Está en la página 1de 50

23 June 2011

Equity
Sector Review
www.sgresearch.com

Capital Goods
Chinese construction bubble Preparing for a potential burst Overweight
Stock selection Preferred

Construction in China - boom or bubble?

The exponential growth of real estate and infrastructure spending in China over the past decade has raised concerns over the emergence of a construction bubble that could burst any time soon. Various data indicate that China has over built over the past decade; China is consuming 1,400kg of cement per head per annum, more than 4x higher than the world average and above the level consumed by Spain ahead of its housing crisis. China is building almost 2 billion sqm of new housing per annum, enough to accommodate 60 million people while around 20 million are migrating to the cities every year. In terms of roads and railways, we found that China is also ahead of its development curve. While we acknowledge the long-term prospects offered by the Chinese economy and its urbanisation, we believe the current pace of construction activity is unsustainable and a painful adjustment will come sooner or later. The recent weakness in Chinese construction equipment data could be a first warning signal that the Chinese construction growth story might not go on forever. Such concerns have been partly reflected in the weakness of Chinese construction machinery stocks (-16%) and commodities (-13% for main base metals on average) since early April.

Siemens
Least preferred

Sandvik

Biggest near-term risk for capital goods lies in mining

European capgoods companies have a limited direct exposure to the Chinese construction market. The stocks with the strongest exposure are Assa Abloy (9% of group sales), Volvo (8%) and Schneider (4%). The biggest risk relates to the mining industry, in our view. Any construction downturn in China would have severe consequences on commodity demand and prices, leading to lower capex plans from miners. Stocks with the highest exposure to the mining industry are Sandvik (36% of group sales) and Atlas Copco (26%). We now believe mining capex could peak at a record high level in 2011 with latest consensus forecasts for the top five miners suggesting a decline in capex post-2011.

Key recommendation

Trading at a premium to the sector despite significant exposure to the

Chinese construction risk, Atlas Copco (rating lowered from Buy to Hold) and Sandvik (rating lowered from Hold to Sell), now have unappealing risk/reward profiles. Although declining construction equipment sales in China could hurt sentiment, we maintain our Hold rating on Volvo but lower our TP to SEK110. Schneider would not be immune to a collapse in the Chinese construction market; however, the shares remain good value with significant exposure to the energy efficiency and industrial productivity themes.
Key recommendations
Price 21/06 TP 12m Reco P/E 12e (x) EV/EBIT 12e (x) Div. yield Comments 11e

Atlas Copco Sandvik Schneider Volvo


Sbastien Gruter (33) 1 42 13 47 22

161 108 113 106

150 90 140 110

Hold Sell Buy Hold

14.0 12.4 11.4 9.1

10.0 9.5 8.4 6.5

3.2 Sizeable exposure to mining capex and to China 3.9 Sizeable exposure to mining capex and highly sensitive to volume 3.5 Exposed to Chinese construction but appealing play on energy efficiency 3.3 Exposed to Chinese construction equipment but low valuation
Adrien de Susanne (33) 1 42 13 01 61
adrien.de susanne@sgcib.com

Gal de Bray, CFA (33) 1 42 13 84 14


gael.de-bray@sgcib.com

Colin Campbell (44) 20 7762 5609


colin.campbell@sgcib.com

sebastien.gruter@sgcib.com

Societe Generale (SG) does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that SG 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. PLEASE SEE APPENDIX AT THE END OF THIS REPORT FOR THE ANALYST(S)

CERTIFICATION(S), IMPORTANT DISCLOSURES AND DISCLAIMERS AND THE STATUS OF NON-US RESEARCH ANALYSTS.

Macro

Commodities

Forex

Rates

Equity

Credit

Derivatives

Capital Goods

Contents
3 4 6 8 8 10 12 14 16 18 18 19 20 21 23 23 24 26 27 29 29 30 31 32 34 36 38 40 42 44 Sector leading indicators Investment summary Key recommendations Construction in China is running ahead of its development curve China - A construction-led economy Chinese construction bubble Myth or reality? Real estate Long-term demand is there but how to sustain current development rates? Infrastructure Is there anything left to be built? Cement consumption highlights significant over construction Early signs of weakness in China Some weakness has emerged in construction equipment data Share price performance reflects growing concerns Sell-off in commodity indices Monetary tightening and weak PMI data but IP and FAI remain strong Focus on the Chinese construction equipment industry The Chinese construction and mining equipment market Overview of the main Chinese players Moving up the value chain The excavator example Looking abroad for development as volume could stall in China Who is exposed and to what extent? Mining exposure is the biggest threat China - Key driver of sales growth over the past few years Chinese competition likely to intensify outside China Forecasts edged down to reflect the increased uncertainty Company profiles Assa Abloy Atlas Copco Sandvik Schneider Volvo Legrand

23 June 2011

Capital Goods

Sector leading indicators


China PMI is weakening
60 58 56 54 52 50 48 46 44 42 40
May-05 Aug-05 Nov-05 Feb-06 May-06 Aug-06 Nov-06 Feb-07 May-07 Aug-07 Nov-07 Feb-08 May-08 Aug-08 Nov-08 Feb-09 May-09 Aug-09 Nov-09 Feb-10 May-10 Aug-10 Nov-10 Feb-11 May-11

China FAI and IP growth (yoy, %)


Chinese PMI is on a downward trend albeit remaining above the critical mark (50). May data was slightly better than expected
40
35 FAI yoy growth IP yoy growth

30
25

20
15 10 5 0

Feb-09

Feb-10

Aug-06

Nov-06

Aug-07

Nov-07

Aug-08

Nov-08

Aug-09

Aug-10

Nov-09

May-06

May-07

May-08

May-09

May-10

Nov-10

Feb-11

Feb-07

Feb-08

Source: Datastream

Source: National Bureau of Statistics

Chinese real estate growth (yoy, %)


40%
35%

Excavator deliveries in China


Growth in Chinese real estate has averaged 25% from 2003 to 2010.
44,000 40,000 36,000 32,000 28,000 24,000 20,000 16,000 12,000 8,000 4,000 Oct-03 Apr-04 Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11
Apr-01 Oct-01 Apr-02 Oct-02 Apr-03

May-11

Despite weakening PMI data, Chinese fixed asset investment and industrial production growth kept surprising on the upside over past three months

30%
25%

20%
15%

Following a surge in excavator deliveries over the past three years, weaker data are emerging (-12% yoy in May)

10% 2003 2004 2005 2006 2007 2008 2009 2010 Q1 11

Source: National Bureau of Statistics

Source: CCMA

Chinese construction equipment market ($bn)


70
60

Chinese CE market shares


The Chinese construction equipment market has grown by 25% p.a. on average and has reached $60bn according to CCMA.
Caterpillar 9% Volvo 7%

50
40 30

Others 9% Other Chinese 18%


XGMA 3%

Komatsu 5% Hitachi 4%

Kobelco 1% Zoomlion 11% Hunan Liugong Sunward 1% 5%


Sany Heavy 11%

20
10

Lonking 4%

0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

XCMG Shantui 8% 4%

The Chinese construction equipment market is dominated by domestic players and their control of the market has tended to increase.

Source: CCMA

Source: SG Cross Asset Research

Exposure to China (2010 revenues)


16% 14%
12%

China - Contribution to groups growth 04-10


ABB, SKF, Schneider and Atlas Copco derive more than 10% of their revenues from China
60%
50% 40% 30%

10%
8% 6%

20%
10%
Assa Abloy

4%
2%
Assa Abloy

China has been a key driver of organic sales growth for European capgoods companies.
Schneider Volvo CE
SKF

Schneider

SKF

Sandvik

Alstom

Siemens

Legrand

Sandvik

0%

0%

Volvo

Source: SG Cross Asset Research, Company Data

Source: SG Cross Asset Research, Company Data

Siemens

Philips

Atlas

Atlas

ABB

ABB

23 June 2011

Capital Goods

Investment summary
Despite tightening measures, weakening PMI and much weaker construction equipment data over the past couple of months, growth in industrial production and fixed asset investment in China remained very healthy in May. In this unclear environment, we revisit the debate on the outlook for the Chinese construction industry in this report and assess the likely consequences that the bursting of a Chinese construction bubble would have on the European capital goods industry.

Chinese construction is ahead of its development curve


Various data, such as cement consumption and the number of sqm built within a year, indicate that China is running ahead of its development curve.

In 2010, Chinas cement consumption exceeded 1,800mt, representing around 55% of

global consumption and about 25x more than US consumption. With average consumption of 1,400kg per head, China stands well above the world average ex-China of 300kg. History shows that such high consumption is hard to sustain for a number of years and ultimately leads to a construction crisis sooner or later. With around 1.8bn square metres of new residential floor space completed in 2010, China has built the equivalent of Spains housing floor space stock. This construction has already

provided accommodation for 60 million people while the urban population has only increased by c. 20 million. If China were to keep its current construction rate over the next five years, the 9bn sqm new housing area built would provide accommodation for 300 million more people by 2015. China would thus have the available floor space stock to accommodate an urbanisation rate of 65-70%...IMFs forecast for 2030!

Early signs of weakness in China


According to the China Construction Machinery Association, the excavator sales volume of China's main construction machinery companies in May 2011 stood at about 14,000 sets, down by c. 65% from March 2011. The sales volume of loaders and bulldozers also saw sharp drops in May, with that of loaders plunging 45% from March, the largest drop since 2001. On a 12-month rolling forward basis, the situation is not yet alarming but our analysis indicates that we are likely to see a plateau at best and a sharp correction in a worst case scenario.

But no immediate trigger for a downturn


In our view, Chinese construction needs to slow down to avoid a large construction bubble. However, as we have seen with the 12th five-year plan (planned building of 36 million units of affordable housing between 2011 and 2015), the central government is unlikely to promote such a policy as construction remains the easiest way to achieve its internal GDP growth targets and reduce the risk of political unrest among its population. We therefore face difficulties in determining the external trigger point that will lead to a slowdown or correction in Chinese construction activity.

Chinese construction machinery companies looking overseas


In this report, we also analyse the Chinese construction equipment market and the emergence of large domestic players which will increasingly be competing with the likes of Caterpillar, Komatsu or Volvo within the next few years. Chinese companies are looking overseas to offset a potential slowdown in their domestic market and the likely resulting overcapacity is creating
4 23 June 2011

Capital Goods

heightened competition in the global markets, particularly in other emerging markets. We expect the largest Chinese manufacturers to become much more aggressive internationally over the next few years, especially in emerging markets like India or Brazil. For instance, Sany Heavy is planning to raise $3bn to finance its international expansion through an IPO on the Hong Kong stock exchange. XCMG is following the same path by planning to raise $1.5-2bn fresh equity. Fortunately, most of the capital goods companies we cover do not operate in the construction equipment business (loaders, excavators, bulldozers, etc) where the competitive risks look highest. But other industries are also likely to see intensifying Chinese competition in the international markets if Chinas economy slows down.

What are the implications for the European capital goods companies?
The companies in our coverage universe generally have a limited direct exposure to Chinas construction market, the most exposed being Assa Abloy (9% of group sales), Volvo (8%), Schneider (4%), Atlas Copco (3%) and Legrand (3%). We find that Japanese construction equipment manufacturers, Hitachi and Komatsu, together with Kone, have more than 10% exposure.

In our view, the biggest risk for engineering companies relates to their exposure to the mining

industry. A fall in Chinese construction activity would have a severe impact on global cement,

iron ore, coal and copper consumption which would likely lead to sharp reductions in global mining capex programmes. Within our coverage, Sandvik and Atlas Copco both have a sizeable exposure to the mining sector, deriving respectively 36% and 26% of their revenues from this industry.

A fall in commodity prices would also have knock-on effects on the GDP outlook for countries

that derive a sizeable portion of their wealth from natural resources like in South America and

the Middle East/Africa.

A slowdown in the Chinese economy and capex-related industries is likely to create

overcapacity in the domestic market, prompting Chinese players to accelerate their expansion in the overseas markets. The construction equipment industry is likely to be the hardest hit. Other

industries that are strategic and have a concentrated customer base should also see increased competition. In the following table, we rank each company in our universe, based on their exposure to the areas most at risk in the event of a bursting of a Chinese construction bubble, including: 1) the Chinese construction market itself, 2) the mining industry, and 3) emerging countries in general. We also look at their resilience characteristics, including: 1) their cost structure (variable vs fixed), 2) their aftermarket/service exposure, and 3) their backlog. Overall, we estimate that companies such as Volvo and Sandvik would offer the highest risk profile in a China construction collapse scenario and could be expected to trade at a discount if uncertainties remain. On the other hand, companies such Legrand, Siemens and Smiths show the highest resilience scores.

23 June 2011

Capital Goods

SG Capital Goods universe


Risk areas Chinese construction Mining industry Emerging markets Cost structure Resilience characteristics Aftermarket/ service Backlog/ visibility Ranking

Volvo Sandvik Atlas Vallourec MAN Scania Philips SKF ABB Nexans Schneider Assa Abloy GKN Alstom Invensys Legrand Siemens Smiths

--------

--------+++ ++

--------------+ + + ++ ++ +++ + --

-----

----

--

----

+ + +

+ +++ + +

++ + ++

+ + + ++ ++

Source: SG Cross Asset Research

Key recommendations
Atlas Copco (HOLD from BUY, TP cut to SEK150) - Although Atlas has limited direct exposure

to the Chinese construction industry, its indirect exposure through the mining industry is sizeable. Raising uncertainty around the Chinese construction activity led us to revise our former optimistic scenario on mining capex and forecast a plateau in 2012 and a slight decline in 2013. We have cut our forecasts and reduced our target price to SEK150 from SEK200. Ongoing uncertainty around Chinese growth and weaker newsflow on mining capex are likely to prevent the shares from expanding their premium any further as we had previously hoped. We thus lower our rating to Hold.
Sandvik (SELL from HOLD, TP cut to SEK90) Sandvik has only marginal exposure to the

Chinese construction market albeit the stock has by far the largest exposure to the mining industry. As such any negative newsflow from China and on mining capex outlook is likely to weigh on future price performance. In addition, we do not expect new management to radically change Sandvik and its vertically integrated business profile. Sandvik remains overly leveraged to volume outlook and therefore, in times of uncertainty, we believe the risk/reward ratio is skewed to the downside. We have cut our forecasts to reflect more cautious assumptions for the mining capex cycle and we reduced our target price to SEK90 from SEK115.
Schneider (BUY, TP of 140) - Schneider derives around 12% of sales from China, of which

around 35% comes from the construction markets. Schneiders presence in China is broadbased, including product development, local production and commercial activity, with a vast and diffuse distribution network. The group offers a complete range of low and medium voltage products, secure power and industrial automation products in the country. While the bursting of a construction bubble in China would directly affect around 4% of group sales, we believe that Schneiders exposure to the energy efficiency, industrial productivity and smart grid themes should allow it a structural growth premium versus the sector average.

23 June 2011

Capital Goods

Volvo (HOLD, TP cut to SEK110) - Volvos direct exposure to the Chinese construction theme

mainly stems from its Construction Equipment (CE) division (21% of group revenues in 2010). We estimate that, through its Volvo and Lingong brands, the groups construction equipment sales in China will reach 8% of revenues this year. Reflecting our forecast downgrade, we have reduced our target price to SEK110 from SEK125. We maintain our Hold recommendation on valuation grounds although we believe weakening sentiment on the Chinese construction equipment industry is likely to keep weighing down the shares.
Legrand (BUY, TP of 35) - Legrand derives just 3% of sales from China. The low voltage

industry is characterised by a local market structure, a recurring and diffuse flow of activity and the need to establish privileged relationships with numerous distributors and specifiers. In such an environment, Legrands capacity for continuous innovation gives it solid pricing power (+3% expected in 2011e). In 2010, Legrand also launched new ranges in wiring devices (K5 and Meidian) and in audio & video door entry systems in China, which should help the group gain market share in a more difficult environment. Moreover, a weakness in China should be more than offset by a potential recovery in mature countries, where building market volumes remain 23% below the pre-crisis level. Another accelerated book building from KKR and Wendel (combined stake of 21.3%) would likely trigger a re-rating in our view, as the perception of overhang would vanish and the free float be further enlarged.
Assa Abloy (HOLD, TP SEK170) Following the acquisition of Panpan, Assa Abloy derives c.

9% of its revenues from the Chinese construction industry. The stock harbours the highest direct exposure to the Chinese construction market within our coverage universe. Against this, Assa Abloy still offers some leverage on the long awaited rebound in the US and European construction markets, which should keep driving the shares going forward. In addition, Assa Abloy offers a defensive business model investors are likely to appreciate in the event of a bursting of a Chinese construction bubble. We therefore maintain our Hold rating on the stock and our SEK170 target price remains unchanged.

23 June 2011

Capital Goods

Construction in China is running ahead of its development curve


The outlook for the Chinese construction industry is dominating the current debates among investors. Is the Chinese construction boom sustainable or could it burst? We believe that the exuberance of the Chinese construction market is obvious. Various data, such as cement consumption and the number of sqm built within a year, indicate that China is running ahead of its development curve. Thus, Chinese construction needs to slow down to avoid a larger construction bubble with many underperforming projects. However, as we have seen with the 12th five-year plan, the central government is unlikely to promote such a policy as construction remains the easiest way to achieve its internal GDP growth targets and to reduce the risk of political unrest among the population. We thus face difficulties in determining the external trigger point that will lead to a slowdown or correction in Chinese construction activity. Tighter monetary policy could be a trigger although so far it has had little effect on prices or construction volumes.

China - A construction-led economy


China is undoubtedly a capex-led economy. Investments represented 46% of the countrys GDP in 2009 while private consumption was only 36% of GDP. In comparison, in the US, investments were 16% of GDP in 2009 and private consumption 71%. A developing country like India has ratios of 58% consumption / 31% investment. Such reliance on investment is unprecedented among larger nations and all countries that have experienced a significant investment boom since WW2 have all gone through a recession sooner or later. While we understand that this high share of investment is allowing China to catch up with other developed countries, the length and magnitude of Chinas boom gives cause for concern. The key issue with such an enormous investment boom is the diminishing efficiency of investments.
Breakdown of GDP by country: investment vs private consumption
Gross fixed
100 90 80 70 60

Share of investment in GDP since 1953: China vs Spain, South Korea and Japan
50 45 40

Household consumption

China

Korea

Spain

Japan

35 30
25 20 15 10 5
1953 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009
Source: IMF

50
40 30 20 10 0

China

India

Korea

Russia

Japan

Euro Area

Brazil

United States

Source: IMF

23 June 2011

Capital Goods

Construction A key component of Chinese GDP growth


In 2010, we estimate China spent more than $1,000bn on construction (including residential /non residential real estate and infrastructure), representing around 20% of its nominal GDP, or almost twice the world average as the left-hand chart shows. Construction spending in China grew at an outstanding rate of 17% per annum over the last 20 years, rising from $50bn in 1990 to around $1,100bn. The scale of the Chinese construction market outpaced that of the US last year and became the largest construction market worldwide with around 15% share.
Construction as % of GDP China stands well ahead
21% 19% 1200 17% 15% 13% 11% 9% 7% 1000

China vs US construction spending (US$bn)


1400

China

US

800
600 400 200

Spain

Italy

France

World

China

India

Japan

Germany

US

UK

5%

0
1990 1992 1994 1996 1997 1998 1999 2001 2003 2005 2006 2007 2008 2009 2010
1991 1993 1995 2000 2002 2004

Source: SG Cross Asset Research, IMF, Global Insight

A major driving force behind the surge in construction spending in China was the sharp increase in the countrys urbanisation rate over the past two decades. Between 1990 and 2010, the urban population more than doubled and the urbanisation rate reached 47.5% in 2010 according to the latest data from the Chinese National Bureau of Statistics. Within the 12th five-year plan (2011-2015), the target is to increase this rate to 51.5% by moving c. 80 million people from rural areas to the cities.
Urbanisation - A major driving force behind high construction spending
800 700 600 500 40% Urban population Urbanization rate 55% 50% 45%

400 35%
300 200 100 0

30%
25% 20%

1990

1992

1994

1996

1998

2000

2002

2005

2007

2009

1991

1993

1995

1997

1999

2001

2003

2004

2006

2008

2010

Source: SG Cross Asset Research, Global Insight, National Bureau of Statistics

2015 target

23 June 2011

Capital Goods

The new five-year plan should not break the trend but growth may slow
Contrary to initial expectations, the 12th five-year plan released in March did not signal any major changes for the Chinese construction sector. The concept of the new plan has initially been to move China away from an export and infrastructure-driven economy to a balanced consumer demand-driven economy. In the guidance documents released in October 2010 there was a request for a dramatic social welfare reform to create a security network for the people, increase consumer spending and balance exports with a local consumer-led economy. The reality of the plan, released in March, does not deviate too much from previous plans with lots of focus on infrastructure projects, a higher urbanisation rate and housing building. However, it appears that targets under the new plan, if achieved, should mean lower growth rates for fixed asset investment and construction. Growth in fixed asset investment is expected to slow down from 24.7% p.a., between 2005 and 2010, to 16.2% p.a. between 2011 and 2015. However, it is worth noting that this forecast is based on a targeted GDP growth rate of just 7% over the same period. A growth rate of c. 20% in fixed asset investment would therefore be likely if GDP growth were to be above the targeted figure as in the 11th plan.

