Friday, October 30, 2009
Electronic Arts: Gains in Online Gaming and Wii
A New York presenter likes Electronic Arts (ERTS: NASDAQ, $18.70). The gaming industry has been hit by the weak economy, but there are indications of bottoming in the space. The company has made significant gains in the digital area and on the Wii platform and is in a great position as we're entering the all-important holiday season. New releases have been selling very well, with FIFA 2010 breaking records as the fastest-selling sports game in history. The company's impressive balance sheet allows it to both support the established franchises and make significant investments in pursuit of growth opportunities. The presenter targets $25, or 30% upside form the current level, based on forward earnings estimates.
UnitedHealth: Trading at Discount to Peers While Lower Risk
Our New York presenter likes UnitedHealth (UNH: NYSE, $26.47) at this level. This leading managed care player is trading at a discount to peers, but its diverse business model holds less risk in light of some of the upcoming regulatory changes facing the industry. The company has improved its service levels recently and customer retention reflects that trend. The scale of UNH's operations and the reach of its provider network would allow the company to benefit significantly from expansion of coverage under the healthcare reform. Cost pressures are a challenge, but the company has been able to raise prices to offset higher medical costs. The presenter conservatively targets $30, but notes that $35 is possible if more favorable assumptions are proven valid.
Wednesday, October 28, 2009
Customer Growth Partners - Holiday 2009 Forecast
Craig Johnson, President of Customer Growth Partners and Roulston Research's Consumer community Chair has issued a Holiday 2009 Forecast. Craig believes holiday retail sales will grow by 2.4% y-o-y, a sharp turnaround from last year’s 4.1% decline. In issuing the forecast, Craig noted that his estimate of $502 billion in predicted 2009 November-December sales still lagged the peak $511.1 billion in 2007 sales -- and were barely above the $497.1 billion level seen in 2006.
He believes that Americans have endured a series of economic body blows over the past year, from the housing and credit crises to rising unemployment, but they’re now beginning to pick themselves off the mat, dust themselves off -- and start to shop again. With unemployment near 10%, this will not be a great holiday season, but compared with last year when the economy was in freefall, retailers will see a return of topline growth -- and many will enjoy robust, if not record, fourth-quarter earnings.
The real wildcards will be if employment takes another leg down, and if energy prices take another leg up -- which will turn holiday sales negative a second year in a row.
He believes that Americans have endured a series of economic body blows over the past year, from the housing and credit crises to rising unemployment, but they’re now beginning to pick themselves off the mat, dust themselves off -- and start to shop again. With unemployment near 10%, this will not be a great holiday season, but compared with last year when the economy was in freefall, retailers will see a return of topline growth -- and many will enjoy robust, if not record, fourth-quarter earnings.
Highlights of CGP’s 2009 Holiday forecast include:
- November-December 2009 retail sales will increase to $502 billion, up from $490 billion in the similar period of 2008;
- The 2.4% rise represents a sharp turnaround from 2008’s 4.1% YOY decline;
- 2009 Holiday sales will be paced by 10.8% year-over-year growth in e-commerce and other direct-to-consumer sales, also a strong rebound from last year. According to the DOC, fourth quarter 2008 e-commerce sales fell by 5%, the first ever YOY decline in holiday period e-commerce sales;
- Clothing and accessories sector sales will rise by 8.8%, a major turnaround from 2008’s unprecedented 13% decline -- but still below sales levels achieved in either 2006 or 2007;
- Lagging sectors will include the long-suffering home-improvement retailers, predicted to see a 10.4% YOY decline, and the home-furnishings sector, with a 6.6% drop;
- Discount and other value retailers will shine in holiday 2009, led by off-price retailers such as TJX and Ross Stores, low-price players such as Aeropostale and Forever 21, such Big Boxers as Costco and Wal-Mart, and e-commerce retailers Amazon and Gilt.com;
- Electronics retailers -- from Best Buy and Hhgregg to Apple, Amazon and Wal-Mart -- will see exceptional unit growth, particularly in flat panel TV’s, e-readers, laptops and mobile phones, but will be held back by sharply falling consumer electronics prices;
- The predicted 2.4% holiday season increase represents CGP’s Base Case forecast, which assumes that the unemployment rate remains in the 9.8% to 9.9% range, and that energy prices remain stable at about $2.70/gallon regular gasoline; and
- CGP also prepared two sensitivity analysis forecasts. Under the high unemployment/ high-energy price scenario, holiday sales would decline by 1.5%; and under the falling unemployment/low-energy price scenario, holiday sales would rise by 4.4%.
The real wildcards will be if employment takes another leg down, and if energy prices take another leg up -- which will turn holiday sales negative a second year in a row.
Thursday, October 22, 2009
Cinemark: Betting on 3-D Uptake
Our NY presenter is bullish on Cinemark's (NYSE: CNK) prospects. This movie chain is perfectly positioned for the long-anticipated transition to the 3-D standard. Consumers have embraced the better viewing experience 3-D offers and are willing to pay a $2-$5 premium for tickets. Attendances for 3-D screenings are twice as high as for regular movies. Movie studios will save on prints and shipping costs to distribute prints around the country. Some majors have already agreed to use their savings from the new platform to help movie chains finance the cost of installing digital projectors. JP Morgan is also putting together a financing package to facilitate this transition.
