Tesla questions remain, BP and HSBC profits leap, GME roars higher on equity offering

Morning Note

Record highs for the S&P 500 and Nasdaq yesterday failed to really kick start the European session this morning with the major bourses all looking a bit sloppy in the face of a raft of big corporate earnings announcements. We’re into the meat of earnings season proper now with 173 S&P 500 companies that account for around half the market capitalisation are reporting this week. So far so good: of those that have already reported, revenues are up 10% on average, while earnings are up by a third. A stunning turnaround from last year’s pandemic washout, driven by a combination of massive fiscal stimulus, extraordinarily accommodative monetary policy and a vaccine-led cyclical bounce back of epic proportions.

Tesla posted better-than-expected earnings in the first quarter. The company posted GAAP net income of $438m with earnings per share coming in at $0.93 on $10.39 billion in revenue, up 74% from a year ago. Some $518m in regulatory credits helped, whilst it added $101m to its bottom line from the sale of Bitcoin after its $1.5bn ‘investment’ announced in February. Is this an automaker or not? I have been very sceptical about this Bitcoin position and what it exposes the company to. Shares slipped more than 2% in after-hours trade following the results. Still, it was a record quarter for sales and progress is being made on the delayed new models with the new Model S landing on customers’ driveways by May 2021 and Model X deliveries to commence in Q3. Tesla also pointed to Model Y production ramps at Fremont and Shanghai going well. Meanwhile buildout of Berlin ‘Gigafactory’ is continuing to move forward, with production and deliveries remaining on track for late 2021, Tesla said. Chip shortages are a problem, but Tesla suggests it’s finding ways around. And although margins did pic up, there are maybe some questions over margins with the lower average selling prices – excluding regulatory credits the margins in the core auto business were 22%. I don’t think these results really tell us an awful lot more than we already know about Tesla.

BP profits jumped to $2.6bn, easily beating analyst expectations and well ahead of last year. Looney says the company is in good shape. As he puts it, these results really put to rest some of the fears investors may have had around this stock as it’s managed to reduce net debt ahead of schedule and is delivering shareholder returns. Looney seems really committed to pushing the dividend, which I suppose you can do if you are not doing any more oil and gas exploration. Still, he better keep some back for those wind turbines. BP is confident that China and the US will drive the recovery in crude demand.

The reduction in net debt is eye-catching, with the figure down around $18bn in the last year from $51.4bn to $33.3bn, meeting the objective a year early. Reported profit for the quarter was $4.7bn, compared with $1.4bn profit in Q4 2020 and a loss of more than $4.3bn a year before. Underlying replacement cost profit came in at $2.6bn, compared with $0.1bn for the previous quarter. BP said this was driven by an exceptional gas marketing and trading performance, significantly higher oil prices and higher refining margins. Dividend of 5.25 cents per share declared and shares rose more than 2% in early trade in London.

HSBC profits rose 79% from a year ago on a mixture of improving economic conditions and a reduction in provisions for bad loans. Among other things, the company noted solid growth in Hong Kong and UK mortgages. Interestingly for a bank that has been seen to put all its eggs in one Asian basket as other regions have been less profitable, all regions were profitable in Q1 and notably the UK bank reported pre-tax profits of over $1bn in the quarter. Reported profit after tax was up 82% to $4.6bn, while reported profit before tax rose 79% to $5.8bn. The bank said that reduced revenues, which fell 5% $13bn, continued to reflect low-interest rates. Provisions for bad loans were less than expected, particularly in the UK, mainly reflecting a better economic outlook and government support schemes. As such reported provisions for bad loans was a net release of $0.4bn, compared with a $3.0bn charge a year ago. Shares rose a touch in early trade.

Sticking with banks – UBS this morning admitted it took a $774m hit from the Archegos fiasco. This is not as large as the $5.5bn for Credit Suisse, but nevertheless shows how the fallout was wider than initially thought. Despite this, profits at UBS rose 14% to $1.8bn. Wealth management profits rose 16%, whilst investment banking was down 42%. UBS, which has fallen 2% this morning on the update, says it has now unwound all its exposure to Archegos. Nomura meanwhile says it is 97% out and has taken a $2.3bn loss on its Archegos exposure, adding that it expects to book about $570m more in charges related to Archegos this financial year.

