a00--20101231 Australia Cover 2...Economic outlook: Tiger taming 16 Baseline economic forecast 16 Correlations may be misleading 20 One step forward, one step back 24 ... Leighton

4 January 2011 Nomura

N O M U R A I N T E R N A T I O N A L ( H K ) L I M I T E D

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Nomura Anchor Reports examine the key themes and value drivers that underpin our sector views and stock recommendations for the next 6 to 12 months.

Any authors named on this report are research analysts unless otherwise indicated. See the important disclosures and analyst certifications on pages 69 to 72.

Strategy | A U S T R A L I A 2011 Outlook

Mixo Das +852 2252 1424 [email protected]

Richard Johnson +61 2 8062 8412 [email protected]

Sunny side up We retain our Bullish stance on Australian equities entering 2011. As deflation fears recede and investors reallocate funds from bonds to equities globally, developed markets will be favoured, in our view. Given its attractive valuation and excellent return profile, Australia stands to benefit.

In contrast to most markets in the region, monetary conditions in Australia will likely ease in 2011, as the RBA is already past the bulk of tightening and is in a position to conduct policy more flexibly. In addition, the AUD is likely to remain stable against the US$ (meaning it will weaken against most trade partners’ currencies). Commodity prices are likely to remain strong over the next two years, keeping terms-of-trade elevated. Despite the favourable conditions, Australian equities are cheap at 11.5x 2011F earnings and a dividend yield of 4.6%.

We continue to recommend switching from banks to consumer staples and initiate a new switch from US to Australian health care. We also recommend owning a basket of Australian LNG players.

A rebalancing economy

One step forward, one step back

Linking into the Silk Road

TOPDOWN

Stocks for action

Stock Rating PricePrice

target

Amcor (AMC AU) BUY 6.8 7.55

Cochlear (COH AU) BUY 80.4 89.0

Myer Holdings (MYR AU) BUY 3.6 4.50

RIO Tinto (RIO LN) BUY 4,584p 5,900p

Westpac (WBC AU) BUY 22.4 25.0

Woodside (WPL AU) BUY 42.6 56.4

Leighton (LEI AU) REDUCE 30.9 28.6

Pricing as of 30 December, 2010

Analysts Mixo Das

+852 2252 1424

[email protected]

Richard Johnson

+61 2 8062 8412

[email protected]

Stephen Roberts

+61 2 8062 8631

[email protected]

And the Australia Research team

Don’t miss our companion outlook reports on Asia and Global Economics,

published 6 December 2010.

4 January 2011 Nomura 1

Strategy | A U S T R A L I A 2011 Outlook

Mixo Das +852 2252 1424 [email protected]


Action After narrowly missing a recession in 2008-09, Australia’s economy has taken full

advantage of the upturn in commodity trade as China and India have returned to trend-line growth. The domestic economy has begun to rebalance itself as better employment conditions have allowed the central bank to tighten rates. With the terms of trade at the highest level ever, the currency is well supported. A minerals investment boom is emerging, which we think ought to go some way in improving the economy's competitive position in commodities.

Anchor themes With funds flowing out of global bond markets as deflation fears subside, Australia looks attractively priced for international investors at 11.5x 2011F earnings and a dividend yield of 4.6%.

With the country's productive capacity almost used up, the RBA will need to be on guard to contain inflation. With real rates positive and further rate hikes up to 5.25% in 2011, the A$ ought to remain strong against the US$, underwriting total returns.

Sunny side up A rebalancing economy

Australia has gone a long way to address its overleveraged problems, in contrast to others like China and India, where the economies/markets appear unbalanced in relation to inflationary pressures. By pre-emptively raising rates, the RBA has bought itself flexibility, while other Asian central banks have maintained loose monetary policy in hopes that China will take the lead in controlling inflation.

One step forward, one step back

With the focus on the mining boom, Australia has taken a back foot in productivity. Multi-factor productivity growth has declined in the past decade and is now in negative territory. The demographics are also decidedly turning against Australia, with the working-age population nearing a peak. This, combined with declining productivity, bodes ill for sustainable growth. The manufacturing sector in particular looks most worrisome with its productivity losses and lack of capital expenditure.

Linking into the Silk Road

Nomura's regional energy team expects a five-fold increase in Australia's LNG export capacity, given that the building of several projects is under way. The team expects a quadrupling of gas production from the current 47bcm to just under 200bcm by 2020F. The expansion of LNG projects in Western Australia’s offshore basin alongside Coal Seam Gas (CSG) projects in Eastern Australia and ventures in Papua New Guinea ought to lift Australasia from number six to the largest LNG exporter in the world by 2015F, we expect.

N O M U R A I N T E R N A T I O N A L ( H K ) L I M I T E D

TOPDOWN

Market calls

We retain a positive view on Australian equities entering 2011. We continue to recommend switching from banks to consumer staples and initiate a new switch from US to Australian health care. We also recommend owning a basket of Australian LNG players.

Analysts Mixo Das

+852 2252 1424

[email protected]

Richard Johnson

+61 2 8062 8412

[email protected]

Stephen Roberts

+61 2 8062 8631

[email protected]

and the Australia Research team

Stock Rating PricePrice

target

Amcor (AMC AU) BUY 6.8 7.55

Cochlear (COH AU) BUY 80.4 89.0

Myer Holdings (MYR AU) BUY 3.6 4.50

RIO Tinto (RIO LN) BUY 4,584p 5,900p

Westpac (WBC AU) BUY 22.4 25.0

Woodside (WPL AU) BUY 42.6 56.4

Leighton (LEI AU) REDUCE 30.9 28.6

Pricing as of 30 December, 2010

Strategy | Australia Mixo Das


Contents

Top picks 3

Recommendations 4

Sunny side up 6

Sector Aggregates and Indices 12

Quantitative Insights 14 Australia Factor Returns 15

Economic outlook: Tiger taming 16

Baseline economic forecast 16

Correlations may be misleading 20

One step forward, one step back 24

Linking into the Silk Road 28

Economic housing: the next driver? 33

Impact from Basel III 36

Appendix 1: Commodity Price Forecasts 38

Appendix 2: Nomura FX forecasts 39

Stock picks 41 Amcor 42

Cochlear 46

Leighton Holdings 50

Myer Holdings 54

Westpac Banking Corp 58

Woodside Petroleum 62

Rio Tinto 66

Also see our Anchor Report: Asia Pacific Strategy — Deflation, inflation and the return of the productive economy (6 December, 2010)

Also see our NOMURA: 2011 Global Economic Outlook — Rocky Road of Recovery (6 December, 2010)

http://www.nomura.com/research/GetPub.aspx?spid=7226

http://grp.uk.nomura.com/research/getpub.aspx?pid=407182



Stocks for Action

Top picks

Exhibit 1. Top Picks

Company Price

(local) Price target

(local) Nomura

rating Analyst comment Analyst(s)

Amcor (AMC AU) 6.8 7.55 BUY Packaging share prices have historically performed best during periods of acquisition-sponsored earnings growth. Amcor is in just such a period.

Richard Johnson Simon Thackray

Cochlear (COH AU) 80.4 89.0 BUY We believe the market size of cochlear implantation is large, with the major potential growth impediment being a rise in cochlear implant support staff.

Dr. David Stanton Zara Lyons

Myer Holdings (MYR AU)

3.55 4.50 BUY An emerging sustainable improvement in underlying sales fundamentals points to solid value opportunities in the Australian discretionary retail sector. Recent sector weakness on tightened policy rates provides a good entry point, in our view, with solid employment and wage growth set to drive discretionary spend in 2011F.

Nick Berry David Cooke Rob Freeman

Rio Tinto (RIO LN) 4,584p 5,900p BUY A prolonged period of high commodity prices will spur super-normal free cashflow over the next several years, particularly in iron ore, coal, and copper. We prefer those miners more inclined to return excess cash to shareholders.

Paul Cliff

Westpac (WBC AU) 22.4 25.0 BUY We believe the current valuation discount to peers presents a good opportunity for investors looking to achieve exposure to a quality domestic banking franchise.

Victor German Anthony Hoo Prue Rydstand

Woodside (WPL AU) 42.6 56.4 BUY Clean and efficient natural gas is expected to see robust demand growth in the Asia Pacific region in the medium and longer term. We expect global attention to turn to Australia’s vast gas reserves, especially once new infrastructure is built.

Xavier M Grunauer

Leighton (LEI AU) 30.9 28.6 REDUCE Whilst broader macroeconomic and resource themes tend to dominate the sector, company-specific risks remain in our view and we see EPS remaining sensitive to impairment and the risk of further provisions on major contracts.

Richard Johnson Simon Thackray

Note: pricing as of 30 December, 2010

Source: Bloomberg, Nomura estimates



Market calls

Recommendations On 2 September 2010, we initiated a trade to be long consumer staples versus banks. Banks in Australia, we note, have long-term funding issues and regulatory overhang. Consumer stocks, in contrast, will likely see benefits over time, in our view, as the income shock percolates through the economy.

Exhibit 2. Australia consumer staples vs banks

90

92

94

96

98

100

102

104

2-S

ep

9-S

ep

16-S

ep

23-S

ep

30-S

ep

7-O

ct

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ct

28-O

ct

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ov

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ov

25-N

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23-D

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30-D

ec

Source: Bloomberg, Nomura

We now also recommend a switch from US healthcare stocks into Australian healthcare stocks. The healthcare sector in Australia is likely to see improving ROE and better growth in 2011 compared to US counterparts, in our view. It is also one of the few sectors in Australia that has been improving productivity and is one of the top sectors for additional expenditure allocation in Australia. The sector is currently seeing positive analyst earnings revisions, according to data compiled by Nomura Strategy Insight (please contact your sales representative to receive access to the Nomura Strategy Insight website).

Exhibit 3. Australia / US healthcare

0

5

10

15

20

25

30

Apr

-00

Oct

-00

Apr

-01

Oct

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Apr

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Oct

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Oct

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Apr

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Oct

-09

Apr

-10

Oct

-10

Source: Bloomberg, Nomura research

We continue to prefer consumer stocks to banks

We believe Australian healthcare sector should continue to outperform the US sector



Exhibit 4. Australia healthcare – earnings estimate revisions

(80)

(60)

(40)

(20)

0

20

40

60

80

100M

ar-0

5

Jul-0

5

Nov

-05

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Nov

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Mar

-07

Jul-0

7

Nov

-07

Mar

-08

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Nov

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Mar

-09

Jul-0

9

Nov

-09

Mar

-10

Jul-1

0

Nov

-10

Note: (Upgrade – Downgrade) / (Upgrade + Downgrade). In %

Source: Nomura Strategy Insight

We also recommend owning a basket of Australian LNG players – Woodside, Oil Search, Santos and Origin. Nomura's regional energy team expects a five-fold increase in Australia's LNG export capacity and a quadrupling of gas production from the current 47bcm to just under 200bcm by 2020F.

Exhibit 5. Australian LNG players consensus valuations

Nomura Price PER (x) PBR (x) Dividend yield (%) ROE (%)

Name Ticker Rating (local) FY1F FY2F FY1F FY2F FY1F FY2F FY1F FY2F

Woodside WPL AU BUY 42.8 22.0 23.3 3.0 2.8 2.4 2.2 14.7 13.5

Origin ORG AU BUY 17.0 22.4 18.6 1.5 1.4 3.0 3.2 6.5 7.9

Oil Search OSH AU BUY 7.2 73.7 65.6 3.4 3.2 0.6 0.6 4.6 5.2

Santos STO AU BUY 13.3 33.0 29.4 1.5 1.5 2.9 2.5 5.1 5.1

Note: as of 30 Dec 2010. IBES consensus estimates

Source: Bloomberg; Nomura International (Hong Kong) limited – Investment Strategy

Exhibit 6. Australian LNG players performance

72

90

108

126

144

162

180

Jan-

09

Feb

-09

Mar

-09

Apr

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May

-09

Jun-

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Jul-0

9

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-10

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-10

Benchmark Performance

Basket Performance

Note: as of 30 Dec 2010. Benchmark is MSCI Australia. Performance in USD

Source: Bloomberg; Nomura International (HK) Ltd – Investment Strategy

Australia Healthcare sector is seeing upward earnings estimate revisions

We recommend holding a basket of participants in Australian rapidly growing LNG sector

LNG players will continue to outperform the market



Australia outlook 2011

Sunny side up We upgraded the Australian equity market to Bullish on 7 October 2010. We retain a positive view on Australian equities entering 2011. Stronger commodity demand, a firm currency, stable inflation and continued capital spending will likely produce favourable returns despite a decline in productivity and peaking demographics, in our view.

We continue to recommend switching from banks to consumer staples and initiate a new switch from US to Australian health care stocks. We also recommend owning a basket of Australian LNG players — namely Woodside, Oil Search, Santos and Origin.

Insatiable demand from Asia in general and China in particular for Australia’s exports means that Australia is seeing an unprecedented improvement in its terms of trade. This is causing significant additions to personal income and corporate wealth. Apart from the first-round benefits to the mining sector, this additional wealth will likely start to show in incremental investment and benefit companies that help to increase productivity, in our view. Finally, as the income shock to the mining sector starts to percolate into the rest of the economy, personal consumption may surprise on the upside given very low expectations.

One of our key investment themes for 2011 is the movement of funds away from fixed income into equities. The much higher returns on investment in equity markets, alongside easing deflation fears, ought to be rewarded by global investors reallocating money away from fixed income. In this respect, developed markets should benefit due to their larger market capitalisation and bigger free float, and as emerging markets see diminishing returns.

Exhibit 7. Flows into emerging markets and forward relative returns

Note: * Purchases of Global Emerging Market Equity Funds as a percentage of market capitalisation, 12-month moving average

Source: EPFR, FTSE, Datastream, Nomura International (Hong Kong) Limited – Investment Strategy

Among developed markets, Australian equities should benefit, in our view, as they offer attractive ROE and ROA while real interest rates are positive.

With economic growth reviving and the central bank raising rates seven times, there has been a noticeable divergence in investment styles. Income themes such as dividend yield have sharply underperformed while momentum and earnings have been stellar outperformers. Also, with the yield curve flattening, financial indicators such as ROE and pre-tax margin are likely to become more important (Exhibits 35-38).

We retain our Bullish view on Australian equities

Recommendations: Banks to Consumer Staples, US to Australia Healthcare, Australian LNG players

Investors will reallocate funds from fixed income to equities in 2011

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Emerging market returns relative to developed (RHS, inverted)

Net Purchases of Global Emerging Markets* (LHS)

As emerging markets see diminishing returns, flows are likely to favour developed markets



Exhibit 8. Australia vs World ROA

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18

Jan-

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Australia World

Note: FTSE World indices

Source: Nomura Strategy Insight

The Australian equity market, however, remains quite inexpensive. Valuation multiples remain low even as the risk premium continues to reduce. In comparison to government bonds, equities also look inexpensive, having been cheaper only during 2008-09.

Exhibit 9. Australia 1yr fwd earnings yield–1-yr govt bond yield

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(%)

Note: FTSE world Index for earnings yield.

Source: Nomura Strategy Insight, Bloomberg, Nomura International (Hong Kong) Limited – Investment Strategy

We believe that Australia’s biggest driver in the recent past and the near future has been and will be the strong demand for commodities. We expect commodity prices to remain strong over the next two years (Appendix 1). On the back of strong commodity demand, Australia has seen unprecedented improvement in its terms of trade, which is in turn driving investment expenditure.

Commodity prices are likely to remain strong over the next two years…

Australia offers better returns than other developed markets

Australian equities are still cheap, especially in comparison to bonds



Exhibit 10. Australia: terms of trade (% y-y)

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40Ju

n-84

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Source: CEIC, Nomura International (Hong Kong) Limited – Investment Strategy

The composition of Australia's improving terms of trade has been far more broad-based than investors assume. The country has accrued gains not only from higher base metal prices such as copper and ferrous metals such as iron ore, but also from firmer soft commodity prices. Moreover, lesser-known metal prices such as titanium and uranium have also rallied. In addition, Australia has attained lower import prices from the deflationary pressures that have emerged from China and in technology.

Exhibit 11. Australia: selected export price indices

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Mineral Fuels

Food & Live Animals

Metals excl Non MonetaryGold

Source: Bloomberg, Nomura International (HK) Investment Strategy

Exhibit 12. Australia: selected import price indices

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Capital Goods

Consumption Goods

Machinery and IndustrialEquipment

Source: Bloomberg, Nomura International (HK) Investment Strategy

Australia is the fastest-growing economy in the G10 and is now seeing inflationary pressures build due to limited spare capacity in the economy. Consensus GDP growth estimates for 2011F are very strong at 3.7%. SMEs are also seeing improvement in business conditions and expect 2011 to be better than 2010. In the labour market, even with record participation rates, unemployment is low.

…helped further by a broad-based weakening in import prices

…implying that improvements in the terms of trade are likely to be sustainable…

Australia is the fastest-growing country in the G10…



Exhibit 13. Australia: consensus 2011 GDP growth estimate (% y-y)

2011 GDP Growth Estimate

2.5

2.7

2.9

3.1

3.3

3.5

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3.9

4.1F

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Source: Bloomberg, Nomura International (Hong Kong) Limited – Investment Strategy

The RBA has had to be the leader of this rate hike cycle. After raising rates seven times in the past 15 months, Australia is one of the few countries in Asia with positive real interest rates. At this point, we think that the bulk of the tightening is already done and it gives the RBA much more flexibility in conducting monetary policy going forward. Our economist, Stephen Roberts, expects the RBA to hike twice in March and May 2011 to 5.25%. The rate differential to the Fed’s target will then be over 500bps.

Exhibit 14. RBA rate forecast (%)

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Estimate

Source: Bloomberg, Nomura Global Economics, Nomura International (Hong Kong) Limited – Investment Strategy

Our FX team forecasts the Australian dollar will hold around parity against the greenback in 2011F and 2012F. According to the FX team, the Australian dollar is more stretched now than when it reached its previous peak of A$0.985/US$ in July 2008. However, the team believes that as Australia is the only strong economy in the G10, the degree of stretch is now more sustainable than it was in the past. The Australian dollar is likely to retrace back towards fair value only when substitute assets provide a reasonable investment outlook, which for now looks unlikely.

The RBA has aggressively intervened to control inflation by raising rates 7 times in the past 15 months…

…and is now expected to raise rates just twice more in 2011



Exhibit 15. Key factors (and impacts) in the Australian dollar outlook

Country-specific factors Likely Impact

Rate differential Direction: bullish ↑

Mispricing: bearish ↓

Terms of trade bullish ↑

Resource production bullish ↑

Valuation & competitiveness very bearish ↓

Private capital flows bearish ↓

Fiscal policy bullish ↑

Housing neutral —

Global factors

Global risk sentiment neutral —

Global USD direction neutral (for AUD) —

Source: Nomura research

Exhibit 16. Australia: monetary conditions index

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No

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Loose

Tight

Note: M3 (% y-y) - real interest rate (%) – REER (% y-y). Source: Bloomberg, CEIC, Nomura

Despite the RBA having to deal with inflationary pressures due to rising commodity prices, strong GDP growth and a small and narrowing output gap, long-term inflation expectations have remained well under control within the RBA’s target 2-3% range all year. Our economist thinks inflation is likely to remain around and slightly exceed the top of the RBA’s target range over the next two years.

Exhibit 17. Australia: break-even inflation (10-year)

2.2

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4,000

4,200

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5,000

5,200AU 10yr BE (LHS)

AOI (RHS)


The RBA has been successful so far in keeping inflation in check

Given that the bulk of the RBA’s tightening and AUD strengthening is done, monetary conditions are not that tight anymore

Our FX team believes that the AUD is “sustainably overvalued”



In terms of valuation, the market is certainly still attractive, in our view. At a forward 2011F P/E of 11.5x, only Korea and China H-shares are cheaper. P/BV of 1.7x is also fairly reasonable and well below the long-term average. Please see the Quantitative Insight section for more on historical valuations for Australia.

