Sectoral perspective after 9/11

Telecommunications: overweight

Source: Bloomberg and own elaboration (data as of 10/17/01)
European telecommunications companies have outperformed stock market indices since September 11th. Their defensive nature, coupled with the benefits of lower interest rates, has been a positive factor. We maintain our overweight recommendation for the sector due to two factors:
We believe that both European and American interest rates still have room to fall until early next year (see macroeconomic outlook). This factor particularly benefits this sector, whose companies are characterized by a high debt-to-EBITDA ratio as a result of significant investments (infrastructure, UMTS licenses).
Furthermore, global telecommunications operators have a defensive profile (less exposed to the economic cycle), since fixed-line revenues account for more than 70% of the results of the main European companies, with little difference in the breakdown of activities between them. Therefore, the current climate of macroeconomic uncertainty (which we expect to continue in the coming weeks) also benefits these companies.
These two factors benefit global telecommunications operators (Telefónica, France Telecom, etc.) more than mobile operators (Telefónica Móviles, Orange) and telecommunications equipment manufacturers (Nokia, Ericsson). This trend aligns with our preferences for the coming weeks, maintaining a defensive stance in our recommendations.
We welcome the recent changes to the UMTS license allocation process in France, which may lead other European countries to follow suit or to provide other forms of support to telecommunications operators (such as promoting consolidation or reducing infrastructure requirements). Support measures of this kind would be highly beneficial for these companies, as they would improve their return on invested capital and reduce the debt on their balance sheets.
Telefónica continues to strike us as an interesting option in the medium term. The catalyst for a sustained recovery in its value is an improvement in the Latin American situation, which accounts for 50% of its operating profit.
Banking sector: neutral

Source: Bloomberg and own elaboration (data as of 10/17/01)
The slowdown in economic growth is negatively impacting the banking sector, whose main source of income and assets, lending, is suffering from the delayed economic recovery caused by the US terrorist attacks. Likewise, the economic slowdown is leading to an increase in loan defaults, which translates into higher provisions for bad debts, thus reducing these institutions' profits. Furthermore, the year-to-date poor performance of capital markets is lowering brokerage and investment fund fees, and is also causing the postponement of many IPOs and mergers and acquisitions, the main source of income for investment banks.
Regarding the impact of interest rate cuts on the banking sector, in the medium term they reduce bank spreads (the difference between the rates they charge on loans and what they pay on deposits), although in the short term they are positive, since they are applied to bank liabilities (lower returns on deposits) before they are applied to assets (loans). On the positive side, the economic stimulus that interest rate cuts aim to stimulate is beneficial for the sector.
In terms of subsectors, the biggest beneficiaries have been retail banks, particularly British banks, which have acted as safe havens. Investment banks and asset managers, on the other hand, and global banks, have performed the worst due to their high exposure to risk markets, both financial (capital markets) and geographic (emerging markets), respectively. We maintain our Neutral recommendation. We continue to favor the more defensive (retail) banks, with BNP Paribas, Barclays, and Abbey being our preferred stocks. Should economic conditions improve and risk premiums decrease, global banks could experience significant gains. We maintain our pessimistic outlook for investment banks in the short term.
Regarding BSCH and BBVA, despite the initial sharp decline due to their high exposure to Latin America, they have recovered virtually all the ground lost since September 11th. Any improvement in the Latin American situation would act as a catalyst for these stocks, although, for the moment, we remain neutral on both. Banco Popular is performing best in the current environment. Its status as a purely domestic, retail bank has allowed it to outperform its competitors. Bankinter remains a strong player in the domestic retail market, although its internet-based nature and high multiples, which anticipated a high rate of future growth, have led to weaker performance. We view positively the decision to raise capital through mortgage securitization, a necessary solution to improve the bank's capital ratios after the strong loan growth experienced. Negotiations with the Bank of Spain regarding the amount and time needed to cover the charges for the issuance of convertible bonds for employees through the personnel expenses account will slow its share price in the coming weeks, despite not altering the bank's net worth.
Utilities: neutral