Chinese construction bubble Myth or reality?


Within this section we set the scene by examining the opposing bear and bull arguments on the Chinese construction bubble; myth or reality?

The Bears Prices too high and oversupply


Price gains, rapid credit growth, oversupply and multiple property ownership are all cited as evidence of a housing bubble by the bears. We detail the key arguments below:
Price overheating The average apartment price to household income stands at 8x at a national level. A usual level in developed economies is at 3-5x; prior to the financial crisis the

US and Spain were both at 6x. The bears thus believe migrants could no longer afford to live in cities, urbanisation would stall, prices could fall and as a result real estate construction spending is likely to shrink. However it is worth noting that this Chinese data is distorted by large disparity between tier 1, 2 or 3 cities. For instance, Tier 1 cities like Shanghai or Beijing have ratios of 17x and 22x respectively, while in several tier 3 cities the ratio stands below 3x.

Oversupply, available floor space, ghost cities It is common to hear stories about ghost

cities in China. Built for 1 million people and currently inhabited by just a few thousand, the new city of Ordos has been the flagship of the bears. Other examples like the worlds largest retail mall at the Pearl River Delta with 99% of shops unleased are often cited as evidence of the over-exuberance of the Chinese construction industry.

Reliability or lack of data called into questions Bears often stress the low reliability or even

the lack of data supplied by the Chinese government bodies to fully assess the housing situation in China. For instance, there is no housing vacancy statistics, which leads bears to say that housing inventory might be too huge to be held publicly.

The bulls Geographical disparity and low level of mortgage debt


The bulls often state that housing prices are unlikely to collapse, that central government has still plenty of construction projects in the pipeline and finally that China is unique and making a comparison with other nations history is therefore pointless:

10

23 June 2011

Capital Goods

Housing prices are unlikely to collapse - The bulls believe that housing prices are unlikely to

collapse and as such China should not experience the same situation as the US or Japan. The dynamics displayed by lenders, borrowers and homeowners in China over the past two years are very different to those observed in the US and Japan. A crucial starting point is the recognition that China does not have a homogenous property market. Of the 7.3bn square metres of floor space completed in China in the past five years, 45% was in commodity building and 55% was non-commodity building. The importance of this fact is that it is only the commodity building stock that is tradable and therefore price variable. The remaining 55% is non-tradable being either state-owned, non-transferrable or simply having no marketable price. Also, one of the most crucial dynamics in understanding the outlook for Chinese housing prices is the very low level of mortgage debt held. Despite the dramatic pick-up in housing market leverage over the past two quarters, the average level of mortgage debt held at a national level is about 30%. The following table lists the main differences between the housing situation in China vs the US or Japan pre-housing collapse.
Is Chinas housing market as susceptible to correction as in the US or Japan?
China USA Japan

Pockets of excessive valuations in residential property in certain cities. Underinvestment in affordable economic housing.

Bubble largely concentrated in housing.

Bubble concentrated in both housing and commercial real estate.

Housing investment emerges as the most profitable The belief in ever-increasing prices drove lending. and least volatile asset class. The use of banks as fiscal agents saw an explosion Explosion of low-documentation lending and of bank lending in China. greater penetration of the markets by non-bank lenders. Borrowers must have a 30% down-payment for a No checks on borrowers within the originate to first home (40% for a second home) and mortgage distribute model. Securitisation was seen as repayments cannot be greater than 50% of income. shifting risk. No teaser rates. Teaser rates for first two years created a time bomb. Monetary policy was held too low for too long after the Tech-Wreck recession. Long bond yields fell below fair value given high foreign participation in UST market.

A belief in ever increasing land prices.

Greater competition in the loans market saw smallto medium-sized banks move into traditional mortgage lending. No check on borrowers because of secure collateral.

Step interest rate loan put in place to ease income constraint. The Plaza Accord of 1985 saw the BoJ cut the discount rate five times from 5.0% to 2.5% to help exporters hit by the stronger yen. Financial excess was created, which flowed into asset markets.

China used its banks as fiscal agents to implement policy stimulus. Actual liquidity flows have been highly variable. The equity market has fallen over the course of the lending spree whilst house prices deviated to the upside from existing strong trend long-run growth.
Source: SG Cross Asset Research

China is unique, comparison with developed countries is pointless Bulls also highlight that

China is unique and could not be compared to other developed nations and their history. The size of its population, the disparity between regions and the centralised nature of the government makes China unique.

Central government has large infrastructure projects in the pipeline Bulls often stress that

central government will support the construction industry. The affordable housing programme or the large infrastructure projects already engaged should provide a sufficient floor to prevent a potential collapse in the construction activity. Within the 12th five year plan, the Chinese government plans to build 36 million units of affordable housing between 2011 and 2015. The governments affordable housing programme envisages 7 million units built per year on average (ow 10 million in 2011 and 2012). However, the IMF forecasts there will be 380 million more inhabitants in urban areas by 2030 (70% urbanisation rate). Assuming an average of 3-4 persons per new home, a new urban population of 380 million means 95-125 million new homes to be built over the next 21 years. This means that China needs to build around 5

23 June 2011

11

Capital Goods

million (or 500m sqm per year) new homes every year to digest its rising urbanisation rate, i.e. less than the 10 million affordable housing units targeted by the central government in 2011 and 2012. China also has a lot of infrastructure projects already under way. If China were to sharply curtail lending growth, half-finished projects would turn into non-performing loans souring the banking system. If central government were to continue with a generous liquidity policy, lending would be towards increasingly marginal investment and infrastructure projects or trophy projects for which the economic returns would be dubious.
China still has a lot of infrastructure to complete
Fixed Asset Investment, RMB 9.0 tn 8.0 7.0 6.0 0.15 5.0 4.0 0.1 3.0 2.0 1.0 0.0 2008 2009 2010 2011 2012 2013 2014 2015 0 0.05 Probability density 0.25

65% occurs after 2011 81% occurs after 2010


0.2

Source: SG Cross Asset Research/Economics

With the vast expansion of Chinas rail network already completed, our economists believe the low hanging fruit in terms of fiscally sound projects has already been picked. Still, as the chart above shows, the skew of projects approved and for which funding has already commenced is dramatically weighted towards future years. Approximately 65% of the total fixed asset investment envelope that was approved by China occurs either during or after 2011, not before.

Real estate Long-term demand is there but how to sustain current development rates?
Soaring house prices in Chinese cities have driven widespread concerns over the emergence of a large property bubble that could burst any time. The pace of Chinese real estate construction is unprecedented, raising questions about the balance between supply and demand for housing. Real estate investment growth averaged 25% over the past eight years and growth even increased to 34% in Q1 2011.
Chinese real estate investment yoy growth
40%

35%

30%

25%

20%

15%

10% 2003 2004 2005 2006 2007 2008 2009 2010 Q1 11


Source: National Bureau of Statistics

12

23 June 2011

Capital Goods

Rome was not built in a day but in China it takes less than two weeks!
Recently, the Economist released a report on Chinas housing and came to the conclusion that although there could be a short-term mild correction, strong underlying demand for housing means that any correction will be short-lived. Higher urbanisation and steady growth in incomes mean that demand for housing will remain strong for a long time. However, this report also brings to the fore some alarming data in our view. The following chart shows that China has built the entire European housing floor space stock (limited to Czech Republic, Sweden, Portugal, Greece, Poland, Netherlands, Spain, UK, Italy, France and Germany) in less than 10 years. Within 10 years, China has built slightly more than 16 billion sqm of completed residential floor space, enough to provide accommodation for 600 million people assuming 30 sqm per capita. Over the same period, the urban population increased by just 185 million. With around 1.8 billion square metres of new residential floor completed in 2010, China has built the equivalent of Spains housing floor space stock. This construction has already provided accommodation for 60 million people while the urban population only increased by c. 20 million. If China were to keep its current construction rate within the next five years, the 9 billion sqm of new housing built would provide accommodation for 300 million more people. China would thus have the available floor space stock to accommodate an urbanisation rate of 65-70%... the IMFs forecast for 2030!
Cumulative new residential floor space in China vs floor space stock in Europe (in m sqm)
20,000 18,000 16,000

14,000
12,000 10,000 8,000 6,000 4,000 2,000 -

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010 EU f loor space stock

Source: SG Cross Asset Research, The Economists

Another key data point of this study highlights that with 31 sqm per capita and an average personal disposal income of less than $2,000 China is more than 50% overhoused compared to the world average. Several studies have analysed the existing strong correlation between floor space and income. This would mean that the last 10 years of new residential construction building were unnecessary, once compared to Chinese peoples purchasing power. The report gives several explanations to justify such a high ratio, including the shrinking size of a Chinese household due to the one-child policy and lower building quality. Although we understand the need for more housing construction as the rural population gradually moves to the cities, we are concerned by its development pace. At the current growth rate and assuming that the average number of people per household remains flat, the residential floor space per head would reach 40 sqm by 2015, above that of the UK or

23 June 2011

13

Capital Goods

Germany while its urbanisation rate and living standards stand well below those of these countries. This will make China even more disconnected from the trend line.
Household indicators (2010) China in 2010 and 2015 vs. other countries
India UK Japan US China 2010 China 2015

Urban population (%) Households (,000) Average no. of people per household Residential floor space per head (sqm) Personal disposal income per head (US$)
Source: SG Cross Asset Research, Economist Intelligence Unit

30% 223,340 5.3 10.5 1,110

90% 26,140 2.4 35.5 23,970

67% 50,200 2.5 33.3 26,080

82% 115,990 2.7 64.6 35,970

48% 396,000 3.3 31 1,870

52% 410,055 3.3 40 3,012

Elevators & skyscrapers Examples of real estate exuberance


To further highlight the exuberance of the Chinese real estate market, we looked at the elevator industry. Sixty percent of the worlds new elevators go to China. The number of units delivered reached more than 300,000 in 2010 against around 10,000 in 1990, a compound growth rate of nearly 20%. The most surprising data is that, with an installed base of around 1.6 million units, the current delivery rate represents around a 20% increase in the installed base per year. Such an increase in the installed base looks unsustainable in the mid-term.
Elevators Unit delivery per year
400,000 350,000 300,000 250,000 200,000 150,000 100,000 50,000 -

Source: Kone

Real estate analysts often assess the pace of real estate construction by looking at the number of skyscrapers built around the world. Today China can boast nearly half of all skyscrapers due for completion worldwide in the next six years. Currently China has more than 200 skyscrapers (defined as a building over 150 metres tall) under construction, which is equivalent to the total number of skyscrapers in the US. In five years time, China is expected to have 800 skyscrapers. Skyscrapers are often seen as a trophy building yielding low returns and thus can be viewed as evidence of construction exuberance.

Infrastructure Is there anything left to be built?


Following a review of the Chinese real estate market we now turn our focus to data on the development of infrastructure in China. We conclude that a lot remains to be donebut also that a lot has already been achieved and, as with real estate, China seems to be running ahead of its development curve. The pace of infrastructure building in China has been unprecedented and looks unsustainable in our view.
14 23 June 2011

Capital Goods

Roads A lot has already been achieved


We first looked at the development of roads in China. We found that there are less than three metres of road per inhabitant while the worldwide average stands at 14-15 metres per inhabitant or 14 metres in the US. This data would suggest that there is still plenty of room for further investment. However, when compared to the car fleet, China stands well ahead of developed countries. Indeed, we find that China has almost 60 metres of paved roads per car while a similar ratio for developed countries stands between 15m and 35m. Obviously, the number of cars in China is expected to increase over-proportionally within the next few years, albeit it is likely to be insufficient to bring China back to international standards.
Paved roads per capita (metres)
50 45 40 35 30 25 20 15 10 5 0
Russia

Paved roads per car (metres)


70 60 50 40 30 20 10

China

France

Germany

Australia

India

Turkey

Brazil

Italy

Japan

US

Canada

Poland

Spain

Sweden

China Spain France US Germany Italy

Source: SG Cross Asset Research, CIA Factbook

The development of Chinas highways is even more impressive. The network has been built from scratch at the end of the 1980s to reach nearly 74,000km in 2010. The Chinese highway network is almost on a par with that of the US despite having four times less cars. Under the 12th five year plan the network is expected to expand by a further 34,000km, which is more or less in line with the 33,000km of roads added under the 11th plan.
Development of Chinese highways since 1990
80,000 70,000 60,000 7,000 50,000 40,000 6,000 5,000 4,000 3,000 20,000 2,000 10,000 1,000 Total network (km) - LHS New build (km) - RHS 10,000 9,000 8,000

30,000

1992

1993

1994

1998

1999

2000

2003

2004

2005

2009

Source: National Bureau of Statistics

2010

1990

1991

1995

1996

1997

2001

2002

2006

2007

2008

23 June 2011

15

Capital Goods

Railways Investments seem to have peaked in 2010


The Ministry of Railways (MOR) announced that high-speed trains should connect all Chinese provinces capitals and cities with more than 500,000 habitants by 2020, which represents about 18,000km of high speed rail lines, compared with only 1,200km in 2008. By 2020, Chinas infrastructure should account for almost 50% of the worlds total high-speed rail lines. Under the Chinese Mid- and Long-Term Railway Network Plan, investments in railway infrastructure has grown rapidly, with an average annual investment seen at around RMB600bn over 2009-2012e on average, up from RMB337bn in 2008 and RMB179bn in 2007. However, 2011 is seen as a turning point for spending on infrastructure. Facing financing constraints and increased losses, MOR has decided to cut spending on infrastructure from the planned RMB700bn to RMB600bn. It is clear that MOR has to face a declining rate of return on new projects and many new lines appear to be under-utilised. We would not be surprised to see further spending cuts. A recent New York Times article reported that MOR has reduced the average operating speed on the new high speed line between Beijing to Shanghai and on other lines as well. This action is aimed at cutting maintenance and operating costs and improving safety. In addition the article reveals that the average ticket cost for the Shanghai-Beijing line was around $60, a months salary in the rural areas.
High-speed rail (km)
12,000

Chinese railway infrastructure spending (RMBbn)


In operation In construction
800 700 600 623 736 600 600

10,000

8,000

500 400 337

6,000 300 4,000 200 89 100 2,000 0 155 179

2005

2006

2007

2008

2009

2010

2011e

China Spain Japan France Others Germany Italy Belgium


Source: International Union of Railways

Source: MOR

Cement consumption highlights significant over construction


A final example of an over-exuberant Chinese construction market can be found in the countrys cement consumption. In 2010, Chinese cement consumption exceeded 1,800 million tonnes, representing around 55% of worldwide consumption and about 25x the US level of consumption. Per capita, the picture looks even more worrying. Indeed with average consumption of 1,400kg per head, China stands well above the world average ex-China of 300kg and the US consumption of 225kg per capita. The following chart on the right-hand side highlights the strong correlation between GDP and cement consumption per capita based on US and French historical data. It reveals that a countrys consumption per capita keeps on increasing until it reaches $5,000 per capita. Comparing Chinese cement consumption with that of the US is somewhat misleading since cement consumption in the US is mostly used for infrastructure and little for residential building. We believe Spain or France would provide more relevant comparables. French
16 23 June 2011

2012e

Capital Goods

cement consumption has a similar pattern than that of the US although it used more cement per capita in the early stage of its development. Spain represents an interesting example for assessing the outlook for Chinese cement consumption. Indeed, Spain had an over-proportional consumption per capita for years before it crashed with the financial crisis and the bursting of its construction bubble. Spanish annual cement consumption peaked at nearly 1,300kg per capita in 2007, ahead of the financial crisis. Four years later, Spanish consumption stands barely at around 500kg per capita, a 60% fall from its peak. Could China follow a similar pattern? Our analysis indicates that such high cement consumption is unsustainable and all countries where cement consumption has exceeded 1,000kg per capita for a number of years have gone through a construction crisis sooner or later.
Cement consumption per capita (kg)
1,600 1,400 1,200 1,000 800 600 400 200

Cement consumption per capita (kg) vs GDP per capita


Spain France
1,600 1,400 1,200 1,000 Spanish construction bubble

US

China

US

China

France

Spain

Cement consumption (kg per capita)

800
600 400 200

Maturity phase
5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 50,000

1900 1904 1908 1912 1916 1920 1924 1928 1932 1936 1940 1944 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008

GDP per capita (PPP, current $)


Source: SG Cross Asset Research, OECD, Cembureau

Source: SG Cross Asset Research, US Geological Survey, Italcementi

23 June 2011

17

Capital Goods

Early signs of weakness in China


Some weakness has emerged in construction equipment data
We have seen some weakness recently coming from China for construction equipment. According to the China Construction Machinery Association (CCMA), the excavator sales volume of China's main construction machinery companies in May 2011 stood at about 14,000 sets, down by c. 65% from March 2011. In addition, the sales volume of loaders and bulldozers also saw sharp drops May, with that of loaders falling 45% from March, the largest drop since 2001. Although the usual seasonal pattern may explain some of this weakness, it is worth noting that we have seen a sharp slowdown in the yoy growth rates in April and May, highlighting a worrying downward trend.
Monthly data of deliveries of excavators, loaders and bulldozers in China (units)
May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11

Excavator Yoy chge Loader Yoy chge Bulldozer Yoy chge


Source: CCMA

16,264 128% 22,389 80% 1,815 147%

11,734 83% 17,510 35% 1,426 107%

8,939 55% 15,823 50% 961 55%

8,756 41% 15,461 40% 946 49%

11,528 48% 17,685 47% 980 21%

12,350 42% 15,283 37% 1,240 65%

14,323 65% 15,535 32% 923 22%

13,427 55% 18,463 21% 1,023 29%

10,922 36% 14,128 27% 1,379 78%

20,279 136% 16,304 87% 1,197 53%

43,063 43% 39,988 37% 2,407 71%

27,334 25% 28,692 -3% 1,653 1%

14,288 -12% 22,805 2% 1,194 -34%

A primary reason for the slide stems from financing constraints in civil engineering. Another possible reason comes from the irrationality of the Chinese construction equipment industry as some local players used aggressive selling techniques (like zero down-payment mortgages) to boost their market share. This type of behaviour seems to be increasing. At a recent meeting in June, the head of CCMA expressed concern over aggressive sales techniques which could lead to a price war in the entire industry. On a 12-month rolling forward basis the situation is far from alarming, as shown by the following charts. However, based on our analysis, we are likely to see a plateau at best and a sharp correction in a worst case scenario.
Excavator deliveries 12M average
18,000
16,000 14,000
20,000 15,000

Loader deliveries 12M average


25,000

Bulldozer deliveries 12M average


1,400 1,200
1,000

12,000 10,000
8,000 6,000

800
600 400

10,000
5,000

4,000 2,000
Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11

200
-

Source: SG Cross Asset Research, CCMA

18

23 June 2011

Feb-07 May-07 Aug-07 Nov-07 Feb-08 May-08 Aug-08 Nov-08 Feb-09 May-09 Aug-09 Nov-09 Feb-10 May-10 Aug-10 Nov-10 Feb-11

