20% market share in the U. We sense that the threshold level of real GDP needed to generate favorable flex-staffing growth has dropped due to the enhanced secular attraction of flex staffing following the Great Recession. Morgan Securities LLC Andrew C. Robert Half primarily addresses mid-market companies. Start declines have narrowed in Fall 2011 for the sector. still near the lowest level in a decade.com J. With new 2011 regulations finalized and Congress in gridlock. extended labor recovery causing continued stock volatility. we do not expect much higher education change in DC during 2012. DC storm for Education stocks has passed. MAN. We favor APOL and STRA. 138 . Volshteyn Towers Watson U. marketplace.6 $3. while more European-exposed MAN is trading at an almost 30% discount to its normal recessionary level. assuming a conducive economy in 2012. Still.r.69 Dec $0.North America Equity Research December 2011 US Year Ahead 2012 Business & Education Services Business Services/Staffing to Outperform in Decent Recovery.mcgarrett@jpmchase. below historical expansionary cycle multiple of 1. other than current uncertainty around Pell Grant funding. and commercial staffing is enjoying some solid seasonal lift in late 2011. especially in the U. and should benefit from much faster growth and higher profitability than most staffing companies through the cycle.S.2 18. flexible staffing growth is solid amid low GDP. and strong revenue growth into 2012. Staffing stocks more than discounting a normal recession.48 $34. and Apollo has already seen starts return to growth.S. staffers should see a powerful combination of expanding multiples. the labor supply is tightening within professional staffing. We continue to see solid prospects in staffing fundamentals. McGarrett (1-212) 622-5841 molly.g.05 $1. For-profit education institutions are eager to return their focus to operations and students. So.44 $1.. Steinerman AC (1-212) 622-2527 andrew. allowing staffers to push for higher bill rates in those areas. U.S. Robert Half International (RHI) – Overweight – Dec 12 Price Target: $40 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil.P. we recognize that flex staffing in key European markets has slowed remarkably in late 2011.centric RHI is currently trading at its normal recessionary EV/S multiple (based on valuation lows around the 2011 recession).com Molly R.4x EV/S using 2012E revenues.26 $19.
We see ongoing data-center consolidation driven by virtualization as the key driver for this growth. strengthen as companies look for more ways to reduce costs. Morgan India Private Limited Ciena Corp.P. macro risks to enterprise spending.com J. Morgan Securities LLC Rajat Gupta (91-22) 6157-3347 rajat. CFA AC (1-415) 315-6713 rod.145 Valuation: Target reflects 23x 2012E EPS.58 $0.hall@jpmorgan. Best Idea – Riverbed (RVBD) We continue to like Riverbed (RVBD) against a backdrop of slowing growth. Handsets We believe that handset demand will shift with the macroeconomy. Data Networking We believe data-center virtualization will continue to be a major driver of growth in 2012. we believe European carriers have been reducing capex ahead of the cycle.26 30. We also see the increasing complexity of various data center management/security/monitoring products as a key opportunity.S. We believe the WAN optimization market which Riverbed leads will continue to experience rapid growth even in a slow economy. increased competition from Cisco. This adds up to a tough start to 2012 for equipment manufacturers and then an uncertain H2 given the continued threat of economic slowdown. we see direct data center–oriented companies like FFIV as increasingly predictable in terms of their growth profile and so less attractive from a momentum point of view. Cisco Systems Corning F5 Networks Infinera Juniper Networks Motorola Mobility QUALCOMM Research in Motion Riverbed Tellabs CIEN CSCO GLW FFIV INFN JNPR MMI QCOM RIMM RVBD TLAB N N UW N UW N N OW N OW UW Telecom Infrastructure Normally.) $26.com Joseph Park (1-415) 315-6760 joseph.x.b. Both the consolidation trend and the migration to cloud-based services should. We also believe that optical networking companies like CIEN and INFN may see a pulse of investment with the advent of less-expensive 100G technology beginning in mid-2012. Large builds like Sprint and AT&T (LTE) in the U. However.com J. RIM and Nokia are also making a run at the socalled “3rd OS” position though we aren’t sure there is room for such in the market as Apple and Android continue to power ahead. 139 .firstname.lastname@example.org Ashwin Kesireddy (1-415) 315-6756 ashwin. we are cautious on most infrastructure names in early 2012 with the exception of Cisco (diversified into data networking).89 $1.P. 34% premium to SMid-cap peers. However. smartphones should continue to become a larger proportion of overall handset demand in 2012. in our view. should help to partially offset this European effect but not completely.0 email@example.com Dec $0.kesireddy@jpmorgan. Of ten large carriers that we track in Europe six were already running below expectations on capex as of Q211 and this trend continued into Q3. We also believe that WANOP benefits from the move of businesses toward cloud-based services and away from owned infrastructure. telecom carriers would be the last to see the effects of a downturn since their customers typically reduce spending on everything else before they get to the telephone. We believe that key trends in 2012 will be increased spending on WAN optimization products like those of Riverbed as data centers consolidate.North America Equity Research December 2011 US Year Ahead 2012 Communications Equipment & Data Networking Riverbed Our Top Pick in a Slowing World Rod Hall. We see this trend as positive for Qualcomm’s chipset business and potentially also helpful to royalties as smartphones cause a temporary shift upward in overall market ASPs for 3G devices. However.70 $18. As a result.74 $44. Riverbed (RVBD) – Overweight – Dec 12 Price Target: $29 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. if anything.2 $4. Risks: Data-center consolidation does not drive uptake of WAN optimization as expected.
