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Top 10 US Ideas Quarterly
Q1 Top 10 Ideas
Strategy
Equity | 03 January 2017 Corrected
Top 10 US Ideas – 1Q17
The backdrop for risk assets has changed dramatically over the past year. As Michael
Hartnett pointed out, 2016 saw global interest rates fall to 5,000-year lows and the
likely end of what has been the greatest bull market in bonds ever. We experienced a
historic US Presidential election and Republican sweep of Congress on November 9th.
Later that same month, OPEC reached a historic deal to reduce crude production by
1.2mn b/d with non-OPEC producers delivering an additional 600k b/d of cuts – the first
such joint curb since 1998. Risk assets responded with 30-year Treasury reaching a
yield of 2.088% in July, US equity markets reaching all-time highs, and oil prices rallying
more than 40% since the start of the year. Given the Republican sweep - and the
resulting likelihood that the logjam of Washington gridlock will be broken - our Top 10
stock selections are more heavily geared toward companies that may benefit from
increased fiscal stimulus, a more pro-business agenda, and/or tax-policy reform. Our
current strategy stands in stark contrast to our stance last year of looking for defensive
growth ideas.
United States
Alpha Generation Research
MLPF&S
Anthony Cassamassino
Strategist
MLPF&S
+1 212 449 6874
anthony.cassamassino@baml.com
Derek Harris
Strategist
MLPF&S
+1 646 743 0218
derek.harris@baml.com
Eight Buys and two Underperforms
Our 1Q17 list includes eight Buys and two Underperforms across six sectors. Our Buys
are Aetna Inc, Dover Corp, General Dynamics, Hess, MGM Resorts, Norfolk Southern, SVB
Financial, and Texas Instruments. Our Underperforms are Consolidated Edison, and
TripAdvisor.
How the list will be maintained and updated
We will publish this list at the beginning of each quarter. Ideas will generally remain on
the list through the quarter unless coverage is dropped or the recommendation changes.
Any security which is removed will not be replaced. If there are any changes to the list
during the quarter we will publish the change in a research report. Securities are
intended to stay on the list for one quarter, though some may be chosen for the next
quarter’s list. We will publish performance quarterly
Unauthorized redistribution of this report is prohibited. This report is intended for amanda.ens@baml.com
Table 1: Top 10 US Ideas List – 1Q17
Company Ticker Analyst Rating Recommendation Price PO Mkt Cap (bn)
Aetna Inc AET Fischbeck,Kevin B-1-7 BUY $124.45 $149.00 $44,657.00
Dover Corp DOV Obin,Andrew B-1-7 BUY $75.19 $85.00 $11,921.00
General Dynamics GD Epstein,Ronald J. B-1-7 BUY $173.21 $200.00 $57,215.00
Hess HES Leggate,Doug B-1-7 BUY $62.90 $80.00 $19,090.00
MGM Resorts MGM Kelley,Shaun C-1-9 BUY $28.50 $33.00 $11,993.00
Norfolk Southern NSC Hoexter,Ken B-1-7 BUY $108.82 $122.00 $33,393.00
SVB Financial SIVB Poonawala,Ebrahim B-1-9 BUY $170.38 $190.00 $8,584.00
Texas Instr. TXN Arya,Vivek B-1-7 BUY $74.15 $82.00 $73,899.00
Consolidated
Edison ED Chin,Brian A-3-7 UNDERPERFORM $74.07 $59.00 $20,526.00
TripAdvisor TRIP Schindler,Nat C-3-9 UNDERPERFORM $46.95 $41.00 $9,071.00
Source: BofA Merrill Lynch Global Research
BofA Merrill Lynch does and seeks to do business with issuers covered in its research reports. As a
result, investors should be aware that the firm may have a conflict of interest that could affect the
objectivity of this report. Investors should consider this report as only a single factor in making
their investment decision.
