8/3/2019 Us Best Ideas for 2011 http://slidepdf.com/reader/full/us-best-ideas-for-2011 1/28 U.S. Best Ideas for 2011 RBC's U.S. Equity Analysts and Strategists are pleased to provide the 2011 release of our "Best Ideas" portfolio. Over the past two years, the absolute total return of RBC's Best Ideas' selections have handily beat the return of the S&P 500 by over 1,900 basis points* each year, and we hope to repeat this success in 2011. Each senior equity analyst** is asked to pick a single stock in their coverage that they strongly believe will provide a superior absolute total return over the next 12 months. Fifty- two companies have been selected and described by our team, preceded by thoughts, insights and predictions from RBC's Equity Strategist, Technical and Quantitative Strategists', and ou U.S. Chief Economist. As always, we encourage our clients to reach out to the analysts identified in this report to continue the discussion on their picks and sectors. To all of our clients around the globe: Happy Holidays and Best Wishes to You and Your Families In 2011! Table of Contents Summary of U.S. Best Ideas for 2011 ..................................................................................... U.S. Equity Strategy — Key Themes...................................................................................... U.S. Technical Research ......................................................................................................... U.S. Quantitative Research ..................................................................................................... U.S. Market Economics .......................................................................................................... Best Ideas Equity Selections: Communications, Media, Entertainment, & Technology........................................................... Consumer .................................................................................................................................1 Diversified Industrials..............................................................................................................1 Energy......................................................................................................................................1 Financial Institutions................................................................................................................2 Health Care ..............................................................................................................................2 Metals and Mining ...................................................................................................................2 REITs .......................................................................................................................................2 RBC Capital Markets, LLC December 9, 2010 This report is priced as of market close December 7, 2010 EST. All values in U.S. dollars unless otherwise noted. For Required Non-U.S. Analyst and Conflicts Disclosures, please see page 26. * Returns are based on an equal weighted portfolio priced on the dates of original publication respectively. The 2009 Best Ideas measures a full one year, whereas the 2010 Best Ideas return is from December 22, 2009 through December 7, 2010. These returns are inclusive of dividends and are in comparison to the returns of the S&P500 over the same periods. ** Each analyst must have six or more companies under coverage to be included. Please refer to our published research posted on RBC Insight for a complete analysis of the companies mentioned in this report.
RBC's U.S. Equity Analysts and Strategists are pleased to provide the 2011 release of our"Best Ideas" portfolio. Over the past two years, the absolute total return of RBC's Best Ideas'selections have handily beat the return of the S&P 500 by over 1,900 basis points* each year,and we hope to repeat this success in 2011.
Each senior equity analyst** is asked to pick a single stock in their coverage that theystrongly believe will provide a superior absolute total return over the next 12 months. Fifty-two companies have been selected and described by our team, preceded by thoughts, insights
and predictions from RBC's Equity Strategist, Technical and Quantitative Strategists', and ouU.S. Chief Economist. As always, we encourage our clients to reach out to the analystsidentified in this report to continue the discussion on their picks and sectors.
To all of our clients around the globe: Happy Holidays and Best Wishes to You and YourFamilies In 2011!
Table of Contents
Summary of U.S. Best Ideas for 2011 .....................................................................................
U.S. Equity Strategy — Key Themes......................................................................................
U.S. Technical Research .........................................................................................................
U.S. Quantitative Research .....................................................................................................
U.S. Market Economics ..........................................................................................................
This report is priced as of marketclose December 7, 2010 EST.
All values in U.S. dollars unlessotherwise noted.
For Required Non-U.S. Analyst andConflicts Disclosures, please seepage 26.
* Returns are based on an equalweighted portfolio priced on the datesof original publication respectively.The 2009 Best Ideas measures a full oneyear, whereas the 2010 Best Ideas returnis from December 22, 2009 throughDecember 7, 2010. These returns are
inclusive of dividends and are incomparison to the returns of the S&P500over the same periods.
** Each analyst must have six or morecompanies under coverage to beincluded.
Please refer to our published researchposted on RBC Insight for a completeanalysis of the companies mentioned inthis report.
All U.S.-based analysts in this list are employed by RBC Capital Markets, LLC.Others are as follows: * RBC Dominion Securities Inc. ** Royal Bank of Canada Europe Limited
Priced at market close EST on December 7, 2010. All prices in US$ unless otherwise noted. Ratings: TP - Top Pick, O – Outperform, SP - Sector Perform, U – UnderperformRisk Qualifiers: Avg - Average Risk, AA - Above Average Risk, Spec – Speculative
2
Summary of U.S. Best Ideas for 2011
Company Name Ticker Price Rating Risk Analyst Sector Page
Alliance Data Systems Corp. ADS 67.88 O AA Perlin, Daniel R. Business Services & Financial Technology 8
Annaly Capital Management, Inc. NLY 18.12 TP Avg Arnold, Jason Mortgage REITs 24
B/E Aerospace, Inc. BEAV 38.36 TP Avg Bondada, R. Rama Aerospace & Defense 15
Baxter International Inc. BAX 49.43 O Avg Novarro, Glenn Medical Supplies/Diversified Healthcare 21
Barrick Gold Corporation ABX 54.16 O Avg Walker, Stephen Golds 23Best Buy Co., Inc. BBY 41.59 TP Avg Ciccarelli, Scot Hardline Retail 13
BreitBurn Energy Partners L.P. BBEP 20.10 O AA Potter, Chad MLPs 18
Broadcom Corporation BRCM 45.31 O AA Sanganeria, Mahesh Semiconductors 8
Cablevision Systems Corporation CVC 33.23 O AA Vineyard, Ryan Cable 8
Cameco Corporation CCJ 37.93 O AA Phillips, H. Fraser Diversified Metals & Mining 23
Caterpillar Inc. CAT 90.35 O Avg Weber, Seth Machinery 15
Chevron Corporation CVX 86.30 TP Avg Rousseau, Jacques Integrated Oil & Gas 18
CIENA Corporation CIEN 15.74 O Spec Sue, Mark Communications Equipment 9
Clean Harbors, Inc. CLH 76.47 TP AA Sullivan, Jamie Industrial Equipment & Services 15
Compellent Technologies, Inc. CML 33.53 O Spec Daryanani, Amit Enterprise Systems & Hardware 9
Constant Contact, Inc. CTCT 29.00 O Spec Breza, Robert Application Software 9
CoreSite Realty Corporation COR 13.38 O Avg Rodgers, Dave REITs 24
CSX Corp CSX 64.11 O Avg Spracklin, Walter Railroads 16
Cubist Pharmaceuticals, Inc. CBST 21.62 O AA Kantor, Jason Biotechnology 21
Dendreon Corporation DNDN 37.36 O AA Yee, Michael Biotechnology 21Domtar Corporation UFS 81.81 TP AA Quinn, Paul Paper & Forest Products 16
EZchip Semiconductor Ltd. EZCH 28.90 O Spec Meron, Daniel Israeli Technology 9
FirstMerit Corporation FMER 18.44 O AA Arfstrom, Jon Commercial Banks 20
Forest Oil Corporation FST 36.04 O AA Hanold, Scott Oil & Gas Exploration & Production 18
General Cable Corporation BGC 34.40 O AA Bush, Stuart Energy Technology 10
GenOn Energy Inc. GEN 3.62 O AA Johong, Lasan Independent Power Producer 18
Gen-Probe Incorporated GPRO 54.31 O Avg Bonello, Bill Diagnostic Products and Research Tools 22
Harley-Davidson HOG 33.59 O AA Aaron, Ed Leisure Products 13
Internap Network Services Corp. INAP 5.59 O AA Atkin, Jonathan Telecommunication Services 10
Juniper Networks, Inc. JNPR 34.08 O AA Sluymer, Robert Technical Research 5
LaSalle Hotel Properties LHO 25.38 TP Avg Salinsky, Mike REITs 24
National Oilwell Varco, Inc. NOV 62.57 O Avg Hallead, Kurt Oil & Gas Equipment & Services 19
Newell Rubbermaid Inc. NWL 17.52 O AA Gere, Jason Household and Personal Care 13
Oil States International, Inc. OIS 62.62 O AA Marchon, Victor Oil & Gas Equipment & Services 19Owens Corning OC 28.00 O Avg Wetenhall, Robert C. Building Products 14
Phillips-Van Heusen Corporation PVH 68.80 O Avg Tubin, Howard Apparel Retail 14
Plains Exploration PXP 30.77 O AA Mariani, Leo Oil & Gas Exploration & Production 19
U.S. Equity Strategy — Key ThemesMyles Zyblock, CFA (Chief Institutional Strategist & Director of Capital Markets Research);(416) 416-842-7805, [email protected]
• Maintain above-benchmark weightings in equities;
• Raise exposure to cyclical sectors and groups;
• Place more emphasis on stock selection.
