Presentation Transcript

1. Oliver Gilvarry ACMA 8th November 2011 “You Stole the Sun from My Heart” – A European Lament. ACA Evening Seminar - Pensions & Investments
2. Current Environment Equity and debt markets remain volatile, with large swings in asset prices. Investors remain unsure of direction with ability to make investment decisions hampered by number of factors. These include; Lack of policy direction from Europe. Fiasco of Debt Ceiling negotiations in the US. Concerns over double dip scenario within developed economies. Lack of monetary policy tools due to low interest rate environment. Within Europe, lack of realistic policies on Greece has meant crisis has moved to core nations. Source: Bloomberg; Source: Bloomberg
3. Current Environment Europe continues to dominate headlines internationally with US funding for European banks remaining difficult to source. Contagion from Greece already happening with European bank share prices falling and cost of funding for these banks increasing. Market starting to price in possibility of uncontrolled Greek default, with uncertainty over next tranche of €8bn due to be released to Greece. Large budget deficit in the US and political impasse there means room for manoeuvre to support growth is limited. Economic growth continues to be weakdue to lack of consumer spending, government austerity measures, low business confidence and lack of availability of credit. Immediate result is lowering of growth numbers in developed economies plus low interest rates in coming years.
4. European & Global issues While Ireland has been dealing with its banking issues and implementing significant austerity measures, other European countries have not. Lending monies to indebted borrowers is not a solution and markets await a lasting solution. Lack of policy decisions in Europe has meant the market concerns moved onto Spain and Italy resulting in ECB purchases of both countries debt to keep bond yields at sustainable levels. Ireland has been differentiated from Portugal and Greece due to the actions taken domestically and from the results achieved at the European Summit on the 21st of July. Italian Government future continues to weigh on markets. Source: Bloomberg Source: Bloomberg 4
5. Is the Greek position sustainable? The graph to the left shows what adjustment must be made by Greece to reduce its debt levels. Involves Primary Balance (Taxation less Spending (Excl. interest) of 6% of GDP from 2014. Has to be achieved in an environment with growth of circa 2%. Extremely difficult if not impossible to achieve. 5
6. What is the impact on European Banks? Exposure to Greece is largest for German banks at 19%, followed by France at 9%. Total exposure to Greece, Ireland & Portugal is €74bn for German, France, Benelux & UK banks. Capital raisings within European banking system to be €108bn. Will be achieved from dividend suspension (SocGen) and deleveraging, with capital raises last option. 6
7. European & Global issues With the lack of policy response, global growth looks set to be significantly slower than what was previously expected. The US recovery is much slower than expected due to high unemployment, weak housing and high personal debt levels. A similar situation is seen in the UK, but growth numbers are holding up better than other European peers. This has been due to implementation of QE plus ultra low interest rates. Economic growth remains weak within peripheral countries in Europe, but even core countries are experiencing weaker growth. 7
8. Our Global Macro View Growth in the world economy will be weaker than previously expected and our growth estimates are lower than consensus. Due to weaker growth and lack of inflation, interest rates will remain at current low levels for 2012 and 2013. Austerity measures will remain in place in Europe to decrease deficit levels, but we expect further interest rate cuts from the ECB in 2012. We predict € base rate of 0.75% by end of 2012. This will be required to offset lower growth levels in Euro-Zone as austerity measures continue to be implemented. Our base case sees no Euro-Zone break-up or exit of any members, but risk of uncontrolled Greek default is growing. While small, we still see risk of a wrong policy decision by large Euro-Zone member that could result in a split.
9. Irish Banking – Post Stress Test & Re-Cap The Irish banking system is now believed to have been sufficiently capitalised to offset loan impairments arising both from bad loans being written off and from losses arising on sale of other loans. This has been achieved at a significant cost to the tax-payer (€65bn or 43% of GDP). Funding remains a problem for Irish as well as other European banks as the sector remains heavily reliant on ECB/domestic Central Banks for funding. This will only be reversed from disposal of assets. This process is well underway and probably more advanced than most commentators accept. Attraction of private funding for BOI is a significant positive and is the start of the rehabilitation of financial system. 9 Source: Company accounts, Central Bank of Ireland, Dolmen Securities
10. Irish Banking – Near Term Outlook While European debt issues remain to the fore and Irish Sovereign bonds yields remain at crisis levels, Irish banks access to other international banks and to mobile corporate deposits will remain restricted. As a consequence the reliance on Central Bank funding will continue and elevated funding costs will pressurise any return to stability/operational profitability within the banks. This can be seen from continuously falling margins, despite increases in standard variable mortgage rates and other loans. The natural consequence of the banking guarantee and the CBI ELA facility for the banks ensures that the viability and recovery of the banking system remains intertwined with the perceived fortunes of the Irish Bond market. Also exposure of domestic banks to Irish sovereign debt remains high. Any sovereign haircut, will result in further recap needs for domestic Irish banks. Source: Company accounts, Central Bank of Ireland Source: Company accounts, Dolmen Securities 10
11. Irish Banking – Near Term Outlook Level of credit within the economy continues to contract. The banking system is not currently in a position to supply significant amounts of credit into the economy. As focus within banks is on; Dealing with remaining problem loans, De-leveraging, Restructuring and downsizing their businesses. And only then will credit be available and offered But supply of credit is only one aspect of the problem. A lack of demand from both households and businesses is being driven by the continued uncertainty. Source: Central Bank of Ireland Source: Central Bank of Ireland 11