Refer to important disclosures on page 27 to 30. Analyst Certification on page 17. Price Objective
Basis/Risk on page 15. 11698831
Timestamp: 03 January 2017 12:05AM EST
Top 10 US Ideas Quarterly
Our Top 10 US Ideas are based on our view that these companies could have the most
significant market and business related catalysts over the next three months. The list
reflects primarily a bottoms-up approach, with calendar-specific events noted for most
stocks. We constructed our list by canvassing BofAML Fundamental Equity Research
analysts in order to find 10 BofAML-covered stocks which we think will significantly
outperform or underperform peers during the quarter. We considered only Buy-rated
names for outperform ideas and Underperform-rated names for underperform ideas. We
then narrowed the list after consulting our Equity Research colleagues.
To be eligible for the list, the stock must be covered by BofA Merrill Lynch AMRS
fundamental equity analysts with a rating of Buy or Underperform, for long and short
stock recommendations, respectively.
Stocks will be chosen on a discretionary basis by the Alpha Generation team, which
currently includes strategists with experience choosing stocks for BofAML’s US 1 list.
Stocks will be chosen for the list using a bottoms-up approach after taking into account
the views of the relevant BofA Merrill Lynch Fundamental Equity analyst and upcoming
catalysts. Diversity of the list and BofAML macro views will also be factors in choosing
stocks for the list.
Stocks on the list will generally remain on the list during the quarter. However, a stock
will be removed interim quarter if considered ineligible due to a change in the stock’s
fundamental rating, or if the stock is no long covered by BofA Merrill Lynch fundamental
Equity Research. When stocks are removed during the quarter, they will not be replaced.
Stocks will generally be removed from the list at the end of the quarter in conjunction
with the publication of the next quarter’s list, but may on select occasions remain on the
list if the identified catalyst remains relevant or a new catalyst is expected to drive the
requisite over/under performance. Any intra-quarter actions to the list will be announced
in a research report.
The Top 10 list will be published on or close to the first day of each quarter. In addition,
we may also publish research reports updating the catalysts’ status or other news on
particular stocks during the quarter.
How the list will be maintained and updated
We will publish this list at the beginning of each quarter. Ideas will generally remain on
the list through the quarter unless coverage is dropped or the recommendation changes.
Any security which is removed will not be replaced. If there are any changes to the list
during the quarter we will promptly publish a note explaining the change. Securities are
intended to stay on the list for one quarter, though some may be chosen again for the
next quarter’s list.
2 Top 10 US Ideas Quarterly | 03 January 2017
Aetna (AET)
Kevin Fischbeck +1 646 855 5948
Research Analyst, MLPF&S
Buy, PO $149
1Q investment thesis
Based on past precedence, our view is that the AET/HUM deal is more likely than not to
be approved by the courts (ruling likely to come in January 2017). PF 2018 earnings
should be close to $11.50 (vs $9.70 consensus), even before taking into account the
upside from tax reform (+15% to EPS) and rising interest rates (+5%). In the event that
the deal breaks, we see little downside and potential upside in 1Q17 in the form of
capital deployment (AET remains underlevered and in the absence of a deal could look to
aggressively repurchase stock). Current estimates do not include share repurchase and
based on its history of repurchasing shares using free cash flow and its balance sheet
capacity, we expect AET to repurchase a significant amount (~10%) of its shares in
2017 post deal break, providing initial downside support and ultimately driving upside to
Street estimates.
Table 1: Aetna key stock data
Industry
Managed Care
Market Cap (mn) $44,657
Price $124.45
P/E (2017) 14.4x
% of sell-side rated Buy 70.0%
Short interest % of float 2.25%
Source: Bloomberg and BofA Merrill Lynch Global Research estimates
Deregulation/Gov’t Legislation: Repeal and Replace of the ACA creates some
uncertainty, but neither AET nor HUM derive a significant amount of EPS from the ACA.
Meanwhile, Republicans have historically supported Medicare Advantage (80% of HUM’s
revenue), and we expect a stronger rate environment under this Administration than
over the past 8 years.
Tax Policy: As a domestic only company with a relatively high tax rate (est. 35% in
2017), AET would benefit from tax reform. We believe that some benefit would be lost
to minimum MLR rebates or competition, but if taxes are lowered 15%, then we assume
that they keep about 2/3 of the benefit (19% to EPS).
Catalysts: Deal resolution, capital allocation update, tax reform, rising interest rates.