Leading domestic and global macro data have turned up since the summer and argue for anongoing economic and earnings recovery. Exhibit 1, LHS, shows that the business cycle has neverbeen more important for equity market performance than it now is. At the same time, our top-down model suggests that S&P 500 earnings per share will probably finish the year near $81,expanding to $88 for calendar 2011. Fundamental progress, when combined with “reflationary”monetary policy settings (Exhibit 1, RHS), probably carries share prices higher through comingquarters. We recommend that investors maintain a positive strategic bias towards the equitymarket and tactically add exposure on price pullbacks.
Exhibit 1: Correlation of Business Cycle with S&P 500 Returns; “Reflation” Benefits Equities
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
1.0
Jan-58 Jan-68 Jan-78 Jan-88 Jan-98 Jan-08
Rolling 10-yr Correlation: S&P 500 Returns and RBC Business Cycle Indicator*
Long-run Correlation
* Based on the ISM Mfg and Non-Mfg Indices and Initial Unemployment Claims.Source: RBC Capital Markets, ISM, Dept. of Labor, Haver Analytics
Meanwhile, incoming macroeconomic signals support broader cyclical sector leadership. Amongthe cyclicals, we are currently overweight Energy and Technology and believe that it is anopportune time to add exposure to Industrials. Corporate spending on machinery and equipment isstrong and is likely to remain so given low capital costs, solid cash flow growth and an investmentcycle that is barely keeping up with the pace of depreciation (Exhibit 2, LHS). It is noteworthythat Chinese Industrials have turned up because this has typically offered a four-month leadingwindow into the performance of S&P 500 Industrials (Exhibit 2, RHS).
Exhibit 2: Capex Cycle Barely Keeping up with Depreciation; China Pointing the Way for S&P 500 Industrials
Finally, we believe that stock-picking will make a noticeable comeback in the year ahead. “Low-quality” leadership, valuation spread compression and the macro “risk on” and “risk off” mentalityhave been some of the bigger performance drivers during this cyclical bull market. Through thisperiod, performance correlations have remained high and some investors have gone so far as tosay that bottom-up analysis is ‘dead’. In our opinion, the shelf life on performance homogeneity islimited by the fact that, beyond a certain minimum timeframe after a major market or economiclow, company-specific fundamental divergences become more apparent.
Exhibit 3: Correlation between Stocks & Bond Y ields; Performance Correlation within the Stock Market
Average Correlation of S&P 500 Stocks vs. Index (60-Days Trailing)
Source: RBC Capital Markets Quantitative Research
Don’t read us wrong. Macro factors will continue to play a big role in the return-generatingprocess, but we also think these are becoming marginally less important. The correlation betweenbroad asset classes has loosened just a bit, providing an early clue that investors have shifted awayfrom their near universal macro focus. As one example, we’d note that the positive correlationbetween bond yields and stock prices has declined from 0.83 to 0.08 between July 2010 and thepresent (Exhibit 3, LHS). This has coincided with the decline in the performance correlationbetween stocks within the market from 0.79 to 0.58 (Exhibit 3, RHS). Taken together, these datatell us that systemic factors are being awarded incrementally less weight in the decision tree as theeconomic and market cycle has matured.
Bottom line: Stay long stocks, add exposure to cyclicals and pay special attention to theportfolio’s bottom-up attributes.
Technology effectively sat out the last bull cycle between 2003-2007 but is increasingly showing technical evidence of becoming a leadership theme through 2012. There are two main technical points supporting this view.
• A New Equity Market Cycle Is Underway - Technical evidence continues to build that a new market cycle developedbetween July and September 2010, broadly favouring Cyclicals. Our expectation is that equities will move higher intoQ1/Q2 2012 based on a broad range of macro barometers bottoming following a 12-15 month correction.
• Technology Is Emerging After 5+ Years of Technical Purgatory - We’ve Seen This Movie Before. Technology stocksare broadly showing evidence of early leadership in this new upside move developing in Cyclicals. The improvement issignificant given the sector effectively traded sideways in broad real price ranges for 5+ years. See Chart 1. Historically,groups that emerge from multi-year trading ranges or ‘long bases’ with positive relative performance often stage multi-year bull cycles as illustrated by POT during the 2003 upside re-acceleration. See chart 2. Technology appears to befollowing its post-bubble consolidation into 2010.
• JNPR Is Illustrative of Many Long Base Profiles in Technology - JNPR is illustrated as one of the long-base profilesthat appear to be on the verge of emerging on the upside. Supporting the bullish longer-term technical outlook for thesestocks is that their relative performance is leading to the upside. See Chart 3. CHKP, our Best Idea for 2010, is featured asan example of the many Technology stocks re-accelerating longer-term. See Chart 4.
Exhibit 1:Technology shouldlead during thiscycle. Multi-yearreal price tradingrange poised toresolve to theupside, but moreimportantly, relativeperformance isleading to theupside on a capweighted and on anequally weighted
Exhibit 3: JNPR is agood example of thebroader themedeveloping inTechnology, as it ispoised to break outof a multi-yeartrading range.Relativeperformance to theS&P 500 is leading tothe upside.
Exhibit 2: POT realprice profile isillustrative of the 5-year consolidationsthat developedbetween 1998-2003for many Industrials,Materials andEnergy. The keytechnical data pointsupporting the realprice break-outs isthat relativeperformance wasleading to theupside.
U.S. Quantitative ResearchRonald Dottin (Analyst); (212) 858-7484, [email protected]
Focus On Metrics and Not LabelsWe think the theme for 2011 will be to avoid the trappings of traditional labels. Stocks that are
generally considered defensive or growth have decoupled from the quantitative metrics that definethese styles. For example, “defensive sectors” like healthcare and staples have beenunderrepresented on our quality composite. Technology stocks are significantly underrepresentedon our beta metrics, while energy and utilities are overrepresented on growth metrics like capex tosales.
The output of our screens may be highlighting some fundamental shifts within the equity market –mature industries are experiencing cyclical growth and newly established companies are enteringthe mature phase of their business life cycle. We think the key to outperformance for manystylistic managers in 2011 will be to hold their nose and buy the unconventional names that arespringing up on the models that define their disciplines.
We continue to believe that sales-oriented factors will be on the forefront of investor’s minds inthe year to come. The upward surprise in earnings has largely come on the back of easy comps andproductivity gains. The signs that we’ve approached the final stages for this type of bottom-linegrowth propelling stock prices are clearly visible. Our previous study found that investors arediscounting the magnitude of the effect that current earnings growth has on stock performance byalmost 50% when compared to the last time S&P 500 quarterly EPS entered the $20+ range
Sales growth and upside surprises in sales expectations have generally been harder to find over thelast couple of years. We think, however, that investors are likely to use the top line to gauge thepulse of business and economic activity over the next 12 months, more so than earnings. Thesignificance of the growth in final sales has steadily picked up over the past few months and isnow one of the better performing indicators in our library of factors. The metric looks at totaltrailing 12-month sales minus account receivables on a year-over-year basis.
However, there are a few names that have ranked consistently within the top quintile of this metricbut have significantly underperformed the broader market. AKS, X, PWR, CHK, MU, V, HPQ,and MSFT all fall into this category and we would expect them to retrace a good portion of their
performance losses provided that they can continue to remain within the top 20% of S&P 500stocks on our final sales growth metric.
U.S. Market EconomicsTom Porcelli (Chief U.S. Economist); (212) 618-7788; [email protected]
Some Good News for 2011The Fed is getting their wish. Over recent months several Fed officials have highlighted that
monetary policy can only do so much in reviving economic activity. It bordered on Fed officialspractically pleading for some form of fiscal stimulus to supplement Quantitative Easing (QE). Itseems they may have received their wish. It was recently announced that politicians will attempt topush through a series of extensions and fresh tax cuts to stimulate economic growth.
The most powerful of the measures is a new proposal to cut Social Security taxes for one year. If passed, we estimate the impact would boost our scenario for 2011 GDP growth by 1ppt, to about3%. The bulk of this jolt comes from consumer spending. This assumes consumer spendingpatterns remain steady, where they spend about 90% of disposable income. So nearly all of the$120bn in new stimulus from the reduction in the Social Security tax would make its way back into the economy. Of course, in the absence of this legislation getting passed, the profile wouldlook rather different.
Even before this tax proposal, however, we were becoming slightly more upbeat about thebackdrop. We have been encouraged by the pick up in the pace of small business hiring recently,something that was lacking through most of 2010. Keep in mind that small business typicallyleads the recovery in employment.
Small business has been all but absent from what has been a very modest recovery thus far. In fact,one of the reasons growth has been so weak in the immediate aftermath of the recession (around3% compared to 7% following other severe post-war recessions) is that small business has notparticipated.
The new legislation should help turn the sector around. What it does is provide clarity in terms of the tax structure for the next two years and a significant injection to disposable income whichshould help juice sales. Uncertainty with regards to legislation and weak sales are their twobiggest concerns and the reason for what was until recently an utter lack of hiring.
The small business sector accounts for about half of economic activity and thus kick-starting this
space should add yet another layer of support to the broad economy.