Exhibit 18. Regional valuation comparison

P/E (x) P/BV (x) P/CF (x) P/S (x)

Market Index

Universe 2010F 2011F 2010F 2011F 2010F 2011F 2010F 2011F

Australia AOI 13.8 11.5 1.9 1.7 9.5 8.1 1.5 1.4

China CSI 300 15.6 13.0 2.3 2.1 9.9 7.7 1.2 1.0

Hong Kong HSI 14.4 12.2 1.9 1.7 9.5 8.6 2.5 2.3

HSCCI 14.4 13.2 2.2 2.0 8.2 7.2 2.3 2.1

HSCEI 11.8 9.9 2.1 1.9 7.5 6.6 1.0 0.8

HSCI 15.2 13.0 2.0 1.8 10.0 9.3 2.1 1.8

India SENSEX 18.6 15.8 3.4 2.7 21.6 11.3 2.2 2.0

Indonesia JCI 18.5 15.5 3.8 3.2 12.6 10.8 2.6 2.3

Korea KOSPI 11.0 10.2 1.5 1.4 8.0 7.6 1.0 0.9

Malaysia KLCI 17.2 15.3 2.3 2.1 10.0 9.1 2.1 2.0

Philippines PASHR 18.0 16.2 2.5 2.3 10.4 10.2 2.3 2.1

Singapore FSTAS 15.3 14.0 1.7 1.6 10.7 9.0 1.4 1.3

Taiwan TWSE 15.4 13.4 2.1 1.9 9.0 8.1 1.0 0.9

Thailand SET 14.8 12.7 2.1 1.9 8.9 8.2 1.0 0.9

Data as of 30 Dec 10 Source: Bloomberg, IBES, Nomura International (HK) Quantitative Strategies

In comparison with the rest of the region, the equity market in Australia looks attractively priced, with high double-digit earnings growth forecast for 2011F and a dividend yield of 4.6%, which is the highest in Asia. Profitability is exceptional, with Australia also ranking highest in terms of expected ROA for 2011F.

Exhibit 19. Regional comparison

EPS growth (%) Dividend yield (%) ROE (%) ROA (%)

Market Index

Universe 2010F 2011F 2010F 2011F 2010F 2011F 2010F 2011F

Australia AOI 12.0 18.8 4.1 4.6 13.7 15.2 8.9 12.2

China CSI 300 28.9 19.9 2.2 2.6 16.4 17.3 7.2 7.6

Hong Kong HSI 22.3 17.4 3.1 3.6 13.5 14.8 7.3 7.7

HSCCI 13.1 9.2 2.7 2.9 15.8 15.6 9.3 9.4

HSCEI 25.8 18.6 3.3 4.0 19.2 20.2 6.4 6.8

HSCI 24.7 17.0 2.6 3.0 13.5 14.7 7.0 7.5

India SENSEX 11.4 17.7 1.0 1.4 15.4 17.3 15.4 10.8

Indonesia JCI 29.6 18.9 2.1 2.6 22.3 23.0 8.9 11.6

Korea KOSPI 34.3 8.0 1.7 2.1 14.7 14.3 8.7 8.5

Malaysia KLCI 28.3 12.5 3.1 3.4 12.9 13.9 6.5 6.9

Philippines PASHR 18.0 11.1 2.4 2.6 14.4 15.1 5.3 7.6

Singapore FSTAS 14.4 9.7 2.7 2.9 10.7 11.0 5.7 5.6

Taiwan TWSE 59.0 13.9 3.7 4.2 13.4 14.3 8.9 9.3

Thailand SET 19.3 16.9 3.3 3.6 15.1 15.9 8.1 9.2

Data as of 30 Dec 10 Source: Bloomberg, IBES, Nomura International (HK) Quantitative Strategies

In terms of valuation, the market is certainly still attractive



Sector Aggregates and Indices

Exhibit 20. Sector aggregate metrics

Sector

ROE change

(2011 vs 2010)*

ROE 2011F

Netincome margin

Operating margin

P/E 2011F

P/B 2011F

Div yld 2011F Beta

Metals & Mining 6.5 14.5 15.6 22.4 12.4 2.0 0.0 1.3

Oil, Gas and Chemicals 3.9 6.1 10.0 8.2 14.9 1.6 0.0 1.0

Health Care 2.7 17.8 9.5 16.9 17.8 4.1 2.8 0.4

Transport 2.7 8.1 -0.6 8.3 14.6 1.1 4.7 1.1

Hotels, Leisure and Other Services 1.7 19.6 8.4 15.7 15.7 2.4 4.3 0.5

Commercial Services 1.5 18.9 6.6 9.9 15.0 2.4 2.9 0.9

Real Estate 1.0 10.7 4.4 0.8 13.0 1.5 3.9 0.6

Telecommunication Services 0.8 16.8 16.7 21.5 11.3 2.1 4.8 0.5

Food, Beverages and Staples retailing

0.6 10.8 2.8 5.9 15.0 1.3 4.8 0.4

Media 0.6 11.2 11.2 13.7 12.6 1.3 5.1 0.8

Diversified Financials 0.6 12.3 13.7 14.1 14.8 2.1 5.2 1.1

Insurance 0.4 13.9 7.6 12.9 11.9 1.8 4.9 0.7

Construction, Engineering and Machinery

0.4 15.4 4.2 5.9 13.6 2.0 3.7 1.1

REITs 0.3 6.8 16.0 32.7 11.8 0.8 6.9 1.3

Banks 0.0 14.3 13.6 18.7 11.4 1.7 6.1 1.2

Utilities -0.1 7.9 8.1 18.4 16.6 1.2 8.9 0.6

Software & Services -2.0 28.7 16.9 23.2 15.0 4.2 4.3 0.7

Building & Packaging Products -2.5 6.9 1.0 5.7 14.4 1.0 4.7 1.0

Durables and Durables retailing -3.5 20.5 5.3 7.1 11.6 2.3 5.3 0.8

Note: Median of constituents except Net Income Margin and Operating Margin which are sum of total. Sorted by ROE change. IBES estimates. Based on AOI members as of 20 Dec 2010 over $100mn market cap. *calculated as sector median ROE for 2011 – sector median ROE for 2010.

Source: Factset, Bloomberg, IBES, Nomura International (HK) – Investment

Exhibit 21. Materials

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

Ap

r-00

Ap

r-01

Ap

r-02

Ap

r-03

Ap

r-04

Ap

r-05

Ap

r-06

Ap

r-07

Ap

r-08

Ap

r-09

Ap

r-10

Source: Bloomberg, Nomura Int’l (HK) – Investment Strategy

Exhibit 22. Banks

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

Ap

r-00

Ap

r-01

Ap

r-02

Ap

r-03

Ap

r-04

Ap

r-05

Ap

r-06

Ap

r-07

Ap

r-08

Ap

r-09

Ap

r-10




Exhibit 23. Consumer Staples

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000A

pr-

00

Ap

r-01

Ap

r-02

Ap

r-03

Ap

r-04

Ap

r-05

Ap

r-06

Ap

r-07

Ap

r-08

Ap

r-09

Ap

r-10


Exhibit 24. Consumer Discretionary

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

Ap

r-00

Ap

r-01

Ap

r-02

Ap

r-03

Ap

r-04

Ap

r-05

Ap

r-06

Ap

r-07

Ap

r-08

Ap

r-09

Ap

r-10


Exhibit 25. Energy

0

5,000

10,000

15,000

20,000

25,000

Ap

r-00

Ap

r-01

Ap

r-02

Ap

r-03

Ap

r-04

Ap

r-05

Ap

r-06

Ap

r-07

Ap

r-08

Ap

r-09

Ap

r-10


Exhibit 26. Healthcare

0

2,000

4,000

6,000

8,000

10,000

12,000

Ap

r-00

Ap

r-01

Ap

r-02

Ap

r-03

Ap

r-04

Ap

r-05

Ap

r-06

Ap

r-07

Ap

r-08

Ap

r-09

Ap

r-10


Exhibit 27. Industrials

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

Ap

r-00

Ap

r-01

Ap

r-02

Ap

r-03

Ap

r-04

Ap

r-05

Ap

r-06

Ap

r-07

Ap

r-08

Ap

r-09

Ap

r-10


Exhibit 28. Telecom

0

500

1,000

1,500

2,000

2,500

3,000

3,500

Ap

r-00

Ap

r-01

Ap

r-02

Ap

r-03

Ap

r-04

Ap

r-05

Ap

r-06

Ap

r-07

Ap

r-08

Ap

r-09

Ap

r-10




Quantitative Insights Sandy Lee / Quantitative Research Team

Exhibit 29. Australia: mutual fund investing

(2,000)

(1,000)

0

1,000

2,000

3,000

4,000

Apr

-03

Dec

-03

Aug

-04

Apr

-05

Dec

-05

Aug

-06

Apr

-07

Dec

-07

Aug

-08

Apr

-09

Dec

-09

Aug

-10

300

400

500

600

700

800

900

1,000

1,100

1,200MSCI Australia (RHS)

Cumulative net inflow (LHS)

Cumulative net inflow (US$mn) Benchmark (US$, MSCI index)

Note: updated up to 30 November, 2010

Source: Bloomberg, IBES, Datastream, Nomura Int’l (HK) – Quant Research

Exhibit 30. Australia: Rolling fwd calendar year P/B

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

Jan-

96

Dec

-96

Nov

-97

Oct

-98

Sep

-99

Aug

-00

Jul-0

1

Jun-

02

May

-03

Apr

-04

Mar

-05

Feb

-06

Jan-

07

Dec

-07

Nov

-08

Oct

-09

Sep

-10

1,500

2,500

3,500

4,500

5,500

6,500

7,500

8,500Index

+

-

Price

P/BV

Current PBV = 2.33x High on 11/01/07 5.46xMean PBV = 2.85x Low on 07/17/96 1.88x

Rolling P/BV (x)

Note: updated up to 17 Dec, 2010


Exhibit 31. Australia: 12m Fwd P/E Band

1,500

2,500

3,500

4,500

5,500

6,500

7,500

Apr

-93

Jun-

94

Aug

-95

Oct

-96

Jan-

98

Mar

-99

May

-

Aug

-01

Oct

-02

Dec

-03

Mar

-05

May

-

Jul-0

7

Sep

-08

Dec

-09

AUAOI

9x

6x

21x

18x

12x

15x

Current PE = 13.3x

Mean PE = 16x

High on 03/22/00 22.5x

Low on 11/20/08 8.9x



Exhibit 32. Australia: Rolling dividend yield

0123456789

10

Jan-

97

Dec

-97

Dec

-98

Dec

-99

Dec

-00

Dec

-01

Dec

-02

Dec

-03

Dec

-04

Dec

-05

Dec

-06

Dec

-07

Dec

-08

Dec

-09

Dec

-10

Yield (%)

++2

-

-2

Mean DY = 3.7%



Exhibit 33. Australia: Cumulative market breadth

(14,000)

(12,000)

(10,000)

(8,000)

(6,000)

(4,000)

(2,000)

0

2,000

4,000

Dec

-05

Apr

-06

Aug

-06

Dec

-06

Apr

-07

Aug

-07

Dec

-07

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Aug

-10

2,5003,0003,5004,0004,5005,0005,5006,0006,5007,0007,500

Cumulative breadth (AU)

AUAOI IndexAUAOI



Exhibit 34. Australia: Implied risk premium

(4)

(2)

0

2

4

6

8

Apr

-93

Jul-9

4

Oct

-95

Jan-

97

Apr

-98

Jul-9

9

Nov

-00

Feb

-02

May

-03

Aug

-04

Nov

-05

Mar

-07

Jun-

08

Sep

-09

Dec

-10

+2

-2

-

+Mean RP = 0.5%

Risk premium (%)





Australia Factor Returns

Exhibit 35. Size, momentum and liquidity factors

(80)

(60)

(40)

(20)

0

20

40

60

80

100

120

140

De

c-98

Jun-

99D

ec-

99Ju

n-00

De

c-00

Jun-

01D

ec-

01Ju

n-02

De

c-02

Jun-

03D

ec-

03Ju

n-04

De

c-04

Jun-

05D

ec-

05Ju

n-06

De

c-06

Jun-

07D

ec-

07Ju

n-08

De

c-08

Jun-

09D

ec-

09Ju

n-10

Market cap *

Price momentum (1M)

Price momentum (12M -1M)

Volume turnover ratio

Exhibit 36. Valuation factors

(60)

(40)

(20)

0

20

40

60

De

c-98

Jun-

99D

ec-

99Ju

n-00

De

c-00

Jun-

01D

ec-

01Ju

n-02

De

c-02

Jun-

03D

ec-

03Ju

n-04

De

c-04

Jun-

05D

ec-

05Ju

n-06

De

c-06

Jun-

07D

ec-

07Ju

n-08

De

c-08

Jun-

09D

ec-

09Ju

n-10

Dividend yield Earnings yield B/P

Cashflow yield EBITDA/EV

Exhibit 37. Revision and earnings yield factors

(20)

0

20

40

60

80

100

De

c-98

Jun-

99D

ec-

99Ju

n-00

De

c-00

Jun-

01D

ec-

01Ju

n-02

De

c-02

Jun-

03D

ec-

03Ju

n-04

De

c-04

Jun-

05D

ec-

05Ju

n-06

De

c-06

Jun-

07D

ec-

07Ju

n-08

De

c-08

Jun-

09D

ec-

09Ju

n-10

Revision indexChange in earnings yieldStarMine predicted surpriseNormalised E/PSales growth (FY2)EPS growth (FY2)

Exhibit 38. Financial and risk factors

(60)

(40)

(20)

0

20

40

60D

ec-

98Ju

n-99

De

c-99

Jun-

00D

ec-

00Ju

n-01

De

c-01

Jun-

02D

ec-

02Ju

n-03

De

c-03

Jun-

04D

ec-

04Ju

n-05

De

c-05

Jun-

06D

ec-

06Ju

n-07

De

c-07

Jun-

08D

ec-

08Ju

n-09

De

c-09

Jun-

10

Return on equityShareholders’ equity ratioPretax profit marginVolatilityEstimate dispersionDefault probability *

Source: Worldscope, I/B/E/S, Nomura research

Note: Data are based on estimates for stocks in the MSCI Australia Index. Factor returns are annualised figures.

Factor returns and rankings are generated by calculating the subsequent performance of an equal-weighted portfolio that is long the highest one-third and short the one-third with the lowest scores (country and sector diversified for regional universe and sector diversified for country universe), except for the factors marked with *, which are reverse-based



Australia economics

Economic outlook: Tiger taming

Stephen Roberts +612 8062 8631 / [email protected]

Tatiana Byrne +612 8062 8505 / [email protected]

Above-trend GDP growth later in 2011, driven by a major increase in investment spending in the resources sector, will have policymakers trying to tame growth and limit inflationary pressure.

Baseline economic forecast

GDP growth

We expect persistently strong GDP growth from mid-2011 and in 2012 (3.3% in 2011, up from 2.8% in 2010, and accelerating to 3.6% in 2012), above the long-term trend (3.3%), with very rapid growth in exports and pronounced acceleration in business investment spending the main drivers. Another feature is unusually strong GDP growth in current prices (exhibit below, LHS). Our forecast increases in export volumes and a record lift in spending on resource projects both derive from our view of robust growth in major Asian export markets, especially with China taking close to a quarter of merchandise exports, thus keeping commodity prices elevated.

Very rapid growth in export volumes and business investment spending will be tempered, in our view, by cautious household and government spending extending through 2011 and 2012. We see a high household debt burden weighing on household spending, especially with borrowing interest rates pushing further above the average of the past decade on more policy rate hikes in the first half of 2011 on our forecasts. We believe that the lift in the household savings ratio to a quarter-century high (exhibit below, RHS) is likely to persist over at least the next year, helping to maintain below-long-term-average growth in nominal and real retail sales and constraining housing activity, notwithstanding the persistent undersupply of new homes relative to what strong population growth implies for demand for new homes.

We also see weaker government spending acting as a drag on growth through 2011. On our calculations, the end of several big post global financial crisis (GFC) spending initiatives in 2010, including the major impetus to construction spending from the schools building programme, will see government spending providing 1.3 percentage points (pp) less impetus to GDP growth than in 2010.

Exhibit 39. Australia: real and nominal GDP growth

(4)

(2)

0

2

4

6

8

10

12

Dec-02 Dec-04 Dec-06 Dec-08 Dec-10 F Dec-12 F

(% y-y) Real GDP

Nominal GDP

Nomura forecast

Source: Nomura Global Economics

Exhibit 40. Australia: household savings ratio

(4)

0

4

8

12

Sep-04 Sep-05 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10

% disposable income


We expect above-trend GDP growth from mid-2011 on record resource investment spending

Weighed by a heavy debt burden, household spending is likely to stay cautious

Weaker government spending is also likely to temper the pace of GDP growth, in our view



Inflation

Economic spare capacity is limited, especially in the labour market where we see the unemployment rate falling below 5% in 2011 – a level that in the past has been consistent with higher wage increases and rising inflation. In the private sector in 2011, we see annual wage increases above 4%, on the edge of presenting wage-push inflation pressure, compared with a well-contained 3.2% average estimated annual increase through 2010. While Australian dollar strength (we forecast AUD/USD appreciating to 1.02 by end-2011) and forward-looking monetary-policy tightening by the Reserve Bank (RBA) may limit how far inflation rises, we still expect year-on-year CPI and underlying inflation to move a little above the RBA’s target band in the second half of 2011 (Exhibit below, LHS) and stay elevated in 2012.

Balance of payments

We expect the current-account deficit to narrow to AUD25bn (1.8% of GDP) in 2011 from AUD35bn (2.6% of GDP) in 2012, due mostly to stronger export volumes and prices, but also with the firmer AUD exchange rate providing a valuation effect containing the net-income deficit. A relatively high household savings ratio in 2011 and a smaller government deficit in FY11 – effectively less government dissaving – also point to a smaller call on overseas savings to fund Australian investment.

Policy responses

We believe policymakers will have to deal with the consequences of a massive, positive shock to national income and GDP growth from a once-in-a-century improvement in the terms of trade (Exhibit below, RHS). We see policy to be set to offset this in part, making space by limiting growth in government and household spending.

Apart from the run-off in government spending post GFC, we see the RBA working to establish a cash rate early in 2011 consistent with commercial banks’ standard variable mortgage interest rates of around 8.50%, about 1pp above the long-term average. Our forecast is that two more 25bp cash rate hikes to 5.25% should suffice and, given that the RBA probably wants to establish the rate level ahead of accelerating business investment in mid-2011, these should be complete by 3Q11. At this stage, we view March and May as likely months for the next two hikes allowing for an accumulation of firmer economic readings, notably monthly labour market readings, as well as signs in the 4Q10 CPI report (due in late January 2011) and the 1Q11 CPI (due in late April) that inflation is threatening to accelerate.

Exhibit 41. Australia: annual inflation

Nomura forecast

1

3

5

7

Dec-99 Dec-02 Dec-05 Dec-08 Dec-11

CPIAverage underlyingupper band levellower band levelRBA forecast (CPI)RBA forecast (average underlying)

(% y-y)

Source: ABS, RBA Nomura Global Economics

Exhibit 42. Australia: terms of trade

Index, 2005-2006=100

50

60

70

80

90

100

110

120

130

140

Dec-92 Dec-97 Dec-02 Dec-07 Dec-12

Terms of trade

Nomura forecast

RBA forecast


Limited economic capacity could add to wage pressure, with inflation moving above the RBA’s target

Stronger exports should contribute to the current-account deficit narrowing to 1.8% of GDP in 2011

Policymakers need to offset the positive shock to GDP growth from terms-of-trade strength

Monetary policy is likely to become tighter, with the RBA likely to hike twice in 2011, we think



Risks to our forecasts

We think that any substantial setback in Asian growth, especially in Chinese growth, would present downside risk to growth. We conclude this because at present a substantial share of Australia’s merchandise exports are destined for Asia (75% in the 12 months to June 2010), the share of exports destined for China has grown rapidly over the past decade (Exhibit below, LHS), and these exports are dominated by key commodity exports, such as iron and coal (Exhibit below, RHS). However, the potential downside risk to Australian growth would, in our view, be limited by two considerations:

1.) The export transmission channel to Australian growth is quite narrow. The total export proportion of real GDP is comparatively modest at 23.3% in Q3 2010, although on our forecasts this share climbs to 25% by the end of 2012.

2.) A strong fiscal position with a low deficit and almost no net government debt as well as a strong monetary policy position after seven RBA cash rate hikes in the last 15 months mean that policymakers are in a position to respond with aggressively expansionary policies in the event of any substantial downside risk to growth prospects.

We think that worse global financial market conditions, through the channel of higher Australian bank funding costs and borrowing interest rates, could intensify deleveraging in the heavily indebted household sector, limiting growth in household consumption spending more than we currently forecast. Given the build-up in household savings since the GFC, however, the household sector is comparatively well-placed to manage higher debt servicing. Compounding pressures on household income and wealth would probably need to be in play too, event s such as sharply falling house prices (unlikely while population growth continues to outstrip by some way the supply of new homes), or a sharp lift in the unemployment rate.