Latest report: MCO rally has just begun; beneficiaries of the non-Health
Care upside from Trump
1Q risks: Risks to the downside are courts not approving the HUM acquisition, lowerthan-expected
membership growth and higher than expected cost trend. CMS will issue
the rate update for 2018 for Medicare Advantage in late February, a reg which we
expect to be benign, but which could be worse than expected.
Company Description: Aetna is one of the nation's largest managed care organizations,
covering roughly 23 million members. The company focuses on three main business
segments: Health Care (health insurance, dental, behavioral health and pharmacy benefit
Top 10 US Ideas Quarterly | 03 January 2017 3
products), Group Insurance (including life, disability and long term care insurance
products) and Large Case Pension (a legacy business which is largely in runoff).
Dover (DOV)
Andrew Obin +1 646 855 1817
Research Analyst, MLPF&S
Buy, PO $85
1Q investment thesis
We think the Street is underestimating ’17 EPS upside potential from Energy recovery
given the segment’s close correlation to N.A. rig count and short-cycle nature of the
business, as well as incremental accretion from Wayne acquisition. DOV is expected to
host an analyst dinner on January 12 th which will provide a 4Q update and preview 2017
results. We think the meeting will be a positive catalyst for the stock, providing more
visibility on Energy orders post-OPEC meeting, highlighting sustainability of the EMV
cycle in Wayne into ’19. Investors will also likely get an update on execution turnaround
in the Refrigeration business, removing one of the biggest overhangs on the stock.
Table 1: Dover key stock data
Industry
Industrial Machinery
Market Cap (mn) $11,921
Price $75.19
P/E (2017) 19.6x
% of sell-side rated Buy 25.0%
Short interest % of float 1.54%
Source: Bloomberg and BofA Merrill Lynch Global Research estimates
Deregulation/Gov’t Legislation:
We expect Trump’s administration to prioritize US energy independence, with
deregulation benefiting domestic shale produces, which should be an attractive tailwind
to DOV’s Energy segment.
Tax Policy:
Our estimates are based on 29% tax rate in ‘17/18. We calculate that under Ryan’s
proposed plan, we can see about 19% upside to EPS. We estimate that under Trump’s
proposed plan, we can see about 24% upside to EPS.
Catalysts:
January 12 th – investor dinner with management
January 26 th – 4Q results
Rig count release
Latest report: Dover Corp: Adjusting for Wayne, EMV cycle extension; Rig
count going up, LII read-across
1Q risks: With so much of DOV’s EPS upside tied to Energy segment recovery, we view
oil price volatility (from stronger US$ or other unexpected macro headlines) as the
biggest risk to our thesis. Weaker-than-expected execution in Refrigeration or Fluid
business would be another risk, offsetting Energy upside.
4 Top 10 US Ideas Quarterly | 03 January 2017
Company Description: Dover is a diversified, global manufacturer of industrial products.
It comprises more than 30 independent companies that operate in four segments:
Refrigeration & Food Equipment, Fluids, Energy, and Engineered Systems.
General Dynamics (GD)
Ronald Epstein +1 646 855 5695
Research Analyst, MLPF&S
Buy, PO $200
1Q investment thesis
General Dynamics is a defensive large cap value stock with potential cyclical growth.
The company has a history of annual dividend increases with a dividend yield of 1.7%.
Concerns about weakening demand for Gulfstream business jets in General Dynamic’s
Aerospace segment have weighed down sentiment. However, using a sum-of-the-parts
analysis that values GD’s defense businesses in line with the pure play defense average,
this would imply that GD’s Aerospace segment is trading at a significant discount to the
market at 12x P/E multiple on 2018E earnings. Considering the strength in Gulfstream’s
product portfolio and margin performance, we would expect Aerospace to trade at least
at 18x P/E multiple on 2018E earnings.