Shares in GameStop rallied almost 12% and added a further 9% in after-hours trade to hit $184.50 after the company completed its at-the-market equity offering. In an update to investors yesterday, management said they had sold 3.5m shares of common stock and generated aggregate gross proceeds before commissions and offering expenses of approximately $551m, Roughly, that means they got this offering off at about $157 per share. Net proceeds will be used to continue accelerating GameStop’s transformation as well as for general corporate purposes and further strengthening the company’s balance sheet.

As I previously argued, shareholders who have been bidding up the stock should be pleased by the offering. Although it entrails a meaty dilution, the cash call is entirely expected and without a big capital raise now that takes advantage of rally in the stock, Chewy.com founder Cohen might not have the cash to fulfil the ambition of becoming the Amazon of Gaming.

Elsewhere, oil prices trade higher with WTI back above $62 as OPEC’s technical committee stuck to an optimistic view of demand growth whilst also cautioning about the rise of the coronavirus in India, the world’s number three importer of crude. The technical committee, which met ahead of Wednesday’s meeting, indicated that demand growth is still seen around 6m bpd in 2021, whilst the stock surplus should be eliminated by the end of the second quarter. There are also concerns about Japan, the fourth largest importer of oil. Copper prices continue to advance, hitting a fresh 10-year high this morning, whilst US 10-year yields pulled back from 1.6% yesterday in a choppy session ahead of this week’s Fed meeting.

FOMC preview: Wait and see mode

The Federal Reserve kicks off its two-meeting today. This week’s meeting of the Federal Open Market Committee (FOMC) ought to pass off without too much fanfare or market noise. Even as the economic indicators improve, the Federal Reserve remains in emergency mode. The Fed should be thinking about thinking about tapering, but it likely will not want to signal this just yet. It remains the case, it should be noted, that the Fed is now in a reactive policy stance where it is waiting for the data to hit certain thresholds rather than acting pre-emptively. We also know that not only is the Fed happy to let inflation get hot, but it is also focused squarely not just on employment but the ‘right’ people getting jobs. It’s a central bank that is taking a political angle to its policy making. In any event, tapering of the Fed’s $120bn-a-month asset purchase programme will be signalled well in advance, and this is not the time to do it.

Bond yields have cooled somewhat since the March meeting, with the 10-year note chopping around in a 1.55%-1.60%. In any event, if the rise in nominal yields was not a worry then, it’s certainly not one now. Fed speakers including chairman Powell have made it clear they think rates will move up because of the screaming cyclical bounce, not because people are worried about inflation.

Meanwhile, since the March meeting the pace of vaccinations has meant over half of all adults in the US have had at least one vaccination. Jobless claims have hit the lowest since the pandemic struck more than a year before and retail sales are powering head. The IHS Markit composite PMI hit a record high in April as all corners of the economy picked up steam. Despite this the Fed will remain cautious with regards to the outlook, citing the risk of fresh infections. Chairman Powell will need to acknowledge the economic recovery in progress but seek to tamp down expectations. And despite the strong demand impulse combining with weak supply to put upwards pressure on prices, he will stick to the line that any inflation will be temporary.

Best UK shares for trading a Covid vaccine-led reopening story in 2021

Equities
Investments
D’ya like dags? Or indeed goats. The market rally in November was led by the dogs of the markets: energy, financials and Value were among the best shares to buy. Here are a few big-name stocks to watch in December and into 2021 on a ‘back to normal’ trade.

Macro highlights

  • Vaccines to support a return to near-normal by year-end 2021
  • Economic recovery will not be instantaneous but steady improvements are expected
  • Earnings per share should increase as corporates benefit from pro-cyclical growth
  • Inflation to rise as output gap closes and enormous savings glut is spent

Effective vaccines will be rolled out in 2021 in the developed world, supporting a return to normal economic and social activity by the year end. Whilst there are risks associated with the delivery of vaccination programmes globally, overall, it looks like countries will be able to support a ‘return to near-normal’ by the end of next year.

Return to normal ought to support European and UK equity markets with their strong weighting towards more cyclical stocks and sectors vs the US which has led the way with big tech and growth. A powerful value rotational trade was the dominant market trend in November 2020, leaving financials, energy and travel stocks among the top shares to buy, and while it will not move in a straight line upward, this pivot ought to continue through the earlier part of 2021 as markets adjust to economic and social activity returning to normal. December has begun very much like November was.

Britain has been hobbled by Brexit uncertainty for 4 years and UK equities have underperformed peers. Even allowing for the November recovery which was the best month for the FTSE 100 in 31 years, UK stocks have not had a good time of it in recent years. However, with Brexit risks likely to disappear and the UK in possession of the means to deliver a comprehensive vaccination programme, the outlook for the economy – and UK equities – may be about to improve. The FTSE 100 has an expected 2021 dividend yield of 4%, making it the most attractive among developed market stock indices. Is the dog of all dogs to finally ready to bark?