low capital expenditures. Western Union WNS Holdings Ltd. FleetCor Genpact Global Payments Green Dot Heartland Payment Systems MasterCard MoneyGram Paychex Inc VeriFone Visa Inc. Payment processing companies have historically been a relative safe haven for investors during times of economic slowdowns or uncertainty. and payment processing and services companies. CFA Alliance Data Cardtronics.com J. Smith.05 $18. markets. and high free cash flow.99 $215.P. increased pricing pressure.30 $384. as financial institutions are likely to seek better economics in the coming year as regulatory pressures impact FI revenue streams. data processing. Inc. Risks: Material adverse impact from pending debit interchange regulation. CFA AC (1-212) 622-6632 tien-tsin. The payment processing space is characterized by recurring revenues that are generally insensitive to minor fluctuations in output and consumer spending (due to ongoing secular tailwinds). Morgan Economists predict. in line with our multiyear EPS growth forecast. ACN ADP BR CTSH CSC EXLS FIS FISV FLT G GPN GDOT HPY MA MGI PAYX PAY V WU WNS WXS OW N OW OW UW OW UW N N N OW OW N OW N UW (rs) OW OW UW N The Computer Services and IT Consulting coverage universe encompasses IT consulting. high incremental margins. major issuer defection.) ADS CATM N OW SYNT VRTU OW N $371. and recently announced several new processing and issuer wins that provide built-in growth next year. Morgan Securities LLC Tien-tsin Huang.firstname.lastname@example.org 17. as J. 140 . Smith. should domestic fiscal policy tighten and growth moderate. Amid a backdrop of potentially slowing domestic GDP growth and European uncertainty. we believe MasterCard is the most compelling large-cap growth idea in our payment processing coverage universe due to its 1) reasonable valuation (shares trade in line with our multi-year earnings growth rate) and 2) attractive business model which is both defensive (MA can reduce discretionary operating expenses in the face of slowing volume growth) and offensive (the company benefits from improved consumer confidence and spending).com Stephanie Davis (1-212) 622-6591 stephanie. and we believe that theme will hold in 2012.00 Dec $14. MasterCard has limited exposure to debit-card regulation.1 $47. Slower growth and a continuation of elevated unemployment levels will likely be neutral to slightly negative for the HR and payroll providers. Virtusa Corp. and an improving economic growth outlook throughout email@example.com. CFA Accenture plc Automatic Data Processing Broadridge Cognizant Computer Sciences ExlService Holdings Inc. The potential for a mild recession in Europe is a risk but is likely priced in many IT services stocks.l. CFA (1-212) 622-6743 reginald.S. Regulation will continue to be the focus for the FinTech names. MasterCard (MA) – Overweight – Dec 12 Price Target: $435 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil.North America Equity Research December 2011 US Year Ahead 2012 Computer Services & IT Consulting Expecting Better Performance as Regulation Uncertainty Shifts to Execution Tien-tsin Huang.davis@jpmorgan. Best Idea – MasterCard (MA) MasterCard (MA) is the number two credit and debit network worldwide and benefits from the ongoing global secular shift towards card-based and electronic payments. Finally. MasterCard’s business is highly defensable and characterized by recurring revenues. deceleration in GDV growth.628 Target reflects 17x 2013E EPS. Inc Puneet Jain Syntel. representing a slight discount to MA’s historical PEG ratio. Unlike Visa. with innovation and strong sales execution serving as potential offsets to the tough macro backdrop. IT services stocks should benefit from a rising stock market. FIS Fiserv. larger-thananticipated legal settlements for pending legal/regulatory cases. Inc. increased competition from alternative payment processing providers. Wright Express Reginald L. unforeseen payment processing regulation in non-U.P.com Reginald L.58 $21.75 20.