Cinemark has the best operating metrics in the space. Its presence in Latin America, a less competitive market, helps diversify revenue streams. The stock pays a 6.4% dividend yield. The upside from the $11 level where the name was recommended is 40-70% in the next 2-3 years, depending on how fast the 3-D switch progresses.
Cinemark has the best operating metrics in the space. Its presence in Latin America, a less competitive market, helps diversify revenue streams. The stock pays a 6.4% dividend yield. The upside from the $11 level where the name was recommended is 40-70% in the next 2-3 years, depending on how fast the 3-D switch progresses.
Wednesday, October 21, 2009
Tatum/Roulston Report
Tatum's survey is unparalleled in the ability to capture consistent opinions from Tatum's nearly 1,000 executives across the nation who act as CFOs, Controllers and CIOs in a broad base of industries across the country.
Tatum is a nationwide firm specializing in the providing financial and information technology services and executive fulfillment to companies across the country. For the past seven years Tatum's monthly Survey of Business Conditions has provided useful insight regarding business conditions. Roulston Research has partnered with Tatum LLC to produce abstracts of the business outlook from data collected by Tatum. In the Tatum/Roulston Report, Roulston Research believes most surveys, for example, do not identify a broad spectrum in volume of respondents, regionalism, company size or consistent respondents. In addition government results are usually reported 30-60 days after measurement period before revisions are made 30 days later. Most surveys’ conclusions are thus old news, but more importantly have not had a predictive result on earnings trends. The Tatum/ Roulston Report is not constructed with these issues that may distort or delay results. Instead, it is timely and immediate, with a consistent survey constituency of professionals primarily operating in high levels in the financial and technology departments of companies where the rubber meets the road. This joint effort with Tatum is a unique partnership that will provide a differentiated view of business trends - The Tatum/ Roulston Report.
Visit our website to view the latest Survey.
This month, BusinessWeek featured Tatum's survey in a discussion of current trends among executives, especially in the healthcare and technology industries. Follow this link to the Business Week article.
Tatum is a nationwide firm specializing in the providing financial and information technology services and executive fulfillment to companies across the country. For the past seven years Tatum's monthly Survey of Business Conditions has provided useful insight regarding business conditions. Roulston Research has partnered with Tatum LLC to produce abstracts of the business outlook from data collected by Tatum. In the Tatum/Roulston Report, Roulston Research believes most surveys, for example, do not identify a broad spectrum in volume of respondents, regionalism, company size or consistent respondents. In addition government results are usually reported 30-60 days after measurement period before revisions are made 30 days later. Most surveys’ conclusions are thus old news, but more importantly have not had a predictive result on earnings trends. The Tatum/ Roulston Report is not constructed with these issues that may distort or delay results. Instead, it is timely and immediate, with a consistent survey constituency of professionals primarily operating in high levels in the financial and technology departments of companies where the rubber meets the road. This joint effort with Tatum is a unique partnership that will provide a differentiated view of business trends - The Tatum/ Roulston Report.
Visit our website to view the latest Survey.
This month, BusinessWeek featured Tatum's survey in a discussion of current trends among executives, especially in the healthcare and technology industries. Follow this link to the Business Week article.
Tuesday, October 20, 2009
Changing dynamics alter traditional spreads in US natural gas-crude oil markets
Stephen Maloney
Copyright 2009, Towers Perrin
All rights reserved
While crude oil markets are enjoying a breakout, why isn't natural gas keeping pace? Isn't there supposed to be some kind of multiplier relating the two commodities? Shouldn't rising hydrocarbon prices lift all boats? After all, the recession is over, right?
Maybe it's a storage problem so let's check the numbers.
As of October 9, 2009, US crude oil stocks were 337.8 million barrels, up from 309.2 million barrels a year ago. That's a 9.2% increase over last year and well outside the normal range for this time of year.
Natural gas stocks as of October 2, 2009 stood at 3,658 billion cubic feet (Bcf). That's up from 3,266 Bcf a year ago or a 14.6 % increase and also outside the normal range for this time of year.
So, we're not seeing an inordinate swing in storage volumes relative to normal ranges for this time of year.
Now, let's look at the prices.
WTI spot prices on October 9 were $71.75 a barrel, up from $69.80 the previous week. In contrast, spot prices for natty gas are around $3.82 per MMBtu and not showing much strength above the NYMEX $4 handle.
Let's put this in context. A barrel of oil is worth roughly 5.8 MMBtu. So, $71.75 per barrel of WTI crude prices a barrel's energy content at about $12.37 per MMBtu. On an energy content basis, oil prices are currently about 3.24 times higher than energy prices for an equivalent amount of natural gas. And, crude oil prices are in breakout.
By comparison, a year ago, WTI prices last year were $77.44 and heading south. Henry Hub prices were then around $8 per MMBtu. On an equivalent MMBtu basis, the conversion multiple last year was 1.67.
