LatAm Year Ahead 2011 - Rede Globocolunas.cbn.globoradio.globo.com/platb/files/621/2010/11/JP-Morgan-Latam20111.pdfBuenaventura Peru (1) Eletropaulo Brazil 0 Source: J.P. Morgan. Note:

Latin America Equity Research 12 November 2010

LatAm Year Ahead 2011 Stay Invested

Head of Latin America Research Ben Laidler AC

(1-212) 622-5252 [email protected]

J.P. Morgan Securities LLC

Contents Strategy .........................................................5Sectors.........................................................49Economics and Commodities ....................113LatAm Data................................................135 For a complete list of contributors to this report, please see table of contents on page 3.

See page 158 for analyst certification and important disclosures, including non-US analyst disclosures. J.P. Morgan 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.

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Latin America Equity Research November 2010

Ben Laidler (1-212) 622-5252 [email protected]

LatAm Year Ahead 2011 — Stay Invested What to own • Brazil

• Colombia

• Argentina

• Off-Index

• Discretionary

• Financials

• Telecoms

Focus on sectors within countries rather than country recommendations.

What to avoid • Chile

• Peru

• Materials

• Utilities

• Staples

A detailed view of our country and sector recommendationswithin LatAm is available on page 14. For more detail please see country and sector pages.

10 Top Analyst Picks

(See page 16)

Top Picks Country To PT (%) Vale Brazil 49.4 PDG Realty Brazil 41.6 Cemex Mexico 35.7 Bradesco Brazil 34.9 Santander Brasil Brazil 34.7 Corporacion Geo Mexico 32.3 ICA Mexico 32.1 Grupo Mexico Mexico 31.1 Copasa Brazil 29.0 Brasil Foods SA Brazil 26.9

10 Stocks to Avoid (See page 17)

Stock to avoid Country To PT (%) Ecopetrol Colombia (36) SQM Chile (28) Grupo Financiero Inbursa Mexico (24) Telmex SA Mexico (21) Fibria Brazil (13) CPFL Energia Brazil (6) IAM Chile (4) Bancolombia Colombia (2) Buenaventura Peru (1) Eletropaulo Brazil 0 Source: J.P. Morgan. Note: To PT = Returns to analyst price target from 28 Oct 2010.

The year-ahead process The goal of this document is to present our key strategy themes for 2011 using most- and least-favored stocks from J.P. Morgan’s LatAm equity research team.

This 150+ page handbook includes strategy sections from our country strategists as well as overviews on the outlook for each major company sector and the analysts’ top picks and stocks to avoid for the year ahead. Analysts were asked to pick 1-2 large cap stocks that should lead performance in 2011 as well as a large cap stock they expected to underperform. We are positive LatAm into 2011. Macro fundamentals are robust, credit conditions very supportive, EM fund inflows expected to remain strong. Valuations are not stretched, and the earnings backdrop robust. Risks range from the fiscal and interest rates outlook in Brazil, to the security situation in Mexico, and the presidential elections in 2011 in Argentina and Peru. Capital control risks also remain real, especially in Brazil.

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Table of Contents Strategy

LatAm Strategy (Ben Laidler) .......................................................................... 6

EM Equity Strategy (Adrian Mowat)............................................................... 18

Brazil Strategy (Emy Shayo Cherman) .......................................................... 30

Mexico Strategy (Ben Laidler) ....................................................................... 32

Chile Strategy (Brian P Chase)...................................................................... 34

Colombia Strategy (Brian P Chase)............................................................... 36

Peru Strategy (Brian P Chase) ...................................................................... 38

Argentina Strategy (Brian P Chase) .............................................................. 40

Sectors

Agribusiness, Pulp & Paper (Debbie Bobovnikova, CFA).............................. 44

Financials (Saul Martinez) ............................................................................. 50

Financials (SMid) (Frederic de Mariz)............................................................ 56

Food, Beverages & Tobacco (Alan Alanis) .................................................... 62

Homebuilders (Adrian E Huerta).................................................................... 70

Metals & Mining (Rodolfo R. De Angele, CFA) .............................................. 78

Oil, Gas & Petrochemicals (Sergio Torres).................................................... 86

Retail & Healthcare (Andrea Teixeira, CFA) .................................................. 92

Telecom, Media & Technology (Andre Baggio, CFA) .................................. 100

Utilities (Anderson Frey, CFA) ..................................................................... 106

Economics and Commodities

Global Economic Outlook (Bruce Kasman) ................................................. 115

Brazil Economics (Fabio Akira).................................................................... 122

Mexico Economics (Gabriel Casillas) .......................................................... 123

China Economics (Qian Wang/Grace Ng/Lu Jiang)..................................... 124

China Infrastructure (Qian Wang/Grace Ng/Lu Jiang) ................................. 126

China FAI (Qian Wang/Grace Ng/Lu Jiang) ................................................ 130

Market Forecasts......................................................................................... 131

J.P. Morgan FX............................................................................................ 132

Commodities Forecasts............................................................................... 133

Appendix

LatAm Data.................................................................................................. 135

Note: All ratings and prices are as of the close on October 28, 2010, unless otherwise noted.

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Strategy


6


LatAm Strategy We are positive LatAm into 2011. Macro fundamentals are robust, credit conditions very supportive, EM fund inflows expected to remain strong. Valuations are not stretched, and the earnings backdrop robust. Risks range from the fiscal and interest rates outlook in Brazil, to the security situation in Mexico, and the presidential elections in 2011 in Argentina and Peru. Capital control risks also remain real, especially in Brazil. We are overweight Brazil relative to MSCI LatAm index, as valuations are reasonable, flows returning, and market overhangs – such as the Petrobras offering and the presidential election – are lifting. We also see outperformance from Colombia and Argentina. We are neutral Mexico, and underweight Chile. We focus on domestic stocks for which we see good growth and reasonable valuations, such as financials and homebuilders.

Fundamentals to remain robust: 2010 and 2011 GDP growth expectations have been rising, and are above long-term potential GDP growth. This has been supporting the earnings revision cycle. Inflation expectations have also been rising, and Central Banks are expected to gradually tighten policy in 2011, within the constraint of appreciating currencies but partly offset by output gaps remaining in some countries. Long-term REERs point to the undervaluation of the Mexican Peso, and overvaluation of the Brazilian Real. For more on economics team’s view, please see Latin America Outlook Presentation.

LatAm GDP outlook 2010e 2011e Long-term Forecast Current Forecast Current potential Jan-10 forecast Jan-10 forecast GDP growth

LatAm 4.4 5.7 3.4 4.1 3.4 Argentina 4.0 8.5 3.0 5.5 3.5 Brazil 6.2 7.5 4.0 4.5 4.0 Chile 5.0 5.5 5.0 6.0 4.2 Colombia 3.0 4.5 4.0 4.1 4.5 Ecuador 2.0 2.5 3.0 3.0 3.0 Mexico 3.5 4.5 2.5 3.5 2.5 Peru 5.5 8.2 6.0 6.0 6.0 Venezuela 1.0 -2.2 2.5 1.0 3.0 Source: J.P. Morgan Economics.

Ben Laidler AC

(1-212) 622-5252 [email protected] J.P. Morgan Securities LLC

Bloomberg JPMA LAIDLER <GO>

LatAm inflation outlook

2010e 2011e Forecast in Current Forecast in Current Jan-10 forecast Jan-10 forecast

Latin America 7.2 7.3 6.8 7.3 Argentina 9.0 10.5 10.0 12.0 Brazil 4.7 5.4 4.6 5.1 Chile 2.5 3.8 3.0 3.4 Colombia 3.8 2.7 4.0 4.0 Ecuador 4.0 3.4 3.8 3.8 Mexico 5.1 4.8 4.0 4.0 Peru 2.0 2.4 2.5 2.5 Venezuela 40.0 33.0 40.0 35.0

Source: J.P. Morgan Economics.

Credit conditions remain supportive: This could support a meaningful multiple rerating and increased equity fund flows and is already altering corporate behavior. The strong outperformance of EM corporates has significantly improved relative valuations. The lower LatAm cost of equity has pushed up ‘fair value’ for stocks. Regional corporates are responding by releveraging and stepping up M&A activity, and financials are boosting capital. EM corporates are seeing strong fund inflows. This is a mirror of what equities are seeing. We believe the drivers here are sustainable into 2011, with risk-free rates likely to stay very low, EMBI spreads tight, and the EM growth premium high. See our recent note for details: LatAm Strategy – Credit rally supports equities.

LatAm ‘fair value’ vs 12m fwd P/E

5.0

7.0

9.0

11.0

13.0

15.0

03 03 04 05 06 07 08 09 10

12 mth Fw d PE Gordon Grow th

Source: MSCI, IBES, Datastream.

https://mm.jpmorgan.com/PubServlet?action=open&doc=GPS-478319-0.pdf





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Implied P/E – LatAm corp’s & equities

0.0

3.0

6.0

9.0

12.0

15.0

18.0

21.0

2001 2003 2004 2005 2006 2007 2008 2009 2010

Cembi Latin HY Cembi Latin IG MSCI LatAm CEMBI LatAm Broad

P/E:CEMBI Latin IG - 19.5xCEMBI Latin - 17.4xCEMBI Latin HY- 12.6xMSCI LatAm - 11.9x

Source: J.P. Morgan, MSCI, Datastream. * 12m fwd MSCI LatAm P/E and inverse of J.P. Morgan CEMBI Corporate Bond Yields.

EM fund flows continue strong: Year-to-date equity fund flows into EM have exceeded US$70 billion, above the previous record of US$64bn in 2009. These flows have been focused on ETF products and on EM and Asia funds. Flows into LatAm, as proxied by LatAm funds, have been poor. Fund flows should continue strong, as both global equity allocations increase, EM allocations within global equities are built, and LatAm flows within EM recover as Brazil ‘overhangs’ lift. This is a phenomenon across the asset class and has arguably been more powerful in corporate and FX markets so far. We generally see this as another source of upside risk to multiples. Risk here is from issuance, which has been high. Please see our weekly fund flows product for details: Herd Instinct.

GEM fund cumulative US$bn flows

22.4

40.8

(39.4)

64.469.7

(60)

(30)

0

30

60

90

120

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2006 2007 2008 2009 2010

Source: EPFR Global.

2010 LatAm fund flows, US$mn

(2,500)

(1,500)

(500)

500

1,500

2,500

Jan 10 Feb 10 Apr 10 May 10 Jul 10 Aug 10 Oct 10

ETF Flow sTotal Flow s

Source: EPFR Global, J.P. Morgan.

Capital control risks: Virtually every EM CB has intervened, and a number already have controls. Pressure will likely continue, as we expect more FX appreciation, with US$ weakness to persist and EM inflows to build. We see ‘real’ capital controls, such as unremunerated reserve requirements and minimum holding periods, as unlikely. An increase in transaction costs – such as Brazil’s 2% equity IOF – is a last resort, but arguably near inevitable in this flows environment. It is not enough to change our positive view on Brazil, where the potential upside beats a moderate potential transaction cost increase. For details see our report: The threat from capital controls.





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Other risks: Brazil fiscal and rates outlook. In the short term we await to see the composition of Dilma Rousseff’s first cabinet and the outlines of fiscal policy going forward. This is important as an early indication of the policy direction of the new administration at a time when inflation expectations are drifting higher and the economy is growing above potential. Mexico security concerns. Investor angst here is high. We see this as an unfortunate issue that detracts from growth (1-1.5%pa) at a bad time, with the economy weak. We believe greater concerns here are likely overdone, with violence localized and largely between cartels. The risk is that this spreads to Mexico City or cartels decide to openly target the State and civilians. The electoral calendar in 2011 is significant. Peru presidential elections are in April, with three centrist candidates leading in the polls and leftist Ollanta Humala currently 4th. He is likely to rise somewhat (and this could unnerve markets) though unlikely to ultimately prevail. Argentina also goes to the polls in October. The political environment has been thrown open by the unexpected death of ex-President Kirchner. This potentially opens the way for a more market-friendly candidate, possibly from within the Peronist party.

Valuations are not stretched: We do not see LatAm valuations as demanding, with most metrics within historical ranges or at discounts to peers’. LatAm is currently trading on 11.9x 12m forward P/E, compared to 11.6x for emerging markets and 11.5x for global equities. This 12m forward P/E is at the top end of the region’s 15-year average. As highlighted before, the current regional cost of equity would argue for significant multiple expansion from these levels. When comparing EM countries we are also careful to adjust for index composition. This makes commodity-heavy indices such as Brazil more expensive and staples-heavy indices such as Mexico and Chile somewhat cheaper.

15-year MSCI LatAm 12m fwd P/E

5.00

7.00

9.00

11.00

13.00

15.00

95 97 98 99 00 01 02 03 04 05 06 07 08 10

EM Latam Av erage +1SD -1SD

Source: IBES, MSCI, J.P. Morgan.

Sector-neutral P/E Sector-Neutral P/E 12 Mth Fwd P/E Diff

Chile 16.0 17.8 (1.8) Mexico 14.5 15.3 (0.9) Indonesia 14.8 15.3 (0.5) Korea 9.9 10.0 (0.0) South Africa 11.8 11.7 0.2 EM 11.9 11.6 0.3 Turkey 11.4 10.9 0.5 India 17.7 17.0 0.6 Brazil 12.3 11.1 1.2 China 14.3 12.0 2.3 Taiwan 15.6 12.9 2.8 Russia 11.8 6.6 5.2

Source: MSCI, IBES, J.P. Morgan. Sector-neutral P/E multiplies the country sector P/E by the MSCI Emerging Markets Index sector weight.

LatAm enjoyed a strong earnings recovery cycle in 2010. We expect this to stabilize in 2011. LatAm earnings growth (local currency) is forecast at 21% for next year versus 15% for developed markets. This is a high number, and we see risks as balanced. Commodity earnings have been easing – especially in steels and Petrobras. Domestic earnings have been moving higher as GDP expectations are raised, and earnings remain below all-time highs despite higher nominal GDP growth. Forecasts for Mexico and Brazil are very similar (~20-21%).

LatAm EPS growth expectations EPS Growth Expectations % 2010e 2011e 2012e

Colombia 29.4 52.5 5.0 Peru 27.3 31.6 13.1 S.Africa 26.5 27.1 17.8 India 23.4 22.7 17.6 Brazil 16.3 21.6 11.5 EM Latam 15.8 21.4 16.1 Indonesia 20.3 20.9 13.5 Mexico 9.0 20.4 16.3 EM 30.6 17.2 14.0 Malaysia 29.4 15.7 11.2 Russia 29.8 15.4 17.1 Global 36.2 15.3 13.2 DW 37.2 15.0 13.0 China 26.7 14.9 16.4 EMEA 25.0 14.7 15.6 EM Asia 40.7 14.6 13.9 Korea 51.4 13.1 11.1 Chile 23.0 11.2 7.1 Taiwan 89.1 9.4 11.2 Turkey 18.5 8.2 13.6 Argentina 5.4 6.4 18.1 Czech -4.8 3.3 5.7

Source: MSCI, IBES, J.P. Morgan.


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MSCI LatAm EPS revision cycle

80.090.0

100.0110.0120.0130.0140.0150.0

Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10

2011 EPS 2010 EPS


MSCI Brazil domestic vs commodity 12m fwd earnings integer

60.0

90.0

120.0

150.0

180.0

Jan 07 Aug 07 Mar 08 Oct 08 May 09 Dec 09 Jul 10

Brazil Commodities Brazil Domestics


Attractive risk/reward for 2011 justifies continued bullish positioning. We run three valuation scenarios for 2011. The MSCI LatAm potential upside is 53% and the potential downside 14%. For details see our report: Measuring the risk/reward.

1. The positive view is that lower risk-free rates are sustainable for 2011, as we forecast, and this justifies further multiple rerating. This could be significant. Our Gordon-growth ‘fair’ value target is near 15.0x earnings, over 30% above current multiples. This indicator has tracked well historically. Upside here is concentrated in Brazil. This targets 53% upside for the region and 70% for Brazil. Mexico is penalized by a potentially too aggressive 2.5% potential GDP growth. 2. The mid-case assumes current multiples are fair, at the top end of long-term historical ranges, and consensus earnings growth correct, at a reasonable premium to nominal GDP growth. This targets respectable 18% upside, with all countries closely clustered. This would be our Mexico base case. 3. The cautious view assumes both a derating and that earnings fall. A derating scenario back to long-term historical multiples (down 14%, from 12.0x to 10.5x earnings) and a 20% fall in index earnings versus current expectations, as we assume earnings growth only in line with nominal GDP growth. This shows 14% downside for the region, led by Colombia, with Chile defensive. Our baseline view is somewhere between the more bullish two scenarios, looking for even lower Treasury yields and tight EM spreads, whilst the relative Emerging growth and earnings premium remain high, continuing to attract flows and support multiples. QE2 and recent developed market data have reduced downside tail-risks.

Summary year-end 2011 target and index levels Positive Target % Upside Mid-Case Target % Upside Cautious Target % Upside LatAm 122,500 53 94,500 18 69,000 (14) Brazil 122,000 70 84,500 18 61,500 (14) Mexico 39,500 8 42,500 17 31,600 (13) Chile 5,450 8 5,700 13 4,700 (6) Colombia 16,000 1 18,000 14 10,600 (33) Argentina 2,300 (31) 3,950 19 3,275 (1) Peru 41,300 101 24,500 19 16,500 (20) Source: J.P. Morgan estimates.



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We remain overweight Brazil, with valuations significantly derated, strongly returning flows, and multiple overhangs (election, rate cycle, Petrobras, China slowdown) reduced. Fiscal policy and equity IOF risks remain but are manageable. The focus remains on domestic stocks, especially those with growth at reasonable multiples, such as financials and homebuilders. We have good growth visibility, the earnings revision cycle remains positive, and valuations ex-staples are all cheap/fair. Top-performing staples and retailers are expensive and will likely keep performing in this environment if they can continue delivering on earnings. However, this does not mean the risk/reward is attractive. We are selective and own CBD. We see cheap, underowned, but low-growth sectors – such as utilities and telecom – as value traps but have continued to selectively add where we see pockets of growth (such as NII Holdings and TSU). In our model portfolio, we are neutral energy (positive oil and E+P but cautious Petrobras), and underweight materials – we are positive Vale but own no Steels. The sector is cheap (though earnings are falling), underowned, and benefiting in the short term from perceived QE upside, though global growth remains subpar and the sector chronically oversupplied.

Brazil macro outlook


Brazil interest rate futures

9.510.010.511.011.512.012.513.0

Feb 10 Apr 10 Jun 10 Aug 10 Oct 10

Jan-11 Jan-12

Source: Bloomberg.

We are neutral Mexico. The market has performed well in the last month on signs of a bottoming in US growth expectations (we took our global growth numbers up for the first time since April) and moderate Mexican consumer acceleration. We do not see Mexico as underweight, with the market well supported by a gradual US growth reacceleration, high equity market correlation, undervalued currency, easy monetary policy, and valuations less expensive than they ‘seem’. However, the traditional drivers of Mexican outperformance are lacking – major market sell-off, strong US data surprise, or strong local consumer recovery. We focus on domestic recovery plays – Televisa, First Cash, AMX – and special situations – Cemex and ICA.

US Economic Activity Surprise Index

(40.0)(30.0)(20.0)(10.0)

0.010.020.030.040.0

Jan 09 May 09 Sep 09 Jan 10 May 10 Sep 10

Source: Bloomberg, J.P. Morgan.

Mexico consumer confidence and formal employment

Source: J.P. Morgan Economics, INEGI, IMSS.


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In the smaller markets, we struggle to see a sustainable second leg to the well-known (and very positive) Chilean story. Valuations are high, and the stocks we want to own (banks/discretionary) are even pricier. We do see further fundamental upside in Colombia on the ongoing reform agenda, investment grade outlook, and capital markets development, but would play this off index (through Copa and Pacific Rubiales) given high on-index valuations. We remain exposed to Argentina. Valuations have become expensive at first glance, but the outlook for real political change – however moderate – means the market still likely has upside. Penetration rates are low and nontraditional valuation metrics (franchise value, replacement cost) attractive. We stick with GF Galicia.

12 mth fwd P/E relative to MSCI LatAm: Smaller markets at premium to LatAm

0.20.71.21.72.22.73.23.7

Jan-03 Feb-04 Mar-05 Apr-06 May -07 Jun-08 Jul-09 Aug-10

Chile Argentina Peru Colombia

Source: IBES, Datastream, MSCI.

Colombia pension fund equity exposure to rise on multifunds/demographics

Estimated End-2010AUM Equity % Limit % Cushion %

1 0.0 0.0 NM 0.0 20.0% 0.0 NM2 90.6 39.4 43.5% 40.8 45.0% (1.4) -1.5%3 0.0 0.0 NM 0.0 70.0% 0.0 NM

Total 90.6 39.4 43.5% 40.8 45.0% (1.4) -1.5%

Pro Forma 2011AUM Equity % Limit % Cushion %

1 4.5 0.9 20.0% 0.9 20.0% 0.0 0.0%2 53.4 24.0 45.0% 24.0 45.0% 0.0 0.0%3 32.6 22.8 70.0% 22.8 70.0% 0.0 0.0%

Total 90.6 47.8 52.8% 47.8 52.8% 0.0 0.0%

Source: Superfinanciera and J.P. Morgan estimates.

Can Cristina maintain her currently positive image?

0.0%

20.0%

40.0%

60.0%

J-08 M-08 S-08 J-09 M-09 S-09 J-10 M-10 S-10

Source: Management y Fit and J.P. Morgan.


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Latin America Model Portfolio by Country Change Port. MSCI Dev. P/E P/E EPS ROE Analyst Ticker Price* 1 M YTD Weight (%) 10E 11E growth 10E (%) (%) (%) (%) (x) (x) 10E (%)

Brazil 245,843 1.2 4.1 70.3 67.8 2.5 12.9 10.6 16.3 13.7 Bradesco BBDC4 BZ 36.5 6.9 21.4 10.0 4.5 5.5 14.1 12.7 26.3 21.8 Saul Martinez CBD PCAR5 BZ 66.1 11.1 1.7 6.0 0.4 5.6 30.5 24.9 -7.7 6.9 Andrea Teixeira Cetip CTIP3 BZ 19.1 17.6 33.7 5.0 0.0 5.0 31.2 23.5 22.0 38.2 Frederic de Mariz Gafisa GFSA3 BZ 14.3 2.8 0.9 5.0 0.4 4.6 17.0 12.7 31.3 9.3 Adrian E Huerta NII Holdings NIHD US 42.6 0.3 26.9 5.0 0.0 5.0 25.5 13.0 -26.4 8.9 Andre Baggio OGX OGXP3 BZ 22.9 0.7 33.6 4.0 1.9 2.1 nm nm -96.4 2.1 Sergio Torres PDG Realty PDGR3 BZ 22.2 5.7 28.0 5.0 0.8 4.2 15.2 9.8 67.8 13.3 Adrian E Huerta Petrobras PN PETR4 BZ 27.0 -1.4 -26.4 10.0 13.0 -3.0 8.3 10.4 -1.8 10.3 Sergio Torres Santander Brasil SANB11 BZ 25.0 5.9 4.6 7.0 0.5 6.5 15.4 11.7 23.7 11.6 Saul Martinez TIM Participacoes TSU US 34.1 4.5 14.8 2.0 0.2 1.8 31.0 15.0 -41.9 5.2 Andre Baggio Vale PN VALE/P US 28.9 3.7 16.4 11.3 11.0 0.3 9.6 7.0 202.0 23.3 Rodolfo R. De Angele Mexico 33,431 7.7 18.5 18.0 18.2 -0.2 17.7 14.7 9.0 16.5 AMX AMX US 58.0 6.6 23.4 6.0 6.4 -0.4 15.8 13.5 -24.9 25.0 Andre Baggio Cemex CX US 9.2 10.7 -19.1 3.0 1.0 2.0 nm nm -233.3 -0.8 Adrian E Huerta First Cash FCFS US 29.5 10.4 32.9 3.0 0.0 3.0 17.2 14.7 23.7 18.7 Ben Laidler ICA ICA* MM 33.3 8.2 9.2 3.0 0.0 3.0 31.1 22.5 -8.5 3.7 Adrian E Huerta Televisa TV US 22.9 21.1 10.3 3.0 1.2 1.8 22.4 17.5 16.1 20.0 Rajneesh Jhawar Chile 5,971 3.9 38.6 3.7 7.1 -3.4 19.6 17.6 23.0 12.2 Cencosud CENCOSUD CI 3,717.2 14.0 116.1 3.7 0.8 2.9 38.9 30.3 78.6 8.0 Andrea Teixeira Colombia 3,120 6.5 58.1 6.0 3.8 2.2 25.9 17.0 26.9 na Copa CPA US 50.6 -3.8 -7.1 3.0 0.0 3.0 10.6 7.7 3.2 na Jamie Baker Pacific Rubiales PRE CN 33.4 18.0 116.4 3.0 0.0 3.0 37.2 13.8 -266.7 18.2 Sergio Torres Argentina 254,619 21.7 65.0 2.0 0.0 2.0 14.9 14.0 5.4 na GF Galicia GGAL US 15.1 51.9 162.8 2.0 0.0 2.0 24.8 17.6 24.5 14.5 Saul Martinez Peru 3,376 14.8 47.9 0.0 3.1 -3.1 19.9 15.1 27.7 EMF LATAM 79,524 3.1 11.3 100.0 100.0 0.0 14.2 11.6 15.8 13.9 Source: Bloomberg, MSCI, J.P. Morgan estimates. All estimates are for the calendar year. Updated as of 3 November 2010.

Our LatAm model portfolio is a vehicle to express our strategy views on regional equity markets, sectors, and stocks. This portfolio will normally include stocks which will be constructed relative to the MSCI EM Latin America Index and will be updated on a regular basis through our ‘LatAm Key Trades’ publication. The portfolio is primarily driven by our fundamental analyst views, and we use our analysts’ published company valuation and estimates to support inclusion, but a strategy overlay is incorporated and hence the published strategy may on occasion differ from analyst views. Analyst ratings are driven by company attractiveness relative to their sector coverage, whereas we take a regional LatAm view. The portfolio can include: 1) non-Latin America listed stocks, to the extent the region is a significant company driver; and 2) stocks not currently covered by JPM analysts, to the extent these are heavily weighted MSCI Latin America Index companies, though these companies must always be incorporated at a neutral relative weighting so as to express no strategy or fundamental view.

This portfolio has been run since November 2007. Year to date in 2010 the portfolio is up 22.0% compared to a rise for the MSCI LatAm index of 12.0%. This return is indicative only and is calculated on price returns only, excluding dividends but also excluding trading costs – which an invested portfolio would bear. Portfolio changes are implemented on the day of ‘Key Trades’ publication.


13


Latin America Model Portfolio by Sector Change Port. MSCI Dev. P/E P/E EPS ROE Analyst Ticker Price* 1M YTD Weight (%) 10E 11E Growth 10E (%) (%) (%) (%) (x) (x) 10E (%)

Discretionary 667.8 2.1 9.2 13.0 5.3 7.7 17.6 13.8 27.9 16.1 Gafisa GFSA3 BZ 14.3 2.8 0.9 5.0 0.4 4.6 17.0 12.7 31.3 9.3 Adrian E Huerta PDG Realty PDGR3 BZ 22.2 5.7 28.0 5.0 0.8 4.2 15.2 9.8 67.8 13.3 Adrian E Huerta Televisa TV US 22.9 21.1 10.3 3.0 1.2 1.8 22.4 17.5 16.1 20.0 Rajneesh Jhawar Staples 628.8 3.4 21.9 9.7 11.6 -1.9 24.0 19.8 21.5 12.9 CBD PCAR5 BZ 66.1 11.1 1.7 6.0 0.4 5.6 30.5 24.9 -7.7 6.9 Andrea Teixeira Cencosud CENCOSUD CI 3717.2 14.0 116.1 3.7 0.8 2.9 38.9 30.3 78.6 8.0 Andrea Teixeira Energy 1161.3 2.6 -15.5 17.0 16.6 0.4 10.9 10.2 7.1 9.7 OGX OGXP3 BZ 22.9 0.7 33.6 4.0 1.9 2.1 nm nm -96.4 2.1 Sergio Torres Pacific Rubiales PRE CN 33.4 18.0 116.4 3.0 0.0 3.0 37.2 13.8 -266.7 18.2 Sergio Torres Petrobras PN PETR4 BZ 27.0 -1.4 -26.4 10.0 13.0 -3.0 8.3 10.4 -1.8 10.3 Sergio Torres Financials 1064.7 3.3 22.0 27.0 22.3 4.7 14.7 12.3 19.6 16.2 GF Galicia GGAL US 15.1 51.9 162.8 2.0 0.0 2.0 24.8 17.6 24.5 14.5 Saul Martinez Cetip CTIP3 BZ 19.1 17.6 33.7 5.0 0.0 5.0 31.2 23.5 22.0 38.2 Frederic de Mariz Bradesco BBDC4 BZ 36.5 6.9 21.4 10.0 4.5 5.5 14.1 12.7 26.3 21.8 Saul Martinez First Cash FCFS US 29.5 10.4 32.9 3.0 0.0 3.0 17.2 14.7 23.7 18.7 Ben Laidler Santander Brasil SANB11 BZ 25.0 5.9 4.6 7.0 0.5 6.5 15.4 11.7 23.7 11.6 Saul Martinez Industrials 277.0 3.8 28.5 6.0 4.6 1.4 27.4 22.0 24.6 10.2 Copa CPA US 50.6 -3.8 -7.1 3.0 0.0 3.0 10.6 7.7 3.2 na Jamie Baker ICA ICA* MM 33.3 8.2 9.2 3.0 0.0 3.0 31.1 22.5 -8.5 3.7 Adrian E Huerta Materials 1219.1 3.0 12.3 14.3 24.4 -10.1 13.3 9.5 40.1 15.6 Cemex CX US 9.2 10.7 -19.1 3.0 1.0 2.0 nm nm -233.3 -0.8 Adrian E Huerta Vale PN VALE/P US 28.9 3.7 16.4 11.3 11.0 0.3 9.6 7.0 202.0 23.3 Rodolfo R. De Angele Telecoms 588.6 3.6 8.1 13.0 8.7 4.3 12.4 10.7 15.4 27.1 AMX AMX US 58.0 6.6 23.4 6.0 6.4 -0.4 15.8 13.5 -24.9 25.0 Andre Baggio NII Holdings NIHD US 42.6 0.3 26.9 5.0 0.0 5.0 25.5 13.0 -26.4 8.9 Andre Baggio TIM Participacoes TSU US 34.1 4.5 14.8 2.0 0.2 1.8 31.0 15.0 -41.9 5.2 Andre Baggio Utilities 383.9 2.3 9.2 0.0 5.5 -5.5 11.7 10.7 8.8 8.7 EMF LATAM 79524.0 3.1 11.3 100.0 100.0 0.0 14.2 11.6 15.8 13.9 Source: Bloomberg, MSCI, J.P. Morgan estimates. All estimates are for the calendar year. Updated as of 3 November 2010.

LatAm Model Portfolio sector allocation relative to MSCI Emerging Latin America Markets Index

-12 -10 -8 -6 -4 -2 0 2 4 6 8 10

MaterialsUtilitiesStaplesEnergy

IndustrialsTelecomsFinancials

Discretionary

Source: MSCI, J.P. Morgan estimates. Updated as of 3 November 2010.


14


LatAm Model Portfolio country allocation relative to MSCI Emerging Latin America Markets Index

-4.0 -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0

Chile

Peru

Mex ico

Argentina

Colombia

Brazil

Source: MSCI, J.P. Morgan estimates. Updated as of 3 November 2010.

Historical changes to model portfolio Bought Sold

Nov 10 TIM Participacoes BM&F Bovespa Sep 10 Cetip, OGX, Cemex Banrisul, Banorte, Urbi Aug 10 GF Galicia, Banrisul, Cencosud Lan Airlines, OGX, Banco Macro Jul 10 Televisa, Banorte Cemex, Ternium Jun 10 Gafisa, Copa Holdings Metalurgica Gerdau, Tenaris May 10 NIHD, Cemex, First Cash Financial Vivo, Grupo Mexico, Banorte Mar 10 BM&F Bovespa, Metalurgica Gerdau, Vivo, Pacific Rubiales Cielo, Gerdau, Silver Wheaton Feb 10 None None Jan 10 ICA, CBD Cemex, Lojas Renner, Gafisa Nov 09 Santander Brazil, Cielo, Lan Airlines BM&F Bovespa, Banco do Brasil, Santander Chile Oct 09 OGX, Silver Wheaton ALL, Televisa Sep 09 Itauunibanco, Geo, ALL Banco Bradesco, Urbi, TAM Aug 09 Gerdau, Gafisa Bradespar, GVT Jun 09 BM&F Bovespa, Banco Macro Porto Seguro, Credicorp May 09 Ternium, Grupo Mexico Copa Holdings, Femsa. Apr 09 Lojas Renner, Banorte, Santander Embraer, Walmex, Entel Mar 09 Banco do Brasil, ALL, Tenaris, Geo Bradesco, SLC, Ternium, Asur Feb 09 Banco Itau, Entel, Slc Agricola, Cemex Unibanco, Urbi, Gafisa, Santander Chile Dec 08 Porto Seguro, Bradesco, Credicorp Telecom Arg., CCR, Banco do Brasil Oct 08 Asur, Walmex, Bradespar, Urbi Banorte, Lojas Renner, Homex Sep 08 GVT,PDG Realty CTC, Coeur d'Alene, Rodobens Aug 08 Homex Megacable, Urbi Jul 08 Embraer VCP Jun 08 Petrobras PN ADR, CCR, CTC, Coeur d'Alene Petrobras ON, NETC, Silver Wheaton Apr 08 Banco do Brasil, Megacable B2W Feb 08 Urbi, Rodobens, Gafisa, Telecom Argentina Cesp, Company SA, Cyrela

Source: J.P. Morgan Strategy.


15


Analysts’ Top Picks Top picks

Name Share Price % Change Bloomberg JPM Analyst Mkt Cap, P/E (X) P/E (X) EPS EPS Yield (%) ROE (%) Price Target to target Ticker Rating US$ MM 2010E 2011E 2010E 2011E 2011E 2011E

Brazil AES Tiete 23.5 27.0 15.6 GETI4 BZ OW Anderson Frey 4,835 10.7 9.9 2.19 2.38 10.7 181.4 Banrisul 18.0 20.0 2.6 BRSR6 BZ OW Frederic de Mariz 4,267 11.2 9.6 1.61 1.88 4.2 19.0 Bradesco 34.8 47.0 26.7 BBDC4 BZ OW Saul Martinez 73,018 13.5 12.1 2.59 2.88 2.9 21.2 Brasil Foods 24.4 31.0 23.5 BRFS3 BZ OW Alan Alanis 12,881 26.3 14.4 0.93 1.70 1.5 8.8 Cetip 18.0 20.0 3.7 CTIP3 BZ OW Frederic de Mariz 2,568 29.4 22.2 0.61 0.81 3.1 45.3 Copasa 26.4 34.0 21.6 CSMG3 BZ OW Anderson Frey 1,895 6.4 6.0 4.13 4.39 8.3 12.0 DASA 20.6 18.0 -13.7 DASA3 BZ OW Andrea Teixeira 2,816 24.2 18.7 0.85 1.10 30.6 31.2 Hypermarcas 28.0 30.0 7.9 HYPE3 BZ OW Andrea Teixeira 8,847 28.3 20.7 0.99 1.35 2.1 7.6 OGX 21.7 20.3 -10.1 OGXP3 BZ OW Sergio Torres 42,952 nm nm 0.06 0.02 0.0 0.6 PDG Realty 10.6 15.0 36.6 PDGR3 BZ OW Adrian E Huerta 7,144 14.5 9.4 0.73 1.13 1.7 19.2 Santander Brasil 24.5 33.0 27.2 SANB11 BZ OW Saul Martinez 58,007 15.1 11.5 1.62 2.13 5.2 14.4 Sao Martinho 21.6 13.0 -43.5 SLCE3 BZ N Debbie Bobovnikova 1,339 33.2 22.5 0.65 0.96 1.1 11.1 Tim Participacoes 32.2 40.0 17.6 TSU US OW Andre Baggio 8,417 29.5 14.3 1.86 3.84 1.7 10.0 Vale 31.8 47.5 40.4 VALE US OW Rodolfo R. De Angele 173,421 10.9 7.7 2.92 4.13 2.9 23.3 Mexico America Movil 57.1 72.0 21.6 AMX US OW Andre Baggio 119,244 15.8 13.4 44.98 52.72 0.7 26.1 Cemex 8.8 12.0 22.4 CX US OW Adrian E Huerta 9,800 nm nm -0.16 0.02 0.0 0.1 Compartamos 85.9 100.0 8.7 COMPARTO MM OW Frederic de Mariz 3,216 19.7 16.1 4.36 5.34 1.3 34.8 Corporacion Geo 39.3 52.0 32.5 GEOB MM OW Adrian E Huerta 1,762 12.2 9.6 3.23 4.08 0.0 22.0 FEMSA 52.9 59.0 5.2 FMX US OW Alan Alanis 20,060 13.1 11.5 4.05 4.61 8.0 11.0 First Cash Financial 29.4 34.5 14.5 FCFS US OW Ben Laidler 913 17.1 14.6 1.72 2.01 0.0 17.9 Grupo Mexico 40.4 53.0 25.4 GMEXICOB MM OW Rodolfo R. De Angele 26,902 17.2 10.9 0.19 0.30 5.2 24.6 Grupo Televisa 22.2 27.5 17.5 TV US OW Rajneesh Jhawar 13,699 22.0 17.2 12.54 16.02 1.4 23.0 ICA 32.5 43.0 26.9 ICA* MM OW Adrian E Huerta 1,781 30.4 22.0 1.07 1.48 0.0 4.9 Chile Antofagasta 1326.0 1100.0 -23.0 ANTO LN OW Amos Fletcher 22,718 16.5 11.4 80.30 116.50 0.5 116.5 CCU 56.1 62.0 5.5 CCU US OW Alan Alanis 3,744 15.1 13.7 3.70 4.08 4.5 21.6 Falabella 4849.5 4556.0 -4.5 FALAB CI N Andrea Teixeira 23,833 38.5 31.4 125.92 154.40 0.8 13.0 Colombia Exito 23080.0 17800.0 -27.7 EXITO CB N Andrea Teixeira 4,477 55.5 42.8 415.58 539.80 0.0 4.3 Millicom 94.7 120.0 28.9 MICC US OW Jean-Charles Lemardeley 10,140 14.2 11.8 6.69 8.00 7.3 26.1 Pacific Rubiales 31.7 36.0 8.1 PRE CN OW Sergio Torres 8,843 35.2 13.0 0.90 2.43 0.0 34.1 Peru Credicorp 124.7 120.0 -5.9 BAP US N Saul Martinez 10,171 17.2 15.2 7.23 8.20 1.7 22.1 Silver Wheaton 27.6 31.0 -11.6 SLW US OW John Bridges 12,106 38.3 21.0 0.72 1.31 0.0 18.5 Argentina Grupo Clarin 10.0 9.0 -10.0 GCLA LI OW Rajneesh Jhawar 1,437 3.4 2.5 2.92 4.00 0.0 12.7 Tenaris 41.3 52.0 14.8 TS US OW Sergio Torres 26,733 20.1 16.0 2.06 2.59 0.9 14.8

Source: Bloomberg, J.P. Morgan estimates. J.P. Morgan ratings: OW = Overweight; N = Neutral; UW = Underweight.


16


Analysts’ Top Stocks to Avoid Top stocks to avoid

Name Share Price % Change Bloomberg JPM Analyst Mkt Cap, P/E (X) P/E (X) EPS EPS Yield (%) ROE (%) Price Target to target Ticker Rating US$ MM 2010E 2011E 2010E 2011E 2011E 2011E

Brazil Cyrela Brazil Realty 22.8 29.0 30.3 CYRE3 BZ UW Adrian E Huerta 5,536 12.1 9.9 1.88 2.31 0.0 20.1 Eletropaulo 29.9 30.0 0.0 ELPL6 BZ UW Anderson Frey 3,229 4.8 8.4 6.29 3.54 13.8 18.0 Fibria 30.0 26.0 -16.7 FIBR3 BZ UW Debbie Bobovnikova 8,587 17.1 96.9 1.76 0.31 0.0 5.0 Minerva SA 6.1 8.1 34.1 BEEF3 BZ N Alan Alanis 376 10.6 5.8 0.58 1.05 0.0 10.8 Panamericano 7.7 10.0 37.7 BPNM4 BZ UW Frederic de Mariz 1,043 12.1 7.2 0.64 1.07 8.0 16.4 Tele Norte Leste 48.5 57.0 14.9 TMAR5 BZ N Andre Baggio 7,699 5.6 6.7 8.60 7.21 8.9 14.9 Usiminas 21.0 26.0 13.3 USIM5 BZ UW Rodolfo R. De Angele 14,775 20.5 11.1 1.02 1.88 3.1 8.8 Mexico Consorcio Ara 7.6 9.0 15.5 ARA* MM UW Adrian E Huerta 829 11.5 9.9 0.66 0.77 1.3 10.1 Grupo Inbursa 53.9 41.0 -21.6 GFINBURO MM UW Saul Martinez 14,247 25.3 21.0 2.13 2.57 1.4 12.2 Organizacion Soriana 37.2 31.0 -17.6 SORIANAB MM UW Andrea Teixeira 5,536 21.6 18.9 1.72 1.97 0.4 9.7 Telmex SA 15.2 12.0 -24.3 TMX US UW Andre Baggio 14,410 12.7 13.2 18.51 17.30 5.0 37.0 Chile IAM 747.0 720.0 -4.0 IAM CI N Anderson Frey 1,561 16.1 16.1 46.36 46.36 5.9 8.1 SQM 51.5 37.0 -29.4 SQM US N Brian P Chase 13,799 43.6 30.4 1.18 1.69 0.0 24.6 Colombia Bancolombia 66.0 65.0 -3.9 CIB US UW Saul Martinez 13,322 20.0 17.9 3.30 3.68 1.8 18.4 Ecopetrol 4360.0 2795.0 -39.9 ECOPETL CB UW Sergio Torres 102,728 22.1 14.9 197.47 292.19 3.3 34.5 Peru Buenaventura 51.7 46.0 -16.9 BVN US N John Bridges 15,262 19.8 14.6 2.61 3.55 0.9 26.5 Argentina Edenor 10.3 na na EDN US UW Anderson Frey 485 13.3 12.2 0.77 0.84 0.0 7.0

Source: Bloomberg, J.P. Morgan estimates. J.P. Morgan ratings: OW = Overweight; N = Neutral; UW = Underweight.


17


Emerging Market Equity Strategy The Drivers 1. The declining EM risk premium continues

2. Strong demand from EM credit continues

3. High nominal growth and nominal FX appreciation

4. DM neither a driver nor a drag

Potential Returns MSCI EM end-2011 target 1500 (+25%) • Forward PE at 1500 is 13 (based on consensus 2012

EPS)

• Current credit conditions, FX appreciation, earnings growth, and earnings estimate revisions provide upside

Other targets KOSPI 2300, NIFTY 7000

Investment themes 1. China drifts away from the Asian growth model

2. Structural OW on domestic demand

3. FDI in non-China EM increases

4. Growth premiums continue to expand

5. CEMBI Surfers still riding in 2011

6. Warning flags: Real credit growth and core CPI

7. Beware co-investing with governments

8. Liquidity without a valuation anchor

9. Higher REER bad for exporters’ margins

Risks Market Risks • Lack of valuation cushion • Bond market volatility • High correlation Policy and Political risks • Capital controls • Anti-asset inflation policies • Trade wars • Leadership change in China, Thai and Philippines

elections • Strained social contract Economic risks • Uncertain outlook for commodities • Unintended consequences of QE2 • Public sector debt stress in developed economies

Key issues for 2011 – Briefing notes 1. Scale of emerging markets

2. Capital controls and FX intervention

3. Western-China-driven growth

4. Strength of consumption in China

5. China’s infrastructure investment

6. Will China have a housing inventory problem?

Market Performance MSCI EM and MSCI World performance

50

250

450

650

850

1050

1250

88 90 92 94 96 98 00 02 04 06 08 10

MSCI EM

MSCI World

Source: Bloomberg, 8 November 2010.


18


Emerging Market Equity Strategy We are bullish on EM equities. Our end 2011 target for MSCI EM is 1500 (+25%). Based on consensus 2012 EPS the forward PE at 1500 is 13. Current credit conditions could support a larger re-rating (please see page 27 for potential returns). MSCI EM life high is 1338 (29 October 2007).

What about the biggest bull market of your career? Between 11 March 2003 and 29 October 2007 MSCI EM increased from 270 to 1338; +395%, or an annualized return of 38%. On 2 March 2009 EM was 475. The index is 140% higher today. To match the 2003/7 bull market MSCI EM would need to be 2351 by 20 October 2013. This requires an annualized return of 21%.

In last year’s Emerging Markets Year Ahead our end-2010 MSCI EM target was 1200. The index is within 5% of this target. But the ride was not smooth; between 15 April and 25 May the index declined by 19% to 855. Zero interest rates, QE2, currency wars, and high correlation across asset classes are likely to lead to volatility in 2011. Even with this year’s volatility, EM volatility-adjusted returns are the highest for growth assets.

Our asset allocation starts with long-term trends (EM consumer, China’s changing economic policy, sector RoEs and investment cycles, currencies, etc.) combined with short-term tactical allocation driven by market factors (relative valuations and performance, retail activity, consensus positioning). Benchmark composition often represents historical rather than future growth trends. We are bullish on the Brazilian and Chinese domestic economies yet have been underweight these markets in 2010. We have been overweight Brazilian and Chinese domestic demand but underweight the larger sectors, i.e., energy, materials and Chinese SoEs. As was the case in 2010, focus on sectors within countries rather than simple country asset allocation (see page 26).

Investors are seeking carry, growth and momentum. Both emerging fixed income and equity markets offer this. For now it is foolish to fight the trend. But remember the risks (see page 31). QE2 is an experiment. China’s ability to rebalance the driver of growth from investment to consumption is also an experiment.

Monitor the data; core inflation, property sales, actual commodity demand rather than financial demand, etc.

MSCI EM performance

200

400

600

800

1000

1200

1400

Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10

Source: Bloomberg.

Valuations in EM trend rather than mean revert

712172227323742

88 89 90 91 92 93 95 96 97 98 99 00 02 03 04 05 06 07 09 10

Forw ard PE based on Trend EPS

Forw ard PE based on Consensus EPS

Source: Datastream, MSCI, IBES. Note: MSCI EM fwd PE based on trend and consensus EPS. The trend EPS is calculated by plotting a trend line through the log chart of MSCI EM realized EPS.

Higher risk-adjusted returns in EM

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10

EM

World

US

Source: Bloomberg Note: EM, US and World: Three-month rolling returns adjusted for 90-day volatility.


19


There is limited statistical evidence of valuations mean reverting in EM (see figure on previous page). Investors should focus on factors that are currently driving a re- or derating. The rerating factors are:

1. Expanding growth premium in a low-growth world

2. Equities are cheap relative to sovereign and corporate bonds

3. Accelerating investment and consumption growth in key EMs

4. Lower relative risk profile of EM versus DM

Base Case In the risk section on page 31 we highlight the risks to our base case.

The declining EM risk premium continues Emerging economies survived the big ugly experiment of an extreme external demand shock and a credit crisis. This hit EM economies when they were a year into a tightening cycle. In passing this test and with the economies recovering ahead of developed economies, the risk premium demanded for EM should decline. Note that stock-specific risk (corporate governance, transparency, policy risk, etc.) is still higher.

Strong demand for EM credit and carry continues Investor appetite for risk has slowly increased since 9 March 2009. The bias is corporate credit for yield and emerging markets for growth. EM US dollar and local currency credit offers both and is thus attracting large flows relative to its market cap. J.P. Morgan forecast for this to continue in 2011. We maintain our CEMBI surfer theme of favoring current account deficit markets.

High nominal growth and nominal FX appreciation Data support positive nominal GDP revisions. These data include strong retail sales, car sales and loan growth. EM Central Banks are slowing FX appreciation but not reversing the trend.

DM neither a driver nor a drag Focus on the local EM dynamics rather than swings in net exports. Economic expansion in the US and Euro Area resumed in 3Q09. J.P. Morgan forecast 2011 GDP growth of 2.5% and 1.5% for the US and Euro Area respectively. This growth may be politically unacceptable as it is too slow to reduce unemployment, but for EM, slow DM growth is a benign to positive backdrop. It is benign for external demand and positive as interest rates remain low.

EMBI and earnings yield spread between EM and DM

0200400600800

1000120014001600

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10-1

01

23

45

6Earnings Yield Spread betw een EM and DM (RHS)

EMBI Spread (LHS)

Source: Bloomberg, MSCI.

EM net debt inflow (Cum. USD bn)

34

-14

31

59

-20

0

20

40

60

80


2007

2008

2009

2010

Source: J.P. Morgan estimates and EPFR Global.

EM net equity inflows (Cum. USD bn)

41

-40

6469

-60

-40-20

020

4060

80


2007

2008

2009

2010

Source: EPFR Global.


20


Investment Themes China drifts away from the Asian growth model China is a souped-up version of the Asian growth model. Investment rather than consumption drives growth. This requires a transfer of wealth from the household sector to the corporate sector through low wages, low return on savings and undervalued currency. 2010 policy and the 12th Five-Year Plan all point to a move toward consumption. This is a long-term positive. But it may mean that the growth in Chinese commodity demand is overestimated. Beneficiaries of the change are a small part of the benchmark, which may result in ongoing underperformance of MSCI China.

Structural OW on domestic demand This is where the growth is (globally). We acknowledge that these stocks do trade at a premium and the call is consensus.

Beware co-investing with governments A third of MSCI market cap is companies in which governments are the controlling shareholder. It can be profitable being a minority shareholder in these companies when the major shareholder offers favorable policies and is focused on returns. With today’s flood of capital into EMs, investor-friendly policies may not be a top priority and thus these companies could be at risk from politically expedient policies.

SoEs are 79% of MSCI China market cap. Policies designed to boost consumption by increasing the household income-to-GDP ratio will reduce the ratio of profits to GDP. SoEs in our view are particularly vulnerable to policy risk. Our structural bias is to be underweight SoEs. Russian oils stocks’ underperformance is notable, with Rosneft, Lukoil and Gazprom unchanged year to date. In contrast, Russian financials are up 25% ytd. Gazprom, with one-sixth of the world’s oil reserves, has a 2011e PE of 4. Russian energy stocks are unlikely to rerate while the market fears higher taxes.

Household income growth lagging tax and profits

343%

512%

748%

258%

0%100%200%300%400%500%600%700%800%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

GDPGov ernmentProfitsIncome

Source: J.P. Morgan economics. Note: Income proxy is the change in urban per capita household income; Profits are the growth in aggregate industrial profits.

EM and US as a share of global consumption %

20

25

30

35

40

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

US

EM

Source: J.P. Morgan economics.

Ownership structure in MSCI EM

Family19%

Cross h h ldi

Institutional27%

MNC5%

Gov ernment30%

Source: MSCI, Datastream, J.P. Morgan Strategy.


21


FDI in non-China EM increases Higher labor cost, strengthening Renminbi and tensions between Japan and China improves the attractiveness of other emerging markets for FDI. The main beneficiaries are ASEAN, Turkey and Mexico. Note in table below that a small change in China’s share of FDI could lead to a large increase in FDI in ASEAN.

FDI into China and ASEAN US$ billions

China Indonesia Malaysia Philippines Thailand 2007 138.4 6.9 8.6 2.9 11.3 2008 147.8 9.3 7.2 1.5 8.6 2009 78.2 4.9 1.4 1.9 6.0

Source: CEIC.

Warning flags: Real credit growth and core CPI Central banks responding to inflation have always ended the bull market in EM. As of now EM central banks have maintained a pro-growth bias even when headline inflation is higher than the target level. Each week we publish a detailed table on inflation in our dashboards.

The warning flags are a combination of higher real credit growth and rising core CPI. These conditions increase the probability of the central bank moving to a policy designed to slow growth in order to fight inflation. EM equities are growth assets. Lower growth and higher discount rates result in a derating.

Real credit growth and Core CPI Real Credit Growth %oya Core CPI %oya China 15 0.7 Brazil 14 5 Korea 3 2 Taiwan 4 0.7 India 9 9 South Africa 2 3 Russia 0.1 5 Mexico 3 4 Malaysia 11 1.1 Indonesia 14 5 Turkey 16 4 Thailand 4 1.1 Source: CEIC, J.P. Morgan economics, Bloomberg and central bank websites, September 2010. Note: Credit growth as of June 2010 for China, Korea, Taiwan, India, Malaysia, Indonesia, Thailand and August 2010 for Brazil. Growth premiums continue to expand Lack of developed world growth combined with low discount rates supports high growth premium. Maintain a structural bias to high growth themes; EM consumer. Compare valuations with other growth stocks rather than markets.

CEMBI surfers still riding in 2011 Demand for EM credit remains strong (see Error! Reference source not found.). The yield on the emerging market corporate bond indices (CEMBI) is 5.3%; this is lower than the average investment grade bond yield in past decade (JULI). Our bias is to own current account deficit markets when credit conditions are favorable; OW India and Turkey.

EM equities cheap relative to bonds

5

8

11

14

17

20

01 02 03 04 05 06 07 08 09

CEMBI (1/y ld) Fw d PE

Source: MSCI, Bloomberg, J.P. Morgan Indices. Note: The inverse of the CEMBI yield is used to compare PEs with EM corporate bond yields.

Liquidity without a valuation anchor The range of valuations since late 2007 is extremely wide. Correlation of risk asset is high, indicating that asset-specific fundamentals are secondary to general market trend. Higher commodity prices are partly justified by monetary conditions rather than supply or demand. Equities are inexpensive relative to bonds but if economic activity improves then bonds are expensive.

Risk assets march in step: Correlation with MSCI US

-0.6

-0.4-0.2

0.00.2

0.40.6

0.8

93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

JPM TR Energy

JPM Precious Metals TR

JPM Industrial Metals Index

Source: Bloomberg, J.P. Morgan indices. Note: Three year correlation of monthly returns of MSCI US vs. JPMCI Energy, Precious metals and Industrial metals.


22


The lack of valuation anchors in equities, bonds, commodities and currencies means a wide range of possible returns and high volatility. It is critical to keep monitoring the fundamentals while acknowledging that the near term drivers of markets are dominated by momentum and casual relationships between asset classes. When implied volatility is low, consider buying protection. Remember that the 2003/7 EM bull market had five 15-20% corrections.

YTD Returns and Correlation with MSCI US Year to date

return 3 year correlation of monthly

returns with MSCI US Topix -6 0.8 Energy -4 0.6 US cash 0.2 -0.4 GSCI TR 4 0.6 Global Gov Bonds 6 -0.3 MSCI Europe 7 0.9 EM FX 8 0.8 US Fixed Income 9 0.2 MSCI AC World 9 1.0 EM Local Bonds 10 0.5 US High Grade 11 0.4 S&P500 12 1.0 MSCI EM 15 0.9 EM $ Corp. 16 0.6 EMBIG 17 0.7 Gold 27 0.1 Source: Bloomberg.

Higher REER bad for exporters’ margins Capital-flows support EM FX appreciation. Nominal appreciation combined with inflation differentials results in a real effective exchange rate appreciation. In China there have been a number of large wage increases in foreign owned export factories. This is bad for margins. Avoid export industries in Brazil and China with a large labor cost.

Movement in major currencies

-20 -10 0 10 20 30 40 50 60 70

HKD

CNY

PHP

TWD

INR

RUB

MYR

JPY

SGD

TRY

THB

HUF

MXN

CZK

PLN

IDR

KRW

BRL

ZAR

AUD

Av g 05-07 Mar low

Source: Bloomberg.