Capital Goods

Share price performance reflects growing concerns


Following a massive outperformance of Chinese construction machinery stocks from 2005 (+690% over the past six years), we have seen a much weaker price performance since early April. Driven by weaker construction equipment data and a weakening PMI as tightening starts to produce some effects, Chinese construction machinery stocks have underperformed the broader Chinese market by 6-7% since the end of March.
Absolute performance - Chinese construction machinery Relative performance - Chinese construction machinery stocks stocks index index vs Shanghai composite index
2500 9 8 2000 7 6 1500 5 4

1000

3
500 2 1 0
09/06/06

09/06/08

09/12/08

09/06/09

09/12/09

09/06/10

09/12/10

09/06/11

09/06/05

09/12/05

09/12/06

09/06/07

09/12/07

Mar-06

Mar-07

Mar-08

Mar-09

Dec-05

Dec-07

Dec-08

Dec-09

Dec-10

Dec-06

Mar-11

Mar-10

Jun-05

Jun-06

Jun-07

Jun-08

Jun-10

Sep-05

Sep-06

Sep-09

Source: SG Cross Asset Research, Datastream

We have also seen a sharp contraction in P/Es of Chinese construction machinery stocks since the start of the year. On average they now trade on 11x 12-months forward P/E compared to 16x two months ago and an historical average of 17x. The stocks now trade at a 10-15% discount to their Western peers while they used to trade at a 10-20% premium historically.
Chinese construction machinery (*) - 12M forward PE
40 35 30

25 20
15 10 5 0

Sep-06

Sep-07

Sep-08

Sep-09

Dec-08

Dec-09

Sep-10

Dec-10

Dec-05

Dec-06

Dec-07

Jun-06

Jun-07

Jun-08

Jun-09

Mar-08

Mar-09

Mar-10

Jun-10

Sep-10

Sep-07

Sep-08

Source: SG Cross Asset Research, Datastream, * Includes Sany Heavy Industry, IMM, Lonking, Shantui, Liugong; Zoomlion, XGMA

Mar-11

Mar-06

Mar-07

Jun-11

Jun-09

23 June 2011

19

Capital Goods

Sell-off in commodity indices


The increase in Chinas demand for mineral resources associated with its urbanisation and industrialisation, combined with the size of its population, has meant that China has been the dominant contributor to growth in mineral resource demand over the past decade. China represents more than half of global demand for metallurgical coal and iron ore as the following left-hand side chart highlights. Therefore, China is a key driver of commodity prices and the strength or weakness of the Chinese economy drives most commodity prices. We have witnessed a recent sell-off in commodity prices on the back of negative sentiment around China.
China - A major driver of commodity demand
70% 60% 2002 2009

Base metal index *


2100 1900

1700
50% 40% 30% 20% 10% 0% Met coal Iron ore Thermal coal Aluminium Copper Nickel

1500 1300

1100
900 700

Mar-08

Mar-09

Mar-10

May-08

May-09

May-10

Mar-11

Jul-08

Jul-09

Jan-08

Jan-09

Jan-10

Jul-10

500

Jan-11

Source: BHP Billiton

Source: Datastream * Includes LME Aluminium, Copper, Lead, Nickel and Zinc

A fall in Chinese construction activity would have a severe impact on global cement, iron ore, coal and copper consumption. We now discuss the potential knock-out effect of a fall in Chinese construction activity on these commodities/products:

Cement consumption to be hard hit The impact on cement consumption is straight

forward. A hundred percent of cement consumption is used for construction (30% towards property, 30% towards infrastructure and 40% towards other construction) and China represents 55% of global consumption. The fall in cement consumption is likely to be over proportional to the fall in Chinese construction activity as the more defensive renovation market is usually less cement intensive. A 20% fall in Chinese construction activity could easily lead to a 30%-40% fall in Chinese cement demand and therefore a 15-20% reduction in global cement demand.

A new shock for steel and iron ore demand - We estimate the construction sector accounts for

up to 50-60% of the total steel consumption in China (around 600 million tons in total, 45% of global steel consumption). Now, steelmakers use 1.6 tons of iron ore and 0.5 tons of coking coal to make 1 ton of steel. Therefore, a 20% fall in Chinese construction activity would reduce global steel demand by at least 4% and iron ore demand by at least 6%. In 2009, steel demand fell by 6.5% and on average prices halved between 2008 and 2009. Although iron ore consumption did not fall in 2009 thanks apparently to China, average prices fell by 15%. In the event of a fall in Chinese construction activity, iron ore prices would be under strong pressure bearing in mind the large increase in production capacity expected to come on stream over the next five years.
Copper demand would be impacted to some extent We estimate that about 30-35% of copper demand is used by the construction industry and China accounts for nearly 40% of

global demand. Therefore, a 20% fall in Chinese construction activity would have at least a 23% negative impact on global copper demand. Back in 2009, a 3% fall in copper demand led to a 25% drop in the copper average price.
20 23 June 2011

May-11

Sep-08

Nov-08

Sep-09

Nov-09

Sep-10

Nov-10

Capital Goods

Monetary tightening and weak PMI data but IP and FAI remain strong
China is trying to engineer a soft landing for an economy that has been flying at hypersonic speed and still has plenty of rocket fuel left in the tanks. As the economy tracks lower, policymakers also have to keep an eye on the corporates, local governments and the asset bubbles that have been created by arguably the greatest quantitative easing experiment ever undertaken. China pumped the equivalent of 50% of GDP into the economy over 2008-2010. To date, monetary policy actions have barely kept up with the additional liquidity being generated by Chinas enormous stock of FX reserves they havent even begun to drain the excess liquidity that was created over the past two years. Hence, it is not surprising that our economists Taylor rule analysis currently finds that China is around 400bp behind the curve. They argue that this is the largest distortion in monetary policy settings since the first part of 2008 when the PBOC was assessed as being nearly 600bp behind the curve. It was the over-tightening through the first part of 2008 (not just interest rates, but reserve requirement ratios and administrative measures that included aggressive credit controls and compulsory treasury purchases for targeted commercial banks) that proved to be a significant contributory factor to the sharp slowdown in the Chinese economy in the fourth quarter of 2008. Tightening measures implemented by the central government have so far proved inefficient. The reserve requirement ratio was hiked by 50bp in June, which takes it to an unprecedented 21.5% for major financial institutions. This is expected to lock up an additional CNY370bn of liquidity. However, to put that into context, Chinas bank lending was CNY680bn in the month of March alone. China has raised the RRR five times so far this year and 11 times since the beginning of this tightening cycle. In addition to greater administrative vigilance over bank lending, particularly to the housing market and local governments, interest rates have risen four times since October.
Chinas version of quantitative easing
45 40 35 30 25
20 15 10 5 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Source: SG Cross Asset Research

Chinas implied Taylor rule gap is extremely wide


20

%
PBoC 1yr lending rate
Taylor rule implied policy rate

Increases in Money Stock as % of GDP

China's "QE"
37

15 10 5

0
-5 -10 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Will China over-tighten policy as growth continues to accelerate in 2011 forcing a much harder than soft landing of the economy in 2012? Our economists now believe that the balance of probabilities has shifted to this conclusion. The economy has already gotten away from the Peoples Bank of China while the Politburo is endorsing a steady as she goes approach to tightening. Ultimately, they believe China will find itself in a process of policy catch-up, likely

23 June 2011

21

Capital Goods

to be triggered as inflation remains high. That policy catch-up, with history as a guide, is likely to be overdone. If that happens, then the Chinese economy will inevitably overcool as a result.

Chinese PMI remains slightly above 50


A slowdown is nonetheless obvious as recent PMI data stresses. Chinese PMI data started falling at the end of last year but remain above 50, the critical point between expansion and correction. However, with further tightening in sight as inflation is still not contained it is possible to see PMI data crossing the 50 mark in H2, weighing on industrial stocks exposed to the Chinese growth story.
Chinese monthly PMI from 2005
60 58 56

54
52 50 48 46 44 42 40

Jul-06

Jul-07

Jul-09

Oct-06

Apr-07

Apr-09

Oct-09

Oct-05

Oct-07

Oct-08

Apr-10

Apr-05

Apr-06

Apr-08

Jul-10

Jul-05

Jul-08

Oct-10

Jan-07

Jan-10

Jan-06

Jan-08

Jan-09

Source: Datastream

while IP and FAI growth remains as strong as ever


Despite monetary tightening and weakening PMI data, Chinese economy is still flourishing. Both growth in industrial production (IP) and Fixed Asset Investment remained very healthy in May. Industrial production growth was better than expected, rising 13.3% yoy. Fixed asset investment grew 25.8% yoy between January and May and 26.7% yoy in May alone. This was the fourth positive surprise in a row from this series. Our economists believe that the inconsistency between the strong investment figure and the soft monetary data reveals that the fast development of the non-banking financial sector is playing a bigger and bigger role in raising capital and funding economic activity.
Chinas Fixed Asset Investment growth (yoy %)
36 34 32 30 28 26 24

Chinas industrial production growth (yoy %)


25 23 21 19

17
15 13

11
9 7
Aug-06 Aug-07 Aug-08
Aug-09

22

May-07

May-08

May-09

May-10

May-06

Aug-10

20

May-11

Feb-09

Feb-10

Nov-06

Nov-07

Nov-09

Nov-10

Nov-08

Feb-11

Feb-07

Feb-08

Aug-06

Aug-07

Aug-08

Aug-09

May-07

May-08

May-09

May-10

May-06

Aug-10

Jan-11
Feb-11

Source: Datastream

Source: Datastream

22

23 June 2011

May-11

Feb-09

Nov-06

Nov-07

Nov-09

Feb-10

Feb-07

Feb-08

Nov-10

Nov-08

Apr-11

Capital Goods

Focus on the Chinese construction equipment industry


Within this section, we describe the construction equipment market in China and its key players. China now stands as the largest and the fastest growing construction equipment market globally. The boom in construction equipment has led to the emergence of large Chinese players which are gradually moving up the value chain and have ambitions to grow internationally. Although they do not represent a short-term threat for the main Western players, competition is only expected to get tougher and tougher in the mid-term. Last year during a presentation, Caterpillar CEO said that the leading player in China will be the global leader in 2020 and we fully agree with this statement. So far, they have enjoyed little success internationally but we think that the strength of their domestic market was a major impediment to this. As we foresee a slowdown in construction equipment growth in China, international expansion would be key for Chinese companies to keep their strong growth trajectory.

The Chinese construction and mining equipment market


According to the China Construction Machinery Association (i.e. CCMA), Chinas construction machinery industry revenue increased from $7bn in 2001 to an estimate of almost $60bn in 2010, which represents annualised growth of 25%, more or less in line with the growth in Chinese fixed asset investment. China is by far the largest market for the construction & mining equipment industry, in terms of volume as well as value.
Chinas construction machinery industry ($bn)
70 60 50 40 30

25% CAGR

20
10 0 2001
Source: CCMA

2002

2003

2004

2005

2006

2007

2008

2009

2010

According to Komatsu data, China represents more than 35% of annual demand for the seven biggest categories of construction equipment in 2011. Its share of the global market has soared from just 10% back in 2005. In some market segments like wheeled loaders, Chinas domination is astonishing. According to Off-Highway Research, 60% of wheeled loaders in 2008 (so pre-crisis) were manufactured and sold by Chinese companies (75% if we include SEM and Lingong which are respectively part of Caterpillar and Volvo).

23 June 2011

23

Capital Goods

Annual demand for 7 major construction equipment categories 2008 global market share of wheeled loaders (units) (units)
Japan
China 400,000

Europe
Others

North America
China share 40%

CNH 2%
Caterpillar 16%

JCB 2%

Kawasaki 2%

Longlong 15%

350,000
300,000 250,000 200,000 150,000 100,000 50,000

35%
30% 25% 20% 15% 10% 5% Changlin 3% Foton 4%
Source: Off-Highway Research

Komatsu 5%

Liugong 14%

Volvo 14%

XEMC 12%

2003
Source: Komatsu

0%
2004 2005 2006 2007 2008 2009 2010 2011e

Chenggong 5%

Xugong 6%

Overview of the main Chinese players


There are approximately 890 machinery manufacturers in China, mainly concentrated in the Hunan, Shandong and Jiangsu provinces. The fragmented nature of the Chinese construction equipment industry is due to the large number of small- and medium-sized enterprises. CCMA promotes the consolidation of Chinese industry under the 12th five year plan.

Western manufacturers still dominate the high end segments


The top five Chinese players account for around one-third of the total market share. Domestic brands are strong in segments with high demand for basic machine types like loaders or forklift trucks. On the other hand, foreign brands usually dominate segments requiring more advanced design and manufacturing techniques, like hydraulic excavators and drilling machines. We estimate foreign brands represent around a third of the market, with Caterpillar (including SEM), Volvo Construction Equipment (including Lingong) and Komatsu standing as the largest foreign players in the Chinese market. They respectively enjoy 9%, 7% and 5% market share as the following chart shows.
Estimated market shares of the Chinese construction & mining equipment industry
Caterpillar 9% Others 9%

Volv o 7%

Komatsu 5% Hitachi 4% Kobelco 1% Hunan Sunward 1%

Other Chinese 18%

XGMA 3%
Zoomlion 11% Sany Heav y 11%

XCMG 8%
Shantui 4%
Source: SG Cross Asset Research, CCMA, Company Data

Luigong 5% Lonking 4%

24

23 June 2011

Capital Goods

The main Chinese construction equipment companies often have a broad product portfolio ranging from loaders to road and concrete machineries. Sany Heavy Industry, Zoomlion and XCMG are almost full liners offering a complete product range for the construction industry.
Main Chinese construction equipment companies and their product portfolio
Loaders Excavators Material Handling Drilling equipments Road machinery Concrete machinery Bulldozers Mining equipment

Sany Heavy Zoomlion XCMG Liugong Shantui Lonking XGMA Hunan Sunward IMM Shaanxi Construction Dingsheng Tiangong Dagang XuanHua Changlin
Source: SG Cross Asset Research, Company Data

X X X X X X X X X X X X X

X X X X X X X

X X X X

X X X X X X X

X X X X X X X X X

X X X X X X

X X X X X X

X X

Despite strong domestic growth Chinese companies are still subscaled


In terms of scale, only seven companies exceed RMB10bn revenues (i.e. $1.5bn) as the following chart highlights. Sany Heavy Industry, Zoomlion and XCMG are the three largest companies with respective revenues of RMB34bn (i.e. $5bn), RMB32bn (i.e. $4.8bn) and RMB25bn (i.e. $3.7bn). Chinese companies are therefore still lagging behind the global players. Only six Chinese companies are within the top 20 and the revenues of the largest Chinese company (i.e. Sany Heavy Industry) are six times lower than Caterpillars, the global leader.
2010 revenues of main Chinese construction & mining 2010 revenues from construction & mining equipment Global equipment companies (RMB m) peer comparison (US$bn)
35,000 30,000 25,000 20,000 15,000 10,000 5,000 15 35 30 25

20

10
5

Zoomlion

Changlin

XCMG

XGMA

IMM

XuanHua

Shaanxi Construction

Dingsheng Tiangong

Sany Heavy

Liugong

Shantui

Hunan Sunward

Lonking

JCB

XCMG

Deere

Zoomlion

Kobelco

Doosan Infracore

Komatsu

Sandvik M&C

Sany Heavy

Atlas M&C

Volvo CE

Hitachi

Terex

Caterpillar

CNH

Joy Global

Liebherr

Liugong

Shantui

Source: SG Cross Asset Research

Lower price and lower quality albeit good profitability


The average profitability of the top 10 Chinese companies is more or less in line with that of the leading players in the developed countries. However, compared to Western manufacturers, Chinese companies did not experience a downturn in 2008-2009 and therefore

Lonking

23 June 2011

25

Capital Goods

their average profitability has kept on expanding in the meantime. With an average EBIT margin of 15% in 2010, the profitability of the Chinese companies is 200-300bp higher than that of the leading players in developed countries. A key competitive advantage of the Chinese companies is obviously their cost base which allows them to sell equipment at large discounts compared to Western manufacturers (from 30% up to 80% on some products). Zoomlions cost base is a fair reflection of the competitive advantage of domestic brands, with production staff costs representing only 3% of its cost of sales. The lower quality of products is also responsible for the price differential albeit as we discuss later Chinese companies are quickly moving up the value chain.
Average EBIT margin China vs developed countries
18.0%
16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% 2005 2006 2007 2008 2009 2010 China Average US, EU & Japan Average

A highly competitive cost base Zoomlions example


R&D 1%

Staff costs 3%

Sales & marketing 8%

SG&A 6%

Others 2%
Depreciation 1%

Raw materials/compo nents 79%

Source: SG Cross Asset Research

Moving up the value chain The excavator example


The Chinese excavator industry is a good example of how fast Chinese companies are moving up the value chain. The hydraulic equipment used in excavators subjects hydraulic fluid to extremely high pressures, which requires strong expertise and precision machinery. Since China is a relative newcomer to this field, foreign companies have historically dominated the Chinese market for excavators. According to CCMA 2010 data, foreign brands had 70% of the Chinese excavator market in terms of volume. However, it is worth noting that this market share has been on a downward trend for the past few years as Chinese companies are successfully moving up the value chain. Their market shares rose from 22% in 2006 to above 30% in 2010 as the chart on the right-hand side shows. Data for the first three months of 2011 show an acceleration of this trend with the share of Chinese manufacturers increasing to more than a third. Chinese companies like Sany have successfully entered the excavator market by 1) entering the small- to medium-size excavator market, and 2) importing hydraulic components from Rexroth (part of Bosch group) or Kawasaki. Sany Heavy has thus seen its market share grow from less than 2% in 2006 to more than 8% in 2010, just behind Kobelco. Similarly, according to a May article in Reuters, XCMG is in talks to buy a 50% stake in two hydraulic parts makers in Germany and Holland. This access to the latest hydraulic technology would certainly boost the companys competiveness and should allow it to gain market share in the excavator market.

26

23 June 2011

Capital Goods

Excavators 2010 market shares (units)


Xiagong Hunan 2% JCM Sunward 2% 3% Futian Lovol 3% Liugong Machinery Yuchai 3% 5%
Volvo 5%

Excavators - Evolution of market shares


Foreign 100% Chinese

Sumitomo Other 2% 3%

Komatsu 14%

90% 80% Doosan 13%

22.6%

21.9%

26.3%

28.2%

30.5%

70%
60%

50% Caterpillar 6%
Kobelco 9% Hitachi 11% Hyundai 11% 40% 30% 20% 10% 0% 2006
Source: CCMA Source: CCMA

77.4%

78.1%

73.7%

71.8%

69.5%

Sany Heavy Industry 9%

2007

2008

2009

2010

Looking abroad for development as volume could stall in China


Fully aware that the sharp volume growth enjoyed over the last few years is unlikely to go on forever, Chinese companies are looking abroad to be able to maintain their strong growth trajectory. In 2010, Chinas exports of construction machinery reached $9.3bn (up 35% from 2009 albeit still 25% down vs 2008), with the majority being components and low to mediumend products. However, a portion of these exports (albeit unquantified) was accounted for by foreign companies which are manufacturing parts or complete equipment in China and then shipping them abroad.
Export of construction & mining equipments ($m) Breakdown of the export of construction & mining equipment by value
Other Excavator 4% 5% Bulldozer 3%

14,000 12,000 10,000


8,000 6,000 4,000 2,000 2001
Source: CCMA

Loader 9%

Component 35%

Crane 11% Fork-lift truck 5% Grader / leveller 3% Earth Lifting / moving / handling grading machine machine 3% 5% Road roller / tamping machine 3%

2002

2003

2004

2005

2006

2007

2008

2009

2010
Source: CCMA

Elevator / Concrete escalator machine 10% 4%

A relative lack of success internationallyso far


The Chinese construction equipment companies are still relatively undeveloped on a global scale. The top three Chinese manufacturers have each reported only between $250-350m revenues outside China as the following table shows. Sany Heavy has been the most successful in increasing its non-domestic revenues from c. $220m to c. $325m between 2009 and 2010. However, it is interesting to note that the non-domestic revenues of these companies are similar to their 2007 level. Clearly the export potential has shrunk during the downturn, although we could have expected Chinese companies to outperform the broader market.