Exhibit 43. Australia’s major export markets

0

10

20

30

40

50

60

70

Oct-00 Oct-02 Oct-04 Oct-06 Oct-08 Oct-10

Japan China

Korea India

Big 4 total

(% of exports)

Source: ABS and Nomura Global Economics

Exhibit 44. Australia’s major export commodities

0

10

20

30

40

50

Oct-00 Oct-02 Oct-04 Oct-06 Oct-08 Oct-10

Iron ore Coal LNGCoal + Iron ore+ LNG

(% of exports)

Source: ABS and Nomura Global Economics

Large export exposure to Asia would reduce growth on any major Asian growth setback

The extent of the growth reduction would be limited by the relatively narrow export channel

Sound fiscal and monetary settings mean policymakers are able to respond forcefully to weakness

A high household debt burden could also limit growth on higher borrowing interest rates



Exhibit 45. Australia macro forecasts

% y-y growth unless otherwise stated 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 2010 2011 2012

Real GDP (sa, % q-q, annualised) 0.8 4.0 3.2 3.2 4.0 4.0 3.6 3.6 - - -

% q-q, sa 0.2 1.0 0.8 0.8 1.0 1.0 0.9 0.9 - - -

% y-y 2.7 3.0 3.2 2.8 3.6 3.6 3.8 3.9 2.8 3.3 3.6

Household consumption 3.2 2.9 2.8 2.5 2.4 2.3 2.3 2.3 2.7 2.5 2.4

Government (total spending) 9.0 4.3 (0.2) (1.0) (1.6) (1.0) 1.0 2.2 8.7 (1.2) 2.0

Investment (private) 2.6 1.1 7.6 10.8 12.0 13.5 11.3 7.9 0.8 11.0 7.0

Exports 4.2 4.2 9.3 6.7 5.4 5.5 7.4 9.5 5.1 6.7 9.0

Imports 12.9 5.3 7.9 8.4 4.8 7.1 9.2 9.9 12.2 6.2 7.9

Contribution to GDP growth (% points):

Domestic final sales 4.3 2.8 3.1 3.2 3.5 4.0 4.3 3.9 3.6 3.5 3.4

Inventories and statistical discrepancy 0.1 0.4 0.1 0.0 (0.1) 0.0 0.0 0.0 0.6 (0.4) (0.1)

Net trade (1.7) (0.2) 0.0 (0.4) 0.2 (0.4) (0.5) (0.3) (1.4) 0.2 0.3

Unemployment rate 5.2 5.0 5.0 4.9 4.9 4.8 4.8 4.7 5.2 4.9 4.7

Employment, ‘000 35.7 30.0 25.0 25.0 25.0 25.0 28.0 28.0 30.1 25.0 28.0

Consumer prices 2.8 3.0 2.9 3.0 3.2 3.3 3.3 3.2 3.0 3.1 3.1

Trimmed mean 2.5 2.5 2.5 2.8 3.0 3.1 3.1 3.1 2.7 2.9 3.1

Weighted median 2.3 2.8 2.6 2.9 3.1 3.2 3.2 3.1 2.7 3.0 3.1

Federal deficit (%of GDP) FY end-June (4.2) (2.8) (1.0)

Current account deficit (%GDP) (2.6) (1.8) (2.3)

Cash rate 4.50 4.75 5.00 5.25 5.25 5.25 5.25 5.25 4.75 5.25 5.25

90-day bank bill 4.97 5.00 5.25 5.50 5.50 5.50 5.50 5.50 5.00 5.50 5.50

3-year bond 4.75 5.20 5.30 5.60 5.90 6.20 6.20 6.10 5.20 6.20 6.00

10-year bond 4.96 5.50 5.70 5.90 6.10 6.30 6.30 6.20 5.50 6.30 6.10

A$/US$ 0.97 0.96 0.96 0.98 1.00 1.02 1.02 1.02 0.96 1.02 1.02

Note: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are period average. All forecasts are modal forecasts (i.e., the single most likely outcome). Table last revised 5 November 2010.

Source: Australian Bureau of Statistics; Reserve Bank and Nomura Global Economics



A rebalancing market

Correlations may be misleading The past three years have provided a number of textbook examples of countries falling to the problems of running current account deficits financed by short-term portfolio flows which have resulted in asset markets eventually collapsing. Paradoxically, Australia emerged unscathed from the financial crisis of 2008 and indeed, was one of the few countries able to show positive quarterly growth through 2008-09 despite its persistent current account deficit. Superficially, investors will consider overweighting Australia within international portfolios as being distinguished by China's demand for commodities. Certainly a glance at the terms-of-trade for both economies provides a real time view of the changes in underlying profitability within the two economies. But, there has been certainly a much more noticeable difference in performance of the two exchange rates even though the countries run opposite current account positions. The counterintuitive performance of exchange rates relative to their current account positions suggests that equity investors need to be careful in their asset allocation process.

Exhibit 46. Terms of trade : Australia vs China

(30)

(20)

(10)

0

10

20

30

40

Se

p-05

Ma

r-06

Se

p-06

Ma

r-07

Se

p-07

Ma

r-08

Se

p-08

Ma

r-09

Se

p-09

Ma

r-10

Se

p-10

Australia China(% y-y)

Source: CEIC: Nomura International (Hong Kong) Limited – Investment Strategy

Exhibit 47. FX rates: AUD/CNY

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

Jan-

05

Jul-0

5

Jan-

06

Jul-0

6

Jan-

07

Jul-0

7

Jan-

08

Jul-0

8

Jan-

09

Jul-0

9

Jan-

10

Jul-1

0

Source: Bloomberg; Nomura International (HK) Limited – Investment Strategy

Again, a glance at interest rate differentials suggests very different monetary policies than the markets are assuming. Unlike other countries, Australia has positive real interest rate differentials after raising interest rates seven times since the financial crisis commenced versus just once by China. Moreover, Australia's yield curve has begun to flatten, suggesting that the rapid policy tightening phase is over while our China economists expect the central bank to raise rates by a further 75bps in 2011 despite the Christmas hike. By pre-emptively raising rates, the RBA has bought itself flexibility in contrast to other Asian central banks that have maintained a loose monetary policy amid hopes that China would take leadership in controlling inflation.

In contrast to many markets in Asia, Australia has done much towards rebalancing its economy…

…however, this has not been reflected in financial markets



Exhibit 48. Real interest rates (%): Australia, China and India

(12)

(10)

(8)

(6)

(4)

(2)

0

2

4

6Ju

l-05

No

v-05

Ma

r-06

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6

No

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r-07

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No

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No

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r-09

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No

v-09

Ma

r-10

Jul-1

0

No

v-10

China Australia India

Note: CPI adjusted 1 year government bond yields

Source: Bloomberg: Nomura International (Hong Kong) Limited – Investment Strategy

The same is also true for property markets. On the surface, the economies of Australia, China and India have very different growth profiles but all three having been experiencing upward pressure on their property markets. To keep property prices in check, Australia has let conventional monetary policy work through higher mortgage rates while China has used administrative measures. Interestingly, this might allow Australia to avoid a hard landing for its economy in the future and protect its banking system from ill-advised lending policies.

Exhibit 49. Property prices: Australia vs China

(15)

(10)

(5)

0

5

10

15

20

Se

p-06

De

c-06

Ma

r-07

Jun-

07

Se

p-07

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c-07

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Jun-

08

Se

p-08

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Ma

r-09

Jun-

09

Se

p-09

De

c-09

Ma

r-10

Jun-

10

Se

p-10

Australia China(% y-y)

Source: CEIC: Nomura International (Hong Kong) Limited – Investment Strategy

While exports will have a high correlation to terms-of-trade and exchange rates, the services sector may be influenced by broader economic variables. Indeed, a glance at the lead indicators in the US and Europe perhaps offers investors potential earnings surprises. After a decade of overseas acquisitions, Australian earnings have become more sensitive to global growth outside the commodity sector.

Despite vastly different policy stances…

Improvements in global economic conditions benefit the large services sector

Australia’s positive real interest rate is quite distinctive

…Australia and China’s house prices have followed the same path



Exhibit 50. US non-manufacturing ISM

35

40

45

50

55

60

65

Ma

r-98

Ma

r-99

Ma

r-00

Ma

r-01

Ma

r-02

Ma

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r-04

Ma

r-05

Ma

r-06

Ma

r-07

Ma

r-08

Ma

r-09

Ma

r-10

(diffusion index)

Source: Bloomberg: Nomura International (HK) Limited – Investment Strategy

Exhibit 51. German IFO – business climate

80

85

90

95

100

105

110

115

Jun-

92

Jun-

93

Jun-

94

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Jun-

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Jun-

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Jun-

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Jun-

07

Jun-

08

Jun-

09

Jun-

10

(2000=100)

Source: Bloomberg; Nomura International (HK) Limited – Investment Strategy

Ironically, the economy and Australian investor sentiment may be far more influenced by changes in global monetary conditions and demand than is currently discounted. The reliance of the Australian financial sector in the past to overseas funding was demonstrated in 2008-09 but the turnaround in global credit conditions perhaps has been under-estimated alongside the change in OECD lead indicators.

Exhibit 52. TED spread vs Australian bank performance relative to global banks

0

100

200

300

400

500

600

700

800

900

De

c-06

Ma

r-07

Jun-

07

Se

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De

c-10

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0FTSE AU banks relative to global banks - lhs

TED spread % - rhs

Source: Bloomberg; Thomson Reuters Datastream: Nomura International (Hong Kong) Limited – Investment Strategy

Hence, while Australia runs a current account deficit and appears to be 'reliant on commodities', the reality, in our view, is that there are far more economic variables that determine the 'flow of funds' than the market is attributing. Indeed, we would suggest that Australia will perhaps perform relatively better versus other Asian equity markets as global bond yields rise. Intuitively, countries running current account deficits ought to experience pressure on asset markets as global bond yields rise, but with both an improving terms-of-trade and resilient portfolio flows, Australia may result in better total returns than investors are imagining, in our view. Further, the dividend yield of the equity market stands at a premium to global stock markets.

Investors are not acknowledging the multiple factors playing into Australia’s benefit

Australian banks and A$ are highly sensitive to global risk levels



Exhibit 53. Australia vs World: dividend yield

1

2

3

4

5

6

7

8

Jan-

88

Jan-

90

Jan-

92

Jan-

94

Jan-

96

Jan-

98

Jan-

00

Jan-

02

Jan-

04

Jan-

06

Jan-

08

Jan-

10

Australia World(%)

Note: FTSE World indices are used

Source: Nomura Strategy Insight; Nomura International (Hong Kong) Limited – Investment Strategy

Exhibit 54. Australia: P/E premium over World

(60)

(50)

(40)

(30)

(20)

(10)

0

10

20

Jan-

88

Jan-

90

Jan-

92

Jan-

94

Jan-

96

Jan-

98

Jan-

00

Jan-

02

Jan-

04

Jan-

06

Jan-

08

Jan-

10

(%)

Note: FTSE World indices are used

Source: Nomura Strategy Insight; Nomura International (Hong Kong) Limited – Investment Strategy

Perhaps Australia, 'the lucky country', has earned its iconic status by a combination of fortuitous factors, but company earnings reflect the reality of a much more diversified earnings stream than is being represented by consensus. Ironically, markets may have failed to see that Australia is far more 'advanced' than other developed economies in addressing their imbalances.

Exhibit 55. MSCI Australia US$ relative to MSCI World US$

250

350

450

550

650

750

850

De

c-00

Jun-

01

De

c-01

Jun-

02

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c-10


Australia’s underperformance in 2010is unlikely to be repeated this year



Productivity

One step forward, one step back With the focus on the mining boom, Australia has taken a back foot in productivity. Multi-factor productivity growth has declined in the past decade. The trend is decidedly downwards and is now in negative territory. The demographics are also decidedly turning against Australia, with the working-age population nearing a peak. This combined with the declining productivity bodes ill for sustainable growth. Although productivity is key for all markets in the region, its importance is possibly most pronounced in Australia.

Exhibit 56. Australia: multi-factor productivity growth (% y-y)

(5)

(4)

(3)

(2)

(1)

0

1

2

3

4

5

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

Source: CEIC, ABS, Nomura International (Hong Kong) Limited – Investment Strategy

However, domestic income growth this decade has still been the strongest among the last four. This primarily comes about through growth in population and an improvement in the terms of trade. The terms of trade have improved further since the publication of the data used in the chart below and is expected to remain strong over the next year.

Exhibit 57. Australia: contribution to real domestic income growth

(0.5)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

1970s 1980s 1990s 2000s*

Growth in MFP Growth in Labor input

Growth in Capital input Growth in Terms-of-trade

(% y-y)

Note: * up to June 2009. Source: Australia Productivity Commission, Nomura International (Hong Kong) Limited – Investment Strategy

Australia has however benefited from a combination of three factors that have together more than compensated for the lack of productivity growth. The first is the unprecedented improvement in the terms-of-trade. The second is the increasing demographic dividend. The working-age population as a percentage of the total in Australia had been rising over the past decade. But this is likely to reverse now, as working-age population starts to decline.

Multi-factor productivity growth is now negative

Dismal contribution from productivity countered by terms-of-trade and labour growth

Multi-factor productivity growth has declined in the past decade, and demographics data may not offer many reasons to cheer



Exhibit 58. Australia: working-age population (20-65 yrs old) % of total

Working Age %

54

55

56

57

58

59

60

61

62

1986

1989

1992

1995

1998

2001

2004

2007

2010

2013

2016

2019

2022

2025

2028

2031

2034

2037

2040

2043

2046

2049

(%)

Source: US Census Bureau, Nomura International (Hong Kong) Limited – Investment Strategy

Thirdly, overall population growth has recently been the highest in 40 years. Australia is quite unique in its population set-up in terms of the importance of immigration in overall growth. The Productivity Commission estimates that in 2010, over a quarter of Australia’s population consisted of those born overseas, compared with a 3% worldwide average. Population growth in Australia has therefore been quite robust due to immigration flows (increasingly from China and India), even though the domestic fertility rate has been on a long-term decline, according to the Productivity Commission. Australia’s population is currently growing at 2% p.a. compared to a growth of 0.3% in the developed world (according to the US census bureau). This has in part also helped put a floor on asset prices.

Exhibit 59. Australia: population growth breakdown

Note: Natural increase = births – deaths. NOM = Net Overseas Migration

Source: Australia Productivity Commission, Nomura International (Hong Kong) Limited – Investment Strategy

In terms of sectors, agriculture and utilities along with the two big sectors — mining and manufacturing — are all losing ground on productivity.

The favourable demographic trend is starting to reverse now

Australia’s population is growing at around 2%, due largely to immigration, while developed world population is growing at 0.3%



Exhibit 60. Growth in multifactor productivity by sector and cycle (% y-y)

Source: Australia Productivity Commission, Nomura International (Hong Kong) Limited – Investment Strategy

Exhibit 61. Manufacturing real unit value added index

0.60

0.70

0.80

0.90

1.00

1.10

1.20

Jun-

68

Jun-

70

Jun-

72

Jun-

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Jun-

98

Jun-

00

Jun-

02

Jun-

04

Jun-

06

Jun-

08

Jun-

10

Note: Manufacturing PPI: Articles manufactured / Manufacturing PPI: Materials Used


This is also evident in the chart below. New capital expenditure plans in the manufacturing sector are non-existent. In contrast, the mining sector has seen increasing planned capex in recent years. As the mining sector gains from higher mineral prices, aggressive capacity expansion through capex and M&A is becoming more common.

Exhibit 62. Private new capital expenditure expected — long term (A$mn)

0

5,000

10,000

15,000

20,000

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35,000

40,000

45,000

1995

1996

1997

1998

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2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Mining

Manufacturing

Others

Note: Average of estimates as of 4 quarters to March of each year. 2011 number average of June and Sep quarter.


Manufacturing is the biggest loser. Financial services and trade/transport are gainers

Although the long-term value added in manufacturing trend of is positive, it has been on a decline over the past decade

Mining sector engaging in increasing capital spending while manufacturing sits out



The other longer-term benefit of terms-of-trade improvements will eventually start to show in greater income for the household sector. Over the past 30 years, consumption patterns in Australia show that the financial services, eating out, household equipment, recreation and healthcare sectors are the most elastic and are likely to see the highest incremental allocation.

Exhibit 63. Australia household expenditure and elasticity

Sector % of total

expenditure [A]% of incremental

expenditure [B]Elasticity

[B] / [A]

Purchase of vehicles 3 11 3.7

Insurance & other financial services 10 19 1.9

Hotels, cafes & restaurants 7 10 1.4

Furnishings & household equipment 5 7 1.4

Recreation & culture 12 14 1.2

Health 6 6 1.0

Clothing & footwear 4 4 1.0

Transport services 3 3 1.0

Electricity, gas & other fuel 2 2 1.0

Alcoholic beverages 2 2 1.0

Cigarettes & tobacco 2 2 1.0

Other Goods & services 6 4 0.7

Communications 3 2 0.7

Food 11 6 0.5

Education services 3 1 0.3

Rent & other dwelling services 17 5 0.3

Operation of vehicles 5 1 0.2

100 100

Note: based on quarterly data since 1974

Source: CEIC, Nomura International (HK) Limited – Investment Strategy

Highlighted sectors will see the highest incremental spending



LNG in Australia

Linking into the Silk Road Over the past five decades Australia has experienced a series of commodity booms. Gold, uranium, copper and titanium have all experienced significant investment expansion and, more recently, nickel and iron ore. Oil and gas have had much more mixed records, and the cycle has been dominated by offshore development.

Exhibit 64. Oil&Gas: Trends in planned development capex, 2009-13F (source file not available)

Source: BP, Company data, Nomura research

Exhibit 65. Petroleum Exploration: expenditure — offshore (A$mn)

0

100

200

300

400

500

600

700

800

900

1,000

Sep

-74

Sep

-76

Sep

-78

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-80

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-82

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-84

Sep

-86

Sep

-88

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-92

Sep

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-00

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-02

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-08

(A$mn)


However, a transformation is occurring in Australia as China's pipe distribution network and import capability are now able to meet the country's burgeoning demand for natural gas. The same demand growth is also seen in India. Natural gas demand in China and India is likely to triple over the next decade, while Australia, with ample supplies and new projects coming on stream, is likely the biggest beneficiary. Malaysia and Qatar will also benefit, in our view.

Australia ranks second highest in the world in terms of planned capex over the next three years in the Oil&Gas sector

Offshore exploration expenditure has dominated the current capex cycle



Exhibit 66. Gas pipelines in China

Source: IEA

China's natural gas industry is still in its infancy, contributing only 3.7% of primary energy demand in 2009 (BP statistical review), far below the world's average of 23.8%. With natural gas prices at a 30% discount to those of electricity, oil and diesel in China, there is strong substitution effect possible longer term. Ironically, gas supply shortages in China have limited its gas industry development. However, a series of pipelines (such as W-to-E pipelines II and III, Sichuan-to-East) coming on-stream in the next couple of years, together with increasing imported LNG supplies, is likely to make natural gas a viable alternative to other fuels, in our view. In India, despite being the third-largest consumer of natural gas in Asia, it still accounts for only 12% of the energy basket.

Exhibit 67. China natural gas consumption, 2009 and 2020F

Source: BP Stats review, EIA, Nomura research

Currently, Asia-Pacific accounts for approximately 16.8% of global natural gas demand and 14.6% of it supply. However, within the region there is a supply and demand mismatch between the different countries resulting in significant trade. With limited inter-country pipeline infrastructure in the region, 89% of the trade in 2009 was done via LNG. The Asia Pacific region accounts for about 63% of global LNG trade; 31% was imported from the Middle East.

A transformation is occurring as piping infrastructure gets built out in China

Natural gas consumption in China is set to grow



Exhibit 68. Global natural gas production vs trade, 2009

Pipeline

2,987

LNG

0

1,000

2,000

3,000

4,000

Production Trade

877

(billion cubic metres)

Source: BP Stats Review 2010, Nomura research

Over the past two to three years, China has secured several long-term contracts globally to gain access to natural gas through LNG to secure its future supplies of the commodity. The three Chinese oil giants Petrochina (along with parent CNPC), Sinopec and CNOOC are active players in the LNG market, with CNOOC the most aggressive. Reliance industries’ strong operational performance makes it one of the key beneficiaries in India.

