Financial Pacific - Cut S&P 500 EPS on weaker global GDP (third party)


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Financial Pacific - Cut S&P 500 EPS on weaker global GDP (third party)

  1. 1. ab Global Equity Research Americas UBS Investment Research Equity Strategy US Equity Strategy Equity Strategy Cut S&P 500 EPS on Weaker Global GDP 5 September 2011 2011 Goes from $99.35 to $95.00, 2012 from $108 to $101 Four reasons: A) UBS cut 2012E global GDP growth from 3.8% to 3.3%, including a 100 bps cut for Europe, which accounts for ~14% of S&P revenues. B) Sharp decline since April in ISM Manufacturing to ~50. C) Margin pressure from higher unit labor costs, which rose 1.1% sequentially in Q2 2011. D) Weaker Thomas M. Doerflinger, Ph.D. revenue in 2012 if commodity prices decline and currency comparisons reverse. Strategist Rising GDP, Declining Profits: Not At All Unusual +1-212-713 2540 In Q2 2011 net margins were elevated & revenues strong (up 13% y/y), setting up Jonathan Golub, CFA tough comparisons. We expect profits for the next five quarters to be somewhat Strategist below Q2 2011 EPS (adjusted for BAC write-down and exceptionally high P&C losses) despite rising GDP. This is consistent with historical norms. In 1985, 1989, +1-212-713 8673 1995, and 1998 the ISM Manufacturing fell below 50 and profits declined for Natalie Garner, CFA several quarters despite solid GDP growth. One reason, which is relevant now: Strategist weaker commodity prices boost real GDP but reduce profits (which are nominal). +1-212-713 4915 Lowering S&P 500 2011 year-end target to 1350 from 1425 Manish Bangard, CFA We are reducing our 2011 year-end price target for the S&P 500 index to 1350 Strategist from 1425 to reflect our updated 2012 earnings estimates. Our 1350 target leaves P/E multiples unchanged at 13.5x our $101 EPS estimate. We believe that current +1-212-713 3036 stock valuations reflect recessionary concerns that are not likely to materialize and Vishal Patel expect equities to re-rate through year-end. Our new target implies 15% upside Associate Strategist from current levels. +1-212-713 4027 Table 1: S&P 500 Earnings GAAP Change Write- Pro Forma Change Pro Forma EPS yr/yr offs EPS yr/yr bottom-up Consensus 2010 Q1 17.89 120.9% 1.82 19.71 53.5% Q2 20.07 40.7% 1.41 21.48 34.0% Q3 19.89 35.9% 1.86 21.75 32.9% Q4 20.86 31.7% 1.69 22.55 32.4% Year 78.70 49.0% 6.79 85.49 37.3% 2011 Q1A 21.68 21.2% 1.82 23.50 19.2% Q2E 22.75 13.4% 1.41 24.16 12.5% 24.16 Q3E 21.75 9.4% 1.75 23.50 8.0% 25.10 Q4E 18.84 -9.7% 5.00 23.84 5.7% 26.38 YearE 85.02 8.0% 9.98 95.00 11.1% 98.72 2012 YearE 92.00 8.2% 8.00 101.00 6.3% 112.54 Note: Pro forma actuals are operating EPS as per First Call consensus. We suggest using pro forma EPS to measure change. For PEs, use pro forma reduced by normal level of write-offs. Source: Standard & Poor’s, First Call, and UBS. This report has been prepared by UBS Securities LLC ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 10. UBS does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
  2. 2. US Equity Strategy 5 September 2011Q2 S&P 500 EPS was $24.16, close to our $24.35 estimate. Adding back $1.30from the Bank of America charge and $0.30 for abnormally high P&Ccatastrophic losses, adjusted Q2 earnings were $25.76. We were alreadyexpecting profits to flatten out in the second half of 2011, with marginsremaining near 2010 levels. However the ten point decline in the ISMManufacturing since April, global financial turmoil, and a cut in the UBSforecast of 2012 global GDP growth from 3.8% to 3.3% drive the following cutsin our forecast:Table 2: Pro Forma S&P 500 EPS: Old and New Estimates YOY % Old Estimate