Equity Structured Products and Warrants This material has been produced by RBS sales and trading staff and should not be considered independent. The Round Up 15 April 2010Issue No. 311 The Round Up is a comprehensive daily note produced by the RBS Warrants team providing an overview of market movements along with quality ideas for warrant traders and investors. EquitiesMove Last % Move Range Volume ASX 200 +43.1 4994.7 +0.9% u.c to +45 $5.4 bn(A) SPI - yesterday +30.0 5035.0 +0.6% -9 to +32 3,601(L) Dow Jones +103.7 11123.1 +0.9% +1 to +106 Avg S&P 500 +13.4 1210.7 +1.1% +1 to +13 Avg Nasdaq +38.9 2504.9 +1.6% +14 to +39 Avg FTSE +34.6 5796.3 +0.6% u.c to +51 Low CommoditiesMove Last % Today % Past Month Oil-WTI spot +1.94 85.99 +2.3% +5.8% Gold Spot +0.40 1155.75 +0.0% +4.3% Nickel (LME) +40.57 1194.68 +3.5% +21.5% Aluminium (LME) +1.18 110.19 +1.1% +8.9% Copper (LME) +2.26 359.11 +0.6% +6.8% Zinc (LME) +3.31 110.10 +3.1% +5.2% Silver -0.01 18.45 -0.1% +7.8% Sugar +0.55 17.53 +3.2% -10.9%Global Market Action Scoreboard, commentary Aussie Market Action SPI Comment, Events & Dividends News Corp. (NWSKZJ) MINI Trading Buy - 2Q result drives higher guidance Equinox (EQNKZA) MINI Trading Buy – Favoured copper playQBE (QBEKZM) MINI Trading Buy – Valuation looks compellingAustralian Strategy Loan growth to stay on the mat
0.1%andYoY1.1%vs1.2%.TheFedBeigeBookshowedeconomicactivityincreasedinallbut1ofthe12districtsandBusinessInventorieswere0.5%vs0.4%expected. Financials -JP's,up4.1%,reportedstrongnumbersovernightandtoppedtheDow.BoAwas2ndbestontheDowup3.9%whilstontheS&P100Citiwasthemostactivelytradedandbestup6.7%withRegionsFinancialbouncingback5.8%.Goldmansrose3.2%andMSadded2.2%despitesomequeriesoverrealestateinvestments. Tech -Intelclimbed3.3%afterreportingstrongnumbersposttheclosetheprevioussessionwhilstApplerose1.3%aftersayingiPaddemandwashigherthanexpected.MicronTech,thebiggestUSchipmakerjumped5%andTexasInstruments,the2ndbiggestmaker,climbed4%. United Kingdom & Europe Commentary
UK Banks -BankswerestrongertodayasJPMorganreportedbetterthanexpectedresultsleadingtheglobalfinancialsintotheblack.BarclaysandStandardCharteredthestandoutsfinishingup2.9%and2.8%respectively.
MINI Trading Buy: News Corp (NWSKZJ) – 2Q result drives higher guidance
News Corp reported a strong 2Q10 result and raised FY10 guidance. We expect the focus to now turn to FY11 earnings,with RBS Research FY11F EPS of US$1.13 c13% ahead of Bloomberg consensus of US$1.00. We see the return to ad
growth at the WSJ as a key positive for sentiment towards News Corp's newspaper assets.RBS Research has a $20.87 Target Price on NWS which represents a healthy 17.4% upside. Get Long NWS withNWSKZJ.
Source: IRESS
2Q10 result strong and upgrade to guidance; raise FY11F EPS to US$1.13
2Q10 operating profit of US$1,212m was above RBS Research’s US$983m forecast and up 44% on the pcp. 2Q10normalised EPS of US$0.25 was ahead of RBS Research’s US$0.20 forecast (consensus US$0.20). The companydoubled its FY10 op profit growth guidance to ‘low 20’s’ from ‘high single to low double digit’. We believe this guidanceremains conservative in light of the 26% growth already delivered in the first half and pcp’s getting easier. RBS has raisedFY10F op profit to US$4,340m or 26% growth (vs +20% previously).Cable continues to power ahead
Cable had another very strong quarter, with op profit up 35%. RBS raise FY10F cable op income 9% to US$2.23bn.Cable makes up over 50% of News Corp’s op profit and is the key driver of earnings growth. Filmed earnings were alsostrong, with very strong Avatar profits still to come.
