whatifchinaslowsdown-whatifscenario

27 July 2015

Stratégie Typologie

What if the slowdown in China is sharp and lasts?

China is currently faltering, and a slump would upset world balances: recoupling

developed and emerging economies, a price drop in many commodities,

transformations in global industry. In this note we outline an adverse, but possible

scenario (GDP +4%), in which investment and consumer durable purchases would

be affected.

The Chinese currency would not depreciate significantly. Keenness to

internationalise the currency is obliging the Chinese authorities to ensure its relative

stability. We expect a target of 6.35 vs. the $ (vs. ~6.11). But commodities would

be hard hit. Brent prices could slide by $15 to $17 compared with our 2016 baseline

scenario (57.3 $), with the re-emergence of a super contango, similar to 2008/09.

Iron ore prices would continue to fall, towards $40/tonne, more sharply than copper

or zinc prices. Gold would benefit somewhat with prices climbing to $1,300/oz.

This scenario would be positive for fixed income markets with expansionist

monetary policies (Fed, ECB and satellite central banks) maintained for longer. Bull

flattening and the compression of sovereign spreads would be the order of the day.

Regarding equity markets, the scenario would corroborate our existing plays,

i.e. a preference for developed country stocks, with Europe to the forefront, and the

Value theme. In terms of cross-asset allocation, we would opt for a defensive

portfolio by reducing exposure to CVaR, and share and corporate bond pockets in

favour of greater exposure to Treasuries and gold.

In terms of sector exposure, semiconductors would be directly and sharply affected

were an adverse scenario to materialise, with Infineon to the forefront (ca.40% of its

activity is in China). In the automotive sector it would be a reversal of fortunes to

which car makers Volkswagen and BMW would be the most exposed. Auto parts

makers (Faurecia, Plastic Omnium, Valeo), would be harder hit than tyre makers.

Capital goods stocks would also suffer, especially Schneider (15% of its sales are

generated in China). Then there are the industries that are indirectly exposed to the

Chinese market: for oil companies, the impact would be felt via oil prices and we

think that Shell would be hardest-hit. Oil companies’ E&P capex and margins would

be under heavy pressure, but we would still prefer asset-light profiles. Indeed, GTT

would still be our top pick among oil services companies. The pricing and product

mix would impact the tubes and equipment segment. The predictable fall in iron ore

prices calls for caution on ArcelorMittal. Last, apart from the spectre of rising

Chinese exports, tied to a drop in local demand, we would be more concerned about

the impact on the Asia region’s economy, which would primarily affect

LafargeHolcim and to a smaller extent HeidelbergCement and Italcementi. In the

Utilities sector, the indirect impact would primarily derive from downward pressure

on wholesale electricity and recycled raw materials prices with CEZ Fortum,

Vattenfall and E.ON most affected. Last, we think that European banks would be

well-shielded from an adverse scenario on the whole, as only Standard Chartered

and HSBC have substantial activities in China.

Economic Research Patrick Artus +33 1 58 55 15 00

Sylvain Broyer +49 69 97153 357

Alicia Garcia Herrero +852 3900 8680

Commodities Abhishek Deshpande +44 20 321 692 23

Nic Brown +44 20 321 692 39

Bernard Dahdah +44 20 32 16 91 31

Fixed Income and Forex Strategy Nordine Naam +33 1 58 55 14 95

Strategy Fixed income Cyril Regnat +33 1 58 55 82 20

Jean-François Robin +33 1 58 55 13 09

Strategy Equity Sylvain Goyon +33 1 58 55 04 62

Strategy Cross-asset Emilie Tetard + 33 1 58 19 98 15

Equity and Credit Research Banks

Elie Darwish +33 1 58 55 84 32 Robert Sage +44 20 3216 91 70

Cars

Georges Dieng +33 1 58 55 05 34

Michael Foundoukidis +33 1 58 55 04 92

Oil

Baptiste Lebacq +33 1 58 55 29 28

Alain Parent +33 1 58 55 21 82

Anne Pumir +33 1 58 55 05 20

Industrials

Sven Edelfelt +33 1 58 55 29 03

Sandra Pereira +33 1 58 55 98 66

Utilities

Philippe Ourpatian +33 1 58 55 05 16

Ivan Pavlovic +33 1 58 55 82 86

Semi conductors

Maxime Mallet +33 1 58 55 37 71

Stéphane Houri +33 1 58 55 03 65

Global Markets research.natixis.com

Accès Bloomberg NXGR

Distribution of this report in the United States. See

important disclosures at the end of this report.

http://equity.natixis.com/site/Home/Welcome

Global Markets Research I 2

Contents

1. Introduction 3

2. Slowdown in Chinese growth: empirical evidence, causes and structure 4

In the short/medium term: risk of subdued growth in China 4

What accounts for this weakening of the Chinese economy? 5

In the long term, decline in Chinese potential growth 7

Slowdown in growth in the short term: a mixed picture 8

Conclusion: The Chinese government will try to restore growth, but what would happen if the Chinese economy slowed down markedly? 9

3. Immediate effects 12

Forex: CNY depreciation likely to be very limited 12

Oil: three scenarios are conceivable, each pointing to much lower prices 13

Basic metals: a sharply impacted market 15

Precious metals: gold is a winner, but just a little 19

4. Our strategic views 20

Fixed income strategy: lower rates, everywhere 20

Strategy equity: still our preference for Europe and Value 22

Cross-asset strategy: a more defensive strategy 25

5. Sectors affected by the slowdown in investment and consumer durable purchases 27

Semiconductors: the market would mature 27

Car makers: reversal of fortune 28

Auto Parts: harder-hit than tyre makers 29

Integrated oil: direct impact hit by oil prices 31

Oil services: deteriorating outlook for recovery 32

Tubes and equipment: pressure on pricing and the mix 33

Steel: pressure already visible … and it could increase 34

Other industrials: larger direct exposure 36

Cement: at little risk 37

Utilities : affected by prices decrease 40

Banks: almost all European well-shielded from Chinese risk 41


1. Introduction

China is a structural player for the global economy. Indeed, in 2010 it became the number two

economy and has tripled its economic expansion over twenty years to reach 15% of world GDP. On

a constant growth basis, it could even topple the US (a quarter of world GDP) from its number one

slot by 2030. By chalking up close to 20% of world investment since 2005, China has a sweeping

impact on the commodities market. Note, for example, that China now consumes 51% of world coal,

50% of copper and 11% of oil.

But the economy is unbalanced. In particular, domestic consumption is very low: barely 8% of world

consumption, versus 15% for the US, a massive gap relative to the total number of inhabitants (four

times greater than the US). Even though the authorities have made great progress in terms of

salaries/wages and currency revaluation, China now faces many obstacles to development

(overinvestment, an unsustainable debt level, bursting of the real estate bubble). To avoid the

‘middle income trap’ threat, the economy will have to be revamped, and this implies a clear, lasting

slowdown for growth.

A lasting slowdown for the Chinese economy would have major repercussions worldwide, well

beyond simple trade links with its geographic neighbours and commodity exporting countries. Its

current surpluses, relatively closed capital markets and a currency long maintained at an artificially

low level have made China a leading global financier. Having fed the commodities super cycle,

China has driven growth in emerging countries; by joining the WTO, it has lengthened geographical

production lines, helping raise world trade volumes. A change in regime for Chinese growth would

certainly upset these balances. It would contribute to a ‘recoupling’ of growth paces between

developed economies and emerging economies. It would impact the prices of many commodities

and imply many mutations for world industry.

Indeed, for many industrial groups, China’s and its neighbours’ surging growth has become a real

alternative to the structural lack of organic pace in Europe (car makers, capital goods, aerospace-

defence notably). A change in economic regime in China, combined with tenuous improvement in

growth potential in Europe, would clearly dent the perception, on equity and credit markets, of the

groups most exposed to this zone.

In this report, our experts identify which markets, sectors and companies would be hardest hit by a

shift in Chinese economic regime, and, of course, what strategic allocation to prefer if the adverse

scenario we describe in these pages materialises.

Sylvain Broyer

Thibaut Cuilliere

Stéphane Houri


2. Slowdown in Chinese growth:

empirical evidence, causes and structure

The various available indicators confirm the growth slowdown in China. In the short/medium term, it

is due to the loss of industrial cost competitiveness, the exhaustion of construction stimulus

measures as a method to boost activity, and the declining effectiveness of the expansionary

monetary policy.

In the longer term, it is due to the decline in productivity gains as a result of the weakening of

investment and the distortion of the structure of the economy towards services, as well as population

ageing.

The nature of the slowdown is particular: it is barely affecting household consumption (with the

exception of cars), thanks to the rapid wage increases and the low level of inflation; it is primarily

concerning exports and corporate investment, especially investment in industrial machinery and

equipment. We must obviously take into account the fact that the Chinese authorities will continue to

combat the slowdown in growth.

In the short/medium term: risk of subdued growth in China

If we look at official indicators, the Chinese economy is slowing down markedly.

Chart 1: China: GDP growth and manufacturing production (Y/Y as %)

Sources: Datastream, NBS, Natixis

But when we look at indicators that are normally correlated to growth (imports in volume terms

and electricity production, we realise that Chinese growth in all likelihood is markedly lower than that

shown by official figures.

Patrick Artus

Sylvain Broyer

Alicia Garcia Herrero

0

3

6

9

12

15

18

21

24

0

3

6

9

12

15

18

21

24

02 03 04 05 06 07 08 09 10 11 12 13 14 15

GDP in volume Manufacturing output


Chart 2: China

Imports and real GDP (Y/Y as %) Electricity production and real GDP (Y/Y as %)


What accounts for this weakening of the Chinese economy?

First, the loss of industrial competitiveness due to the rapid increases in wages and labour

costs, themselves linked to the political determination to increase the weight of consumption in

GDP. The result of this loss of industrial competitiveness is offshoring of production to some

extent but especially a fall in exports, a decline in the weight of goods assembled in China

(processed goods) in exports and a stagnation or a fall in production in many industrial

sectors.

Chart 3: China

Nominal per capita wage and unit labour cost (as % per year) Household consumption (as % of real GDP)

Exports Total exports in value terms (Y/Y as %)

Sources: Datastream, China Customs, Natixis,NBS

-9

-6

-3

0

3

6

9

12

15

-30

-20

-10

0

10

20

30

40

50

02 03 04 05 06 07 08 09 10 11 12 13 14 15

Imports of goods and services (G) GDP in volume (D)

-20

-10

0

10

20

30

40

-20

-10

0

10

20

30

40

02 03 04 05 06 07 08 09 10 11 12 13 14 15

Electricity production GDP in volume

4

6

8

10

12

14

16

18

20

4

6

8

10

12

14

16

18

20

02 03 04 05 06 07 08 09 10 11 12 13 14

Nominal wage per capita Unit labour cost 34

36

38

40

42

44

46

02 03 04 05 06 07 08 09 10 11 12 13 14 15

-30

-20

-10

0

10

20

30

40

50

60

70

-30

-20

-10

0

10

20

30

40

50

60

70

02 03 04 05 06 07 08 09 10 11 12 13 14 15

Total exports in value (yoy %)

Exports of assembled products as % of total exports

-50

-25

0

25

50

75

100

125

150

-50

-25

0

25

50

75

100

125

150

02 03 04 05 06 07 08 09 10 11 12 13 14 15

Automotive Textiles

Steel Household equipment


Second, the end of the Chinese government’s ability to use investment in construction

(housing, public infrastructure) to boost activity. Far too much has already been built and we can

currently see a slowdown in investment in construction and, which is an associated indicator, a

decline in cement production.

Chart 4: China

Housing construction* (surface in millions of square meters)

Investment in construction and cement production (Y/Y as %)

* seasonally adjusted series


More generally, this shows the loss of effectiveness of monetary policy. Although it has

become more expansionary in the recent period, it is not jump-starting credit. Even credit

coming from shadow banking is slowing.

0

20

40

60

80

100

02 03 04 05 06 07 08 09 10 11 12 13 14 15

-30

-20

-10

0

10

20

30

40

50

60

-30

-20

-10

0

10

20

30

40

50

60

02 03 04 05 06 07 08 09 10 11 12 13 14 15

Construction investment Cement production


Chart 5: China

Interest rate on loans and banks’ reserve requirement ratios (as %)

Total credit (Y/Y as %)

New loans (in RMB bn per month)

Sources: Datastream, PBOC, Natixis

In the long term, decline in Chinese potential growth

Chinese potential growth is declining because productivity gains are slowing down, and also

because of population ageing, which will be drastic from the 2020s because the only children will

join the labour force. It is possible that potential growth will only be around 4 to 5% out to the end of

this decade, and 2 to 3% in the next decade.

Chart 6: China

Per capita productivity (as % per year) Population aged 20 to 60 (as % per year)

Sources: Datastream, NBS, Natixis Sources: UNO, World Bank, Natixis

3

4

5

6

7

8

9

98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

98 01 04 07 10 13 16 19 22 25 28

0

3

6

9

12

15

18

21

24

0

1

2

3

4

5

6

7

8

02 03 04 05 06 07 08 09 10 11 12 13 14 15

1-year loan rate (lhs)

Required reserve ratio for large banks (rhs)

Required reserve ratio for small banks (rhs) 5

10

15

20

25

30

35

02 03 04 05 06 07 08 09 10 11 12 13 14 15

-300

0

300

600

900

1 200

1 500

1 800

2 100

02 03 04 05 06 07 08 09 10 11 12 13 14 15


The slowdown in productivity gains is explained by the slowdown in corporate investment and the

distortion of the Chinese economy towards services, where both the productivity level and

productivity gains are already weak.

