Global equity strategy - Credit Suisse

Global equity strategy Andrew Garthwaite and team Our concerns about China

25th June 2013

DISCLOSURE APPENDIX CONTAINS ANALYST CERTIFICATIONS AND THE STATUS OF NON-US ANALYSTS. FOR OTHER IMPORTANT DISCLOSURES, visit www.credit-suisse.com/ research disclosures or call +1 (877) 291-2683. U.S. Disclosure: Credit Suisse does and seeks to do business with companies 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.

Research analysts

Andrew Garthwaite, [email protected], +44 20 7883 6477

Marina Pronina, [email protected], +44 20 7883 6476

Mark Richards, [email protected], +44 20 7883 6484

Sebastian Raedler, [email protected], +44 20 7888 7554

Robert Griffiths, [email protected] +44 207 883 8885

Nicolas Wylenzek, [email protected] +44 20 7883 6480

2

We are bears of China GDP growth medium term (Slide 3 to Slide 13): high leverage, slowing

sensitivity of growth to leverage, de facto tightening, housing looks a bubble, infrastructure

investment is already running at 20% YoY, labour force has contacted last year, wage growth is

picking up & the real cost of capital has turned positive. In year one of a 10 year term, reform likely

to be preferred to growth! We would not be surprised if Chinese trend GDP growth eased to 6%.

However, we don’t think Chinese GDP growth will fall below 6%, over the next year, as:

government debt-to-GDP is 72% (nominal rates are below nominal GDP growth), loan-to-deposit

ratio in banking system is still 72% and mortgage debt-to-GDP is one third of US levels.

Chinese GDP growth below 6% would be a problem for global markets. Up to that level, the

fall in commodity prices might help developed market GDP growth, reduce inflation (which makes

central banks more stimulatory) and postpone Fed tapering. Limiting overcapacity might also help

some of those industries where China has over-expanded (solar, wind, aluminium etc).

Investment conclusions (Slide 14 to Slide 28): our preferred China-related shorts are mining,

steel, mining equipment, the Australian dollar and domestic Australia. We think that the China

consumer should be resilient: with the consumer share of GDP at half the levels of those in the

US, c12% Chinese discretionary consumption growth is possible even in a lower growth

environment. That said, we are underweight food producers and tobacco, on the back of

worries about earnings momentum, positioning and valuations.

Summary

30

35

40

45

50

55

60

65

3

4

5

6

7

8

9

10

11

12

13

2005 2006 2007 2008 2009 2010 2011 2012 2013

GDP, y/y%, 3m lag

China PMI manufacturing neworders (HSBC), rhs

China PMI new orders (NBS),rhs

5

6

7

8

9

10

11

12

13

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

0.6

0.7

0.8

0.9

1.0

1.1

1.2

1.3

1.4

GDP, y /y %, 3m lag

China PMI new orders/ stock of finished goods, rhs

4

6

8

10

12

14

96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13

-15

-10

-5

0

5

10

15

20

25

30

35China GDP, y /y %

Electricity output, y /y %, 3mma, rhs

latest

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

2005 2006 2007 2008 2009 2010 2011 2012 2013

32

37

42

47

52

57

62

67Chinese M1 grow th / M2 grow th

Chinese manufacturing PMI new orders, rhs

3 3 3 3 Source: Thomson Reuters, Credit Suisse research

China growth momentum is weakening: PMI new orders, M1 versus M2 and

electricity output all appear consistent with slowing GDP growth

The ratio of M1 to M2 and manufacturing PMI new

orders have both fallen since March

China PMI new orders relative to inventories

points to a slowdown in growth Electricity output growth remains weak

China manufacturing PMIs are weakening

5%

7%

9%

11%

13%

15%

17%

19%

21%

23%

1997 1999 2001 2003 2005 2007 2009 2011 2013

China wage growth, %

-5

-3

-1

1

3

5

7

9

2005 2006 2007 2008 2009 2010 2011 2012 2013

20

30

40

50

60

70

80

China headline inflation (y oy , %), w ith CS projection

China PMI - input prices, lead 4 months

We find ourselves worried about Chinese growth in the medium term as: 1) Our China economists predict

inflation of 3.9% by year-end and 4.9% by mid-2014 (although we would note that PMI input prices have fallen

recently). Wage growth and minimum wage growth are modestly accelerating again. There is no obvious labour

shortage – unlike in 2009 and 2010

4 Source: Thomson Reuters, Credit Suisse research

The price component of PMI is falling, but our

economists are more concerned about inflation

0.6

0.7

0.8

0.9

1.0

1.1

Mar-01 Jan-02 Nov-02 Sep-03 Jul-04 May-05 Mar-06 Jan-07 Nov-07 Sep-08 Jul-09 May-10 Mar-11 Jan-12

