The Great Debate-Deutsche Banks View

Saw what I thought was a pretty good report out of Deutsche Bank last week about economic prospects in 2010.  Here are the excerpted highlights.  Note also their end of the year fair value for the S&P 500 is in the same ball park as ours. 

Strong Earnings Momentum: Cash Build to Push Enterprise Spend & Payouts

Strong earnings momentum: Q4 2009 highlights

Earnings Characteristics: 

(i) The bottom line beat by 10%, the fourth big beat in a row; ex-TARP repayment charges, S&P 500 EPS came in at $19.2 (annualized $76.8);

(ii) Top line beat at 70% of firms;

(iii) Top line has grown sequentially for 2 and the bottom line for 4 quarters;

(iv) Operating margins rose again for Ex-Financials (+20bps);

(v) Cash flow was strong, 25% above cash earnings;

(vi) Signs of writeoff-provisioning cycle peaking, with most banks expecting declining credit costs ($11.5 of S&P 500 earnings in 2009);

(vii) Guidance rose for EPS, sales and capex; the Consumer sectors, Tech and the Industrials guided EPS up, Energy, Utilities and Materials down; (viii) The bottom up consensus rose to $82 for 2010 (Figures 1-17).

Cash builds: Sales and production rise; inventories, SG&A and capex fall

Ex-Financials sales have risen sequentially for 2 quarters, as has production, but inventories have fallen for 6 quarters in a row, the worst decline in our 30 year sample. Rising earnings but falling working capital and SG&A expenses have meant rising operating cash flows. Capex fell again, but the rate of decline continued to moderate. Cash balances continue to rise and are up 50% since mid 2008.

To come: Pick up in enterprise spend, payouts and M&A

{Deutsche Bank's} fundamental thesis remains that enterprise spend and hiring will determine both the speed of recovery and whether it becomes self-sustaining. Very low ratios of inventories, SG&A and capex to sales or cash flows, combined with very high cash levels, point to an imminent increase in enterprise spend, a rise in payouts and a strengthening M&A bid (Figures 28-31).

Strategy implications: Reiterate $80.8 EPS and 1325 S&P 500 target

Strong earnings momentum and a turn in provisioning argue for revising up estimates, but faster than expected dollar appreciation argues against. An imminent increase in enterprise spending, positive guidance, and a turn in provisioning argue for overweighting the Financials, Industrials, Consumer Discretionary and Tech, which is how we are positioned. Negative guidance and a strengthening dollar argue for underweighting Energy and Materials, with underweights for Utilities and Telecom supported by negative guidance and poor earnings momentum, respectively. 

Source:  "Strong Earnings Momentum", Chada, Binky along with Parker, Keith & Thatte, Parage.  US Equity Strategy, Deutsche Bank 02.23.10 {Cover Page-Summary}.

*At the time of this publication we were long ETFs related to the S&P 500 in client and personal accounts.  Long ETFs related to the Financial, energy and technology sectors in certain client and personal accounts.  Long ETFs related to the industrial sector in certain client accounts.  Lumen Capital Management maintains a business relationship with Deutsche Bank and its President, Christopher R. English is a former employee of the firm.