WSJ delivers advertising growth – a key positive for sentiment A key positive was an improved Newspaper performance, with the Wall Street Journal print ad revenue up 5%. This setsthe WSJ apart from its US newspaper peers, which continue to report big declines in ad revenues. TV op profit stayedweak, but stations returned to revenue growth (+6% in 2Q10) and News Corp said 3Q10 station revenue was up 18-19%.Sky Italia was the main disappointment, with subscribers falling 63,000.
RBS MINIs over NWS Security ExPrc Stop Loss CP ConvFac Delta Description
MINI Trading Buy: Equinox (EQNKZA) – Wet season almost over, still favoured copper play Now that the wet season is almost over and guidance is still intact, we expect the market to become more comfortablewith the outlook. We believe EQN continues to have the greatest expansion potential of the copper stocks; maintain Buy.Buy Long MINI EQNKZA for short term trade to $4.80 or hold for the long term.
Source: IRESS
Result below forecast on debt refinancing chargesThe reported net loss of US$183m was skewed by a non-cash mark-to-market hedge loss of US$329m. The underlyingprofit of US$38m (ex non-cash derivative loss) was lower than RBS Research expected, mostly due to higher financingcosts related to refinancing the Lumwana project debt (not forecast). Cash costs of US$1.53/lb in 4Q09 were also aboveRBS estimate of US$1.35/lb owing to additional expenses preparing for the wet season.
2010 guidance maintained at 135ktThe company has reconfirmed its guidance of 135kt at a cash cost of US$1.35/lb for CY10, which factors in lowerproduction in 1Q10 due to the wet season impacts. Management did not elaborate on how much production was down,only noting the wet season had been neither good nor bad. The worst of the rains are expected to stop over the next fewweeks.
On track to hit 20Mtpa in 2H10
Ramp up to a nameplate capacity of 20Mtpa is on track for 2H10. The company expects to continue the ramp up processover the next two years, with the aim of achieving a 24Mtpa rate within18 months or reaching full production. We aremore conservative and don’t expect a consistent throughput of 24Mtpa until 1Q13. An expansion beyond 20Mtpa in thenear term may also require opening up of the Chimiwungo pit, which could incur additional capex.
Investment view – wet season uncertainty evaporatingEQN continues to have the greatest expansion potential of the copper stocks RBS cover, in our view, and trades at asignificant discount to our NPV. We see this discount correcting as production results improve through 2010 andexpansion plans move closer to reality. RBS Research maintain Buy call on a 12-month view. There is still some risk that1Q production may disappoint the market, but long term we believe the stock should rerate significantly once the ramp upis complete.
RBS MINIs over EQN
Security ExPrc Stop Loss CP ConvFac Delta Description
MINI Trading Buy: QBE Insurance (QBEKZM) – Valuation looks compelling QBE has now fallen 13% since its FY09 result compared to a rise in the All Ords of 3%. We believe that thisreaction is overdone and with the stock offering a 6.5% dividend yield we switch to a Buy (from Hold). The main
catalyst for QBE remains rising interest rates but further acquisitions should also boost growth. We maintainour Buy call.
Get long QBE with QBEKZM for a rebound to RBS Target Price of $23.50.
Source: IRESS
Share price – 16% underperformance since the resultQBE has underperformed the ASX All Ordinaries by 16% over the past week with the stock now down 13% since the daybefore the result compared to the market which has risen 3%. Last year’s result delivered a similar reaction, although thiswas compounded by the global financial crisis (GFC), with the stock falling 21% in the two weeks after its full year resultversus the market down 3%. In the month after, QBE bounced back 26% against a market recovery of 16%. Sounderperformance of 18% was quickly followed by outperformance of 10%.
