Consumer Discretionary Sector Presentation Arshan Ameen Brian Beck Josh Bernath Ryan Calloway Bryan Chard February 10, 2009 – FIN 724/824

Agenda Sector Composition Business Analysis Key Economic Drivers Financial Analysis Valuation Analysis Recommendation

Sector Composition Overview Consists of companies that compete for the disposable income of consumers (you!) Industries include goods: –Automotive, household durables, consumer retailers And services: –Hotels, restaurants, and media production

Sector Composition Top 10 Industries in Sector (Market Value Weighted)

Sector Composition Top 10 Companies in Sector (% of Sector Market Value) News Corporation

Sector Composition Performance Sector market cap: $599 billion, 8.1% of S&P 500 Year-to-date performance: -9.1% (S&P %) Sector has underperformed the S&P 500 over the past 10 years

Business Analysis Overview Mature Phase of Life Cycle Cyclical performance tied to overall economy –Currently in a recession that started in December 2007 –Average length of recession is 11 months –13 months and counting –Consumer Discretionary will not see any significant gains until economy recovers

Business Analysis Five Forces Model Barriers to Entry –Typically high –Most industries are competitive –Many mature industries Threat of Substitutes –High –Many discretionary goods have similar competing brands Bargaining Power of Suppliers –Relatively low –Many products are similar –Depends on industry Bargaining Power of Customers –Relatively high –Customer demand drives the supply of discretionary goods Competitive Rivalry –High –Many companies offering similarly attractive goods

Stimulus Package Impact Where are the funds going?

Stimulus Package Impact Timeline Direct Consumer Benefits: –Refundable tax credits –$500 for most individuals –$1,000 for most working couples Indirect Consumer Benefits: –Job creation –Health insurance assistance

Key Economic Drivers Overview Unemployment Disposable Personal Income Federal Funds Rate Consumer Confidence

Key Economic Drivers Unemployment Strong negative correlation with unemployment R = Unemployment rate at 7.6% as of January 2009, highest since 1992 Sector returns are suffering as unemployment soars

DPI is the amount of income left over after taxes and normal expenses (discretionary) Positively correlated to the sector returns, not as strong as expected Obama’s stimulus package could have an effect on DPI Key Economic Drivers Disposable Personal Income

Federal Funds rate and sector return are inversely related As federal funds rate increases the sector returns begin to decrease (approx. 1 year time lag) R = Recently the Fed has slashed rates in hopes to stimulate the struggling economy Key Economic Drivers Federal Funds Rate

Strong positive correlation with sector returns R = 0.71 As consumer confidence increases, so does sector returns Consumer confidence is at a historic low of 37.7 Key Economic Drivers Consumer Confidence Index

Sector revenues increased steadily until 2006 when they seemed to plateau Recent recession has caused revenues to decrease and trend downward Financial Analysis Sector Sales Overview

Sector is down when compared to S&P 500 on Revenues, Margins, and Growth rate, and at the bottom of all three 3 over the past 10 years Total Return seems to be trending upward relative to the market, however Financial Analysis Selected Metrics vs. S&P 500

The S&P 500 has seen revenue growth slow down over the past quarter, and earnings decrease significantly over the past 5 quarters and expected to continue into the future Financial Analysis S&P 500 Overview

The sector has seen steep declines in revenue and earnings, and momentum shows that they will only get worse Financial Analysis Sector Overview

Disney’s Revenues dropped in Q after several consecutive quarters of growth Disney’s EPS dropped in Q3 2008, and got worse in Q Financial Analysis Walt Disney

Both revenues and earnings have decreased significantly for Home Depot over the past 8 quarters, and signs point to further drops in the coming months Financial Analysis Home Depot

Cash flows generally increase year after year, but sector spends a fair amount on investing and financing activities Financial Analysis Cash Flow

Valuation Analysis Consumer Discretionary Stand-Alone Currently below 5- year mean for every metric 5-year lows for every metric occurred in Q Movement in 2009 is trending down

Valuation Analysis Consumer Discretionary vs. S&P 500 Price/Yr. Fwd. Earnings is above 5-year mean, but well below trading levels in late 2007/early 2008 Price/EBITDA, Sales & Adj. Cash Flow are near their 5-year averages 2009 movement is trending down

Valuation Analysis Industry Valuations vs. Sector vs. S&P 500 Note: Industry breakdown excludes Auto Manufacturers and Homebuilders due to non-meaningful multiples

Valuation Analysis Industry Valuations vs. Sector vs. S&P 500 Note: Industry breakdown excludes Auto Manufacturers and Homebuilders due to non-meaningful multiples

Valuation Analysis Industry Valuations vs. Sector vs. S&P 500 Note: Industry breakdown excludes Auto Manufacturers and Homebuilders due to non-meaningful multiples

Valuation Analysis Industry Valuations vs. Sector vs. S&P 500 Note: Industry breakdown excludes Auto Manufacturers and Homebuilders due to non-meaningful multiples

Valuation Analysis Summary Multiples have contracted during 2008 and into 2009, as a result of the recession Education, Discount Retail and Fast Food Restaurants are trading higher than other industries –Education is trading at a premium to its 5-year mean on several metrics  Overvalued Historical References: – Recession: Consumer discretionary valuations picked up after experiencing 50% of the recession –2001 Recession: Consumer discretionary valuations picked up after experiencing 75% of the recession What inning are we in? Most valuations hit 5-year lows in 2008, we are at least through 50% (we hope) Sector Valuation Forecast: –Multiples will contract into 2 nd half of 2009, retesting Q lows –Valuations will begin to trend upwards in late 2009 and early 2010

Recommendation Current SIM portfolio weighting is 9.67% compared to S&P’s weight of 8.19% (1.48% overweight) We recommend reducing the weight in the SIM portfolio by 198 bps to 7.69% (or 50 bps underweight) Sector is cheap, and rightfully so, as it has underperformed the S&P 500 for the past 10 years –Relative to market, we continue to expect lower returns for sector Limited positives for future: –Oil prices stay at current level Risks surround the recession: –Unemployment rises –Lack of available credit continues, etc. Mood is undoubtedly bleak Overweight: Apparel Retail, Hotel & Gaming  Unprecedented lows Underweight: Education & Education Services  Unprecedented high

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Valuation Analysis Industry Valuations vs. Sector vs. S&P 500 Note: Industry breakdown excludes Auto Manufacturers and Homebuilders due to non-meaningful multiples

Valuation Analysis Industry Valuations vs. Sector vs. S&P 500 Note: Industry breakdown excludes Auto Manufacturers and Homebuilders due to non-meaningful multiples

Valuation Analysis Industry Valuations vs. Sector vs. S&P 500 Note: Industry breakdown excludes Auto Manufacturers and Homebuilders due to non-meaningful multiples

Valuation Analysis Growth Rate Comparison Current Consensus Growth Rate of Consumer Discretionary Sector: 10.40% Current Consensus Growth Rate of S&P 500: 10.15%

Sector Performance Sector vs. S&P 500 – 15 Years

Industry Performance Education & Education Services vs. S&P 500 – 10 Years

Industry Performance Apparel Retail vs. S&P 500 – 10 Years

Industry Performance Hotel/Gaming vs. S&P 500 – 10 Years