23


Focus on sectors within countries rather than country recommendations The table below provides a level summary of our views on sectors within countries. Financials is 26%, Materials is 15% and Energy is 14% of EM. All recommendations are relative to EM. The Industrials sector consists of an eclectic group of stocks. We do not rate the sector. Key country and sector recommendations, performance and fundamentals

Country/Sector Wt Rec Demand Performance (USD Returns)

PE EPS Growth (%)

EPS CAGR

EPS CAGR

PEG DY (%)

ROE (%)

Classific-ation

Jan 06 to date

EM low to date

12M YTD 10E 11E 10E 11E (06-11) by SD Ratio 10E 10E

EM 100 -- 64 154 24 17 13.5 11.6 28.4 16.3 8.4 0.5 1.7 2.4 14.8 China 18.5 N 149 167 15 12 14.3 12.2 26.8 17.6 14.1 0.9 1.1 2.5 16.2 China Financials 7.2 N DD 215 173 9 10 12.9 10.6 25.7 21.7 26.2 1.1 0.5 2.9 17.7 China Energy 3.2 UW GPT 144 236 27 21 12.6 11.4 26.2 10.4 10.4 0.7 1.3 3.2 17.4 China Telecom 2.1 UW DD 111 53 12 14 12.9 12.1 3.0 6.9 9.3 0.8 1.4 3.3 15.2 China Industrials 1.5 n/a 50% DD 92 176 17 15 14.9 13.6 64.7 10.1 10.5 0.2 1.7 1.8 11.7 China CS 1.1 OW DD 303 225 36 14 22.7 18.8 13.7 20.9 17 1.5 1.2 1.6 17.7 China Materials 1.0 UW GPT 132 335 9 8 17.0 12.5 54.2 36.2 2.5 0.1 7.6 1.4 11.8 China CD 1.0 OW DD 133 272 28 11 18.4 15.6 38.3 18.1 13.4 0.8 1.5 1.8 21.6 Brazil 16.2 N 146 190 9 7 13.5 11.2 15.5 20.1 9.2 0.6 1.5 2.6 14.1 Brazil Financials 4.3 OW DD 159 260 25 21 14.6 12.3 17.2 18.8 10.7 0.6 1.4 2.7 16.2 Brazil Materials 4.0 N GPT 201 219 13 11 11.5 8.1 87.8 41.5 14.6 0.2 1.1 2.4 17.9 Brazil Energy 3.7 UW GPT 130 126 -18 -17 11.6 12.0 -15.0 -3.1 0.7 0.0 13.4 1.9 10.1 Brazil CS 1.4 N DD 185 227 29 25 23.5 19.0 21.3 23.6 16.2 0.3 1.7 2.5 12.8 Korea 13.4 UW 28 163 32 19 10.6 10.0 46.7 5.3 10.3 0.3 1.0 1.0 14.2 Korea IT 3.4 UW GC/C 11 155 23 7 9.5 10.6 82.8 -10.4 11.0 0.0 0.8 0.1 17.8 Korea Financials 2.1 UW DD -17 92 5 3 10.6 8.8 61.7 19.5 1.6 0.0 8.0 2.2 10.6 Korea Industrials 2.3 n/a 60% DD 72 226 51 39 13.9 12.1 42.3 14.3 9.9 0.3 1.4 1.0 12.6 Korea Materials 1.9 N GPT 192 270 43 17 10.1 9.7 22.9 3.2 13.7 1.7 0.7 1.1 15.2 Korea CD 2.1 OW GC 55 283 70 49 10.6 8.9 9.2 18.9 27.4 0.5 0.4 0.7 17.6 Taiwan 10.5 N 19 102 21 8 14.1 12.7 86.7 11.5 4.3 0.1 3.5 3.4 13.4 Taiwan IT 6.0 N GC/C 4 97 16 1 12.6 11.4 125.1 10.5 3.4 0.0 4.1 3.4 16.4 Taiwan Financials 1.6 OW DD 6 117 11 6 19.6 15.0 29.0 30.6 20.1 0.0 1.1 2.6 6.9 Taiwan Materials 1.4 N GPT 87 114 37 24 16.8 15.4 28.9 9.3 -0.8 0.0 NM 3.9 11.3 India 8.1 OW 123 186 39 25 20.8 17.0 19.8 22.2 12.7 0.8 1.9 1.2 16.1 India Financials 2.3 OW DD 153 209 48 42 24.9 19.8 17.5 25.3 15.7 1.6 1.7 1.0 11.8 India IT 1.3 OW GCap 84 171 50 27 24.8 20.4 15.8 21.2 13.3 1.3 2.0 1.3 24.7 India Energy 1.1 OW GPT 202 140 23 10 16.5 13.2 40.1 24.7 12.7 0.9 1.7 1.1 15.9 South Africa 7.4 N 53 182 36 24 14.6 11.6 28.0 25.8 8.9 0.4 2.1 2.9 15.3 SA Materials 1.9 UW GPT 33 210 31 16 19.5 12.5 236.8 55.8 20.3 0.2 4.4 1.9 12.7 SA Financials 1.9 N DD 39 162 35 23 12.3 10.4 14.9 18.7 3.9 0.2 3.4 4.1 12.3 SA Cons Discr 1.0 OW DD 106 320 58 40 17.0 14.1 19.3 20.8 11.9 1.2 1.8 1.9 17.2 SA Telecom 1.0 OW DD 60 147 25 19 12.9 10.8 18.5 19.0 9.1 0.7 1.6 3.2 20.8 Russia 6.0 N 5 154 10 8 7.8 6.2 44.0 25.0 6.8 0.3 1.2 1.9 13.3 Russia Energy 3.3 UW GPT -20 115 -3 -2 5.6 4.8 25.9 16.2 6.2 0.4 0.9 2.2 14.2 Mexico 4.3 UW 58 136 31 21 17.8 14.8 7.4 20.4 5.5 0.3 4.3 2.4 16.4 Mexico Telecom 1.6 N DD 86 116 27 24 13.5 11.7 13.7 15.5 16.4 1.5 1.1 3.9 41.4 Mexico CS 1.1 UW DD 100 144 40 19 23.2 19.3 -5.0 20.4 18.7 0.6 1.3 1.4 14.3 Malaysia 2.8 OW 108 108 33 32 17.7 14.8 25.7 19.7 7.6 0.3 2.4 3.1 12.6 Indonesia 2.3 N 227 259 48 36 17.4 14.7 19.9 17.7 18 1.1 1.1 2.3 24.2 Turkey 1.8 OW 55 225 57 43 11.6 10.8 18.4 8.0 12.8 0.8 0.9 2.4 17.7 Turkey Financials 1.1 OW DD 78 316 69 50 10.7 10.2 14.4 5.1 20 0.8 0.5 1.8 18.4 Thailand 1.7 OW 101 224 72 58 15.2 13.2 17.2 15.0 5.9 0.2 2.6 3.0 15.8 Chile 1.7 N 145 174 56 41 19.7 17.2 22.3 15.0 18.2 1.5 1.2 1.7 11.6 Poland 1.6 N 19 94 23 19 13.7 11.7 25.0 16.7 1.1 0.1 12.8 3.2 11.8 Philippines 0.5 OW 123 159 48 40 18.8 16.4 18.1 14.2 4.3 0.3 4.8 3.4 16.0 Hungary 0.4 N 1 134 6 4 12.9 10.0 -3.4 29.6 -4.9 -0.2 NM 3.0 10.4 Czech Republic 0.4 N 25 54 -10 -3 10.8 10.2 -2.4 5.5 8.7 0.6 1.2 6.4 17.5

Source: MSCI, IBES, Bloomberg, J.P. Morgan, 5 November 2010. Note: Outperformance of more than 2% vs. MSCI EM. Underperformance of more than 2% vs MSCI EM. DD=Domestic Demand, GPT=Global Price Takers, GC/C=Global Capex/Consumer, GC=Global Consumer, GCap=Global Capex.


24


Potential Returns and Earnings Estimates End-2011 strategy team index forecasts • MSCI EM 1500 (+25%)

Base case • Current MSCI EM forward PE 11.6

• 2012 MSCI EM EPS 112 (before currency appreciation)

• EM FX appreciation 5%

• 10% re-rating to forward PE 13

Statistical warning EM equity markets’ valuations trend rather than mean-revert. Indices also evolve with sector composition changing. The growth characteristics of stocks also change and thus their valuations. Prior to the mid-90s current account crisis, fixed exchange rates and high nominal growth supported high valuations. Investors should be suspicious of statistical justification for index targets.

Pick your methodology To illustrate the impact of different methodologies on potential returns we calculate index targets using six assumptions:

1. Current earnings to bond yield ratio using September 2011 yield forecast and end-2011e PE.

5. Five-year average earnings to bond yield ratio using September 2011 yield forecast and end-2011e PE.

6. Current forward PE multiplied by 2012e EPS based on the lower of 2012e EPS growth or potential nominal GDP.

7. Current forward PE multiplied by 2012 EPS forecast.

8. Three-year average PE multiplied by 2012 EPS forecast.

9. Gordon Growth model theoretical PE multiplied by 2012e EPS. This generates PE in excess of 30 for six markets as local bond yields in these countries are very low relative to nominal GDP growth and RoE.

Current forward PE with standard deviation ranges Index Current

Fwd PE Avg 10Y

+1 SD -1 SD Top Decile

Bottom Decile

EM 11.7 10.7 12.2 9.2 12.6 8.8 EM Asia 12.7 11.5 13.3 9.7 14.0 9.3 Latam 11.8 10.0 11.7 8.4 12.3 8.0 EMEA 9.3 9.8 11.4 8.2 11.7 8.0 China 13.0 13.1 16.3 9.8 17.3 9.9 India 17.2 14.1 17.3 10.8 18.0 9.9 Indonesia 14.9 9.6 12.9 6.2 13.7 5.0 Korea 9.9 9.1 10.9 7.2 11.6 6.5 Malaysia 15.0 14.1 15.5 12.7 15.9 12.3 Philippines 16.6 13.9 16.1 11.7 17.1 11.5 Taiwan 12.8 14.3 18.0 10.6 20.4 11.4 Thailand 12.3 10.4 11.8 9.0 12.1 8.9 Brazil 10.5 8.0 10.4 5.6 11.7 5.3 Mexico 15.1 12.1 13.8 10.4 14.1 9.8 Chile 17.4 15.6 17.6 13.5 18.2 12.8 S Africa 11.7 10.0 11.4 8.7 11.7 8.1 Russia 6.4 7.9 10.3 5.6 11.1 4.6 Turkey 11.2 9.1 11.2 7.1 11.7 6.5 Source: MSCI, IBES, Datastream, 5 November 2010. Note: Current PE > +1SD in red.

Consensus Earnings Growth Forecast (%) Index Consensus Earning Growth (%) EPS growth

10E 11E 12E CAGR 11/ 06 EM 30.6 17.2 14.0 8.2 Brazil 18.4 21.0 11.0 9.0 Chile 23.1 12.0 11.0 18.3 China 26.7 14.9 16.4 14.3 Czech Republic (4.8) 3.3 5.7 9.1 Hungary (2.9) 29.8 21.9 (4.9) India 23.4 22.7 17.6 10.6 Indonesia 20.3 20.9 13.5 18.3 Korea 51.4 13.1 11.1 8.6 Malaysia 29.4 15.7 11.2 7.8 Mexico 2.9 28.9 13.1 5.7 Peru 27.3 31.6 13.1 8.4 Philippines 22.2 12.2 14.8 4.4 Poland 23.9 16.9 9.3 1.1 Russia 29.8 15.4 17.1 6.8 South Africa 26.5 27.1 17.8 9.0 Taiwan 89.1 9.4 11.2 5.4 Thailand 19.1 18.7 15.9 7.2 Turkey 18.5 8.2 13.6 12.9

Source: MSCI, Datastream, IBES, J. P. Morgan, 5 November 2010.


25


Pick your methodology and thus your return: Percentage return to end-2011 targets based on multiple methodologies Index

Level (1)

Current EY/BY

(2) 5yr avg EY/BY

(3) FWD PE

2010 EPS = GDP

(4) Current FWD PE

(5) 3year

average FWD PE

Median Max Min Range of returns

(6) Gordon Growth

PE Brazil 249321 14 0 7 14 11 11 14 0 14 (38) Chile 5942 13 31 6 13 (1) 13 31 (1) 33 (21) China 73 15 5 11 18 15 15 18 5 12 169 India 839 25 2 12 29 8 12 29 2 27 110 Indonesia 4672 10 27 8 14 (7) 10 27 (7) 34 127 Korea 543 4 20 5 11 7 7 20 4 16 153 Malaysia 558 14 8 8 14 3 8 14 3 11 123 Mexico 33913 18 10 6 18 (6) 10 18 (6) 24 (2) Philippines 774 29 41 7 20 (5) 20 41 (5) 47 115 Poland 1904 12 6 6 12 2 6 12 2 10 39 Russia 815 20 85 7 20 42 20 85 7 79 486 South Africa 808 16 9 7 22 (1) 9 22 (1) 23 17 Taiwan 301 6 63 6 14 42 14 63 6 57 172 Thailand 425 8 15 7 24 (12) 8 24 (12) 36 165 Turkey 1038342 15 59 7 15 (15) 15 59 (15) 74 51 Source: MSCI, IBES, Datastream, Bloomberg, J.P. Morgan. 5 November 2010 Note: All returns are local currency; please email [email protected] for the assumptions.

Consensus EPS estimates and revisions since the beginning of 2010 Index Actual Current Consensus EPS Consensus EPS beginning of this Year Revision in Consensus EPS (%)

08 09 10E 11E 12E 10E 11E 12E 10E 11E 12E EM 58 65 84 98 112 77 93 104 9.3 6.0 7.5 Brazil 15593 16618 19678 23812 26435 17942 21381 25574 9.7 11.4 3.4 Chile 236 247 303 339 376 276 317 381 9.5 6.9 (1.2) China 3.31 3.76 4.79 5.51 6.41 4.64 5.39 6.03 3.3 2.1 6.2 Czech 34.7 34.7 33.0 34.1 36.0 33.8 36.0 37.2 (2.4) (5.2) (3.1) Hungary 170 106 103 134 163 116 150 171 (11.1) (11.1) (4.4) India 29 34 42 51 60 42 50 61 (0.5) 2.3 (1.1) Indonesia 213 224 269 325 369 261 309 369 3.1 5.4 (0.0) Israel 18 21 27 31 37 28 33 34 (4.7) (4.5) 8.5 Korea 22 35 49 55 61 47 52 55 5.0 6.5 11.6 Malaysia 31 25 32 37 41 30 35 39 5.3 6.6 5.4 Mexico 1446 1713 1763 2272 2588 2063 2440 2834 (14.6) (6.9) (8.7) Peru 63 71 90 119 135 89 102 111 1.5 16.6 20.8 Phi 30 34 42 47 54 41 46 70 2.5 1.1 (22.6) Poland 148 109 136 159 173 116 144 158 16.5 9.9 10.1 Russia 111 91 118 136 159 98 144 151 19.8 (5.8) 5.4 S Africa 57 42 52 66 78 56 71 85 (6.6) (6.9) (8.0) Taiwan 7.0 11 21 23 26 17 22 24 23.2 8.1 10.6 Thailand 19 24 28 33 39 27 31 35 5.3 6.2 11.2 Turkey 70564 72915 86436 93550 106291 78669 93247 108651 9.9 0.3 (2.2) Source: MSCI, Datastream, IBES, J. P. Morgan, 5 November 2010.


26


Dissection of EM EPS growth The objective Disaggregate the EM EPS growth into countries, sectors and key sectors in countries.

Main observations on 2011e EPS growth • MSCI EM weighted and median EPS growth is

17%. This is 5% higher than our economists’ 2011 nominal GDP growth forecast of 12%.

• Financials and materials are the highest contributors to 2011e earnings growth.

• The contribution of IT and healthcare is the lowest (see top table, next page).

• Two sectors contribute c20% of MSCI EM 2011e EPS growth; Brazilian steel and Russian oil & gas sectors (2011e EPS growth for Vale, Sider and Gazprom is estimated by IBES to be 41%, 44% and 23% respectively).

• Note that the weighted EPS growth for Taiwan electronic components is high at 62% (primarily due

to losses or low profits at AU Optronics, Chimei Innolux, Chunghwa picture tubes, E-Ink). The median EPS growth is 24% (see second table on next page).

Dataset IBES EPS forecasts for MSCI EM constituents

Calculation The index’s calendar year EPS is calculated using the profit-weight of the constituents.

Index EPS = I x (∑ (C-EPS x FFS) / ∑ (FFS x P))

where C-EPS = Index constiuent’s EPS, FFS = free float shares for the constituents, I = index level and P = current market price.

The check Median EPS growth of the index constituents: Reviewing the median helps identify sectors in which a single stock’s impact on weighted EPS growth is large. This could be due its large weight in the index or moving from loss to profit.

Emerging markets earning growth and contribution

Country Mkt Cap Earnings weights (%) Index EPS Growth Median EPS Growth Contribution to Earning growth (%) Weight 2010E 2011E 2012E 2010E 2011E 2012E 2010E 2011E 2012E 2010E 2011E 2012E

Brazil 16.2 16.4 16.9 16.6 18.4 21.0 11.0 18.4 24.1 19.0 9 20 15 Russia 6.0 11.2 12.4 12.4 29.8 15.4 17.1 33.4 34.5 15.4 13 20 13 China 18.7 17.0 16.7 17.1 26.7 14.9 16.4 25.0 21.1 18.8 15 15 20 South Africa 7.4 6.9 7.4 7.6 26.5 27.1 17.8 14.4 19.4 18.3 6 10 9 Korea 13.2 17.6 16.2 15.7 51.4 13.1 11.1 31.8 14.3 12.9 24 8 13 India 8.1 5.3 5.5 5.8 23.4 22.7 17.6 12.9 19.3 20.2 4 7 8 Taiwan 10.5 10.3 9.6 9.5 89.1 9.4 11.2 25.3 13.3 10.0 20 6 8 Mexico 4.4 3.1 3.4 3.4 2.9 28.9 13.1 15.6 17.2 12.4 0 5 4 Indonesia 2.3 1.8 1.9 1.8 20.3 20.9 13.5 18.7 20.4 12.0 1 2 2 Malaysia 2.8 2.2 2.2 2.1 29.4 15.7 11.2 19.7 12.5 10.0 2 2 2 Thailand 1.8 1.6 1.6 1.6 19.1 18.7 15.9 15.5 19.9 15.7 1 2 2 Poland 1.6 1.5 1.5 1.5 23.9 16.9 9.3 15.0 20.5 13.8 1 2 1 Chile 1.7 1.2 1.2 1.1 23.1 12.0 11.0 33.8 16.5 8.9 1 1 0 Peru 0.8 0.5 0.6 0.5 27.3 31.6 13.1 23.4 34.8 18.1 0 1 1 Colombia 0.9 0.4 0.5 0.5 29.4 52.5 5.0 30.4 33.3 25.0 0 1 0 Turkey 1.9 2.2 2.0 2.0 18.5 8.2 13.6 13.5 8.7 14.2 1 1 2 Hungary 0.4 0.4 0.5 0.5 (2.9) 29.8 21.9 (0.9) 20.3 10.0 0 1 1 Egypt 0.4 0.5 0.5 0.6 32.7 19.6 42.9 34.9 17.5 19.4 1 1 1 Philippines 0.5 0.4 0.3 0.3 22.2 12.2 14.8 20.7 14.3 12.5 0 0 0 Czech Republic 0.4 0.5 0.4 0.4 (4.8) 3.3 5.7 (7.8) 5.0 7.7 0 0 0 Morocco 0.2 0.1 0.1 0.1 4.1 10.7 9.2 (0.4) 12.7 13.0 0 0 0 Source: IBES, Datastream, J.P. Morgan calculations. Note: Sorted by 2011e earning growth contribution.


27


EM Sectors’ earning growth and contribution EM Sectors Mkt Cap Earnings weights (%) Index EPS Growth Median EPS Growth Contribution to Earning growth (%)

Weight 2010 2011 2012 2010 2011 2012 2010 2011 2012 2010 2011 2012 Financials 26.3 24.1 25.2 25.9 25.1 22.2 16.8 20.7 19.4 16.1 19 31 31 Materials 14.6 13.8 15.3 15.2 63.7 31.0 16.4 31.0 23.7 15.5 21 24 14 Energy 14.3 19.9 19.3 18.8 11.8 10.2 9.0 21.5 15.5 14.0 13 15 16 Utilities 3.4 2.8 3.5 3.3 7.4 26.5 14.2 1.9 13.2 9.0 -1 7 2 Consumer Discretionary 6.8 6.4 6.4 6.5 28.6 15.5 13.7 19.5 17.2 16.1 6 6 7 Telecommunication Services 7.8 8.3 7.9 7.7 7.4 10.7 10.7 7.0 6.7 9.1 3 5 6 Industrials 7.3 6.6 6.4 6.4 47.5 13.9 15.4 20.7 15.2 16.8 9 5 6 Consumer Staples 6.7 4.4 4.2 4.2 18.1 11.4 16.1 18.1 17.2 14.3 3 3 4 Information Technology 11.9 13.6 11.9 11.9 118.5 7.6 13.2 33.3 15.4 12.4 27 3 11 Health Care 0.8 0.5 0.5 0.5 32.7 15.6 13.8 14.3 17.6 19.9 0 0 1 EM 100 100.0 100.0 100.0 30.6 17.2 14.0 19.9 17.5 14.8 100 100 100 Source: IBES, Datastream, J.P. Morgan calculation. Note: Sorted by 2011e earnings growth contribution.

Countries’ sub-industry contributing 70% of EM earning growth Country Sub-Industry Mkt Cap Earnings weights (%) Index EPS Growth Median EPS Growth Contribution to Earning growth

(%) Weight 2010 2011 2012 2010 2011 2012 2010 2011 2012 2010 2011 2012

Brazil Steel 3.8 4.6 5.6 5.5 107 42.0 11.7 47.7 41.1 13.9 10 11 5 Russia Integrated Oil & Gas 2.9 7.4 7.3 7.2 24.6 15.6 13.2 17.4 4.1 11.5 6 7 7 China Diversified Banks 4.5 5.1 5.1 5.4 22.1 17.5 20.2 25.0 17.4 17.8 4 5 7 Russia Diversified Banks 1.0 0.8 1.3 1.3 456 95.0 15.4 456 95.0 15.4 3 4 1 Brazil Diversified Banks 3.7 3.6 3.6 3.7 17.8 19.1 15.0 23.8 17.1 14.9 2 4 4 Korea Diversified Banks 1.2 1.5 1.9 1.9 77.8 43.6 16.8 65.2 15.0 11.8 3 4 2 South Africa Gold 0.9 0.5 0.7 0.7 (377) 82.8 6.1 (3.7) 79.1 17.8 3 2 0 Taiwan Electronic Components 0.9 0.6 0.8 0.9 (202) 61.0 36.7 46.4 24.2 13.7 4 2 2 Korea Electric Utilities 0.2 (0.1) 0.2 0.3 623 (437) 40.7 NM NM 40.7 (0) 2 1 Russia Div. Metals & Mining 0.4 0.4 0.6 1.0 NA 84.6 84.7 NM 84.6 84.7 0 2 4 Brazil Homebuilding 0.5 0.7 0.8 0.9 52.1 37.8 22.6 64.6 35.2 23.8 1 1 1 Mexico Wireless Telecom 1.5 1.5 1.5 1.4 18.0 14.3 12.5 18.0 14.3 12.5 1 1 1 Mexico Construction Materials 0.2 (0.2) 0.0 0.0 (194) (120) 100.0 NM NM 100.0 (1) 1 0 S Africa Wireless Telecom 0.9 1.0 1.0 1.0 23.2 20.0 13.0 23.3 15.8 9.0 1 1 1 Russia Oil & Gas E&P 0.4 0.9 0.9 0.9 8.7 21.1 7.6 8.7 21.1 7.6 0 1 0 China Life & Health Insurance 1.6 0.8 0.8 0.9 9.8 24.2 24.1 13.6 25.4 24.7 0 1 1 Taiwan Electronic Mftg Services 0.9 0.8 0.9 0.9 27.5 21.8 18.8 4.2 18.5 18.8 1 1 1 South Africa Diversified Banks 0.7 0.8 0.9 0.9 14.4 21.9 23.0 11.0 20.2 24.2 0 1 1 Taiwan Diversified Banks 0.8 0.7 0.8 0.7 63.4 25.0 2.2 34.0 25.0 0.0 1 1 0 S Africa Precious Metals 0.6 0.4 0.5 0.5 43.1 48.3 22.1 16.7 41.2 26.3 0 1 1 India Diversified Banks 1.3 0.7 0.7 0.8 18.4 23.0 23.6 19.7 22.9 23.7 0 1 1 India Steel 0.5 0.5 0.5 0.6 56.3 33.3 19.9 11.7 20.0 21.9 1 1 1 China Real Estate Development 0.9 0.9 0.9 0.9 18.9 17.2 25.6 22.8 19.4 24.3 1 1 2 Russia Steel 0.3 0.2 0.3 0.4 (571) 61.7 29.2 504 55.5 29.3 1 1 1 South Africa Int Oil & Gas 0.7 0.9 0.9 0.9 15.4 17.2 20.5 15.4 17.2 20.5 0 1 1 China Oil & Gas E&P 1.2 1.1 1.1 1.0 71.9 12.8 6.4 74.1 22.5 15.1 2 1 0 Korea Construction & Eng. 0.6 0.5 0.5 0.6 67.9 28.8 16.1 29.9 13.8 18.1 1 1 1 Poland Diversified Banks 0.7 0.5 0.5 0.6 24.0 29.0 19.4 25.8 28.2 18.5 0 1 1 India It Consulting & Other svs 1.3 0.7 0.7 0.8 12.3 19.1 19.8 11.2 18.5 20.7 0 1 1 Mexico Div Metals & Mining 0.3 0.3 0.4 0.4 52.8 45.5 18.8 52.8 45.5 18.8 0 1 0 Indonesia Coal & Consumable 0.3 0.2 0.3 0.3 20.0 58.0 1.9 (10.3) 52.3 1.2 0 1 0 India Oil & Gas R&M 0.9 0.7 0.7 0.7 16.9 19.0 14.0 22.2 17.4 10.5 0 1 1 Korea Steel 0.9 1.4 1.3 1.2 24.3 9.1 9.2 34.3 7.0 8.3 1 1 1 Thailand Diversified Banks 0.6 0.6 0.6 0.6 19.9 21.0 14.5 19.9 25.9 14.7 0 1 1 Korea Auto Manufacturers 1.0 1.4 1.3 1.2 55.1 8.7 7.3 50.5 9.7 7.0 2 1 1 Colombia Diversified Banks 0.2 0.2 0.2 0.2 36.9 66.3 (8.2) 36.9 66.3 (8.2) 0 1 (0) China Coal & Consumable Fuels 0.9 0.8 0.7 0.7 35.0 14.5 13.7 45.1 13.7 11.8 1 1 1 Russia Wireless Telecom 0.4 0.4 0.4 0.5 132.6 27.5 20.0 25.0 35.6 29.3 1 1 1 Taiwan Communications Equip 0.5 0.4 0.4 0.4 66.7 29.0 11.9 19.2 47.7 (13.8) 1 1 0 Brazil Packaged Foods & Meats 0.3 0.2 0.2 0.3 81.9 61.5 35.9 223.1 46.2 41.4 0 1 1

Source: IBES, Datastream, J.P. Morgan calculation. Note: Sorted by 2011 earning growth contribution.


28


Risks to our strategy Market risks Lack of valuation cushion Our strategy is biased toward growth with good momentum but at a valuation premium. A growth premium is justified in a world where growth is in short supply. High valuations are vulnerable to a reversal in EM portfolio flows and stock-specific risk.

Bond market volatility The Fed’s objective with QE2 is to lower bond yields. The result is that bonds are expensive relative to J.P. Morgan’s growth forecasts. Higher US growth could lead to a spike in bond yields.

High correlation High correlation between risk assets may propagate volatility. A counter-trend rally in the US dollar may drive that volatility.

Policy and Political risks Capital controls Strong foreign inflows and continued FX appreciation have prompted EM central banks to implement capital control measures. These include: 1) Increase in IOF tax on foreign purchase of fixed income instruments from 2% to 6% in Brazil; 2) One-month minimum holding period restriction on SBI bonds in Indonesia; 3) 15% withholding tax on foreign bond holders in Thailand; 4) Restrictions on forward currency positions of foreign bank branches and local banks in South Korea. For equity investors, controls designed to reduce the effective carry in fixed income markets are ok. Broader capital controls which reduce the ability of equity investors to buy and sell would be negative as they reduce liquidity and increase volatility.

Anti-asset inflation policies Central banks are targeting asset prices in EM to counter asset inflation. These policies introduce economic and sector-specific risks. Note how poorly real estate stocks have performed in EM despite low interest rates.

Trade wars High US unemployment, China’s large current account surplus and polarized politics in the US increase the risk of a trade war.

Politics: Elections and change of leadership in Brazil and China Leadership change in China will occur in 2012. The transition may result in confusion on policy. Brazil’s new president needs to maintain reform momentum and develop infrastructure.

2011 election calendar Jan Feb Mar Apr

Peru Presidential & Legislative

May Jun Vietnam Presidential Turkey Parliamentary

Jul Aug Philippines Subnational - Legislative

Sep Oct Argentina Presidential Poland Parliamentary

Nov Dec Russia Parliamentary Thailand Parliamentary (Tentative)

Source: IFES.

EM CPI and earnings yield

3456789

101112

Jan-02 Jun-03 Nov -04 Apr-06 Sep-07 Feb-09 Jul-10

3

6

9

12

15

EM central banks' av erage target range ceiling

EM CPI %oy a(LHS)

MSCI EM 12m Fw d PE(RHS inv erted)

Source: J.P. Morgan economics, IBES, MSCI, November 2010. Note: CPI data is to August 2010.

Strained social contract Political and regulatory risk is high. The corporate sector has emerged from the global recession and credit crunch stronger than the households. Note that profits as a share of GDP are near cyclical highs but unemployment is 10%. Policy makers constrained by high fiscal deficits are likely to redress this imbalance through higher taxes and increased regulation. This would add to business costs and delay normal investment decisions, threatening the recovery.


29


As is the case in the US, Chinese corporate share of GDP increased while the household share decreased. Labor disputes and subsequent large pay increases may start to reverse this trend. This rebalancing is healthy and should move China to a more sustainable growth model. But near term the result is likely lower profit margins.

Economic risks Uncertain outlook for commodities Our commodities and energy underweight is driven by a combination of long-term economic cycles and a potential inflection point in the growth of Chinese material demand. The timing is complicated by the large influence of financial investors on commodity markets. The timing risk in a bearish view on commodity companies is high. Industrial metal prices rallied since May while global leading indicators fell. Correlation of commodities to risk assets (equities) is high today. Momentum in a world of zero interest rates is an attractive attribute. An UW commodity call is unlikely to work at this point. When it does eventually, the correction may prove to be violent as financial investors exit.

Unintended consequences of QE2 If QE2 results in a sharp increase in commodity prices it may choke off growth and ultimately be counterproductive.

Peripheral Europe sovereign stress Greek, Irish and Portuguese bond spreads to German bunds are at record highs. Sovereign stress could disrupt risk appetite as it did in 2Q10.

US state and municipal stress US states and municipalities are required to balance their budgets. The result may be rising unemployment as US local government downsizes. This would place a larger burden on the private sector to create jobs.

Strained social contract: US profit share and unemployment

810121416182022

70 75 80 85 90 95 00 05 10

0

3

6

9

12

% sa

Unemploy ment rate (inv erted)

Profit share

Source: J.P. Morgan. Note: Chart shows % share of gross value added, J.P. Morgan forecast for 2010.

Shares outstanding in commodity ETF

30000

60000

90000

120000

150000

180000

210000

Dec-07 May -08 Oct-08 Mar-09 Aug-09 Jan-10 Jun-10 Nov -10

Source: Bloomberg, DBCSO Index.

Peripheral stress in Europe

0

12

3

4

56

7

Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 100

2

4

6

8

10Greece (RHS)

Ireland (LHS)

Source: Bloomberg Note: Spread of Greek and Irish 10-year bond yields to German bunds.


30


Brazil Strategy Key country dynamics Domestic growth and China’s demand for commodities are the main drivers for Brazil in 2011, together with a clearer definition of policies to be adopted by the newly elected government. The exchange rate is an important focus, with capital control risks on the rise.

Growth characteristics and how they are changing Credit growth at around 20% combined with the best labor market in a generation provides for a sturdy outlook for consumption in 2011. We forecast GDP of 4.5% in 2011, on top of 7.5% in 2010e. Strong growth is adding to inflation risks, and we expect a rise in interest rates in 2011. Although GDP is little influenced by commodities (exports = 11%), Brazil’s two largest companies are commodity driven. Over the next few years, investment (under 18% of GDP) will need to rise to meet the country’s need for more capacity and infrastructure. This would also allow for faster sustainable growth in the years to come.

Drivers of returns – Multiples and growth Valuation is not an impediment to Brazil’s performance. The country is trading in line with the five-year average, with commodities cheaper than domestics but with the latter likely delivering more growth in the short/medium run. Flows are key for performance and are catching up in 4Q 2010 after being lackluster most of the year. With major hurdles behind (large capitalizations, elections) and DM prospects of a muddle-through, inflows into Brazilian equities are likely to be boosted in 2011.

Recommendations We recommend exposure to domestic names and are focused on financials and homebuilders. Although we like discretionary, we feel that there are better entry points considering the strong performance of late. In financials, Bradesco is our top pick, a blue chip, large cap bank that can better withstand the rise in interest rates as about 30% of its business is insurance. In homebuilders, we like PDG: the stock is cheaper than peers’, benefits from the Agre acquisition are not fully priced, the company is fully exposed to the high-growth lower-income segment. On the commodity side, we likeVale: it is cheap, with risks mostly priced in already, while China appears to be rebounding. In the oil and gas sector, we recommend OGX as the better vehicle to get exposure to offshore as more of the company’s findings are turning into reserves.

Emy Shayo Cherman AC

(5511) 3048-6684 [email protected] Banco J.P. Morgan S.A.

Bloomberg JPMA SHAYO <GO>

Household consumption rising above GDP (4Q/4Q rolling average)

-1.0%0.0%1.0%2.0%3.0%4.0%5.0%6.0%7.0%8.0%

1Q-03 1Q-04 1Q-05 1Q-06 1Q-07 1Q-08 1Q-09 1Q-10

GDP Household Consumption

Source: IBGE.

Unemployment rate (%)

6

7

8

9

10

11

Jan-

06

Jul-0

6

Jan-

07

Jul-0

7

Jan-

08

Jul-0

8

Jan-

09

Jul-0

9

Jan-

10

Jul-1

0

Source: IBGE.

BRL (rh, inverted scale) versus BZ Commodity Export Index (lh)

150

200

250

300

350

400

450

500

2/4/05 9/2/05 3/31/06 10/27/06 5/25/07 12/21/07 7/18/08 2/13/09 9/11/09 4/9/10

1.51.61.71.81.92.02.12.22.32.42.5

BZ Commodity Index

BRL

Source: Bloomberg; J.P. Morgan.

Foreign Net Inflows into Brazilian Equities (secondary) R$bi

-1.09

2.211.65

4.04

1.14 0.930.51

-2.10-1.25

3.15

-1.08-1.51

-0.15

3.51

-0.60

3.14

1.60

-3-2

-101

23

45

Jun-

09

Jul-0

9

Aug-

09

Sep-

09

Oct-0

9

Nov-

09

Dec-

09

Jan-

10

Feb-

10

Mar

-10

Apr-1

0

May

-10

Jun-

10

Jul-1

0

Aug-

10

Sep-

10

Oct-1

0

YTD 2010 = R$4.7 biYTD 2009 = R$19.2 bi

Source: BM&FBovespa; Bloomberg.


31


Top picks and stocks to avoid Mkt cap P/E (x) EPS Div. yield ROE Price Code Rating (US$MM) 10E 11E 10E 11E 11E (%) 11E (%) Top picks Bradesco 34.8 BBDC4 OW 73,018 13.5 12.1 2.59 2.88 2.9% 21.2% PDG Realty 10.6 PDGR3 OW 7,144 14.5 9.4 0.73 1.13 1.7% 19.2% VALE 31.8 VALE OW 173,421 10.9 7.7 2.92 4.13 2.9% 23.3% OGX 21.7 OGXP3 OW 42,952 nm nm 0.06 0.02 0.0% 0.6% Stocks to avoid Usiminas 21.0 USIM5 UW 14,775 20.5 11.1 1.02 1.88 3.1% 8.8% Eletropaulo 29.9 ELPL6 UW 3,229 4.8 8.4 6.29 3.54 13.8% 18.0% Tele Norte Leste 48.5 TMAR5 N 7,699 nm nm 8.60 7.21 8.9% 14.9% Source: Bloomberg, J.P. Morgan estimates. Note: Share prices and valuations are as of October 28, 2010.

MSCI Brazil absolute and Relative to EMF Index

0

200

400

600

800

1000

1200

1400

Dec-02 Mar-04 May -05 Aug-06 Oct-07 Jan-09 Mar-10

Absolute Relativ e to MSCI EMF Index

Source: MSCI, Datastream.

MSCI fair value range

(135082)

(119256)

(124074)

(212792)

(196127) (326196)

(89127) (277670)

(273109)(445307)

(339385)

(211296)

50000 150000 250000 350000 450000

FWD PE

PE

PB

DY

BY/EY

BY/DY

Source: MSCI, IBES, Datastream, J.P. Morgan.

Currency outlook (BRL/USD)

1.4

1.6

1.8

2.0

2.2

2.4

2.6

2.8

3.0

Dec 04 Apr 06 Jul 07 Nov 08 Feb 10 Jun 11

Consensus

J.P. Morgan

J.P. Morgan forecast:end Dec 10: 1.70end Mar 11 : 1.80end Jun 11: 1.82


MSCI EPS integer over time

80

90

100

110

120

130

140

150

Feb-09 Jul-09 Dec-09 May -10 Oct-10

2010

2011



32


Mexico Strategy Key country dynamics The key constraints on Mexican equities are structurally lower US GDP growth and a lackluster Mexican consumer rebound. This is offset by a cheap currency, easy monetary policy, a gradual reacceleration of US economic growth – at least into mid-2011 – and a high market correlation with US equities. Additionally, we view some concerns as currently overdone – such as the fiscal situation (oil production has stabilized) and security environment (violence localized) – whilst others are not – such as Mexico’s declining equity market relevance on lack of issuance.

Growth characteristics and how they are changing Mexican GDP growth is set to slow next year (to 3.5% from an estimated 4.5% in 2010), along with the US (2.7% GDP growth to 2.5% in 2011e). Manufacturing and IP, which led the sharp growth recovery from the -6.5% seen in 2009, should slow and domestic demand increasingly come to the fore. Consensus MSCI Mexico earnings growth could be at risk, with expectations for 18% growth versus only 12% this year. Growth is expected to be led by staples and materials.

Drivers of returns – Multiples and growth Mexico is trading at the high end of traditional valuation ranges, and we do not see room for significant multiple expansion. The valuation premiums to other markets are lower than they seem, often just reflecting Mexico’s high staples and telecom index composition. Whilst the traditional drivers of Mexican outperformance – 1) significant market weakness, 2) strong US macro surprise, 3) strong Mexico consumer recovery – look absent to us in 2011, we do expect respectable absolute performance. Local investors remain underweight the market and are seeing robust inflows. Foreign investors remain moderately overweight.

Recommendations Our strategy focus is on stocks exposed to the strengthening domestic demand environment at reasonable valuations. We also like a number of special situations exposed to recovering infrastructure segments. We would avoid very defensive staples with high valuations and low gearing to the strengthening consumer.

Ben Laidler AC


Bloomberg JPMA LAIDLER <GO>

Contributions to GDP growth, 2008-2011e


Mexico 12 mth fwd PE

7.00

9.00

11.00

13.00

15.00

17.00

95 97 98 99 00 01 02 03 04 05 06 07 08 10

Mex ico Av erage +1SD -1SD

Source: MSCI, IBES, Datatsream.

Mexico consumer confidence and formal employment

Source: J.P. Morgan Economics, INEGI, IMSS.


33


Top picks and stocks to avoid Mkt cap P/E (x) EPS Div. yield ROE Price Code Rating (US$MM) 10E 11E 10E 11E 11E (%) 11E (%) Top picks America Movil 57.1 AMX OW 119,244 15.8 13.4 44.98 52.72 0.7% 26.1% Cemex 8.8 CX OW 9,800 nm nm -0.16 0.02 0.0% 0.1% Grupo Televisa 22.2 TV OW 13,699 22.0 17.2 12.54 16.02 1.4% 23.0% ICA 32.5 ICA* OW 1,781 30.4 22.0 1.07 1.48 0.0% 4.9% First Cash Financial 29.4 FCFS OW 913 17.1 14.6 1.72 2.01 0.0% 17.9% Stocks to avoid Telmex 15.2 TMX UW 14,410 12.7 13.2 18.51 17.30 5.0% 37.0% Grupo Inbursa 53.9 GFINBURO UW 14,247 25.3 21.0 2.13 2.57 1.4% 12.2% Consorcio Ara 7.6 ARA* UW 829 11.5 9.9 0.66 0.77 1.3% 10.1% Source: Bloomberg, J.P. Morgan estimates. Note: Share prices and valuations are as of October 28, 2010.

MSCI Mexico absolute and relative to EMF Index

050

100150200250300350400450500





(196457)

(20184)

(14776)

(24866)

(25349)

(17980) (22590)

(29973)

(25937)

(125613)

(41784)

(33101)

0 50000 100000 150000 200000 250000

FWD PER

PER

PBR

DY

BY/EY

BY/DY


Currency outlook (MXN/USD)

9.0

10.0

11.0

12.0

13.0

14.0

15.0

16.0


J.P. Morgan

Consensus

J.P. Morgan forecast:end Dec 10: 12.50end Mar 11: 12.50end Jun 11: 12.25



70

75

80

85

90

95

100

105


2010

2011



34


Chile Strategy Key country dynamics Chile will look to build on the momentum of an historic 2010, which saw the inauguration of center-right Piñera (after 20 years of the center-left Concertacion), an 8.8-magnitude earthquake (5th largest in history), World Cup success (advancing to the round of 16), the country’s 200-year anniversary and the unprecedented extraction of 33 miners trapped underground for 68 days. Confidence is running high, and the country appears to be entering a period of renewal, which could accelerate the path to developed country status (possibly by the end of the decade). However, with expectations mounting, there is room for disappointment, especially if social/political differences get in the way of progress.

Growth characteristics and how they are changing For the first time in recent years, Chile is expected to lead regional growth in the coming year on the back of an aggressive Piñera pro-growth agenda, accelerated by ongoing earthquake reconstruction efforts. This should be further helped by supportive demand dynamics out of China and expansionary fiscal policies (benchmark rate not likely to surpass 4.25% – lowest YE11e level in the region), not to mention micro-level incentives for investment by both locals and foreigners.

Drivers of returns – Multiples and growth The top-down scenario remains attractive, but valuations are lofty at nearly 18x forward P/E, representing a 50% premium to LatAm, which is just ahead of historical levels (despite recent factors that are working to close the spread – such as the move to IFRS and regional expansion). As the Chile premium suggests, performance is largely tied to supportive domestic flows (and limited foreign ownership). This support was strong in 2010 given weakness elsewhere. In the event that key markets, such as Brazil, China and the US, perform well in 2011 (especially relative to domestic fixed income), this will likely limit domestic flows, specifically from pension funds, which may be forced to trim domestic equity positions to remain within their limits.

Recommendations Although we like the Chile growth profile, we focus on names that are expanding abroad (Falabella, CCU). We also find copper play Antofagasta at an attractive valuation with significant growth potential. We avoid utility IAM, given strong relative outperformance in the utilities sector and potential Aguas Andinas share sale overhang. We also see limited upside after the speculative rise in SQM’s share price.

Brian P. Chase AC

56 2 425 5245 [email protected] Inversiones y Asesorias Chase Manhattan Ltda.

Bloomberg JPMA CHASE <GO>

Business and consumer confidence returning to historical highs

2535455565

J-06 S-06 M-07 J-08 S-08 M-09 J-10 S-10

Bus Conf Cons Conf

Source: Adimark and ICARE.

Chile GDP growth (oya) catching back up to EM standards

-2%

3%

8%

13%

85 87 89 91 93 95 97 99 01 03 05 07 09 11E

EM Chile

Source: World Bank and J.P. Morgan.

Chile fwd P/E premium to LatAm at historical levels

0.60.91.21.51.82.12.4

94 96 97 98 99 00 01 02 03 04 05 06 07 09 10

Source: Datastream and J.P. Morgan.

Chile fwd P/E premium to EM vs. AFP % ownership of free float (RHS)

0.51.01.52.02.5

Feb-97 Jul-99 Dec-01 May -04 Oct-06 Mar-090%

20%

40%

60%Premium to EM % of Free Float

Source: Datastream, SAFP and J.P. Morgan.


35


Top picks and stocks to avoid Mkt cap P/E (x) EPS Div. yield ROE Price Code Rating (US$MM) 10E 11E 10E 11E 11E (%) 11E (%) Top picks Falabella 4849.5 FALAB N 24,106 38.5 31.4 125.92 154.40 0.8 13.0 CCU 56.1 CCU OW 3,647 15.1 13.7 3.70 4.08 4.5 21.6 Antofagasta Minerals 1326.0 ANTO OW 22,744 16.5 11.4 80.30 116.50 0.5 116.5 Stocks to avoid IAM 747.0 IAM N 15,735 1,558 16.1 16.1 46.36 46.36 5.9 SQM 51.5 SQM N 13,873 43.6 30.4 1.18 1.69 0.0 24.6 Source: Bloomberg, J.P. Morgan estimates. Note: Share prices and valuations are as of October 28, 2010.

MSCI Chile absolute and relative to EMF Index

0

100

200

300

400

500

600

700





(4293)

(4068)

(2181)

(4723)(2906)

(5772)

(6797)

(3979)

1000 2000 3000 4000 5000 6000 7000

FWD PER

PER

PBR

DY

BY/EY

BY/DY


Currency outlook (CLP/USD)

400

450

500

550

600

650

700

750

800


Consensus

J.P. Morgan forecast:end Dec 10: 480end Mar 11: 505end Jun 11: 500



75

85

95

105

115

125

135


2010

2011



36


Colombia Strategy Key country dynamics The long-term structural rerating story continues in 2011 with the implementation of a new pension multifund system and potential advancements in tax/fiscal reform, which will likely result in investment grade. This should continue to drive investment growth in the country. We are also likely to see improvements on the trade front, including restored relations with Venezuela and numerous pending trade agreements. With key FARC leaders out of the picture, Colombia will move a step closer to peace, which could yield additional dividends. We see the key risk as reform watered down in order to maintain political consensus.

Growth characteristics and how they are changing Despite the structural improvements and macro-level progress, which is boosting investment, Colombia still faces challenges in achieving its full growth potential (JPM 2011e GDP growth at just 4.1%), primarily on the private consumption side. We believe this represents an opportunity for the Santos Administration, but major progress will take time, requiring a combination of job creation and investment diversity initiatives (via payroll tax reform and education/innovation programs). We also see access to credit as a key theme, with current caps limiting expansion in the lower-income segments (as well as for SMEs).

Drivers of returns – Multiples and growth Colombia shares a similar dynamic with Chile, as supportive domestic flows (and limited foreign ownership) help prop up valuations (current premium well ahead of historical averages). This is furthered by local accounting rules and complicated cross-holding structures, not to mention hidden assets. While growth fundamentals may not justify current valuations, we see flow support continuing in 2011 on the back of the multifund switch and Andean stock exchange integration, which should keep valuations riding high.

Recommendations We focus on selective growth opportunities at reasonable valuations (Pacific Rubiales, Millicom) and second-tier-liquidity stocks that have lagged this year (Exito) but could benefit from supportive domestic/regional flows. We avoid the large/liquid names that have led 2010 outperformance (Bancolombia, Ecopetrol), especially as flows may be redirected to second tier names and a series of new listings.

Brian P. Chase AC



Investment growth driving internal demand recovery

-20.0-10.0

0.010.020.030.0

1Q08 3Q08 1Q09 3Q09 1Q10

Internal DemandInv estmentConsumption

Source: BanRep.

Exports likely to continue their gradual recovery

-50%

0%

50%

100%

Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10

Import Grow th Ex port Grow th

Source: BanRep.

Colombia fwd P/E premium to LatAm above historical averages

0.00.51.01.52.02.53.03.5

94 96 97 98 99 00 01 02 03 04 05 06 07 09 10

Source: Datastream, Superfinanciera and J.P. Morgan.

Pension fund equity exposure to rise on multifunds / demographics Estimated End-2010

AUM Equity % Limit % Cushion %1 0.0 0.0 NM 0.0 20.0% 0.0 NM2 90.6 39.4 43.5% 40.8 45.0% (1.4) -1.5%3 0.0 0.0 NM 0.0 70.0% 0.0 NM

Total 90.6 39.4 43.5% 40.8 45.0% (1.4) -1.5%

Pro Forma 2011AUM Equity % Limit % Cushion %

1 4.5 0.9 20.0% 0.9 20.0% 0.0 0.0%2 53.4 24.0 45.0% 24.0 45.0% 0.0 0.0%3 32.6 22.8 70.0% 22.8 70.0% 0.0 0.0%

Total 90.6 47.8 52.8% 47.8 52.8% 0.0 0.0%

Source: Superfinanciera and J.P. Morgan estimates.


37


Top picks and stocks to avoid Mkt cap P/E (x) EPS Div. yield ROE Price Code Rating (US$MM) 10E 11E 10E 11E 11E (%) 11E (%) Top picks Pacific Rubiales 31.7 PRE OW 9,070 35.2 13.0 0.90 2.43 0% 34.1% Almacenes Exito 23080.0 EXITO N 4,520 55.5 42.8 415.58 539.80 0% 4.3% Millicom 94.7 MICC OW 10,460 14.2 11.8 6.69 8.00 7.3% 26.1% Stocks to avoid Bancolombia 66.0 CIB UW 13,419 20.0 17.9 3.30 3.68 1.8% 18.4% Ecopetrol 4360.0 ECOPETL UW 102,932 22.1 14.9 197.47 292.19 3.3% 34.5% Source: Bloomberg, J.P. Morgan estimates. Note: Share prices and valuations are as of October 28, 2010.

MSCI Colombia absolute and relative to EMF Index

0200400600800

100012001400160018002000





(536)

(1024)

(897)

(949)

(2178)

(3357)

(2693)

(2725)

0 500 1000 1500 2000 2500 3000 3500

FWD PER

PER

PBR

DY


Currency outlook (COP/USD)

1,600

1,800

2,000

2,200

2,400

2,600

2,800

3,000


J.P. Morgan


Consensus



50

80

110

140

170

200


2010

2011



38


Peru Strategy Key country dynamics 1H11 will be dominated by the run-up to April presidential elections. Although we saw political overhang in 1H10, it has since started to dissipate as leftist candidate Humala is running 4th. The three currently leading candidates are all center-right, suggesting that it is unlikely we will see any meaningful changes to Peru’s market-oriented macroeconomic policy. We believe this will help cement the current economic consensus in the country. However, given Peru’s history of surprises on election day, we don’t rule out intensified noise and/or a renewed overhang leading up to the elections, especially considering that most polls don’t include rural areas, which tend to favor Humala. In addition, the emergence of Keiko Fujimori as the leading contender could reignite some historical social/political polemics.

Growth characteristics and how they are changing After a return to Asia-level GDP growth in 2010 (JPMe GDP growth of 8.2%), we expect growth to taper off to 6% in 2011, mainly due to a pullback in stimulus and tighter monetary policy. However, with tame inflation, strong commodity prices, growing credit growh and the CB on hold, there is room for upside surprises. In addition, given strong economic ties to China, progress there will be a key determinant of the extent of growth.

Drivers of returns – Multiples and growth Valuation premiums are a bit ahead of historical levels. However, they are still lower than other Andean peers’, primarily due to commodity exposure and liquid gaps (index top and bottom heavy). We believe that scarcity value in the liquid names (BAP, BVN, SCCO) is relevant and if polling data continue to suggest political continuity, it is likely to boost these names and possibly widen the premiums. We also see Peru as a beneficiary of Andean stock exchange integration, as domestic investors in Chile and Colombia look to diversify away from their home markets.

Recommendations We focus on playing continued strong domestic growth and potentially positive election results through the only liquid domestic proxy, leading bank Credicorp. We also play precious metal momentum and our generally bullish stance on silver through Silver Wheaton. We avoid Buenaventura given strong outperformance recently, but acknowledge its reserve replacement track record and scarcity value as a liquid Peruvian name.

Brian P. Chase AC



Poll figures have not changed much in past 15 months

0%

10%

20%

30%

Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10

Fujimori Castaneda Toledo Humala

Source: Ipsos-Apoyo.

Humala well behind in run-off scenarios 51% 51%

28% 29%

0%

20%

40%

60%

Scenario 1 Scenario 2

FujimoriHumalaCastaneda

Source: Ipsos-Apoyo.

Recovery thus far led by investment

-20.0

0.0

20.0

40.0

1Q06 3Q06 1Q07 3Q07 1Q08 3Q08 1Q09 3Q09 1Q10

Internal Demand Inv estmentConsumption

Source: BCRP.

Peru fwd P/E premium ahead of historical averages

0.00.51.01.52.02.5

06 07 08 09 10

Source: Datastream and J.P. Morgan.


39


Top picks and stocks to avoid Mkt cap P/E (x) EPS Div. yield ROE Price Code Rating (US$MM) 10E 11E 10E 11E 11E (%) 11E (%) Top picks Credicorp 124.7 BAP N 10,099 17.2 15.2 7.23 8.20 1.7% 22.1% Silver Wheaton 27.6 SLW OW 11,374 38.3 21.0 0.72 1.31 0% 18.5% Stocks to avoid Buenaventura 51.7 BVN N 14,939 19.8 14.6 2.61 3.55 0.9% 26.5% Source: Bloomberg, J.P. Morgan estimates. Note: Share prices and valuations are as of October 28, 2010.

MSCI Peru absolute and relative to EMF Index

0

200

400

600

800

1000

1200





(634)

(1764)

(970)

(751)

(2635)

(3495)

(2285)

(3026)

0 500 1000 1500 2000 2500 3000 3500 4000 4500

FWD PER

PER

PBR

DY


Currency outlook (PEN/USD)

2.5

2.7

2.9

3.1

3.3

3.5


J.P. Morgan

Consensus


Source Bloomberg, J.P. Morgan.


70

90

110

130

150

170


2010

2011



40


Argentina Strategy Key country dynamics All eyes will be on the political situation in 2011 ahead of October presidential elections. The outlook is highly uncertain as most candidates will likely have to reinvent themselves after the death of ex-President Nestor Kirchner. We see this as a potential opportunity for Cristina Fernandez Kirchner and Peronist dissidents (PJ) to unite, while key opposition groups (PRO and Radicals) now face the challenge of adjusting their campaign from a primarily anti-Kirchner stance to a more progressive form. We take a cautious stance and see a Peronist win as the base case but acknowledge that any move toward political/economic orthodoxy and subsequent reform would be a big catalyst for the market.

Growth characteristics and how they are changing After accelerated growth in 2010 (JPMe GDP growth 8.5%), growth in 2011 will taper off (JPMe GDP growth 5.5%) as activity is curbed by rapidly rising inflation (JPMe proxy 25-30%). The use of fiscal resources should remain strong, especially in an election year and helped by what we expect to be robust agricultural commodity prices. Risks to growth (upside and downside) are largely tied to the global economy.

Drivers of returns – Multiples and growth With the near-term “spread reduction trade” priced and the longer-term “election trade” accelerated on the death of Nestor Kirchner, we believe multiples are for the most part accurately reflecting the current balance of risks. We only see an opportunity for significant further multiple expansion in the event of a more orthodox political and economic environment, backed by a reform agenda. Although there is growing optimism for a move in that direction, we believe it is still too early to tell who will win in 2011 and whether or not a reform agenda can and will be implemented. Furthermore, while the focus is on politics, at the micro level we are likely to see slower growth and inflation thinning margins.

Recommendations We focus on names with solid growth prospects in the coming year at attractive valuations that will likely benefit from the immediate political situation (Clarin and Tenaris). We avoid utilities, such as Edenor, which face an uncertain potential reform agenda. That said, the shares are likely to move on any signs of political progress.

Brian P. Chase AC



Can Cristina maintain her currently positive image?

0.0%

20.0%

40.0%

60.0%

J-08 M-08 S-08 J-09 M-09 S-09 J-10 M-10 S-10


Voting intentions suggest the 2011 race is wide open

39%

6% 6% 5% 4% 3% 3% 2% 4%

25%

0%

10%

20%

30%

40%

50%

CFKCobo

s

Alfonsin

Macri

De Narv

aezDuha

ldeScio

li

Reutem

ann Other

Undecid

ed


Inflationary pressures starting to rise

0.00

10.0020.00

30.00

J-04 S-04 M-05 J-06 S-06 M-07 J-08 S-08 M-09 J-10 S-10

Indec Priv ate

Source: Indec and J.P. Morgan.


41


Top picks and stocks to avoid Mkt cap P/E (x) EPS Div. yield ROE Price Code Rating (US$MM) 10E 11E 10E 11E 11E (%) 11E (%) Top picks Grupo Clarin 10.0 GCLA OW 1,437 3.4 2.5 2.92 4.00 0% 12.7% Tenaris 41.3 TS OW 26,237 20.1 16.0 2.06 2.59 0.9% 14.8% Stocks to avoid Edenor 10.3 EDN UW 494 13.3 12.2 0.77 0.84 0% 7.0% Source: Bloomberg, J.P. Morgan estimates. Note: Share prices and valuations are as of October 28, 2010.

MSCI Argentina absolute and relative to EMF Index

0100200300400500600700800900

1000





(15631857)

(64068241)

(4509706)

(21956168)

(13335147)

(66024799)

(50289622)

(33410334)

400000 15400000 30400000 45400000 60400000

FWD PER

PER

PBR

DY

`

Source: MSCI, IBES, Datastream, J.P. Morgan

Currency outlook (ARS/USD)

2.8

3.0

3.2

3.4

3.6

3.8

4.0

4.2

4.4

4.6


J.P Morgan


Consensus



50

60

70

80

90

100

110


2010

2011


42





Sectors


44


Agribusiness, Pulp and Paper Key country dynamics Grain prices seem to be well supported at current levels even after a 30-60% rally since early July. Robust Chinese demand along with concerns over supply, especially in light of a La Nina year, should keep risk premiums high. As J.P.Morgan’s Soft Commodity Strategy team highlights, there’s a real possibility of corn prices hitting $7/bu in ’11, which would reverberate through the rest of the grain complex. Sugar prices continue to confound, having gone from 30c/lb to 13c/lb and back again in the course of 2010, with the only constant volatility. Any shortfall in Indian and Brazilian production estimates could take sugar prices higher still. That being said, we believe any supply squeeze would be relatively temporary and see sugar prices settling at closer to 15-18c/lb longer term. We remain structural bulls on pulp but cautious on 12M outlook. Pulp prices as of October were already 5% below their June peak, and we expect another ~17% decline through 2011 as pulp supply recovers from market- and weather-related downtime in ’09-’10 and as end demand remains lackluster. That being said, any significant improvement in developed world employment should lead to improved paper demand and poses upside risk to our outlook.

Growth characteristics and how they are changing Growth in 2011 for our covered names will be more a function of commodity prices than of capacity expansions. Longer term, we see all of our companies as having a global cost advantage and expanding production through greenfields, debottlenecking and M&A.

Drivers of returns – Multiples and growth We are not expecting multiples rerating as we do not see structural changes justifying it. Multiples should continue to reflect cyclical trends (peak multiples on trough earnings and vice versa). Near-term growth will remain dependent on commodity prices.

Recommendations We highlight the Brazilian sugar and ethanol producer Sao Martinho (SMTO3/OW) as the best play on higher near-term sugar prices. We are UW on Fibria (FIBR3/FBR) as we believe pulp sector momentum will remain negative in ’11 and valuations are not yet attractive enough to justify owning at this point of the cycle.