Upside to the consensus EPS estimate seems plausible in 2011 and should provide the necessarycatalyst to drive the stock higher over the next 12-months. Although there remain several puts andtakes to ADS’s possible FY11 results, we have identified $1.04 in net additions to FY10 core EPSto arrive a potential FY11 core EPS of $7.04. This is roughly $0.24 above the current consensusand could drive core average EPS upside surprise of ~$0.05 per quarter next year. Even if the full$0.24 per share potential is not fully recognized, it still increases our conviction that upside toestimates is achievable. Key ingredients for potential upside to 2011 estimates include:
Guidance for 2010 = $5.70
+ $0.30 (“air pocket” from the timing of late fees vs. statement fees)
We expect the company to continue to outgrow earnings relative to peers. Above-average revenuegrowth, we believe, will come from (1) market share gains in multiple sub-segments, (2) exposureto several high growth sub-segments, and (3) entry into new markets through in-house productdevelopment as well as acquisitions. We expect the company to leverage its size to negotiatefavourable wafer processing, packaging and testing prices and to stay ahead of peers inmanufacturing technology node transition, resulting in better gross margins compared to peers.The company will continue to amortize its R&D dollars over a broad product portfolio giving it asignificant edge over peers.
CVC is a best-in-class operator in an industry we believe will continue to enjoy secular tailwinds.We’d point to the following elements that make CVC uniquely attractive versus peers and offerpotential upside to shares: 1) best track record in cable, with industry-leading operational andfinancial metrics; 2) initiatives to reduce already industry-low capital intensity; 3) a fully upgradedplant; 4) a tightly knit geographic concentration; 5) highest income subscriber demographics in itsfootprint; 6) ample room to grow the company’s share repurchase program and; 7) recent steps(intention to sell the content business) transitioning to a pure-play cable operator.
Ciena stands to benefit from the early stages of a product cycle as its new Core Director FS and5400 series are receiving initial orders. As it relates to the Nortel acquisition, we believe thatCiena has made meaningful progress in portfolio integration, network management, operationsand IT as well as improving the supply chain. With much of the integration work behind it, Ciena
is shifting its focus to cross selling the expanded product offering. Improved execution andincreased scale may smooth out the earnings allowing for improved visibility. Historically, Cienahas seen strong sequential growth following a major product cycle and we expect to see a similartrend as the new CoreDirector FS turns into meaningful revenue. Improved execution and anincreased focus on efficiency may further improve the financial model.
Entering a period of easier year-over-year comparables, we expect 2011 to be strong forCompellent due to numerous factors, including: (i) Compellent's mid-November refresh of itshardware and software management platforms; (ii) increasing total addressable market to includethe medium and entry-level, high-end storage area network market due to more robust data
management features; (iii) expansion of go-to-market channel partners due to the storageindustry's recent consolidation, likely resulting in some channel partners defecting to operate withsmaller vendors or the acquiring vendors preferring to push indirect selling efforts through theirexisting partners; and (iv) more deals in the midrange storage market over the coming year, as endusers purchase one of the refreshed midrange storage platforms (i.e., EMC's upcoming CLARiiONand Celerra, NetApp's FAS3200 and FAS6200, and Compellent). From a valuation perspective,we assume an upside enterprise value-to-FTM revenue multiple of 5.0x and a downside multipleof 2.0x depending on the direction of execution relative to Street consensus estimates. Currently,Compellent trades at ~3.9x our assessment of the Street consensus FTM revenue estimate,suggesting slightly positive execution sentiment and ample room for further improvement.
Constant Contact (NASDAQ: CTCT)
Robert Breza (Analyst); (612) 313-1207, [email protected] Contact has maintained its top-tier growth profile and impressive consistency over thepast several years, despite a challenging macro backdrop, as small businesses continue to find itsvalue proposition compelling. We look for that leading growth profile and consistency to persistthrough 2011 as the end market continues to stabilize/improve and more focus is placed on amulti-product growth strategy which should leverage ample cross and up-sell opportunities andincrease overall usage, ARPU and retention across the 415,000+ paying customer base. Morespecifically, Event Marketing should emerge as a more meaningful growth driver as the productgains traction and the company should leverage its position as a trusted marketing partner to rollout social media marketing solutions, which should culminate in the release of a paid SocialMedia product. Finally, a case can be made for the stock being undervalued relative to its peers,trading at 17.5x FY’11E P/CF vs. the On Demand peer group average of 23.9x.
EZchip is our top secular growth idea as its networking chips are set to benefit from booming IPdata traffic which increases the need for high speed processing and ushers in the adoption of merchant silicon at the expense of in-house designs. Indeed, the company secured multiple designwins for the next 5+ years with Cisco, Ericsson, ZTE, Ciena and others, counting 11 of the 14leading networking vendors as its customers.
We believe EZchip revenues may rise by 3-5x in the coming years, with higher earnings growththanks to strong operating leverage. And though quarterly performance may vary on order shifts orcustomer dynamics (like capex changes, Juniper phase-out, slower ramp-up with Cisco etc.), webelieve the long term trajectory is promising and shares are attractive on a 12-month basis.
We believe EZCH numbers have upward bias, and this, along with the expected ramp of next-genNP-4 network processing units in 2H11, may drive multiple expansion; considering the strongoutlook, valuation seems undemanding at 15x unlevered earnings vs. high-growth peers at 21x.
Further out, EZCH may also be a possible M&A target for its technology edge and customer base.
Key risks: Customer concentration and dependency on CSCO, JNPR, ZTE and other keynetworking vendors, positioning at the bottom of the food chain driving vulnerability to inventorycorrections as well as capex trends, competition, macro, technology changes and execution risks.
We believe BGC will benefit as a late cycle industrial play as earnings power ramps fromincreased capacity absorption in 2011, giving investors visibility to peak earnings power of $5+.Signs of wire and cable industry volume recovery signal strong earnings power in 2011/2012 with$1.5B - $2.5B unused top-line capacity at accretive incremental margins when industry utilization
rates move to 80-85% from ~65% in Q310. Commodity inflation helps the top line and thus EPSgrowth but at lower margins amid a low utilization pricing challenge. Solid leverage to renewablesand transmission infrastructure structural growth trends with recent high profile project approvalsin the U.S. provide further support for our outlook. Street estimates are conservative assumingcurrent copper prices; RBC 2011 is $3.15 vs Street $2.73; stock is at 10.8x our 2011 EPS. Switchto average cost inventory accounting reduces the risk of guidance surprise by giving managementmore visibility amid copper volatility. Solid balance sheet and $1B+ available liquidity allowsBGC to pursue accretive acquisitions in strategic geographies at attractive asset pricing.
We believe the following are key catalysts for Internap in 2011: 1) favorable reward/risk profile as
the company trades at a markedly lower multiple vs. peers; and 2) the potential for improvedorganic growth and operating trends in the datacenter and IP business segments. We think thatrecent and continuing bookings strength could drive a return to growth in consolidated and IPservices revenues during the coming few quarters. 3) INAP appears on track to conclude itsproactive churn of lower-margin partner revenues in its datacenter business during 4Q10, with astrong demand pipeline that can replenish these revenues with higher-margin contracts in itscompany-owned facilities. Over time, we believe INAP’s datacenter revenues could return toindustry levels of double-digit growth.
There are few global internet names that are growing revenue north of 50%, have expandingmargins, and trade at below 25x EPS (PCLN is alone in this group). The story for 2011 is similarto 2010: share gains, growth from underpenetrated international hotel markets, and earningsupside potential. The global recovery in the hotel market helps PCLN's model via better uniteconomics from higher ADRs. Margins improve on higher ADR and continued mix shift tohigher-margin international regions.
PCLN already holds the leading footprint in hotel bookings in Europe via booking.com, and asolid position in SE Asia and U.S. with its other brands. The travel industry has shown a reboundin 2H10 across nearly every metric, a trend which is expected to continue in 2011. As theEuropean hotel market is far more fragmented than the U.S., individual relationships with hotel
operators take time to establish. PCLN’s large supply in Europe and considerable headstart on thedemand side (traffic) with consumers gives the company a competitive advantage over thecompetition. Any threat from a Google/ITA merger (only focuses on U.S. airlines) or moves tobring services in-house like AA Direct Connect are expected to have minimal impact, other thanheadline risk.
Investor sentiment remains sceptical, but may improve with rising visibility to next generation,alluring, touch-screen handsets and tablets based off RIM’s updated QNX operating system, alongwith sustained financial strength. These catalysts have the potential to spark investor realizationthat RIM will narrow the perceived competitive gaps and invigorate consumer uptake, whileleveraging significant built-in advantages (50M+ users, 565 carriers in 175+ countries, push'crackberry' messaging experience, efficient network infrastructure, data efficiency) to sustainglobal Smartphone leadership. Risks and challenges remain; the onus is on RIM to execute andshow it can offer a competitive and distinctive user experience over Apple and Android, includingin content and applications, where - while not matching the competition - it needs to showdeveloper momentum and offer a satisfying experience. As well, RIM needs to defend itsEnterprise franchise as businesses open up their networks to competing Smartphones. Upcoming
catalysts include next-gen QNX-based software and hardware expected early 2011 with Flashsupport, superior data efficiency, etc.