Natural gas prices are not keeping up with crude oil price increases.
Admittedly, a year-to-year comparison is not really fair. After all, US natural gas prices follow a cyclical pattern timed to the onset of winter. Prices tend to peak in late July-early August. That period also coincides with peak volatility reflecting the uncertain requirements of the upcoming
winter heating season and the uncertain potential for supply disruption associated with the beginning of hurricane season in the US Gulf Coast. So, there should be some risk premium to price into natural gas spot or prompt month prices. And, we should vary that premium through the year. As the winter heating season ends in late winter-early spring, the price topology can be as exciting as riding the "Rebel Yell" (ask Brian Hunter, formerly of Amaranth, to explain why Mar-Apr spreads are called the "widow maker").
Clearly, the evidence is "all hydrocarbons are the same" is NOT true on an equivalent heat rate basis. Maybe they once were, but not at this moment and not at certain times of the year.
What's changed?
First, crude oil is an international market while natural gas is currently dominated by pipelines.
In addition, we're seeing the increasing role natural gas is playing in domestic electric power generation. In contrast, crude oil has no role in electricity generation.
Utilities don't burn oil anymore to make electricity. Rather, they mostly burn US and Canadian produced natural gas and US coal. In fact, roughly a third of natural gas demand goes to generating electricity. And, over the past year, electric generation went down pretty hard due to the recession. When people talk about wind and solar reducing the dependency on foreign oil, they're wearing leisure suits and playing an 8-track tape from the 1970s.
Electricity generation directly taps into the real US economy (i.e., the one that employs working people - not NYSE). With US industrial capacity utilization running below 70%(!), it's not surprising that July net electric generation (a peak demand month) fell off the table some 7.6% this year. Coal was the big loser with its less liquid market taking a stomach churning 15% drop in generation. The (relative) big winner was natural gas demand for generation which was only down 0.4%.
The new dynamics of natural gas markets are breaking a lot of traditional notions. For example, while demand for generation softened, natural gas prices responded to market dynamics quicker than the coal market such that gas-fired generation actually stole market share from coal in many areas, including the Midwest. In effect, the higher spark spreads made gas-fired generators relative money makers this summer compared to coal generation while large segments of the US industrial sat idle. Wild.
We're still a long way from a US economy running at its normal 80% or so capacity utilization. The US economy will need a few years of white-knuckled growth combined with some serious capacity rationalizations to get there. Meanwhile, natural gas rigs are dropping off in an attempt to match supply to demand.
Shifting markets aren't the only change impacting natural gas markets. We also have seen a very quiet tropical storm season which has also moderated the volatility spikes we often see in the summer going into the fall.
All in all, while domestic supplies of natural gas heroically stole some domestic demand from coal it otherwise couldn't keep pace with crude oil's breakout driven by USD collapse and Chinese demand. Still, there may be some late inning hopes - despite threats (or promises - take your pick) of global warming, it may well be a colder winter this year. Cold temps can be beautiful music for natural gas producers.
Clearly, traditional market dynamics for natural gas were impacted by this recession and the "dog that didn't bark" (no headline-making hurricanes to speak of). And, so, the spreads between WTI crude oil and Henry Hub natural gas have widened beyond traditional bands.
What about the future? Will the US natural gas market continue to experience domestic dynamics? Or, will LNG expose the market to the trans-Atlantic spreads and transform US storage into a swing player not unlike the WTI-Brent spreads?
In my next blog, I'll talk about LNG.
Stephen Maloney
Managing Consultant, Risk and Financial Services
Towers Perrin
steve.maloney@towersperrin.com
www.towersperrin.com/energy
Copyright 2009, Towers Perrin
All rights reserved
While crude oil markets are enjoying a breakout, why isn't natural gas keeping pace? Isn't there supposed to be some kind of multiplier relating the two commodities? Shouldn't rising hydrocarbon prices lift all boats? After all, the recession is over, right?
Maybe it's a storage problem so let's check the numbers.
As of October 9, 2009, US crude oil stocks were 337.8 million barrels, up from 309.2 million barrels a year ago. That's a 9.2% increase over last year and well outside the normal range for this time of year.
Natural gas stocks as of October 2, 2009 stood at 3,658 billion cubic feet (Bcf). That's up from 3,266 Bcf a year ago or a 14.6 % increase and also outside the normal range for this time of year.
So, we're not seeing an inordinate swing in storage volumes relative to normal ranges for this time of year.
Now, let's look at the prices.
WTI spot prices on October 9 were $71.75 a barrel, up from $69.80 the previous week. In contrast, spot prices for natty gas are around $3.82 per MMBtu and not showing much strength above the NYMEX $4 handle.
Let's put this in context. A barrel of oil is worth roughly 5.8 MMBtu. So, $71.75 per barrel of WTI crude prices a barrel's energy content at about $12.37 per MMBtu. On an energy content basis, oil prices are currently about 3.24 times higher than energy prices for an equivalent amount of natural gas. And, crude oil prices are in breakout.
By comparison, a year ago, WTI prices last year were $77.44 and heading south. Henry Hub prices were then around $8 per MMBtu. On an equivalent MMBtu basis, the conversion multiple last year was 1.67.