Debbie Bobovnikova, CFA AC


Bloomberg JPMA BOBOVNIKOVA <GO>

Pulp inventories vs. prices

343434313232

3641

44485046504743

3534292827 2527

30282625272529

3432

2626

450

550

650

750

850

950

Jan-

08M

ar-0

8M

ay-0

8Ju

l-08

Sep-

08No

v-08

Jan-

09M

ar-0

9M

ay-0

9Ju

l-09

Sep-

09No

v-09

Jan-

10M

ar-1

0M

ay-1

0Ju

l-10

Sep-

10

20253035404550

Day s Inv entory (RHS) BEK, $/tonne to Europe

Source: PPPC, RISI, J.P. Morgan.

Sugar stock/use vs. prices, 00/01-10/11

05

10152025

00/01 02/03 04/05 06/07 08/09 10/11

0%

10%

20%

30%

40%

Price ($c/lb) Stock-to-Use (%)

Source: USDA, Bloomberg and J.P. Morgan.

Cotton stock/use vs. prices, 00/01-10/11

0255075

100

00/01 02/03 04/05 06/07 08/09 10/11

0%20%40%60%80%

Price ($/lb) Stock-to-Use (%)


Soy stock/use vs. prices, 00/01-10/11

0

5

10

15

00/01 02/03 04/05 06/07 08/09 10/11

0%

10%

20%

30%

Price ($/bu) Stock-to-Use (%)



45


Top picks and stocks to avoid Mkt cap P/E (x) EPS (R$) Div. yield ROE Price (R$) Code Rating (US$MM) 10E* 11E* 10E* 11E* 11E* (%) 11E* (%) Top picks Sao Martinho 23.00 SMTO3 OW 1,529 22 9 1.06 2.55 1.2% 11.6% Stocks to avoid Fibria 30.03 FIBR3 UW 8,266 17 97 1.76 0.31 0% 5% Source: Bloomberg, J.P. Morgan estimates. Note: SMTO3 share price and valuation are as of November 8, 2010. Note: * CY10E = SMTO FY11E, CY11E = SMTO FY12E. FIBR3 share price and valuation are as of October 28, 2010.

Paper and pulp absolute and relative to MSCI LatAm

050

100150200250300350400450500



Source: MSCI, Bloomberg, IBES, Datastream, J.P. Morgan.

Paper and pulp EPS integer

60

70

80

90

100

110

120

130

140


2010

2011


Paper and pulp 12 mth fwd PE

5

13

21

29

37

45

95 97 98 99 00 01 02 03 04 05 06 07 08 10

PE Av g +1SD -1SD


Paper and pulp trailing PB

0.5

0.8

1.1

1.4

1.7

2

95 97 98 99 00 01 02 03 04 05 06 07 08 10

PB Av g +1SD -1SD



46


Sao Martinho SMTO.SA www.saomartinho.ind.br

Overweight R$23.00 (08 Nov 10) Price Target: R$29 End Date: Dec 2011

Company description São Martinho is a top-five sugar and ethanol producer in Brazil. In the 2009/10 crop year, São Martinho crushed 13 mt of sugarcane, of which 65% was owned (40% came from third parties) and 40% was destined for sugar production (60% to ethanol). São Martinho operates 3 mills, 2 in São Paulo state and one in Goiás state. The company’s Goiás unit (Boa Vista mill) started up in the 2009 crop and will exclusively produce ethanol and electricity. São Martinho (SMTO3 BZ) shares are listed on Bovespa’s Novo Mercado.

Investment case We see Sao Martinho as the best way to gain exposure to stronger global sugar and Brazilian ethanol prices. Given the diversification of the rest of its listed domestic peers, SMTO is now the most exposed operationally to S&E. In addition, we believe the company has interesting partnerships with both Petrobras (rated Neutral by JPM LatAm oil & gas analyst Sergio Torres) and with biotech producers, the latter potentially leading to new revenue streams.

Potential for earnings upgrades Given the sharp rally in sugar and ethanol prices since midyear, there should be significant upside to consensus estimates if it is sustained. Our FY11E EBITDA of R$493m is 8% above consensus.

Prospects for re-/derating We see Sao Martinho as a well-managed company, with good capital discipline and corporate governance. On the other hand, lack of share liquidity is a concern for many investors, as is the volatility of the sector, which we do not foresee changing in the near term. Hence we are not looking for a rerating.

Price target and risks We have an OW rating on SMTO3 and a price target of R$29/sh for Dec.’11 based on a mix of: (1) DCF of R$27.5 using normalized sugar prices of 15c/lb and BRL of R$2.05 (equivalent to sugar prices of 18c/lb at spot BRL) and a WACC of 9.3% which incorporates a risk premium for lower share liquidity; (2) 5x multiple on FY12 EBITDA resulting in R$28.3; (3) replacement value analysis leading to R$27.1; and (4) recent M&A multiples of $100/tonne implying FV of R$36.1. Key risks to our rating and estimates on SMTO are: (1) evolution of sugar and ethanol prices; (2) stronger-than-expected BRL; (3) operational problems; (4) worse-than-expected economics of farnesene JV.

Brazil Agribusiness Debbie Bobovnikova AC




Price performance R$

12

16

20

24

R$

Nov-09 Feb-10 May-10 Aug-10 Nov-10

Source: Bloomberg and J.P. Morgan.

Performance 1M 3M 12M

Absolute (%) 23.4 46.9 23.7 Relative (%) 7.6 18.1 14.1

Source: Bloomberg. Priced as of the close on November 8, 2010; see our note out November 9 for further details.

Company Data Price (R$) 23.00Date Of Price 08 Nov 1052-week Range (R$) 23.00 -

12.55Mkt Cap (R$ mn) 2,599.00Fiscal Year End MarShares O/S (mn) 113Price Target (R$) 29.00Price Target End Date

31 Dec 11

Sao Martinho S.A. (SMTO3.SA;SMTO3 BZ) 2010A 2011E 2012E 2013E 2014EEPS Reported FY (R$) 0.82A 1.06 2.55 2.04 1.79Revenues FY (R$ mn) 1,183A 1,293 1,562 1,427 1,386EBITDA FY (R$ mn) 374A 493 646 535 488Source: Company data, Bloomberg, J.P. Morgan estimates.


47


Sao Martinho: Summary of Financials Income Statement FY10A FY11E FY12E FY13E FY14E Balance Sheet FY10A FY11E FY12E FY13E FY14E Revenues 1,183 1,293 1,562 1,427 1,386 Cash 131 708 912 1,117 1,282 Cost of goods sold 928 947 987 970 980 Accounts receivable 42 40 48 44 43 SG&A 412 427 372 366 378 Inventories 218 293 287 285 283 Depreciation 262 286 222 223 230 Other current assets 137 127 127 127 127 EBITDA 374 493 646 535 488 Net PP&E 2,548 2,426 2,525 2,584 2,645 EBITDA margin 31.6% 38.1% 41.4% 37.5% 35.2% Other assets 137 127 127 127 127 Financial income 105 14 42 54 66 Total assets 3,321 3,825 4,131 4,388 4,612 Financial expense 171 69 43 46 53 Short-term debt 327 327 279 253 217 FX & Monetary gains (losses) (3) 0 - - - Accounts payable 76 80 92 90 90 Other Nonoperarting income 0 0 0 0 0 Other current liabilities 79 90 90 90 90 Equity income 0 0 - - - Long-term debt 628 619 663 777 891 EBT 128 163 384 307 269 Deferred taxes 225 219 219 219 219 Taxes (32) (43) (96) (77) (67) Other liabilities 296 296 296 296 296 Minority interest 0 0 0 0 0 Total liabilities 1,631 1,632 1,640 1,725 1,803 Extraordinary 0 0 - - - Minority interest 0 0 0 0 0 Net income 93 120 288 230 202 Shareholders' equity 1,689 2,193 2,491 2,663 2,808 Net income margin 7.9% 9.3% 18.4% 16.2% 14.6% Liabilities + Equity 3,321 3,825 4,130 4,388 4,611 EPS 0.82 1.06 2.55 2.04 1.79 Revenue growth 52.8% 9.3% 20.8% (8.7%) (2.9%) Net debt 825 239 30 (87) (175) EBITDA growth 58.2% 32.0% 31.0% (17.1%) (8.9%) Net Debt/Capital 31.2% 7.6% 0.9% (2.4%) (4.5%) Net income growth (233.4%) 29.1% 139.4% (20.0%) (12.3%) Debt/Capital 28.8% 24.7% 22.8% 23.5% 24.0% FCF growth - - - - - Net Debt/EBITDA 2.2 0.5 0.0 (0.2) (0.4) Operating Data, Ratios FY10A FY11E FY12E FY13E FY14E Valuation, Macro FY10A FY11E FY12E FY13E FY14E Capex 313 174 320 282 290 EV/EBITDA 9.2 5.8 4.1 4.7 5.0 Change in working capital 12 (49) 10 4 3 P/E 27.9 21.6 9.0 11.3 12.9 Free cash flow 35 202 239 189 145 P/BV 1.5 1.2 1.0 1.0 0.9 Dividends 18 15 30 72 58 EV/tonne 263 222 194 181 168 Dividend % of net income 19.7% 12.7% 10.4% 31.3% 28.5% FCF yield 1.4% 7.8% 9.2% 7.3% 5.6% Capex/depreciation 1.2 0.6 1.4 1.3 1.3 Dividend yield - - - - - CAPEX/sales 26.4% 13.5% 20.5% 19.8% 21.0% ROE 5.5% 5.5% 11.6% 8.7% 7.2% Working capital 242 290 280 276 272 Net income margin 7.9% 9.3% 18.4% 16.2% 14.6% Working capital/sales - - - - - Net revenue/Assets 35.6% 33.8% 37.8% 32.5% 30.1% Assets/Equity 2.0 1.7 1.7 1.6 1.6 Shipments 1,906 1,781 1,936 1,917 2,005 ROIC 3.6% 5.4% 11.1% 8.0% 6.5% Avg price/t 621 726 807 744 691 Shares 113 113 113 113 113 Cash COGS/t 353 368 395 390 374 ADRs - - - - - EBITDA/t 196 277 334 279 243 DCF 27.47 Shipments chg 25.9% (6.6%) 8.7% (1.0%) 4.6% WACC 9.3% Avg price/t chg 621 726 807 744 691 Perpetual Growth 2.2% Cash COGS/t chg 353 368 395 390 374 Cost of equity 11.8% EBITDA/t chg 25.7% 41.2% 20.5% (16.3%) (12.9%) Cost of debt 4.6% Capex 313 174 320 282 290 Maintenance 217 114 160 167 175 Expansion 96 60 160 115 116 Source: Company reports and J.P. Morgan estimates. Note: R$ in millions (except per-share data). Fiscal year ends Mar


48


Fibria FIBR3.SA www.fibria.com.br

Underweight R$30.03 (28 Oct 10) Price Target: R$26 End Date: Dec 2011

Company description Fibria was formed by the merger of VCP and Aracruz and is the leading market pulp producer in the world, with 11% global market share. It has 5.6mt of market pulp capacity at 5 sites in Brazil along with 540,000 ha of eucalyptus plantations. The company is controlled by the Votorantim Group (29%) and by the local development bank, BNDES (30%), and has recently migrated to the Novo Mercado level of the Bovespa, the highest corporate governance standard in Brazil.

Investment case Despite our structurally optimistic view on the sector, we continue to see downside to near-term pulp prices and believe that neither sector momentum nor company valuations provide reasons for owning the stock at this point.

Potential for earnings upgrades Fibria is highly sensitive to changes in pulp prices given its operational focus (>90% of profits) and levered balance sheet (4.7x ND/EBITDA as per last reported balance sheet). Every $30/t move in the pulp price leads to a 10% change in EBITDA. Our sense is that consensus estimates are assuming flat pulp prices for ’11, suggesting downside risk to estimates if we are right on the pulp cycle outlook.

Prospects for re-/derating Cyclical stocks tend to trade at higher multiples on trough earnings and vice versa. Given our expectation of still an above average cyclical year in ’11 for prices (BEK avg of $800/t vs. normalized $750), we believe the stock should trade at or below a normalized multiple of ~8x.

Price target and risks We rate Fibria UW and have a R$26 ($16) Dec-11 price target. Our price target is based on: (1) DCF analysis using 9.6% WACC (R$24/sh); (2) 8x target multiple on ’11E EBITDA (R$24/sh) and (3) replacement value (R$30.5/sh). Key upside risks to our UW rating include: (1) higher pulp prices; (2) weaker BRL; (3) potential divestiture of paper assets.

Brazil Pulp and Paper Debbie Bobovnikova, CFA AC



20

30

40

R$

Oct-09 Jan-10 Apr-10 Jul-10 Oct-10

Price Performance

Source: Bloomberg.


Absolute (%) 8.2 5.8 19.9 Source: Bloomberg.

Company Data Price (R$) 30.03Date Of Price 28 Oct 1052-week Range (R$) 41.50 -

22.98Mkt Cap (R$ mn) 14,052.09Fiscal Year End DecShares O/S (mn) 468Price Target (R$) 26.00Price Target End Date

31 Dec 11

Fibria Celulose S.A. (FIBR3.SA;FIBR3 BZ) 2009A 2010E 2011EEBITDA FY (R$ mn) 1,472 2,806 2,620Bloomberg EBITDA FY (R$ mn) 1,580 2,955 3,454EPS Reported FY (R$) 1.44 1.76 0.31Source: Company data, Bloomberg, J.P. Morgan estimates.


49


Fibria: Summary of Financials Income Statement FY09A FY10E FY11E FY12E FY13E Balance Sheet FY09A FY10E FY11E FY12E FY13E Revenues 6,000 7,173 7,142 7,204 7,853 Cash 3,898 327 851 625 906 Cost of goods sold - - - - - Accounts receivable 842 829 857 865 942 SG&A 639 657 683 694 754 Inventories 948 1,047 1,027 1,027 1,077 Depreciation 1,248 1,466 1,330 1,405 1,534 Other current assets 671 412 398 398 398 EBITDA 1,472 2,806 2,620 2,747 3,019 Net PP&E - - - - - EBITDA margin 24.5% 39.1% 36.7% 38.1% 38.4% Other assets - - - - - Financial income 487 143 20 51 38 Total assets 28,324 28,239 28,827 29,613 30,437 Financial expense (1,492) (821) (730) (750) (766) Short-term debt - - - - - FX & Monetary gains (losses) 2,775 (22) (435) (362) (296) Accounts payable - - - - - Other Nonoperarting income 0 0 - - - Other current liabilities 94 159 158 160 174 Equity income - - - - - Long-term debt - - - - - EBT - - - - - Deferred taxes - - - - - Taxes - - - - - Other liabilities - - - - - Minority interest - - - - - Total liabilities 18,290 12,641 12,685 12,898 13,080 Extraordinary 0 0 - - - Minority interest - - - - - Net income - - - - - Shareholders' equity 10,015 15,579 16,124 16,696 17,338 Net income margin - - - - - Liabilities + Equity - - - - - EPS 1.44 1.76 0.31 0.60 0.99 Revenue growth - - - - - Net debt 10,817 10,387 9,864 10,311 10,155 EBITDA growth - - - - - Net Debt/Capital 43.7% 39.5% 36.7% 37.3% 35.7% Net income growth - - - - - Debt/Capital - - - - - FCF growth - - - - - Net Debt/EBITDA 6.4 3.7 3.8 3.8 3.4 Operating Data, Ratios FY09A FY10E FY11E FY12E FY13E Valuation, Macro FY09A FY10E FY11E FY12E FY13E Capex 1,609 1,247 1,400 2,409 1,949 EV/EBITDA 12.9 8.6 9.0 8.7 7.9 Change in working capital (121) 200 50 (16) (71) P/E 21.3 17.5 98.7 51.1 31.1 Free cash flow (2,038) 1,467 560 (377) 271 P/BV - - - - - Dividends - - - - - EV/tonne - - - - - Dividend % of net income - - - - - FCF yield 7.7% (6.7%) 8.6% 2.6% 8.3% Capex/depreciation - - - - - Dividend yield 9.8% 32.6% 118.6% 229.0% 376.6% CAPEX/sales - - - - - ROE 5.6% 5.3% 0.9% 1.7% 2.7% Working capital - - - - - Net income margin - - - - - Working capital/sales - - - - - Net revenue/Assets - - - - - Assets/Equity - - - - - Shipments - - - - - ROIC 3.8% 5.6% 4.6% 4.7% 5.1% Avg price/t - - - - - Shares - - - - - Cash COGS/t - - - - - ADRs - - - - - EBITDA/t - - - - - DCF Shipments chg - - - - - WACC Avg price/t chg - - - - - Perpetual Growth Cash COGS/t chg - - - - - Cost of equity EBITDA/t chg - - - - - Cost of debt Capex 1,609 1,247 1,400 2,409 1,949 Maintenance - - - - - Expansion - - - - - Source: Company reports and J.P. Morgan estimates. Note: R$ in millions (except per-share data). Fiscal year ends Dec


50


Financials Key country dynamics We continue to see mostly favorable credit dynamics in the region. In Brazil, Peru, Chile, and Argentina, we believe that credit growth should remain healthy in 2011. We are forecasting loan growth of 17%-19% for the banks we cover in these markets. Asset quality trends should also continue improving, albeit at a more moderate pace than in 2010. In addition, we are seeing rapidly improving credit trends in Mexico and Colombia, which we expect to continue. However, continued low benchmark rates could pose risk to NIMs in Mexico.

In contrast with the positive credit trends, we have a cautious view of the Brazilian merchant acquiring business. We believe pressure on MDRs and POS rental rates should be meaningful in the coming years.

What could be the positive drivers for banks? Operating dynamics remains favorable for Brazilian banks. We see good double-digit earnings growth driven by 15%-20% loan growth, some efficiency improvements, and lower credit losses. For Banorte, loan growth will likely re-emerge and delinquency rates should continue declining, thereby leading to healthy earnings growth of 26.5% in 2011, according to our estimates. We see continued high-20% ROEs for Santander Chile and Banco de Chile in an environment of moderate inflation and good economic growth. Bancolombia should generate ROE expansion (albeit from a relatively low high-teen range) as loan growth picks up and, possibly, interest rates rise. At Credicorp, strong loan growth and cost controls should offset lower trading gains and drive 13% earnings growth in 2011.

Drivers of returns – Multiples and growth When regressing expected 2011 and 2012 ROEs against price-to-book value multiples for Latin American banks in our coverage universe, Santander Brasil, Itau Unibanco, Bradesco, and Banco do Brasil trade roughly 5%-20% below the fair price to book value predicted by the regression analysis. We expect a convergence of multiples across the region as the Brazilian banks continue posting good results and some of the “macro” overhangs related to the sector (election cycle, equity offerings) have been removed.

Recommendations Overweight: Santander Brasil (top pick), Banco Bradesco, Banco Itaú Unibanco, Grupo Financiero Galicia, Bladex. Avoid: Grupo Financiero Inbursa, Bancolombia, Redecard, and Cielo.

Saul Martinez AC


Bloomberg JPMA MARTINEZ <GO>

Regression of risk-adjusted ROE to price-to-book value multiples: Brazilian banks are still trading below the regression line

MacroGFGalicia

Bladex

Credicorp

Bancolombia

GFInbursaGFNorte

Banco de Chile

Santander Chile

Santander BrasilBanco do Brasil

Itau Unibanco

Bradesco

0.0

1.0

2.0

3.0

4.0

5.0

6.0

0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0% 20.0%

Risk Adjusted ROE (2011-2012)

P/BV

Source: J.P. Morgan and Bloomberg, share price data as of October 28, 2010. Risk-adjusted ROE calculated by subtracting est COE from forecast ROE in 2011 and 2012.

Share price performance in local currency – YTD: Latin American financials ex-Brazil were the main outperformers

81%

57% 56%

42% 42% 40% 38% 36%29% 27%

22%17% 13% 13% 10% 10% 7% 6% 6% 3% 3%

-21%

-5%

Mac

ro

Cred

icorp

Banc

o de

Chil

e

Sant

ande

r Chil

e

Inbu

rsa

Banc

olom

bia

Peru

Inde

x

Chile

Inde

x

Com

parta

mos

Arge

ntina

Inde

x

Porto

Seg

uro

Brad

esco

Banc

o do

Bra

sil

Bano

rte

Mex

ico In

dex

Blad

ex

Itau

Uniba

nco

KBW

ban

k In

dex

S&P

Sant

ande

r Bra

sil

Ibov

espa

Cielo

Rede

card

Source: Bloomberg. Share price data through October 28, 2010. Credicorp’s share price is adjusted for the performance of the currency (Nuevo Sol).


51


Top picks and stocks to avoid Mkt cap P/E (x) EPS Div. yield ROE Price Code Rating (US$MM) 10E 11E 10E 11E 11E (%) 11E (%) Top picks Santander Brasil R$24.57 SANB11 OW 54,565 15.0 10.7 R$1.62 R$2.13 5.2 14.4 Bradesco R$34.96 BBDC4 OW 76,854 13.5 12.2 R$2.59 R$2.88 2.9 21.2 Stocks to avoid Bancolombia (ADR) $66.04 CIB US UW 13,007 20.0 18.0 $3.30 $3.68 1.8 18.4% Source: Bloomberg, J.P. Morgan estimates. Note: Share prices and valuations are as of October 28, 2010.

Financials absolute and relative to MSCI LatAm

0

200

400

600

800

1000

1200




Financials EPS integer

80

90

100

110

120

130

140

150

160


2010

2011


Financials 12 mth fwd PE

4

6

8

10

12

14

16

95 97 98 99 00 01 02 03 04 05 06 07 08 10

PE Av g +1SD -1SD


Financials trailing PB

0.5

11.5

22.5

3

3.54

4.5

95 97 98 99 00 01 02 03 04 05 06 07 08 10

PB Av g +1SD -1SD



52


Banco Santander Brasil SANB11.SA www.santander.com.br

Overweight R$24.57 (28 Oct 10) Price Target: R$33 End Date: Dec 2011

Company description Santander Brasil is Brazil’s 3rd-largest private bank, based on assets, loans, deposits. The bank serves individuals and corporates and has grown through acquisitions, notably of Banespa, in November 2000 and Banco Real from ABN AMRO in 2008. The bank IPO’d in October 2009. As of Sept 2010, the bank has assets of R$357bn, loans of R$153bn and equity of R$73.0 bn.

Investment case As a leading financial institution, Santander should benefit from growth in penetration. In addition, earnings growth driven by volumes, cost saves, lower credit losses, coupled with capital optimization, should drive meaningful ROE expansion. We see adjusted IFRS ROE growing to 16.4% by 2012 from 11-12% now. This should see P/BV expansion from its current 1.7x BV. Our 2011 price target of R$33 is based on a target 11E book value multiple of 2.2x.

Potential for earnings upgrades There is a lack of consensus about which accounting standards sell-side analysts base financial projections for Santander Brasil on (IFRS or Brazilian GAAP). Hence, it is difficult to assess the extent earnings upgrades are possible. Our forecasts and the company’s primary reporting standard is IFRS. We forecast IFRS earnings growth of 28.8 % in 2011 and 17.3% in 2012.

How much is already priced in? We do not believe the multiyear ROE expansion is adequately priced. In 2012, we expect the bank to generate adjusted IFRS ROE of 16.4%. Based on current ROEs vs P/BV multiples for publicly traded Latin American banks in our coverage universe, this ROE is consistent with a P/BV multiple of 2.1x.

Price target and risks YE11 R$33/share, US$18/ADR (at JPM’s 2011 FX of R$1.8). We use a residual income model & regression of risk-adjusted ROE to P/BV. Key risks: resumption of asset quality deterioration; failure to realize cost synergies from Banco Real merger; slower loan growth recovery; business disruptions due to IT integration issues; negative ruling from federal government on deductibiltiy of goodwill amortization for tax purposes; negative actions taken by Santander Spain that could impact the growth and profitability of Santander Brasil.

Brazil Financial Institutions Saul Martinez AC



18

20

22

24

26

R$


Price Performance

Source: Bloomberg.


Absolute (%) 13.8 12.7 9.0 Relative (%) 7.3 -1.3 -13.2

Source: Bloomberg.


17.93Mkt Cap (R$ mn) 93,376.32Fiscal Year End DecShares O/S (mn) 3,800Price Target (R$) 33.00Price Target End Date

31 Dec 11

Banco Santander (Brasil) S.A. (SANB11.SA;SANB11 BZ) 2009A 2010E 2011E 2012EEPS - Recurring (R$) Q1 (Mar) 0.21 0.37A Q2 (Jun) 0.44 0.38A Q3 (Sep) 0.33 0.42A Q4 (Dec) 0.31 0.46A FY 1.31 1.62A 2.13 2.57EPS Reported FY (R$) 1.70 1.99A 2.56 3.00Source: Company data, Bloomberg, J.P. Morgan estimates. Please note that EPS Recurring stands for EPS IFRS adjusted and EPS Reported stands for EPS IFRS.


53


Banco Santander (Brasil) S.A.: Summary of Financials Income Statement FY09A FY10E FY11E FY12E FY13E Balance Sheet FY09A FY10E FY11E FY12E FY13E Interest Income 40,436 40,480 47,213 53,179 - Securities 82,816 85,319 98,828 110,688 -Interest Expense (18,269) (16,555) (19,862) (22,113) - Cash and Due from Banks 27,269 58,697 73,371 81,442 -Net interest Income 22,167 23,925 27,351 31,067 - Interbank Investment - - - - -LL Provision (9,983) (8,520) (9,612) (10,818) - Loan and Leasing Operatings 152,163 178,077 210,876 248,134 -Net Interest Income after Provision 12,184 15,405 17,739 20,249 - Other Receivables and Assets 17,984 17,715 19,521 21,511 -Fee Income 6,238 6,991 7,969 9,005 - Permanent Asset 35,739 36,319 32,964 32,964 -Other Non Interest Income 2,874 1,583 1,693 1,784 - Total assets 315,971 376,127 435,560 494,739 -Personnel Expenses - - - - - Total deposits 170,636 215,669 246,667 280,696 -Non Interest Expenses (10,947) (11,241) (11,803) (12,747) - Demand deposits - - - - -Other Non Interest Expense (5,615) (3,214) (3,131) (3,445) - Savings deposits - - - - -Non-Operating Income/(Expenses) - - - - - Interbank deposits - - - - -Non recurring income (losses) 3,403 240 150 150 - Time deposits - - - - -Pretax income 8,137 9,763 12,616 14,997 - Interest bearing liabilities 27,178 30,438 33,273 36,253 -Taxes (2,629) (2,190) (2,902) (3,599) - Other Current Liabilities 48,893 57,318 79,680 97,769 -Statutory Profit Sharing - - - - - Total Liabilities 246,707 303,426 359,619 414,717 -Minority Interests - - - - - Shareholders' equity 69,265 72,695 75,934 80,015 -Extraordinary 51 30 0 0 - Net Income 5,508 7,573 9,715 11,397 - Recurring Net Income 5,457 7,543 9,715 11,397 - Dividends 1,575 3,939 4,857 5,699 - Operating Data, Ratios FY09A FY10A FY11E FY12E FY13E Valuation, Macro FY09A FY10A FY11E FY12E FY13E Per share analysis P/E 14.5 12.3 9.6 8.2 -EPS 1.31 1.62 2.13 2.57 - P/BV 1.8 1.7 1.6 1.5 -EPADR 0.87 0.92 1.18 1.38 - Dividend yield 1.7% 4.2% 5.2% 6.1% -BVPS 13.76 14.34 15.20 16.27 - ROE 9.9% 11.6% 14.4% 16.4% -Dividend per Share 0.41 1.04 1.28 1.50 - ROA 1.5% 1.9% 2.1% 2.2% -BVADR 7.88 8.20 8.21 8.47 - Dividend/ADR 0.21 0.59 0.71 0.80 - Shares 3,800 3,800 3,800 3,800 - ADRs - - - - -Growth EPS growth 3.2% 38.2% 28.8% 17.3% - Fee income 5.5% 12.1% 14.0% 13.0% - Non interest expenses (5.1%) 2.7% 5.0% 8.0% - Loan (1.3%) 15.9% 18.4% 17.7% - Deposits (6.4%) 26.4% 14.4% 13.8% - Ratios NIM 9.6% 9.4% 9.2% 8.9% - Fees/Expenses 57.0% 62.2% 67.5% 70.6% - PDL/Loans 6.7% 5.7% 5.1% 4.8% - LL Reserves/Total Loans 92.5% 5.8% 5.2% 5.7% - LL Reserves/NPL 101.7% 102.0% 102.0% 102.0% - Cost/Income 38.5% 36.4% 33.4% 31.8% - Loans/Deposits 89.2% 82.6% 85.5% 88.4% - Loans/Assets 48.6% 49.1% 50.2% 52.0% - Equity/Assets 21.9% 19.3% 17.4% 16.2% - Dividend Payout 28.8% 52.2% 50.0% 50.0% - Source: Company reports and J.P. Morgan estimates. Adjusted IFRS figures. Note: R$ in millions (except per-share data). Fiscal year ends Dec.


54


Bancolombia CIB www.grupobancolomia.com

Underweight $68.74 (4 Nov 10) Price Target: $65 End Date: Dec 2011

Company description Bancolombia is Colombia’s largest bank (23% loan share). It also owns Banagricola, El Salvador’s largest bank (31% share). The company also provides financial products in Panama, Peru, Brazil, the US and Spain.

Investment case Bancolombia is the leader in the underpenetrated Colombian and El Salvador banking systems. Economic activity is improving and rates are unsustainably low in Colombia and likely to increase, benefiting earnings and profitability. We forecast local currency earnings growth of 19.2%, on average, from 2010 to 2012, and for ROEs to expand to 19.2% in 2012 from 17.9% in 2010. Newly elected President Santos has a market-friendly economic policy. This could lead to policy changes, such as modifications to the existing usury laws, that would increase the maximum interest rate that can be charged by banks.

Potential for earnings upgrades Faster-than-expected economic growth and an increase in NIMs due to higher rates lead to upside risk to consensus local currency numbers. US$ earnings could also benefit if the Colombian peso remains strong. Our 2011 EPADR estimate incorporates an average COP/US$ exchange rate of 2,200 versus the November 4th exchange rate of COP1,818/US$.

Prospects for re-/derating Even factoring in improving prospects, the bank is pricing ample improvement. The stocks trades 3.4x bv and 18.0x 12e local EPS (18x 12e US$ earnings). It is generating ROEs of about 18%. Our regression of ROE to P/B using a cross section of LatAm banks, shows this is consistent with a 2.8x P/B multiple.

Ultimately, we feel Bancolombia benefits from scarcity value; being the only domestic-focused stock with a liquid ADR. Hence, it may be susceptible to the emergence of alternative domestic investment opportunities. Operationally, while good local currency earnings growth is likely, Bancolombia has lost share in consumer lending and struggled with costs.

Price target and risks YE11 US$60/ADR (at JPM’s end-2011e FX of COP$2,200). We use a residual income model and regression of risk-adjusted ROE to P/B. Key risks: faster-than-expected improvement in economic conditions; a faster-than-expected rebound in NIMs; value-creating acquisitions; and continued positive sentiment toward the country’s improving macroeconomic and political dynamics.

Colombia Financial Institutions Saul Martinez AC



35

45

55

65

$


Price Performance

Source: Bloomberg.


Absolute (%) 2.9 6.6 56.1 Relative (%) -1.0 5.5 48.2


Company Data Price ($) 68.74Date Of Price 04 Nov 1052-week Range ($) 69.44 -

40.10Mkt Cap ($ mn) 13,538.81Fiscal Year End DecShares O/S (mn) 197Price Target ($) 65.00Price Target End Date

31 Dec 11

Bancolombia S.A. (CIB;CIB US) 2009A 2010E 2011E 2012EEPADR - Recurring ($) Q1 (Mar) 0.65 0.89A Q2 (Jun) 0.68 0.77A Q3 (Sep) 0.72 1.03A Q4 (Dec) 0.64 0.96A FY 2.77 3.65A 3.97 4.28Source: Company data, Bloomberg, J.P. Morgan estimates.


55


Bancolombia: Summary of Financials Income Statement FY09A FY10E FY11E FY12E Balance Sheet FY09A FY10E FY11E FY12E Interest Income 6,427,698 5,009,056 6,053,546 7,315,953 Securities 8,436,244 8,895,070 9,517,725 10,183,965 Interest Expense (2,625,416) (1,575,512) (2,049,436) (2,601,836) Loans, gross 42,041,974 47,811,195 55,561,779 64,647,131 Net interest Income 3,802,282 3,433,543 4,004,110 4,714,117 Cash and due from Banks 7,372,359 5,417,489 5,742,538 6,144,516 LL Provision (1,153,374) (594,373) (694,071) (917,678) Repurchase Agmt and Derivatives - - - - Net Interest Income after provision 2,648,908 2,839,170 3,310,040 3,796,439 Loan loss reserves (2,431,667) (2,453,431) (2,497,502) (2,715,179) Fee Income 1,506,273 1,573,672 1,762,513 1,956,389 Other assets 6,445,455 7,225,066 7,663,474 7,719,250 Foreign Exchange and Trading transaction 380,676 495,949 547,232 547,232 Total assets 61,864,365 66,895,388 75,988,014 85,979,682 Non Interest Income 198,761 193,658 183,975 193,174 Total deposits 42,149,330 43,978,839 50,920,026 58,554,431 Non Interest Expenses (3,000,674) (3,189,237) (3,489,950) (3,854,198) Other funding 5,428,960 5,890,742 6,479,816 7,127,798 Non Operating results - - - - Bonds and subordinated debts - - - - Pretax income 1,733,944 1,913,212 2,313,809 2,639,036 Other liabilities 7,253,246 9,118,253 9,572,115 10,048,671 Taxes (462,013) (530,139) (654,172) (746,493) Total liabilities 61,864,365 66,895,388 75,988,014 85,979,682 Statutory Profit Sharing - - - - Minority Interest (15,081) (17,260) (18,468) (19,761) Shareholder's equity 7,032,829 7,907,555 9,016,057 10,248,783 Net Income 1,256,850 1,365,813 1,641,169 1,872,782 Recurring Net Income 1,170,050 1,365,813 1,641,169 1,872,782 Dividends - - - - Operating Data, Ratios FY09A FY10A FY11E FY12E Valuation, Macro FY09A FY10A FY11E FY12E Per share analysis P/E 23.1 18.8 17.3 16.1 EPS 2.97 3.65 3.97 4.28 P/BV 3.9 3.5 3.4 3.0 BVPS 17.44 19.66 20.41 22.94 Dividend yield 1.6% 2.0% 1.9% 2.1% Dividend per Share 1.08 1.34 1.29 1.46 ROE 17.8% 19.1% 19.4% 19.4% ROA 1.9% 2.2% 2.3% 2.3% Growth EPS growth (2.6%) 31.9% 8.8% 7.8% Shares - - - - Fee income 14.7% 4.5% 12.0% 11.0% ADRs 197 197 197 197 Non interest expenses 10.1% 7.0% 9.9% 9.6% Loan (5.8%) 13.7% 16.2% 16.4% Deposits 4.4% 4.3% 15.8% 15.0% Ratios NIM 6.6% 5.7% 6.0% 6.2% Fees/Expenses 53.3% 52.0% 53.0% 53.7% PDL/Loans 3.9% 3.3% 3.1% 3.0% LL Reserves/Total Loans 5.8% 5.1% 4.5% 4.2% LL Reserves/NPL 149.4% 155.5% 145.0% 140.0% Cost/Income 49.7% 55.0% 52.6% 50.5% Loans/Deposits 99.7% 108.7% 109.1% 110.4% Loans/Assets 68.0% 71.5% 73.1% 75.2% Equity/Assets 11.4% 11.8% 11.9% 11.9% Dividend Payout 36.3% 36.8% 32.5% 34.2% Source: Company reports and J.P. Morgan estimates. Note: $ in millions (except per-share data). Fiscal year ends Dec


56


SMid Cap Financials Key country dynamics SMid caps should continue to experience above-system growth in 2011, especially in SME lending and microlending, on the back of favorable macroeconomic trends and low leverage. We like banks with solid balance sheets, especially good access to funding, as we view this is as a structural weakness of small banks (Figure 1). 2010 was about asset quality; in 2011, investor focus will be on possible pressure on margins.

In our coverage of 6 SMid cap financials in Brazil and Mexico, we like Banrisul, Cetip and Compartamos. We base our preference for SMid caps on: 1) strong balance sheets (high BIS, high loan-loss coverage, stable funding, low debt ratio); 2) low risk of pricing/margin pressure; 3) best EPS growth; 4) M&A potential; 5) limited political/regulatory risk; 6) product diversification in 2011e adding new revenues sources; 7) attractive growth-adjusted valuations.

Growth characteristics and how they are changing In Brazil, SME lenders (roughly half of Banrisul’s portfolio is small corporate) should see loan growth above 25% versus a system average of ~20%, adding to recent strong loan growth in Brazil (Figure 2). With loan growth and stable asset quality viewed as a given, investors will focus on margin compression (on the back of changes in mix and/or increased competition). We expect Cetip to see strong earnings growth (JPMe 34% growth in EPS in 2011) on the back of higher volumes.

In Mexico, Compartamos should continue to grow, on the back of 1) the underpenetration of lending, especially for lower-income segments; 2) the benign regulatory environment (we don’t think problems in Indian microfinance will spill over to other markets); 3) contained competition.

Drivers of returns – Multiples and growth Loan growth will be the main earnings driver, while inflows (especially from foreign investors) will continue to support valuations. Efficiency gains will also drive earnings growth, and we expect efficiency to improve (at Banrisul) or remain stable (at Cetip and Compartamos).

Recommendations Overweight: Banrisul, Cetip, Compartamos. Stocks to avoid: PanAmericano.

Frederic de Mariz AC *

(55-11) 3048-3398 [email protected] Banco J.P. Morgan SA

Bloomberg JPMA DEMARIZ <GO>

Figure 1: Brazil/Mexico: Access to funding remains a key bottleneck for small banks, hence our focus on balance sheet strength (market share of deposits of top 5 banks)

31%39%

47%53%

64% 65% 69% 70% 76% 76% 77% 82% 86% 89%

USA

Spain Ita

ly

Arge

ntina

Colom

bia

Fran

ce UK

Portu

gal

Braz

il

Chile

Mex

ico

Swed

en

Peru

Belgi

um

Source: Central banks and J.P. Morgan.

Figure 2: Brazil: Loans-to-GDP ratio: We expect SME lending to play a key role in the next growth phase

20

25

30

35

40

45

50

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

Source: Brazilian Central Bank.

* Registered/qualified as a research analyst under NYSE/NASD rules.


57


Top picks and stocks to avoid Mkt cap P/E (x) EPS Div. yield ROE Price Code Rating (US$MM) 10E 11E 10E 11E 11E (%) 11E (%) Top picks Banrisul R$18.00 BRSR6 OW 3.949 11.6x 10.0x 1.61 1.88 3% 19.0% Compartamos MXN85.93 COMPARTO OW 3.032 20.1x 16.4x 4.36 5.34 1% 34.8% Cetip R$17.95 CTIP3 OW 2.387 29.8x 22.3x 0.61 0.81 1% 45.3% Stocks to avoid PanAmericano R$7.73 BPNM4 UW 1,110 11.9x 7.2x 0.64 1.07 8% 16.4% Source: Bloomberg, J.P. Morgan estimates. Note: Share prices and valuations are as of October 28, 2010.

Loan growth 35%

27%

44%

25%17%

28%24%

30%

20%15%

ABC Brasil Banrisul BicBanco Compartamos PanAmericano

2010e 2011e

Source: J.P. Morgan estimates.

Non performing loans to total loans

2.5%

10.2%

6.8%

2.4%

10.5%

2.3%

9.8%

6.0%

2.8%

10.2%


2010e 2011e


Cost to income

26%

50%

24%

51% 50%

25%

48%

22%

50% 50%


2010e 2011e


EPS growth

40%

22% 26% 21% 22%

-16%

17% 16% 20%34%

22%

66%

ABC Brasil Banrisul BicBanco Cetip Compartamos PanAmericano

2010e 2011e



58


Banrisul BRSR6.SA www.banrisul.com.br

Overweight R$18.00 (28 Oct 10) Price Target: $20 End Date: Dec 2011

Company description Banrisul is the largest of the small caps under our coverage. It is also the only small bank with access to retail funding. The bank is controlled by the state of Rio Grande do Sul (owns 57%) and has a dominant market share in its home state (17% loan market share). The bank offers a wide variety of loans, including individual (45% of total book, mostly payroll), corporate (32% of loans), real estate (8% of loans), and agribusiness (7% of loans). Banrisul is the 11th-largest bank by assets in Brazil and has a market share of 0.8% of total loans in the Brazilian banking system (largest bank, Banco do Brasil, has 21%).

Investment case We have an Overweight rating on the stock (BRSR6) due to the bank’s strong funding structure (based on stable and cheap retail funding), good loan growth outlook (around 25% in 2010-12e), and solid coverage of nonperforming loans (ratio of loan-loss reserves to loans past due 60 days or more 226% in 2Q10).

Potential for earnings upgrades We expect loan growth to be the main driver of earnings growth, as net interest margins and loan-loss provisions should remain relatively stable in the next 12 months. Additionally, improved operating efficiency (historically a weak point at Banrisul) should continue improving, mostly on the back of lower administrative expenses.

Prospects for derating Lower-than-expected loan growth and the potential appointment of a new and heterodox management team at the bank could disappoint investors.

Price target and risks Our Dec-11 price target of R$20 is based on a residual income methodology and a regression of ROE and P/BV multiples for banks. We assume a cost of equity of 13.1% and long-term earnings growth of 5%. Risks to our price target and OW rating include 1) political interference at the bank; 2) lower-than-expected loan growth; 3) limited gains in efficiency.

Latin America SMid Cap Financials Frederic de Mariz AC *



11

13

15

17

19

R$

Mar-10 Jun-10 Sep-10

Price Performance

Source: Bloomberg.


Absolute (%) 9.4 29.7 36.7

Source: Bloomberg. * Registered/qualified as a research analyst under NYSE/NASD rules.



31 Dec 11

Banrisul (BRSR6.SA;BRSR6 BZ) 2008A 2009A 2010E 2011E 2012EEPS - Recurring (R$) Q1 (Mar) 0.30 0.26 0.30A Q2 (Jun) 0.46 0.25 0.45A Q3 (Sep) 0.27 0.36 0.43A Q4 (Dec) 0.00 0.45 0.44A FY 1.03 1.32 1.61A 1.88 2.18Source: Company data, Bloomberg, J.P. Morgan estimates.


59


Banrisul: Summary of Financials Income Statement - Annual FY08A FY09A FY10E FY11E Income Statement - Quarterly 1Q10A 2Q10A 3Q10E 4Q10E Net interest income 1,722 2,542 2,791 3,136 Net interest income 647 711 706 727Provisions (257) (423) (534) (608) Provisions (154) (127) (130) (123)Noninterest income 539 579 641 718 Noninterest income 150 157 164 170Total revenues 2,004 2,699 2,898 3,246 Total revenues 644 741 740 774 Expenses (1,171) (1,846) (1,888) (2,065) Expenses (462) (464) (472) (490)Earnings before taxes 704 853 1,010 1,181 Earnings before taxes 182 277 268 283Income taxes (83) (268) (305) (366) Income taxes (48) (83) (80) (94)Profit sharing and minority interest (30) (45) (45) (47) Profit sharing and minority interest (11) (11) (11) (11)Net income - Reported 421 541 660 768 Net income - Reported 122 183 177 179Nonrecurring income (losses) (AT) 0 0 0 0 Nonrecurring income (losses) 0 0 0 0Net income - Core 421 541 660 768 Net income - Core 122 183 177 179Diluted shares outstanding 409 409 409 409 Diluted shares outstanding 409 409 409 409 EPS - Reported 1.03 1.32 1.61 1.88 EPS - Reported 0.30 0.45 0.43 0.44EPS - Core 1.03 1.32 1.61 1.88 EPS - Core 0.30 0.45 0.43 0.44Dividends 0.74 0.56 0.65 0.75 Dividends 0.10 0.19 0.18 0.17 Balance Sheet FY08A FY09A FY10E FY11E Balance Sheet 1Q10A 2Q10A 3Q10E 4Q10E Securities 6,111 7,408 8,418 8,839 Securities 7,760 8,091 8,253 8,418Total gross loans 11,453 13,414 17,023 21,109 Total gross loans 14,766 15,442 16,060 17,023Loan loss reserves 971 1,017 1,177 1,469 Loan loss reserves 1,082 1,039 1,109 1,177Total net loans 10,483 12,398 15,846 19,640 Total net loans 13,684 14,403 14,951 15,846Total earning assets 24,495 28,197 32,037 35,142 Total earning assets 28,913 29,980 30,997 32,037Total assets 25,205 29,084 33,222 37,981 Total assets 29,864 31,099 32,028 33,222 Total deposits 14,256 16,370 19,275 22,076 Total deposits 16,520 17,145 18,093 19,275Total liabilities 22,126 25,676 29,420 33,719 Total liabilities 26,384 27,509 28,334 29,420Common equity 3,079 3,408 3,802 4,262 Common equity 3,480 3,590 3,694 3,802Shareholders' equity 3,079 3,408 3,802 4,262 Shareholders' equity 3,480 3,590 3,694 3,802 Ratio Analysis (%) FY08A FY09A FY10E FY11E Ratio Analysis (%) 1Q10A 2Q10A 3Q10E 4Q10E Average loan growth 34.2% 20.5% 26.8% 24.0% Average loan growth 9.8% 4.8% 4.0% 6.0%Average earning assets growth 19.3% 20.0% 14.4% 14.4% Average earning assets growth 3.2% 4.0% 2.7% 3.8%Average deposit growth 15.3% 14.8% 17.7% 15.0% Average deposit growth 0.9% 3.8% 6.0% 7.0%Avg loans / avg deposits 85.9% 90.1% 97.0% 105.0% Avg loans / avg deposits 98.0% 98.9% 97.5% 97.0% Net interest margin 7.8% 9.7% 9.1% 8.9% Net interest margin 9.0% 9.5% 9.1% 9.1%Efficiency ratio 4.7% 6.0% 5.5% 5.3% Efficiency ratio 5.9% 5.5% 5.5% 5.5%Return on assets (ROA) 1.8% 2.0% 2.1% 2.2% Return on assets (ROA) 1.7% 2.4% 2.2% 2.2%Return on equity (ROE) 14.3% 16.7% 18.3% 18.5% Return on equity (ROE) 14.2% 20.7% 19.4% 19.1% Tangible common equity ratio - - - - Tangible common equity ratio - - - -BIS ratio 20.1% 17.5% 16.5% 15.7% BIS ratio 16.5% 15.7% 15.7% 15.5% NPAs / gross loans 14.2% 11.9% 10.2% 9.8% NPAs / gross loans 11.3% 10.8% 10.4% 10.2%Net chargeoffs / average loans 1.7% 2.2% 1.5% 1.5% Net chargeoffs / average loans 2.2% 1.7% 1.5% 1.3%Loan loss reserves / loans 8.5% 7.6% 6.9% 7.0% Loan loss reserves / loans 7.3% 6.7% 6.9% 6.9%Loan loss reserves / NPLs 59.6% 63.9% 67.8% 71.0% Loan loss reserves / NPLs 65.0% 62.4% 66.5% 67.8% Source: Company reports and J.P. Morgan estimates. Note: R$ in Millions (except per-share data).


60


Banco PanAmericano BPNM4.SA www.panamericano.com.br

Underweight R$7.73 (28 Oct 10) Price Target: $10 End Date: Dec 2011

Company description PanAmericano offers consumer loans to the lower-income segments of the population, making it an ideal play on rising income levels in Brazil. Roughly two-thirds of the bank’s loan portfolio are vehicle lending, with payroll and credit cards making up the rest of the portfolio. The bank has a network of 199 points of sale, 2.1 million clients and 12.1 million issued credit cards. The bank currently has a market share of 0.4% of loans in the Brazilian banking system (the leader, Banco do Brasil, has a market share of 21%).

Investment case We have an out-of-consensus Underweight rating on the stock (BPNM4), due to 1) accounting issues and weak internal controls; 2) uncertainties around the new management team; 3) weaker funding structure than that of other banks in our coverage universe (roughly half of the funding comes from loan cessions, loan securitization and time deposits with a special guarantee), and 4) lower loan growth outlook in auto loans than in other loan segments.

Potential for earnings upgrades The bank will continue to suffer from high loan loss provisioning levels (D-H ratio at 10.9% as of 2Q10). Also, tougher competition in the auto lending segment could put pressure on margins.

Prospects for rerating We have a cautious view on the benefits that CEF could bring to PanAmericano. CEF announced the purchase of 37% of PanAmericano in Dec-09. The stock could rerate if the new management team of PanAmericano were to articulate how the agreement with CEF could 1) improve the funding structure of PanAmericano and/or 2) bring revenue synergies.

Price target and risks Our Dec-11 price target of R$10 is based on a residual income model and a regression analysis of ROE and P/BV. We consider a cost of equity of 13.1% and a long term earnings growth of 6%. Risks to our UW rating relate to a redefinition of the strategy of the bank by the new management team, an improvement in funding structure and significant revenue synergies with CEF.

Latin America SMid Cap Financials Frederic de Mariz AC *



7.5

8.5

9.5

10.5

R$

Apr-10 Jul-10 Oct-10

Price Performance

Source: Bloomberg.


Absolute (%) -23.4 -23.9 -37.9


Company Data Price (R$) 7.73Date Of Price 28 Oct 1052-week Range (R$) 12.36 - 6.55Mkt Cap (R$ mn) 1,888.78Fiscal Year End DecShares O/S (mn) 244Price Target (R$) 10.00Price Target End Date 31 Dec 11

Banco PanAmericano (BPNM4.SA;BPNM4 BZ) 2008A 2009A 2010E 2011E 2012EEPS - Recurring (R$) Q1 (Mar) 0.28 0.29 0.18A Q2 (Jun) 0.36 0.06 (0.09)A Q3 (Sep) 0.27 0.19 0.24A Q4 (Dec) 0.04 0.23 0.28A FY 0.94 0.77 0.64A 1.07 1.19Source: Company data, Bloomberg, J.P. Morgan estimates.


61


Banco PanAmericano: Summary of Financials Income Statement - Annual FY08A FY09A FY10E FY11E Income Statement - Quarterly 1Q10A 2Q10A 3Q10E 4Q10E Net interest income 1,777 2,237 2,732 2,952 Net interest income 697 639 691 705Provisions (542) (730) (744) (768) Provisions (172) (250) (144) (177)Noninterest income 180 118 175 194 Noninterest income 39 44 45 46Total revenues 1,415 1,625 2,163 2,378 Total revenues 565 433 592 574 Expenses (1,189) (1,148) (1,566) (1,720) Expenses (391) (397) (402) (377)Earnings before taxes 99 257 410 472 Earnings before taxes 126 (23) 150 157Income taxes (3) (82) (193) (151) Income taxes (51) 11 (75) (78)Profit sharing and minority interest (0) (0) (1) (1) Profit sharing and minority interest (0) (0) (0) (0)Net income - Reported 96 174 217 320 Net income - Reported 75 (11) 75 79Nonrecurring income (losses) (AT) 14 (205) (246) (246) Nonrecurring income (losses) (79) (68) (50) (50)Net income - Core 236 189 157 261 Net income - Core 44 (21) 58 69Diluted shares outstanding 250 244 244 244 Diluted shares outstanding 244 244 244 244 EPS - Reported 0.94 0.77 0.64 1.07 EPS - Reported 0.18 (0.09) 0.24 0.28EPS - Core 0.94 0.77 0.64 1.07 EPS - Core 0.18 (0.09) 0.24 0.28Dividends - 0.16 0.19 0.27 Dividends 0.00 0.19 0.00 0.00 Balance Sheet FY08A FY09A FY10E FY11E Balance Sheet 1Q10A 2Q10A 3Q10E 4Q10E Securities 736 1,377 1,862 1,881 Securities 1,161 1,826 1,844 1,862Total gross loans 6,631 8,784 10,317 11,865 Total gross loans 8,984 9,183 9,642 10,317Loan loss reserves 522 578 704 829 Loan loss reserves 577 660 671 704Total net loans 6,108 8,206 9,613 11,036 Total net loans 8,407 8,524 8,972 9,613Total earning assets 8,900 10,363 12,481 14,688 Total earning assets 11,346 12,064 12,852 13,438Total assets 8,976 11,591 13,725 15,216 Total assets 11,812 12,583 13,053 13,725 Total deposits 4,413 6,922 0 0 Total deposits 7,115 7,476 0 0Total liabilities 7,789 10,277 12,228 13,523 Total liabilities 10,424 11,212 11,624 12,228Common equity 1,188 1,314 1,497 1,693 Common equity 1,388 1,371 1,429 1,497Shareholders' equity 1,188 1,314 1,497 1,693 Shareholders' equity 1,388 1,371 1,429 1,497 Ratio Analysis (%) FY08A FY09A FY10E FY11E Ratio Analysis (%) 1Q10A 2Q10A 3Q10E 4Q10E Average loan growth 33.0% 32.5% 17.5% 15.0% Average loan growth 29.9% 21.9% 20.7% 17.5%Average earning assets growth (12.8%) 46.4% 21.4% 11.7% Average earning assets growth 57.1% 36.4% 24.8% 21.4%Average deposit growth 20.1% 19.5% 25.0% 15.0% Average deposit growth 28.7% 29.3% 34.4% 25.0%Avg loans / avg deposits 81.1% 89.9% 84.5% 84.5% Avg loans / avg deposits 87.4% 79.8% 81.3% 84.5% Net interest margin 20.0% 21.6% 21.9% 20.1% Net interest margin 24.6% 21.2% 21.5% 21.0%Efficiency ratio 10.3% 9.5% 10.5% 9.9% Efficiency ratio 11.0% 11.3% 10.5% 9.5%Return on assets (ROA) 2.9% 1.8% 1.2% 1.8% Return on assets (ROA) 1.5% (0.7%) 1.8% 2.1%Return on equity (ROE) 20.0% 15.1% 11.2% 16.4% Return on equity (ROE) 13.1% (6.1%) 16.5% 18.8% Tangible common equity ratio - - - - Tangible common equity ratio - - - -BIS ratio 24.2% 17.0% 17.6% 17.1% BIS ratio 14.8% 14.3% 18.0% 17.6% NPAs / gross loans 12.2% 10.5% 10.5% 10.2% NPAs / gross loans 10.8% 10.9% 10.7% 10.5%Net chargeoffs / average loans 5.0% 6.7% 5.8% 5.8% Net chargeoffs / average loans 6.4% 6.2% 6.0% 5.8%Loan loss reserves / loans 7.9% 6.6% 6.8% 7.0% Loan loss reserves / loans 6.4% 7.2% 7.0% 6.8%Loan loss reserves / NPLs 11.2% 8.1% 7.5% 6.9% Loan loss reserves / NPLs 2.1% 1.8% 1.8% 2.0% Source: Company reports and J.P. Morgan estimates. Note: R$ in Millions (except per-share data).


62


Food, Beverages & Tobacco Key sector dynamics LatAm beverage markets are mainly oligopolies with rational pricing and stable volume growth. Companies have seen aggregate sales CAGR of 12% last decade. They have little or no debt, robust margins and high ROICs. On the other side, LatAm food can be divided in two: packaged food companies with branded products, and meat/commodities beef companies with volatile margins (raw material and Fx). For tobacco, it is all about brands and pricing power while containing higher taxes and usage restrictions.

Growth characteristics and how they are changing Economics, demographics and specific company strategies should keep driving organic LatAm staples growth, especially in beverages. For the food sector we expect a confluence of both organic and inorganic growth as we expect consolidation in the food space to continue. In our view, tobacco sector growth will be driven mostly via pricing and innovation and despite stable to declining volumes.

Drivers of returns – Multiples and growth Emerging market staples are trading above developed markets’. This is a first. Plus, the LatAm staples group is already trading at a record premium of 70% over the rest of the LatAm MSCI. We don’t see this gap spreading further, but it should remain stable. A key valuation driver should be use of cash, specifically how much is returned to shareholders. These beverage and tobacco companies pose upside risks to increased dividends. Meat (beef) companies face a different challenges related to how to maintain or expand their low profitability and their delevering process.

Recommendations Despite some relatively rich valuations we still see as an opportunity FMX (OW) for EPS growth, CCU (OW) for its relative value and Modelo (OW) for event-driven growth. Among food companies, we prefer processed food powerhouse and poultry exporter Brasil Foods (OW). This company has a solid growth outlook and material upside risk to merger synergies. On our sole tobacco company, Souza Cruz, we currently remain Neutral on valuation. In one sentence, our sector has high-quality names that are not cheap but pose selected opportunities with the right risk/reward balance.

Alan Alanis AC


Bloomberg JPMA ALANIS <GO>

Top 8 LatAm bevcos more than tripled revenues ($ bn) this decade Robust top-line CAGR of 12% in the last decade – most of which was organic

16 17 17 20 2429

3542 45 45

50

102030405060

00 01 02 03 04 05 06 07 08 09 10ES

Source: Company reports and J.P. Morgan estimates for AmBev, FEMSA, Grupo Modelo, CCU, Coca-Cola FEMSA, Embotelladora Arca, Andina and Contal.

MSCI EM vs. Developed Market consumer staples, 12 mo. fwd P/E EM staples now trading at 15% premium vs. a 15-year avg. discount of 16%

5

15

25

35

Dec-95 Dec-97 Dec-99 Dec-01 Dec-03 Dec-05 Dec-07 Dec-09

MSCI DM Staples MSCI EM Staples

Source: Datastream.

MSCI LatAm Consumer Staples vs. MSCI LatAm, 12 mo. fwd P/E LatAm staples now trading at 70% premium to the market

49

141924

Dec-95 Dec-97 Dec-99 Dec-01 Dec-03 Dec-05 Dec-07 Dec-09

MSCI Latam Consumer Staples MSCI Latam

Source: Datastream.