Australia’s natural gas, unlike that from Russia or Qatar, cannot be piped on land to international demand centres. It must be shipped in the form of LNG to countries that have the infrastructure to store LNG and convert it back to natural gas. As natural gas is a much cleaner fuel than regular petroleum distillates, LNG terminals are being rapidly built across the world. Global LNG Info reports that as of Dec 2010, there are 71 re-gasification terminals, while 22 are under construction and a further 42 are planned. Nomura's regional energy team expects a five-fold increase in Australia's LNG export capacity as several projects are in the process of being built. They expect a quadrupling of gas production from 47bcm to just under 200bcm by 2020F.

Exhibit 69. Australia’s oil and gas basins, pipelines and LNG hubs

Source: Australian Government Department of Resources, Nomura

Further, as liquefaction and re-gasification infrastructure is being expanded, LNG becomes a viable option

Transport of natural gas has large potential as distribution infrastructure gets built.

Given Australia’s location, LNG is the only option to exploit the vast conventional and un-conventional reserves



Conventional wisdom would not expect Australia to be the world's sixth-largest LNG exporter, given that it is a net importer of crude oil. Ironically, it is not oil that is causing the dramatic change in natural gas but Coal Seam Gas (CSG) and the development of projects in Papua New Guinea. The expansion of LNG projects in the Western Australian offshore basin alongside overseas ventures ought to lift Australasia from number six to the largest LNG exporter in the world by 2015F, we expect.

Exhibit 70. Current and expected 2015F LNG capacity by country

0

10

20

30

40

50

60

70

80

Aus

tral

asia

Qat

ar

Indo

nesi

a

Nig

eria

Alg

eria

Mal

aysi

a

Trin

idad

Egy

pt

Expected addtions by 2015(mtpa)

Source: Nomura estimates, company data

One of the idiosyncrasies about Australia's energy sector is that domestic growth is not strong enough to consume the production of natural gas. By 2020, a quarter of Australia's gas production is expected to come from unconventional reserves and, in particular, CSG reserves in Eastern Australia. While West Coast production has been recognised as the main source of conventional gas production, it is the East Coast production that is likely to show the strongest growth in unconventional production, in our view. Over time, Australia’s LNG exports have the potential to become as large as its mineral ore exports, as LNG demand is estimated to remain very strong over the coming decade.

Exhibit 71. Global LNG demand estimates

0

50

100

150

200

250

300

350

400

450

500

2004 2006 2008 2010F 2012F 2014F 2016F 2018F 2020F

Japan Korea Taiwan USA

Mexico Argentina Dominican Rep Puerto Rico

Belgium France Greece Italy

Portugal Spain Turkey UK

China India New entrants

(bcm)

Source: Company data, Nomura estimates, BP Statistical Review, Shell

LNG exports of Australia are already about 4% of total. A five-fold increase makes it comparable to current levels of iron ore exports

Australia is about to undertake a rapid expansion in LNG capacity

LNG demand is set to remain very robust in the next decade



Exhibit 72. Proposed LNG capacity and contracted volumes to date

0

20

40

60

80

100

120

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

LNG (mtpa) Proposed capacity Sold in LT contracts

Source: Company data, Nomura estimates

Interestingly it is Japan that accounts for Australia's primary customer presently for LNG, with China far behind with 20% of the total.

Exhibit 73. Australia’s LNG exports by destination

China20%

India5%

Taiwan2%

Japan66%

South Korea7%

Source: BP Statistical Review of World Energy June 2010, Nomura estimates

Since the formation of the Gas Exporting Countries Forum (GECF) in 2001, Russia has been looking to join with Qatar and Algeria to push for the formation of an OPEC-like cartel for natural gas. This cartel would help coordinate production among natural gas producers and help keep supply and prices in check. However, given the widely dispersed natural gas assets unlike concentrated oil pockets, a natural gas cartel has not become a reality yet. And an unrestrained production binge has left the world with a 30% oversupply of natural gas (according to the IEA). This has meant that natural gas has been the worst-performing major commodity in 2010. A formation of a cartel would possibly bring production under check and boost prices.

Much of the upcoming increase in capacity in Australia is already backed up by long-term contracts

Japan is the largest importer of Australian LNG, although China and India are increasing in importance



China’s steel consumption

Economic housing: the next driver? The Australian market is greatly exposed to policy in China. Mineral ores and coal form around half of Australia’s merchandise exports (a majority of it heading to China), and around three-quarters of the incremental steel consumption in China in 2010 is expected to have come from construction (divided equally among property, infrastructure and rural construction), according to our economics team. Thus, any slowdown in China’s construction activity will quickly impact both export prices and the current account balance.

So, is China’s housing construction about to slow given the surge of micro-measures to contain property prices? The answer is probably “yes”, in our view. However, while private housing growth might be much slower in 2011 as compared to 2010, our China property analyst sees a surge in economic housing next year, keeping overall housing construction growth quite high.

As the government pushes on its drive to provide housing for the low-middle-income households and with economic housing being an important part of the 12th Five-Year Plan, these estimates are very likely to see upside surprise, in our view. China will likely chalk out proper incentives for involved parties (local governments and developers) to mend the so-far poor completion rates in economic housing. This year the Ministry of Housing and Urban Rural Development (MoHURD) has already signed more binding agreements with local government officials on their 2010 targets, which could hold them accountable if they fail to fulfil their stated targets.

On the construction starts front, it was agreed by local governments that some 5.8mn units of subsidised housing would be started in 2010, including 1mn units of low rent housing, 2mn units of economic housing and 2.8mn units of relocation housing for squatter settlement redevelopment. According to Xinhua news, longer-term goals might be to provide around 25-30mn units of subsidised housing in the next five years, to help lower-income households meet their housing needs. This translates into around 5-6mn units of subsidised housing to be built per year.

Investors anticipating a slowdown in iron ore and coal exports to China on the back of policy measures are likely to get disappointed.

Exhibit 74. Steel production intensity and economic development

Note: 2009 prices converted at 2005 PPP exchange rates; 5 year-moving averages; US iron production intensity prior to 1897; Japan steel production is by fiscal year prior to 1980

Sources: Conference Board Total Economy Database (January 2010); IMF; Japan Iron and Steel Federation; Johnston and Williamson (2010); Maddison (2009); RBA; US Bureau of Mines; US Geological Survey; World Steel Association (worldsteel) Source: RBA

Despite a possible slowdown in private property construction in China, the upcoming surge in economic housing will keep overall construction robust

China is issuing laws and setting up incentives for involved parties (local governments and developers) to mend the so-far poor completion rates in economic housing.

China’s steel consumption is likely to continue to rise in coming years



Exhibit 75. China steel demand breakdown forecast (mn tons)

2006 2007 2008 2009 2010F 2011F 2012F

Construction 187 209 239 285 326 353 371

Property 69 84 99 107 115

Infrastructure 111 133 144 157 165

Rural development 59 68 83 89 92

Machinery 58 66 75 97 114 127 140

Auto 20 23 26 30 35 38 42

Home appliance 8 9 10 11 14 16 17

Shipbuilding 6 7 7 14 16 18 21

Oil & gas 6 6 7 7 10 11 11

Others 70 87 61 92 77 73 71

Total steel demand 356 408 426 535 591 636 673

Source: China Steel Association, Nomura estimates

Exhibit 76. China property: housing starts forecast

2007 2008 2009 2010F 2011F

Starts in ‘000 sqm

Total Residential Starts 787,955 836,421 932,984 1,288,777 1,546,532

Growth rate (%y-y) 22 6 12 38 20

Private Housing 739,852 780,203 879,438 1,216,777 1,354,532

Growth rate (%y-y) 23 5 13 38 11

Economic Housing 48,103 56,219 53,547 72,000 192,000

Growth rate (%y-y) 10 17 -5 34 167

Source: CEIC, Nomura estimates

Exhibit 77. Targeted economic housing supply over 2010-15F

0

10

20

30

40

50

60

70

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

E

2011

E

2012

E

2013

E

2014

E

2015

E

Avg GFA delivery between 2004-09:

35m sqm / year

Targeted GFA delivery between2010-15:

50m sqm / year

(mn sqm)

43%

Source: CEIC, Soufun, Nomura estimates

The construction sector will account for 75% of the incremental demand for steel in China

Slowdown in private housing growth is being compensated by rapid increase in economic housing

China’s economic housing is starting to pick up



Exhibit 78. New urban households and new homes sold

0

2

4

6

8

10

12

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

Mn units New urban households

New commodity residential units sold

Note: Assume average 90sqm per unit for new residential units sold

Source: CEIC, Nomura research

Over 55mn urban households have yet to buy a new home



Australia Banks

Impact from Basel III Victor German

The core proposals of the Basel III address capital, leverage, liquidity and net stable funding. In his recently published note Can’t get it… pay for it, dated 17 December 2010, our Australian banks analyst Victor German highlights his view on the impact on Australian banks:

Capital (Tier 1) ratio: while all Australian banks are short on capital on a Core Tier 1 basis, the majors should be able to largely close the gap with organically generated capital.

Leverage: every Australian bank already exceeds the minimum 3% leverage threshold.

Liquidity coverage ratio (LCR): the Basel committee recently detailed plans to allow banks to establish contractual liquidity facilities with their central bank (subject to a fee) to meet a shortfall in the LCR due to lack of adequate liquid assets (in countries where govt debt is small). Australia is one such country. Meeting the LCR is likely to cost banks ~4% of annual earnings (or ~A$1bn pa).

Net Stable Funding Ratio (NSFR): banks will need to raise an additional A$30-60bn (per bank) of term funding over the next 8 years to meet the 100% NSFR.

Our analysts estimate an overall 5-6bp impact on margins over the next 3-5 years. Higher quality liquids and the fee that the banks are likely to be required to pay to the RBA will take off 2-3bps per year (with a cumulative impact of ~5% per year by FY15). Also, they estimate a ~3bp impact on margins as banks term out their short-term funding to meet 100% net stable funding requirements.

Exhibit 79. Australia banks LCR and NSFR

38

85

62

15

0

20

40

60

80

100

Liquidity coverage ratio Net stable funding ratio

(%)

Jul-10 Required

100 100

Source: APRA

Exhibit 80. NSFR of Australian banks

90

86 8685

84 84

80

82

84

86

88

90

92

ANZ NAB WBC BOQ BEN CBA

(%)

Source: Nomura estimates, BIS, company data

While Australian banks qualify on leverage targets and will likely be able to grow capital organically, NSFR and LCR will cost 5-6bps on margins over the next 3-5 years



Exhibit 81. Basel III estimated capital requirement

Source: BIS, Nomura Research

Exhibit 82. Tier 1 Capital of Australian banks

6.6 6.7 6.76.6

6.4 6.4

6.7

5.6

5.0

5.5

6.0

6.5

7.0

7.5

ANZ CBA NAB WBC

(%)

As reported Nomura estimates CBA (double gearing adj)


Tier 1 capital ratio is total Tier 1 capital by total risk-weighted assets. BIS will limit core Tier 1 capital to common equity and retained earnings. To qualify for additional Tier 1, equity instruments must be considered to be loss absorbent on a going concern basis, are required to be subordinated, have discretionary non-cumulative dividends/coupons and not have a maturity date or incentive to redeem. This must reach a minimum of 7% by 2019 plus an additional 2.5% countercyclical buffer and an additional buffer for systemically important banks.

The leverage ratio has been proposed to supplement the existing Tier 1 ratio. It is calculated as the new definition of Tier 1 as a percentage of total exposures (total balance sheet assets and off balance sheet assets) and has been indicated by Basel as being a minimum 3% (which Basel will test during a parallel run period, with final adjustments to be made in 2017).

The LCR aims to ensure banks have sufficient liquidity to survive an acute short-term stress scenario for a minimum 30-day time horizon.

The key aim of NSFR is to achieve a better alignment between the durations of assets and liabilities. Like the liquidity ratio, weights are assigned to the elements of the available and required amount of stable funding. Importantly, this requirement is not due to come into force until 2018, and hence, banks will have a long-dated timeframe to position for this.



Appendices

Appendix 1: Commodity Price Forecasts

Exhibit 83. Commodity price forecasts

Commodity Unit 2010E 2011F 2012F 2013F Long-term

Base metals

Aluminium ($/t) 2,104 2,206 2,275 2,325 2,425

Copper ($/t) 7,485 8,377 8,818 7,937 4,960

Nickel ($/t) 21,380 19,841 19,290 18,739 18,739

Zinc ($/t) 2,029 1,950 2,000 2,100 2,100

Precious metals

Gold ($/oz) 1,189 1,250 1,150 1,050 950

Platinum ($/oz) 1,598 1,681 1,725 1,700 1,650

Palladium ($/oz) 484 508 520 530 510

Iron Ore (fines) (CY)

China Spot CIF ($/t) 147 169 160 130 80

Realised Aus FOB ($/t) 115 159 152 128 70

Australian Coal

Hard Coking (CY) ($/t) 191 241 250 220 140

Thermal (JFY) ($/t) 98 110 120 100 80

Brent Crude * ($/barrel) 79 95 110 75

China Natural Gas** ($/MMBtu) 4 4.5 5.25

Petrochems

Polyethylene (HDPE) ($/t) 1,143 1,240 1,486

Polyester (PTA) ($/t) 933 1,100 1,196

Plastics (PVC) ($/t) 942 1,035 1,113

Plastics (Polypropelene) ($/t) 1,223 1,310 1,526

China HRC Steel (RMB/t) 4,868 5,598 5,766

Agricultural Commodities ***

Wheat ($/t) 218 201 206 210

Rice ($/t) 453 436 426 427

Oilseeds ($/t) 410 412 405 401

Butter ($/t) 3043 2821 2716 2709

Note: Nomura forecasts except Agricultural Commodities

* period average prices

** Petrochina, Sinopec, CNOOC's average well head prices

*** OECD-FAO Agricultural Outlook forecasts

Source: Nomura estimates, OECD-FAO



Appendix 2: Nomura FX forecasts

Exhibit 84. Exchange rate forecasts

Change (%)

Currency Now Q1 2011 Q2 2011 Q3 2011 Q4 2011 2012 2011* 2012

CNY 6.6 6.5 6.4 6.3 6.22 5.9 5.7 5.1

HKD 7.8 7.75 7.75 7.75 7.75 7.75 0.3 0.0

IDR 8973 8900 8800 8680 8520 8200 5.0 3.8

INR 44.8 44.1 43.4 42.9 42.3 40.3 5.6 4.7

KRW 1126 1080 1060 1040 1020 960 9.4 5.9

MYR 3.07 3.00 2.97 2.93 2.88 2.72 6.2 5.6

PHP 43.8 42.4 41.9 41.4 40.9 38.9 6.6 4.9

SGD 1.29 1.27 1.25 1.24 1.22 1.17 5.1 4.1

THB 30.1 29 28.5 28.1 27.8 26.8 7.5 3.6

TWD 29.1 29.6 29.3 29 28.7 27.5 1.5 4.2

DXY 79.5 79.2 78.5 78.4 78.3 81.1 -1.5 3.6

JPY 81.5 80 82.5 85 85 90 -4.3 -5.9

EURJPY 108 106 111 115 115 117 -6.1 -1.7

EUR 1.3 1.32 1.34 1.35 1.35 1.30 1.5 -3.7

CHF 0.9 1.05 1.06 1.06 1.07 1.09 -14.1 -1.9

EURCHF 1.2 1.38 1.42 1.43 1.44 1.42 -15.4 1.4

GBP 1.5 1.63 1.68 1.71 1.73 1.71 12.0 -1.2

EURGBP 0.9 0.81 0.80 0.79 0.78 0.76 9.5 2.6

AUD 1.02 0.96 0.98 1.00 1.02 1.02 0.3 0.0

CAD 1.0 0.97 0.97 0.99 0.99 1.00 1.0 -1.0

NZD 0.8 0.77 0.80 0.82 0.84 0.84 8.8 0.0

EURNOK 7.8 7.8 7.6 7.6 7.7 7.7 1.6 0.0

EURSEK 9.0 8.9 8.8 8.9 9 9 -0.2 0.0

BRL 1.7 1.72 1.68 1.65 1.62 1.6 2.4 1.2

CLP 468 475 465 450 440 420 6.0 4.5

MXN 12.4 11.9 11.8 11.75 11.7 11.5 5.6 1.7

* from current values

As of 30 Dec 2010.

Source: Nomura FX team estimates. Last published in Global FX weekly 17 December 2010



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Stock picks


Amcor AMC AU

BASIC MATERIALS | AUSTRALIA


Simon Thackray +61 2 8062 8409 [email protected]

Inexpensive growth Synergies are a key source of growth

AMC has highlighted that the Alcan integration is very much on track and the focus is increasingly starting to shift towards leveraging the strategic benefits of the group’s dominant positions in key flexible packaging markets. AMC’s outlook is assisted by its acquisition synergies, the contribution from which should be material over the next three years, in our view. Around 40% of our forecast EBIT growth in FY11F is due to synergies, 60% in FY12F and 59% in FY13F.

Well placed to solve the flexibles challenge ... at last

One of the critical questions, in our view, is the extent to which Amcor's acquisition of Alcan will enable it to build a more sustainable business model for its European flexible packaging business, which has, in our view, long been its Achilles’ heel. Following the acquisition of the Alcan assets, AMC now has the opportunity to transform this business from one characterised as being a producer of intermediate products caught between both larger customers and suppliers, to one that is a more integral part of a far more harmonious industry supply chain, where pricing power (or lack thereof) is not the sole determinant of value. This will not be easy to achieve and will require tight management but the early signs look good.

Well positioned for strong growth in FY11 and FY12

Recent commentary on current trading has been pragmatic given the anaemic state of key markets (particularly in Europe), FX and resin price headwinds. Underlying markets remain subdued but are generally stable after the sharp volume declines in food and beverage end-user markets last year. We have incorporated this scenario into our forecasts but despite these headwinds still expect above average EPS growth of +30% in FY11F and 18% in FY12F.

Key financials & valuations30 Jun (A$mn) FY10 FY11F FY12F FY13F

Revenue 9,878 11,810 12,825 13,150

Reported net profit 183 417 635 740

Normalised net profit 409 570 675 740

Normalised EPS (A$) 0.35 0.47 0.55 0.61

Norm. EPS growth (%) (14.0) 32.6 18.4 9.6

Norm. P/E (x) 19.2 14.5 12.2 11.1

EV/EBITDA (x) 9.3 6.9 6.4 6.0

Price/book (x) 2.0 2.0 1.9 1.8

Dividend yield (%) 4.4 4.7 5.0 5.3

ROE (%) 5.2 10.2 15.1 16.6

Net debt/equity (%) 74.8 76.7 73.7 66.5

Earnings revisions

Previous norm. net profit 570 675 740

Change from previous (%) - - -

Previous norm. EPS (A$) 0.47 0.55 0.61

Source: Company, Nomura estimates

Share price relative to MSCI Australia

1m 3m 6m

4.7 3.7 5.8

10.8 8.9 26.2

0.5 (0.0) (5.4)

Easy


52-week range (A$)

3-mth avg daily turnover (US$mn)

Mondrian Investment Partners Limited

Stock borrowability

6.6

Major shareholders (%)

Commonwealth Bank of Australia 7.1

Absolute (A$)

Absolute (US$)

Relative to Index

Estimated free float (%)

Market cap (US$mn) 8,415

100.0

7.00/5.81

31.28

5.65.86.06.26.46.66.87.07.2

De

c09

Jan

10

Fe

b10

Mar

10

Ap

r10

Ma

y10

Jun

10

Jul1

0

Au

g10

Se

p10

Oc

t10

Nov

10

9095100105110115120125130

Price

Rel MSCI Australia(A$)

Closing price on 30 Dec A$6.75

Price target A$7.55(set on 12 Aug 10)

Upside/downside 11.9%Difference from consensus 2.0%

FY12F net profit (A$mn) 635Difference from consensus -5.9%Source: Nomura

Nomura vs consensus Consensus forecasts appear to include synergy assumptions at the lower end of the guidance range. This appears to us to be overly conservative.

Maintained

BUY

N O M U R A A U S T R A L I A L I M I T E D

Action We are buyers for the benefits of the undemanding multiple and the well-above

average forecast EPS growth, notwithstanding FX and raw material cost headwinds. Even if markets remain subdued for the next six to 12 months, EPS growth should still be attractive, in our view, as the material acquisition synergies are extracted.

Catalysts Confidence should rise as evidence of synergies emerge and as the full structural

benefits of the transformational Alcan acquisition are better understood and recognised by the market.

Anchor themes

Packaging share prices have historically performed best during periods of acquisition-sponsored earnings growth. Amcor is in just such a period.