New Estimate change 2010 Full Year 85.49 85.49 37% 2011 Q1 A 23.50 23.50 19% Q2 P 24.35 24.16* 12% Q3 E 25.50 23.50 8% Q4 E 26.00 23.84 6% Full Year 99.35 95.00 11% 2012 Full Year 108.00 101.00 6%*25.76 excluding BAC write-off and unusual P&C lossesSource: FactSet, First Call, UBSTable 3: Weak ISM, Flat-to-Down Profits, Strong GDP—1985, 1989, 1995, 1998 SPX EPS in Real GDP 4 quarters growth inQuarter ISM fell below 50 ending in SPX EPS in 4 Quartersfor significant period of # of Months quarter ISM following % after ISM fell time below 50 fell below 50 4 quarters Change below 50 Q1 1985 8 16.39 14.52 -11.4% 4.2% Q2 1989 13 26.33 23.49 -10.8% 2.5% Q2 1995 12 37.12 39.28 5.8% 4.0% Q2 1998 7 45.07 46.6 3.4% 4.8%Source: Institute of Supply Management, Standard & Poor’s, Dept. of CommerceWe are cutting our H2 2011 estimate by 8% and boosting our 2011 write-offestimate by $2.00. Our new annual estimate of $95.00 is close to the $96.00estimate we went to on January 10 of this year. These changes are fairlyconsistent with our July 26 report on Q2 profits which said, “Weakermomentum may raise concerns regarding H2 profits.” (US Equity StrategyComment, July 26.) Since then macro data has been weaker than expected.S&P Is Not GDP: Flat-to-down Profits in aGrowing EconomyWe now forecast earnings in Q3 2011, Q4 2011 and Q1 2012 of about $23.50per quarter, which is almost 9% below adjusted Q2 2011 earnings of $25.76.This might seem inconsistent with the UBS forecast of 2.0-2.5% US GDPgrowth in H2 2011 and in 2012. However, as Table 3 shows, it is not uncommonfor profits to flatten out or decline modestly when, following a period of strongprofit growth, the ISM Manufacturing falls below 50 for a number of months: UBS 2
  3. 3. US Equity Strategy 5 September 2011 GDP and profits were strong in 1984 but economic growth slowed in 1985 due to a super-strong dollar that hurt U.S. manufacturers. Profits declined 11% in 1985 despite 4% GDP growth. With inflation picking up, the Fed tightened in 1988-89 and profits declined despite positive GDP growth. Productivity was poor in this period and margins declined once pricing power waned. In 1995 the Fed engineered a nifty “soft landing” but profits were below the Q2 1995 peak for three quarters. In 1998, during the Asian financial crisis, exports weakened and commodity prices dropped. Profits flattened out even though U.S GDP grew 4% in 1998.One reason why profits were flat-to-down in these episodes despite solid GDPgrowth is that weaker commodity prices reduce profits (which are nominal) butboost GDP (which is real). While it is by no means clear that the ISM will fallbelow 50 in coming months, as it did in these previous scenarios, pressure onprofits will be significant because U.S. real GDP will grow only 2-2.5% vs. 4%in these earlier periods of flat-to-down earnings. (One big difference betweennow and then: a stagnant housing market.)Revenues and MarginsOur profit forecast is consistent with this historical pattern. For the next fourquarters, profits will be modestly below the Q2 2011 peak (adjusted); four-quarter totals nearly flatten out for a few quarters (Table 4). However, we don’texpect a significant annual profit decline (as occurred in 1985 and 1989)because our economists remain fairly positive on manufacturing. Industrialproduction is expected to re-accelerate in H2 211 and rise 4.7% in 2012 on a Q4/ Q4 basis.In our forecast revenue growth slows from 9% in 2011 to 5% in 2012 while the2012 net margin is 30 bps below the Q1 2011 peak of 8.9% (Table 5). Typicallyrevenues rise ~1% from Q2 to Q3, but we expect revenues to decline 1.6% fromQ2 2011 to Q3 due to lower energy prices and weaker global GDP. Materialsand energy are 15% of index revenue, and commodity prices should be down~5% from Q2 to Q3, implying a 0.8% reduction in revenue in just these twosectors. In our forecast, revenues rise 3.3% sequentially in Q4, weaker than theseasonal norm of 4.8%. The 5% revenue growth we forecast for next year isbelow the bottom-up consensus of nearly 6%; our forecast is particularlycautious given that analysts have tended to underestimate revenues for the pastfew quarters. UBS 3
