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UBS Investment Research
US Morning Meeting Highlights
Global Equity Research
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Initiation of CoverageCBOE Holdings, CBOE.O Alex Kramm, CFA p.8Industry Leader with Many Options12-month rating: Prior: Not Rated => Neutral, FY10E US$1.12, FY11E US$1.60, PT- => US$29.00, Mkt Cap US$2.83bn
Estimate / Price Target RevisionsFord, F.N Colin Langan, CFA p.3Pricing, Not Mix, Boosts Results12-month rating: Buy (Unchanged), FY10E US$1.35=>US$1.80, FY11EUS$1.90=>US$2.25, PT Prior: US$15.00 => US$17.00, Mkt Cap US$42.8bnJohnson Controls, JCI.N Colin Langan, CFA p.4A Rare Miss; Waiting for a Catalyst12-month rating: Neutral (Unchanged), FY10E US$2.00=>US$1.98 , PT US$30.00,Mkt Cap US$19.6bnKimberly-Clark, KMB.N Gail S. Glazerman, CFA p.6Some optimism heading into second half12-month rating: Buy (Unchanged), FY10E US$4.91=>US$4.85, FY11EUS$5.37=>US$5.28, PT US$74.00, Mkt Cap US$26.5bnHoneywell Intl. Inc., HON.N Jason Feldman p.102Q Solid and Guidance Raised12-month rating: Neutral (Unchanged), FYE -, PT Prior: US$42.00 => US$45.00, MktCap US$32.4bnIngersoll-Rand, IR.N Jason Feldman p.112Q results reflect incremental progress12-month rating: Neutral (Unchanged), FY10E US$2.25=>US$2.35, FY11EUS$2.70=>US$2.80, PT US$38.00, Mkt Cap US$12.0bnSchlumberger, SLB.N Angie Sedita p.7International recovery slow and steady12-month rating: Buy (Unchanged), FY10E US$2.79=>US$2.83, FY11EUS$3.70=>US$3.77, PT US$86.00, Mkt Cap US$70.8bn
Company UpdateBroadcom, BRCM.O Uche Orji p.13Expecting Solid 2Q10 Results12-month rating: Buy (Unchanged), FY10E US$1.82, FY11E US$2.00, PT US$41.00,Mkt Cap US$16.6bnMedtronic, MDT.N Bruce Nudell, PhD p.9AMPLIFY: Focus on cancer signal12-month rating: Buy (Unchanged), FY11E US$3.51, FY12E US$3.74, PT US$53.00,Mkt Cap US$40.4bn
26 July 2010http://www.ubs.com/investmentresearch
This package has been prepared by UBS Securities LLC UBS 1ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 16UBS does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may havea conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making theirinvestment decision.
Under Armour, UA.N Michael Binetti p.5Solid Fall Orders Should Drive 2H Optimism12-month rating: Buy (Unchanged), FYE -, PT US$38.00, Mkt Cap US$1.90bnWal-Mart, WMT.N Neil Currie p.5Back to the Future for Wal-Mart12-month rating: Buy (Unchanged), FY11E US$3.92, FY12E US$4.30, PT US$60.00,Mkt Cap US$195bnVerizon, VZ.N John C. Hodulik, CFA p.14Cost cutting drives increasing EPS outlook12-month rating: Neutral (Unchanged), FY10E US$2.22, FY11E US$2.25, PTUS$28.00, Mkt Cap US$79.2bn
Industry UpdateCommunications Technology Nikos Theodosopoulos p.12
Communications Equipment - AT&T and VZ Capex Updates and ThoughtsSemiconductor Capital Equipment Stephen Chin p.12
Semiconductor Equipment Industry Update - More DRAM & Foundry orders fromTaiwanConsumer, Non-Cyclical Nik Modi p.7
UBS Consumer Staples - Bentonville Moving FastSemiconductors Uche Orji p.13
UBS SemiBytes - Results buoy secular growth names. Week 3: BRCM, RFMD, LSI,NETL, CAVM, MXIMPaper Products Gail S. Glazerman, CFA p.3
U.S. Paper & Forest Products - July paper and board price updateDiversified Financial Alex Kramm, CFA p.8
US Exchanges - Will FCM Mandate Reshuffle the CDS Deck?Auto Parts Colin Langan, CFA p.4
US Auto Suppliers - HON Q2 Read Throughs for BWA & JCIRetailers, Specialty Roxanne Meyer, CFA p.6
US Specialty Retail - Sequential Downtick in Overall Promo Levels; Early BTS TeenPricing SnapshotAerospace David E. Strauss p.10
U.S. Aerospace & Defense Playbook - The Week Ahead
UBS Global I/OSemiconductors Gareth Jenkins p.11
UBS Global I/O: Semiconductors - Microsoft licensing ARM IP
Global StrategyBanks Philip Finch p.9
Global Banks Reality Check - Post stress test
US Equity StrategyEquity Strategy Jonathan Golub, CFA p.14
US Equity Strategy - Great Results! Stealth Tightening?Equity Strategy Thomas M. Doerflinger,
Ph.D.p.15
UBS Client Flow Watch - Even more net buying of US equities
EconomicsEconomics Maury N. Harris p.15
US Economic Perspectives - Bottom Fishing
US Morning Meeting Highlights 26 July 2010
UBS 2
Basic MaterialsU.S. Paper & Forest Products Gail S. Glazerman, CFA.................. +1 212 713 3486
[email protected] paper and board price update. General upward momentum continues
Overall paper and paperboard pricing trends were stable to positive in July. The coated papergrades and uncoated groundwood finally gained some traction (+3-7% m/m). Newsprint pricingcontinues to edge up (11th consecutive increase). Bleached board added to recent gains(+3.5% in July). Containerboard was steady ahead of the August price initiative. Uncoated freewas stable after realizing at least 75% of the broad-based May hike.. Containerboard, bleached board and uncoated free still have best trendsWhile containerboard and uncoated free prices were flat in July, they have seen some of thestrongest price performance during the downturn and subsequent recovery. Uncoated free,containerboard and bleached board prices have rebounded to levels above prior peak. This hasbeen supported by capacity closures (5-7% of each grade) and low inventories. In contrast,even after recent gains, coated paper and newsprint are still 14-20% below prior peaks.. Next month’s decision on containerboard is keyPulp & Paper Week pricing decisions are most significant for containerboard since the majorityof box prices are indexed off the newsletter’s reported pricing. We expect August pricing to beout the weekend of Aug 20th. Given high utilization, very low inventories and expectation forseasonally stronger demand ahead of the holidays, we expect at least partial recognition.Containerboard remains our preferred paper/board grade and International Paper our top pick.
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Consumer, CyclicalFord (F.N) Colin Langan, CFA.......... +1-212-713 9949
Price (23 Jul 2010)...................... US$12.7212-month rating...............Buy (Unchanged)12m price target.....Prior: US$15.00 =>US$17.00Mkt Cap......................................US$42.8bn
Full-Year EPS2010E......................... US$1.35 => US$1.802011E......................... US$1.90 => US$2.25
Pricing, Not Mix, Boosts Results. Ford reported EPS of $0.68, better than our $0.47 and consensus of $0.40Ford’s auto pre-tax profit was $2.1bn, compared to a $1.0bn loss last year and a $1.3bn profit inQ1. The y/y improvement was driven by volume/mix ($1.5bn) and pricing ($1.1bn). The beatcame from N America ($450m), Ford Credit ($380m), and Europe ($210m). Ford generated$2.6bn in auto CFO during the quarter and targets reaching a net cash position by the end of2011. This implies at least a $5.4bn further reduction in debt.. Car and truck profit gap shrinking; H2 earnings headwindsWe were surprised by the small mix impact in Q2 despite the Super Duty launch. Traditionally,full-size pickups were one of the biggest factors impacting Ford’s earnings. This difference likelyreflects the improved profitability of Ford’s car line-up. We expect global pre-tax earnings will berelatively flat in the second half due to lower profits from Europe (-$870m y/y) and Ford Credit(-$490m y/y). However, we expect N American pre-tax profits to be up $1.2bn y/y.. Raising EPS est to $1.80 from $1.35 (2010) and to $2.25 from $1.90 (2011)We are raising EPS estimates for 2010 to $1.80 from $1.35, 2011 to $2.25 from $1.90, and2012 to $2.50 from $2.05. The 2010 increase is driven by the Q2 beat, improved pricing, andbetter operating leverage. Increased EPS estimates for subsequent years reflect improvedpricing and operating leverage.. Valuation: Maintain Buy rating; raising price target from $15 to $17Our new $17 price target is based on 5.0x our revised 2011 EBITDAP estimate.