EMC Emulex Corp. Apple is trading well below its three-year average of 16. Morgan Global Manufacturing PMI declined in November and remains at a depressed level.j. Fusion-io Hewlett-Packard IBM Lexmark International NetApp Orbotech QLogic Corporation Seagate Technology STEC Western Digital Xerox Corporation Anthony Luscri National Instruments ARX AAPL BRCD DELL EMC ELX FIO HPQ IBM LXK NTAP ORBK QLGC STX STEC WDC XRX N OW UW UW N UW N UW OW UW OW N UW N UW N UW Best Idea – Apple (AAPL) Overweight-rated Apple (AAPL) remains one of our top picks in IT Hardware. the J. Risks: Incremental macroe weakness or slowing expansion. the recent reading does not provide a good setup for a year-end IT spending push or for the start to 2012. Morgan CIO Survey published on September 29 pointed to tough times ahead.9 $363.70 $310. Breakout revenue growth.s. Apple is the only stock in our coverage list for which we expect both revenue and EPS estimates to have upside potential in the next 6-12 months. Apple navigated the prior global downturn in 2008-09 better than most tech companies.a. and EMEA likely usher in more fiscally disciplined spending and government infrastructure decreases.P.1 9. Apple (AAPL) – Overweight – Dec 12 Price Target: $525 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. As a result. The J.2x.com We first called out the increasing risk of macroeconomic pressures in our April 18 Quarterly Crossroads industry report. we prefer market share gainers.com Anthony Luscri (1-415) 315-6702 anthony.9x our C2012 EPS estimate. that stand to post above-peer revenue and earnings growth in spite of challenging times. to be negatively affected in the next 12 months. multi-year growth opportunities.com J.Our Dec-12 price target of $525 implies 34% upside from current levels. Brocade Dell Inc. As austerity measures in the U.moskowitz@jpmorgan. Our view is based on 1) continued macroeconomic uncertainty. In our view.17 $39. Apple is trading as a “value stock” and not as the high-growth story in large-cap equities.luscri@jpmorgan. Similarly. Add in iTunes and iCloud. and we think that the duration and severity of the macroeconomic slowdown could be worse than investors anticipate. despite current macroeconomic challenges and a large revenue base. slower rate of new product refreshes. 141 . In our view. Asia and Latin America also offer significant.50 Sep $27. But Apple Offers Partial Buffer to Weather the Storm Mark Moskowitz AC (1-415) 315-6704 mark. including technology.North America Equity Research December 2011 US Year Ahead 2012 IT Hardware Macro Challenges May Worsen. it is this disconnect that could drive many stock valuations lower in the near to midterm.53 11.S. gross margin pressure. Spending cuts have begun. as well as sustainable market penetration with the Mac. such as Apple. Key drivers include increasing sales momentum for iPhone and iPad. At 10. Our latest research indicates that CIO budgets remain under pressure.353 Valuation: Target reflects a weighted blend of EV/EBITDA and P/E scenarios utilizing historical peak/trough multiples. and we think that Apple’s current model is even stronger. and we think that Apple’s digital “way of life” underpins a formidable moat to fend off competitive and economic challenges.kim@jpmorgan. and the items that stand to be affected the most in a protracted downturn include hardware and services. particularly MacBook Air. including high-priority items. and incremental market penetration opportunities are offsets at Apple that most tech companies do not possess. Our current estimates point to above-peer revenue and earnings growth. disruption in competitive dynamics. especially China. 2) our recent CIO survey.95 $426. Geographically. Mike Kim (1-415) 315-6755 mike.P. We recommend that investors take advantage of the recent cooling-off period in the stock. Morgan Securities LLC Mark Moskowitz Aeroflex Apple Inc. and 3) inputs from our primary research contacts.68 $35. In our view. we expect all industry verticals.) NATI OW $390. which points to a tepid spending environment exiting 2011. upward-trending margins.P. We expect this dynamic to be compounded by any moderation in growth out of Asia-Pacific.
Inc. LRCX had $575mn set aside for this activity. we expect Foundry capex will decline the most of all segments y/y as factory utilization rates remain low exiting C11. high exposure to Foundry & Memory and high level of volatility in memory pricing and associated capital spending of these customers. William Peterson (1-415) 315-6711 william.North America Equity Research December 2011 US Year Ahead 2012 Semiconductor Capital Equipment Look for Fundamentals to Trough in C1Q12.blansett@jpmorgan. to remain relatively flat at low levels. 142 . likely troughing in C1Q12. we believe investors will get more positive on the outlook for semi capex and SemiCap stocks.10 $34. cross-cycle average P/S multiple for LRCX. Lam Research (LRCX) – Overweight – Dec 12 Price Target: $56 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil.com J. KLA-Tencor Lam Research MEMC Electronic Materials Novellus Systems Photronics Veeco Instruments AMAT KLAC LRCX WFR NVLS PLAB VECO N N OW UW OW N OW Best Idea – Lam Research (LRCX) Our top pick in Semiconductor Capital Equipment is Lam Research (LRCX) with its higher-than-average exposure to memory which we expect to outperform in terms of capex in 2012.0x our C12 revenue estimate of $2.86 $1.54 N/A 27.peterson@jpmorgan. Morgan Securities LLC Applied Materials. Lam Research is poised to capitalize on share gain momentum in its core Etch equipment business as well as benefit from Single Wafer Wet and Bevel Clean. and DRAM capex.c. two equipment segments that are relatively small but have significantly outgrown the WFE market over the past ten years. With weaker macro demand as a backdrop. Our Dec-12 price target of $56. It’s Time to Load Up for the Next Cycle Christopher Blansett AC (1-415) 315-6708 christopher. We expect aggressive share repurchase would increase EPS meaningfully in C12. We believe 3. Overall. Lam Research has been very vocal in regards to share repurchase. We expect NAND capex to be flat to modestly down given secular growth in end demand. with over $2bn in cash and short-term investments.2x our C12 revenue estimate. That being said. SemiCap stocks generally discount fundamentals 3-6 months ahead and we think it is the right time in the cycle to take long positions in the sector. as of the end of C3Q11. As it becomes more apparent that semi fundamentals have troughed in C4Q11/C1Q12. Foundry and Intel capex should decline meaningfully in C12 after a relatively large spend in C11. At this time. In addition.124 Risks: Protracted semi capex down cycle exacerbated by weak consumer demand. for the year we estimate semi capex will decline 15-20% from C11 levels.4bn. We think it’s the right time in the cycle to get long SemiCap stocks. increased competition in Clean.00 for LRCX is based on 3.com We believe C1Q12 will be the fundamental trough quarter for the SemiCap sector and expect fundamentals to improve throughout the remainder of the year.) $42. which has been weak for a number of quarters.0x represents a forward-looking.86 $59. LRCX is trading at 2. We expect C12 Wafer Fab Equipment (WFE) spending to return to C10 levels.P.8 N/A $5.r. Overall.92 Jun $5.