MSCI LatAm Consumer Staples (index constituents) Company Weights AmBev PN 18.6% Walmex 15.6% FMX 11.7% BRFS 9.7% Cencosud 6.2% Natura 4.8% CRUZ3 4.0% Hypermarcas 4.0% Modelo 3.6% Kimber 3.5% CBD 3.2% Bimbo 2.7% JBS 2.4% KOF 2.3% Cosan 1.9% Exito 1.9% MRFG3 1.4% CCU 1.3% Conchatoro 1.2% Total 100%

Source: Datastream. In bold the names under our food, beverage and tobacco coverage.


63


Top picks and stocks to avoid Mkt cap P/E (x) EPS Div. yield ROE Price Code Rating (US$MM) 10E 11E 10E 11E 11E (%) 11E (%) Top picks FEMSA 26.4 CSMG3 OW 1,783 6.4 6.0 4.13 4.39 8.3 12.0 Brasil Foods 23.5 GETI4 OW 5,246 10.7 9.8 2.19 2.38 10.7 181.4 Stocks to avoid Minerva 40.4 CPFE3 UW 11,368 13.7 13.9 2.94 2.90 5.4 25.3 Source: Bloomberg, J.P. Morgan estimates. Note: Share prices and valuations are as of October 28, 2010.

Food and beverages absolute and relative to MSCI LatAm

0

100

200

300

400

500

600




Food and beverages EPS integer

70

80

90

100

110

120

130


2010

2011


Food and beverages 12 mth fwd PE

8

10

12

14

16

18

20

22

95 97 98 99 00 01 02 03 04 05 06 07 08 10

PE Av g +1SD -1SD


Food and beverages trailing PB

0.5

1

1.5

2

2.5

3

3.5

4

95 97 98 99 00 01 02 03 04 05 06 07 08 10

PB Av g +1SD -1SD



64


Brasil Foods BRFS3.SA www.perdix-international.com


World’s largest exporter of chicken Brasil Foods (BRFS3) is the merged entity of Perdigao and Sadia, the two leading poultry companies in Brazil. With $15bn in annual revenues, Brasil Foods is the fourth-largest protein co. in the world. It sells mainly poultry. Most BRFS sales are in the domestic Brazilian market, yet it is the global leader in chicken exports. Domestically, BRFS3 is the undisputed leader in processed foods, which have better margins than commodity proteins. The co. also sells pork, beef cuts, milk and other dairy products. Its operations are fully integrated, and it owns the largest number of consumer brands in Brazil. Undisputed leader in the growing Brazilian market Poultry has been the fastest-growing protein globally for well over a decade. Strong demand continues in Brazil and abroad. The premium in price of beef vs. chicken is well above the historical average. We expect beef prices to remain high; given this and recent increases in corn and soy prices, we estimate we are entering a year when prices for global poultry should increase. In this sense, Brasil Foods is well positioned to benefit from this situation. Potential for earnings upgrades – More synergies, less taxes For a LatAm meat company, Brasil Foods’ ’10e net debt to EBITDA of 1.9x is one of the lowest. Plus, once Brazil’s regulatory authority, CADE, approves the integration with Sadia, we believe the company is likely to positively surprise the market with synergies materially higher than its current guidance of R$500mn/year. Net net: with higher-than-expected FCF generation, we see upside risk to our ’11e EPS estimate of R$1.44 for BRFS3. Stock should at least maintain its valuation multiple Although at 8.5x ’11e EV/EBITDA and 17.0x ’11e P/E the stock does not look cheap, we believe these multiples have yet to capture the full value of the company given a) post integration BRFS will have unparalleled scale and pricing power in Brazil, b) that BRFS3 should be a key beneficiary of accelerated global growth in poultry market and, lastly, c) its potential to deliver higher-than-guidance synergies from the merger and yet-to-be-accounted tax benefits. Dec ’11 PT offers 27% potential upside – with some risks Using perpetuity growth of 3% and a WACC of 9.5%, our DCF model indicates a Dec ’11 PT of R$31 for BRFS3, implying 27% upside & a 2% div yield. Key risks are a) a weaker-than-expected rebound in poultry market; b) failure to deliver expected synergies; and c) Fx & grain price volatility.

Latin America Food, Beverage and Tobacco Alan Alanis AC



19

21

23

25

27

R$


Price Performance

Source: Bloomberg.


Absolute (%) 2.0 8.6 10.9

Source: Bloomberg.



31 Dec 11

BRF - Brasil Foods SA (BRFS3.SA;BRFS3 BZ) 2009A 2010E 2011E 2012EEBITDA FY (R$ mn) 1,222 2,340 2,970 3,655EV/EBITDA FY 19.9 10.9 8.6 7.0Revenues FY (R$ mn) 20,936 23,040 25,313 27,735EPS Reported FY (R$) 0.28 0.53 1.44 1.60P/E FY 88.5 46.0 17.0 15.3Source: Company data, J.P. Morgan estimates.


65


Brasil Foods SA: Summary of Financials Income Statement - Annual FY09A FY10E FY11E Income Statement - Quarterly 1Q10A 2Q10A 3Q10E 4Q10E Revenues 20,936 23,040 25,313 Revenues 5,047 5,532 5,924 6,537 Cost of goods sold (16,207) (16,867) (18,431) Cost of revenues (3,768) (4,018) (4,338) (4,743) Gross profit 4,729 6,173 6,881 Gross profit 1,279 1,514 1,586 1,794 SG&A (4,313) (4,639) (4,797) Other operating expenses (1,008) (1,121) (1,198) (1,313) LFL Operating income 416 1,534 2,084 Operating income 271 393 388 482 LFL EBITDA 1,222 2,340 2,970 EBITDA 447 587 595 710 Interest, net 588 (698) (598) Interest, net (156) (170) (211) (161) Pretax income 740 563 1,633 Pretax income 51 151 112 249 Equity income 0 - - Equity income 0 1 - - Income taxes (499) (71) (294) Income taxes 7 (13) (20) (45) Tax rate 67.3% 12.6% 18.0% Tax rate (13.7%) 8.6% 18.0% 18.0% Net income - operating 220 460 1,252 Net income - operating 53 131 86 191 Non-operating income / (expense) (263) (273) 147 Non-operating income / (expense) (64) (72) (65) (72) Net income - reported (GAAP) 241 463 1,255 Net income - reported (GAAP) 53 132 87 192 Diluted shares outstanding 872 872 872 Diluted shares outstanding 872 872 872 872 EPS (LFL) 0.28 0.53 1.44 EPS (LFL) 0.06 0.15 0.10 0.22 EPS - reported (GAAP) 0.28 0.53 1.44 EPS - reported (GAAP) 0.06 0.15 0.10 0.22 EPS - consensus (I/B/E/S) 0.76 0.80 1.32 EPS - consensus (I/B/E/S) 0.12 0.19 0.27 0.32

Balance Sheet and Cash Flow Data FY09A FY10E FY11E Ratio Analysis FY09A FY10E FY11E FY12E Cash and cash equivalents 4,244 2,967 3,101 Reported sales growth (5.4%) 10.0% 9.9% 9.6% Accounts receivable 1,787 2,149 2,282 organic growth (5.4%) 10.0% 9.9% 9.6% Inventories 3,101 3,350 3,605 volume change - - - - Current assets 10,446 9,683 10,327 price / mix change - - - - FX - - - - PP&E 9,275 9,382 9,562 Other - - - - Goodwill - - - Intangibles 3,792 3,825 3,825 Gross margin 22.6% 26.8% 27.2% 27.2% Total assets 25,714 25,681 26,821 SGA / sales - - - - EBIT margin 2.0% 6.7% 8.2% - Short-term debt 2,914 1,926 1,930 EBITDA margin 5.8% 10.2% 11.7% 13.2% Current liabilities 5,877 5,149 5,453 Return on equity (ROE) 1.8% 3.4% 8.8% 9.1% Return on invested capital (ROIC) - - - - Long-term debt 5,884 5,715 5,737 Total liabilities 12,575 12,118 12,520 EBITDA growth (47.4%) 91.5% 26.9% 23.0% EBIT growth (71.5%) 268.8% 35.9% - Shareholders' equity 13,135 13,558 14,293 Net income growth - operating - 92.4% 171.0% - EPS growth - operating - 92.4% 171.0% 0.0% Net Income (including charges) 241 463 1,255 D&A 806 807 886 Core operating cycle (days) - - - - Other adjustments - - - Working capital as % of sales - 15.2% 14.6% 14.6% Change in working capital 1,173 (255) (208) Cash flow from operations 3,007 887 1,689 Net debt 4,554 4,675 4,565 4,467 Net debt / EBITDA 3.2 1.9 1.5 1.2 Capex 1,198 887 1,266 Net debt / capital (book) 20.8% 22.1% 20.8% 19.4% Free cash flow 0 1,005 1,121 Free cash flow / share 0.00 1.15 1.29 P/E 89.4 46.5 17.2 15.4 Enterprise value / EBITDA 19.9 10.9 8.6 7.0 Cash flow from investing activities 894 (855) (1,266) Enterprise value / revenues 0.8 1.1 1.0 0.9 Cash flow from financing activities (5,142) (1,310) (289) FCF yield 0.0% 4.7% 5.2% 11.0% Share buybacks - - - Dividend yield 0.1% 0.7% 1.5% 1.6% Dividends 0.03 0.18 0.36 Market Cap / cash earnings - - - - CFO / FV - - - - Source: Company reports and J.P. Morgan estimates. Note: R$ in millions (except per-share data). Fiscal year ends Dec


66


FEMSA FMX www.femsa.com

Overweight $54.92 (28 Oct 10) Price Target: $59 End Date: Dec 2011

A consumer conglomerate FEMSA (FMX) is a holding company with three major investments: (a) 100% ownership of Oxxo, a chain of +8k convenience stores in Mexico that is among the fastest-growing and most profitable retailers in the region. (b) 54% ownership and full management control of Coca-Cola FEMSA (KOF), the largest Coke bottler in Latin America. KOF sells Coke products in nine Latin American countries – including Mexico and Brazil – for the equivalent of what would be more than 1 out of 10 Coke products in the world. (c) 20% ownership of Heineken, a leading global beer company. At a very attractive discount to the sum of its parts FMX’s valuation gets a deep discount for its corporate structure. We believe this is unmerited and unsustainable. Both Heineken and KOF are listed, so taking their current prices, we see Oxxo with an implied EV/EBITDA multiple of only 7x. This is half the current valuation of Walmex, Mexico’s leading retailer. Yet Oxxo has faster growth, better margins and more scale versus its competitors. Furthermore, Oxxo keeps opening stores at a pace of almost 3 per day. Working capital of the business is a beauty – all they sell is cash, all they buy is on credit. Payback for store investments is ~ 3 years. From a net cash position, FMX balance sheet is getting even stronger We expect dividends coming from Heineken to increase, as well as those coming from KOF. On top of that, Oxxo should continue to grow and expand its margins regardless of the economic scenario. Catalysts include higher dividends and continued growth FMX (ex-KOF) is already sitting on +$500mn of net cash. So absent any large acquisition, shareholders of FMX have material upside risk on dividends (currently 2% for ’11e). Also, we see room for multiple expansion if KOF resumes double-digit growth next year. Price target and risks Our PT for FMX is based on the PT of Heineken (rated N by JPM European beverages analyst Mike Gibbs), our Dec 11 PT of $79 for KOF, and a 14x ’11e EBITDA for Oxxo (similar to Walmex’s historical average). We apply a 10% holdco discount to obtain a Dec ’11 PT of $59. Key risks are macro, particularly around Fx. Also, volatility of Heineken and KOF stock prices.




40

44

48

52

56

$


Price Performance

Source: Bloomberg.


Absolute 3% 13% 22% Source: Bloomberg.

Overweight Company Data Price ($) 52.92Date Of Price 28 Oct 1052-week Range ($) 55.50 -


31 Dec 11

FEMSA (FMX;FMX US) 2009A 2010E 2011E 2012EEPS Reported FY ($) 2.11 2.90 3.38P/E Majority FY 26.0 18.9 16.2EBITDA FY ($ mn) 2,736 2,462 2,529EV/EBITDA FY 7.0 8.8 7.8Source: Company data, Bloomberg, J.P. Morgan estimates.


67


FEMSA: Summary of Financials Income Statement FY09A FY10E FY11E FY12E Balance Sheet FY09A FY10E FY11E FY12E Revenues 14,506 14,266 14,826 - Cash 1,350 2,475 3,349 - Cost of goods sold (7,816) (8,170) (8,662) - Accounts receivable 901 443 471 - SG&A (4,695) (4,195) (4,157) - Inventories 1,137 720 812 - Operating Profit (EBIT) 1,995 1,901 2,006 - Other current assets 366 393 425 - EBIT Margin 13.8% 13.3% 13.5% - Net PP&E 5,326 3,211 3,457 - Depreciation 741 560 523 - Goodwill - - - - EBITDA 2,736 2,462 2,529 - Other assets 1,679 737 1,003 - EBITDA margin 18.9% 17.3% 17.1% - Total assets 16,160 11,964 13,354 - Net Interest - - - - FX Gains (Losses) - - - - Short-term debt 678 207 178 - Monetary gains (losses) - - - - Accounts payable 2,777 1,867 1,886 - Other Nonoperarting income - - - - Other current liabilities 13 13 14 - EBT 1,403 1,850 1,946 - Long-term debt 2,585 1,520 1,300 - Taxes (441) (443) (490) - Pension plan and seniority premium 257 133 131 - Minority interest - - - - Other liabilities 13 13 14 - Extraordinary - - - - Total liabilities 7,293 5,081 4,781 - Net income 962 1,408 1,456 - Minority interest - - - - Shareholders' equity 8,867 11,701 13,213 - Number of ADRs (million) 358 358 358 - Liabilities + Equity 16,160 16,782 17,994 - EPADS 2.11 2.90 3.38 - Revenue growth (0.9%) (1.7%) 3.9% - EBITDA growth (1.7%) (10.0%) 2.7% - Net debt 1,912 (749) (1,870) - Gross Profit growth (1.2%) (8.9%) 1.1% - Net Debt/Equity 21.6% (6.4%) (14.2%) - Net Debt/Capital 15.8% (5.6%) (12.7%) - Net Debt/Annualized EBITDA 0.7 (0.3) (0.7) - Operating Data, Ratios FY09A FY10E FY11E FY12E Valuation, Macro FY09A FY10E FY11E FY12E Capex (1,012) (713) (680) - EV/EBITDA 7.0 8.8 7.8 - Change in working capital 217 (64) (120) - P/E 20.8 13.6 11.9 10.7 Free cash flow 908 1,191 1,180 - P/BV 2.1 1.6 1.4 - P/S 1.3 1.3 1.2 - Cash from Operating Activities 1,920 1,904 1,859 - FCF yield 5.0% 6.5% 6.5% - Dividend yield 0.6% 1.0% 1.5% - Cash from Investing Activities (1,012) (713) (680) - ROE 10.8% 12.0% 11.0% - Net income margin 6.6% 9.9% 9.8% - Cash from Financing Activities 302 (1,058) (495) - Net revenue/Assets 0.9 1.2 1.1 - Assets/Equity 1.8 1.0 1.0 - Net change in cash 1,210 133 685 - ROIC 12.8% 13.3% 15.5% - Net cash at Beginning 697 1,357 2,383 - Net Cash at End 1,907 1,489 3,068 - Dividends (124) (200) (294) - DCF Assumptions Dividend % of net income 12.9% 14.2% 20.2% - WACC Capex/depreciation 1.4 1.3 1.3 - Perpetual Growth CAPEX/sales 7.0% 5.0% 4.6% - Cost of equity Working capital 287 1,945 2,979 - Cost of debt Working capital/sales 2.0% 13.6% 20.1% - Source: Company reports and J.P. Morgan estimates. Note: $ in millions (except per-share data). Fiscal year ends Dec


68


Minerva BEEF3.SA www.minerva.com

Neutral R$6.14 (28 Oct 10) Price Target: R$8.10 End Date: Dec 2011

A sophisticated Brazilian exporter of beef Minerva (BEEF3) is the 3rd-largest beef producer in Brazil, with a slaughtering capacity of ~9k head/day in 10e. It’s a pure beef player that gets 70% of its revenues from exports. Minerva’s main products are fresh and processed beef, but the company is also Brazil’s largest live cattle exporter. Meat packers are seeing profit margin compression International beef prices are increasing, but not at the same pace as rising cattle prices. In fact, Brazilian cattle prices are now more expensive than in the US and Australia, the other two big players in the international beef market. Also, we don’t see much space for beef producers to increase prices domestically to protect margins as the beef price premium over chicken is above the historical average. Substitution toward poultry may accelerate. Hence we have a bearish view on the overall beef sector. This industry outlook leads us to believe that BEEF3 should be a stock to avoid in ’11, despite its professional and sophisticated management team. Volatility of earnings may continue Minerva’s involvement in complex financial instruments such as derivative hedges clouds earning estimates. Thus, consensus EPS estimates vary by orders of magnitude. At +4x net debt to EBITDA, Minerva is among the most levered companies in LatAm staples. We see limited potential for earnings upgrades, as these are likely to remain volatile for this producer of meat as a commodity (low-margin business). It may take many consistent (good) quarters for rerating up At 6x ’11e EV/EBITDA and 9x ’11e P/E Minerva looks inexpensive (thus our Neutral rating); but it is likely to remain that way, in our view. There is downside risk to its margins due to continued high cattle prices. Its lack of operating leverage gives limited scope for rerating. Dec. ’11 PT offers nice upside, but with high risks – Remain N Using perpetuity growth of 3% and a WACC of 10.7%, our DCF model indicates a Dec 11 PT of R$8.1 for BEEF3, implying ~30% upside. This apparent high return poses high risks, thus our relative skepticism. Furthermore, outstanding warrants (BEEF11) likely to be exercised would be dilutive. Add to macro and Fx risks, other risks inherent to the meat packing industry, such as changes in trade restrictions and further sector consolidation.




5.5

6.5

7.5

R$


Price Performance

Source: Bloomberg.


Absolute (%) -11% -10% 1%

Source: Bloomberg.

Neutral Company Data Price (R$) 6.14Date Of Price 28 Oct 1052-week Range (R$) 7.92 - 5.31Mkt Cap (R$ mn) 649.23Fiscal Year End DecShares O/S (mn) 106Price Target (R$) 8.10Price Target End Date 31 Dec 11

Minerva SA (BEEF3.SA;BEEF3 BZ) 2009A 2010E 2011E 2012EEBITDA FY (R$ mn) 182 238 282 324Revenues FY (R$ mn) 2,602 3,435 4,011 4,544EV/EBITDA FY 9.4 7.2 6.1P/E FY 6.2 NM 9.0 7.4EPS Reported FY (R$) 1.00 (0.08) 0.69 0.83Source: Company data, Bloomberg, J.P. Morgan estimates.


69


Minerva SA: Summary of Financials Income Statement - Annual FY09A FY10E FY11E Income Statement - Quarterly 1Q10A 2Q10A 3Q10E 4Q10E Revenues 2,602 3,435 4,011 Revenues 744 888 893 909 Cost of goods sold (2,132) (2,769) (3,233) Cost of revenues (611) (711) (718) (729) Gross profit 470 666 778 Gross profit 133 177 175 180 SG&A (329) (467) (536) Other operating expenses (92) (124) (124) (127) LFL Operating income 141 199 242 Operating income 41 53 51 54 LFL EBITDA 182 238 282 EBITDA 54 62 60 63 Interest, net (68) (186) (100) Interest, net (65) (67) (30) (24) Pretax income 73 1 123 Pretax income (23) (17) 17 25 Equity income - - - Equity income - - - - Income taxes 7 0 (30) Income taxes 0 0 0 0 Tax rate 10.0% 0.0% 24.0% Tax rate 0.0% 0.0% 0.0% 0.0% Net income - operating - - - Net income - operating - - - - Non-operating income / (expense) - - - Non-operating income / (expense) - - - - Net income - reported (GAAP) 81 1 94 Net income - reported (GAAP) (23) (17) 17 25 Diluted shares outstanding 105 135 135 Diluted shares outstanding 105 106 135 135 EPS (LFL) - - - EPS (LFL) - - - - EPS - reported (GAAP) 1.00 (0.08) 0.69 EPS - reported (GAAP) (0.22) (0.16) 0.12 0.18 EPS - consensus (I/B/E/S) 1.00 0.16 0.57 EPS - consensus (I/B/E/S) 0.09 0.12 0.15 0.11

Balance Sheet and Cash Flow Data FY09A FY10E FY11E Ratio Analysis FY09A FY10E FY11E FY12E Cash and cash equivalents 424 682 583 Reported sales growth 22.7% 32.0% 16.8% 13.3% Accounts receivable 199 189 216 organic growth - - - - Inventories 270 281 320 volume change - - - - Current assets 1,216 1,553 1,577 price / mix change - - - - FX - - - - PP&E 765 849 909 Other - - - - Goodwill - - - Intangibles - - - Gross margin 18.1% 19.4% 19.4% 19.5% Total assets 2,073 2,486 2,683 SGA / sales - - - - EBIT margin 5.4% 5.8% 6.0% 6.1% Short-term debt - - - EBITDA margin 7.0% 6.9% 7.0% 7.1% Current liabilities - - - Return on equity (ROE) 15.4% 0.1% 10.8% 11.8% Return on invested capital (ROIC) 4.9% 6.2% 6.6% - Long-term debt - - - Total liabilities 1,546 1,800 1,825 EBITDA growth 18.9% 30.5% 18.6% 14.9% EBIT growth 11.3% 40.9% 21.7% 15.2% Shareholders' equity 527 686 858 Net income growth - operating - - - - EPS growth - operating - - - 21.0% Net Income (including charges) 81 1 93 D&A 41 39 40 Core operating cycle (days) - - - - Other adjustments - - - Working capital as % of sales 21.1% 18.0% 17.4% 17.2% Change in working capital (15) (69) (79) Cash flow from operations 153 0 65 Net debt 799 761 820 877 Net debt / EBITDA - - - - Capex (138) (123) (100) Net debt / capital (book) - - - - Free cash flow - - - Free cash flow / share - - - P/E 6.1 NM 8.8 7.3 Enterprise value / EBITDA 9.4 7.2 6.1 - Cash flow from investing activities (138) (122) (100) Enterprise value / revenues 0.7 0.5 0.4 0.4 Cash flow from financing activities (33) 380 (63) FCF yield - - - - Share buybacks - - - Dividend yield 0.0% 0.0% - - Dividends 0.00 0.00 - Market Cap / cash earnings - - - - CFO / FV - - - - Source: Company reports and J.P. Morgan estimates. Note: R$ in millions (except per-share data). Fiscal year ends Dec


70


Homebuilders Key country dynamics We continue to prefer the Brazilian Homebuilders vs the Mexican names as we expect Brazil’s macroeconomic scenario to continue supporting the sector on the back of positive government participation and a robust growth outlook. Further, we believe the expected tightening in the Selic that could begin in 2011 represents only a marginal adjustment to government monetary policy and is already priced in. Despite cost pressures in Brazil, companies have been able to maintain margins given a positive outlook on housing prices. On the other hand, in Mexico companies are in a transition phase, moving more toward the AEL segment and also entering the informal sector (self employed and informal jobs) where there is high pent-up demand but not much mortgage availability yet. Moreover, the focus is now on free cash flow generation, which is still at question given its WC demands. Revenue growth should remain in the low double digits in the near term.

Growth characteristics and how they are changing Despite the positive outlook for all income segments in Brazil, given attractive mortgage conditions and pent-up demand, the companies have been increasing their exposure to the lower-income segment to benefit from the government’s housing program and its shorter cycle. In Mexico, the sector is still recovering from the credit crisis, which reduced mortgage availability, especially from Fovissste and banks (which are focused on the middle-income and residential segments). As a result, companies remain focused on the AEL segment and are in fact increasing their exposure further due to its resilient characteristics.

Drivers of returns – Multiples and growth We are not expecting multiple expansion in Brazil or in Mexico as in both countries companies are trading in line with their 12-month averages (around 10.0-11.0x), so earnings growth will drive the upside, in our view. However, we believe investors could pay a higher multiple in Mexico if the economic outlook improves and in Brazil if companies start to generate cash. Regarding growth, we assume a conservative view for all the companies.

Recommendations PDG is the top pick among the BZ HB as its earnings have upside potential on the back of the Agre acquisition. Geo is our top pick among the MX HB given its strong growth and potential improvement in margins. We recommend that investors avoid Cyrela given current uncertainties about future results.

Adrian Huerta AC *

(52 81) 8152-8720 [email protected] J.P. Morgan Casa de Bolsa, S.A de C.V., J.P. Morgan Grupo Financiero.P. Morgan Securities LLC

Bloomberg JPMA HUERTA <GO>

Selic should not have a negative impact on Brazilian homebuilders

-

50

100

150

200

250

300

May

-06

Aug-

06No

v-06

Feb-

07M

ay-0

7Au

g-07

Oct-0

7Fe

b-08

Apr-0

8Ju

l-08

Oct-0

8Ja

n-09

Apr-0

9Ju

n-09

Sep-

09De

c-09

Mar

-10

Jun-

10Au

g-10

Nov-

10Ja

n-11

Mar

-11

May

-11

Jul-1

1Se

p-11

Nov-

11

7.0

9.0

11.0

13.0

15.0

17.0BZ HB index Selic

Source: J.P. Morgan estimates and Bloomberg.

Working capital for MX continues to deteriorate Adj. Cash Conversion Cycle - In Days

0

100

200

300

400

500

1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10

Geo Homex Urbi

Source: Company reports.

BZ HB vs IBOV

70

80

90

100

110

120

130

Jan-

10

Feb-

10

Mar

-10

Apr-1

0

May

-10

Jun-

10

Jul-1

0

Aug-

10

Sep-

10

Oct-1

0

Ibov BZ HB

Source: J.P. Morgan estimates and Bloomberg.

MX HB vs Bolsa

20

40

60

80

100

120

Jan-

07

Apr-0

7

Jul-0

7

Oct-0

7

Jan-

08

Apr-0

8

Jul-0

8

Oct-0

8

Jan-

09

Apr-0

9

Jul-0

9

Oct-0

9

Jan-

10

Apr-1

0

Jul-1

0

Oct-1

0

Source: Bloomberg and J.P. Morgan estimates.

* Registered/qualified as a research analyst under NYSE/NASD rules.


71


Top picks and stocks to avoid Mkt cap P/E (x) EPS Div. yield ROE Price Code Rating (US$MM) 10E 11E 10E 11E 11E (%) 11E (%) Top picks PDG R$21.18 PDGR3 BZ OW 6,874 14.5 9.4 1.46 2.26 - 19.2% Geo Ps39.31 GEOB MM OW 1,747 12.2 9.7 3.23 4.08 - 22.0% Stocks to avoid Cyrela R$22.80 CYRE3 BZ UW 5,659 12.2 9.9 1.88 2.31 - 20.1% Source: Bloomberg, J.P. Morgan estimates. Note: Share prices and valuations are as of October 28, 2010.

Homebuilders absolute and relative to MSCI LatAm

0

100

200

300

400

500

600

700

800




Homebuilders EPS integer

90

100

110

120

130

140

150

160

170


2010

2011


Homebuilders 12 mth fwd PE

3

6

9

12

15

18

95 97 98 99 00 01 02 03 04 05 06 07 08 10

PE Av g +1SD -1SD


Homebuilders trailing PB

00.5

11.5

22.5

33.5

44.5

5

95 97 98 99 00 01 02 03 04 05 06 07 08 10

PB Av g +1SD -1SD



72


Corporacion Geo GEOB.MX www.corporaciongeo.com

Overweight Ps39.31 (28 Oct 10) Price Target: Ps52 End Date: Dec 2011

Company description Geo is the largest homebuilder in Mexico, selling more than 56k units per year and focused mainly on lower-income housing, with revenues of more than Ps18 bn in 2009. The company has operations in 17 states and 56 cities.

Investment case Geo is our top pick among the MX HB given its strong top-line growth of ~15% and its potential to improve operating margins. Also, the company has made significant progress on its debt profile and maintains the lowest net investment in land, which has helped it to post the highest ROEs among its peers at more than 20%.

Potential for earnings upgrades In the 1H10, the company grew more than expected, with revenues +14% yoy vs 8-11% guidance. Further, Geo released a 5-year target growth plan recently, and it expects to build 100K homes by 2015 (12.5% CAGR) and to expand gross margins by 3pp and SG&A by 1pp; however, in our estimates we are only incorporating a 1pp increase in gross margins to be conservative.

Prospects for re-/derating Despite the company’s robust growth plans, it trades at a discount to peers on P/E basis, given a lower net margin. This should change as Geo executes its growth plans, improves margins and starts to generate positive FCF.

Price target and risks We ate Geo Overweight with a Dec-11 price target of Ps52, which is the average of our DCF-based valuation and our GGM-based valuation. The COE of 10.6% is based on a beta of 1.2, country risk of 1.6%, and a risk-free rate of 3.0%, resulting in a WACC of 10.9%. We see lower-than-expected growth in revenues as the main downside risk. The company needs to generate significant FCF in 2H10 in order to be neutral to slightly positive in FCF for the year. Negative FCF for the year likely will be taken negatively by investors.

Mexico Homebuilders Adrian E Huerta AC *

(52 81) 8152-8720 [email protected] J.P. Morgan Casa de Bolsa, S.A de C.V., J.P. Morgan Grupo Financiero


32

35

38

41

Ps


Price Performance

Source: Bloomberg.


Absolute (%) 8 15 9 Relative (%) 2 8 -11


Company Data Price (Ps) 39.31Date Of Price 28 Oct 1052-week Range (Ps) 44.60 -

30.75Mkt Cap (Ps mn) 21,084.15Fiscal Year End DecShares O/S (mn) 536Price Target (Ps) 52.00Price Target End Date

31 Dec 11

Corporacion Geo (GEOB.MX;GEOB MM) 2008A 2009A 2010E 2011EEPS Reported FY (Ps) 2.75 2.85 3.23 4.08Bloomberg EPS FY (Ps) 3.10 3.25 3.04 3.58EBITDA FY (Ps mn) 4,119 4,401 4,515 5,201Revenues FY (Ps mn) 17,453 19,211 19,821 22,361Source: Company data, Bloomberg, J.P. Morgan estimates. 'Bloomberg' above denotes Bloomberg consensus estimates.


73


Corporacion Geo: Summary of Financials Income Statement - Annual FY08A FY09A FY10E FY11E Balance Sheet FY08A FY09A FY10E FY11E Net Revenues 17,453 19,211 19,821 22,361 Cash 2,578 3,393 4,474 4,252 Cost of goods sold (11,662) (13,135) (13,442) (15,053) Accounts receivable 8,346 9,877 815 919 Gross profit 5,791 6,076 6,379 7,308 Inventories 10,462 12,247 22,474 25,307 Gross margin 33.2% 31.6% 32.2% 32.7% Land bank 4,852 4,901 5,131 5,742 SG&A (1,672) (1,676) (1,864) (2,107) Real Estate & Construction 5,610 7,346 17,343 19,566 Other Operating Expenses - - - - Others current assets 731 861 1,296 1,296 EBIT 2,914 3,306 3,286 3,893 Net PP&E 1,717 2,010 2,050 2,106 Depreciation (277) (276) (456) (503) Other assets 919 1,381 747 747 EBITDA 4,119 4,401 4,515 5,201 Total Assets 25,141 30,227 32,382 35,233 EBITDA margin, % 23.6% 22.9% 22.8% 23.3% ST Loans 4,523 2,660 2,774 2,774 Financial income 102 124 81 134 Accounts Payables 2,812 3,836 4,075 4,735 Financial expense (614) (667) (660) (628) Suppliers 2,011 3,298 3,375 3,780 Other Nonoperating income (7) (70) (60) (70) Land Payables 801 538 699 955 Equity income - - - - Other current liabilities 1,775 1,610 3,055 3,055 EBT 2,293 2,620 2,647 3,329 LT Debt 2,921 5,587 6,473 6,473 Taxes (731) (963) (794) (999) Deffered taxes 2735.8 3616.6 4013.6 4013.6 Minority interest (89) (107) (119) (140) Other non current liabilities 1,775 1,610 3,055 3,055 Extraordinary - - - - Total Liabilities 14,821 18,609 21,690 22,350 Net income 1,473 1,529 1,734 2,191 Minority Interests 942 1,749 1,487 1,487 Net income margin 8.4% 8.0% 8.7% 9.8% Shareholders Equity 10,320 11,618 10,339 12,530 EPS 2.75 2.85 3.23 4.08 Liabilities and Equity 25,141 30,227 32,029 34,880 Net Revenue growth 16.5% 10.1% 3.2% 12.8% Net debt 4,866 4,853 4,773 4,995 EBITDA growth 15.8% 6.8% 2.6% 15.2% Net Debt/Equity 52% 49% 54% 45% Net income growth 1.7% 3.8% 13.4% 26.4% Debt/Equity 79% 84% 104% 84% FCF growth (75.2%) (692.1%) (8.4%) 2.1% NetDebt/EBITDA 118% 110% 106% 96% Operating Data, Ratios FY08A FY09A FY10E FY11E Valuation, Macro FY08A FY09A FY10E FY11E Working Capital changes (3,763) (2,292) (2,285) (2,278) EV/EBITDA 6.0 5.4 5.3 4.7 FCFF-firm (247) 1,461 1,337 1,365 land adj. 6.0 5.4 5.3 4.7 Dividends - - - - P/E 14.5 14.0 12.4 9.8 Dividend % of net income - - - - land adj. - - 12.0 9.5 P/BV 2.2 2.1 2.4 1.9 P/CE 7.9 7.3 8.0 7.7 Working capital 15,996 18,288 19,214 21,492 Working capital/sales 91.7% 95.2% 96.9% 96.1% FCF yield (1.2%) 7.0% 6.4% 6.6% Units 51,879 56,559 57,443 62,424 Dividend yield 0.0% 0.0% 0.0% 0.0% Avg. price/Unit (Ps '000) 336 340 345 358 Capex/Revenues 3.3% 3.0% 2.5% 2.5% Cash Earnings 2,651 2,865 2,587 2,694 Units chg 13% 9% 2% 9% Coverage EBIT/Interest) 6.7 6.6 6.8 8.3 Avg.price/Unit chg 3% 1% 2% 4% ROE 17.1% 15.9% 18.5% 22.0% Days receivable 175 188 15 15 ROIC 21.3% 20.1% 18.8% 16.9% Days inventory 327 340 610 614 Shares 536 536 536 536

adj. (excl. land) 176 204 471 474 Days payable 88 107 111 115 WACC 10.9% -

adj. (excl. land) 63 92 92 92 Perpetual Growth 4.0% - Cash Conversion Cycle 414 421 515 514 Cost of equity 10.6% - Adj. Cash Conversion Cycle 287 300 394 398 Cost of debt 11.2% - Source: Company reports and J.P. Morgan estimates. Note: Ps in millions (except per-share data). Fiscal year ends Dec.


74


PDG Realty PDGR3.SA www.pdgrealty.com.br


Company description PDG became the largest market cap (around USD6.9bn) company among the BZ HB after acquiring AGRE early in the year, thereby gaining exposure to the mid- and high-income segments and now having exposure to all income segments. The company is geographically diversified, has one of the best management teams among its peers, with a strong focus on cash flows and with management interest aligned with minority shareholders.

Investment case We believe that the recent acquisition of AGRE will provide room for stronger top-line growth versus peers’ and will allow the company to deliver one of the highest operating margins in the industry. PDG also offers opportunities to improve AGRE’s lower ROEs through better operating efficiencies and lower financial expenses.

Potential for earnings upgrades We believe that the company offers one of the highest potential upsides to earnings given the lack of track record for the combined company as PDG has only reported one quarter consolidating AGRE. We believe investors are still conservative on growth and margin assumptions for PDG.

Prospects for re-/derating Currently PDG is trading at 9.4 P/E 11E, in line with Cyrela and Rossi and at a discount to MRV; however, we believe that if margins improve and growth accelerates, it could trade at least in line with MRV’s multiples.

Price target and risks We rate PDG Overweight with a Dec-11 price target of R$30, which is the average of our DCF-based valuation and GGM-based valuation. The COE of 11.6% used is based on a beta of 1.3x, country risk of 2.1%, and a risk-free rate of 3.0%, resulting in a WACC of 10.5%. The main risks to our positive view are lower-than-expected synergies from the AGRE acquisition impacting our forecasts on growth and margins resulting in lower-than-expected results. Given its significant exposure to lower income, through Goldfarb, PDG can also be impacted by changes in MCMV policy and CEF execution capabilities.

Brazil Homebuilders Adrian E Huerta AC *



12

16

20

24

R$


Price Performance

Source: Bloomberg.


Absolute (%) 2 15 51 Relative (%) 10 34




31 Dec 11

PDG Realty (PDGR3.SA;PDGR3 BZ) 2009A 2010E 2011EEPS Reported FY (R$) 0.87 1.46 2.26EBITDA FY (R$ mn) 417 1,366 1,878P/E FY 24.4 14.5 9.4Revenues FY (R$ mn) 1,984 5,332 7,498Bloomberg EPS FY (R$) 0.93 1.50 2.19Source: Company data, Bloomberg, J.P. Morgan estimates.


75


PDG Realty: Summary of Financials Income Statement - Annual FY09A FY10E FY11E FY12E Balance Sheet FY09A FY10E FY11E FY12E Net Revenues 1,984 5,332 7,498 7,883 Cash 1,099 723 268 1,250 Cost of goods sold (1,294) (3,253) (4,724) (4,966) Accounts receivable 2,509 6,282 7,806 7,775 Gross profit 690 2,080 2,774 2,917 Inventories 1,678 3,805 4,406 4,629 Gross margin 29.0% 33.0% 32.0% 32.0% Land bank 1,010 2,205 2,315 2,431 SG&A (268) (713) (886) (937) Real Estate & Construction 668 1,600 2,091 2,199

Selling expenses (129) (316) (424) (451) Others current assets 177 617 617 617 G&A (140) (397) (462) (486) Net PP&E 82 86 64 40

Depreciation (5) (43) (60) (63) Other assets 308 629 629 629 EBITDA 417 1,366 1,878 1,990 Total Assets 6,103 13,295 14,944 16,094 EBITDA margin, % 21.0% 25.6% 25.0% 25.2% ST Loans 543 1,833 2,025 2,025 Financial income 79 230 203 239 Accounts Payables 788 1,394 1,568 1,647 Financial expense (27) (210) (106) (111) Suppliers 640 292 411 432 Other Nonoperating income 21 0 0 0 Land Payables 148 1,102 1,157 1,215 Equity income - - - - Other current liabilities 165 362 362 362 EBT 371 1,023 1,540 1,661 LT Debt 963 1,973 2,181 2,181 Taxes (37) (199) (265) (278) Deffered taxes 87.8 51.6 51.6 51.6 Minority interest 4 (21) (32) (35) Other liabilities 165 362 362 362 Extraordinary 0 0 0 0 Total Liabilities 3,142 7,241 7,815 7,894 Net income 338 803 1,244 1,348 Minority Interests 20 101 133 168 Net income margin 17.0% 15.1% 16.6% 17.1% Shareholders Equity 2,961 6,054 7,129 8,200 EPS 0.87 1.46 2.26 2.45 Liabilities and Equity 6,103 13,295 14,944 16,094 Net Revenue growth 61.1% 168.8% 40.6% 5.1% Net debt 407 3,083 3,938 2,956 EBITDA growth 62.7% 227.7% 37.5% 6.0% Net Debt/Equity 14% 52% 56% 37% Net income growth 85.3% 137.5% 54.8% 8.4% Debt/Equity 51% 64% 60% 52% FCF growth 27.2% 1.3% (64.6%) (514.6%) NetDebt/EBITDA 98% 226% 210% 149% Operating Data, Ratios FY09A FY10E FY11E FY12E Valuation, Macro FY09A FY10E FY11E FY12E Working Capital changes (1,439) (2,201) (1,952) (113) EV/EBITDA 15.6 6.6 5.3 4.5 FCFF-firm (1,048) (1,062) (376) 1,559 P/E 24.4 14.5 9.4 8.7 Dividends - - - - P/BV 1.5 1.0 0.9 0.8 Dividend % of net income 13.5% 10.5% 16.1% 23.1% P/CE - - - - Working capital 3,399 8,692 10,644 10,757 FCF yield 0.0% 0.0% 0.0% 0.0% Working capital/sales 171.4% 163.0% 142.0% 136.5% Dividend yield 0.6% 0.7% 1.7% 2.7% Launches (Co's share) 3,027 7,000 8,400 9,240 Capex/Revenues (0.6%) (0.5%) (0.5%) (0.5%) Pre-sales (Co's share) 2,670 6,577 7,712 8,201 Inventory/Revenues 84.6% 71.4% 58.8% 58.7% Units 32,129 58,333 67,308 71,191 Assets/Equity 207.5% 223.3% 213.6% 200.4% Price/M2 158 150 156 162 Coverage (EBIT/Interest) - - - - Price/Unit 159 165 172 177 ROE 15.3% 15.0% 19.2% 17.9% Launches chg 16% 131% 20% 10% ROIC 12.4% 12.8% 15.2% 14.6% Pre-sales chg 47% 146% 17% 6% Shares 390 551 551 551 Units chg 14% 82% 15% 6% Price/M2 chg (29%) (5%) 4% 4% WACC 10.5% Perpetual Growth 3.0% Days receivable 462 430 380 360 Cost of equity 11.6% Days inventory 473 427 340 340 Cost of debt 8.6% Days payable 147 96 77 77 Source: Company reports and JPMorgan estimates. Note: R$ in millions (except per-share data). Fiscal year ends Dec


76


Cyrela Brazil Realty CYRE3.SA www.cyrela.com.br


Company description Cyrela is the second-largest homebuilder in Brazil in market cap and is considered a premium player in the sector given its long track record. The company is a diversified player, acting on the lower-income segment via its “Living” brand, which launched more than 16k units in 2009, representing 40% of its total launches. Cyrela is present in 66 cities and 16 states, having one of best geographic diversifications, with a land bank of R$34.9bn in PSV.

Investment case It is our stock to avoid given the lack of good results in 1H10 as the company launched only 24% of full-year guidance vs 40-50% from peers, and also due to weakening margins in recent quarters on the back of higher-than-expected costs.

Potential for earnings upgrades We see limited room for positive earnings surprise in the short term, and given its increasing focus on the lower-income segment, margins are not likely to improve from the levels seen in recent quarters. It is important to flag that in the last 3 quarters Cyrela reported higher-than-expected project costs.

Prospects for re-/derating Despite its weak results in 1H10 Cyrela is trading in line with peers at 9.9x P/E 11E and 2.3x P/BV. We believe these valuations already reflect a potential recovery in 2H10 and 2011 results.

Price target and risks We rate Cyrela Underweight with a Dec-11 price target of R$29, which is the average of our DCF-based valuation and GGM-based valuation. The COE of 11.6% used is based on a beta of 1.30, country risk of 2.1%, and a risk-free rate of 3.0%, resulting in a WACC of 10.3%. The main upside risks to our price target and rating include better-than-expected margins as we are assuming a conservative approach on the name given the weak results in 2Q. We are also not incorporating company launch and presale guidance for 2012, which, if it follows plan, could result in higher-than-expected growth in the coming years.

Brazil Homebuilders Adrian E HuertaAC



16

20

24

R$


Price Performance

Source: Bloomberg.


Absolute (%) -8 -2 7 Relative (%) -9 -7 -10




31 Dec 11

Cyrela Brazil Realty (CYRE3.SA;CYRE3 BZ) 2009A 2010E 2011E 2012EEPS Reported FY (R$) 1.73 1.88 2.31 2.56EBITDA FY (R$ mn) 921 1,101 1,374 1,449P/E FY 13.2 12.2 9.9 8.9Revenues FY (R$ mn) 4,088 5,215 6,150 6,461Bloomberg EPS FY (R$) 1.70 1.81 2.24 2.83Source: Company data, Bloomberg, J.P. Morgan estimates.


77


Cyrela Brazil Realty: Summary of Financials Income Statement - Annual FY09A FY10E FY11E FY12E Balance Sheet FY09A FY10E FY11E FY12E Net Revenues 4,088 5,215 6,150 6,461 Cash 1,666 1,002 1,882 3,036 Cost of goods sold (2,639) (3,384) (3,966) (4,168) Accounts receivable 4,917 6,429 6,739 6,550 Gross profit 1,449 1,830 2,183 2,294 Inventories 3,362 3,856 4,055 4,258 Gross margin 34.5% 33.8% 34.0% 33.5% Land bank 2,256 2,579 2,708 2,844 SG&A (572) (763) (875) (914) Real Estate & Construction 1,106 1,276 1,346 1,415

Selling expenses (291) (412) (461) (485) Others current assets 293 402 402 402 G&A (281) (351) (414) (430) Net PP&E 241 276 282 288

Depreciation (36) (52) (61) (65) Other assets 60 72 72 72 EBITDA 921 1,101 1,374 1,449 Total Assets 10,551 12,049 13,444 14,620 EBITDA margin, % 22.5% 21.1% 22.3% 22.4% ST Loans 392 537 574 574 Financial income 211 303 347 394 Accounts Payables 306 464 542 569 Financial expense (225) (237) (265) (224) Suppliers 292 357 421 443 Other Nonoperating income 111 5 5 5 Land Payables 306 464 542 569 Equity income - - - - Other current liabilities 1,948 2,302 2,394 2,489 EBT 941 1,054 1,308 1,431 LT Debt 2,231 2,337 2,499 2,499 Taxes (73) (130) (147) (154) Deffered taxes 177.5 194.9 204.7 214.9 Minority interest (98) (104) (123) (129) Other liabilities 1,948 2,302 2,394 2,489 Extraordinary 0 0 0 0 Total Liabilities 6,445 7,239 7,735 7,944 Net income 729 793 975 1,081 Minority Interests 253 339 462 591 Net income margin 17.8% 15.2% 15.9% 16.7% Shareholders Equity 4,105 4,810 5,710 6,676 EPS 1.73 1.88 2.31 2.56 Liabilities and Equity 10,551 12,049 13,444 14,620 Net Revenue growth 43.6% 27.6% 17.9% 5.1% Net debt 957 1,871 1,192 37 EBITDA growth 98.4% 19.6% 24.8% 5.5% Net Debt/Equity 25% 42% 23% 1% Net income growth 162.7% 8.8% 22.9% 10.8% Debt/Equity 68% 64% 59% 51% FCF growth 358.5% (62.9%) (258.4%) 56.3% NetDebt/EBITDA 104% 170% 87% 3% Operating Data, Ratios FY09A FY10E FY11E FY12E Valuation, Macro FY09A FY10E FY11E FY12E Working Capital changes (2,072) (1,429) (276) 130 EV/EBITDA 12.5 11.2 8.4 7.1 FCFF-firm (1,413) (524) 830 1,297 P/E 13.5 12.4 10.1 9.1 Dividends 0 0 0 0 P/BV 0.9 0.8 0.7 0.6 Dividend % of net income 0.0% 0.0% 0.0% 0.0% P/CE - - - - Working capital 7,973 9,820 10,252 10,239 FCF yield (13.1%) (4.9%) 7.7% 12.0% Working capital/sales 195.0% 188.3% 166.7% 158.5% Dividend yield 0.0% 0.0% 0.0% 0.0% Launches (Co's share) 4,465 5,450 6,268 6,894 Capex/Revenues (3.9%) (1.1%) (1.1%) (1.1%) Pre-sales (Co's share) 4,088 5,032 5,720 6,274 Inventory/Revenues 82.2% 73.9% 65.9% 65.9% Units 26,417 40,370 44,640 47,216 Assets/Equity 273.8% 269.5% 256.2% 240.3% Price/M2 0 0 0 0 Coverage (EBIT/Interest) 3.7 4.2 4.6 5.6 Price/Unit 207 195 203 209 ROE 24.4% 19.1% 20.1% 19.1% Launches chg 18% 22% 15% 10% ROIC 11.3% 11.6% 12.4% 11.8% Pre-sales chg 18% 23% 14% 10% Shares 422 423 423 423 Units chg - - - - Price/M2 chg - - - - WACC 10.3% Perpetual Growth 3.0% Days receivable 439 450 400 370 Cost of equity 11.6% Days inventory 465 416 373 373 Cost of debt 8.1% Days payable 227 197 179 178 Source: Company reports and J.P. Morgan estimates. Note: R$ in millions (except per-share data). Fiscal year ends Dec.


78


Metals & Mining Key sector dynamics The key themes for the metals and mining sector in 2011 should be (1) the outlook for China’s commodity demand, (2) the pace of global economic growth, (3) industry fundamentals, and (4) government regulations. China remains the center stage of global commodity demand and should be strong in 2011 (partially offsetting weakness in the developed world) – it should announce its 12th 5-year plan in 1Q11, which our China economist believes will re-emphasize its commitment to urbanization and infrastructure development. The outlook for different subsectors appears to be mixed, and we believe iron ore and copper will be outperformers in 2011 as their supply remains tight relative to steel, which should continue to be in gross overcapacity. Finally, government regulations should be a source of noise, especially for the miners, but further clarity should ease concerns.

Growth characteristics and how they are changing Given J.P. Morgan expects the global economy to grow at 3.0% in 2011, the sector should continue to build on the growth shown in 2010. However, we highlight two key points: (1) Emerging economies should grow at a faster rate compared to the developed ones (5.8% vs. 1.9%), led by China (9.0%); and (2) The growth should be relatively moderate compared to 2010e.

Drivers of returns – Multiples and growth We believe the main drivers of returns will be both sector/stock rerating/derating as well as changing earnings expectations for the different subsectors. We highlight steel as a sector in whixh we see risks of downward revision of earnings, and a potential derating as the industry could stabilize at a lower normal given slower recovery in demand as well as weaker margins. Iron ore and copper, on the other hand, should benefit from both upward revision of estimates and a potential rerating, mainly as the overhang of government influence eases as more clarity emerges on regulations.

Recommendations Within miners, we recommend Vale (OW) and Grupo Mexico (OW) as the best vehicles to gain exposure to iron ore and copper, respectively, our favored commodities. We remain cautious on the steel sector, especially Brazilian flat steels, and see Usiminas (UW) as the most exposed to (1) the deteriorating pricing environment, and (2) higher raw material costs that we do not expect to subside meaningfully until 2014.

Rodolfo R. De Angele, CFA AC

(55-11) 3048-3888 [email protected] Banco J.P. Morgan S.A.

Bloomberg: JPMA ANGELE <GO>

Global GDP should grow by 3.0% in ’11, driven by EMs, especially China

4% 3%2% 2%

7% 6%

10% 9%

0%

2%

4%

6%

8%

10%

2010 2011

% Y

oY

Global Dev eloped markets Emerging markets China Source: J.P. Morgan estimates.

World steel capacity utilization remains much below pre-crisis peak of 91%, even though production is close to pre-crisis levels

60708090

100110120130

Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10

50%

60%

70%

80%

90%

100%Global steel output World steel capacity utilization

Source: Bloomberg.

Brazilian flat-steel imports have stabilized at high levels

0

100

200

300

400

500

Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10

0%5%10%15%

20%25%30%35%Flat-steel imports (LHS) Imports as a % of Apparent Consumption

Source: SECEX/MDIC, IAB (Brazilian Steel Institute) and J.P. Morgan.

In valuation terms, miners remain at a discount to the steelmakers

7.55.9

8.66.1

7.65.2

6.95.1

15.812.111.4

9.2

2010E 2011ELatam Steel Global Steel Latam Mining ex -Precious

Global Mining ex -Precious Latam Precious Metals Global Precious Metals



79


Top picks and stocks to avoid Mkt cap P/E (x) EPS Div. yield ROE Price Code Rating (US$MM) 10E 11E 10E 11E 11E (%) 11E (%) Top picks Vale $31.80 VALE OW 163,216 10.2 7.4 2.92 4.13 3.0 23.3 Grupo Mexico Ps40.44 GMEXICOB OW 25,453 17.5 10.9 0.19 0.30 5.1 24.6 Stocks to avoid Usiminas R$20.96 USIM5 UW 12,386 21.2 12.1 1.02 1.88 2.95.4 xx.xx Source: Bloomberg, J.P. Morgan estimates. Note: Share prices and valuations are as of October 28, 2010. Vale price refers to ONs. Price for PNs was $28.29.

Metals & Mining absolute and relative to MSCI LatAm

0

200

400

600

800

1000

1200




Metals & Mining EPS integer

70

80

90

100

110

120

130

140

150

160


2010

2011

Source: MSCI, Bloomberg, IBES, Datastream, J.P. Morgan. Metals & Mining 12 mth fwd PE

3

6

9

12

15

18

95 97 98 99 00 01 02 03 04 05 06 07 08 10

PE Av g +1SD -1SD


Metals & Mining trailing PB

0

0.51

1.5

2

2.53

3.5

4

95 97 98 99 00 01 02 03 04 05 06 07 08 10

PB Av g +1SD -1SD



80


Grupo Mexico GMEXICOB.MX www.gmexico.com

Overweight Ps40.44 (28 Oct 10) Price Target: Ps53 End Date: Dec 2011

Company description Grupo Mexico is one of the largest copper producers in globally, and has copper operation in Mexico, Peru and the US through its subsidiaries SCCO (80%) and Asarco (100%). The company has a $5.6B expansion plan in place that should increase its copper capacity by ~600kt to over 1.5Mtpy. It also has railroad operations in Mexico and controls a leading market share through its two subsidiaries Ferromex (56%) and Ferrosur (75%).

Investment case We remain bullish on copper prices and see GMex as a unique copper growth story with large capex expansions in regions with relatively stable business environments. In addition, we view Asarco as a hidden asset in GMex’s portfolio, especially with copper above $8,000/t. Finally, GMex trades at a 31% discount to its NAV, which is unwarranted, in our view, and we believe it should trade at a ~15% discount that incorporates any concerns related to the “holding” nature of the company. Trading at 5.4x ’11e EBITDA, it remains cheap vs. SCCO at 8.9x and peers at 5.7x.

Potential for earnings upgrades We remain 4% above consensus on ’11e EBITDA and believe consensus should move up as we see more upgrades on copper price assumptions.

Prospects for re-/derating We see multiple potential catalysts for rerating of GMex shares over the next 12 months – a SCCO-Asarco merger and the IPO of the railroad business, which should bring transparency to GMex valuation. On the other hand, potentially any significant increase in hedging of copper production may cause a derating as investors may not get the desired exposure to copper prices.

Price target and risks We base our price target and OW rating on GMex on an SOTP analysis – Dec’11 PT of Ps53.0 ($4.32/sh at JPMe FX rate for end-11 of Ps12.25/USD), assuming a holding company discount of 15%. The main downside risks are (1) weaker copper and moly prices; (2) appreciation of USD vs. MXN or PEN; (3) slower global growth, especially China; (4) recurrence of mining strikes; and (5) revocation of railroad concessions, weaker domestic economy, etc.

Mexico Metals & Mining Rodolfo R. De Angele, CFA AC


Bloomberg: JPMA ANGELE <GO>

26

30

34

38

42

Ps


Price Performance

Source: Bloomberg.


Absolute (%) 12.1 22.4 24.8 Relative (%) 4.9 11.8 17.4

Source: Bloomberg.

Note: Prices as of close on 28th October, 2010. Performance in USD relative to Mexican Bolsa.

Company Data Price (Ps) 40.44Date Of Price 28 Oct 1052-week Range (Ps) 42.00 -

25.52Mkt Cap (Ps mn) 314,825.40Fiscal Year End DecShares O/S (mn) 7,785Price Target (Ps) 53.00Price Target End Date

31 Dec 11

Grupo Mexico (GMEXICOB.MX;GMEXICOB MM) 2009A 2010E 2011E 2012EEPS - Recurring FY ($) 0.12 0.18 0.30 0.40Revenues FY ($ mn) 4,785 7,981 10,599 12,828EBITDA FY ($ mn) 2,126 3,768 5,588 7,323EV/EBITDA FY 16.3 8.2 5.4 4.1P/E FY 28.8 17.5 10.9 8.1Source: Company data, Bloomberg, J.P. Morgan estimates.