Table 1: General Dynamics key stock data
Industry
Aerospace & Defense
Market Cap (mn) $57,215
Price $173.21
P/E (2017)* 17.9x
% of sell-side rated Buy 76.2%
Short interest % of float 1.02%
Source: Bloomberg and BofA Merrill Lynch Global Research estimates
Gov’t Legislation: 56% of sales are from the US government
General Dynamics’ primary customer is the US Department of Defense, which accounted
for 47% of total sales in 2015. The remaining 9% are to other non-DoD US government
agencies like the intelligence community. For the military, which is a defensive sector,
GD is engaged in engineering, manufacturing, and support of land and expeditionary
combat vehicles and systems, armaments, munitions, and shipbuilding and marine
systems. Major products include Virginia-class nuclear-powered submarine and Ohio
class ballistic nuclear submarine replacement, Arleigh Burke-class Aegis destroyer,
Abrams M1A2 tank, Stryker 8-wheeled assault vehicle, medium-caliber munitions and
gun systems, tactical and strategic mission systems. The company also provides
information systems and technologies.
Disruptor: Gulfstream G650 has unrivaled performance in the most profitable
business jet market segment
There is no direct competitor aircraft currently in service in the market to match the
performance of the Gulfstream G650/650ER. The G650ER has a range of 7,500 nautical
miles at Mach 0.85, but can fly faster at Mach 0.90 with a range of 6,400 nautical miles.
The Dassault Falcon 8X has a range of only 6,450 nautical miles. Meanwhile,
Bombardier’s response to the G650 has been delayed another year with the entry into
service of the Global 7000 (range of 7,300 nautical miles) in 2H18. Gulfstream book-tobill
in 3Q16 was 1:1 on a dollar value basis and 1.2:1 on an aircraft unit basis. In our
view, market share gains in a soft demand environment could provide Gulfstream a solid
foundation to bridge the Gulfstream G450/550 to the G500/600.
Top 10 US Ideas Quarterly | 03 January 2017 5
Catalysts: Stable Aerospace earnings & US defense spending
Operating weakness for Bombardier’s Global family, which competes with the
Gulfstream family, has weighed down investor sentiment for large cabin business jets
and General Dynamics. However, Gulfstream’s more conservative production rates,
attractive product positioning, higher quality backlog, and better operating performance
compared to Bombardier lower Gulfstream’s near- and medium-term earnings risks, in
our view. The key catalyst for General Dynamics is the upcoming earnings result that
demonstrates how EBIT in the Aerospace segment remains stable despite a more tepid
market outlook from Bombardier.
We continue to view GD as a beneficiary of positive inflection in US defense spending.
We expect the recent Republican victory in the White House and the Senate to be seen
as incrementally positive for defense. Political control is a key driver of defense
spending, and defense stock valuations are tied to changes in defense spending related
to the modernization accounts. Our Political Control Model (PCM) analysis highlights a
Republican President and Republican Senate is the best case for Budget Authority in
defense modernization accounts. Our PCM analysis suggests that the Republican sweep
could increase the Budget Authority for defense investment accounts by a CAGR of 12-
13% (FY17E-21E). This compares to the BofAML forecast of a 5% CAGR and the FY17
Green Book forecast of a 1% CAGR.
Additionally, GD’s Marine Systems segment is a direct beneficiary of the US pivot to the
Pacific. The Pacific is a hotbed of maritime activity particularly as China expands its
territorial waters. As the US focus on naval superiority strengthens, we might see upside
to shipbuilding spending.
Latest report: General Dynamics: Gulfstream still undervalued; raise PO to
$200 and reiterate Buy 30 November 2016
1Q risks: large cabin business jets market deterioration and US defense spending
There is risk of market deterioration in large cabin business jets that could increase
earnings risks for Gulfstream. Additionally, delays in government contracting or lower
than expected increase in US defense spending could provide downside risks to our
estimates.
Company Description
General Dynamics is a major US government contractor engaged in combat vehicles and
systems, armaments, munitions, ordnance, shipbuilding and information systems and
technologies. It is also the parent company of Gulfstream in its Aerospace segment,
which is the most profitable airplane manufacturing company in the world.