Avnet stated its book-to-bill for 1Q12 is approaching parity.P. We believe we are in Phase II of the semiconductor upturn as companies have stopped lowering estimates. ON Semi. We expect Consensus estimates to rise in late 1Q12 as semiconductor companies raise guidance. far below the 5% unit growth for PCs and 8% unit growth for handsets. Microchip. INTC and TXN raised guidance in 2Q09 on stronger demand and Consensus estimates rose. Driving Upside in 2012: Hop in the Minivan! Chris Danely AC (1-415) 315-6774 chris. and we expect upside to Consensus estimates in 1Q12 as orders and fundamentals improve. During the previous upturn in 2009. Texas Instruments (TXN) – Overweight – Dec 12 Price Target: $33* Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. In early 1Q09 both INTC and TXN lowered firstname.lastname@example.org $1. AMD ALTR ADI AVGO CY INTC LLTC MXIM MCHP ONNN RFMD TXN XLNX N N OW N UW OW N UW N OW UW OW OW FCS ISIL OW N Best Idea – Texas Instruments (TXN) Texas Instruments (TXN) is our top pick due to a bottom in fundamentals and upside potential to Consensus estimates throughout 2012. We believe Phase III of the upturn will occur when several semiconductor companies report improving order rates as demand stabilizes and inventory needs to be replenished.4 $34. Arrow. as they have been over the previous six weeks.North America Equity Research December 2011 US Year Ahead 2012 Semiconductors Semiconductor Fundamentals Bottoming. Valuation: Target reflects average of P/S and P/E based on historical trends. We believe this is hard evidence that semiconductors are under-shipping end demand.com J.) $30. Texas Instruments. 143 . weaker-than-expected global economic recovery.42 $36. We believe we are now in Phase II of the upturn—semiconductor companies stop lowering estimates. We expect this to continue through the end of the year. and Avnet have recently stated order rates continue to be email@example.com 17. as multiple semiconductor companies and distributors have indicated orders remain stable and book-to-bill for 1Q12 appears to be close to parity. we continue to see evidence of a bottom in semiconductor fundamentals.i. Multiple semiconductor companies and distributors such as Intel. Phase IV: Estimates start to move up—likely late 1Q12.83 $1. we reiterate our positive stance on the sector and continue to recommend buying stocks ahead of the recovery. As a result. Phase III: Orders improve—expected early 1Q12. Risks: Sudden economic decline in a particular country or geographic region. Phase I of the Upturn: Stabilizing orders—already happened. Same thing happened during last upturn in 2009. INTC and TXN orders stabilized in late 4Q08.r. 2011. We also expect roughly 10% EPS accretion in C12 from its recent acquisition of National Semiconductor.75 16.34 Dec $2. Morgan Securities LLC Christopher Danely Advanced Micro Devices Altera Analog Devices Avago Technologies Cypress Semiconductor Intel Linear Technology Maxim Integrated Products Microchip Technology ON Semiconductor Corporation RF Micro Devices Texas Instruments Xilinx Venk Nathamuni Fairchild Semiconductor Intersil Corporation As we approach 2012. and should lead to a bounce in order rates during 1Q12 due to inventory replenishment.com Venk Nathamuni (1-415) 315-6783 venkatesh. and in late 1Q09 both companies’ orders improved.b. The SIA data combined with 4Q11 guidance indicate semiconductor units should decline 6% during 2H11.com Shaon Baqui (1-415) 315-6766 shaon. the first time in almost a year. but neither stock traded down. Subsequently. Semis under-shipping end demand by at least 10%.759 * Target and estimates as of December 9. Phase II: Companies stop lowering estimates—happening firstname.lastname@example.org $24. We believe Phase IV of the upturn will be when semiconductor companies raise expectations on the back of a continued improvement in order rates.
