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    Clsa asia themes 2011 Clsa asia themes 2011 Document Transcript

    • Asia Themes 2011 Best ideas in Asian equities 16 December 2010Trendlines (As at 15 Dec) What to watch for?Large-cap BUYs with Anirudha DuttaBaidu BIDU USBank of China 3988 HKChina Construction Bk 939 HKChina Mobile 941 HK We expect more of the same in 2011: Western economic growthChina Telecom 728 HK disappointments, reflation of Asian assets and more intervention to curbInfosys INFO IB inflation. Earnings growth should moderate sharply after a sterling 2010, while there isPetroChina 857 HKPing An Insurance 2318 HK headroom for a rerating of Asia ex-Japan valuations, currently near 20-year means. ChrisStandard Chartered 2888 HK Wood remains sanguine with expectations of an asset bubble in Asia supporting hisTencent 700 HKLarge-cap SELLs Overweight stance on the region for now. Russell Napier warns of more governmentBYD 1211 HK interference as the belief that markets have failed will spur politicians to establish theirCathay Financial 2882 TT primacy over the world of finance. Capital controls are now just a matter of time. EricChalco 2600 HKCNOOC 883 HK Fishwick also expects tightening in 2H11, as well quicker Asian domestic consumption andLG Electronics 066570 KS construction activity thanks to QE2. From China, Andy Rothman hopes that inflation willMega Financial 2886 TTPICC 2328 HK moderate as both monetary policy and weather conditions normalise. Sector themesS-Oil 010950 KS include: stronger credit growth for banks; reviving consumption; strength in enterpriseTelkom Indonesia TLKM IJ spending on tech; return of revenue growth for telcos; resources M&As. Meanwhile, AmarZijin Mining 2899 HK Gill identifies a few ROIC-Ebit/EV gems. By market, look for companies taking advantageValuations above mean of China’s various advances; best-managed Indian firms that leverage rising commodityMSCI Asia ex-Japan trailing PE prices; reform plays in Malaysia; dividend-payers in Singapore; and growth stocks in 30 (x) Thailand. Our Feng Shui master warns that the bunny is an ecstatic but unpredictable 25 Max 25.46 animal. Enjoy the ride and best wishes for the Year of the Rabbit. 20 15 Avg 14.26 GLOBAL STRATEGY: How does Asias asset bubble play out? Chris Wood remains 10 Min 9.63 steadfast in his belief that global recovery is subpar and the extremely easy monetary 5 policy in the West has set the stage for an Asian asset bubble. While this is the near-term argument for remaining Overweight Asian equities, the long-term consequence will be an 93 94 96 98 00 02 04 06 08 10Source: CLSA Asia-Pacific Markets inevitable boom-bust cycle in the region. However, Chris is more optimistic about Asian governments, which understand the risks and seek to counter them.Hypergrowth in Chindonesia® GLOBAL STRATEGY: Will the free movement of capital survive? No, it will not, if Russell Napier is right. He argues that as governments step back into the marketplace to assert the primacy of politics over finance and mark the end of long-term deflation, the secondary-market valuation for capital will decline. The USA is likely to stand out as an anti-Merkelist bastion and in the near term attract more capital. GLOBAL ECONOMICS: What does QE2 mean for Asia? Eric Fishwick expects cost of capital to come down globally thanks to QE2. This will boost credit, domestic consumption and construction activity in Asia. Regional currencies should remain soft and inflation is likely to rise. Eric believes monetary authorities will start tightening in 2H11 and the region will become more “Chinese” in how it administers banking systems, ie, using capital controls to restrict inflows at source.Also inside CHINA STRATEGY: Will inflation rise further? Andy Rothman remains a bull on China. While he expects CPI to moderate next year, as weather and monetary policy normalise, heAsia: Autos; Banks; believes equities and real-estate prices will surge on increasing wealth. Ample domesticConsumer; Resources;Technology; Telecoms; Social liquidity will shrug off concerns about rate hikes and Which countries will be FII favourites?responsibility; Thematics fuel a large asset-inflation cycle. YTD net FII inflowAustralia: Market 833% ASIA THEMATICS. Desh Peramunetilleke, Amar Gill, (US$m) (%)China: Strategy; Market; Andrew Riddick and Evelyn Moore also highlight their 30,000 YTD net 500A shares % YoY (RHS) investment themes and ideas for 2011. Desh expects 25,000 400Hong Kong: Property 20,000 300 rising costs to put pressure on margins, with India, 15,000 200India: Market; Economics; Indonesia and Thailand most at risk. Amar’s high- 10,000 100Politics ROIC-EV/ Ebit screen has so far worked well in locating 5,000 0Japan: Market 0 (100) outperformance. And for the long-term believers in ourMalaysia: Market India Phil Thailand Taiwan Pakistan Indo Vietnam Japan Korea Billion Boomers story, Andrew and Evelyn recommendSingapore: Market buying into plays that serve the growingThailand: Market discretionary-consumption market and companies that Note: FII = Foreign institutional investment.Asia: Feng Shui; Review are building strong franchises. Source: Bloomberg, CLSA Asia-Pacific Marketswww.clsa.comFind CLSA research on Bloomberg, Thomson Reuters, CapIQ and themarkets.com - and profit from our evalu@tor® proprietary database at clsa.com
    • Asia Themes 2011ContentsWhat are the themes for 2011? Which stocks might get discovered?Introduction by Anirudha Dutta ........................... 3 Asia thematics by Amar Gill .............................. 18How does Asias asset bubble play out? Seeking Asian exposure without EM risk?Global strategy by Christopher Wood ................... 4 Australia market by Scott Ryall ......................... 18Will the free movement of capital survive? How do you fight hot money?Global strategy by Russell Napier ........................ 5 China strategy by Francis Cheung ...................... 19What does QE2 mean for Asia? How to play to become No.1?Global economics by Eric Fishwick ....................... 6 China market by Danie Schutte ......................... 20Will inflation rise further? Will small still be beautiful?China strategy by Andy Rothman ........................ 7 China A shares by Manop Sangiambut ................ 21What is the key earnings risk in 2011? Will HK property prices fall in 2011?Asia microstrategy by Desh Peramunetilleke ......... 9 Hong Kong property by Nicole Wong .................. 22Where to invest in Asia? Commodity curse in 2011?Asia sales view by Evelyn Moore ......................... 9 India market by N Krishnan .............................. 23Does consumer remain the way to go? Will the investment upturn lose steam?Asia sales view by Andrew Riddick ..................... 10 India economics by Rajeev Malik ....................... 24Is the global sector in a sweet spot? Is politics a risk?Asia autos by Geoff Boyd ................................. 11 India politics by Anirudha Dutta......................... 25Will the sector continue to outperform? Is there “good” and “bad” inflation?Asia banks by Daniel Tabbush........................... 12 Japan market by Andreas Schuster .................... 26Will Asian Boomers ride high? Will the nation push meaningful reforms?Asia consumer by Aaron Fischer, Anirudha Dutta . 13 Malaysia market by Clare Chin .......................... 27How will miners spend their capital? Does a strong currency hurt its status?Asia resources by Andrew Driscoll, Daniel Meng .. 14 Singapore market by Ashwin Sanketh ................ 28Will 2011 be a “cleaner” year? Can the SET go up three years in a row?Asia technology by Bhavtosh Vajpayee .............. 15 Thailand market by Tim Taylor .......................... 29Can data push revenue growth? Will the Rabbit leap into a wall?Asia telecoms by Elinor Leung........................... 16 Asia Feng Shui by Philip Chow ........................... 29Is Asia becoming more responsible? How did our 2010 predictions fare?Asia social responsibility by Simon Powell ........... 17 Asia review by Amar Gill ................................... 30Related reports to key themes2 16 December 2010
    • Asia Themes 2011Asia - INTRODUCTIONWhat are the themes for 2011?Remain Overweight Asia.Next year is likely to be similar in many ways to 2010, but watch for increasedpolicy risks. The recovery in the West remains anaemic and the USA is still ina deflationary mode. Asian asset prices will continue to inflate as long as theregion is coupled to US monetary policy. Hence, we are likely to see moregovernment intervention in Asia even as inflation remains stubbornly high. Fornow, we are Overweight the region. We provide insights from our strategists Anirudha Duttaand research/sector heads in the following pages. (91) 2266505056 anirudha.dutta@clsa.comMacro and global - From Washington with love US recovery remains weak and the outlook on EU is pessimistic; monetary policy in the West will remain loose; secondary-market valuations will decline as governments step back into the marketplace. Ample liquidity in Asia should result in asset inflation, particularly in Still rising equities and property; China will be the epicentre of the Asian asset Asian inflation weighted for GDP bubble. 10 (% YoY) 9 With accelerating domestic consumption and construction in the region, 8 inflation will remain a key concern in 2011. 7 Increased government intervention, first in property and likely to follow 6 5 with capital controls; the renminbi should continue to appreciate, by 4 7% next year. 3 A key risk is margin pressure. 2 1Sectors - A(utos) to T(echnology) 0 (1) Autos are in a sweet spot globally with developed-market capacity 98 99 00 01 02 03 04 05 06 07 08 09 10 addition muted and demand from the emerging world surprising on the Source: CEIC, CLSA Asia-Pacific Markets upside. A brilliant year awaits Asian banks, with healthy credit growth, widening margins and limited provision costs; focus on banks with high ROAs. Sharply up since the downturn Asian consumers remain upbeat and will benefit from the positive job US-dollar market performance since end-2008 outlook and wage inflation in 2011; buy affluence and companies that Indonesia are building strong sustainable franchises. Thailand Hong Kong residential-property prices will continue to rise; we prefer Phillipines Korea the landlords to the developers. India Resources companies are well placed with healthy cashflows and Taiwan Singapore therefore, capex and M&A will remain in focus. MSCI Asia A positive year ahead for technology: enterprise spending will remain Malaysia Hong strong after a decade of underinvestment; new products will keep China consumer demand high. Stop worrying about wage inflation. USA (%) Japan Telcos will witness revenue growth again on growth in data revenue, 0 100 200 300 cheaper smartphones and Asian telcos’ own application stores. Valuations are undemanding. Source: Bloomberg, CLSA Asia-Pacific MarketsMarkets of choice Australia offers exposure to the growth of Asia without emerging- Upgrades are moderating market risk. Consensus EPS forecasts 50 (%) With China emerging as the No.1 global consumer, there are multiple ways to play the theme. Negative sentiment for the policy-sensitive 2010E 45 stockmarket could reverse as weather and monetary policy normalise. 2011E 2012E Commodity-price hikes and governance issues plague the Indian 40 market. Inflation, high prices of resources and tight liquidity conditions are likely to be transient and we expect a revival in investment 35 demand. 30 Return of inflation is good news for Japan, an oversold market with undemanding valuations. We see upside potential. 25 Malaysia is likely to see progress in reforms notwithstanding the Feb 09 Sep 09 Apr 10 Nov 10 sceptics, which will drive a market rerating. Source: Datastream16 December 2010 3
    • Asia Themes 2011 After two years of positive returns, Singapore is no longer cheap. Focus on dividend-related investment themes. A continuation of capex and credit growth alongside a return of the present government after the next election will boost earnings in Thailand. Markets will react positively.Valuations - Room for upside. We forecast Asia ex-Japan earningsgrowth to sharply moderate from 42.3% this year to 13.6% in 2011. The12-month forward PE, at 12.1x, suggests valuations are not yet demandingin the aggregate. We estimate strong free-cashflow growth of 98% for nextyear. This, coupled with reasonable valuations, should provide upside toregional markets even as EPS growth slows. Our strategists remainOverweight Asia, while being cognisant of the risks, particularly fromgovernment action. Meanwhile, according to our new Feng Shui master, theyear of the Metal Rabbit can be quite unpredictable, if history is any guide.Global - STRATEGYHow does Asias asset bubble play out?Asia to enter a bubble if US interest rates take a long time to normalise.The macroeconomic backdrop in America remains deflationary; hencethe Federal Reserve’s willingness to embark on QE2. The US bondmarket continues to signal a subpar recovery. The more anaemic theWestern recovery proves to be, the longer it will take for Westerninterest rates to normalise and so the more likely it will be that Asiaenters into an asset bubble. Christopher WoodUnhealthy US recovery. By the first half of 2011, it should become (852) 26008516 christopher.wood@clsa.comapparent whether US consumption and employment are really normalising.The view here is that neither will recover healthily. This also seems to bethe message from the US government-bond market, which has remainedrelatively well bid, despite the ongoing rally in the S&P500 amid risingoptimism. Indeed the 10-year Treasury bond yield is still 117bps lower Bond yield still below April highthan the 2010 high reached in April. In this sense, the US bond market S&P500 and US 10-year Treasury bond yieldcontinues to send an entirely different message from the US stockmarket. 1,500 S&P500 (LHS) (%) 4.5Asian asset bubble . . . China is likely to be the epicentre of an Asian 1,400 US 10-year Treasury bond yield 4.0bubble. The situation in the West is critical in terms of how the Asian cycle 1,300evolves. Western policy is likely to remain super-easy because of the 1,200 3.5lacklustre outlook for consumption and employment in an American 1,100economy, where consumption still accounts for 70.4% of total nominal 1,000 3.0GDP and 88.5% of nominal private-sector GDP. Another reason for policy 900remaining super-easy in the West is the potentially systemic issue of 800 2.5Euroland sovereign debt. 700 600 2.0. . . and tightening policies. Asian governments and central banks are Jan 08 Dec 08 Dec 09 Dec 10going to have to be very aggressive if they really want to head off the riskof an asset bubble in an environment where Western monetary policy Source: Datastream, Bloombergstays so easy. Such an aggressive approach is theoretically possible interms of much higher interest rates and allowing currencies to float freely.But the most likely outcome at present is that Asian tightening policies will Continue to Overweight Asiacontinue primarily to address symptoms of the bubble risk, such as higher MSCI AC Asia ex-Japan relative to MSCI AC Worldproperty prices, not the cause of it. 300 (Jan 1988=100)Renminbi appreciation. One important aspect of this potential Asianpolicy response remains Chinese currency policy. For now the view here 250remains that China will allow only an incremental appreciation of 5-7% peryear. Still, the political noise on the Chinese exchange-rate issue is likely 200to escalate next year if the US labour market continues to be unhealthy. 150Remain Overweight Asia. The extremely easy monetary policy in theWest remains a perfect ingredient for an asset bubble in Asia, which is 100an argument for now to remain Overweight on the region. From a 50longer-term perspective, the other side of an asset bubble in Asia, with 1988 1995 2003 2010China at its epicentre, is a deflationary bust. This is why it is correct tosay that an extended period of near-zero rates in the USA has the Source: Datastreampotential to destabilise Asia in the sense that the long-term healthy4 16 December 2010