81


Grupo Mexico: Summary of Financials Income Statement FY09A FY10E FY11E FY12E FY13E Balance Sheet FY09A FY10E FY11E FY12E FY13E Revenues 4,785 7,981 10,599 12,828 14,897 Cash 1,335 4,093 4,929 4,987 5,518 COGS ex D&A (2,519) (4,012) (4,740) (5,178) (5,998) Accounts receivable 628 800 987 1,195 1,388 SG&A (140) (201) (270) (327) (380) Inventories 825 600 701 766 887 Depreciation (407) (590) (628) (648) (707) Other current assets 688 589 727 880 1,022 EBITDA 2,126 3,768 5,588 7,323 8,519 Total Current Assets 3,475 6,081 7,344 7,828 8,815 EBITDA margin 44.4% 47.2% 52.7% 57.1% 57.2% Net PP&E 5,698 6,864 7,547 8,226 8,737 Financial income 91 62 168 168 168 Other assets 2,394 1,624 2,005 2,427 2,818 Financial expense (130) (302) (341) (349) (319) Total assets 11,567 14,570 16,897 18,480 20,370 FX & Monetary gains (losses) 0 0 0 - - Short-term debt 570 211 240 219 211 Other Nonoperarting income 10 (11) 35 43 50 Accounts payable 0 0 0 0 0 Equity income 0 0 0 0 0 Other current liabilities 906 1,359 1,678 2,031 2,358 EBT 1,689 2,927 4,822 6,536 7,711 Total Current Liabilities 1,476 1,570 1,917 2,250 2,569 Taxes (559) (1,045) (1,760) (2,386) (2,815) Long-term debt 2,848 3,852 4,375 4,006 3,850 Minority interest (165) (458) (750) (1,017) (1,200) Deferred taxes 0 0 0 0 0 Extraordinary (80) 28 26 27 29 Other liabilities 798 1,817 2,243 2,715 3,152 Net income 886 1,452 2,338 3,160 3,726 Total liabilities 5,122 7,239 8,536 8,971 9,571 Net Income Recurring 965 1,424 2,312 3,133 3,697 Minority Interests 1,390 1,429 1,429 1,429 1,429 Net income margin (recurring) 20.2% 17.8% 21.8% 24.4% 24.8% Shareholders' equity 5,055 5,902 6,932 8,080 9,369 EPS 0.11 0.19 0.30 0.41 0.48 Liabilities + Equity 11,567 14,570 16,897 18,480 20,370 EPS Recurring 0.12 0.18 0.30 0.40 0.47 Revenue growth (19.5%) 66.8% 32.8% 21.0% 16.1% Net debt 2,083 (30) (314) (761) (1,457) EBITDA growth (25.6%) 77.3% 48.3% 31.0% 16.3% Net Debt/Capital 24.6% (0.3%) (2.7%) (6.2%) (10.8%) Net income growth (17.3%) 63.9% 61.0% 35.2% 17.9% Debt/Capital 40.3% 40.8% 40.0% 34.3% 30.2% FCF growth (186.1%) (410.3%) (44.4%) 48.1% 23.5% Net Debt/EBITDA 1.0 (0.0) (0.1) (0.1) (0.2) Operating Data, Ratios FY09A FY10E FY11E FY12E FY13E Valuation, Macro FY09A FY10E FY11E FY12E FY13E Capex 599 719 1,311 1,327 1,218 EV/EBITDA 16.3 8.2 5.4 4.1 3.4 Change in working capital 1,170 (547) 150 110 170 P/E 26.4 17.9 11.0 8.1 6.9 Free cash flow (1,371) 4,255 2,366 3,505 4,329 P/BV 5.0 53.3 45.4 39.0 33.6 Dividends 445 764 1,308 2,012 2,436 EV/tonne 4,386 4,267 3,136 2,565 1,889 Dividend % of net income 50.3% 52.6% 55.9% 63.7% 65.4% FCF yield (0.4%) 1.4% 0.8% 1.1% 1.4% Capex/depreciation 1.5 1.2 2.1 2.0 1.7 Dividend yield 1.7% 3.0% 5.1% 7.9% 9.6% CAPEX/sales 12.5% 9.0% 12.4% 10.3% 8.2% ROE 17.5% 24.6% 33.7% 39.1% 39.8% Working capital 1,354 807 957 1,067 1,236 Net income margin 20.2% 17.8% 21.8% 24.4% 24.8% Working capital/sales 28.3% 10.1% 9.0% 8.3% 8.3% Net revenue/Assets 41.4% 54.8% 62.7% 69.4% 73.1% Assets/Equity 2.3 2.5 2.4 2.3 2.2 Shipments 507 482 645 775 1,024 ROIC 11.7% 18.0% 24.3% 30.9% 33.4% Avg price/t 9,438 16,570 16,441 16,559 14,541 Shares 7,785 7,785 7,785 7,785 7,785 Cash COGS/t 4,969 8,329 7,353 6,684 5,855 ADRs - - - - - EBITDA/t 4,192 7,823 8,669 9,453 8,316 WACC 9.9% Shipments chg 0.3% (5.0%) 33.8% 20.2% 32.2% Perpetual Growth 3.0% Avg price/t chg (19.8%) 75.6% (0.8%) 0.7% (12.2%) Cost of equity Cash COGS/t chg (13.7%) 67.6% (11.7%) (9.1%) (12.4%) Cost of debt EBITDA/t chg (25.8%) 86.6% 10.8% 9.0% (12.0%) Capex 599 719 1,311 1,327 1,218 Maintenance 176 327 271 311 384 Expansion 423 392 1,040 1,015 834 Source: Company reports and J.P. Morgan estimates. Note: $ in millions (except per-share data). Fiscal year ends Dec.


82


Vale VALEp www.vale.com

Overweight PN $28.29 (28 Oct 10) Price Target (PN): $41.50 End Date: Dec 2011

Company description The world’s 2nd-largest miner, largest iron ore producer, and 2nd-largest nickel producer also produces manganese, alloys, thermal & coking coal, bauxite, alumina, aluminum, copper, cobalt, fertilizers. Most operations are in Brazil, with presence in Canada (Inco), other LatAm, Africa, Indonesia, China.

Investment case We remain bullish iron ore and China commodity demand. Given Vale’s cost-leadership, reserve quality and expected growth, we believe it is best leveraged to benefit from this tightness. The current share price fails to capture the potential, in our view. Our model suggests the current share price implies $53/t (FOB Brazil) for fines; low vs a current and YTD average of ~$120/t. At 4.9x ’11e EBITDA, Vale is cheap vs. respective historical and peer averages of 6.8x and 5.6x, and more than discounts higher capex and royalties/taxation concern.

Potential for earnings upgrades Iron ore market remains very tight, and given the steep cost curve, marginal increase in demand can lift prices sharply and, in our view, presents the biggest potential for earnings upgrades. Similarly, higher prices for other commodities could add similar upside risks, and vice versa.

Prospects for re-/derating Vale could rerate if concerns related to a slowdown in the global economy (double dip) mitigate and/or investor optimism on China demand improves further (announcement of China’s 12th 5-year plan could reinforce this). In addition, detailed disclosure of Vale’s capex plan as well as clarity on new regulations for the industry should help by removing potential overhangs. If these concerns continue or become more widespread, the stock may derate.

Price target and risks We base our Overweight and price target for Vale PNs on a combination of DCF and an EV/EBITDA multiple of 7.5x, and use a WACC of 9.2% and 3% perpetuity growth. We then add a “voting share” premium of 14% (historical average) to arrive at our fair value for Vale ONs. Risks are a weaker-than-expected global economy, especially China; harsher-than-expected government regulation; capex delay and/or cost run-ups; and higher operating costs.

Brazil Metals & Mining Rodolfo R. De Angele AC


Bloomberg JPMA ANGELE <GO>

Price performance (PN - US$)

1620242832

Oct-09 Feb-10 Jun-10 Oct-10

Source: Bloomberg Performance

1M 3M 12M Absolute (%) 4.3 17.5 32.3 Relative (%) 3.1 9.3 12.5

Source: Bloomberg

Overweight Com pany Data Price ($) 28.29Date Of Price 28 Oct 1052-week Range ($) 29.67 -

19.89Mkt Cap ($ mn) 151,784.75Fiscal Year End DecShares O/S (mn) 5,365Price Target ($) 41.50Price Target End Date

31 Dec 11

Com. Vale do Rio Doce (CVRD) (VALEp;VALE/P US) 2009A 2010E 2011E 2012EEPS - Recurring FY ($) 1.00 3.02 4.13 4.62Revenues FY ($ mn) 23,311 41,995 54,963 61,085EBITDA FY ($ mn) 9,629 24,188 34,785 38,832EV/EBITDA FY 17.7 7.0 4.8 4.1P/E (USD) FY 28.8 9.5 7.0 6.2Source: Company data, Bloomberg, J.P. Morgan estimates. (1) P/E multiples calculated assuming 100% PNs. P/E multiples, considering ONs as well, are 10.3x, 7.4x and 6.6x for '10, '11 and '12, respectively. (2) Shares O/S in the 'Company Data' table represents the total number of shares outstanding for Vale, i.e. ONs and PNs.


83


Vale PN: Summary of Financials Income Statement FY09A FY10E FY11E FY12E FY13E Balance Sheet FY09A FY10E FY11E FY12E FY13E Revenues 23,311 41,995 54,963 61,085 57,600 Cash 11,040 19,359 31,110 51,339 63,607 COGS ex D&A (11,030) (14,466) (16,483) (18,332) (19,099) Accounts receivable 3,120 7,633 9,987 11,090 10,460 SG&A (1,130) (1,548) (2,026) (2,252) (2,124) Inventories 3,196 4,589 5,305 5,845 6,093 Depreciation (2,722) (3,033) (3,744) (3,957) (4,136) Other current assets 3,938 3,986 5,215 5,791 5,462 EBITDA 9,629 24,188 34,785 38,832 34,804 Total Current Assets 21,294 35,567 51,617 74,065 85,622 EBITDA margin 41.3% 57.6% 63.3% 63.6% 60.4% Net PP&E 68,810 79,416 89,816 99,256 105,611 Financial income 381 282 282 469 766 Other assets 12,175 22,528 27,231 28,775 26,319 Financial expense (1,558) (2,076) (2,076) (2,646) (3,167) Total assets 102,279 137,512 168,664 202,097 217,553 FX & Monetary gains (losses) 675 119 (305) (304) (283) Short-term debt 2,982 4,071 4,071 4,071 4,071 Other Nonoperarting income (2,503) (2,633) (2,717) (2,874) (2,814) Accounts payable 2,309 3,862 5,054 5,612 5,293 Equity income 433 1,169 1,308 1,358 1,088 Other current liabilities 3,890 6,080 7,955 8,834 8,332 EBT 6,952 18,640 27,895 31,189 26,744 Total Current Liabilities 9,181 14,014 17,080 18,517 17,696 Taxes (2,100) (3,485) (6,695) (7,485) (6,419) Long-term debt 19,898 26,844 33,589 40,350 45,294 Minority interest (107) (141) (332) (296) (286) Deferred taxes - - - - - Extraordinary 171 (151) 0 0 0 Other liabilities 12,703 23,014 24,980 31,493 29,134 Net income 5,349 16,033 22,176 24,766 21,127 Total liabilities 41,782 63,871 75,649 90,359 92,124 Net Income Recurring 5,178 16,184 22,176 24,766 21,127 Minority Interests 3,562 4,811 6,890 8,277 9,291 Net income margin (recurring) 22.2% 38.5% 40.3% 40.5% 36.7% Shareholders' equity 56,935 68,830 86,125 103,461 116,137 EPS 1.00 2.99 4.13 4.62 3.94 Liabilities + Equity 102,279 137,512 168,664 202,097 217,553 EPS Recurring 1.00 3.02 4.13 4.62 3.94 Revenue growth (37.7%) 80.2% 30.9% 11.1% (5.7%) Net debt 11,840 11,555 6,549 (6,918) (14,243) EBITDA growth (52.8%) 151.2% 43.8% 11.6% (10.4%) Net Debt/Capital 14.2% 11.1% 5.0% (4.4%) (8.1%) Net income growth (59.6%) 199.7% 38.3% 11.7% (14.7%) Debt/Capital 27.4% 29.6% 28.8% 28.4% 28.2% FCF growth (124.3%) (480.9%) 76.2% 33.5% 2.7% Net Debt/EBITDA 1.2 0.5 0.2 (0.2) (0.4) Operating Data, Ratios FY09A FY10E FY11E FY12E FY13E Valuation, Macro FY09A FY10E FY11E FY12E FY13E Capex (11,024) (12,826) (15,384) (14,688) (11,822) EV/EBITDA 17.7 7.0 4.8 4.1 4.4 Change in working capital 17 (2,210) (1,232) (783) (110) P/E 28.4 9.4 6.8 6.1 7.2 Free cash flow (1,958) 7,459 13,143 17,545 18,027 P/BV 1.8 2.4 1.9 1.6 1.4 Dividends (2,724) (3,000) (4,881) (7,430) (8,451) EV/tonne 727 643 576 502 439 Dividend % of net income 50.9% 18.7% 22.0% 30.0% 40.0% FCF yield (1.3%) 4.9% 8.6% 11.5% 11.8% Capex/depreciation 4.0 4.2 4.1 3.7 2.9 Dividend yield 1.8% 2.0% 3.2% 4.9% 5.6% CAPEX/sales 47.3% 30.5% 28.0% 24.0% 20.5% ROE 9.4% 23.3% 25.7% 23.9% 18.2% Working capital 4,055 6,265 7,497 8,280 8,390 Net income margin 22.2% 38.5% 40.3% 40.5% 36.7% Working capital/sales 17.4% 14.9% 13.6% 13.6% 14.6% Net revenue/Assets 22.8% 30.5% 32.6% 30.2% 26.5% Assets/Equity 1.8 2.0 2.0 2.0 1.9 Shipments 247,261 281,284 308,962 330,012 363,340 ROIC 6.6% 18.8% 20.7% 19.1% 14.7% Avg price/t 94 149 178 185 159 Shares 5,365 5,365 5,365 5,365 5,365 Cash COGS/t 45 51 53 56 53 ADRs 5,365 5,365 5,365 5,365 5,365 EBITDA/t 39 86 113 118 96 WACC 9.2% Shipments chg (16.5%) 13.8% 9.8% 6.8% 10.1% Perpetual Growth 3.0% Avg price/t chg (25.4%) 58.4% 19.2% 4.0% (14.4%) Cost of equity 11.1% Cash COGS/t chg (10.9%) 15.3% 3.7% 4.1% (5.4%) Cost of debt 8.8% EBITDA/t chg (43.5%) 120.8% 30.9% 4.5% (18.6%) Capex (11,024) (12,826) (15,384) (14,688) (11,822) Maintenance (2,158) (2,270) (2,539) (3,051) (3,570) Expansion (8,866) (10,557) (12,845) (11,637) (8,251) Source: Company reports and JPMorgan estimates. Note: $ in millions (except per-share data). Fiscal year ends Dec


84


Usiminas USIM5.SA www.usiminas.com.br


Company description Usiminas is the largest flat-steel producer in Brazil, with ~9.5Mtpy of crude steel capacity. It has two plants – its original plant in Ipatinga and the plant of former Cosipa in the state of São Paulo. The company produces a broad range of steel products and is the main domestic supplier for the automotive and auto parts industries in Brazil. Aside from this, USI also owns iron ore mines and has interests in logistics and capital goods assets.

Investment case We expect the outlook for Usiminas to continue to be challenging in the medium term, driven by deteriorating fundamentals for the Brazilian flat-steel industry. Imports into Brazil, in our view, are here to stay as Brazil lacks rolling capacity to supply the flat-steel demand in the domestic market, keeping prices as well as domestic premiums under pressure. In addition, the company should continue to suffer higher raw material costs, which we believe are unlikely to subside meaningfully until 2014. We see potential in USI’s mining unit, but there are challenges related to finding a viable solution for the port.

Potential for earnings downgrades We believe there are downside risks to the consensus expectations for domestic steel prices, as premiums should remain under pressure, driven by continued strong inflow of imports and a strong Real. In addition, we expect raw material prices to remain tight, keeping margins under check. Finally, a potential delay in the recovery of heavy plates should cause further downside to earnings.

Prospects for re-/derating Global steel supply discipline (resulting in higher prices) and any weakening in raw material costs should help rerate Usiminas. In addition, a solution to the port issues and/or a potential IPO of the mining unit could rerate the stock.

Price target and risks We rate Usiminas UW based on our Dec 11 price target of R$26/share UPDATE, which is derived from a combination of DCF (80%) and multiples (20%). We use a WACC of 10.9%, perpetuity growth of 3% and target EV/EBITDA of 5.0x (historical average). The main upside risks are related to depreciation in BRL, higher international steel prices and potential increases in steel import duties.

Brazil Metals & Mining Rodolfo R. De Angele AC


Bloomberg JPMA ANGELE <GO>

Price performance (R$)

18

22

26

30

R$


Price Performance

Source: Bloomberg.


Absolute (%) -17.8 -9.3 -8.3 Relative (%) -10.8 -29.0 -21.3

Source: Bloomberg.


19.57Mkt Cap (R$ mn) 21,215.63Fiscal Year End DecShares O/S (mn) 1,012Price Target (R$) 26.00Price Target End Date

31 Dec 11

Usiminas (USIM5.SA;USIM5 BZ) 2009A 2010E 2011E 2012E 2013EEPS - Recurring FY (R$) 1.10 1.02 1.88 2.45 2.63Revenues FY (R$ mn) 10,924 14,183 16,049 17,831 18,103EBITDA FY (R$ mn) 1,715 3,230 4,413 5,503 5,572Bloomberg EBITDA FY (R$ mn)

1,537 3,113 4,202 5,103

EV/EBITDA FY 16.3 7.8 6.1 5.2 5.3P/E (USD) FY 24.6 23.4 13.3 10.7 10.2Source: Company data, Bloomberg, J.P. Morgan estimates. 'Bloomberg' above denotes Bloomberg consensus estimates.


85


Usiminas: Summary of Financials Income Statement FY09A FY10E FY11E FY12E FY13E Balance Sheet FY09A FY10E FY11E FY12E FY13E Revenues 10,924 14,183 16,049 17,831 18,103 Cash 3,083 6,477 5,097 5,345 6,052 COGS ex D&A (8,465) (10,119) (10,732) (11,413) (11,601) Accounts receivable 1,793 2,113 2,247 2,496 2,534 SG&A (740) (870) (824) (826) (839) Inventories 3,637 3,996 4,238 4,507 4,581 Depreciation (975) (822) (917) (1,073) (1,143) Other current assets 815 780 882 980 995 EBITDA 1,715 3,230 4,413 5,503 5,572 Total Current Assets 9,329 13,366 12,464 13,328 14,162 EBITDA margin 15.7% 22.8% 27.5% 30.9% 30.8% Net PP&E 11,562 14,580 17,059 18,172 19,453 Financial income 378 394 618 478 499 Other assets 4,857 5,149 5,595 6,022 6,087 Financial expense (627) (999) (1,326) (1,403) (1,494) Total assets 25,747 33,094 35,118 37,522 39,702 FX & Monetary gains (losses) 818 (372) (270) (222) (27) Short-term debt 917 785 739 781 832 Other Nonoperarting income 251 (187) (211) (234) (238) Accounts payable 815 1,068 1,063 1,130 1,149 Equity income 40 211 221 243 234 Other current liabilities 1,506 1,471 1,665 1,850 1,878 EBT 1,599 1,454 2,528 3,291 3,403 Total Current Liabilities 3,238 3,324 3,466 3,761 3,859 Taxes (489) (419) (628) (810) (740) Long-term debt 6,124 9,280 8,734 9,239 9,839 Minority interest 0 0 0 0 0 Deferred taxes - - - - - Extraordinary 128 0 0 0 0 Other liabilities 812 921 1,042 1,157 1,175 Net income 1,239 1,035 1,901 2,481 2,663 Total liabilities 10,173 13,525 13,241 14,157 14,873 Net Income Recurring 1,111 1,035 1,901 2,481 2,663 Minority Interests 355 377 377 377 377 Net income margin (recurring) 10.2% 7.3% 11.8% 13.9% 14.7% Shareholders' equity 15,219 19,193 21,500 22,988 24,453 EPS 1.22 1.02 1.88 2.45 2.63 Liabilities + Equity 25,747 33,094 35,118 37,522 39,702 EPS Recurring 1.10 1.02 1.88 2.45 2.63 Revenue growth (30.4%) 29.8% 13.2% 11.1% 1.5% Net debt 3,957 3,588 4,376 4,675 4,619 EBITDA growth (71.5%) 88.3% 36.7% 24.7% 1.3% Net Debt/Capital 17.8% 12.3% 14.1% 14.2% 13.2% Net income growth (62.8%) (16.4%) 83.6% 30.5% 7.3% Debt/Capital 31.6% 34.4% 30.6% 30.4% 30.4% FCF growth (110.9%) (522.6%) (62.7%) (345.5%) 36.7% Net Debt/EBITDA 2.3 1.1 1.0 0.8 0.8 Operating Data, Ratios FY09A FY10E FY11E FY12E FY13E Valuation, Macro FY09A FY10E FY11E FY12E FY13E Capex 2,061 3,392 3,396 2,186 2,424 EV/EBITDA 16.3 7.8 6.1 5.2 5.3 Change in working capital 811 (488) (309) (400) (86) P/E 22.4 21.3 12.1 9.8 9.3 Free cash flow 364 (1,540) (574) 1,409 1,926 P/BV 1.5 1.2 1.1 1.0 1.0 Dividends 700 461 665 992 1,198 EV/tonne 4,928 3,838 3,759 3,599 3,498 Dividend % of net income 56.5% 44.5% 35.0% 40.0% 45.0% FCF yield 1.6% (6.6%) (2.5%) 6.0% 8.2% Capex/depreciation 2.1 4.1 3.7 2.0 2.1 Dividend yield 3.3% 2.2% 3.1% 4.7% 5.6% CAPEX/sales 18.9% 23.9% 21.2% 12.3% 13.4% ROE 8.1% 5.4% 8.8% 10.8% 10.9% Working capital 4,164 4,651 4,960 5,360 5,446 Net income margin 10.2% 7.3% 11.8% 13.9% 14.7% Working capital/sales 38.1% 32.8% 30.9% 30.1% 30.1% Net revenue/Assets 42.4% 42.9% 45.7% 47.5% 45.6% Assets/Equity 1.7 1.7 1.6 1.6 1.6 Shipments 5,631 7,065 7,407 7,805 8,007 ROIC 2.4% 5.6% 8.1% 9.7% 9.4% Avg price/t 1,940 2,007 2,167 2,285 2,261 Shares 1,012 1,012 1,012 1,012 1,012 Cash COGS/t 1,503 1,432 1,449 1,462 1,449 ADRs - - - - - EBITDA/t 305 457 596 705 696 WACC 10.9% Shipments chg (21.5%) 25.5% 4.8% 5.4% 2.6% Perpetual Growth 3.0% Avg price/t chg (11.4%) 3.5% 7.9% 5.4% (1.0%) Cost of equity Cash COGS/t chg 22.2% (4.7%) 1.2% 0.9% (0.9%) Cost of debt EBITDA/t chg (63.6%) 50.1% 30.4% 18.3% (1.3%) Capex 2,061 3,392 3,396 2,186 2,424 Maintenance 476 439 466 506 531 Expansion 1,585 2,957 2,930 1,680 1,893 Source: Company reports and JPMorgan estimates. Note: R$ in millions (except per-share data). Fiscal year ends Dec.


86


Oil, Gas & Petrochemicals It’s all about creating economic value. The value chain of oil production has many moving parts, but at the end of the day what matters here as in any other business is adding value to the base of capital employed. Production growth, backlog growth and asset growth matter little if the returns on new investments don’t cover the cost of capital, in our view.

Bullish oil curve favors all; one must be selective An improved outlook for oil prices has emerged in tandem with global currency issues benefiting the earnings outlook of the sector as a whole. As always, we favor portfolios that can beat the performance of the underlying commodity. Services & equipment are now a large portion of our coverage, and there we focus on exposure to capex trends and superior earnings power relative to peers.

Integrated oils: Petrobras and Ecopetrol are both national oil companies (NOCs) with the mandate to supply the domestic fuels market. This imposes significant pressure on their E&P segments to keep replenishing reserves. Historically PBR has done a great job, but we are worried about its ability to add value on the recent asset purchase for $43 billion. In the meantime Ecopetrol is expanding production of low-cost barrels and finding new ways to boost its exploration success.

E&P: The appeal of independent E&P names keeps growing; emphasis remains on exploration. The market will operate in 2011 with 2 new players in Brazilian E&P, HRT and Karoon. The heavyweight remains OGX, which was our top pick in 2010. In Colombia, juniors are spreading, with adult names being scarce.

Services & equipment: The cycle stage still appears to favor exploration over development, and the key is gaining exposure to capex trends. Tenaris is enhancing positioning with minimal investments but more importantly it stands to benefit from cost reductions. Lupatech is investing in value-neutral ventures in order to gain access to new sources of revenue.

Petrochemicals: The change in scope of PBR’s Comperj project changed drastically the outlook for Braskem in the Brazilian market.

Recommendations Our top picks for 2011 are Tenaris (TS US), the world’s most profitable OCTG producer, and Pacific Rubiales (PRE CN), the largest and most dynamic independent E&P producer in Colombia.

Sergio Torres AC


Bloomberg JPMA TORRES <GO>

Integrated oils EV/DACF 10E 11E 12E

Petrobras 9.5x 9.5x 10.4xPetrochina 7.7x 7.2x 6.6x

Ecopetrol 18.3x 14.1x 12.5xMajors 5.8x 5.2x 4.9x

Sinopec 6.1x 5.4x 5.0x

P/E 10E 11E 12EPetrobras 9.8x 12.2x 12.2x

Petrochina 13.2x 12.8x 12.0xEcopetrol 25.6x 17.9x 14.9x

Majors 9.6x 8.8x 8.3xSinopec 9.4x 8.2x 8.0x

Source: J.P.Morgan estimates, Bloomberg.

E&P EV/EBITDA 10E 11E 12E

OGX n.m n.m n.mPacific Rubiales 9.1x 4.5x 3.4x

Gran Tierra Energy 5.0x 3.9x 3.1xLatam Peers 10.2x 9.8x 6.8xGlobal Peers 28.2x 7.3x 20.4x

EV/BOE 2P 2P+2C JPMeOGX n.m 9.9 5.9

Pacific Rubiales 30.3 13.5 9.6 Gran Tierra Energy 56.7 34.6 7.4

Latam Peers 14.0 6.0 n.mGlobal Peers 18.5 11.2 10.7

Source: J.P.Morgan estimates, Bloomberg.

Oil services & equipment EV/EBITDA 10E 11E 12E

Tenaris 11.3x 7.9x 7.0x Vallourec 6.2x 7.9x 6.6x

TMK 8.1x 6.2x 4.8x Lupatech 14.4x 9.2x 5.9x

P/E 10E 11E 12ETenaris 20.0x 15.9x 14.0x

Vallourec 25.3x 12.3x 10.2x TMK 20.2x 11.0x 7.2x

Lupatech n.m 16.8x 13.3x Source: J.P.Morgan estimates, Bloomberg.


87


Top picks and stock to avoid Mkt cap P/E (x) EPS Div. yield ROE Price Code Rating (US$MM) 10E 11E 10E 11E 11E (%) 11E (%) Top picks Pacific Rubiales 31.69 PRE CN OW 36.4 13.2 0.90 2.43 - 15.2 Tenaris 41.33 TS US OW 11.4 7.9 2.11 2.68 - 13.3 Avoid Lupatech 21.55 LUPA3 BZ N 604 16.8 13.3 0.11 1.28 - 1.0 Source: Bloomberg, J.P. Morgan estimates. Note: Share prices and valuations are as of October 28, 2010.

Energy absolute and relative to MSCI LatAm

0200400600800

100012001400160018002000




Energy EPS integer

70

80

90

100

110

120

130

140


2010

2011

Source: MSCI, Bloomberg, IBES, Datastream, J.P. Morgan. Energy 12 mth fwd PE

3

6

9

12

15

18

95 97 98 99 00 01 02 03 04 05 06 07 08 10

PE Av g +1SD -1SD


Energy trailing PB

00.5

11.5

22.5

33.5

44.5

95 97 98 99 00 01 02 03 04 05 06 07 08 10

PB Av g +1SD -1SD



88


Pacific Rubiales Energy PRET.TO www.pacificrubiales.com

Overweight C$31.69 (28 Oct 10) Price Target: C$36 End Date: Dec 2011

Pacific Rubiales is the largest independent E&P company in Colombia and the second-largest operator after NOC Ecopetrol. PRE has been a successful growth and value play since 2009. In our view, PRE’s low risk development story is already priced in, but we believe that the risk/reward is still attractive. PRE is our favorite stock to play the potential of heavy oil in Colombia.

Low-risk exploration in attractive prospects should drive value in 2011. PRE has 2P reserves of 269 mn boe but has identified ~628 mn bbl of prospective oil resources in Colombia and Peru. PRE’s track record in exploration is over 80% success in Colombia, and it has recently acquired exploration licenses in onshore Guatemala that are believed to be exposed to a continuation of the onshore basins in Mexico.

Our price target is not fully loaded. We are conservative in our NAV assumptions because we are only assuming half of the prospective resource estimated by PRE. Our estimates have upside from further drilling success that could confirm the company’s prospective figures, from the gas export project that could start in 2013 and from further analysis of the prospects in Guatemala and block CPO-12 in Colombia.

The company still trading at compelling multiples. PRE is trading at 3.7x EV/EBITDA for 2011e. Our Dec’11 target price of C$36/share implies an EV/EBITDA exit multiple of 3.9x 2012e. With the company having doubled production in 2010 to 67 kboed (net after royalties), we expect production to grow 67% in 2011 and 22% in 2012, excluding exploration potential.

Main risks: 1) unsuccessful exploratory drilling; 2) uncertainty over capital expenditures; 3) disappointing results at Rubiales field tests for secondary recovery; and 4) a decline in oil prices.

Colombia Exploration & Production Sergio Torres AC



10

20

30

C$


Price Performance

Source: Bloomberg, J.P.Morgan.


Absolute (%) 15 29 29


Company Data Price (C$) 31.69Date Of Price 28 Oct 1052-week Range (C$) 33.58 -

12.86Mkt Cap (C$ mn) 8,356.65Fiscal Year End DecShares O/S (mn) 264Price Target (C$) 36.00Price Target End Date

31 Dec 11

Pacific Rubiales Energy Corp (PRE.TO;PRE CN) 2009A 2010E 2011E 2012EEPS FY ($) (0.54) 0.90 2.43 2.39Bloomberg EPS FY ($) (0.40) 1.05 2.49 2.96P/E FY NM 35.1 13.0 13.2EBITDA FY ($ mn) 222 898 1,705 1,976EV/EBITDA FY 33.8 7.6 3.7 2.7ROE FY (10.2%) 18.2% 34.1% 24.1%ROCE FY (10.2%) 18.5% 44.9% 45.4%Source: Company data, Bloomberg, J.P. Morgan estimates. 'Bloomberg' above denotes Bloomberg consensus estimates.


89


Pacific Rubiales: Summary of Financials Income Statement - Annual FY09A FY10E FY11E FY12E Income Statement - Quarterly 1Q10A 2Q10A 3Q10E 4Q10E Revenues 639 1,633 3,132 3,452 Revenues 381 - - - Cost of products sold (488) (993) (1,931) (2,229) Cost of products sold (196) - - - Gross profit 151 640 1,200 1,223 Gross profit 184 - - - SG&A (125) (115) (160) (178) SG&A (62) - - - DD&A (196) (396) (701) (797) DD&A (65) - - - Other operating expenses (292) (597) (1,231) (1,431) Other operating expenses (131) - - - Operating Income 26 525 1,040 1,045 Operating Income 122 - - - EBIT 26 525 1,040 1,045 EBIT 122 - - - EBITDA 222 898 1,705 1,976 EBITDA 187 - - - Net interest income / (expense) (48) (84) (61) (53) Net interest income / (expense) (14) - - - Income applicable to minority interests 2 0 0 0 Income applicable to minority interests 0 - - - Pretax income (109) 430 999 1,011 Pretax income 81 - - - Taxes (46) (142) (300) (303) Taxes (49) - - - Tax rate (%) - - - - Tax rate (%) - - - - Reported net income (154) 288 699 708 Reported net income 32 - - - Non-recurring items, disc ops - - - - Non-recurring items, disc ops - - - - Adjusted net income (154) 288 699 708 Adjusted net income 32 - - - Average diluted shares outstanding 283 283 283 283 Average diluted shares outstanding 292 - - - EPS (0.54) 0.90 2.43 2.39 EPS 0.11 - - - EPS growth rate (%) - (287.7%) 142.6% 1.2% EPS growth rate (%) - - - - Dividend per share 0.00 0.00 0.00 0.00 Dividend per share 0.00 - - - WTI crude price ($/bbl) 61.66 79.50 86.00 83.00 WTI crude price ($/bbl) 78.76 - - - Henry Hub natural gas price ($/mcf) 3.44 3.50 3.65 3.58 Henry Hub natural gas price ($/mcf) 3.51 - - - Balance Sheet and Cash Flow Data FY09A FY10E FY11E FY12E Ratio Analysis FY09A FY10E FY11E FY12E Cash and cash equivalents 399 568 1,363 2,377 Valuation Other current assets 21 21 21 21 P/E (adjusted) (59.9) 31.9 13.2 13.0 Total current assets 594 763 1,558 2,572 P/CF 24.0 44.3 9.3 7.3 Net PP&E 1,991 1,991 1,991 1,991 Enterprise value/EBITDA 33.8 7.6 3.7 2.7 Other assets 177 177 177 177 EV/DACF 54.2 7.7 4.6 3.2 Total assets 2,763 2,932 3,727 4,740 Ratios Total debt 621 621 651 651 Net debt/equity 14.8% 3.2% (29.3%) (50.0%) Total liabilities 1,262 1,262 1,292 1,292 Net debt/capital 29.3% 27.1% 21.1% 15.9% Minority interests - - - - Net coverage ratio 4.6 10.4 24.8 25.7 Preferred stock - - - - ROE (10.2%) 18.2% 34.1% 24.1% Shareholders' equity 1,501 1,670 2,436 3,449 ROCE (10.2%) 18.5% 44.9% 45.4% Net Income (154) 288 699 708 Yield and cash returns DD&A (196) (396) (701) (797) CFPS 1.31 0.71 3.39 4.30 Deferred taxes - - - - CF yield (241.1%) 69.5% 136.8% 171.8% Other - - - - FCF yield - - - - Cash earnings 26 525 1,040 1,045 Dividend yield 0.0% 0.0% 0.0% 0.0% Change in working capital (87) 0 0 0 Dividend payout ratio 0.0% 0.0% 0.0% 0.0% Cash flow from operations 111 695 1,380 1,486 Buyback yield - - - - Capex (393) (853) (613) (473) Total cash returns (%) 573.0% 31,588.8% 67,971.8% 69,153.6% Dividends 0 0 0 0 Share buybacks (net) - - - - Change in debt 426 0 30 0 Mkt Cap (current) ($bn) 8.59 Change in preferred stock - - - - Enterprise Value (current) 5,724 Other uses of cash - - - - Change in cash 308 167 797 1,013 Free cash flow 549 325 30 0 Source: Company reports and J.P. Morgan estimates. Note: $ in millions (except per-share data). Fiscal year ends Dec


90


Tenaris TS www.ir.tenaris.com


TS is one of the best early-cycle plays. We believe oil prices will lead a reactivation of exploration and development drilling globally. Tenaris is the most profitable manufacturers of steel tubular goods for the oil and gas industry. The company has a leading footprint in the niche of premium (oil country tubular goods (OCTG). We believe that Tenaris (TS) is likely to keep its dominance position on global OCTG market and gain market share in other key growing markets such as the US, Saudi Arabia, Iraq and, yes, Brazil.

We project an annualized earnings expansion of 12.9% between 2009 and 2012, mostly driven by cost reduction and volume growth. Reduction in structural costs is a major differentiating factor because the industry is suffering from sluggish pricing and cost pressures. Equipment producers with global footprints, such as TS, offer investors a broadly diversified play on oil, gas, onshore and offshore projects, with ROCEs that are bouncing from the cycle trough.

Benefits from expansion to be visible as early as 2011. TS is adding capacity in its Mexico plant in late 2010. Ramp-up of capacity would allow TS to export low-diameter OCTG out of Mexico to the US shale gas market, among other destinations. New facilities could also allow TS to reallocate output from higher-cost sites, such as Europe.

We don’t see risk of overcapacity in seamless OCTG. For now we believe the NA market appears in check. With the countervailing duties on China there is a shortfall of about 1.5 mn tons of seamless pipe in the US alone. Planned expansions are targeting such shortfall.

We have a YE11 target of $52/ADR, derived from a combination of SOTP model and target multiples. On an EV/EBITDA basis, TS is trading at 7.9x, similar to peer Vallourec. We believe TS deserves a premium because it generates ~22% higher EBITDA per ton than VK (rated OW by JPM European machinery analyst Alessandro Abate).

Global Oil Services & Equipment Sergio Torres AC



32

36

40

44

48

$


Price Performance

Source: Bloomberg, J.P.Morgan.


Absolute (%) 7.8 3.3 12.3


Company Data Price ($) 41.33Date Of Price 28 Oct 1052-week Range ($) 47.79 -


31 Dec 11

Tenaris SA (TS;TS US) 2009A 2010E 2011E 2012EEPS FY ($) 2.05 2.06 2.59 2.95Bloomberg EPS FY ($) 2.02 2.00 2.97 3.58Revenues FY ($ mn) 8,183 7,869 9,434 10,474EBITDA FY ($ mn) 2,114 2,192 2,940 3,282EV/EBITDA FY 9.5 9.6 6.9 6.0P/E FY 20.2 20.0 15.9 14.0Source: Company data, Bloomberg, J.P. Morgan estimates. 'Bloomberg' above denotes Bloomberg consensus estimates.


91


Tenaris SA: Summary of Financials Income Statement - Annual FY09A FY10E FY11E FY12E Income Statement - Quarterly 1Q10A 2Q10A 3Q10E 4Q10E Revenues 8,183 7,869 9,434 10,474 Revenues 1,639 1,982 1,900 2,349 Cost of products sold (4,598) (4,133) (4,671) (5,202) Cost of products sold (916) (1,112) (942) (1,163) Gross profit 3,318 3,330 4,218 4,692 Gross profit 652 798 828 1,052 SG&A (1,235) (1,547) (1,824) (1,990) SG&A (292) (337) (415) (503) DD&A (266) (405) (546) (579) DD&A (71) (71) (130) (133) Other operating expenses (4,865) (4,539) (5,217) (5,781) Other operating expenses (987) (1,183) (1,072) (1,296) Operating Income 1,847 1,787 2,394 2,702 Operating Income 309 405 413 550 EBIT 1,847 1,787 2,394 2,702 EBIT 309 405 413 550 EBITDA 2,114 2,192 2,940 3,282 EBITDA 380 531 543 683 Net interest income / (expense) (89) (59) (57) (30) Net interest income / (expense) (13) (18) (14) (15) Income applicable to minority interests (46) (36) (40) (50) Income applicable to minority interests (3) (13) (10) (10) Pretax income 1,785 1,771 2,337 2,672 Pretax income 328 400 399 535 Taxes (511) (517) (767) (882) Taxes (105) (105) (131) (176) Tax rate (%) - - - - Tax rate (%) - - - - Reported net income 1,208 1,219 1,530 1,740 Reported net income 220 282 258 350 Non-recurring items, disc ops - - - - Non-recurring items, disc ops - - - - Adjusted net income - - - - Adjusted net income - - - - Average diluted shares outstanding - - - - Average diluted shares outstanding - - - - EPS 2.05 2.06 2.59 2.95 EPS 0.37 0.48 0.44 0.59 EPS growth rate (%) (43.2%) 0.9% 25.5% 13.8% EPS growth rate (%) (1.3%) 28.5% (8.4%) 35.3% Dividend per share 0.86 0.38 0.38 0.52 Dividend per share 0.00 0.42 0.00 0.19 WTI crude price ($/bbl) 61.66 79.94 86.00 83.00 WTI crude price ($/bbl) 78.76 76.00 80.00 85.00 Henry Hub natural gas price ($/mcf) - - - - Henry Hub natural gas price ($/mcf) - - - - Balance Sheet and Cash Flow Data FY09A FY10E FY11E FY12E Ratio Analysis FY09A FY10E FY11E FY12E Cash and cash equivalents 2,123 980 1,691 2,468 Valuation Other current assets 502 481 481 481 P/E (adjusted) 20.2 20.0 15.9 14.0 Total current assets 5,622 5,623 7,066 7,446 P/CF 21.6 21.7 16.0 14.0 Net PP&E 3,255 3,711 3,868 3,522 Enterprise value/EBITDA 9.5 9.6 6.9 6.0 Other assets 502 481 481 481 EV/DACF - - - - Total assets 13,483 13,796 15,182 15,440 Ratios Total debt 1,447 1,213 1,213 1,292 Net debt/equity - - - - Total liabilities 4,391 4,111 4,217 4,263 Net debt/capital 13.7% 11.1% 10.0% 10.4% Minority interests 629 619 619 619 Net coverage ratio 17.6 26.3 36.5 41.4 Preferred stock - - - - ROE 14.0% 13.0% 14.8% 15.7% Shareholders' equity 9,092 9,685 10,965 11,177 ROCE 21.6% 19.1% 24.2% 26.8% Net Income 1,208 1,219 1,530 1,740 Yield and cash returns DD&A (266) (405) (546) (579) CFPS 1.92 1.90 2.58 2.95 Deferred taxes 861 0 0 0 CF yield - - - - Other - - - - FCF yield - - - - Cash earnings 1,132 1,122 1,526 1,740 Dividend yield 2.0% 0.9% 0.9% 1.2% Change in working capital 1,737 (1,077) (625) 362 Dividend payout ratio 28.5% 20.0% 20.0% 20.0% Cash flow from operations 3,064 372 1,491 2,732 Buyback yield - - - - Capex 461 881 490 511 Total cash returns (%) - - - - Dividends 508 226 224 305 Share buybacks (net) - - - - Change in debt (1,465) (239) 0 79 Mkt Cap (current) ($bn) 25.15 Change in preferred stock - - - - Enterprise Value (current) Other uses of cash - - - - Change in cash 4 (1,032) 776 1,996 Free cash flow (1,176) 1,962 2,308 1,526 Source: Company reports and J.P. Morgan estimates. Note: $ in millions (except per-share data). Fiscal year ends Dec


92


Retail & Healthcare Key country dynamics Solid growth in both the retail and healthcare sectors in Brazil has been led by strong consumer demand driven by: (1) Income mobility to middle-income segment. (2) Strong job creation, which is driving unemployment rates to record lows. (3) Inflation under control. These factors are leading to record-high consumer confidence.

As a result we believe the country is the best positioned in terms of growth within Latin America for retailers and healthcare names, while we are still cautious with retail in Mexico. While there is some evidence of economic recovery, correlation with the US economy is still high.

Growth characteristics and how they are changing In Brazil, both sectors are growing fast, on the back of the solid growth of the Brazilian economy. We expect solid growth to continue but to slightly decelerate in 2011 given tougher comparisons.

Drivers of returns – Multiples and growth Main drivers of growth for the retail sector are (1) consumer confidence, (2) unemployment rate and wage mass increase, (3) inflation, and (4) credit supply.

For the healthcare sector, the main drivers are: (1) wage mass increase; (2) formal job creation; and (3) increased penetration of private healthcare spending within the population, which is currently very low.

Nevertheless, we don’t expect further reratings for the sectors given recent outperformance. Any potential appreciation is likelier to come from earnings surprises.

Recommendations OW: Hypermarcas (HYPE3) is a core holding in Brazil consumer, given its focus on high-growth lower-income segments such as pharma and HPC. Its accelerated M&A allows for more synergies in 2011-2013e. It trades at a relatively cheap P/E 11e of 20.7x, a 25% discount to Brazilian peers that we view as unwarranted given high EPS CAGR 10-13e of 20%. OW: DASA (DASA3): We expect revenue growth to pick up in 2011 as the company has resumed M&A. DASA will likely start capturing revenue synergies as a result of its integration with MD1. UW: SORIANA (SORIANAB): Lack of catalysts in the short/mid term and rich valuation, trading at 12-M forward P/E of 18.5x, a 20% premium to historical, and 12-M fwd EV/EBITDA of 9.7x, 23% above historical, which in our view does not reflect the risks.

Andrea Teixeira AC



Bloomberg JPMA TEIXEIRA <GO>

Middle-income expansion is a positive driver for retailers and healthcare companies in Bz

13,0% 11,6% 11,6% 12,6% 13,3% 14,4% 15,5%

44,2% 42,5% 42,3% 46,7% 48,6% 48,9% 51,9%

14,2% 15,5% 15,7% 15,3% 13,3% 15,0% 14,2%28,6% 30,4% 30,4% 25,4% 24,8% 21,7% 18,4%

0%

20%

40%

60%

80%

100%

2002 2003 2004 2005 2006 2007 2008

A&B C D E Source: FGV.

Recent consumer deleverage in BZ supports Bz Retailers

Source: BACEN, J.P. Morgan estimates.

Wage mass growing steadily in Brazil

Source: IBGE.

Unemployment rates at lowest levels

Source: IBGE.

6.0%

7.0%

8.0%

9.0%

10.0%

11.0%

Jan-

06

May

-06

Sep-

06

Jan-

07

May

-07

Sep-

07

Jan-

08

May

-08

Sep-

08

Jan-

09

May

-09

Sep-

09

Jan-

10

May

-10

Unemploy ment Rate

-20%-15%-10%-5%0%5%

10%15%20%

Jan-

03Ap

r-03

Jul-0

3Oc

t-03

Jan-

04Ap

r-04

Jul-0

4Oc

t-04

Jan-

05Ap

r-05

Jul-0

5Oc

t-05

Jan-

06Ap

r-06

Jul-0

6Oc

t-06

Jan-

07Ap

r-07

Jul-0

7Oc

t-07

Jan-

08Ap

r-08

Jul-0

8Oc

t-08

Jan-

09Ap

r-09

Jul-0

9Oc

t-09

Jan-

10Ap

r-10

Jul-1

0

16.5%

5%

10%

15%

20%

25%

Jan-

05Ma

r-05

May-0

5Ju

l-05

Sep-

05No

v-05

Jan-

06Ma

r-06

May-0

6Ju

l-06

Sep-

06No

v-06

Jan-

07Ma

r-07

May-0

7Ju

l-07

Sep-

07No

v-07

Jan-

08Ma

r-08

May-0

8Ju

l-08

Sep-

08No

v-08

Jan-

09Ma

r-09

May-0

9Ju

l-09

Sep-

09No

v-09

Jan-

10Ma

r-10

May-1

0Ju

l-10

Brazil


93


Top picks and stocks to avoid Mkt cap P/E (x) EPS Div. yield ROE Price Code Rating (MM) 10E 11E 10E 11E 11E (%) 11E (%) Top picks Hypermarcas R27.99 HYPE3 BZ OW R$14,941 28.3 20.7 0.99 1.35 DASA R$21.07 DASA3 BZ OW R$6,555 30.9 17.8 0.68 1.18 300.7 31.9 Stocks to avoid Soriana Ps37.40 SORIANAB MM UW Ps67,320 21.6 18.2 1.73 2.06 0.4 10.2 Source: Bloomberg, J.P. Morgan estimates. Note: DASA3 and SORIANAB share prices and valuations are as of November 9, 2010; HYPE3 valuations share prices and valuations are as of October 28, 2010.

Retail absolute and relative to MSCI LatAm

0

200

400

600

800

1000

1200

1400




Retail EPS integer

50

70

90

110

130

150

170


2010

2011

Source: MSCI, Bloomberg, IBES, Datastream, J.P. Morgan. Retail 12 mth fwd PE

5

10

15

20

25

30

35

40

95 97 98 99 00 01 02 03 04 05 06 07 08 10

PE Av g +1SD -1SD


Retail trailing PB

0

2

4

6

8

10

12

14

95 97 98 99 00 01 02 03 04 05 06 07 08 10

PB Av g +1SD -1SD



94


Diagnosticos da America (DASA) DASA3.SA www.dasa.com.br

Overweight R$21.07 (9 Nov 10) Price Target: $26 End Date: Dec 2011

Company description Dasa is the largest diagnostic laboratory in Brazil. Its business model is divided into three segments: (1) private clinical and image analysis, (2) public services provider and (3) lab-to-lab operations. Its growth is based on a mix of organic growth and acquisitions. Currently, Dasa is established in 12 states and holds 21 different brands (after acquisition of MD1 and Cerpe).

Investment case Our positive view on the company is due to its leading position in the most important markets in Brazil (SP and RJ after the acquisition of MD1) and its exposure to less affluent demographic sectors.

Potential for earnings upgrades Dasa announced in the beginning of October the acquisition of MD1, the fourth-largest laboratory in Brazil. The integration process has the potential to create both revenue and cost synergies. DASA should also still benefit from margin expansion as new management is focused on increasing profitability.

Prospects for re-/derating Although the stock has been performing strongly lately (more than +40% YTD), we think there is more upside to come. After its weak period of top-line expansion, we expect revenue growth to pick up in 2011 since the company will likely capture revenue synergies as a result of operating leverage from growth and the integration of recent acquisitions MD1 and Cerpe. Dasa trades at a 15% premium to Fleury on a P/E 11e basis, which we believe is warranted given (1) its position in less affluent segments, (2) higher diversification of payers and (3) higher stock liquidity.

Price target and risks Our R$26 price target (end date Dec-11) is based on a 9-year discounted free cash flow to firm (no acquisitions) at a 10.3% nominal reais discount rate and 5.0% perpetuity growth. Main risks to our thesis are (1) if management does not deliver its guidance of 27.5% EBITDA margin, (2) pricing pressure and/or increased competition for acquisitions, and (3) economic slowdown.

Brazil Retail & Healthcare Andrea Teixeira, CFA AC



12

16

20

R$


Price Performance

Source: Bloomberg.


Absolute (%) 3.0 27.5 73.1


Company Data Price (R$) 21.10Date Of Price 09 Nov 1052-week Range (R$) 22.00 -


31 Dec 11

Diagnosticos da America (DASA) (DASA3.SA;DASA3 BZ) 2009A 2010E 2011E 2012EEPS Reported FY (R$) 0.66 0.68 1.18 1.33EV/EBITDA FY 21.9 17.3 11.7P/E FY 31.7 30.9 17.9 15.8EBITDA FY (R$ mn) 319 401 580 655Source: Company data, Bloomberg, J.P. Morgan estimates. Adj. EPS=EPS (reported)+Goodwill Tax Shield.

http://www.dasa3.com.br/


95


Diagnosticos da America (DASA): Summary of Financials Income Statement FY09A FY10E FY11E FY12E FY13E Balance Sheet FY09A FY10E FY11E FY12E FY13E Revenues 1,388 1,505 2,158 2,385 2,626 Cash 287 268 396 780 1,044 Cost of Services (943) (947) (1,346) (1,488) (1,627) Accounts receivable 269 283 393 475 522 SG&A (256) (260) (371) (399) (428) Inventories 47 47 67 72 79 Operating Profit (EBIT) 189 298 441 497 572 EBIT Margin 13.6% 19.8% 20.4% 20.9% 21.8% Depreciation 105 103 139 158 161 Other current assets 110 106 152 170 187 EBITDA 319 401 580 655 732 Net PP&E 425 575 586 591 606 EBITDA margin 23.0% 26.6% 26.9% 27.5% 27.9% Other assets 159 163 233 91 101 Financial income 12 98 28 47 90 Total assets 1,619 1,794 2,177 2,529 2,890 Financial expense (41) (164) (96) (102) (102) Technical Reserves - - - - - FX & Monetary gains (losses) - - - - - Short-term debt 152 113 113 113 113 Other Nonoperarting income 4 8 11 12 13 Accounts payable 50 67 94 102 111 Equity income - - - - - Other current liabilities 156 224 315 343 374 EBT 152 240 384 454 572 Long-term debt 545 494 494 494 494 Taxes 2 (83) (131) (154) (194) Deferred taxes 8 18 16 76 84 Minority interest (1) 0 0 0 0 Other liabilities 168 179 256 287 317 Extraordinary 0 0 0 0 0 Total liabilities 1,080 1,095 1,288 1,415 1,493 Net income 153 157 367 415 492 Minority Interests 0 0 0 0 0 Net income margin 6.0% 10.4% 11.7% 12.6% 14.4% Shareholders' equity 539 699 889 1,113 1,397 Technical Reserve Provisions - - - - - Liabilities + Equity 1,619 1,793 2,177 2,529 2,890 Goodwill Amortisation - - - - - Adjusted Net Incoome 84 157 253 300 377 EPS 0.66 0.68 1.18 1.33 1.58 Revenue growth 22.0% 8.4% 43.4% 10.5% 10.1% Net debt 410 339 211 (173) (437) EBITDA growth 14.0% 25.6% 44.6% 13.1% 11.7% Net Debt/Capital 33.2% 25.9% 14.1% (10.0%) (21.8%) Net income growth (418.8%) 87.1% 61.6% 18.3% 25.9% Debt/Capital 56.4% 46.5% 40.6% 35.3% 30.3% FCF growth 19.2% (74.9%) (348.9%) 72.3% 25.4% Net Debt/EBITDA 1.3 0.8 0.4 (0.3) (0.6) Operating Data, Ratios FY09A FY10E FY11E FY12E FY13E Valuation, Macro FY09A FY10E FY11E FY12E FY13E Capex 93 96 150 162 162 EV/EBITDA 21.9 17.3 11.7 - - Change in working capital 4 73 (56) (70) (70) P/E 31.7 30.9 17.8 15.8 13.3 Free cash flow (273) (69) 171 294 369 P/BV 12.2 9.4 7.4 5.9 4.7 Dividends 0 9 63 75 94 P/S 4.7 4.4 3.1 2.8 2.5 Dividend % of net income 0.0% 5.6% 25.0% 25.0% 25.0% FCF yield 1.7% 1.8% 3.0% - - Capex/depreciation 0.9 0.9 1.1 1.0 1.0 Dividend yield 0.0% 41.6% 300.7% 355.8% 447.9% CAPEX/sales 6.7% 6.4% 7.0% 6.8% 6.2% ROE 16.5% 25.3% 31.9% 30.0% 30.1% Working capital 272 296 402 444 490 Net income margin 6.0% 10.4% 11.7% 12.6% 14.4% Working capital/sales 19.6% 19.7% 18.6% 18.6% 18.6% Net revenue/Assets 85.8% 83.9% 99.1% 94.3% 90.9% Assets/Equity 3.0 2.6 2.5 2.3 2.1 Adjusted MLR - - - - - ROIC 15.7% - - - - HC Members ('000) - - - - - Shares 230 230 311 311 311 Dental Plan Members ('000) - - - - - ADRs - - - - - Total Membership ('000) - - - - - % of Individual Plans/Total - - - - - DCF Market Share - - - - - WACC 10.3% Average Ticket (R$/month) - - - - - Perpetual Growth 5.0% # of PSCs 321 337 466 475 482 Cost of equity 10.4% Revenue/Requisition 58 58 68 68 69 Cost of debt 15.0% Capex 93 96 150 162 162 Maintenance - - - - - Expansion - - - - - Source: Company reports and J.P. Morgan estimates. Note: R$ in millions (except per-share data). Fiscal year ends Dec


96


Hypermarcas HYPE3.SA www.hypermarcas.com.br

Overweight R$27.99 (28 Oct 10) Price Target: $30 End Date: Dec 2011

Company description Hypermarcas, one of the leading consumer products company in Brazil, is established in 3 segments: pharmaceutical, household/personal care and food.

Investment case Hypermarcas is a combination of fast-growing consumer exposure in Brazil with a defensive profile as its portfolio is mostly composed of staple goods. Still, the HPC and pharma industries are very fragmented, meaning that there is enough room for additional M&A. Still, even if acquisitions stop, we estimate an improvement in EBITDA margin of at least 200bps.

Potential for earnings upgrades The company is targeting 15% same brand sales (SBS) growth for the next few years, which we view as conservative. We believe that the market might incorporate higher estimates as the company delivers stronger results. Also, Hypermarcas has the potential to unlock value by delivering more than official guidance of R$2.5bn in acquisitions for 2010-2011 (it has already delivered R$1.3bn). Recent debenture issue of R$1bn may indicate a continued interest in shopping.

Prospects for re-/derating Our Dec 11 price target is R$30, derived from a 50/50 mix of organic model (R$29 per share) and acquisitions-plus-growth DCF (R$32/share) and considering company official M&A guidance. Also, we ran a sensitivity analysis incorporating an additional R$1bn in M&A, which added R$1 to our PT. Hypermarcas currently trades at P/E 11e of 21x, a 16% discount to Brazil peers, which we view as unwarranted given high EPS CAGR 10-13e of 20%.

Price target and risks Our price target is based on a 9-year DCF analysis at 11.3% WACC and perpetuity growth of 6%. We blend the organic and the organic-plus-acquisitions scenarios 50/50 in our price target valuation. Main risks to our thesis are (1) increasing competition for acquisitions, (2) potential overhang from private equity fund which owns 17.3% of the company and (3) Hypermarcas is reliant on founder “Junior” to prospect for and negotiate deals.

Brazil Retail & Healthcare Andrea Teixeira, CFA AC



20

24

28

R$

Mar-10 Jun-10 Sep-10 Dec-10

Price Performance

Source: Bloomberg.


Absolute (%) -2.8 21.6 27.8

Source: Bloomberg.



31 Dec 11

Hypermarcas S.A. (HYPE3.SA;HYPE3 BZ) 2009A 2010E 2011E 2012E 2013EAdj. EPS FY (R$) 1.21 0.99 1.35 1.55 1.73P/E FY 23.1 28.2 20.7 18.1 16.2Source: Company data, Bloomberg, J.P. Morgan estimates. *Adj. EPS = EPS (reported) + Goodwill Tax Shield.

http://www.hypermarcas.com.br/


97


Hypermarcas: Summary of Financials Income Statement - Annual FY09A FY10E FY11E Income Statement - Quarterly 1Q10A 2Q10A 3Q10E 4Q10E Revenues 2,025 3,262 4,111 Revenues 657 758 855 993 COGS (843) (1,416) (1,781) COGS (274) (327) (359) (455) Gross profit 1,182 1,847 2,330 Gross profit 383 431 496 538 SG&A (718) (1,138) (1,415) SG&A (222) (299) (285) (333) Operating income 464 708 915 Operating income 161 132 211 205 EBITDA 503 784 1,044 EBITDA 175 150 234 226 Interest, net 15 (166) (157) Interest, net (60) (44) (57) (5) Other Income 0 0 0 Other Income 0 0 0 0 Pretax income 479 542 758 Pretax income 101 88 153 200 Income taxes (166) (194) (258) Income taxes (39) (35) (52) (68) Tax rate (34.6%) (35.7%) (34.0%) Tax rate (38.4%) (39.5%) (34.0%) (34.0%) Net income - reported (GAAP) 517 529 758 Net income - reported (GAAP) 93 91 153 191 Diluted shares outstanding 421 534 548 Diluted shares outstanding 481 541 548 548 EPS- Reported 0.74 0.65 0.91 EPS- Reported 0.13 0.10 0.18 0.24 Adj. EPS 1.21 0.99 1.35 Adj. EPS 0.19 0.17 0.28 0.35 Balance Sheet and Cash Flow Data FY09A FY10E FY11E Ratio Analysis FY09A FY10E FY11E Cash and cash equivalents 499 1,753 1,550 Sales growth 51.9% 61.1% 26.0% Accounts receivable 725 1,000 1,161 Same store sales growth - - - Current assets 1,836 3,612 3,677 EBITDA growth 60.8% 56.0% 33.1% EBIT growth 67.0% 52.6% 29.1% PP&E 296 868 846 EPS growth - operating 753.3% (18.3%) 36.6% Total assets 6,278 9,466 9,504 Gross margin 58.4% 56.6% 56.7% Short-term Debt 889 900 649 EBIT margin 22.9% 21.7% 22.2% Current liabilities 1,292 1,487 1,334 EBITDA margin 24.8% 24.0% 25.4% Long-term Debt 1,322 2,214 1,796 Total liabilities 6,278 9,466 9,504 Shareholders' equity 3,437 5,341 5,655 Debt / EBITDA 4.4 4.0 2.3 D&A 39 76 130 Change in working capital (319) (338) (171) Enterprise value / Revenues - - - Cash flow from operations 207 173 514 Enterprise value / EBITDA 29.1 18.2 13.2 Capex (1,961) (1,488) (103) P / E 23.1 28.3 20.7 Free cash flow (1,342) (962) 1,182 Free cash flow / share (3.19) (1.80) 2.16 Dividends 0.00 0.00 185.40 Source: Company reports and J.P. Morgan estimates. *Adj. EPS = EPS (reported) + Goodwill Tax Shield. Note: R$ in millions (except per-share data). Fiscal year ends Dec.