China City labour market demand/supply ratio

Labour shortage

Labour surplus

The urban labour market demand/supply ratio suggests a

continued labour shortage

Chinese wage growth is accelerating again (in US$ terms)

5 5 5

2) Total leverage is around 230% of GDP. Half of new loans in the last year have come from the shadow

banking system. Total government debt is 72% of GDP (including all off balance sheet lending by local

government), compared to an official figure of 15% of GDP. The local government’s deficit is 8.5% of GDP,

compared to the central government’s deficit of 2%of GDP. Shibor lending rates have recently spiked.

China looks overleveraged for its GDP pc

Source: Thomson Reuters, Credit Suisse research

Hong KongSingapore

China

Chile

Malaysia

RussiaMexico

South Africa

Czech Republic

Brazil

Indonesia

PolandIndiaEgypt

Turkey

Hungary

Norway

Germany

Denmark

Canada

France

UK

Japan

AustraliaUS

Italy

Ireland

Spain

Portugal

Greece

0%

60%

120%

180%

240%

300%

360%

420%

0 10,000 20,000 30,000 40,000 50,000 60,000 70,000

GDP per capita, USD

Tot

al d

ebt l

ess

FX

res

erve

s, %

GD

PGovernment 72%

Central government 15%

Local government 36%

Other 21%

Households 31%

Corporates 127%

Corporate loans & bonds 100%

Outstanding bankers' acceptance notes 11%

Other 16%

Total debt 230%

Note: shadow bank lending 44%

Trust funds 14%

Bank Wealth Management Products 15%

Broker Asset Management 4%

Underground lending 8%

LGFV corporate bonds outstanding 3%

China: total non-financial debt (% of GDP)

100%

110%

120%

130%

140%

150%

160%

170%

180%

190%

Jun-02 Jun-04 Jun-06 Jun-08 Jun-10 Jun-12

China: total social financing, % of GDP

China’s social lending is ahead of trend

0

2

4

6

8

10

12

2007 2008 2009 2010 2011 2012 2013

1-mth SHIBOR

Shibor lending rates have recently spiked to the

highest level in 6 years

6

0

1

2

3

4

5

6

Q1 2004 Q1 2005 Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010 Q1 2011 Q1 2012 Q1 2013

New RMB loans (4Q sum) / Annual change in GDP

New total social financing (4Q sum) / Annual change in GDP

0%

2%

4%

6%

8%

10%

12%

14%

16%

Q12004

Q12005

Q12006

Q12007

Q12008

Q12009

Q12010

Q12011

Q12012

Q12013

Non-bank lending

RMB loans

New lending as % of annual GDP

Increasing reliance on debt: more credit is required to

generate an extra unit of GDP

New social lending continues to rise

Total social financing is rising at 23% per year. The sensitivity of GDP growth

to credit is close to all-time lows.

New loans in May dropped, but are still well above average

Total social financing is rising at 23% per year


10%

15%

20%

25%

30%

35%

40%

45%

50%

1954 1973 1992 2011

Japan Korea China

Japan peak in 1973 at 36%

Korea peak in 1991 at 38%

Investment, % of GDPChina: latest 48%

7 7 7

3) Growth is becoming even more imbalanced: China’s investment share of GDP is now at 48%, 10 percentage points higher than any other country has had in recent history. In the decade after investment share of GDP peaked in other industrializing countries, GDP growth fell by between a quarter and a half.

0%

2%

4%

6%

8%

10%

US Peak = 1979 Japan Peak =

1973

Korea = 1991 China Peak =

2010

10y before peak

at peak

10y after peak

20y after peak

Trailing 10y GDP growth around the

peak of investment share in GDP:

China’s investment share of GDP is already considerably

higher than it ever was in Japan and Korea

An economy’s growth tends to slow once the

investment share of GDP has peaked


-2

8

18

28

38

48

58

2005 2006 2007 2008 2009 2010 2011 2012 2013

Industrial

Infrastructure

Real estate

China investment spending, 3mma, y/y%

Infrastructure investment growth has picked up – but this is not the full picture, since it only represents 30% of urban fixed asset investment. Investment by industry (mining, manufacturing and construction) is 40% of the total and this remains weak.