  4. 4. US Equity Strategy 5 September 2011Table 4: S&P 500 Profit Progression Pro forma EPS with Q2 2011 adjusted q/q % chng 4-quarter total 2011 Q1 A 23.50 4.2% 89.28 Q2 P 25.76 9.6% 93.56 Q3 E 23.50 -8.8% 95.31 Q4 E 23.84 1.4% 96.60 2012 Q1 E 23.00 -3.5% 96.10 Q2 E 25.50 10.9% 95.84 Q3 E 25.75 1.0% 98.09 Q4 E 26.75 3.9% 101.00Source: FactSet, UBSTable 5: S&P 500 Revenue, Divisor, Net Margin Sales Divisor $ trillion YoY y/y chg Margin 2007 1Q07 $2.25 5.1% -0.7% 9.0% 2Q07 2.36 6.8% -1.9% 9.2% 3Q07 2.37 6.5% -1.6% 8.0% 4Q07 2.46 7.2% -2.4% 5.7% 2008 1Q08 2.41 7.1% -2.7% 6.9% 2Q08 2.52 6.8% -1.8% 6.9% 3Q08 2.44 2.8% -1.4% 6.3% 4Q08 2.12 -14.0% -0.8% 2.3% 2009 1Q09 2.01 -16.3% -0.2% 5.5% 2Q09 2.05 -18.7% 0.3% 6.9% 3Q09 2.08 -14.8% 1.2% 6.9% 4Q09 2.21 4.4% 2.4% 6.8% 2010 1Q10 2.21 9.9% 4.0% 8.0% 2Q10 2.26 10.3% 3.4% 8.6% 3Q10 2.29 10.2% 2.5% 8.6% 4Q10 2.42 9.5% 2.1% 8.5% 2011 1Q11A 2.41 8.8% 0.8% 8.9% 2Q11P 2.53 12.0% 0.6% 8.7% 3Q11E 2.49 8.4% 0.2% 8.6% 4Q11E 2.57 6.0% -0.4% 8.4% 2012 1Q12E 2.52 4.8% -1.1% 8.2% 2Q12E 2.60 2.9% -1.6% 8.8% 3Q12E 2.63 5.6% -1.8% 8.7% 4Q12E 2.73 6.4% -2.0% 8.7%Source: FactSet, Standard & Poor’s, UBS UBS 4
  5. 5. US Equity Strategy 5 September 2011Difficult ComparisonsPervasive economic pessimism obscures the reality that profits have been verystrong. S&P 500 EPS in the four quarters ending Q2 2011 (adjusted) were 84%above the four quarters ending Q3 2009. Revenue growth in Q2 2011 for currentindex constituents was 13% (Table 6) and the net margin of 8.7% was nearhistorical peaks. It will be tough for firms to maintain the Q2 profit level in theface of: A) weaker global growth that pressures commodity prices and corporaterevenue, B) sharply rising labor costs in some areas, such as Chinesemanufacturing, global mining, and Silicon Valley, C) weaker productivitygrowth that boosts unit labor costs. We highlighted some of these issues back inJanuary (Margin Headwinds, Jan. 26), but they are a much bigger problemwhen economic growth slows and it is harder to pass on cost increases. This isgood news for consumers and inflation-fighters at the Fed but bad news forprofits.Table 6: Revenue Growth of S&P 500 Firms, Year-over-Year Changes Q2 2011 Rep’t Season 2011 2010 # of % of tot. Chng. Firms Repor YoY Q1 Q4 Q3 Q2 Q1 2010 2009 2008 2007 2006 2005Basic Materials 30 100% 18.4% 16.9% 13.2% 16.9% 22.2% 22.2% 18.3% -22.5% 9.2% 10.0% 9.8% 8.9%Consumer, Cyclical 78 100% 9.2% 6.8 5.6 5.2 10.6 11.5 8.2 -5.7 -4.9 1.4 6.6 9.9Consumer, Non-Cyc. 38 94% 10.7% 9.1 7.1 5.0 4.7 5.6 5.7 -1.0 9.2 13.2 10.2 7.7Energy 41 100% 38.8% 26.4 17.6 17.1 27.0 36.5 23.5 -34.6 24.2 7.8 9.7 29.4Financials 81 100% 5.7% -1.4 5.6 4.8 -0.3 7.9 4.5 13.2 -20.8 9.3 21.1 22.9Health Care 52 100% 6.6% 5.1 5.3 9.0 11.0 12.6 9.4 5.5 7.9 9.6 13.2 11.4Industrials 58 99% 9.4% 9.7 8.1 8.5 6.9 1.2 5.9 -11.4 7.4 9.2 10.5 10.6Technology 73 99% 15.2% 16.1 15.8 20.6 21.7 19.1 19.2 -5.3 5.3 11.2 10.2 7.2Telecommunications 8 100% 7.6% 3.2 2.0 1.7 2.2 2.1 2.3 2.8 1.4 27.7 29.3 8.4Utilities 33 100% 8.5% -2.2 1.5 10.0 3.3 1.7 3.9 -12.4 8.2 6.4 3.1 11.7TOTAL 492 99% 13.1% 9.2% 8.6% 9.2% 10.1% 11.8% 9.8% -7.6% 3.5% 8.8% 11.7% 13.7%Excl Energy, Util 418 99% 9.5% 7.1% 7.5% 8.1% 