Corporate Strategy Weekly Radar Update

Week ending Friday 7 December 2012 (SUN rally + Italian PM Monti resigns)
Financial Services SUNs share price finished the week at $10.20 (up 5.3%), outperforming the broader ASX200 (up 1.0%) and the Financials index (up 1.7%) driving the Groups market capitalisation above that of QBE. o The most likely source of buying is the Capital Group, probably the worlds largest fund manager, who have been thoroughly studying SUN as an investment. SUN became the largest Australian domiciled insurer after overtaking QBE in terms of market capitalisation. The last time SUN was over $10 was on 7 Oct 2008. By contrast, QBE is trading at 8year lows (mid $10) on fear of a capital raising and the impact of a rate cut on yield guidance. IAGs commercial insurance arm (CGU) flagged that low interest rates could force an increase of up to 8% for business insurance premiums, particularly in longer tail classes. o Long tail classes are the most vulnerable to rate movements due to a greater reliance on investment earnings, which continues to be impacted by low returns. Projected investment income on claims reserves are factored into pricing, so a sustained period of low yields tends to push premiums up. Commentators also note the shift in 'pricing power' back to insurers after years of discounting, particularly in the fragmented CI market. Governance advisers Ownership Matters (OM) recommend that shareholders vote against BoQs March share placement due to the size of the discount to the share price resulting in significant dilution to existing shareholders. A vote against director Carmel Gray (former SUN exec) has also been recommended for board accountability reasons o The deal has been criticised for its similarity to the selective and opaque placements made during the GFC - of the $150M raised, 42% reportedly went to non-existing shareholders. OM is recommending against retrospective ratification of the placement at the Banks AGM next week. NAB is facing a potential backlash from institutional investors ahead of its AGM next week, with many frustrated over the Banks underperformance relative to peers (statutory profit down $1.1b for FY to 30 September and an increase in bad debts to $2.6b). o NABs relative poor performance is attributed to underperformance of its UK business (Clydesdale and Yorkshire Banks), bcse of the recession, and of its WM arm ($2.3b in outflows for FY12). NABs share price is down 21% since Sept 2005, in contrast to the other Big 4 whose prices have risen between 11-58% over the same period. There is also potential for a vote against the remuneration report and the re-election of some board members incl CFO Mark Joiner. o However, on the upside, shareholders are paid a significant dividend for their patience: ~7.55% fully franked (~ 11% grossed up). A significant return for a big4 stock, also the reason some dont think NABs underperformance will continue for too much longer. Moodys predicts major bank profits will stagnate in 2013 and bad debt charges will rise because of the weakening economy. They do acknowledge the big banks have little exposure to mining, so will instead be affected by the broader economic slowdown. Moody's expects 'earnings growth' to slow due to low credit growth, a lower interest rate environment and ongoing funding pressures. o However they also acknowledge that despite threats to growth, the outlook for Australian banks, especially compared to the EU and the US, remains stable and profitability is likely to remain strong. Citi announced it will cut 11,000 jobs (~4% of its workforce), mostly in the Banks consumer banking business, to reduce costs. o Whilst Citis strategy continues to focus on its 'global footprint', they are cutting areas where scale does not provide meaningful returns. Impact on Australian operations is expected to be minimal. Other industries(continued) .. and the re-structure of its supply chain: earnings have risen 145% over 3 years and ROC has improved from 7.2% to 18.8%. Gourmet Food Holdings, the parent company of iconic brands such as Rosella and Aristocrat, was placed into receivership after creditors failed to find a buyer. The company is considered another casualty of difficult retail and manufacturing conditions and the outcome indicative of broader issues facing smaller food manufacturers, subdued consumer spending and pressure from large retailers including Coles and Woolworths. US Liquefied Natural Gas (LNG) could become a rival to Australia as a supplier to Asia: 15 US companies are seeking licences from US congress to export cheap shale gas as LNG Democrat Senator and incoming chairman of the US Senate Energy Committee, Ron Wyden of Oregon is opposing it because of the strain on demand and environment impact)

Macro Economy, Politics and Regulation

The RBA cut the cash rate by 0.25% taking official interest rates to 3% and matching the record low levels of the GFC. The high $A, declining export prices and a weaker global outlook were referenced as reasons for the cut. o The move was widely expected by analysts and follows the release of ABS economic data which showed (1) a 7.6% fall in residential building approvals for October; (2) a wages drop (0.2%) in the Sept Qtr for the first time since 2009; (3) a 2.9% reduction in company profits- the 8th consecutive quarterly drop; and (4) Sept Qtr GDP growth the smallest gain in 6 quarters (0.5% and 3.1%pa, seasonally adjusted). The cut has sparked fresh debate on the feasibility and sensibility of returning the federal budget to surplus in the current environment. o Most banks including SUN, NAB, CBA, WBC and BoQ passed on 0.20% of the cut, citing high deposit costs. o The majority of economists are predicting at least one additional rate cut of 0.25bp in 1Q2013, taking the cash rate to 2.75%, the lowest in the RBAs 52 year history. On a more positive note, Aust unemployment unexpectedly fell to 5.2% (3-month low), down from 5.4% in Oct. The result was ahead of analyst expectations (5.5%) and was driven by growth in part-time work, while full-time employment fell. o The surprise result may temper expectations for further rate cuts, although slowing GDP growth could provide the impetus for a reduction in Q1 2013. Greece launched a discounted buy-back of privately held sovereign debt (33% of its face value) to lower its interest costs (part of a re-packaged plan): the buy-back is a condition for the release of the latest instalment of EU-IMF funds o Analysts estimate the buy-back could eliminate 20b off the countrys debt, although there is doubt over the volume of private investor participation. S&P's subsequently cut Greeces debt rating from CCC (lowest level before default) to selective default, considering the buy-back the launch of a distressed debt restructuring. The latest UK budget and economic update forecasts GDP to contract -0.1% in 2012, a sharp downward revision from the +0.8% growth forecast in the March budget. The forecast for 2013 has also been cut and GDP growth is not expected to return to pre-GFC levels until 2014. o The UK budget deficit remains one of the highest in the OECD and stabilisation of govt debt has been pushed out to 2016/17, Other industries when it is forecast to reach ~80% of GDP. The revisions could K-Mart managing director Guy Russo flagged plans to aggressively place the UKs triple-A rating in jeopardy. grow market share following 3 years of restructuring. In Breaking news, Italys Prime Minister Mario Monti is to quit o K-Mart's Everyday Low Prices' positioning appears to have worked with after losing former PM Silvio Berlusconis party support to pass consumers and reflects the simplification of the product range, the exit the 2013 budget. Berlusconi announced he's running for PM of unprofitable categories and brands,... (ct'd) (more debrief this coming week)