Amcor Richard Johnson


Valuation and rating

Strengthening fundamentals The ability to acquire earnings at bottom-of-the-cycle prices should have put Amcor in a sweet spot — something that has yet to be fully reflected in its share price, in our view.

History has long suggested that the sub-optimal market dynamics of consumer packaging make restructuring and acquisitions an ever-present part of the industry’s profit equation. Packaging company share prices, as a result, often perform best during acquisition-sponsored growth phases.

Apart from the last few months of 2008 and early 2009, when AMC’s defensive characteristics supported share price outperformance, there have been two big upward moves in AMC’s share price in the past ten years, both of which corresponded with acquisitive-based growth phases. Prior to this latest acquisitive phase, the most recent was in 2001-02. The creation of Amcor Flexibles Europe in April 2001 and the A$2.9bn acquisition of Schmalbach-Lubeca’s global PET and Closure operations in May 2002 supported a 62% rise in the share price from around A$5.57 to A$9.05 (the broader market rose by around 8% over this period).

We believe the EPS accretion and perceived strategic benefits of the expansion were the main factors behind the move in the share price. And, in our view, there is every reason to think the same thing should happen again following the transformational moves the company has made.

The main negative risk to our view would be a further unexpected strengthening of the A$. Concerns about the euro in particular have overshadowed the share price in recent weeks and this may continue on for awhile yet. AMC’s greatest currency sensitivity post its recent acquisitions is the €/A$ rate. We estimate that the sensitivity of post-tax profit to a 1c movement in the €/A$ rate is A$4.5mn. A 1c movement in the US$/A$ exchange rate is A$3mn. Our forecasts assume an A$/€ ex change rate of 0.74 in both FY11 and FY12, which is broadly where the spot rate is currently.

Price target and valuation Our price target for Amcor of A$7.55 is based on our DCF analysis of A$7.94 per share to which we apply a 5% discount to account for acquisition integration risks.

Exhibit 85. Amcor: DCF valuation assumptions

Target D/DE ratio (%) 40.0

Tax rate (%) 30.0

Long run growth rate (%) 2.0

Risk free rate (%) 5.25

Equity beta 1.1

Equity risk premium (%) 6.0

Cost of debt (%) 6.0

WACC (pre tax) 9.5

Source: Nomura estimates

Risks to our investment view

The main downside risk to our price target would be a failure to integrate the acquired assets smoothly. One of the main challenges will be the manufacturing footprint rationalisation programme, which we expect will account for around one-third of the total synergy savings from Alcan. This element of the programme will, however, be at the back end of the three-year programme. Other risks relate to volume pressures in key markets (European food flexibles, PET, Australia, Sunclipse), inability to fully pass on or retain movements in raw material costs, weak growth in Europe and a rising Australian dollar.

Our PT of A$7.55 is derived using DCF analysis and factors in acquisition integration risks



Acquisition synergies a key growth driver

Financial statements

Income statement (A$mn)

Year-end 30 Jun FY09 FY10 FY11F FY12F FY13F

Revenue 9,539 9,878 11,810 12,825 13,150Cost of goods sold (8,480) (8,664) (10,164) (11,025) (11,256)Gross profit 1,059 1,214 1,645 1,800 1,894SG&A (412) (455) (639) (656) (660)Employee share expenseOperating profit 647 759 1,007 1,144 1,234

EBITDA 1,059 1,214 1,645 1,800 1,894Depreciation (412) (455) (639) (656) (660)AmortisationEBIT 647 759 1,007 1,144 1,234Net interest expense (182) (183) (220) (211) (212)Associates & JCEsOther incomeEarnings before tax 465 576 787 933 1,022Income tax (98) (148) (202) (244) (267)Net profit after tax 367 428 584 690 755Minority interests (6) (19) (14) (15) (15)Other itemsPreferred dividendsNormalised NPAT 360 409 570 675 740Extraordinary items (149) (226) (153) (40) - Reported NPAT 212 183 417 635 740

Dividends (286) (360) (391) (415) (439)Transfer to reserves (75) (177) 26 220 301

Valuation and ratio analysisFD normalised P/E (x) 16.5 19.2 14.5 12.2 11.1

FD normalised P/E at price target (x) 18.4 21.4 16.2 13.7 12.5 Reported P/E (x) 28.1 42.9 19.8 13.0 11.1 Dividend yield (%) 5.0 4.4 4.7 5.0 5.3 Price/cashflow (x) 9.1 10.0 7.0 7.2 6.6 Price/book (x) 1.9 2.0 2.0 1.9 1.8 EV/EBITDA (x) 10.3 9.3 6.9 6.4 6.0 EV/EBIT (x) 16.9 14.9 11.3 10.0 9.2 Gross margin (%) 11.1 12.3 13.9 14.0 14.4 EBITDA margin (%) 11.1 12.3 13.9 14.0 14.4 EBIT margin (%) 6.8 7.7 8.5 8.9 9.4

Net margin (%) 2.2 1.9 3.5 5.0 5.6 Effective tax rate (%) 21.1 25.7 25.7 26.1 26.1 Dividend payout (%) 135.3 196.8 93.7 65.4 59.4 Capex to sales (%) 5.9 5.3 5.9 5.5 4.9 Capex to depreciation (x) 1.4 1.1 1.1 1.1 1.0

ROE (%) 7.1 5.2 10.2 15.1 16.6 ROA (pretax %) 8.0 7.9 8.7 9.3 9.8

Growth (%)Revenue 2.4 3.6 19.5 8.6 2.5 EBITDA (1.0) 14.6 35.5 9.4 5.2

EBIT (1.6) 17.4 32.6 13.7 7.8

Normalised EPS (4.5) (14.0) 32.6 18.4 9.6 Normalised FDEPS (4.5) (14.0) 32.6 18.4 9.6

Per shareReported EPS (A$) 0.24 0.16 0.34 0.52 0.61Norm EPS (A$) 0.41 0.35 0.47 0.55 0.61Fully diluted norm EPS (A$) 0.41 0.35 0.47 0.55 0.61

Book value per share (A$) 3.58 3.33 3.35 3.53 3.78DPS (A$) 0.34 0.30 0.32 0.34 0.36Source: Nomura estimates



Alcan debt and equity funded

Cashflow (A$mn)


EBITDA 1,059 1,214 1,645 1,800 1,894Change in working capital 168 (311) 81 (109) 30Other operating cashflow (571) (120) (551) (543) (671)Cashflow from operations 656 783 1,175 1,148 1,253Capital expenditure (564) (521) (700) (700) (650)Free cashflow 91 262 475 448 603Reduction in investments (198) 45 - - -

Net acquisitions (100) (2,466) (231) - - Reduction in other LT assets (117) (340) 20 (121) (266)Addition in other LT liabilities 46 498 - - - Adjustments 158 319 30 71 216Cashflow after investing acts (120) (1,683) 294 398 553Cash dividends (311) (286) (391) (439) (439)Equity issue 29 1,571 - - - Debt issueConvertible debt issueOthers 332 477 96 41 (113)Cashflow from financial acts 50 1,761 (295) (398) (552)Net cashflow (70) 79 (0) (0) 0Beginning cash 258 189 267 267 267Ending cash 188 267 267 267 267Ending net debt 2,643 3,044 3,141 3,182 3,068Source: Nomura estimates

Balance sheet (A$mn)

As at 30 Jun FY09 FY10 FY11F FY12F FY13F

Cash & equivalents 189 267 267 267 267Marketable securitiesAccounts receivable 1,141 1,787 2,362 2,565 2,630Inventories 980 1,469 1,653 1,796 1,709

Other current assets 9 23 23 23 23Total current assets 2,318 3,546 4,305 4,650 4,629LT investments 509 464 464 464 464Fixed assets 3,796 4,801 5,024 5,055 5,006Goodwill 1,499 1,836 1,836 1,836 1,836Other intangible assetsOther LT assets 324 664 645 766 1,032Total assets 8,446 11,310 12,274 12,771 12,967Short-term debt 956 1,379 1,379 1,379 1,379Accounts payable 1,754 2,495 3,337 3,621 3,581

Other current liabilities 274 372 370 322 372Total current liabilities 2,984 4,245 5,085 5,322 5,331Long-term debt 1,876 1,933 2,029 2,070 1,957Convertible debtOther LT liabilities 511 1,009 1,009 1,009 1,009Total liabilities 5,370 7,186 8,123 8,401 8,296Minority interest 63 56 56 56 56Preferred stockCommon stock 2,440 4,030 4,030 4,030 4,030Retained earnings 884 695 722 942 1,242

Proposed dividends

Other equity and reserves (312) (657) (657) (657) (657)Total shareholders' equity 3,013 4,068 4,094 4,314 4,615

Total equity & liabilities 8,446 11,310 12,274 12,771 12,967

Liquidity (x)

Current ratio 0.78 0.84 0.85 0.87 0.87 Interest cover 3.6 4.1 4.6 5.4 5.8

LeverageNet debt/EBITDA (x) 2.50 2.51 1.91 1.77 1.62

Net debt/equity (%) 87.7 74.8 76.7 73.7 66.5

Activity (days)Days receivable 45.5 54.1 64.1 70.3 72.1 Days inventory 45.1 51.6 56.1 57.2 56.8

Days payable 77.2 89.5 104.7 115.5 116.8 Cash cycle 13.4 16.2 15.5 12.1 12.2 Source: Nomura estimates


Cochlear COH AU

HEALTH CARE & PHARMACEUTICALS | AUSTRALIA

Dr David Stanton +61 2 8062 8410 [email protected]

Zara Lyons +61 2 8062 8407 [email protected]

Healthy hearing Cochlear continues to dominate the cochlear market

We believe COH is likely to see strong cochlear volume growth in FY11F, given that sales growth in 2QFY10 reached 20% in countries where Nucleus 5 has been introduced. In addition, we believe solid FY11F NPAT growth is achievable due to ongoing manufacturing efficiencies.

Cochlear on the way to becoming a “hearing-loss leader”

Besides cochlear implants (CI), Cochlear also produces bone anchored hearing aid (BAHA) and Hybrid implants. We believe Cochlear is attempting to become a ‘hearing-loss leader’. We estimate that up to 55,000 Americans could benefit from a cochlear implant per year, which corresponds to the global industry’s 20,000 per annum.

We already factor in strong cochlear growth

Overall, we believe growth rates in the cochlear industry and bilateral implantation rates have the potential to gain market share due to increased utilisation rates for Cochlear’s products. We expect Cochlear to register strong growth in the near to medium term.

BUY rating and price target of A$89.00

United Nations data suggest cochlear manufacturers will not outgrow the market for cochlear implants. We believe investors may be willing to pay a higher P/E premium should the global CI market become (albeit temporarily) more consolidated. To determine the potential P/E expansion possible, we look at the example of AB’s 2004 withdrawal. At that time, we believed AB had c. 25% global market share. After this withdrawal, COH’s 12-month P/E expanded 51.7% to 26.7x in 12 months. Should this multiple be applied to COH’s new 12-month forward EPS of A$3.45, this implies COH’s share price could re-rate to A$92.17.


Revenue 735 879 1,009 1,029

Reported net profit 155.2 183.5 213.2 241.8

Normalised net profit 155.2 183.5 213.2 241.8

Normalised EPS (A$) 2.76 3.24 3.76 4.27

Norm. EPS growth (%) 17.9 17.6 16.1 13.4

Norm. P/E (x) 29.8 25.3 21.8 19.2

EV/EBITDA (x) 19.6 16.6 14.6 12.9

Price/book (x) 10.5 9.3 8.2 7.3

Dividend yield (%) 2.3 2.8 3.2 3.7

ROE (%) 38.7 39.2 40.3 40.5

Net debt/equity (%) 26.0 33.4 28.7 17.2

Earnings revisions

Previous norm. net profit 183.5 213.2 241.8





1m 3m 6m

4.4 16.3 9.9

10.6 22.1 31.1

0.2 13.2 (0.5)

Easy


52-week range (A$)


Colonial FS

Stock borrowability

4.6


Capital Group 7.8

Absolute (A$)

Absolute (US$)

Relative to Index



100.0

81.7/61.3

13.31

59

64

69

74

79

84

Dec

09

Jan1

0

Feb

10

Mar

10

Ap

r10

Ma

y10

Jun1

0

Jul

10

Au

g10

Se

p10

Oct

10

No

v10

80

90

100

110

120

130

Price



Price target A$89.0(set on 6 Dec 10)


FY12F net profit (A$mn) 213.2Difference from consensus 6.4%Source: Nomura

Nomura vs consensus The major difference in our forecasts compared with the Street is our house view on AUD/USD, which we forecast to reach 0.97 in 2011F.

Maintained

BUY


Action Besides cochlear implants, Cochlear also produces BAHA and Hybrid implants.

Cochlear continues to roll out its fifth-generation cochlear implants, which consist of an implant and an external processor. In Europe and the US, Cochlear Nucleus 5 has received approvals for sale. We expect implant growth of 20% in FY11F. We note that COH’s major competitor has issued a worldwide recall of its implant.

Catalysts We believe key catalyst for P/E re-rating is evidence of market share gains by

Cochlear due to competitor recall, underpinned by its newly released Nucleus 5.

Anchor themes

Cochlear implants can help patients who have severe to profound sensor neural hearing loss and are unable to benefit adequately from the use of hearing aids. We believe the market size of cochlear implantation is large, with the major potential growth impediment being a rise in cochlear implants support staff.

CONVICTION CALL CONVICTION CALL CONVICTION CALL CONVICTION CALL

Cochlear Dr David Stanton


Valuation and rating

Valuation We outline below COH’s positives.

Dominant market position – COH has been commanding a market share of 70% for some time, because of its history of innovation and incumbency. We believe this dominant market share is more likely than not to continue.

Good safety record – Based on latest data from PubMed, COH’s cochlear failure rate was 2%, compared with its major competitor, ABC, at 7%. We believe this will be a very valuable marketing tool for potential implant candidates.

Market size is large – UN data suggest there are many more potential cochlear candidates than actual patients implanted with cochlear in a given year in a developed country alone. Hence, we believe the potential market for cochlear implantation is large, and is likely to grow.

Bilateral opportunity – We believe bilateral (both-sided) cochlear implantation is a potential growth driver for COH. At present, management estimates 15% of total candidates get bilateral cochlear, with most of them in Australia, the EU and the US. On a global basis, if this increases to 25%, it would increase our valuation by 8%.

Rollout of Nucleus 5 is likely to lead to strong volume growth – COH has released a new cochlear implant platform, known as Generation 5. The average volume growth rate over the past five half-year following these launches was 23%, compared with the long-term average rate of 17%. This suggests that COH’s cochlear may see continued strong volume growth after the release of Generation 5.

Total recall by COH’s competitor

One of COH’s major competitors in the cochlear implant market, Advanced Bionics (AB), the CI subsidiary of Sonova Group (SOON VX, Not rated), issued a voluntary product recall of its HiRes 90K CI device worldwide due to two instances of a rare malfunction that required removal of the implant. AB’s market withdrawal will inevitably result in competitors taking market share. As market leader with c. 70% share, COH is well positioned to benefit from this recall. We note management believe that the newly released Nucleus 5 will continue to underpin growth in FY11 and software enhancement will be available towards the end of 2011, which should facilitate upgrade processor sales. We believe AB’s recall will underpin solid FY11F growth for COH. Given the life-changing nature of CI, we believe there are likely to be lingering reputational issues for AB should it return to the market at some time in the future. We believe potential recipients and surgeons are likely to prefer to use other CIs, rather than risk using AB’s CI. This has the potential to lead to prolonged market-share gains for COH. We believe AB’s next CI product launch is likely to be two-three years away.

Valuation methodology and risks to our investment view

We use a blend of three valuation methodologies to derive a valuation for COH: DCF, a capitalisation of EV/EBITDA and normalised P/E multiples. Upside risks include faster-than-expected growth in cochlear and BAHA sales. Downside risks include faster-than-expected new product launches from its competitors ABC and Med-El.

Exhibit 86. Valuation methodology

Metric Weight (%) Valuation (A$ ps) Blended valuation (A$ ps)

DCF valuation 33.3 85.41 28.47

P/E valuation* at (26.9x FY1) 33.3 85.67 28.56

EV/EBITDA valuation* at (19.5x FY1) 33.3 95.96 31.99

Price target 89.01

* P/E and EV/EBITDA multiples have a 15% premium to average of comparable companies (from Factset consensus).

Source: Nomura estimates, Factset consensus estimates

COH’s cochlear implant failure rate was 2%

The average rate of volume growth over the past five half-year following previous cochlear generation launches was 23%

AB’s CI malfunction has led to required removal of the implant in recipients

We use a blend of three valuation methodologies to derive our price target




COH has not issued guidance for FY11F



Revenue 695 735 879 1,009 1,029Cost of goods sold (196) (202) (250) (290) (301)Gross profit 498 533 628 719 728SG&A (324) (313) (363) (415) (386)Employee share expenseOperating profit 175 219 265 304 343

EBITDA 199 242 289 328 367Depreciation (22) (23) (24) (24) (25)Amortisation (3) - - - - EBIT 175 219 265 304 343Net interest expense (7) (11) (12) (10) (9)Associates & JCEsOther income 9 1 - - - Earnings before tax 176 209 253 294 333Income tax (46) (54) (70) (81) (92)Net profit after tax 131 155 183 213 242Minority interests - - - - - Other itemsPreferred dividendsNormalised NPAT 131 155 183 213 242Extraordinary items - - - - - Reported NPAT 131 155 183 213 242

Dividends (90) (107) (128) (149) (169)Transfer to reserves 41 48 55 64 73




ROE (%) 38.2 38.7 39.2 40.3 40.5 ROA (pretax %) 29.8 33.5 34.4 34.9 37.3

Growth (%)Revenue 15.5 5.8 19.6 14.9 1.9 EBITDA 8.4 21.6 19.1 13.5 11.9

EBIT 7.4 25.6 20.9 14.6 12.7

Normalised EPS 12.3 17.9 17.6 16.1 13.4 Normalised FDEPS 12.9 17.6 17.6 16.1 13.4





COH continues to generate significant levels of cash

Cashflow (A$mn)


EBITDA 199 242 289 328 367Change in working capital (3) (96) (53) (52) (13)Other operating cashflow (50) 33 (82) (91) (101)Cashflow from operations 147 180 154 185 253Capital expenditure (27) (81) (73) (31) (32)Free cashflow 120 98 80 154 221Reduction in investments - - - - -

Net acquisitions (20) (11) (8) - - Reduction in other LT assets (15) 15 - - - Addition in other LT liabilities 0 8 - - - Adjustments 15 (23) - - - Cashflow after investing acts 100 87 72 154 221Cash dividends (90) (107) (128) (149) (169)Equity issue 14 20 4 - - Debt issue 17 (32) 43 - - Convertible debt issueOthers 1 (5) - - - Cashflow from financial acts (57) (124) (82) (149) (169)Net cashflow 43 (37) (9) 5 52Beginning cash 37 80 43 33 38Ending cash 80 43 33 38 90Ending net debt 109 114 166 161 109Source: Nomura estimates



Cash & equivalents 80 43 33 38 90Marketable securitiesAccounts receivable 194 236 282 328 339Inventories 106 104 125 145 150

Other current assets 12 90 90 90 90Total current assets 392 473 531 601 670LT investments - - - - - Fixed assets 47 50 88 91 93Goodwill 174 160 160 160 160Other intangible assets 35 52 71 76 81Other LT assets 33 17 17 17 17Total assets 679 752 867 945 1,021Short-term debt - 74 94 94 94Accounts payable 65 71 85 98 102

Other current liabilities 52 69 69 69 69Total current liabilities 117 213 247 261 264Long-term debt 189 83 106 106 106Convertible debtOther LT liabilities 9 17 17 17 17Total liabilities 315 313 370 384 387Minority interest - - - - - Preferred stock - - - - - Common stock 97 117 121 121 121Retained earnings 251 299 354 418 491

Proposed dividends

Other equity and reserves 16 22 22 22 22Total shareholders' equity 364 438 497 561 634

Total equity & liabilities 679 752 867 945 1,021

Liquidity (x)



Net debt/equity (%) 29.8 26.0 33.4 28.7 17.2


Days payable 116.9 122.4 113.5 115.4 121.6 Cash cycle 174.4 174.1 161.6 165.6 176.2 Source: Nomura estimates


Leighton Holdings LEI AU

INDUSTRIALS/ENGINEERING & CONSTRUCTION | AUSTRALIA

Simon Thackray +61 2 8062 8409 [email protected]


Macro myopia Nearer-term issues outweigh long-term upside

Leighton Holdings (LEI) rightly points to a pipeline of long-term growth opportunities across a wide range of attractive geographies. Whilst we acknowledge this long-term growth potential given leverage to attractive macro themes, we also believe a number of medium-term risks may leave LEI vulnerable to a significant PE de-rating. In particular, we continue to expect a significant Middle East JV impairment charge and further profit downgrades attributed to trouble with major civil projects (eg. Airport Link and Victorian Desalination). With no changes to our forecasts, we maintain our REDUCE recommendation.