US Morning Meeting Highlights 26 July 2010
UBS 3
Johnson Controls (JCI.N) Colin Langan, CFA.......... +1-212-713 [email protected]
Price (23 Jul 2010)...................... US$29.1112-month rating......... Neutral (Unchanged)12m price target..........................US$30.00Mkt Cap......................................US$19.6bn
Full-Year EPS2010E......................... US$2.00 => US$1.98
A Rare Miss; Waiting for a Catalyst. Adjusted Q3 EPS of $0.54 slightly below consensus estimatesAdjusted Q3 EPS of $0.54 missed our $0.56 estimate and consensus of $0.55. Revenues wereinline, driven by higher Auto Experience and Power Solutions sales, but offset by lower BuildingEfficiency sales. JCI pointed to the high-end of its $1.90-$1.95 FY10 guidance, reflecting higherN American production. Importantly, the company lowered its Building Efficiency guidance,reducing sales growth expectations to 3%-5%, from 5% previously, and margins to 5.2% - 5.4%from 5.6% - 5.8% previously.. Unclean quarter unusual for JCIJCI was negatively impacted by a few different items during the quarter. Some of theseincluded: 1) an impairment charge; 2) costs associated with integrating Visteon; and 3) Mexicanwork stoppages. While all of these were non-recurring, only the impairment was quantified. Thenet effect is “clean” EPS of ~$0.55.. US stimulus related sales much slower than expectedEarlier this year, JCI estimated stimulus spending would open up a $3bn opportunity to 2011and 2012 building efficiency sales. To date, however, only $430mm of this has been realized,which is significantly lower than expected.. Slightly lower 2010 estimates; maintain Neutral and $30 PTWe are slightly lowering our FY10 EPS from $2.00 to $1.98 on the lower Building Efficiencyguidance, slightly offset by higher Auto Experience and Power Solutions. Despite the decrease,our new estimate is still above JCI’s raised FY10 guidance. Our $30 price target is based on7.8x our 2011 EBITDA estimate.
US Auto Suppliers Colin Langan, CFA......................... +1-212-713 [email protected] Q2 Read Throughs for BWA & JCI. BWA: Q2 sales in-line with our forecast; Q3 guidance looks low
HON competes with BWA in turbochargers, each accounting for about 35% of the globalmarket. This Friday, HON reported a 30% y/y increase in Transportation Systems (TS) sales aswell as a 180 bps q/q margin improvement. Turbo sales were up 41% y/y, and European dieselpenetration continues to increase. Consistent with HON’s results, we are forecasting a 43% y/yincrease in BWA’s engine segment and a 40 bps q/q margin increase. Our Q2 BWA EPSestimate of $0.68 is above consensus of $0.66. HON guided to 3-14% y/y Q3 TS sales growth,slightly lower than our 14% y/y Q3 forecast for BWA’s engine segment. HON’s YTD turbo winsare estimated at over $2bn in sales over the life of the programs. HON also reported that it isgaining share in turbos; however we estimate that BWA's turbo sales were down less in 2009than HON’s (BWA down ~24%, HON down 34%).. JCI: HON guides to 3–6% y/y increase in Q3 ACS salesHON’s Automation and Controls Solutions (ACS) segment competes directly with JCI’s buildingefficiency division. ACS sales were up 7% y/y, better than JCI’s building efficiency growth of 2%in Q3. HON reported that conditions were improving in this segment and guided to a 3-6% y/yincrease in Q3 excluding acquisitions. This is significantly lower than JCI’s Q4 building efficiencyguidance of 12-19% y/y. Like JCI, HON is seeing higher demand for energy efficient projects.. Maintain Neutral rating on JCI and Buy rating on BWAOur $30 price target for JCI is based on 7.8x our 2011 EBITDA estimate, and our $50 pricetarget for BWA is based on 7.0x our 2011 EBITDA estimate.
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US Morning Meeting Highlights 26 July 2010
UBS 4
Under Armour (UA.N) Michael Binetti.................+1-212-713 [email protected]
John Proven...................... +1 212 713 1458Associate [email protected]
Price (23 Jul 2010)...................... US$37.4212-month rating...............Buy (Unchanged)12m price target..........................US$38.00Mkt Cap......................................US$1.90bn
Full-Year EPS
Solid Fall Orders Should Drive 2H Optimism. Forecasting $0.05 for UA in 2Q (Street: $0.03); Maintain Buy RatingOur 2QE EPS of $0.05 is based on 16% rev growth, +150bp in YOY GM improvement, and90bp in SG&A inflation YOY. While 2Q is a low-volume quarter for UA, we believe that guidancefor 2H will be the key driver of UA’s stock near term. Sporting goods contacts suggest thatorders for the important fall season have been accelerating lately. We believe a solid outlook forback-to-school should allow UA to provide more constructive guidance for 2H, which shouldsupport the stock in the near term.. Hoping to See Margin Trends Improve in 2QWhile margin improvements have lagged our expectations for UA in recent quarters, we wouldhope to start seeing accelerating improvements in 2Q based on: 1) diminished levels ofliquidations through low-margin third-party channels YOY; 2) higher rev growth contributionsfrom high-margin businesses (apparel & DTC); and 3) lapping the beginning of heavy footwearmarkdowns in 2Q09.. Street Estimates Still Not Reflecting Emerging 2011 Growth DriversIn our May 26 upgrade note, we noted several 2011 EPS drivers that we believe are still notreflected in Street ests, including: 1) the launch of hybrid cotton apparel (US cotton athleticapparel is a $12B mkt, vs $2-3B for performance fabrics); 2) acquisition of the licensed hats/bags business; and 3) strong initial orders of core performance apparel for spring 2011. Weforecast $1.38 in EPS for 2011, and believe that rising Street estimatess (currently at $1.29) willbe a catalyst for UA shares in coming months.. Valuation: Buy; $38 Price TargetOur $38 PT is 28x our 2011 EPS estimate of $1.38 (+22% YOY) and implies a 1.7x PEG.
Wal-Mart (WMT.N) Neil Currie........................ +1-203-719 [email protected]
Krista Zuber.......................+1-212-713 2599Associate [email protected]
David Eads........................ +1 212 713 3630Associate [email protected]
Price (23 Jul 2010)...................... US$51.6712-month rating...............Buy (Unchanged)12m price target..........................US$60.00Mkt Cap.......................................US$195bn
Full-Year EPS2011E............................................. US$3.922012E............................................. US$4.30
Back to the Future for Wal-Mart. Rapid transformation…to what WMT used to look likeIn a meeting with the company’s US buying team, we believe that senior WMT executivesindicated a virtual U-turn in merchandising and pricing strategy. The company hopes to return tothe Wal-Mart of three years ago in terms of assortment and rollback activity. Much of this hasalready been highlighted in recent UBS reports, but we believe the intended changes will takeplace by the end of August. Recent deep rollbacks, not the required return, but a startWe believe recent deep rollbacks, heavily funded by the company, did not achieve intendedtargets but helped to kick-start Wal-Mart’s intention to improve its diminished price perception.Future rollbacks, like those of three years ago, will be more broad-based and feature key trafficdrivers.. Better balance between sales and returns in prospectWhile Wal-Mart is set to revert to type as far as consumers and vendors are concerned (a goodthing, we think) we believe it will retain many successful behind-the-scenes elements of ProjectImpact and continue to push productivity and structural inventory programs. This should providea better balance between ROI and top line performance.. Valuation: Maintain Buy. Conference call MondayOur price target is based on a target P/E ratio of 14x our calendar 2011 EPS estimate. Alongwith our Staples Team, we will host a conference call at 2pm on Monday July 26 to discuss. TollFree: 800-920-2905, Toll: 212-231-2928, Code: 21477437.
US Morning Meeting Highlights 26 July 2010
UBS 5
US Specialty Retail Roxanne Meyer, CFA...................... +1 212 713 [email protected]
Janice Ong........................................+1 212 713 9325Associate [email protected]
Sequential Downtick in Overall Promo Levels; Early BTS Teen PricingSnapshot. Increased focus on fall; week-to-week downtick in promo levelsWe saw a sequential downtick in promotional levels last week; ironically, those we’d expect tobe cleaner for BTS saw an uptick. Less promotional: ANN, Banana Rep, CWTR, JCG, Urban,and WH|BM. More: ARO, AEO, EXPR and Gap.. Early BTS Teen Pricing Snapshot (see Charts 1 & 2 inside)Looking at the 3 A’s, ARO remains the low priced leader with AEO and Hollister 1.6x moreexpensive and A&F 2.7x more. The spread has narrowed meaningfully vs LY when AEO was1.8x, Hollister 2.0, and A&F 3.6x more than ARO. Compared to ARO, denim is 20-25% higher atHollister, 30-35% at AEO, and >2x at A&F; woven shirts are 70% higher at Hollister, ~2x atAEO, and ~3x at A&F.. AEO: week-over-week uptick in promos; website issues last weekAEO’s key promos: 1) try on any jeans, get a free phone (w/ 2 year plan) and 2) 20% off anypurchase including 2+ pairs of jeans (7/21-27). All graphic tees were B1G1 50% and shorts$29.95. AEO's website was down last Mon-Thurs due to external server issues; in response,offered free shipping through Sunday, 7/25.. ANN: Seeing incremental improvement for fall; very low markdown levelsANN flowed in early fall, with a focus on animal print, neutrals and lower entry level price points(down double digits to LY). The in-store pant shop features 3 fits, starting at $88; some +Facebook chatter. Minimal clearance (breadth 10-15%; depth 50% off). Loft much lesspromotional to last week; new assortment strong.