Chart 7: China

Investment in machinery and equipment (Y/Y as %) Value added by sector (in volume terms, as % of real GDP)


Slowdown in growth in the short term: a mixed picture

The Chinese economy is currently characterised by rapid wage growth and a low level of inflation

due to the fall in commodity prices and the excess production capacity in industry.

Chart 8: China: Inflation (CPI, Y/Y as %)

Sources: Datastream, Natixis

So real wage growth remains rapid, which explains why household consumption remains

strong, with the exception of cars.

-10

0

10

20

30

40

50

04 05 06 07 08 09 10 11 12 13 14 15

-2

0

2

4

6

8

10

02 03 04 05 06 07 08 09 10 11 12 13 14 15

0

10

20

30

40

50

0

10

20

30

40

50

98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

Agriculture Construction

Manufacturing Services


Chart 9:

Household consumption and retail sales (in volume terms, Y/Y as %)

Car sales (Y/Y as %)

Sources: Datastream, NBS, Natixis Sources: Datastream, CAAM, Natixis

In contrast, it is corporate investment that is weak as a result of the deterioration in cost

competitiveness and the stagnation of industrial production as well as very rapid leveraging of the

corporate sector.

Companies exposed to Chinese consumers are therefore much less affected than those exposed to

Chinese companies or investment.

Conclusion: The Chinese government will try to restore growth, but what would happen if the Chinese economy slowed down markedly?

We believe there is a serious risk that Chinese growth may weaken further:

In the short/medium term as a result of the deterioration in competitiveness, the end of

construction-led stimulation of activity, and the loss of effectiveness of monetary policy;

In the long term as a result of the fall in productivity gains and, subsequently, population ageing.

But we should nevertheless not forget that the Chinese government will continue to try to stimulate

growth.

In a short-term perspective, with new infrastructure investments (New Silk Road project), an even

more expansionary monetary policy, and stock market support measures.

In a long-term perspective, by favouring a rise up the value chain for the economy thanks to

spending on R&D and support for technological companies (Table 1 and Chart 10).

-20

0

20

40

60

80

100

02 03 04 05 06 07 08 09 10 11 12 13 14 15

0

3

6

9

12

15

18

21

24

0

3

6

9

12

15

18

21

24

02 03 04 05 06 07 08 09 10 11 12 13 14 15

Household consumption in volume

Retail sales in volume


Table 1: Total spending on R&D (as % of nominal GDP)

% United States Euro zone Japan China

1998 2.50 1.71 2.96 0.64

1999 2.54 1.76 2.98 0.75

2000 2.62 1.78 3.00 0.91

2001 2.64 1.80 3.07 0.96

2002 2.55 1.81 3.12 1.07

2003 2.55 1.81 3.14 1.13

2004 2.49 1.78 3.13 1.22

2005 2.51 1.78 3.31 1.31

2006 2.55 1.80 3.41 1.35

2007 2.63 1.81 3.46 1.39

2008 2.77 1.89 3.47 1.46

2009 2.82 1.99 3.36 1.66

2010 2.74 1.99 3.25 1.75

2011 2.76 2.04 3.38 1.84

2012 2.70 2.09 3.34 1.98

2013 2.73 2.09 3.47 2.08

Sources: OECD, Eurostat, Natixis

Chart 10: China: Investment in hi-tech equipment and other electronic equipment (Y/Y as %)


Lastly, given all the factors we have just discussed we could imagine a situation where Chinese

growth slows down more than what we currently expect in our baseline scenario (6% growth in 2015

and 2016 after taking into account the impact of the stock market collapse). China could find a

growth base of around 4 to 5% per year, which corresponds to potential GDP as we saw above.

In that case, what could be the result of such a slowdown?

We should expect the transformation of the Chinese growth model to continue, i.e. the weight of

consumption in GDP will continue to increase and that of investment will continue to decrease.

Assuming that this transformation will take place at more or less the same pace in the coming years,

consumption should then increase by 7% per year. Note that household spending on capital goods

(household equipment) and durable goods (cars) probably will grow more slowly than in the past and

less than other types of goods, because of credit restrictions.

-10

0

10

20

30

40

50

60

70

04 05 06 07 08 09 10 11 12 13 14 15


atixistal investment might grow no more than 3% per year. We believe residential construction will

slow down the most (to as low as 1% per year) for the same reasons, i.e. credit restrictions. The

non-residential part of construction is likely to remain somewhat stronger because of spending on

infrastructure, e.g. the new Silk Road project (3% per year). Corporate investment, lastly, is also

likely to slow down because of the overcapacity and the upgrade in the capital stock.

The table below compares such an adverse scenario with the average growth rates in China in the

2000-2013 period. We see that consumption would be unlikely to slow down substantially, as

opposed to investment.

Chart 11: China

Composition of domestic demand (% of GDP) Investment in fixed capital (% of GDP)

Sources: Datastream, Natixis Source: NBS

Table 2: An adverse growth scenario for China (growth rate per year, in real terms)

% 2000/2013 average 2015 scenario 2016 scenario Adverse scenario

GDP 9.9 6.0 6.0 4-5

Consumption 8.0 6.3 6.6 7

Government spending on consumption 9.1 6.4 6.6 4

Total Investment 12.3 4.4 4.6 3

o/x residential construction Na 1

o/w non-residential construction Na 3

o/w equipment and machinery Na 2

Source: Natixis

The countries most affected by a structural slowdown in the Chinese economy would primarily be

the economies in the Asia Pacific region, but also more distant countries that provide China with

commodities (Africa, OPEC, Chile, Brazil and Russia) and capital goods or durable consumer

goods, e.g. the euro zone and Norway.

Table 3: Exports to China (2014, as % of nominal GDP)

Japan South Korea

Taiwan Singapore Malaysia Vietnam Indonesia Philippines Thailand Australia New Zealand United States

Canada

2,7 10,1 28,8 16,7 8,6 9,5 2,0 2,9 6,6 5,7 4,2 0,7 1,0

Chili Argentina Brazil Mexico India Africa Euro zone CEEC UK Sweden Russia OPEC Norway

7,1 0,9 1,8 0,5 1,6 4,3 1,5 0,7 0,5 0,9 2,0 5,2 0,9

Sources: IMF, Natixis

5

10

15

20

25

30

5

10

15

20

25

30

04 05 06 07 08 09 10 11 12 13 14 15

Equip Residential construction Construction ex residential

10

15

20

25

30

35

40

45

50

10

15

20

25

30

35

40

45

50

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

Government spending Private-sector consumption

investment


3. Immediate effects

Forex: CNY depreciation likely to be very limited

Following the sharp slump in equities during June and July, the PBoC has slightly increased its

Chinese yuan (CNY) fixing from a low of 6.1104 on 8 July to a high of more than 6.1175 on 18 July,

i.e. a change of +0.1% in the space of 10 days. Despite this small change, the increase in the

PBoC’s fixing has given rise to fears of a change of strategy by China. Yet the movement has

remained relatively small compared with previous episodes of risk aversion. Similarly, the CNH has

appreciated slightly against the CNY on expectations of PBoC action. On the other hand, CNY

forwards have appreciated, reflecting expectations the currency will depreciate.

Chart 12:

CNY and bands of fluctuation CNY 12m FWD and CNH/CNY premium/discount

Source: Bloomberg

How has the CNY behaved in previous major phases of economic slowdown? Following the Lehman

crisis, China’s GDP slowed markedly from a high of 11.2% in 2008 to 6.2% in the first quarter of

2009, while the USD/CNY exchange rate remained unchanged in the face of a sharply rising dollar

and significant capital outflows. In response, however, China put in place an economic stimulus

package.

The current situation is quite different to that in 2008. This time around, the slowdown in the Chinese

economy is linked to domestic factors. China’s economy is more indebted than in 2009, which limits

the use of fiscal stimulus. It is also more fragile as a result of the ongoing economic transition, and in

the event of a hard landing, one can assume that deflationary pressures would intensify. But a

depreciation of the CNY would hardly be beneficial, as it would only fuel the already large capital

outflows of the past few quarters. Moreover, it would not augur well to let the CNY depreciate

significantly, considering that China has requested its currency be included in the IMF’s Special

Drawing Rights (SDR) basket of currencies. Inclusion in the SDR basket is a major step for the

internalisation of the yuan.

The IMF reviews the monetary units in the SDR basket every five years. In 2010, China’s request

was rejected but this time, the Chinese authorities have taken a number of steps with a view to

internationalising their currency. The IMF is set to issue a final decision by the end of the year. The

question will be whether China’s capital markets are sufficiently open for the CNY to become a

reserve currency in the international monetary system on a level footing with the dollar, euro, sterling

Nordine Naam

5.9

6.0

6.1

6.2

6.3

Jul-1

4

Aug

-14

Sep

-14

Oct

-14

Nov

-14

Dec

-14

Jan-

15

Feb

-15

Mar

-15

Apr

-15

May

-15

Jun-

15

Fixing CNY Band +2% Band -2%

-0.01

0.01

0.03

0.05

0.07

0.09

6.20

6.25

6.30

6.35

6.40

6.45

Jul-1

4

Aug

-14

Sep

-14

Oct

-14

Nov

-14

Dec

-14

Jan-

15

Feb

-15

Mar

-15

Apr

-15

May

-15

Jun-

15

CNY FWD 12m Discount/Premium (rhs)


and yen. The likelihood of the CNY’s inclusion has increased, given that since 2010, the CNY has

become the second-most-used currency in global trade and the fifth for international payments.

Moreover, the Chinese authorities are planning to further open up the capital account in the coming

months with a view to making their currency convertible in the medium term. In this context, China is

unlikely to let its currency correct out to the end of the year. On the other hand, a gradual

depreciation of the CNY to as far as 6.35 or even 6.40 is possible as the dollar rises, once the IMF

has made its decision towards the year end.

Oil: three scenarios are conceivable, each pointing to much lower prices

Chinese oil demand so far

Between 2006 and 2013, annual demand for oil products grew at 6% yoy on average in China, with

peak growth seen in 2010 at 12.7% yoy. However annual demand slowed significantly in 2014 due

to reforms made by the Chinese government to address overcapacity, pollution and a general

slowdown in the economic activity which led to oil products demand growing by only 1.7% yoy last

year. In the first 5 months of 2015, growth in oil product demand (excluding SPR demand) was quite

strong at 5.5% yoy mainly driven by consumer-driven fuels such as gasoline and jet kerosene and

some other light ends used in petrochemicals. According to the IEA’s medium term report, Chinese

demand for oil is expected to grow by a total of 1.7mbpd between 2014 and 2020, an average

annual growth of 280,000bpd.

Chart 13: China demand by product (1 000 b/d)

Sources: PIRA, ODI (2012 and 2013 Data)

Abhishek Deshpande

Other

Fuel Oil

Naphtha

Gasoline

Jet Kero

Gasoil/Diesel

0

2 000

4 000

6 000

8 000

10 000

12 000

2012 2013 2014 2015 2016


What if? scenario

The IMF currently forecasts Chinese GDP to slow down from 6.76% in 2015 to 6.3% in 2020.

According to Natixis, China is expected to grow by 6% in 2015 and 2016, below IMF estimates. If

GDP was to slow down to 4%, it would be 3 percentage points below the consensus.

Chart 14: China GDP – IMF forecasts (%)

Source: IMF

For Chinese oil demand, it really narrows down to industrial demand which is most directly related to

GDP slowdown. We have already seen a slowdown in Chinese diesel demand in 2014. Chinese oil

products demand on a very linear extrapolation of GDP with oil demand would slow rapidly to 0.6%

yoy in 2017 and then decline on a yoy basis from 2018 onwards if GDP was to slow down to 4% by

2020. However we know Chinese demand today has become significantly reliable on consumer

driven fuels such as gasoline and jet kerosene. Hence we consider three potential scenarios below.

Chart 15: China GDP vs total oil demand growth (%)

Sources: Natixis, IMF

5.0

5.5

6.0

6.5

7.0

7.5

2014 2015 2016 2017 2018 2019 2020

-10

-5

0

5

10

15

20

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

2016

2018

2020

China GDP (%) China GDP slows to 4%

Annual growth in demand (%, rhs) Annual growth in demand wtih GDP slowdown to 4% (%, rhs)


Three potential scenarios in the future:

Assuming that gasoil + fuel oil demand declines with GDP, as seen in the linear extrapolation of

GDP with total oil product demand, we see three potential scenarios for demand for gasoline+jet

kerosene+ naphtha +other products (including light ends for petro chemicals):

It keeps rising at the pace expected by IEA in 2016. Then we see oil product demand rising by

2.67% yoy on average between 2016 and 2020, assuming a 1% yoy decline in gasoil and fuel oil

demand.

It grows at half the rate as expected by IEA in 2016. Total oil product demand will rise by only

1.1% yoy between 2016 and 2020, assuming 1% decline in gasoil and fuel oil demand.

It grows at a quarter of the rate expected by IEA in 2016. Total oil product demand will grow by

0.4% yoy on average between 2016 and 2020, assuming a 1% yoy decline in gasoil and fuel oil

demand.