We are highlighting tw telecom as our best long idea for 2011. The company provides managednetwork services, specializing in Ethernet and transport data networking, Internet access, local andlong distance voice, voice over Internet Protocol (VoIP) and network security services toenterprise organizations and communications services companies in 75 markets throughout theU.S.
We believe the company’s operating metrics heading into 2011 augur well for financial results.
Current enterprise demand for tw telecom’s services is strong, as year-to-date bookings haveincreased 20% y/y, and demand for Ethernet and VPN services increased 28% in the latest quarter.We believe a growing contribution from enhanced products (i.e. fractional Ethernet) iscontributing to this demand. Based on other underlying operating metrics, such as salesforceproductivity, customer growth and deal size, we believe enterprise demand should remain strongheading into 2011.
Specifically, net customer additions and customer churn are at their best levels since 4Q07, whichwe believe is indicative of tw telecom’s selling success into enterprise customers and fewer SMBcustomer losses (via the 2006 Xspedius acquisition). In addition, we believe the company shouldbe able to maintain and/or improve upon current salesforce productivity, defined as incrementalgross customer additions/sales associate. We estimate that 3Q10 salesforce productivity increasedto 1.52 (vs. 1.30 in 2Q10), and is indicative of an improving enterprise IT spending environment.We estimate the four-year average salesforce productivity ratio to be 1.68 gross customer
adds/sales associate, with a range of 1.18-2.53.Finally, we believe the company is beginning to see a growing contribution of larger revenue dealsin its sales funnel. As such, we believe the company is well positioned for continued strongrevenue, EBITDA and free cash flow growth in 2011. All considered and given the high fixed costnature of tw telecom’s business model, we maintain that greater-than-expected enterprise demandfor the company’s services and products should result in financial outperformance.
We think the following factors could provide upside to Street estimates and lead tooutperformance in VIA.B shares in C2011: 1) aggressive return of capital to shareholders, 2)accelerated path to profitability at EPIX (given the recent Netflix distribution deal) leading tosignificant improvement in the below-the-line “equity in income of investees” line item, 3)
narrowing gap vs. peers on cable networks advertising growth through sustained ratingsimprovement, and 4) overall efficiency in execution at the cable networks leading to meaningfulmargin expansion. Further, Viacom offers both relative and absolute value, trading at just ~11xforward P/E vs. the large-cap media average at ~15x and pure-play cable channel peers closer to~20x – we’d note that over 90% of Viacom’s operating profit is generated from its cable networksbusiness.
Picking one stock for the full year is even more difficult than usual, in our view, since so much of
the expected performance is likely to hinge on whether the economy weakens further (favoringmore defensive stocks like auto part retailers such as O’Reilly, and dollar stores such as DollarTree), or continues to strengthen (which may favor CarMax). However, we believe that Best Buylikely has the best risk/reward in our universe. While we expect sales to weaken in thespring/summer months (which may cause the stock to lag for a portion of the year), we alsobelieve that sales will strengthen towards the holidays, and suspect the stock will react positivelyto those improvements. In addition, we believe that the combination of an inexpensive valuation(roughly 5x our calendar 2011 EBITDA estimate and 11x-12x our calendar 2011 EPS estimate,while the valuations of many other consumer-related stocks have soared), improved capitalallocation (BBY is now aggressively buying back its own stock), and expanding margins from therapid growth in high-margin “customer acquisition” strategies like Best Buy Mobile, shouldenable BBY shares to generate significant gains in 2011.
Harley-Davidson, Inc. (NYSE: HOG)Ed Aaron, CFA (Analyst); (303) 595-1127, [email protected]
We are going back to the well and recommending HOG as our best idea for the secondconsecutive year. The restructuring story has unfolded nicely over the past several quarters, andwe expect this progress to continue. With significant margin improvement opportunity still aheadand U.S. dealer inventories sitting at or near 10-year lows, we believe the company is wellpositioned to capitalize on an eventual demand recovery. While we have not yet seen evidence of a demand inflection, retail trends appear to have stabilized. Meanwhile, a healthy used bike marketserves as an encouraging leading indicator of future new bike demand. Given our view thatestimates and valuation do not reflect expectations for a recovery scenario, we believe any demandimprovement would be incremental to the stock. In a scenario in which demand improves 15%-20% from current depressed levels and restructuring savings are fully realized, we believe Harley
is capable of earning $3.00/share of EPS upon completion of the restructuring.
With a long-term focus on leveraging the portfolio towards faster growth and fueling the growththrough margin expansion and scale synergies, NWL has laid the foundation towards achievingdouble-digit EPS growth over the new few years in our view. NWL shares remain inexpensive,and we believe a higher multiple is warranted given the good growth, especially if the economyrecovers. Top-line organic sales growth should continue to be in the 3-5% range as NWL executeson its strong momentum in all three segments on the strength of new innovation, expandeddistribution, shelf-space gains and international expansion. Good recent trends have been withoutthe aid of the economy, so upside is possible if the economy recovers. NWL continues to make the
right choices with investments and while factors such as commodities remain a wild card,management manages gross margin admirably. Some SG&A leverage is possible as well andwhen taken together, management’s goal of achieving 15% operating margins could happenwithin the next few years. Finally, we believe NWL could look towards lifting its dividend closertowards the payout ratio of its peers.
Robert C. Wetenhall, Jr. (Analyst); (212) 618-3251, [email protected]
We believe that OC currently offers investors the prospect of the best risk-adjusted return in thebuilding products sector for three reasons. First, we think that investors continue to underestimatethe attractive growth profile of the composite solutions business (~35% of sales) which weestimate can grow sales by at least 10% in FY11E due to exposure to recovering demand trends in
emerging markets. Second, we think that price increases in the insulation business (25% of revenues) will support a return to breakeven levels of profitability in that division. In our opinion,many investors remain sceptical that OC will be able to realize any type of price increase at all.We think, however, that the company’s sizable market share will help it achieve at least a portionof its pricing objectives. Third, we think that the roofing business (40% of revenues) willcomfortably sustain operating margins in excess of 20% next year although some investors remainunconvinced. From our perspective, the combination of recovering demand trends and a highdegree of scepticism are positioning OC to exceed low investor expectations.
Phillips-Van Heusen Corporation is one of the world’s leading apparel companies. The company
controls a diverse portfolio of owned and licensed brands including: owned – Calvin Klein,Tommy Hilfiger, Van Heusen, ARROW, and IZOD; and licensed – Geoffrey Beene, Chaps, SeanJohn, and Donald J. Trump. PVH acquired Tommy Hilfiger in 2010 and this deal is expected todouble the company’s revenue base, increase geographic diversity, and bring control over twoleading fashion brands. We believe this opens significant opportunities for revenue growth,synergies, and leverage over the long term. On the fashion side of the business, preppy, classic,and heritage, in our opinion, are where the fashion direction has been moving. This shouldcontinue to benefit Tommy Hilfiger, as well as some core PVH brands including IZOD andARROW. An experienced management team, strong momentum in established brands, andsubstantial growth opportunities make PVH our best idea of 2011.
Sonic Corp (NASDAQ: SONC)
Larry Miller (Analyst); (404) 260-4878, [email protected] in restaurants are rising, something we expect to continue as employment improvesthroughout 2011. In this backdrop, Sonic’s sales should turn positive, particularly as it laps easycomparisons. Stronger sales should lead to a restoration of earnings per share to the $0.90-$1.00range over time and pave the way for a low- to mid-teens stock price. Over the intermediate term,we expect to see commodity inflation, which could aid Sonic as it will improve its pricing power,reduce competitive discounting, and poses little risk to margins since it’s 90% franchised.
B/E Aerospace remains our Top Pick for the smid-cap aerospace and defense sector in 2011. B/E
Aerospace has one of the highest exposures to the continued recovery in commercial aerospace(~80% of 2010E revenues) in our coverage universe. The company's aerospace exposure is about a60/40 split between OEM and aftermarket, both of which we expect to grow substantially in 2011.Although the stock has had a strong run over the past 12 months and enjoys a premium valuationrelative to its peers, we think that the company has the ability to deliver above-average earningsgrowth based on its exposure to growth in widebody production and airline capacity. Furtherenhancing its growth profile is the company’s ability to make accretive bolt-on acquisitions. Wethink, given its growth profile and historical valuation premium along with a bright outlook forwidebody aircraft, which the company is heavily geared towards, B/E Aerospace’s stock priceshould outperform its smid-cap aerospace peers.
Caterpillar, Inc. (NYSE: CAT)
Seth Weber (Analyst); (212) 618-7545, [email protected] catalysts that we expect to drive shares higher include improving demand for CAT’sconstruction machinery, continued strength in mining equipment, and upward revisions toconsensus estimates. We expect demand for CAT’s construction machinery to improve asspending on global infrastructure remains strong, activity in U.S. commercial constructionrecovers, and equipment buyers face declining availability/rising prices for used products. In themeantime, CAT’s mining equipment business should benefit from continued strength in globalcommodity prices/mining capex as well as the integration of the Bucyrus acquisition, where weanticipate CAT will cross-sell the sector’s most comprehensive portfolio to new and existingcustomers. We view the acquisition as providing a bridge to get CAT/investor sentiment closer tothe company’s $8-$10 EPS objective for 2012 (consensus $7.34) while we also see potential formargin upside from the core business, where recent execution has been better than expected; weestimate every 50 basis points of margin upside translates to an additional $0.25 to our 2012 EPS.
