Quarter Ended 30 June 2010

Macro Economic Environment
In Quarter 2 the Euro, global equities and lower rated government bonds suffered significant falls as investors sought refuge in secure havens such as Gold, the US Dollar, the Swiss Franc and US treasuries.  Equity markets suffered as European sovereign debt concerns came to the forefront of investors' macro economic worries.  The introduction of budget deficit cutting programmes concerned investors with implications of a lengthening deflationary and recessionary period.  Initial inflation fears at the start of the quarter, reflected by the 10 year US Treasury yielding 4%+, quickly reversed to fears of deflation, as this yield dropped below 3% by quarter end. 

UK Macro
The UK election, despite fears of the effects of a hung parliament, finished with a Conservative / Liberal Democrat coalition.  One of the first pieces of policy enacted by the coalition government was an emergency budget.  The budget could truly be defined as that of a Conservative party with significant spending cuts and expected job losses in the public sector.  Pre election all political parties indicated that the severity of the upcoming budget was a necessary evil to compensate for the loss of tax revenues from the financial sector  and the associated budget deficit.  The Bank of England in contrast to the restrictive fiscal policy enacted by the government continued to provide monetary stimuli and maintained interest rates at 0.5% despite ifnlation persisting above 3%. 

US Macro
The primary concern for the US economy is the lack of job growth post the introduction of monetary and fiscal stimuli.  The US economy has experienced jobless recoveries in the recent past, however, for the next leg of the recovery to be filfilled a confident consumer is paramount.  Consumer confidence and increasing numbers in the workforce are needed for any significant recovery in consumer spending.  Whilst home prices in metropolitan areas have begun to increase year on year there remains an oversupply of residential and commercial property, which is also providing negative sentiment for the US consumer.  With upcoming mid-term elections in the background the Obama administration, in contrast to its global peers, will likely attempt further fiscal stimuli.  Corporate earnings remain relatively strong with the expectation of a 27% increase in Q2 earnings year on year.  However, with existing consumer headwinds Appian expects earnings revisions on a downward basis for second half of 2010.

EU Macro
Investors re-evaluated the risks with regard Eurozone banks, particularly French banks with their exposure to their Greek acquisitions, Cajas or Spanish savings banks and their property exposures and Landesbanks in Germany with their exposure tot he property and CDO markets.  The lack of transparency associated with their exposure to the prperty and CDO markets.  The lack of transparency associated with possible future write downs of these assets on the balance sheets of these differing institutions has created a sense of mistrust in the inter-bank lending market.  Due to a lack of a liquid corporate bond market in the Eurozone, the banking system is the primary source of funds and credit for Eurozone corporations and hence it is of utmost importance that the issues associated with Eurozone banks are resolved. 

Ireland Macro
Ireland recorded a positive GDP figure as exports became a more important element of Irish economic growth.  However, GNP, which is possibly more relevant to Irish consumers and their related confidence, was still negative.  Continuing deflation and contraction of the economy via consumer spending and the construction sector pushed the Irish unemployment rate to 13.4%, the highest since September 1994.  The sentiment of recovery in the economy for the consumer may be 18-24 months away and will be highly dependent on the Global economy and future domestic fiscal policy.

Republic Services Group
During the second quarter we invested in Republic Services Group.  RSG is the second largest operator in the US waste management industry, a relatively stable and defensive sector, which has strong pricing power.  RSG is a large scale, cost efficient operator with very robust cash generation.  We purchased the shares at just above book value, which we considered an attractive valuation for the earnings profile and future prospects of the company.  We expect RSG will improve profitability through growth in sales volume (reflecting population growth and a gradual economic pick-up), driving further cost savings from the integration of a recent acquisition, and over the long term through price increases at a rate above inflation. In addition, the strong free cash generation will also generate equity value (annual free cash flow is c.6.5% of the company's value).  This cash generation can be used to further reduce the company's net debt, increase dividend payouts or for further acquisition activity by RSG, as the company is a positive consolidator in a fragmented market. 

Ahold
Appian's other equity purchase in Q2 was Ahold, a Dutch headquartered supermarket group which generates two thirds of its sales in the US.  Having successfully restructured over recent years, Ahold is now strategically positioned to grow its business.  As its valuation reflected little future growth potential we were attracted to the stock.  The company is positioned to deliver growth in the nearer-term through the re-emergence of food price inflation and the ability to improve the margins and sales per square foot in recently acquired units.  Longer-term, Ahold has ample financial resources to make further bolt-on acquisitions of poor performing smaller competitors in its core market in the US Northeast.  Regarding downside risks, we were reassured by Ahold's leading market positions, its ability to use cost savings to more than offset the impact of price competition, its strong balance sheet, robust cash generation (which can be used to increase dividends or for share buybacks) and a valuation that is lower than most of its quoted retailer peers.

Conclusion
With widespread fears of the possibility of a double dip, equity markets will continue to be volatile.  In Appian's view it is unlikely that the scenario of a double dip will materialise particularly with the continuing significant monetary and fiscal stimuli.  However, Appian as always, will remain vigilant with regard to the risk of such an eventuality, with a special focus being attributed to the strength or otherwise of the US consumer.

Pat Kilduff
Investment Manager
June 2010