Our US capital goods analyst, Julian Mitchell, highlights that Chinese machine tool orders were

down 44% year-on-year in May (see his report i-Spy Global Industrials Weekly, June 24) and that

railway investment in China is likely to fall sharply.

https://plus.credit-suisse.com/u/BQJUbU



-

200

400

600

800

1,000

1,200

1,400

1,600

1998 2000 2002 2004 2006 2008 2010 2012

Completed

Sold

Starts

China residential construction, 12m mav, 1m sqm

9 9 9

4) Housing in China looks like a classic bubble. It’s clear that the authorities do not want house

prices to rise much. In March, authorities tried to clamp down on property via implementing the

capital gains tax among other measures.

0

10

20

30

40

50

60

70

US 2002-2007 Japan 1985-90 Korea 1994-98 UK 2002-2007 China 2007-12e

Trough to peak in bank credit / GDP (% point) Max 2-year change (% point)

The increase in China’s bank credit to GDP ratio was

greater than in other notable credit booms

Chinese tier 1 cities are more expensive than developed

market cities according to the IMF house price to wage ratio

0%

2%

4%

6%

8%

10%

12%

14%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Ireland Spain

China US

Residential investment, % of GDP

Housing investment is approaching peak levels seen in

other housing booms (as % of GDP)

Source: IMF data, Thomson Reuters, Credit Suisse research

Residential real estate starts have fallen slightly but

are still 20% ahead of sales

10 10 10

When did a housing bubble not end in a bust? However, there are some differences in China:

There is not a lot of consumer debt in housing. Total mortgage debt-to-GDP is 18% (compared to

76% of GDP in the US in 2006) – and corporate debt in property is only 13% of GDP.

Banks will continue to lend: the typical loan-to-value ratio on home-related loans is 50%; banks’

loan-to-deposit ratio, at 71%, is low; in 2004, banks were recapitalised using FX reserves (which

stand at 45% of GDP), and banks lend when they are told to lend.

Social housing completions should rise (from 5m to 6m in 2013), though social housing starts fall

from 10m in 2011 to 7m in 2013.

Our worry is the proportion of local government revenue from housing/ property development

(expropriation of land)….30% to 40%.

-2

0

2

4

6

8

10

2001 2003 2005 2007 2009 2011 2013

Deposit rate

Headline CPI

5) The working age population started declining in 2012 (by 3m), suggesting GDP can only grow in line with

productivity (c6%). Evidence for this: labour shortage in spite of the slowdown; 6) China is moving from a

negative to a positive cost of capital, owing to deposit de-regulation.

11

Deposit growth has increased (January data point

likely distorted by the Chinese New Year) Real deposit rates are now positive

10

15

20

25

30

35

1998 2001 2004 2007 2010 2013

China, Loans, y /y %

Deposits, y /y %


88

93

98

103

108

113

118

-3%

-1%

1%

3%

5%

7%

9%

11%

13%

Q1 1998 Q1 2000 Q1 2002 Q1 2004 Q1 2006 Q1 2008 Q1 2010 Q1 2012

China, current account, % of GDP, 4q lag

Chinese yuan TWI, inverted, rhs

7) The RmB has appreciated strongly year to date – this puts pressure on the external balance and

corporate margins. Low margin, strong currency, rise in real cost of capital, slowing growth=a NPL problem

(officially 1% of loans and our banks team believe will rise to 7 ½% of loans).