CLH is the only end-to-end non-nuclear hazardous waste provider in North America, andmaintains approximately 70% of commercial incineration capacity with 550,000 tons. We like itsposition in this highly regulated market as waste volumes recover, combined with its IndustrialServices segment tapping secular growth opportunities in oil sands and oil/gas shale formations.Guidance for 2011 (5%-8% core growth, 17% EBITDA margins) appears conservative, in ouropinion, with several sources of potential upside particularly on margins as wastevolumes/utilization increase, waste mix improves from chem/manufacturing/pharma end-markets,pricing power is exercised in both environmental and industrial businesses and additional $5million in Eveready acquisition synergies are delivered. CLH is investing capital in growth
opportunities, including oil sands capacity in northern Alberta, early moves into the Bakkenoil/gas formation and another 50,000 tons of incinerator capacity to come online over the next twoto three years. Lastly, we expect a net cash position going into 2011 and its strong track record of accretive M&A offers further upside potential.
Core to our investment thesis on the railroads is the theme of operating leverage, which is builtaround the following key trends: 1) steady pricing; 2) rebounding volumes; and 3) structural costsavings. We see CSX as one of the railroads that is best positioned to capitalize on theseopportunities. First, CSX has reported robust pricing over the past couple of years, at a level that
mostly exceeds its peers. The company expects that same-store pricing will exceed rail inflation inthe longer term, in line with our view, and perhaps represents a bias to the upside of our 3.5% to4% 2011 pricing assumption. In terms of cost-saving initiatives, CSX reported a record operatingratio of 69.1% in the third quarter, representing the first ‘sub-70s’ operating ratio the railroad hasever attained, despite the 10% Y/Y increase in volumes. The company is now targeting a ratio of 65% within five years. We consider the current trends as significant and sustainable given the costsaving the company has achieved so far, and we believe further improvements could result in ahigher earnings base compared to pre-recession levels. Finally, CSX, at a P/E ratio of 13.0x (2011estimates) is currently trading below the group average at 13.8x.
The key catalyst for 2011 is the company’s promise to return the majority of free cash flow toinvestors. We anticipate that Domtar will double the current $1/share dividend and add $300million to the current $150 million share buy back program. This effectively allows the companyto repurchase approximately 10% of its outstanding shares. The continuing U.S. economicrecovery is expected to deliver steady paper earnings in 2011. At the same time, changes to thecompany’s pulp capacity have lowered earnings sensitivity and volatility (less hardwood, morefluff pulp). From a financial perspective, Domtar is trading at inexpensive metrics based on our2011 forecast (EV/EBITDA is currently 3.8x).
We like PCP as our top pick for large cap aerospace & defense in 2011. The fundamentals for
PCP’s later cycle aerospace, power and industrial end markets continue to improve, and thesegenerate ~90% of revenues. When coupled with some of the most effective management in theA&D sector, and an aggressively controlled fixed-cost base, we expect the leverage fromincreased volumes to come in ahead of the targeted 30-35% incremental margins over the nextyear. With an impressive track record of deploying cash, we expect management to continuemaking accretive bolt-on acquisitions, adding to our organic EPS growth projection of 15% perannum over the next two fiscal years. We expect the company to maintain a premium valuationversus its aerospace peers as PCP’s above-average earnings growth and solid execution gathermomentum as the up-cycle progresses.
With the company more than surviving in 2010 despite a significant decline in its FleetManagement Solutions revenue and EBIT contribution, we believe that fundamentals for this unit,primarily the full service lease product line, stabilized in recent months. Following stable butsynthetic (i.e. fuelled by tax-rate changes, share repurchases, etc.) earnings in 1H11, we believeRyder is likely to experience a material improvement in earnings in 2H11 that should last for 24months or longer depending on the strength of a more robust recovery in the U.S. economy versusthe uptick experienced during 2010. We believe there are five catalysts that should drive the stock higher: 1) a material increase in full service lease demand as economic activity further acceleratesand truck capacity tightens; 2) robust demand for commercial rental service should continue in thenear term and augment the full service lease business, again as U.S. economic activity accelerates
and capacity tightens; 3) the fleet maintenance product offering should continue to strengthen asthe average age and miles on the U.S. trucking fleet rise further; 4) rising used equipment pricesshould provide the company with above-average gains on sale as demand for well-maintainedused equipment picks up momentum and available inventory remains limited; and 5) with a statedgoal of a 275% debt to equity target (versus 180% as of 9/30/1010) the company has adequate drypowder for further acquisitions, share repurchases and an increased dividend. We believe thatRyder may be range bound (i.e. mid $40s) in early 2011 until the company provides 2011 earningsguidance and/or experiences an increase in full service leased vehicles. However, once demandaccelerates, we believe the company will see a meaningful jump in earnings growth versus whatwe view as conservative Street expectations. At this point, we believe shares of Ryder are underowned and will see greater interest as the early cycle truckload investors look for a later cyclederivative play. As such, we recommend that investors get into Ryder early, before the companyexperiences the inflection point in its full service leasing business.
Over the past year BBEP has significantly paid down its debt position, settled its lawsuit and
resumed paying its distribution, which has brightened the partnership's outlook. BreitBurn unitscurrently yield more than 7.7% and the partnership has ample distribution coverage, providing theability to steadily increase its distribution for several quarters to come. We see upside optionalityfrom the redeployment of capital raised from the potential monetization of the partnership's125,000 net acres prospective for the burgeoning Collingwood shale, a liquids-rich play inMichigan. Additional upside could come from horizontal oil in Florida, where BBEP’s first wellproduced more than 1,200 barrels of oil per day.
Chevron’s strong share price performance in recent years relative to its peers should continue in2011, in our view, due to its world class upstream assets, solid balance sheet and robust financial
results. In the upstream, Chevron’s net income per barrel of oil equivalent leads the integrated oilpeer group due to its oil-weighted portfolio and low cost structure. As a result of its strong balancesheet, with more cash than debt, Chevron re-started its share repurchase program in 4Q10 and weexpect the company to buy back $4 billion of its shares in 2011. Lastly, the company’s strongupstream results and lower downstream exposure than its peers has allowed Chevron to close thereturn on capital employed (ROCE) gap with ExxonMobil from an average of 9% in 2005-2009,to 3-4% in the coming years, according to our calculations. This improved financial performanceshould narrow the valuation gap between the two companies, in our view, since ExxonMobil stilltrades at a large premium to Chevron (4.8x 2011 EV/EBITDA versus 3.6x 2011 EV/EBITDA).
Forest Oil is our top idea in the E&P space given its exposure to the Granite Wash, strong growthrates, and compelling valuation. The company has rights to 103,000 net acres in the Granite Washplay, providing the most relative leverage for any E&P company to that area. The Granite Washhas become one of the leading plays in the industry since horizontal drilling has unlockedadditional potential. The company’s first 20 wells had average initial production rates of 25-30MMcfe/d with a significant contribution coming from oil and condensates. We think the companyhas over a five-year inventory of high-quality drilling prospects in the Granite Wash. Additionally,FST’s assets in the Haynesville and Nikanassin provide good rates of return even at current lownatural gas prices. Additional upside potential exists in 106,000 acres in the Eagleford Shale and272,000 acres in the Utica Shale. We expect FST to grow production 20+% over the next coupleof years at cash flow levels.
GenOn Energy Inc. (NYSE: GEN)Lasan Johong (Analyst); (212) 428-6462, [email protected]
Having combined with Mirant in December 2010, we believe that GenOn will achieve $150MMin synergy savings right out of the gate. Shortly thereafter, we believe that additional synergysavings will be identified that should propel stock price performance. However, the main eventwill be in the recovery of power demand that we expect should propel earnings and cash flowgrowth, which should be helped by natural gas fundamentals in 2H11 and accelerating into 2012.To illustrate the power of demand, we believe investors need to look no further than 3Q10 resultswhere demand increased 9%, creating a 17% increase in heat rates and a 45% increase in grossprofit.
National Oilwell Varco, Inc. (NYSE: NOV)Kurt Hallead (Analyst); (512) 708-6356, [email protected]
We believe NOV shares will outperform the oil service group in 2011 as all elements of thecompany’s business are expected to accelerate into the pending up-cycle. We believe NOV canapproach prior cycle high EPS in ’12 on rig tech backlog that is half of its 2008 peak and surpassit as new rig orders get booked.
Primary catalysts of the story are expected to be Petroleum Services and Supplies (PSS) operatingleverage, the reacceleration of rig orders and potentially accretive M&A.