Despite buzz, need some Asian perspective

Despite the emphasis on the company’s recent tour (see Chinese whispers, 25 November 2010) that it was leveraged to the growing Asian market, it is worth remembering that Leighton Asia (Indonesia, Mongolia, HK/Macau) currently only represents 6% of FY10 revenue. This portion will undoubtedly rise once opportunities pursued come online; however, this will more likely be a post FY12 story.

Valuation below DCF to account for risks

Our price target is derived by applying an equal weighting of 50% to our DCF of A$32.34/share and 50% to our market-weighted peer-based P/E valuation of A$24.86/share. We think this valuation methodology allows sufficient discounting for any working capital cashflow volatility that is inherently difficult to forecast, as well as providing an anchor to the broader earnings risks reflected in market-based valuations. Our price target therefore is A$28.60/share and at >5% below the current trading price, we recommend REDUCE until risks subside.


Revenue 14,545 15,415 16,026 17,360

Reported net profit 615 504 588 715

Normalised net profit 632 504 588 715

Normalised EPS (A$) 1.00 1.68 1.95 2.38

Norm. EPS growth (%) (53.0) 66.9 16.6 21.6

Norm. P/E (x) 31.0 18.6 15.9 13.1

EV/EBITDA (x) 5.1 5.3 4.9 4.5

Price/book (x) 3.6 3.5 3.3 3.0

Dividend yield (%) 4.8 4.0 4.4 5.3

ROE (%) 25.1 19.2 21.2 24.1

Net debt/equity (%) 13.9 16.5 18.2 17.1

Earnings revisions

Previous norm. net profit 504 588 715





1m 3m 6m

(1.3) (5.9) 7.4

4.6 (1.2) 28.2

(5.8) (10.1) (3.5)

Hard


9,520

45.0

41.27/28.00

33.57

Absolute (A$)

Absolute (US$)

Relative to Index


Market cap (US$mn)


Hochtief Limited 55.0

52-week range (A$)


Stock borrowability

26

31

36

41

46

Dec

09

Jan1

0

Feb

10

Mar

10

Ap

r10

Ma

y10

Jun1

0

Jul

10

Au

g10

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p10

Oct

10

No

v10

80

85

90

95

100

105

110

Price



Price target A$28.60(set on 2 Nov 10)

Upside/downside -8.0%Difference from consensus -20.7%

FY12F net profit (A$mn) 588Difference from consensus -13.8%Source: Nomura

Nomura vs consensus We believe further contract losses and impairments will cause consensus downgrades in FY11 through to FY12. REDUCE for risk avoidance.

Maintained

REDUCE


Action Ongoing concerns about cost overruns and time delays for major civil projects

combine with our view of impending balance sheet impairment and the likelihood of a further profit downgrade. Uncertainty around ownership of the majority shareholders and the potential unsettling effect on management adds to the risks not fully reflected in the current share price. We retain a REDUCE rating.

Catalysts Further possible downgrades to FY11F NPAT expectations combine with

leadership uncertainty associated with a successful bid by ACS for HOT (LEI major shareholder) to create a series of downside risks for LEI.

Anchor themes

Whilst broader macroeconomic and resource themes tend to dominate the sector, company-specific risks remain in our view and we see EPS remaining sensitive to impairment and the risk of further provisions on major contracts.

CONVICTION CALL CONVICTION CALL CONVICTION CALL CONVICTION CALL

Leighton Holdings Simon Thackray


Valuation methodology

Detailed valuation methodology

Exhibit 87. DCF valuation assumptions

Target D/DE ratio (%) 25

Tax rate 30

Long-run growth rate (%) 2.5

Risk-free rate (%) 5.25

Equity beta 1.47

Equity risk premium (%) 6

Cost of debt (%) (pre-tax) 8.25


Exhibit 88. LEI valuation using peer FY11F consensus P/E weighted by USD market cap

Company/peer Mkt cap

(US$mn)FY11 PE

(x)Weighted PE

(x)

LEI - Nomura 10,138 19.9 19.9

LEI - consensus 10,138 15.3 1.5

Transfield 1,529 13.4 0.2

Downer 1,772 9.4 0.2

UGL 2,553 15.0 0.4

Balfour Beatty 3,026 7.9 0.2

Bilfinger Berger 3,420 9.7 0.3

Ferrovial 8,410 44.5 3.6

Vinci 29,531 11.6 3.3

Bouyges 15,671 8.2 1.2

ACS Actividades de Construccion y Servicios SA 16,234 12.9 2.0

Hochtief AG 5,849 15.8 0.9

Acciona 5,548 15.9 0.9

Total 113,820 15.0 14.7

Valuation per share using FY11 EPS (Nomura) $24.86

Source: Bloomberg and Nomura estimates


During the period of senior management change, we believe uncertainty around the forward EPS forecasts, coupled with the concerns about balance sheet risk, a possible P/E de-rating and uncertainty surrounding the ACS-HOT bid may cap share price performance in the next six to 12 months. Furthermore, if contract mining machinery acquisition costs rise further than expected this would negatively affect our valuation. However, we acknowledge the long-term growth potential of LEI and the share price/work-in-hand relationship that can see the stock reacting positively to individual contract announcements.




EPS subject to material downside risk from impairment and writedowns



Revenue 13,257 14,545 15,415 16,026 17,360Cost of goods sold (12,042) (12,883) (13,766) (14,242) (15,391)Gross profit 1,215 1,662 1,649 1,784 1,969SG&A (610) (794) (1,023) (1,044) (1,084)Employee share expenseOperating profit 605 868 626 740 885

EBITDA 1,247 1,692 1,649 1,784 1,969Depreciation (642) (824) (1,023) (1,044) (1,084)AmortisationEBIT 605 868 626 740 885Net interest expense (141) (165) (165) (167) (167)Associates & JCEs 379 202 216 216 242Other income 18 (41) (2) (3) (3)Earnings before tax 861 864 675 786 956Income tax (228) (235) (173) (201) (245)Net profit after tax 632 629 502 585 712Minority interests (1) 3 2 3 3Other itemsPreferred dividendsNormalised NPAT 632 632 504 588 715Extraordinary items (192) (17) - - - Reported NPAT 439 615 504 588 715

Dividends (339) (449) (378) (412) (501)Transfer to reserves 101 166 126 176 215




ROE (%) na 25.1 19.2 21.2 24.1 ROA (pretax %) na 14.8 11.1 12.1 13.5

Growth (%)Revenue 28.8 9.7 6.0 4.0 8.3 EBITDA 11.9 35.7 (2.6) 8.2 10.4

EBIT (10.0) 43.5 (27.9) 18.2 19.6

Normalised EPS (53.0) 66.9 16.6 21.6 Normalised FDEPS (53.0) 66.9 16.6 21.6





Despite cash up 45% y-y we are concerned this may be flattered by advance payments and duplicate final contract payments

Cashflow (A$mn)


EBITDA 1,247 1,692 1,649 1,784 1,969Change in working capital (178) 179 6 (108) 41Other operating cashflow (194) (132) (347) (363) (405)Cashflow from operations 876 1,739 1,308 1,313 1,605Capital expenditure (1,064) (895) (1,127) (1,144) (1,304)Free cashflow (188) 844 181 169 302Reduction in investments (59) (129) 6 (229)

Net acquisitions 149 (80) 416 339 326Reduction in other LT assets (155) (77) (225) 3Addition in other LT liabilities 276 (59) 29 44AdjustmentsCashflow after investing acts (40) 826 333 317 446Cash dividends (415) (359) (420) (394) (451)Equity issue 691 46 - - - Debt issue (283) 195 - - - Convertible debt issueOthers 26 (60) - - - Cashflow from financial acts 19 (178) (420) (394) (451)Net cashflow (21) 648 (88) (77) (5)Beginning cash 687 666 1,314 1,226 1,149Ending cash 666 1,314 1,226 1,149 1,144Ending net debt 613 357 444 522 527Source: Nomura estimates



Cash & equivalents 666 1,314 1,226 1,149 1,144Marketable securitiesAccounts receivable 2,392 2,452 2,576 2,678 2,901Inventories 577 556 566 624 675

Other current assets 79 37 28 33 40Total current assets 3,713 4,359 4,396 4,484 4,759LT investments 1,842 1,902 2,031 2,025 2,254Fixed assets 1,820 2,034 1,986 1,938 2,013Goodwill 124 125 125 125 125Other intangible assetsOther LT assets 192 347 424 649 646Total assets 7,692 8,766 8,962 9,221 9,797Short-term debtAccounts payable 3,615 3,792 3,922 3,980 4,301

Other current liabilitiesTotal current liabilities 3,615 3,792 3,922 3,980 4,301Long-term debt 1,279 1,670 1,670 1,670 1,670Convertible debtOther LT liabilities 460 736 677 705 749Total liabilities 5,354 6,198 6,270 6,356 6,720Minority interest (1) 3 3 3 3Preferred stockCommon stock 1,172 1,233 1,233 1,233 1,233Retained earnings 1,120 1,372 1,496 1,670 1,881

Proposed dividends

Other equity and reserves 48 (41) (41) (41) (41)Total shareholders' equity 2,339 2,565 2,688 2,862 3,073


Liquidity (x)



Net debt/equity (%) 26.2 13.9 16.5 18.2 17.1


Days payable 98.7 104.9 102.3 101.5 98.2 Cash cycle (29.4) (28.1) (27.9) (26.2) (24.1) Source: Nomura estimates


Myer Holdings MYR AU

CONSUMER RELATED/RETAIL | AUSTRALIA

Nick Berry +61 2 8062 8404 [email protected]

David Cooke +61 2 8062 8408 [email protected]

Rob Freeman +61 2 8062 8402 [email protected]

Bucking the trend Forecasting solid market-share growth

Our analysis suggests that not only is Myer’s store rollout program feasible, its quick action in securing new store leases through to FY14F has placed it at a distinct advantage to its competition (particularly in David Jones and Target). As a result, the department store (DS) category is set the ‘buck the trend’ of a 20-plus year decline in market share to specialty retailers, and we forecast total sales growth ahead of market in FY11F. Assuming the lower end of management ROIC guidance, Myer’s 14 new stores account for A$0.63 of our A$4.50 DCF-based valuation.

Margin where it matters

Following four years of significant investment to rationalise its cost base, investment focus now turns to top-line and gross margin growth. We forecast significant margin upside in further Exclusive Brands sales penetration (c120bp), reduced shrinkage (c50bp), increased direct sourcing (c10-15bp) and increased buying power as new stores open. In our view a 10%-plus EBIT margin is achievable (FY10A: 8.1%).

Near-term headwinds provide attractive entry point

Discretionary retail share prices have underperformed the broader market in recent months, with Myer no exception. In our view this reflects concerns around higher interest rates, unseasonal sales promotional depth and a view to a rapidly overheating housing market. With the RBA recently moving to a more neutral stance on rates these concerns should abate for consumers in 2011, combining with strong employment and wage growth to drive discretionary spend. Myer is our preferred exposure trading on a PEG of 1.0x with a dividend yield of c7%, versus the market cap. weighted average of the discretionary retailers under coverage of 1.3x and 5.7% respectively.

Key financials & valuations01 Jul (A$mn) FY10 FY11F FY12F FY13F

Revenue 3,324 3,499 3,678 3,845

Reported net profit 67.2 182.3 215.1 236.4

Normalised net profit 163.5 182.3 215.1 236.4

Normalised EPS (A$) 0.30 0.31 0.37 0.41

Norm. EPS growth (%) 30.3 4.4 18.7 9.9

Norm. P/E (x) 12.1 11.5 9.7 8.8

EV/EBITDA (x) 7.1 6.4 5.4 4.9

Price/book (x) 2.4 2.2 2.1 2.0

Dividend yield (%) 5.9 6.8 8.1 8.8

ROE (%) 10.9 20.4 22.5 23.2

Net debt/equity (%) 36.6 30.0 20.2 14.5

Earnings revisions

Previous norm. net profit 182.3 215.1 236.4





1m 3m 6m

(2.2) (5.1) 13.0

3.6 (0.3) 34.8

(6.8) (9.2) 3.1

Easy


52-week range (A$)


Stock borrowability


na na

Absolute (A$)

Absolute (US$)

Relative to Index



100.0

3.99/2.97

13.22

2.8

3.03.23.43.63.84.04.2

De

c09

Jan

10

Fe

b10

Mar

10

Ap

r10

Ma

y10

Jun

10

Jul1

0

Au

g10

Se

p10

Oc

t10

Nov

10

80859095100105110115120

Price



Price target A$4.50(set on 16 Sep 10)


FY12F net profit (A$mn) 215.1Difference from consensus 6.0%Source: Nomura

Nomura vs consensus We believe consensus forecasts and price targets could be factoring in lower gross margin expansion from Exclusive Brands gains as a portion of total sales.

Maintained

BUY


Action 1Q11 sales ahead of expectations and Myer’s inaugural investor day, both in

November, provided comfort that sales and margin growth initiatives remain on track. Unseasonal promotional depth – while a near-term margin headwind – appears more than captured at current trading levels, and combined with a c7% yield should see the company appeal to both growth and value investors alike.

Catalysts 2Q11 sales due February should prove a positive share price catalyst, with initial

contributions from new stores expected to drive market share gains.

Anchor themes

An emerging sustainable improvement in underlying sales fundamentals points to solid value opportunities in the Australian discretionary retail sector. Recent sector weakness on tightened policy rates provides a good entry point, in our view, with solid employment and wage growth set to drive discretionary spend in 2011.

Myer Holdings Nick Berry


Drilling down

Valuation Key drivers for Myer include:

Growing Exclusive Brands (EB) should expand GM 120bp: Our analysis suggests Myer achieves a 70% first margin (i.e. GM pre-promotional/discount funding) on its EB sales – clothing brands owned and produced by third-party manufacturers for Myer. Growing EB as a proportion of sales from FY10’s 17% to c22% should see c125bp of upside to group gross margin by FY13F/FY14F. We understand EB are on track for 18% sales share in FY11F.

Further shrinkage reduction should yield c50bp of GM upside: Shrinkage (stolen and unaccounted for products) currently accounts for c1-2% of Myer’s sales, or A$35-70mn pa. Myer has several initiatives underway to reduce shrinkage, including: the introduction of CCTV to all stores and all distribution centres; electronic article systems (EAS); and fitting room management reviews. To date, an annualised 51bp of shrinkage reduction (cA$16-17mn) has been achieved, and we calculate a further approximate 50bp benefit through FY12F.

New store rollout program feasible and a key differentiator: Our analysis suggests Myer’s signed leases on 14 new stores are a key advantage versus the competition, with retail space supply limited in FY13F. Assuming the lower end of new store returns guidance the 14 new stores contributes A$0.63 of our valuation.

Taking EB international: At its recent strategy day Myer alluded to discussions with offshore counterparts in the UK to develop an international distribution channel for EB. We view this sort of brand management/licensing approach as a positive, low risk approach to maximizing the significant margin potential in EB.

Loyalty program MYERone underpinning growth: Our analysis indicates MYERone members spent A$2,197mn (+8.8% y-y) at Myer in FY10, representing additional sales of A$178mn or 7.74x total company sales growth of A$23mn. Myer should be able to leverage its MYERone customer base to increase targeted marketing programs and the efficiency of marketing dollars spent


We value Myer at A$4.50 per share using our preferred discounted cashflow (DCF) methodology (WACC and terminal growth rate unchanged at 9.4% and 2.5% respectively). We set our price target in line with our valuation. New store openings contribute A$0.63 of the valuation and the underlying business accounts for the remainder.


A forecast sustainable improvement in underlying sales fundamentals is central to our positive investment thesis for Myer. In our view, the core risks to this macro forecast include: a series of further rapid interest rate rises (either through policy implementation or bank variable rate increases); evidence of a structural shift in consumption patterns impacting margin mix longer term; a collapse in Australian house prices; a lower-than-expected AUD/USD (Nomura forecasts 97c for FY11); or a material increase in unemployment. Positive risks include: faster/deeper penetration of exclusive brands sales than forecast; greater strength in the consumer spending recovery than forecast; and market-share gains from competitor disruption due to brand repositioning (eg. Kmart). The key neutral risk is how Myer deploys its balance sheet capacity in the medium term (we view investment in third-party channel distribution of EB as most likely).




Myer Melbourne reopening, plus several store refurbishments


Year-end 01 Jul FY09 FY10 FY11F FY12F FY13F

Revenue 3,261 3,324 3,499 3,678 3,845Cost of goods sold (1,983) (2,007) (2,092) (2,198) (2,288)Gross profit 1,278 1,318 1,406 1,481 1,557SG&A (1,042) (1,047) (1,113) (1,148) (1,196)Employee share expense - - - - - Operating profit 236 270 293 333 362

EBITDA 301 336 370 419 458Depreciation (65) (65) (77) (86) (96)Amortisation - - - - - EBIT 236 270 293 333 362Net interest expense (82) (42) (33) (26) (24)Associates & JCEs - - - - - Other income - - - - - Earnings before tax 154 228 260 307 338Income tax (45) (65) (78) (92) (101)Net profit after tax 109 164 182 215 236Minority interests - - - - - Other items - - - - - Preferred dividends - - - - - Normalised NPAT 109 164 182 215 236Extraordinary items - (96) - - - Reported NPAT 109 67 182 215 236

Dividends - (122) (140) (169) (183)Transfer to reserves 109 (55) 42 46 53


FD normalised P/E at price target (x) 19.7 15.3 14.4 12.2 11.1 Reported P/E (x) 15.6 29.1 11.5 9.7 8.8 Dividend yield (%) - 5.9 6.8 8.1 8.8 Price/cashflow (x) 10.2 8.1 7.3 6.4 6.5 Price/book (x) 4.3 2.4 2.2 2.1 2.0 EV/EBITDA (x) 9.2 7.1 6.4 5.4 4.9 EV/EBIT (x) 11.7 8.8 8.0 6.8 6.2 Gross margin (%) 39.2 39.6 40.2 40.3 40.5 EBITDA margin (%) 9.2 10.1 10.6 11.4 11.9 EBIT margin (%) 7.2 8.1 8.4 9.1 9.4

Net margin (%) 3.3 2.0 5.2 5.8 6.1 Effective tax rate (%) 29.2 28.4 30.0 30.0 30.0 Dividend payout (%) - 182.0 77.0 78.4 77.5 Capex to sales (%) 3.6 3.1 3.4 2.5 2.5 Capex to depreciation (x) 1.8 1.6 1.5 1.1 1.0

ROE (%) 32.1 10.9 20.4 22.5 23.2 ROA (pretax %) 13.4 14.8 15.7 17.5 18.6

Growth (%)Revenue (1.8) 1.9 5.2 5.1 4.5 EBITDA 9.3 11.5 10.2 13.3 9.1

EBIT 10.7 14.6 8.5 13.6 8.6

Normalised EPS 0.5 30.3 4.4 18.7 9.9 Normalised FDEPS 0.5 28.6 5.9 18.7 9.9


Book value per share (A$) 0.83 1.47 1.59 1.70 1.80DPS (A$) - 0.21 0.24 0.29 0.32Source: Nomura estimates



Capex delay on POS

Cashflow (A$mn)

Year-end 01 Jul FY09 FY10 FY11F FY12F FY13F

EBITDA 301 336 370 419 458Change in working capital (5) 3 11 23 (14)Other operating cashflow (129) (98) (95) (118) (125)Cashflow from operations 167 241 286 324 318Capital expenditure (119) (105) (119) (92) (96)Free cashflow 48 136 167 232 222Reduction in investments 2 2 (2) - -

Net acquisitions - - - - - Reduction in other LT assets 15 21 - - - Addition in other LT liabilities 33 (14) - - - Adjustments (50) (10) 2 - - Cashflow after investing acts 47 134 167 232 222Cash dividends - - (131) (154) (174)Equity issue - 315 - - - Debt issue - (364) - - - Convertible debt issue - - - - - Others (2) (164) - - - Cashflow from financial acts (2) (213) (131) (154) (174)Net cashflow 46 (79) 36 78 47Beginning cash 139 185 106 142 220Ending cash 185 106 142 220 268Ending net debt 694 314 278 200 152Source: Nomura estimates


As at 01 Jul FY09 FY10 FY11F FY12F FY13F

Cash & equivalents 185 106 142 220 268Marketable securities - - - - - Accounts receivable 33 24 35 37 38Inventories 356 353 339 368 404

Other current assets 29 - - - - Total current assets 602 483 516 625 710LT investments 8 6 8 8 8Fixed assets 372 468 510 516 516Goodwill 350 350 350 350 350Other intangible assets 559 571 571 571 571Other LT assets 97 76 76 76 76Total assets 1,987 1,954 2,031 2,145 2,231Short-term debt - - - - - Accounts payable 468 438 462 515 538

Other current liabilities 127 120 104 104 104Total current liabilities 594 557 566 619 643Long-term debt 879 420 420 420 420Convertible debt - - - - - Other LT liabilities 133 119 119 119 119Total liabilities 1,607 1,096 1,105 1,158 1,182Minority interest - - - - - Preferred stock - - - - - Common stock 85 517 554 554 554Retained earnings 314 320 372 433 495

Proposed dividends - - - - -

Other equity and reserves (19) 20 - - - Total shareholders' equity 380 857 926 987 1,049


Liquidity (x)



Net debt/equity (%) 182.6 36.6 30.0 20.2 14.5


Days payable 83.2 82.3 78.5 81.3 84.0 Cash cycle (15.2) (14.8) (15.0) (18.9) (18.9) Source: Nomura estimates


Westpac Banking Corp WBC AU

FINANCIALS/BANKS | AUSTRALIA

Victor German +61 2 8062 8411 [email protected]

Anthony Hoo +61 2 8062 8414 [email protected]

Prue Rydstrand +61 2 8062 8413 [email protected]

Quality franchise at a discount Sector leading capital position at a discount

WBC’s sector-leading capital position, combined with its strong levels of organic capital generation (41bps in FY10 vs peers at 5-20bps), suggest to us that it is well placed to meet the more stringent Basel III requirements over the coming years. This, combined with WBC’s strong return on capital (~23% in 2H10), makes it challenging for us to justify a valuation discount to peers.