    • Asia Themes 2011domestic demand story anticipated in the original Billion Boomersreport (The Real Pacific Century - Asia’s Billion Boomers, September2002) is fast-forwarded into a boom-bust cycle. Still, it is a positivethat the Chinese leadership, as well as other Asian governments,understands this risk and will be seeking to counter it.Global - STRATEGYWill the free movement of capital survive?From mercantilism to Merkelism and the perils to capital.The Merkelists’ desire to assert the primary of politics over financereverses the assertion of Thatcherism that ‘you can’t buck the market.’Government retreat from the marketplace and a long disinflationdramatically lifted the secondary-market valuation of capital from 1982 to2000. We need to realise that we are faced with governments steppingback into the marketplace and the end of that disinflation - a combination Russell Napierthat should structurally reduce secondary-market valuations for capital. (44) 1316549830 russell.napier@clsa.comMerkelism is a convenient label. However, it is not confined to the ex-members of the Free German Youth Movement of the GermanDemocratic Republic. Merkelism is a global movement forced uponpoliticians by perceived market failures. Of course, many of these failuresstem from government intervention, most notoriously the refusal ofChina to permit exchange-rate revaluation, but this is irrelevant in thereactionary world, which is politics. Merkelism will have manymanifestations; the key one for investors will be that politicians will seek ‘I won’t let up on this because otherwisesolutions to Greenspan’s flaw. The flaw, as the Maestro outlined in that primacy of politics over finance can’ttestimony before Congress, is that the ‘enlightened self-interest’ of the be enforced,’ Angela Merkel, Chancellor ofprivate sector cannot correctly determine the appropriate level of credit Germanyfor an economy. This is now the job of the authorities.‘Primacy of politics over finance’. Anyone serious in asserting thisneeds to make capital as sluggish and inflexible as labour and government.The superior speed of capital has allowed it to arbitrage labour andgovernment and thus asserted the primacy of finance over politics. Capitalcontrols, whether introduced proactively in a Merkelist conversion orreactively in a crisis, are now just a matter of time.Capital controls - A barrier to arbitrage. The emerging-market Merkelists Current account directs economic adjustmentbelieve that they will be able to target interest rates, thus credit, and their Brazil’s financial and current accountsexchange rates simultaneously. The emerging-market authorities are 25 (US$bn) Financial accountmarching down this route to avoid the credit bubble they suffered in the mid- 20 Current account1990s and the US endured for the past decade or more. Such controls are 15likely to be insufficient to control credit and defeat inflation and this willinevitably lead the Merkelists to seek to more directly control bank credit. 10Almost certainly one day they will have to follow Volcker rather than Merkel 5and attack their endemic inflation problems with interest rates and abandon 0the attempt to ‘whip inflation now’ with administrative measures. Thisapproach is currently too radical, as it will inflict the political pain of higher (5)interest and exchange rates simultaneously. Political expediency is driving the (10) 09 97 99 01 03 05 07 75 77 79 81 83 85 87 89 91 93 95emerging-market authorities to Merkelism rather than monetarism. As withthe USA in the 1970s, monetarism is a medicine too strong for all but those Source: Datastreamalready weakened by a prolonged period of Merkelism.Merkelism will spread. Most investors will be surprised that theMerkelist drive to assert the ‘primacy of politics over finance’ will alsoinflict Asia. Forecasting its spread within Europe is much less contentious.When all else fails, Merkelism can save the euro but at the expense of thefree movement of capital and by cajoling private-sector savings intopublic-sector debt. Many might see such a move as imminent as the fiscalglue to cement the euro as it melts in the heat of Spain. This might be truebut ignores that fact that when the fiscal arbitrage that passes good creditto bad credits reaches its limit, there is another solution in reserve. Themonetisation of European sovereign debt by the European Central Bank(ECB) will save the euro.16 December 2010 5
    • Asia Themes 2011Markets versus central banks. Markets can take on and defeat USA as an anti-Merkelist bastiongovernments whose fire power is limited to the funds they can extract Gross Federal debt as a portion of GDPfrom their citizens. However, markets must bend to the central bankers 140 (%)whose fire power is unlimited as they conjure money out of thin air. Most 120believe that the ECB would never pull this rabbit out of a hat because once 100upon a time, in 1923, another European central bank tried a similar trick.However, with the failure of the commercial banking system of Europe 80assured, if the euro fails then the ECB will have to follow the Fed and the 60Bank of England to defeat the markets. If the ECB saves the euro then 40Merkelism need not. However, it will not be held in abeyance for long.Once we thought Merkelism would appear to save the sovereign debt of 20Portugal, Ireland, Greece and Spain. Of course, if the ECB saves them, 0then one day Merkelism will appear but to save the sovereign debt of 1940 1952 1964 1976 1987 1999 2011EGermany itself. Source: whitehouse.govWill the USA hold out? The USA is likely to stand out as an anti-Merkelist bastion. As the owner of the reserve currency, it must resist anymovement towards the capital controls that would restrict the injection offoreign savings, which send it to work every morning. This resistance mayeven attract more capital as capital considers the balance between politicsand finance to be in its favour in the USA. However, the primacy of financein the USA is not some cunning legacy of Alexander Hamilton, but a resultof a society addicted to the easiest money of all - the easy money calledthe reserve currency. Even the USA will question the primacy of financewhen it realises that finance is not always cheap and readily available.That day for America will dawn when Volcker comes to Asia. When theemerging markets are forced to attack their endemic inflation with highinterest rates and flexible exchange rates, then the USA will have to paythe real cost of finance. It is a price that it arguably has not paid for acentury and at least not since the seventies. Emerging-market savings willno longer be on tap and US Treasury yields will soar. Then, and probablyonly then, will the USA be forced to impose capital controls, assert theprimacy of politics over finance and bring Merkelism to America.Global - ECONOMICSWhat does QE2 mean for Asia?Asia to see credit growth and faster consumption and construction.QE2 will drive down the cost of capital globally and thus Asia is likely to seecredit growth and accelerating domestic consumption and construction activityin 2011. But GDP growth will be slower amid weak world trade. Malinvestmentresulting from emerging-market monetary policy internationalising QE2 willdefine the end-game for this cycle, but the party could last several years. Themore immediate problem is consumer-price inflation. We expect Asian Eric Fishwickmonetary authorities to start tightening in 2H11. (852) 26008033 eric.fishwick@clsa.comThe “Bernanke put”. QE2 will drive down the cost of capital on a globalscale. It will accelerate credit cycles in those countries in which, as a resultof interest-rate and exchange-rate practices, import US liquidity. Thisincludes most of Asia. Next year is likely to see credit growth and domestic Importing US liquidityconstruction activity accelerate. Most of Asia is export-driven, so in the Aggregate Asian forex reservesweak-world-trade environment that we expect for 2011 GDP growth will beslower than this. But consumption and investment will be stronger than 5.0 (US$tn) (US$tn) 2.0previous export-GDP correlations would suggest. QE2 represents the 4.5 Rolling 12M change 1.8 4.0 1.6“Greenspan put” supersized into the “Bernanke put” of 2011. Our bearish Level (LHS) 3.5 1.4economic forecast makes it a certainty that the US will extend QE2 into 3.0 1.22H11 and potentially beyond. 2.5 1.0Don’t overplay euro weakness. QE2 will generate liquidity flows into 2.0 0.8risk assets far greater than the Fed’s direct purchases of Treasuries if it 1.5 0.6 1.0 0.4makes the US dollar appear a risk-free short. At the moment, this is not 0.5 0.2the case as the euro is contaminated by sovereign-risk concerns. Event 0.0 0.0risk in the euro will dissipate only by Portugal and likely Spain following 2004 2005 2006 2007 2008 2009 2010Ireland and Greece in accessing International Monetary Fund andEuropean Union funding. So doing will require aggressive austerity Source: Datastream, CEIC, CLSA Asia-Pacific Markets6 16 December 2010
    • Asia Themes 2011measures vindicating a pessimistic outlook for EU growth. As the bailout Credit decoupling Asiapacts are progressively triggered for Portugal and finally for Spain, liquidity Real GDP forecastsrisk overhanging the euro will dissipate. As this happens, the currency 2009 2010CL 2011CL 2012CLshould again start to outperform the dollar. Australia 1.3 2.7 3.9 3.6 China 9.1 10.2 8.9 9.5Asia a soft-currency region in 2011. With export growth already under Hong Kong (2.8) 7.0 5.4 4.3pressure and China unwilling to allow anything more than a cosmetic India 7.4 8.8 8.3 9.0appreciation of the yuan, Asia as a whole in 2011 will be a soft-currency Indonesia 4.5 5.9 5.7 6.0region. Exchange rates will appreciate versus the US dollar but only Korea 0.2 6.4 5.1 5.4because the latter is even weaker. Asian currencies will fall relative to Malaysia (1.7) 6.7 4.3 4.5physical stores of value (gold and commodities in general), freely floating Philippines 1.1 7.0 4.8 5.3commodity currencies (the Australian and New Zealand dollars) and, as Singapore (1.3) 15.0 4.0 5.0sovereign risk dissipates, the euro. Taiwan (1.8) 10.2 5.1 4.1Asia coupled to US monetary policy. In Asia, QE2 will appear as a Thailand (2.3) 7.7 4.0 4.7reduced cost of capital as underleveraged banks try to raise loan/depositratios (LDRs). The return on savings will also fall (especially in real terms). Memo: USA (2.6) 2.8 1.8 1.1With cyclical (export) sectors weak, liquidity will pool in property markets. Memo EU (3.6) 1.1 0.0 0.5The combination of QE2 and Asian monetary policy will support both China is a small upward revision. Recent PMI datadomestic credit growth and fixed capital formation. With exports under suggest that sequentially 4Q will be stronger than 3Q and this pushed the CY10 number up a little and the CYpressure, Asian economies will appear finally to have decoupled from world- number up about 0.5ppts. Ill characterise as 8-9% in thetrade flows. Our forecasts for 2011 are slower than 2010 but far from text. Source: CLSA Asia-Pacific Marketspessimistic given our US and EU assumptions. Asia will have decoupled, butonly by virtue of remaining intimately coupled to US monetary policy.Inflation will rise in Asia. On the street, liquidity is likely to be mostvisible as persistent upward pressure on property prices. Consumer-priceinflation is already appearing in Asian inflation statistics today. Asia, likemost emerging markets, is vulnerable to rising food prices because of thelarge weight of unprocessed food in Consumer Price Indices (CPIs).Inflation has started to rise across Asia and we expect headline rates torise further as QE2 continues.Asia will become more “Chinese”. QE2 has the potential to make the Rerun of 2008 inflation, for longermost economic difference in economies like Indonesia and India, which Average CPI inflation (2009 GDP weights)historically have had high cost of capital and constrained bank balance 18 (% YoY)sheets. More and more aggressive interference in property markets and 16 Overallattempts to control banks’ ability to lend will characterise 2011. There is 14 Food Non-foodalso likely an increase in the use of capital controls to restrict inflows into 12monetary systems at source, as is the case in China (which is therefore 10 8one of the countries best able to handle them). And in 2011 we would 6expect the rest of the region to become more “Chinese” in how it 4administers banking systems. 2Tightening will occur in second half. Eventually, Asian monetary 0authorities will be forced to react. But historical precedent, both in how (2) 2003 2004 2005 2006 2007 2008 2009 2010they respond to terms of trade shocks and their willingness to raise rateswhile US rates remain low, suggests that interest rates and exchange rates Source: CEIC, CLSA Asia-Pacific Marketswill lag inflation. By end-2011, we expect interest rates to be raised andattitudes towards currency appreciation to be more open. But it will havetaken inflation rates at or around 10% to have caused the shift.China - STRATEGYWill inflation rise further?CPI to moderate next year as climate and monetary policy normalise.Inflation in China is primarily a weather-driven phenomenon, withmonetary policy playing a supporting role. As these factors normalise nextyear, the increase in CPI will not be dramatically higher than the 3.6%average annual rate of the five pre-stimulus years. Still, we expect highlevels of liquidity and rising income to fuel price surges in the country’stwo asset classes - equities and real estate. Andy Rothman (86) 2123066000Largely bad weather. The primary driver of CPI inflation has been bad andy.rothman@clsa.comweather across the country, leading to a sharp fall in fresh vegetable andfruit supplies. Food accounted for 74% of the November CPI rise, while16 December 2010 7