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Consumer, Non-CyclicalKimberly-Clark (KMB.N) Gail S. Glazerman, CFA..... +1 212 713
Price (23 Jul 2010)...................... US$63.6412-month rating...............Buy (Unchanged)12m price target..........................US$74.00Mkt Cap......................................US$26.5bn
Full-Year EPS2010E......................... US$4.91 => US$4.852011E......................... US$5.37 => US$5.28
Some optimism heading into second half. 2Q EPS of $1.20 vs $0.97 in 2Q09 and consensus $1.13KMB earned $1.20/share in 2Q10, up from $0.97 last year and $1.14 in 1Q10. Our estimate was$1.15 and consensus was $1.13. Segment EBIT was lower than we expected with weakerPersonal Care and Health Care only partially offset by higher Consumer Tissue/KC Pro EBIT.Corporate items were lower than we expected. Lower tax rate also helped 2Q. The comps wereeasy as 2Q09 absorbed $0.19 hit from severance costs and 1Q10 saw $0.05 non-recurring taxitems.. Improving outlook…holding guidanceKMB has absorbed $305mm inflation ytd and expects $700-800 mm inflation in 2010. But pulpcosts are falling, and should be lower in 2011. KMB sees potential for stronger volume in 2H10vs 1H. There is some price recovery still coming through and management hopes to hold pricesdespite falling input costs. While KMB tweaked budget assumptions a bit they continue toforecast 2010 EPS $4.80-5.00. They still see risk that EPS will fall towards the lower end of thisrange.. A bit obscured by inflation, but deliveringKMB is posting good results with new products (double digit growth in fem care & adultincontinence). Chinese personal care volumes rose 25% y/y in 2Q. Lower 2010 volumeguidance is mainly due to unique issues in Venezuela rather than slower market growth.. ValuationOur price target is $74 which assumes the shares trade at 14x our 2011 EPS estimate. Thisreflects a modest discount to historic trend given macro uncertainty.
US Morning Meeting Highlights 26 July 2010
UBS 6
UBS Consumer Staples Nik Modi...........................................+1-212-713 [email protected]
David Palmer...................................+1-212-713 [email protected]
Kaumil S. Gajrawala....................... +1-212-713 [email protected]
Jeffrey Birnbaum, CFA..................... +1-212-713 [email protected]
Michael Kwon................................... +1-212-713 7983Associate [email protected]
Zach Poelma.................................... +1-212-713 9307Associate [email protected]
Benjamin Schmid..............................+1 212 713 6268Associate [email protected]
Bentonville Moving Fast. Change at Walmart = Positive for Consumer Staples VendorsAs we indicated in our inaugural report on the implications of recent management changes atWalmart for consumer staples companies, we believe the mega retailer is likely to pursue amore vendor-friendly philosophy going forward. This will mean: 1) rapid re-implementation ofaction alley (key for the many impulse categories in CPG), 2) no more surprise/deep rollbacks,and 3) more collaboration between Walmart’s buyers and the vendor community. This shouldlead to better visibility/profitability for CPG vendors.. Field Work Uncovering Confirming Data Points By the DayWalmart is moving fast. We have picked up 3 incremental data points since our last report: 1)the rollbacks did not meet Walmart’s internal return thresholds, 2) Walmart seems focused onmoving back to a pre-Project Impact merchandising philosophy in very short order and 3)Walmart’s buyer community has been directed to “collaborate/listen/partner” with the vendorcommunity—a reversal of the adversarial relationship that become the norm over the past 2years.. Uniform Positive for Staples…with a Few Real Stand OutsWe believe all staples companies will benefit from these changes, with a few companies poisedto experience material, “needle moving” impact. We believe affected companies fall into one ormore of the following categories: Companies that (1) were affected by the roll back initiative, (2)will benefit from SKU re-stocking, and/or (3) have significant leverage to Walmart (% of sales).These companies, in order of importance, are: 1) Energizer, 2) Clorox, 3) Cott, 4) ConAgra, and5) PepsiCo. Details by company are in the body of this report.
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EnergySchlumberger (SLB.N) Angie Sedita.......................1-212-713 3587
Sasha Sanwal, CFA.......... +1-212-713 4907Associate [email protected]
Alston Mason.................... +1-212-713 8696Associate [email protected]
Price (22 Jul 2010)...................... US$59.3512-month rating...............Buy (Unchanged)12m price target..........................US$86.00Mkt Cap......................................US$70.8bn
Full-Year EPS2010E......................... US$2.79 => US$2.832011E......................... US$3.70 => US$3.77
International recovery slow and steady. Q2 EPS of $0.68 vs our $0.66 estimate – essentially in-line quarterQ2 was helped by a lower tax rate (+$0.02) and share count (+$0.01). NAM revenues were+2.4% better than our forecast, but Europe/CIS/Africa was -7% below. Total margins were in-line with our forecast, w/ NAM better than our ests.. International outlook improving at a slow and steady paceWe believe that the international markets will show a gradual recovery for both revenues andmargins. Increases in activity should drive revenues and margins, versus pricing. This recoverywill be more tempered than in past cycles, in our view. SLB sees Brazil, North Sea and Russiadriving 2H-10. For a more robust recovery to occur we believe oil prices need to be higher and/or that IOCs and NOCs need to gain greater confidence in the global economic outlook.. N.Am driven by strong US land, GOM reduces EPS $0.08-$0.10 in 2H-10SLB expressed confidence in the offshore markets outside of the US; however the GOMmoratorium shaves $0.08-$0.10 off 2H-10. Impressive strength was seen in US land w/ a 35%gain in revenue and 15% increase in margins. Importantly SLB’s US reorganization should havea larger impact in 2011, but starts in Q3-10. However, the outlook for US land in 2011 remainsunclear given gas prices.. Reiterate Buy, SLB trading at discount to historical premium of 20%-25%SLB’s historical multiple premium has been 20%-25% and is currently 10%. For long-terminvestors we believe these price levels offer a compelling opportunity to buy a high qualitycompany without paying a sizable premium. Our $86 PT is based on a 23x ‘11E P/E multipleversus the group average of 19.5x.
US Morning Meeting Highlights 26 July 2010
UBS 7
FinancialCBOE Holdings (CBOE.O) Alex Kramm, CFA............ +1 212 713 4060
Price (23 Jul 2010)...................... US$27.1512-month rating..... Prior: NotRated => Neutral12m price target..................- => US$29.00Mkt Cap......................................US$2.83bn
Full-Year EPS2010E............................................. US$1.122011E............................................. US$1.60
Industry Leader with Many Options. Initiating with a Neutral ratingWe are initiating coverage of CBOE Holdings (CBOE) with a Neutral rating and a $29 pricetarget. We have a favorable fundamental view of CBOE, as we believe the company representsa pure play on the secular growth in the US options business. We also believe CBOE’s industryleadership and its near monopoly in the index options business sets the company apart frommany peers.. Attractive secular growth profile with upside potential from new marketIn addition to key growth drivers for CBOE’s base business, such as product innovation, marketstructure changes, and wider adoption of options by investors, we look for the company’s newoptions market “C2” to add an additional growth leg. We expect C2 to enable CBOE to competemore effectively and potentially drive substantial upside from electronification of the indexcomplex.. Consolidation a potential exit strategyWe believe the market is broadly viewing CBOE as an acquisition candidate. While we do notsee potential buyers rushing to acquire CBOE in the near term, we believe M&A speculation willlikely 1) drive short-term volatility in the shares from time to time; and 2) result in the sharestrading at a premium to what the market would otherwise consider fair value.. Valuation: $29 price target only offers limited upside from current levelsOur $29 price target applies an 18x multiple on our FY11 EPS estimate of $1.60. At 17xestimated 2011 earnings, the shares are trading at a significant premium to peers. We wouldlook for more value elsewhere in the exchange group at present.
US Exchanges Alex Kramm, CFA............................+1 212 713 [email protected] FCM Mandate Reshuffle the CDS Deck?. Financial regulatory reform bill requires FCM structure for cleared swaps
Discussions with dealers suggest increased uncertainty around the future structure of thecleared swaps market. We believe section 724 (Swaps; Segregation and BankruptcyTreatment) of the Dodd-Frank Act is intended to create a segregation and bankruptcy regime forcleared swaps that mirrors the current structure of the futures markets. Dealers that intend toclear swaps for customers will have to register as FCMs and hold customer margin insegregated accounts.. Time is ticking for ICE to restructure clearing modelICE’s CDS clearing model is an extension of the current OTC structure (DCM model) and webelieve it would have to be restructured to conform with new legislation. We have said for awhile that the OTC clearing model will likely evolve over time and therefore we believe ICE isprepared to adapt. That said, delays and uncertainty around a transition could result in thecompany losing some of its front-runner position on CDS and open the door for competitors. Westill believe ICE is positioned to see meaningful upside from buy-side clearing of CDS, but webelieve uncertainties will have to be addressed in the very near term.. A second act for CME on CDS clearing?We believe the current uncertainty could breathe some new life in CME’s struggling CDSventure. CME chose the FCM route for its CDS clearing model and we believe most dealers areready to clear on the platform today. As the buy-side is starting to get ready for clearing of OTCswaps, we believe it could favor the certainty of CME’s model. We also believe CME isbecoming more open to addressing push-back by FCMs on its default fund structure in regardsto CDS.