98


Soriana SORIANAB.MX www.soriana.com

Underweight Ps37.40 (9 Nov 10) Price Target: Ps38 End Date: Dec 2011

Company description Organizacion Soriana is a food retailer operating 500 stores (as of 3Q10) across Mexico. The store formats are mostly hypermarkets, clubs and convenience stores.

Investment case Our negative view on Soriana is due to a lack of catalysts in the short/middle term. Soriana has been experiencing weak sales growth despite easy comparisons. Last year, the company was hard hit by the economic downturn. We still see competition and cautious consumer purchase of discretionary categories in Mexico as dragging Soriana’s growth. Also, the stock is trading at rich valuations, at P/E 11e of 22.1x and EV/EBITDA 11e of 10.8x.

Potential for earnings upgrades We see limited room for positive earnings surprises as the improvement in SSS performance expected for the 4Q10 and 2011 seems already priced into consensus. We expect Soriana to continue to face headwinds from heavy competition as (1) Walmex is aggressively lowering prices and has greater bargaining power with suppliers; (2) Fourth-largest competitor Chedraui is now well capitalized and is gaining share (SSS at 3Q10 stood at 4.4% vs. 2.9% for Soriana and 2.8% for Walmex).

Prospects for re-/derating We believe further recovery is priced in, as Soriana is trading at significant premiums to its historical averages. At a 12-month forward P/E, the stock trades at 23.3x, a 44% premium, and 12-month fwd EV/EBITDA of 11.1x, 47% above historical, which in our view do not reflect the risks.

Price target and risks Our Ps38 December 2011 price target is based on a 50/50 blend of a 9-year DCF at 7.4% nominal WACC, 4% growth and 16.8x P/E 12E (30% discount to peers). Upside risks to our cautious view include: (1) faster-than-anticipated recovery in the economy; and (2) better-than-anticipated execution, i.e., no market share losses.

Mexico Retail & Healthcare Andrea Teixeira, CFA AC



30

34

38

Ps


Price Performance

Source: Bloomberg.


Absolute (%) 4.4 9.1 17.5


Company Data Price (Ps) 37.40Date Of Price 09 Nov 1052-week Range (Ps) 40.10 -

29.58Mkt Cap (Ps mn) 67,320.00Fiscal Year End DecShares O/S (mn) 1,800Price Target (Ps) 38.00Price Target End Date

31 Dec 11

Organizacion Soriana (SORIANAB.MX;SORIANAB MM) 2009A 2010E 2011E 2012EEPS FY (Ps) 1.59 1.73 2.06 2.21EV/EBITDA FY 11.3 10.5 9.3 8.5P/E FY 23.5 21.6 18.2 17.0EBITDA FY (Ps mn) 6,568 7,107 7,837 8,418Source: Company data, Bloomberg, J.P. Morgan estimates.


99


Organizacion Soriana: Summary of Financials Income Statement FY09A FY10E FY11E FY12E FY13E Balance Sheet FY09A FY10E FY11E FY12E FY13E Revenues 88,637 93,853 100,365 107,127 115,242 Cash 2,139 1,119 1,301 2,114 2,263 Cost of goods sold (70,344) (74,573) (79,746) (85,065) (91,452) Accounts receivable 3,305 4,384 4,667 4,981 5,359 SG&A (13,710) (14,225) (14,909) (16,040) (17,303) Inventories 11,084 13,207 13,817 14,505 15,344 Operating Profit (EBIT) 4,584 5,055 5,710 6,022 6,488 EBIT Margin 5.2% 5.4% 5.7% 5.6% 5.6% Depreciation 1,984 2,052 2,127 2,396 2,626 Other current assets 89 95 102 108 117 EBITDA 6,568 7,107 7,837 8,418 9,114 Net PP&E 37,610 38,615 40,142 43,036 47,162 EBITDA Margin 7.4% 7.6% 7.8% 7.9% 7.9% Other Assets 11,367 12,135 12,920 13,790 14,835 Financial income 148 166 38 59 95 Total assets 65,594 69,555 72,948 78,535 85,079 Financial expense 885 601 459 459 459 Short-term debt 3,529 4,039 2,039 2,039 2,039 FX & Monetary gains (losses) 79 66 0 0 0 Accounts payable 15,976 17,057 18,403 19,864 21,605 Other Nonoperating income 0 (4) 0 0 0 Other current liabilities 0 0 0 0 0 Equity income - - - - - Long-term debt 5,500 4,592 4,592 4,592 4,592 EBT 3,842 4,558 5,151 5,514 6,008 Deferred taxes 7,532 8,041 8,561 8,909 9,584 Taxes (974) (1,423) (1,442) (1,544) (1,682) Other liabilities 1,127 1,203 1,281 1,367 1,470 Minority interest - - - - - Total liabilities 33,664 34,932 34,876 36,771 39,291 Extraordinary - - - - - Minority interest 0 0 0 0 0 Net Income 2,868 3,110 3,708 3,970 4,326 Shareholders' equity 31,930 34,623 38,072 41,764 45,788 Net income margin 3.2% 3.3% 3.7% 3.7% 3.8% Liabilities + Equity 65,594 69,555 72,948 78,535 85,079 EPS 1.59 1.73 2.06 2.21 2.40 Revenue growth (7.3%) 5.9% 6.9% 6.7% 7.6% Net Debt 6,889 7,512 5,331 4,517 4,368 EBITDA growth 8.0% 8.2% 10.3% 7.4% 8.3% Net Debt/Capital 16.8% 17.4% 11.9% 9.3% 8.3% Net income growth 66.4% 8.4% 19.3% 7.1% 9.0% Debt/Capital 22.0% 20.0% 14.8% 13.7% 12.7% FCF growth (133.8%) (101.0%) (6104.7%) (47.5%) 170.4% Net Debt/EBITDA 1.0 1.1 0.7 0.5 0.5 Operating Data, Ratios FY09A FY10E FY11E FY12E FY13E Valuation, Macro FY09A FY10E FY11E FY12E FY13E Capex 1,164 3,100 3,655 5,290 6,752 EV/EBITDA 11.3 10.5 9.3 8.5 7.9 Change in working capital (479) 2,127 (447) (451) (518) P/E 23.5 21.6 18.2 17.0 15.6 Free Cash Flow 4,141 (41) 2,459 1,291 3,490 P/BV 2.1 1.9 1.8 1.6 1.5 Dividends 0 70 260 278 303 P/S 0.8 0.7 0.7 0.6 0.6 Dividend % of net income 0.0% 2.3% 7.0% 7.0% 7.0% FCF yield 5.6% (0.1%) 3.4% 1.8% 4.9% Capex/Depreciation 0.6 1.5 1.7 2.2 2.6 Dividend yield 0.0% 0.1% 0.4% 0.4% 0.4% Capex/Sales 1.3% 3.3% 3.6% 4.9% 5.9% ROE 9.3% 9.5% 10.2% 9.9% 9.9% Working capital (1,498) 629 182 (268) (786) Net income margin 3.2% 3.3% 3.7% 3.7% 3.8% Working capital/sales (1.7%) 0.7% 0.2% (0.3%) (0.7%) Net revenue/Assets 1.4 1.3 1.4 1.4 - Assets/Equity 2.1 2.0 1.9 1.9 - Sales Area (Sq,m) 2,824,481 2,923,125 3,058,125 3,253,981 3,515,043 ROIC 5.7% 7.3% 8.2% - - Floor Space Growth 1.5% 2.5% 5.5% 4.0% 7.2% Shares 1,800 1,800 1,800 1,800 1,800 No. of Stores 471 511 566 634 718 ADRs - - - - - SSS growth (nominal terms) (10.3%) (0.7%) 0.8% 0.7% 0.7% # of PL cards issued - - - - - DCF % of sales in 0+5x (no interest) - - - - - WACC 7.4% % of sales on interest plans - - - - - Perpetual Growth 4.0% Bad Debt Provisions - - - - - Cost of equity 7.7% Personal Loans Portfolio - - - - - Cost of debt 4.1% Capex 1,164 3,100 3,655 5,290 6,752 Maintenance - - - - - Expansion - - - - -

Source: Company reports and J.P. Morgan estimates. Note: Ps in millions (except per-share data). Fiscal year ends Dec


100


Telecom, Media & Technology Key country dynamics We believe investors should only have a selective exposure to the sector, either through high- growth/underpenetrated market stories or through stocks offering a mix of growth and cash flow (like TSU/AMX). Generally, telecom stocks tend to be defensive, while media stocks are more cyclically exposed, as are tech stocks. We believe the telecom sector could offer attractive cash flow and dividend yields, compensating for slower growth. Media stocks fared better in earnings than developed peers as most of the media expenditure is still staple variety rather than discretionary. Tech stocks offer highest growth among TMT sector, as LatAm is still underpenetrated, with high demand.

Growth characteristics and how they are changing Among telecom companies, growth is mainly driven by the increasing contribution from data revenues: companies are investing a large amount in data networks, and there will be a 3G license auction in Brasil (NIHD likely to be the only bidder) as there was in Mexico. Looking at media companies, we could see them grow, on increasing pay-TV penetration and also from the offer of combined services. Tech companies could benefit from good economic momentum, given higher demand.

Drivers of returns – Multiples and growth TMT investors benefit from attractive cash flow yields as well as good dividend distribution, as the sector usually provides low growth for reasonable cash generation, and thus is considered defensive. We believe exposure should be taken in stocks with cheap FCF yield relative to EBITDA growth.

Recommendations OW: TIM Participações (TSU): only pure mobile player in Brazil, with the highest growth among Brazilian telcos; lower exposure to MTR changes; valuation of 9.3% FCF yield and 2.9 x EV/EBITDA 2011E.

UW: Telmex (TMX): weak trends, demonstrated by double-digit EBITDA decline over the last six quarters; rich valuation relative to higher-growth LatAm peers; tough outlook, given rising competition in Mexico.

Andre Baggio AC


Bloomberg JPMA BAGGIO <GO>

EV/EBITDA is a key metric for the sector . . . .

3.42.9

6.45.5

4.4 4.2

7.2

4.65.1 5.5

012345678

VIV TSU AMX ENTEL NIHD TEO PT TI VOD TEF


. . . and we should also look at FCF yields

10.8% 9.4%8.0% 7.0%

-1.2%

4.4%7.8%

15.1%

11.4% 10.3%

-5%

0%

5%

10%

15%

20%

VIV TSU AMX ENTEL NIHD TEO PT TI VOD TEF


Best combination: cheap FCF yield relative to EBITDA growth EBITDA CAGR 2011-2013E

VIV

TSU

AMXENTEL

TEO

PTTIVOD

TEF

-5%

0%

5%

10%

15%

4% 6% 8% 10% 12% 14% 16%

2011 FCF yield Source: J.P. Morgan estimates.

EBITDA CAGR, 2011-2013e, for covered telecom stocks

6%

9%

5% 5%

14%

-3%-5%

0%

5%

10%

15%

VIV TSU AMX ENTEL NIHD TEO



101


Top pick and stock to avoid Mkt cap P/E (x) EPS Div. yield ROE Price (US$) Code Rating (US$MM) 10E 11E 10E 11E 11E (%) 11E (%) Top pick TIM Participacoes 31.85 TSU OW 7,900 29.4 14.3 0.19 0.4 1.7% 10% Stock to avoid Telmex 15.02 TMX UW 13,586 12.2 13.0 0.8 0.7 5% 37% Source: Bloomberg, J.P. Morgan estimates. Note: Share prices and valuations are as of October 28, 2010.

Telecom absolute and relative to MSCI LatAm

0

100

200

300

400

500

600




Telecom EPS integer

90

100

110

120

130

140

150


2010

2011

Source: MSCI, Bloomberg, IBES, Datastream, J.P. Morgan. Telecom 12 mth fwd PE

6

9

12

15

18

21

24

95 97 98 99 00 01 02 03 04 05 06 07 08 10

PE Av g +1SD -1SD


Telecom trailing PB

0

1

2

3

4

5

95 97 98 99 00 01 02 03 04 05 06 07 08 10

PB Av g +1SD -1SD



102


TIM Participacoes TSU www.tim.com.br


Company description TIM Participações S.A. (NYSE: TSU) provides telecommunication services all across Brazil. Most of its revenues come from mobile, and it also has long distance and data transmission services. TSU is controlled by the Telecom Italia group.

Investment case TSU is our top pick: (i) turnaround to go on, demonstrated by better FCF; (ii) higher growth among Brazilian telcos; (iii) increasing presence as data service provider; (iv) lower MTR exposure, even when compared to VIV/TSP combined; (v) cheap valuation of 9.8% FCF yield 2011e and 2.8x EV/EBITDA (still cheap on ON+PNs, at 8.1%/3.4x).

Potential for earnings upgrades We believe TSU could upgrade earnings if: (1) it maintains a high number of subscriber additions without substantial dilution in ARPU, (2) it is able to increase levels of data as % of service revenues toward the ones reported by Vivo and Claro, as well as improve its offer of data services; (3) it reduces advertisement expenses.

Prospects for re-/derating The market could derate TSU, if: 1) results from the free on-net minutes strategy disappoint in ARPU; 2) competition increases with the entry of new players (5th license); and 3) capex rises as result of more voice or data traffic, depressing FCF.

Price target and risks We rate TSU OW and our Dec 11 price target is $40 based on the average of our DCF and multiples valuation. Our DCF valuation is based on 9.4% WACC, 1.5% LT growth and yields, a $43.3 fair value. Our multiples-based valuation derives from a 10% target FCF yield, resulting in a fair value of $36.7. The downside risks are mentioned above.

Brazil Telecom, Media & Technology Andre Baggio AC



22

26

30

34

$


Price Performance

Source: Bloomberg.


Absolute (%) 14% 27% 29%

Source: Bloomberg.



31 Dec 11

Div. Yield 1.5%Debt/Total Capital 17.9%

TIM Participacoes (TSU;TSU US) 2009A 2010E 2011E 2012ERevenues FY (R$ mn) 13,907 14,406 15,862 17,220EBITDA FY (R$ mn) 3,571 4,195 4,704 5,111EBITDA Margin FY (R$) 26% 29% 30% 30%EPS FY (R$) 3.20 1.86 3.84 6.14Bloomberg EPS FY (R$) 0.03 1.95 4.07 5.47P/BV FY 1.8 1.5 1.5 1.5Source: Company data, Bloomberg, J.P. Morgan estimates.


103


TIM Participacoes: Summary of Financials Income Statement FY09A FY10E FY11E FY12E FY13E Balance Sheet FY09A FY10E FY11E FY12E FY13E Net Revenue 13,907 14,406 15,862 17,220 18,348 Cash 2,559 1,852 2,040 2,214 2,359 Cash Costs -10,336 -10,211 -11,158 -12,110 -12,879 Accounts receivable 2,480 2,881 3,172 3,444 3,670 EBITDA 3,571 4,195 4,704 5,111 5,469 Inventories 406 248 273 296 316 EBITDA margin 26% 29% 30% 30% 30% Other current assets 1,321 1,662 1,824 1,975 2,101 Depreciation and Amortisation -3,141 -3,198 -3,149 -2,989 -2,883 Net PP&E 5,323 5,333 4,984 4,795 4,788 EBIT 444 997 1,555 2,121 2,586 Other Assets 5,360 5,341 5,341 5,341 5,341 Net interest expense 253 -278 -187 -32 -32 Total assets 17,450 17,317 17,634 18,066 18,574 Other nonoperating income 0 0 0 0 0 Short-term debt 1,417 1,597 1,597 1,597 1,597 EBT 697 719 1,368 2,089 2,554 Accounts payable 0 0 0 0 0 Taxes -6 -259 -419 -568 -608 Other current liabilities 4,320 4,607 5,066 5,493 5,848 Minority interest 0 0 0 0 0 Long-term debt 2,743 1,502 642 816 961 Extraordinary - - - - - Deferred taxes 1,013 709 698 715 715 Net Income 691 460 949 1,521 1,946 Other liabilities -365 118 129 112 111 Adj. Net Income 691 460 949 1,521 1,946 Total liabilities 9,127 8,533 8,131 8,732 9,232 Shares Outstanding 2,476 2,476 2,476 2,476 2,476 Minority interest 0 0 0 0 0 EPS 3.20 1.86 3.84 6.14 7.87 Shareholders' equity 8,323 8,785 9,504 9,333 9,342 Adj. EPS 2.79 1.86 3.84 6.14 7.87 Liabilities + Equity 17,450 17,317 17,634 18,066 18,574 Revenue growth 5.8% 3.6% 10.1% 8.6% 6.5% Net Debt 1,684 1,317 269 269 269 EBITDA growth 23.2% 17.5% 12.1% 8.7% 7.0% Adj. Net Debt 1,684 1,317 39 -1,652 -3,590 Net income growth 249.8% -33.4% 106.3% 60.2% 28.0% Net Debt/Capital 9.6% 7.6% 1.5% 1.5% 1.4% FCF growth -72.1% -605.5% 125.7% 32.3% 14.6% Debt/Capital 23.8% 17.9% 12.7% 13.4% 13.8% Net Debt/EBITDA 0.5 0.3 0.1 0.1 0.0 Operating Data, Ratios FY09A FY10E FY11E FY12E FY13E Valuation, Macro FY09A FY10E FY11E FY12E FY13E Capex -2,671 -3,000 -2,800 -2,800 -2,876 EV/EBITDA 4.7 3.5 3.0 2.5 2.0 Change in working capital -243 -90 -20 -19 -16 Adj. P/E 19.7 29.5 14.3 8.9 7.0 Free Cash Flow Equity -112 566 1,278 1,691 1,938 P/BV 1.8 1.5 1.5 1.5 1.6 Dividends/Share 0.68 0.82 0.93 6.83 7.83 Dividend % of net income 24.3% 44.3% 24.3% 111.2% 99.6% FCF yield -0.7% 4.2% 9.2% 11.9% 13.3% Consolidated Dividends 168 204 230 1,691 1,938 Dividend yield 1.2% 1.5% 1.7% 12.4% 14.3% Sharebuybacks 0 0 0 0 0 ROE 8.3% 5.2% 10.0% 16.3% 20.8% Capex/Depreciation 0.9 0.9 0.9 0.9 1.0 Net revenue/Assets 0.8 0.8 0.9 1.0 1.0 Capex/Sales 19.2% 20.8% 17.7% 16.3% 15.7% Assets/Equity 2.1 2.0 1.9 1.9 2.0 Working capital 111 201 221 240 256 Working capital/sales 0.8% 1.4% 1.4% 1.4% 1.4% ROIC 3.5% 6.2% 9.7% 13.2% 16.6%

Net income margin 5.0% 3.2% 6.0% 8.8% 10.6% Shares 2,476 2,476 2,476 2,476 2,476 ADRs 248 248 248 248 248 Lines in Service 0 0 0 0 0 Broadband Subs 0 0 0 0 0 Broadband Net Adds 0 0 0 0 0 WACC 9.6% Mobile Subs 41,115 48,052 52,857 57,085 60,510 Perpetual Growth 1.5% Mobile Net Adds 4,713 6,937 4,805 4,229 3,425 Cost of equity 10.8% Mobile ARPU 26.54 24.58 23.65 23.42 23.42 Cost of debt 5.2% Mobile MOU 83 0 0 0 0 Subsidiary Share 0.0% PayTV subs 0 0 0 0 0 Fx, Avg 1.99 1.79 1.83 1.88 1.92 Quarterly Data 1Q10A 2Q10A 3Q10E 4Q10E Quarterly Data 1Q11E 2Q11E 3Q11E 4Q11E Revenue 3,296 3,559 3,680 3,870 Revenue - - - - Net Income 30 101 121 208 Net Income - - - - EPS 0.13 0.41 0.48 0.84 EPS - - - - Source: Company reports and J.P. Morgan estimates. Note: R$ in millions (except per-share data). Fiscal year ends Dec.


104


Telmex TMX www.telmex.com

Underweight $15.15 (28 Oct 10) Price Target: $12 End Date: Dec 2011

Company description Telmex provides fixed-line telecommunications services in Mexico. The company’s service coverage comprises the operation of the nation’s most complete local and long distance networks. Additionally, Telmex offers services such as connectivity, internet access, co-location, web hosting and interconnection services to other telecommunications operators.

Investment case The key reasons for our UW rating are: (1) Continuing weak core trends at TMX as demonstrated by double-digit EBITDA decline over the last six quarters; (2) Likelihood of adverse regulation hurting trends further; (3) Less alignment with Carlos Slim, given recent AMX-CGT-TII transaction, which lowered his effective stake in TMX significantly; (4) Rising competition in Mexico, especially from cable operators.

Potential for earnings upgrades We believe TMX could upgrade earnings if it is able to control costs, which have increased in line with inflation although revenues have been declining. Moreover, TMX could get a pay-TV license, which would help trends.

Prospects for re-/derating The market could rerate TMX, if trends improved or if there is an expectation of a tender offer for minorities from its controlling shareholder AMX at a premium to market price. No such offer has been announced.

Price target and risks Our PT of US$12 is based on a combination of DCF ($14.1 value), growth model ($10.1) and multiples ($11.5). Our DCF methodology and uses a WACC of 10.4%, LT growth of -1% and LT margin of 39%. We rate TMX UW in light of weak trends, rich valuation relative to higher-growth LatAm peers, and a tough outlook. Upside risks to our rating are the same as the ones mentioned in the above paragraph (better trends, a tender from AMX).

Mexico Telecom, Media & Technology Andre Baggio AC



13

15

17

19

$


Price Performance

Source: Bloomberg.


Absolute (%) 2% -1% -18%

Source: Bloomberg.



31 Dec 11


Telmex SA (TMX;TMX US) 2009A 2010E 2011E 2012ERevenues FY (Ps mn) 119,100 112,804 108,244 103,133EBITDA FY (Ps mn) 52,315 45,385 42,811 40,308EBITDA Margin FY (Ps) 44% 40% 40% 39%EPS FY (Ps) 22.28 18.51 17.30 15.23P/BV FY 4.7 4.7 4.8 7.6P/E FY 8.4 10.1 10.8 12.3Source: Company data, Bloomberg, J.P. Morgan estimates.


105


Telmex SA: Summary of Financials Income Statement FY09A FY10E FY11E FY12E FY13E Balance Sheet FY09A FY10E FY11E FY12E FY13E Net Revenue 119,100 112,804 108,244 103,133 99,549 Cash 14,380 10,958 10,958 10,958 10,958 Cash Costs -66,785 -67,419 -65,433 -62,825 -60,853 Accounts receivable 0 0 0 0 0 EBITDA 52,315 45,385 42,811 40,308 38,696 Inventories 0 0 0 0 0 EBITDA margin 44% 40% 40% 39% 39% Other current assets 37,456 38,503 37,113 35,361 34,132 Depreciation and Amortisation -17,943 -17,357 -16,424 -14,836 -12,511 Net PP&E 104,305 97,170 90,343 84,650 80,964 EBIT 34,372 28,028 26,388 25,473 26,186 Other Assets 22,214 20,103 20,103 20,103 20,103 Net interest expense -5,411 -5,546 -5,789 -5,871 -5,498 Total assets 178,355 166,735 158,516 151,071 146,157 Other nonoperating income 0 0 0 0 0 Short-term debt 19,769 3,790 3,790 3,790 3,790 EBT 28,963 23,858 21,209 18,733 19,794 Accounts payable 0 0 0 0 0 Taxes -8,486 -7,157 -6,151 -5,620 -5,938 Other current liabilities 17,519 23,012 22,181 21,134 20,400 Minority interest 0 0 0 0 0 Long-term debt 83,105 96,547 91,039 85,709 80,000 Extraordinary 0 0 0 0 0 Deferred taxes 0 0 0 0 0 Net Income 20,477 16,700 15,058 13,113 13,856 Other liabilities 19,641 8,326 8,326 19,174 19,174 Adj. Net Income 16,506 13,403 12,435 11,164 12,580 Total liabilities 140,034 131,676 125,337 129,807 123,364 Shares Outstanding 18,383 17,564 17,296 17,170 17,115 Minority interest 0 0 0 0 0 EPS 22.28 18.51 17.30 15.23 16.19 Shareholders' equity 38,321 35,059 33,180 21,264 22,793 Adj. EPS 18.50 14.70 14.21 13.00 14.67 Liabilities + Equity 178,355 166,735 158,516 151,071 146,157 Revenue growth -4.0% -5.3% -4.0% -4.7% -3.5% Net Debt 88,494 89,379 83,871 78,541 72,832 EBITDA growth -9.3% -13.2% -5.7% -5.8% -4.0% Adj. Net Debt 121,494 110,716 97,055 84,803 72,846 Net income growth 1.5% -18.4% -9.8% -12.9% 5.7% Net Debt/Capital 49.6% 53.6% 52.9% 52.0% 49.8% FCF growth -4.0% -33.5% 13.4% -8.2% -7.7% Debt/Capital 57.7% 60.2% 59.8% 59.2% 57.3% Net Debt/EBITDA 1.7 2.0 2.0 1.9 1.9 Operating Data, Ratios FY09A FY10E FY11E FY12E FY13E Valuation, Macro FY09A FY10E FY11E FY12E FY13E Capex -9,001 -10,000 -9,596 -9,143 -8,825 EV/EBITDA 5.8 6.1 6.0 6.1 6.2 Change in working capital 963 -5,493 831 1,047 734 Adj. P/E 10.1 12.7 13.2 14.4 12.8 Free Cash Flow Equity 29,480 19,592 22,209 20,388 18,822 P/BV 4.7 4.7 4.8 7.6 7.3 Dividends/Share 16.42 10.02 9.88 9.48 8.02 Dividend % of net income 73.7% 52.7% 56.8% 62.0% 49.5% FCF yield 13.1% 9.0% 11.5% 10.8% 10.3% Consolidated Dividends 15,093 8,803 8,547 8,136 6,865 Dividend yield 8.8% 5.4% 5.3% 5.1% 4.3% Sharebuybacks 4,095 6,074 2,553 1,322 648 ROE 53.4% 47.6% 45.4% 61.7% 60.8% Capex/Depreciation 0.5 0.6 0.6 0.6 0.7 Net revenue/Assets 0.7 0.7 0.7 0.7 0.7 Capex/Sales 7.6% 8.9% 8.9% 8.9% 8.9% Assets/Equity 4.7 4.8 4.8 7.1 6.4 Working capital 19,937 15,491 14,932 14,227 13,732 Working capital/sales 16.7% 13.7% 13.8% 13.8% 13.8% ROIC 18.3% 15.4% 15.8% 17.9% 19.0%

Net income margin 17.2% 14.8% 13.9% 12.7% 13.9% Shares 18,383 17,564 17,296 17,170 17,115 ADRs 919 878 865 858 856 Lines in Service 15,882 15,509 15,124 14,671 14,231 Broadband Subs 6,524 7,349 8,112 8,598 8,770 Broadband Net Adds 1,514 825 763 487 172 WACC 10.4% Mobile Subs 0 0 0 0 0 Perpetual Growth -1.0% Mobile Net Adds 0 0 0 0 0 Cost of equity 11.1% Mobile ARPU 0.00 0.00 0.00 0.00 0.00 Cost of debt 4.2% Mobile MOU 0 0 0 0 0 Subsidiary Share PayTV subs 0 0 0 0 0 Fx, Avg 13.50 12.68 12.35 12.38 12.65

Source: Company reports and J.P. Morgan estimates. Note: Ps in millions (except per-share data). Fiscal year ends Dec.


106


Utilities Key sector dynamics In Brazil, the main sector drivers for 2011 should be: (1) inflation. If inflation expectations increase in 2011, most companies in the sector provide a hedge due to indexed tariffs; (2) energy prices. With long-term electricity supply-vs.-demand balance still comfortable, free market prices seem capped for the near term, limiting upside to generators. Outcome of new capacity auctions will give the market more visibility on balance and price trend; (3) regulation. The pending issue of concession renewals might be tackled in 2011; additionally, while water companies are expected to benefit from new regulation, uncertainty should be high for power discos as they start their 3rd cycle of tariff resets. Overall, we remain lukewarm on the sector outlook for 2011 and recommend investors to selectively focus on individual cases of potential regulatory upside and stocks that provide inflation hedges. In Chile, expectation of tight reserve margin in 2011 means thinner margins for generators (especially heavily hydro-based) and overall growth outlook remains uncertain for major players.

Growth characteristics and how they are changing Despite the high demand growth and increased need for new capacity, auction for greenfield projects should remain competitive, thereby limiting the upside for generators. Discos should also benefit less from demand growth in the future due to recent changes in tariff regulation.

Drivers of returns – Multiples and growth Valuation discount of Brazilian to global utilities is sustained by high local interest rates, and we do not expect this to change in 2011. Major potential for re-deratings will come from regulatory changes. Although cost cutting and M&A are potential drivers for power discos, we are skeptical on execution during 2011.

Recommendations Our top picks among Latin American utilities are: Brazilian water utility Copasa (CSMG3) due to expected rerating coming from a new tariff framework, and Brazilian power utility AES Tiete (GETI4) due to earnings stability, high dividend yield and inflation hedge on revenues. We recommend that investors avoid Brazilian power utility Eletropaulo (ELPL6), due to the risk related to the tariff reset process in July 2011 and potential nonrecurring R$1bn liability, and vertical Brazilian utility CPFL Energia (CPFE3), due to relatively expensive valuation.

Anderson Frey AC


Bloomberg JPMA FREY <GO>

Inflation expectations in Brazil for 12M forward In %

3.5

4.0

4.5

5.0

5.5

6.0

6.5

Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10

IPCA IGPM

Source: Brazilian Central Bank consensus.

Forecast of reserve margin in Brazil for electricity In % of total sector assured generation capacity

-10

-5

0

5

10

15

2010e 2011e 2012e 2013e 2014e 2015e 2016e 2017e 2018e 2019e

gov ernment alternativ e w ith some project delay s alternativ e w ith some project cancellations

Source: EPE and J.P. Morgan estimates.

Global utilities valuation 2011E P/E and EV/EBITDA, see our weekly report for list of companies

4

6

8

10

12

14

16

Brazil Chile Asia Pacific Europe USA

2011e P/E 2011e EV/EBITDA

Source: J.P. Morgan estimates. Priced as of 28-Oct.-2010.

Declining regulatory returns for power utilities After-tax, real, regulated WACC for Brazilian utilities

11.26%9.18%

9.95%

7.24% 7.15%

0%

2%

4%

6%

8%

10%

12%

Discos 2003-05 Transcos 2005-09 Discos 2007-10 Transcos 2009-13 Discos 2011-14

Source: ANEEL.


107


Top picks and stocks to avoid Mkt cap P/E (x) EPS Div. yield ROE Price Code Rating (US$MM) 10E 11E 10E 11E 11E (%) 11E (%) Top picks Copasa 26.4 CSMG3 OW 1,783 6.4 6.0 4.13 4.39 8.3 12.0 AES Tiete 23.5 GETI4 OW 5,246 10.7 9.8 2.19 2.38 10.7 181.4 Stocks to avoid Eletropaulo 29.9 ELPL6 UW 2,936 4.8 8.5 6.29 3.54 12.3 18.0 CPFL Energia 40.4 CPFE3 UW 11,368 13.7 13.9 2.94 2.90 5.4 25.3 Source: Bloomberg, J.P. Morgan estimates. Note: Share prices and valuations are as of October 28, 2010.

Utilities absolute and relative to MSCI LatAm

0

100

200

300

400

500

600

700

800




Utilities EPS integer

90

100

110

120

130

140

150

160

170

180


2010

2011

Source: MSCI, Bloomberg, IBES, Datastream, J.P. Morgan. Utilities 12 mth fwd PE

5

10

15

20

25

30

95 97 98 99 00 01 02 03 04 05 06 07 08 10

PE Av g +1SD -1SD


Utilities trailing PB

0

0.2

0.4

0.6

0.8

1

1.2

1.4

95 97 98 99 00 01 02 03 04 05 06 07 08 10

PB Av g +1SD -1SD



108


COPASA CSMG3.SA www.copasa.com.br


Company description Controlled by the state government of Minas Gerais in Brazil, COPASA (CSMG3) is a water utility providing water distribution for 603 municipalities (population of 13.8mn) and sewage collection for 156 municipalities (population of 7.8mn) in the state.

Investment case CSMG3 trades at a valuation discount to peer SABESP, global water utilities and Brazilian electric utilities, mainly due to the lack of a regulatory framework in which the company’s capex is properly remunerated by market-based return rates. Nevertheless, a regulatory agency was created in the state and is expected to develop a new and market-friendly tariff framework during 2011, to be implemented by Mar 2012. Additionally, COPASA benefits from high cost efficiency relative to peers, high corporate governance, high volume growth prospects and a high dividend yield (2010e at 7.8%).

Potential for earnings upgrades For 2011, positive surprises on earnings could come from: (1) sales volume growth above our 9.5% estimate; and (2) tariff adjustment above inflation in March. For the long term, since there is still uncertainty regarding the final design of the new tariff framework, we chose to be more conservative and assume a mild tariff reset of +2.3% in March 2012 (i.e., below inflation). Earnings upside could come from a better outcome.

Prospects for re-/derating While globally water utilities trade at a valuation premium to electric utilities, in Brazil CSMG3 currently trades at a significant discount to electricity peers. We expect valuation convergence under a new tariff framework.

Price target and risks We have a DCF-based 2011YE price target of R$34, with 9.1% real cost of equity and 0% perpetuity growth. The main risks are: (1) worse-than-expected tariff reset; (2) sales volume growth for 2011 below our expectation; (3) below-inflation tariff adjustment in Mar 2011; (4) lower-than-50% earnings payout; and (5) high increases in operating costs.

Brazil Utilities Anderson Frey AC



20

24

28

32

36

R$


Price Performance

Source: Bloomberg.


Absolute (%) 3.2 5.5 -15.9 Relative (%) -1.5 -2.9 -25.6




31 Dec 11


Cia Saneamento Minas Gerais (CSMG3.SA;CSMG3 BZ) 2009A 2010E 2011E 2012E 2013ERevenues FY (R$ mn) 2,229 2,332 2,589 2,874 3,188EBITDA FY (R$ mn) 939 951 1,074 1,152 1,267EBITDA Margin FY (R$) 42.1% 40.8% 41.5% 40.1% 39.7%EPS Reported FY (R$) 4.73 4.13 4.39 3.80 4.13Bloomberg EPS FY (R$) 4.18 4.11 4.00 4.00P/E FY 5.6 6.4 6.0 6.9 6.4P/BV FY 0.8 0.8 0.7 0.7 0.6Source: Company data, Bloomberg, J.P. Morgan estimates. 'Bloomberg' above denotes Bloomberg consensus estimates.


109


COPASA: Summary of Financials Income Statement FY09A FY10E FY11E FY12E FY13E Balance Sheet FY09A FY10E FY11E FY12E FY13E Net Revenues 2,229 2,332 2,589 2,874 3,188 Cash 415 48 73 41 39 Cost and Expenses (1,546) (1,648) (1,787) (1,991) (2,213) Accounts receivable 404 423 469 521 578 EBITDA 939 951 1,074 1,152 1,267 Other current assets 112 112 112 112 112 EBITDA margin (%) 42.1% 40.8% 41.5% 40.1% 39.7% Long Term assets 967 977 999 1,025 1,053 Depreciation (256) (267) (272) (268) (293) Net fixed assets 5,025 5,708 6,236 6,804 7,385 EBIT 683 684 802 883 975 Total assets 6,923 7,267 7,889 8,502 9,166 Net Financial Result 13 (42) (112) (252) (290) Short-term debt 201 201 201 201 201 FX & Monetary gains (losses) (2) (8) (4) (25) (25) Accounts payable 97 103 112 124 138 Non-operating income 0 0 0 0 1 Other current liabilities 327 273 273 273 273 EBT 522 425 460 406 442 Long-term debt 1,709 1,861 2,222 2,583 2,973 Taxes (148) (157) (181) (168) (183) Other long-term liabilities 858 858 858 879 901 Minority interest 0 0 0 1 2 Total liabilities 3,191 3,297 3,666 4,061 4,487 Net income 546 476 506 438 476 Minority interest 0 0 0 0 0 Net Margin (%) 24.5% 20.4% 19.5% 15.2% 14.9% Shareholders' equity 3,731 3,970 4,223 4,442 4,680 Shares 115 115 115 115 115 Liabilities + Equity 6,923 7,267 7,889 8,502 9,166 EPS 4.73 4.13 4.39 3.80 4.13 Net debt 2,035 2,501 2,837 3,250 3,664 Operating Data, Ratios FY09A FY10E FY11E FY12E FY13E Valuation, Macro FY09A FY10E FY11E FY12E FY13E Change in working capital (54) (21) (61) (64) (71) Sales (million m3) 960.7 1009.6 1105.6 1192.3 1264.5 Capex (1,045) (950) (800) (836) (874) Connections 5,242 5,549 6,512 6,946 7,595 FCFF (309) (178) 58 84 140 Avg.Tariff ($/m3) 2.6 2.6 2.6 2.7 2.8 FCFE (52) (76) 303 189 236 # employees 11,540 11,655 11,655 11,655 11,655 Dividends 158 238 253 219 238 Dividend % of net income 29.0% 50.0% 50.0% 50.0% 50.0% FX rate (eop) 1.74 1.75 1.85 1.93 2.00 Net debt to EBITDA 2.2 2.6 2.6 2.8 2.9 Inflation (%) (1.7%) 9.2% 5.2% 4.5% 4.5% Net Debt to Equity 54.5% 63.0% 67.2% 73.2% 78.3% GDP growth (%) (0.2%) 7.5% 4.5% 4.0% 4.0% Current ratio 1.5 1.0 1.1 1.1 1.2 Interest Rates (%,eop) 8.8% 10.8% 12.5% 10.5% 9.5% Interest Coverage (69.6) 22.4 9.6 4.6 4.4 Capex/depreciation 4.1 3.6 2.9 3.1 3.0 EV/EBITDA 5.7 5.6 5.0 4.6 4.2 Net Margin (%) 24.5% 20.4% 19.5% 15.2% 14.9% P/E 5.5 6.3 5.9 6.9 6.3 Revenues/Assets 0.3 0.3 0.3 0.3 0.3 P/BV 0.8 0.8 0.7 0.7 0.7 Assets/Equity 1.9 1.8 1.9 1.9 2.0 FCFE yield (%) (1.7%) (2.5%) 10.0% 6.2% 7.8% ROE (%) 14.6% 12.0% 12.0% 9.9% 10.2% Dividend yield 5.3% 7.9% 8.4% 7.3% 7.9%

Source: Company reports and J.P. Morgan estimates. Note: R$ in millions (except per-share data). Fiscal year ends Dec.


110


ELETROPAULO ELPL6.SA www.eletropaulo.com.br


Company description Controlled by the US utility AES and BNDES (Brazilian Development Bank), Eletropaulo (ELPL6 BZ) is a pure power distribution company that owns the concession for the metropolitan area of Sao Paulo city and serves 6.0 million customers (9% market share in Brazil).

Investment case We believe that the stock’s performance in 2011 should be capped by the following potential negative drivers: (1) increased likelihood of a cash disbursement of ~ R$1.1bn in the judicial dispute with Brazilian utility Eletrobras; and (2) uncertainty regarding the outcome of the July 2011 tariff reset. Moreover, we expect sustainable dividend yields to decrease post 2011 to levels below of those of more predictable utilities in Brazil, which is a major negative since a high dividend yield has been for years one of the highlights of ELPL6’s investment case.

Potential for earnings upgrades Since the potential cash disbursement of R$1.1bn in the judicial dispute with Eletrobras is not yet included in our estimates, this represents the single highest downside risk for 2011 earnings. The second major source of downside (or upside) is the outcome of the July 2011 tariff reset. We assumed a 1.6% tariff increase allowed by the regulator.

Prospects for re-/derating ELPL6 currently trades at similar valuation levels to other power utilities in Brazil. Although we do not expect this to change in the near future, we do expect a relevant reduction in profitability after the July 2011 tariff reset.

Price target and risks We have a DCF-based 2011YE price target of R$30, with 10.0% real cost of equity and 0% perpetuity growth. The main risks: (1) a better-than-expected outcome from the July 2011 tariff reset; (2) lower-than-expected expense with pension liability; (3) a favorable resolution to the ~R$1.1bn debt dispute with Eletrobras; (4) steep reduction in controllable costs; and (5) a sooner-than-expected restart of the sale process of a controlling stake by BNDES.

Brazil Utilities Anderson Frey AC



28

32

36

40

R$


Price Performance

Source: Bloomberg.


Absolute (%) -1.0 -10.3 8.0 Relative (%) -5.7 -18.6 -1.8




31 Dec 11


ELETROPAULO (ELPL6.SA;ELPL6 BZ) 2009A 2010E 2011E 2012E 2013ERevenues FY (R$ mn) 8,050 8,758 8,931 9,439 10,118EBITDA FY (R$ mn) 1,573 1,983 1,353 1,340 1,459EBITDA Margin FY (R$) 19.5% 22.6% 15.2% 14.2% 14.4%EPS Reported FY (R$) 6.35 6.29 3.54 3.11 3.18Bloomberg EPS FY (R$) 5.45 6.16 4.02 3.36P/E FY 4.7 4.8 8.5 9.6 9.4P/BV FY 1.5 1.5 1.5 1.5 1.5Source: Company data, Bloomberg, J.P. Morgan estimates. 'Bloomberg' above denotes Bloomberg consensus estimates.


111


ELETROPAULO: Summary of Financials Income Statement FY09A FY10E FY11E FY12E FY13E Balance Sheet FY09A FY10E FY11E FY12E FY13E Net Revenues 8,050 8,758 8,931 9,439 10,118 Cash 1,249 931 669 419 213 Cost and Expenses (6,477) (6,776) (7,578) (8,100) (8,660) Accounts receivable 1,434 1,363 1,396 1,475 1,581 EBITDA 1,573 1,983 1,353 1,340 1,459 Other current assets 959 999 899 799 799 EBITDA margin (%) 19.5% 22.6% 15.2% 14.2% 14.4% Long Term assets 1,505 1,360 1,331 1,331 1,331 Depreciation (382) (398) (400) (414) (427) Net PP&E 6,699 6,916 7,136 7,355 7,574 EBIT 1,192 1,585 953 926 1,032 Other fixed assets 10 10 10 10 10 Net Financial Result 5 (112) (158) (251) (262) Total assets 11,855 11,578 11,439 11,388 11,507 FX & Monetary gains (losses) 224 9 (11) 0 0 Short-term debt 624 115 300 300 300 Non-operating income 0 75 75 75 0 Accounts payable 830 836 868 918 984 EBT 1,421 1,557 859 750 770 Other current liabilities 2,225 1,791 1,679 1,579 1,579 Taxes (357) (505) (267) (230) (237) Long-term debt 1,505 1,360 1,331 1,331 1,331 Minority interest - - - - - Other long-term liabilities 3,391 4,196 3,980 3,978 3,978 Net income 1,063 1,053 592 520 533 Total liabilities 8,574 8,297 8,158 8,106 8,172 Shares 167 167 167 167 167 Minority interest 0 0 0 0 0 EPS 6.35 6.29 3.54 3.11 3.18 Shareholders' equity 3,281 3,281 3,281 3,281 3,335 Liabilities + Equity 11,855 11,578 11,439 11,388 11,507 Change in working capital 160 510 (47) (30) (40) Capex (516) (615) (620) (633) (646) Net debt 3,999 3,742 3,999 4,248 4,454 FCFF 861 1,448 532 519 523 Net debt to EBITDA 2.5 1.9 3.0 3.2 3.1 FCFE 1,406 1,533 256 274 299 Net Debt to Equity 121.9% 114.1% 121.9% 129.5% 133.6% Dividends 1,080 1,053 592 520 480 Current ratio 1.0 1.2 1.0 1.0 0.9 Dividend payout (%) 101.6% 100.0% 100.0% 100.0% 90.0% Interest Coverage (318.9) 17.8 8.6 5.3 5.6 Operating Data, Ratios FY09A FY10E FY11E FY12E FY13E Valuation, Macro FY09A FY10E FY11E FY12E FY13E Nominal Capacity (avg MW) - - - - - FX rate (eop) 1.74 1.75 1.85 1.93 2.00 Distribution Customers ('000) 6,036 6,279 6,524 6,774 7,029 Inflation (%) (1.7%) 9.2% 5.2% 4.5% 4.5% Distribution Demand (GWh) 34,436 35,965 37,156 38,456 39,802 GDP growth (%) (0.2%) 7.5% 4.5% 4.0% 4.0% Avg.GenerationTariff ($/MWh) - - - - - Interest Rates (%,eop) 10.1% 10.0% 12.1% 11.1% 10.0% Avg.Regulated Disco Tariff ($/MWh) 437.4 454.4 461.4 470.9 486.8 # employees 4,360 4,360 4,360 4,360 4,360 EV/EBITDA 5.2 4.1 6.1 6.1 5.6 Net RAB 5,522 5,892 6,283 6,554 6,816 P/E 4.7 4.7 8.4 9.6 9.3 P/BV 1.5 1.5 1.5 1.5 1.5 Capex/depreciation 1.4 1.5 1.5 1.5 1.5 FCFE yield (%) 28.1% 30.6% 5.1% 5.5% 6.0% Revenue/Employee ('000) 1,846 2,009 2,048 2,165 2,321 Dividend yield 22.5% 22.0% 12.4% 10.8% 10.0% Net Margin (%) 13.2% 12.0% 6.6% 5.5% 5.3% Revenues/Assets (%) 67.9% 75.6% 78.1% 82.9% 87.9% genco EV/kW capacity - - - - - Assets/Equity 3.6 3.5 3.5 3.5 3.5 disco EV/customer 1.4 1.3 1.3 1.2 0.7 ROE (%) 32.4% 32.1% 18.0% 15.8% 16.0% discoEV/Net RAB 1.5 1.4 1.3 1.2 0.7 Source: Company reports and J.P. Morgan estimates. Note: R$ in millions (except per-share data). Fiscal year ends Dec.


112




Econom

ics and Com

modities


114



115


Global Economic Outlook

• Global GDP growth slowdown may have already bottomed.

• Data flow has been generally positive, with our global PMIs signaling a slight pickup in growth this quarter.

• Global GDP growth in 2011 revised up a touch, the first upward revision since April.

• Inflation pressures muted well past 2011 in the major developed economies; return to target unlikely.

• Fed and BoJ open quantitative easing spigot, BoE likely to follow by early next year.

Laying the seeds for 1H11 acceleration

We are becoming more confident that the seeds are being sowed for a lift to above-trend growth starting in 1H11. The latest developments in the US, Europe and Asia all suggest that earlier drags are fading. And while midyear shocks will reverberate through production plans as firms slow the pace of inventory accumulation, evidence suggests this adjustment is moving forward constructively. Largely in response to the stronger-than-expected Chinese data out last month, we have marked up our global GDP outlook for 2011(%oya) to a modestly above-trend pace of 3% from 2.9% as of the last GMOS. Although the change is small, it is the first upward revision since late April and the momentum in positive data surprises has turned positive in the last four weeks after a midyear run of negative outturns. Consequently, along with our tiny upward revision to the growth outlook, the risk bias has shifted to the upside.

The deceleration in global economic activity looks to have continued in the current quarter. After jumping 3.9% annualized in 2Q10, global GDP growth downshifted to a 2.7%pace last quarter and is projected to step further down to a2.3% pace this quarter. Some deceleration should not have been a surprise as the record surge in global manufacturing in the first year of the recovery came off the boil. However, the downshift was amplified by an unexpected slowing in consumer and business spending, coupled with deterioration in sentiment and risk appetites. Given the global nature of the step down in manufacturing output growth, the deceleration has been broad-based, with growth slowing across the developed and emerging markets.

Bruce Kasman

(1-212) 834-5515 [email protected] JPMorgan Chase Bank NA

David Hensley


Joseph Lupton


Carlton Strong (1-212) 834-5612 [email protected] JPMorgan Chase Bank NA

Michael Mulhall (1-212) 834-9123 [email protected] JPMorgan Chase Bank NA

Nikolaos Panigirtzoglou

(44-20) 7777-0386 [email protected] J.P. Morgan Securities Ltd.

Grace Koo


John Normand


Paul Meggyesi (44-20) 7859-6714 [email protected] J.P. Morgan Securities Ltd.

The forces behind the midyear slowdown—a policy-induced downshift in China, a sovereign debt crisis in Europe and a slide in consumer confidence and spending in the US—were broad-based and together posed a legitimate risk to an expansion still in its early stages. Also of concern was that these drags would be magnified by a sharper retrenchment in business spending. Another worry was of a negative feedback loop where slower growth fed weakness through a deterioration in financial conditions. In the event, firms appear to be bending modestly in the face of slower growth but continue to increase capital spending and hiring. Moreover, financial conditions remain a positive for growth, helped in part by the easing signals sent by central banks.


116


Economic Activity Surprise Index (EASI)

-60-45-30-15

01530

-10

-5

0

5

Index

2007 2008 2009 2010

U S

Eu r o ar ea

Source: J.P. Morgan.

China provides the most concrete signs that drags are abating. The latest figures confirm that the most intense phase of the midyear inventory correction has passed and that growth bottomed in 2Q. A steady rebound is now under way, with domestic demand rising at a robust pace despite softness in the export sector. We expect economic activity in China to accelerate further in the coming quarters, fueled by ongoing strengthening in domestic demand. With monetary conditions still very easy and government infrastructure projects for next year to begin ramping up, the risk of overheating is now increasing. We have thus raised our estimate for China’s real GDP growth in coming quarters.

Recent developments suggest the risks to our Euro area growth forecast are to the upside, with a shallower and shorter soft patch than the one currently in our projections. While the downward pressure on growth in the periphery remains intense, the extent of the spillover to the area wide economy looks to be more moderate than we have been anticipating. Indeed, German business surveys continue to impress.

In the US, developments are less clear-cut, with consumer confidence still depressed and the impact of an imminent fiscal tightening uncertain. However, goods consumption rebounded smartly in the three months ending in September and the latest reading on October auto sales points to a further acceleration into the current quarter. In addition, an upturn in investment and hours worked remains intact. A key issue relates to the impact of the Fed’s recently announced quantitative easing package. While we are not building in significant growth benefits from these actions in our forecast, the Fed’s success in promoting more stimulative financial conditions helps limit downside risks as the economy continues to move forward at a modest pace. Perhaps the most important effect of the Fed’s actions will be its impact on confidence and asset prices.

Inflation probability distribution for 2011 (developed)

05

1 01 52 02 53 0

-0 . 5 -0 . 0 0 . 0 -0 . 5 0 . 5 -1 . 0 1 . 0 -1 . 5 1 . 5 -2 . 0 2 . 0 -2 . 5 2 . 5 -3 . 0 > 3 . 0

% , p ro b a b ility (b a s e d o n 1 9 2 p o s s ib le o u tc o m e s )

H e a d lin e in fla tio n (% 4 Q / 4 Q )

M e a n = 1 . 1 %J . P . M o rg a n fc s t = 1 . 0 %P ro b (< ta rg e t) = 6 4 %

Source: J.P. Morgan.

The most recent readings from our J.P. Morgan global PMIs are adding some upside risk to the projected further slowing in growth in the current quarter. Based on the data in hand, the J.P. Morgan all-industry PMI (out tomorrow) appears to have jumped from 52.6 to just under 55, a large move that would be the first increase since peaking back in April and erase all of the decline since July. If the current level of the index holds through the end of the year, global GDP could expand at an annualized pace of 2.9%, over 1/2%-point stronger than our current forecast. More importantly, it is signalling that the midyear slowdown may have already bottomed as of the third quarter.

Deflation odds low, inflation odds also low

Although economic activity appears set to accelerate into 2011, we are still only looking for trend-like growth in 1H11 and a move to above trend by 2H11. Consequently, the elevated levels of economic slack—primarily in the US, Euro area, Japan and UK—will remain in place well past 2011 and so too will the downward pressure on inflation. Despite a year of above-trend growth in the first year of the recovery and a jump in commodity prices from their recession lows, core inflation rates in the developed markets (DM) have slid to the lowest level in over 50 years. In this regard, the historical record is clear: the level of economic slack matters more than its change. Since 1970, negative output gaps in every OECD country have been associated with declines in core inflation even in periods of above-trend growth. Phillips-curve-based model estimates suggest headline inflation will fall further next year in the developed markets, reaching just 0.1%oya by the end of 2011. By contrast, the J.P. Morgan forecast looks for headline inflation to remain near 1%oya.


117


The J.P. Morgan forecast rests on two key factors that should stabilize inflation next year. The first is that inflation expectations remain anchored near central bank targets. Improved monetary policy over the past two decades supports the view that expectations will remain anchored. With that said, the greater risk is that expectations will move down in line with the recent decline in core inflation. The second factor underlying the J.P. Morgan forecast is the considerable evidence that the transmission of slack to inflation is diminished at lower levels of inflation. Institutional as well as behavioral impediments create significant downward nominal rigidities in the price-setting process, thereby putting a floor under inflation.

In a recent report, we estimate that DM inflation will average 1.1%oya in 2011 across a wide range of possible behavioral and economic scenarios (“Stuck in a low inflation rut,” Global Issues, October 27, 2010). This result is in line with the J.P. Morgan forecast. Deflation for the DM as a whole is unlikely, with a probability of just 2%, but is somewhat more likely in the US. Although deflation risks appear low, our analysis shows that it will be difficult for central banks to raise inflation to a level with which they are comfortable. We estimate a two-thirds probability that inflation in the developed markets remains below central bank targets by the end of next year.

Although the risk of a deflationary spiral appears low, this will be of limited comfort to central banks, who face a formidable challenge in returning inflation to a level with which they are comfortable. Large negative output gaps continue to exert a powerful downward pull on inflation. As an illustration, we estimate that GDP growth would need to reach about 5.5% in the US, 3.3% in the Euro area and 5.8% in Japan in 2011 to return inflation to target in the coming year. Moreover, these calculations assume stable inflation expectations, anchored at central bank targets. If inflation expectations move down in coming quarters, in line with past experience, growth will need to be even stronger.

It is against this backdrop that the Fed has reopened the quantitative easing spigot today, roughly in line with market expectations. While the recent FOMC statement indicated inflation is only somewhat low, recognizing that the unemployment rate will remain elevated for some time suggests an admission of failure on both legs of its dual mandate. The BoJ has also already acted with the announcement of a wide-ranging new asset-purchase program.

The initial installment was modest in size, although officials have said they will expand it if necessary. We also look for the Bank of England to renew its bond-buying program by early next year, although, with inflation proving stickier at an elevated level, this is a much closer call. In sharp contrast to each of these central banks, the ECB has indicated it sees the potential costs of quantitative easing as outweighing any potential benefits. That said, none of these central banks is expected to begin raising rates until mid-2012 at the earliest.

Note: This piece is excerpted from the issue of Global Markets Outlook and Strategy dated November 3, 2010.


118


Global Economic Outlook

Note: For some emerging economies, 2010-2011 quarterly forecasts are not available and/or seasonally adjusted GDP data are estimated by J.P. Morgan. Bold denotes changes from last edition of Global Markets Outlook and Strategy published November 3, 2010, with arrows showing the direction of changes. Underline indicates beginning of J.P. Morgan forecasts. Source: J.P. Morgan estimates.