    • Asia Themes 2011residence expenses contributed another 18%. Ninety-two percent of theheadline CPI increase came from just those two categories. We are notarguing that the sharp rise in the growth rate of money supply has had no Sinology China Macro Strategyinflationary impact, but monetary conditions account for only a small shareof the CPI surge. Fresh veggies and fruit the key driverIt isn’t always money. Core CPI was only 1.5% in November. The sharp CPI-Food, CPI-Fresh veggie and CPI-Fresh fruitfall in money velocity has largely neutralised last year’s dramatic increase 135 (% YoY) CPI-Foodin money supply. Monetary policy accounts for only a small share of the 130 CPI-Fresh vegetableCPI increase, and the growth rate of money supply is normalising. 125 CPI-Fresh fruit 120Social unrest. Higher food prices are unlikely to result in social instability. 115The key factor is that a decade of rapidly rising income has left Chinese far 110better equipped than many of their emerging-market counterparts to 105manage higher food prices. 100Higher rates. Beijing is once again using administrative measures to cool Jan 10 Mar 10 Jun 10 Aug 10 Nov 10off inflation. But as was the case in 2008, we don’t expect the Party to Source: CEICfreeze food prices. The Communist Party will keep raising interest ratesuntil food prices cool off. This means two to three more 25bp increases arelikely by mid-2011. Lending and one-year deposit rates should rise in Higher reserve requirementtandem. CPI-Food and RRRHigher RRR. Bank reserve-requirement ratios (RRRs) will also rise with 125 (%) 20CPI, but as with interest rates, this is primarily a political signal that will 120 CPI-Food 18have little impact on food prices or bank lending. Demand for credit will RRR (RHS) 16 115remain strong, and supply is controlled by quota. With the system-wide 14 110 12loan/deposit ratio still at about 66%, well below the 75% ceiling, very few 10 105banks will find their lending constrained by a much higher RRR. 8 100 6Not significant tightening. Higher real rates and RRR will have little 95 4impact on the economy or on the housing market, and do not foreshadow Jan 04 Sep 05 Jun 07 Feb 09 Nov 10significantly tighter monetary policy next year. New lending will be very Note: non-food inflation before 2005 is based onlow in December as the Party sticks close to its full-year target, but in estimate. Source: CEIC2011 loans outstanding is likely to rise by 14-15%, near the averageannual rate of 15.7% during the five pre-stimulus years.FAI will stay strong. Nominal fixed-asset investment (FAI) growth, No significant tighteningwhich drives commodities demand, will normalise at about 25% YoY this RRR, interest rate, M2 and loan growthyear and next, roughly the same pace as in the six pre-stimulus years. 45 (%) (%) 10.0 40 Loan growth YoY (LHS)No change to currency policy. The Party does not consider the 35 Required reserve ratio (LHS) M2 growth YoY (LHS) 9.0exchange rate as a tactical tool for managing short-term problems such as 30 Interest rate for one-year loans 8.0high food prices. Rather, gradually moving the currency towards a market- 25 20 7.0based equilibrium rate is considered a long-term structural adjustment. 15The renminbi is appreciating at a 5-7% annualised pace against the dollar, 10 6.0and we expect that to continue for the next couple of years. 5 5.0 Jan 04 Sep 05 Jun 07 Feb 09 Nov 10Non-food inflation. There are two factors keeping non-food prices low.First, steady gains in productivity. Second, overcapacity in most Source: CEICmanufacturing sectors severely limits the ability of firms to raise finalgoods prices.Hot money. A second round of quantitative easing in the USA has sparked Asset-price, not CPI inflationexpectations of a wave of “hot money” into emerging markets. In China, Shanghai composite index, interest rate and RRRhowever, the key will continue to be domestic liquidity. Capital-account Shanghai stock composite index (LHS) Benchmark interest rate for one-year loanscontrols make it difficult to move money into the country, and the absence Required reserve ratio 7,000 (%) 19of a significant bond market will make other emerging markets more 6,000 17attractive to many investors. 5,000 15 13 4,000Asset-price, not CPI inflation. While we expect CPI to be moderate next 3,000 11 9year, high levels of liquidity and rising income are very likely to fuel price 2,000 7rises in China’s two asset classes, equities and real estate. We note that in 1,000 52007, when rates rose seven times and the RRR was increased 10 times, Jan 07 Jul 07 Dec 07 Jun 08 Dec 08the Shanghai composite index rose from 2,800 to 5,300. If this time Source: CEICinvestors also shrug off inflation and higher rates, there is ample domesticliquidity - household bank deposits equal to US$4.4tn, larger than thecombined GDPs of Russia, India and Brazil - available to fuel a large asset-price inflation cycle.8 16 December 2010
    • Asia Themes 2011Asia - MICROSTRATEGYWhat is the key earnings risk in 2011?Rising costs and easing demand create widespread margin pressure.Margins remain a key EPS-growth driver at almost any point in the cycle.From a top-down perspective, there are some reasons to be concernedabout margins. Costs are rising, particularly raw-material and energyprices. This, and easing demand, creates widespread margin pressure.Analysts underestimating these headwinds in their bottom-up forecastscould put earnings at risk in 2011. Our India, Indonesia and Thailand Desh Peramunetillekeanalysts exhibit the most optimism in margin assumptions presently. (852) 26008293 desh.peramunetilleke@clsa.comRising costs add to margin pressure. Producer prices have risen Margin squeeze aheadsignificantly in Asia, with the Producer Price Index (PPI) outpacing the PPI/CPI relationship with Ebitda marginsConsumer Price Index (CPI). History shows that this will create major Avg PPI YoY (LHS) 12 (%) (%) 20headwinds for Ebitda margins. We expect by 2011 gross margins to hit an Avg CPI YoY (LHS) Expected 10 19all-time low as variable costs increase more than we forecast due to higher Ebitda margin 8input prices and rising wages in the region. 18 6 17Peaking operating leverage. Any decline in global growth impacts Asian 4 16earnings due to the high levels of operating leverage in the region. Given 2 15the focus on manufacturing, Asian firms tend to have high proportions of 0 (2) 14fixed costs. This means that any increase in sales goes directly to the Highier PPI (4) hurts margins (5.0) 13bottom line, so earnings growth can be spectacular when economic times 98A 99A 00A 01A 02A 03A 04A 05A 06A 07A 08A 09A 10F 11F 12Fare good. The recovery of Asian markets in 2009 saw operating leveragepeaking at 3.1. This should see a steady decline to 1.2x in 2011, Source: CLSA Asia-Pacific Marketshighlighting the pressure on margins. EPS for our Asia ex-Japan (exfinance) universe is set to grow by 8.4% in 2011 but a 1ppt decline inmargins would see growth become negative at -1.2%.Focus on sustainable growth. Asia has long been a paradise for growth-at-a-reasonable-price (Garp) investors. However, pricing growth based onratios such as PE/G has always been a challenge given the volatility andlow reliability of EPS forecasts, especially when margin optimism in analystestimates remain a concern. One of our recent reports introducedsustainable growth as a reliable long-term measure and a key componentbehind through-the-cycle valuation analysis. Sustainable growth (SG),defined as ROE X (1 - payout ratio), is the core organic growth potential ofa company, excluding M&A and any increase in gearing. Our backtestsfurther highlight that price of sustainable growth (PSG), defined as (12-month forward PE/SG), is a better predictor of share-price performancethan PE/G for Asia. We found J-curve-driven Chindonesia® to be cheap ona PSG basis.Asia - SALES VIEWWhere to invest in Asia?Buy affluence, sell peasantry.Investors should structure their portfolio holdings to buy plays on affluenceand sell those on peasantry in 2011, in order to profit from Asia’s seriouswealth creation. Apart from higher wages, wealth will come from improvedinvestment returns, availability of leverage, new investment and consumercredit products, and less savings for non-discretionary expenses. Labour isno longer docile, but aspirational and connected. Social networks and Evelyn Moorebroadband have brought branded goods and luxury living to billions. (1) 2145288820 evelyn.moore@clsa.comBuy stocks that service emerging wealth. Margins, valuationexpansion and shareholder profits will come from companies positioned tosell to and service emerging wealth. Two decades ago, profits in Asiastemmed from first-time buyers of government housing, taxi rides, eatingout, and wardrobes beyond workplace uniforms. Today, the riches want toown the best-in-show products, to hide and insure assets, to be amongtheir own kind, to give children superior educations and to feel and look16 December 2010 9
    • Asia Themes 2011good to infinity. Buy stocks representing the best brands in discretionary Be long the yellow metalitems, land, travel, organic goods, online shopping, private transport, cool Gold pricetech gadgetry, blue-chip financial services, insurance, education and 1200 (US$/oz)healthcare, and companies focusing on broadband buildout and internet 1000mobility. Steer away from staples, utilities, bicycles and cigarette stocks.Think paintings, not paint. In sum, when choosing stocks in Asia, buy 800affluence and sell peasantry. 600Behavioural finance will rule gold and Japan trades. Therefore, be 400long gold as investors and pundits re-anchor their price target from recentall-time high of US$1,423/oz to the inflation-adjusted high of US$2,387/oz. 200When people think of something being at record highs, they are less likely 0to buy, but when they reframe on a new anchor, their loss-aversion bias Dec 44 Dec 57 Dec 70 Dec 83 Dec 96 Dec 09kicks in and they are driven to act in order to take advantage of thisapparent “deal” before the “cheap” offering of gold disappears. Ready your Source: Bloombergportfolio for the view that gold has another 68% to go before it simplymatches its real money peak of 30 years ago. Recent performance ofJapanese equities and the yen will lead equity investors to re-anchor froma view of multidecade decline to multiyear recovery.Asia - SALES VIEWDoes consumer remain the way to go?Thought-provoking insights on companies with economic moats.A CLSA salesman caught singing the praise of non-CLSA research neverendears himself to his research colleagues. At the risk of being hung out todry, my recommendation is to get hold of some of the reports boutiqueinvestment-fund managers Arisaig & Partners produces, for some provokingthought process. As they say in their consumer-sector research, ifconsumers don’t eat it, drink it, clean with it, wear it or shop in it, they do Andrew Riddicknot own it. These are the areas where cyclicality is most reduced and quality (852) 26008836of earnings most increased. andrew.riddick@clsa.comDominant Asian companies create value. Arisaig constructed a simple, Upside in Asian demandequally-weighted index of 54 Asian dominant consumer companies and Swiss-watch imports to GDPlooked at what might have happened if they had had the wisdom and 150 Swiss-watch imports (US$/capita)foresight to buy and hold these since 1 January 1997 through to 31 Hong KongDecember 2009. During a period in which the MSCI Asia ex-Japan returned 100 Singaporea net 4.2% Cagr with EPS growth of negative 0.1%, this index returned Saudi UAE31.0% Cagr with a 23.2% EPS Cagr. Consumer-staple companies in Africa 50 China Thailand Arabia Taiwan Franceand Latin America achieved similar massive outperformance over the same UK USAperiod. But not only there: as it happens, the story in the USA back in the 0 Germany1980s is just as impressive. Stocks with high "moats" (brand, distribution, 0 Russia 20,000 Spain 40,000 60,000scale) generate high ROEs, create cash and permit growth, both organic Italy Japan GDP/capita (US$)and acquisitive. ¹ Assuming 50% of exports to HK are re-exported to China. This is a meaningful adjustment to achieve asPower of compounding. The conviction in the power of compounding conservative a result as Hong Kong is the largest importerunderlies Arisaig’s research. To quote, ‘what matters more than short term of Swiss-made watches in the world (imports are 3x larger than China). The federation also bases its Chinavaluations is that we own for the long haul the alpha generating per-capita calculation on an urban population of 594mbusinesses that have what it takes to compound earnings come rain or (not 1.3bn). The data are based on annual data, collected monthly. Source: Fed of Swiss Watch Industryshine (in short: scalability, high gross margins and low capital intensity).In other words, it makes a great deal more sense to let the bestbusinesses do the heavy lifting for us than to make the mistake of trying Power of compoundingto time or finesse markets and sectors.’ Whether you agree with Arisaig or Compounded returns versus MSCI AxJnot, their research underpins such a provocative and persuasive conclusion. 450 (%) 400 15% compoundedA 15% compounded is what you need. ‘Sometimes people forget the 350simple maths: US$1m invested in a business that compounds its 300 250earnings at 15% would be worth US$16m in 20 years. This would be 200US$12m if the valuation compressed from say 25x to 18x in a straight 150 6% compounded MSCI AxJline over that period. However, US$1m invested in a fund rotating across 100 50sectors within a universe growing its earnings at say 6% (which is what 0history suggests is likely) would be worth US$3m in 20 years; and, no Dec 99 May 03 Aug 06 Dec 09doubt, less taking account of transaction costs and the inevitable Source: Bloomberg, CLSA Asia-Pacific Marketsmisjudgements along the way.’10 16 December 2010
    • Asia Themes 2011Masterly inaction. With a portfolio on 25x forward earnings, a period ofconsolidation probably beckons, while some of their research is clearly alsodesigned to be self-serving. But it offers a rock whereby to try to look atvarious investment opportunities. Increasingly I accept that the lack ofpatience and unwillingness when investing in good businesses to givethem time to do their work is one of the greatest errors of many investors.For the time being that is not something Arisaig can be criticised for. NorWarren Buffet. There is a message in this.Asia - AUTOSIs the global sector in a sweet spot?A healthy world supply/demand picture after the GM restructure.The global auto sector should remain in a sweet spot after therestructuring of General Motors. This is due to lacklustre capacityexpansion in developed markets and surprisingly strong addition in theemerging world. Healthy free-cashflow generation in Asia raises thequestion on deployment. We continue to like Kia Motors, GuangzhouAutomobile, Great Wall and Toyota in Japan. Maruti Suzuki is a toplong-term pick in India, though we are hesitant about it near term. Geoff BoydPost GM restructuring. During 2000-08, General Motors famously (65) 64167853“pushed” production into its US inventory system, forcing large incentives geoff.boyd@clsa.comto move vehicles to customers. It was trapped in a vicious circle of highfixed costs and declining market share but rising debt-service obligations. Suggests a healthier USAThe bankruptcy that followed has shed its debt and the company is acting Ford operating marginmore rationally now to allow demand to “pull” its production schedule. 8 (%)Widening margins. As a result of GM’s more rational tone, the market 6has turned more positive on the sector and consensus is forecasting 2010- 412 operating margin of 7.4% for companies like Ford. This compares with 2 0the negative 4.1% and negative 1.5% the US automakers reported for the (2)five and 10 years to 2009. We believe this indicates a better pricing (4)environment in the USA, despite the generally weaker demand this year. (6) Avg 2004-09 Avg 1999-09 Avg 2010-12FUS demand is ticking up. The overall US auto market was up 17% YoY inNovember to a 12.3m run rate, beating our 13% expectation. Industry Source: Bloombergexecutives talk about dealers seeing people who “want” to buy a car, ratherthan “need” to buy one. Some forecast 13m units of sales in 2011, while JDPowers expects 15m vehicles in 2012, both ahead of our current forecasts of Indicative of global margin trend12.5m and 13.5m. On the supply side, we see Volkswagen adding capacity Volkswagen operating marginbut not a dramatic rampup overall to disrupt the enjoyable returns. 7 (%) 6Europe also improves. Renault and Fiat represent the mass-market 5European manufacturers and we note that 2010-12 consensus margin 4estimates have improved versus history: 3.1% for Renault versus the 3 21.1% it achieved over 2004-09; 4.6% for Fiat versus 3.8%; and 8.0% for 1Daimler versus 3.3% and 9.0% for BMW versus 6.4% in recent years. An 0improved Chinese business partly explains this, but also a generally Avg 2004-09 Avg 1999-09 Avg 2010-12Fhealthy premium segment. Giant Volkswagen should also reach 5.8% Source: Bloombergoperating margin versus the 4% it achieved over the past decade.Some disparities. The Japanese companies are suffering the mostrelative to the past decade, due mostly to the strong yen. We forecastoperating margins of 1.2%, 6.0% and 6.0% for Toyota Motor (7203 JP -¥3,260 - BUY), Honda Motor (7267 JP - ¥3,170 - U-PF), and NissanMotor (7201 JP - ¥809 - U-PF) in 2011. This compares to a decadeaverage of 8.1%, 7.7% and 7.8%. We also expect demand from Europe tobe down YoY, post stimuli in key markets like Germany.China still going strong. Latest data suggest China might finish 2010 up30% YoY versus our forecast of 26% YoY from a couple months ago, and19% at the start of the year. Demand growth is outstripping capacityadditions, and this will remain the case for 2011, so we expect industrymargins to remain at healthy levels.Top picks. We like Toyota in Japan, Kia Motors (000270 KS - 51,300 won- O-PF) in Korea, as well as Guangzhou Automobile (2238 HK - HK$10.58 -BUY), SAIC Motor (600104 CH - Rmb17.21 - BUY) and Great Wall Motor(2333 HK - HK$24.80 - BUY) in China. Abhijeet Naik still likes MarutiSuzuki (MSIL IB - Rs1,413.5 - O-PF) as a long-term pick but expects it tolanguish on price wars with Toyota’s new models in India near term.16 December 2010 11