As for HDDs.email@example.com J. Saqib Jalil (1-415) 315-6761 saqib.84 $2. we estimate BRCM’s revenues will grow nearly 8% compared to forecast growth of 1% for overall semi revenues by J. commentary from several semi companies and distributors (CAVM. As 2011 draws to a close. Broadcom Corporation (BRCM) – Overweight – Dec 12 Price Target: $45 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. BRCM’s revenues have grown 15% per year while the semi industry has grown only 4% per year. ARW) during the last earnings season suggests a bottoming in order rates and a return to more normal patterns. In 2012. Chris Danely.sur@jpmorgan. In 2011. the recent flooding in Thailand has placed a severe constraint on near-term HDD growth. Risks: Ultra-competitive environment in WLAN & combo solutions.80 firstname.lastname@example.org run-rate 2H12E non-GAAP EPS. Morgan’s Large-Cap Semiconductor analyst. Over the last five years. Looking back on 2011. infrastructure. Also. we anticipate a modest recovery through the 1H.P. we believe the market has already baked in these developments and is discounting a larger-than-warranted impact to 2012 revenues and earnings. However.com John S.North America Equity Research December 2011 US Year Ahead 2012 SMid Semiconductors Signs of Bottoming in Demand and Market Segment Recovery Set Up a Positive 2012 Harlan Sur AC (1-415) 315-6700 harlan. and we believe that it will continue to drive robust growth in 2012. given the pent-up demand over the course of the manufacturing recovery.224 Valuation: Target reflects 13. Ahn (1-415) 315-6758 john. we anticipate the company will experience multiple new customer program ramps utilizing its combo connectivity. MCHP.8 $16. We believe BRCM continues to exhibit solid fundamentals that will enable it to keep outperforming the market for the foreseeable future. we believe that the same market segments (comm. 144 . TXN.s. In particular. smartphones/tablets) that drove strong growth over the past couple of years will continue to provide attractive expansion opportunities in 2012. and settop-box solutions. setting the stage for a move up in SMid semi stocks. Ethernet controller and switch. FCS. The one market vertical that bucked the trend and remained strong through the macro sluggishness was smartphones/tablets.P.89 $29. MRVL. as getting capacity back online will likely be a protracted process lasting several quarters. In terms of market segments.17 Dec $2. We also believe that IT spending will recover in 2012 as corporations take stock of the increasing demand on data processing/storage infrastructure.70 $2. we see positive indications that SMid semi companies could see a modest recovery in 1H12 and a stronger snapback in 2H12.) $30. particularly for product cycle–driven stocks like BRCM and CAVM. Morgan Securities LLC Broadcom Corporation Cavium Networks Entropic Communications Freescale Semiconductor LSI Corporation Marvell Technology Group Mellanox Technologies Micron Technology NVIDIA Corporation NXP Semiconductors PMC-Sierra SanDisk Corp BRCM CAVM ENTR FSL LSI MRVL MLNX MU NVDA NXPI PMCS SNDK OW OW N OW N OW N N N N N N Best Idea – Broadcom Corporation (BRCM) Broadcom Corporation (BRCM) has a solid track record of significantly outgrowing the overall semiconductor market. slower or delayed Nokia & Samsung 2.5G & 3G ramp. the global macroeconomic uncertainty has resulted in pushouts of wireless infrastructure projects by carriers as well as more conservative deployment of enterprise IT capex by corporations. consistent with estimated 12-15% revenue and earnings growth for the foreseeable future.6 10. and BRCM’s earnings have grown by 16% per year over the same period. carriers likely will have better clarity regarding wireless network requirements in the New Year and should resume 3G and 4G network deployments in earnest during 1H. microwave backhaul. enterprise server/storage. We believe the 2H will exhibit a larger snapback in HDD shipments.10 $46.com Despite some near-term challenges for our universe of SMid semiconductor companies.
LogMeIn Microsoft Oracle Corp.657 Valuation: Target reflects DCF analysis incorporating our Base Case scenario for XenDesktop revenue. For investors that are more optimistic on the market. . PROS Holdings Qlik Technologies Inc. U.com SolarWinds Symantec Taleo TIBCO Software Inc VMware BMC CA CARB CTXS LOGM MSFT ORCL PRO QLIK QSFT RHT CRM SWI SYMC TLEO TIBX VMW UW OW OW UW OW N OW N OW OW UW N OW OW OW OW N Best Ideas – Avoid Citrix Systems. CA Technologies Carbonite Inc. We believe that almost half of worldwide IT and Software spending will see a net negative impact due to pressure from these macro forces. Therefore.S. the U. in our view.P. we like Overweight-rated ORCL.748 * Target as of December 9.8 27.1 45.griffin@jpmorgan. Risks: Emerging as one of a few server virtualization players. Inc.) $50. as the real business momentum of the company is exaggerated with a simple calculation of billings proxy.55 $53. as we estimate that European governments account for 10-15%. and is unlikely to be adopted by the masses of corporations given such an elusive ROI.s.77 Feb $0. economy. Valuation: Target reflects DCF scenario analysis. (1-212) 622-1303 kenneth. In addition. 