Consolidated Edison (ED)
Brian Chin +1 646 855 5855
Research Analyst, MLPF&S
Underperform, PO $59
1Q17 investment thesis
Since the November elections, utility valuations have not adequately adjusted to the
rapid shift towards a rising-rate environment and have decoupled from historically
predicative valuation patterns. Looking at studies of 10yr Yields v. Utility PEs, BBB
Yields v. Utility PEs, and Utility Div. Yields v. Rates are the best examples of this
6 Top 10 US Ideas Quarterly | 03 January 2017
dislocation (more metrics can be found in our Alternating Currents Weekly). We rate ED
Underweight to take advantage of this sector dislocation. ED on its own is
fundamentally overvalued. ED trades at a 0.5x premium to its peers despite having
slower than average growth prospects, increasing regulatory complexity, and the
overhanging risk of fines for the Harlem explosion.
Table 1: ConEd key stock data
Industry
US Electric Utilities
Market Cap (mn) $22,400
Price $74.07
Total Debt / 2019 EBITDA 3.88
% of sell-side rated Sell 26.3%
Short interest % of float 3.94%
Source: Bloomberg and BofA Merrill Lynch Global Research estimates
Not your grandmothers ConEd – increasing complexity changes investment story
ConEd is facing very slow growth electric demand growth in its utilities with 0.2% y/y
growth in its CECONY subsidiary through 20201 and -0.1% growth in its O&R
subsidiary. To offset this slow growth, ConEd has been increasing the complexity of its
business by purchasing gas and electric transmission assets which have higher growth
potential but face more market risk (most notably the JV with Crestwood in the
Stagecoach midstream pipeline system). Furthermore, the regulatory regime in New
York is undergoing a fundamental shift as the Reforming Energy Vision (REV) program is
implemented. REV seeks to fundamentally change how utilities are compensated by
creating more of a ‘platform’ for energy delivery. Slow growth, changing business mix,
and new regulatory constructs add considerable risk to what used to be a “go to” vanilla
regulated utility.
An overvalued Sector and Potential Catalysts
For a long time, ConEd was viewed as the quintessential utility and, during the run-up in
Utility valuations in 2016 its shares outperformed despite its weakening fundamentals.
As the story becomes more complex and the utility sector adjusts to lower valuation we
would expect ED to underperform with a similar symmetry to other utility stocks.
Latest reports:
Recent BofA Merrill Lynch Global Research Reports
Title: Subtitle Primary Author Date Published
Utilities: Fed promises more hikes; utes face more downside Brian Chin 15 December 2016
risk in early 2017
Utilities: Alternating Currents Weekly Brian Chin 18 December 2016
1Q17 risks: Risks to our thesis are primarily macro related. If utility sector valuations
remain disconnected from historical fundamentals for the quarter or if rising interest
rates significantly reverse course our Underweight rating on ConEd could not
materialize.
Company Description: Consolidated Edison (ED) is the owner of Consolidated Edison
Company of New York (CECONY) and Orange & Rockland Utilities (O&R) providing
electric, gas and steam service to 3.5 million customers in New York City and the
northern suburbs. ConEd also has a transmission segment with gas pipeline, storage,
and electric transmission. Finally, ConEd has three competitive energy businesses:
ConEd Development (energy infrastructure), Energy (wholesale services), and Solutions
(retail services).
Top 10 US Ideas Quarterly | 03 January 2017 7
Hess Corporation (HES)
Doug Leggate +1 713 247 6013
Research Analyst, MLPF&S
Buy, PO $80
1Q17 investment thesis
Broad expectations of a pro-energy agenda from the incoming administration set a
theoretically constructive backdrop for the US oils. Along with the tailwind from
renewed OPEC support for oil prices, we view the broader energy sector as a
momentum play in the early part of 2017 where stock specific catalysts can re-emerge
to differentiate relative performance within the large cap US oils. We view Hess as the
most catalyst rich large cap US E&P for 2017 with a return to growth and
disproportionate exploration risk from a company with the highest cash margins in the
sector, second best balance sheet and significant oil leverage to our base case that is an
oil recovery in 2017. Hess remains amongst our top ideas in the US large cap oil sector
for 2017, and we retain our Buy rating, and $80 PO.