    • Asia Themes 2011Asia - BANKSWill the sector continue to outperform?Healthy credit growth, widening margins and limited provision costs.A brilliant year awaits Asian banks, with healthy credit growth, wideningmargins and limited provision costs. What’s more, Tier I ratios are highand remain liquid - which is good in the new world of Basel III. Positivestructural factors are plentiful, including limited consumer-loan penetrationand young population. We remain Overweight Asian banks, focusing onhigh-ROA, high-growth markets. Our top picks are Bank of China, Bank Daniel TabbushCentral Asia, HDFC Bank and Standard Chartered. (66) 22574631 daniel.tabbush@clsa.comCredit growth. For the highest-growth countries, credit growth is 15-25%per annum and more countries are likely to enter this range during 2011. Focus on high growthWith increased investments in India, growth will rise and increased LDR versus Loan growthcorporate facilities in Thailand will drive growth in the country. Where 10CL LDR (%) Loan growth (% YoY) India 78 25Indonesia’s banks become more aggressive at raising loan/deposit ratios Indonesia 77 22(LDR), loan growth will accelerate. China has seen its loan growth step HK 67 20 China 61 18down already, where study of our China Reality Research (CRR) team Singapore 72 17suggests it will rise marginally. But for more developed regions, including StanChart 88 12Australia, Korea and Japan, expect subpar loan volume to continue. Malaysia 83 12 Philippines 66 10Credit quality. The global financial crisis was not global, as it never really Thailand Korea 85 127 10 5hit Asia. Nonperforming loans did not rise during 2009-10, even though Taiwan 73 4Asian banks prepared for the worst, with higher provision costs. Going into Australia 131 4 HSBC 89 12011, the region’s NPLs/loans should be below pre-Asian Crisis (1997) Japan 65 (4)lows, at 2.5% versus 3.9% in 1996. Where many banks have seen 50- Average 83 1180% lower provision costs during 2010, persistently low loan-loss Source: Company reports, CLSA Asia-Pacific Marketsprovisions (LLP) will characterise 2011. With average NPL-coverage rates Key driver for Chinaat 131% on 11CL, this is in a different league to pre-Asian financial crisis, China - Non-interest income to assets, 10CLat 72%. Indonesia and the Philippines stand out, where LLP/loans remain Thailandhigh at 1.5-1.8% this year. Phils Indonesia StanChar HSBCChina’s banks. A simple chart showing share-price performance of Malaysia Avg IndiaIndonesian, Indian, Thai, Malaysian and Philippine banks during 2010 Japan Singshows no discrimination, with a 55% increase. Adding China to the chart Taiwan Australia HK (%)leads to anomaly in performance, up 10% during the year. And yet, there China Koreaare many similarly positive structural features, no NPL formation, 17-20% 0.0 0.5 1.0 1.5 2.0 2.5ROE and 1.2-1.5% ROA. Performance has been frustrating in 2010, butwith far less in the way of regulatory risk, good NPL trends and still good Source: Company reports, CLSA Asia-Pacific Marketsprofit growth, China’s banks will shine in 2011. Continue to improveStanChart and HSBC. The big shock in 2011 for Standard Chartered StanChart CB - Fee income vs loan growth(2888 HK - HK$217.60 - BUY) will be its consumer-banking (CB) Fee growth (LHS) 50 (%) (%) 120transformation, where the income delta has been negative for two years. Loan growth 100 40While wholesale banking remains strong, credit costs low, meaningful 80 30growth in CB will drive 14% EPS growth. HSBC’s (5 HK - HK$81.95 - O-PF) 60 20 40ROA should see the best improvement among major Asian banks, from 2025bps in 2009 to 85bps in 11CL, and 2010 should mark the first year of 10 0more normal credit costs. An improved focus on commercial banking in 0 (20) 01A 02A 03A 04A 05A 06A 07A 08A 09A 10CLAsia and Hong Kong will support revenue, allowing for total EPS growth of29% in 11CL. Source: Company reports, CLSA Asia-Pacific MarketsROA and recommendations. Countries with higher ROAs typically O-WT on higher returnsperform better and we doubt that will change in 2011. This is a key reason Change in ROA, 11CL versus 10CLfor our Overweight stance on markets with higher returns. When we Korea HSBClooked at actual stock performance over the past 15 years, the bank Taiwan StanChar Thailandbasket of high-ROA countries only underperformed in just one year. This Asia avg Singcompares with five years of underperformance for high-ROE countries. We Japan Malaysia Philsare Overweight China, Indonesia, India, Hong Kong, Thailand, Malaysia China Australia Indiaand the Philippines, and Underweight Japan, Australia, Korea, Singapore HK Indonesia (%)and Taiwan. Our top stock picks are Bank of China (3988 HK - HK$4.22 - 0 10 20 30 40 50BUY), Bank Central Asia (BBCA IJ - RP6500 - O-PF), HDFC Bank (HDFCBIB - RS2236.1 - BUY) and StanChart. Source: CLSA Asia-Pacific Markets12 16 December 2010
    • Asia Themes 2011Asia - CONSUMERWill Asian Boomers ride high?Chindonesian consumers remain upbeat amid wage inflation.China, India and Indonesia’s (Chindonesia®) consumer sectors shouldexhibit J-curve hypergrowth over the next five to 10 years on risingincomes and propensity to consume and take risks. Even in the face ofslower global growth, their consumers remain upbeat and will benefit fromstrong liquidity inflows and wage inflation in 2011. Our top picks are AirChina, Baidu, Bank of China, Cathay Pacific, HDFC Bank, Evergreen, Aaron FischerWant Want, Parkson Retail, Sands China, Wynn Macau and SAIC. (852) 26008256 aaron.fischer@clsa.comRise of the middle class. We estimate that the middle class makes up19% of Asia ex-Japan’s population, and that should rise to 30% in fiveyears, or an 11% Cagr. The aggregate number of those in the region’smiddle class will increase from 570m currently to 945m by 2015. Chinawill account for two-thirds of the new members, while Chindonesia® willrepresent 90% of the 375m increment. We expect the social cluster’sconsumption spending to increase from US$2.9tn to US$5.1tn over thisperiod. For more of our analysis, see our spring report, Mr & Mrs Asia -Moving up the J-curves.High aspirations, though grounded in reality. This autumn, we Anirudha Duttarevisited the Chinese, Indian and Korean respondents in our 20 20 20 (91) 2266505056project in 2005. Now 25 years old, our 20 20 20s have certainly moved anirudha.dutta@clsa.comahead: most are now working, many of them outside their home countries- and also spending. Despite the financial crisis, they remain optimisticoverall and confident about the future - not only for themselves, but theircountries. That said, they clearly have a more mature and balanced viewthan they did in 2005.Responsible hedonists. Now that most of our 20 20 20s are finallyearning a wage, they spend a good deal of it. This is clearly a generationof “baby” consumer Boomers. But whereas brand awareness is high(particularly for electronics), brand loyalty is not (especially when it comesto clothing and sports goods). Pragmatism rules and the brands must beseen to offer value. Our 20 20 20s may be consumer Boomers, but they’renot spendthrifts. Most manage to save a significant amount of theirearnings, typically with the aim of buying big-ticket items such as cars andtravel, and eventually a home of their own (except in Korea, where rentingis the norm).Moving up the J-curves. Some key trends of this generation: low loyaltyto brands; high savings rate but not financially savvy; increasinglypurchasing everything online; and priority areas of spend are travel, houseand car. Key sectors to benefit from the growing consumption would beonline travel companies, airlines, hotels, real estate, retail financialservices, automotive plays and companies earning the loyalty of thisgeneration by building strong franchisees. Global brands that have astrong resonance with this generation are Apple (i-Whatever), Canon(7751 JP - ¥4,080 - BUY), Nokia, Samsung Electronics (005930 KS -929,000 won - O-PF) and Sony (6758 JP - ¥2,988 - BUY).Top picks and risks. We project hypergrowth in discretionary spendingon autos, transport and tech, while telecoms should see a more moderateincrease. Travel and buying a house are among the top priorities for theAsian Boomers. Our top consumer plays include Air China (753 HK -HK$8.88 - BUY), Baidu (BIDU US - US$106.62 - BUY), Cathay Pacific (293HK - HK$23.70 - O-PF), HDFC Bank (HDFCB IB - RS2236.1 - BUY),Evergreen (238 HK - HK$5.45 - BUY), Want Want China (151 HK -HK$6.76 - BUY), Parkson Retail (3368 HK - HK$12.86 - BUY), Sands China(1928 HK - HK$16.58 - BUY), Wynn Macau (1128 HK - HK$17.06 - BUY)and SAIC Motor (600104 CH - RMB17.21 - BUY). However, rising interestrates and policy intervention could impact high-value discretionaryspending in 2H11.16 December 2010 13
    • Asia Themes 2011Asia - RESOURCESHow will miners spend their capital?Capital management in focus for Asia’s mining companies.With balance sheets bulging, capital expenditure reaccelerating and moreM&A activity, capital management is an increasingly important investmenttheme for mining companies. Wide-scale capital returns are unlikely, so acompany’s organic growth opportunities and M&A strategy is key todelivering superior returns. Names to focus on in this theme include BHPBilliton, Adaro and Riversdale Mining. Andrew Driscoll, CFAA two-year turnaround. What a difference two years can make. From (852) 26008528 andrew.driscoll@clsa.comdistressed balance sheets and slashed capital-expenditure plans followingthe 2H08 commodity-demand shock, miners’ balance sheets are bulgingonce more. This is thanks to two years of strong demand recovery andelevated commodity prices. The weighted average gearing level (netdebt/equity) for our universe of mining stocks has decreased from 50% atthe end of 2008 to around 10% in 10CL. This is particularly true for thecoal sector, where resilient pricing in 2H08/1H09 has contributed tobalance-sheet support: 56.3% of the 16 coal producers we cover in Asiahave a net-cash position.Capital returns unlikely. While large-cap miners typically have adividend policy of distributing 20-30% of earnings, few outside the majors Daniel Menghave a track record of share buybacks or special dividends. We don’t (852) 26008355expect this to change, at least in the near term, with most companies daniel.meng@clsa.comindicating a preference for investment in organic growth or pursuing M&Aopportunities, rather than returning capital to shareholders. It seems thatmining companies believe they can spend it better than investors. Amongthe majors, BHP Billiton (BHP AU - A$45.65 - O-PF) has recommenced asuspended buyback that will see the company purchase A$4.2bn of itsshare this year. Rio Tinto (RIO AU - A$87.90 - O-PF) will also commencea new progressive dividend programme.Organic growth options. The capital-expenditure cycle reaccelerated in Building up cash2H09 as improved balance sheets and confidence in the economic recovery Weighted average net gearing of our coverageprompted miners to commit to a raft of expansion plans and new 60 (%)developments. Our coverage universe is set to increase capital expenditure 50 40from US$31bn in 2009 to US$34bn this year and US$37-40bn in 11-12CL. 30This reflects a combination of brownfield and greenfield developments, 20with investment heavily geared towards the iron-ore and coal sectors. We 10 0note that capital spending in China has lagged target levels in the past two (10)years due principally to government delays in permitting. Working capital 2004 2005 2006 2007 2008 2009 2010 2011is also set to rise to support higher levels of production. Source: Companies, CLSA Asia-Pacific MarketsM&A activity to continue. After a hiatus in 2H08 and 2009, mining-sector M&A is back in a big way. Miners have announced some US$130bnof deals in 2010, with coal and gold being the two hot segments. Givenstrong balance sheets and opportunity for consolidation in the mid-tier M&A back in voguespace, this theme is set to continue. The Chinese and North American coal M&A in the global mining and metal sectormajors and Coal India are all seeking acquisitive growth, with the 200 (US$bn)Australian coal miners in the cross-hairs, and Whitehaven Coal (WHC AU 150 Pending M&A- A$7.02 - O-PF) and Riversdale Mining (RIV AU - A$16.23 - BUY) potential Completed M&Atargets, in our view. Among the Chinese coal names, we believe Yanzhou 100Coal (1171 HK - HK$22.45 - O-PF) is best placed in terms of capital 50management. We also like Adaro Energy (ADRO IJ - RP2550 - BUY) in 0Indonesia. Among the diversified majors, Rio Tinto has indicated appetite 01 02 03 04 05 06 07 08 09 YTD 10for only modest-sized acquisitions, but further investment in Toronto-listedIvanhoe Mines appears likely at some stage. The multibillion dollar Source: Bloombergquestion mark remains BHP Billiton’s next move, with our money on an oil& gas play.14 16 December 2010