8.2% 9.3% 8.3% -1.8% -0.1% 9.1% 12.4% 11.7%Source: FactSet, Compustat, UBSMargin pressures are evident in Q2 2011 data on manufacturing unit labor costs(Table 7). Looking at sequential change from Q1 2011 to Q2 2011, Manufacturing productivity declined 0.4%, the first decline since Q4 2008. Manufacturing compensation rose 0.8%, similar to the pace of the previous four quarters. Consequently manufacturing unit labor costs rose 1.1%, the first increase in eight quarters. Over the previous seven quarters, unit labor costs declined 0.9% on average. Meanwhile, manufacturing capacity utilization flattened out, limiting corporate pricing power. (Admittedly it rose nicely, by 38 bps, in July.) UBS 5
  6. 6. US Equity Strategy 5 September 2011Table 7: Manufacturing Productivity, Compensation, Unit Labor Costs (q/q % change)and Capacity Utilization Capacity Productivity Compensation Unit Labor Costs Utilization2008 Q1 0.2% 1.4% 1.2% 78.5 Q2 -1.7% 0.2% 1.9% 76.77 Q3 -1.3% 1.3% 2.6% 74.13 Q4 -1.5% 2.4% 4.0% 70.082009 Q1 -0.3% 0.1% 0.5% 66.18 Q2 1.5% 1.9% 0.4% 64.65 Q3 3.1% 0.3% -2.7% 66.21 Q4 1.8% 0.8% -1.0% 67.732010 Q1 1.2% -0.7% -1.8% 69.44 Q2 1.3% 0.9% -0.3% 71.37 Q3 0.5% 0.4% -0.1% 72.57 Q4 1.2% 0.6% -0.6% 73.32011 Q1 1.0% 1.0% 0.0% 74.51 Q2 -0.4% 0.8% 1.1% 74.54Source: Bureau of Labor Statistics, Federal ReserveQ3 2011 ProfitsOver the past year, the bottom-up S&P EPS estimate for a given quarter wasfairly stable during the third month of the quarter and then rose ~5% duringearnings season. Q3 2011 will likely be different, with the bottom-up estimatedeclining significantly in September (particularly because Q3 is “back-endloaded”) and then rising modestly during earnings season.Forecasting is particularly difficult at inflection points, and we have lowconfidence in our Q3 forecast. We assume the bottom-up number declines 9%over the next month and rises 3% during earnings season. In July somebellwether companies such as 3M, UPS, ITW, and Emerson Electric notedweakening business activity, and since then conditions have deteriorated.Profit Pressures . . .A variety of forces are likely to impede profit growth in coming quarters:Weaker U.S. manufacturing in a more sluggish global economy. Much hingeson whether ISM Manufacturing remains depressed for many months or isboosted by rising auto output and exports. Keep a close eye on the ISM ExportOrder Index, which dipped a worrisome 3.5 points to 50.5 in August, probablyin response to weaker demand in Europe. Our impression is that manufacturingis soft but by no means collapsing; “hard data” on manufacturing has beenstronger than “sentiment” indicators.Europe. UBS economists recently cut European 2012E GDP growth from 2% to1%. Europe accounts for 14% of S&P 500 revenues and a higher share of profitsbecause corporate margins are higher outside the U.S. and high-marginindustries have high foreign exposure. (Europe generates 44% of S&P 500 UBS 6
  7. 7. US Equity Strategy 5 September 2011foreign sales, which account for 32% of S&P 500 sales; see Chart 1.) Mostmajor U.S. multinationals have substantial operations in Europe, particularlythose in the technology, branded consumer goods, pharmaceutical, medicalequipment, and industrial sectors. Tech and healthcare names are particularlyvulnerable to cuts in spending by European governments.Chart 1: Share of Foreign Revenues by Region, 2008 Japan ANZ Canada 6% 3% 13% Mex ico Asia Ex Japan 5% 16% Latin America Africa 9% 2% Middle East 2% Eastern Europe Western Europe 3% 41%Source: Census, BEAPrices of oil and other commodities will be a key profit driver. Revenues inthe energy and materials sectors rose 34% y/y in Q2 and accounted for 42% ofthe