Margin trends stabilised and improved funding position

After experiencing a material NIM decline over the first three quarters of 2010, the stabilisation of margin trends occurred in the 4Q10. Further, WBC improved its funding position and trading income levels normalised from the highs of 2H09, suggesting that WBC’s NIM performance is unlikely to be materially different to peers’, which was a key market concern.

Good credit quality and strong provisioning levels

WBC’s impairment charge declined materially in 2H10, and its impaired assets to non-housing loans remain at the bottom end of peers, which suggests bad debts are likely to be lower in FY11. Additionally, it boasts the strongest provisioning levels (to credit risk weighted assets) of the majors, which should see it benefit from a gradual capital release as conditions improve.

Valuation potential upside

WBC is trading at a 15% FY11F P/E discount to its closest peer CBA, which we believe is not warranted given WBC’s strong organic capital generation and sector-leading capital position. We continue to see potential valuation upside and retain WBC as our top pick in the sector.

Key financials & valuations30 Sep (A$mn) FY10 FY11F FY12F FY13F

PPOP 9,938 10,163 10,806 11,434

Reported net profit 6,346 6,179 6,900 7,128

Normalised net profit 5,879 6,379 6,900 7,128

Normalised EPS (A$) 1.98 2.12 2.26 2.30

Norm. EPS growth (%) 22.2 7.1 6.6 1.8

Norm. P/E (x) 11.8 11.0 10.4 10.2

Price/adj. book (x) 1.68 1.61 1.53 1.46

Price/book (x) 1.68 1.61 1.53 1.46

Dividend yield (%) 6.1 6.4 6.9 7.0

ROE (%) 16.5 14.9 15.6 15.1

ROA (%) 1.05 0.97 1.01 0.97

Earnings revisions

Previous norm. net profit 6,379 6,900 7,128





1m 3m 6m

5.8 (2.7) 6.5

12.1 2.2 27.1

1.7 (6.7) (4.6)

Easy


52-week range (A$)


na

Stock borrowability

na


na na

Absolute (A$)

Absolute (US$)

Relative to Index



1.0

28.25/20.79

204.3

20

22

24

26

28

30

De

c09

Jan

10

Fe

b10

Ma

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Ap

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Ma

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Jun1

0

Jul1

0

Aug

10

Sep

10

Oc

t10

Nov

10

80

859095100105110115

Price



Price target A$25.00(set on 6 Dec 10)


FY12F net profit (A$mn) 6,900Difference from consensus 4.5%Source: Nomura

Nomura vs consensus We continue to believe WBC’s current valuation discount to peers is unjustifiable given healthy levels of organic capital generation and a strong RoTE profile.

Maintained

BUY


Action Pleasing trends evident in the FY10 result (stabilisation of the NIM and normalised

trading income levels) suggest that WBC’s underlying performance is unlikely to lagpeers in FY11F, although underlying profit growth expectations remain a key issue for the bank sector. This, coupled with WBC’s sector-leading capital position, strong organic capital generation capabilities and prudent provisioning levels, suggests to us that the relative PE discount to CBA and ANZ is not justifiable. Maintain BUY.

Catalysts We believe the valuation gap between WBC and peers is likely to close as the

market refocuses its attention towards WBC’s superior returns and capital position.

Anchor themes

The current valuation discount to peers presents a good opportunity for investors who are looking to achieve exposure to a quality domestic banking franchise.

Westpac Banking Corp Victor German


Key issues

Sector-leading capital position … strong provisioning On a Basel III basis, WBC estimates that it would have a Core Tier 1 of ~6.7% (vs ANZ at 6.6%). This strong position, combined with WBC’s organic capital generation (41bps vs peers at 5-19bps), suggests it is the best-placed major to reach the more stringent minimum capital requirements under Basel III. Further, WBC’s strong provisioning levels vs peers should see it benefit from a capital release as conditions improve.

Exhibit 89. Banks Tier 1 under Basel III

6.6 6.7 6.76.6

6.4 6.4

6.7

5.6

5.0

5.5

6.0

6.5

7.0

7.5

ANZ CBA NAB WBC

(%)

As reported Nomura estimates CBA (double gearing adj)


Exhibit 90. Collective provision to Credit RWA

10594

142138 135

113

7275

106

89

112

125

131

125

150

100

133

146

92

135

0

50

100

150

200

ANZ CBA NAB WBC

(bps)

2H08 1H09 2H09 1H10 2H10

Note: Organic capital generation is cash earnings, ex net dividend and RWA movements.


Tough revenue environment … but normalising trends Operating revenue was under pressure in FY10 as: 1) banks reduced exception fees (~A$300mn impact for WBC), 2) trading revenue normalised from the exceptionally strong levels of FY09, and 3) margins were under pressure from higher funding costs.

Additionally, we flag that WBC’s NIM appears to have normalised following a poor 1H10 performance. Pleasingly, WBC has rectified its bias towards short-term funding (now~23% of total funding vs 32% for 2007), and it is now in line with peers, suggesting that NIM performance is unlikely to be dissimilar to peers.

While we expect revenue growth to remain subdued in FY11, given margins are likely to remain under pressure and volumes are not likely to rebound strongly, we see less obvious headwinds for banks. In this respect, WBC is arguably better positioned than peers, having undertaken broader fee reductions as well as experiencing a rebasing of its trading revenue to more normalised levels.


We maintain our 12-month target price of A$25.00/share, which is based broadly on the mid-point of our DCF and SOTP (P/E-based) valuations of A$27.77/share and A$23.49/share respectively. Our DCF assumes a WACC of 11.25% (beta of 1.0, risk-free rate of 5.25%, equity risk premium of 6%) and terminal growth rate of 5%, which is based on LT GDP growth.


Key downside risk is from a material deterioration in the credit quality in the St George portfolio, market-share losses in the mortgages portfolio due to higher interest rates versus peers, and material changes in the regulatory environment for retail banks due to government intervention.

We value WBC using the midpoint of our SOTP and DCF valuations




Profit and Loss (A$mn)

Year-end 30 Sep FY09 FY10 FY11F FY12F FY13F

Interest income 30,446 34,077 37,213 40,011 43,276Interest expense (19,013) (22,222) (25,198) (27,482) (30,178)Net interest income 11,433 11,855 12,016 12,529 13,098Net fees and commissions 2,637 2,433 2,576 2,766 2,963Trading related profits 1,294 1,825 1,942 2,094 2,251Other operating revenue 901 797 757 813 871Non-interest income 4,832 5,055 5,275 5,673 6,085Operating income 16,265 16,910 17,290 18,201 19,182Depreciation (401) (509) (565) (587) (614)Amortisation - - - - - Operating expenses (6,133) (6,463) (6,563) (6,808) (7,135)Employee share expenseOp. profit before provisions 9,731 9,938 10,163 10,806 11,434Provisions for bad debt (3,238) (1,456) (1,083) (992) (1,299)Other provision chargesOperating profit 6,493 8,482 9,080 9,814 10,135Other non-operating income - - - - -

Associates & JCEs - - - - - Pre-tax profit 6,493 8,482 9,080 9,814 10,135Income tax (1,958) (2,537) (2,633) (2,846) (2,939)Net profit after tax 4,535 5,945 6,447 6,968 7,196Minority interests (71) (66) (68) (68) (68)Other items - - - - -

Preferred dividends - - - - - Normalised NPAT 4,464 5,879 6,379 6,900 7,128Extraordinary items (1,018) 467 (200) - - Reported NPAT 3,446 6,346 6,179 6,900 7,128DividendsTransfer to reserves 3,446 6,346 6,179 6,900 7,128

Valuation and ratio analysisFD normalised P/E (x) 14.4 11.8 11.0 10.4 10.2 FD normalised P/E at price target (x) 16.0 13.0 12.2 11.5 11.2 Reported P/E (x) 18.1 10.6 11.0 10.0 9.8 Dividend yield (%) 5.1 6.1 6.4 6.9 7.0 Price/book (x) 1.8 1.7 1.6 1.5 1.5 Price/adjusted book (x) 1.8 1.7 1.6 1.5 1.5 Net interest margin (%) 2.33 2.21 2.16 2.09 2.02

Yield on interest earning assets (%) 6.21 6.35 6.68 6.68 6.68 Cost of interest bearing liabilities (%) na na na na naNet interest spread (%) na na na na naNon-interest/operating income (%) 29.7 29.9 30.5 31.2 31.7 Cost to income (%) 40.2 41.2 41.2 40.6 40.4 Effective tax rate (%) 30.2 29.9 29.0 29.0 29.0 Dividend payout (%) - - - - - ROE (%) 12.2 16.5 14.9 15.6 15.1 ROA (%) 0.67 1.05 0.97 1.01 0.97 Operating ROE (%) 22.9 22.0 21.9 22.2 21.5 Operating ROA (%) 1.26 1.40 1.42 1.44 1.37

Growth (%)Net interest income 58.3 3.7 1.4 4.3 4.5 Non-interest income 24.1 4.6 4.3 7.5 7.3 Non-interest expenses 30.4 5.4 1.5 3.7 4.8 Pre-provision earnings 55.9 2.1 2.3 6.3 5.8 Net profit 19.8 31.7 8.5 8.2 3.3 Normalised EPS (18.3) 22.2 7.1 6.6 1.8 Normalised FDEPS (18.9) 22.7 6.7 6.5 1.8


We see NIM coming under pressure… decreasing by ~5bps per year



Balance Sheet (A$mn)

As at 30 Sep FY09 FY10 FY11F FY12F FY13F

Cash and equivalents 3,272 4,464 4,759 5,147 5,567Inter-bank lending 9,974 12,588 13,419 14,514 15,699Deposits with central bank - - - - - Total securities 80,994 91,701 97,758 105,735 114,363Other interest earning assetsGross loans 467,843 482,366 514,487 555,780 600,516Less provisions (4,384) (4,711) (5,283) (5,025) (4,819)Net loans 463,459 477,655 509,204 550,755 595,697Long-term investments - - - - - Fixed assets 766 1,322 1,409 1,524 1,649Goodwill 11,541 11,504 10,258 10,258 10,258Other intangible assets - - - - - Other non IEAs 19,581 19,043 20,301 21,957 23,749Total assets 589,587 618,277 657,108 709,891 766,981Customer deposits 329,456 337,385 359,669 389,018 420,762Bank deposits, CDs, debentures 9,235 8,898 9,486 10,260 11,097Other interest bearing liabilities 1,671 635 677 732 792Total interest bearing liabilities 340,362 346,918 369,832 400,010 432,651Non interest bearing liabilities 212,654 231,241 244,784 264,498 285,927Total liabilities 553,016 578,159 614,615 664,508 718,578Minority interestCommon stock 23,637 24,686 25,486 26,455 27,486Preferred stock (188) (190) (190) (190) (190)Retained earnings 11,244 13,750 15,325 17,246 19,235Proposed dividends - - - - -

Other equity 1,878 1,872 1,872 1,872 1,872Shareholders' equity 36,571 40,118 42,493 45,383 48,403

Total liabilities and equity 589,587 618,277 657,108 709,891 766,981Non-performing assets (A$) 3,770 4,585 5,714 4,558 3,192

Balance sheet ratios (%)Loans to deposits 142.0 143.0 143.0 142.9 142.7 Equity to assets 6.2 6.5 6.5 6.4 6.3

Asset quality & capitalNPAs/gross loans (%) 0.8 1.0 1.1 0.8 0.5 Bad debt charge/gross loans (%) 0.69 0.30 0.21 0.18 0.22 Loss reserves/assets (%) 0.74 0.76 0.80 0.71 0.63 Loss reserves/NPAs (%) 116.3 102.7 92.5 110.2 151.0 Tier 1 capital ratio (%) 8.1 9.1 9.1 9.2 9.2 Total capital ratio (%) 10.8 11.0 10.9 10.8 10.7

Growth (%)Loan growth 47.8 3.1 6.6 8.2 8.2 Interest earning assets 34.1 5.0 6.6 8.2 8.2 Interest bearing liabilities 34.2 1.9 6.6 8.2 8.2 Asset growth 34.1 4.9 6.3 8.0 8.0 Deposit growth 41.0 2.4 6.6 8.2 8.2

Per shareReported EPS (A$) 1.25 2.14 2.05 2.26 2.30Norm EPS (A$) 1.62 1.98 2.12 2.26 2.30Fully diluted norm EPS (A$) 1.57 1.92 2.05 2.18 2.22DPS (A$) 1.16 1.39 1.46 1.55 1.58PPOP PS (A$) 3.53 3.34 3.37 3.54 3.69BVPS (A$) 12.43 13.42 14.03 14.76 15.52ABVPS (A$) 12.43 13.42 14.03 14.76 15.52NTAPS (A$) 8.51 9.57 10.64 11.43 12.23


WBC is well positioned to reach Basel III requirements


Woodside Petroleum WPL AU

OIL & GAS/CHEMICALS | AUSTRALIA

Xavier M Grunauer +61 2 8062 8416 [email protected]

2011 – major milestones ahead Pluto to deliver in September

Pluto’s LNG foundation project is now 95% complete with the first shipment from the 4.3mtpa train scheduled for September 2011. With construction delays behind us, and fresh delays not expected, we are looking for Pluto’s first train to benefit from a rising oil price assumptions and expectations that costs could continue to rise in Australia, increasingly becoming a burden on competing LNG projects.

FID of Pluto’s second train expected late 2011 Following the acquisition of Hess interests in the Central Hub (WA-404-P), we expect WPL to be able to move forward with Pluto’s expansion train (T2) in 2011 with our models pricing in final investment decision (FID) by mid 2011, first LNG by 2015, and expected project costs of US$9.5bn.

New management and Sunrise With both CEO Don Voelte and CFO Mark Chatterji stepping down by YE11, we see an opportunity for fresh management to revisit negotiations with Timor-Leste with our models pointing to A$1.6 per share of value locked into WPL’s 33% stake of this 5 TCF project.

Shell’s sell-down to potentially create opportunities We are of the opinion that Shell’s search for a strategic investor to take its 24% stake in WPL realises a window for new entrants who can benefit from this stake, and in turn, add value to Woodside’s shareholders.

BUY rating with a A$56.4 per share price target Our valuation models point to A$6 per share being locked into Pluto’s expansion projects, with a further S$1.6 per share locked into Sunrise, we are of the opinion that developments in 2011 could unlock value for shareholders. We reaffirm our BUY rating.

Key financials & valuations31 Dec (US$mn) FY09 FY10F FY11F FY12F

Revenue 3,450 4,159 4,723 8,443



Normalised EPS (US$) 1.93 1.81 2.15 4.31

Norm. EPS growth (%) (11.7) (5.9) 18.9 100.0

Norm. P/E (x) 25.2 23.5 19.9 9.9

EV/EBITDA (x) 13.1 12.3 11.1 5.4

Price/book (x) 3.9 3.2 3.2 2.5

Dividend yield (%) 2.4 2.6 2.6 2.6

ROE (%) 21.2 14.6 16.1 28.5

Net debt/equity (%) 42.4 28.7 26.9 9.1

Earnings revisions



Previous norm. EPS (US$) 1.81 2.15 4.31



1m 3m 6m

2.0 (2.5) 2.3

7.9 2.3 21.9

(2.6) (6.8) (9.9)

Easy


34,102

65.0

49.28/40.56

189.7

Absolute (A$)

Absolute (US$)

Relative to Index


Market cap (US$mn)


RD SHELL 24.3

52-week range (A$)


Stock borrowability

39

41

43

45

47

49

51

Dec

09

Jan1

0

Feb

10

Mar

10

Ap

r10

Ma

y10

Jun1

0

Jul

10

Au

g10

Se

p10

Oct

10

No

v10

9092949698100102104106

Price



Price target A$56.4(set on 22 Jun 10)


FY11F net profit (US$mn) 1,689Difference from consensus 16.6%Source: Nomura

Nomura vs consensus Earnings estimates for 2011 come in ahead of consensus on above consensus oil price call of US$95/bbl average for the year.

Maintained

BUY


Action We expect 2011 to be a year of change for Woodside with the much-awaited

commissioning of Pluto’s first train expected to increase daily production by 45% in Q411. The new capacity has been well timed, ahead of rising construction costs in Australia and concurrent with our expectations of rising oil prices. Well-flagged changes in management in FY11 along with Shell’s search for a strategic buyer of its 24% stake in Woodside are all expected to bring about positive change. BUY.

Catalysts The confirmation of gas volumes in the Central Hub, along with the successful

delivery of Pluto’s first shipments, is expected to be well received by the market.

Anchor themes

Clean and efficient natural gas is expected to see robust demand growth in the Asia Pacific region in the medium and longer term. We expect global attention to turn to Australia’s vast gas reserves, especially once new infrastructure is built.

Woodside Petroleum Xavier M Grunauer


Major milestones ahead

Pluto’s T1 – ahead of the competition Woodside’s Pluto Foundation reports a 95% complete project, with a revised start-up and first LNG now scheduled for September 2011, three months behind our previously modelled start-up of July 1, 2011. The company points to flare tower design problems as the main cause of delays, which contribute to an additional A$0.9bn in costs. Also included in the cost overrun are sourcing costs associated with missed LNG cargoes, with the company pointing to these costs as being less significant and not material.

With regards to Pluto expansion projects, company guidance points to two more exploration wells in the Central Hub which together with drilling successes and acquisition in the Central Hub (WA-404-P), position the company well to be in a position of having sourced sufficient gas to take a 90% stake in Pluto’s T2 expansion train which DCF model now pricing in T2 expansion at an expected cost of US$9.5bn.

While the company is not keen to share cost estimates for Pluto expansion projects on the grounds that Australia has become a very competitive environment, we now have included Pluto T2 into our core production model coming online in early 2015, which in turn implies a FID for Pluto T2 in the coming year, with our models pointing to mid-year 2011 as most likely given Woodside’s drilling and appraisal schedule.

Life post Shell’s sell-down of a 10% stake in Woodside We are of the opinion that announcements by Shell (8 November 2010) that it was looking for a strategic investor to take the remaining 24.27% stake realises a potential window for new entrants who can benefit from an equity stake in Woodside. We are of the opinion that there are only a handful of companies that could benefit from owning a 24% stake in Woodside, and more importantly, could receive approval from both Woodside shareholders and Australia’s Foreign Investment Review Board. We see three clear potential acquirers:

BHP (BHP AU): Potentially creating a merger of equals

Chevron (CVX US): Leveraging project synergies with Wheatstone LNG

Conoco (COP US): Benefiting from west coast consolidation?