Source: Bloomberg and own elaboration (data as of 10/17/01)
Traditionally, electricity sector stocks have outperformed the market during times of uncertainty. Given the current market conditions, we recommend holding the electricity sector, based on its safe-haven nature.
Lower interest rates also benefit companies with significant financial leverage. Recurring and stable earnings, along with high dividend yields (3-4%), should support the sector's strong stock market performance. Our top picks in Spain would be Unión Fenosa, and within Europe, the German companies E.On and RWE.
Oil companies: neutral

Source: Bloomberg and own elaboration (data as of 10/17/01)
Despite the continued weakness in oil prices, European and American oil companies (with the exception of Repsol) have recovered to pre-attack levels. Only BP has announced that the terrorist attacks of September 11 will not impact its third-quarter profits. However, what has gone unmentioned are the "consequences of the attack," the indirect effect that has driven the price of oil closer to $20/barrel and several dollars below OPEC's target range. Consequently, the companies themselves have not yet revised their profit expectations downward for the last quarter of this year and for 2002.
The price of crude oil at which an oil company begins to be profitable can be placed around $16/barrel, with exceptions such as Totalfina (whose investments begin to be profitable at $10 per barrel and which achieves a 14% ROE at $15 per barrel). Repsol is the most sensitive to variations in the price of crude oil, while ENI, BP, and Royal/Shell are less sensitive. Regarding sensitivity to exchange rates (USD), Repsol is again the most sensitive, as it is to production volume. BP is the most affected by sensitivity to the price of natural gas. Finally, variations in refining and marketing margins affect Repsol and Totalfina the most.
Second-quarter results were characterized by few surprises in the Exploration and Production division, very strong results in the refining and marketing segment, and very weak figures in the chemicals segment. For this third quarter, profits will remain fairly flat in the E&P and chemicals segments, and comparative figures for refining and marketing will be negative quarter-over-quarter due to weakening margins, especially refining margins.
Within the sector, the favorites in an environment of low oil prices and weakening margins are integrated companies like Totalfina and ENI, which also have feasible targets for increasing hydrocarbon production between 5,5% and 6%. Repsol is the most sensitive to improvements in these two key factors.
Construction: overweight

Source: Bloomberg and own elaboration (data as of 10/17/01)
Regarding construction activity, these companies offer high visibility of results, which the market appreciates during times of uncertainty about the severity of the economic slowdown, such as the present. Listed construction companies benefit from the increased budget allocation for infrastructure, which is crucial given the saturated residential construction market. However, some of them are not unaffected by external factors, such as the performance of the airline sector (all except ACS offer ground handling and airport services) or decisions concerning the 3G network (the Xfera consortium, which affects ACS and, to a lesser extent, FCC).
The possibility of corporate activity could work in the sector's favor, although at the moment only Dragados and Sacyr have suggested the benefits of greater consolidation.
We maintain our Overweight recommendation in anticipation of strong results. Among the companies most benefited by the infrastructure plan, we would highlight ACS and Ferrovial, which has also benefited from the MIG agreement (which opens the door to international infrastructure projects). In the case of ACS, we cannot forget that the freezing of the UMTS project it had initiated through Xfera has negatively impacted its share price in recent weeks (-8,8% vs. -3,5% for the sector average), so we believe that this freeze is largely reflected in the current prices.
We maintain our positions in FCC (which has been negatively impacted by its airport services division, and the potential sale of a portion of its construction business to Vivendi is currently on hold) and Dragados (where the potential merger with Sacyr could face difficulties due to a lack of agreement on the distribution of power). We underweight Acciona because of its shift towards the airport business, and it is not expected that it will divest its Airtel sale options.
Central reserves: neutral