Two major caveats to this thesis – a Brexit deal and effective vaccination rollout are both essential, and not a slam dunk certainty.

GOAT: Get Out And Travel picks

IAG (LON: IAG) – Return of lucrative transatlantic routes will be big fillip for IAG shares. In the 11 months to December the stock was down by around 60%, making it the worst performer on the FTSE 100. Nevertheless, the stock rallied over 80% in the month of November as vaccine optimism drove the rotation trade. Whilst this may effectively have priced reopening in 2021, there could be further upside driven by on-the-ground improvements to travel. In addition to the roll-out of vaccines, efforts by airlines like BA and airports like Heathrow to find creative solutions to ending quarantine requirements for travellers such as digital health passes will progress and make it easier for travel to take place. Shares are not expected to get back to pre-pandemic levels next year – passenger travel levels are not seen returning to 2019 numbers for some years. But a steady reopening of the economy and pent-up demand among holidaymakers to get out and travel ought to support earnings recovery in 2021.

Cineworld (LON: CINE) – A GOAT favourite but huge debts are a factor. Shares have been very volatile, with the price collapsing when the company announced closure of UK and US screens due to pandemic and then surging on news of Pfizer’s vaccine in November. YTD, the stock was the worst performer on the FTSE 350 to the end of November. Cineworld was bloated before the pandemic – net debt is over $8bn thanks mainly to two large leveraged acquisitions in recent years. The fear is that there have been permanent behavioural shifts in consumers that will mean the market is forever smaller, however the stock is probably already reflective of these risks. It is hard to gauge right now what permanent damage is done to cinemas, but the advance of over-the-top streaming services, especially Netflix with its vast Hollywood budgets and ability to make feature films, has dealt another big blow.

Cineworld shares have recovered a further portion of the losses after the company secured a new debt facility of $450m and issued equity warrants representing over 11% of share capital. It also managed to get banks to waive debt covenants until June 2022 and further reduced costs. This new facility should act as a bridge to get to a point where it can reopen screens in the UK and US and get the cash flow moving in the right direction again. However, the company is working on the assumption that can reopen in May. Under this base case scenario, Cineworld has sufficient headroom for 2021 and beyond. But in the event of a further delay to cinema reopening, whilst it has sufficient liquidity ‘for a number of additional months’, it ‘may require lender support in order to deploy that liquidity’, management said today. Bums on seats by May is dependent entirely on a vaccine – if there is a stock trading on this vaccine roll-out it’s Cineworld. Warner Bros decision to stream all new releases as soon as they they hit the big screen is a blow and sent shares lower by 14% on Dec 4th.

Energy has been a laggard but the likes of Shell (LON: RDSA) and BP (LON:BP) should stand to benefit from stronger average crude pricing in 2021. Both fell by around 40% in the 11 months to Dec YTD. Whilst the International Energy Agency (IEA) has been right to sound cautious over the demand pickup in the early part of 2021, oil markets will be trading largely on sentiment. There are clear near-term risks from rising inventories – a lockdown in the US would lead to demand destruction in Q1. Tertiary lockdowns in Europe cannot be ruled out in Q1 and even Q2 should the virus reappear in strength. OPEC and allies will continue to hold the fort, albeit not as comfortably as in the past. Towards the end of the year, oil markets may also benefit from an expected supply crunch. The spectacular collapse in oil markets due to the pandemic led to a massive wave of capex cuts – according to Rystad about $100bn cut – which threaten to flip the market from glut to crunch as vaccines start to take effect and boost the demand side. Risks remain for old world energy players though as ESG investing takes on added importance.

Reflation picks: Banks

Lloyds (LON: LLOY), Natwest Group (LON: NWG) both were among the largest decliners on the FTSE 350 YTD through to the end of November, down in the region of 30-40%. Both have a lot exposure to the UK economy, especially the housing market and consumer spending. Two factors could support gains. First, the reflationary environment in 2021 as vaccines encourage a return to normal ought to see a steepening yield curve and support net interest margins. Secondly, clarity over Brexit should be a positive for the UK economy. Other factors, like the remarkable resilience of the housing market and relative strength in consumer spending, are also supportive.