Table 1: Hess key stock data
Industry
US oil and gas exploration and production
Market Cap (mn) $19,090
Price $62.90
EV/Debt adjusted cash flow (2017)* 9.4x
% of sell-side rated Buy 46.4%
Short interest % of float 8.52%
Source: Bloomberg and BofA Merrill Lynch Global Research estimates
Deregulation / Gov’t Legislation
While the potential for a less onerous regulatory backdrop, and greater access to Federal
lands for exploration and development, the majority of current activity remains
dominated by private lands thereby limiting any material changes arising from a
Republican administration. The exception is the potential for more receptive backdrop
for infrastructure development that can improve regional pricing through improved
access to takeaway capacity.
Tax Policy:
For the majority of the US E&P’s, changes in corporate tax rates have negligible impact
given that substantial net operating losses and deferred tax credits means that cash
taxes remain de minimis for the foreseeable future.
Catalysts:
News flow starts with an expected capex budget unchanged from 2016 at ~$2bn, the
company has stated it expects a return to drilling in the Bakken with a stated ramp up to
6 rigs from 2 currently returning the play to growth in 2017.. The first Guyana
development (Liza) expected to achieve FID by 2Q17 and which we expect to confirm
industry leading economics. Start-up of the first of two major developments – the North
Malay basin gas play in 3Q17, putting Hess back on a growth track and turning attention
to the Stampede start up in the US GoM in early 2Q18. In the background is an
exploration test every 45-60 days any one of which could materially change the scale of
the Hess business model of the next decade.
8 Top 10 US Ideas Quarterly | 03 January 2017
Latest reports: Tales from the road (Dec 1, 2016); Speculation builds over
Payara (Dec 19, 2016)
1Q17 risks: We expect a supportive commodity backdrop, spending clarity and
confirmed return to growth all punctuated by a steady stream of large scale exploration
news flow to support relative performance for Hess in 1Q17. Greatest risk to the
broader energy sector comes from adherence of the OPEC agreement to support oil
prices through coordinated production cuts; With this backdrop note that Hess retains
one of the most resilient balance sheets in the sector, with adjusted net debt / cap of
just 14% and $2.9bn of net cash on the balance sheet at end 3Q16.
Company Description: Hess Corp (HES) is a mid-sized oil & gas company with 1.0bn
boe of proved reserves at end 2015. E&P operations are focused in the US onshore,
deep water GOM, North Sea, Guyana, West Africa, and Asia.
MGM Resorts International (MGM)
Shaun Kelley +1 646 855 1005
Research Analyst, MLPF&S
Buy, PO $33
1Q investment thesis
MGM is a levered play to improving/accelerating US economic growth. The US makes up
80% of EBITDA (70% Vegas, 20% Macau, 10% US regional) and the company has 4-5x
net debt/EBITDA which is high, but coming down to under 4x by end of 2017 which
could allow for a possible upgrade to investment grade by the end of 2017 or early
2018.
MGM has high operating leverage (50%+ flow through of revenues) and should benefit
from any macroeconomic improvement as well as already healthy/strong Las Vegas
fundamentals (visitation +3% YTD, RevPAR +6% which is one of best hotel markets in
the US). MGM benefits from both consumer (80%) and business (20%) travel. There is
zero supply growth in Las Vegas the next 2-3 years and virtually no Airbnb/disruption
risk as staying at integrated casino resorts on the Strip is key to the experience.
MGM should see accelerating growth in 2017 to a very high +24% Y/Y on an organic
basis. We think this is some of the highest growth we will see in the Gaming, Lodging &
Leisure industries. MGM should also see a meaningful free cash flow inflection in 2017
as capex falls off dramatically after its 2 new property openings in Washington DC and
Cotai/Macau.
Table 1: MGM key stock data
Industry
Gaming
Market Cap (mn) $11,993
Price $28.50
P/E (2017) 21.6x
% of sell-side rated Buy 95.7%
Short interest % of float 2.94%
Source: Bloomberg and BofA Merrill Lynch Global Research estimates
Top 10 US Ideas Quarterly | 03 January 2017 9
Deregulation/Gov’t Legislation: There aren’t any clear/obvious changes here that
would impact MGM. As a labor intensive business, changes to overtime rules or the
Affordable Care Act as it relates to company level costs could be modestly beneficial.
Tax Policy: MGM will be a cash tax payer in 2017. Tax policy should be mixed. While
they get some meaningful interest shield from their decent amount of debt, they also
have relatively high capex that could benefit them if expensed as incurred. Import tariffs
should be limited in impact as it’s mostly a domestic, services based business with
limited COGS.