While our previous thoughts of Darwin becoming an LNG hub have yet to materialise, we are of the opinion that as operator of Darwin’s 3.6mtpa LNG facility, Conoco would benefit from an expanded footprint, potentially adding Woodside-led Sunrise LNG if it can negotiate approval from Timor-Leste, and potentially bringing Browse natural gas to Darwin as well. We could envision a scenario where Conoco swaps Shell’s 24% stake in Woodside for a stake in Conoco/Origin’s CSG to LNG project (APLNG). The combination would bring Woodside’s marketing expertise to Conoco upstream global experience. From Origin’s point of view, including Shell in the fray could facilitate new offtake agreements facilitating FID of APLNG earlier than expected.

Valuation methodology and risks to our investment view Near term, we expect Pluto to have a significant impact on Woodside’s balance sheet once it is up and running. We expect daily production to increase by over 45% in 4Q11, increasing the company’s leverage to global oil prices as we price in US$110 oil in 2012. We value Woodside using a combination of a DCF model and a sum-of-the-parts (SOTP) approach. Our DCF valuation focuses on WPL's core business and makes use of an 8.5% WACC and a 3.5% terminal growth rate. The fair value of the core business, which includes Pluto T1 and T2, comes in at A$48/share. Our SOTP valuation adds the present value of longer-term LNG projects not accounted for in our DCF valuation, which include Pluto T3 along with Sunrise and Browse. All in, we arrive at a price target of A$56.4 per share.

Risks to our forecasts and investment view include oil price volatility, operational risks from offshore operations, and project risk from delays and large cost overruns.

We arrive at a price target of A$56.4 per share

Conoco could swap Shell’s 24% stake in Woodside for a stake in APLNG

First LNG now expected in September 2011, three months delay on our estimates




EBITDA to rise as Pluto comes online

Income statement (US$mn)

Year-end 31 Dec FY08 FY09 FY10F FY11F FY12F

Revenue 5,106 3,450 4,159 4,723 8,443Cost of goods sold (2,220) (1,146) (1,921) (2,088) (3,120)Gross profit 2,885 2,304 2,238 2,636 5,323SG&A (74) (33) (55) (55) (75)Employee share expense - - - - - Operating profit 2,811 2,270 2,183 2,581 5,248

EBITDA 3,637 3,078 2,965 3,287 6,384Depreciation (826) (808) (782) (706) (1,136)Amortisation - - - - - EBIT 2,811 2,270 2,183 2,581 5,248Net interest expense (20) (13) 23 - (10)Associates & JCEs - - - - - Other income - - - - - Earnings before tax 2,792 2,258 2,206 2,581 5,238Income tax (1,269) (816) (785) (892) (1,860)Net profit after tax 1,522 1,441 1,421 1,689 3,378Minority interests - - - - - Other itemsPreferred dividendsNormalised NPAT 1,522 1,441 1,421 1,689 3,378Extraordinary itemsReported NPAT 1,522 1,441 1,421 1,689 3,378

Dividends (433) (823) (862) (862) (862)Transfer to reserves 1,089 618 558 826 2,515




ROE (%) na 21.2 14.6 16.1 28.5 ROA (pretax %) na 16.8 12.8 14.7 28.0

Growth (%)Revenue (32.4) 20.6 13.6 78.8 EBITDA (15.4) (3.7) 10.8 94.2

EBIT (19.2) (3.8) 18.2 103.3

Normalised EPS (11.7) (5.9) 18.9 100.0 Normalised FDEPS (5.3) (1.4) 18.3 100.0

Per shareReported EPS (US$) 2.18 1.93 1.81 2.15 4.31Norm EPS (US$) 2.18 1.93 1.81 2.15 4.31Fully diluted norm EPS (US$) 1.95 1.85 1.82 2.15 4.31

Book value per share (US$) 6.75 11.83 13.54 13.28 16.91DPS (US$) 0.62 1.10 1.10 1.10 1.10Source: Nomura estimates



Debt accounts for Pluto T2 construction

Cashflow (US$mn)

Year-end 31 Dec FY08 FY09 FY10F FY11F FY12F

EBITDA 3,637 3,078 2,965 3,287 6,384Change in working capital - (797) 366 95 596Other operating cashflow (412) (808) (807) 74 (2,403)Cashflow from operations 3,225 1,474 2,524 3,456 4,577Capital expenditure (3,894) (4,761) (3,259) (3,203) (2,993)Free cashflow (668) (3,287) (735) 253 1,585Reduction in investments 9 (13) - -

Net acquisitionsReduction in other LT assets 10 (23) - - Addition in other LT liabilities 98 (42) 267 - AdjustmentsCashflow after investing acts (668) (3,171) (814) 520 1,585Cash dividends (217) (292) (262) (262) (533)Equity issue 217 1,317 1,060 262 533Debt issue 904 2,989 (145) (253) (1,585)Convertible debt issueOthers 271 716 (267)Cashflow from financial acts 904 4,285 1,369 (520) (1,585)Net cashflow 235 1,114 555 0 (0)Beginning cash (136) 99 1,213 1,768 1,768Ending cash 99 1,213 1,768 1,768 1,768Ending net debt 3,751 3,050 2,797 1,212Source: Nomura estimates

Balance sheet (US$mn)

As at 31 Dec FY08 FY09 FY10F FY11F FY12F

Cash & equivalents 99 1,213 1,768 1,768 1,768Marketable securities - - - - - Accounts receivable 375 505 498 592 1,185Inventories 76 110 122 122 122

Other current assets 44 603 85 85 85Total current assets 594 2,431 2,473 2,567 3,160LT investments 126 118 131 131 131Fixed assets 9,557 15,089 16,495 16,389 18,245Goodwill - - - - - Other intangible assets - 26 - - Other LT assets 214 204 227 227 227Total assets 10,491 17,841 19,352 19,314 21,763Short-term debt - - - - - Accounts payable 1,175 1,192 1,000 1,189 2,377

Other current liabilities 486 395 440 440 440Total current liabilities 1,660 1,587 1,440 1,629 2,817Long-term debt 2,078 4,963 4,818 4,565 2,980Convertible debt - - - - Other LT liabilities 1,878 1,976 1,934 2,201 2,201Total liabilities 5,617 8,526 8,192 8,395 7,998Minority interest 160 459 541 511 511Preferred stock - - - - - Common stock 1,379 3,648 4,845 4,064 4,064Retained earnings 3,296 5,153 4,857 6,284 9,129

Proposed dividends - - - - -

Other equity and reserves 40 55 917 61 61Total shareholders' equity 4,715 8,856 10,619 10,409 13,254


Liquidity (x)

Current ratio 0.36 1.53 1.72 1.58 1.12 Interest cover 143.4 179.0 na na 524.8

LeverageNet debt/EBITDA (x) net cash 1.22 1.03 0.85 0.19

Net debt/equity (%) net cash 42.4 28.7 26.9 9.1

Activity (days)Days receivable 46.6 44.0 42.1 38.5 Days inventory 29.5 22.0 21.3 14.3

Days payable 376.9 208.2 191.3 209.1 Cash cycle - (300.8) (142.2) (127.9) (156.3) Source: Nomura estimates


Rio Tinto RIO LN

EUROPEAN METALS & MINING | EMEA

Paul Cliff +44 20 7102 4349 paul [email protected]

High iron prices to boost RIO Record iron prices to turn Rio net cash by end-2011F

We forecast 2011F iron ore prices will rise by 38% y-y on strong China steel demand and weak domestic iron production. With more than two-thirds of 2011F EBITDA likely to be derived from iron business, we anticipate Rio Tinto will generate significant cash over the next 12 months and turn net cash by end-2011F, spurring the group to return cash to shareholders. Further, we see incremental positives in other divisions, with improvements in aluminium margins through divestments of higher-cost European smelters and minor expansions in Australian coal production.

Organic growth firmly in focus

We anticipate Rio Tinto will keep organic growth in focus. Significant cash generation from iron ore should help the company to fund its impressive organic growth portfolio, which is one of the most attractive in the sector. We see the expansion of the Pilbara iron ore operations by 100 mtpa as value accretive for shareholders, contributing 653p or 11% to our £59 NPV price target. Rio Tinto also seeks to increase its stake in the world-class Oyu Tolgoi copper-gold project (550 ktpa copper, 650 koz pa gold), which will help to increase copper volumes as other mines struggle to maintain stable production.

Share buybacks likely in 2H 2011F

With a manageable US$11bn capex budget for 2011F, Rio Tinto should generate enough cash next year to turn net cash by end-2011F and leave the miner with nearly US$50bn in balance sheet headroom, on our estimates. We believe the group will likely initiate a share buyback programme in 2H 2011F after regaining a single-A credit rating.

Key financials & valuations31 Dec (US$mn) FY09 FY10F FY11F FY12FRevenue 42,320 51,025 57,808 60,394



Normalised EPS (US$) 3.57 6.89 9.92 10.79

Norm. EPS growth (%) 93% 44% 9%

Norm. P/E (x) 19.8 10.2 7.1 6.6

EV/EBITDA (x) 10.8 6.2 4.3 3.5

Price/book (x) 3.0 2.4 1.8 1.5

Dividend yield (%) 0.5 1.3 1.3 1.4

ROE (%) 13.7 23.4 25.8 22.4

Net debt/equity (%) 29.0 14.6 -6.9 -31.1

Earnings revisions



Previous norm. EPS (US$) 6.89 9.92 10.79


Share price relative to FTSE All Share

1m 3m 6m

12.4 23.2 54.4

11.0 20.6 58.9

4.2 15.3 32.8


17.0


Shining Prospects PTE 19.8

52-week range (p)

3-mth avg daily turnover (£mn)

Blackrock

Stock borrowability

92,887

92%

2812-4584

205

Absolute (p)

Absolute (US$)

Relative to Index


Market cap (£mn)

2500

3000

3500

4000

4500

5000

Dec

-09

Jan-

10

Feb

-10

Mar

-10

Apr

-10

May

-10

Jun-

10

Jul-1

0

Aug

-10

Sep

-10

Oct

-10

Nov

-10

Dec

-10

2400

2500

2600

2700

2800

2900

3000

3100

3200Price

rel FTSE All-Share

(GBp)

Closing price on 30 December 4584.0p

Price target 5900p

Upside/downside 28.7%Difference from consensus 20.1%FY10F net profit (US$mn) 13,489

Difference from consensus -3.0%Source: Nomura

Nomura vs consensus We are 18% and 26% ahead of 2011F and 2012F consensus EPS, with our iron ore forecasts 24% and 25% ahead of consensus estimates, respectively.

Maintained

BUY

N O M U R A I N T E R N A T I O N A L P L C

Action

We expect Rio Tinto, our top mining pick, to outperform the sector on high iron ore prices that will help the miner to turn net cash by end-2011F, with excess cash likely to be returned to shareholders. A return to its old self, with a conservative balance sheet and M&A strategy, should return the miner to its former ‘best-in-class’ status with renewed emphasis on organic growth, especially in iron ore. BUY.

Catalysts

Higher-than-expected iron ore prices will serve as a catalyst. Rio Tinto regaining its single-A credit rating could also be a catalyst for share buybacks in 2011.

Anchor themes

A prolonged period of high commodity prices will spur super-normal free cashflow over the next several years, particularly in iron ore, coal and copper. We prefer miners that are more inclined to return excess cash to shareholders.

Rio Tinto Paul Cliff



Our NPV-based target price of £59 assumes a WACC of 8%, which is the lowest in the mining sector, and shared only with BHP Billiton.

Risks to our call

The primary risk to our positive call on Rio Tinto is a slump in iron ore prices, derived either from stronger than Chinese domestic production or a softening of Chinese iron demand due to lower steel production.

Exhibit 91. Mining valuation sheet (based on Nomura commodity forecasts)

Mkt Cap Nomura Current Base Growth Total Price/ P/E EV/ EBITDA

FCF yld (%)

Company (mn) Rating Price NPV Options NPV Total NPV 10F 11F 12F 10F 11F 12F 11F

Xstrata (XTA LN)

$69,119 Buy £15.25 £13.5 £3.4 £16.9 0.90 13.5 9.2 7.5 8.2 5.5 4.4 12.1

Rio Tinto (RIO LN)

$138,156 Buy £45.84 £40.3 £18.8 £59.1 0.77 10.2 7.1 6.7 6.2 4.2 3.6 13.4

BHP Billiton (BLT LN)

$226,631 Reduce £26.16 £17.3 £5.3 £22.6 1.16 12.4 8.5 7.5 7.0 4.6 3.7 12.9

Vale Common (VALE US)

$178,993 Buy $33.77 $32.7 $6.5 $39.2 0.86 11.4 5.9 5.2 7.7 3.4 2.6 17.4

Anglo American (AALN LN)

$64,507 Buy £33.76 £27.0 £8.5 £35.5 0.95 12.6 7.9 6.9 8.8 5.3 4.4 11.7

ENRC (ENRC LN)

$21,016 Reduce £10.53 £8.4 £1.3 £9.6 1.09 9.6 6.9 6.6 6.6 4.7 4.2 14.2

Kazakhmys (KAZ LN)

$13,588 Reduce £16.38 £13.7 £0.8 £14.4 1.14 9.4 6.9 6.3 5.4 3.8 3.1 12.6

Antofagasta (ANTO LN)

$24,967 Buy £16.34 £11.5 £2.2 £13.8 1.19 20.1 11.3 10.3 12.4 6.9 5.8 9.1

First Quantum (FM CN)

$9,295 Buy C$108.00 C$66.0 C$35.0 C$101.0 1.07 14.5 11.5 6.9 8.4 6.0 3.1 7.9

Vedanta (VED LN)

$12,833 Neutral £25.50 £21.2 £1.8 £23.0 1.11 8.0 5.1 4.3 7.0 4.6 3.6 14.9

Boliden (BOL SS)

SEK 37,115 Reduce SEK136 SEK78 SEK10 SEK88 1.54 12.4 13.3 11.6 7.2 6.7 6.0 8.2

Eramet (ERA FP)

EUR 6,858 Neutral EUR 257 EUR 188 EUR 51 EUR 239 1.08 16.0 10.9 11.5 8.1 6.2 5.9 -2.6

Lonmin (LMI LN)

$5,902 Reduce £19.83 £10.5 £3.3 £13.8 1.43 29.8 18.6 17.3 16.8 11.6 10.4 1.9

Norsk Hydro (NHY LN)

NOK 65,619 Neutral NOK 43 NOK 46 n/a NOK 46 0.93 36.6 18.8 15.2 9.5 6.7 5.8 4.1

Average Diversified Mining Sector 0.93 12.0 7.7 6.8 7.6 4.6 3.7 13.5%

Weighted Average Mining Sector 0.98 15.8 9.3 8.3 8.4 5.0 4.1 13.4%

Source: Company data, Bloomberg, Datastream, Nomura estimates

Exhibit 92. Iron ore spot and contract prices

0

50

100

150

200

250

US$/tonneIron ore spot (inc. Freight) Spot Australia FOBContract Australia FOB Forecast Contract Australia FOBAustralian Freight

Q4 2010

Source: Bloomberg, Nomura estimates

Exhibit 93. Rio Tinto: EBITDA by segment (2011F)

Iron ore68%

Coal & Energy9%

Industrial Minerals

2%

Aluminum5%

Copper 16%

Diamonds0.2%

Others0%

Source: Company data, Nomura estimates

Rio Tinto Paul Cliff


Financial statements $ mn 2009 2010E 2011E 2012E 2013E 2014E 2015E

Iron Ore & Pellets

Iron Ore Production (kt) (Attributable) 171,546 176,171 176,627 183,727 183,727 183,727 183,727

Benchmark Fines Price ($/tonne) (CY) (65%) 71 115 159 150 128 98 83

% Change (YoY) -24.8% 62.2% 38.2% -5.5% -15.0% -23.5% -15.4%

Revenue 12,598 22,454 31,149 30,857 26,233 20,068 16,985

Costs ($ mn) 5,486 6,399 8,368 7,756 7,344 7,995 6,836

Costs ($/tonne) 32 36 47 42 40 44 37

EBITDA 7,112 16,055 22,781 23,102 18,889 12,073 10,149

Aluminum & Alumina

Alumina Production (Kt) 8,815 9,350 10,510 11,910 12,310 12,310 12,310

Aluminum Production (Kt) 3,794 3,747 3,767 3,767 3,767 3,767 3,767

Aluminum Price ($/tonne) 1,670 2,104 2,206 2,275 2,325 2,375 2,425

Revenue 12,038 12,589 13,485 14,216 14,615 14,920 15,225

Aluminum 8,856 8,670 9,142 9,427 9,634 9,841 10,049

Alumina & bauxite 4,176 3,390 3,784 4,214 4,393 4,477 4,562

Other Products (994) 530 558 576 589 601 614

Total Costs 10,901 12,144 11,676 12,145 12,385 12,552 12,719

Cost for aluminum production ($ mn) 8,250 8,044 8,280 8,407 8,499 8,590 8,681

Alumina 1,585 1,970 2,078 2,142 2,190 2,237 2,284

Shipping/Other 1,653 567 598 617 631 644 658

Cost of smelting 5,012 5,507 5,604 5,648 5,679 5,709 5,739

$/tonne 1,321 1,470 1,488 1,499 1,508 1,516 1,524

Costs for alumina & bauxite production 3,758 3,607 2,876 3,202 3,338 3,403 3,467

Other Costs (1,107) 493 519 536 547 559 571

EBITDA 594 2,667 1,809 2,071 2,231 2,368 2,506

Australian Coal Business

Hard Coking Coal Production (Kt) 7,468 9,414 10,220 9,560 9,980 9,980 9,980

Semi Soft Coking Coal production (Kt) 2,884 3,360 3,200 3,200 3,200 3,200 3,200

Thermal Coal Production (Kt) 19,618 19,543 20,425 21,900 19,752 19,752 19,752

Hard Coking Coal Price ($/tonne) (CY) 173 191 241 250 220 180 150

Semi-soft Coking Coal ($/tonne) (CY) 124 134 172 179 157 129 107

Thermal Coal ($/tonne) (CY) 84 91 107 118 105 85 80

Revenue 3,870 4,025 5,202 5,535 4,772 3,887 3,420

Costs 2,071 2,431 2,792 2,930 2,710 2,581 2,543

per tonne ($) 69.1 75.2 82.5 84.5 82.3 78.4 77.2

EBITDA 1,799 1,594 2,410 2,605 2,063 1,306 877

Copper

Attributable Mined Copper Production (Kt) 810 707 769 759 750 741 733

Copper Price ($/tonne) 5,164 7,485 8,377 8,818 7,937 7,165 6,614

Revenue 6,206 7,159 8,326 8,618 7,710 6,943 6,364

of which: provisional pricing - - - - - - -

Costs 2,732 2,614 3,323 3,120 2,647 2,493 2,318

EBITDA 3,474 4,545 5,436 5,905 5,063 4,450 4,046

Other Segments EBITDA

Industrial Minerals 1,216 469 703 703 703 703 703

Diamond (7) 71 76 159 164 159 154

US Coal Business 497 208 178 139 139 139 139

Other/Corporate (373) (15) 235 206 1,033 1,002 924

Rio Tinto Consolidated EBITDA 14,312 25,594 33,628 34,891 30,285 22,200 19,497

Net Income 6,298 13,498 19,366 20,755 18,532 13,888 12,686

Diluted EPS 3.57 6.89 9.89 10.60 9.46 7.09 6.48

Diluted EPS (Consensus) 6.74 6.74 7.95 7.87 NA NA NA

P/E 19.3x 10.0x 7.0x 6.5x 7.3x 9.7x 10.6x

EV/EBITDA 10.5x 6.0x 4.1x 3.3x 3.2x 3.7x 3.6x

Net Debt 18,920 8,933 -7,398 -26,531 -44,353 -57,677 -69,138

Net debt/EBITDA 1.32 0.35 (0.22) (0.76) (1.46) (2.60) (3.55)

Total Firm NPV 146,132

Less Net Debt (H1 10A) 12,411

Less minority interest 11,652 NPV of firm: Breakup 146,132

NPV of equity ($ mn) 122,069 Iron Ore 84,717

NPV per share (GBp) 4,030 Alcan Aluminium 24,067

Value of growth options (GBp) 1,882 Australian Coal 6,735

Total NPV per share (Gbp) 5,912 Copper 26,791

Target Price (GBp) 5,900 Other 3,823

US dollars in millions unless otherwise noted Source: Company data, Nomura estimates



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