23 June 2011

27

Capital Goods

One of the big issues in our view stems from the focus of Chinese companies over the past few years on the strength of their domestic market. Indeed, their investments have been skewed towards their domestic market to benefit from its exponential growth over the past couple of years.
Non-domestic revenues of the top three Chinese companies ($m)
2000 1800 1600 Zoomlion Sany XCMG

641
1400 1200

1000
577 800 600 400 200 202 458 273 218 239 610 383 2007
Source: Company Data

323

326 272 2010

0
2008 2009

We expect the largest Chinese manufacturers to become much more aggressive internationally over the next few years, especially in emerging markets like India or Brazil. For instance, Sany Heavy is planning to raise $3bn to finance its international expansion through an IPO on the Hong Kong stock exchange. XCMG is following the same path by planning to raise $1.5-2bn new equity. A few days ago, XCMG announced it would invest $200m in Brazil to establish a new plant. Zoomlion also raised equity last year to finance its international expansion. The group (unrealistically?) aims to derive more than 50% of its revenues internationally (vs only 6% in 2010).

28

23 June 2011

Capital Goods

Who is exposed and to what extent?


Mining exposure is the biggest threat
We have tried to assess the exposure of our coverage universe to the Chinese construction market. We have estimated the companies direct exposure to this market as well as their indirect exposure, through their mining equipment activities, since a slump in the Chinese construction market would have a severe impact on commodity demand/prices and therefore on the mining capex industry. Overall, direct exposure to the Chinese construction market is relatively low, with most industrial companies deriving less than 10% of their revenues from this market. We find that only Japanese construction equipment manufacturers, Hitachi and Komatsu, together with Kone, have more than 10% exposure as the following chart highlights. Nonetheless, the biggest risk for engineering companies lies in their exposure to the mining industry. Within our coverage, Sandvik and Atlas Copco both have sizeable exposure to mining, deriving respectively 36% and 26% of their revenues from this industry. The following chart shows the direct and indirect exposure of a few engineering companies. The list is obviously not exhaustive.
Exposure to Chinese construction market and mining as % of 2010 sales
100% 90% 80% 70% 60% 50% 100% 17% 36% 26% 12% 1% Chinese construction exposure Mining exposure

40%
30% 20% 10% 0%
Joy Global

24%
26% 3%
Atlas Copco

27% 1%

18%
9%
Caterpillar

5% 8%

12%
Kone

9%
Assa Abloy

4%

3%
Legrand

Hitachi

Komatsu

Metso

Volv o

Source: SG Cross Asset Research, Company data

Mining capex could be sharply reduced


Driven by the strong rebound in commodity prices and greater optimism from miners, we have seen a strong and quick rebound in mining capex from 2009 lows. We forecast global mining capex to reach $125bn in 2011, surpassing the 2008 peak. Now question marks remain for mining capex beyond 2011. Based on IBES forecasts for the top five miners, capex should decline by 7% for 2012 and by a further 11% for 2013. Consensus forecasts for Vale are the key driver behind the slide, with 2012 capex seen 20% below the $24bn planned for 2011. A significant slowdown in Chinese construction would be expected to drive commodity prices lower and trigger new long-term plans from the miners. Indeed, their capex/production plans are based on the assumption that Chinese appetite for commodities will remain firm in the foreseeable future.
23 June 2011 29

Schneider

Sandv ik

Capital Goods

Mining capex vs base metal index ($bn)


Global Mining capex US$bn (RHS)

Net capex outlook for top five miners ($m) *


140 70,000

450 400 350 300

IBES +56%
60,000

SGe

MEG Base Metal Index (LHS)

120
100 50,000 80 40,000 60 +21%

-7% -11%

250
200 150 100

30,000
40 20,000 20 10,000 0

50
0

2011E

1990

1991

1993

1995

1996

1998

1999

2001

2003

2004

2006

2007

2008

2009

1992

1994

1997

2000

2002

2005

2010

2010 2011e 2012e 2013e

Source: SG Cross Asset Research, Metal Economics Group

Source: SG Cross Asset Research, IBES, * Includes BHP Billiton, Rio Tinto, Vale, Xstrata, Anglo American

A fall in commodity prices would obviously have knock-on effects on the GDP outlook for countries that derive a sizeable portion of their wealth from natural resources, like Australia, South Africa or Brazil.

China - Key driver of sales growth over the past few years
Unsurprisingly, China has been a key driver of sales growth for most capgoods companies over the past few years. The following chart shows the contribution of China to the groups revenues between 2004 and 2010 (excluding acquisitions and FX). On average, higher revenues in China accounted for c. 25% of the total revenue growth observed between 2004 and 2010. A third of Schneiders revenue growth over the period was driven by China. Atlas and Sandvik experienced a more moderate direct contribution from China, albeit this was due to the sharp increase in revenues derived from the mining industry. Indeed, we estimate higher mining revenues contributed respectively c.70% and c.50% to the revenue growth seen at Sandvik and Atlas Copco between 2004 and 2010.
Contribution from China and Mining to group revenues between 2004 and 2010
Contribution f rom China 120% 100% 80% 60% Contribution f rom Mining

40%
20% 0% Sandv ik Atlas Volv o CE Schneider SKF Assa Abloy ABB Siemens
Source: SG Cross Asset Research

30

23 June 2011

Capital Goods

Chinese competition likely to intensify outside China


Chinese companies are expected to look increasingly overseas to offset a potential slowdown in their domestic market and the likely resulting overcapacity, creating heightened competition in the global markets, particularly in other emerging markets. Fortunately, most capital goods companies under our coverage do not operate in the construction equipment business (loaders, excavators, bulldozers, etc) where the competitive risks look highest. But other industries would also likely see intensifying Chinese competition in international markets if Chinas economy slows down. Generally speaking, we believe that capital goods companies are set to experience growing competition from Chinese companies and price pressure when the following conditions are in place:
1) The industry is strategic. For the Chinese government, which is currently building the

countrys infrastructure (power installed base, grid network, transportation network), associated capital goods industries are strategic for the countrys development. This explains why China has prevented foreign companies from entering freely into these markets, required technology transfers and systematically favoured the development of local champions.
2) The customer base is highly consolidated, with only a handful of clients (utilities,

municipalities) by country. This gives customers stronger bargaining power. It also enables the low-cost competition to address these markets more efficiently as their commercial efforts can be focused on a small number of key clients. In contrast, in scattered markets such as the low-voltage industry, it is very time-consuming and expensive for a new entrant to build up the required commercial network to address all distributors and electricians.
3) Demand is characterised by big-ticket contracts (typically worth more than 15m). By nature,

the larger the contract, the greater the price sensitivity, as price increases represent a significant additional amount of spending by the client. In contrast, when demand is characterised by a flow of low-ticket items (switches, bearings, locks, etc.), the products sold only represent a small cost component of customers total manufacturing or installation costs, which limits price pressure.

Power, Rail and T&D clearly at risk healthcare relatively immune in our view
As illustrated below, we believe that the power generation, rail transportation and T&D sectors typically share these characteristics, making them particularly exposed to Chinese competition. In theory, given Chinas new focus on upgrading its healthcare architecture (with a $123bn investment programme), the healthcare industry could be next on the list. However, unlike in the power or rail markets, western companies have so far enjoyed relatively unimpaired access to the Chinese market. The Chinese government seems to be more interested in quickly modernising/building out its healthcare system than trying to build an industrial base in this area. Global players have traditionally operated in the urban space (3,600 existing hospitals and 2,000 county hospitals under construction) and should now gradually benefit from Chinas huge investments outside urban areas (80,000 hospitals which should increasingly get access to basic ultrasound and imaging systems).

23 June 2011

31

Capital Goods

Low-cost competition more likely to hit big ticket items with a consolidated customer base

Industries most at risk


Attractive Pricing risks but volatile

Consolidation of the customer base

Nuclear
High

Transportation

Auto Equipment Wind Power T&D

Mining equipment

Fossil Power Generation

Medical Equipment

Automation Cable

Low

Compressors

Bearings

Tooling

Locks Ultra - low Voltage

Pricing power High Size of each contract Low

Source: SG Cross Asset Research

Forecasts edged down to reflect the increased uncertainty


Given the mounting uncertainty on the outlook for Chinese construction, we have reduced our forecasts for both the Chinese construction equipment and global mining equipment industries;
Chinese construction equipment We have reduced our forecasts for Chinese construction equipment. We still forecast good growth for 2011 as a whole given the strength of the first

quarter. However, we now estimate deliveries could fall in 2012 and trend back to a more normalised level following several years of over-proportional growth.
Construction equipments in China Excavator, loader and bulldozer deliveries per annum
2006 2007 2008 2009 2010 2011e 2012e

Excavator Yoy chge Loader Yoy chge Bulldozer Yoy chge


Source: SG Cross Asset Research, CCMA

43,346 50% 119,868 13% 6,087 19%

66,171 53% 161,812 35% 7,382 21%

76,612 16% 165,335 2% 8,776 19%

92,619 21% 143,355 -13% 8,580 -2%

165,804 79% 216,691 51% 13,911 62%

190,000 15% 230,000 6% 14,500 4%

140,000 -26% 190,000 -17% 11,500 -21%

Mining capex Mining capex will likely reach a record high level in 2011, a level which looks unsustainable if we rely on IBES forecasts for the top five miners. In addition, growing

uncertainty on Chinese construction prompts us to assume a more cautious outlook for the mining equipment industry. A sharp contraction in Chinese construction activity would be likely to trigger further downgrades, whereas ongoing strength in Chinese FAI would lead to upgrades to our new forecasts. We prefer to err on the side of caution as long as visibility on the Chinese construction market remains low.
Global mining equipment industry
2008 2009 2010 2011e 2012e 2013e

New forecasts ($m) yoy change Old forecasts ($m) New vs Old
Source: SG Cross Asset Research

45,400 11% 45,400

31,780 -30% 31,780

38,000 20% 38,000

52,300 38% 53,500 -2%

54,000 3% 59,000 -8%

50,000 -7% 63,000 -21%

32

23 June 2011

Capital Goods

These revised forecasts for the Chinese construction and global mining industries led us to downgrade our estimates for the most exposed companies to these industries. Atlas Copco and Sandvik are the most impacted, with 2013e EPS downgrades of 13% for both stocks. Volvo is likely to be impacted through its CE division. However, the negative impact on CE has been offset by more optimistic truck delivery forecast following the strong May delivery data released recently. Our EPS forecasts have thus been largely unchanged. We have marginally lowered our forecasts on Assa Abloy by applying more a cautious forecast on Chinese construction growth (9% of group revenues). Finally, we have left unchanged our forecasts on Legrand and Schneider which derive just 3% and 4% of sales respectively from the Chinese construction market.
Main changes to our forecasts Assa Abloy and Atlas Copco
Assa Abloy 2011e 2012e 2013e 2011e Atlas Copco 2012e 2013e

Revenues - New forecasts Revenues - Old forecasts % change SG adj. EPS - New forecasts SG adj. EPS - Old forecasts % change
Source: SG Cross Asset Research

41,456 41,578 -0.3% 12.7 12.8 -0.4%

45,108 45,489 -0.8% 14.2 14.4 -1.3%

47,869 48,540 -1.4% 15.4 15.7 -1.9%

78,756 78,939 -0.2% 10.5 10.5 -0.1%

85,568 89,620 -4.5% 11.5 12.4 -7.2%

89,380 99,935 -10.6% 12.3 14.1 -12.9%

Main changes to our forecasts Sandvik and Volvo


Sandvik 2011e 2012e 2013e 2011e Volvo 2012e 2013e

Revenues - New forecasts Revenues - Old forecasts % change SG adj. EPS - New forecasts SG adj. EPS - Old forecasts % change
Source: SG Cross Asset Research

92,955 95,048 -2.2% 7.7 7.8 -1.3%

99,130 104,237 -4.9% 8.7 9.3 -6.4%

101,904 112,317 -9.3% 9.3 10.7 -13.4%

300,771 297,495 1.1% 8.7 8.4 3.8%

336,794 341,954 -0.9% 11.6 11.6 0.4%

362,029 372,860 -2.2% 13.0 13.2 -1.3%

Our forecasts for Atlas Copco, Sandvik and Volvo now differ materially from consensus which still assumes steady growth in the companies end-markets, including both the Chinese construction and the global mining equipment industries.
SG 2012e forecasts vs consensus
Atlas Copco 0%
-1% -2%

SG 2013e forecasts vs consensus


Volvo 0%
-2% -4%

Sandvik

Atlas Copco

Sandvik

Volvo

-3%
-4% -5%

-6%
-8% -10%

-6%
-7% -8%

-12%
-14% -16%

-9%
Revenues EBIT

-18%
Revenues EBIT

Source: SG Cross Asset Research, Datastream

23 June 2011

33

Capital Goods

Machinery (Sweden)

ASSA ABLOY
Rating reiterated Defensive appeal vs Chinese construction risk

Hold (12m)
Price 21/06/11 12m target

Exposure to China

Following the acquisition of Panpan (security doors), Assa Abloy now

derives c.9% of its revenues from the Chinese construction industry. The stock harbours the highest direct exposure to the Chinese construction market within our coverage. The groups exposure to China has climbed from just 1% in 2004 via acquisitions and organic growth. We calculate that China contributed c.25% of the groups organic sales growth between 2004 and 2010. In China, Assa Abloy now offers a complete product range and has become the largest lock company.
Chinese competition threat

SEK165.5
Sector Weighting

SEK170.0

Overweight
Preferred stock

Siemens
Least preferred stock

Sandvik
Type of investment

The Chinese lock industry is highly fragmented and as a result

no major competitors have yet emerged. Over the past few years, Chinese lock products

M&A Defensive
1 year
Price
210

have made some inroads in emerging markets (notably in South East Asia and LatAm) albeit with mixed success. Local standards and brand strength remain key barriers to entry within the lock industry.

MA 100

Target price & rating

Despite its large direct exposure to the Chinese construction market,

Assa Abloy still offers some leverage on the long-awaited rebound in the US and European
180

non-residential construction markets, which should remain key drivers of the shares going forward. In addition, Assa Abloy offers a defensive business model (low capital intensity and high share of aftermarket) that investors are likely to appreciate in the event of a burst of the

150

120 2010
(m) 13.5 9 4.5 0 2010 2011

Chinese construction bubble. We therefore maintain our Hold rating on the stock. Our
2011

SEK170 TP is unchanged; it is derived on a DCF (8.5% WACC, 2% LT growth and 16% normalised margin). We have marginally reduced our EPS forecasts by 1-2% for 2012 and 2013 to reflect a more cautious growth outlook in China. The shares trade on 11.6x P/E for 2012e, largely in line with the sector average. Key upside (downside) risk to the stock achieving our TP would come from a rebound in US/EU non residential construction that is stronger (weaker) than expected.
Next events & catalysts

Source: SG Cross Asset Research

Q2 results on 27 July.

Assa Abloy on www.sgresearch.com

Share data

Financial data

12/10

12/11e

12/12e

12/13e

Ratios

12/10

12/11e

12/12e

12/13e

RIC ASSAb.ST, Bloom ASSAB SS 52-week range EV 11 (SEKm) Market cap. (SEKm) Free float (%) Performance (%) Ordinary shares Rel. Eurofirst 300 1m
-6.2 -2.9 -4.6 -3.7

Revenues (SEKbn) EBIT margin (%) Rep. net inc. (SEKbn) EPS (adj.) (SEK) Dividend/share (SEK) Payout (%) Interest cover (x) Net debt/equity (%)
Prev. EPS change (22/06/11) Sebastien Gruter (33) 1 42 13 47 22
sebastien.gruter@sgcib.com

36.82 16.5 4.05 10.95 4.00 36.2 8.9 59.3

41.46 16.2 4.55 12.71 5.10 41.0 10.0 62.6


12.77

45.11 16.5 5.28 14.22 5.70 39.5 10.3 45.4


14.41

47.87 16.9 5.72 15.40 6.20 39.6 13.9 29.1


15.70

P/E (x) FCF yield (/EV) (%) Dividend yield (%) Price/book value (x) EV/revenues (x) EV/EBIT (x) EV/IC (x) ROIC/WACC (x)
CAGR 10-13e: +12.0%

14.6 7.9 2.5 2.9 1.83 11.5 2.0 1.6

13.0 6.4 3.1 2.6 1.82 11.2 1.8 1.5

11.6 7.8 3.4 2.3 1.61 9.7 1.7 1.5

10.7 8.6 3.7 2.0 1.45 8.6 1.6 1.6

196.5-146.5 75,253 60,559 67.3 3m 12m


-3.6 -7.3

Gael de-Bray (33) 1 42 13 84 14


gael.de-bray@sgcib.com

Colin Campbell (44) 20 7762 5609


colin.campbell@sgcib.com

Societe Generale (SG) does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that SG 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. PLEASE SEE APPENDIX AT THE END OF THIS REPORT FOR THE ANALYST(S)

CERTIFICATION(S), IMPORTANT DISCLOSURES AND DISCLAIMERS AND THE STATUS OF NON-US RESEARCH ANALYSTS.