145 .42 $31.com Marc P Griffin (1-212) 622-5615 marc.r.com Darren Jue (1-212) 622-4071 darren. Red Hat Inc (RHT) – Underweight – Dec 12 Price Target: $32* Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil.63 29. customers moving to reduce dependence on VMware.r. While we agree with our strategist’s anticipation of a volatile 2012.com J.21 Dec $2. share gains in Linux market. This likely will dilute constructive moves. We believe RHT is misunderstood by investors. (CTXS) – Underweight – Dec 12 Price Target: $53 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. .S. Citrix Systems. compliance. ORCL is likely to experience a positive secular trend of its own making related to its Exadata product line. (CTXS)/Red Hat Inc (RHT) In this context. government for about 10%. Risks: Embedded XenDesktop functionality could spur upgrade cycle.05 $1.) $73. some highly regulated industries that are most likely to adopt Desktop Virtualization for security. .83 $1. Inc. “All That Remains Is . We have written extensively on this subject. but have a more pessimistic view of what the fallout of European.talanian@jpmorgan. with the most recent note.49 $50. For CTXS. but in our view is worth the cost in such an uncertain time. “As Nero Fiddled .com We agree with our economist’s view of the U.jue@jpmorgan. Financial Services.23 $88. Morgan Securities LLC BMC Software. stops paying sales commission on subscription renewals. and Financial Services (including Insurance) for about 20% of worldwide IT and Software spending. we believe the opportunity for Desktop Virtualization is much more cannibalistic than incremental. Quest Software Red Hat Inc salesforce. Exacution” dated November 17.08 $2. leverage to economic recovery. and Health Care).email@example.com $9.11 48.46 $2.S. we believe deep global macro forces will hamper progress. Inc. and control reasons are likely to see incremental pressure (Government. Inc. 2011. we believe investors should position defensively to offset any potential downward market forces.p.com Sandeep Madhur (1-212) 622-6516 sandeep. Citrix Systems.difucci@jpmorgan.” published October 24. An annualized billings analysis is more appropriate. Federal government. In addition. we believe Red Hat will not see leverage in the most important expense line of a software company—Sales & Marketing—since it has to pay its sales force high commissions on subscription renewals.North America Equity Research December 2011 US Year Ahead 2012 Software Likely to Get Worse Before It Gets Better John DiFucci AC (1-212) 622-2341 john. and potential Financial Services weakness will mean for IT spending worldwide. our best ideas are to underweight CTXS and RHT.8 $13. See our note. . Kenneth R Talanian Jr.
com Saket Kalia. Inc.00 $78. one of the three main segments in the data-center industry. Roughly 95% of revenue is recurring in nature and there is only approximately 8% customer churn each year. CFA Advent Software Akamai Technologies. we would point to high-quality cyclical names like Autodesk and Rovi. but provides some stability with its recurring revenue during choppy environments. is growth of 15-20% for the next five firstname.lastname@example.org@jpmorgan. Amdocs ANSYS. Within email@example.com 34. Equinix (EQIX) – Overweight – Dec 12 Price Target: $120 Price 12/6/2011 52-Wk Range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil.48 $107.4 $4. we believe this makes for an attractive investment opportunity. because if investors are highly confident in forward estimates we would expect share prices to be much higher than current levels. Our expectation for the data-center industry. CFA Mentor Graphics Monotype Imaging ADVS AKAM DOX ANSS AZPN ADSK BLKB CDNS CHKP CMVT CSGS EQIX FTNT INTU MOTR NSR PMTC ROVI SSNC SNPS VRSN WBSN UW N N N OW OW N OW N N N OW N OW OW N OW OW OW OW N UW After a very big 2010 when our software technology coverage outperformed the market by almost a factor of three times. combine this with 45%+ EBITDA margins and this is a very attractive business model with high visibility and cash flow generation.com Lauren Choi (1-212) 622-6102 lauren.1% year to date. Our Dec-12 price target of $120 is based on an EV/EBITDA multiple of 8. 146 . Demand for Equinix data-center solutions is being spurred by several large trends including enterprises moving more solutions to both private and public clouds and users digesting more content over the Internet given the rapidly increasing use of mobile devices like smartphones for Internet access (mobile data). a stable recurring revenue model. capital-intensity of business could have some expansion drag on incremental margin. Inc Intuit Motricity. But for investors that are in the camp of believing another potential economic meltdown is imminent our most defensive name remains Neustar.78 Dec $2.8x for the last three years.) ARBA SNCR OW N MENT TYPE N OW $102.98 $3. the S&P 500 up 0. which we currently estimate at $12bn of annual revenue. Rovi SS&C Technologies Synopsys Inc VeriSign Websense Lauren Choi Ariba.4 29. For our favorite pick we are going with a stock we believe offers considerable upside in more favorable economic times.859 Risks: More customers opting for in-house or generic wholesale data-center capacity. For those that believe a resolution of the European financial and economic situation can be achieved in the near term. CFA AC (1-212) 622-6389 sterling. 2011 has been almost a mirror image of the overall market with performance roughly flat year to date vs.North America Equity Research December 2011 US Year Ahead 2012 Software Technology Waiting for Macro Clarity So Investors Can Focus on Company Fundamentals Sterling Auty. CFA (1-212) 622-6477 saket. and with several large trends providing a tailwind to growth. recurring revenue leveling out. Best Idea – Equinix (EQIX) Sometimes having your head in the cloud is a good thing Equinix (EQIX) has established itself as the clear leader in the collocation segment of the data-center industry. we expect Equinix to continue to be the number one provider of collocation.9x versus the average of 9. and high margins. Morgan Securities LLC Sterling Auty. it appears that at least the first part will be much more about the macro backdrop than company fundamentals in terms of stock price performance. Looking to 2012.com J. Aspen Technology Autodesk Blackbaud Inc Cadence Design Systems Check Point Software Comverse Technology CSG Systems Equinix Fortinet.P.78 $2. Inc. Inc Neustar Parametric Technology Corp. Inc Synchronoss Technologies Saket Kalia.