All of the scenarios above point to an even weaker pricing scenario than what we have assumed

with the return of Iranian oil. With the return of Iranian oil we were expecting crude oil stocks to

continue rising in 2016, putting pressure on oil prices as the call on OPEC will still be lower than

actual OPEC production by over 1m b/d even in 2016. Weak Chinese demand will further reduce

call-on-OPEC and lead to a further increase in crude and oil product stocks globally. In our central

scenario we were expecting Brent prices to average $56.7/bbl in 2015 and $57.3/bbl in 2016 and

then slowly recovering from 2017 onwards. But if Chinese demand were to weaken as early as

2016, then we can expect oil prices to range between $40-50/bbl in 2016 and then remain under

pressure i.e. between $50-60/bbl until 2017. We can very easily expect a super contango like 2008-

09 where oil will have to move to floating storage and spot prices will come under significant

pressure, as in order to justify oil on floating storage you need at least $1.1/bbl/month of contango.

Basic metals: a sharply impacted market

China is undergoing a seismic restructuring away from its old, unsustainable, investment-driven

economic model towards a more sustainable economic model based around consumption,

innovation and the influence of the price mechanism. This inevitably means slower growth in

demand for raw materials such as industrial metals, and more emphasis on new technology and

consumer-oriented industries, in particular when combined with the country’s new focus upon

environmental protection and the quality of the environment.

This was starkly illustrated earlier this year by the recognition that Chinese demand for steel had

peaked, causing steel and iron ore prices to collapse. Chinese steel output is now expected to fall by

1% in 2015 to around 814mn tonnes, according to the China Iron and Steel Association, with

demand expected to soften in tandem. From the perspective of the global iron ore, coking coal and

steel industry, this represents a key turning point, since growth in Chinese demand for and output of

steel has been a key driver behind the industry’s recent expansion.

From an economic development perspective, a peak in Chinese steel output would be a very

significant milestone. In long-term models of economic development, the steel intensity of economic

growth typically peaks ahead of other industrial metals as countries move up the industrial value-

added chain. In general, demand for energy and agricultural products continues to expand as per

capita income increases, even as demand for metals begins to fall.

Nic Brown


Chart 16: Commodity intensity of demand – the US as a case study

Sources: BHP, World Bank

Chart 17: China – Commodity intensity of demand, 2000/2014 (2005 = 100)

Source: Natixis

In China, centrally planned expansion of the metals industry has been used as a key exogenous

driver of economic growth. This makes it particularly difficult to know what will happen as China

morphs from its “old” growth model (unsustainable growth based on centrally planned investment)

into a new model (sustainable growth based on profit-maximising behaviour and consumer

demand).

This new aspirational economic model is already having a far-reaching effect upon the Chinese

economy and markets.

0

50

100

150

200

250

300

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Electricity Steel Copper


Chart 18: HSBC China PMI SA

Source: Bloomberg

One by one, China’s heavy industries are undergoing major restructuring. In early-2014, temporary

cutbacks occurred in aluminium output as electricity prices were raised for less-efficient producers.

Later in the year, stainless steel producers also cut back, reducing demand for nickel sharply as they

ran down accumulated inventories.

This year, China’s authorities have focused upon the steel industry. After years of rapid growth,

China is now perceived to have reached “peak steel,” i.e. steel consumption per capita is expected

to fall over the coming years. As a result, iron ore and metallurgical coal markets face a period of

major consolidation as overcapacity erodes prices and profitability.

Conditions in China’s steel industry continue to deteriorate. While iron ore prices have staged a

small consolidation over the past three months, the steel industry still faces substantial excess

supply. Despite curbs on exports of born-based steel at year-end, Chinese steel exports increased

by 28% yoy during 2015H1. This exodus of surplus steel was not enough to prevent domestic steel

prices from falling by over 30% ytd. As a result, profitability in China’s steel industry has deteriorated

to a multi-year low.

With the rapid expansion in iron ore mining (and transportation) capacity undertaken by the world’s

large mining companies running headlong into an abrupt halt in Chinese demand for iron ore, prices

have already collapsed. From $140/tonne at end-2013, iron ore prices fell below $50/tonne in April

this year. If Chinese steel output does indeed fall by 2-3% per annum over the coming years, as

projected by CISA, it would be reasonable to think that iron ore prices can fall further. At current FX

rates, $40/tonne represents a point at which enough of the global mining industry might be forced to

close unprofitable operations in order to support prices. Forecasts for a worst-case scenario are

complicated by the fact that weakness in fundamentals results in a depreciation of FX rates for

producing countries, lowering the dollar price at which their mines break even.

Chinese apparent demand for nickel dropped by around 16% in 2014 as the stainless steel industry

went through a period of weak end-user demand and destocking. Reflecting the weakness of nickel

prices so far this year, restructuring in the stainless steel industry may be contributing to a second

year of abnormally low apparent demand, although destocking from accumulated inventories may

also be a contributory factor.

Given these developments, nickel prices have already collapsed to the point at which Asian ore and

NPI producers are holding back unprofitable output. Even with a further slowdown in China,

destocking in the stainless steel industry should soon come to an end, boosting apparent demand,

and lower output of NPI would force stainless steel producers to look elsewhere for nickel inputs. It

47

48

49

50

51

52

53

54

55

Jun-

12

Aug

-12

Oct

-12

Dec

-12

Feb

-13

Apr

-13

Jun-

13

Aug

-13

Oct

-13

Dec

-13

Feb

-14

Apr

-14

Jun-

14

Aug

-14

Oct

-14

Dec

-14

Feb

-15

Apr

-15

Jun-

15

Manufacturing Services

Heavy industry

Technology, sectors focused onconsumption


is therefore unlikely that nickel prices will fall any further below recent lows of around

$11,000/tonne, even in a situation in which Chinese GDP growth slowed abruptly.

Chinese demand for lead fell by 3% in 2013 and a further 6% in 2014. This weakness in demand

reflects a combination of weaker demand for e-bikes as well as a structural shift away from lead-acid

batteries towards lithium-ion batteries. Over the coming years, this trend may be accentuated by an

increase in supply of recycled lead.

Our forecasts for lead already factor this negative outlook into our central scenario, in which we see

lead prices averaging $1,800/tonne this year. Were Chinese growth to slow abruptly, prices could

fall further, with $1,500/tonne a reasonable downside target.

Chinese demand for aluminium is expanding rapidly, but it is unlikely that this growth will be enough

to absorb the recent expansion in aluminium capacity. As a result, an increase in Chinese exports of

aluminium products is weighing upon global aluminium prices.

Within the global aluminium industry, costs of production range from around $1,400/tonne to

$1,900/tonne. With the collapse in aluminium premiums, many western producers already find

themselves producing at a loss, even as producers elsewhere continue to drive costs lower through

investment in new technology and cheaper energy inputs.

Were Chinese growth to slow abruptly, we would expect to see widespread shutdowns across the

global aluminium industry, supporting prices in the region of $1,700/tonne.

Chinese end-user demand for copper remains robust, but growth in apparent demand has

weakened perceptibly this year due to the absence of substantial purchases from China’s SRB. As a

result, copper prices fell to a multi-year low of $5,400/tonne in January.

This decline in copper prices is already percolating through the copper production chain, resulting in

slower mine output growth and, via lower TC/RCs, slower growth in output of refined copper. In our

lower case scenario, we would expect this natural reflex to become more exaggerated, thereby

limiting any potential downside in copper prices. Were Chinese growth to slow abruptly, we would

envisage copper prices stabilising somewhere around $5,300/tonne.

Zinc prices are currently benefiting from the imminent closure of Century and Lisheen, due to take

effect in September this year. The resultant shortfall in mined output is expected to have a significant

negative effect upon supply; hence our lower case scenario for zinc prices envisages a very modest

fall to around $1,825/tonne.


Precious metals: gold is a winner, but just a little

Gold investment purchases in China occur when gold is seen as a buying opportunity (strong

fluctuation in the price). This contrasts with the west, where investors are also heavily influenced by

the opportunity cost of holding gold, and are therefore sensitive to yields and the wider economic

climate.

Indian demand for gold also has a different pattern. Indeed, demand for gold is mostly sensitive to

GDP growth and purchasing power. Purchasing the metal is intrinsically linked to festivals and

weddings.

We would therefore suggest that Chinese investment demand for the metal would not be as

much affected by a drop in GDP growth as by fluctuations in the price of the metal itself.

That said, in a situation whereby cuts in interest rates and a devaluation in the RMB would occur,

this could potentially alter investor habits and encourage a safe haven flight but we think this is

not likely to be widespread.

In the immediate aftermath, a potential slowdown in demand for jewellery is more likely to occur

as this demand is more sensitive to lower GDP and income growth. Chinese jewellery demand

for the metal represents over three quarters of total local demand and 20% of global demand for

the metal.

China is the largest producer of the metal. From the local gold producer’s side we do not expect

that production should be affected.

As for the international price of gold, fears of a US currency debasement have dissipated and so

we have seen the latter competing, if not replacing, gold as the main safe haven. Higher Fed

interest rates should make gold even less attractive. Earlier in June when the Shanghai gold

exchange fell sharply, we did not witness Chinese inflows of gold and the price of gold

denominated in dollars continued to drop.

Chart 19: Shanghai composite and gold price

Source: Bloomberg

In the event of a slowdown in the Chinese economy, local jewellery demand is expected to slow

down but not collapse, whereas investment demand for the metal is likely to continue to be more

focused on gold as a buying opportunity. That said, in the event of a currency devaluation (in efforts

to support growth), we could see a strong inflow into gold from local investors which would raise the

price of gold in RMB. This should also lift the price of gold denominated in dollars but not

considerably. Prices could reach $1,300/oz as the stronger dollar would also be counterbalancing

Chinese gold purchases.

Bernard Dahdah

1 100

1 120

1 140

1 160

1 180

1 200

1 220

1 240

1 260

2 600

3 000

3 400

3 800

4 200

4 600

5 000

5 400

5 800

Mar-15 Apr-15 May-15 Jun-15 Jul-15

Shanghai Composite Price of gold ($/oz, rhs)


4. Our strategic views

Fixed income strategy: lower rates, everywhere

As we have seen above, the slowdown in Chinese growth will lead not only to lower growth rates in

developed and emerging countries, but also to lower inflation rates than those expected by

investors. This of course points to a lower interest-rate regime on a global scale for a prolonged

period.

A first effect for the market is that monetary policies will remain highly accommodating for

longer than currently expected. The US Federal Reserve, which is set to start hiking its policy

rates this year, could delay this decision until 2016. In particular, the Chinese growth slowdown

has led to an umpteenth downward revision in long-term levels of the Fed Funds rate, and

therefore lower dots than those the FOMC members currently expect.

The ECB would not be impervious to a significant Asian growth shock. With lower oil prices, the

profile of European inflation would be revised downwards markedly. In their scenario of Chinese

stress, our economists are forecasting inflation of just 0.9% in 2016 with an oil price of between 40

and 50 dollars per barrel, compared with 1.3% expected in our main scenario. In such a case it

would make sense for the central bank to decide to extend its QE, perhaps until the end of the

first half of 2017, and to begin tapering thereafter. This would of course mean much larger excess

reserves in the euro zone, potentially diverging some 700bn from the main scenario by end-2017.

Chart 20: Much more accommodating central banks

Federal Reserve dots vs. futures Size of the ECB’s balance sheet (EUR bn)

2015 2016 2017 Long term

Sept.-14 1.25 to 1.5 2.75 to 3 3.75 3.75

Dec.-14 1 to 1.25 2.5 3.5 to 3.75 3.75

Mar-15 0.5 to 0.75 1.75 to 2 3 to 3.25 3.75

Jun-15 0.5 to 0.75 1.5 to 1.75 2.75 to 3 3.75

New forecasts 0 to 0.25 0.75 to 1 1.75 to 2 3 to 3.25?

Sources: Bloomberg, Fed, Natixis

Cyril Regnat

Jean-François Robin

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Jul-1

5

Sep

-15

Nov

-15

Jan-

16

Mar

-16

May

-16

Jul-1

6

Sep

-16

Nov

-16

Jan-

17

Mar

-17

May

-17

Jul-1

7

Sep

-17

Nov

-17

Futures contracts FF Natixis' FF scenario

Risk scenario

1 000

1 500

2 000

2 500

3 000

3 500

4 000

4 500

Feb

-09

Aug

-09

Feb

-10

Aug

-10

Feb

-11

Aug

-11

Feb

-12

Aug

-12

Feb

-13

Aug

-13

Feb

-14

Aug

-14

Feb

-15

Aug

-15

Feb

-16

Aug

-16

Feb

-17

Aug

-17

Balance - Core scenario Balance - Risk scenario


Given this influx of liquidity, downward pressure on the euro would also have an impact on

European central banks, leading them to adopt even more accommodating policies. The

Danish National Bank, the SNB and Eastern European banks (Poland, Czech Republic, etc.) come

to mind in particular.

This context would of course provide significant support for bond markets and for sovereign issuers

in particular. The abundance of liquidity and an unconducive global economic context for risk-taking

(in particular as a result of the downward revision in growth levels) mean that the current

environment of low long-term interest rates will persist for a long time yet.