Valuation looks more compelling – PE, PER and dividend yieldQBE is trading below its historical PE and PER since listing. On a PE basis, the stock is on 11x Bloomberg consensusone-year forward estimates, only slightly behind its long-term average of 12x. However, on a PE relative basis the stock istrading on 78% versus its longterm average of 88%. More importantly, the dividend yield is now 6.5% compared to its
historical yield of 4.0%, which we believe should provide good support for the stock.
Catalysts – rate rises and further acquisitionsThe main catalyst for QBE appears to be rising global interest rates, which we anticipate will start coming through in2H10. Management has calculated that a 1% rise in global interest rates would add A$316m to FY10 NPAT. Otherpotential catalysts include further acquisitions, a softer AUD and evidence of a hardening in overseas insurance markets.
Investment view – switch to a Buy recommendation (from Hold)In our view, QBE's track record in underwriting and acquisition execution remains strong. Furthermore, the companyretains a strong balance sheet with cA$1bn of debt capacity available for acquisitions. The valuation appeal is just toostrong and so we switch to a Buy recommendation (from Hold).QBE last traded $22.13, BUY QBEKZM for 1-for-1 upside towards RBS Target Price of $23.50
RBS MINIs over QBE Security ExPrc Stop Loss CP ConvFac Delta Description
RBS Round Up Corner: Loan growth to stay on the mat
We believe consensus forecasts for Australian lending growth are overdone. In our view, housing loan growth
will be constrained by structural drags and a strong rebound for business lending will not emerge until 2013.We have cut our total lending growth for the majors to 6% in FY11-12F from 7.5% and 8.5%.
Loan growth to disappoint in this cycleWe think Bloomberg consensus forecasts for Australian lending growth are overdone. Australia’s system total lendinggrowth fell from 16.3% in December 2007 to just 0.8% in November 2009. Many forecasters see a decent cyclicalrebound for lending growth as Australia and New Zealand emerge from their slumps. Our view is that housing loan growthwill be constrained by structural drags over the long term and that business lending’s cyclical rebound will take severalyears to gain traction.
Housing loans – great party but the hangover loomsWe are cautious on the long-term outlook for housing loan growth. Despite a sharp drop in interest rates in 2008-09 andbig support from government handouts, Australian system housing loan growth looks likely to peak at just 8.5% in thenext few months. In previous decades, this would have been a cyclical low growth rate. The recent decline in new loanapprovals suggests that growth in outstanding loans will slide to the 5-7% range in 2011/12. High household leveragesupports our cautious view.
Business loans – sluggish recovery for company loan appetiteWe forecast the 2010-13 business loan recovery will be drawn out, despite a good outlook for business investment. In theearly 1990s and early 2000s cycles, Australian business lending only regained 10% growth three years after each trough.If this holds in the next few years, business lending growth won’t reach double-digit figures again until end-2012.Australia’s relatively high business debt-to-GDP ratio should also restrain loan growth.
Our major bank cash EPS forecasts fall by 1% for FY11 and 2% for FY12We have cut our forecast for system total lending growth for FY11 and FY12 to 6% from 7.5% and 8.5%. We doubt themajor banks can offset sluggish system loan growth by grabbing market share. We have cut our cash EPS forecasts forthe major banks by about 1% for FY11 and about 2% in FY12. The depressed loan growth for Australia and New Zealandsupports our preference for ANZ, as its Asian expansion strategy will decrease its reliance on the local market.
Consensus asset growth assumptions are too high, in our viewAustralia experienced a lending boom from 2003 to 2008 where loan growth easily outstripped nominal GDP. The boomwas led initially by housing with business lending taking over in late 2006. Annual lending growth in the previous cyclepeaked in December 2007 as the global crisis took hold.