Source: Bloomberg and own elaboration (data as of 10/17/01)
The coming months will be tough for the sector: reduced flight frequencies from airlines, fear of flying (75% of Amadeus' profit comes from airline bookings, and 98% from bookings and related services), with airlines as customers also facing a difficult situation. Although some companies in the sector (like Amadeus) had the third quarter covered, we will likely see downward revisions of estimates for Q4 and 2002. As a reference, we have the statements from its competitor Sabre, according to which if global airline bookings in the fourth quarter fall between 20% and 30% year-on-year (-12% in Q3, although higher than the 45% drop in the period from September 11-30), its earnings per share would be between $0,05 and -$0,15 (compared to $0,39 in Q3). After the heavy accumulated losses and subsequent partial recovery in Amadeus, we are maintaining our positions while awaiting estimates of the impact on results for the next quarter and year 2002, which we expect to learn with the publication of Q3 results (November 5).
Media: neutral

Source: Bloomberg and own elaboration (data as of 10/17/01)
With the delay in the expected economic recovery, advertising spending is one of the most directly affected areas, reducing the main source of revenue for media companies. We underweight Prisa and Recoletos due to their high exposure to advertising, anticipating poor results for Q3. Thus, we have seen how the Pearson group, the largest shareholder of the Recoletos Group, has announced that 2001 profits will be well below initial forecasts, estimated to be 40% lower than last year, with advertising revenue particularly impacted in the fourth quarter by the expected drop in consumer spending.
Sogecable, on the other hand, is less exposed to advertising and benefits from the depreciation of the dollar (35% of its costs are payments for film rights, which are made in dollars) and from speculation regarding possible corporate moves. Maintain positions.
As for TPI, the directory business is characterized as defensive within the advertising sector. The order book for this year was over 75% full a few weeks ago, so the 2001 results shouldn't be bad. The key will be the company's outlook for next year. Overweight.
Other technologies: neutral

Source: Bloomberg and own elaboration (data as of 10/17/01)
Indra, which could benefit from its Defense division (20% of the business), should have no problem meeting its 2001 profit targets given its high sales coverage ratio. We are closely monitoring the 2002 outlook in a sector (Information Technology, 80% of the business) marked by profit warnings. However, it is worth noting Indra's attractive mix, both geographically and by sector market, which provides relative protection in an environment of economic slowdown. Hold.
Gamesa has been negatively impacted in the aircraft components sector (mainly commercial aircraft). Its main customer, Embraer, has cut its supply forecasts to 14% in 2001 and 34% in 2002. After the significant losses, hold.
Feeding: neutral
In times of reduced visibility, money tends to flow into defensive or safe-haven sectors in search of security, so the food sector could continue to outperform the market. The food industry is mature, which explains the downward adjustment in long-term growth rates (due to increased competition, customer power, etc.), although this does not prevent the fundamentals from remaining relatively stable despite the economic situation.

Source: Bloomberg and own elaboration (data as of 10/17/01)
The current problem is the gradual adjustment in the valuations of these companies, as they have generally outperformed the market over the last year and a half. Despite this, and given the current situation, we would recommend maintaining exposure to the sector, but with a selective approach. We would choose high-quality, large-cap stocks, such as Danone or Nestlé, as well as small-cap stocks with significant discounts and interesting potential, such as Ebro Puleva.
Tobacco: neutral

Source: Bloomberg and own elaboration (data as of 10/17/01)
Tobacco prices have traditionally outperformed the market during times of uncertainty, especially when consumer confidence is declining. Events such as the Gulf War in 1990 and the 1987 stock market crash exemplify this. The main difference between the United States and Europe is the risk of litigation, which is significantly more limited in Europe.
In any case, the sector's defensive strength during times of crisis should allow it to continue outperforming the market until the uncertainty surrounding confidence dissipates. In the case of Altadis, results will continue to be positive, thanks to the progressive operational improvement stemming from merger synergies and the restructuring process.
Internet: neutral