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US Morning Meeting Highlights 26 July 2010
UBS 8
Global Banks Reality Check Philip Finch.....................................+44-20-7568 [email protected]
Alastair Ryan...................................+44 20 7568 [email protected]
John-Paul Crutchley....................... +44-20-7568 [email protected]
Philipp Zieschang............................. +41-44-239 [email protected]
Heather Wolf, CFA........................... +1-212-713 [email protected]
Matteo Ramenghi........................... +39-02-7210 [email protected]
Peter Carter.................................... +44 20 7568 [email protected]
Post stress test. European banking stressFrom a global banks perspective, we view the European banking stress test as a missedopportunity to raise large-scale capital needed to help address structural challenges in thesector. While the stress test showed impressive regulatory co-ordination and good disclosure,we question whether the framework was sufficiently robust, raising some concerns over itscredibility.. Regulatory reformsWith global rules under Basel III likely to be pushed out, what matters today are localregulations, which clearly vary from country to country, raising the prospect of an unevenregulatory playing field. While the new US financial sector legislation is a clear risk to industryearnings power, in our view, the regulatory framework elsewhere (i.e., Asia and Canada) islikely to remain stable and supportive.. Fundamental outlookWith the second-quarter reporting season underway, we outline the following sectorfundamental trends that we expect in the second half of this year: (1) top-line pressure; (2)peaking provisions; (3) capital markets headwinds; (4) increased capital-raisings; and (5)potential sector consolidation.. Investment strategyStrategically, we maintain our underweight stance in Europe in light of structural headwinds, andprefer banks in emerging markets and Canada, which are better capitalised with strong depositplatforms and superior growth prospects. Reflecting this, our preferred list includes HSBC,Scotiabank, Akbank, Sberbank, Banco do Brasil and Punjab National Bank.
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HealthcareMedtronic (MDT.N) Bruce Nudell, PhD........... +1 212 713 2716
Rajeev Jashnani, CFA....... +1 212 713 [email protected]
Mike Duncan, CFA............ +1 212 713 3910Associate [email protected]
Price (23 Jul 2010)...................... US$36.5812-month rating...............Buy (Unchanged)12m price target..........................US$53.00Mkt Cap......................................US$40.4bn
Full-Year EPS2011E............................................. US$3.512012E............................................. US$3.74
AMPLIFY: Focus on cancer signal. US BMP usageAn FDA panel will discuss MDT’s Amplify (BMP) app for posterior lateral fusion (PLF) on 7/27.US BMP sales have stalled at $800M following safety issues in cervical apps and highpenetration in thoracic-lumbar fusion. Virtually all BMP use is spinal (95%+) and off-label(90%+). We estimate that 85% of spinal use is for TL fusion, virtually all of this involves PLF,and that TL penetration is 40%+.. Conventional non-inferiority endpoints met in 463 pt pivotal trialOverall success (no neuro worsening, no revisions, no device related SAE, fusion success, anddisability index improvement) were similar between A and control (C; bone harvest) at 24months (60.5% A v. 55.5% C) and 60 months (43.9% A v. 35.1%). Fusion success was higherwith A at 24 months (95.9% v. 89.3%). The FDA was disturbed by the relatively low mid-termsuccess rate in part because contribution of fusion (v decompression) to symptom relief is TBD.. Cancer signal was FDA’s focusAt 60 MO, there were 15 cancer events in 12 A patients versus 5 events in 5 C pts. Pooled MDTstudies (1152 BMP pts v 1008 C pt; 3.3 yr FU) showed 27 cancer events in BMP arms v. 12 inC. HR was 1.50 (NS). Shorter term Wyeth studies showed less of signal. Given high A dose(3X) rel to current BMP, we expect a cancer surveillance study and a tougher label if approved.Cancer signal makes panel a difficult call with asymmetric risk given our muted expectations forgrowth.. ValuationOur DCF-based price target is $53.
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IndustrialU.S. Aerospace & Defense Playbook David E. Strauss............................. +1-212-713 6185
Darryl Genovesi................................+1-212-713 4016Associate [email protected]
The Week Ahead. What’s next for aerospace and defense?Big week for earnings with BEAV/BA/GD/HXL/GR/LLL/LMT/NOC/RTN/TGI all reporting, andEADS reporting in Europe. We prefer BEAV/GD into earnings. We think BEAV can raise 2010guidance Tuesday as Zodiac’s recent results and comments at Farnborough suggest the cabinretrofit market is beginning to recover. We think GD is likely to raise guidance Wednesday andthink Gulfstream bookings will show improvement over Q1. Conference call schedule and dial-innumbers are listed on page 3.. Prefer the aftermarket namesWith production rate increases behind, we see more EPS upside with aftermarket than OE.While Q2 aftermarket results have been mixed, we think most noteworthy data point so far isHON’s expectation for aftermarket growth to double or triple flight hour growth in Q4, implyingthe beginning of a reversal in spare parts inventory destocking and deferred maintenance. GR/TDG/COL remain our top aero picks.. Selective in defenseFor defense, we continue to think the base budget will hold up fairly well despite the difficultfiscal environment, including a FY12 base budget that includes modest real growth and a higherthan expected FY12 supplemental request, which we think can provide upside for the stocks.However pension is risk. Our top picks are GD/NOC/ATK.
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Honeywell Intl. Inc. (HON.N) Jason Feldman................ +1-212-713 [email protected]
Winnie Clark, CFA.............+1-212-713 4103Associate [email protected]
Price (22 Jul 2010)...................... US$43.5012-month rating......... Neutral (Unchanged)12m price target.....Prior: US$42.00 =>US$45.00Mkt Cap......................................US$32.4bn
Full-Year EPS
2Q Solid and Guidance Raised. 2Q EPS of $0.60 vs. guidance update of $0.53-$0.57 (cons. $0.57)Sales of $8.2B increased 8% YoY (core also +8%, with M&A & FX flattish) vs. consensus of$8.0B and guidance of $7.8-$8.1B. Aerospace, Transportation, and Specialty Materials revenuewere all above HON’s expectations, while ACS was roughly in-line. Segment margins of 13.6%improved 130bps YoY and 30bps QoQ.. ’10 Guidance raised to $2.40-$2.50 (was $2.30-$2.45) vs. consensus $2.48Guidance now includes costs/dilution related to the pending Sperian acquisition. HON isforecasting ’10 sales of $32.4-$32.9B (was $31.5-$32.3B) vs. consensus $32.2B. For 3Q, HONexpects $0.57-$0.62 (including $0.03-$0.04 in dilution from Sperian acq.) vs. consensus $0.66,with sales of $8.0-$8.3B vs. consensus $8.1B.. Results show continued end market improvement and solid executionRevised guidance now includes a number of incremental non-operational headwinds(acquisition related costs, higher restructuring). Consequently, the outlook for HON’s underlyingbusinesses improved more than is implied by the headline guidance number. We also believethere is growing evidence that later cycle end markets (most notably commercial aftermarket)are beginning to improve, which bodes well for ‘11. We caution that pension expense(admittedly non-cash) could be a greater headwind than expected based on moves in thediscount rate/ROA over the rest of ‘10.. Raising PT to $45, from $42; Maintain Neutral ratingOur revised PT reflects a ~30% premium (was 20%) to the mkt multiple on our ‘11 EPS est.(was based on ‘10). The larger premium reflects the incremental, non-cash pension headwind in‘11 (premium roughly unchanged on pension-adjusted EPS).