In the United States, given the deferment of the rate-hike cycle, we can therefore imagine a

downward shift in the yield curve, with 10-year interest rates returning to around 1.50-1.75%. At

the same time, under the effect of the additional liquidity and structurally lower inflation, German

rates would follow the same path, with 10-year Bunds returning to a range of 0.25-0.50%, which

is what we had at the start of the year. In contrast to the US yield curve, this would therefore mean a

significant flattening of core euro-zone yield curves through a fall in long-term interest rates.

This bull flattening configuration would probably be see spreads between the various issuers in

the euro zone continue to contract, as excessively low yields on core bonds lead investors to

extend their duration but also to position themselves in ever-riskier securities (search for yield + QE

effect).

Chart 21: Towards lower long-term interest rates in the United States and the euro zone

Yields on 2-year and 10-year US Treasuries 10-year Bunds and 5-year/5-year forward inflation

Source: Bloomberg, Natixis

With a longer-lasting European QE programme, one could also think that the matter of relative

liquidity of some sovereign euro-zone bonds would resurface or even intensify in some cases. The

ECB would then be likely to further extend its list of eligible issuers to offer additional substitutes.

1.4

1.6

1.8

2.0

2.2

2.4

2.6

2.8

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2010 2011 2012 2013 2014 2015

Bund 10 year (L.) Inflation € 5a5a (rhs)

1.0

1.5

2.0

2.5

3.0

3.5

4.0

0.0

0.2

0.4

0.6

0.8

1.0

1.2

2010 2011 2012 2013 2014 2015

Tnote 2 year (L.) Tnote 10 year (rhs)


Strategy equity: still our preference for Europe and Value

The slump in China’s financial markets has revived concerns about the country’s economic

growth. The former are not directly linked to the latter as China is a highly banked economy

and equity wealth effects on household consumer spending are still only marginal, but our

economists think that China’s economic growth could continue to slow down in the coming

years. They expect Chinese consumer spending to be only marginally affected, but

investment spending could come to an abrupt halt.

As far as investment strategies are concerned, we believe this risk underpins our arbitrage choices.

Prefer equities in developed countries vs. emerging markets.

Play the relatively favourable economic momentum in Europe. The slowdown in China could

reduce demand for commodities and thus drag commodity prices (including oil prices) further

downwards, which mostly benefits growth in the euro zone. The unknown element, however, is

how this additional drop in the oil price will influence the Fed’s decision to tighten its monetary

policy.

Besides our preference for Europe, international themes would be penalised in favour of

Value themes (which are more domestics). We would clearly see the premium of growth stocks

narrowing ever faster, whereas stocks exposed to Europe would benefit from improved visibility

on the European economic cycle.

Before carrying out any precise quantification company-by-company, we asked our equity analysts

to examine their stock coverage and list the companies most exposed to China (i.e. those that could

potentially come under pressure) and also those most exposed to Europe (i.e. those that could be

relatively protected). The table below shows relative exposure rates and thus establishes a list of our

preferred stocks should China’s economy slow down significantly.

Sylvain Goyon


Table 4: Stocks most exposed to China

Stocks Sector Exposure to China Comment

Airbus Group Aero/Defence > 20% of commercial aircraft deliveries, i.e. 12% of sales and 19% of EBIT (2015 estimates)

MTU AeroEngines Aero/Defence 8% of sales and EBIT (2015 estimates)

Rolls-Royce Aero/Defence 9% of sales and 8% of EBIT (2015 estimates)

Safran Aero/Defence 17% of sales and 20% of EBIT (2015 estimates) Potentially penalised by a negative wealth effect

Thales Aero/Defence 3% of sales and EBIT (2015 estimates) Not at risk Zodiac Aerospace Aero/Defence 10% of sales and EBIT (2015 estimates)

Essilor Consumer goods 2% of sales and 7% of organic growth

ABI Brewers 3/4% of EBITA

Carlsberg Brewers 10% of EBITA

Heineken Brewers 4% of EBITA

SABMiller Brewers 5% of EBITA

ADP Concessions Chinese passengers account for 1% of traffic, 10% of retail sales (i.e. 1.5% of ADP’s sales)

Stock impact due more to general sentiment than direct exposure

Peugeot Car makers 25% of sales volumes and 60/65% of earnings (before tax)

Exposure to China (% of pre-tax profits) should fall to 40/50% as Europe is set to grow more rapidly

Volkswagen Car makers 36% of sales volumes and 50% of earnings (before taxes)

BMW Car makers 21% of sales volumes and 35% of earnings (before taxes)

SEB Retail 20% of sales, 15% of EBIT By far the company most exposed to China EDF Energy Minority stake in 2 EPRs in China

Veolia Environnment/Suez Environment < 10% of sales

Faurecia Auto suppliers 30% of earnings

L'Oréal Food HPC 7% of sales

Intercontinental Hotels 12/13% of sales

Hermes Luxury 34.1% of sales in Asia ex-Japan Also exposed to Europe (35.1% of sales) Kering Luxury 24.7% of sales in Asia ex-Japan Also exposed to Europe (31.4% of sales) LVMH Luxury 29% of sales in Asia ex-Japan Also exposed to Europe (19% of sales) Tod's Luxury 23% of sales Identically exposed to Europe (23% of sales) JC Decaux Media 20% of sales But also 66% exposed to Europe bioMérieux Midcaps pharma 3% of sales

Ingenico Payment 15% of sales

Ipsen Pharma 15% of sales

Novartis Pharma 20% of sales

Aixtron Semis 80% of sales

Infineon Semis 40% of sales

Melexis/STM Semis <40% of sales Diageo Spirits 7% of EBITA 2/3% of sales but exposed via 33% stake in

Moet-Hennessy (10% of Diageo’s net profit) Pernod Ricard Spirits 20% of operating profit At risk but less exposed than Remy Cointreau

Remy Cointreau Spirits 30% of group EBITDA Exposed mainly to the cognac market so vulnerable to any slowdown

Kuoni Tour operator 5/10% of sales

Source: Natixis


Table 5: Main exposures to Europe

Stock Sector Exposure to Europe

Eiffage Concessions 98% of sales

Peugeot Car makers 63% of sales

Renault Car makers 62% of sales

Darty Retail 100% of sales and EBIT

Fnac Retail 95% of sales, 100% of EBIT

Veolia/Suez/Seché Environment

Faurecia Auto suppliers >50% of earnings

Beiersdorf Food HPC 37% of sales

Orpea/Korian Healthcare midcap 100% Europe

NH Hoteles Hotels 90% of sales

Solocal Media 100% France

Wirecard Payment 70% of sales

Rubis/OMV Oil Exposed to refining in Europe

Ipsen Pharma 65% of sales

Novartis Pharma 40% of sales

Enel Green Power/EDPR Renewables > 70% of EBITDA

Elior Catering 85% of sales

Elmos Semis 57% of sales

Micronas Semis 33% in Europe

KPN Telecoms 100% of sales

Numericable-SFR Telecoms 100% of sales

Iliad Telecoms 100% of sales

Swisscom Telecoms 100% of sales

Orange Telecoms 80% of sales

TeliaSonera Telecoms 75% of sales

Telecom Italia Telecoms 71% of sales

Vodafone Telecoms 67% of sales

Deutsche Telecom Telecoms 65% of sales

TUI/Thomas Cook Tour operator 90/95% of sales

Source: Natixis


Cross-asset strategy: a more defensive strategy

A slowdown in China would have repercussions on the global recovery and trigger a rise in risk

aversion. This means that a more defensive profile should be chosen in a portfolio allocation,

with a reduction in the level of CVaR5% (Conditionnal Value At Risk of 5%) from 8% (core scenario)

to 5%. The direct consequence would be a reduction in the proportion of equities and credit

compared with our current allocation. Equities, for example, which are favoured in our core scenario,

would be reduced from 43.5% of the portfolio to 27.5%.

Conversely, there would be global flows repatriated to sovereign bonds (which would be

increased to 49% of the portfolio), especially as in such a scenario, the accommodating monetary

policies would have to be continued. As usual in this type of risk regime, the big winner would

therefore be US Treasuries (despite sales from China, as we have seen recently) and 10-year

interest rates would return to the 1.50-1.75% region1. The current interest rate level would make US

bonds very attractive in total return terms in the event of another fall. But the Bund’s risk-free asset

status would also come into full effect, while we would play a curve flattening and look for the

longest maturities in view of the QE/liquidity effect.

Subsequently, we would play a rebalancing towards Spanish and Italian bonds, which on the

whole are benefiting from a favourable ECB monetary policy (especially a continuation of the QE

programme) and from the search for yield, given the ever lower yield levels on core paper.

Emerging countries together with industrial commodities (base metals and energy) would be

the first to suffer from a slowdown in Chinese activity. That would translate into a loss of

momentum for the region (without counting India, Asia already accounts for more than 30% of our

emerging equities index), but also a weakening for exporter countries, while the decline in Chinese

demand would automatically put pressure on commodity prices 2.

On the other hand, we would take a long gold bet. Risk aversion combined with lower interest

rates and accommodating monetary policies encourage gold buying even though Chinese demand

as such probably would be affected (nevertheless with possible switches from buyers of Chinese

equities who have got their fingers burnt). Our strategists have a target of $1,300 for gold.

Lastly, in geographical terms, the scenario calls for a refocus on Europe, with companies that on

the whole would benefit from the fall in energy commodity prices3, banks that have little direct

exposure4, not to mention the fact that European risky assets would continue to benefit from the

continuation of the QE programme. So for equities and credit as a whole, European companies

continue to account for 26% of our portfolio and for the majority of its CVaR.

1 Read the recommendations of our fixed income strategists 2 Read the recommendations of our commodities strategists 3 Read les recommendations of our equities strategists 4 Read the recommendations of our bank analyst

Emilie Tetard


Table 6: Proposal for an asset allocation in a scenario of slowdown in Chinese activity

% Natixis Portfolio - Central scenario Natixis Portfolio - China crisis Tactical reco

Equities 43.5 27.5 UW

Equities US 11.5 7.0

Equities UK 7.5 3.0

Equities Emerging

European equities 24.5 17.5

EuroStoxx 50 16.0 10.0

Equities Mid Caps Europe 3.5 3.5

Equities Switzerland 5.0 4.0

Commodities 15.0

GSCI Energy UW

GSCI Precious metals 15.0 OW

GSCI Industrial metals UW

Sovereign Bonds 38.5 47.0 OW

Sov. Bonds Ger-Fr 1-3 years 2.0 3.0

Sov. Bonds Ger-Fr 7-10 years 4.5 9.0 OW

Sov. Bonds It-Spa 1-3 years 15.0 4.0

Sov. Bonds It-Spa 7-10 years 16.0 16.0

US Treasuries 7-10 years 1.0 15.0 OW

EUR Inflation indexed

Corporate Bonds 17.0 10.5 UW

Credit € IG Fin. 4.5 2.5

Credit € IG Non Fin. 7.0 5.0

Credit US IG Non Fin. 2.5 2.0

Crédit € High Yield 3.0 1.0

Crédit US High Yield UW

Cash € 1.0

Risk Statistics

CVaR 5% (monthly, %) 8 5 ↘

Volatility (annualized, %)

5% chg. (monthly, %)

NB: Weights are rounded to 1 decimal place. OW = Overweight, UW = Underweight, N = Neutral.

Source: Natixis


5. Sectors affected by the slowdown in

investment and consumer durable purchases

In terms of sector exposure, semiconductors would be directly and sharply affected were an adverse

scenario to materialise, with Infineon to the forefront (ca.40% of its activity is in China). In the

automotive sector it would be a reversal of fortunes to which car makers Volkswagen and BMW

would be the most exposed. Auto parts makers (Faurecia, Plastic Omnium, Valeo), would be

harder hit than tyre makers. Capital goods stocks would also suffer, especially Schneider (15% of

its sales are generated in China). Then there are the industries that are indirectly exposed to the

Chinese market: for oil companies, the impact would be felt via oil prices and we think that Shell

would be hardest-hit. Oil companies’ E&P capex and margins would be under heavy pressure, but

we would still prefer asset-light profiles. Indeed, GTT would still be our top pick among oil services

companies. The pricing and product mix would impact the tubes and equipment segment. The

predictable fall in iron ore prices calls for caution on ArcelorMittal. Last, apart from the spectre of

rising Chinese exports, tied to a drop in local demand, we would be more concerned about the

impact on the Asia region’s economy, which would primarily affect LafargeHolcim and to a smaller

extent HeidelbergCement and Italcementi. In the Utilities sector, the indirect impact would primarily

derive from downward pressure on wholesale electricity and recycled raw materials prices with CEZ

Fortum, Vattenfall and E.ON most affected. Last, we think that European banks would be well-

shielded from an adverse scenario on the whole, as only Standard Chartered and HSBC have

substantial activities in China.

Semiconductors: the market would mature

The recent slump by the stock market in China and the imbalance inherent in its growth model,

which was bound to correct, is prompting fears of a slowdown in investment in the private sector.

The group with the most exposure in our universe is Infineon. Against this backdrop, we prefer

ASML, Dialog, ams and ASMi.

If China’s growth does slow to 4/5% (vs. nearly 10% in the past), it would have a negative impact on

the structural growth of the semiconductors market, given the way the country has grown in

importance in the last decade. In ten years, the semiconductors market has already shifted from

long-term growth of 15% to only 6/7%. This slowdown could continue, to the tune of around 1 to 2

points, notably in automotive (slower volume growth, weaker advance in electronics content),

industrials (lower spending on transport and energy infrastructure and plant equipment although the

New Silk Road initiative limits the downside risk) and even in the wireless segment (China is now a

major market for equipment makers such as Apple). The semiconductors market could thus move in

line with world GDP growth, becoming a mature market.