Natural gas prices are not keeping up with crude oil price increases.
Admittedly, a year-to-year comparison is not really fair. After all, US natural gas prices follow a cyclical pattern timed to the onset of winter. Prices tend to peak in late July-early August. That period also coincides with peak volatility reflecting the uncertain requirements of the upcoming
winter heating season and the uncertain potential for supply disruption associated with the beginning of hurricane season in the US Gulf Coast. So, there should be some risk premium to price into natural gas spot or prompt month prices. And, we should vary that premium through the year. As the winter heating season ends in late winter-early spring, the price topology can be as exciting as riding the "Rebel Yell" (ask Brian Hunter, formerly of Amaranth, to explain why Mar-Apr spreads are called the "widow maker").
Clearly, the evidence is "all hydrocarbons are the same" is NOT true on an equivalent heat rate basis. Maybe they once were, but not at this moment and not at certain times of the year.
What's changed?
First, crude oil is an international market while natural gas is currently dominated by pipelines.
In addition, we're seeing the increasing role natural gas is playing in domestic electric power generation. In contrast, crude oil has no role in electricity generation.
Utilities don't burn oil anymore to make electricity. Rather, they mostly burn US and Canadian produced natural gas and US coal. In fact, roughly a third of natural gas demand goes to generating electricity. And, over the past year, electric generation went down pretty hard due to the recession. When people talk about wind and solar reducing the dependency on foreign oil, they're wearing leisure suits and playing an 8-track tape from the 1970s.
Electricity generation directly taps into the real US economy (i.e., the one that employs working people - not NYSE). With US industrial capacity utilization running below 70%(!), it's not surprising that July net electric generation (a peak demand month) fell off the table some 7.6% this year. Coal was the big loser with its less liquid market taking a stomach churning 15% drop in generation. The (relative) big winner was natural gas demand for generation which was only down 0.4%.
The new dynamics of natural gas markets are breaking a lot of traditional notions. For example, while demand for generation softened, natural gas prices responded to market dynamics quicker than the coal market such that gas-fired generation actually stole market share from coal in many areas, including the Midwest. In effect, the higher spark spreads made gas-fired generators relative money makers this summer compared to coal generation while large segments of the US industrial sat idle. Wild.
We're still a long way from a US economy running at its normal 80% or so capacity utilization. The US economy will need a few years of white-knuckled growth combined with some serious capacity rationalizations to get there. Meanwhile, natural gas rigs are dropping off in an attempt to match supply to demand.
Shifting markets aren't the only change impacting natural gas markets. We also have seen a very quiet tropical storm season which has also moderated the volatility spikes we often see in the summer going into the fall.
All in all, while domestic supplies of natural gas heroically stole some domestic demand from coal it otherwise couldn't keep pace with crude oil's breakout driven by USD collapse and Chinese demand. Still, there may be some late inning hopes - despite threats (or promises - take your pick) of global warming, it may well be a colder winter this year. Cold temps can be beautiful music for natural gas producers.
Clearly, traditional market dynamics for natural gas were impacted by this recession and the "dog that didn't bark" (no headline-making hurricanes to speak of). And, so, the spreads between WTI crude oil and Henry Hub natural gas have widened beyond traditional bands.
What about the future? Will the US natural gas market continue to experience domestic dynamics? Or, will LNG expose the market to the trans-Atlantic spreads and transform US storage into a swing player not unlike the WTI-Brent spreads?
In my next blog, I'll talk about LNG.
Stephen Maloney
Managing Consultant, Risk and Financial Services
Towers Perrin
steve.maloney@towersperrin.com
www.towersperrin.com/energy
Monday, October 19, 2009
Wal-Mart Continues its Aggressiveness
Craig Johnson, our Consumer chair, believes that recent moves by Wal-Mart to demonstrate its desire to continue its aggressiveness by seeking new avenues of competition.
Recently the company started to
Recently the company started to
- sell dozens of toys for $10 each
- offer a wireless service priced below competitors
- cut prices on 10 highly anticipated hardcover books to $10 on Walmart.com
After both retailers then cut their prices on those books to $9, on Friday Walmart.com shaved a penny off that price to come in at $8.99 each. Walmart.com has threatened to drop prices even further. The company said it would adjust its pricing as needed to ensure it offered the lowest prices on its top 10 pre-selling books.
Craig believes that this is a demonstration that they are "more aggressive and they will cede no ground to the competition, whether it's the Best Buy's of the world, or Toys "R" Us or ... Amazon." He is of the opinion that "any competitor that underestimates Wal-Mart, does so at its own peril."
Thursday, October 15, 2009
Belo: Positive Trends in Ad Spending
We have recently posted an update from our presenter on Belo Corp (BLC: $5.47). Another shareholder is encouraged by a pickup in ad spending reported by peers in the space. The positive trends appear to be carrying over into Q4. Belo operates in Texas and Pacific Northwest, areas which have not been hurt by the housing crisis as much as other regions in the US, and where population is projected to expand at higher than average rates. The likelihood of breaking covenants is less of a factor now. Q3 earnings by Gannett and others starting next week should show conditions in the space turning less challenging.