93

95

97

99

101

103

105

107

109

Jan 13 Feb 13 Mar 13 Apr 13 May 13 Jun 13

Chinese YuanBrazilian RealIndian RupeeRussia trade

BRIC currencies trade weighted (100= 1st January 2013)

Yuan trade-weighted is the only major

GEM currency to have risen year-to-date

A strong currency should put downward

pressures on the current account balance…

0%

2%

4%

6%

8%

10%

12%

14%

16%

Rus

sia

Indo

nesi

a

Mal

aysi

a

Sou

th A

fric

a

US

Indi

a

Kor

ea

Bra

zil

Glo

bal

Tha

iland

Mex

ico

Tur

key

GE

M

Tai

wan

Pol

and

Chi

na

2013E consensus non-financial margins

… as well as the already low corporate margins

In sum, the main drivers of Chinese GDP growth in the last decade are sharply diminished:

13

Population is peaking ergo rate of growth has to be closer to productivity growth;

The benefits of joining WTO in 2001 a decade ago have severely waned;

The housing boom has led to overbuild and expensive valuations, with residential investment rising

from 5% of GDP in 2001 to 13% of GDP now (with the indirect effect perhaps equally as large);

A rise in the real cost of capital owing to rate de-regulation. Negative real deposit rates for large

portions of the last decade helped to fuel a substantial rise in the investment share of GDP, to an

unprecedented 48% of GDP. Real deposit rates having now turned positive, which will ultimately raise

the real cost of capital, and yet deposit growth is currently close to its lowest rate on record;

Aggregate leverage (private and public) is now 15% above trend and 30% too high relative to other

emerging markets;

The RmB appreciation against other central banks

Policy: in year 1 of a 10 year term. Pursue reform at the expense of growth.

Our Chinese economist, Dong Tao, points out that there is a risk of uncoordinated policy, as individual parts of the state apparatus (such as the central bank) pursue their own agendas.

-8%

-4%

0%

4%

8%

12%

1995 1998 2001 2004 2007 2010 2013

2.1

2.2

2.3

2.4

2.5

2.6

2.7

2.8

2.9

Eur cap goods w ith mining

ex posure on analy st

recommendations rel to

market (+=Buy ; -=Sell)Analy st recommendations,

rhs (1=Buy ; 5=Sell)

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Eur cap goods with mining exposure net margins

Average

-30%

-20%

-10%

0%

10%

20%

30%

40%

1995 1998 2001 2004 2007 2010 2013

Eur cap goods w ith mining ex posure 3m breadth

Rel mkt

50%

60%

70%

80%

90%

100%

110%

120%

130%

140%

150%

1995 1998 2001 2004 2007 2010 2013

Eur cap goods w ith mining ex posure 12m fw d P/E rel mkt

Av erage

14 14 14

Investment implications: 1) We are cautious on capital goods with mining exposure. Valuations are stretched, mining capex is falling as is relative earnings momentum, net sell-side recommendations are still positive and consensus margin estimates are at historical peak levels. More Japanese competition as the Yen weakens.


Capital goods with mining exposures are now neutral on P/E relatives….

…but the stocks are expensive on P/B relatives

Relative earnings momentum is falling

Consensus margin estimates for mining-exposed stocks are at a 6-year high

Australian mining capex growth is slowing

Net sell-side consensus recommendations are still bullish relative to the market

-50%

-30%

-10%

10%

30%

50%

70%

90%

110%

1989 1993 1997 2001 2005 2009 2013

Mining capex , y /y %

Australia

80%

100%

120%

140%

160%

180%

200%

220%

240%

1995 1998 2001 2004 2007 2010 2013

Eur cap goods w ith mining ex posure P/B rel mktAv erage

These are the plays: Sandvik looks expensive

15

Capital goods stocks with significant % mining exposure and their valuations on our aggregate scorecard


Name Absrel to

Industry

rel to mkt %

above/below

average

Abs

rel to mkt %

above/below

average

FCY DY

Price, %

change to

best

3m EPS 3m Sales Credit Suisse rating

Fenner 60% 10.0 75% 11% 2.1 8% 5.5 3.4 52.3 -9.1 -2.3 2.0 Neutral

Caterpillar 40% 11.3 85% -2% 3.1 -22% 6.3 2.3 38.0 -14.4 -7.6 2.1 Outperform

Metso 42% 10.7 80% 13% 1.9 1% 8.9 6.5 11.8 -3.1 -1.5 2.3 Outperform

Sandvik 42% 12.5 93% -1% 3.1 -1% 7.8 4.2 -6.6 -13.8 -3.2 2.7 Underperform

% sales exposure to

Oil & Gas, mining OE

+ mining aftermarket

Consensus

recommendation

(1=Buy; 5=Sell)

-----P/E (12m fwd) ------ 2013e Momentum, %------ P/B ------- HOLT2013e, %

2) Cautious on mining: Dividend yield relatives and P/B relatives are

attractive – but this has been the case for all year!……..