In our stock universe, the group with the most exposure to this risk is Infineon, with close to

40% of its sales generated in China, particularly in the industrial segment. While we are not

concerned about the fiscal Q3 figures (calendar Q2), the guidance over the coming quarters could

be under pressure. From structural growth of around 8%, the group could see its potential reduced

to 6%, which could have consequences for its outlook for improvement in earnings beyond the

current level and therefore for its valuation. Nonetheless, we are maintaining our Buy rating at

Maxime Mallet

Stéphane Houri


this stage despite the risk of volatility. Indeed, the valuation is low and its solid positioning in

industry (world leader) and automotive (world no. 2), should enable it to outperform the

semiconductors market over the next few years.

By contrast, a number of groups seem to be relatively immune to this slowdown, particularly

ASML which offers the best long-term visibility in the sector, thanks to its de facto monopoly position

in the upcoming generations of EUV lithography machines. Dialog should continue to take

advantage of growth in iPhone volumes and from product and client diversifications. Looking beyond

the likely loss of the NFC booster contract with Apple, growth for ams should be driven by the ramp-

up of biosensors that measure cholesterol, alcohol, blood sugar (diabetics) and blood oxygenation

levels. Technological transitions (10nm then 7nm) and the ramp-up of ALD (Atomic Layer

Deposition), in the face of other deposition techniques, should shield ASMi from a broad-based

slowdown in growth, including in China.

Car makers: reversal of fortune

No car makers will be spared to an adverse growth scenario for China, affecting investment

and durable goods purchases, but Volkswagen and BMW seem the most exposed.

A more marked economic slowdown would inevitably have a significant effect on Chinese

automotive demand, which is clearly already in a normalisation phase. After a decade of strong

growth (+24% per year between 2000 and 2010), the Chinese light vehicle market grew just 8% per

year in 2011/2014. 2015 looks set to be a lacklustre year with a fall of 2.3% in June (base effects

and statistical distortions) and limited growth expected for the full year (+2.5%). In our baseline

scenario, we assumed medium-term growth slightly lower than that in GDP, of around 5/6% over

2016/2018e. An adverse scenario (including credit restrictions that would curb the support provided

by the recent development of automotive financing) would call into question the prospect of growth

in demand and could lead to an unprecedented decline, of around 1%/year over this period. This

may look severe in that the Chinese market is anything but uniform and continues to be driven by

Tier3/Tier 5 cities, which have above-average growth potential.

Sector impact: ‘not all of them died, but all were hit’. With the exception of FCA, which has very

little presence in China, and Renault (indirect effect via Nissan), no car makers would be spared by

this new situation. In this scenario, the BMW and Volkswagen groups would be the most severely

affected, with a theoretical impact of around -13% and -9% on 2016/17 EPS estimates. Estimates for

PSA would be lowered by around -7% in the same period, and those for Daimler by around 5.5%.

Such a scenario would unquestionably be bad news for European car makers, for which

China has become one of their main markets and a key contributor to their profitability, and

even to their cash flow (via the dividends paid by Chinese JVs). The valuation of the Chinese

JVs would of course be affected.

China currently accounts for 36% of global volumes at Volkswagen, 25% at PSA, 21% at BMW,

18% at Mercedes, but just 4% at FCA and 1% at Renault whose exposure is mainly indirect via

Nissan, which generates 23/24% of its global sales in China. In terms of estimated profitability

(which includes the share in the earnings of Chinese JVs, the margins on imported vehicles and

parts, as well as royalties), the hierarchy is roughly the same, with more than 50% of profit before

tax coming from China at Volkswagen, nearly 50% in the case of PSA (automatic effect of the

weakness of Europe in the short term, this percentage being set to fall sharply in the medium term),

25% at Daimler and 35% at BMW. As regards cash flow, Volkswagen is certainly the most

Georges Dieng


dependent on China since, with a pay-out of 80% and a cash flow of €3bn in 2014 (and the same in

2015), the dividend paid by the Chinese JVs represents 50% of its FCF and covers the annual

dividend payment of VW AG one and a half times.

Against the backdrop of a deterioration in purchasing power, the recent phenomenon of a shift

in market share in favour of local players (thanks to their offensive in the affordable SUV segment) is

likely to gain strength, thereby weighing on the volumes of the international JVs. Concerning the

premium segment, which is currently penalised by the anti-corruption/anti-ostentation campaigns,

the situation is more uncertain, but the pressure on high-margin imported vehicles is likely to be

maintained (BMW being the most vulnerable).

Moreover, this slowdown in demand would increase pricing pressures, already tangible since

Q2 15, which would be fuelled by the fall in utilisation rates (currently over 100% at PSA, VW and

probably Mercedes). It would also aggravate the already fragile situation of a number of dealers

(particular those that were recently established and are exclusively dependent on sales of new cars),

requiring widespread implementation of the financial support measures that recently affected BMW

in particular.

What counter-measures? The race for growth had hitherto pushed cost and productivity issues into

the background. The ongoing normalisation, and even more so an adverse scenario, would make

them a priority for car makers, like the action plans launched by PSA in cooperation with Dongfeng

(industrial efficiency, “deep” localisation) and those envisaged by Volkswagen, which acknowledges

that it pays 40% more for certain parts than in Germany (!!). Capacity-widening investment plans will

inevitably be recalibrated (particularly at VW, which planned to lift capacities from 4 million vehicles

in 2016 to 5 million by 2019). Conversely, we do not expect car makers to make widespread use of

Chinese capacities to re-export to Europe or the USA (specific features of certain long wheelbase

models).

Faced with faltering Chinese growth, how resilient will car makers be? With the North

American market nearing a cycle high (which we expect in 2016), Europe, which is faring better than

expected, will be the pillar of growth in 2015/2016. The French car makers Renault and Peugeot

look to be the best placed to take advantage (>60% of their sales). While PSA’s situation looks

paradoxical (highly exposed to both China and Europe), it should be underlined that most of the

expected recovery and upwards revisions to estimates stems from the faster-than-expected

recovery in the outlook in Europe. Conversely, German car makers are likely to be particularly hard

hit, with a risk of a 9% downward revision to 2016/17 estimates. BMW (-13%) and VW (-9%) appear

to be the most vulnerable in this context.

Auto Parts: harder-hit than tyre makers

As part of a scenario of much sharper economic slowdown in China, original equipment

suppliers would clearly be more impacted than tyre makers, but probably much less so than

car makers.

In the parts universe, unsurprisingly the most sensitive would be OE suppliers, exposed to

variations in production and hence more cyclical, while the least exposed would be tyre makers,

very insensitive to OE in China and benefiting from the recent surge in the number of cars on the

road (115 million vehicles in 2015 vs. 19 million 10 years ago). They could also indirectly profit from

the market slowdown if consumers postpone their purchases. Hence and as part of this scenario,

we would recommend positioning on tyre makers (Michelin) at the expense of OE suppliers

(Faurecia, Valeo or Plastic Omnium, even Continental to a lesser extent). Remember,

Michael Foundoukidis


moreover, that Pirelli is currently subject to a takeover bid (Chinese) and that Nokian is barely

exposed to China.

With the Chinese auto market slowing for some months already, plus a shift in its mix towards local

OEMs and at the expense of International JVs, a steeper economic slowdown would clearly

have a substantial impact on the auto market and hence on production.

In this context, we have assumed: 1/ stabilisation in auto production in 2016/17 (and not a fall)

given the fact that consumption would still be the main growth driver (+7%/year in our adverse

macro scenario, i.e. the least impacted contributor versus investment or public spending); 2/

ongoing deterioration in the mix in favour of locals given the budgetary constraints that could

weigh on households.

Undeniably, stabilisation of auto production would be bad news for the auto sector as the

country has been by far (>60%), the main locomotive for sector growth worldwide and profits in the

last few years.

OE suppliers may benefit from their more balanced geographic earnings profile than at car

makers (there is no major distortion in favour of China). Moreover, Europe, the main trigger for

earnings improvement in 2015, is firmer than expected and external factors (oil, forex) still

positive. In addition, we do not expect a significant shift in these dynamics in 2016 and

Europe is likely to remain the main growth driver for the sector in 2016.

The weight of China at OE suppliers is much weaker than at OEMs. They generate between

8%e (Plastic Omnium) and 12%e of their sales (Valeo) in China. On the operating level and except

for Faurecia (more linked to its current weakness in other markets), the weight of China (from 10%e

for POM to 18%e for Valeo), though higher than the contribution to sales, remains low relative to that

for some car makers, notably German ones for which almost half of earnings stems from their

Chinese businesses. The situation is still clearly more marked at tyre makers which all generate

under 10% of their sales in China.

Productivity and flexibility on the menu. Hitherto a secondary issue, given the sharp growth in the

last few years, the improvement to productivity (costs management, process, automation, etc.)

would become a priority for most players in this adverse scenario, whether car makers or suppliers,

and underpin the profitability (Autoliv mentioned these efforts on 17/07, underpinning our opinion).

Moreover, parts suppliers have greater flexibility in their industrial bases and could scale down their

capacities, if need be, much more readily and quickly than OEMs (as we saw in Europe and North

America in 2008/09).

The local OEMs offer an opportunity medium term. Next, the exposures of OE suppliers to local

car makers are likely to increase in years to come (at the CMD Valeo mentioned an exposure of

over 30% in its order book … i.e. will transfer to its sales in 2/3 years), Faurecia has recently signed

a significant agreement with Dongfeng, etc.) and thus allow parts suppliers to better manage this

slowdown as market share gains at locals could partly offset the slowdown for the market. Moreover,

in a context of stiffening standards, mentioned above, local players, very exposed to SUVs, will have

greater need of technological depollution solutions proposed by international OE suppliers which

could thus profit from these mix trends (faced with non-existent local competition on these products).

Overall, and as part of this scenario, we would cut our estimates by some 10% for parts

suppliers for 2016/17: -8% for Plastic Omnium -10% for Valeo and -12% for Faurecia while

estimates for tyre makers would be broadly unchanged.


Integrated oil: direct impact hit by oil prices

Downward impact on crude: Slowing Chinese growth, which in our economists’ scenario of

structural weakening could decline to around 4% out to 2020, could result in oil prices falling to

around $50/60/bbl. While the average sensitivity of integrated oil groups is around 1.8% of

attributable net profit for a $1/bbl, ENI is the most sensitive.

Table 7: Sensitivity of earnings to a $1/bbl shift for crude

Shell BP Total ENI Repsol OMV

Oil price Sensitivity: +1$/b

$320m post-tax

$300m pre tax $180m post tax e

$310m pre tax, $170m post tax

€280m pre tax €140m post tax

€30m pre tax €18m post tax

€40m pre tax €24m post taxe

Gearing end of 2013e 13.9% 20.5% 31.9% 22.0% 14.3% 33.6% Crude scenario 2014 99.96

EBIT 2014

20,818 9,074 11,574 2,421 2,238

Net profit 2014 22,562 12,136 12,837 3,711 2,010 1,133

$1/bbl chg % EBIT 1.4% 3.4% 2.4% 1.2% 1.8%

$1/bbl chg % Net 1.4% 1.5% 1.3% 3.8% 0.9% 2.1%

Sources: Companies, Natixis

Volumes threatened in LNG. In the LNG sphere, China represents 8.1% of world demand with

growth estimated at 10.6% in 2014. LNG now amounts to 14.6% of gas consumption in the country.

The economic slowdown is likely to weigh on electricity and hence gas demand. However, the

development of gas usage also responds to energy and environmental diversification

considerations. From this perspective, the impact of the economic slowdown could be limited.

New declines in investments and operating costs in sight. Already faced with a negative price

climate since H2 14, oil groups are thus likely to press on and amplify opex and caped reduction

policies that we detailed in our year-start report ‘What if oil stays low long-term’. The decline in

investments is estimated at -15% internationally and over -35% in the US in 2015 by Schlumberger,

i.e. an overall slide of over 20%. Signs of new investment reductions have recently set in at major

players: at end-June 2015, Petrobras communicated a 37% fall for its capex over 2015/2019

including 50% in exploration; ConocoPhillips stated in mid-July 2015 that it intends to reduce its

investments in deep offshore, notably in the Gulf of Mexico to balance out its 2017 cash flows and

allow an increase of 1cts/quarter for its dividend; finally, the press mention a further reduction in

investments at Shell after the $2bn slide announced in Q1 15. The quarterly publications will offer an

occasion to summarise the situation on achievements and prospects in terms of cost cutting and

investments.

Limited exposure to international oil companies (IOCs). Given the legal and regulatory climate,

international oil groups have limited exposure to production in China and this is mainly focused in

offshore (Bohai Bay basin for ConocoPhillips) and on non-conventional resources. Implantations

have been made, however, in downstream (lubricants, bitumen) and, above all, in chemicals to profit

from the dynamic consumption. Aside from the exposure in China, large petrochemical platforms

have been developed in the zone (Singapore, Taiwan, Korea) to serve the Chinese market.

