DGAP-News: Silvia Quandt&Cie. AG, Merchant&Investment Banking: 2010 mid-year review
ID: 220414
01.07.2010 10:49
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Silvia Quandt Research GmbH
Bernhard Eschweiler
eschweiler@silviaquandt.de
+49 69 95 92 90 93 51
www.silviaquandt.de
Strong momentum versus uncertainty
Estimates for German growth in 2010 are being revised up. The latest
example is the Kiel Institute for World Economics (IfW), which raised its
2010 growth forecast from 1.2% to 2.1%. At the same time, markets and
economists are getting more concerned about 2011, fearing that fiscal
tightening in most OECD countries will stall growth. The IfW, for example,
cut its German growth forecast for 2011 from 1.8% to 1.2%.
The Silvia Quandt view was from the beginning of the year that the German
recovery would gather momentum in 2010. If at all, the forecast has to be
slightly trimmed (from 2.6% to 2.4%) because the rebound was delayed by one
quarter. For 2011, Silvia Quandt forecasts continued solid growth. The
impact of fiscal tightening should be less than feared and partly offset by
very accommodative monetary conditions, stronger corporate and labor market
fundamentals as well as ongoing strong growth in emerging markets.
The economic outlook bodes well for a favorable market environment.
Short-term interest rates will stay close to zero and long-term government
bond yields are likely to fall further. The Euro will be soft, especially
versus emerging market currencies. Earnings estimates have been revised
up, but with the consensus outlook getting more pessimistic the potential
for upside surprises increases. Against this background and very low bond
yields German stocks are cheap. The missing link is confidence, which is
not helped by the ongoing uncertainties surrounding the Euro. Still,
positive growth and earnings news will help the market. Exporters and
companies with overseas activities are a clear buy. Yet, consumer stocks
may surprise more given the expected pick-up in domestic demand. Financial
stocks still face problems, but insurance companies, especially
re-insurers, should show strong operational performance.
Second-quarter surge to show more legs
The upward revisions of 2010 consensus growth forecasts for Germany have
more to do with putting together the facts than vision. After a sluggish
performance around the turn of the year, industrial production (IP) surged
going into spring. In April, IP was already 3.7% above the first quarter
average. Moreover, the simultaneous surge in orders (orders lead
production by two months) suggests that IP rose 5% in the second quarter as
a whole. Even if all other sectors of the economy stayed flat, which is
unlikely, this would imply real GDP growth of 1.5% (6% annualized) between
the first quarter and the second.
The size of the second quarter surge is unlikely to be repeated, but it
probably has more legs than widely expected. Inventories, which had been
rebuilt in the second half of 2009, are running low again. Furthermore,
some sectors, most notably car producers, face order backlogs and are
having to run extra shifts to catch up with demand. Thus, third-quarter
growth is unlikely to show negative payback for the second-quarter surge,
but will probably extend the positive momentum.
Better fundamentals for 2011
The bigger question, however, is what will happen going into 2011? Silvia
Quandt believes that concerns over the impact of fiscal tightening are
overdone.
- First, while the government's overall consolidation program for the
next four years seems large, the measures for the first year (2011) are
small, worth less than 0.5% of GDP, and may not get fully implemented.
- Second, the ECB will stay accommodative while fiscal policy in Europe
is tightening (especially outside of Germany) and inflation remains
absent. Interest rate hikes are unlikely over the forecast horizon.
If at all, the ECB will cut rates to make its intentions clear and
venture further into quantitative easing.
- Third, the corporate sector has recovered exceptionally well from the
crisis, with profits climbing back to pre-recession levels. Combined
with rising sales, this bodes well for new investments and hiring. In
a recent survey, 86% and 80% of companies reported that they would hold
or increase investment and employment respectively.
- Fourth, labor market fundamentals have improved much faster. The
economic recovery clearly sparked the labor market turnaround.
However, corporates' willingness to hire also demonstrates their
confidence in growth as well as their own health. Germans are not big
spenders, but rising employment will undoubtedly help consumption.
- Fifth, prospects for exports are likely to remain favorable in 2011.
True, fiscal austerity will clip demand from the rest of Europe and, to
some extent, other OECD countries. On the other hand, growth prospects
in emerging markets are set to stay bright. If at all, the problems
there will be too much rather than too little. Policymakers are
starting to pull the brakes, but very gently as they increasingly
recognize that they cannot rely on OECD countries for future growth
(see China). Germany is well positioned to benefit from this scenario,
especially if the Euro stays soft, which seems most likely.