With the economy set to rebound in 2010, most sell-side bank earnings forecasts assume a solid recovery in lending
growth. The average current sell-side estimates suggest total lending growth for the big four Australian banks to reach 8%in FY11 and 9% in FY12. We also note the banks also expect sizeable recoveries in Australian lending growth.
Our analysis suggests that these forecasts are overly bullish, and conclude that total lending growth for the majors willhold steady at roughly 6% in FY11 and FY12.
RBS Research have conducted a top-down review of macroeconomic factors that will influencehome and business lending over the medium term, and also a bottom-up review of recent trendsin approvals and paydowns.
RBS Research have arrived at a total lending growth rate of 5.9% in FY11 and FY12. Based on RBS Research forecasts,to arrive at a total lending growth rate of roughly 8-10% (consensus) we would need to see a substantial improvement inbusiness lending of +6-10% above RBS Research forecasts, or a jump in home lending growth of 2-4% above forecast.
As a result RBS Research have made downward revisions to lending growth assumptions for the major banks. RBSResearch have downgraded cash EPS forecasts by ~1% for the majors in FY11 and 2% in FY12. As such, RBSResearch valuation and target prices have been trimmed by roughly 1.7% on average.
The information contained in this report has been prepared by RBS Equities (Australia) Limited (“RBS Equities”) (ABN 84 002 768 701) (AFS Licence No 240530) and hasbeen taken from sources believed to be reliable. RBS Equities does not make representations that the information is accurate or complete and it should not be relied on assuch. Any opinions, forecasts and estimates contained in this report are the views of RBS Equities at the date of issue and are subject to change without notice. RBSEquities and its affiliated companies may make markets in the securities discussed. RBS Equities, its affiliated companies and their employees from time to time may holdshares, options, rights and warrants on any issue contained in this report and may, as principal or agent, sell such securities. RBS Equities may have acted as manager orco-manager of a public offering of any such securities in the past three years. RBS Equities’ affiliates may provide, or have provided banking services or corporate finance tothe companies referred to in this report. The knowledge of affiliates concerning such services may not be reflected in this report. This report does not constitute an offer orinvitation to purchase any securities and should not be relied upon in connection with any contract or commitment. RBS Equities, in preparing this report, has not taken intoaccount an individual client’s investment objectives, financial situation or particular needs. Before a client makes an investment decision, a client should consider whether any
advice contained in this report is appropriate in light of their particular investment needs, objectives and financial circumstances. It is unreasonable to rely on anyrecommendation without first having consulted with your advisor for a personal securities recommendation. The information contained in this report is general advice only.RBS Equities, its officers, directors, employees and agents accept no liability for any loss or damage arising out of the use of all or any part of the information contained in thisreport. This Information is not intended for distribution to, or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to locallaw or regulation. If you are located outside Australia and use this Information, you are responsible for compliance with applicable local laws and regulation. This report maynot be taken or distributed, directly or indirectly into the United States, or to any U.S. person (as defined in Regulation S under the U.S. Securities Act of 1993, as amended).
The warrants contained in this report are issued by RBS Group (Australia) Pty Limited (“RBS”) (ABN 78 000 862 797, AFS Licence No. 247013). The Product DisclosureStatements relating to these warrants are available upon request from RBS Equities or on our website www.rbs.com.au/warrants
RBS Group (Australia) Pty Limited is not an Authorised Deposit-Taking Institution and these products do not form deposits or other liabilities of The Royal Bank of ScotlandN.V. or The Royal Bank of Scotland plc. The Royal Bank of Scotland plc does not guarantee the obligations of RBS Group (Australia) Pty Limited.
Security – refers to the code ascribed to the warrant, ExDate – refers to the date on which the warrant expires or is reset, ExPrc – refers to the exercise price, or second
instalment payment, CP – tells you whether the warrant is a call or a put, ConvFac – the conversion factor of the warrant which tells you how many warrants you need toexercise in order to take possession of 1 share, Delta – tells you how much the warrant will move for a 1c move in the underlying security, Description – Tells you the typeof warrant.
All charts taken from IRESS unless indicated otherwise