34

23 June 2011

Capital Goods

Sales/division 10

Machinery (Sweden)

Price (21/06/11)

12m target

Assa Abloy
EMEA 35% America 26% Asia Pacific 17% Global Technologies 14% Entrance systems 11% Eliminations -2%

HOLD
12/06 365.9 132.01 48,304 -13,560 81 163 61,782 17.5 16.3 22.0 3.7 1.98 10.8 2.5 7.55 8.08 35.82 3.25 31,138 11,202 5,716 -898 4,818 0 -670 -1,529 -871 -10 1,746 2,860 5,716 -704 -1,997 3,015 -739 2,276 -3,132 -1,189 -1,273 24,309 0 3,996 1,297 13,564 81 973 -12,390 12.5 12.5 36.0 18.4 15.5 12.0 8.9 15.4 18.4 8.3 0.0 81.8 90.8 30.8 52.3 12/07 365.9 145.99 53,419 -12,953 201 209 66,364 16.2 14.1 17.8 3.6 1.98 10.4 2.5 9.01 10.34 40.84 3.60 33,549 13,923 6,358 -909 5,449 0 -849 0 -1,241 -10 3,358 3,413 6,358 -25 -2,471 3,862 -751 3,111 -1,376 -1,189 598 25,143 0 4,666 1,156 15,467 201 896 -11,970 14.2 23.1 41.5 19.0 16.2 7.7 7.1 11.2 13.1 19.3 10.8 93.8 76.4 32.9 42.3 12/08 365.9 95.54 34,962 -14,271 226 356 49,103 10.7 8.0 10.0 1.9 1.41 7.6 3.8 8.91 11.92 49.14 3.60 34,918 14,596 6,433 -921 5,512 0 -770 -1,257 -1,061 -25 2,413 3,374 6,433 -5 -1,994 4,434 -829 3,605 -1,819 -1,317 -997 29,727 0 5,042 1,182 18,612 226 1,591 -13,088 12.9 14.2 41.8 18.4 15.8 4.1 0.4 1.2 1.2 -1.1 0.0 91.9 69.5 32.2 36.5 12/09 365.9 105.04 38,438 -11,292 162 430 49,462 11.7 6.6 7.5 2.0 1.41 7.7 3.4 9.01 15.87 51.41 3.60 34,963 13,183 6,415 -1,014 5,401 0 -634 -1,039 -1,081 -32 2,627 3,360 6,415 1,460 -1,963 5,912 -664 5,248 -1,171 -1,303 2,967 29,061 0 3,633 1,182 19,172 162 1,954 -10,110 12.1 13.9 37.7 18.3 15.4 0.1 -11.7 -0.3 -2.0 1.1 0.0 123.3 52.3 41.6 25.1 12/10 365.9 159.35 58,310 -10,626 169 1,595 67,510 14.6 10.3 11.8 2.9 1.83 9.6 2.5 10.95 15.46 55.83 4.00 36,823 14,836 7,064 -995 6,069 0 -680 -32 -1,286 -35 4,045 4,084 7,064 362 -1,675 5,751 -708 5,043 -3,319 -1,068 585 32,210 0 3,473 1,078 20,821 169 4,067 -12,448 13.5 20.2 40.3 19.2 16.5 5.3 2.6 10.1 12.4 21.5 11.1 103.8 59.3 48.0 29.0

SEK165.5
12/11e 365.9 165.50 60,559 -16,080 209 1,595 75,253 13.0 12.1 15.0 2.6 1.82 9.6 3.1 12.71 13.66 63.76 5.10 41,456 16,283 7,844 -1,125 6,719 0 -672 -250 -1,296 -40 4,547 4,738 7,844 -300 -2,468 5,076 -954 4,123 -8,479 -1,464 -5,820 40,518 0 3,351 1,078 23,764 209 3,817 -15,002 12.8 20.4 39.3 18.9 16.2 12.6 5.3 11.0 10.7 16.1 27.5 90.6 62.6 36.5 45.3

SEK170.0
12/12e 365.9 165.50 60,559 -13,535 209 1,595 72,708 11.6 10.2 12.5 2.3 1.61 8.4 3.4 14.22 16.23 73.05 5.70 45,108 17,710 8,662 -1,200 7,463 0 -722 0 -1,504 -46 5,284 5,300 8,662 -202 -2,426 6,035 -1,083 4,953 -635 -1,866 2,451 41,036 0 3,553 1,078 27,228 209 3,617 -12,457 12.8 20.7 39.3 19.2 16.5 8.8 5.5 10.4 11.1 11.9 11.8 96.2 45.4 47.6 42.1 12/13e 365.9 165.50 60,559 -10,125 209 1,595 69,298 10.7 9.4 11.4 2.0 1.45 7.4 3.7 15.40 17.61 82.94 6.20 47,869 18,835 9,329 -1,248 8,081 0 -582 0 -1,823 -50 5,724 5,740 9,329 -276 -2,505 6,547 -1,149 5,398 0 -2,086 3,312 40,937 0 3,830 1,078 30,916 209 3,517 -9,047 13.7 19.7 39.3 19.5 16.9 6.1 6.1 7.7 8.3 8.3 8.8 96.6 29.1 68.4 42.0

EBIT/division 10

EMEA 36%

Valuation* (SEKm) Nb. of shares basic year end/outstanding Share price (average) Average market cap. (SG adjusted) (1) Restated net debt (-)/cash (+) (2) Value of minorities (3) Value of financial investments (4) Other adjustment (5) EV = (1) - (2) + (3) - (4) + (5) P/E (x) Price/cash flow (x) Price/free cash flow (x) Price/book value (x) EV/revenues (x) EV/EBITDA (x) Dividend yield (%) Per share data (SEK) SG EPS (adj.) Cash flow Book value Dividend Income statement (SEKm) Revenues Gross income EBITDA Depreciation and amortisation EBIT Impairment losses Net interest income Exceptional & non-operating items 7.0 6.2 4.2 Taxation Minority interests Reported net income SG adjusted net income Cash flow statement (SEKm) EBITDA Change in working capital Other operating cash movements Cash flow from operating activities Net capital expenditure Free cash flow Cash flow from investing activities Cash flow from financing activities Net change in cash resulting from CF Balance sheet (SEKm) Total long-term assets of which intangible Working capital Employee benefit obligations Shareholders' equity Minority interests Provisions Net debt (-)/cash (+) Accounting ratios ROIC (%) ROE (%) Gross income/revenues (%) EBITDA margin (%) EBIT margin (%) Revenue yoy growth (%) Rev. organic growth (%) EBITDA yoy growth (%) EBIT yoy growth (%) EPS (adj.) yoy growth (%) Dividend growth (%) Cash conversion (%) Net debt/equity (%) FFO/net debt (%) Dividend paid/FCF (%)

America 31% Global Technologies 14% 0 Asia Pacific 14% Entrance systems 10% Eliminations -6%

Sales/region 10

Europe 43%

North. America 32% Asia 15% Autralia/NZ 6% Latin America 2% Africa 2%

Major shareholders (%)


Investment AB Latour Robur unit trusts Alecta

Normalised data
EBITDA margin (%) Normalised growth (%) 18.3 10.6

In red: IFRS Data * Valuation ratios for past years are based on average historical prices and market capitalisations

23 June 2011

35

Capital Goods

Machinery (Sweden)

ATLAS COPCO
Rating downgrade Concerns over Chinese growth should limit further outperformance

Hold (12m)
(from Buy)
Price 21/06/11 12m target

Exposure to China

Atlas Copcos direct exposure to the Chinese construction theme is

rather limited, representing c.3% of group revenues in 2010 on our estimates. However, the groups indirect exposure is sizeable with the group deriving 26% of its sales from the mining industry. Atlas Copco has mainly benefited from the Chinese growth story through its mining equipment business. Indeed, we calculate that China contributed c.20% of Atlas Copco organic sales growth between 2004 and 2010, while mining contributed c.55%. Atlas Copcos revenues from China increased from SEK1.5bn to SEK7.8bn between 2004 and 2010 and now represent some 11% of group revenues.
Chinese competition threat

SEK160.9
Sector Weighting

SEK150.0

Overweight
Preferred stock

Siemens
Least preferred stock

Sandvik
Type of investment

We believe that the risk from Chinese competition over the short

Growth Counter consensus forecast


1 year
Price
180

and medium term is rather limited thanks to Atlas Copcos dominant market positioning, multi-brand strategy, large dealer network and protected IP technology. However, in its construction division, Atlas is only positioned in the high-end segment and thus seems more exposed. Technology still gives the group a major edge, although Chinese competitors are

MA 100

quickly moving up the value chain. In its mining business, Atlas low exposure to the coal industry makes it less vulnerable to the Chinese competition.

150

Target price & rating


120

Reflecting a more cautious outlook for mining capex, we have reduced

our EPS forecasts by 7% for 2012e and 13% for 2013e and cut our target price from
90 2010
(m) 19.5 13 6.5 0 2010 2011

SEK200 to SEK150. Our TP is derived from a DCF inputting WACC of 9.6%, 2.5% LT growth
2011

and a 21% normalised margin. Despite Atlas strong business model and excellent management track record, we believe the growing uncertainty on Chinese growth and mining capex outlook should prevent the shares premium from expanding further. We downgrade the stock to Hold from Buy. On our new forecasts (standing 6% below the street), the shares trade at 10.0x EV/EBIT for 2012e, a 20% premium to the sector average. The key upside (downside) risks to the stock achieving our TP are from higher (lower) commodity prices and stronger- (weaker-) than-expected growth in emerging markets.
Next events & catalysts

Source: SG Cross Asset Research

Q2 results on 18 July

Atlas Copco on www.sgresearch.com

Share data

Financial data

12/10

12/11e

12/12e

12/13e

Ratios

12/10

12/11e

12/12e

12/13e

RIC ATCOa.ST, Bloom ATCOA SS 52-week range EV 11 (SEKm) Market cap. (SEKm) Free float (%) Performance (%) Ordinary shares Rel. Eurofirst 300 1m
-1.9 1.6 -0.1 0.9

Revenues (SEKbn) EBIT margin (%) Rep. net inc. (SEKbn) EPS (adj.) (SEK) Dividend/share (SEK) Payout (%) Interest cover (x) Net debt/equity (%)
Prev. EPS change (22/06/11) Sebastien Gruter (33) 1 42 13 47 22
sebastien.gruter@sgcib.com

69.88 20.8 9.89 8.56 4.00 49.2 17.6 20.0

78.76 22.2 12.44 10.51 5.10 49.9 21.9 25.0


10.57

85.57 22.3 13.60 11.47 5.60 50.1 23.9 4.2


12.41

89.38 22.6 14.59 12.28 6.00 50.0 25.2 nm


14.15

P/E (x) FCF yield (/EV) (%) Dividend yield (%) Price/book value (x) EV/revenues (x) EV/EBIT (x) EV/IC (x) ROIC/WACC (x)
CAGR 10-13e: +12.8%

14.3 5.5 3.3 5.1 2.76 13.5 5.3 3.1

15.3 5.6 3.2 6.4 2.51 11.3 4.8 3.5

14.0 6.6 3.5 5.1 2.24 10.0 4.5 3.6

13.1 7.7 3.7 4.3 2.06 9.1 4.2 3.7

177.4-111.1 197,299 189,358 73.5 3m 12m


29.9 24.9

Gael de-Bray (33) 1 42 13 84 14


gael.de-bray@sgcib.com

Colin Campbell (44) 20 7762 5609


colin.campbell@sgcib.com

Societe Generale (SG) does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that SG 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. PLEASE SEE APPENDIX AT THE END OF THIS REPORT FOR THE ANALYST(S)

CERTIFICATION(S), IMPORTANT DISCLOSURES AND DISCLAIMERS AND THE STATUS OF NON-US RESEARCH ANALYSTS.

36

23 June 2011

Capital Goods

Sales/division 10

Machinery (Sweden)

Price (21/06/11)

12m target

Atlas Copco
Compressor Technique 51%

HOLD
12/06 839.4 84.07 139,178 12,364 92 2,542 0 124,364 16.1 11.5 nm 3.2 2.46 11.2 2.8 5.23 7.32 25.98 2.38 50,512 17,174 11,057 -1,511 9,546 -127 -508 -83 -2,435 -24 15,482 6,579 11,057 -2,353 -4,165 4,539 -7,106 -2,567 21,636 -6,452 12,617 13,216 0 9,084 1,647 32,677 92 14,011 19.8 53.0 34.0 21.9 18.9 -4.2 17.6 -13.1 1.5 3.7 11.8 12.8 nm nm nm 12/07 839.4 106.07 177,839 -19,800 116 3,413 194,343 16.5 16.5 23.3 9.0 3.07 12.9 2.8 6.43 6.41 11.81 3.00 63,355 20,907 15,037 -1,596 13,441 -204 -2,382 -1,171 -3,118 -30 6,589 7,911 15,037 -2,326 -3,861 8,850 -3,262 5,588 -6,614 -27,344 -28,371 22,710 0 14,049 1,728 14,524 116 -18,072 33.2 27.9 33.0 23.7 21.2 25.4 18.2 36.0 40.8 23.0 26.3 69.3 123.4 48.2 66.0 12/08 828.1 86.06 154,645 -23,247 141 1,533 176,500 10.1 11.7 17.2 4.4 2.38 10.9 3.5 8.52 7.37 19.43 3.00 74,177 24,478 16,144 -1,832 14,312 -248 -694 -258 -3,106 -33 10,157 10,402 16,144 -2,991 -4,012 9,141 -3,029 6,112 -1,364 -4,120 628 23,916 0 19,676 1,922 23,627 141 -21,325 28.2 53.2 33.0 21.8 19.3 17.1 11.7 7.4 6.5 32.4 0.0 70.2 89.7 53.1 59.7 12/09 828.1 80.28 136,388 -12,040 162 1,559 147,031 14.2 9.7 6.8 3.8 2.31 12.2 3.7 5.66 8.29 20.98 3.00 63,762 21,042 12,052 -2,171 9,881 -299 -819 -492 -1,995 -32 6,244 6,887 12,052 6,715 -3,460 15,307 -1,055 14,252 -171 -3,652 10,429 27,302 0 12,874 1,768 25,509 162 -10,272 18.7 25.4 33.0 18.9 15.5 -14.0 -21.7 -25.3 -31.0 -33.5 0.0 178.0 40.0 76.7 25.6 12/10 828.1 122.30 186,585 -7,428 180 1,559 192,634 14.3 19.6 15.2 5.1 2.76 11.6 3.3 8.56 6.22 23.97 4.00 69,875 26,407 16,663 -2,151 14,512 -347 -420 -250 -3,576 -30 9,889 10,411 16,663 -1,730 -3,513 11,420 -1,606 9,814 -1,666 -3,266 4,882 26,866 0 13,288 1,578 29,141 180 -5,850 29.9 36.2 37.8 23.8 20.8 9.6 12.4 38.3 46.9 51.2 33.3 93.6 20.0 170.5 49.6

SEK160.9
12/11e 828.1 160.90 189,358 -9,282 218 1,559 197,299 15.3 17.3 18.1 6.4 2.51 10.0 3.2 10.51 9.33 25.20 5.10 78,756 30,762 19,678 -2,192 17,487 -347 -281 0 -4,383 -38 12,438 12,785 19,678 -1,689 -4,825 13,165 -2,346 10,818 0 -10,939 -120 28,647 0 14,977 1,578 30,641 218 -7,704 33.8 41.6 39.1 25.0 22.2 12.7 20.1 18.1 20.5 22.8 27.5 88.5 25.0 161.7 57.3

SEK150.0
12/12e 828.1 160.90 189,358 -3,189 259 1,559 191,246 14.0 17.3 15.9 5.1 2.24 9.0 3.5 11.47 9.33 31.29 5.60 85,568 33,282 21,362 -2,270 19,092 -347 -308 0 -4,794 -41 13,602 13,949 21,362 -1,295 -5,272 14,795 -2,500 12,295 0 -6,201 6,094 28,700 0 16,272 1,578 38,041 259 -1,611 34.5 39.6 38.9 25.0 22.3 8.6 9.0 8.6 9.2 9.1 9.8 91.1 4.2 nm 55.4 12/13e 828.1 160.90 189,358 4,034 302 1,559 184,068 13.1 11.8 13.9 4.3 2.06 8.1 3.7 12.28 13.69 37.69 6.00 89,380 35,353 22,756 -2,570 20,186 -347 -64 0 -5,142 -44 14,589 14,936 22,756 -725 -5,381 16,650 -2,619 14,031 0 -6,809 7,222 28,577 0 16,997 1,578 45,822 302 5,612 35.3 34.8 39.6 25.5 22.6 4.5 4.5 6.5 5.7 7.1 7.1 95.3 nm nm 52.0

Construction & Mining 41% 0 Industrial Technique 8% Eliminations -0%

EBIT/division 10

Valuation* (SEKm) Nb. of shares basic year end/outstanding Share price (average) Average market cap. (SG adjusted) (1) Restated net debt (-)/cash (+) (2) Value of minorities (3) Value of financial investments (4) Other adjustment (5) EV = (1) - (2) + (3) - (4) + (5) P/E (x) Price/cash flow (x) Price/free cash flow (x) Price/book value (x) EV/revenues (x) EV/EBITDA (x) Dividend yield (%) Per share data (SEK) SG EPS (adj.) Cash flow Book value Dividend Income statement (SEKm) Revenues Gross income EBITDA Depreciation and amortisation EBIT Impairment losses Net interest income Exceptional & non-operating items Taxation Minority interests Reported net income SG adjusted net income Cash flow statement (SEKm) EBITDA Change in working capital Other operating cash movements Cash flow from operating activities Net capital expenditure Free cash flow Cash flow from investing activities Cash flow from financing activities Net change in cash resulting from CF Balance sheet (SEKm) Total long-term assets of which intangible Working capital Employee benefit obligations Shareholders' equity Minority interests Provisions Net debt (-)/cash (+) Accounting ratios ROIC (%) ROE (%) Gross income/revenues (%) EBITDA margin (%) EBIT margin (%) Revenue yoy growth (%) Rev. organic growth (%) EBITDA yoy growth (%) EBIT yoy growth (%) EPS (adj.) yoy growth (%) Dividend growth (%) Cash conversion (%) Net debt/equity (%) FFO/net debt (%) Dividend paid/FCF (%)

Compressor Technique 61%

Construction & Mining 37% Industrial Technique 3%

Sales/region 10

Europe 36%

Asia 21% North. America 16% Africa 12% Latin America 10% Autralia/NZ 5%

Major shareholders (%)


Investor ForeningsSparbanken Alecta 15.0 4.6 3.5

Normalised data
EBITDA margin (%) Normalised growth (%) 23.8 13.7

* Valuation ratios for past years are based on average historical prices and market capitalisations

23 June 2011

37

Capital Goods

Machinery (Sweden)

SANDVIK
Rating downgrade Further underperformance driven by clouded outlook on mining capex cycle

Sell (12m)
(from Hold)
Price 21/06/11 12m target

Exposure to China

Sandviks direct exposure to the Chinese construction theme is largely

inexistent (around 1% of group sales). However, the group is by far the most exposed stock to the mining industry (more than one-third of group sales) within our coverage. As a result, Sandvik has benefited from the Chinese growth story through its mining equipment business, with mining contributing c.70% of the groups organic sales growth between 2004 and 2010. Sandviks revenues from China increased from SEK1.5bn to SEK5.5bn between 2004 and 2010 and now represent some 7% of group sales. A bursting of the Chinese construction bubble would predominantly impact Sandvik through its mining equipment business.
Chinese competition threat

SEK108.3
Sector Weighting

SEK90.0

Overweight
Preferred stock

Siemens
Least preferred stock

Sandvik
Type of investment

Sandviks exposure to Chinese competition is limited, although

Overvalued Growth Counter consensus forecast


1 year
Price
145

we expect the group to face increasing competitive pressure in its Materials Technology and Mining businesses (notably for coal). In respect of coal, Sandvik took steps to protect its business by forming a JV with Shandong for roadheaders.
Target price & rating

MA 100

Reflecting a more cautious outlook on mining capex, we have reduced

our EPS forecasts by 6% for 2012e and 13% for 2013e and cut our target price from
120

SEK115 to SEK90. It is derived from a DCF inputting WACC of 9.6%, 2.5% LT growth and a 14% normalised margin. Since we do not expect new management to radically change the groups vertical integration, Sandvik should remain overly leveraged to volume outlook and

95

70 2010
(m) 22.5 15 7.5 0 2010 2011

therefore, in times of uncertainty, we believe the risk/reward ratio is skewed to the downside.
2011

This, allied to the overhang stemming from the low visibility on Chinese growth/mining capex outlook means that underperformance is likely to continue. We downgrade our rating from Hold to Sell. On our new forecasts (standing 8% below the Street), the shares trade at 9.5x EV/EBIT for 2012e, a 15% premium to the sector average. The key upside risk to our TP would come from higher commodity prices.
Next events & catalysts

Source: SG Cross Asset Research

Q2 results on 19 July.

Sandvik on www.sgresearch.com

Share data

Financial data

12/10

12/11e

12/12e

12/13e

Ratios

12/10

12/11e

12/12e

12/13e

RIC SAND.ST, Bloom SAND SS 52-week range EV 11 (SEKm) Market cap. (SEKm) Free float (%) Performance (%) Ordinary shares Rel. Eurofirst 300 1m
-7.2 -3.9 -7.8 -6.9

Revenues (SEKbn) EBIT margin (%) Rep. net inc. (SEKbn) EPS (adj.) (SEK) Dividend/share (SEK) Payout (%) Interest cover (x) Net debt/equity (%)
Prev. EPS change (22/06/11) Sebastien Gruter (33) 1 42 13 47 22
sebastien.gruter@sgcib.com

82.66 13.5 6.61 5.85 3.10 55.7 6.5 61.1

92.96 15.3 8.95 7.69 4.20 55.7 9.3 55.6


7.79

99.13 101.90 16.0 10.13 8.74 4.70 55.0 10.7 42.5


9.33

P/E (x) FCF yield (/EV) (%) Dividend yield (%) Price/book value (x) EV/revenues (x) EV/EBIT (x) EV/IC (x) ROIC/WACC (x)
CAGR 10-13e: +16.5%

16.7 6.9 3.2 3.3 1.73 13.6 2.4 1.3

14.1 4.8 3.9 3.2 1.69 10.8 2.3 1.7

12.4 6.6 4.3 2.8 1.55 9.5 2.2 1.8

11.7 6.9 4.6 2.6 1.48 9.0 2.1 1.8

134.9-85.9 156,678 128,475 63.2 3m 12m


3.1 -0.8

16.3 10.75 9.25 5.00 55.2 12.8 32.2


10.68

Gael de-Bray (33) 1 42 13 84 14


gael.de-bray@sgcib.com

Colin Campbell (44) 20 7762 5609


colin.campbell@sgcib.com

Societe Generale (SG) does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that SG 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. PLEASE SEE APPENDIX AT THE END OF THIS REPORT FOR THE ANALYST(S)

CERTIFICATION(S), IMPORTANT DISCLOSURES AND DISCLAIMERS AND THE STATUS OF NON-US RESEARCH ANALYSTS.