increase in Q2 S&P 500 revenue (Table 6). We estimate that every $10decline in the price of oil prices directly cuts S&P 500 EPS by $2 via lowerprofits in the energy and materials sectors; after netting out the benefit to profitsin other sectors the hit to EPS is about $1.60. UBS currently forecasts a 2012WTI price of $87 versus $89 now, and 2012 Brent of $95 vs. a current quote of$114. (The price of Brent is more relevant to profits of the integrated oilcompanies, the biggest component of S&P energy profits.)Banks’ H2 2011 profits are likely to be hit by a charge for a nationwidesettlement with state attorneys general concerning mortgage foreclosures. Thesize of this hit cannot be forecasted with any precision. However the pre-taxcost could be in the range of $20-25 billion; the after-tax cost, net of reservesalready taken by banks, could be about $10 billion, or a ~$1.00 hit to S&P 500EPS. With the housing slump continuing and litigation proliferating, furthercharges over the next few quarters cannot be ruled out. Other negatives forfinancials include a flattening yield curve, ultra-low short-term rates, weak butgradually improving loan growth, and high legal / regulatory costs. Positivesinclude improving credit quality, rising credit card volumes, and a potentialpick-up in deal activity and trading volumes if and when stock prices rebound.Currency: In Q2 2011 currency boosted multinationals’ revenue growth by 5%;the benefit to overall S&P 500 revenue was 2.5%-3%. UBS forecasts year-end2012 EUR/USD of 1.30, so this benefit is likely to reverse next year. This willslow revenue growth, but exchange rates are not likely to be a key profit driverin 2012. UBS 7
  8. 8. US Equity Strategy 5 September 2011…and PositivesAlthough Europe is a major market for U.S. multinationals, so are emergingmarkets, which account for ~12% of S&P 500 revenue (Chart 1). They havebeen a source of profit upside for quite a few firms, particularly in the industrial,materials, tech, and consumer discretionary sectors. This trend should continue,albeit at a slower pace. UBS forecasts continued robust GDP growth indeveloping economies of 5.5% this year and 5.1% in 2012.Share buy-backs have been increasing rapidly. The quarterly run-rate of netshare buy-backs in H1 2011 was 74% higher than in 2010 (Table 8). With stockprices weak firms should be able to reduce share counts substantially. The S&P500 divisor has already flattened out and should decline about 1.6% next year,boosting S&P 500 EPS. In 2007 and 2008 the divisor declined at a 1.7% rate.Table 8: S&P 500 Diluted Share Count YOY % Change, Spending on Buy-backs,Dividends ($ billions) 2011 2010 2009 2010 2009 2008 2007 2006 Q2 Q1 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Share Count Median 0.0% 0.2% 0.3% 0.4% 0.5% 0.6% 0.5% 0.3% 0.1% -0.4% 0.3% 0.5% -1.0% -1.6% -1.0% Aggregate 0.4% 0.9% 2.8% 7.6% 11.5% 12.4% 11.2% 6.4% 2.2% 0.6% 2.8% 11.2% -0.9% -1.0% -0.9% Dividends (Cash) $64 $59 $53 $54 $54 $54 $55 $51 $57 $74 $225 $235 $264 $206 $183 Net Share Buy-Backs 83 99 58 52 61 39 42 19 (6) (11) 216 36 -142 383 329 Share Buy-Backs 111 136 77 79 81 70 115 36 92 32 318 276 343 508 421 Share Issuance 28 37 19 27 21 31 73 17 99 43 102 240 483 126 91 Dividends + Net Share Buy-Backs1 148 158 111 106 114 93 97 71 50 62 441 271 122 590 5121Not an accurate measure of capital payouts because issuance to employee option holders is at below-market pricesSource: FactSet, Compustat, UBSWith the Fed promising to keep interest rates low through 2012, interestexpense should remain extremely low. In Q1 2011 interest expense / revenuewas just 1.9%, versus a 10-year average of 3.7%.Corporate Caution Whereas in most