Tuesday, October 13, 2009
The Tatum/Roulston Report
The Tatum survey this month clearly reflects that businesses are not in the typical mode of positioning their companies for recovery. Current trends are mixed with a lack of consistency by sector and industry. Perspectives indicate regional factors, government behavour and the financial instituional environment weigh heavily on the corporate outlook.
Backlogs have shown improvement as the significant slowdown last fall and winter has now rightsized inventories and corporate overhead. Expense reduction seems to be largely completed to a level that most companies are not cutting further at this point. Instead they seem to be waiting for an indication of better things to come. The Tatum Survey indicates some pent up need for modest capital expenditures for companies to start to maintain maintenance but not much more. Backlogs are up to replenish inventory pipelines, but a lack of confidence in future visibility is clearly widespread. Continuing capital availability concerns weigh heavily on this economy and most concerning to us is that its difficult to identify any factors that will adjust this environment.
Although the markets have bounced back to reflect maybe an overreaction to the downturn, Wall Street seems to have an uncanny confidence in historical precedence that has a disconnect with Main Street. We have written before that the difference between recession and depression is emotional. Middle America has reacted to the market meltdown, unemployment, government activism and lack of access to financial credit much differently than the East Coast. With the exception of export driven stimulus from the weak dollar and some very isolated individual company(seemingly not even industry wide) recovery, the environment is very sluggish.
Confidence in any government action to improve the sentiment is not only non existent, its sarcastic. With virtually no banking predictability most companies are experiencing very little forecasting capability. Optimism is common, but with very little tangible eveidence of sustainable stability. With the last year's experiences still freshly in the rear view mirror, pundits that believe recent history will not be a lasting scar just don't understand how a dog feels after its owner kicks it. The thought process that the economy will soon be back on a historically comparable trend is somewhat ignorant of the effects of the emotional meltdown we saw over the last 12-18 months. It takes time to forgive and forget unless you may not believe things broke down in the first place.
Backlogs have shown improvement as the significant slowdown last fall and winter has now rightsized inventories and corporate overhead. Expense reduction seems to be largely completed to a level that most companies are not cutting further at this point. Instead they seem to be waiting for an indication of better things to come. The Tatum Survey indicates some pent up need for modest capital expenditures for companies to start to maintain maintenance but not much more. Backlogs are up to replenish inventory pipelines, but a lack of confidence in future visibility is clearly widespread. Continuing capital availability concerns weigh heavily on this economy and most concerning to us is that its difficult to identify any factors that will adjust this environment.
Although the markets have bounced back to reflect maybe an overreaction to the downturn, Wall Street seems to have an uncanny confidence in historical precedence that has a disconnect with Main Street. We have written before that the difference between recession and depression is emotional. Middle America has reacted to the market meltdown, unemployment, government activism and lack of access to financial credit much differently than the East Coast. With the exception of export driven stimulus from the weak dollar and some very isolated individual company(seemingly not even industry wide) recovery, the environment is very sluggish.
Confidence in any government action to improve the sentiment is not only non existent, its sarcastic. With virtually no banking predictability most companies are experiencing very little forecasting capability. Optimism is common, but with very little tangible eveidence of sustainable stability. With the last year's experiences still freshly in the rear view mirror, pundits that believe recent history will not be a lasting scar just don't understand how a dog feels after its owner kicks it. The thought process that the economy will soon be back on a historically comparable trend is somewhat ignorant of the effects of the emotional meltdown we saw over the last 12-18 months. It takes time to forgive and forget unless you may not believe things broke down in the first place.
Finisar: Riding Buildout of Optical Networks
Finisar (NASDAQ:FNSRD) is another name from our recent small cap forum in Boston. Explosion in mobile data traffic and ever-increasing capacity requirements for fixed networks play to company's strength as the market leader in optical components. Margins are poised to rebound as some manufacturing facilities are transferred to off-shore locations and the overall product mix continues to improve with growth in revenues from higher-margin products. The company has secured a new credit facility and priced a $90 million notes offering to boost liquidity and retire outstanding debt with near-term maturity. The target is $15-$16 or 60% from the $9 level where the stock has traded since the last week's presentation. FNSRD has just undergone a reverse 1-to-8 split.
Comtech: Military Play with Call Option on Telecom Recovery
Our Boston presenter likes Comtech Telecommunications' (NASDAQ: CMTL, $31.93) strong presence in military communications. The stock fell from $40 to $20 back in March, when delivery under government contracts was pushed back one year. Now, the company is nicely positioned for fiscal 2010. Increased activity in Afghanistan will be an important factor in near-term growth. CMTL's higher-margin commercial sales are dependent on recovery in the telecom space. The company's operations are globally diversified, with solid presence in emerging markets. There is plenty of cash on the balance sheet to finance acquisitions, but Comtech itself is a likely takeover target for a number of companies. Trading at 5x EBITDA, the upside is 50-60%.
