Thursday, 11th March 2010

City Insider

Positive data and consolidation

08 Mar 2010, by Galvan Research and Trading, the UKs leading CFD advisors.

Perhaps it could be said that now that the UK is no longer officially in recession, a blip to the downside for the UK housing market won’t be quite as painful as it would have been this time last year. Indeed, the easiest explanation for the 1.5% decline in prices for February would be to say that it was largely due to the inclement weather conditions of much of the winter combined with a reticent mortgage approval policy from the banking sector. Otherwise it was a largely positive week for UK economic data with multiyear highs from the service sector, manufacturing and consumer confidence. But as if to cap any irrational exuberance, we were reminded by Capital Economics that the likely effect of the Bank of England’s £200bn Quantitative Easing program was to add between 2 – 3 % to GDP. This week’s interest rate / QE decision of no change reminded us that for the time being at least no further stimulus is likely.

We have grown accustomed to the highly volatile mining sector dominating the FTSE100 leaderboard, and the week was fairly typical in this respect. It helped that the biggest percentage share price gainer Kazakhmys (KAZ) reported a copper output number well ahead of expectations, up to 320,000 tonnes last year versus a forecast 300,000. Another big fundamental plus was the near $1bn reduction in net debt to $628m. It was a similar story of an output spike at silver miner Fresnillo (FRES), something that helped profits for 2009 more than double over the previous year. Fellow miners Xstrata (XTA) and Anglo American (AAL) were both boosted by the rise in metals prices, with the former also underpinned by a pay deal reached at Xstrata Nickel. Switching sectors and chip designer ARM Holdings (ARM) found itself on the right side of an upgrade from RBS and a price target hike from Goldman Sachs. The former highlighted the boom in smartphones, while the latter noted ARM’s dollar earning credentials at a time when Sterling is plunging. In contrast to HSBC’s update this week, at Standard Chartered (STAN) the only real issue was that of executive bonuses given a record profit before taxation in 2009 up 13% to $5.15bn, with bad debt at $2.1bn versus $1.8bn. The wholesale banking division led the group, plus the far-east focussed bank said 2010 has started well. Financials were in recovery mode led by Schroders (SDR) as the fund manager reported a massive rise in net inflows with investors seeking alternatives to rock bottom savings rates. Total profit before tax and after exceptional items was up 12% to £137.5m, although there were still some relics of the bear market left over in terms of lower net revenues and reduced performance fees. It was also noticeable that last month’s laggards interdealer broker ICAP (IAP) and hedge fund manager Man Group (EMG) both saw their share prices bounce back sharply with the FTSE100. A standalone winner was temporary power solutions group Aggreko (AGK), which moved back into bulls good books as profit before tax jumped 28.4% to £244.0m helped by foreign exchange factors. The group was also able to raise guidance on 2010 earnings.

While the RBS (RBS) / ABN Amro deal will go down in history as one of the worst ever corporate takeovers, it perhaps should not be forgotten that RBS / Natwest was one of the more daring coups, with RBS the smaller company of the two. Of course the insurance sector now has Resolution (RSL) to mop up the underperformers, but certainly for Prudential, paying $35bn for AIG (AIG) Asian assets is akin to David slaying Goliath. There are obvious reasons why it could be a good deal – we are near the bottom of the cycle and AIG is hardly in a great bargaining position. What is more, emerging Asian markets are the current great hope for the near future. The big negative is clearly the cost, something which equates to even more than the Pru’s market capitalisation (£15bn) before the deal was announced. Now this value is closer to £12bn, but the fall in the share price could have been a lot worse, and given that the stock market does not seem to have a problem with rights issues of £10bn or much more, the funding may not be a problem either in current conditions. But few would deny that this is not an exceptionally daring deal and that there is little margin of error in terms of the timeline of events from this point on.

On the downside Any company that comes up with a plan for $35bn acquisition has to expect some collateral damage to the share price at some point, and this was the case for Prudential (PRU) this week, with a 12% decline making it the worse performer on the FTSE100. In fact, on a very strong week for leading shares there were only seven shares down on the week, four of which were insurers and two were banks. Prudential appeared to drag down insurance sector consolidator Resolution (RSL) as well as Royal & Sun Alliance (RSA). Resolution shares fell on speculation that as the 111th largest UK company it could be relegated from the FTSE100 on the March 10th reshuffle. RSA was on offer after it estimated liabilities from the Chilean earthquake could amount to as much as £30m, while elsewhere motor insurance group Admiral (ADM) was undermined by competiton / pricing fears which offset a record profits performance for the year. HSBC (HSBA) reported a roughly in line profits number of just over $7bn for 2009, but with impairments over $1bn higher than had been expected. Motor insurance group HSBC dragged down Lloyds Banking (LLOY) as it had also reported higher customer debts last week.

On the commodities front, there was a slight blip to the upside for copper in the wake of the massive Chile earthquake, but apparently the mining areas were not in the affected zones. But with the red metal already near the top of its recent ranges, it needs very little in the way of a fundamental prod to take this market higher.

On the FX front, the week started with a bang for Sterling, and one with severe downside pressure. This was because the penny suddenly dropped that a May General Election was imminent and that there could be a hung Parliament, exactly the wrong scenario for a consistent / coherent approach to dealing with the fiscal issues facing the nation. The low for Sterling / Dollar was below $1.48, with the performance against Euro arguably even worse. Even after the initial overshoot on the downside towards 92p, the cross still settled well over the 90p mark
The Galvan Research Team has this week picked out water utility Northumbrian (RSL) as a buy. We originally picked out Northumbrian as a buy in November 2009 after the Ofwat price recommendations, and we said then we believed Northumbrian Water would be the most proactive of the water utilities in regard to maximising opportunities and improving efficiencies. This remains our view, and the shares are a buy. Elsewhere, we are sellers of Capita (CPI). The disappointing trading update and weak growth guidance in the recent statement makes the shares at 724p look rather exposed toward the upper end of the year trading range. With General Election uncertainty and pressure on margins from reduced customer spend, Galvan Research expect the near term share price performance to be weak at best. Sell.

You can read our in depth view on this stock and a raft of research to help with your trading by visiting the Galvan website.

City Insider - a weekly column from Galvan Research & Trading, the UKs leading CFD advisors. Galvan’s research coverage focuses on Equities but also extends to Indices, Commodities and Currencies.

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