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Ingersoll-Rand (IR.N) Jason Feldman................ +1-212-713 [email protected]
Winnie Clark, CFA.............+1-212-713 4103Associate [email protected]
Price (22 Jul 2010)...................... US$37.2912-month rating......... Neutral (Unchanged)12m price target..........................US$38.00Mkt Cap......................................US$12.0bn
Full-Year EPS2010E......................... US$2.25 => US$2.352011E......................... US$2.70 => US$2.80
2Q results reflect incremental progress. 2Q EPS from cont. ops of $0.76 vs. preannounced $0.74-0.76 & cons. $0.72EPS includes $0.04 restructuring and $0.02 from a divestiture. 2Q sales of $3.7B (+7% YoY,+8% ex-FX) were in-line with the July 16 preannouncement. U.S. sales grew 6%, with int’l +10%(11% ex-FX). 2Q tax rate (cont. ops.) was 18.8% vs. FY10 guidance of 18%. Orders increased~10% in 2Q, with total backlog +15% YoY. Op margin increased 280bps YoY with ~49% YoYincremental margins.. Adj. FY10 EPS outlook now $2.18-2.38 (was $2.00-$2.35) vs. cons. $2.26FY10 guidance still includes $0.25 of restructuring, but excludes the 1Q $0.12 Medicare Part Dcharge. IR expects FY10 sales +4-6% YoY ($13.7-13.9B) vs. prior +3-5% YoY ($13.6-13.8B).Segment FY10 sales growth targets were raised for Industrial and Climate, Residential wasunchanged, and Security was revised lower. 3Q EPS outlook is $0.70-0.80 (Cons $0.78), withsales of $3.65-3.75B (+5-8%).. Signs of improvement, but a few challenges remainIR's 2Q results and revised guidance were roughly in-line with expectations following thecompany's 7/16 pre-announcement. There are signs of improvement in execution, and severalof IR's predominantly later cycle end markets have begun to stabilize/improve. We remainNeutral given what we view as a fair valuation, and we continue to note execution relatedchallenges as productivity is expected to contribute a material portion of FY10 expectedearnings.. We maintain our $38 price target and Neutral ratingOur PT reflects a ~10-15% premium to the market multiple on our revised 2011 EPS estimate(was based on 2010). We maintain our Neutral rating.
TechnologyUBS Global I/O: Semiconductors Gareth Jenkins..............................+44-20-7567 3950
Uche Orji..........................................+1 212 713 [email protected]
Brent Thill........................................+1-415-352 [email protected]
Nicolas Gaudois............................. +82-2-3702 [email protected]
Anuj Krishan...................................+44 20756 [email protected]
David Mulholland............................ 44 20 7568 4069Associate [email protected]
Microsoft licensing ARM IP. Input: Microsoft signs architectural licensing agreement with ARMMicrosoft signed a multi-year architectural licensing agreement with ARM (which providesprocessor designs to semi manufacturers). Disclosure has been limited and although both haveworked together since 1997, it is clear to us that this deal signals closer collaboration andpotentially Microsoft working on processor design.. Output: Impact to ARM – US$10m to EBIT for each 10% market shareWorking off ARM’s estimate for the computing segment in 2014 of 500m units (growing from30m in ’09), we estimate that every 10% market share ARM gains in the applications processorwould contribute $10m in royalty revenues (US$15-20 chip ASP and 1-2% royalty rate) thatflows straight through to EBIT (c.100% gross margin). We also believe ARM is likely to earnc.$0.20 per unit from peripheral chips representing a US$100m opportunity in a 500m unitmarket.. Output: Impact to Microsoft –rational for such a licenseWe believe this is a response from Microsoft to the growth being seen in Apple/Linux basedtablets, and could be a response to the success Apple had in developing it’s own A4 processor(also ARM-based).. Output: Impact to Intel – we see no impact as it’s a new marketIf MSFT is working on its own chip, we see no impact to the established app processorsuppliers. In the future, much will depend on product positioning and investment in a roadmap,which is non trivial. We do not think this deal will imply the use of ARM processors with themainstream Windows OS in PCs; instead we see the potential in addressing a new market andso doesn’t impact AMD and Intel.
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Communications Equipment Nikos Theodosopoulos.....................+1-212-713 [email protected]
Jack Monti, CFA................................+1 212 713 [email protected]
AT&T and VZ Capex Updates and Thoughts. Second Half AT&T + VZ Capex Uninspiring, Except for WirelessAT&T and Verizon have uninspiring second half 2010 capital spending plans, in our view,except in the area of wireless which may continue to yield upside for vendors. UBS fcst AT&T’s2H10 spending flat YoY, with wireless up 41%. Verizon 2H10 may be up 4% YoY on its guidewith strength in wireless (LTE).. UBS AT&T 2H Fcst Flattish YoY, 2Q Capex Inline, Wireless UpsideIn 2H10 AT&T has ~$9.8-$10.8B remaining on its capex guide of $18-$19B w/ ~$8.2B spent in1H10. 2H10 capex could rise by 20%-32% vs. 1H, vs. 5 yr history of ~22% increases. UBS 2H$10B fcst is +21% vs. 1H and flattish YoY vs. 2H09. 2Q $4.9B capex slightly above UBSe.Wireline below, Wireless above.. VZ 2H10/ 2011 Wireline Pressured, 2Q Capex Inline, Wireless UpsideVZ has $9.1-$9.5B remaining on its capex guide of $16.8-$17.2B ($7.7B in 1H10), possiblyrising ~19-24% vs. 1H or 4% YoY vs. 2H09. If history is an indication it may increase 6% vs. 1Hand decrease 10% YoY, though LTE may preclude this scenario. 2Q $4.2B capex slightly aboveUBSe. Wireline below, Wireless above.. Backhaul Vendors In Good 2H Position, Wireline Likely Sees PressureBackhaul vendors in good position for 2H10 capex including JNPR, TLAB, CIEN on next-gen,and TLAB, ADTN, ALU on legacy at T. VZ LTE vendors may see tailwinds. While TLAB andCIEN are benefiting from backhaul spend at T, there is risk of share loss. At T ALU is pot’lgainer vs. TLAB, and CSCO is pursuing 2nd source to CIEN WWP. TLAB and CSCO arealready selling psuedowire and aggregation products to T w/ ALU being tested in 3Q for pot’l shrgain vs. TLAB.
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Semiconductor Equipment Industry Update Stephen Chin.................................. +1-212-713 [email protected] DRAM & Foundry orders from Taiwan. New DRAM semicap orders from Powerchip and ProMOS last week
Our review found ProMOS placed 2 equipment orders last week totaling $43M including $22Mwith Applied Materials and $21 with Lam Research. Our analysis shows these were ProMOS’first semicap equipment orders since Aug-08. We also found Powerchip placed a $48M orderwith ASML last week. Our analysis shows Powerchip has placed 3 orders with ASML so far in2010 totaling $142M.. UMC’s semicap orders were $77M last week, TSMC ordered $54MOur review found UMC placed 4 semicap orders last week, including $21M with Applied, $16Mwith KLA and $16M with Novellus. Our analysis shows UMC ordered $534M of total semicapequipment in 2Q10, up 115% q/q. Our review found TSMC placed 1 order last week with ASMLfor $54M. Our own analysis shows TSMC ordered $1,129M of total semicap equipment in2Q10, up 12% q/q.. Total Taiwanese semicap equipment orders in 2Q10 were up 19% q/qOur analysis shows the 8 big Taiwanese semiconductor companies ordered $2.4B of semicapequipment in 2Q10. Our own analysis also shows 2Q10 semicap orders from Taiwanesefoundry customers were +32% q/q and DRAM orders up 2% q/q. Novellus had the mostmomentum in 2Q10 with its Taiwanese orders up 58% q/q.. Shin-Etsu’s semiconductor wafer results had mixed read-thrus for MEMCShin-Etsu reported Jun-10 results on July 22nd and showed semiconductor wafer sales wereflat q/q as 300mm volumes were flat, which compares to our MEMC semi wafer sales estimateof +12% q/q growth in 2Q10. Shin-Etsu expects 10% semi wafer demand growth through yearend, with a modest recovery in prices.
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Broadcom (BRCM.O) Uche Orji...........................+1 212 713 [email protected]
Steven Chin.......................+1-415-352 [email protected]
Price (23 Jul 2010)...................... US$37.7612-month rating...............Buy (Unchanged)12m price target..........................US$41.00Mkt Cap......................................US$16.6bn
Full-Year EPS2010E............................................. US$1.822011E............................................. US$2.00
Expecting Solid 2Q10 Results. Expect in line to above results on mobile & wireless strengthWe expect BRCM to report Q2 sales/GAAP EPS of $1.62b (+11% q/q)/$0.46 vs cons of$1.59b/$0.46. We model for product GM to decline 50bps q/q to 52.0% due to greater wirelesssales mix, and EBIT margins to expand 190bps to 16.1% on greater operating leverage. Webelieve key product sales drivers in Q2 include combo wireless SoCs in new consumer productssuch as the iPad and iPhone 4, multi-touch controller, and baseband sales into Samsung andNokia.. Market uncertainty over 2H growth likely to be offset by product rampsFor Q3, we model for sales/EPS of $1.70b (+5% q/q)/$0.48 vs cons of $1.66b/ $0.49. Weexpect product GM to remain flat at 51.9% on continued consumer wireless IC growth and offsetby higher margin broadband IC sales as IPTV set-top box products for AT&T’s U-verse areexpected to start ramping. Other seasonal drivers we expect for Q3 include digital TV and Blu-ray/connected media players.. Further operating leverage to be realized as opex remains tameWe continue to expect new wireless and broadband product cycles will drive sales growth andultimately operating leverage as 65nm cost reduction programs lead to improving mobile &wireless division profitability and legal and stock-based comp expenses moderate. Call details:Tuesday 7/27 4:45pm ET, Dial: 847-619-6368.. Valuation: $41 12-month Price Target, Buy ratingOur DCF-based PT of $41 equates to 23x our 2010 GAAP EPS estimate of $1.81 (29x ex-royalties). We assume a WACC of 10.0% and terminal growth of 2.0%.
