>A New York presenter likes Electronic Arts (ERTS: NASDAQ, $18.70). The gaming industry has been hit by the weak economy, but there are indications of bottoming in the space. The company has made significant gains in the digital area and on the Wii platform and is in a great position as we’re entering the all-important holiday season. New releases have been selling very well, with FIFA 2010 breaking records as the fastest-selling sports game in history. The company’s impressive balance sheet allows it to both support the established franchises and make significant investments in pursuit of growth opportunities. The presenter targets $25, or 30% upside form the current level, based on forward earnings estimates.


>Our New York presenter likes UnitedHealth (UNH: NYSE, $26.47) at this level. This leading managed care player is trading at a discount to peers, but its diverse business model holds less risk in light of some of the upcoming regulatory changes facing the industry. The company has improved its service levels recently and customer retention reflects that trend. The scale of UNH’s operations and the reach of its provider network would allow the company to benefit significantly from expansion of coverage under the healthcare reform. Cost pressures are a challenge, but the company has been able to raise prices to offset higher medical costs. The presenter conservatively targets $30, but notes that $35 is possible if more favorable assumptions are proven valid.

>Craig Johnson, President of Customer Growth Partners and Roulston Research’s Consumer community Chair has issued a Holiday 2009 Forecast. Craig believes holiday retail sales will grow by 2.4% y-o-y, a sharp turnaround from last year’s 4.1% decline. In issuing the forecast, Craig noted that his estimate of $502 billion in predicted 2009 November-December sales still lagged the peak $511.1 billion in 2007 sales — and were barely above the $497.1 billion level seen in 2006.

He believes that Americans have endured a series of economic body blows over the past year, from the housing and credit crises to rising unemployment, but they’re now beginning to pick themselves off the mat, dust themselves off — and start to shop again. With unemployment near 10%, this will not be a great holiday season, but compared with last year when the economy was in freefall, retailers will see a return of topline growth — and many will enjoy robust, if not record, fourth-quarter earnings.

Highlights of CGP’s 2009 Holiday forecast include:

  • November-December 2009 retail sales will increase to $502 billion, up from $490 billion in the similar period of 2008;
  • The 2.4% rise represents a sharp turnaround from 2008’s 4.1% YOY decline;
  • 2009 Holiday sales will be paced by 10.8% year-over-year growth in e-commerce and other direct-to-consumer sales, also a strong rebound from last year. According to the DOC, fourth quarter 2008 e-commerce sales fell by 5%, the first ever YOY decline in holiday period e-commerce sales;
  • Clothing and accessories sector sales will rise by 8.8%, a major turnaround from 2008’s unprecedented 13% decline — but still below sales levels achieved in either 2006 or 2007;
  • Lagging sectors will include the long-suffering home-improvement retailers, predicted to see a 10.4% YOY decline, and the home-furnishings sector, with a 6.6% drop;
  • Discount and other value retailers will shine in holiday 2009, led by off-price retailers such as TJX and Ross Stores, low-price players such as Aeropostale and Forever 21, such Big Boxers as Costco and Wal-Mart, and e-commerce retailers Amazon and Gilt.com;
  • Electronics retailers — from Best Buy and Hhgregg to Apple, Amazon and Wal-Mart — will see exceptional unit growth, particularly in flat panel TV’s, e-readers, laptops and mobile phones, but will be held back by sharply falling consumer electronics prices;
  • The predicted 2.4% holiday season increase represents CGP’s Base Case forecast, which assumes that the unemployment rate remains in the 9.8% to 9.9% range, and that energy prices remain stable at about $2.70/gallon regular gasoline; and
  • CGP also prepared two sensitivity analysis forecasts. Under the high unemployment/ high-energy price scenario, holiday sales would decline by 1.5%; and under the falling unemployment/low-energy price scenario, holiday sales would rise by 4.4%.

He notes that last year’s holiday shopping season saw households in almost stark fear financially, as consumers clenched their pursestrings with an increase in the savings rate to 4.7% during the peak December Christmas shopping season, over quadruple the 1.1% savings rate from earlier in 2008. But now savings are now returning to more normalized 3% levels — and with the third quarter GDP growing at about 2% or 3%, the economic clouds are beginning to lift a bit.