Share prices of both have fallen this year as 2020 has really been a story of UK plc risks – negative rates, deficits, pandemic-related GDP destruction and of course Brexit. 2021 should see a more encouraging outlook for the UK economy and the removal of tail risks like no deal Brexit. Near-term, rising unemployment will be a problem but ultimately a ‘return to normal’ in2021 will support financials. A resumption of dividend payments in February when results are announced would be a big help, too. In many ways banks have been unfairly swept up in the markets’ pandemic crossfire as investors followed the playbook of the last war: financials are in much better shape this time and well provisioned to weather the storm. As of the end of November, Lloyds traded at a price to book ratio of 0.55, whilst Natwest was at about 0.47.

Meanwhile Barclays (LON: BARC) price to book was a measly 0.36. Some may doubt the sustainability of handsome trading revenues from its investment bank, but the outlook is still overall positive. Third quarter results smashed expectations, with pre-tax profits of £1.2bn double what was expected. Loan loss provisions were 40% below expectations, albeit higher than last year.

HSBC & BP absorb the damage, oil plunges again

Morning Note

The S&P 500 rallied to close at its highest since March 10th as investors pin their hopes on states reopening in the coming days and weeks, but we’ve had a less impressive session overnight in Asia. European shares are a bit mixed today on a huge day for corporate earnings which are by and large showing up the huge damage being done to heavyweight stocks from Covid-19 and the collapse in oil prices. The FTSE 100 opened mildly lower but is holding the 5800 level. US futures have weakened along with oil, which is coming under intense selling pressure again.

HSBC joined the growing rank of banks setting aside huge amounts of capital to absorb the expected economic hit from the Covid-19 outbreak. Today’s Q1 update showed a 48% decline in reported profits before tax to $3.2bn as it hiked loan loss provisions to $3bn. It comes after a $3.9bn loss in Q4 2019 due to writing down assets in its investment and commercial banking arms in Europe by $7.3bn. Shares slipped nearly 2% in early trade in London.

There are two main challenges for HSBC. First its pivot to Asia and reliance on earnings out east, at a time when emerging market growth could become very challenged due to Covid-19 and a stronger USD. Second, it’s embarking on a major restructuring designed to slash costs that will inevitably be delayed. Management note today they will be slower to reduce risk weighted assets (RWAs).

Having been made to scrap dividends and buybacks by UK regulators, there was chatter HSBC would think about moving its headquarters out of London and back to Hong Kong. Investors residing in the ex-colony were not impressed, with some launching a legal challenge. HSBC took the strange step of apologising to them today for the loss of income. But while regulators over here may be exceedingly cautious and willing to bash the banks at times, it’s nothing on what awaits if you get within reach of Beijing. Reassessment of the West’s relationship with China after Covid-19 suggests it will be prudent to stick to London.

Elsewhere European banks are in full reporting mode this week. Santander profits were down 82% after setting aside €1.6bn in provisions for losses. UBS profits rose 40% and it seems to less exposed to loan loss provisions than many peers.

BP meanwhile faces a single problem – a collapsing oil market as demand falls and prices plunge. Management reported underlying replacement cost profit for the first quarter of $0.8 billion, compared with $2.4 billion for the same period a year earlier. This, they said, reflected lower prices, demand destruction in the downstream particularly in March, a lower estimated result from Rosneft and a lower contribution from oil trading.

As a result, net debt ballooned by $6bn to $51.4bn leaving gearing at 36.2%. But it’s maintained its dividend – for now. The $10bn acquisition of BHP’s shale assets was not such a smart move. As mentioned before, if BP wants to go green and be ‘carbon neutral’ by 2050, it’s going to require higher oil prices to do it. Oil will pay for the shift away from oil. BP shares slipped 2% in early trade.

Finally, highlighting the extent of the damage in US shale, Weir Group reports today that Q1 Oil & Gas orders were down 34%, and expects capex in North America to be down 50% in 2020.

Oil slumps again

On oil, the front-month (June) WTI contract is coming in for the expected bashing. Prices plunged Monday and have extended losses in Asia after USO said it was dumping its June contracts, about 20% of its holdings. It was inevitable that the front month would again hit the skids as we approach tank tops in the US and producers are too slow to turn off the taps. Increasingly there are also signs floating storage is running out for Brent. There is nothing to stop front month WTI approaching zero again with nowhere to stash the oil. The market will remain in steep contango as traders try to find shelter in future months but this only heaps more and more pressure on the front months.

Charts

Having cleared the 50-day simple moving average decisively with yesterday’s close, the S&P 500 is now facing the key resistance around 2885.

WTI has slumped again and continues to make new lows this morning – path to zero is open again.

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