38

23 June 2011

Capital Goods

Sales/division 10

Machinery (Sweden)

Price (21/06/11)

12m target

Sandvik
Mining & Construction 43%

SELL
12/06 1,186.3 85.74 101,716 -13,630 7,897 2,315 120,928 13.2 12.4 25.2 3.9 1.67 7.9 3.8 6.48 6.89 22.04 3.25 72,289 25,205 15,044 -2,976 12,068 0 -955 0 -3,006 -406 7,701 7,684 15,044 -2,920 -3,954 8,170 -4,133 4,037 -1,191 -2,912 -66 27,581 1,095 20,614 3,180 26,146 1,052 2,158 -13,630 19.4 31.0 34.9 20.8 16.7 14.1 12.0 24.4 28.6 28.8 20.4 64.8 50.1 81.3 95.5 12/07 1,186.3 125.02 148,311 -26,840 6,132 3,779 0 177,504 16.2 27.1 305.2 5.2 2.06 10.0 3.2 7.73 4.62 24.12 4.00 86,338 30,362 17,471 -3,077 14,394 0 -1,397 0 -3,404 -478 9,115 9,171 17,471 -6,567 -5,428 5,476 -4,990 486 -5,493 5,286 361 36,099 2,492 29,040 3,100 28,614 1,209 830 -26,840 19.1 33.3 35.2 20.2 16.7 19.4 14.0 16.1 19.3 19.3 23.1 37.6 90.0 47.2 976.4 12/08 1,186.3 82.31 97,645 -32,130 5,291 4,352 0 130,714 12.4 10.1 33.9 2.7 1.41 7.5 3.8 6.63 8.15 30.00 3.15 92,654 31,092 16,538 -3,444 13,094 0 -2,217 -300 -2,741 -364 7,472 7,870 16,538 -1,348 -5,519 9,671 -6,788 2,883 -843 724 2,992 42,947 2,641 34,562 2,735 35,588 1,137 1,204 -32,130 13.8 23.3 33.6 17.8 14.1 7.3 9.1 -5.3 -9.0 -14.2 -21.2 62.0 87.5 36.0 129.6 12/09 1,186.3 64.58 76,615 -29,140 4,398 1,645 0 108,507 nm 6.2 9.5 2.6 1.51 15.8 1.5 -0.35 10.38 24.43 1.00 71,937 17,066 5,263 -4,049 1,214 0 -2,061 -2,625 876 -56 -2,652 -411 5,263 11,632 -4,583 12,312 -4,212 8,100 -1,981 -3,926 2,193 46,354 2,641 20,985 2,735 28,984 970 742 -29,140 1.3 -8.2 23.7 7.3 1.7 -22.4 -27.9 -68.2 -90.7 -105.2 -68.3 918.5 97.3 14.0 14.6 12/10 1,186.3 97.69 115,883 -21,949 6,763 1,645 0 142,950 16.7 9.4 12.9 3.3 1.73 9.0 3.2 5.85 10.38 29.25 3.10 82,657 29,527 15,215 -4,038 11,177 0 -1,616 -148 -2,470 -338 6,605 6,944 15,215 49 -2,951 12,313 -3,332 8,981 -1,215 -1,187 6,579 47,109 2,641 19,898 2,735 34,693 1,233 132 -21,949 12.9 20.7 35.7 18.4 13.5 14.9 15.4 nm nm nm nm 105.3 61.1 50.7 40.9

SEK108.3
12/11e 1,186.3 108.30 128,475 -23,025 6,823 1,645 0 156,678 14.1 12.2 21.3 3.2 1.69 8.4 3.9 7.69 8.88 33.81 4.20 92,955 34,079 18,042 -3,843 14,200 0 -1,427 80 -3,406 -495 8,952 9,123 18,042 -2,876 -4,633 10,534 -4,490 6,044 -1,000 -3,969 1,075 49,027 2,641 22,774 2,735 40,112 1,293 132 -23,025 15.9 23.9 36.7 19.4 15.3 12.5 19.0 18.6 27.0 31.4 35.5 77.4 55.6 57.4 82.4

SEK90.0
12/12e 1,186.3 108.30 128,475 -19,849 6,844 1,645 0 153,523 12.4 9.7 15.0 2.8 1.55 7.5 4.3 8.74 11.20 38.22 4.70 99,130 36,911 19,845 -3,944 15,901 0 -1,382 0 -3,848 -537 10,135 10,364 19,845 -1,513 -5,049 13,283 -4,690 8,593 0 -5,417 3,176 49,593 2,641 24,287 2,735 45,345 1,314 132 -19,849 16.9 23.7 37.2 20.0 16.0 6.6 6.3 10.0 12.0 13.6 11.9 87.7 42.5 73.6 64.9 12/13e 1,186.3 108.30 128,475 -16,730 7,421 1,645 0 150,980 11.7 8.9 14.0 2.6 1.48 7.1 4.6 9.25 12.11 42.18 5.00 101,904 38,968 20,645 -4,048 16,597 0 -1,191 0 -4,083 -576 10,747 10,976 20,645 -1,189 -5,094 14,362 -5,190 9,172 0 -6,053 3,119 50,554 2,641 25,476 2,735 50,039 1,890 132 -16,730 17.0 22.5 38.2 20.3 16.3 2.8 2.8 4.0 4.4 5.9 6.4 87.8 32.2 91.9 64.7

Tooling 29%

Materials technology 21% Seco tools 7% Other 0%

EBIT/division 10

Mining & Construction 42%

Valuation* (SEKm) Nb. of shares basic year end/outstanding Share price (average) Average market cap. (SG adjusted) (1) Restated net debt (-)/cash (+) (2) Value of minorities (3) Value of financial investments (4) Other adjustment (5) EV = (1) - (2) + (3) - (4) + (5) P/E (x) Price/cash flow (x) Price/free cash flow (x) Price/book value (x) EV/revenues (x) EV/EBITDA (x) Dividend yield (%) Per share data (SEK) SG EPS (adj.) Cash flow Book value Dividend Income statement (SEKm) Revenues Gross income EBITDA Depreciation and amortisation EBIT Impairment losses Net interest income Exceptional & non-operating items

Tooling 39% Materials technology 14% Seco tools 10% Other -5%

Sales/region 10

Europe 41%

Asia 17% North. America 15% Autralia/NZ 10% Africa 10% Latin America 7%

Major shareholders (%)


AB Industrivarden JP Morgan Chase Bank State Street Bank and Trus Co 10.4 9.8 6.3

Normalised data
EBITDA margin (%) Normalised growth (%) 19.0 8.2

Taxation Minority interests Reported net income SG adjusted net income Cash flow statement (SEKm) EBITDA Change in working capital Other operating cash movements Cash flow from operating activities Net capital expenditure Free cash flow Cash flow from investing activities Cash flow from financing activities Net change in cash resulting from CF Balance sheet (SEKm) Total long-term assets of which intangible Working capital Employee benefit obligations Shareholders' equity Minority interests Provisions Net debt (-)/cash (+) Accounting ratios ROIC (%) ROE (%) Gross income/revenues (%) EBITDA margin (%) EBIT margin (%) Revenue yoy growth (%) Rev. organic growth (%) EBITDA yoy growth (%) EBIT yoy growth (%) EPS (adj.) yoy growth (%) Dividend growth (%) Cash conversion (%) Net debt/equity (%) FFO/net debt (%) Dividend paid/FCF (%)

* Valuation ratios for past years are based on average historical prices and market capitalisations

23 June 2011

39

Capital Goods

Electrical Equipment (France)

SCHNEIDER
Rating reiterated Compelling valuation and energy-efficiency theme overshadow Chinese construction risk

Buy (12m)
Price 21/06/11 12m target

Exposure to China

Schneider derives around 12% of its sales from China, around 35% of

which come from the construction markets. The groups sales in China grew from 415m in 2004 to 2,269m in 2010 and we estimate that this country alone contributed to one-third of the groups organic sales growth over the period. Schneiders presence in China is broadbased, including product development, local production and commercial activity, with a vast and diffuse distribution network. Schneider has 10% of its workforce in China, and this China-based headcount should be further reinforced by the recent acquisition of Leader Harvest (750 employees in the medium-voltage drives segment). In China, Schneider offers a complete range of low- and medium-voltage products, as well as secure power and industrial automation products. The group is also active in the low-end market through a 5050 JV (created in 2007) with the Delixi Group, focusing on the needs in the Chinese low-

P R E M I U M L I S T

113.3
Sector Weighting

140.0

Overweight
Preferred stock

Siemens
Least preferred stock

Sandvik

M&A
1 year
Price
130

voltage market via a distinct market approach.


Chinese competition threat

Most of Schneiders businesses (low voltage, discrete

MA 100

automation, building automation, secure power) are characterized by high entry costs and solid barriers to entry. Schneider has one of the most deeply rooted networks in China and is increasingly active in the tier-2 and -3 cities. The group should also continue to benefit from

110

90

structurally strong growth for energy-efficient solutions in the industrial markets.


Target price & rating
2010 2011

70
(m) 4.5 3 1.5 0 2010 2011

We reiterate our Buy rating with a DCF-based TP of 140 (norm. EBITA

margin 15%, WACC 8.4%, LT growth rate 2.5%). With the Luminous, Telvent and Leader Harvest deals, we believe management has further underlined its willingness to grow externally through small-/medium-sized deals focused on emerging markets and energy efficiency. This should alleviate investors concerns about a potential large-scale and valuedestroying acquisition and help the shares to re-rate. Risks to our TP: a slowdown in emerging markets.
Next events & catalysts

Source: SG Cross Asset Research

H1 results on 29 July. We expect H1 sales to rise by 21%, including

10.6% organic growth and an 11.2% consolidation effect. H1 EBITA is forecast at 1,537m, up 25%, with a margin of 14.8%, up 50bp.
Schneider on www.sgresearch.com

Share data

Financial data

12/10

12/11e

12/12e

12/13e

Ratios

12/10

12/11e

12/12e

12/13e

RIC SCHN.PA, Bloom SU FP 52-week range EV 11 (m) Market cap. (m) Free float (%) Performance (%) Ordinary shares Rel. Eurofirst 300 1m
0.3 3.6 -2.7 -2.1

Revenues (bn) EBIT margin (%) Rep. net inc. (bn) EPS (adj.) () Dividend/share () Payout (%) Interest cover (x) Net debt/equity (%)
Prev. EPS change (22/06/11) Gael de-Bray (33) 1 42 13 84 14
gael.de-bray@sgcib.com

19.58 15.0 1.72 7.19 3.20 49.7 8.4 18.3

22.34 15.9 2.14 8.61 4.00 50.1 9.1 36.8


8.69

24.85 16.3 2.51 10.04 4.50 47.9 11.9 17.4


9.90

26.41 16.6 2.80 11.10 5.50 52.6 17.4 8.4


10.99

P/E (x) FCF yield (/EV) (%) Dividend yield (%) Price/book value (x) EV/revenues (x) EV/EBIT (x) EV/IC (x) ROIC/WACC (x)
CAGR 10-13e: +15.5%

12.5 6.1 3.6 1.7 1.42 11.6 1.6 1.2

13.2 6.3 3.5 1.9 1.71 10.7 1.6 1.3

11.3 7.5 4.0 1.8 1.42 8.7 1.4 1.3

10.2 8.6 4.9 1.6 1.29 7.8 1.4 1.4

123.2-80.2 38,089 30,813 81.8 3m 12m


22.8 17.3

Adrien de-Susanne (33) 1 42 13 01 61


adrien.de-susanne@sgcib.com

Colin Campbell (44) 20 7762 5609


colin.campbell@sgcib.com

Societe Generale (SG) does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that SG 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. PLEASE SEE APPENDIX AT THE END OF THIS REPORT FOR THE ANALYST(S)

CERTIFICATION(S), IMPORTANT DISCLOSURES AND DISCLAIMERS AND THE STATUS OF NON-US RESEARCH ANALYSTS.

40

23 June 2011

Capital Goods

Sales/division 10

Electrical Equipment (France)

Price (21/06/11)

12m target

Schneider
Power 59%

BUY
12/06 227.7 82.84 18,861 -2,569 558 520 -490 20,978 13.9 11.6 16.6 2.2 1.53 8.8 3.6 5.96 7.16 38.28 3.00 13,730 5,679 2,394 -375 2,019 0 -121 0 -535 -37 1,310 1,323 2,394 -333 -472 1,588 -481 1,107 -735 -547 -174 10,181 1,493 2,273 1,159 8,717 122 660 -1,798 11.7 15.4 41.4 17.4 14.7 17.6 10.7 23.8 28.0 30.1 36.4 87.3 20.3 67.6 60.1 12/07 245.3 96.02 23,553 -5,579 576 704 -794 28,211 13.9 10.9 14.9 2.3 1.63 9.5 3.4 6.93 8.83 41.52 3.30 17,309 7,099 2,977 -416 2,562 0 -266 0 -600 -38 1,583 1,640 2,977 -121 -767 2,090 -560 1,529 -5,317 666 -3,121 14,193 3,714 2,819 996 10,185 129 786 -4,918 11.9 16.8 41.0 17.2 14.8 26.1 13.9 24.4 26.9 16.2 10.0 93.1 47.7 37.8 51.1 12/08 247.4 68.34 16,910 -5,530 492 674 -497 21,761 9.0 6.5 9.0 1.6 1.19 6.8 5.0 7.63 10.45 44.08 3.45 18,311 7,415 3,209 -455 2,754 0 -314 0 -555 -41 1,682 1,833 3,209 -72 -628 2,509 -693 1,816 -587 -783 446 15,221 3,991 2,706 1,463 10,906 145 860 -4,553 10.9 16.0 40.5 17.5 15.0 5.8 6.6 7.8 7.5 10.2 4.5 97.5 41.2 42.3 45.6 12/09 262.8 60.48 15,892 -3,855 756 482 -891 19,130 15.2 5.6 7.2 1.4 1.21 8.3 3.4 3.98 10.74 44.75 2.05 15,793 6,221 2,306 -483 1,823 0 -384 0 -293 -42 852 986 2,306 813 -454 2,665 -576 2,089 -103 -125 1,861 15,077 3,919 2,164 1,491 11,757 131 1,052 -2,812 7.1 7.5 39.4 14.6 11.5 -13.8 -15.7 -28.1 -33.8 -47.9 -40.6 151.7 23.7 42.3 25.1 12/10 272.0 89.97 24,468 -3,817 1,140 911 -786 27,728 12.5 10.5 13.7 1.7 1.42 8.0 3.6 7.19 8.59 54.36 3.20 19,580 7,738 3,448 -517 2,931 0 -347 0 -566 -76 1,720 1,893 3,448 -206 -980 2,262 -528 1,734 -1,749 89 74 17,913 4,258 2,908 1,504 14,785 204 1,592 -2,736 10.7 13.0 39.5 17.6 15.0 24.0 9.3 49.5 60.8 80.9 56.1 90.3 18.3 66.4 49.3

113.3
12/11e 272.0 113.30 30,813 -7,088 1,443 927 -328 38,089 13.2 11.6 15.2 1.9 1.71 9.0 3.5 8.61 9.78 58.96 4.00 22,339 8,935 4,080 -529 3,551 0 -389 0 -716 -87 2,136 2,317 4,080 -331 -1,117 2,632 -632 2,000 -2,646 -923 -1,569 20,489 5,511 3,239 1,504 16,036 291 1,592 -6,007 11.3 13.9 40.0 18.3 15.9 14.1 9.5 18.3 21.2 19.7 25.0 87.4 36.8 42.0 53.5 12/12e 272.0 113.30 30,813 -4,187 1,589 945 -328 35,316 11.3 10.2 13.3 1.8 1.42 7.7 4.0 10.04 11.08 64.15 4.50 24,845 10,062 4,563 -506 4,057 0 -341 0 -866 -105 2,511 2,700 4,563 -363 -1,219 2,981 -682 2,299 0 -1,100 1,199 20,443 5,402 3,603 1,504 17,447 396 1,592 -3,106 12.1 15.0 40.5 18.4 16.3 11.2 7.1 11.8 14.2 16.6 12.5 86.4 17.4 80.2 52.3

140.0
12/13e 272.0 113.30 30,813 -2,723 1,907 965 -328 34,150 10.2 8.9 11.3 1.6 1.29 7.0 4.9 11.10 12.71 69.90 5.50 26,405 10,773 4,876 -503 4,373 0 -251 0 -967 -126 2,796 2,985 4,876 -226 -1,230 3,419 -723 2,697 0 -1,233 1,464 20,442 5,313 3,829 1,504 19,010 522 1,592 -1,642 12.9 15.3 40.8 18.5 16.6 6.3 6.3 6.9 7.8 10.6 22.2 89.5 8.4 134.3 54.5

Industry 18% IT 14% Buildings 7% CST 2%

EBIT/division 10

Valuation* (m) Nb. of shares basic year end/outstanding Share price (average) Average market cap. (SG adjusted) (1) Restated net debt (-)/cash (+) (2) Value of minorities (3) Value of financial investments (4) Other adjustment (5) EV = (1) - (2) + (3) - (4) + (5) P/E (x) Price/cash flow (x) Price/free cash flow (x) Price/book value (x) EV/revenues (x) EV/EBITDA (x) Dividend yield (%) Per share data () SG EPS (adj.) Cash flow Book value Dividend Income statement (m) Revenues Gross income EBITDA Depreciation and amortisation EBIT Impairment losses Net interest income Exceptional & non-operating items 8.2 4.2 4.1 Taxation Minority interests Reported net income SG adjusted net income Cash flow statement (m) EBITDA Change in working capital Other operating cash movements Cash flow from operating activities Net capital expenditure Free cash flow Cash flow from investing activities Cash flow from financing activities Net change in cash resulting from CF Balance sheet (m) Total long-term assets of which intangible Working capital Employee benefit obligations Shareholders' equity Minority interests Provisions Net debt (-)/cash (+) Accounting ratios ROIC (%) ROE (%) Gross income/revenues (%) EBITDA margin (%) EBIT margin (%) Revenue yoy growth (%) Rev. organic growth (%) EBITDA yoy growth (%) EBIT yoy growth (%) EPS (adj.) yoy growth (%) Dividend growth (%) Cash conversion (%) Net debt/equity (%) FFO/net debt (%) Dividend paid/FCF (%)

Power 62%

Industry 19% IT 13% Buildings 4% CST 2%

Sales/region 10

Europe 33%

North. America 25% Asia 24% Others 18%

Major shareholders (%)


Capital research CDC Employees

Normalised data
EBITDA margin (%) Normalised growth (%) 16.6 4.5

* Valuation ratios for past years are based on average historical prices and market capitalisations

23 June 2011

41

Capital Goods

Machinery (Sweden)

VOLVO
12m target downgrade Weakening Chinese construction equipment data likely to weigh on the share

Hold (12m)
Price 21/06/11 12m target

Exposure to China

Volvos direct exposure to the Chinese construction theme mainly stems

from its Construction Equipment (CE) division (21% of group revenues in 2010). We estimate that, thanks to its Volvo and Lingong brands, the groups construction equipment sales in China should account for 8% of the groups revenues this year. Volvo is also indirectly exposed to the Chinese construction theme via its mining business (mostly hydraulic excavators and trucks). Volvos revenues in China increased from SEK6bn (3% of group revenues) to almost SEK23bn (9% of group revenues) between 2004 and 2010. The bulk of the growth came from CE and the successful integration of Lingong (acquired in 2007). We calculate that more than half of Volvo CEs organic sales growth between 2004 and 2010 came from China.