    • Asia Themes 2011Asia - TECHNOLOGYWill 2011 be a “cleaner” year?Consumer and business demand likely to move in tandem.The sector endured a “messy” year in 2010. Business spending has revivednicely, but the distracting influence of tablets on sales of traditionalgadgets has spooked consumer demand. Wage-inflation worries persist.However, moderated estimates, inventory and valuations, and strongholiday sellthrough bode well. The sector should also cleanse itself oflingering overcapacity next year - TFT-LCD should be the first, but Dram Bhavtosh Vajpayee, CFAand perhaps LED should also look healthier in 2H11. (852) 26008388 bhavtosh.vajpayee@clsa.comConsumer demand has sorted itself out. The success of the iPadcreated a US$30bn market for tablets (estimates for 2011), forcing adramatic reset of the consumer wallet last year. China’s PC-shipmentgrowth fell to 12% in 3Q10, down from 30%+ levels in the previous fourquarters, raising further worries. Mid-year, estimates for PCs and TVs were Sober and healthiercut, and tech underperformed. Since September 2010 though, we have Consumer demand estimatesargued that this process of recalibration has ended, and estimates are now 20low enough to warrant no more surprises. At 3.5% YoY value growth for (% YoY)2011, global consumer-tech-demand forecasts are at their most sobered 15levels of the decade, barring the downturn, and the street expects 10consumer PCs to show zero growth YoY in 1H11. We like this setup, amidpositive holiday season sell through in North America, modest valuations, 5and strong dividend support. China’s long-term PC trajectory should 0stabilise at about 18% shipment growth, impressive for what is now the (5)world’s No.1 PC market. (10)Business spending on a roll. If technology somewhat held on amid the 2005 2006 2007 2008 2009 2010E 2011E 2012Evagaries of consumer spending, its other half - enterprise demand - shouldtake a bow. Businesses spent heavily after many years of sloth - Source: CLSA Asia-Pacific Marketsenterprise servers, PCs, software and IT services all sold briskly, and withthe refresh cycle at an early stage, we see more to come in 2011. Our CIOsurvey indicates that upto 70% of companies will be running Windows 7 byend of 2011, up from less than 15% now. There is much left to be done in Still attractivereversing a decade of underinvestment in enterprise IT. Encouragingly, Valuationsbudgets for 2011 are being framed on time. Taiwan Japan Korea Tech PE (x) 11.3 15.7 9.5Wage inflation will be passé. Wage inflation hit media headlines in Ex-tech market PE (x) 13.9 12.6 10.02010, raising persistent margin fears for assemblers. These worries have Tech PB (x) 2.1 1.3 1.3been proven overdone, as we have noticed some pass through of costs to Ex-tech market PB (x) 1.8 1.0 1.2customers, while crashing component prices for Dram and TFT-LCD panels Tech ROE 12M forward (%) 19.8 9.2 16.8helped extract more wiggle room. Wage inflation is a two-decade reality in Ex-tech ROE 12M forward (%) 14.2 8.5 13.7Chinese manufacturing, but in 2011, it needn’t be a bugbear, in our view. Source: CLSA Asia-Pacific MarketsProduct innovation continues. Tens of tablets are set for launch nextyear. Intel’s Sandybridge, Google’s Gingerbread and initial takes onWindows 8 are some of the key events to watch. LED-TV penetration will Sector starting to outperformcontinue to rise, while its usage in general lighting should also go up. MSCI Asia Tech versus MSCI AsiaOverall, the sector has no dearth of new products in the offing, but unlike2010, which was as creative as messy for stock returns, 2011 should also 120 (rebased) MSCI Asia Tech xJapanbe a year to make money. 115 MSCI Asia-Tech 110 MSCI Asia PacMore positive than negative. We continue to like the beleaguered PC 105space, where Acer (2353 TT - NT$96.2 - BUY) is our top pick, but we also 100like Lenovo (992 HK - HK$5.30 - O-PF) and Asustek (2357 TT - 95NT$278.5 - BUY). Among the assemblers, Quanta Computer (2382 TT - 90 85NT$63.2), Compal Electronics (2324 TT - NT$39.3 - O-PF) and Wistron 80(3231 TT - NT$60.6 - O-PF) will start to ship tablets and more televisions, 75expanding their repertoire beyond just notebooks. Hon Hai (2317 TT - 70NT$115.0 - BUY) had a tough 2010, but 2011 should show it has the Jan 07 Oct 07 Jul 08 May 09 Feb 10 Dec 10means to fight back on wage-inflation headwinds. AdvancedSemiconductor (2311 TT - NT$32.6 - BUY) is our top semicon pick, but Source: Bloomberg, CLSA Asia-Pacific Marketswe also believe sceptics will blink against TSMC’s (2330 TT - NT$69.0 - O-PF) continued financial performance. In Korea, Samsung Electronics(005930 KS - 929,000 won - O-PF) continues to consolidate its dominance16 December 2010 15
    • Asia Themes 2011in memory semicons, while handsets, TVs and now tablets add furthermomentum. A bottoming-out also seems to be at hand for TFT-LCD panelmakers - LG Display (034220 KS - 41,600 won - O-PF), among them, butalso Taiwan’s AU Optronics (2409 TT - NT$30.6 - O-PF) and ChimeiInnolux (3481 TT - NT$38.3 - O-PF). In Japan, Sony (6758 JP - ¥2,988 -BUY) is in a midst of a turnaround that nearly makes yen/US-dollarvagaries irrelevant - cost-savings should ride over it all.Asia - TELECOMSCan data push revenue growth?Data volume could reach a hockey-stick growth stage.Asian telcos’ revenue is growing again due to rising data volume and theincreasing popularity of smartphones and wireless broadband service. Datagrowth may reach a hockey-stick growth stage in 2011 with regionaloperators building out their own application stores and China driving downsmartphone prices. We expect Hong Kong, Japan and Korea to enjoy thebiggest leverage of data growth, while China should see the largest data Elinor Leung, CFAupside. Our top picks are China Mobile and SK Telecom. (852) 26008632 elinor.leung@clsa.comData revenue up 20-30% in most Asian countries. Hong Kong, Taiwanand Singapore have showed the fastest real data (non-messaging) growth in2010, given low bases and market affluence. 3G users account for more Regrowing toplinethan 50% of their customers and smartphone users have also increased to Revenue growth10-20% of total. Data Arpu of smartphone subscribers is normally two to Revenue growth (%)three times that of feature-phone users. Thailand and Malaysia have HKbenefited from a strong wireless-broadband uptick. Internet access has been Smartone FY10 7 HTHK 1H10 5the most popular mobile data application in Asian emerging markets. Given PCCW 1H10 3the low fixed broadband penetration, wireless broadband has become the Taiwanprimary form of internet access in these countries. TWM 9M10 1 FET 1H10 (1)Asian telcos want their own app stores. Japan is the pioneer in Singaporedeveloping data applications (apps). NTT Docomo has launched a wide Singtel 1HFY11 10range of data services from social-networking services, entertainment Starhub 9M10 5(movie, music, games, books), location-based service to mobile payment. M1 9M10 0Korea’s SK Telecom (017670 KS - 175,500 won - BUY) has also announced Koreathat it will invest 1tn won (US$888m) to speed up its mobile data platform. SKT 9M10 3 KT 9M10 6The country remains relatively protective of its mobile data market, Malaysiafavouring domestic players. Foreign apps store such as Apple’s iTune Store Celcom 1H10 13and Google’s Andriod Market have yet to offer Korean songs and games. All Maxis 1H10 2three Korean telcos have already launched their mobile apps store. China Digi 9M10 9Mobile (941 HK - HK$77.40 - BUY) has launched big marketing campaigns Thailandto invite students and young people to write apps and has received 100,000 AIS 9M10 6 Source: Companies, CLSA Asia-Pacific Marketssubmissions. In the recent Asia-Pacific Economic Cooperation CEO Summit,company chairman Wang Jianzhong said he believes China’s future datacontribution will reach Japan’s level (50% of Arpu).Smartphones get cheaper. China’s large mobile market has helped Real data growthsupport the proliferation of mid- to low-end smartphones and drive down Real data growth (non-messaging)prices globally. About 19% of smartphones sold this year was whitebox,while nearly 80% of China Mobile’s 30 TD smartphones available in the 60 (%) 10CL 12CLstores were sold for US$150-300. With subsidies, the smartphones only 50cost US$0-150. We believe China is one of the best positioned markets for 40mobile data growth given its good telecom infrastructure and large 30internet market and culture. Its 3G users are likely to reach 46m by year- 20end and should double in 2011. Majority of the 3G subscribers are 10smartphone users. 0 Docomo Smartone SKT CMHKTop picks. Asian telcos are trading at undemanding 13x 11CL PE, 15-20%below the historical average. China Mobile and SK Telecom are best Source: CLSA Asia-Pacific Marketspositioned for the new data era and their valuations are attractive at 7-11x11CL PE with 4-5% yields and potential data upside.16 16 December 2010
    • Asia Themes 2011Asia - SOCIAL RESPONSIBILITYIs Asia becoming more responsible?It’s all about environmental and labour standards.After the BP and Foxconn events this year, world investors are puttingmore focus on the environmental, social and governance (ESG) risks andopportunities facing the stocks they own. ESG investing is on the rise andin some parts of the world pension-fund managers are mandated to investalong these lines. Companies can disclose their activities throughcorporate-social-responsibility (CSR) reporting, which is rising fast in Asia, Simon Powelldespite still being essentially a voluntary activity. (852) 26008626 simon.powell@clsa.comReporting on the rise. Corporate social responsibility, if defined by thepublication of CSR reports, apears to be on the rise in Asia. The regionnow accounts for more than 20% of global CSR reports versus 12% justfive years ago. Based on the absolute number of companies, Europe stillleads the way. We believe this reflects the pull effect of European fundsand legislation in 2000 that required pension funds to highlight tomembers if they take into account the environmental and socialgovernance of the companies they invest inCSR reporting remains largely voluntary. Unlike in Europe andAustralia, CSR reporting remains mostly a voluntary affair in China, Japan,Malaysia, Thailand, Hong Kong and Singapore. Recent policy moves inIndonesia and the Philippines could represent a move towards mandatoryreporting. In August 2007, the Philippines’ Board of Investment startedrequiring CSR programmes and reporting. Back in 2007, the Indonesiangovernment enacted a corporate law that required most companies outsideof the financial sector to disclose their CSR activities.It’s different in Asia. The concept of CSR is rooted in the Western Asia CSR reporting rising fastprinciples of liberal democracy, justice and social equity. We believe Asian Number of companies registering CSR reportsfirms, operating in fast-growing economies with different environmental andlabour standards, face unique issues, where many of these Western 700 (No. of companies)principles may not apply. Investors who have a focus on CSR need to assess 600 Asia Europe Northern America Africaregional CSR through a set of “Asian lenses”. Our November Corporate 500 Latin America Oceaniagoodguys? report analyses the CSR reports of 50 of Asia’s largest companies. 400While the move to more reporting is positive, we are critical of the lack of 300disclosure and transparency in many. While CSR’s deeper subtleties in the 200West are yet to emerge in Asia, we believe here it is all about environmental 100and labour standards. Related laws will only tighten over time, so firms that 0are doing the most in these areas should be able to maintain their ROEs and 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009outperform those that are lagging in CSR.Three approaches to responsible investing Source: Global Reporting InitiativeType Detail ExamplesNegative The exclusion of certain companies or industry sectors from Armaments, firearms and military contractingscreening investment portfolios on the basis of their profile against Nuclear power various social, environmental and ethical criteria TobaccoPositive The building of investment portfolios from companies that have Environmental policy, codes, managementscreening been actively selected on the basis of their strong performance systems on social, environmental or ethical issues Respect for human rights, working conditionsEngagement The use by investors of robust dialogue with the boards or other Discussions on risks related to: management of companies with the aim of altering corporate Lack of policy on climate change behaviour in relation to social, environmental or ethical issues Activities in Burma Pricing of medicines in developing countriesIntegration Environmental and social governance is incorporated into all The ESG impacts to earnings are assessed and investment analysis and decision making priced into the stockSource: CLSA Asia-Pacific Markets16 December 2010 17
    • Asia Themes 2011Asia - THEMATICSWhich stocks might get discovered?ROIC screen to identify undercovered stocks with rerating potential.Our high-ROIC-Ebit/EV basket was up 39% YTD to 10 December, almostthree times the return of MSCI Asia ex-Japan. Part of the power of thescreen is in identifying stocks that are undercovered. As these stocks crossUS$1bn market cap, they get onto more investors’ radar screen. Some ofare mid caps of about US$5bn in size. Advanced Info Services, KangwonLand, Soho China, China Zhongwang, TVB, CJ Corp, Berau Coal and Wan Amar GillHai Lines are potential outperformers into 2011. (65) 65122337 amar.gill@clsa.comThe ROIC-Ebit/EV screen in brief. Our screen picks stocks with pretaxROIC above 25%, of which we take those in the top quintile on Ebit/EV.We derive the data from Bloomberg, with ROIC and Ebit based on trailing Outperforming12-month reported financials. We use a cutoff market cap of US$1bn and ROIC-Ebit/EV screens and MSCI AxJUS$1m average daily volume. 220 (rebased to 100) Stocks not coveredStar performers often the unrated stocks. As we use Bloomberg data, 200 ROIC+Ebit/EV basketthe universe of stocks goes beyond our core coverage. We have found that 180 MSCI Asia ex-Japanthe strongest performers in this basket have tended to be stocks not well 160covered by the street - at least we do not cover them. Most of them are 140just getting over our market-cap (US$1bn) and liquidity (US$1m/day) 120thresholds. Some are companies that have fallen out of favour, thus we 100(possibly other brokers as well) have dropped coverage. Those on this 80screen are able to generate a good return on capital; applying an Ebit/EV June 09 Dec 09 Jun 10 10 Dec 10valuation overlay the screen helps to pick those that are potentially due fora rerating. YTD, the stocks not under our coverage in this basket are up Source: Bloomberg, CLSA Asia-Pacific Markets42.5%, against the 38.9% return for the ROIC-Ebit/EV screen. Worth a closer lookWhich stocks have potential to rerate? Twenty stocks in the basket ROIC and Ebit/EVare not under our coverage (see sidebar). Most are just above the US$1bn Company Code ROIC (%) Ebit/EV (%)market-cap cutoff. Of the larger ones are two of the Thai telcos, Advanced China Zhongwang 1333 HK 26.2 35.6 Soho China 410 HK 32.4 29.1Info Services and Total Access Communication, with the latter at an Taekwang Industrial 003240 KS 30.2 24.9Ebit/EV of almost 14%. From Korea, Kangwon Land in the past 12 months Wan Hai Lines 2615 TT 35.7 18.7generated a pretax ROIC of 29%, while CJ Corp has an ROIC of 73%; both Shenzhou Int’l Green Cross 2313 HK 006280 KS 39.1 41.3 15.8 14.8are currently at Ebit/EV of 10%. The mid caps from China in the list are Total Access Comm DTAC TB >100 13.8China Zhongwang and Soho China. At around US$2bn market cap but not Berau Coal BRAU IJ >100 13.8 Hyundai Home 057050 KS 58.2 12.0under our coverage are TVB of Hong Kong and Berau Coal of Indonesia. Grand Korea Leisure 114090 KS 62.4 11.8 361 Degrees 1361 HK 30.6 11.8Buyer beware! The trouble with using trailing data is that the businesses Fufeng 546 HK 30.1 10.8for some of the companies may be heading down. The attractive trailing Peak Sport 1968 HK 26.1 10.6valuations could thus be misleading about prospects. Hence, the approach Powerchip Tech 5346 TT 35.8 10.5 Asiana Airlines 020560 KS 27.9 10.3works as a basket, or as a prompt of which stocks are worth further Television Broadcasts 511 HK 30.5 10.2investigation. We provide a list of stocks with above US$1bn market cap Xingda Intl 1899 HK 25.6 10.2that show up on the screen and may be worth a closer look in the sidebar. CJ Corp 001040 KS 73.1 10.1 Kangwon Land 035250 KS 29.0 10.0 Advanced Info ADVANC TB 167.5 9.9 Source: Bloomberg, CLSA Asia-Pacific MarketsAustralia - MARKETSeeking Asian exposure without EM risk?Major iron-ore and coal suppliers to China and India.For investors with similar concerns to Russell Napier about corporategovernance, currency controls, liquidity and/or sovereign risk, Australia istheir answer. China and other emerging markets are driving demand forenergy and materials, of which Australian companies are among the leadingproviders. A range of secondary beneficiaries will also see topline growth. Thekey risk is labour- cost inflation. In addition, those companies exposed to Scott Ryalldomestic discretionary consumer spending look unlikely to share in the upside. (61) 285714251 scott.ryall@clsa.comResources - Excellent exposure to Asian growth. Leading the pack isBHP Billiton (BHP AU - A$45.65 - O-PF) and Rio Tinto (RIO AU -A$87.90 - O-PF). Both operate a suite of world-class assets, generally inOrganisation for Economic Cooperation and Development (OECD) countries,but supply the bulk of their output to emerging markets, in particular18 16 December 2010