4 $4.P. we expect EMS to see a growing addressable market driven by increased outsourcing from nontraditional sources such as the medical.North America Equity Research December 2011 US Year Ahead 2012 Technology Supply Chain We Favor Jabil’s Clear Growth and Margin Improvement Plan Amid the Uncertain Macro Steven O’Brien AC (1-212) 622-6554 steven.) $20. Despite having a clear revenue growth and margin improvement strategy and delivering consistent results.obrien@jpmorgan. But we see a trend toward supply chain consolidation in these industries benefiting larger EMS companies.com J. ShoreTel and Mitel could face a challenging year. not growth. While enterprise voice vendors’ VoIP call control systems provide compelling value through efficiency improvement and expense savings.34 $2. Risks: Slowing product demand resulting in fewer new outsourced manufacturing projects. Morgan Securities LLC Amphenol Fabrinet Flextronics General Cable Jabil Circuit Mitel Networks Molex Powerwave Technologies ShoreTel TE Connectivity APH FN FLEX BGC JBL MITL MOLX PWAV SHOR TEL N OW OW N OW N N N OW (rs) We believe the EMS industry may be underappreciated with near-trough valuations over fears of a cyclical downturn and concerns aggressive competition could arise as new business pipelines slow. we continue to believe rising employment is the primary catalyst for system upgrades. we remain concerned with Amphenol’s ~18% exposure to defense and Molex’s 19% exposure to consumer electronics. We expect above-peer growth to be driven by the burgeoning materials business. We recognize that moderately high inventory levels for communications and networking. with J. could have a dampening effect during 1H12. OEMs choosing to manufacture more products in house. However. However. Jabil Circuit (JBL) – Overweight – Dec 12 Price Target: $22 Price 12/6/2011 52-wk range High Low FY End Last (A) FY EPS Cur (E) P/E Next (E) Cur Next Mkt Cap (mil. are rewarded with premium valuations.343 Valuation: Target reflects peer average 4. such as Jabil Circuit and Flextronics. Morgan’s expectation for elevated unemployment levels in 2012. the after-market services business.55 $2.86 $23. We estimate nearly 75% of General Cable’s business is tied directly or indirectly to construction spending which may be finally nearing a bottom. medical. industrial. The government and education verticals represent over 10% of industry demand and tightening public sector spending may also be a headwind.5x EV/EBITDA on 2012E.09 $13. from which EMS companies still derive the majority of revenues (although not necessarily profits). and an early move toward supply chain inventory reduction which began in June. We maintain our cautious view toward General Cable due to its 30% exposure to Europe and North Africa. Also. as well as the increasing opportunities from industrial. and cleantech industries where outsourced manufacturing penetration is low. We expect electronic connector demand to reflect global GDP plus a small margin derived from content growth. While admittedly not exciting from a growth perspective. we do not expect EMS competitors to chase growth via price as high margins and ROIC. These growth opportunities now represent 40% of JBL’s revenue and carry margins substantially above the corporate average. and energy industries.P. Best Idea – Jabil Circuit (JBL) We continue to believe Jabil Circuit (JBL) is positioned to deliver multi-year margin improvement while outgrowing peers. We believe a weak macro environment could provide incentive for OEMs in these industries to move to variable cost structures and capture manufacturing and procurement savings.2 7. A first-half 2012 recession could depress both demand and prices. Hence.83 8. we believe connectors could be relatively stable during an uncertain 2012 due to diverse geographic revenue streams. Hence. low customer concentration risks.94 Aug $2. Jabil trades at a discount to peers. declining materials costs. we believe an investment strategy based on timing cyclical upturns may forego a compelling opportunity at current attractive valuations. 147 .
North America Equity Research December 2011 US Year Ahead 2012 148 .