1) PSS margins back to 20%. From 2004-2005 the segment averaged annual margins of 21%.The margin bottomed in 2009 at 12.1% and has steadily risen to 15.1% in 3Q10. This shouldcontinue and we are forecasting margins of 17.4% and 20.1% in ‘11/’12 respectively; 2) Rig Technot just about deepwater. The drivers in this segment have become more diverse and will soonbe diluted by FPSOs ($100-150mn max ticket) in addition to rapid growth in demand for frac andcoiled tubing equipment. Adding to this mix are jackups and land rigs; and, 3) M&A: We wouldnot be surprised to see NOV deploy $1-2bn in the next two years. NOV has a strong track record of executing both bolt-on and large landscape-altering transactions. NOV has $2.7bn of cash on its balance sheet and we estimate will generate free cash flow of $1.8bn in ’11.
Niska Natural Gas Storage Partners, L.P. (NYSE: NKA)
TJ Schultz, CFA (Analyst); (512) 708-6385, [email protected] expect the NKA units to outperform the broader midstream MLP universe in 2011. It is ouropinion that natural gas storage will remain strong in 2011, which should benefit NKA. Also, thepartnership’s AECO project is set to come into service below the originally provided budget,which should improve the accretion multiple for the project. Additionally, management hasupdated guidance with increased DCF/EBITDA expectations for 2011. We are expectingdistribution increases in 2011 and beyond based on our increased estimates for the partnership.Finally, the partnership continues to trade at a discount to its peer group and we expect this tocorrect over time.
Oil States International (NYSE: OIS)Victor Marchon (Analyst); 713-292-5368, [email protected]
Our positive view is driven by the company’s attractive business mix and strong execution. Thecompany's oil sands and Offshore Products operations have an element of revenue visibility (termcontracts and backlog), along with growth opportunities; and its North Americandrilling/completion related businesses provide exposure to the positive shift in onshorefundamentals.
We like Plains for its nearly 60% crude weighting, emerging positions in the Granite Wash andEagle Ford, along with its liquidity position post the anticipated sale of the deepwater GOMassets. The pending asset sale is the largest potential catalyst for the stock and should dramaticallyimprove PXP’s balance sheet, with net debt-to-forward EBITDAX going from 3.4x to roughly2.3x. We expect PXP to receive at least $1.5 billion for the deepwater GOM assets, and the move
to more of a focused onshore story should be well received by investors. A potential stock buyback resulting from the sale should also help instill confidence. We believe there is a goodchance that the company’s Granite Wash well results will continue to be a positive catalyst, givenstrong well results to date. Production in the recently acquired Eagle Ford acreage is expected tocome online in late 2010, and we are expecting the play to provide substantial production growthin 2011. With production in California also continuing to grow nicely, we expect PXP to groworganic production by 19% in 2011 and 16% in 2012. We believe the stock is very cheap. At ~$30per share, it trades around 5.4x projected 2011 EBITDAX when the deepwater GOM sale isfactored in, a more than 40% discount to peers at 9.4x. In addition, the stock trades at a discount toNAV of more than 40%, while peers trade at a slight premium.
We believe FirstMerit's management team has properly positioned the company to protectinvestors from further credit deterioration and to take advantage of market share growth
opportunities. In our view, FirstMerit is among the best of the mid cap regional banks positionedto take advantage of such growth opportunities. Our sense is that significant opportunities remainin both Northeast Ohio and Chicago for organic growth through market share movement andpotential line utilization improvement. Additionally, the company remains willing and able to bean active acquirer. Chicago presents the greatest opportunity and we expect to see the companyadd to its current franchise as targets become available. We believe the company will seesignificant revenue growth throughout 2011 as a result of organic growth, market share gains andacquisitions. We view FirstMerit as a bank with a high-quality core franchise and strong earningspower, which should drive solid long-term upside to both book value and share price.Additionally, the shares offer an attractive 3.5% dividend yield.
Earnings in 2011 are expected to increase 70% to $0.85 per share from $0.50 per share in 2010.Normalized earnings should eventually exceed $2.00, in our view. We anticipate credit willimprove throughout 2011, which should be the main driver for earnings growth. We think Websteris a likely acquisition candidate due to its strong CT deposit franchise and could be valued up at to$30 per share or 1.5x in an acquisition.
Led by a shareholder-driven management team, Wells Fargo has a proven ability to consistentlydeliver superior revenue growth from its well-diversified business model and attractive franchisethat now runs coast-to-coast. While acknowledging the challenges of regulatory reform and theweak economy, management still expects to grow revenues 10% annually primarily through
market share gains and increased cross-selling of both its legacy Wells and new Wachoviacustomers. Meanwhile credit continues to improve, and thus we see opportunities for furtherdeclines in provisions and other workout costs. Overall, Wells still has many ways to driveearnings higher, in our view, such that our normalized EPS estimate of $3.40 looks increasinglyconservative. Beyond that, we expect Wells to be among the first group of banks allowed to raiseits dividend in early 2011, as it begins to deploy its excess capital. Given all this, we believe theshares can sustain a premium valuation over time.
XL Capital (NYSE: XL)Mark Dwelle (Analyst); (804) 782-4008, [email protected]
2010 was a key transition year for XL Capital and we believe 2011 is the year where this will berecognized by investors. Concerns about capital and the company’s investment portfolio have
given way to an excess capital position and the company’s recently announced $1 billion sharebuyback program. While the company will face the same pricing headwinds as its peers headinginto January 1 reinsurance renewals, we believe it is better positioned than it was a year ago tomaintain, or possibly expand its presence on business that remains adequately priced. Animproving investment portfolio could provide a further tailwind to book value growth, as it did formuch of 2010, and we continue to regard XL as a company which could become an acquisitiontarget at some point. XL shares are currently trading at less than 70% of the company’s $29.56book value (as of September 30) which is a discount to its closest peers which largely trade in arange of 80% to 100% of book value. We see scope for multiple expansion as this gap getseliminated, augmented by book value growth from operations and buybacks.
BAX disappointed investors in April, 2010, lowering EPS guidance due to 1) a slowing IVIG
market, 2) share loss in the IVIG market, and 3) the need to reduce IVIG pricing to stem the shareloss. Since April, IVIG market growth has stabilized and market share declines have abated.Moreover, the recent recall troubles of Octapharma should lead to pricing stability. This should setup the company to return to double digit earnings growth in 2011. With sentiment low, asevidenced by the shares underperformance in 2010 (down 15% YTD), we like the risk/rewardprofile of the company going into 2011. We believe that 2011 consensus expectations areachievable, if not beatable, and believe the stock’s valuation does not reflect the company’semerging pipeline of next generation IVIG and hemophilia products, as well as its novel homedialysis system.
Our positive thesis is based on CBST’s current low valuation and our expectation for multipleexpansion following a potential settlement of its patent dispute with TEVA Pharmaceuticals inH1:11. CBST currently trades at approximately 2x 2011 consensus revenues (biotech industryaverage revenue multiple is ~4x). The discount is largely due to the overhang of the TEVAParagraph IV challenge and the upcoming court date on April 25, 2011. We believe a favorablesettlement could drive the multiple from 2x to 3x revenue, which would put CBST shares at $31based on 2011 consensus. Near term, CBST shares could be under pressure from weaker thananticipated Cubicin sales in Q3 and potential ongoing weakness in Q4, creating a great entry pointahead of the anticipated settlement and potential resumption of growth in 2011. Over the next 12months, we also expect CBST to report Phase II data from its two most advanced pipelineproducts (H2:11), which could further add value.
Dendreon’s Provenge is the only non-chemotherapy treatment for asymptomatic or minimallysymptomatic, metastatic hormone refractory prostate cancer (estimated 8-15K patients treatableper year, $93K per patient). Dendreon's custom vaccine has a short duration of therapy (1 month),benign side effects, and leaves patients eligible for subsequent therapies, making it an attractiveoption for both patients and physicians. Despite solid fundamentals, Dendreon has remained rangebound due to investor concerns about CMS reimbursement, revenue growth and Provenge’sapprovability in Europe. However, we believe these concerns will be resolved and the stock should go higher in 2011 when 1) management reveals its EU strategy by early 2011 and a likelyplan to file for regulatory approval outside the U.S. without major new requirements; 2) FDAapproval of remaining workstations in NJ in March’11 quadruples capacity, currently a limitingfactor in revenue generation, followed by additional capacity coming online with approval of LA
and Atlanta facilities in H2:11; 3) executing on quarterly sales and meeting revenue guidance for2011 of 350-$400M and Q4:11 guidance of $175M - $200M. Meeting guidance should precipitateinvestor confidence in a $700- $800M annual run rate for 2012 and increase conviction thatProvenge is a unique oncology franchise with blockbuster potential.
We are bullish on GPRO given the product pipeline, especially PANTHER and HPV. PANTHERis a fully automated molecular testing instrument with a smaller footprint and lower price pointthan Gen-Probe's flagship TIGRIS instrument (and the ability to process quantitative assays,which TIGRIS is not equipped to do). PANTHER was launched in Europe in late November 2010
and is expected in the U.S. by 2012. PANTHER is expected to be a catalyst for HPV market sharegains in Europe, where Gen-Probe has not gained much share because the TIGRIS system issimply too big for most European labs. We also believe that the PANTHER launch will help Gen-Probe gain CT/NG share with smaller labs that might currently be using the smaller and lessexpensive BD Viper. HPV is a $250 million market dominated by one player, QIAGEN. GPRO'sassay will run on its TIGRIS and PANTHER instruments, which are fully automated. QIAGEN islabor intensive. Large labs already have TIGRIS for CT/NG testing. Being able to consolidateCT/NG and HPV onto one automated platform should be very appealing to those labs. Large labsprobably perform 50%+ of HPV.