12. Outlook for Ireland While exports have remained strong and the current account has moved into surplus, we along with our main economic partners are facing anemic economic growth next year. Our Irish growth numbers are weaker than consensus at 1.10% from 2012 and 1.75% in 2013, but with slow global growth, Irish GDP will also be weak. While the banking problem has been the main focus of attention, the budget deficit remains large and reductions promised must be delivered. The deficit in 2011 is estimated to be 10% of GDP or €15.7bn, greater than the Dept. of Social Protection 2011 spend of €13.4bn. Source: CSO 12
13. Debt Sustainability for Ireland The reduction in Irish bailout interest rates achieved in July has improved the situation. The reduction achieved was circa 2%, with the Dept. of Finance (DoF) predicting this will be closer to 3% once finalised. Assuming the same growth numbers as the DoF, the ESRI adjusted the previous Troika numbers to determine Irish debt dynamics, which are outlined below. 13
14. Is debt reduction achievable? Using the past as a guide, Ireland has a track record in reducing its national debt by running large primary surpluses. Budgetary discipline, continued strong current account surpluses and ensuring economic growth allowed this debt reduction in the 1980’s. 14 Source: OECD, IMF
15. Can Ireland do it twice? 15
16. Can Ireland do it twice? Situation is different to 1980’s with personal debt higher and banking problems much larger. Lower growth environment in major trading partners also an issue, with the UK and core Euro-Zone facing anemic growth next year. Number of tailwinds will offset weaker growth environment in our view; Interest Rate reduction from European part of bailout. Lower recapitalisation cost for the banking system. ECB rate cuts next year, every 25bps will releases €132m back into the economy due to lower tracker payments. Budget 2012 adjustment will be€3.8bn than the previously guided €3.6bn due to the weaker growth outlook. Will mean difficult choices have to be made, but only option to ensure Ireland can achieve debt stability and continue on path to exit Troika programme. 16
17. Strategic Equity Outlook 2011 While earnings downgrades are likely in the coming weeks, the rate of decline in markets is pricing in an excessive decline in earnings expectations. We believe the following factors will ultimately support equity markets into the final quarter of the year. The recent move by the ECB to cut interest rates is a sign that further easing is likely. Economic indicators while weaker in recent weeks continue to be positive across most of the major economies, indicating that the global economy continues to recover albeit at a slower pace than originally envisaged at the start of the year. Emerging market growth continues to outpace developed markets by a significant degree. This will continue to be supportive for global economic growth with internal demand in China in particular being the key driver of demand. Corporate profitability continues to be positive and even with earnings downgrades we still expect full-year 2011 earnings growth in the region of 10% leaving equity market valuations looking attractive. 17
18. Strategic Equity Outlook 2011 This improvement in profitability has resulted in a 9% increase in dividends as well as an increase in M&A activity and share buy-backs. Buy-backs in particular have recorded strong growth with a total of $274bn in the US for the first half of the year up from $189bn for the first half of 2010. The recent rally in bond markets coupled with the strong increase in the rate of dividend payouts means that most equity markets continue to yield more than their corresponding 10 year bond. This, combined with the current low earnings multiples for the major indices, adds to the valuation argument for the asset class. 18
19. Strategic Equity Outlook 2011 While we continue to be positive on the outlook for equity markets in 2011, the current period of market volatility will persist for a number of weeks driven by; Euro-zone sovereign debt issues. Global growth concerns. Increased funding requirements for European banks which potentially will limit the supply of credit. Chinese economic data. The ending of the second programme of Quantitative Easing by the Federal Reserve and uncertainty over future policy direction. 19
20. Current Equity Strategy Buy/long focus on those companies that display the following characteristics: Strong under-leveraged balance sheets Strong cash-flows Earnings visibility High operating leverage Revenue exposure to BRIC economies Potential for value releasing activity such as M&A 20
21. Current Sector Preferences Telecommunications: Offer predictable cash flow supporting strong dividend and share buybacks. (Vodafone, KPN) Pharmaceuticals: Renewed focus by sector on cost reductions resulting in stronger balance sheets which supports attractive dividends and share buybacks. (GSK, Novartis, Pfizer) Food Manufacturing: Improved cost management and smarter pricing policy is delivering strong revenue and margin gains. (Danone, Unilever, Kerry Group, Glanbia) International Brands: Strong demand from faster growing emerging markets is off-setting a slowdown in more mature developed markets. (Coca-Cola, McDonalds, Hugo Boss, Burberry) 21
22. Current Sector Preferences Oil/Gas and Miners: Emerging market exposure, stronger commodity prices, potential for M&A activity and strong balance sheets and cash flows all positive for the sectors. (Royal Dutch Shell, Exxon Mobile, BG Group, BP, Tullow Oil) Technology: Balance sheet strength supportive of M&A and share buybacks, while increased corporate spending to off-set lower government and consumer spending. (Microsoft, Intel, Apple, SAP) Insurance: Offer a strong capital position, increase in premiums and operational restructuring all positive for the sector. (Aviva, Prudential) Industrials: Most vulnerable to economic slowdown however high emerging market exposure, strong balance sheets and operating efficiencies provide support to sector. (Siemens, Caterapillar, BMW, Illinois Toll Works) 22
23. Contact Details Oliver Gilvarry Head Of Research Dolmen Stockbrokers 75 St. Stephen’s Green, Dublin 2. Phone: (01) 633 3633 Fax: (01) 633 3857 Email: oliver.gilvarry@dsl.ie