Anne Pumir


Table 8: Exposure to China for the main oil groups

2014 production

(in bpd)

% of total production

2014 refining capacity

(in kboepd)

% of total refining

capacity

2014 ethylene capacity

(in Mt)

% of total ethylene capacity

2014 PTA capacity

(in Mt)

% of total PTA

capacity

Royal Dutch Shell 25,000 0.8%

0.475 8.2% BP

3.3,(1) 64.7% 1.8 26.9%

Total 12,000 0.6% 49,000 2.2% ENI 9,000 0.5%

ExxonMobil

67,000 1.3% 0.3 3.3%

Chevron 16,000 0.6% ConocoPhillips 40,000 2.5% Total 102,000 2.4% 116,000 0.8%

1 Olefins and derivatives capacity


Shell the most determined in China. In the sample of majors, Shell is the group that has focused

most on expanding in the country by forging partnerships with the three Chinese majors (CNPC,

Sinopec and CNOOC) in China and abroad (Australia and Brazil notably) by investing over $1bn in

2013 in the country. Shell is also one of the main suppliers of LNG to China, a position still

reinforced by the merger underway with BG: according to Wood Mackenzie, Shell and BG together

wold represent 13% of Chinese LNG imports and this would reach 28% in 2017.

Opportunities in China? However, China seems to be making headway in the reform plan for its oil

industry. The reforms, which mainly apply to the onshore sector, chiefly concern the gradual opening

of exploration and development to private enterprises, deregulation for natural gas imports, access

of third parties to oil and gas infrastructures. At this stage, the SOE (State Owned Enterprise) reform

does not slate extra incentives for foreign investments but these are likely to be associated via

‘mixed/hybrid’ holdings which allow the injection of capital and limit recourse to debt. The groups

already present in the county could thus be able to increase their exposure.

Oil services: deteriorating outlook for recovery

Slowing Chinese growth and ensuing slide for crude would most likely result in an accentuation of

the scenario for the oil services sector that we laid out in the year-start Cross Expertise report ‘What

if oil stays low long-term?’:

Increased pressure on E&P capex for oil companies: they are expected to fall 20% in 2015e,

and this contraction would then continue in 2016 (-10%?) and 2017.

Postponement of the recovery for demand for the most early-cycle businesses, such as

seismic, and launches of new developments postponed, notably in offshore, where marginal

costs are higher. We slated a business recovery as of 2017, this would then be pushed out to

2018, but on low bases.

The Chinese services groups (COSL, COOEC), faced with the slowdown for their domestic

market, could seek to redeploy outside the country, as was the case for Korean engineering

players in the Middle East in 2008/2009.

Maintained pressure on margins, which will lead to new restructuring and new asset write-offs.

Some groups look clearly exposed to this risk: CGG, PGS, Bourbon, Saipem, SBM Offshore.

Alain Parent


Though the direct exposure to China of groups in our sample is very slight, it is interesting to raise

the specific case of GTT, tributary of future LNG demand. China indeed represents 8.1% of world

LNG demand (2014), and the LNG contributes to the tune of 14% of gas consumption in the country.

The economic slowdown is likely to drag on electricity demand and hence of gas, but this also looks

dictated by energy and environmental diversification considerations (substitution for coal), which is

likely to limit the impact on an economic slowdown on Chinese LNG demand.

This Chinese slowdown scenario does not prompt us to alter our sector hierarchy, and we

maintain our preference for ‘asset light’ profiles. GTT remains our top pick. We steer clear of

the most fragile financial structures (CGG, PGS, SBM Offshore, Bourbon).

Tubes and equipment: pressure on pricing and the mix

We do not think the tubes sector will emerge unscathed from a structural let-up in the

Chinese economy and in investment in particular, even though the Chinese market is not one

of the sector’s primary outlets.

Amid the slowdown in the pace of Chinese growth and to respond to a more challenging

environment and based on oil prices of $40/50 in 2016 and $50/60 in 2017, oil companies are likely

to once again cut their investment spending. The North American market, which is the biggest

consumer of tubes and the quickest to react, should once again see spending on the part of E&P

companies being revised down.

Pressure on drilling: we think that despite the numerous cost cuts over the past few years, the rig

count on the North American market could fall by a further 20% on current levels.

Chart 22: Development costs depending on the permit ($/b)

Source: Rystad Energy

Amid this, after a very bleak 2015, orders are not likely to recover in early 2016. In the event of a

potential stock replenishment at distributors, negotiations would likely leave very low margins for

tube manufacturers. Moreover, 2016 will see the coming on-stream of Tenaris’ new US plant

(600,000 tonnes), further upsetting the market’s balance.

Baptiste Lebacq

0

20

40

60

80

100

120

140

160

2011 2012 2013 2014 2015

Bakken Eagle Ford Permian Delaware Permian Midland Niobrara


Chart 23: North American market balance (Mt)


Heading for further asset impairments? This change in the market’s balance could prompt

companies to book impairment charges on the North American market. As a reminder, Vallourec’s

asset impairments in 2014 did not affect this region (but rather the new Brazilian plant and its

European ones). All players in our sample could then be impacted by accounting adjustments, even

Schoeller Bleckmann which has already booked impairment charges after the acquisition of

Resource Well Completion end-2014.

Also pressure in the rest of the world: in the rest of the world, the pace of new projects could be

slowed down, such as the development of the Vaca Muerta field in Argentina. Only the Middle East

might be a safe haven. Indeed, despite the fall in oil prices from their all-time high, the rig count has

slid by just 6% (401 rigs) in the region and it even increased 16% in Saudi Arabia (with 121 rigs in

operation in June 2015).

A real risk of downtrading: in onshore drilling, there is a risk that players could switch to less

premium tubes to reduce costs. For instance, in the last Abu Dhabi tender invitation, the NOC

awarded some of the tube supply contracts to the Chinese company TPCO. Indeed, this last had in

the past been pre-selected for a previous contract.

Steel: pressure already visible … and it could increase

Though the Chinese market accounts for a large share of world steel consumption, big

European players have only limited access to it (ArcelorMittal generates around 1% of its

sales in China). If a slowdown of the Chinese market therefore has only a small direct impact

on the activity of these groups, it may however affect the global market outlook. Besides the

pressure driving exports, it should be noted that the strength of Chinese demand determines

not only trends in raw materials prices (iron ore and coal) but also in steel prices.

A decline in steel consumption in China…

For the first time since 1995, Chinese apparent demand for steel fell in 2014 (-3.3%) due to

government efforts in particular to curb artificial activity in the real estate market and the slowdown in

the outlook for the automotive market (see the Auto section). This situation is likely to last according

to the World Steel Association, which, in April 2015, forecast a decline of 0.5% in apparent demand

for steel in China in both 2015 and 2016. The World Steel Association is more cautious than

Sandra Pereira

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

Q1 10 Q1 11 Q1 12 Q1 13 Q1 14 Q1 15 Q1 16 Q1 17

US Steel Tenaris Vallourec TMK-Ipsco TPCO Benteler demand


ArcelorMittal, which, at its Q1 15 results publication, still expected a small increase in apparent steel

demand in 2015 (between 0.5% and 1.5% versus between +1.5% and +2.5% previously). In the

medium term, the World Steel Association does not expect a significant recovery.

…resulting in a rise in exports …

With overcapacity in China still at a high level (the ratio of production to production capacities stood

at 70% in 2014 versus 75% in 2013 and 77% in 2012 by our estimates), the slowdown in Chinese

demand therefore resulted in a rise in Chinese steel exports (+28% in the first five months of the

year), which now represent nearly 13% of production in the first five months of 2015 (versus 11.5%

in 2014 and 8% in 2013). At the publication of its Q1 15 results, ArcelorMittal mentioned that it had

suffered a deterioration in its operating performances in the USA against the backdrop of stronger

competition from imports from China. In the first three months of the year, imports of Chinese steel

into the USA grew 29%.

Chart 24: Growth of steel consumption and production in China (‘000t) and growth in Chinese steel exports (‘000t)

Sources: Bloomberg, WSA, Natixis

…and pricing pressures

This pressure to export is particularly strong as the price difference between flat steel in China and

that in North America ($151/t) makes importing steel from China particularly attractive, and moreover

represents a risk for flat steel prices in the USA and to a lesser extent in Europe. In this respect, it

should be noted that a number of complaints have been filed by the European steel association,

Eurofer, for dumping relating to imports of certain types of steel from China.

The fall in steel prices also stems from the fall in raw materials prices. The slowdown in apparent

demand for steel has resulted in a fall in consumption of iron ore in China, weighing heavily on iron

ore prices, which fell by nearly 49% at the end of 2014 (fall of 30% on average over the full year), as

mining groups did not adjust their production. This decrease continued in 2015 with a further fall of

23% to $54/t.

0%

5%

10%

15%

0

20 000

40 000

60 000

80 000

100 000

2001

2002

2003

2004

2005

2006

2011

2012

2013

2014

2015

Export Export/Prod (rhs)

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

0

100 000

200 000

300 000

400 000

500 000

600 000

700 000

800 000

900 000

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

YT

D

Production Consumption

Variation production (rhs) Variation consumption (rhs)


Chart 25: Steel prices (HRC) per region and iron ore prices compared to ArcelorMittal EBITDA expectations

Sources: Bloomberg, Natixis

The threat of a more pronounced slowdown than expected therefore raises fears of:

An increase in the pressures driving Chinese steel exports for at least as long as it takes the

Chinese steel industry to rationalise production. In this respect, it should be noted that the

Chinese government has presented a plan aimed at reducing the steel production capacities of

its blast furnaces by 80 million tonnes by 2017, which will probably not be sufficient. These

measures are also part of the pollution reduction process initiated by the Chinese government in

2013.

But also, a further fall in iron ore prices, which could slide to $40/t according to our economists.

Caution recommended on ArcelorMittal

The fall in iron ore prices and the deterioration in performances on the US market had led

ArcelorMittal to lower its EBITDA target, which is now for between $6bn and $7bn (versus between

$6.5bn and $7bn previously, and $7.3bn at the end of 2014). The weakness of iron ore prices had

moreover led S&P to lower the group’s rating by one notch to BB at the start of February 2015 after

the rating agency cut its estimates for iron ore prices to $65 per tonne in 2015 and 2016. While the

further reduction since then in S&P’s iron ore price forecasts, which are now for a price of $45/t,

$50/t and $55/t in the period 2015/2017, did not lead to any further negative action on the group’s

rating, a greater erosion in prices could put pressure on the group’s operating performances, as

illustrated by the chart above on the right, which shows the close correlation between EBITDA

estimates and iron ore prices, and therefore its rating, other things being equal. In 2014,

ArcelorMittal’s mining division accounted for 18% of its EBITDA (compared with 29% in 2013).

Other industrials: larger direct exposure

The slowdown in industrial activity in China is also likely to affect the activity of industrial

gases groups, which are directly exposed to this market. Respectively number 2 and 3 on the

market behind Chinese group Yingde Gases, German industrial gases group Linde generated just

under 8% of its sales in China in 2014 while its French counterpart, Air Liquide, does not disclose its

direct exposure. While the slowdown of the Chinese economy is likely to weigh on the industrial

gases market, it should be buoyed by growth drivers that are not correlated to economic activity:

The rebalancing of the Chinese industrial sector;

-200

-100

0

100

200

300

400

500

600

700

800

900

1 000Ja

n-09

Jun-

09

Nov

-09

Apr

-10

Sep

-10

Feb

-11

Jul-1

1

Dec

-11

May

-12

Oct

-12

Mar

-13

Aug

-13

Jan-

14

Jun-

14

Nov

-14

Apr

-15

Price difference China-North AmericaChinaEuropeNorth America

40

60

80

100

120

140

160

180

5 000

5 500

6 000

6 500

7 000

7 500

8 000

8 500

9 000

9 500

Jun-

13

Aug

-13

Oct

-13

Dec

-13

Feb

-14

Apr

-14

Jun-

14

Aug

-14

Oct

-14

Dec

-14

Feb

-15

Apr

-15

Jun-

15

Consensus EBITDA 14 Consensus EBITDA 15

Iron ore price ($/t) (rhs)


The increase in on-site outsourcing of production, which is likely to rise from 42% in 2014 to 50%

in 2019 (in line with the global average);

Growing energy needs in a more demanding regulatory climate as regards environmental

protection, resulting in big opportunities for industrial gases producers. Indeed, industrial gases

are at the heart of manufacturing processes for cleaner and renewable energies (conversion of

fossil energies, for example).

Chart 26: Outlook for the industrial gases market in China and organic growth in activity for Schneider by region

Sources: Yingde Gases, Schneider, Natixis

The issuer in our sample that it most exposed to China is capital goods manufacturer

Schneider, which in 2014 generated 15% of its sales in China. The group already suffered in

2012 from a slowdown in its activity on the Chinese market, as the chart on the right above shows,

with a decrease in organic growth in activity in Asia Pacific. While the situation has since stabilised

at a low level (still affected by the weakness of the residential market, including in Tier 2 and Tier 3

cities, and the slowdown in manufacturing activity), Schneider experienced an overall slowdown in

organic growth in activity in emerging countries in 2014, with the rate of growth converging with that

in mature countries. A sharper slowdown of the Chinese economy would therefore be negative for

the group.

Cement: at little risk

The threat from China needs to be put into perspective as far as Europe’s cement companies

are concerned, because 1/ these companies have little exposure to China, at just 2% of

EBITDA in LafargeHolcim’s case, 2/ cement travels badly, do imports account for just 2.8% of

global cement consumption. If demand slows down, Chinese exports could double (30/40 Mt)

but we think these imports will be limited to traditional importing countries. Chinese cement

companies could step up their efforts to expand internationally, as Anhui Conch is doing.