16

50%

60%

70%

80%

90%

100%

110%

120%

130%

140%

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

12m fwd dividendyield mining rel. world

0.5

0.7

0.9

1.1

1.3

1.5

1.7

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Global mining P/B rel

P/B relative of global mining is close to a record low…

… whereas the 12m fwd dividend yield is at a record high.


4.0

4.2

4.4

4.6

4.8

5.0

5.2

5.4

5.6

5.8

6.0

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

Equally-weighted metals real price index (logs) 100-year average

Real industrial commodity prices are at 100-year norms, suggesting that

earnings levels are realistic (i.e. not artificially low)……..

17

50

75

100

125

150

175

200

1.0

1.2

1.4

1.6

1.8

2.0

2.2

2.4

2.6

2.8

3.0

2005 2006 2007 2008 2009 2010 2011 2012

European mining relative

Chinese Iron Ore USD/tonne (rhs)

CS Iron Ore forecast, end 2013

Iron ore prices are expected to fall to $90 per tonne…falling iron ore prices are normally bad for mining

Real prices are above their 100-year average


20%

40%

60%

80%

100%

120%

140%

160%

1992 1995 1998 2001 2004 2007 2010 2013

World mining stocks 12m fw d P/E rel mkt

Av erage

Pan Eur sectors FCFY 2013e

0%

2%

4%

6%

8%

10%

12%

14%

Tel

ecom

s

En.

Util

s.

Util

ities

Med

ia

Tob

acco

Pha

rma

Hot

els

& L

ei

Met

& M

in

Com

ml S

vs

S/W

& S

vs

Hea

lthca

re

Bev

erag

es

Aut

os

Foo

d R

tl

Cap

Goo

ds

Ret

ail

Fd

Pro

ds

H/H

& P

er P

rod

Con

s D

ur &

App

Ene

rgy

Sem

is

Market ex -financials

0.3

0.8

1.3

1.8

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

1990 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

Diversified mining CFROI®, lhs

Price/Cost Ratio

R2 = 0.66

Implied price/cost ratio

Our model implies a price/cost ratio of 0.9 for 2016 down from 1.07 now which suggests 4% upside in metal prices if costs inflation runs at 4% p.a.

Consequently, we think it is not unfair to look at P/E and FCF yield relatives

– and these are not yet attractive.

18

Mining has moderate FCF yields

Global mining’s P/E relative is at historical average levels

Mining stocks are implying a minor rise in in metal prices if we assume 4% p.a. cost inflation

Source: CS HOLT, Thomson Reuters, Credit Suisse research

Australia

Canada

Denmark

Europe

Japan

Mexico

Norway

New Zealand

Switzerland

United States

Czech Republic

Finland

Hungary

Korea

Poland

Turkey

China

Russia

Brazil

Thailand

Singapore

India

South africa

-100%

-50%

0%

50%

100%

150%

200%

-80% -60% -40% -20% 0% 20% 40% 60%

Net international creditor(IIP % GDP)

Undervalued currency (vs OECD PPP)

Overvalued currency

50

55

60

65

70

75

80

300

400

500

600

700

800

900

1000

1100

1200

2006 2007 2008 2009 2010 2011 2012 2013

CRB metals, lhs

Australian dollar,trade-weighted, rhs

50

55

60

65

70

75

80

1

1.2

1.4

1.6

1.8

2

2.2

2.4

2.6

2.8

2007 2008 2009 2010 2011 2012 2013

Mining sector relative

Australian dollar, trade-weighted, rhs

3) Short the Australian dollar: The AUD is still c40% overvalued and has a lot

further to fall to play catch up with mining or industrial commodity prices.

19

The Australian dollar is around 40% overvalued, despite Australia being a net international debtor

The Australian dollar has remained stronger than implied by the fall in metals prices…

…with its detachment from the global mining sector even more pronounced


75%

85%

95%

105%

115%

125%

135%

1996 1998 2001 2004 2007 2010 2013

Australia rel World: P/B

Average (+/- 1SD)

75%

80%

85%

90%

95%

100%

105%

110%

115%

120%

125%

1996 1998 2001 2004 2007 2010 2013

Australia rel World: P/E

Average (+/- 1SD)

On the Australian equity market, valuations appear stretched relative to global

markets. We have a short Delta one basket of domestic Australian stocks (CSAPASHT

index).