Monday, October 12, 2009
Decoupling trans-Atlantic crude oil markets
(From Steve Maloney at Towers Perrin, steve.maloney@towersperrin.com)
The continued decline of the USD has been an important factor in the equity price rally that began in March. We've seen the effects of USD weakness in other commodities, notably gold and crude oil. Storage is the new international bank with excess oil supply serving as a currency hedge. Clearly, this is no way to run a reserve currency but can be a great opportunity for companies positioned to play it.
The Obama Administration is clearly deploying a weak dollar policy in an attempt to restart the US industrial economy. Deficit spending and low interest rates come at a price. The Fiscal 2009 Federal deficit is at least $1.4 billion and next year looks even worse. According to Bloomberg, the dollar lost over 10% of its value on a trade-weighted basis the past six months, the biggest drop since 1991. Worse, the dollar represents less than 40% of new reserves, down from the 63% 10-year average.
With dollars practically free, the flood of USD dollars is fueling talk about restructuring the world's reserve currencies. Long before the 2010 resets and IMF policy changes, markets are already responding by breakouts in crude oil and gold prices.
Crude oil price dynamics can create interesting inter-market effects as well which reinforce the breakout dynamics.
In the US, one of the more important price benchmarks is West Texas Intermediate (WTI). The WTI market comprises pipeline flows gathered in Midland which may be directed to the US Gulf Coast or to the storage facilities in the vicinity of Cushing, Oklahoma. Flow through Cushing continues up towards refineries and other processing facilities in the Chicago area. In 1983, NYMEX created the WTI contract with delivery in Cushing based, in part, on ready access to US refineries then concentrated in the US Gulf Coast. WTI is considered "sweet" in that it has less than 1% sulfur making the grade ideal as refinery feed for the higher resulting yields. With refineries driving US industrial production in the Midwest and the Gulf Coast, WTI prices were excellent marks for the physical product. As formulas-based trading emerged in 1986, financial markets synchronized with NYMEX and later the commodity markets of ICE and Dubai.
Similarly, Brent crude oil is located on the other side of the Atlantic Basin. Like WTI, Brent is a commingled crude with low sulfur content and ideal as refinery feed used for motor fuel and industrial products. Brent was originally drawn from both the Brent and Ninian systems in the North Sea. As the original Brent field declined, Platts introduced a new price benchmark in 2002 combining Brent with production from the Forties and Oseberg. Ekofisk was added to the mix in 2007. So, when we talk about Brent today, we're really talking about North Sea oil from several sources.
Since both WTI and Brent are sweet crude, one would expect the price spreads across the Atlantic Basin would reflect market coupling, modulated by the cost of freight. Consequently, we would expect WTI to price at a premium to Brent. This premium can erode or go negative due to pipeline interruptions, supply chain constraints, and US refinery outages. Such outages occur during the hurricane season impacting the US Gulf Coast in late-summer and early fall which present spikes when refineries or production is halted.
However, those traditional market dynamics have changed, partly due to shifts in the US physical market, amplified by the decline in US industrial production, and amplified by the collapse of the dollar.
The US physical market changed as a result of interconnection with Canadian products increasing the supply to Cushing. This supply enhancement was driven by the strong US economy of several years ago. As this supply grew ahead of the declining US economy, prices sifted to contango. This shift has been amplified by growing storage capacity in the Cushing vicinity. With storage costing some $1.25-$1.75 per barrel-month, the convenience yield was running in the range of ~50% annualized return for much of the past year.
The Brent market has seen similar dynamics, though without the pipeline and hurricane effects. Like WTI, the price curves are in contango which provides incentives for storing crude ahead of demand. While Cushing saw tank farms expand, Platts reported charters by BP and Shell of very large crude carriers starting a year ago mooring off the UK coast.
As crude prices fell, we also saw spikes in the WTI-Brent spread volatilities. These spikes can be explained, in part, by the disproportionate storage additions at Cushing compared to storage available for Brent. However, the final complication has been the decline in the USD, and falling refinery utilizations (and margins) reflecting the overall collapse of the US industrial economy. For example, US industrial utilizations remain stuck below 70%, compared to the long-term average of 80%. By comparison, lows in previous US recessions were in the range of 75%. These lows are even more pronounced in the Midwest where a substantial portion of Cushing flows were directed. US industrial demand has retreated to levels seen around 2002 or so. Today, Cushing inventories have ranged well above 30 million barrels, compared to inventories in the 2004-2005 period of 15 million to 20 million barrels.
By comparison, European industrial utilization declines lagged US declines. The lagging differential injected volatility and anomalous behavior in the spreads.
Looking ahead, the continued weakness of the USD combined with differences in supply chain dynamics between the US and Europe may create arbitrage opportunities in the WTI-Brent spreads that were heretofore episodic. Unless new dynamics emerge, the increased volatility combined with this weakness can continue to drive crude oil into storage ahead of production needs. As long as the industrial economy and the USD remains weak, storage will serve as an attractive currency hedge. But, with increased demand, there may not be as much letup in price pressures.
In my next blog, I'll talk about the effects of recent developments on traditional spreads between natural gas and crude oil markets.