Source: Bloomberg and own elaboration (data as of 10/17/01)
The internet sector has recovered in recent sessions, following the trend in the markets. From a fundamental perspective, the declines experienced in previous months are due to the slowdown in the advertising market, which is not expected to recover until the second half of next year. This represents a significant portion of companies' revenue (approximately 65% for Terra and 80% for Yahoo). Companies' strategies are focused on cost reduction while awaiting a rebound in demand. We do not expect this scenario to change in the coming weeks, and uncertainty regarding the recovery of the advertising market will persist. We recommend holding these stocks in the short term after the recent price increases. In the medium term, the higher beta of these stocks will further benefit these companies in a scenario of gradual market recovery.
Highways: overweight

Source: Bloomberg and own elaboration (data as of 10/17/01)
The toll road sector has performed well in recent weeks. Two factors are currently benefiting it, and we believe these will continue to do so: a high dividend yield (approximately 4,5%) and a declining interest rate environment, which favors these companies whose valuation is directly correlated with the bond market. Despite the recent rally, significant macroeconomic uncertainties remain, leading us to recommend overweighting this sector as we approach year-end.
Hotel Sector: neutral

Source: Bloomberg and own elaboration (data as of 10/17/01)
The hotel industry is a cyclical business, closely tied to the performance of the economy, and is therefore negatively impacted by the global economic slowdown. Furthermore, the US attacks and the current war situation, in addition to delaying economic recovery, create a climate of fear surrounding travel, and consequently, hotel occupancy decreases as hotel reservations, both for rooms and conferences, are canceled.
We don't foresee a recovery in the sector until confidence is restored, and this is an exogenous variable for the hotel industry. Among the industry segments that will perform worst, business hotels (typically urban) stand out compared to resort hotels. Within the latter, winter tourism hotels will be the most affected, compared to summer tourism hotels, which are further off. The hotel chains that will be most impacted are those with high exposure to North American clientele, high operating leverage, and significant outstanding investments (Accor would be the stock to avoid).
We remain neutral on the sector, which has already reflected most of these circumstances in its share prices, but we lack good visibility in the short term. Furthermore, continued profit warnings from companies and downward revisions to estimates will prevent a sustained rebound in share prices.
Insurance sector: neutral
Insurers suffered a severe blow after the September 11 attacks because they were the hardest hit sector and would have to bear the greatest costs (nearly $30.000 billion). However, the initial impact was excessive, in many cases exceeding the compensation they would have to pay out, and their share prices have since recovered. Despite this recovery, we still believe that some companies, especially reinsurers, have upside potential and could therefore perform well in the coming months, such as Swiss Re and Munich Re (although we still prefer the former due to its greater exposure to fixed income versus equities and government debt versus corporate bonds), as well as AEGON.

Source: Bloomberg and own elaboration (data as of 10/17/01)
The increase in insurance premiums following the attacks, as well as the rise in the number of policies issued, will be the catalysts for the sector in the stock markets in the medium term. In the short term, we maintain a cautious outlook on the sector given that the exact amounts that insurers will have to cover are still unknown, and the current war situation calls for a conservative approach.
Pharmaceutical Sector: neutral

Source: Bloomberg and own elaboration (data as of 10/17/01)
The pharmaceutical sector has been one of the best performing on the stock market since the US attacks, demonstrating its status as a safe-haven sector, as these companies are not significantly affected by the economic slowdown and will continue selling medications regardless of the economy's performance. The strong performance of pharmaceutical companies in recent weeks suggests they should consolidate their current levels, especially if market risk premiums decrease. Should economic and military tensions resurface, the pharmaceutical sector would again show relatively better performance.
On the other hand, uncertainty about upcoming FDA meetings, where conditions for drug approval have recently been tightened, as well as the expiration of patents on important products (with the consequent emergence of generic drugs that steal market share) will continue to weigh on the sector.
In Europe, our main bets are Sanofi-Synthélabo, Aventis and Glaxo, while in the US we prefer Bristol Myers, American Home Products and Johnson&Johnson (3Q results above expectations).