    • Asia Themes 2011China. As can be seen in the charts, China is the key source of marginal China is the key driverdemand for iron ore and coal (India is also a major coal consumer). BHP Global iron-ore demandand Rio are top Australian producers of both and account for much of the 1,800 (m tonnes)supply increase over the forecast period. We continue to prefer BHP’s more 1,600diverse commodity mix (no commodity makes up more than one-third of 1,400earnings) to Rio’s dependence on iron-ore (about half of earnings). 1,200 1,000Independent coal producers and developers. Riversdale Mining (RIV 800AU - A$16.23 - BUY) is our preferred coal play, with its unique and much- Other 600sought-after exposure to hard coking coal. Macarthur Coal (MCC AU - Europe 400A$12.84 - BUY) offers direct exposure to the Asian steel markets through its North Asia 200 China (domestic + import)dominant position in the seaborne pulverised-coal-injection market. Investor 0sentiment on gold is buoyant, Chinese imports are surging and we believe 2008 2009 10CL 11CL 12CL 13CL 14CLNewcrest Mining (NCM AU - A$40.83 - BUY), Asia’s own gold major, offersthe most secure and low-risk exposure to the yellow metal. Source: ABARE, CLSA Asia-Pacific MarketsSecondary beneficiaries. These are the suppliers of products and Mainly from China and Indiaservices to the miners. Key exposures: commercial explosives to the Global coal (coking and thermal) demandmining industry - Orica (ORI AU - A$25.03 - BUY) and Incitec Pivot (IPL 1,600 (m tonnes)AU - A$3.76 - O-PF); engineering and project management to oil & gas - 1,400 China India Japan Other Asia South Korea EuropeWorleyParsons (WOR AU - A$27.45 - BUY); contract mining - Leighton 1,200 Global other(LEI AU - A$33.62 - SELL) and Monadelphous (MND AU - A$17.39); mine 1,000construction - Boart (BLY AU - A$4.48); and infrastructure construction to 800support production and export of resources - Leighton, Downer (DOW AU -A$4.65), Decmil (DCG AU - A$2.65), Asciano (AIO AU - A$1.62 - SELL) 600and QR National (QRN AU - A$2.77). We forecast significant demand for 400these firms over the coming two years. 200 0And then the companies that have Asian assets. Goodman (GMG AU - 2008 2009 10CL 11CL 12CL 13CL 14CLA$0.66 - O-PF) is a global developer/fund manager of logistics-warehouseassets. It is 18% owned by China Investment and has one of the largest Hong Source: ABARE, CLSA Asia-Pacific MarketsKong logistics-warehouse business (US$1.6bn assets under management). Itis also growing in China: US$200m of assets in Shanghai and a project-development agreement with Langfang municipal government.China - STRATEGYHow do you fight hot money?Use quantitative tightening to battle quantitative easing.The Chinese government is worried that hot money may have contributedto inflation. The PBOC in an unprecedented move raised the reserve-requirement ratio (RRR) twice in 10 days in November and once inDecember with more measures to follow. If China continues to experiencehot-money flows and inflation continues to rise, Beijing is likely toimplement new quantitative tightening measures. This may be good for Francis Cheungthe economy, but will hurt sentiment in the policy-sensitive stockmarket. (852) 26008548Hot money has the government worried. The unusual amount of hot- francis.cheung@clsa.commoney flows in September has the Chinese government worried, especially Hot money worries governmentswith the USA’s QE2, which caught China by surprise. Beijing is even more Measures in other countriesconcerned that the inflows maybe part of the reason why the country’s CPI Country Year Measuresinflation has soared. It has already announced some measures to curb hot Brazil 1993-97 - Tax on capital flows on stockmarketmoney but has yet to reveal the full extent of its plan. Investors that are - Tax on foreign loans and FX transactionslooking to benefit from QE2 flows to the stock market need to be aware Chile 1991-98 - Introduced URRthat China will not just sit and not take countermeasures, especially when - Raised the discount rateit believes it is the cause of rising inflation. Colombia 1993-98 - Introduced URR 2007-08 - Introduced of URRPlans to trap hot money. China has a closed capital account and the - Set limits on the currency derivative positions of banksability to manage/restrict hot-money flows better than most countries. Theeasiest way to circumvent capital controls is to disguise it as trade or Croatia 2004-08 - Uplift reserve requirements on bank foreign financingsforeign direct investment. People’s Bank of China (PBOC) governor Zhou Malaysia 1994 - Ban fixed income sales to non-residentsXiaochuan had already confidently talked about the central bank’s plan: - Ceilings on banks net liability position‘We can have our own administrative measures to block the flow of this Thailand 1995-96 - Introduction of URRhot money . . . we will collect and put this money into a pool so that it will - Introduced asymmetric open-position limitsnot affect the economy’. 2006-08 - Introduction of URR Source: Wind, CLSA Asia-Pacific Markets16 December 2010 19
    • Asia Themes 2011New measures announced hint at things to come. The State A weaker base effect in 2Q10administration of Foreign Exchange has taken action and announced seven CPI food indexpolicies to plug some of these loopholes. 170 (Dec 2000 = 100) 165 Impose a floor on banks’ net forex balance, which cannot be less than 160 the level as at 8 November 2010. This should prevent excessive forex 155 150 flows from building up at the banks and not entering the market. 145 Strengthen forex settlement management. Banks will be restricted in 140 135 using letters of credit for settlement. 08 09 09 09 09 09 09 09 09 09 09 09 10 10 10 10 10 10 10 10 10 09 10 Mar Apr Mar Apr Feb Aug Sep Feb Aug Sep Dec Dec Jan May Jun Oct Nov Jan Oct May Jun Jul Jul Manage quotas of foreign short-term debt financial institutions use. For trade and forex transactions, strengthen identification process of Source: Wind, CLSA Asia-Pacific Markets parties. Check whether if transactions are legitimate or getting around forex controls. More capital control to manage hot money Strengthen the supervision of foreign direct investment, which is a An uptick in hot money in September 2010 large source of capital inflows. 50 (US$bn) 40 30 Restrict repatriation of capital by Chinese companies that raised capital 20 overseas. 10 0 (10) Restrict onshore companies/individuals setting up offshore companies. (20) (30) (40)New quantitative tightening. If hot-money flows continue and inflation 08 09 09 09 09 09 09 09 09 09 09 09 10 10 10 10 10 10 10 10 09 10remains a problem, the PBOC is likely to announce more serious capital Mar Apr Mar Apr Feb Aug Sep Feb Aug Sep Dec Dec Jan Oct May Jun Nov Jan May Jun Jul Julcontrols. Governor Zhou’s plan to keep hot money in a pool sounds like he Note: Hot money = FX change - current-account surplus -intends to use unremunerated reserve requirement (URR), which is one of FDI (3mma). Source: Wind, CLSA Asia-Pacific Marketsthe most popular forms of capital management. Under such a plan, banksand financial institutions are required to deposit at zero interest rate withthe central bank an amount of funds equal to the net increase in foreignexchange. Brazil, Chile, Columbia, and Thailand have adopted URR. It isusually used on foreign loans, but could be extended to trade transactionsand portfolio flows. There is also consideration of imposing a “Tobin tax”which is a tax on conversion of forex into the yuan that would discourageshort-term capital flows.Stock market is the path of least resistance. The government believesasset inflation is potentially more destructive than CPI inflation, as Japan’sexample illustrated. With inflation concerns, the government will remainvigilant and will continue to tighten controls on property. The relativelytight liquidity condition and increased housing supply, which startedconstruction since 4Q09, are likely to put home prices under pressureespecially in 1H11. If excess liquidity has to flow somewhere, the path ofleast resistance is the A-share stock market, which should perform bettergiven low government intervention.For more of our 2011 outlook for China, see our recent Bull riding report.China - MARKETHow to play to become No.1?China to rack up more number-ones in consumption-related sectors.While the credit crisis has slowed growth in developed markets, China’ssuccessful stimulus programmes has propelled the Middle Kingdom in itsquest for top status in various sectors. The country’s population remainsthe largest in the world at 1.3bn; India is the only competition at 1.2bn.With China clinching more No.1 spots, investors should be tilting portfoliosto benefit from the resulting consumption shift towards Asia. Danie Schutte, CFA (852) 26008573Recovery in developed-market banks. We have seen radical shifts in danie.schutte@clsa.comthe global financial landscape following the outbreak of the subprime crisisin 2007. China’s banks have underperformed their global peers during2010, as the developed-market institutions recovered from a low base.Despite these trends, the total market cap of PRC banks (US$965bn)remain well above their US peers’ US$765bn. With forecast 8% GDPgrowth, the Chinese banks are likely to increase its lead in 2011. In Hong20 16 December 2010
    • Asia Themes 2011Kong, we like Bank of China (HK) (2388 HK - HK$25.85 - BUY). For China tops despite underperformancedirect exposure, consider Bank of China (3988 HK - HK$4.22 - BUY) and Global banks’ market capitalisationChina Construction Bank (939 HK - HK$7.10 - BUY). China USA UKHighspeed rail branches out. China has 7,430km of rail track, more Canadthan triple than that of its nearest rival, Japan. Of that, five rail lines, for a Japan Austratotal 1,989km, are designed for 350km/hour, with a further 10,000km Franceunder construction. The country is embarking on a plan to build a matrix of Spain Italy (US$bn)four major north-south and four east-west routes using high-speed rail to 0 200 400 600 800 1,000cover 13,000km. The original target was to complete major trunk routesby 2020, but with the acceleration of infrastructure spending this has been Note: Data as at close of 1 December 2010. Source: Bloomberg, Datastream, CLSA Asia-Pacific Marketsbrought forward to 2015. For direct exposure, investors should look atChina Automation (569 HK - HK$6.39 - O-PF) and Hollysys (HOLI US -US$15.45 - O-PF), but note the theme extends beyond this, to the Already leading with plans to quadrupleconsumer, hospitality and property sectors, among others. Global high-speed rail track ChinaGaming bonanza. Macau has been the largest gaming market in the world Japan Francesince it overtook Las Vegas in 2006. We see more room for growth and little Spain Italyconcern for saturation in the market, while America’s expected modest Germany Korea Before 2000recovery in 2011 will mitigate oversupply concerns. The appetite to gamble Taiwan Benelux 2000-05is much more prominent in Asia versus the USA. In Asia, gaming is mostly Turkey Netherlands 2006-10 UK (km)either a habit or a business, resulting in a much larger average bet than in SwitzerlandLas Vegas, where gaming is a consumer-discretionary item. Meanwhile, the 0 2,000 4,000 6,000 8,000Asian wealth effect should follow the J-curve, and will continue to fuel sector Source: World Bank, CLSA Asia-Pacific Marketsgrowth. Our top Macau picks are Sands China (1928 HK - HK$16.58 - BUY)and Wynn Macau (1128 HK - HK$17.06 - BUY). Low adoption leaves room for growthBroadband - High growth, low penetration. In 2009, China attained Broadband penetrationseveral world’s No.1s: internet user base of 384m (versus 240m in the 50 (%)USA); mobile user base of 747m; handset shipments of 347m units; and Urban Ruralbroadband subscriber base of 103m. It was also the second-largest PC 40installed base in the world with 180m units versus the USA’s 291m. In 303Q10, for the first time ever, China became the world’s largest market for 20PC shipments. Comparing this to its population, however, we still see low 10penetration rates. Only 29% of the country is online, 8% has their own 0broadband connection, 56% uses mobile phones and 14% owns a PC. 2005 2006 2007 2008 2009China still has plenty of room to grow. We prefer internet names such as Source: CNNIC, CLSA Asia-Pacific MarketsBaidu (BIDU US - US$106.62 - BUY) and Tencent (700 HK - HK$182.00 -BUY) over the more-capital-intensive telecom companies.China - A SHARESWill small still be beautiful?Market volatility due to tightening concerns offers buying opportunity.Manop Sangiambut (86) 2120205910 manop.sangiambut@clsa.comWe expect a shift in outperformance from small-cap growth stocks to A-share large caps due to rate hikes and the former’s frothy valuations. TheSME Composite has outrun the CSI300 - a key proxy for A shares to theglobal investment community - this year. A return to a stronger CSI300would boost sentiment of overseas investors. We see ongoing marketvolatility due to tightening concerns as buying opportunity. Our picks for an Manop Sangiambutinflation/rate-hike scenario: Ping An, Suning, Shanghai Jahwa and banks. (91) 2266505056 anirudha.dutta@clsa.comSmall is beautiful. On the face of it, the A-share market has had a bad Unprecedented divergenceyear in 2010, with the CSI300 down 13% YTD so far this year, significantly CSI300 versus SME Composite 12M performanceunderperforming the HSCEI. However, the mood among A-share investorshas not been entirely bearish. There has been an extreme split in the way 1,000 (rebased) (%) 350 CSI300 (LHS)investors view large and small caps. The SME Composite index rose 21% 800 SME Composite (LHS) 250YTD this year, arguably one of the better performing indices in the region. SME out(under)performing CSI 150 600Evidently, the CSI300 turnover also tumbled from more than 50% of 50market total historically to below 40% this year. What has caused this shift 400 (50)is the tightening policy that restricts property and bank performance and 200 (150)China’s 12th Five-Year Plan to spur interest in small-cap emerging-growth 0 (250)names. All are supported by a wave of small-cap IPOs. Valuation also Jun 05 Mar 07 Jan 09 Oct 10reflects this contrast. The CSI300 is on 12x 11E PE versus 25x for the SMEComposite and 42x for the GEM board. Source: CLSA Asia-Pacific Markets16 December 2010 21