UBS SemiBytes Uche Orji..........................................+1 212 713 [email protected]
Steven Eliscu.................................. +1-415-352 [email protected]
Parag Agarwal.................................+1 212 713 [email protected]
Steven Chin.....................................+1-415-352 [email protected]
Results buoy secular growth names. Week 3: BRCM, RFMD, LSI, NETL,CAVM, MXIM. Week Ahead: BRCM, RFMD, LSI, NETL, CAVM, MXIM resultsFor earnings season week 3, we expect solid Broadcom results and guidance, demonstratingcontinued operating leverage on sales growth led by consumer applications and basebandsales into Samsung, Nokia. Given the recent share price appreciation for NetLogic and Cavium,we believe the stocks have limited near-term upside without solid double-digit q/q salesguidance. RFMD’s potential share losses at Nokia & Maxim’s potential capacity constraintskeep us on the sidelines.. Charts: Market share: few changes in processors but big shifts in chipsetsIn 2Q10, Intel gained 20 bps of overall microprocessor unit market share on gains in server,desktop processors to 82.0%. NVIDIA’s -32% q/q for C2Q chipset unit shipments is consistentwith our F2Q -30% q/q MCP business sales estimate.. Review: TXN, ALTR, LLTC, XLNX, ISIL, CY, SWKS, SNDK resultsWith declining risk aversion on largely consistent positive earnings results, we saw a semisector rebound accentuated by the strong growth and outlook of our secular growth names –Altera, Xilinx and Skyworks, which provided a boost to other secular growth names includingCavium, NetLogic and Atmel. While we remain Neutral on valuation, TI, Linear and Cypressalso posted strong results with solid C3Q guidance on strong end-market trends incommunications, smartphones and industrial applications. We remain positive on SanDiskbased on: 1) better than expected gross margin, 2) strong secular trends driving NAND Flashdemand to be in balance with supply, and 3) expectations of a smooth CEO transition.
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TelecommunicationsVerizon (VZ.N) John C. Hodulik, CFA..... +1-212-713 4226
Batya Levi......................... +1-212-713 [email protected]
Marc Albanese...................+1 212 713 2555Associate [email protected]
Price (23 Jul 2010)...................... US$28.0212-month rating......... Neutral (Unchanged)12m price target..........................US$28.00Mkt Cap......................................US$79.2bn
Full-Year EPS2010E............................................. US$2.222011E............................................. US$2.25
Cost cutting drives increasing EPS outlook. Similar to AT&T, EPS beats on wireless and wireline marginsWe are raising our 2010 EPS estimate to $2.22 from $2.10 after baking in more aggressive costcutting efforts and the effects of the 11K headcount reductions. We are also increasing our 2011estimate to $2.25 from $2.10, previously, suggesting 7% EPS growth off the adjusted 2010base.. Wireless segment sees better than expected subscriber adds and marginsWireless margins of 47.5% were well ahead of expectations (UBSe 46.2%), shrugging off higherthan expected net adds and a higher than usual upgrade rate. Management was bullish on itsability to take share, grow adds and accelerate revenue growth while maintaining industryleading margins. Capex in the segment will continue to ramp as the company approaches itsLTE launch in 4Q.. Expect cost cutting to help offset Frontier sale in 2H wireline marginsWe expect margin declines from the Frontier sale to be partially offset by cost cutting efforts andbelieve wireline operating margins will remain in the black in 3Q. Enterprise trends continue toimprove, turning positive in 2Q for the first time with the help of strong CPE sales. FiOS addscame in as expected but net broadband adds were light. Coupled with the strong margins, thissuggests management took its foot off the pedal, leaving the door open to cable share gains.. Valuation: Maintain NeutralWe maintain our PT of $28 per share. VZ trades at 5.7x 2011E EBITDA and 12.4x P/E, a 3%premium to the S&P500. Our PT is DCF based (8% WACC, 2% growth).
Equity StrategyUS Equity Strategy Jonathan Golub, CFA.....................+1-212-713 8673
Chip Miller, CFA, CPA.................... +1-212-713 [email protected]
Manish Bangard..............................+1 212 713 [email protected]
Thomas M. Doerflinger, Ph.D........... +1-212-713 [email protected]
Natalie Garner, CFA......................... +1-212-713 [email protected]
Great Results! Stealth Tightening?. Another quarter of strong resultsDespite rising concerns coming into 2Q reports, companies are handily beating consensusestimates and posting robust growth. Cyclicals have upsided expectations by 10% on the backof 17% top-line and 72% bottom-line growth.. Financials produced biggest surprises on lower credit lossesFinancials have missed top-line expectations due to lower trading volumes, tighter spreads, andtough investment banking comps. However, the sector has beaten bottom-line estimates by27%, largely due to lower credit losses at the biggest banks. Management commentary points toa continuation of each of these trends over the remainder of the year.. The key 2Q takeaway — big banks are reinforcing capital positionsWhile results have been better than expected, the biggest takeaway from this earnings seasonhas been comments from big bank CEOs and CFOs regarding their capital positions. Morespecifically, they describe actions taken to further shore up their balance sheets — guardingagainst uncertainties surrounding the recently passed Dodd-Frank Act and new Basel capitalstandards. These actions should lower bank ROEs, and may act as ‘Stealth Tightening’ for thebroader economy — similar in many ways to additional Fed tightening.
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EconomicsUS Economic Perspectives Maury N. Harris...............................+1-212-713 2472
Drew T. Matus................................. +1-203-719 [email protected]
Samuel D. Coffin.............................+1-203-719 [email protected]
Kevin Cummins.............................. +1-203-719 [email protected]
Bottom Fishing. Fishing for a Red Herring?Neither recent data nor expected future inflation measures signal price deflation. Temporaryfactors that have helped limit inflation over the last few months have begun to abate, suggestingthat the medium-term bias is toward modestly higher inflation. Overall, the evidence pointstoward very little inflation – but not deflation – this year, followed by a gradual rise in inflationover the next few years.. The past week: public policymakers vs. business worldFed Chair Bernanke’s semiannual Monetary Policy Report to Congress testimonycommunicated Fed policymakers’ “unusually uncertain” economic outlook. And the recentbehavior of Congress itself also has not inspired confidence in sustained economic recovery.On the other hand, the private sector’s behavior is becoming firmer ground for such confidence.Q2 corporate earnings reports so far have been generally better than expected. For smallerfirms, a hopeful sign is the apparent Q2 turnaround in business lending at smaller banks.. The week aheadThe market’s focus is likely to be on the Q2 GDP report due out on Friday, as concerns about a“double dip” and deflation continue to hold markets captive. We expect a modest slowing in Q2growth relative to Q1 but look for a modest acceleration in final demand. The Fed’s Beige Bookreport of regional business conditions in early Q3 should provide some economic insight aheadof the upcoming July ISM and jobs reports in the first week of August. We will scrutinize Q2housing vacancy data to determine how much vacant supplies for sale were trimmed by theexpiring homebuyer tax credits.
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Equity StrategyUBS Client Flow Watch Thomas M. Doerflinger, Ph.D........ +1-212-713 2540
Natalie Garner, CFA........................+1-212-713 [email protected]
Jonathan Golub, CFA....................... +1-212-713 [email protected]
Chip Miller, CFA, CPA...................... +1-212-713 [email protected]
Manish Bangard................................+1 212 713 [email protected]
Even more net buying of US equities. US Client Flow: Highest net buying in 22 weeksUS clients continued net buying US equities for a seventh straight week. The buying was broad-based, with only intermediaries net selling. Hedge funds continued the net buying begun in thelast four-week period.. Sector details: Broad-based increases in net buyingBoth US clients and foreign clients were net buyers of most US sectors. US clients increasedtheir net buying of financials, media, and telecoms and went from being net sellers to net buyersof consumer. Only healthcare and industrials were net sold by US clients. Foreign clientsincreased their net buying of most sectors, with only telecoms seeing net selling.. Foreign Client Flow: Only corporate clients are net sellingForeign clients also continued net buying US equities for a seventh straight week. Both longonly funds and intermediaries increased their net buying of US equities. Only corporate clientswere net sellers.
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Required Disclosures
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This package contains summaries of UBS research content. For a complete copy of the non-summarized version, please contact your UBSsales representative.