119


Central Bank Watch Change from Forecast

Official interest rate Current Aug '07 (bp) Last change Next meeting next change Dec 10 Mar 11 Jun 11 Sep 11 Dec 11

Global GDP-weighted average 1.79 -316 1.80 1.85 1.92 1.96 2.05 excluding US GDP-weighted average 2.44 -237 2.45 2.52 2.61 2.67 2.80Developed GDP-weighted average 0.61 -358 0.62 0.63 0.65 0.68 0.72Emerging GDP-weighted average 5.09 -201 5.11 5.26 5.47 5.56 5.79 Latin America GDP-weighted average 7.24 -217 7.27 7.74 8.33 8.39 8.40 CEEMEA GDP-weighted average 4.08 -294 4.05 4.07 4.13 4.32 4.80 EM Asia GDP-weighted average 4.71 -154 4.75 4.82 4.97 5.02 5.22

The Americas GDP-weighted average 1.28 -453 1.29 1.38 1.49 1.51 1.55United States Federal funds rate 0.125 -512.5 16 Dec 08 (-87.5bp) 14 Dec 10 On hold 0.125 0.125 0.125 0.125 0.125Canada Overnight funding rate 1.00 -325 8 Sep 10 (+25bp) 7 Dec 10 1 Mar 11 (+25bp) 1.00 1.25 1.50 1.75 2.25Brazil SELIC overnight rate 10.75 -125 21 Jul 10 (+50bp) 8 Dec 10 Mar 11 (+25bp) 10.75 11.50 12.50 12.50 12.50Mexico Repo rate 4.50 -270 17 Jul 09 (-25bp) 26 Nov 10 On hold 4.50 4.50 4.50 4.50 4.50Chile Discount rate 2.75 -225 16 Sep 10 (+50bp) 16 Nov 10 16 Nov 10 (+25bp) 3.25 4.00 4.25 4.25 4.25Colombia Repo rate 3.00 -600 30 Apr 10 (-50bp) 19 Nov 10 1Q 11 (+50bp) 3.00 4.00 5.00 5.50 5.50Peru Reference rate 3.00 -150 9 Sep 10 (+50bp) 11 Nov 10 May 11 (+25bp) 3.00 3.00 3.50 4.25 4.50

Europe/Africa GDP-weighted average 1.45 -322 1.45 1.45 1.46 1.51 1.62Euro area Refi rate 1.00 -300 7 May 09 (-25bp) 4 Nov 10 On hold 1.00 1.00 1.00 1.00 1.00United Kingdom Repo rate 0.50 -500 5 Mar 09 (-50bp) 4 Nov 10 On hold 0.50 0.50 0.50 0.50 0.50Sweden Repo rate 1.00 -250 26 Oct 10 (+25bp) 15 Dec 10 15 Dec 10 (+25bp) 1.25 1.25 1.25 1.50 2.00Norway Deposit rate 2.00 -250 5 May 10 (+25bp) 15 Dec 10 3Q 11 (+25bp) 2.00 2.00 2.00 2.25 2.75Switzerland 3-month Swiss Libor 0.25 -225 12 Mar 09 (-25bp) 4Q 10 Jun 11 (+25bp) 0.25 0.25 0.50 0.75 1.00Czech Republic 2-week repo rate 0.75 -200 6 May 10 (-25bp) 4 Nov 10 2Q 11 (+25bp) 0.75 0.75 1.00 1.25 1.75Hungary 2-week deposit rate 5.25 -250 26 Apr 10 (-25bp) 29 Nov 10 3Q 11 (+25bp) 5.25 5.25 5.25 5.50 5.75Israel Base rate 2.00 -200 27 Sep 10 (+25bp) 22 Nov 10 22 Nov 10 (+25bp) 2.25 2.50 2.75 3.25 3.50Poland 7-day intervention rate 3.50 -100 24 Jun 09 (-25bp) 23 Nov 10 2Q 11 (+25bp) 3.50 3.50 3.75 4.00 4.25Romania Base rate 6.25 -75 4 May 10 (-25bp) 5 Jan 11 3Q 11 (+25bp) 6.25 6.25 6.25 6.50 6.75Russia 1-week deposit rate 2.75 -25 31 May 10 (-50bp) Nov 10 3Q 11 (+25bp) 2.75 2.75 2.75 3.00 3.50South Africa Repo rate 6.00 -350 9 Sep 10 (-50bp) 18 Nov 10 18 Nov 10 (-50bp) 5.50 5.50 5.50 5.50 5.50Turkey 1-week repo rate 7.00 -1050 - 11 Nov 10 4Q 11 (+50bp) 7.00 7.00 7.00 7.00 8.00

Asia/Pacific GDP-weighted average 3.01 -119 3.03 3.09 3.19 3.24 3.37Australia Cash rate 4.75 -150 2 Nov 10 (+25bp) 6 Dec 10 1Q 11 (+25bp) 4.75 5.00 5.25 5.50 5.75New Zealand Cash rate 3.00 -500 29 Jul 10 (+25bp) 8 Dec 10 10 Mar 11 (+25bp) 3.00 3.25 3.50 3.75 4.00Japan Overnight call rate 0.05 -48 5 Oct 10 (-5bp) 5 Nov 10 On hold 0.05 0.05 0.05 0.05 0.05Hong Kong Discount window base 0.50 -625 17 Dec 08 (-100bp) 4 Nov 10 On hold 0.50 0.50 0.50 0.50 0.50China 1-year working capital 5.56 -101 19 Oct 10 (+25bp) 1Q 11 2Q 11 (+25bp) 5.56 5.56 5.81 5.81 6.06Korea Base rate 2.25 -225 9 Jul 10 (+25bp) 15 Nov 10 4Q 10 (+25bp) 2.50 2.75 2.75 2.75 3.00Indonesia BI rate 6.50 -200 5 Aug 09 (-25bp) 4 Nov 10 2Q 11 (+25bp) 6.50 6.50 6.75 6.75 6.75India Repo rate 6.25 -150 2 Nov 10 (+25bp) 16 Dec 10 1Q 11 (+25bp) 6.25 6.50 6.50 6.75 7.00Malaysia Overnight policy rate 2.75 -75 8 Jul 10 (+25bp) 12 Nov 10 On hold 2.75 2.75 2.75 2.75 2.75Philippines Reverse repo rate 4.00 -350 9 Jul 09 (-25bp) 18 Nov 10 2Q 11 (+25bp) 4.00 4.00 4.25 4.50 4.50Thailand 1-day repo rate 1.75 -150 26 Aug 10 (+25bp) 1 Dec 10 1 Dec 10 (+25bp) 2.00 2.00 2.00 2.00 2.00Taiwan Official discount rate 1.500 -163 30 Sep 10 (+12.5bp) 23 Dec 10 3Q 11 (+12.5bp) 1.50 1.50 1.50 1.625 1.75Bold denotes move since last GMOS and forecast changes. Source: J.P. Morgan.


120


Capital Controls and FX Intervention State of current FX regime, capital controls and possible future Intervention measures in Emerging Markets FX regime Recent measures Possible future measures

China Closed Capital Account. Bond Investment only possible through QFI, but discouraged by authorities

None None

India Strict Limits on size of foreign bond investment. Limit of $5bn on government bonds and $15 bn on corporates

In September, SEBI announced the increases in the FII Limits to $10bn for

government bonds and $20bn for corporates

Potential for currency intervention, but we expect no action against bonds.

Indonesia Interest and an income tax at 20%, but majority of investors use tax treaties to reduce these taxes between 0-10%

1-month minimum holding period for foreigners investing in SBIs

Further restrictions on SBIs; Tax increases are unlikely as it needs

parliamentary approval Korea Withholding tax was made exempt on MSB and KTB since May

2009 In June, caps on foreign banks FX forward positions were announced leading to less

MSB holdings.

Possibly reimposing WHT on MSBs and KTBs. Further lowering of cap on foreign

banks FX fwd positions. Malaysia No taxes None None Philippines Income tax of 20% on interest income and capital gains. None None Singapore Open capital account. No taxes. None None Sri Lanka Strict Limits on size of foreign investment in T-bonds and T-bills at

10% of total outstanding. Investment in corporate bonds is not permitted.

None Easing of capital controls.

Taiwan Time deposits are not allowed for foreigners. FINI account required for foreign investment, frequest inspections of custodian banks

Verbally discourage fixed income investment by FINI accounts, propose mandatory use of USD for foreigners

equity margin accounts.

None

Thailand Foreigners exempt from WH tax for government bonds 15% WHT was reintroduced to equalize with current tax regime for domestic

holders.

Potential introduction of across the board tax on all fixed income inflows with

potential restrictions on minimum holding period.

Argentina Non Convertible and capital outflow controls remain in place with a minimum holding period of 1year and US$2mm outflow per month

None None

Brazil Non Convertible. Tax of 6% on foreign fixed income investment and 2% on equity investment. Increase margin for derivative transactions

Increase IOF Tax on fixed income investment to 4% on Oct 4th and to 6% on

Oct 18

Risks remain high for further interventions.

Chile Non Convertible. No capital controls None Near-term risks are limited although an increase in FX intervention is possible if

CLP rallies further Colombia Non Convertible. 33% tax on income and capital gains and 6% WHT

on coupon payments for bonds with maturities up to 5 years and 4% for longer bonds.

USD purchases of $20mm day Risks remain high for further interventions both in spot FX and potentially increases

in Reserve Mexico Free floating and deliverable. No FX controls. Banxico sells $600mm

of USDMXN puts per month. None None

Peru Non Convertible. Reserve Requirements on foreign deposits (120%), 30% tax on interest paid to non-residents. Limits on pension

fund short USD positions

Reinstated 4% fee on Bank CDs Unlikely to initiate new tax measures but purchases of USD have been high this

year at $8bn YTD. Czech Free floating and convertible None None Hungary Free floating and convertible. It is important to note the heavy

indebtedness of the private sector in foreign currency debt. None None

Israel Free floating and convertible. Interventions in the fx market have been substantial and we estimate have been running at a $700mm

per month pace.

None None

Poland Free floating and convertible. None None Russia Managed float vs a basket of EUR and USD (45%/55%). Current

band of the basket is between 32.90 and 36.90 Recently widened the band Moving toward more currency flexibility

South Africa Freely convertible. SARB does intervene on occasion. No capital controls

None Risk of more aggressive intervention

Turkey Freely floating and convertible. CBRT engages in daily FX auctions of $40mm USD and sets a weekly guidance of an extra amount.

Lowered the interest rate on foreign currency deposit rates to 0.25% from

2.50%. Increased weekly auction amounts to $500mm most recently.

Risk of aggressive and unorthodox intervention is low, but policy of building

reserves remains in place.

Source: J.P. Morgan, “Get over It: EM FX Appreciation and Interventions Are Here to Stay,” Sclater -Booth et al, 21 Oct 10.


121


Foreign exchange reserve appreciation (YTD)

15.3 15.012.2

8.56.4 6.1 5.3 3.7

0.1 -1.7

9.412.2

4.15.26.8

23.6 17.7 16.9 15.5

-100

10203040506070

Indo

nesia

Philip

pines

Mex

ico

Braz

il

Polan

d

Thail

and

Russ

ia

Turk

ey

China

Taiw

an

Kore

a

Peru

Colom

bia

Czec

h

Arge

ntina

Chile

India

Sout

h Af

rica

Mala

ysia

-50510152025USD Bn % change

Source: Bloomberg.

FX appreciation vs. US$ (YTD %)

12.1 11.0 10.98.6

7.0 6.5 6.3 5.6 5.4 5.2 4.9 4.8 3.9 3.4 2.8 2.2 2.1-4.0-2.5

-5

0

5

10

15

Thail

and

Mala

ysia

Colom

bia

Philip

pines

Sout

h Af

rica

Mex

ico

Turk

ey

Czec

h

Indo

nesia

Taiw

an

India

Kore

a

Chile

Peru

Braz

il

China

Polan

d

Russ

ia

Arge

ntina

Source: Bloomberg.

10-year government bond yields (%)

11.9

8.0 7.8 7.15.6 6.0 5.4

4.5 5.33.9 3.6 3.13.5 2.9 2.7 2.4 2.4 2.2 1.4 0.91.3

3.55.47.0

8.3

3.13.74.05.2

3.74.15.15.2

6.5

02468

101214

Braz

il

India SA

Turk

ey

Indo

nesia

Colom

bia

Polan

d

Mex

ico

Philip

pines

Peru

Kore

a

Russ

ia

Mala

ysia

China

Czec

h

Thail

and

Taiw

an

Pre-tax After-tax

Source: Bloomberg, J.P. Morgan calculations. Note: After-tax assumes US institutional investor tax treatment.


122


Brazil Economics Inflation risks on the rise Despite the slowdown observed in the central quarters of the year, the economic activity scenario remains very robust, especially due to the domestic demand drivers. The labor market is extremely tight, with the unemployment rate at a historical low and real wage gains accelerating at a worrisome pace. On top of that, credit conditions continued to improve despite the 200bp monetary tightening implemented between April and September. Against this backdrop of strong domestic demand expansion, we believe Brazil’s growth rate will reaccelerate by the end of this year and will begin 2011 on a strong footing. The resumption of growth in an environment of already tight utilization rates will put even more pressure on headline and core inflation, which are already running above the BCB target of 4.5%.

Will Rousseff rebalance Brazil’s policy mix? The economic policy mix in the last year of the Lula Administration has been clearly unbalanced, with the expansionary fiscal policy putting upward pressure on interest rates, and the high yields of local rates market attracting short-term capital inflows. The problem is that the government has responded to the resulting fx appreciation pressures with the imposition of new taxation on foreign capital inflows instead of promoting a fiscal adjustment aimed at reducing aggregate demand. We expect that the next administration will promote some fiscal correction, but the resumption of a monetary tightening is inevitable, in our view. Our forecast is that the Selic rate will be increased by 175bp next year, to 12.50%. Assuming some policy action will be taken by the next administration, we anticipate growth will moderate to 4.5% next year (from 7.5% in 2010), which will help to reduce inflation from 5.6% this year to a still-above-target 5.1% in 2011.

All eyes on cabinet formation The market expects a market-friendly cabinet, with ex-Finance Minister Palocci likely setting the agenda from the Chief of Staff’s chair. BCB Governor Meirelles is seen as an invaluable asset and should be retained, either remaining at the BCB or being appointed to a more political position. If Meirelles leaves the BCB, an appointment from within is likely. For the finance portfolio, Guido Mantega and Luciano Coutinho are the leading contenders, in our view.

Fabio Akira AC (55-11) 3048-3634 [email protected] Banco J.P. Morgan S.A.

76

78

80

82

84

86

88 6

8

10

12

14

% of full capacity, saHigh utilization of labor and capital resources

% of labor force, sa, inverted

FGV operating rates

Unemployment rates

03 05 07 09

3

4

5

6

7

%oya, nsaIPCA headline and core inflation

Headline

Core

2006 2007 2008 2009 2010

Source: BCB and J.P. Morgan.

Brazil: economic indicators

Average2003-07 2008 2009 2010f 2011f

Real GDP, % change 4.0 5.1 -0.2 7.5 4.5Consumption* 2.7 4.5 3.1 6.1 4.3Investment* 1.2 2.7 -3.4 4.5 1.7Net trade* 0.0 -2.0 0.1 -3.1 -1.6

Consumer prices, %oya 7.1 5.7 4.9 5.0 5.6% Dec/Dec 6.0 5.9 4.3 5.6 5.1

Producer prices, %oya 9.6 13.7 -0.2 4.5 3.1Government balance, % of GDP -3.3 -1.9 -3.3 -3.4 -2.5

Exchange rate, units/$, eop 2.36 2.31 1.74 1.70 1.85Merchandise trade balance ($ bil.) 37.9 24.9 25.0 13.7 -0.6 Exports 117.3 198.7 153.5 196.7 221.0 Imports 79.3 173.8 128.5 183.0 221.6

Current account balance 9.4 -29.2 -25.2 -49.3 -68.3 % of GDP 1.0 -1.8 -1.6 -2.4 -3.1

International reserves, ($ bil.) 83.8 192.8 236.8 292.3 300.3Total external debt, ($ bil.) 229.9 306.4 301.2 335.2 352.2 Short term† 32.7 38.8 30.8 29.8 29.8

Total external debt, % of GDP 25 18 19 16 16Total external debt, % of exports‡ 157 124 160 137 131Interest payments, % of exports‡ 11 7 9 7 6

* Contribution to growth of GDP.† Debt with original maturity of less than one year.‡ Exports of goods, services, and net transfers.


123


Mexico Economics External demand might curb growth, but auto

sector and credit could boost domestic demand

Unfortunately, gubernatorial elections will likely create a political impasse for structural reforms

Sluggish growth and well-behaved inflation will keep Banxico on hold all year long

Favor long MXN over front-end receivers in TIIE swaps

Fundamentals and politics in 2011 Structural change in the auto sector and credit growth could overcompensate sluggish US growth The externally driven manufacturing production has led Mexico’s economic recovery throughout the year. Nevertheless, growing concerns about longer-term sluggish growth in the US is posing risks ahead. In this context, we believe Mexico’s GDP will grow 3.5% in 2011 (consensus: 3.5%). We could even see lower growth rates in Mexico. Nevertheless, it is our take that the structural change that the auto sector has experienced in the Mexican economy and credit growth in Mexico will help to overcompensate US growth’s sluggishness. On the one hand, several automakers across the world have reallocated part of their production to Mexico to benefit from a weaker peso, skilled Mexican labor, still-high transport costs, and the country’s strategic geographic location.

On the other hand, commercial banks’ credit might post significantly high growth rates in 2011. The Mexican banking system is composed of 41 well-capitalized commercial banks. The average capitalization index stands at 17.7, with a range of 12.3 to early 240. Unfortunately, total commercial bank credit to the private sector represents less than 15% of GDP. After the credit boom in Mexico in 2004-2006, nonperforming loans increased significantly, making banks rethink their credit-giving policies. Nevertheless, commercial banks have now “cleaned up” their credit balances and employment conditions have improved significantly in the past 12 months. As a result, we believe that it is highly likely that all these factors will probably lead to an ascending trend in the country’s domestic credit cycle.

Gabriel CasillasAC (52-55) 5540-9558, [email protected]

Banco J.P. Morgan S.A., Institución de Banca Múltiple J.P.Morgan Grupo Financiero

Gubernatorial elections will likely create a political impasse for structural reforms There is no doubt that Mexico needs several structural reforms, particularly meaningful fiscal and labor-market reforms as well as new guidelines to empower antitrust officials to dilute monopolies and foster competitiveness. We strongly believe that the lack of these structural reforms is restraining domestic demand and Mexico’s potential GDP. Furthermore, the prevailing legal uncertainty with regard to enforcing contracts is short-circuiting the credit intermediation function of commercial banks. Unfortunately, the seemingly large GDP growth rates that the country has observed in 2010 appear to be providing a “false sense of security” to government officials, particularly legislators, who have now downplayed the need for reforms in Mexico. Furthermore, with gubernatorial elections in six states next year, particularly in the highly populated State of Mexico, it is going to be difficult to secure congressional approval for the key reforms that the country needs.

Not all long-term plans are negative. We believe infrastructure projects, including construction of roads, water treatment plants, and massive transportation systems, will play an important role in the next two years. This is mainly because several projects that had been in a feasibility study phase over the past two years are now ready to start construction. Furthermore, several projects suffered important delays because of the global financial crisis. However, state-owned development bank BANOBRAS has modified its lending framework to provide guarantees in addition to funding and is now working with the National Infrastructure Fund to also provide direct, nonrefundable funds to projects with a high social return.

Banxico to keep rates on hold throughout the year The growth backdrop we have sketched above, in addition to well-anchored medium-term inflation expectations and moderate wage increases, clearly support our “low-for-long” monetary policy call, in which we anticipate that the first hike will not take place until 2Q12 (consensus: 1Q12).

Market strategy We favor long MXN over receivers in the front end of the TIIE swap curve.


124


China Economics Growth momentum in China’s economy improved moderately in 3Q10, with real GDP rising 8.1%q/q saar by our calculation, exceeding our forecast of 7.5% and following a 7.2%q/q saar expansion in 2Q. The latest macro figures confirm our view that growth bottomed in 2Q and has been on a steady rebound since, with domestic demand rising at a solid pace despite softness in the export sector and with the most intense phase of inventory correction gradually fading. We expect growth in China to pick up steadily in coming quarters, with further solid expansion in domestic demand in particular. Local governments are anticipated to gear up for the start of new projects going into 2011. This, along with the central government’s efforts to meet the 5.8-million-unit housing target, solid private consumption and investment demand, the gradual fading of the inventory drag, and largely accommodative monetary conditions, could increase the risk of overheating by early next year. We have moderately increased our estimate for China’s real GDP growth in coming quarters. Our forecast for 2010 full-year GDP growth has been fine-tuned to 10.0%oya (previously: 9.8%), while our estimate for 2011 GDP growth is now 9.0%oya (previously: 8.6%). We have also revised the forecast for 2010 average CPI inflation rate to 2.9%oya (previous forecast: 2.8%). The forecast for 2011 average CPI inflation now stands at 3.2%oya, taking into account the impact of potential further resource and energy price liberalization. Indeed, we believe the PBoC’s 25bp rate hike effective on October 20th is intended to signal that the central bank is keen to contain inflation expectations. As such, we expect headline CPI inflation to peak in coming months, with the inflation rate gradually stabilizing at around 3.2% by early next year. Our US team is looking for the Fed to maintain its fed funds target rate through to 2Q12, and to begin QE2 in early November. So these factors imply the PBoC would be somewhat constrained should it want to undertake further rate hikes. We now expect the PBoC to be on hold in coming months as it monitors the impact of tightening measures on the property sector. We expect the next rate hike to come in 2Q11, and we look for a total of two rate hikes next year. For the property sector, we believe the authorities will continue to focus on sector-specific measures, targeting both the demand and the supply sides, in an effort to contain further rises in property prices.

Qian Wang (852) 2800 7009, [email protected]

Grace Ng (852) 2800 7002, [email protected]

Lu Jiang (852) 2800 7053, [email protected]

JP Morgan Chase Bank, N.A., Hong Kong

6

8

10

12

14

16

0

5

10

15

20

%oyaChina: real GDP growth

%q/q, saar

00 02 04 06 08 10

%oya%q/q, saar

Source: CEIC and J.P. Morgan estimates.

-4-202468

10

2002 2003 2004 2005 2006 2007 2008 2009 2010-50510152025

China: headline CPI, food prices, and nonfood CPI inflation%oya, both scales

CPI

Nonfood CPI

CPI: food prices



125


Meanwhile, CNY/USD appreciation has accelerated in recent weeks, and the trend could continue post the US midterm elections and G-20 summit in November. The probability of more significant near-term CNY/USD appreciation could yet be capped by Chinese policymakers’ fears over ongoing uncertain external demand and its impact on exports, and if the spot rate begins to show more two-way volatility when political pressure starts to ease later this year. Our forecast is for the CNY/USD rate to be unchanged at 6.6 at year-end, with the bilateral rate expected to appreciate steadily toward 6.3 by end-2011. On the fiscal front, we expect the focus to shift from infrastructure investment toward consumption and achieving more balanced growth. In addition to structural reforms and the gradual buildup of social security, urbanization and infrastructure spending will likely remain a key focus in the 12th five-year plan. Therefore, solid public investment and steadily strengthening private consumption should ensure that the economy expands at a solid 8% pace over the next five years, despite soft global demand. This, together with the government’s commitment to increase the supply of housing, suggests that commodity demand from China will remain solid in coming years. However, the government’s firm resolve to conserve energy and slower the pace of private investment growth, given the softer global demand and abundant capacity in many manufacturing sectors, suggests that the booming pace of China’s commodity demand growth during the past decade is unlikely to be repeated.

12345678

% per annum China: benchmark lending and deposit rates

04 05 06 07 08 09 10 11

1-year lending rate

1-year deposit rate

J.P. Morganforecasts



126


China Infrastructure Target railway capex for 2010 and 2011 As per the Ministry of Railway’s (MOR) plan announced in July 2009, the total railway spending target for 2010 and 2011 is Rmb825 billion and Rmb900 billion respectively. The target capex on civil works, which accounts for c.85% of the total railway capex, is Rmb700 billion for 2010 and Rmb750 billion for 2011. This implies that spending on civil works is estimated to increase by 17% in 2010 and 7% in 2011. This is significantly lower than the average growth rate of 64% in the last four years.

Strong railway spend so far Railway capex is up 27% yoy in 9M2010. The MOR’s railway spending amounted to Rmb491 billion in the first nine months, achieving 60% of the full-year target of Rmb825 billion, ahead of last year’s ratio of 55% over the same nine-month period. Within this, a total of Rmb430 billion was spent on civil works, forming 88% of the railway spending and achieving 61% of the full-year target, ahead of last year’s 57%. For the final quarter of the year, the pace of increase is expected to soften markedly to a meager 3% yoy, assuming the MOR’s target is kept unchanged. It is likely that the current target may be exceeded if the current momentum is maintained.

Qian Wang (852) 2800 7009, [email protected]

Grace Ng (852) 2800 7002, [email protected]

Lu Jiang (852) 2800 7053, [email protected]

JP Morgan Chase Bank, N.A., Hong Kong

Target railway length Based on the latest version of the MOR’s medium- to long-term railway development plan (announced in 2008), China plans to achieve a total ending length of 120,000km by 2020. During late 2008 and early 2009, in response to the financial crisis outside China, the MOR fast-tracked a number of projects on back of the government’s aggressive fiscal stimulus. With this year’s ending length at approximately 90,000km, our regional infrastructure team expects China to achieve a total railway length of 110,000km by 2012. The MOR’s existing medium-term target of 120,000km of railway network by 2020 can be achieved as early as 2015.

Expectations from the 12th Five-Year Plan While the 12th Five-Year plan has not yet been officially announced, our regional infrastructure team believes that there is a high likelihood of upward revisions to railway infrastructure spending and increases in the MOR’s medium-term railway operating length target. The government has emphasized on several occasions that improving transportation links, particularly the railway network, is vital to rebalancing economic growth across regions.

China infrastructure spending outlook Spending (Rmb B) 2005 2006 2007 2008 2009 2010E 2011E 2012E Capex on total railway spending 120 208 255 414 701 825 900 880 Capex on civil works 89 155 177 337 600 700 750 700 Capex on locomotives and others 31 52 78 77 101 125 150 180 % capex on civil works 74 75 69 81 86 85 83 80 % capex on locomotives and others 26 25 31 19 14 15 17 20 Y/Y growth (capex on civil works) 75 14 90 78 17 7 (7) Y/Y growth (capex on locomotives) 68 49 (1) 31 23 20 20 Ending railway length (km) 75,438 76,919 77,904 79,625 86,500 90,000 93,500 108,000 MOR’s railway spending during the year 89 155 177 337 600 700 750 700 Highway/Tollroads (Rmb B) 649 688 967 1160 1276 na Source: MOR, J.P. Morgan estimates.


127


Western-China-driven growth

Western China Western China includes six provinces (Gansu, Guizhou, Qinghai, Shaanxi, Sichuan, and Yunnan), five autonomous regions (Guangxi, Inner Mongolia, Ningxia, Tibet, and Xinjiang), and one municipality (Chongqing). The major cities (with a population over 5 million) are Chengdu, Chongqing, Xi'an, Kunming, Wulumuqi.

Land area and population Western China accounts for 71% of mainland China’s area. Its population as of 2009 was 370 million, or 27.5% of China’s total population.

GDP growth From 2000 to 2008, Western China’s GDP growth consistently lagged that of the non-western regions (see table top right). As a result, Western China’s share of China’s real GDP experienced a steady decline during the period (see figure top right). In 2007, Western China accounted for 15.9% of China’s real GDP growth, lower than its share in 2000 (16.3%). However, in 2009 the trend reversed, with Western China’s GDP growing at 12.4%, higher than the non-western region’s at 11.5%. The two main reasons for this were: a) With its greater reliance on China’s exports, the impact of the global recession in 2008 was more severe on Eastern China; and b) Western China benefited from China’s massive infrastructure spending in 2009, as significant resources were allocated to the western region, which has poor infrastructure facilities.

Per-capita GDP There is significant scope for economic development in Western China compared to the more developed coastal regions. 2009 average per capita GDP in the 12 western provinces was Rmb17,595. This is less than half of the per capita GDP of Rmb42,469 in the coastal provinces. The average per capita urban income for the 12 western provinces was Rmb13,896. This is only 70% of the average in coastal provinces (Rmb19,766).

Real GDP growth – Western China lagged until 2008

89

101112131415

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Western region

Non-w estern region

Source: CEIC, J. P. Morgan Economics.

Western China’s real GDP as % of national real GDP

15.8

16.0

16.2

16.4

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009


GDP per capita – Western vs. coastal provinces (Rmb/yr)

-5,000

10,00015,00020,00025,00030,00035,00040,00045,000

99 00 01 02 03 04 05 06 07 08 09

Coastal Western


http://en.wikipedia.org/wiki/Gansu

http://en.wikipedia.org/wiki/Guizhou

http://en.wikipedia.org/wiki/Qinghai

http://en.wikipedia.org/wiki/Shaanxi

http://en.wikipedia.org/wiki/Sichuan

http://en.wikipedia.org/wiki/Yunnan

http://en.wikipedia.org/wiki/Autonomous_region_of_China

http://en.wikipedia.org/wiki/Guangxi

http://en.wikipedia.org/wiki/Inner_Mongolia

http://en.wikipedia.org/wiki/Ningxia

http://en.wikipedia.org/wiki/Tibet_Autonomous_Region

http://en.wikipedia.org/wiki/Xinjiang

http://en.wikipedia.org/wiki/Municipality_of_China

http://en.wikipedia.org/wiki/Chongqing


128


Policy initiatives and projects announced in 2010 In 2000, Beijing adopted the ‘Go West’ policy to develop its relatively isolated and underdeveloped Western China region. The main components of the policy included infrastructure development, attracting foreign investment, improving ecological protection, promoting education, and retaining high-skilled labor from moving to richer provinces. From 2000 to 2009, China launched 120 projects with a total cost of Rmb2.2 trillion (source: Reuters).

In 2010, the following projects and preferential policies were announced to further improve the development of the western region:

1. The National Development Reform and Commission (NDRC) announced on 6 July that China will embark on 23 new projects in the west region this year totaling Rmb682 billion (US$100 billion). These projects range from railway, airports, power grids, power stations, wind powers to coal mines.

2. China’s State Council announced on 7 July that the new resource tax, which was levied in Xinjiang as of 1 June 2010, and is charged at 5% of the revenue of coal, oil and gas companies, should be extended to all 12 provinces in Western China. The resource tax reform will help the local governments in Western China to collect taxation revenue to develop the local economy and gradually bridge the gap between developed coastal regions and the less developed western regions.

3. The state council confirmed that the encouraged industries in Western China will be entitled to 15% preferential income tax rate for another 10 years. In comparison, the income tax rate of Chinese enterprises in other regions will be unified to 25%. This measure should help boost Western China’s medium-term growth by attracting more factories/companies and creating more job opportunities.


129


Chinese retail sales (%yoy)

0

5

10

15

20

25

Jan-99 Jul-00 Jan-02 Jul-03 Jan-05 Jul-06 Jan-08 Jul-09


Consumer loan increase as a % of total loan increase

0%

3%

6%

9%

12%

15%

Jan-

09Fe

b-09

Mar

-09

Apr-0

9M

ay-0

9Ju

n-09

Jul-0

9Au

g-09

Sep-

09Oc

t-09

Nov-

09De

c-09

Jan-

10Fe

b-10

Mar

-10

Apr-1

0M

ay-1

0Ju

n-10

Jul-1

0Au

g-10

Source: CEIC, J. P. Morgan.

Chinese car sales (%yoy)

-40-20

020406080

100120

01 02 03 04 05 06 07 08 09 10

Source: J.P. Morgan Economics, September 2010.

Wage growth (%yoy)

8

10

12

14

16

18

20

22

1Q01 1Q02 1Q03 1Q04 1Q05 1Q06 1Q07 1Q08 1Q09 1Q10


Minimum wage increases in several provinces and municipalities in 2010

Provinces/ Minimum monthly wage (RMB)

Recent minimum wage increase

Adjustment effective

Municipals Before After (%) date Shanghai 960 1,120 17% 1-Apr-10 Zhejiang 960 1,100 15% 1-Apr-10 Guangdong 860 1,030 20% 1-May-10 Beijing 800 960 20% 1-Jul-10 Jiangsu 850 960 13% 1-Feb-10 Tianjin 820 920 12% 1-Apr-10 Shandong 760 920 21% 1-May-10 Fujian 720 900 25% 1-Mar-10 Hubei 700 900 29% 1-May-10 Shanxi 736 850 16% 1-Apr-10 Jilin 650 820 26% 1-May-10 Ningxia 560 710 27% 1-May-10

Source: finance.sina, Bloomberg news. Note: Except Shanghai and Beijing, all districts in the table have multiple tiers of minimum wages. The minimum wages and increase % shown for those districts are of the highest tier.

% of households grouped by annual income as of 2008 Annual income % of households <RMB10000 1.5 RMB10000-20000 9.9 RMB20000-30000 17.7 RMB30000-40000 18.3 RMB40000-50000 15.0 RMB50000-60000 10.8 RMB60000-70000 7.8 RMB70000-80000 5.3 RMB80000-90000 3.7 RMB90000-100000 2.6 >RMB100000 7.5 Source: CEIC.


130


China FAI: Do not extrapolate Can housing starts continue to grow in 2011 or will there be an inventory correction? Residential construction (advanced 12 months) versus sales (millions of square meters GFA per month)

0

20

40

60

80

100

120

140

160

Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11

Estimated total monthly residential construction starts Monthly residential sales

Source: CEIC, J.P. Morgan calculations. Notes: Monthly total construction data is available in China. The ratio from 2005 to 2010 of residential construction to total construction is 80%. This ratio is used to estimate the residential starts from the monthly total construction starts. The monthly total constructions starts and monthly residential sales data are seasonally adjusted.

Per capita consumption of cement (tonnes) vs. adjusted per capita nominal GDP

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

0 6000 12000 18000 24000 30000 36000 42000 48000

Russia (1991-2009E)

Brazil (1985-2009E)

India (1985-2009E)

China (1985-2010E)

US (1930-2008)

UK (1985-2009E)

Germany (1985-2009E)

Japan (1985-2009E)

Taiwan (1985-2009)

South Korea (1985-2009E)

Mexico (1985-2009E)

GDP per capita (USD)

Cement consumption per capita (tonnes)

US 2008

Russia 2009E

Brazil 2009E

Mexico 2009E

S. Korea 2009E

Taiwan 2009

UK 2009E

Germany 2009E

Japan 2009E

India 2009E

China 2010 E

China 2009

1993: per capita cement consumption peaked in Taiwan

1997: per capita cement consumption peaked in Korea

Source: US Geological Survey and J.P. Morgan estimates. Note: The GDP per capita is restated for today's dollars by adjusting the deflator series.

Note: Increases in affordable housing construction starts 167M sq m of GFA in 2011 – just six weeks of private construction starts (J.P. Morgan estimates, see China affordable housing, Kwong et al, 27 October 2010).


131


Market Forecasts

Source: Bloomberg, Datastream, IBES, Standard & Poor’s Services, J.P. Morgan estimates.


132


J.P. Morgan FX Forecasts vs. Forwards & Consensus Exchange rates vs. U.S dollar

CurrentMajors Oct 1 Dec 10 Mar 11 Jun 11 Sep 11 Dec 11 forward rate Consensus** Past 1mo YTD Past 12mos

EUR 1.37 1.30 1.30 1.30 1.30 1.25 -8.5% -0.7% 7.3% -4.2% -5.8%JPY 83.3 79 81 83 85 88 -6.1% 3.8% 1.4% 11.9% 7.9%GBP 1.58 1.49 1.48 1.48 1.49 1.47 -6.7% -5.5% 2.4% -2.0% -0.8%AUD 0.97 0.93 0.95 0.99 1.01 0.98 6.9% 12.1% 7.1% 8.3% 12.4%CAD 1.03 1.03 1.02 0.99 0.97 0.99 4.8% 5.1% 2.5% 2.0% 5.3%NZD 0.74 0.71 0.72 0.76 0.77 0.74 3.7% 7.1% 4.3% 2.1% 3.6%

JPM USD index 82.2 82.8 82.9 82.7 82.3 83.9 -3.1% -2.0% -2.4%DXY 78.7 81.4 81.7 81.7 81.7 84.5 -4.6% 1.1% 2.2%

Europe, Middle East & AfricaCHF 0.98 0.99 0.98 0.96 0.96 1.00 -2.8% 6.8% 4.0% 5.9% 6.0%ILS 3.63 3.75 3.75 3.75 3.75 3.75 -2.2% 1.8% 4.2% 4.4% 3.7%

SEK 6.71 6.92 6.92 6.88 6.88 7.20 -5.2% 0.3% 8.6% 6.7% 4.9%NOK 5.85 6.00 5.92 5.92 5.85 6.08 -1.4% 0.2% 5.9% -0.9% -0.8%CZK 17.79 18.85 18.65 19.23 18.85 19.20 -6.7% 0.9% 8.5% 3.3% -1.9%PLN 2.87 3.00 2.96 2.92 2.88 2.96 0.5% 0.9% 8.0% -0.3% 1.0%HUF 200 212 212 208 206 212 -1.1% 0.5% 11.3% -5.6% -8.0%RUB 30.49 29.66 29.21 28.99 29.36 29.74 7.7% 1.8% 0.7% -1.5% -1.1%TRY 1.45 1.50 1.50 1.49 1.48 1.41 11.2% 8.2% 4.9% 3.7% 3.3%ZAR 6.92 7.00 7.15 7.30 7.70 8.10 -8.2% -1.8% 5.4% 6.7% 10.4%

Americas ARS 3.96 4.05 4.15 4.15 4.25 4.25 6.7% 3.7% -0.3% -4.1% -3.0%BRL 1.67 1.75 1.80 1.82 1.83 1.85 0.2% 1.0% 4.3% 4.2% 6.4%CLP 481.8 480 505 500 500 500 0.0% 2.6% 3.1% 5.3% 15.0%COP 1795 1800 1830 1850 1880 1900 -2.5% 3.1% 0.9% 13.9% 7.0%MXN 13.08 12.50 12.50 12.25 12.25 12.25 7.5% 4.9% 4.3% 4.3% 9.1%PEN 2.80 2.78 2.84 2.82 2.79 2.78 1.4% 2.5% -0.1% 3.3% 2.9%VEF 4.29 4.30 5.50 5.50 5.50 5.50 -21.9% -12.0% 0.1% -49.9% -49.9%

LACI 114.37 112.71 110.48 110.90 110.37 109.91 3.1% 4.0% 6.9%

Asia CNY 6.69 6.60 6.50 6.40 6.30 6.20 4.6% 4.1% 1.8% 2.1% 2.0%HKD 7.76 7.78 7.78 7.79 7.80 7.80 -0.7% -0.4% 0.2% -0.1% -0.1%IDR 8920 8700 8600 8550 8500 9200 2.2% -3.4% 1.0% 5.4% 8.1%INR 44.5 45.5 44.5 44.0 43.5 42.0 12.1% 6.6% 5.3% 4.7% 7.4%

KRW 1130 1150 1180 1140 1100 1100 4.1% -1.6% 4.8% 3.0% 3.9%MYR 3.09 3.10 3.07 3.04 3.02 3.02 3.8% 2.0% 1.5% 11.1% 12.8%PHP 43.72 43.25 42.75 42.25 42.00 42.25 7.7% 4.0% 3.1% 5.6% 7.7%SGD 1.31 1.32 1.30 1.29 1.28 1.33 -1.3% -0.9% 2.7% 7.1% 7.9%TWD 31.30 31.20 31.00 30.75 30.50 30.50 -1.4% 0.4% 2.4% 2.2% 3.2%THB 30.18 30.25 30.10 30.00 29.70 30.80 -1.1% 0.6% 3.2% 10.6% 11.0%

ADXY 115.0 115.1 115.9 117.4 119.0 119.0 2.6% 3.9% 4.5%

Exchange rates vs EuroJPY 114 103 105 108 111 110 2.6% 4.5% -5.5% 16.8% 14.5%GBP 0.87 0.87 0.88 0.88 0.87 0.85 2.0% -4.8% -4.5% 2.3% 5.4%CHF 1.34 1.29 1.27 1.25 1.25 1.25 6.3% 7.5% -3.0% 10.6% 12.5%SEK 9.21 9.00 9.00 8.95 8.95 9.00 3.6% 1.0% 1.2% 11.4% 11.3%NOK 8.03 7.80 7.70 7.70 7.60 7.60 7.8% 0.9% -1.3% 3.4% 5.3%CZK 24.4 24.50 24.25 25.00 24.50 24.00 2.0% 1.6% 1.1% 7.8% 4.2%PLN 3.94 3.90 3.85 3.80 3.75 3.70 9.8% 1.6% 0.7% 4.1% 7.2%HUF 274 275 275 270 268 265 8.1% 1.2% 3.7% -1.5% -2.3%RON 4.27 4.15 4.10 4.05 4.00 3.90 16.7% 6.3% -0.2% -0.8% 0.2%TRY 1.98 1.95 1.95 1.94 1.92 1.76 21.6% 9.0% -1.9% 8.4% 9.9%RUB 41.86 38.56 37.98 37.69 38.17 37.18 17.7% 2.6% -6.1% 3.3% 5.2%

↑ indicates revision resulting in stronger local FX , ↓ indicates revision resulting in weaker local FX* Negative indicates JPM more bullish on USD than consensus,** Consensus Economics Publication: Foreign Exchange Consensus Forecasts September 2010

Source: J.P.Morgan

JPM forecast gain/loss vs Dec-11* Actual change in local FX vs USD

Actual change in local FX vs EUR


133


Commodities Forecasts • J.P. Morgan are above consensus with oil and copper forecasts.

• J.P. Morgan are below consensus with nickel forecasts.

• China’s share of 2010 global demand is 8% (oil), 41% (iron ore), 41% (aluminum), 39% (copper) and 31% (nickel).

Energy Forecasts: Oil, thermal and coking coal WTI Crude (US$/bbl) Q4 10 Q1 11 Q2 11 Q3 11 Q4 11 2012 2013 2014

J.P. Morgan forecasts 86 88 88 90 89.75 105 120 Forward price 85.6 88.8 89.8 90.4 90.0 92 92 92 Consensus Price 80 81.4 82.75 85 85 93 106 95

WTI (billions bbls) 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Total Oil Supply 77.6 77.5 80.3 83.6 84.8 85.6 85.6 86.6 85.2 86.9 88.3 Total Oil Demand 77.5 78.3 79.2 83.1 84.4 85.4 86.8 86.2 84.9 87.3 88.9 Surplus (Deficit) 0.1 -0.8 1.1 0.5 0.4 0.2 -1.2 0.5 0.2 -0.4 -0.6 China Demand 4.7 5.0 5.6 6.4 6.7 7.2 7.6 7.7 8.3 9.2 9.6

WTI (change) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Price Global Supply 1% 1% 5% 2% 1% 2% -1% -1% 3% 2% Global Demand 0% 4% 4% 1% 1% 0% 1% -2% 2% 2% Chinese Demand 8% 10% 16% 4% 8% 4% 2% 7% 10% 5% China's share of demand

6% 7% 8% 8% 8% 9% 9% 10% 10% 11%

Coal (USD/tonne) Q3'10 Q4'10 CY2010E Q1'11 Q2'11 Q3'11 Q4'11 CY2011E 2012E 2013E Hard coking coal 225 205 190 205 220 210 210 211 210 210 Thermal coal 100 100 95 95 100 105 105 101 105 105

Coal (change) Q3'10 Q4'10 CY2010E Q1'11 Q2'11 Q3'11 Q4'11 CY2011E 2012E 2013E Hard coking coal -9% -7% 8% 7% -5% 0% 0% 0% 0% Thermal coal 0% -5% 0% 5% 5% 0% -4% 4% 0% Source: J.P. Morgan estimates, Bloomberg.

Iron Ore Forecasts Iron Ore

(US$/tonnes) 4Q10E 1Q11E 2Q11E 3Q11E 4Q11E 2010E 2011E 2012E 2013E 2014E

J.P. Morgan forecasts 145 140 150 150 140 145.1 145 145 116 98.6 Forward Price 158 156 153 149 144 145 145 132

Iron ore (000s tonnes)

2005 2006 2007 2008 2009e 2010e 2011e 2012e 2013e 2014e

World Supply 1313 1491 1634 1758 1651 1806 1933 2059 2206 2339 World Demand 1299 1482 1619 1725 1631 1806 1937 2052 2154 2261 Balance: Surplus (Deficit)

14 9 15 33 20 0 -4 8 52 78

China Demand 471 597 709 823 894 979 1067 1147 1214 1286

Price 0% 0% -20% -15% Global Supply 14% 10% 8% -6% 9% 7% 7% 7% 6% Global Demand 14% 9% 7% -5% 11% 7% 6% 5% 5% Chinese Demand 27% 19% 16% 9% 10% 9% 8% 6% 6% China's share of demand

36% 26% 32% 33% 39% 41% 43% 45% 47% 49%

Source: J.P. Morgan estimates, Bloomberg.


134




LatAm

Data


136



137


LatAm Dashboards Profit Outlook: Earnings Forecasts Matrix for Countries and Sectors

Weight Weight WeightEM (%) Consensus LATAM (%) Consensus Brazil (%) Consensus

2010 2011 2012 2010 2011 2012 2010 2011 2012Total Market 100.0 28.1 16.4 13.9 Total Market 100.0 15.8 21.4 16.1 Total Market 100.0 16.3 21.6 16.1Consumer Discretionary 6.8 29.0 14.1 14.4 Consumer Discretionary 5.3 45.1 27.9 17.6 Consumer Discretionary 4.8 46.7 34.5 21.2Consumer Staples 6.8 19.5 11.6 11.2 Consumer Staples 11.9 11.5 21.5 13.3 Consumer Staples 8.8 21.3 23.6 18.7Energy 14.0 17.9 15.7 12.0 Energy 16.3 -14.8 7.1 8.8 Energy 22.5 -15.5 6.1 5.2Financials 26.4 24.7 21.8 17.2 Financials 22.2 18.4 19.6 16.6 Financials 26.5 16.9 18.7 15.7Health Care 0.8 24.0 17.2 16.1 Health Care 0.0 NA NA NA Health Care 0.0 NA NA NAIndustrials 7.2 30.7 13.8 15.7 Industrials 4.5 -18.1 24.6 26.7 Industrials 3.3 -47.7 39.7 31.6Information Technology 12.0 57.3 4.7 11.0 Information Technology 1.1 12.1 1.6 2.2 Information Technology 1.6 12.1 1.6 2.2Materials 14.5 52.7 27.4 13.0 Materials 24.4 84.5 40.1 19.7 Materials 25.1 105.0 41.2 11.1Telecommunication Services 8.0 8.0 10.9 10.9 Telecommunication Services 8.8 3.1 15.4 6.9 Telecommunication Services 2.4 -17.5 15.7 9.0Utilities 3.5 9.3 16.9 14.7 Utilities 5.5 5.6 8.8 19.4 Utilities 5.0 18.8 8.8 12.1

Weight Weight WeightMexico (%) Consensus Chile (%) Consensus Argentina (%) Consensus

2010 2011 2012 2010 2011 2012 2010 2011 2012Total Market 100.0 9.0 20.4 16.3 Total Market 100.0 23.0 11.2 7.1 Total Market 100.0 17.1 4.8 6.7Consumer Discretionary 9.7 39.9 14.0 9.4 Consumer Discretionary 4.6 65.0 18.7 19.6 Consumer Discretionary 0.0 NA NA NAConsumer Staples 25.4 -4.9 20.4 4.5 Consumer Staples 15.2 84.1 12.7 8.3 Consumer Staples 0.0 NA NA NAEnergy 0.0 NA NA NA Energy 0.0 NA NA NA Energy 10.0 NM -41.8 9.6Financials 6.0 39.4 27.2 15.7 Financials 9.7 26.7 9.4 23.1 Financials 44.5 7.0 3.6 11.8Health Care 0.0 NA NA NA Health Care 0.0 NA NA NA Health Care 0.0 NA NA NAIndustrials 4.7 23.8 -3.7 NA Industrials 20.5 51.3 27.5 NA Industrials 0.0 NA NA NAInformation Technology 0.0 NA NA NA Information Technology 0.0 NA NA NA Information Technology 0.0 NA NA NAMaterials 16.2 -10.2 50.4 25.8 Materials 23.1 177.0 4.1 14.6 Materials NA NA NA NATelecommunication Services 38.0 13.4 15.3 8.1 Telecommunication Services 2.7 -2.3 15.4 7.4 Telecommunication Services 39.4 21.4 27.7 3.3Utilities 0.0 NA NA NA Utilities 24.1 -19.6 8.0 27.8 Utilities 0.0 NA NA NA

Weight Weight WeightPeru (%) Consensus Colombia (%) Consensus MSCI Brazil (%) Consensus

2010 2011 2012 2010 2011 2012 2010 2011 2012Total Market 100.0 27.7 31.1 22.5 Total Market 100.0 26.9 47.1 -34.8 Petrobras 19.0 -0.9 -4.1 0.9Consumer Discretionary 0.0 NA NA NA Consumer Discretionary 0.0 NA NA NA Vale 16.4 97.4 47.8 12.4Consumer Staples 0.0 NA NA NA Consumer Staples 5.9 20.1 38.8 24.6 Itauunibanco 9.4 32.1 20.1 15.4Energy 0.0 NA NA NA Energy 29.0 26.3 42.3 NA Bradesco 6.6 13.9 16.4 12.3Financials 30.8 21.4 18.2 NA Financials 39.5 36.7 67.0 NA Ambev 3.4 13.9 12.5 6.5Health Care 0.0 NA NA NA Health Care 0.0 NA NA NA Itausa 3.0 29.9 16.6 42.9Industrials 0.0 NA NA NA Industrials 0.0 NA NA NA OGX 2.9 89.7 75.7 172.3Information Technology 0.0 NA NA NA Information Technology 0.0 NA NA NA BM&F Bovespa 2.7 37.9 19.2 19.5Materials 69.2 31.5 38.2 24.3 Materials 16.3 -0.2 45.7 NA CSN 2.1 -33.0 62.2 5.8Telecommunication Services 0.0 NA NA NA Telecommunication Services 0.0 NA NA NA Banco do Brasil 1.9 19.9 12.9 18.4Utilities 0.0 NA NA NA Utilities 9.2 21.1 16.7 10.6 BRF Foods 1.6 5.3 66.7 32.9

Weight Weight WeightMSCI Mexico (%) Consensus MSCI Chile (%) Consensus MSCI Latam (others) (%) Consensus

2010 2011 2012 2010 2011 2012 2010 2011 2012AMX 35.5 -1.6 15.9 36.7 Copec 13.7 70.8 25.0 27.9 Buenaventura 1.2 13.6 36.0 -4.4Walmex 10.6 -42.9 19.5 22.0 Cencosud 11.3 112.8 21.7 16.2 Ecopetrol 1.1 31.4 31.4 52.2Grupo Mexico 7.8 81.6 49.3 18.1 Enersis 9.5 -11.0 3.7 -1.4 Southern Copper 1.0 77.0 50.1 22.7Femsa 7.3 28.9 18.6 25.3 CMPC 9.5 157.4 17.4 20.6 Credicorp 1.0 26.3 18.1 18.0Grupo Televisa 6.6 -3.5 13.2 10.1 Endesa 9.4 -2.6 1.5 4.9 Bancolombia 0.5 11.0 24.1 20.5Cemex 5.0 -141.4 -228.2 171.9 SQM 7.5 -2.4 20.1 41.5 Suramericana 0.5 2.0 2.0 NABanorte 3.8 23.6 28.8 24.5 Lan Airlines 6.8 125.8 15.0 17.0 Bancolombia SA 0.4 11.0 24.1 20.5Telmex 2.6 -12.0 4.1 3.7 Santander Chile 6.7 21.4 11.0 7.6 Inveragos 0.4 NA NA NAInbursa 2.2 17.2 12.7 -3.0 CAP 6.1 -1501.5 19.6 7.8 ISA 0.3 30.3 -3.3 NAGrupo Modelo 2.2 20.4 9.8 7.9 Falabella 4.6 79.1 22.8 20.1 Cementos Argos 0.2 1.7 -7.1 22.6Grupo Carso 2.1 4.9 -11.5 -18.0 Colbun 3.1 16.7 -14.3 91.7 Exito 0.2 17.5 24.9 57.8

Source: I/B/E/S, Bloomberg, MSCI, J.P. Morgan Updated as October, 2010Note: Average earnings growth calculated based on earnings aggregate of MSCI contituents from IBES.


138


Profit Growth Outlook: Changes in 2010 and 2011 EPS Forecasts

Source: I/B/E/S Updated as of October 2010Notes: The dashboard aims to show changes in earnings expectations. All year ends are for December. EPS figures are normalized, starting at 100 on base date Feb 2009 for ease of comparison. These numbers are directly from IBES aggregate and may differ from those in the growth expectations pages where adjustments are made for exceptional items.

World EM Asia EM Europe

Brazil

Emerging Markets (EM)

Mexico Chile

Argentina Peru Colombia

EM Latin America

85

95

105

115

125

135

Feb-09 Jul-09 Dec-09 May-10 Oct-10

2010

2011

85

95

105

115

125

135

145

155


2010

2011

8595

105115125135145155165


2010

2011

8090

100110120130140150160


2010

2011

80

90

100

110

120

130

140

150


2010

2011

70

80

90

100

110

120

130


2010

2011

70

75

80

85

90

95

100

105


2010

2011

75

85

95

105

115

125

135


2010

2011

50

60

70

80

90

100

110


2010

2011

70

90

110

130

150

170


2010

2011

50

80

110

140

170

200


2010

2011


139


Profit Growth Outlook: Changes in 2010 and 2011 EPS Forecasts

Source: I/B/E/S Updated as of October 2010Notes: The dashboard aims to show changes in earnings expectations. All year ends are for December. EPS figures are normalized, starting at 100 on base date Feb 2009 for ease of comparison. These numbers are directly from IBES aggregate and may differ from those in the growth expectations pages where adjustments are made for exceptional items.