Putting it all together, the Silvia Quandt forecast calls for 2.1% growth
in 2011. This is a tad lower than the 2.4% growth estimate for 2010, but
well above consensus forecasts, which are currently around 1.6% and likely
to move lower. The main drivers of growth are expected to be investment
(0.8% growth contribution), private consumption (0.6% growth contribution)
and trade (0.5% growth contribution).
Low bond yields and a soft Euro
The economic and policy outlook is positive for the market environment.
The combination of fiscal consolidation and
accommodative monetary policy means that long-term government bond yields
will be well supported. For banks, the carry game is still one of the best
ways to generate low-risk income, which will be needed to restore balance
sheet health. Ten-year German government bond yields, for example, are
expected to dip below 2% over the forecast horizon.
Fiscal tightening and easy monetary conditions also mean a softer currency.
The Euro has limited downside versus the Dollar from current levels since
the US is likely to run a similar policy mix. Negative political news
concerning Europe could lead to a temporary move toward parity. Otherwise,
the trading range is likely to be between 1.15 to 1.30 USD/EUR. On a
trade-weighted basis, however, the Euro is likely to trade softer,
especially since China restarted its liberalization policy, which should
lead to a broader strengthening of emerging markets' currencies.
More good news for equities
Better than expected economic growth, low interest rates and a soft Euro
bode well for equities. At the start of the year, we argued that corporate
earnings would be stronger. At that time, DAX 2010 EPS consensus estimates
stood at 455 points, up 29% year-on-year. Still, consensus forecasts
underestimated the earnings momentum. DAX 2010 EPS estimates stand now at
598 points. Hence, while the DAX remained almost unchanged for the year,
earnings estimates rose by 31%. Not only had the analysts underestimated
the growth potential. In a recent survey by the Handelsblatt, 60% of
corporate leaders replied that the first half of 2010 developed better than
anticipated. The better performance of aggregate earnings also reflects
the fact that the DAX is less geared towards the financial sector than
other major European indices. The market cap of financials is about two
thirds of that of industrials in the DAX, while it is more than four times
in the UK.
Earnings momentum to lead to more trust
The positive 2010 earnings figures result from a higher-than-expected 2009
base, strong order intake in Q4 2009, which turned into sales and profits
in Q1/Q2 2010 and continuous improvements in competitiveness as well as
product and market strategies. Germany produces goods, which are in global
demand. The car industry is a good example of the combination of branding
and cost efficient production. This mix allows the industry to perform
successfully against the competition in fast growing economies.
These developments not only secure 2010 earnings estimates, but will also
improve trust in 2011 estimates, currently at 680 DAX points. High
earnings momentum and increasing confidence in turn should lead to higher
valuations. The DAX trades at just 10.3 times 2010 earnings and 9 times
2011profits - reflecting an implicit untypically high risk premium
investors take into consideration when investing in equities. In stark
contrast, bond investors appear to expect record low risk in sovereign
bonds, with Bunds trading at a bond market P/E (inverse yield) of 38.5
times. This mismatch is largely the result of equity investors
capitulating in 2009: insurers paired equity holdings, trustees cut equity
exposure and individual investors favoured passive investment strategies,
if any at all.
The Silvia Quandt view of further downside for bond yields implies earnings
yield ratios (EYR) of 26% for 2010 and 23.4% for 2011. This stands against
a long-term average of more than 60%. The high risk aversion appears to be
unsustainable. However, critics of the EYR model highlight that current
interest rates are a result of monetary actions (i.e. central banks
purchase programs) rather than market preferences.
Comparing equity market valuations with BBB bond yields would be more
appropriate, as both instruments are fed by the same corporate
profitability. Interest payments, however, are paid out of EBIT. EPS or
dividends reflect net earnings profitability. The latter could rise
significantly, while interests on bonds remain unchanged. In any case, both
investment vehicles should yield almost the same: current BBB bond spreads
are 548 bps over 5- year bond rates of 1,75%, suggesting a P/E of 13.8
times, or 10.4 times after-tax earnings. This would lead to a DAX level of
6,625 (trailing 12 months earnings) or 7,275 on 2011 earnings. Performance
potential for broader indices (HDAX) is similar, for the MDAX slightly
lower.