SEK105.5
Sector Weighting

SEK110.0

Overweight
Preferred stock

Siemens
Least preferred stock

Sandvik
Type of investment

Change in management Undervalued


1 year
Price
135

Chinese competition threat

Volvo does not face a significant threat from Chinese

competition within its Truck and Construction Equipment businesses in the short term. However, in both industries, Chinese players are eager to play a bigger role internationally with a particular focus on emerging markets. At CE, Volvo has developed a dual-brand strategy to target the medium- and high-end markets, allowing the group to compete on a level playing field with the Chinese players. In its Truck business, no real strategy has been implemented to contain rising Chinese competition risk.
Target price & rating

MA 100

110

85

Driven by a more cautious outlook on the Chinese construction

60 2010
(m) 60 40 20 0 2010 2011

2011

equipment market, albeit partly offset by higher truck delivery forecast (following the strong May delivery data), we have reduced our EPS forecasts by just 1% for 2013e. Reflecting increased risks relating to Chinese growth, we have reduced our DCF-derived (WACC of 10%, LT growth of 2% and normalised margin of 8%) target price to SEK110 from SEK125. We maintain our Hold rating on valuation grounds (the stock is trading on 6.5x EV/EBIT for 2012e vs 7.4x for Scania and MAN) although we believe weakening sentiment on the Chinese construction equipment industry is likely to hurt the shares. Key downside (upside) risk to the stock achieving our TP would come from lower (stronger) operating leverage at Trucks.
Next events & catalysts

Source: SG Cross Asset Research

Q2 results on 22 July.

Volvo on www.sgresearch.com

Share data

Financial data

12/10

12/11e

12/12e

12/13e

Ratios

12/10

12/11e

12/12e

12/13e

RIC VOLVb.ST, Bloom VOLVB SS 52-week range EV 11 (SEKm) Market cap. (SEKm) Free float (%) Performance (%) Ordinary shares Rel. Eurofirst 300 1m
-8.0 -4.7 -1.5 -0.5

Revenues (SEKbn) EBIT margin (%) Rep. net inc. (SEKbn) EPS (adj.) (SEK) Dividend/share (SEK) Payout (%) Interest cover (x) Net debt/equity (%)
Prev. EPS change (22/06/11) Sebastien Gruter (33) 1 42 13 47 22
sebastien.gruter@sgcib.com

257.37 294.21 329.46 354.16 6.9 10.87 5.36 2.50 0.0 5.5 33.3 9.0 17.72 8.74 3.50 28.6 10.7 17.2
8.42

P/E (x) FCF yield (/EV) (%) Dividend yield (%) Price/book value (x) EV/revenues (x) EV/EBIT (x) EV/IC (x) ROIC/WACC (x)
CAGR 10-13e: +34.5%

16.0 9.5 2.9 2.4 0.59 13.4 1.6 0.7

12.1 13.0 3.3 2.5 0.78 8.7 1.5 1.1

9.1 16.7 4.4 2.1 0.67 6.5 1.5 1.4

8.1 19.4 4.9 1.8 0.59 5.7 1.5 1.6

121.7-82.1 230,583 215,536 62.4 3m 12m


10.5 6.3

10.3 23.55 11.62 4.60 30.1 19.6 4.3


11.57

10.5 26.43 13.04 5.20 35.3 35.4 nm


13.21

Colin Campbell (44) 20 7762 5609


colin.campbell@sgcib.com

Societe Generale (SG) does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that SG 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. PLEASE SEE APPENDIX AT THE END OF THIS REPORT FOR THE ANALYST(S)

CERTIFICATION(S), IMPORTANT DISCLOSURES AND DISCLAIMERS AND THE STATUS OF NON-US RESEARCH ANALYSTS.

42

23 June 2011

Capital Goods

Sales/division

Machinery (Sweden)

Price (21/06/11)

12m target

Volvo
Trucks 63% Construction Equipment 20% Buses 8% Financial Services 3% Volvo Penta 3% Volvo Aero 3% other -1%

HOLD
12/06 1,368.1 75.31 106,915 22,104 284 -1,096 -11,090 86,191 5.9 8.3 8.0 1.8 0.35 2.8 13.3 12.79 9.07 42.94 10.00 248,135 55,893 30,810 -11,000 19,810 0 -100 0 3,981 50 26,042 25,895 30,810 1,765 -6,699 25,876 -13,000 12,876 -5,600 -6,075 1,201 124,039 8,045 24,813 8,692 86,904 284 22,104 13.5 31.5 22.5 12.4 8.0 7.3 8.0 18.4 22.9 133.6 nm 70.0 nm nm 47.2 12/07 1,369.1 118.38 168,717 -4,250 579 1,562 171,984 8.6 23.9 37.6 2.9 0.62 5.2 4.2 13.75 4.96 40.59 5.00 276,795 62,635 33,057 -12,474 20,583 0 -675 0 6,528 96 27,679 27,864 33,057 -9,993 -4,674 18,390 -12,005 6,385 -11,023 8,410 3,772 162,487 25,436 42,719 9,774 82,202 579 -4,250 11.6 32.7 22.6 11.9 7.4 11.6 4.0 7.3 3.9 7.5 -50.0 60.7 5.1 nm 318.4 12/08 1,370.1 73.80 109,928 -29,763 630 1,301 139,020 15.0 8.8 nm 1.8 0.47 5.0 2.7 4.90 8.37 41.45 2.00 295,836 62,322 27,978 -13,524 14,454 0 -1,842 0 -3,638 -74 9,941 9,941 27,978 -23,304 -3,905 769 -15,199 -14,430 9,536 7,034 3,168 196,381 32,886 60,665 11,705 84,010 630 -29,763 6.2 12.0 21.1 9.5 4.9 6.9 4.0 -15.4 -29.8 -64.3 -60.0 -65.5 35.2 75.6 nm 12/09 1,370.1 53.49 80,590 -41,489 629 1,456 121,252 nm 5.4 27.2 1.6 0.58 nm 0.0 -7.26 9.92 32.76 0.00 208,487 28,909 -1,133 -15,200 -16,333 0 -3,560 0 5,775 -33 -14,717 -14,717 -1,133 16,900 -880 14,887 -10,900 3,987 -8,700 -4,200 -9,113 174,282 30,556 39,631 8,051 66,405 629 -41,489 -6.8 -19.6 13.9 -0.5 -7.8 -29.5 -39.0 nm nm -248.0 -100.0 -52.6 61.9 2.6 102.8 12/10 1,370.1 85.54 126,549 -24,694 1,011 1,456 150,798 16.0 7.3 10.8 2.4 0.59 4.7 2.9 5.36 11.65 36.07 2.50 257,373 59,893 31,808 -13,974 17,834 0 -2,487 0 -4,168 -346 10,865 10,865 31,808 -84 -6,623 25,101 -9,000 16,101 0 0 16,101 170,868 29,642 39,715 7,510 73,110 1,011 -24,694 8.1 15.6 23.3 12.4 6.9 23.4 25.9 nm nm 173.8 na 128.1 33.3 101.9 0.0

SEK105.5
12/11e 1,370.1 105.50 215,536 -15,045 1,457 1,456 230,583 12.1 8.2 10.3 2.5 0.78 5.7 3.3 8.74 12.86 42.31 3.50 294,205 70,985 40,170 -13,607 26,564 0 -1,728 0 -7,202 -446 17,720 17,720 40,170 -2,017 -8,398 29,755 -9,000 20,755 0 -5,068 15,688 166,262 29,642 41,732 7,510 85,762 1,457 -15,045 12.4 22.3 24.1 13.7 9.0 14.3 20.5 26.3 48.9 63.1 40.0 112.6 17.2 207.6 24.4

SEK110.0
12/12e 1,370.1 105.50 215,536 -4,514 2,050 1,456 220,645 9.1 8.2 8.2 2.1 0.67 4.6 4.4 11.62 12.86 50.43 4.60 329,461 80,291 48,136 -14,151 33,985 0 -978 0 -9,572 -593 23,552 23,552 48,136 -3,354 -9,840 34,942 -9,000 25,942 0 -7,095 18,848 161,111 29,642 45,085 7,510 102,220 2,050 -4,514 16.2 25.1 24.4 14.6 10.3 12.0 12.0 19.8 27.9 32.9 31.4 108.2 4.3 nm 27.3 12/13e 1,370.1 105.50 215,536 6,069 2,712 1,456 210,723 8.1 5.5 7.2 1.8 0.59 4.1 4.9 13.04 19.03 58.87 5.20 354,158 84,493 52,006 -14,858 37,147 0 -293 0 -10,688 -662 26,427 26,427 52,006 -3,380 -10,058 38,568 -9,000 29,568 0 -9,324 20,244 155,253 29,642 48,465 7,510 119,323 2,712 6,069 18.2 23.9 23.9 14.7 10.5 7.5 7.5 8.0 9.3 12.2 13.0 110.2 nm nm 31.5

EBIT/division

Valuation* (SEKm) Nb. of shares basic year end/outstanding Share price (average) Average market cap. (SG adjusted) (1) Restated net debt (-)/cash (+) (2) Value of minorities (3) Value of financial investments (4) Other adjustment (5) EV = (1) - (2) + (3) - (4) + (5) P/E (x) Price/cash flow (x) Price/free cash flow (x) Price/book value (x) EV/revenues (x) EV/EBITDA (x) Dividend yield (%) Per share data (SEK) SG EPS (adj.) Cash flow Book value Dividend Income statement (SEKm) Revenues Gross income EBITDA Depreciation and amortisation EBIT Impairment losses Net interest income Exceptional & non-operating items Taxation Minority interests Reported net income SG adjusted net income Cash flow statement (SEKm) EBITDA Change in working capital Other operating cash movements Cash flow from operating activities Net capital expenditure Free cash flow Cash flow from investing activities Cash flow from financing activities Net change in cash resulting from CF Balance sheet (SEKm) Total long-term assets of which intangible Working capital Employee benefit obligations Shareholders' equity Minority interests Provisions Net debt (-)/cash (+) Accounting ratios ROIC (%) ROE (%) Gross income/revenues (%) EBITDA margin (%) EBIT margin (%) Revenue yoy growth (%) Rev. organic growth (%) EBITDA yoy growth (%) EBIT yoy growth (%) EPS (adj.) yoy growth (%) Dividend growth (%) Cash conversion (%) Net debt/equity (%) FFO/net debt (%) Dividend paid/FCF (%)

Trucks 56%

Construction Equipment 34% Buses 4% Volvo Penta 3% Volvo Aero 2% Financial Services 1% other -1%

Sales/region

W. Europe 34%

Asia 25% North. America 18% Latin America 11% Others 7% East. Europe 5%

Major shareholders (%)


Renault SA Capital Group Funds Industrivarden 6.8 5.4 4.2

Normalised data
EBITDA margin (%) Normalised growth (%) 11.0 2.4

* Valuation ratios for past years are based on average historical prices and market capitalisations

23 June 2011

43

Capital Goods

Electrical Equipment (France)

LEGRAND
Rating reiterated A market characterised by high entry costs and favourable pricing trends

Buy (12m)
Price 21/06/11 12m target

Exposure to China

Legrand derives just 3% of its sales from China but the group claims to

hold the number one position in wiring devices following the acquisition of TCL Electrical in 2005. Legrand has one of its largest industrial production facilities in the country, supplying the local residential market and exporting wiring devices to the UK, the Middle East and the US; 13% of the groups R&D workforce is also based in China.
Chinese competition threat

28.4
Sector Weighting

35.0

Overweight
Preferred stock

The Chinese ultra-low voltage market is highly fragmented

Siemens
Least preferred stock

(>1,000 local participants) and the distribution network is scattered and very specialised. As a result, we think acquisitions of local, small-scale manufacturers are required to enlarge the groups access to the Chinese market, and thus should represent a growth opportunity over

Sandvik
Type of investment

Undervalued M&A Pricing power


1 year
Price
32

time. Note also that Legrand launched new ranges in wiring devices (K5 and Meidian) and audio & video door entry systems in China in 2010, which should help the group gain market share. Generally speaking, the low voltage industry is characterised by a local market structure (varies in terms of national standards and aesthetic preferences), a recurring but diffuse flow of activity and the need to establish privileged relationships with numerous distributors and specifiers. In such a protected environment, Legrands capacity for continuous innovation gives it solid pricing power (+3% SGe 2011) in our view.

MA 100

28

24

Target price & rating


2010 2011

Building market volumes in mature markets remain 23% below pre-

20
(m) 7.5 5 2.5 0 2010 2011

crisis levels but are showing early signs of improvement. We reiterate our Buy rating and DCF-based target price of 35 (growth 2%, normalised margin 19%, WACC 8.4%). Risks to our TP: KKR and Wendel (combined stake of 21.3%) may decide to sell additional shares in the market.
Next events & catalysts

Source: SG Cross Asset Research

Q2 results on 28 July. We expect Q2 sales to rise by 6.6% including

5.6% organic growth, 3.7% consolidation effects and 2.6% negative currency effects. EBITA is seen at 227m, up 7% yoy, with a margin of 21.3%, unchanged from last years recordhigh level. Management should reiterate its FY guidance for 5% organic growth and a margin of at least 20%.
Legrand on www.sgresearch.com

Share data

Financial data

12/10

12/11e

12/12e

12/13e

Ratios

12/10

12/11e

12/12e

12/13e

RIC LEGD.PA, Bloom LR FP 52-week range EV 11 (m) Market cap. (m) Free float (%) Performance (%) Ordinary shares Rel. Eurofirst 300 1m
-4.8 -1.7 0.3 1.0

Revenues (bn) EBIT margin (%) Rep. net inc. (m) EPS (adj.) () Dividend/share () Payout (%) Interest cover (x) Net debt/equity (%)
Prev. EPS change (22/06/11) Gael de-Bray (33) 1 42 13 84 14
gael.de-bray@sgcib.com

3.89 20.2 419 1.63 0.88 55.0 7.1 43.8

4.25 20.8 520 2.03 1.05 52.9 13.5 39.2


2.04

4.61 21.5 602 2.32 1.15 50.0 15.8 26.3


2.31

4.91 22.0 677 2.59 1.25 48.4 24.1 13.9


2.58

P/E (x) FCF yield (/EV) (%) Dividend yield (%) Price/book value (x) EV/revenues (x) EV/EBIT (x) EV/IC (x) ROIC/WACC (x)
CAGR 10-13e: +16.6%

15.4 7.9 3.5 2.4 2.03 11.2 2.4 1.8

13.9 6.5 3.7 2.5 2.06 9.9 2.2 1.9

12.2 8.0 4.1 2.2 1.83 8.5 2.1 2.0

11.0 9.2 4.4 2.0 1.64 7.5 2.0 2.2

32.0-23.5 8,759 7,459 73.2 3m 12m


5.5 0.8

Adrien de-Susanne (33) 1 42 13 01 61


adrien.de-susanne@sgcib.com

Colin Campbell (44) 20 7762 5609


colin.campbell@sgcib.com

Societe Generale (SG) does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that SG 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. PLEASE SEE APPENDIX AT THE END OF THIS REPORT FOR THE ANALYST(S)

CERTIFICATION(S), IMPORTANT DISCLOSURES AND DISCLAIMERS AND THE STATUS OF NON-US RESEARCH ANALYSTS.

44

23 June 2011

Capital Goods

Sales/division 10
Others 27%

Electrical Equipment (France)

Price (21/06/11)

12m target

Legrand
France 24% Other Europe 19% Italy 15% North. America 14%

BUY
12/06 269.7 22.00 5,933 -1,898 24 38 7,818 14.8 9.5 12.0 2.7 2.09 10.1 2.3 1.48 2.33 8.01 0.50 3,737 1,855 773 -157 616 0 -192 0 -83 -3 252 370 773 -37 -154 582 -125 456 -88 -114 254 4,394 1,840 439 155 2,160 9 102 -1,743 12.4 18.7 49.6 20.7 16.5 15.1 7.8 16.9 21.1 71.2 22.6 107.8 80.4 26.2 29.6 12/07 271.0 24.70 6,693 -2,010 9 34 8,678 14.2 9.7 12.0 3.1 2.10 9.9 2.8 1.73 2.55 7.85 0.70 4,129 2,068 877 -153 724 0 -66 0 -175 -2 421 465 877 18 -211 684 -133 552 -270 -417 -135 4,460 1,784 417 125 2,128 3 81 -1,885 14.5 19.6 50.1 21.3 17.5 10.5 8.6 13.5 17.5 16.9 40.0 100.4 88.4 31.7 32.9 12/08 262.8 17.08 4,489 -2,006 12 18 6,489 11.6 7.8 10.4 2.1 1.54 7.5 4.1 1.48 2.20 8.30 0.70 4,202 2,132 860 -162 698 0 -148 0 -143 -2 350 388 860 -19 -263 578 -148 430 -132 -263 35 4,449 1,773 445 144 2,180 6 63 -1,862 13.5 16.2 50.7 20.5 16.6 1.8 -0.1 -2.0 -3.7 -14.9 0.0 101.7 85.2 28.3 41.7 12/09 263.1 16.16 4,251 -1,469 9 7 5,722 12.9 5.8 6.4 1.8 1.60 7.7 4.3 1.26 2.78 9.08 0.70 3,578 1,877 745 -166 579 0 -102 0 -131 -2 290 333 745 242 -250 738 -72 666 -5 -107 554 4,365 1,770 296 129 2,389 5 172 -1,340 11.4 12.7 52.5 20.8 16.2 -14.9 -13.9 -13.3 -17.0 -14.9 0.0 160.0 56.0 34.9 27.5 12/10 263.1 25.06 6,594 -1,334 13 33 7,909 15.4 9.0 10.4 2.4 2.03 8.3 3.5 1.63 2.80 10.38 0.88 3,891 2,093 950 -166 784 0 -111 0 -227 -1 419 437 950 76 -277 749 -104 645 -289 -181 176 4,641 1,768 269 137 2,731 5 205 -1,198 15.3 16.4 53.8 24.4 20.2 8.7 3.6 27.5 35.5 29.9 25.7 108.1 43.8 45.9 35.7

28.4
12/11e 263.1 28.35 7,459 -1,321 12 33 8,759 13.9 12.1 15.0 2.5 2.06 8.3 3.7 2.03 2.35 11.48 1.05 4,250 2,282 1,049 -165 884 0 -65 0 -263 -1 520 544 1,049 -93 -328 628 -121 507 -262 -232 13 4,824 1,735 361 137 3,020 5 205 -1,185 16.0 18.1 53.7 24.7 20.8 9.2 6.7 10.4 12.7 24.5 19.3 94.5 39.2 54.6 54.2 12/12e 263.1 28.35 7,459 -1,013 10 33 8,449 12.2 10.3 12.4 2.2 1.83 7.3 4.1 2.32 2.76 12.62 1.15 4,605 2,491 1,152 -160 992 0 -63 0 -297 -2 602 622 1,152 -53 -360 739 -127 612 0 -303 308 4,763 1,710 414 137 3,321 5 205 -876 17.2 19.0 54.1 25.0 21.5 8.4 6.4 9.8 12.2 14.2 9.5 98.0 26.3 78.2 49.2

35.0
12/13e 263.1 28.35 7,459 -648 9 33 8,083 11.0 9.1 10.9 2.0 1.64 6.5 4.4 2.59 3.10 13.95 1.25 4,915 2,674 1,239 -157 1,081 0 -45 0 -334 -2 677 693 1,239 -28 -379 831 -137 695 0 -329 366 4,719 1,692 442 137 3,670 5 205 -511 18.6 19.4 54.4 25.2 22.0 6.7 6.7 7.5 9.0 11.5 8.7 99.3 13.9 132.7 47.1

EBIT/division 10

France 34%

Valuation* (m) Nb. of shares basic year end/outstanding Share price (average) Average market cap. (SG adjusted) (1) Restated net debt (-)/cash (+) (2) Value of minorities (3) Value of financial investments (4) Other adjustment (5) EV = (1) - (2) + (3) - (4) + (5) P/E (x) Price/cash flow (x) Price/free cash flow (x) Price/book value (x) EV/revenues (x) EV/EBITDA (x) Dividend yield (%) Per share data () SG EPS (adj.) Cash flow Book value Dividend Income statement (m) Revenues Gross income EBITDA Depreciation and amortisation EBIT Impairment losses Net interest income Exceptional & non-operating items 10.5 10.5 5.0 Taxation Minority interests Reported net income SG adjusted net income Cash flow statement (m) EBITDA Change in working capital Other operating cash movements Cash flow from operating activities Net capital expenditure Free cash flow Cash flow from investing activities Cash flow from financing activities Net change in cash resulting from CF Balance sheet (m) Total long-term assets of which intangible Working capital Employee benefit obligations Shareholders' equity Minority interests Provisions Net debt (-)/cash (+) Accounting ratios ROIC (%) ROE (%) Gross income/revenues (%) EBITDA margin (%) EBIT margin (%) Revenue yoy growth (%) Rev. organic growth (%) EBITDA yoy growth (%) EBIT yoy growth (%) EPS (adj.) yoy growth (%) Dividend growth (%) Cash conversion (%) Net debt/equity (%) FFO/net debt (%) Dividend paid/FCF (%)

Italy 24% Others 20% Other Europe 13% North. America 9%

Sales/region 10
Others 27%

France 24% Other Europe 19% Italy 15% North. America 14%

Major shareholders (%)


KKR Wendel Employees

Normalised data
EBITDA margin (%) Normalised growth (%) 25.5 5.9

* Valuation ratios for past years are based on average historical prices and market capitalisations

23 June 2011

45

Capital Goods

APPENDIX
COMPANIES MENTIONED ABB (ABBN.VX, Hold) Alstom (ALSO.PA, Sell) Anglo American (AAL.L, Hold) Assa Abloy (ASSAb.ST, Hold) Atlas Copco (ATCOa.ST, Hold) BHP Billiton (BLT.L, Hold) Caterpillar (CAT.N, No Reco- ) GKN (GKN.L, Buy) Invensys (ISYS.L, Hold) Legrand (LEGD.PA, Buy) MAN (MANG.DE, Buy) Nexans (NEXS.PA, Hold) Philips (PHG.AS, Buy) Rio Tinto (RIO.L, Buy) Sandvik (SAND.ST, Sell) Schneider (SCHN.PA, Buy) Siemens (SIEGn.DE, Buy) SKF (SKFb.ST, Buy) Vale (VALE.N, Buy) Volvo (VOLVb.ST, Hold) Wendel (MWDP.PA, Buy) Xstrata (XTA.L, No Reco) Scania AB (SCVb.ST, Buy) ANALYST CERTIFICATION Each author of this research report hereby certifies that (i) the views expressed in the research report accurately reflect his or her personal views about any and all of the subject securities or issuers and (ii) no part of his or her compensation was, is, or will be related, directly or indirectly, to the specific recommendations or views expressed in this report: Gal de Bray, Adrien de Susanne, Colin Campbell.