Stephen Maloney
Managing Consultant, Risk and Financial Services
Towers Perrin
steve.maloney@towersperrin.com
The continued decline of the USD has been an important factor in the equity price rally that began in March. We've seen the effects of USD weakness in other commodities, notably gold and crude oil. Storage is the new international bank with excess oil supply serving as a currency hedge. Clearly, this is no way to run a reserve currency but can be a great opportunity for companies positioned to play it.
The Obama Administration is clearly deploying a weak dollar policy in an attempt to restart the US industrial economy. Deficit spending and low interest rates come at a price. The Fiscal 2009 Federal deficit is at least $1.4 billion and next year looks even worse. According to Bloomberg, the dollar lost over 10% of its value on a trade-weighted basis the past six months, the biggest drop since 1991. Worse, the dollar represents less than 40% of new reserves, down from the 63% 10-year average.
With dollars practically free, the flood of USD dollars is fueling talk about restructuring the world's reserve currencies. Long before the 2010 resets and IMF policy changes, markets are already responding by breakouts in crude oil and gold prices.
Crude oil price dynamics can create interesting inter-market effects as well which reinforce the breakout dynamics.
In the US, one of the more important price benchmarks is West Texas Intermediate (WTI). The WTI market comprises pipeline flows gathered in Midland which may be directed to the US Gulf Coast or to the storage facilities in the vicinity of Cushing, Oklahoma. Flow through Cushing continues up towards refineries and other processing facilities in the Chicago area. In 1983, NYMEX created the WTI contract with delivery in Cushing based, in part, on ready access to US refineries then concentrated in the US Gulf Coast. WTI is considered "sweet" in that it has less than 1% sulfur making the grade ideal as refinery feed for the higher resulting yields. With refineries driving US industrial production in the Midwest and the Gulf Coast, WTI prices were excellent marks for the physical product. As formulas-based trading emerged in 1986, financial markets synchronized with NYMEX and later the commodity markets of ICE and Dubai.
Similarly, Brent crude oil is located on the other side of the Atlantic Basin. Like WTI, Brent is a commingled crude with low sulfur content and ideal as refinery feed used for motor fuel and industrial products. Brent was originally drawn from both the Brent and Ninian systems in the North Sea. As the original Brent field declined, Platts introduced a new price benchmark in 2002 combining Brent with production from the Forties and Oseberg. Ekofisk was added to the mix in 2007. So, when we talk about Brent today, we're really talking about North Sea oil from several sources.
Since both WTI and Brent are sweet crude, one would expect the price spreads across the Atlantic Basin would reflect market coupling, modulated by the cost of freight. Consequently, we would expect WTI to price at a premium to Brent. This premium can erode or go negative due to pipeline interruptions, supply chain constraints, and US refinery outages. Such outages occur during the hurricane season impacting the US Gulf Coast in late-summer and early fall which present spikes when refineries or production is halted.
However, those traditional market dynamics have changed, partly due to shifts in the US physical market, amplified by the decline in US industrial production, and amplified by the collapse of the dollar.
The US physical market changed as a result of interconnection with Canadian products increasing the supply to Cushing. This supply enhancement was driven by the strong US economy of several years ago. As this supply grew ahead of the declining US economy, prices sifted to contango. This shift has been amplified by growing storage capacity in the Cushing vicinity. With storage costing some $1.25-$1.75 per barrel-month, the convenience yield was running in the range of ~50% annualized return for much of the past year.
The Brent market has seen similar dynamics, though without the pipeline and hurricane effects. Like WTI, the price curves are in contango which provides incentives for storing crude ahead of demand. While Cushing saw tank farms expand, Platts reported charters by BP and Shell of very large crude carriers starting a year ago mooring off the UK coast.
As crude prices fell, we also saw spikes in the WTI-Brent spread volatilities. These spikes can be explained, in part, by the disproportionate storage additions at Cushing compared to storage available for Brent. However, the final complication has been the decline in the USD, and falling refinery utilizations (and margins) reflecting the overall collapse of the US industrial economy. For example, US industrial utilizations remain stuck below 70%, compared to the long-term average of 80%. By comparison, lows in previous US recessions were in the range of 75%. These lows are even more pronounced in the Midwest where a substantial portion of Cushing flows were directed. US industrial demand has retreated to levels seen around 2002 or so. Today, Cushing inventories have ranged well above 30 million barrels, compared to inventories in the 2004-2005 period of 15 million to 20 million barrels.
By comparison, European industrial utilization declines lagged US declines. The lagging differential injected volatility and anomalous behavior in the spreads.
Looking ahead, the continued weakness of the USD combined with differences in supply chain dynamics between the US and Europe may create arbitrage opportunities in the WTI-Brent spreads that were heretofore episodic. Unless new dynamics emerge, the increased volatility combined with this weakness can continue to drive crude oil into storage ahead of production needs. As long as the industrial economy and the USD remains weak, storage will serve as an attractive currency hedge. But, with increased demand, there may not be as much letup in price pressures.
In my next blog, I'll talk about the effects of recent developments on traditional spreads between natural gas and crude oil markets.