These estimates are based on today's risk aversion, which appears to be
elevated and should decline in the coming quarters. The upcoming regulatory
changes initiated by the G20 nations (>90% of global GDP) would, we
believe, provide more transparency in the financial sphere, which leads to
less uncertainty. Initial effects are expected in lower BBB bond spreads,
followed by increasing appetite for equities.
Sector performance to vary
- In financials, banks might recover from their weak performance. G20
indications suggest less capital requirements than feared, while stock
exchanges should benefit from more 'traffic' onto their derivative
platforms. Insurers should continue to focus on operational excellence,
with re-insurers potentially in a better position than direct insurers.
The real estate sector might benefit most from an opening of a
securitisation market. The latter might be a 'side-effect' from more
transparency.
- German exporters should continue to perform well. The Euro exchange
rate seems to develop into an additional 'stimulus package'. This
appears not to be
fully priced in today's markets. Automobiles and industrial stocks
outperformed the DAX by a threefold, while chemicals underperformed.
- Consumer related stocks already reflected the better than anticipated
employment scenario in Germany and outperformed the DAX, despite
widespread fears of declining consumer demand and higher savings. With
employers more likely to hire than fire, the fear will disappear.
German Christmas sales might be good: consumer/retail stocks typically
achieve 4/5 of their annual profits in the final quarter.
- Utilities in Germany underperformed the broader indices significantly
since the Lehman debacle. Lately, they were target for potential
additional tax and fee burden. Also, they are involved in the weaker
CEE countries. All this, however, is unlikely to justify a 20% discount
to current DAX valuation and an 18% under-performance year-to-date.
- Technology and software stocks outperformed the DAX, similar to
industrial shares. However, this does not include renewable energy
stocks, which carry a high weight in the TECDAX and pulled this index
lower. Despite the rise, renewables appear to be still attractive,
benefiting also from renewed M&A activities.
What can go wrong?
While earnings levels are stable, earnings momentum is set to weaken. If
there were already a reflection of the earnings momentum in current share
prices, we would worry. The overall macro-economic picture also suggests a
stabilisation of current growth estimates.
A source of concern, however, remains on the political side: The G20
nations need to find a common ground of understanding in terms of
regulation, control and cooperation. Key risks for the German economy are
newly emerging trade barriers. Some points of concern might be found in the
G20 statement, which request a more 'balanced' economic development in
China and Germany. As mentioned before, German exports are a function of
demand - mainly in those countries, which request a more balanced growth
(the US wants to double exports in the future to boost employment).
A further uncertainty lies in governments' needs for new income sources,
i.e. higher taxation. If introduced just in Germany, it would create risks
to P/E based valuations and could impair dividend payments (as indicated by
the German utilities on the back of the so-called 'nuke fuel tax'). Given
current valuations, it seems that these concerns are more than fully priced
in.
Aside of these 'eco-political' risks, uncertainty might re-emerge, if the
current coalitions finds it impossible to continue with its work. A
political vacuum in the latter half of the year would - we believe - impair
investment sentiment.
Next triggers
The DAX outperformed major European indices. We expect this trend to
continue in the 2nd half of the year, but with a lower margin. The main
reason is that the financial sector should recover some of its losses in
the next months. This sector is more significant in indices outside of
Germany. Trigger could be the partial repayment of state funds, both in
Germany (Aareal bank started already) and in Europe.
German stocks should benefit from the Q2/H1 2010 reporting season, which
should quantify the positive surveys of the IFO and ZEW institutes.
Companies might lift their 2010 guidance at that time, giving investors
more comfort to re-invest funds into equities. Asset based sectors might be
in the focus of this investor segment. First indications of such moves
might emerge after the summer break and ahead of the November G20 financial
summit.
Note: the macro view was written by Bernhard Eschweiler, senior economic
advisor, and the equity strategy was written by Ralph Groenemeyer, head of
research.
Disclaimer
This analysis was prepared by Bernhard Eschweiler, Senior Economic Advisor,
and Ralf Groenemeyer, Head of Research , and was first published 1. July
2010, Silvia Quandt Research GmbH, Grüneburgweg 18, 60322 Frankfurt is
responsible for its preparation. German Regulatory Authority: Bundesanstalt
für Finanzdienstleistungsaufsicht (BaFin), Graurheindorfer Str. 108, 53117
Bonn and Lurgiallee 12, 60439 Frankfurt.