We believe UHS offers visible growth in its diversified business lines, a proven management teamwith a long-term track record, a reasonable balance sheet, and solid free cash flow generation – allat an attractive valuation of approximately 6.9x 2011 EBITDA and 11.6x 2011 EPS. Havingcompleted a transformative acquisition of PSYS in November 2010, UHS’ EBITDA is wellbalanced between the traditional acute care hospital business (46%) and the behavioral healthcare(54%). In the near term, we expect solid fundamentals in the behavioral sector (lower bad debt andbetter volume growth), along with significant synergies from the PSYS acquisition to drive solidpredictable growth. Longer term, we expect economic improvement in one of UHS’ key acute caremarkets (Las Vegas) as well as the positive impact from healthcare reform beginning in 2014 todrive solid earnings and free cash flow growth.
Warner Chilcott PLC (NASDAQ: WCRX)
Shibani Malhotra (Analyst); (212) 618-3266, [email protected] highlight WCRX as our top pick based on a combination of (unwarranted in our view)weakness in the name recently and our expectations for multiple expansion in 2011. WCRX nowtrades at close to 5.5 x 2011E earnings in part due to lingering concerns regarding franchisesustainability, which we argue should have been alleviated with the recent approval of Atelvia andLoestrin Lo, and the FDA’s Citizens’ Petition response regarding Asacol generics. Over the nextfew months, we expect that stronger-than-anticipated uptake of Atelvia and Loestrin Lo willreinforce investor confidence in key franchises (and their sustainability) and also in management’sabilities to execute. Moreover, we expect the company to issue first-time guidance for 2011 in lateJan 2011 which should help quantify the considerable earnings leverage following the company’sacquisition of P&G pharma and the positive impact on earnings from ongoing debt payback. Weare particular bullish on Atelvia given we see this as genuinely differentiated from otherbisphosphonates since patients do not have to fast for 30 minutes after taking the drug. On
Loestrin Lo, our conversations with physicians suggest that a significant proportion of womenwould prefer to limit their long-term exposure to hormones, which should result in strong uptakeof the product out of the gate.
Barrick is the largest global gold producer and is viewed as the industry leader in building and
operating large-scale gold mines with an enviable portfolio of organic growth opportunities. Witha strong, A-rated balance sheet and an estimated ~$5.7B in available liquidity, Barrick is wellpositioned to complete construction of Pueblo Viejo (60% ABX/40% GG) in the DominicanRepublic by Q4/11 and Pascua-Lama on the Chile/Argentina border by Q1/13, and also advanceits feasibility stage projects. Barrick is trading at an attractive valuation at 1.4x NAV relative to itsNorth American Tier I peers at 1.6x NAV and we estimate Barrick is pricing in $985/oz goldcompared to current gold price of $1350/oz. Potential share price catalysts include: continuedstrong quarterly financial results driven by expanding margins; completion of the SupplementaryEnvironmental Impact Study (SEIS) by early 2011 at Cortez Hills; a resolution to the El Morrodispute by mid-2011; and commissioning of Pueblo Viejo by the end of 2011.
Cameco Corporation (NYSE: CCJ)
H. Fraser Phillips (Analyst); (416) 842-7859, [email protected] remains the leader in the uranium industry, in our view, with the largest and highestquality assets in the business. The company has a strong balance sheet and is beginning togenerate free cash flow that should support longer-term growth. Progress at Cigar Lake andCameco’s other exploration and development projects hold out the possibility of longer-termupside. While the shares have increased substantially from the lows earlier this year, we believethey will continue to benefit from strong uranium markets and have further upside potential. Itappears that the character of the spot uranium market has changed markedly over the past fewmonths from one that was heavily oversupplied with weak demand to one that has high levels of demand with very little supply, and recent news from China indicated that the NDRC increased itstarget for nuclear power for 2020 to 112GW from 70GW. Following this news, we increased our2010 and 2011 spot and term prices and changed our valuation metrics to reflect a bull marketscenario for uranium. We rate Cameco Outperform, Above Average Risk.
Rio Tinto is a dual-listed company in the UK and Australia. It also has ADRs listed on the NYSE.It is one of the world's largest mining conglomerates with major interests in copper, iron ore, coal,aluminum, mineral sands, borax, diamonds and gold. It is one of the largest single producers of copper, iron ore, steaming coal, TiO2 slag and borax. Operations are characterized by world-classdeposits - principally opencut, mostly in the lowest-cost quartile and located in North and SouthAmerica, Australia, Indonesia, Europe and Southern Africa. No specific commodity is targetedalthough preference is given to commodities where it can exert some level of pricing power. Itmaintains a zero hedging policy on currencies and commodities. RIO is a world-class companywith consistently high margins and cash flows, and superior rates of return. The company recently
announced plans for $11 billion of expansion and sustaining capital expenditure during 2011focused primarily in the high-margin iron ore and copper businesses.
We continue to view Annaly Capital as a compellingly attractive total return story for 2011 – after
recommending it as our best idea for 2010. Very low borrowing costs (tied to Fed funds rate) willlikely persist for some time, supporting strong earnings and dividend distributions. Maturities of older swaps are expected to accelerate in the year ahead, offering additional support to earningsand even some room for earnings and dividend growth – a view we believe is not reflected inconsensus estimates. Leverage remains modest at less than 6x D/E, well-below the historical rangeof 8x-12x, meaning ample room to deploy capital as investment opportunities become moreattractive. Risk stems from a dramatic spike upward in short-term/long-term rates, which we donot view as a near-term risk given still anemic macroeconomic/housing market conditions.Valuation upside potential to roughly 1.3x-1.4x book value, combined with our forward 12-monthdividend yield expectation of approximately 15% suggests very attractive returns for the yearahead.
We look for COR’s business activities and success as a public company to accelerate during 2011,leading to solid earnings growth and strong returns for investors. COR’s emergence as the thirdand smallest publicly-traded data center REIT—with its IPO during 2H10—offers investors theopportunity to participate in the upside of a unique portfolio, in our view. Its participation in boththe retail and wholesale channels of the power-based data center business, its control of fiberdense, network-based assets as well as its strong balance sheet each should drive flexibility and thesuccessful pursuit of internal and external growth. Core portfolio occupancy of close to 80%, in-place leases that we believe are well below market and expected annual rollover of close to 20%offer near-term opportunities. Longer-term, development potential aggregating more than $800million with returns of 10% or better should supplement the existing opportunities for earningsand cash flow growth. Finally, solid access to capital and an experienced management team should
lead the way to success in its first full year as a public company.
Positioned for outsized growth while trading at a suppressed valuation currently, we believeupside potential for LHO in 2011 is compelling. Attractive urban positioning in Washington, DC,Boston, NYC, West Hollywood and San Francisco (55% of NOI) should support outsizedRevPAR growth while we look for significant improvement out of San Diego and Philadelphia(22% of NOI). Sector-leading margins aided by aggressive asset management with limitedrenovation disruptions should support strong EBITDA growth while, with ample capacity relativeto limited near-term maturities, we expect LHO to remain aggressive on the acquisition front.Attractive financial leverage (6.8x TTM EBITDA) utilizing preferred equity should magnify the
upside, supporting outsized earnings growth while trading at a sizable discount to our forwardNAV outlook. Currently in line with peers on a forward EV/EBITDA basis vs. a historic 3xmultiple premium, we view valuation to be highly attractive.
Tanger is the only pure-play, publicly traded REIT that focuses solely on the factory outlet sector.Retail real estate continues its steady recovery and, as it does, the strongest demand by retailers foradditional space is in the value category. As part of this surge in value-based retailing, full-pricedretailers are looking to add stores to their existing outlet center concepts or to introduce new
concepts. In addition, the supply of outlet centers has not kept pace with demand which has driventhis sector to occupancy levels well above that of typical retail real estate. We expect the strongdemand for value by consumers and hence by retailers to drive not only above-average internalgrowth at Tanger, but also strong returns from new development. We look for Tanger to add twonew centers annually on a base of only 31 existing centers. With double-digit unlevered returnsexpected from each new development and a very low levered balance sheet, we believe Tanger isin an ideal position to grow both the share price and dividend over the next several years.
Non-U.S. Analyst DisclosureDes Kilalea and Paul Quinn (i) are not registered/qualified as research analysts with the NYSEand/or FINRA and (ii) may not be associated persons of the RBC Capital Markets, LLC andtherefore may not be subject to FINRA Rule 2711 and NYSE Rule 472 restrictions on
communications with a subject company, public appearances and trading securities held by aresearch analyst account.