The real wildcards will be if employment takes another leg down, and if energy prices take another leg up — which will turn holiday sales negative a second year in a row.

>Our NY presenter is bullish on Cinemark’s (NYSE: CNK) prospects. This movie chain is perfectly positioned for the long-anticipated transition to the 3-D standard. Consumers have embraced the better viewing experience 3-D offers and are willing to pay a $2-$5 premium for tickets. Attendances for 3-D screenings are twice as high as for regular movies. Movie studios will save on prints and shipping costs to distribute prints around the country. Some majors have already agreed to use their savings from the new platform to help movie chains finance the cost of installing digital projectors. JP Morgan is also putting together a financing package to facilitate this transition.

Cinemark has the best operating metrics in the space. Its presence in Latin America, a less competitive market, helps diversify revenue streams. The stock pays a 6.4% dividend yield. The upside from the $11 level where the name was recommended is 40-70% in the next 2-3 years, depending on how fast the 3-D switch progresses.

>Tatum/Roulston Report

October 21, 2009

>Tatum’s survey is unparalleled in the ability to capture consistent opinions from Tatum’s nearly 1,000 executives across the nation who act as CFOs, Controllers and CIOs in a broad base of industries across the country.

Tatum is a nationwide firm specializing in the providing financial and information technology services and executive fulfillment to companies across the country. For the past seven years Tatum’s monthly Survey of Business Conditions has provided useful insight regarding business conditions. Roulston Research has partnered with Tatum LLC to produce abstracts of the business outlook from data collected by Tatum. In the Tatum/Roulston Report, Roulston Research believes most surveys, for example, do not identify a broad spectrum in volume of respondents, regionalism, company size or consistent respondents. In addition government results are usually reported 30-60 days after measurement period before revisions are made 30 days later. Most surveys’ conclusions are thus old news, but more importantly have not had a predictive result on earnings trends. The Tatum/ Roulston Report is not constructed with these issues that may distort or delay results. Instead, it is timely and immediate, with a consistent survey constituency of professionals primarily operating in high levels in the financial and technology departments of companies where the rubber meets the road. This joint effort with Tatum is a unique partnership that will provide a differentiated view of business trends – The Tatum/ Roulston Report.

Visit our website to view the latest Survey.

This month, BusinessWeek featured Tatum’s survey in a discussion of current trends among executives, especially in the healthcare and technology industries. Follow this link to the Business Week article.

>Stephen Maloney
Copyright 2009, Towers Perrin
All rights reserved

While crude oil markets are enjoying a breakout, why isn’t natural gas keeping pace? Isn’t there supposed to be some kind of multiplier relating the two commodities? Shouldn’t rising hydrocarbon prices lift all boats? After all, the recession is over, right?

Maybe it’s a storage problem so let’s check the numbers.

As of October 9, 2009, US crude oil stocks were 337.8 million barrels, up from 309.2 million barrels a year ago. That’s a 9.2% increase over last year and well outside the normal range for this time of year.

Natural gas stocks as of October 2, 2009 stood at 3,658 billion cubic feet (Bcf). That’s up from 3,266 Bcf a year ago or a 14.6 % increase and also outside the normal range for this time of year.

So, we’re not seeing an inordinate swing in storage volumes relative to normal ranges for this time of year.

Now, let’s look at the prices.

WTI spot prices on October 9 were $71.75 a barrel, up from $69.80 the previous week. In contrast, spot prices for natty gas are around $3.82 per MMBtu and not showing much strength above the NYMEX $4 handle.

Let’s put this in context. A barrel of oil is worth roughly 5.8 MMBtu. So, $71.75 per barrel of WTI crude prices a barrel’s energy content at about $12.37 per MMBtu. On an energy content basis, oil prices are currently about 3.24 times higher than energy prices for an equivalent amount of natural gas. And, crude oil prices are in breakout.

By comparison, a year ago, WTI prices last year were $77.44 and heading south. Henry Hub prices were then around $8 per MMBtu. On an equivalent MMBtu basis, the conversion multiple last year was 1.67.

Natural gas prices are not keeping up with crude oil price increases.