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UBS Investment Research: Global Equity Rating Allocations
UBS 12-Month Rating Rating Category Coverage[1] IB Services[2]Buy Buy 54% 41%Neutral Hold/Neutral 37% 32%Sell Sell 9% 24%
UBS Short-Term Rating Rating Category Coverage[3] IB Services[4]Buy Buy less than 1% 22%Sell Sell less than 1% 0%
1:Percentage of companies under coverage globally within the 12-month rating category.2:Percentage of companies within the 12-month rating category for which investment banking (IB) services were provided within the past 12 months.3:Percentage of companies under coverage globally within the Short-Term rating category.4:Percentage of companies within the Short-Term rating category for which investment banking (IB) services were provided within the past 12months.Source: UBS. Rating allocations are as of 30 June 2010.UBS Investment Research: Global Equity Rating Definitions
UBS 12-Month Rating DefinitionBuy FSR is > 6% above the MRA.Neutral FSR is between -6% and 6% of the MRA.Sell FSR is > 6% below the MRA.
UBS Short-Term Rating Definition
BuyBuy: Stock price expected to rise within three months fromthe time the rating was assigned because of a specificcatalyst or event.
SellSell: Stock price expected to fall within three months fromthe time the rating was assigned because of a specificcatalyst or event.
KEY DEFINITIONS
Forecast Stock Return (FSR) is defined as expected percentage price appreciation plus gross dividend yield over the next 12 months.Market Return Assumption (MRA) is defined as the one-year local market interest rate plus 5% (a proxy for, and not a forecast of, theequity risk premium).Under Review (UR) Stocks may be flagged as UR by the analyst, indicating that the stock's price target and/or rating are subject topossible change in the near term, usually in response to an event that may affect the investment case or valuation.Short-Term Ratings reflect the expected near-term (up to three months) performance of the stock and do not reflect any change in thefundamental view or investment case.Equity Price Targets have an investment horizon of 12 months.
EXCEPTIONS AND SPECIAL CASES
UK and European Investment Fund ratings and definitions are: Buy: Positive on factors such as structure, management, performance
US Morning Meeting Highlights 26 July 2010
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record, discount; Neutral: Neutral on factors such as structure, management, performance record, discount; Sell: Negative on factors suchas structure, management, performance record, discount.Core Banding Exceptions (CBE): Exceptions to the standard +/-6% bands may be granted by the Investment Review Committee (IRC).Factors considered by the IRC include the stock's volatility and the credit spread of the respective company's debt. As a result, stocksdeemed to be very high or low risk may be subject to higher or lower bands as they relate to the rating. When such exceptions apply, theywill be identified in the Company Disclosures table in the relevant research piece.
Company DisclosuresCompany Name Reuters 12-mo rating Short-term
ratingPrice Price date
Abercrombie & Fitch Co.16b ANF.N Neutral N/A US$36.80 23 Jul 2010Advanced Micro Devices16b,20 AMD.N Neutral (CBE) N/A US$7.82 23 Jul 2010Aeropostale Inc.16b ARO.N Neutral N/A US$30.88 23 Jul 2010Akbank4a,16b AKBNK.IS Buy N/A TRY8.50 23 Jul 2010Alberto-Culver16b ACV.N Neutral N/A US$29.40 23 Jul 2010Alliant Techsystems16b ATK.N Buy N/A US$67.12 22 Jul 2010Altria Group4a,16b,18a,22 MO.N Buy N/A US$22.12 23 Jul 2010American Eagle Outfitters Inc.16b AEO.N Neutral N/A US$12.87 23 Jul 2010ANZ Banking Group2,4a,5a,5b,16b ANZ.AX Buy N/A A$22.41 23 Jul 2010ARM Holdings Plc5b,14,16b ARM.L Neutral N/A 353p 23 Jul 2010Avon Products16b AVP.N Buy N/A US$29.44 23 Jul 2010Banco de Sabadell2,4a SABE.MC Sell N/A €4.18 23 Jul 2010Banco do Brasil16b,20,22 BBAS3.SA Buy (CBE) N/A R$29.48 23 Jul 2010Bank of Nova Scotia2,3b,4a,4b,6a,16b BNS.TO Buy N/A C$50.12 23 Jul 2010BBVA2,4a,5b,15,16b BBVA.MC Sell N/A €9.84 23 Jul 2010BE Aerospace Inc.16b,20 BEAV.O Neutral (CBE) N/A US$29.11 22 Jul 2010Boeing Co.2,4a,5b,6a,6b,6c,7,8,16b BA.N Neutral N/A US$66.60 22 Jul 2010BorgWarner Inc.16b BWA.N Buy N/A US$42.97 23 Jul 2010Broadcom Corporation16b BRCM.O Buy N/A US$37.76 23 Jul 2010Brown-Forman Corp.16b BFb.N Neutral N/A US$63.08 23 Jul 2010Campbell Soup Co.4a,5b,6a,6b,6c,7,16b CPB.N Neutral N/A US$36.25 23 Jul 2010Cavium Networks Inc16b CAVM.O Buy N/A US$30.49 23 Jul 2010CBOE Holdings Inc.2,4a,5b,6a,16b CBOE.O Not Rated N/A US$27.15 23 Jul 2010Chico's FAS Inc.16b,20 CHS.N Neutral (CBE) N/A US$10.24 23 Jul 2010Church & Dwight16b CHD.N Neutral N/A US$66.21 23 Jul 2010Clorox16b CLX.N Buy N/A US$65.43 23 Jul 2010CME Group Inc.2,4a,6a,6c,7,16b CME.O Neutral N/A US$286.56 23 Jul 2010Coca-Cola Co.6b,6c,7,16b,22 KO.N Buy N/A US$54.75 23 Jul 2010Coldwater Creek Inc.16b,20 CWTR.O Neutral (CBE) N/A US$3.89 23 Jul 2010Colgate-Palmolive16b CL.N Buy N/A US$83.47 23 Jul 2010Commerzbank2,4a,5b,14,16b,22 CBKG.DE Sell N/A €6.44 23 Jul 2010ConAgra Foods Inc.4a,6a,6b,7,16b CAG.N Buy N/A US$23.93 23 Jul 2010Constellation Brands Inc.16b STZ.N Buy N/A US$17.06 23 Jul 2010Cott Corp.16b COT.N Buy N/A US$6.21 23 Jul 2010Crédit Agricole2,4a,5b,16b CAGR.PA Neutral N/A €9.36 23 Jul 2010Cypress Semiconductor8,16b CY.O Neutral N/A US$11.19 23 Jul 2010Dean Foods Company16b DF.N Neutral N/A US$11.91 23 Jul 2010DnB NOR2,4a,5b DNBNOR.OL Buy N/A NKr75.05 23 Jul 2010Dr Pepper Snapple GroupInc.2,4a,6a,6b,6c,7,16b,22
DPS.N Neutral N/A US$39.82 23 Jul 2010
Energizer Holdings16b ENR.N Buy N/A US$53.59 23 Jul 2010Estée Lauder16b EL.N Neutral N/A US$62.67 23 Jul 2010Esterline Technologies Corp.16b ESL.N Neutral N/A US$48.81 22 Jul 2010Express Inc2,4a,5b,16b EXPR.N Buy N/A US$18.63 23 Jul 2010Ford Motor Co.2,4a,5b,6a,6b,6c,7,14,16b F.N Buy N/A US$12.72 23 Jul 2010Gap Inc.16b GPS.N Neutral N/A US$18.41 23 Jul 2010General Dynamics Corp.16b GD.N Buy N/A US$61.03 22 Jul 2010General Mills Inc.6b,6c,7,16b GIS.N Buy N/A US$35.52 23 Jul 2010Goodrich Corp.2,4a,6a,6b,6c,7,16b GR.N Buy N/A US$69.77 22 Jul 2010H.J. Heinz Company4a,6a,6b,6c,7,16b HNZ.N Neutral N/A US$45.76 23 Jul 2010
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Company DisclosuresCompany Name Reuters 12-mo rating Short-term
ratingPrice Price date
Hain Celestial Group13,16b HAIN.O Neutral N/A US$20.60 23 Jul 2010Hansen NaturalCorporation4a,6a,6b,7,16b
HANS.O Buy N/A US$43.01 23 Jul 2010
Hexcel Corporation16b HXL.N Neutral N/A US$18.40 22 Jul 2010Honeywell InternationalInc.4a,6a,6b,6c,7,16b,18b
HON.N Neutral N/A US$42.66 22 Jul 2010
HSBC2,4a,5b,6a,16a,16b,22 HSBA.L Buy N/A 646p 23 Jul 2010Ingersoll-Rand Co.16b,18k,22 IR.N Neutral N/A US$36.80 22 Jul 2010Intel Corp.6b,7,8,16b,18c INTC.O Buy N/A US$21.69 23 Jul 2010IntercontinentalExchange,Inc.4a,6a,16b
ICE.N Buy N/A US$108.36 23 Jul 2010
International Paper2,4a,6a,6b,6c,7,16b,22 IP.N Buy N/A US$24.98 23 Jul 2010J. Crew Group Inc.16b JCG.N Neutral N/A US$36.54 23 Jul 2010Johnson Controls Inc.16b,22 JCI.N Neutral N/A US$29.11 23 Jul 2010Kellogg Co.16b K.N Buy N/A US$51.10 23 Jul 2010Kimberly-Clark4a,5b,6b,6c,7,16b KMB.N Buy N/A US$63.64 23 Jul 2010Kraft Foods Inc.4a,6b,6c,7,16b KFT.N Buy N/A US$29.62 23 Jul 2010LAM Research Corp.16b LRCX.O Buy N/A US$42.30 23 Jul 2010Limited Brands, Inc.16b LTD.N Buy N/A US$25.62 23 Jul 2010Linear Technology Corp.16b LLTC.O Neutral N/A US$32.24 23 Jul 2010Lloyds BankingGroup2,3d,4a,5b,6a,12,14,16b,22