Company disclosures
Article 34b of the German Securities Trading Act (Wertpapierhandelsgesetz)
in combination with the German regulation concerning the analysis of
financial instruments (Finanzanalyseverordnung) requires an enterprise
preparing a securities analysis to point out possible conflicts of interest
with respect to the company or companies that are the subject of the
analysis. A conflict of interest is presumed to exist, in particular, if an
enterprise preparing a security analysis:
(a) holds more than 5 % of the share capital of the company or companies
analysed;
(b) has lead managed or co-lead managed a public offering of the
securities of the company or companies in the previous 12 months;
(c) has provided investment banking services for the company or companies
analysed during the last 12 months for which a compensation has been or
will be paid;
(d) is serving as a liquidity provider for the company's securities by
issuing buy and sell orders;
(e) is party to an agreement with the company or companies that is the
subject of the analysis relating to the production of the recommendation;
(f) or the analyst covering the issue has other significant financial
interests with respect to the company or companies that are the subject of
this analysis, for example holding a seat on the company's boards.
In this respective analysis the following of the above-mentioned conflicts
of interests exist: none
Silvia Quandt Research GmbH, Silvia Quandt&Cie. AG, and its affiliated
companies regularly hold shares of the analysed company or companies in
their trading portfolios. The views expressed in this analysis reflect the
personal views of the analyst about the subject securities or issuers. No
part of the analyst's compensation was, is or will be directly or
indirectly tied to the specific recommendations or views expressed in this
analysis. It has not been determined in advance whether and at what
intervals this report will be updated.
Equity Recommendation Definitions Silvia Quandt Research GmbH analysts rate
the shares of the companies they cover on an absolute basis using a 6 -
12-month target price. 'Buys' assume an upside of more than 20 % from the
current price during the following 6 - 12-months. These securities are
expected to out-perform their respective sector indices. Securities with an
expected under-performance to their respective sector index are rated
'avoids'. Securities where the current share price is within a 5 % range of
the sector performance are rated 'neutral'. Securities prices used in this
report are closing prices of the day before publication unless a different
date is stated. With regard to unlisted securities median market prices are
used based on various important broker sources (OTC-Market).
Disclaimer This publication has been prepared and published by Silvia
Quandt Research GmbH, a subsidiary of Silvia Quandt&Cie. AG. This
publication is intended solely for distribution to professional and
business customers of Silvia Quandt&Cie. AG. It is not intended to be
distributed to private investors or private customers.
Any information in this report is based on data obtained from publicly
available information and sources considered to be reliable, but no
representations or guarantees are made by Silvia Quandt Research GmbH with
regard to the accuracy or completeness of the data or information contained
in this report. The opinions and estimates contained herein constitute our
best judgement at this date and time, and are subject to change without
notice. Prior to this publication, the analysis has not been communicated
to the analysed companies and changed subsequently. This report is for
information purposes only; it is not intended to be and should not be
construed as a recommendation, offer or solicitation to acquire, or dispose
of, any of the securities mentioned in this report. In compliance with
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affiliates may have access from a business relationship with the issuer.
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an analysis of the securities and is therefore not included in this report.
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and/or clients may conduct or may have conducted transactions for their own
account or for the account of other parties with respect to the securities
mentioned in this report or related investments before the recipient has
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GmbH or its affiliates, its executives, managers and employees may hold
shares or positions, possibly even short sale positions, in securities
mentioned in this report or in related investments. Silvia Quandt&Cie. AG
in particular may provide banking or other advisory services to interested
parties. Neither Silvia Quandt Research GmbH, Silvia Quandt&Cie. AG or
its affiliates nor any of its officers, shareholders or employees accept
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referred to herein may involve significant risk, are not necessarily
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herein may fluctuate and/or be affected by changes in exchange rates. Past
performance is not indicative of future results. Investors should make
their own investment decisions without relying on this publication. Only
investors with sufficient knowledge and experience in financial matters to
evaluate the merits and risks should consider an investment in any issuer
or market discussed herein and other persons should not take any action on
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Specific notices of possible conflicts of interest with respect to issuers
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investors). Neither this publication nor any copy of it may be taken or
transmitted into the United States of America or distributed, directly or
indirectly, in the United States of America.
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