    • Asia Themes 2011Rate hike will change landscape. The critical question is whether we CSI300 not good proxy for A shares in 2010will see a shift in the so-called investment style from small caps to large CSI300 turnover as a portion of total marketcaps. If history provides any guidance, it will depend on the way interest 65 (%) (%) 7rate moves up. During the last rate-hike cycle, large caps outperformed 60 6small caps. With many small-cap names, in particular GEM-listed stocks, 55having frothy valuations, we believe rate hikes will trigger large-cap 5outperformance. Our view is that there would be at least one rate hike by 50 4year-end and a couple more next year. These should trigger NIM 45expansion for banks, investment gains for insurance firms and a shift in 3 40fund flow to large caps. In addition, history also suggests as rate hikes CSI300 2progress, negative real interest rate widen. Especially this time round, rate 35 SME100 (RHS)hikes started when real rate is in negative territory. With household 30 1deposit standing above US$4tn this year, we believe liquidity is still Jan 07 Apr 08 Jul 09 Oct 10abundant, while concerns about significant new-loan slowdown and Source: CLSA Asia-Pacific Marketsasymmetric rate hikes should be overdone.Positive on A shares. We see the ongoing correction in the A-sharemarket as a buy opportunity. Our index target is 4,200 for 2011. We areOverweight banks, brokers, insurance, consumer, IT, nonferrous metalsand coal. We have Neutral/Underweight stance on property, steel,healthcare, machinery, construction, telcos and utilities. Under aninflation/rate-hike scenario, we like Ping An (601318 CH - Rmb60.95),Suning (002024 CH - Rmb14.30 - BUY) and Shanghai Jahwa (600315 CH -Rmb37.13 - BUY).Hong Kong - PROPERTYWill HK property prices fall in 2011?Upside in residential prices is capped. We prefer landlords.Residential prices will continue to rise as the purchasing power of cash inHong Kong-dollar terms is likely to fall further before the USA stops easing.However, the upside will be capped, hence our Underperform call on SunHung Kai Properties and Henderson Land. The landlords stand tobenefit as this is the only segment that is still a clean proxy for theeconomic growth backed by China. We prefer Wharf, which should enjoy a Nicole Wongstructural rerating as it turns into an offshore China-consumption play. (852) 26008207 nicole.wong@clsa.comResidential prices - Muted downside but capped upside. Thoselooking for a substantial residential-price correction will be disappointed.We expect prices in the near term to only dip by 2%. Governmenttightening measures will reduce short-term investment demand, which weestimate accounts for about 15-20% of total. Note, however, that for thecoming year at least, primary supply remains some 30-40% below normaldemand level. Meanwhile, secondary-market participants who had plannedto sell to move on to the next profitable trade might now just hold on totheir exiting property to optimise profit, reducing supply.Policy moves. On 19 November, the HK government introduced much Growth of resi prices drive developer perfmore stringent property tightening measures than the market expected: Sun Hung Kai NAV discount and Centa City Indexthe 5-15% short-term resale stamp duty is essentially a capital-gain tax - 8 (% MoM) Centa City Index (%) 50 SHKP NAV disc (RHS)an unprecedented concept in the property market of Hong Kong. This, 6 40 30along with the raised down payment requirement, will significantly reduce 4 20the attractiveness of physical properties as an asset class for short-term 2 10 0investment. A watertight defence: even less expected was the 0 (2)synchronised lift in the down payment requirement for all non-residential (4) (10) (20)properties to 50%, which ring-fenced the commercial properties against a (6) (30)potential liquidity shift from the residential segment. (8) (40) SHKP avg NAV (10) disc=(13.5%) (50)Sabotaged relationship. Even if the measures cannot dislodge the 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10uptrend in physical prices, they will still damage the prices’ high-betarelationship with demand, which is the key appeal of HK property stocks Source: Centaline, CLSA Asia-Pacific Marketsthat trade on the capital-value cycle.Underweight developers; Overweight landlords. We maintain ourUnderperform rating on Sun Hung Kai Prop (16 HK - HK$132.40 - U-PF)and Henderson Land (12 HK - HK$53.75 - U-PF). We are SELLers of22 16 December 2010
    • Asia Themes 2011property agent Midland (1200 HK - HK$6.36 - SELL), the key loser in the Demand will spill over to decentralized arealatest tightening given its reliance on market churn (which is fuelled Central office rental indexmainly by investment demand) and the lack of NAV for downside 250protection. Central-office landlord Hongkong Land (HKL SP - US$6.88 - 200O-PF) is not directly exposed to policy risks but the stock is pricing in high 150expectations. We recommend Wharf (4 HK - HK$57.55 - BUY) instead,whose shopping malls are honey pots for mainland shoppers and hence 100deserves a structural rerating as an offshore China consumption play. And 50of course, it doesn’t hurt as some of the Central tenants are feeling the 0temptation to move to cheaper decentralised offices. Wharf’s Tsimshatsui Jan 84 Oct 92 Jul 01 Apr 10office should gain greater bargaining power. Source: Jones Lang LaSalleIndia - MARKETCommodity curse in 2011?Rising commodity prices are headwinds going into 2011.If Goldilocks were an investor in equities in 2010, she would have had tolook no further than India for the metaphorical bowl of porridge. However,after the 23% rebound in the Sensex from its mid-year low, against abackdrop of “just right” conditions, rising commodity prices are set to playspoilsport. The key question for 2011 is whether the market will be able toovercome such headwinds. We are concerned, but to us it appears a N Krishnantactical issue. (91) 2266505070 krishnan@clsa.comGoldilocks no more? While India’s strong consumer-led rebound ingrowth has stood out amid an uncertain global outlook, the weakconditions of world markets have, for most part of the year, also helpedrein in inflationary pressures. The attraction of growth and expansion inyield differentials lured a record US$29bn of net inflow from foreigninstitutional investors (FIIs) and pushed up market PE to a 25% premiumvis-à-vis the 10-year average. With all commodity classes rallying in Benefitting from the carry traderesponse to signals that central banks will support loose monetary policies, Yield differentialthe Goldilocks scenario is unwinding. 140 (US$bn) US 10-year (LHS) 14 India 10-yearInflation fears to resurface. While the pause the Reserve Bank of India 120 Capital flows 12 100 10(RBI) signals reflects its desire to assess the unfolding global scenario and 80 8the impact of an effective 300bp tightening in the policy rate, a rethink on 60 6the inflation trajectory could cause the central bank to change tack sooner; 40 4non-food inflation has inched up from the August-2010 trough and global 20 2commodity-price surges will prompt manufacturers to hike prices of value- 0 0added products further. The past few weeks have seen such 2000 2002 2004 2006 2008 2010 1H10announcements by Maruti (MSIL IN - Rs1,413.5 - O-PF), Hero Honda andHyundai India. Source: Bloomberg, RBI, CLSA Asia Pacific MarketsTwin deficits. The hardening price of crude oil will also raise the riskperception for the Indian market, given its adverse impact of the current Non-food inflation troughed in Septemberaccount and the fiscal deficit. India’s dependence on imports for up to 70%of its crude-oil requirement implies that a rise in crude price to US$120/bbl Inflationcan tip the current-account deficit to 4.5-5% of GDP. In the current 10 (%)scenario, where capital inflows have come predominantly from portfolio 8investors in equities, risk-aversion can set in quickly. The reluctance of the 6 4government to pass on higher petroleum product prices to the consumer 2will impinge on the fiscal deficit as well, reversing the expectations of a 0continued improvement on this front in FY12. (2)Earnings boost, but PE under pressure. With the huge weighting of (4) Apr 06 Oct 07 Apr 09 Oct 10sectors like oil & gas and metals in the aggregate earnings pool, the initialimpact on Sensex earnings could be positive. However, the rising macro Source: Office of Economic Advisor, CEIC, CLSA Asia-concerns will weigh on PE. A flashback to 2007-08 shows commodity price Pacific Marketsresets fuelled the last leg of earnings upgrades, but multiples started toderate three months before the market eventually peaked. Tactical shiftstowards emerging markets like Russia and Brazil, which are morepositively geared to strong commodity prices and trade at a substantialdiscount to the Indian market, are also likely to play out.16 December 2010 23
    • Asia Themes 2011Where to hedge? While the market looks vulnerable to a tactical Derating ahead of market peakcorrection on a continued commodity rally, the fragile state of some of the Market PElargest global economies raises question on the sustainability of high 12 (%) WPI YoY (LHS) (x) 26 CRR (LHS)commodity prices. We would thus be less worried about the likelihood of a 11 1-year fwd PE 24 10lasting impact on the market or economy. Meanwhile, some of the best- 9 22 20managed Indian companies are positively leveraged to global commodities. 8 18Aluminium play Hindalco (HNDL IN - Rs224.7 - BUY) will see a capacity- 7 16 6driven 23% Cagr in volume from FY12 and enhanced degree of integration 5 14through startup of its Utkal Alumina project. Tata Steel (TATA IN - 4 12 3 10Rs645.5 - O-PF) is directly leveraged to improved pricing in Europe Jan 07 Apr 07 Jul 07 Oct 07 Jan 08 Apr 08 Jul 08through Corus, but also has wide-margin, integrated capacity comingwithin India over the next 12 months. Concerns about an acquisition bid Source: Bloomberg, CLSA Asia-Pacific Marketsby the Vedanta group has hampered onshore exploration and productionmajor Cairn India’s (CAIR IN - Rs336.4 - O-PF) share-price performance,but with visible production rampup and a Rs40 upgrade to fair value forevery US$10/bbl rise in the crude price, the risk-reward is favourable.India - ECONOMICSWill the investment upturn lose steam?Infra spending and private-sector capex to push investments in 2011.A key concern about India’s macro outlook is whether the ongoinginvestment cycle will lose steam. This could be a function of a still-cautiouscorporate sector, political fallout from corruption-related scandals, and/orslower pace of loan approvals by public-sector banks following a recentbribery scandal. However, we expect the investment upturn to furtherstrengthen in 2011-12 due to the combined effect of higher infrastructure Rajeev Malikspending and an increase in private-sector capex. (65) 64167890 rajeev.malik@clsa.comVulnerable to global conditions. In an interdependent world, noeconomy is immune to a deceleration in growth in developed markets, andIndia is no exception. If global growth disappoints more than what we We project a strong investment upturnexpect, the Indian economy will be affected via the financial markets and India GDP growth versus investment rateconfidence channels, apart from export transmission. However, India’s realsector impact will be much less pronounced than in other Asian economies 50 (% of GDP) GDP growth (RHS) (%) 14 Investment ratebecause the country is less geared to exports. 45 12 Actual Forecast 40 10Investment spending will rise sharply. The main reason for the 35 8collapse in investment spending after the Lehman bust was the lack of 30 6available financing as local bank lending tightened, international capitalmarkets froze, and stock prices plunged. Demand dynamics are now 25 4compelling and an investment rebound is already underway that should be 20 2the start of a multiyear upturn in investment spending. In the first-half of 01 03 05 07 09 11 13 15the current fiscal year (FY11), gross fixed capital formation (GFCF) Source: CEIC, RBI, CLSA Asia-Pacific Marketsincreased 14.9%YoY relative to GDP growth of 8.9%.Corporate capex will also pick up. The slowdown in some infrastructure On a gradual uptrendcontracts, such as in roads, this year is likely to reverse next year. Also, Net FDIIndia is a supply-constrained economy that has not added significant 35 (US$bn)capacity in the past couple of years. With GDP growth running at 8-9% Actual Forecast 30annually, further capacity additions by the private sector will have to occur. 25Credit availability and bureaucracy are key risks. Additionally, it is 20important to bear in mind that India has the second-highest GDP growth 15 10rate despite having the third-lowest loans/GDP ratio in Asia. This indicates 5that the economy is less reliant on bank credit compared to other 0countries, partly because of its heavier dependence on the service sector 92 94 96 98 00 02 04 06 08 10 12for growth and a large informal economy. Still, it would be important forthe government to ensure that there is no slowdown in either the pace of Source: CEIC, RBI, CLSA Asia-Pacific Marketsinfrastructure contracts awarded or in credit disbursal to the infrastructuresector, so as to avoid any downside risk to economic growth.24 16 December 2010
    • Asia Themes 2011India - POLITICSIs politics a risk?Various sectors see increased government-intervention risk.As we expected, India has divested minority stakes in profit-makingpublic-sector undertakings (PSUs) in 2010. But there has been no progresson various pending reform bills. We expect the government to be on theback foot in 2011 thanks to alleged scams and scandals, and decision-making is likely to be slow. A busy election calendar at the state level willnot help in 1H2011. Thus, politics remains a key risk, with metals & Anirudha Duttaminerals, infrastructure, real estate and banking being the most vulnerable. (91) 2266505056 anirudha.dutta@clsa.comDisappointing 2010. We had expected that in 2010 the government waslikely to move forward on the various economic bills and relaxing fixed-direct-investment (FDI) controls on certain sectors, such as retail andinsurance since this was relatively an election free year with Bihar being theonly major state election. We had also anticipated India to push forward A key challenge for the UPA governmentwith minority-stake sale in profit making PSUs. Lacking political consensus Inflation likely to moderatewithin the coalition, the government did not push through the economic 18 (% YoY)reforms proposals and bills. However, it made good progress on stake sale 15in PSUs and in the auction of 3G spectrum. In 2H10, the Congress party and 12the government got embroiled in multiple alleged scams and scandals, 9which have brought the functioning of the latter to a virtual standstill. 6Congress is on the back foot due to the scams and persistent high inflation, 3and the opposition looks reinvigorated. Internal law and order issues like 0Naxals and separatism in Jammu and Kashmir remain key concerns. (3) Apr 05 Mar 07 Dec 08 Oct 10Can the India investment story be dented? Scandals, corruption and Source: Bloomberg, CLSA Asia-Pacific Marketsuncertainty around policy-making can dent the investment case. The newfound enthusiasm of the Environment Ministry threatens to derail numerouslarge projects, even as it has rightly brought focus on balanced developmentand environment protection. While it is nobody’s case that environment normsbe flouted, companies like Korea’s Posco (005490 KS - 477,500 won - O-PF)have been waiting for more than five years for different clearances. Thebanking scandal involving a few PSU banks and institutions can result indecision paralysis, especially if a witch hunt commences on past loan decisions Strength in parliamentand waivers. At its best, the slowdown will last a few quarters and its worst Number of seats in parliamentcan be longer. At risks are delays in large projects, introduction of the goods & BJD, 14services tax, change in FDI norms in insurance, retail and airline, and key bills CPI(M), Others,in banking reforms, land acquisition and higher education. 16 89 INC, 208Positive message from Bihar. The 2G scam has revived the memories of DMK, 18 AITC, 19the Bofors scandal in the late 1980s and the accompanying political JD(U), 20uncertainty. We do not see the risk of political instability yet. Meanwhile, the BS, 21 BJP, 116Bihar elections reinforce a positive message being seen in many state SP, 22elections in recent times - good performance gets rewarded. Hopefully, it willencourage more states to deliver on governance and economic growth, as has Figures indicate number of seats. Source: Electionbeen the case in the states of Gujarat, Madhya Pradesh, Delhi, Chattisgarh Commission of India, CLSA Asia-Pacific Marketsand now Bihar. Key state elections in 2011 are in West Bengal, Tamil Naduand Kerala, which also raise the spectre of increased government interventionin various sectors, especially if inflation remains high.Japan - MARKETIs there “good” and “bad” inflation?A return to inflation could prove to be a true catalyst.Japan disappointed for most of 2010. More recently, signs of a reboundmade heavily underweight investors nervous and a move to neutral levelswould trigger a surge that lasts into 2011. The market is also attractivefrom a fundamental perspective: a strong profit rebound on the back ofserious restructuring has pushed margins back to pre-crisis levels, thestrong yen notwithstanding. Valuations are undemanding even for quality Andreas Schusterstocks. But the return to inflation in 2011 could be the true game-changer. (813) 45805752 andreas.schuster@clsa.com16 December 2010 25