Historical Price: ASSA-ABLOY (ASSAb.ST)

2008/2009 Change 25/07/08 20/10/08 New Target: 88.0 New Rating: Sell New Target: 60.0 New Target: 55.0 New Target: 52.0 New Target: 80.0 New Target: 97.0 New Target: 105.0

2010/2011 22/04/10 15/07/10 15/07/10 28/10/10 30/11/10 13/01/11 29/04/11

Change New Target: 133.0 New Rating: Hold New Target: 171.0 New Target: 160.0 New Rating: Sell New Target: 170.0 New Rating: Hold

189
169 149

20/10/08 19/01/09 02/04/09 23/04/09 30/07/09 29/10/09

129
109 89 69 49 06/08 09/08 12/08 03/09 06/09 09/09 12/09 03/10 06/10 09/10 12/10 03/11
Price Target MA100 Change Reco

Source: SG Cross Asset Research

46

23 June 2011

Capital Goods

Historical Price: Atlas Copco (ATCOa.ST)


206 186 166

2008/2009 Change 21/10/08 24/10/08 03/02/09 28/04/09 23/10/09 20/11/09 New Target: 57.0 New Target: 55.0 New Target: 52.0 New Target: 78.0 New Target: 91.0 New Target: 95.0

2010/2011 14/01/10 29/04/10 19/07/10 05/10/10 05/10/10 25/10/10 13/01/11 03/02/11 21/04/11

Change New Target: 111.0 New Target: 117.0 New Target: 125.0 New Rating: Buy New Target: 145.0 New Target: 165.0 New Target: 200.0 New Target: 190.0 New Target: 200.0

146 126
106 86 66 46 06/08 09/08 12/08 03/09 06/09 09/09 12/09 03/10 06/10 09/10 12/10 03/11
Price Target MA100 Change Reco

Source: SG Cross Asset Research

Historical Price: Legrand (LEGD.PA)


35

2008/2009 Change 23/07/08 08/09/08 20/10/08 20/10/08 07/05/09 30/07/09 30/07/09 17/09/09 28/10/09 06/11/09 New Target: 17.5 New Target: 17.0 New Rating: Sell New Target: 11.0 New Target: 13.5 New Rating: Hold New Target: 15.5 New Target: 18.8 New Target: 20.0 New Target: 21.0

2010/2011 12/01/10 12/01/10 05/02/10 07/05/10 05/11/10 10/01/11

Change New Rating: Buy New Target: 23.0 New Target: 24.0 New Target: 28.0 New Target: 32.0 New Target: 35.0

30

25

20

15

10 06/08 09/08 12/08 03/09 06/09 09/09 12/09 03/10 06/10 09/10 12/10 03/11
Price Target MA100 Change Reco

Source: SG Cross Asset Research

Historical Price: SANDVIK (SAND.ST)

2008/2009 Change 21/07/08 New Target: 73.0 New Target: 39.0 New Target: 35.0 New Rating: Buy New Target: 68.0 New Target: 74.0 New Target: 90.0

2010/2011 12/01/10 05/05/10 05/10/10 05/10/10 10/01/11 03/02/11

Change New Target: 100.0 New Target: 120.0 New Rating: Sell New Target: 90.0 New Target: 115.0 New Rating: Hold

133

29/10/08 20/11/08 30/04/09 30/04/09 20/07/09 02/11/09

113

93

73

53

33 06/08 09/08 12/08 03/09 06/09 09/09 12/09 03/10 06/10 09/10 12/10 03/11
Price Target MA100 Change Reco

Source: SG Cross Asset Research

23 June 2011

47

Capital Goods

Historical Price: Schneider (SCHN.PA)

2008/2009 Change 25/07/08 New Target: 75.0 New Target: 67.0 New Target: 52.0 New Target: 48.0 New Rating: Buy New Target: 60.0 New Rating: Hold New Target: 67.0 New Target: 70.0

2010/2011 12/01/10 19/02/10 22/04/10 23/07/10 02/08/10 18/11/10 10/01/11 10/01/11 08/03/11

Change New Target: 74.0 New Target: 77.0 New Target: 84.0 New Target: 90.0 New Target: 95.0 New Target: 105.0 New Rating: Buy New Target: 135.0 New Target: 140.0

138

29/09/08 20/10/08 18/12/08 08/06/09 08/06/09 03/08/09 14/09/09 01/12/09

118

98

78

58

38 06/08 09/08 12/08 03/09 06/09 09/09 12/09 03/10 06/10 09/10 12/10 03/11
Price Target MA100 Change Reco

Source: SG Cross Asset Research

Historical Price: VOLVO 'B' (VOLVb.ST)


128

2008/2009 Change 30/03/09 30/03/09 27/04/09 27/04/09 06/10/09 06/10/09 New Rating: Hold New Target: 39.0 New Rating: Sell New Target: 43.0 New Rating: Buy New Target: 79.0

2010/2011 16/04/10 26/04/10 10/01/11 10/01/11 07/02/11 25/03/11 28/04/11

Change New Target: 93.0 New Target: 110.0 New Rating: Hold New Target: 125.0 New Target: 120.0 New Target: 115.0 New Target: 125.0

108

88

68

48

28 06/08 09/08 12/08 03/09 06/09 09/09 12/09 03/10 06/10 09/10 12/10 03/11
Price Target MA100 Change Reco

Source: SG Cross Asset Research

SG RATINGS BUY: expected total return of 10% or more over a 12 month period. HOLD: expected total return between -10% and +10% over a 12 month period. SELL: expected total return of -10% or worse over a 12 month period. Sector Weighting Definition: The sector weightings are assigned by the SG Equity Research Strategist and are distinct and separate from SG research analyst ratings. They are based on the relevant MSCI. OVERWEIGHT: sector expected to outperform the relevant broad market benchmark over the next 12 months. NEUTRAL: sector expected to perform in-line with the relevant broad market benchmark over the next 12 months. UNDERWEIGHT: sector expected to underperform the relevant broad market benchmark over the next 12 months.

Equity rating and dispersion relationship


250 48% 40%

200

150 50% 100 39% 13% 50 48%

0 Buy
Companies Covered

Hold
Cos. w/ Banking Relationship

Sell

Source: SG Cross Asset Research

48

23 June 2011

Capital Goods

MSCI DISCLAIMER: The MSCI sourced information is the exclusive property of Morgan Stanley Capital International Inc. (MSCI). Without prior written permission of MSCI, this information and any other MSCI intellectual property may not be reproduced, redisseminated or used to create any financial products, including any indices. This information is provided on an as is basis. The user assumes the entire risk of any use made of this information. MSCI, its affiliates and any third party involved in, or related to, computing or compiling the information hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any of this information. Without limiting any of the foregoing, in no event shall MSCI, any of its affiliates or any third party involved in, or related to, computing or compiling the information have any liability for any damages of any kind. MSCI, Morgan Stanley Capital International and the MSCI indexes are service marks of MSCI and its affiliates or such similar language as may be provided by or approved in advance by MSCI.

IMPORTANT DISCLOSURES

Alstom Alstom Alstom Caterpillar Caterpillar Legrand MAN Rio Tinto Schneider Schneider Vale Wendel Wendel Xstrata

SG acted as joint bookrunner in Alstom's senior bond issue. SG acted as financial advisor to Alstom for the acquisition of Areva T&D. SG is a lender to Alstom Group. SG acted as joint bookrunner in Caterpillar Financial Services' senior bond issue. SG acted as joint bookrunner of Caterpillar's bond issue. SG acted as joint bookrunner in legrand's bond issue (4.375% 21/03/18 EUR). SG is acting as Mandated Lead Arranger of the acquisition facilities set up by MAN for the acquisition of Brazil-based Volkswagen Truck & Bus SG acted as financial advisor to Apollo in acquiring together with the Fonds Stratgique d'Investisssement (FSI) 61% stake in Alcan Engineering Products from Rio Tinto SG acted as Joint Dealer Manager in Schneider's bond tender offer. SG acted as financial advisor to Alstom for the acquisition of Areva T&D. SG is acting as financial adviser to Vale S.A. in respect of its offer to acquire Metorex Limited. SG acted as joint bookrunner in the WENDEL's senior bond issue. SG acted as joint bookrunner in Wendel's senior bond issue (tap) (4.875% 26/05/16 EUR). SG is acting as co-bookrunner in Glencore's IPO.

Director: A senior employee, executive officer or director of SGAS and/or SGCIB is a director and/or officer of Alstom. SG or its affiliates act as market maker or liquidity provider in the equities securities of ABB, Alstom, Atlas Copco, MAN, Philips, Schneider, Siemens, Volvo. SG or its affiliates expect to receive or intend to seek compensation for investment banking services in the next 3 months from Alstom, BHP Billiton plc, GKN, MAN, Rio Tinto, Siemens, Vale, Volvo, Wendel. SG or its affiliates have received compensation for investment banking services in the past 12 months from Alstom, Caterpillar, MAN, Schneider, Vale, Wendel. SG or its affiliates managed or co-managed in the past 12 months a public offering of securities of Alstom, Caterpillar, Wendel. SGAS had a non-investment banking non-securities services client relationship during the past 12 months with ABB, Rio Tinto, SKF, Schneider, Siemens, Vale, Volvo, Xstrata. SGAS received compensation for products and services other than investment banking services in the past 12 months from ABB, Rio Tinto, SKF, Schneider, Siemens, Vale, Volvo, Xstrata. SGCIB received compensation for products and services other than investment banking services in the past 12 months from ABB, Alstom, BHP Billiton plc, Legrand, Nexans, Philips, Rio Tinto, Sandvik, Scania AB, Schneider, Siemens, Vale, Volvo, Wendel, Xstrata.

FOR DISCLOSURES PERTAINING TO COMPENDIUM REPORTS OR RECOMMENDATIONS OR ESTIMATES MADE ON SECURITIES OTHER THAN THE PRIMARY SUBJECT OF THIS RESEARCH REPORT, PLEASE VISIT OUR GLOBAL RESEARCH DISCLOSURE WEBSITE AT http://www.sgresearch.com/compliance.rha or call +1 (212).278.6000 in the U.S.
The analyst(s) responsible for preparing this report receive compensation that is based on various factors including SGs total revenues, a portion of which are generated by investment banking activities. Non-U.S. Analyst Disclosure: The name(s) of any non-U.S. analysts who contributed to this report and their SG legal entity are listed below. U.S. analysts are employed by SG Americas Securities LLC. The non-U.S. analysts are not registered/qualified with FINRA, may not be associated persons of SGAS and may not be subject to the FINRA restrictions on communications with a subject company, public appearances and trading securities held in the research analyst(s) account(s): Sbastien Gruter Socit Gnrale Paris, Gal de Bray Socit Gnrale Paris, Adrien de Susanne Socit Gnrale Paris, Colin Campbell Socit Gnrale London

IMPORTANT DISCLAIMER: The information herein is not intended to be an offer to buy or sell, or a solicitation of an offer to buy or sell, any securities and has been obtained from, or is based upon, sources believed to be reliable but is not guaranteed as to accuracy or completeness. SG does, from time to time, deal, trade in, profit from, hold, act as market-makers or advisers, brokers or bankers in relation to the securities, or derivatives thereof, of

23 June 2011

49

Capital Goods

persons, firms or entities mentioned in this document and may be represented on the board of such persons, firms or entities. SG does,, from time to time, act as a principal trader in debt securities that may be referred to in this report and may hold debt securities positions. Employees of SG, or individuals connected to them, may from time to time have a position in or hold any of the investments or related investments mentioned in this document. SG is under no obligation to disclose or take account of this document when advising or dealing with or on behalf of customers. The views of SG reflected in this document may change without notice. In addition, SG may issue other reports that are inconsistent with, and reach different conclusions from, the information presented in this report and is under no obligation to ensure that such other reports are brought to the attention of any recipient of this report. To the maximum extent possible at law, SG does not accept any liability whatsoever arising from the use of the material or information contained herein. This research document is not intended for use by or targeted to retail customers. Should a retail customer obtain a copy of this report he/she should not base his/her investment decisions solely on the basis of this document and must seek independent financial advice. The financial instrument discussed in this report may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein. The value of securities and financial instruments is subject to currency exchange rate fluctuation that may have a positive or negative effect on the price of such securities or financial instruments, and investors in securities such as ADRs effectively assume this risk. SG does not provide any tax advice. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized. Investments in general, and derivatives in particular, involve numerous risks, including, among others, market, counterparty default and liquidity risk. Trading in options involves additional risks and is not suitable for all investors. An option may become worthless by its expiration date, as it is a depreciating asset. Option ownership could result in significant loss or gain, especially for options of unhedged positions. Prior to buying or selling an option, investors must review the "Characteristics and Risks of Standardized Options" at http://www.optionsclearing.com/publications/risks/riskchap.1.jsp. Important European MIFID Notice: The circumstances in which material provided by SG European Fixed Income (Credit) & Forex Research, SG Commodity Research, SG Convertible Research and SG Equity Derivatives Research have been produced are such (for example, because of reporting or remuneration structures or the physical location of the author of the material) that it is not appropriate to characterize it as independent investment research as referred to in the European Markets in Financial Instruments Directive and that it should be treated as marketing material even if it contains a research recommendation (recommandation dinvestissement caractre promotionnel). However, it must be made clear that all publications issued by SG will be clear, fair and not misleading. For more details please refer to SGs Policies for Managing Conflicts of Interest in Connection with Investment Research posted on SGs disclosure website referenced herein. Notice to French Investors: This publication is issued in France by or through Socit Gnrale ("SG") which is authorised and supervised by the Autorit de Contrle Prudentiel and regulated by the Autorite des Marches Financiers. Notice to U.K. Investors: This publication is issued in the United Kingdom by or through Socit Gnrale ("SG"), London Branch . Socit Gnrale is a French credit institution (bank) authorised and supervised by the Autorit de Contrle Prudentiel (the French Prudential Control Authority). Socit Gnrale is subject to limited regulation by the Financial Services Authority (FSA) in the U.K. Details of the extent of SG's regulation by the FSA are available from SG on request. The information and any advice contained herein is directed only at, and made available only to, professional clients and eligible counterparties (as defined in the FSA rules) and should not be relied upon by any other person or party. Notice to Polish Investors: this document has been issued in Poland by Societe Generale S.A. Oddzial w Polsce (the Branch) with its registered office in Warsaw (Poland) at 111 Marszakowska St. The Branch is supervised by the Polish Financial Supervision Authority and the French Autorit de Contrle Prudentiel. This report is addressed to financial institutions only, as defined in the Act on trading in financial instruments. The Branch certifies that this document has been elaborated with due dilligence and care. Notice to U.S. Investors: For purposes of SEC Rule 15a-6, SG Americas Securities LLC (SGAS) takes responsibility for this research report. This report is intended for institutional investors only. Any U.S. person wishing to discuss this report or effect transactions in any security discussed herein should do so with or through SGAS, a broker-dealer registered with the SEC and a member of FINRA, 1221 Avenue of the Americas, New York, NY 10020. (212)-278-6000. Notice to Singapore Investors: This document is provided in Singapore by or through Socit Gnrale ("SG"), Singapore Branch and is provided only to accredited investors, expert investors and institutional investors, as defined in Section 4A of the Securities and Futures Act, Cap. 289. Recipients of this document are to contact Socit Gnrale, Singapore Branch in respect of any matters arising from, or in connection with, the document. If you are an accredited investor or expert investor, please be informed that in SG's dealings with you, SG is relying on the following exemptions to the Financial Advisers Act, Cap. 110 (FAA): (1) the exemption in Regulation 33 of the Financial Advisers Regulations (FAR), which exempts SG from complying with Section 25 of the FAA on disclosure of product information to clients; (2) the exemption set out in Regulation 34 of the FAR, which exempts SG from complying with Section 27 of the FAA on recommendations; and (3) the exemption set out in Regulation 35 of the FAR, which exempts SG from complying with Section 36 of the FAA on disclosure of certain interests in securities. Notice to Hong Kong Investors: This report is distributed in Hong Kong by Socit Gnrale, Hong Kong Branch which is licensed by the Securities and Futures Commission of Hong Kong under the Securities and Futures Ordinance (Chapter 571 of the Laws of Hong Kong) ("SFO"). This document does not constitute a solicitation or an offer of securities or an invitation to the public within the meaning of the SFO. This report is to be circulated only to "professional investors" as defined in the SFO. Notice to Japanese Investors: This publication is distributed in Japan by Societe Generale Securities (North Pacific) Ltd., Tokyo Branch, which is regulated by the Financial Services Agency of Japan. This document is intended only for the Specified Investors, as defined by the Financial Instruments and Exchange Law in Japan and only for those people to whom it is sent directly by Societe Generale Securities (North Pacific) Ltd., Tokyo Branch, and under no circumstances should it be forwarded to any third party. The products mentioned in this report may not be eligible for sale in Japan and they may not be suitable for all types of investors. Notice to Australian Investors: This document is issued in Australia by Socit Gnrale (ABN 71 092 516 286) ("SG"). SG is regulated by APRA and ASIC and holds an AFSL no. 236651 issued under the Corporations Act 2001 (Cth) ("Act"). The information contained in this document is only directed to recipients who are wholesale clients as defined under the Act. Notice to Canadian Investors: This document is for information purposes only and is intended for use by Permitted Clients, as defined under National Instrument 31-103, Accredited Investors, as defined under National Instrument 45-106, Accredited Counterparties as defined under the Derivatives Act (Qubec) and "Qualified Parties" as defined under the ASC, BCSC, SFSC and NBSC Orders http://www.sgcib.com. Copyright: The Socit Gnrale Group 2011. All rights reserved. This publication may not be reproduced or redistributed in whole in part without the prior consent of SG or its affiliates.

50

23 June 2011