Conflicts DisclosuresThis product constitutes a compendium report (covers six or more subject companies). As such,RBC Capital Markets chooses to provide specific disclosures for the subject companies byreference. To access current disclosures for the subject companies, clients should refer tohttps://www.rbccm.com/GLDisclosure/PublicWeb/DisclosureLookup.aspx?entityId=1 or send arequest to RBC CM Research Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29thFloor, South Tower, Toronto, Ontario M5J 2W7.
The analyst(s) responsible for preparing this research report received compensation that is basedupon various factors, including total revenues of the member companies of RBC Capital Marketsand its affiliates, a portion of which are or have been generated by investment banking activities of the member companies of RBC Capital Markets and its affiliates.
Distribution of RatingsFor the purpose of ratings distributions, regulatory rules require member firms to assign ratings toone of three rating categories - Buy, Hold/Neutral, or Sell - regardless of a firm's own ratingcategories. Although RBC Capital Markets' ratings of Top Pick/Outperform, Sector Perform andUnderperform most closely correspond to Buy, Hold/Neutral and Sell, respectively, the meaningsare not the same because our ratings are determined on a relative basis (as described above).
Distribution of RatingsRBC Capital Markets, Equity Research
Investment BankingServ./ Past 12 Mos.
Rating Count Percent Count Percent
BUY[TP/ O] 652 50.20 193 29.60
HOLD[SP] 592 45.60 121 20.44
SELL[U] 55 4.20 10 18.18
Conflicts PolicyRBC Capital Markets Policy for Managing Conflicts of Interest in Relation to InvestmentResearch is available from us on request. To access our current policy, clients should refer tohttps://www.rbccm.com/global/file-414164.pdf or send a request to RBC CM ResearchPublishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29th Floor, South Tower, Toronto,Ontario M5J 2W7. We reserve the right to amend or supplement this policy at any time.
Dissemination of Research and Short-Term Trading CallsRBC Capital Markets endeavors to make all reasonable efforts to provide research simultaneouslyto all eligible clients, having regard to local time zones in overseas jurisdictions. RBC CapitalMarkets’ equity research is posted to our proprietary websites to ensure eligible clients receivecoverage initiations and changes in ratings, targets and opinions in a timely manner. Additionaldistribution may be done by the sales personnel via email, fax or regular mail. Clients may alsoreceive our research via third-party vendors. Please contact your investment advisor or
institutional salesperson for more information regarding RBC Capital Markets’ research. RBCCapital Markets also provides eligible clients with access to SPARC on the Firm’s proprietaryINSIGHT website. SPARC contains market color and commentary, and may also contain Short-Term Trade Ideas regarding the publicly-traded common equity of subject companies on whichthe Firm currently provides equity research coverage. SPARC may be accessed via the followinghyperlink: www.rbcinsight.com. A Short-Term Trade Idea reflects the research analyst’sdirectional view regarding the price of the subject company’s publicly-traded common equity inthe coming days or weeks, based on market and trading events. A Short-Term Trade Idea maydiffer from the price targets and recommendations in our published research reports reflecting theresearch analyst’s views of the longer-term (one year) prospects of the subject company, as aresult of the differing time horizons, methodologies and/or other factors. Thus, it is possible that asubject company’s common equity that is considered a long-term ‘sector perform’ or even an‘underperform’ might be a short-term buying opportunity as a result of temporary selling pressurein the market; conversely, a subject company’s common equity rated a long-term ‘outperform’could be considered susceptible to a short-term downward price correction. Short-Term TradeIdeas are not ratings, nor are they part of any ratings system, and the Firm generally does notintend, nor undertakes any obligation, to maintain or update Short-Term Trade Ideas. Securitiesand Short-Term Trade Ideas discussed in SPARC may not be suitable for all investors and havenot been tailored to individual investor circumstances and objectives, and investors should maketheir own independent decisions regarding any securities or strategies discussed herein.
Analyst CertificationAll of the views expressed in this report accurately reflect the personal views of the responsibleanalyst(s) about any and all of the subject securities or issuers. No part of the compensation of theresponsible analyst(s) named herein is, or will be, directly or indirectly, related to the specificrecommendations or views expressed by the responsible analyst(s) in this report.
RBC Capital Markets is the business name used by certain subsidiaries of Royal Bank of Canada, including RBC Dominion Securities Inc., RBC CapitalMarkets, LLC, Royal Bank of Canada Europe Limited and Royal Bank of Canada - Sydney Branch. The information contained in this report has beencompiled by RBC Capital Markets from sources believed to be reliable, but no representation or warranty, express or implied, is made by Royal Bank of Canada, RBC Capital Markets, its affiliates or any other person as to its accuracy, completeness or correctness. All opinions and estimates contained in thisreport constitute RBC Capital Markets' judgement as of the date of this report, are subject to change without notice and are provided in good faith butwithout legal responsibility. Nothing in this report constitutes legal, accounting or tax advice or individually tailored investment advice. This material isprepared for general circulation to clients and has been prepared without regard to the individual financial circumstances and objectives of persons whoreceive it. The investments or services contained in this report may not be suitable for you and it is recommended that you consult an independent investmentadvisor if you are in doubt about the suitability of such investments or services. This report is not an offer to sell or a solicitation of an offer to buy anysecurities. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. RBC CapitalMarkets research analyst compensation is based in part on the overall profitability of RBC Capital Markets, which includes profits attributable to investmentbanking revenues. Every province in Canada, state in the U.S., and most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as the process for doing so. As a result, the securities discussed in
this report may not be eligible for sale in some jurisdictions. This report is not, and under no circumstances should be construed as, a solicitation to act assecurities broker or dealer in any jurisdiction by any person or company that is not legally permitted to carry on the business of a securities broker or dealerin that jurisdiction. To the full extent permitted by law neither RBC Capital Markets nor any of its affiliates, nor any other person, accepts any liabilitywhatsoever for any direct or consequential loss arising from any use of this report or the information contained herein. No matter contained in this documentmay be reproduced or copied by any means without the prior consent of RBC Capital Markets.
Additional information is available on request.
To U.S. Residents:This publication has been approved by RBC Capital Markets, LLC (member FINRA, NYSE), which is a U.S. registered broker-dealer and which acceptsresponsibility for this report and its dissemination in the United States. Any U.S. recipient of this report that is not a registered broker-dealer or a bank actingin a broker or dealer capacity and that wishes further information regarding, or to effect any transaction in, any of the securities discussed in this report,should contact and place orders with RBC Capital Markets, LLC.
To Canadian Residents:This publication has been approved by RBC Dominion Securities Inc. (member IIROC). Any Canadian recipient of this report that is not a DesignatedInstitution in Ontario, an Accredited Investor in British Columbia or Alberta or a Sophisticated Purchaser in Quebec (or similar permitted purchaser in anyother province) and that wishes further information regarding, or to effect any transaction in, any of the securities discussed in this report should contact and
place orders with RBC Dominion Securities Inc., which, without in any way limiting the foregoing, accepts responsibility for this report and itsdissemination in Canada.
To U.K. Residents:This publication has been approved by Royal Bank of Canada Europe Limited ('RBCEL') which is authorized and regulated by Financial Services Authority('FSA'), in connection with its distribution in the United Kingdom. This material is not for general distribution in the United Kingdom to retail clients, asdefined under the rules of the FSA. However, targeted distribution may be made to selected retail clients of RBC and its affiliates. RBCEL acceptsresponsibility for this report and its dissemination in the United Kingdom.
To Persons Receiving This Advice in Australia:This material has been distributed in Australia by Royal Bank of Canada - Sydney Branch (ABN 86 076 940 880, AFSL No. 246521). This material hasbeen prepared for general circulation and does not take into account the objectives, financial situation or needs of any recipient. Accordingly, any recipientshould, before acting on this material, consider the appropriateness of this material having regard to their objectives, financial situation and needs. If thismaterial relates to the acquisition or possible acquisition of a particular financial product, a recipient in Australia should obtain any relevant disclosuredocument prepared in respect of that product and consider that document before making any decision about whether to acquire the product.
To Hong Kong Residents:This publication is distributed in Hong Kong by RBC Investment Services (Asia) Limited and RBC Investment Management (Asia) Limited, licensedcorporations under the Securities and Futures Ordinance or, by Royal Bank of Canada, Hong Kong Branch, a registered institution under the Securities and
Futures Ordinance. This material has been prepared for general circulation and does not take into account the objectives, financial situation, or needs of anyrecipient. Hong Kong persons wishing to obtain further information on any of the securities mentioned in this publication should contact RBC InvestmentServices (Asia) Limited, RBC Investment Management (Asia) Limited or Royal Bank of Canada, Hong Kong Branch at 17/Floor, Cheung Kong Center, 2Queen's Road Central, Hong Kong (telephone number is 2848-1388).
To Singapore Residents:This publication is distributed in Singapore by RBC (Singapore Branch) and RBC (Asia) Limited, registered entities granted offshore bank status by theMonetary Authority of Singapore. This material has been prepared for general circulation and does not take into account the objectives, financial situation,or needs of any recipient. You are advised to seek independent advice from a financial adviser before purchasing any product. If you do not obtainindependent advice, you should consider whether the product is suitable for you. Past performance is not indicative of future performance.