20

The PE relative of Australia is extremely elevated The P/B relative of Australia is less extreme, but remains above average

Consumption, Share of GDP

30%

35%

40%

45%

50%

55%

60%

65%

70%

75%

1995 1996 1998 1999 2000 2002 2003 2005 2006 2007 2009 2010 2012

China United States

GEM consumer story should be much more resilient. (1) The BRIC consumer share of GDP remains abnormally low and the Chinese consumer share of GDP is still just around half that in the US and Japan.

21

Emerging markets have a low consumption share of GDP


In particular, China’s consumption share of GDP is less than half the US levels

40%

45%

50%

55%

60%

65%

1997 2000 2003 2006 2009 2012

G7 consumption share of GDP

BRIC consumption share of GDP

-5%

0%

5%

10%

15%

20%

25%

1997 2001 2005 2009 2013

GEM

Developed

Hourly wages, yoy, %

22 22

(2) The key drivers of consumption are higher wage growth in emerging markets (compounding at c.10% p.a), a fall in the savings ratio (China’s savings ratio is still c.40%) as there are moves towards a more state-sponsored social security system that diminishes the need for individuals to save for old age or ill health. Chinese retail sales have been resilient to swings in the global cycle.

22

Chinese retail sales are growing considerably faster than those in the US


Asian exports have continued to follow the US cycle

-11%

-6%

-1%

4%

9%

14%

19%

24%

2002 2003 2005 2007 2009 2011 2013

US

China

Retail sales y oy , 3mma

20

30

40

50

60

70

1994 1998 2003 2008 2013

-35%

-25%

-15%

-5%

5%

15%

25%

35%

45%

ISM new orders, 6m lead, lhsAsian ex port grow th, y /y , rhs

Emerging market wage growth is running at around 10%

23 23 23

Even with pessimistic assumptions on trend growth, discretionary GEM consumption still rises strongly in nominal terms. (High savings ratios and falling food price-food is a third of CPI-should help). In China’s case even with 6% GDP, discretionary consumption growth can still be c12% and in a currency that is appreciating against the dollar.


0%

5%

10%

15%

20%

25%

30%

35%

40%

US

Kor

ea

Bra

zil

UK

Japa

n

Ger

man

y

Tha

iland

Indi

a

Chi

na

Household savings ratio

(% of disposable income)

Savings ratios are still high in many emerging

markets Food prices have fallen over the past

two years

China grows by 6% per year in real terms between now and 2020, then consumption is likely

to grow by 10%, and discretionary spending by 12%

GDP

2012 Target

Brazil 2.0% 61% 63% 2.3% 64% 65% 2.5% 6.0%

China 6.0% 36% 50% 9.7% 52% 65% 12.0% 14.5%

India 5.0% 56% 62% 6.2% 55% 60% 7.0% 11.0%

Russia 2.0% 51% 56% 3.0% 59% 65% 4.0% 7.5%

BRIC 5.0% 44% 54% 7.1% 56% 64% 8.6% 12.1%

Developed

countries2.4% 64% 74%

Implied nominal

growth

CountryConsumption share of GDP

Consumption

Implied real

growth

Implied real

growth Latest 2020E

Real trend

growth

Discretionary consumption (% of total)

390

410

430

450

470

490

510

Jun-11 Oct-11 Feb-12 Jun-12 Oct-12 Feb-13 Jun-13

CRB Food

The problem has been currency weakness (with exception of China).


EM currencies rel. Euro

-21%

-18%

-15%

-12%

-9%

-6%

-3%

0%

3%

6%

9%

12%

15%

18%

Brazilian Real Indian Rupee Chinese Yuan IndonesianRupiah

Singapore Dollar Russian Rouble South AfricanRand

Q1 vs Q1 Q2 vs Q2 Q3 vs Q3Q4 vs Q4 YTD

Performance of EM currencies relative to Euro (period average) 2012 vs 2011 & YTD 2013:

The indirect plays are cheap direct plays. If we value their emerging market businesses on the valuation of their subsidiaries.