Setting aside the risk of an increase in Chinese exports, we are more concerned about the

impact on the region’s economy.

By nature, cement is not very exportable because it is heavy and sensitive to humidity. Cement

trading amounted to just 117 Mt in 2014, i.e. 2.8% of global consumption of 4.1bnt (4.7% of Chinese

cement consumption of 2.4bnt). We would divide cement-exporting countries into several categories:

Sven Edelfelt

4.7 5.1 5.8 6.5 7.2 7.9 8.6 9.3 10.1 10.8 11.6 12.40

2

4

6

8

10

12

14

2008

2009

2010

2011

2012

2013

2014

2015

e

2016

e

2017

e

2018

e

2019

e

-10%

-5%

0%

5%

10%

15%

20%

Q1-

11

Q2-

11

Q3-

11

Q4-

11

Q1-

12

Q2-

12

Q3-

12

Q4-

12

Q1-

13

Q2-

13

Q3-

13

Q4-

13

Q1-

14

Q2-

14

Q3-

14

Q4-

14

Q1-

15

Emerging countries Mature countries Asia/Pacific


Countries that are natural or regular exporters because they have built up their cement

industries (perhaps partially) with the aim of exporting the product, e.g. Turkey, Greece and

Germany.

Countries that are being undermined by poor domestic demand and temporarily focusing on

exporting their cement production, e.g. Spain, Thailand, South Korea and Japan.

Countries that temporarily find themselves with surplus capacity. The rate at which new

capacity comes on stream can result in a surplus of cement lasting several years. This is the

case in Iran, Vietnam and certain Persian Gulf countries.

Table 9: The world’s biggest cement-exporting countries

Mt Cement and clinker exports

2012 2013 2014

Iran 13.60 18.80 19.40

Vietnam 8.70 16.10 17.00

China 13.60 14.60 15.00

United Arab Emirates 10.60 12.88 13.50

Turkey 13.60 12.40 12.50

South Korea 8.88 9.00 10.30

Spain 6.19 7.00 9.59

Japan 9.70 8.70 8.50

Thailand 11.47 7.99 8.23

Pakistan 8.32 8.29 8.05

India 2.76 4.47 5.95

Greece 4.25 4.76 5.65

Germany 7.02 6.32 5.60

Portugal 2.92 4.95 5.42

Canada 4.11 3.48 3.76

Taiwan 3.69 4.26 3.50

Italy 1.77 2.44 2.50

Belgium 2.57 2.60 2.40

Malaysia 2.67 2.50 2.37

Caribbean 1.91 1.98 2.16

Sources: ICR, Natixis

The threat from Chinese exports needs to be put into perspective as they amounted to just

15 Mt in 2014. Cement markets have high entry barriers, especially in emerging countries where

cement is sold by the bag (between 60% and 70%, depending on the country) and therefore needs

to go through a distributor. Meanwhile, a lot of China’s cement is considered to be of inferior quality

to that produced by European cement companies.

If demand slows down, we think Chinese exports could rapidly jump to between 30 Mt and

40 Mt (a level already reached in 2007). Certain plants near the coast could easily revive their

exporting activity, but these exports would be limited to countries that are traditional importers or

neighbours (countries equipped with infrastructure such as cement grinders). Bear in mind that

China exported between 22 Mt and 36 Mt in 2005/2008, mostly to the USA, a country that has a

structural cement deficit (imports in 2007 amounted to 38.5 Mt, i.e. 31% of cement consumption, vs.

6 Mt today).


Chart 27: China’s cement exports/imports (Mt)

Sources: Bloomberg, ICR, companies, Natixis

Certain Chinese companies could be tempted to adopt a more aggressive international

expansion strategy. Anhui Conch is still the only company with plans to expand internationally, so

far consisting exclusively of building new capacity (Myanmar, Indonesia and Vietnam). Chinese

companies have similar levels of production capacity to Lafarge or Holcim on a standalone basis, i.e.

around 200 Mt (CNBM, Anhui Conch), Heidelbergcement, i.e. around 130 Mt (Jidong Development),

or Italcementi, i.e. around 70 Mt (China Resources). Chinese companies might want to limit their

exposure to their depressed domestic market and diversify their portfolios by 1/ adding new capacity

(we estimate that it takes about 4/5 years to build a new plant, including the time needed to obtain

the operating licence), 2/ generating external growth, as Latam companies are doing. However, their

financial resources might be undermined by a lasting slowdown in their domestic market, which

would hinder such plans.

LafargeHolcim, and to a lesser extent, HeidelbergCement and Italcementi are currently the

companies most exposed to emerging Asia (see map below). LafargeHolcim’s production

capacity in Asia accounts for 42.1% of its total capacity (162.5 Mt) and 21.9% ex-India (68 Mt), of

which 8% in China (31 Mt). Meanwhile, HeidelbergCement’s Asian exposure stands at 22.6%

(29 Mt), consisting mainly of its Indonesian subsidiary Indocement which accounts for 16.0% of its

capacity (20.5 Mt). The Chinese operations of European cement companies are limited to

observation posts in subsidiaries owned jointly with a partner and therefore not consolidated. In

LafargeHolcim’s case, Lafarge’s assets are being taken over purely as part of the merger with

Holcim. We think the new group could seek to merge Lafarge’s former subsidiary with Holcim’s

(currently booked as a JV and not consolidated).

Setting aside the risk of an increase in Chinese exports, we are more concerned about the

impact on the region’s economy. The region’s demand for cement could prove disappointing for

the cement companies operating there.

0%

1%

2%

3%

4%

0

5

10

15

20

25

30

35

4020

05

2006

2007

2008

2009

2010

2011

2012

2013

2014

YT

D 2

015

Exports Share of exports in production (rhs)

-10%

0%

10%

20%

0

500

1 000

1 500

2 000

2 500

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

YT

D 2

015

Consumption Variation production (rhs)

Variation consumption (rhs)


Chart 28: Cement companies operating in Asia

Note: figure in brackets corresponds to % of EBITDA and production capacity/Australia: Cement Australia controlled by LafargeHolcim-

HeidelbergCement joint venture (the group gives capacity at 100% in the registration document)

Sources: Bloomberg, ICR, companies, Natixis

Utilities : affected by prices decrease

The scenario of a severe slump in Chinese growth would affect European utilities in four different

ways and in decreasing order of importance: 1/ wholesale electricity prices via the fall in coal prices,

2/ recycled raw materials prices, 3/ Chinese investment in the nuclear and renewables segments in

Europe and 4/ investment in the Chinese nuclear segment.

Firstly, such a scenario would further depress coal prices, negatively affecting electricity

prices on the different wholesale markets in Europe. Despite the government’s various initiatives

underway to “decarbonise” the Chinese economy and which are likely to structurally affect the

aggregate consumption of this fuel in the years ahead, China still represents 40% of the global coal

market. It still consumes 3 billion tonnes of the fuel, 300 million of which are imported. Therefore, a

sharp let-up in Chinese growth would worsen the market’s overcapacity and the downward pressure

on prices that has been perceptible for the past four years (1-year forward prices have fallen from

$120/tonne in early 2011 to $58/tonnes currently). As coal-fired electricity generation is now a

“marginal” technology on most European wholesale markets, any further downward pressure on coal

prices would also be a drag on electricity prices. Such a scenario would firstly impact those

electricity companies exposed to market risk and with more rigid cost structures, given their

predominantly of nuclear, hydro and/or lignite-fired capacities. This category includes CEZ, Verbund,

Fortum, Vattenfall and E.ON. Given the importance of their coal-fired capacities, RWE and

southern-European electricity companies (EDP, Enel and Iberdrola) would be less affected by this

phenomenon as falling electricity prices on wholesale markets are partly offset by lower coal

sourcing costs, which in themselves depend on the global market situation. For an electricity

Philippe Ourpatian

Ivan Pavlovic

With the participation of Orith Azoulay

LafargeHolcim 68.2 Mt (8%)HeidelbergCement 5.6 Mt (2%)

Italcementi 5,5 Mt (2.8%)

LafargeHolcim 31.6 Mt (2%)HeidelbergCement 7.4 Mt

LafargeHolcim 9.9 Mt (4%)

LafargeHolcim 13.2 Mt (3%)HeidelbergCement 20.5 Mt (19%)


LafargeHolcim 3.5 Mt (1%)HeidelbergCement 2.4 Mt (>1%)

LafargeHolcim 5.7 Mt (>1%)

LafargeHolcim 2.7 Mt (3%)HeidelberCement 2.7 Mt


Italcementi 5.8 Mt (10%)


company such as Fortum, every €1/MWh fall in prices would have a €50m impact on EBITDA, i.e.

4% of the consolidated level forecast for 2015 by the Bloomberg consensus.

This scenario would, moreover, have a negative impact secondary raw materials prices to

which Suez Env. and Veolia Env. are exposed via their Waste division’s recycling activities.

Paper, scrap metal and pasteboard prices, which are set locally, are based on global factors. The

volatility of secondary raw material prices can dent the recycling margin and even push them into

negative territory. This is the specific case of Suez Env. insofar as this company buys waste

destined for recycling from its industrial clients. Although the impact of a fall in secondary raw

materials prices is a direct one, it must be put into perspective for the two environmental services

specialists. In 2014, downward pressure on secondary raw materials price (-12% on paper prices

according to Copacel and -6% on scrap metal according to the French Steel federation) knocked off

€7m from Suez Env.’s EBITDA (1% of the Waste division’s total). For Veolia Env., this low pricing

environment had a 0.6% impact on the Waste division’s sales (€8.5bn, i.e. 36% of consolidated

sales).

Furthermore, this scenario could affect Chinese investment in the European electricity

sector. In the nuclear field, this could compromise the involvement of the two Chinese electricity

companies CGN and CNCC in plans to build the two EPR reactors at Hinkley Point in the UK.

Remember that according to the broad outline of the plans EDF announced in October 2013, the two

companies were expected to acquire a 30 to 40% interest in the project structure designed to hold

the two planned reactors. If they pulled out, this would force EDF to seek new partners to fund this

project, which could be tricky amid the current global energy climate. The potential shelving of the

project would above all be negative for Areva. It would affect the potential for the EPR’s commercial

development, which has already been hit by the difficulties encountered on the OL3 projects in

Finland and in Flamanville in France. Moreover, the scenario of a severe downturn in China could

affect the partnership between EDP and CTG (China Three Gorges) and the latter’s participation in

the Portuguese’s electricity company’s investment in renewables.

All in all, in our universe of coverage, CEZ Fortum, Vattenfall and E.ON emerge as the issuers

that could potentially be the hardest hit by the indirect effects of a sharp Chinese downturn.

Suez Env. and Veolia Env. would also be affected were this scenario to materialise, but to a

far more marginal extent.

Banks: almost all European well-shielded from Chinese risk

Disposals of European banks’ stakes in Chinese banks has been the name of

the game

We believe the European banking sector is well shielded when it comes to direct exposures to the

slowing Chinese economy. Few banks are operationally active in the area on a significant scale

other than Standard Chartered and HSBC whose risk weighted asset allocation at end 2014 was

as follows.

Elie Darwish

Robert Sage


Chart 29: Geographic breakdown of risk-weighted assets

Standard Chartered HSBC

Sources: Natixis, companies

For both banks the most significant Asian market exposure is Hong Kong which we would consider

to be, generally, a lower risk territory. Direct exposures to Mainland China are of greater investor

concern, particularly those to higher risk sectors which both groups have been managing down:

At the end of 2014 Standard Chartered had commodities exposure of $55bn including $29bn

relating to oil and gas. Total net credit exposure to China was $71bn, down 10% from 2013,

including $9bn of Chinese commodities exposure.

HSBC does not disclose its commodities exposure but quantifies its outstandings to oil and gas

at $34bn. Other disclosures reveal that Mainland China customer account balances amounted to

$47bn or 3.5% of the group total. Regarding profits, the group appears quite heavily exposed as

in 2014 the contribution amounted to $2.9bn or 15% of the group total.

Other banks tried to get a foot in the Chinese market by buying strategic stakes in state-owned

banks, usually ahead of their stock-market listings, subject to foreign-ownership caps of 19.99%.

Most of those stakes have now been sold, reducing European sector exposure to China, often

reflecting disappointment at their failure to facilitate any operational or strategic benefit.

Table 10: Example of tie-ups

Western banks Chinese banks Date of tie-up Amount

Goldman Sachs ICBC 2006 $2.6bn

BofA CCB 2005 $3bn

BBVA Citic 2006 €501m

Deutsche Bank Hua Xia Bank 2006 -

UBS Bank of China 2005 $492m

RBS Bank of China 2005 $1.6bn

Source: Natixis

Deutsche Bank still owns 20% of Beijing-based Hua Xia Bank but the China Securities Regulatory

Commission has prohibited investors with more than 5% stakes from selling them for six months.

HSBC’s commitment to Asia is longer term. It has a 19.9% holding in Bank of Communications

(BoCom) which is largely engaged in local business and so sensitive to domestic growth rates. We

expect the Chinese State to support its banking system in the event of economic slowdown so the

main impact for HSBC is likely to be lower earnings and/or dividend contributions from BoCom.