Stephen Maloney
Managing Consultant, Risk and Financial Services
Towers Perrin
steve.maloney@towersperrin.com
Friday, October 9, 2009
Talbots: The Street Underestimates Turnaround
Our Boston presenter highlights Talbot's (TLB: NYSE) margin improvement initiatives under the new management team as the reason to be more confident about the company's prospects. TLB has seen a complete change at the top, which has resulted in refocusing of efforts on the company's core woman business. Strong financial backing on the part of Aeon, a majority shareholder, ensures TLB will have sufficient liquidity. The stock has just been upgraded, but the Street is still underestimating Talbots' recovery potential. TLB has been running, but there is more upside left, possibly 100%+ from the current $11 level.
Thursday, October 8, 2009
Seasonal hiring will be spotty
Craig Johnson, the Chair of our Consumer Community, believes that seasonal hiring among retailers will be down overall but healthier in a few segments.
He believes the stores that will do the best, and those that will hire more seasonal workers, will be some of the discount players like T.J. Maxx, Ross, Aeropostale and Kohl's. Also adding payroll will be Toys R Us, which is installing seasonal stores in storefronts recently vacated due to the recession.
Craig believes that retailers across all segments will not hire as many workers as they have in the past. He sees retailers finding new ways that their current staff can be more productive. The most obvious method will be for management to increase their staff's hours. Current part-time workers are expected to see the biggest increases.
He believes the stores that will do the best, and those that will hire more seasonal workers, will be some of the discount players like T.J. Maxx, Ross, Aeropostale and Kohl's. Also adding payroll will be Toys R Us, which is installing seasonal stores in storefronts recently vacated due to the recession.
Craig believes that retailers across all segments will not hire as many workers as they have in the past. He sees retailers finding new ways that their current staff can be more productive. The most obvious method will be for management to increase their staff's hours. Current part-time workers are expected to see the biggest increases.
Wednesday, October 7, 2009
Retail Review
Today we have a roundtable with some great thoughtleaders in retail. Travelling the last few days with Chris Lee former SR VP with Forever 21 its apparent the trade down in retail is going to be a prevalent issue this Christmas. Chris likes TJ Maxx and other brand players that compete at the lower end like Forever 21 . But its not just loyalty he cites the fact that some stores he thinks are looking at reallocating space as the consumer shows any move up in buying and also looks for foreign players to come in and take advantage of the dollar and cheap real estate to acquire properties , possibly in bulk and in partnership with big retailers rather than the REITS. Look at Sears, Walmart, or even a Macy's to take space and create some kind of store within a store concept.
Tuesday, October 6, 2009
BLC is still a Buy
Our presenter still likes Belo Corp (NYSE: BLC, $5.39), despite an impressive move from $2.02, where the name was recommended back in June. He is adding to his holding. The stock was beaten down on concerns the company may not survive, but investors are feeling more comfortable about Belo's ability to service its debt. The key catalysts for Belo will be mid-term elections next year, Winter Olympics, and a pickup in auto advertising, which contributes 25% of local ad spend. Easier comps should also help. The presenter believes the stock might have another $4-5 of upside left
Black Rock's ETFs
Black Rock's acquisition of IShares has implications for the investment management industry. With this purchase, BLK's AUM mix shifts to about 50/50 active/passive. Given that trading is a diseconomy of scale in the investment management business, this mix allows BLK's growth to continue with a smaller impact from this impediment. Cynically, it might be argued that as a firm grows, there's a risk its results become more average, and that passive management will earn better returns for the firm and its clients. But I won't make that argument. BLK clearly expects that ETFs will be used more broadly in the implementation of investment strategies. I was involved in the design of the first ETF at State Street two decades ago. At the time we thought ETFs were an improvement on many aspects of mutual funds. We also thought the wrap account business would offer benefits to retail investors. Finally, the ETF business has developed enough diversity and complexity where there is probably room for an expansion management activity far beyond strategic asset allocation. IShares has been pushing on the 401(k) market, but there is really little penetration of the large end of the market by ETFs. There has always been this fear that too much passive management will affect the price discovery mechanism for stocks. For any given stock, active managers over time should be the marginal pricers, but as more of the stock is tied up in passive portfolios one would expect more market impact from the trading of a position of a given size. This might cause more valuation discrepancies for active managers to take advantage of. Finally, this acquisition may have an effect on the AUM mix of Merrill brokers, with BLK's ETFs possibly gaining share at the expense of other players.
Thursday, October 1, 2009
Knight Capital Grabbing Share from Rivals
Knight Capital Group (NITE: Nasdaq) is another small cap name from our recent idea forum. The company has seen its trading volumes jump dramatically in recent months and with retail coming back to market the prospects look bright. NITE offers the best trade execution at the lowest available price. The firm has gained share and is now moving into Europe and Asia. The presenter thinks the stock can move to high $20's from $21 currently, based on earnings and comparison to peers.
Boston Idea Forum
Talbots was brought up today as a company in transition that if they simply finish closing what they can and execute some of their other initiatives could be returing near historic margins. Outlet store concept could help make up lost revenues and within two years have an impact as store base expected to get to near 100 stores.
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