cycles over-expansion is a major threat toprofitability, today’s “doom and gloom” atmosphere has caused firms in mostindustries to hire and spend cautiously. (Exceptions are mining and the Internet.)According to the Federal Reserve, industrial capacity rose just 0.6% y/y in July2011. S&P 500 non-financial capex / depreciation was 117% in Q1 2011 and131% in Q2 2011 versus a 2005-2008 average of 140%.Sector TrendsOver the past two months the bottom-up estimate for Q3 2011 earnings declined1.4%, led by financials, energy, and, interestingly, consumer staples (Chart 2).Utilities rose slightly and there was little change for tech, consumerdiscretionary, and health care. In recent months consumer discretionary profitshave been surprisingly strong, given depressed consumer confidence.As of now, Q3 profits are expected by analysts to rise nearly 16% (Chart 3).Over half the gain comes from energy, however—which underscores howsensitive S&P profits are to the direction of energy prices. UBS 8
  9. 9. US Equity Strategy 5 September 2011Chart 2: Change in 2011E Operating Earnings in the Past Two Months ($ millions) All Sectors -1.4% ($3,297) Utilities 0.3% $25 Technology -0.1% ($31) Consumer Discretionary -0.2% ($49) Health Care -0.3% ($72) Telecommunications -4.6% ($250) Industrials -1.5% ($334) Basic Materials -5.3% ($420) Energy -2.0% ($689) Consumer Staples -3.1% ($697) Financials -2.0% ($780) ($1,000) ($800) ($600) ($400) ($200) $0 $200Source: FactSet, First Call, Standard & Poor’s, UBSChart 3: Change in Operating Earnings, by Sector, Q310-Q311 ($ millions) All Sectors 15.7% $31,023 Energy 51 % .1 $1 ,466 1 Financials 14.3% $4,792 Technology 9.1% $3,442 Consumer Discretionary 19.7% $3,298 Industrials 16.0% $3,125 Basic Materials 34.8% $1,931 Consumer Staples 8.1% $1,607 Health Care 4.4% $1,207 Telecommunications 8.4% $403 Utilities -2.4% ($249) ($2,000) $0 $2,000 $4,000 $6,000 $8,000 $10,000 $12,000Source: FactSet, First Call, Standard & Poor’s, UBS UBS 9
  10. 10. US Equity Strategy 5 September 2011 Statement of RiskEquity market returns are influenced by corporate earnings, interest rates, andinvestor demanded risk premiums. The outlook for any and all of these variablesis subject to change. Analyst CertificationEach research analyst primarily responsible for the content of this researchreport, in whole or in part, certifies that with respect to each security or issuerthat the analyst covered in this report: (1) all of the views expressed accuratelyreflect his or her personal views about those securities or issuers and wereprepared in an independent manner, including with respect to UBS, and (2) nopart of his or her compensation was, is, or will be, directly or indirectly, relatedto the specific recommendations or views expressed by that research analyst inthe research report. UBS 10
  11. 11. US Equity Strategy 5 September 2011Required DisclosuresThis report has been prepared by UBS Securities LLC, an affiliate of UBS AG. UBS AG, its subsidiaries, branches andaffiliates are referred to herein as UBS.For information on the ways in which UBS manages conflicts and maintains independence of its research product;historical performance information; and certain additional disclosures concerning UBS research recommendations,please visit The figures contained in performance charts refer to the past; past performance isnot a reliable indicator of future results. Additional information will be made available upon request. UBS Securities Co.Limited is licensed to conduct securities investment consultancy businesses by the China Securities RegulatoryCommission.UBS Investment Research: Global Equity Rating Allocations 1 2 UBS 12-Month Rating