Catalysts: ConAgg should generate RevPAR tailwinds. RevPAR should accelerate in Q1
and could be up double digits in the quarter driven by a strong convention calendar,
headlined by the ConAgg convention which comes only once every 3 years.
MGM also opened its $1.4B National Harbor casino outside of Washington on December
8 th . The first data points here on revenues will come in early January.
MGM’s Cotai casino in Macau opens in 2Q17 and is a new $3B property. We believe
expectations are reasonably low and revenues are still strong in Macau (+ double digits
in 4Q). Despite recent softness, Macau peers still trade at premiums to core MGM
Latest report:
MGM Resorts International: Notes from the road: MGM National Harbor -
the new standard for regionals
1Q risks: Macau sentiment has been fading recently as the RMB continues to
depreciate and investors seek new growth opportunities domestically given the large
cyclical rotations occurring in other sectors.
Company Description: MGM, is a global hotel and casino gaming company, owns and
operates 19 properties located in NV, MD, MS, MI, IL and Macau. It owns a 50% stake in
its CityCenter joint venture on the Las Vegas Strip and a 77% interest in MGM Growth
Properties, a publicly traded gaming focused real estate investment trust (REIT).
Norfolk Southern (NSC)
Ken Hoexter +1 646 855 1498
Research Analyst, MLPF&S
Buy, PO $122
1Q investment thesis
Norfolk Southern is benefiting from a volume inflection, with 9 consecutive weeks of
carload growth year-over-year, after nearly 2 years of sustained negative carload
declines. Aside from the ongoing inflection in data, the company should benefit in 2017
from its own structural efficiency program and many potential macro shifts currently
under President-elect Trump’s Administration. The new management team (Jim Squires
was named CEO in 2015) is working to change the culture and business processes, and
has delivered for a few quarters. It set operating targets for the first time in company
history, targeting $650 million in efficiency gains (+25% to 2015 EPS) and a 65%
operating ratio by 2020. It also set $250 million in efficiency gains and a sub-70%
operating ratio in 2016, allowing it to immediate progress. In January, management has
noted it will further detail its efficiency gain targets, which could be a near-term
catalyst for the shares. Under Trump’s proposal’s, NS could benefit from a lower tax
10 Top 10 US Ideas Quarterly | 03 January 2017
rate, given its 37% current effective tax rate (at 30% adds $10 to valuation and at 20%
adds $25 to valuation), as well as additional infrastructure spend (more aggregates,
cement, rebar, etc…), focus on domestic manufacturing, and repatriation of capital,
which could aid GDP growth. We target NSC to post sustained double-digit EPS growth
and significantly improve free cash flow.
Table 1: Norfolk Southern key stock data
Industry
Railroad
Market Cap (mn) $33,393
Price $108.82
P/E (2017) 17.3x
% of sell-side rated Buy 44.8%
Short interest % of float 1.19%
Source: Bloomberg and BofA Merrill Lynch Global Research estimates
Deregulation/Gov’t Legislation:
The Surface Transportation Board, an independent governing body, formerly under the
Department of Transportation, is set for a significant turnover, with a Republican taking
control of the chairmanship, and 2 new members being added to the 5-person Board (up
to this year the STB was a 3 member Board). The potential for negative impacts from
mandatory open access and rate of return calculation adjustments may be reduced given
the change of administration, which would be a positive for the railroad group.
Tax Policy:
Given their domestic focus, Transportation companies are the highest effective tax
payers in the Industrial and Basic Materials group, with the U.S.-based railroads
averaging a 37% effective tax rate. At a 20% tax-rate, EPS would jump nearly 30%
(though full capex expensing could reduce EBIT to offset a sizeable portion of the gain).
Additionally, cross-border tax increasing cost of goods sold for manufacturing goods
could slow GDP, impacting carload growth over time.
Catalysts:
Near term catalysts include accelerating carload growth, coal turning positive for the rail
industry this week, after 90 consecutive down weeks, and NS’s upcoming January
promise for additional details on its targeted efficiency gains. The company is set to