LLOY.L Buy N/A 64p 23 Jul 2010
Lockheed Martin Corp.2,4a,5b,6a,6b,7,16b LMT.N Neutral N/A US$74.25 22 Jul 2010Lorillard16b LO.N Buy N/A US$76.30 23 Jul 2010Maxim Integrated Products Inc.16b MXIM.O Neutral N/A US$18.29 23 Jul 2010Medtronic, Inc.2,4a,6a,6b,6c,7,16b MDT.N Buy N/A US$36.58 23 Jul 2010Microsoft Corp.2,4a,5b,6a,6b,6c,7,16b MSFT.O Buy N/A US$25.81 23 Jul 2010Molson Coors Brewing16b TAP.N Buy N/A US$46.24 23 Jul 2010NASDAQ OMX Group, Inc.6b,7,16b NDAQ.O Neutral N/A US$18.63 23 Jul 2010NetLogic Microsystems Inc16b NETL.O Buy N/A US$32.33 23 Jul 2010Northrop Grumman Corp.16b NOC.N Buy N/A US$57.90 22 Jul 2010NYSE Euronext4a,5b,12,16b,18l NYX.N Buy N/A US$28.24 23 Jul 2010PepsiCo Inc.2,4a,5b,6a,6b,6c,7,16b,18d PEP.N Buy N/A US$64.45 23 Jul 2010PNC Financial ServicesGroup2,4a,6a,6b,6c,7,16b
PNC.N Sell N/A US$61.02 23 Jul 2010
Precision Castparts Corp.6b,7,16b PCP.N Neutral N/A US$116.00 22 Jul 2010Procter &Gamble2,4a,5b,6a,6b,6c,7,8,16b,18e,22
PG.N Buy N/A US$61.91 23 Jul 2010
Punjab National Bank PNBK.BO Buy N/A Rs1,050.60 23 Jul 2010Ralcorp Holdings Inc.6b,7,16b RAH.N Neutral N/A US$59.54 23 Jul 2010Raytheon Co.2,4a,6a,6c,16b RTN.N Neutral N/A US$48.69 22 Jul 2010Reynolds American16b RAI.N Neutral N/A US$57.08 23 Jul 2010RF Micro Devices16b,20 RFMD.O Neutral (CBE) N/A US$4.23 23 Jul 2010Rockwell CollinsInc.4a,5b,6a,6b,6c,7,8,16b,18f
COL.N Buy N/A US$55.84 22 Jul 2010
SanDisk Corp.16b,20 SNDK.O Buy (CBE) N/A US$41.43 23 Jul 2010Santander2,3a,5b,16b SAN.MC Sell N/A €10.12 23 Jul 2010Sberbank16b,18j,20 SBER.RTS Buy (CBE) N/A US$2.71 23 Jul 2010Schlumberger Ltd.3c,16b,18g SLB.N Buy N/A US$61.30 22 Jul 2010Spirit AeroSystems Holdings16b SPR.N Buy N/A US$20.13 22 Jul 2010SunTrust Banks Inc.4a,6a,6b,6c,7,16b STI.N Sell N/A US$25.04 23 Jul 2010Swedbank2,4a,16b SWEDa.ST Sell N/A SKr79.00 23 Jul 2010Texas Instruments Inc.8,16b TXN.N Neutral N/A US$25.38 23 Jul 2010Textron Inc.4a,5b,6a,6b,6c,7,16b,18h TXT.N Neutral (UR) N/A US$20.22 22 Jul 2010The Hershey Company6b,6c,7,16b HSY.N Neutral N/A US$47.21 23 Jul 2010The Talbots, Inc.16b,20 TLB.N Buy (CBE) N/A US$11.42 23 Jul 2010TransDigm Group Inc.2,4a,6a,16b TDG.N Buy N/A US$51.78 22 Jul 2010Triumph Group Inc2,4a,5b,6a,16b TGI.N Neutral N/A US$71.25 22 Jul 2010
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Company DisclosuresCompany Name Reuters 12-mo rating Short-term
ratingPrice Price date
Under Armour, Inc.16b UA.N Buy N/A US$37.42 23 Jul 2010United TechnologiesCorp.4a,6a,8,16b,18i
UTX.N Buy N/A US$69.53 22 Jul 2010
Urban Outfitters Inc.16b URBN.O Buy N/A US$34.19 23 Jul 2010US Bancorp4a,6a,6b,6c,7,16b USB.N Buy N/A US$23.70 23 Jul 2010Varian Semiconductor EquipmentAssoc.16b
VSEA.O Buy N/A US$29.07 23 Jul 2010
VerizonCommunications4a,5b,6a,6c,7,16b
VZ.N Neutral N/A US$28.02 23 Jul 2010
Wal-Mart Stores2,4a,5b,6a,6b,6c,7,16b WMT.N Buy N/A US$51.67 23 Jul 2010
Source: UBS. All prices as of local market close.Ratings in this table are the most current published ratings prior to this report. They may be more recent than the stockpricing date
2. UBS AG, its affiliates or subsidiaries has acted as manager/co-manager in the underwriting or placement of securities of thiscompany/entity or one of its affiliates within the past 12 months.
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3c. UBS Securities LLC is acting as advisor to Smith International on its announced agreement to be acquired by Schlumberger.
3d. UBS Securities LLC is acting as sole financial advisor to Lloyds Banking group on the announced sale of private equityinvestments from its Bank of Scotland Integrated Finance business to a newly established joint venture called Cavendish SquarePartners that it is forming with Coller Capital.
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8. The equity analyst covering this company, a member of his or her team, or one of their household members has a long commonstock position in this company.
12. Directors or employees of UBS AG, its affiliates or subsidiaries are directors of this company.
13. UBS AG, its affiliates or subsidiaries beneficially owned 1% or more of a class of this company`s common equity securities as oflast month`s end (or the prior month`s end if this report is dated less than 10 days after the most recent month`s end).
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16b. UBS Securities LLC makes a market in the securities and/or ADRs of this company.
18a. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in AltriaGroup.
18b. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position inHoneywell International.
18c. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Intel
US Morning Meeting Highlights 26 July 2010
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Corp.18d. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in
PepsiCo Inc.18e. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Procter
& Gamble Co.18f. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in
Rockwell Collins Inc.18g. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in
Schlumberger.18h. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Textron
Inc.18i. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in United
Technologies Corp.18j. UBS AG, its affiliates or subsidiaries beneficially owned 1% or more of a class of this company`s common equity securities as of
last month`s end (or the prior month`s end if this report is dated less than 10 days after the most recent month`s end).18k. UBS AG, its affiliates or subsidiaries held other significant financial interests in this company/entity as of last month`s end (or the
prior month`s end if this report is dated less than 10 working days after the most recent month`s end).18l. UBS Securities LLC is part of the consortium that has agreed to acquire a significant equity interest in NYSE Amex options
exchange.20. Because UBS believes this security presents significantly higher-than-normal risk, its rating is deemed Buy if the FSR exceeds the
MRA by 10% (compared with 6% under the normal rating system).22. UBS AG, its affiliates or subsidiaries held other significant financial interests in this company/entity as of last month`s end (or the
prior month`s end if this report is dated less than 10 working days after the most recent month`s end).
Unless otherwise indicated, please refer to the Valuation and Risk sections within the body of this report.
ANALYST CERTIFICATION
Each research analyst primarily responsible for the content of this research report, in whole or in part, certifies that with respect to eachsecurity or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views aboutthose securities or issuers; and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specificrecommendations or views expressed by that research analyst in the research report.
For a complete set of disclosure statements associated with the companies discussed in this report, including information on valuation and risk,please contact UBS Securities LLC, 1285 Avenue of Americas, New York, NY 10019, USA, Attention: Publishing Administration.
Additional Prices: Adtran Inc., US$32.29 (23 Jul 2010); Alcatel-Lucent, €2.08 (23 Jul 2010); Ciena Corp., US$13.46 (23 Jul 2010); CiscoSystems Inc., US$23.35 (23 Jul 2010); Juniper Networks, US$28.09 (23 Jul 2010); Tellabs Inc., US$7.65 (23 Jul 2010); Source: UBS. Allprices as of local market close.
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US Morning Meeting Highlights 26 July 2010
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