Consumer Discretionary Energy Financials

Information Technology

Consumer Staples

90

110

130

150

170

190


2010

2011

Materials Telecom

Utilities

Industrials

65

75

85

95

105

115

125


2010

2011

70

85

100

115

130

145


2010

2011

85

95

105

115

125

135

145

155


2010

2011

60708090

100110120130140


2010

2011

95

105

115

125

135

145

155


2010

2011

60

80

100

120

140

160


2010

2011

85

95

105

115

125

135

145


2010

2011

90

110

130

150

170

190


2010

2011


140


Value: Regional and Countries Valuations

28-Oct-10 Avg. Current 12m Avg. Current Avg. CurrentMSCI Index 02-07 Trailing Fwd 2009 2010E 2011E 02-07 Trailing 2009 2010E 2011E 02-07 Trailing 2009 2010E 2011E 2008 2009 2010E 2011E

Brazil 240,463 11.4 13.1 10.9 14.9 12.8 10.6 3.8 3.1 2.4 2.6 3.3 2.0 1.7 2.3 1.8 1.7 18.7 15.3 13.7 16.2Mexico 33,007 15.6 17.8 15.1 19.2 17.6 14.6 1.8 3.4 2.4 2.4 3.6 2.8 2.8 2.6 2.9 2.7 19.3 13.7 16.5 18.6Chile 5,857 25.2 19.9 17.7 23.8 19.3 17.4 2.3 2.5 1.3 1.7 2.6 1.9 2.2 2.5 2.4 2.2 13.3 10.5 12.2 12.7Argentina 239,902 29.0 13.9 13.0 14.4 13.8 12.9 1.3 NA NA NA NA 2.5 1.8 NA NA NA 22.8 NA NA NAColombia* 3,031 17.4 26.7 18.3 33.1 25.7 16.8 3.0 2.1 1.0 1.9 2.2 1.9 2.4 1.5 3.0 3.0 11.4 4.5 11.8 17.6Peru* 3,371 15.2 40.3 16.6 26.5 20.7 15.8 3.8 2.5 0.9 2.1 2.6 3.2 5.7 6.9 5.4 4.5 30.6 13.9 13.8 15.1EMF LATAM* 77,963 13.7 14.6 11.9 16.3 14.0 11.5 2.9 3.1 2.3 2.5 3.3 2.2 1.9 2.4 2.0 1.9 18.5 14.5 13.9 16.3Global* 316 18.4 13.5 11.6 16.4 13.0 11.3 2.1 2.7 2.5 2.7 3.0 2.5 1.7 1.8 1.6 1.5 11.0 11.1 13.1 14.0USA* 1,129 19.0 15.5 13.2 20.1 14.8 12.9 1.8 2.0 1.9 2.0 2.1 2.9 2.0 2.2 2.0 1.8 11.3 11.2 14.1 14.8Europe* 1,151 16.4 10.7 9.0 13.9 10.3 8.8 2.9 3.5 3.3 3.5 4.0 2.3 1.6 1.6 1.6 1.5 15.0 11.7 15.7 17.4Japan* 511 19.4 NM 12.8 NM 14.5 12.4 1.1 2.2 2.1 2.2 2.4 1.8 1.0 1.1 1.0 1.0 7.8 NM 7.0 7.7EMF Asia 667 14.6 14.3 12.4 18.3 13.7 12.2 2.3 2.3 2.0 2.3 2.7 2.0 2.1 2.3 2.1 1.8 10.6 13.2 15.9 16.0EMF EMEA* 418 14.6 11.3 9.1 14.2 10.8 8.9 2.4 2.6 2.3 2.7 3.3 2.3 1.6 1.7 1.5 1.4 17.2 14.0 15.0 16.4Emerging Markets 46,685 14.3 13.6 11.6 16.8 13.1 11.3 2.4 2.4 2.1 2.5 2.9 2.1 2.0 2.2 2.0 1.8 12.3 13.6 15.8 16.4Korea 531 11.5 11.3 10.2 15.7 10.7 10.2 2.0 1.0 0.8 1.0 1.2 1.6 1.5 1.7 1.5 1.3 7.7 11.4 15.0 13.9Taiwan 296 24.7 15.1 12.7 26.0 13.9 12.5 3.0 3.4 2.8 3.5 4.2 2.0 1.9 2.0 1.9 1.7 5.4 8.0 13.9 14.4China 69 16.1 15.1 12.7 18.5 14.6 12.4 2.3 2.4 2.1 2.5 2.9 2.4 2.4 2.7 2.4 2.1 14.2 15.2 17.2 17.9Russia* 836 12.7 8.2 6.4 11.2 7.8 6.2 1.8 1.6 0.3 1.8 2.3 1.8 1.1 1.2 1.1 0.9 17.3 12.7 14.4 15.9South Africa* 778 14.3 14.9 11.8 18.4 14.3 11.5 3.0 2.9 2.4 2.9 3.6 2.6 2.3 2.6 2.2 2.0 19.1 14.4 16.6 18.2India 798 18.9 21.4 17.6 25.0 20.8 17.0 1.5 1.2 1.0 1.2 1.3 3.9 3.4 3.7 3.4 2.9 12.9 14.3 17.0 18.3Malaysia 553 16.3 18.2 15.1 22.0 17.6 14.6 2.4 3.1 2.4 3.2 3.4 2.0 2.2 2.4 2.2 2.1 14.2 11.2 13.1 14.6Poland* 1,836 6.5 13.9 11.9 16.6 13.5 11.6 2.5 3.1 2.3 3.3 4.0 2.2 1.6 1.9 1.6 1.5 15.4 11.6 12.7 12.9Turkey* 1,007,187 7.1 12.1 11.0 14.0 11.8 10.8 2.2 2.5 3.4 2.4 2.9 1.9 2.1 2.4 2.1 1.9 17.8 18.8 19.1 18.2Thailand 395 11.8 15.8 13.7 18.0 15.4 13.4 3.3 2.9 2.6 3.0 3.2 2.2 2.5 2.7 2.4 2.2 12.1 14.9 16.6 17.2Indonesia 4,675 13.0 17.6 14.9 20.5 17.1 14.6 3.2 2.3 2.0 2.4 2.8 3.1 4.3 5.0 4.2 3.6 28.4 26.7 26.5 26.4Hungary* 1,322 12.1 13.1 10.5 12.8 13.1 10.1 1.9 2.8 1.9 3.0 3.8 2.6 1.4 1.6 1.4 1.3 22.0 12.9 11.2 13.2Egypt 1,379 17.8 13.0 10.7 16.4 12.5 10.4 3.0 3.2 2.5 3.3 4.1 4.1 1.4 1.5 1.4 1.3 12.7 12.0 11.8 13.0Czech Republic 333 19.4 10.4 9.9 10.2 10.4 9.8 3.7 6.4 5.4 6.6 6.7 1.9 1.8 1.9 1.8 1.7 19.7 20.1 18.0 18.1Philippines 763 16.9 19.1 16.7 22.0 18.7 16.3 1.9 3.3 3.1 3.4 3.1 1.9 3.0 3.2 3.0 2.8 13.2 14.9 16.5 17.6

Source: I/B/E/S, MSCI, J.P. Morgan* Market forecast numbers are derived from bottom-up calculations of each individual MSCI constituents using I/B/E/S estimates Updated as of October 28For all other markets, forecast numbers are derived from bottom-up calculations of each individual MSCI constituents using JPM estimates for covered stocks and I/B/E/S estimates for the rest.USA, Europe and Japan PE are I/B/E/S aggregate estimates. Japan Valuation estimates are for the financial year ending March

P/E (x) Div. Yield (%) P/BV (x) ROE (%)Prospective Prospective Prospective


141


Value: PE Matrix for Countries and Sectors

12-month forward PE

Glob

al

USA

Euro

pe

Emer

ging

Ma

rket

s

EMF

EMEA

EMF

Asia

EMF

LATA

M

Braz

il

Mexic

o

Chile

Arge

ntin

a

Peru

Colo

mbi

a

Consumer Discretionary 13.9 12.8 12.8 12.8 14.4 12.0 14.4 13.3 15.4 31.0 NA NA NAConsumer Staples 14.5 12.7 14.2 18.4 18.4 17.3 20.4 19.9 20.1 24.0 24.6 NA 34.5Energy 10.4 10.3 8.7 8.2 5.6 12.0 10.3 10.0 NA NA 10.8 NA 20.7Financials 10.9 9.3 9.2 12.3 10.8 12.4 12.6 12.4 15.2 14.1 12.5 15.3 11.3Health Care 11.4 10.5 10.8 18.8 14.1 22.0 NA NA NA NA NA NA NAIndustrials 13.4 12.1 13.2 13.4 10.7 14.4 22.9 24.3 20.9 22.3 NA NA NAInformation Technology 12.8 12.2 13.6 11.2 9.9 12.3 10.4 10.4 NA NA NA NA NAMaterials 11.8 13.6 10.5 11.2 12.2 12.3 10.1 8.6 16.8 19.5 NA 16.6 51.5Telecommunication Services 12.0 13.2 10.4 11.6 10.9 12.3 11.0 8.0 12.0 11.7 9.1 NA NAUtilities 12.3 12.8 10.7 11.8 10.8 13.7 10.9 9.4 NA 13.1 NA NA 37.3Market Aggregate 11.6 13.2 9.0 11.6 9.1 12.4 11.9 10.9 15.1 17.7 13.0 16.6 18.3Sector Neutral* 12.0 11.5 10.9 11.6 10.9 12.9 12.9 12.3 14.4 15.9 12.6 13.5 21.2

Value: P/BV Matrix for Countries and Sectors

Trailing P/B

Glob

al

USA

Euro

pe

Emer

ging

Ma

rket

s

EMF

EMEA

EMF

Asia

EMF

LATA

M

Braz

il

Mexic

o

Chile

Arge

ntin

a

Peru

Colo

mbi

a

Consumer Discretionary 2.1 2.8 2.0 2.7 3.2 2.5 3.0 2.8 3.2 4.9 NA NA NAConsumer Staples 3.0 3.5 3.1 3.5 4.0 3.7 3.1 3.0 3.5 3.0 1.9 NA NAEnergy 1.7 1.9 1.6 1.4 1.0 2.4 1.4 1.4 NA NA 0.7 NA 5.1Financials 1.2 1.1 1.0 2.1 2.0 2.1 2.6 2.5 2.6 4.2 2.7 3.8 2.1Health Care 2.6 2.5 3.1 4.3 3.2 5.2 NA NA NA NA NA NA NAIndustrials 2.1 2.7 2.4 2.1 2.1 2.0 2.8 3.3 1.8 3.2 NA NA NAInformation Technology 2.9 3.7 2.5 2.3 1.1 2.3 18.8 18.8 NA NA NA NA NAMaterials 2.1 2.8 1.9 2.2 2.7 2.0 2.2 2.3 1.3 2.6 NA 7.1 1.4Telecommunication Services 1.9 2.0 1.6 2.5 2.8 2.1 3.3 1.3 5.3 2.8 1.5 NA NAUtilities 1.4 1.5 1.4 1.3 1.1 1.5 1.2 0.9 NA 2.1 NA NA 2.7Market Aggregate 1.7 2.0 1.6 2.0 1.6 2.1 1.9 1.7 2.8 2.2 1.7 5.6 2.3

Source: IBES, MSCI, J.P. Morgan. Note: PEs are derived from bottom-up calculations of each individual MSCI constituents using JPM estimates for covered stocks and IBES estimates for the rest.*Sector neutral PE are calcuated by using sector weights of MSCI EM and sector PE of respective markets (MSCI EM sector PE used where country sector does not exist)

Updated as of October 28


142


Value: Trailing P/BV for Regions/Countries

Source: I/B/E/S Updated as of October 2010Notes: The dashboard aims to show historical consensus trailing P/BV with +/-1 SD bands since Dec 1995 . For EMEA Trailing P/BV since Feb 1999.

World EM Asia EMEA

Brazil


EM Latin America Mexico Chile

Argentina Peru Colombia USA

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

95 97 98 99 00 01 02 03 04 05 06 07 08 10

-1SD

+1SD

0.9

1.2

1.5

1.8

2.1

2.4

2.7

3.0

3.3

95 97 98 99 00 01 02 03 04 05 06 07 08 10

-1SD

+1SD

0.9

1.2

1.5

1.8

2.1

2.4

2.7

3.0

3.3

95 97 98 99 00 01 02 03 04 05 06 07 08 10

-1SD

+1SD

1.0

1.5

2.0

2.5

3.0

3.5

99 00 01 02 03 04 05 06 07 08 09

-1SD

+1SD

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

95 97 98 99 00 01 02 03 04 05 06 07 08 10

-1SD

+1SD

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

95 97 98 99 00 01 02 03 04 05 06 07 08 10

-1SD

+1SD

1.3

1.6

1.9

2.2

2.5

2.8

3.1

3.4

3.7

4.0

95 97 98 99 00 01 02 03 04 05 06 07 08 10

-1SD

+1SD

0.8

1.1

1.4

1.7

2.0

2.3

2.6

2.9

3.2

95 97 98 99 00 01 02 03 04 05 06 07 08 10

-1SD

+1SD

0.0

1.0

2.0

3.0

4.0

5.0

95 97 98 99 00 01 02 03 04 05 06 07 08 10

-1SD

+1SD

1.0

2.0

3.0

4.0

5.0

6.0

7.0

95 97 98 99 00 01 02 03 04 05 06 07 08 10

-1SD

+1SD

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

95 97 98 99 00 01 02 03 04 05 06 07 08 10

-1SD

+1SD

1.0

2.0

3.0

4.0

5.0

6.0

95 97 98 99 00 01 02 03 04 05 06 07 08 10

-1SD

+1SD


143


Value: Forward PE for Regions/Countries

Source: I/B/E/S Updated as of October 2010

World EM Asia EMEA

Brazil


EM Latin America Mexico Chile

Argentina Peru Colombia

7.0

10.0

13.0

16.0

19.0

22.0

25.0

95 97 98 99 00 01 02 03 04 05 06 07 08 10

-1SD

+1SD

5.0

8.0

11.0

14.0

17.0

20.0

95 97 98 99 00 01 02 03 04 05 06 07 08 10

+1SD

-1SD

5.0

10.0

15.0

20.0

25.0

30.0

95 97 98 99 00 01 02 03 04 05 06 07 08 10

+1SD

-1SD3.0

6.0

9.0

12.0

15.0

18.0

95 97 98 99 00 01 02 03 04 05 06 07 08 10

+1SD

-1SD

4.0

6.0

8.0

10.0

12.0

14.0

16.0

95 97 98 99 00 01 02 03 04 05 06 07 08 10

+1SD

-1SD

4

6

8

10

12

14

98 99 00 01 02 03 05 06 07 08 09 10

+1SD

-1SD

7.0

9.0

11.0

13.0

15.0

17.0

95 97 98 99 00 01 02 03 04 05 06 07 08 10

+1SD

-1SD

8.0

11.0

14.0

17.0

20.0

23.0

95 97 98 99 00 01 02 03 04 05 06 07 08 10

+1SD

-1SD

0

5

10

15

20

25

30

95 97 98 99 00 01 02 03 04 05 06 07 08 10

+1SD

-1SD

0

8

16

24

32

95 97 98 99 00 01 02 03 04 05 06 07 08 10

+1SD

-1SD

USA

0

3

6

9

12

15

18

21

24

95 97 98 99 00 01 02 03 04 05 06 07 08 10

+1SD

-1SD

9

12

15

18

21

24

95 97 98 99 00 01 02 03 04 05 06 07 08 10

+1SD

-1SD


144


Fair Value P/E*: Gordon Growth P/E

Source: MSCI, J.P. Morgan.*We use a re-organized Gordon growth model to derive a ‘fair value’ P/E = (ROE-g)/ROEx(COE-g). 1) COE made up of the US 10-year treasury yield as the risk-free rate, the respective country EMBIG spreads, and a fixed equity market risk premium of 5% (30-year average)2) We take the potential GDP growth as the growth rate; 3)the 12m-forward I/B/E/S consensus ROE

Value: Forward PE for Sector

Source: I/B/E/S Updated as of October 2010Notes: The dashboard aims to show historical consensus forward PE with +/-1 SD bands since Dec 1995 . No Heathcare sector

Consumer Discretionary Energy Financials

Materials

Consumer Staples

Industrials Telecom Utilities

5

10

15

20

25

30

95 97 98 99 00 01 02 03 04 05 06 07 08 10

-1SD

+1SD

8

11

14

17

20

95 97 98 99 00 01 02 03 04 05 06 07 08 10

+1SD

-1SD

0

5

10

15

20

95 97 98 99 00 01 02 03 04 05 06 07 08 10

+1SD

-1SD

3

6

9

12

15

18

95 97 98 99 00 01 02 03 04 05 06 07 08 10

+1SD

-1SD

3

6

9

12

15

18

21

98 99 00 01 02 03 05 06 07 08 09 10

+1SD

-1SD

2

4

6

8

10

12

14

16

95 97 98 99 00 01 02 03 04 05 06 07 08 10

+1SD

-1SD

6

9

12

15

18

21

24

95 97 98 99 00 01 02 03 04 05 06 07 08 10

+1SD

-1SD0

8

16

24

32

95 97 98 99 00 01 02 03 04 05 06 07 08 10

+1SD

-1SD

MSCI LatAm MSCI Mexico MSCI ChileMSCI Brazil

5

7

9

11

13

15

17

Jan 03 Feb 04 Mar 05 Apr 06 May 07 Jun 08 Jul 09 Aug 10

12 Mth Fwd PE Gordon Growth P/E

3

6

9

12

15



7

9

11

13

15

17



6

8

10

12

14

16

18

20

22




145


Economic Forecasts: Changes in Real GDP Forecasts

Real GDP Growth (% Y/Y) Change in Forecasts Past 3 months (%) Economic Momentum Inflation JPM

2010E 2011E 2010E 2011E 2010E 2011E 2010E 2011E 2Q10E 3Q 10E 4Q 10E 1Q11E 2010E 2011ELATAM

Argentina 8.5 5.5 8.3 4.8 0.0 1.0 2.0 0.3 12.6 0.0 2.0 6.0 8.2 10.0Brazil 7.5 4.5 7.1 4.5 0.0 0.5 0.6 0.0 5.1 2.3 3.2 5.7 5.0 5.4

Colombia 4.5 4.1 4.6 4.7 0.0 0.0 1.2 0.7 3.9 3.7 4.0 4.0 2.2 3.4Mexico 4.5 3.5 4.7 3.5 0.0 0.0 0.3 -0.1 13.5 -3.6 3.1 2.9 4.2 3.9

Peru 8.2 6.0 7.0 6.0 0.9 0.0 1.0 0.7 12.7 4.8 3.5 5.8 1.7 2.3EMEA

Russia 4.3 4.7 4.2 4.3 -0.7 -0.3 0.2 -0.2 4.3 2.5 5.0 5.0 6.8 7.8South Africa 2.9 3.1 3.1 3.6 -0.2 -0.4 0.0 -0.1 3.2 3.1 3.2 3.1 4.4 4.4

Poland 3.5 3.8 3.2 3.5 -0.1 0.0 0.2 0.0 4.1 3.5 3.5 3.0 2.5 2.8Turkey 7.1 4.3 7.1 4.5 1.2 -0.7 0.8 0.2 11.7 -3.0 -8.5 6.1 8.6 6.5

Hungary 1.0 2.8 0.9 2.6 0.0 -0.3 0.4 -0.2 0.0 2.0 2.0 2.0 4.9 3.6Egypt na na na na na na na na na na na na na na

Czech Republic 2.0 3.2 2.0 2.0 0.0 0.0 0.3 -0.2 3.8 2.5 2.3 2.5 na naMorocco na na na na na na na na na na na na na naJordan na na na na na na na na na na na na na na

AsiaS Korea 6.1 4.0 6.0 4.6 0.0 0.0 0.0 0.0 5.8 2.5 3.8 4.0 2.7 3.3Taiwan 9.9 4.1 4.6 4.0 1.1 -0.1 0.0 0.0 7.2 1.5 2.3 4.2 1.0 1.8China 10.0 9.0 10.0 9.0 0.0 0.2 0.0 0.1 7.2 8.1 8.7 9.5 2.8 2.7India 8.3 8.5 8.4 8.4 0.0 0.0 0.2 na 8.5 8.0 8.9 8.0 11.6 10.2

Thailand 8.5 4.0 7.5 4.5 0.0 -1.0 1.9 0.1 0.6 2.8 2.8 4.9 3.1 1.9Indonesia 6.0 5.4 6.0 6.3 0.0 0.0 0.0 0.0 7.5 4.5 5.0 5.3 5.1 5.3Philippines 7.0 4.5 5.9 5.0 0.2 0.2 1.8 0.7 7.7 0.8 1.6 5.7 3.7 2.3Malaysia 6.8 4.6 6.8 5.2 -0.4 0.0 1.9 0.8 7.2 0.0 2.0 4.9 1.5 1.7

Source: J.P. Morgan estimates, Bloomberg Updated as of October 28Note: Consensus estimates for Jordan, Egypt and Israel sourced from WES and Morocco from EIU

Consensus JPM (% Y/Y)Consensus GDP SAAR

(1.5)

(0.8)

0.0

0.8

1.5

Indon

esia

S Ko

rea

Malay

sia

Colom

bia

Philip

pines

Thail

and

South

Afric

a

Turke

y

Chile

Braz

il

Mexic

o

China Peru

Taiw

an

Hung

ary

Polan

d

Russ

ia

Arge

ntina

Czec

hRe

publi

c

2010E GDP Growth: JPM Minus Consensus Change in Consensus Forecasts for 2010E GDP over last 3 months (%)

(0.6)

0.0

0.6

1.2Cz

ech

Repu

blic

Russ

ia

Hung

ary

Mexic

o

South

Afric

a

India

Taiw

an

Braz

il

Polan

d

S Ko

rea

Indon

esia

China

Thail

and

Turke

y

Arge

ntina

Peru

Colom

bia

Philip

pines

Malay

sia

Chile


146


Economic Forecasts: Policy Rate Trend and Forecasts

Country Official interest rate Q1'10 Q2'10 Q3'10 Current Q4'10F Q1'11F Q2'11F Q3'11F Last Change Next ChangeLatin AmericaBrazil SELIC overnight rate 8.75 10.25 10.75 10.75 10.75 11.50 12.50 12.50 21 Jul 10 (+50bp) Mar 11 (+25bp)Mexico Repo rate 4.50 4.50 4.50 4.50 4.50 4.50 4.75 5.25 17 Jul 09 (-25bp) Jun 10 (+25bps)Chile Discount rate 0.50 0.50 2.50 2.75 3.25 4.00 4.25 4.25 16 Sep 10 (+50bp) 16 Nov 10 (+25bp)Colombia Repo rate 3.50 3.00 3.00 3.00 3.00 4.00 5.00 5.50 30 Apr 10 (-50bp) 1Q 11 (+50bp)Peru Reference Rate 1.25 1.75 3.00 3.00 3.00 3.00 3.50 4.25 9 Sep 10 (+50bp) May 11 (+25bp)Developed MarketsUnited States Federal funds rate 0.125 0.125 0.125 0.125 0.125 0.125 0.125 0.125 16 Dec 08 (-87.5bp) On holdEuro Area Refi Rate 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 7 May 09 (-25bp) On holdJapan Overnight Call Rate 0.10 0.10 0.10 0.05 0.05 0.05 0.05 0.05 5 Oct 10 (-5bp) On holdEurope, Middle East and AfricaCzech Republic 2-week repo rate 1.00 0.75 0.75 0.75 0.75 0.75 1.00 1.25 6 May 10 (-25bp) 2Q 11 (+25bp)Hungary 2-week deposit rate 5.50 5.25 5.25 5.25 5.25 5.25 5.25 5.50 26 Apr 10 (-25bp) 3Q 11 (+25bp)Poland 7-day intervention rate 3.50 3.50 3.50 3.50 3.50 3.50 3.75 4.00 24 Jun 09 (-25bp) 2Q 11 (+25bp)Russia 1-week deposit rate 2.75 3.50 2.75 2.75 2.75 2.75 2.75 3.00 31 May 10 (-50bp) 3Q 11 (+25bp)South Africa Repo rate 6.50 6.50 6.00 6.00 5.50 5.50 5.50 5.50 9 Sep 10 (-50bp) 18 Nov 10 (-50bp)Turkey O/n borrowing rate 6.50 6.50 7.00 7.00 7.00 7.00 7.00 7.00 - 4Q 11 (+50bp)EM AsiaChina 1-year working capital 5.31 5.31 5.31 5.56 5.56 5.56 5.81 5.81 19 Oct 10 (+25bp) 2Q 11 (+25bp)Korea Overnight call rate 2.00 2.00 2.25 2.25 2.50 2.75 2.75 2.75 9 Jul 10 (+25bp) 4Q 10 (+25bp)India Repo rate 5.00 5.00 6.00 6.00 6.25 6.50 6.50 6.75 16 Sep 10 (+25bp) 2 Nov 10 (+25bp)Thailand 1-day repo rate 1.25 1.25 1.75 1.75 2.00 2.00 2.00 2.00 26 Aug 10 (+25bp) 1 Dec 10 (+25bp)Taiwan Official discount rate 1.38 1.38 1.50 1.50 1.50 1.50 1.50 1.63 30 Sep 10 (+12.5bp) 3Q 11 (+12.5bp)

Source: J.P. Morgan Economics, Bloomberg. Updated as of October 28

Emerging Markets policy rateChange in policy rates

-2

2

6

10

14

18

22

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Nominal Policy Rate

Real Rate

-1100 -900 -700 -500 -300 -100 100 300

ColombiaBrazilIndiaPeru

ThailandCzech

PolandKoreaChina

HungaryRussiaJapan

MexicoEU

USATurkeyTaiwanSAfrica

Change from Aug 07

Forecast change to Jun 11


147


Commodity Prices: Movement and Forecasts

Commodity Price ForecastsSpot Price 10Q4 11Q1 11Q2 11Q3 2009 2010E 2011E

82.2 81.0 78.0 81.0 83.0 61.9 78.5 82.582.8 83.0 80.0 83.0 85.0 62.5 79.2 84.53.4 4.5 4.8 5.0 5.3 4.7 5.1 5.4

1,335 1,275 1,250 1,250 1,250 976 1,221 1,43823.7 19.6 19.2 19.2 19.2 14.7 18.7 22.1

1,685 1,700 1,750 1,800 1,800 1,205 1,598 1,600626 600 650 675 675 262 495 613

8,330 6,750 6,750 7,000 6,800 5,157 7,294 8,7132,229 2,100 2,100 2,150 2,175 1,696 2,175 2,3382,467 2,350 2,200 2,100 2,100 1,669 2,143 2,275

23,029 21,000 20,000 20,000 20,000 15,363 22,170 22,0005.6 5.3 5.3 5.2 5.1 3.8 4.2 5.27.1 6.6 7.2 7.1 6.5 5.3 5.9 6.6

12.0 10.5 10.6 10.4 10.2 10.2 10.0 10.4

Source: Datastream, J.P. Morgan Estimates Updated as of October 28

Platinum ($/oz)Palladium ($/oz)

WTI oil $/bbl

Gold ($/oz)Silver ($/oz)

Natural gas $/mmbtuBrent oil $/bbl

Soybeans ($/bushel)

Copper ($/metric ton)Aluminium ($/metric ton)Zinc ($/metric ton)Nickel ($/metric ton)Corn ($/bushel)Wheat ($/bushel)

Gold Silver Platinum Palladium

Zinc Nickel

400.0

600.0

800.0

1,000.0

1,200.0

1,400.0


J.P. Morgan

Copper Aluminum

Crude

500

800

1100

1400

1700

2000

2300


J.P. Morgan

3.0

6.0

9.0

12.0

15.0

18.0

21.0

24.0


J.P. Morgan

125.0

225.0

325.0

425.0

525.0

625.0

725.0


J.P. Morgan

0.0

2,000.0

4,000.0

6,000.0

8,000.0

10,000.0


J.P. Morgan

0.0

1,000.0

2,000.0

3,000.0

4,000.0

5,000.0


J.P. Morgan

0.0

10,000.0

20,000.0

30,000.0

40,000.0

50,000.0

60,000.0


J.P. Morgan

150250350450550650750850950

Jan-02 Apr-03 Jul-04 Oct-05 Jan-07 Apr-08 Aug-09100

200

300

400

500

600

Jan 02 Apr 03 Jul 04 Oct 05 Jan 07 Apr 08 Aug 09100150200250300350400450500550600

Jan-02 Apr-03 Jul-04 Oct-05 Jan-07 Apr-08 Aug-09

900.0

1,200.0

1,500.0

1,800.0

2,100.0

2,400.0

2,700.0

3,000.0


J.P. Morgan

S&P GSCI Industrial Metals Index S&P GSCI Agricultural Index S&P Goldman Sachs Commodity Index

20.0

50.0

80.0

110.0

140.0


J.P. Morgan


148


Economic Forecasts: Currency Movements and Forecasts

Source: Datastream, J.P. Morgan estimates, Bloomberg. Updated as of October 28

Brazilian Real (BRL) Mexican Peso (MXN) Chilean Peso (CLP) Argentinian Peso (ARS)

Euro (EUR) Japansese Yen (JPY)

Chinese Yuan Renminbi (CNY)

Expected % Gain vs USD till December 2010 (J.P. Morgan) Expected % Loss vs USD till December 2010 (J.P. Morgan)

(7.0)

(5.5)

(4.0)

(2.5)

(1.0)

0.5

MYR BR

L

CNY

JPY

CLP

IDR

RUB

EUR0.0

1.02.03.04.05.06.07.08.0

HUF

CZK

TRL

PLN

KRW

ARS

INR

TWD

MXN

THB

PHP

1.41.61.82.02.22.42.62.83.0


Consensus

J.P. Morgan

J.P. Morgan forecast:end Dec 10: 1.70end Mar 11 : 1.80end Jun 11: 1.82

9.0

10.0

11.0

12.0

13.0

14.0

15.0

16.0


J.P. Morgan

Consensus


400450500550600650700750800


Consensus


2.83.03.23.43.63.84.04.24.44.6


J.P Morgan


Consensus

Peruvian Nuevo Sol (PEN)

2.5

2.7

2.9

3.1

3.3

3.5


J.P. Morgan

Consensus


Colombian Peso(COP)

1,600

1,800

2,000

2,200

2,400

2,600

2,800

3,000


J.P. Morgan


Consensus 1.10

1.20

1.30

1.40

1.50

1.60

1.70

1.80


J.P. Morgan

J.P. Morgan forecast:end Dec 10: 1.30end Mar 11: 1.30end Jun 11: 1.30 Consensus

75

85

95

105

115

125


J.P. Morgan

ConsensusJ.P. Morgan forecast:end Dec 10: 79end Mar 11: 81end Jun 11: 83

Taiwan Dollar (TWD)

28

30

32

34

36

38

40


Consensus

J.P. Morgan


6.0

6.5

7.0

7.5

8.0

8.5


J.P. Morgan

Consensus


Russian Rouble (RUB)

212427303336394245


Consensus


J.P.Morgan

South African Rand (ZAR)

5.06.07.08.09.0

10.011.012.013.014.0


Consensus

J.P. Morgan



149


Flows and Positioning

Weekly Index Net Weekly 2010 YTD 2009 12MCountry > 2% OW < 2% UW OW-UW < 0.1% EM % JPM reco chg Flows Agg. Agg. Avg.Russia 16 (17) 8 (11) 8 (6) 3 (3) 6.0 N (%) US$M US$M US$M (x).Indonesia 11 (9) 4 (4) 7 (5) 4 (4) 2.4 N Total EM Equity**** (0.2) 2,691 66,401 64,373 1.4Mexico 10 (8) 5 (5) 5 (3) 3 (3) 4.2 N Global EM Equity* (0.2) 1,646 44,218 29,058 1.3India 12 (10) 10 (7) 2 (3) 1 (1) 8.4 OW LatAm Equity* (1.3) 239 1,390 8,786 1.1Brazil 11 (10) 10 (12) 1 (-2) 0 (0) 16.6 UW EMEA Equity* (1.3) 320 4,695 2,017 1.8China+HK 11 (10) 14 (15) -3 (-5) 0 (0) 17.8 N Asia ex-Japan Equity* 0.2 458 15,131 19,108 0.7South Africa 6 (6) 19 (20) -13 (-14) 2 (2) 7.5 N BRIC Equity* (1.1) 28 966 5,404 0.3Malaysia 2 (2) 18 (19) -16 (-17) 12 (13) 2.9 OW Japan Equity Funds (1.6) (108) (1,461) (5,461) (0.5)China 4 (5) 20 (24) -16 (-19) 0 (0) 17.8 N Developed Europe* (1.7) 838 (10,765) 2,506 1.0Korea 5 (3) 23 (23) -18 (-20) 1 (2) 13.4 N International Equity* (1.4) 490 1,824 18,727 0.6Taiwan 1 (1) 28 (25) -27 (-24) 1 (1) 10.5 N US Equity*** 0.5 5,269 9,727 (8,290) 1.3

US Bond*** 2.7 4,202 140,307 180,622 1.2US Money Market*** 0.1 17,329 (399,002) (466,143) 1.8

Source: J.P. Morgan estimates, Bloomberg and EPFR

Source: EPFR Global, MSCI, J.P. Morgan calculations. The survey covers 45 fund managers. The calculation of OW is greater than 2% overweight versus the MSCI benchmark. UW is less than -2% of benchmark weighting. Fund weightings are as of 30 September 2010 and MSCI weightings as of 1 October 2010. Numbers in brackets are the previous month values. Potentially China stocks have been misclassified as Hong Kong, hence the combined weight for Hong Kong and China. Hong Kong investment may be providing non-China exposure Source: Bloomberg, J.P. Morgan, I:Net, MKK, Lipper FMI, MSCI, Datastream. *EPFR Global data. ***Data from Lipper

FMI. BRIC Funds separated from EM Funds from 11 May 07. 12 month average column shows ratio of current flows to past 12 months rolling average. ****Total EM Equity includes Global EM, LatAm, EMEA, Asia ex Japan and BRIC funds.

EM Managers’ Positioning Relative to MSCI EM: Major EM Markets Regional and US Mutual Fund Flows

Cumulative EM Fund Flows (US$ BN), by Year 2010 LatAm Funds Cumulative Total and ETF Flows (US$ MN)

(3,000)(2,500)(2,000)(1,500)(1,000)

(500)0

5001,0001,500

Jan 10 Feb 10 Mar 10 Apr 10 May 10 Jun 10 Jul 10 Aug 10 Sep 10 Oct 10

ETF Flows

Total Flows

22.4

40.8

(39.4)

64.466.4

(60)

(30)

0

30

60

90

120


2006 2007 2008 2009 2010


150


Economic Forecasts: Credit Risk External (2010E) Fiscal Position Sovereign Ratings (Long Term Foreign Debt)

Foreign CurrentReserves Account 2010F** 2010F** 2010F** 2011F** 2009 2010F** Moody's S & P(US$bil) %GDP (US$bil) %GDP % GDP % GDP % GDP % GDP Rating Action Date Rating Action Date

LATAMArgentina 51.2 0.0 118.0 32.9 -1.5 -1.0 51.2 46.4 B3 O/L changed to stable Aug-14-08 B- Downgrade, O/L stable Aug-11-08

Brazil 262.8 -2.4 221.0 10.9 -3.3 -3.4 64.1 61.7 Baa3 (+) Upgrade, O/L (+) Sep-22-09 BBB- Upgrade, stable 30-Apr-08Colombia 26.5 -2.0 54.3 19.4 -2.7 -4.2 48.8 47.9 Ba1 Upgrade, O/L stable Jun-19-08 BBB- Upgrade, stable 30-Apr-08

Mexico 111.8 -0.8 178.0 16.8 -0.5 -2.5 37.4 34.1 Baa1 Upgrade, O/L stable Jan-06-05 BBB Downgrade, O/L changed to stable Dec-14-09Peru 32.5 -0.7 33.2 22.3 -1.9 -2.5 24.7 22.1 Baa3 Upgrade, O/L changed stable Dec-16-09 BBB- Upgrade, stable 30-Apr-08

EMEARussia 472.9 4.5 502.8 33.5 -5.9 -4.2 8.0 7.9 Baa1 O/L changed to stable, Affirmed Dec-12-08 BBB O/L changed to stable, Affirmed Dec-21-09

South Africa 41.7 -5.0 82.6 24.0 -6.7 -5.0 32.9 38.2 A3 Upgrade, O/L changed to stable Jul-16-09 BBB+ O/L changed to (-), Affirmed Nov-11-08Poland 81.6 -2.5 261.3 51.0 -7.1 -7.0 51.0 53.2 A2 Affirmed, O/L stable Jan-05-10 A- O/L changed to stable, Affirmed Oct-27-08Turkey 78.0 -4.8 273.5 37.4 -5.5 -3.4 55.4 49.0 Ba2 Upgrade, O/L stable Jan-08-10 BB Upgrade, O/L (+) Feb-19-10

Hungary 37.1 0.5 181.4 141.6 -4.0 -4.2 78.3 79.3 Baa1 Downgrade, O/L (-) Mar-31-09 BBB- O/L changed to stable, Affirmed Oct-2-09Czech Republic 44.0 -1.8 84.0 44.5 -5.9 -5.0 35.3 38.5 A1 O/L changed to stable, Affirmed Dec-08-08 A Affirmed, O/L stable Dec-21-09

Morocco* 13.6 -0.9 na na na na na na Ba1 O/L changed to stable Jun-18-03 BB+ Upgrade, O/L stable Mar-23-10Jordan* 5.3 -14.4 na na na na na na Ba2 O/L changed to stable Jan-08-07 BB Affirmed, O/L stable Mar-12-10

AsiaKorea 290.1 2.7 402.9 42.3 -1.7 -0.5 44.4 42.8 A1 Upgrade, O/L stable Apr-14-10 A Affirmed, O/L stable Jan-12-10

Taiwan 387.7 7.4 na na -3.6 -1.5 na na Aa3 Affirmed, O/L stable Jan-24-02 Jan-24-02 AA- O/L changed to (-), Affirmed Apr-14-09China 2766.0 4.8 443.6 7.5 -3.3 -2.1 19.3 19.0 A1 O/L changed to (+), Affirmed Nov-09-09 A+ Affirmed, O/L stable Jan-12-10India 273.6 -3.3 277.9 16.0 -6.8 -5.1 42.3 41.1 Baa3 Upgrade, O/L stable Jan-22-04 BBB- O/L changed to stable, Affirmed Mar-18-10

Malaysia 100.2 15.6 70.0 33.7 -7.1 -5.2 53.3 46.9 A3 Upgrade, O/L stable Dec-16-04 A- O/L changed to stable, Affirmed May-15-08Thailand 155.5 3.7 72.3 22.6 -3.9 -2.5 34.2 34.4 Baa1 Affirmed, O/L (-) Apr-13-10 BBB+ Affirmed, O/L (-) Apr-13-10Indonesia 83.6 0.6 183.0 26.2 -1.6 -2.0 35.8 32.5 Ba2 Affirmed, O/L stable Jan-21-10 BB+ Upgrade, O/L (+) Mar-12-10Philippines 41.4 4.8 56.5 27.8 -3.9 -4.0 52.6 49.3 Ba3 Affirmed, O/L stable Mar-29-10 BB- Affirmed, O/L stable Apr-18-08

Source: Bloomberg, J.P. Morgan Source: Bloomberg, J.P. Morgan Source: Bloomberg, J.P. Morgan Source: Bloomberg, J.P. MorganSource: CEIC, J.P. Morgan estimates, Moody's, Standard & Poor's, Bloomberg * Data from World Economic Outlook for October 2009, ** F denotes forecast.

Updated as of October 28

Public Sector DebtFiscal DeficitExternal Debt

EMBI Global Spreads and Yields EMBI Asia Spreads and Yields EMBI Latin America Spreads and YieldsEMBI Europe Spreads and Yields

100200300400500600700800900

1000

Oct-08 Jul-09 Mar-105.0

7.0

9.0

11.0

13.0

15.0

17.0

Spread (L) Yield

100

200

300

400

500

600

700

800

Oct-08 Jul-09 Mar-104

5

6

7

8

9

10

11

Spread (L) Yield100

300

500

700

900

1100

1300

Oct-08 Jul-09 Mar-104.5

6.5

8.5

10.5

12.5

Spread (L) Yield

100200300400500600700800900

1000

Oct-08 Jul-09 Mar-106.0

9.0

12.0

15.0

18.0

Spread (L) Yield


151


Perspective: Demographic and Key Economic Statistics

Age Gross 2010E Growth Dependency Ratio* Enrollment Ratio US$ Per capita Total Per capita Total Per capitamillion %YoY Young Old Secondary** billion (US$) (%) (%) (%) (%)

USA 310 1.0 na na 98 14,646 47,213 4.1 3.1 3.0 2.0

LATAMBrazil# 194 1.2 0.4 0.1 102 2095 10822 12.5 11.1 3.1 1.7Chile 17 1.0 0.4 0.1 89 199 11632 10.2 8.9 3.6 2.3

Colombia 46 1.5 0.5 0.1 75 298 6418 13.5 12.5 3.9 2.2Mexico 111 1.0 0.5 0.1 80 1046 9450 6.1 4.8 1.5 0.4

Peru 30 1.2 0.5 0.1 92 150 5085 10.9 9.2 5.4 3.8EMEA

Russia# 141 -0.1 0.2 0.2 93 1598 11316 19.9 20.4 5.9 6.4South Africa 49 0.7 0.5 0.1 90 371 7581 10.8 9.8 3.2 2.2

Israel 7 2.2 0.4 0.2 93 199 26845 5.1 3.1 2.8 0.5Poland 38 -0.1 0.2 0.2 97 473 12450 10.7 10.8 3.6 3.8Turkey 76 1.2 0.4 0.1 79 714 9426 13.7 12.1 3.2 1.9

Hungary 10 -0.1 0.2 0.2 97 130 13008 10.5 10.7 1.9 2.1Egypt 78 2.0 0.5 0.1 87 216 2759 8.1 5.9 4.9 2.8

Czech Rep. 10 0.2 0.2 0.2 96 199 19198 13.4 13.2 3.1 3.0Morocco 32 1.4 0.5 0.1 48 94 2909 9.8 8.4 4.9 3.8Jordan 6 2.3 0.5 0.1 87 25 4062 11.4 8.8 6.3 3.9

AsiaKorea 48 0.1 0.3 0.1 91 1013 20981 6.6 6.2 6.0 5.6

Taiwan 23 0.3 0.3 0.1 na 430 18531 2.8 2.4 3.3 2.9China 1354 0.6 0.3 0.1 73 6016 4441 17.6 16.8 10.4 9.7India 1184 1.3 0.5 0.1 54 1682 1415 13.8 12.1 10.0 8.4

Thailand 68 0.7 0.3 0.1 77 325 4709 10.2 9.2 4.4 3.5Indonesia 233 1.2 0.4 0.1 64 729 3129 16.0 14.5 5.2 3.9Philippines 94 1.8 0.6 0.1 86 196 2081 9.9 7.9 4.6 2.7

Source: CEIC, Datastream, Bloomberg, US Consensus Bureau, World Bank, IMF, UNESCO, J.P. Morgan estimates Updated as of October 28* Age dependency ratio defined as dependents to working-age population.** Gross Enrollment Ratio is defined as pupils enrolled in a secondary level, regardless of age expressed as a percentage of the population in the relevant official age group *** 10-year CAGR for period 1999-2009, in local currency. # CAGR for period 1999-2009 ## Population data based on IMF estimate as on July 2007Data for Gross enrollment data for 2004 except for Malaysia, Brazil and Argentina which is for 2003

Real GDP10 year CAGR***

Population and DemographicsPopulation##

Nominal GDP2010E 10 year CAGR***


152


Perspective: Global Emerging Capital Markets

MSCI EMF Index Markets Concentration JPM EMBI Global

Total Market Cap Estimated Free Float Companies Average Daily

Turnover

% of Emerging Market Trading

Volume

Weighting in MSCI EMF

Stocks constituting 75% of Country Market Cap

Stocks constituting 75% of Country Market Cap

Market Capitalisation Issues

US$ Bn (%) Number US $ Mn % (%) Number (%) US$ Bn NumberLATAM

Brazil 1007 58 75 2980 16 16 16 17 50 23Chile 171 36 16 146 1 2 9 69 5 8

Colombia 147 22 8 49 0 1 4 50 7 7Mexico 283 56 21 337 2 4 7 29 50 29

Peru 60 46 3 145 1 1 2 67 8 8EMEA

Russia 640 35 28 1426 8 6 5 25 33 4South Africa 383 70 45 1019 5 7 17 40 4 4

Poland 129 45 22 214 1 2 7 23 3 3Turkey 215 32 20 641 3 2 11 60 22 14

Hungary 27 60 4 81 0 0 2 75 1 1Egypt 36 47 10 53 0 0 7 30 1 1

Czech Republic 41 34 4 55 0 0 3 50 na naMorocco 29 21 3 6 0 0 4 100 1 1

ASIAKorea 779 63 99 3766 20 13 28 18 na na

Taiwan 554 70 118 2207 12 11 31 25 na naChina 1363 49 125 4088 22 18 9 15 7 8India 847 35 60 336 2 8 22 33 na na

Malaysia 256 41 39 292 2 3 20 62 9 7Thailand 172 36 20 494 3 2 14 70 na naIndonesia 214 41 22 252 1 2 10 41 6 5Philippines 57 33 12 44 0 1 7 67 19 14

Total 7407 49 754 18629 100 100 232 141

Source: MSCI, J.P. Morgan Updated as of October 28

Korea13%

Taiwan11%

South Africa7%

Rest of EM16%

Brazil16%

China19%

Mexico4%

India8%

Russia6%

AC World Index Market Capitalisation MSCI Regional Market Capitalisation Top 8 versus Rest of Emerging Markets

EM Asia58%

EM Latin America

24%

EM Europe and Middle East

18%

North America47%

Developed Asia5%

Japan8%

Emerging Markets

11%

Developed Europe

26%


153


Perspective: MSCI Emerging Market Index Composition by Countries and SectorsNumber of Companies: 754 Total Market Capitalization (in billion US$): 7407

MSCI Emerging Markets Free Index

Cons

umer

Di

scre

tiona

ry

Cons

umer

Sta

ples

Ener

gy

Fina

ncial

s

Healt

h ca

re

Indu

stria

ls

Info

rmat

ion

Tech

nolo

gy

Mate

rials

Telec

om S

ervic

es

Utilit

ies

Tota

l

Brazil 0.8 1.4 3.7 4.2 0.5 0.3 4.1 0.4 0.8 16.1Mexico 0.4 1.1 0.3 0.2 0.7 1.7 4.4Chile 0.1 0.3 0.2 0.3 0.4 0.0 0.4 1.7Peru 0.2 0.5 0.8Colombia 0.1 0.3 0.3 0.1 0.1 0.9LatAm 1.3 2.8 3.9 5.3 1.1 0.3 5.8 2.1 1.3 23.8Russia 0.2 3.3 1.0 0.9 0.4 0.3 6.1South Africa 1.0 0.4 0.7 1.9 0.2 0.3 1.9 0.9 7.3Poland 0.0 0.0 0.2 0.8 0.0 0.0 0.2 0.1 0.1 1.6Turkey 0.0 0.2 0.1 1.1 0.2 0.0 0.2 1.9Hungary 0.1 0.2 0.1 0.0 0.4Egypt 0.2 0.1 0.0 0.1 0.5Czech Republic 0.0 0.1 0.1 0.2 0.4Morocco 0.1 0.1 0.2JordanEMEA 1.1 0.8 4.5 5.4 0.2 0.7 0.0 3.0 2.0 0.7 18.3Korea 2.0 0.6 0.4 2.1 0.1 2.2 3.6 1.9 0.4 0.2 13.4China 1.0 1.1 3.1 7.1 0.1 1.4 1.0 1.0 2.1 0.3 18.3Taiwan 0.3 0.2 0.1 1.6 0.4 6.1 1.4 0.5 10.6India 0.4 0.5 1.1 2.2 0.3 0.9 1.3 0.9 0.1 0.4 8.1Malaysia 0.4 0.4 0.0 0.9 0.5 0.0 0.3 0.3 2.9Indonesia 0.4 0.3 0.3 0.7 0.1 0.2 0.3 0.1 2.4Thailand 0.0 0.2 0.7 0.6 0.1 0.1 0.0 1.7Philippines 0.0 0.2 0.1 0.1 0.1 0.5Asia 4.5 3.2 5.7 15.5 0.5 5.6 12.0 5.6 3.8 1.5 57.9Total 6.8 6.8 14.1 26.1 0.8 7.3 12.3 14.4 7.9 3.5 100.0

Source: MSCI, J. P. Morgan Updated as of October 28


154


Other companies recommended in this report (and priced as of October 28, 2010): Bladex (BLX/US$15.29/OW) Cielo (CIEL3.SA/R$14.60/Neutral) Coca-Cola FEMSA (KOF/US$78.40/Neutral) Compania Cervecerias Unidas (CCU/US$56.05/Overweight) Fleury (FLRY3.SA/R$21.85/Neutral) Grupo Modelo (GMODELOC.MX/Ps68.67/Overweight) Heineken (HEIN.AS/€36.34/Neutral) Itau Unibanco Holding SA (ITUB4.SA/R$41.14/Overweight) Redecard (RDCD3.SA/R$22.50/Neutral) SABESP (SBSP3.SA/R$39.79/Neutral) Southern Copper Corporation (SCCO/US$43.08/Neutral) Souza Cruz SA (CRUZ3.SA/R$86.60/Neutral) Telesp (TSP/US$24.24/Overweight) Vallourec (VLLP.PA/€74.75/Overweight) Vivo Participacoes (VIV/US$28.18/Overweight)


155


LatAm Equity Research Ben Laidler, Director of Research [email protected] +1 212 622 5252Equity Strategy / Special Situations Ben Laidler (LatAm & Mexico) [email protected] +1 212 622 5252Emy Shayo (Brazil) [email protected] +55 11 3048 6684Brian Chase (Chile/Argentina/Andes) [email protected] +56 2 425 5245Vinay Joseph (LatAm) [email protected] +91 22 6157 3323Pablo Monsivais (Mexico) [email protected] +52 55 5540 9374Economics / Fixed Income Strategy Joyce Chang (Head of GEM Strategy) [email protected] +1 212 834 4203Luis Oganes (Head of LatAm Economics) [email protected] +1 212 834 4326Fabio Akira Hashizume (Brazil) [email protected] +55 11 3048 3634Gabriel Casillas (Mexico) [email protected] +52 55 5540 9558Julio Callegari (Brazil, Colombia & Peru) [email protected] +55 11 3048 3369Franco Uccelli (Central America & Caribbean) [email protected] +1 305 579 9415Neeraj Arora (Central America & Caribbean) [email protected] +1 212 834 4321Ben Ramsey (Andes) [email protected] +1 212 834 4308Vladimir Werning (Argentina & Chile) [email protected] +1 212 834 4144Agribusiness / Pulp & Paper Debbie Bobovnikova [email protected] +1 212 622 3489Lucas Ferreira [email protected] +55 11 3048 3629Basic Materials Rodolfo Angele (Steel & Mining) [email protected] +55 11 3048 3888Rodrigo Fernandes [email protected] +55 11 3048 3983Mandeep Singh Manihani [email protected] +1 212 622 6433John Bridges (Precious Metals) [email protected] +1 212 622 6430Cement / Construction / Homebuilders Adrian Huerta [email protected] +52 81 8152 8720Marcelo Motta [email protected] +55 11 3048 6712Varun Ginodia [email protected] +91 22 6157 3321Financials / Exchanges / Merchant Acquirers Saul Martinez [email protected] +1 212 622 3602Frederic de Mariz (SMid Cap Financials) [email protected] +55 11 3048 3398Mariana Barros [email protected] +55 11 3048 3480Marina Mansur [email protected] +55 11 3048 3893 Ken Worthington (Exchanges) [email protected] +1 212 622 6613Retail / Healthcare / Cosmetics Andrea Teixeira [email protected] +1 212 622 6735Joao Mamede [email protected] +55 11 3048 3711Felipe Oliveira [email protected] +55 11 3048 3892Beverages / Food / Tobacco Alan Alanis [email protected] +1 212 622 3697Sambuddha Ray [email protected] +91 22 6157 3310Pedro Leduc [email protected] +55 11 3048 3824Telecoms / Media / Technology Andre Baggio [email protected] +55 11 3048 3427Rajneesh Jhawar [email protected] +1 212 622 6480Anna Daher [email protected] +55 11 3048 3756Transport / Aerospace / Industrials Fernando Abdalla [email protected] +55 11 3048 3463Adrian Huerta (Airports) [email protected] +52 81 8152 8720Jamie Baker (Airlines) [email protected] +1 212 622 6713Joe Nadol (Aerospace) [email protected] +1 212 622 6548Utilities & Concessions Anderson Frey [email protected] +1 212 622 6615Pedro Manfredini [email protected] +55 11 3048 3896Energy / Petrochemicals Sergio Torres [email protected] +1 212 622 3378Felipe Dos Santos [email protected] +55 11 3048 3796


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Disclosures

Analyst Certification: The research analyst(s) denoted by an “AC” on the cover of this report certifies (or, where multiple research analysts are primarily responsible for this report, the research analyst denoted by an “AC” on the cover or within the document individually certifies, with respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research analyst’s compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report.

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Neutral (hold)

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J.P. Morgan Global Equity Research Coverage 46% 43% 12% IB clients* 49% 45% 33% JPMS Equity Research Coverage 43% 48% 8% IB clients* 69% 60% 50%

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Options related research: If the information contained herein regards options related research, such information is available only to persons who have received the proper option risk disclosure documents. For a copy of the Option Clearing Corporation’s Characteristics and Risks of Standardized Options, please contact your J.P. Morgan Representative or visit the OCC’s website at http://www.optionsclearing.com/publications/risks/riskstoc.pdf.

Legal Entities Disclosures U.S.: JPMS is a member of NYSE, FINRA and SIPC. J.P. Morgan Futures Inc. is a member of the NFA. JPMorgan Chase Bank, N.A. is a member of FDIC and is authorized and regulated in the UK by the Financial Services Authority. U.K.: J.P. Morgan Securities Ltd. (JPMSL) is a member of the London Stock Exchange and is authorized and regulated by the Financial Services Authority. Registered in England & Wales No. 2711006. Registered Office 125 London Wall, London EC2Y 5AJ. South Africa: J.P. Morgan Equities Limited is a member of the Johannesburg Securities Exchange and is regulated by the FSB. Hong Kong: J.P. Morgan Securities (Asia Pacific) Limited (CE number AAJ321) is regulated by the Hong Kong Monetary Authority and the Securities and Futures Commission in Hong Kong. Korea: J.P. Morgan Securities (Far East) Ltd, Seoul Branch, is regulated by the Korea Financial Supervisory Service. Australia: J.P. Morgan Australia Limited (ABN 52 002 888 011/AFS Licence No: 238188) is regulated by ASIC and J.P. Morgan Securities Australia Limited (ABN 61 003 245 234/AFS Licence No: 238066) is a Market Participant with the ASX and regulated by ASIC. Taiwan: J.P.Morgan Securities (Taiwan) Limited is a participant of the Taiwan Stock Exchange (company-type) and regulated by the Taiwan Securities and Futures Bureau. India: J.P. Morgan India Private Limited is a member of the National Stock Exchange of India Limited and Bombay Stock Exchange Limited and is regulated by the Securities and Exchange Board of India. Thailand: JPMorgan Securities (Thailand) Limited is a member of the Stock Exchange of Thailand and is regulated by the Ministry of Finance and the Securities and Exchange Commission. Indonesia: PT J.P. Morgan Securities Indonesia is a member of the Indonesia Stock Exchange and is regulated by the BAPEPAM LK. Philippines: J.P. Morgan Securities Philippines Inc. is a member of the Philippine Stock Exchange and is regulated by the Securities and Exchange Commission. Brazil: Banco J.P. Morgan S.A. is regulated by the Comissao de Valores Mobiliarios (CVM) and by the Central Bank of Brazil. Mexico: J.P. Morgan Casa de Bolsa, S.A. de C.V., J.P. Morgan Grupo Financiero is a member of the Mexican Stock Exchange and authorized to act as a broker dealer by the National Banking and Securities Exchange Commission. Singapore: This material is issued and distributed in Singapore by J.P. Morgan Securities Singapore Private Limited (JPMSS) [MICA (P) 020/01/2010 and Co. Reg. No.: 199405335R] which is a member of the Singapore Exchange Securities Trading Limited and is regulated by the Monetary Authority of Singapore (MAS) and/or JPMorgan Chase Bank, N.A., Singapore branch (JPMCB Singapore) which is regulated by the MAS. Malaysia: This material is issued and distributed in Malaysia by JPMorgan Securities (Malaysia) Sdn Bhd (18146-X) which is a Participating Organization of Bursa Malaysia Berhad and a holder of Capital Markets Services License issued by the Securities Commission in Malaysia. Pakistan: J. P. Morgan Pakistan Broking (Pvt.) Ltd is a member of the Karachi Stock Exchange and regulated by the Securities and Exchange Commission of Pakistan. Saudi Arabia: J.P. Morgan Saudi Arabia Ltd. is authorized by the Capital Market Authority of the Kingdom of Saudi Arabia (CMA) to carry out dealing as an agent, arranging, advising and custody, with respect to securities business under licence number 35-07079 and its registered address is at 8th Floor, Al-Faisaliyah Tower, King Fahad Road, P.O. Box 51907, Riyadh 11553, Kingdom of Saudi Arabia. Dubai: JPMorgan Chase Bank, N.A., Dubai Branch is regulated by the Dubai Financial Services Authority (DFSA) and its registered address is Dubai International Financial Centre - Building 3, Level 7, PO Box 506551, Dubai, UAE.

Country and Region Specific Disclosures U.K. and European Economic Area (EEA): Unless specified to the contrary, issued and approved for distribution in the U.K. and the EEA by JPMSL. Investment research issued by JPMSL has been prepared in accordance with JPMSL's policies for managing conflicts of interest arising as a result of publication and distribution of investment research. Many European regulators require a firm to establish, implement and maintain such a policy. This report has been issued in the U.K. only to persons of a kind described in Article 19 (5), 38, 47 and 49 of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (all such persons being referred to as "relevant persons"). This document must not be acted on or relied on by persons who are not relevant persons. Any investment or investment activity to which this document relates is only available to relevant persons and will be engaged in only with relevant persons. In other EEA countries, the report has been issued to persons regarded as professional investors (or equivalent) in their home jurisdiction. Australia: This material is issued and distributed by JPMSAL in Australia to “wholesale clients” only. JPMSAL does not issue or distribute this material to “retail clients.” The recipient of this material must not distribute it to any third party or outside Australia without the prior written consent of JPMSAL. For the purposes of this paragraph the terms “wholesale client” and “retail client” have the meanings given to them in section 761G of the Corporations Act 2001. Germany: This material is distributed in Germany by J.P. Morgan Securities Ltd., Frankfurt Branch and J.P.Morgan Chase Bank, N.A., Frankfurt Branch which are regulated by the Bundesanstalt für Finanzdienstleistungsaufsicht. Hong Kong: The 1% ownership disclosure as of the previous month end satisfies the requirements under Paragraph 16.5(a) of the Hong Kong Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission. (For research published within the first ten days of the month, the disclosure may be based on the month end data from two months’ prior.) J.P. Morgan Broking (Hong Kong) Limited is the liquidity provider for derivative warrants issued by J.P. Morgan Structured Products B.V. and listed on the Stock Exchange of Hong Kong Limited. An updated list can be found on HKEx website: http://www.hkex.com.hk/prod/dw/Lp.htm. Japan: There is a risk that a loss may occur due to a change in the price of the


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shares in the case of share trading, and that a loss may occur due to the exchange rate in the case of foreign share trading. In the case of share trading, JPMorgan Securities Japan Co., Ltd., will be receiving a brokerage fee and consumption tax (shouhizei) calculated by multiplying the executed price by the commission rate which was individually agreed between JPMorgan Securities Japan Co., Ltd., and the customer in advance. Financial Instruments Firms: JPMorgan Securities Japan Co., Ltd., Kanto Local Finance Bureau (kinsho) No. 82 Participating Association / Japan Securities Dealers Association, The Financial Futures Association of Japan. Korea: This report may have been edited or contributed to from time to time by affiliates of J.P. Morgan Securities (Far East) Ltd, Seoul Branch. Singapore: JPMSS and/or its affiliates may have a holding in any of the securities discussed in this report; for securities where the holding is 1% or greater, the specific holding is disclosed in the Important Disclosures section above. India: For private circulation only, not for sale. Pakistan: For private circulation only, not for sale. New Zealand: This material is issued and distributed by JPMSAL in New Zealand only to persons whose principal business is the investment of money or who, in the course of and for the purposes of their business, habitually invest money. JPMSAL does not issue or distribute this material to members of "the public" as determined in accordance with section 3 of the Securities Act 1978. The recipient of this material must not distribute it to any third party or outside New Zealand without the prior written consent of JPMSAL. Canada: The information contained herein is not, and under no circumstances is to be construed as, a prospectus, an advertisement, a public offering, an offer to sell securities described herein, or solicitation of an offer to buy securities described herein, in Canada or any province or territory thereof. Any offer or sale of the securities described herein in Canada will be made only under an exemption from the requirements to file a prospectus with the relevant Canadian securities regulators and only by a dealer properly registered under applicable securities laws or, alternatively, pursuant to an exemption from the dealer registration requirement in the relevant province or territory of Canada in which such offer or sale is made. The information contained herein is under no circumstances to be construed as investment advice in any province or territory of Canada and is not tailored to the needs of the recipient. To the extent that the information contained herein references securities of an issuer incorporated, formed or created under the laws of Canada or a province or territory of Canada, any trades in such securities must be conducted through a dealer registered in Canada. No securities commission or similar regulatory authority in Canada has reviewed or in any way passed judgment upon these materials, the information contained herein or the merits of the securities described herein, and any representation to the contrary is an offence. Dubai: This report has been issued to persons regarded as professional clients as defined under the DFSA rules.

General: Additional information is available upon request. Information has been obtained from sources believed to be reliable but JPMorgan Chase & Co. or its affiliates and/or subsidiaries (collectively J.P. Morgan) do not warrant its completeness or accuracy except with respect to any disclosures relative to JPMS and/or its affiliates and the analyst’s involvement with the issuer that is the subject of the research. All pricing is as of the close of market for the securities discussed, unless otherwise stated. Opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients. The recipient of this report must make its own independent decisions regarding any securities or financial instruments mentioned herein. JPMS distributes in the U.S. research published by non-U.S. affiliates and accepts responsibility for its contents. Periodic updates may be provided on companies/industries based on company specific developments or announcements, market conditions or any other publicly available information. Clients should contact analysts and execute transactions through a J.P. Morgan subsidiary or affiliate in their home jurisdiction unless governing law permits otherwise.

“Other Disclosures” last revised September 1, 2010.

Copyright 2010 JPMorgan Chase & Co. All rights reserved. This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of J.P. Morgan.

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