Distribution: underweight cyclical consumption, overweight non-cyclical consumption

Source: Bloomberg and own elaboration (data as of 10/17/01)
The events of September 11th will have a negative effect on consumer sentiment and spending, particularly noticeable in the United States. In Europe, the terrorist attacks are expected to exacerbate the economic slowdown already underway on the continent. Generally, we would take positions in companies with a solid business mix and strong potential, although we believe it is important to distinguish between cyclical and non-cyclical companies within the sector.
Looking back at previous crises, cyclical consumer goods were among the worst-performing sectors, particularly textile distribution and luxury goods. We believe there are companies in the market with solid businesses that stand out for their ability to minimize macroeconomic and sector-specific risks, with Inditex being a prime example. However, the current tight valuation limits upside potential, so we would recommend companies that have been excessively punished but have high upside potential, such as Cortefiel (P/E ratio 9x, EV/EBITDA 4,2x).
Regarding food distribution, it has traditionally been characterized as a defensive sector ("people always eat"), therefore, in principle, it should outperform the market during times of uncertainty. Within the sector, it would also be useful to distinguish between companies with exposure to US markets and those with exposure to non-food distribution (for example, in Carrefour Spain, these represent 35% of total sales). The British company Tesco, in this respect, has a more defensive profile (lower risk, as it has no exposure to the United States and is strongly positioned in the "old/food retail" sector). We believe that Carrefour Spain is currently undervalued in terms of fundamentals; however, its speculative potential (a possible takeover bid by the parent company) could help it continue to perform well in the market.
Aerospace: underweight
Defense: overweight

Source: Bloomberg and own elaboration (data as of 10/17/01)
The September 11 attacks should benefit the defense industry and, conversely, harm commercial business. Public opinion will force increased defense spending, and in this environment, the main beneficiaries will be the "pure-players" in the US defense sector, such as Raytheon, Lockheed Martin, and Alliant Techsystems.
Regarding the commercial business, a rapid slowdown is expected: airlines will cancel routes and consequently cancel orders, therefore inventories are likely to increase, which would also deteriorate cash flows. Both manufacturers (Boeing, Airbus, Bombardier, Embraer, etc.) and parts suppliers will show weakness. We would remain outside the sector.
Airlines: Stay out of the sector

Source: Bloomberg and own elaboration (data as of 10/17/01)
These events are unprecedented for the airline industry. We are facing the worst crisis in the history of commercial aviation, with a greater geographical impact (not just transatlantic) than other industry crises (1988 and 1991). Airlines are experiencing falling revenues and rising costs in a sector with high financial and operational leverage and high capital intensity. The effect could last for the next 9-12 months, and the probability of losses in 2002 is increasing.
In terms of costs, security requirements will increase, as will insurance costs, thus impacting airlines' cost structures. We believe that passenger demand will return to normal over time, allowing airlines to recover their revenue. In any case, current visibility is limited, leaving unanswered questions such as when air traffic levels will normalize, whether the increased security costs will be covered by governments, and so on. Airlines with stronger business models and a more balanced financial position, with a better business mix (less exposure to North Atlantic and Middle Eastern routes), could outperform their peers. Even so, we would remain outside the sector.
Biotechnology: overweight
Biotechnology companies are demonstrating resilience in the current war situation, especially those whose activity involves the detection and treatment of biotechnological and bacteriological substances harmful to humans that could be used by terrorists in their attacks. The sector has high growth potential, although the associated risks and volatility are also very high.

Source: Bloomberg and own elaboration (data as of 10/17/01)
In the US, we favor the largest and most stable in terms of revenue and results: Amgen. In Europe, biotech companies are smaller and more volatile. Our preferences focus on Celltech, Qiagen, and the Spanish company Zeltia. Regarding the latter, we expect its strong performance to continue in the coming days given the positive flow of news we anticipate from the European Society for Oncology Congress in Lisbon (October 22-25), the presentation to analysts with specialist scientists (October 23), and the International Congress of Oncology in Miami (October 29-November 2).