Aviva Investors Market Monitor – 09 February 2011

Reporting season – week 2

With the earnings season now in progress, the past week was full of important corporate announcements that have impacted share performance. This week we discuss the News Corporation earnings report, significant profit downgrades from Myer and AGL Energy, a favourable result from JB Hi-Fi, a new CEO for Asciano and a strong rally for QBE Insurance following news that it will acquire the renewal rights to US insurer Balboa.

News Corporation’s Q2 earnings report was close to expectations and management confirmed that the company is on track to deliver on its full year earnings guidance. In terms of operational highlights, the television segment performed very strongly, underpinned by advertising growth in excess of 20%. Cable network negotiations are also driving strong revenue growth. The weakest segments were publishing and films but this was widely expected.

Myer provided the market with a trading update which revealed a 3.5% fall in sales in the six months ending 29 January 2011. Like-for-like sales declined 5.2% in the same period. This was much weaker than expected and will negatively impact net profit for FY11. Comments from management suggest a competitive retail environment (including consumers purchasing from offshore due to the strong $A), coupled with weaker consumer demand, particularly following the January flooding, were the main reasons for the sales decline. In November 2010, Myer’s guidance suggested growth in net profit after tax (NPAT) in
FY11 of between 5% and 10%. This has now been revised down significantly with Myer forecasting a fall in NPAT of up to 5%.

In stark contrast to Myer, JB Hi-Fi announced a record half year net profit of $87.9 for the six months to end December 2010. Sales rose 8.3% over the period and the company will pay a fully franked interim dividend of 48.0 cents per share. Thirteen new stores were opened in Australia and New Zealand over the period and there are plans to open another 5 in the second half. JB Hi-Fi seems to be addressing the challenge of on-line retailing which is affecting many traditional retail businesses like Myer. The company’s online sales rose 35% over the half year and were up 49% in December. Although sales guidance was
downgraded slightly, the overall result was favourable and defies the weaker trend being experienced by many companies in the retail sector.

AGL Energy announced that recent severe weather events, including the Queensland floods, extreme heat in New South Wales, Victoria and South Australia, and Cyclone Yasi, are expected to reduce forecast underlying NPAT in FY11 by between $30 and $35 million. AGL’s previous forecast for NPAT in FY11 was between $450 million and $480 million. This range has now been revised down to between $415 million and $440 million.

Asciano announced the appointment of John Mullen to succeed Peter Rowsthorn as the company’s new managing director and chief executive officer. Mr Mullen has extensive experience in transport and logistics as he was previously the CEO of DHL Express. He will formally commence as Asciano’s CEO on 14 February 2011.

QBE Insurance performed very strongly on Friday (+7%) following the announcement that it had acquired the renewal rights to US insurer Balboa for a consideration of $700 million. Balboa is currently owned by Bank of America and this attractively structured deal is part of an initial 10-year distribution agreement. Both the purchase price and deal structure are extremely attractive for QBE. Balboa is a very profitable business and it makes good commercial sense for QBE to purchase this US asset at a time when the Australian dollar is trading close to parity with the US dollar. QBE also announced a forecast NPAT for calendar year 2010 that was in line with analysts’ expectations.

Global markets

Major equity markets rallied convincingly as purchasing managers’ surveys from the US, Europe and Asia pointed to accelerating manufacturing and services output. The S&P 500 advanced two per cent to just over 13,000, and the FTSE 100 almost two per cent, closing three points below 6,000. The Nikkei 225 moved up 1.8%, despite corporate releases suggesting Japanese exporters remain hampered by the strength of the yen.

While the equity bull-market that began at the end of August 2010 shows little sign of abating, investors continue to shun ‘core’ bonds forcing yields up, and US ten-year yields hit a nine-month high last week. In the UK, where rising domestic prices are of particular concern, government bond yields rose for a fifth consecutive week, and sterling spiked as high as $1.62, in anticipation of bank base-rate rises in 2011.

The price of copper crossed $10,000 a tonne (or 434 cents a pound), while oil spiked to $103 a barrel midweek on uncertainty over developments in Egypt and the Middle East more generally, before closing a shade below the $100 mark.

Global equities

In a busy week for energy majors, ExxonMobil, the world’s largest company by market capitalisation, registered a near record 53% increase in Q4 net revenue, buoyed by rising oil prices. In the UK, BP announced a full-year loss of $4.9bn – it’s first in nearly twenty years, as the energy giant digested a $41bn charge relating to last year’s Gulf of Mexico disaster – and also the return of dividend payments, which have been suspended for three consecutive quarters. Anglo-Dutch rival Shell shed 3.3% despite reporting a near doubling of 2010 profits to $18.6bn. Elsewhere, GlaxoSmithKline rallied 3.5%, notwithstanding a slump in full-year profits from £8.7bn to £4.5bn, as the UK-based pharma giant announced a £2bn share buy-back programme. US corporate earnings for the final quarter of 2010 have generally surpassed forecasts – and companies as varied as Time Warner, UPS, Dow Chemical, Kellogg and fashion retailer Gap all saw their shares boosted as their revenues exceeded expectations
Over in Asia, Nippon Steel and Sumitomo Metal, two of Japan’s largest steelmakers, unveiled a $24.5bn merger aimed at cutting costs and matching the competitiveness of fast-growing emerging market rivals – while Baidu, China’s largest internetsearch, beat forecasts with a doubling of Q4 net revenue.

Sweden’s government is to sell its 6.3% in Nordea, the Nordic region’s largest bank, in a deal that would raise around $3bn – while LVMH, the world’s largest luxury goods company, reported 2010 sales up 19% to €20.3bn, boosted by rapid growth in Asian markets, and China in particular.

Global bonds

Ben Bernanke on Thursday restated the Federal Reserve’s commitment to a second round of asset purchases, or quantitative easing, which generally supports bond prices. Nonetheless, prices of US government bonds, or Treasuries, slid sharply as the Fed Chairman also voiced concern about the scale of the US budget deficit – which is forecast to hit a mammoth $1,480bn this year, or 10% of GDP. As a result, ten-year yields advanced a chunky 32 basis points to 3.65%.

UK ten-year yields marched up 17 basis points to 3.82% as investors continue to fret about the medium-term outlook for inflation, which could rise to four per cent during 2011. German ten-year yields also increased, although by a less marked 11 basis points to 3.26%, as the European Central Bank considers its response to Eurozone inflation now running at an annualised 2.4% – well above its target of ‘below but close’ to two per cent.

In a relatively quiet week for peripheral bonds, Spain issued €3.5bn of three- and five-year securities in a poorly subscribed auction, raising less than its €4bn target. Nonetheless, benchmark Spanish ten-year yields dropped from 5.51% to 5.16% as Madrid continues to insist the country is not in the same category as other highly indebted Eurozone nations such as Ireland and Portugal.

The above information is of a general nature and has been prepared without taking account of your individual investment objectives, financial situation or particular investment needs. It is not intended as financial advice to retail clients. Before making an investment decision, you should consider the appropriateness of the information, having regard to your objectives, financial situation and needs. We recommend you consult with your financial adviser, who can help you determine how best to achieve your financial goals and whether investing in a fund is appropriate for you. Aviva Investors Australia Limited ABN 85 066 081 114. AFS Licence No. 234483. Level 28 Freshwater Place, 2 Southbank Boulevard, Southbank 3006 GPO Box 2007, Melbourne VIC 3001 Telephone: (03) 9220 0300 Facsimile: (03) 9220 0333 Email: [email protected] Website: www.avivainvestors.com.au Part of the international Aviva plc group.

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