13 $75.73 $21.27 $40.79 $191. Equifax Estee Lauder Endo Pharmaceuticals EOG Resources.83 $13.72 $66.67 $114.98 $54.30 $98. QUALCOMM Quality Systems Research in Motion Rock-Tenn Rovi Republic Services Inc Sprint Nextel Signature Bank Seattle Genetics Ticker ICE IFF INCY INFN INTC IT JBHT JCP JEC JWa JWN KEY KFT KMP KO KSS LYB MAN MCHP MDRX MHP MITL MLM MMI MOLX MRK MRVL MRX MT NBL NOK NSC NSR NUS ONNN ORCL PM PVTB QCOM QSII RIMM RKT ROVI RSG S SBNY SGEN Rating OW OW OW UW OW OW OW OW OW OW N OW N N N UW OW OW N OW OW N OW N N OW OW OW OW OW UW OW N OW OW OW N OW OW OW N OW OW OW N OW N Price $123.44 $39. LyondellBasell Industries ManpowerGroup Microchip Technology Allscripts Healthcare Solutions The McGraw-Hill Companies Mitel Networks Martin Marietta Materials Motorola Mobility Molex Merck & Co.84 $65.L F FDX FFIV FLEX FLR FMER FRC FRX FXCM GILD GM GT HAR HES HGSI HSP HUBG Rating OW OW N OW N OW OW N OW OW UW N OW OW OW OW N OW N OW OW OW OW OW OW N OW OW OW OW N OW N OW OW OW OW OW OW OW OW OW OW OW OW OW OW Price $34.50 $50..58 $9.80 $21.77 $34.com Air Products and Chemicals Amphenol Apollo Group Ashland Inc.05 $10. Hunt Transport Services. Company Name Autodesk AK Steel Altera Alexion Pharmaceuticals Amylin Pharmaceuticals Amazon.85 $24.11 $61.89 $25. Hub Group Ticker ADSK AKS ALTR ALXN AMLN AMZN APD APH APOL ASH ATHN BGC BIN BMRN CAVM CERN CIEN CMA CSCO CSX CTB DNDN DOW ECL EFX EL ENDP EOG EP EXPN.05 $82. Inc.48 $47.41 $74.10 $33.89 $18.68 $14.38 $33.66 $28.63 $17.51 $78.77 $8. Inc. Inc.01 $25.50 $7.42 $7.73 $20.84 $38.49 $29.75 $112.00 $26.P. Comerica Incorporated Cisco Systems CSX Cooper Tire & Rubber Dendreon Dow Chemical Ecolab Inc.38 $5.20 $31.58 $37. Inc.North America Equity Research December 2011 US Year Ahead 2012 Stock Ratings and Prices of Companies Discussed in This Report Ratings and prices for analysts’ second half “best ideas” appear on the corresponding sector page.30 $42.64 $14.22 $33.06 $11. J.36 $7.. Inc. Marvell Technology Group Medicis Pharmaceutical Corp.32 $5.28 $54.15 $2.68 $50.75 $3.13 GBp834 $11. Jacobs Engineering John Wiley & Sons Nordstrom.78 $8.15 $8.06 $27.B.66 $49.72 $35.90 $19. Kohl's Corp. Coca-Cola Co.05 $55.99 $104.35 $37.76 $54. J.20 $45.46 $61.15 $30.59 $32.36 $42.68 $60.73 $75. Penney Co.36 $17.05 $10.99 $82.82 $45.02 $13.50 $19.68 $36.20 149 . Inc FXCM Gilead Sciences General Motors Goodyear Tire & Rubber Harman International Hess Human Genome Sciences Hospira.34 $28. Arcelor Mittal Noble Energy Nokia ADR Norfolk Southern Neustar Nu Skin Enterprises ON Semiconductor Corporation Oracle Corp.50 $25. 2011. Inc.03 $57.06 $27. KeyCorp Kraft Foods Kinder Morgan Energy Partners L.40 $14.70 $37.86 $33. Inc. Stock prices and ratings are as of the close on December 6.33 $36.14 $57. athenahealth General Cable Progressive Waste Solutions Ltd. Philip Morris International PrivateBancorp. BioMarin Pharmaceuticals Cavium Networks Cerner Corp Ciena Corp. El Paso Corp.61 $47.24 Company Name The Intercontinental Exchange International Flavors & Fragrances Incyte Corporation Infinera Intel Gartner Inc.53 $33.C.61 $59. Experian plc Ford Motor Company FedEx Corp F5 Networks Flextronics Fluor Corp FirstMerit Corporation First Republic Forest Laboratories.83 $36.14 $31.73 $33.
35 $24.36 $29. Waste Management Watson Pharmaceuticals U.10 $46.13 $46.North America Equity Research December 2011 US Year Ahead 2012 Company Name ShoreTel SVB Financial Saks.59 $128.80 $26.43 Company Name Vulcan Materials ViroPharma Incorporated Pharmasset Valeant Pharmaceuticals Verizon Communications Warner Chilcott Werner Enterprises Wells Fargo Whole Foods Market Westlake Chemical Corp. Bancorp Visa Inc.73 $9. Steel Corp Yum Brands Zions Bancorporation Ticker VMC VPHM VRUS VRX VZ WCRX WERN WFC WFM WLK WM WPI X YUM ZION Rating N OW N OW N OW OW OW N OW N OW OW OW OW Price $33.27 $26.56 $38. Inc. Strayer Education Swift Transportation AT&T Teva Pharmaceuticals Tesla Motors Tupperware Brands United Parcel Service U.90 $80.94 $45.32 150 .24 $98.23 $71.S. Sara Lee Solera Holdings Stericycle Inc.39 $28.63 $31.87 $56.32 $16.05 $34.90 $23.83 $42.96 $9.21 $95.65 $69.73 $18.27 $57.33 $16.17 $40.37 $64. Varian Medical Ticker SHOR SIVB SKS SLE SLH SRCL STRA SWFT T TEVA TSLA TUP UPS USB V VAR Rating OW OW N OW OW N OW OW (rs) OW OW OW OW OW OW N Price $6.S.61 $62.
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