Sector Outlook Consumer Discretionary

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Sector OutlookConsumer Discretionary

• Erin Bailliard
• Jerron Schmoll
• Neil Sethi

2
Size Composition (as of 12/31/02)

• Sector is 13.44 of SP 500
• Current Weighting 16.37
• Overweight of 2.93 (tied for second largest
  bet)
• In 2002, Sector return was -23.8 compared with
  -22.1 for the SP

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Size Composition (cont.)

• Wide variety of industries ( of Sector)
• Media (30.1)
• Multi-Line Retail (29.6)
• Specialty Retail (17.4)
• Hotels, Restaurants Leisure (7.8)
• Automobiles (4.8)
• Household Durables (3.9)
• Textiles and Apparel (2.3)
• Leisure Equipment (2.1)
• Auto components (2.0)

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Size Composition (cont.)

• Sector dominated by Wal-Mart and Media companies
  ( of Sector)
• Wal-Mart (20.5)
• Viacom (6.6)
• AOL Time-Warner (5.4)
• Home Depot (5.1)
• Wal-Mart Media 50.5 of Sector

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Business Analysis Demand Analysis

• Life Cycle Growth/Mature/Decline
• Business Cycle Highly Cyclical
• Technology Marginal Effect (Media?)
• Government Marginal Effect
• Social Moderate Effect (Neutral)
• Demographics Good long-term (echo boomers)
• Foreign Influence Important (Neutral)

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Business Analysis Demand Analysis (cont.)

• Sector is the most sensitive to economic cycles
  according to SP

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Business Analysis Demand Analysis (cont.)

• Economy is showing signs of recovery, but.

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Business Analysis Demand Analysis (cont.)
"The heightening of geopolitical tensions has
only added to the marked uncertainties that have
piled up over the past three years, creating
formidable barriers to new investment and thus to
a resumption of vigorous expansion of overall
economic activity" - Federal Reserve Chairman
Alan Greenspan in testimony to the Senate Banking
Committee
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Business Analysis Demand Analysis (cont.)

• Even stronger positive correlation between Sector
  returns and consumer spending

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Business Analysis Demand Analysis (cont.)

• Encouraging signs
• Business Week Headline (1/27/03)
• The Heroic Consumer Down, But Not Out Despite
  rising joblessness, shoppers will have the funds
  to soldier on

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Business Analysis Demand Analysis (cont.)

• Consumption and Investment now growing at about
  same speed

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Business Analysis Demand Analysis (cont.)

• However
• Still have Iraq weighing on consumer spending
• Consumer confidence at nineyear low
• Business hesitancy to spend may pull down entire
  economy

13
Business Analysis Supply Analysis

• Supply Growth Mostly mature companies, so
  expect little supply growth, but CF statement
  shows large investing CFs
• Capacity Utilization Varies tremendously
• Time to Build Varies tremendously
• Cost to Build Varies tremendously
• Expansion Plans Low

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Business Analysis Profitability and Pricing

• Product Segmentation (Substitutes)
• High threat discretionary items
• Industry Concentration (Rivalry)
• High rivalry mostly mature/declining
• Ease of Entry (Strength of Entrants)
• Low threat high fixed costs
• Prices of Supply Inputs (Strength of Suppliers)
• Varies
• Strength of Customers
• High threat discretionary items

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Financial Analysis Sales and Earnings - Sector

• Sales grew 5 from 01 to 02
• Earnings grew 40 from 01 to 02
• Mean expectation is for EPS to grow 16 this
  quarter

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Financial Analysis Sales and Earnings
Industries

• Big Three Industries
• Media
• Multi-Line Retail
• Specialty Retail

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Financial Analysis Sales and Earnings Media
18
Financial Analysis Sales and Earnings
Multi-Line Retail
19
Financial Analysis Sales and Earnings
Specialty Retail
20
Financial Analysis - Margins

• Sector profit margin has improved from 2.9
  average in 01 to 3.9 in 02 (4.0 in Q4)

21
Financial Analysis Cash Flow

• Cash Extremely cyclical Currently generating
  large amounts of cash (5 billion in 01) from
  operations, using large amounts in investing.

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Financial Analysis Other
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Valuation Analysis - Ratios

• Sector
• P/S 0.92
• P/B 2.60
• P/CF 10.4
• SP 500
• P/S 0.75
• P/B 2.07
• P/CF 9.45

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Valuation Analysis Ratios (cont.)
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Valuation Analysis Technical Analysis
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Other Analysis Dividend Discount Model

• R (E/Po) payout g
• Po/E 22.2
• E/Po .045
• Payout .18
• Growth .06
• R .0681 6.81

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Recommendation Overweight?

• Sector should outperform because
• In the long term, economy poised to rebound and
  sector is highly cyclical
• Consumption expected to outperform Investment
• StockVal expectation for 16 rise in EPS
• Sector price below both 50- and 200-day moving
  averages

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Recommendation Underweight?

• But
• Sector overpriced relative to SP 500
• StockVal and JP Morgan recommend underweight
• DDM predicts moderate growth of 6.81 (below
  StockVal prediction of 7.0 for SP)
• Large investing CFs means supply growth at wrong
  time?

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Final Recommendation

• Recommend market weight due to numerous
  uncertainties
• Within sector recommend underweight in Media and
  Auto
• Overweight on smaller segments (StockVal expected
  change in EPS in Q1)
• Textiles Apparel (86)
• Hotels, Restaurant, and Leisure (50)
• Auto components (26)

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Questions