Asia59%

Others41%

Asia42%

Others58%


Standard Chartered invested $500m in the 2010 Agricultural Bank of China IPO and has a 19.99%

interest in Bohai Bank which is not currently listed and had a carrying value of $990m at end 2014.

Collateralization of loans a given for banks after State-Owned Entity collapses

in December 2014

Most banks have tightened their lending standards to Chinese companies. Banks have become

more worried about the implicit -but somewhat untested- guarantees supplied to State Owned

entities (SOEs) post the default of Penghui Copper in December 2014. The latter company defaulted

despite being controlled by the city government of Yantai on the Shandong peninsula. The

collateralization of loans has become standard practice and as much as 70% of corporate loans

made in Q4-14 were collateralized, signalling an anticipated rise in corporate defaults e.g. Standard

Chartered recently commented it has increased the level of collateral it holds by 4% in response to

rising bad loans in China and India. Forthcoming credit discipline combined with a less candid risk

approach should ensure a moderate impact for banks on any economic growth downturn in the next

years.

Case study: HSBC and Standard Chartered - credit market considerations

The market has been so far little concerned by developments in China for these two banks. In the

following charts, we compare the spreads of HSBC and Stan Chart vs. those of Lloyds (the latter

bank being insulated from any Chinese turbulence). If HSBC has underperformed Lloyds since the

Chinese stock market rout which started in June 2015, the current difference in spreads in favour of

HSBC (14 bp) is still higher than the level it was in mid-May (8 bp). Stan Chart follows a similar

pattern. All in all, we believe that HSBC and Standard Chartered spreads, just like for other

European banks, are at the moment much more driven by regulatory changes (namely TLAC), which

are leading to a significant shifts in the asset class risk profiles than the Chinese slowdown.

Chart 30: Comparison of z-spreads of HSBC and Stan Chart vs. Lloyds

Source: Bloomberg

The same goes for the AT1 market, where it is difficult to imagine AT1 debt issued by HSBC and

Stan Chart truly outperforming AT1 debt issued by other banks with little or no exposure to the

Chinese market.

However, the impact on the CDS market is greater: the chart below on the left shows that although

the CDS on all 5Y senior debt issued by UK banks widened during the Greek saga, those of HSBC

and Standard Chartered have struggled to tighten since 7 July. To determine whether this is linked

to the situation in the Chinese market, we have looked at the difference between the average 5Y

CDS for Stan Chart and HSBC on the one hand, and between Lloyds and Barclays on the other, and

then compared this difference with the movement on Shanghai’s stock exchange (cf. chart below on

the right). The conclusion is clear: during the Greek crisis, the 5Y CDS of UK banks widened rather

0

10

20

30

40

50

60

Apr-15 May-15 Jun-15 Jul-15

Diff HSBC LLOYDS

-10

0

10

20

30

40

50

60

Apr-15 May-15 Jun-15 Jul-15

Diff STANLN LLOYDS


indiscriminately but, since 7 July when the Greek crisis was resolved (for the short term at least), the

CDS gap has widened to the detriment of the two banks most exposed to the Chinese market

(underperforming by 8bp on average), corresponding to the slump of more than 1,000 points on the

Shanghai stock exchange.

Chart 31:

CDS on 5Y senior debt issued by UK banks CDS differential between Stan Chart / HSBC and Barclays /

Lloyds and exposure to the Chinese market


So the chances are that a potential drop in the Chinese market corresponding to 3 points of GDP

growth would result in the CDS of the European banks most exposed to this region underperforming

substantially, even if only triggered by indirect contagion from China’s equity markets, as was the

case recently.

If the CDS widening were to prove significant, it would no doubt also result in underperformance,

temporarily, by the AT1 debt issued by Stan Chart first of all and by that issued by HSBC to a lesser

extent, which we have not observed as yet.

Chart 32: Recent price trends for AT1 debt in $ issued by HSBC, Stan Chart, Barclays and Lloyds


Case study: HSBC and Standard Chartered - equity market considerations

Strategically we consider that there are specific implications from a slower China for both banks:

At its recent Investor Update in June 2015, the centrepiece of HSBC’s plans for the coming 3

years was stated to be the redeployment of $290bn of RWAs (25% of the group total) into new,

95

97

99

101

103

105

107

109

Mar-15 Apr-15 May-15 Jun-15 Jul-15

HSBC 5 ⅝ 12/29/49 STANLN 6 ½ 12/29/49

LLOYDS 7 ½ 04/30/49 BACR 6 ⅝ 06/29/49

40

50

60

70

80

90

100

110

Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15

Stan Chart HSBC Lloyds Barclays

3 000

3 500

4 000

4 500

5 000

5 500

0

5

10

15

20

25

Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15

CDS différence Shanghaï Stock index (rhs inv.)


higher returning assets. At the same time management intends to pivot the group back more

towards its Asian roots so that a high though unquantified percentage of new RWA generation is

expected to relate to Asia. Even with a strongly performing China this target sounds extremely

challenging but if growth opportunities contract it appears highly likely that the group might miss

this target which would feed through into the downgrading of earnings expectations. As the group

still needs to build its capital ratios to higher levels and its dividend payout ratio is high (2014:

72%), existing concerns over the sustainability of the dividend might intensify which is significant

for the group as the 5% yield is a core part of the investment case.

Standard Chartered has recently changed its management post a period of underperformance

characterised inter alia by weaker growth trends in regulatory capital ratios. Investors are waiting

the unveiling of a new strategy and structural initiatives which might include an increase in

reserving levels following rises in impaired loan and falls in coverage ratios, a dividend cut,

capital raising, disposals and balance sheet downsizing. A more cautious view on the growth

outlook might inform the scope and extent of the review.

Both banks have remained positive on wider impairment trends and the longer term growth outlook

for the region and for China in particular. At this stage we would expect the impact of a slowdown of

China GDP growth to a 4% level to be manageable and manifest more in earnings than balance

sheet metrics. As such we consider that equity prices are more sensitive to this macro trend than

credit spreads.

Reference prices are based on closing prices. The information contained in this document and any attachment thereto is exclusively intended for a client base consisting of professionals and qualified investors. This document and any attachment thereto are strictly confidential and cannot be divulgated to a third party without the prior written consent of Natixis. If you are not the intended recipient of this document and/or the attachments, please delete them and immediately notify the sender. Distribution, possession or delivery of this document in, to or from certain jurisdictions may be restricted or prohibited by law. Recipients of this document are required to inform themselves of and comply with all such restrictions or prohibitions. Neither Natixis, nor any of its affiliates, directors, employees, agents or advisers or any other person accepts any liability to any person in relation to the distribution, possession or del ivery of this document in, to or from any jurisdiction. This document is a financial analysis that has been developed in accordance with legal requirements designed to promote the independence of investment research. Natixis developed this document for investment research activities and not for a public offering of securities nor in its capacity as agent of the issuer of the securities and independently of any issuer of securities mentioned in this document. The investments mentioned in this document may not be suitable for all types of investors. However, it is intended for general distribution and the products or services described herein do not take into account any specific investment objective, financial situation or particular need of any recipient. This document and all attachments are communicated to each recipient for information purposes only and do not constitute a personalized investment recommendation. Natixis has neither verified nor carried out independent analysis of the information contained in this document. Accordingly, no representation, warranty or undertaking, either express or implied, is made to the recipients of this document as to or in relation to the relevance, accuracy or completeness of this document or as to the reasonableness of any assumption contained in this document. Information does not take into account specific tax rules or accounting methods applicable to counterparties, clients or potential clients of Natixis. Therefore, Natixis shall not be liable for differences, if any, between its own valuations and those valuations provided by third parties; as such differences may arise as a result of the application an d implementation of alternative accounting methods, tax rules or valuation models. The statements, assumptions and opinions contained in this document may be changed or may be withdrawn by Natixis at any time without notice. The information contained in this document may include results of analyses from a quantitative model, which represent potential future events that may or may not be realised, and is not a complete analysis of every material fact representing any product. Information may be changed or may be withdrawn by Natixis at any time without notice. More generally, no responsibility is accepted by Natixis, nor any of its holding companies, subsidiaries, associated undertakings or controlling persons, nor any of their respective directors, officers, partners, employees, agents, representatives or advisers as to or in relation to the characteristics of this information. The statements, assumptions and forecasts contained in this document and any attachment thereto reflect the judgment of its author, unless otherwise specified, and do not reflect the judgment of any other person or of Natixis. Natixis shall not be liable for any financial loss or any decision taken on the basis of the information disclosed in this presentation and Natixis does not prov ide any advice, including in case of investment services. In any event, you should request for any internal and/or external advice that you consider necessary or desirable to obtain, including from any financial, legal, tax or accounting adviser, or any other specialist, in order to verify in particular that the transaction described in this document complies with your objectives and constraints and to obtain an independent valuation of the transaction, its risk factors and rewards. Natixis has set up due procedures for the separation of activities, notably in order to prevent conflicts of interest between research activities and its other activities. Details of these “information barriers” are available upon request from the head of compliance. Natixis implemented rules of professional conduct in order to prohibit analysts from executing personal transactions (excluding UCITS, managed accounts, etc.). Natixis also implemented an in-house policy on the remuneration of analysts in order to guarantee their independence and manage potential conflicts of interest. It should be noted that, in the context of its activities, Natixis may have positions in financial instruments and in the issuer concerned by the recommendations or opinions provided in this document or any attachment thereto. Natixis can be remunerated for underwriting services, investment services, advice services and any other investment service provision or banking activity and any other service related to financial instruments of the company or the companies mentioned in this document. In this case, references made to conflicts of interests that Natixis and its affiliates may experience, with respect to the issuer(s) mentioned in this document are available on the website of the Research by clicking on the following link: http: //equity.natixis.com/netis/Disclaimer/Disclaimer_Spe.aspx Natixis is authorized in France by the Autorité de Contrôle Prudentiel et de Régulation (ACPR) as a Bank - Investment Service Provider and subject to its supervision. Natixis is regulated by the Autorité des Marchés Financiers in respect of its investment services activities. Natixis is authorized by the ACPR in France and regulated by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority in the United Kingdom. Details on the extent of regulation by the FCA and the Prudential Regulation Authority are available from Natixis’ branch in London upon request. Natixis is authorized by the ACPR and regulated by the BaFin (Bundesanstalt für Finanzdienstleistungsaufsicht) for the conduct of its business under the right of establishment in Germany. Natixis is authorized by the ACPR and regulated by Bank of Spain and the CNMV (Comisión Nacional de Mercado de Valores) for the conduct of its business under the right of establishment in Spain. Natixis is authorized by the ACPR and regulated by Bank of Italy and the CONSOB (Commissione Nazionale per le Società e la Borsa) for the conduct of its business under the right of establishment in Italy. Natixis is authorised by the ACPR and regulated by the Dubai Financial Services Authority (DFSA) for the conduct of its business in and from the Dubai International Financial Centre (DIFC). The document is being made available to the recipient with the understanding that it meets the DFSA definition of a Professional Client; the recipient is otherwise required to inform Natixis if this is not the case and return the document. The recipient also acknowledges and understands that neither the document nor its contents have been approved, licensed by or registered with any regulatory body or governmental agency in the GCC or Lebanon. All of the views expressed in this research report accurately reflect the research analyst’s personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is or will be, directly or indirectly related to the specific recommendations or views expressed in this research report. I(WE), ANALYST(S), WHO WROTE THIS REPORT HEREBY CERTIFY THAT THE VIEWS EXPRESSED IN THIS REPORT ACCURATELY REFLECT OUR(MY) PERSONAL VIEWS ABOUT THE SUBJECT COMPANY OR COMPANIES AND ITS OR THEIR SECURITIES, AND THAT NO PART OF OUR COMPENSATION WAS, IS OR WILL BE, DIRECTLY OR INDIRECTLY, RELATED TO THE SPECIFIC RECOMMENDATIONS OR VIEWS EXPRESSED IN THIS REPORT. The personal views of analysts may differ from one another. Natixis, its subsidiaries and affiliates may have issued or may issue reports that are inconsistent with, and/or reach different conclusions from, the information presented herein. Natixis, a foreign bank and broker-dealer, makes this research report available solely for distribution in the United States to major U.S. institutional investors as defined in Rule 15a-6 under the U.S. securities Exchange Act of 1934. This document shall not be distributed to any other persons in the United States. All major U.S. institutional investors receiving this document shall not distribute the original nor a copy thereof to any other person in the United States. Natixis Securities Americas LLC, a U.S. registered broker-dealer and member of FINRA, is a subsidiary of Natixis. Natixis Securities Americas LLC did not participate in the preparation of this research report and as such assumes no responsibility for its content. This research report has been prepared and reviewed by research analysts employed by Natixis, who are not associated persons of Natixis Securities Americas LLC and are not registered or qualified as research analysts with FINRA, and are not subject to the rules of the FINRA. In order to receive any additional information about or to effect a transaction in any security or financial instrument mentioned herein, please contact your usual registered representative at Natixis Securities Americas LLC, by email or by mail at 1251 Avenue of the Americas, New York, NY 10020. The stocks mentioned might be subject to specific disclaimers. Please click on the following link to consult them: http: //equity.natixis.com/netis/Disclaimer/Disclaimer_Spe.aspx

http://equity.natixis.com/netis/Disclaimer/Disclaimer_Spe.aspx

http://equity.natixis.com/netis/Disclaimer/Disclaimer_Spe.aspx

Documents

whatifchinaslowsdown-whatifscenario