Rating Category Coverage IB Services Buy Buy 54% 39% Neutral Hold/Neutral 39% 35% Sell Sell 7% 14% 3 4 UBS Short-Term Rating Rating Category Coverage IB Services Buy Buy less than 1% 33% Sell Sell less than 1% 25%1:Percentage of companies under coverage globally within the 12-month rating category.2:Percentage of companies within the 12-month rating category for which investment banking (IB) services were provided withinthe past 12 months.3:Percentage of companies under coverage globally within the Short-Term rating category.4:Percentage of companies within the Short-Term rating category for which investment banking (IB) services were providedwithin the past 12 months.Source: UBS. Rating allocations are as of 30 June 2011.UBS Investment Research: Global Equity Rating Definitions UBS 12-Month Rating Definition Buy FSR is > 6% above the MRA. Neutral FSR is between -6% and 6% of the MRA. Sell FSR is > 6% below the MRA. UBS Short-Term Rating Definition Buy: Stock price expected to rise within three months from the time the rating was assigned Buy because of a specific catalyst or event. Sell: Stock price expected to fall within three months from the time the rating was assigned Sell because of a specific catalyst or event. UBS 11
  12. 12. US Equity Strategy 5 September 2011KEY DEFINITIONS Forecast Stock Return (FSR) is defined as expected percentage price appreciation plus gross dividend yield over the next 12months. Market Return Assumption (MRA) is defined as the one-year local market interest rate plus 5% (a proxy for, and not aforecast of, the equity risk premium). Under Review (UR) Stocks may be flagged as UR by the analyst, indicating that the stocks price target and/or rating aresubject to possible change in the near term, usually in response to an event that may affect the investment case or valuation. Short-Term Ratings reflect the expected near-term (up to three months) performance of the stock and do not reflect anychange in the fundamental view or investment case.Equity Price Targets have an investment horizon of 12 months.EXCEPTIONS AND SPECIAL CASESUK and European Investment Fund ratings and definitions are: Buy: Positive on factors such as structure, management,performance record, discount; Neutral: Neutral on factors such as structure, management, performance record, discount; Sell:Negative on factors such as structure, management, performance record, discount.Core Banding Exceptions (CBE): Exceptions to the standard +/-6% bands may be granted by the Investment ReviewCommittee (IRC). Factors considered by the IRC include the stocks volatility and the credit spread of the respective companysdebt. As a result, stocks deemed to be very high or low risk may be subject to higher or lower bands as they relate to the rating.When such exceptions apply, they will be identified in the Company Disclosures table in the relevant research piece.Research analysts contributing to this report who are employed by any non-US affiliate of UBS Securities LLC are notregistered/qualified as research analysts with the NASD and NYSE and therefore are not subject to the restrictions contained inthe NASD and NYSE rules on communications with a subject company, public appearances, and trading securities held by aresearch analyst account. The name of each affiliate and analyst employed by that affiliate contributing to this report, if any,follows.UBS Securities LLC: Thomas M. Doerflinger, Ph.D.; Jonathan Golub, CFA; Natalie Garner, CFA; Manish Bangard, CFA; VishalPatel.Unless otherwise indicated, please refer to the Valuation and Risk sections within the body of this report. UBS 12
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