Admittedly, a year-to-year comparison is not really fair. After all, US natural gas prices follow a cyclical pattern timed to the onset of winter. Prices tend to peak in late July-early August. That period also coincides with peak volatility reflecting the uncertain requirements of the upcoming
winter heating season and the uncertain potential for supply disruption associated with the beginning of hurricane season in the US Gulf Coast. So, there should be some risk premium to price into natural gas spot or prompt month prices. And, we should vary that premium through the year. As the winter heating season ends in late winter-early spring, the price topology can be as exciting as riding the “Rebel Yell” (ask Brian Hunter, formerly of Amaranth, to explain why Mar-Apr spreads are called the “widow maker”).

Clearly, the evidence is “all hydrocarbons are the same” is NOT true on an equivalent heat rate basis. Maybe they once were, but not at this moment and not at certain times of the year.

What’s changed?

First, crude oil is an international market while natural gas is currently dominated by pipelines.

In addition, we’re seeing the increasing role natural gas is playing in domestic electric power generation. In contrast, crude oil has no role in electricity generation.

Utilities don’t burn oil anymore to make electricity. Rather, they mostly burn US and Canadian produced natural gas and US coal. In fact, roughly a third of natural gas demand goes to generating electricity. And, over the past year, electric generation went down pretty hard due to the recession. When people talk about wind and solar reducing the dependency on foreign oil, they’re wearing leisure suits and playing an 8-track tape from the 1970s.

Electricity generation directly taps into the real US economy (i.e., the one that employs working people – not NYSE). With US industrial capacity utilization running below 70%(!), it’s not surprising that July net electric generation (a peak demand month) fell off the table some 7.6% this year. Coal was the big loser with its less liquid market taking a stomach churning 15% drop in generation. The (relative) big winner was natural gas demand for generation which was only down 0.4%.

The new dynamics of natural gas markets are breaking a lot of traditional notions. For example, while demand for generation softened, natural gas prices responded to market dynamics quicker than the coal market such that gas-fired generation actually stole market share from coal in many areas, including the Midwest. In effect, the higher spark spreads made gas-fired generators relative money makers this summer compared to coal generation while large segments of the US industrial sat idle. Wild.

We’re still a long way from a US economy running at its normal 80% or so capacity utilization. The US economy will need a few years of white-knuckled growth combined with some serious capacity rationalizations to get there. Meanwhile, natural gas rigs are dropping off in an attempt to match supply to demand.

Shifting markets aren’t the only change impacting natural gas markets. We also have seen a very quiet tropical storm season which has also moderated the volatility spikes we often see in the summer going into the fall.

All in all, while domestic supplies of natural gas heroically stole some domestic demand from coal it otherwise couldn’t keep pace with crude oil’s breakout driven by USD collapse and Chinese demand. Still, there may be some late inning hopes – despite threats (or promises – take your pick) of global warming, it may well be a colder winter this year. Cold temps can be beautiful music for natural gas producers.

Clearly, traditional market dynamics for natural gas were impacted by this recession and the “dog that didn’t bark” (no headline-making hurricanes to speak of). And, so, the spreads between WTI crude oil and Henry Hub natural gas have widened beyond traditional bands.

What about the future? Will the US natural gas market continue to experience domestic dynamics? Or, will LNG expose the market to the trans-Atlantic spreads and transform US storage into a swing player not unlike the WTI-Brent spreads?

In my next blog, I’ll talk about LNG.

Stephen Maloney
Managing Consultant, Risk and Financial Services
Towers Perrin

>Craig Johnson, our Consumer chair, believes that recent moves by Wal-Mart to demonstrate its desire to continue its aggressiveness by seeking new avenues of competition.

Recently the company started to

  • sell dozens of toys for $10 each
  • offer a wireless service priced below competitors
  • cut prices on 10 highly anticipated hardcover books to $10 on Walmart.com

The third action prompted a price war with Amazon.

After both retailers then cut their prices on those books to $9, on Friday Walmart.com shaved a penny off that price to come in at $8.99 each. Walmart.com has threatened to drop prices even further. The company said it would adjust its pricing as needed to ensure it offered the lowest prices on its top 10 pre-selling books.

Craig believes that this is a demonstration that they are “more aggressive and they will cede no ground to the competition, whether it’s the Best Buy’s of the world, or Toys “R” Us or … Amazon.” He is of the opinion that “any competitor that underestimates Wal-Mart, does so at its own peril.”