25

Developed market consumer stocks with emerging market exposure are trading

cheaply relative to their foreign-listed subsidiaries


For example, 54% of Unilever’s business comes from emerging markets and Hindustan Unilever (its Indian subsidiary) and Unilever Indonesia (its Indonesian subsidiary) trade on 35x and 37.5x earnings multiples, respectively. Hence if we accord the emerging market business of Unilever the average of these two multiples, the developed market business is to be had almost for free.

Firm Country GEM Exposure 12m fwd PE GEM PE / Main PE* Developed Market P/E*

UK 14.5

Malaysia 21.3

UK/Netherlands 17.8

India 35.0

Indonesia 37.5

Belgium 18.1

Brazil (AMBEV) 20.5

US 19.6

India 29.9

Switzerland 16.9

Malaysia 26.8

India 36.6

*GEM equal weighted

Unilever 54% 204% -3.9

Nestle 42% 187% 6.2

153% 10.4

Anheuser-Busch-Inbev 49% 113% 15.8

Colgate Palmolive 47%

British American Tobacco 60% 147% 4.3

20

60

100

140

180

220

260

1990 1993 1997 2001 2005 2009 2013

GEM indirect play s rel S&P 500

NJA mkt rel S&P 500

50%

80%

110%

140%

170%

200%

1991 1994 1998 2002 2005 2009 2013

12m fw d P/E GEM consumer indirect rel GEM consumer direct

Av erage (+/- 1 SD)

50%

60%

70%

80%

90%

100%

110%

120%

130%

140%

150%

1991 1994 1998 2002 2005 2009 2013

GEM indirect consumer 12m fw d P/E rel World

Av erage

60%

80%

100%

120%

140%

160%

1994 1997 2000 2003 2006 2009 2013

GEM direct consumer play s 12m fw d P/E rel GEM mkt

Av erage

26 26 26

The debate is valuation of the direct plays… The GEM consumer staples are trading close to all-time highs on P/E relatives.

Direct plays on GEM consumption look expensive

relative to emerging markets overall...


...as do indirect plays relative to global markets

Indirect GEM consumer plays at 4% premium over

direct plays on 12m forward P/E

In the long-run indirect consumer plays have been a better

way to play emerging markets than the direct plays

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

2001 2003 2005 2007 2009 2011 2013

BAT 12m fwd PE rel. global

0.6

0.8

1

1.2

1.4

1.6

2001 2003 2005 2007 2009 2011 2013

Unilever 12m fwd PE rel. global

Unilever P/E relatives relative to emerging markets P/E relatives: emerging market funds might now look for direct non-consumer related plays!

27

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

1.1

2001 2003 2005 2007 2009 2011 2013

SAB 12m fwd PE rel. global

Unilever 12m fwd P/E rel. global BAT 12m fwd P/E rel. global

SAB 12m fwd P/E rel. global

0.4

0.5

0.6

0.7

0.8

0.9

1

1.1

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

MSCI Emerging markets 12m fwd PE rel. global

Emerging market 12m fwd PE rel global

is at a 5 year low


-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

1992 1995 1999 2002 2006 2009 2013

GEM indirect consumer %dev from 6mma,

rel to WorldAv erage

-7%

-6%

-5%

-4%

-3%

-2%

-1%

0%

1%

2%

1994 1997 2000 2003 2006 2009 2013

2.1

2.3

2.5

2.7

GEM indirect consumer on analy st recommendations rel to

World (+=Buy ; -=Sell)Analy st recommendations (1=Buy ; 5=Sell)

-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

1992 1995 1999 2002 2006 2009 2013

GEM indirect consumer 3m breadth

Rel World

28 28 28

Indirect GEM plays’ relative earnings momentum have turned negative and

sell side are bullish.

Relative earnings momentum of Indirect GEM

consumer plays have turned negative


Sell-side analyst net buy recommendations on the

indirect GEM consumer plays are now positive

... and not overbought on our price momentum monitor

Companies Mentioned (Price as of 24-Jun-2013)

Anheuser-Busch InBev (ABI.BR, €65.05) British American Tobacco (BATS.L, 3293.0p) Caterpillar Inc. (CAT.N, $81.52) Colgate-Palmolive (CL.N, $56.15) Fenner (FENR.L, 317.0p) Metso (MEO1V.HE, €26.32) Nestle (NESN.VX, SFr59.3) Sandvik (SAND.ST, Skr80.9) Unilever (UNc.AS, €28.82)

Disclosure Appendix

Important Global Disclosures

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