    • Asia Themes 2011We were almost there in 2008. Back in 2008, Japan looked set to A decade in core deflationfinally emerge from its decade of deflation, with the headline figure CPI and CPI ex-food and energyexceeding at one point 2%. Alas, rising commodity prices was almost the 5 (% YoY) CPIsole driver and excluding energy, the return to positive CPI numbers was 4 CPI ex food & energyonly marginal. As a result, many observers feared a margin squeeze as 3 2higher input costs, not an overheating of demand, created inflation. As 1such, many economists labelled this type of inflation as “bad” inflation. 0 (1)Good or bad inflation. It is questionable if inflation can generally be a (2)good thing or if price stability is not preferable. In Japan’s unique situation, (3)however, we would argue that inflation is a positive factor, as the long 88 90 92 94 96 98 00 02 04 06 08 10period of deflation had, beyond the economic impact, also influenced the Source: Ministry of Internal Affairs and Communicationspsyche of the Japanese. As prices for many products have not surged andoften not changed over many decades, it is extremely hard for retailers(and indirectly manufacturers) to raise prices. Where input costs rose orselling prices declined over time, a downward spiral of deflation was set inmovement via lower wages and downward pressure on input costs. In our Inflation through higher input costsview, any factor breaking this downward pressure on prices is welcome. Corporate goods price index 10 (% YoY) CGPIDéjà vu? With continuous upward pressure on commodity prices, we see 8 Core CGPIagain a similar situation as in 2008, when various producers started to 6 4hike their prices or reduce package content without lowering package 2prices. As inflation was set to take off, the missing link to break the 0 (2)deflationary spiral was still a lack of wage growth. Political pressure on (4)companies that were booking record profits at this time intensified - but (6) (8)then the world fell apart with the onset of the financial crisis heralded by (10)the fire sale of Bear Stearns to JPMorgan Chase in March 2008 and later Jan 07 Oct 07 Jul 08 Apr 09 Jan 10 Oct 10amplified by the collapse of Lehman Brothers. Source: Ministry of FinanceWill it be different this time? Now, company margins have alreadyreached pre-crisis levels and if revenues continue to normalise, recordprofits are again within reach in spite of headwinds from a stronger yenand a still sluggish global economy, as corporate Japan has done a Top picksfantastic job in lowering its breakeven points. Inflation pressure is re- Bridgestone (5108 JP)emerging, mainly through higher energy prices. Not the best type of Canon (7751 JP)inflation for sure, but if it will break the deflationary spiral it would be Fujifilm (4901 JP)nevertheless welcome. Key this time round will be if corporations will pass Inpex (1605 JP) Japan Tobacco (2914 JP)on part of their efficiency gains through moderately higher wages. While JGC (1963 JP)this is still very much uncertain, investors putting money on Japan are not Kao (4452 JP)wagering a too risky bet. Kawasaki Kisen (9107 JP) Kubota (6326 JP)Stockmarket near post-bubble low. Still near 1x understated book (as Kyocera (6971 JP) Mitsubishi Corp (8058 JP)land value is not adjusted upward and goodwill is amortised), the market MUFG (8306 JP)is not only cheap but also oversold. The economic recovery is proceeding Shin-Etsu Chemical (4063 JP)faster than anticipated and corporate restructuring has shown impressive Sony (9107 JP)results. Our 12-month Topix target stands at 1,000, but any sign of higher Suzuki (7269 JP) THK (6481 JP)commodity prices translating in faster inflation with wage hikes dampening Tokyo Electron (8035 JP)the impact for consumers would cause us to raise this target. Plenty of Yahoo! Japan (4689 JP)interesting investment opportunities exist.For more, read our 9 December strategy note, All-star lineup.Malaysia - MARKETWill the nation push meaningful reforms?The market needs transformation to kickstart an investment cycle.Eyes start to roll when Malaysia talks about its Economic TransformationProgramme (ETP), which details the roadmap to double GNI/capita toUS$15,000 over the next decade. Investors should have more faith giventhe success of Khazanah’s reforms on government-linked companies (GLC)and the ongoing development of Iskandar Malaysia. Effective reforms willkickstart a new investment cycle, triggering a market rerating. Our top Clare Chinpicks are Maybank, CIMB, Tenaga Nasional, IJM and UEM Land. (60) 320567878 clare.chin@clsa.com26 16 December 2010
    • Asia Themes 2011Sceptics abound. The 2000s was pretty much a lost decade for Malaysia. Malaysia needs a new investment cyclePromises of reforms by the previous administration failed to materialise. Investment/GDPAs a result, the country’s investment/GDP ratio remains depressed at 20%, 50 (%)with a structural growth story missing, while its weighting in MSCI Asia ex- 45Japan fell from 10.6% to 3.2%. Therefore, it is not surprising that sceptics 40are abound when Malaysia talks about reforms again, this time under the 35Najib administration. Many eyes start to roll when the nation talks about 30the ETP, which details the roadmap for the next 10 years and aims to 25 20double GNI/capita to US$15,000. Most investors prefer to watch for some 15milestones, prior to making big investments in the market. 1990 1995 2000 2005 10CL 15CL 20CLSome success stories. However, there have been some successful Source: BNM, CLSA Asia-Pacific Marketsreforms in Malaysia. The case in point is the 10-year GLC TransformationProgramme state investment arm Khazanah has undertaken since 1995.Tasked with improving shareholders’ return, Khazanah’s portfolio hasoutperformed the FBMKLCI and MSCI Malaysia over the past five years.Iskandar Malaysia is also turning into a success story for Malaysia. Thedysfunctional state of Singapore-Malaysia relations over the past 40-oddyears has been on the mend, and this should lead to more cross-borderinvestments to drive a long-term structural growth story.Reforms will trigger market rerating. In short, Malaysia needs to re-engineer its business model to kickstart a new investment cycle. UnderNajibnomics, there are various economic, social and fiscal reforms in placeto deliver investments of US$444bn over the next 10 years. For 2011, thefocus will be on how the ETP sets the stage to enable this. The key focusareas in the immediate term would be the development of Greater KualaLumpur and the oil, gas & energy sector. If Malaysia delivers meaningfulreforms, this will translate into a structural growth story and trigger arerating. Our top picks are Maybank (MAY MK - RM8.48 - BUY), CIMB(CIMB MK - RM8.60 - O-PF), Tenaga (TNB MK - RM8.45 - BUY), IJM (IJMMK - RM6.20 - BUY) and UEM Land (ULHB MK - RM2.80 - BUY).Singapore - MARKETDoes a strong currency hurt its status?Still a passport of choice on favourable “pull” and “push” factors.A stronger currency is unlikely to dampen Singapore’s status as the“passport of choice”. On the contrary, it will accelerate growth of theservices sector at the expense of manufacturing, allowing productivitygains to offset inflationary effects. It will also lift the value of real estateand Singapore-dollar assets. But after two years of positive returns, themarket is no longer cheap. This warrants a focus on dividends. Ashwin Sanketh (65) 64167815Push will meet pull. In addition to the growing “pull” of Singapore’s ashwin.sanketh@clsa.comcharms as a good place to do business and live, “push” factors from theWest - higher taxes and regulatory impositions - will drive more companiesand professionals to adopt Singapore as their domicile, making it the“passport of choice”. Based on our opportunity analysis, sectors set todominate are commodities, private banking, tourism, maritime andbiomedical. Expected growth in tourist arrivals will benefit hospitality, Push and pull make Singapore attractiveconsumer-discretionary, transport and commercial-property (office and Global corporate tax ratesretail) sectors, too. Japan USA India NewA stronger currency will not derail the investment thesis. The Thailand AustraliaSingapore dollar is likely to appreciate particularly with reference to the Indonesia UKgreenback and the euro. However, a stronger local currency will trigger a Malaysia Taiwanfaster restructuring of the economy, favouring the services sector at the China Koreaexpense of labour-intensive manufacturing activity. Consequently, wage Singapore (%) HKgrowth is likely to match productivity gains, staving off the risk of Singaporebecoming a higher-cost economy. A dearer Singapore dollar will be positive 0 10 20 30 40 50for real estate and investments denominated in the currency. Source: CLSA Asia-Pacific Markets16 December 2010 27
    • Asia Themes 2011Enter 2011 cautiously after two years of gains. Following a 49% rallyin 2009, the market has risen a further 10% this year. Consequently,market valuation, at 15x forward earnings, is one standard deviationabove five-year mean and expensive. As such, we continue to recommenda selective stock-picking strategy and highlight dividends as an attractivetheme, especially given the Singapore dollar’s appreciation potential. InUS-dollar terms, our dividend portfolio has returned 11.4% since July 2010.Singapore Press (SPH SP - S$3.99 - O-PF), ST Engineering (STE SP -S$3.34 - O-PF), United Overseas Bank (UOB SP - S$18.00 - BUY) andComfortDelGro (CD SP - S$1.56 - BUY) are key picks.What to buy and what to sell? Reflecting a bias towards our Passport ofchoice thesis and dividends-related investment themes, we are Overweightconsumer discretionary and defensive stocks. The underperformance oflarge caps makes them prime beneficiaries of a liquidity-driven rally -which appears likely, particularly owing to their attractive valuations. Welike UOB, Genting Singapore (GENS SP - S$2.16 - BUY), Tiger Airways(TGR SP - S$1.86 - BUY), Ezra (EZRA SP - S$1.67 - BUY), CapitaLand(CAPL SP - S$3.68 - O-PF), CapitaMall Trust (CT SP - S$1.97 - BUY), STEngineering and ComfortDelGro. We dislike DBS (DBS SP - S$14.02 - U-PF), City Developments (CIT SP - S$12.96 - U-PF), Wilmar Intl (WIL SP- S$5.96 - U-PF), Olam (OLAM SP - S$3.11 - SELL) and StarHub (STH SP- S$2.67 - SELL).Thailand - MARKETCan the SET go up three years in a row?Propensity to disappoint may end if the election works out.Since 1972, there was only one period when the Thai stockmarket rosethree years in a row. As a stockbroker born just slightly before that, Iam naturally a little nervous postulating that the market will rise 19%in 2011, following a 63% gain in 2009 and 37% in 2010 year to date.But 2011 is likely to give us a continuation of capex and credit growth,a freshly legitimised government with policies to prolong growth and a Tim Taylormarket supported by another year of positive earnings surprises. (66) 22574632 tim.taylor@clsa.comThe election may be the saviour. Assuming there are no black swansaround, 2011 will see a general election. The constitution requires one Rarely up three years straightto be held by December, and the Thai people need one to restore faith SET annual returnsin democracy and keep people in jobs and, literally, off the streets. We 150 (%)expect an election before May 2011 and the current Democrat-led 100coalition to receive the mandate from the electorate that it needs to 50start implementing some growth policies. 0Political stability? Only two freshly elected governments have lasted (50)more than two years in the past two decades. Both of them, in 1992 (100)and 2001, implemented growth policies and presided over a doubling of 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009the stockmarket during their term in office. The current government isnearing its second anniversary, suggesting that if it is re-elected it will Source: CLSA Asia-Pacific Marketsstay around for another two years at least. This is a time framerequired to become bullish about policies to promote growth. Greater swing from investmentsRailways and cities. A re-elected government is enough to see Private construction and investment growthanother year of decent growth stemming from the capex and credit 30 (% YoY)recovery that started this year. Earnings growth of 18% should see the Private consumption growth 20market comfortably achieve our index target of 1,200. But if we also Private investment growthsee the government announce policies to add railways and grow cities 10outside Bangkok we may have scope for becoming much more bullish 0about growth beyond 2011. (10)Only one major city. Thailand is an odd country in that it has a land (20)mass the size of France and a population the size of the UK, yet it only Apr 08 Oct 08 Apr 09 Oct 09 Apr 10 Oct 10has one major city. The 2010-11 budget plans to spend 22% more than Source: BOT, CLSA Asia-Pacific Marketsthe previous year, with much of it targeted outside Bangkok. Towns like28 16 December 2010
    • Asia Themes 2011Khon Kaen and Nong Khai in the northeast are booming, which you cancheck if you join our post-Asean Forum tour to the areas and Laos on12-13 February 2011. Towns becoming cities can simultaneously boostthe country’s overall growth and lower risk, as upcountry areas grow alot more rapidly from a low base than Bangkok.Stocks to own for the third year of a rally. Our key picks into 2011are Bangkok Bank (BBL TB - Bt148.5 - BUY), Krung Thai Bank (KTBTB - Bt16.9 - BUY), Preuksa Real Estate (PS TB - Bt19.6 - BUY) andHomePro (HMPRO TB - Bt8.8 - BUY).Asia - FENG SHUIWill the Rabbit leap into a wall?Embrace the new year and watch out for our 2011 guide.To prevent the Feng Shui team from casting another year of evil spellon my shipping stocks, I humbly accepted the appointment as theoracle for 2011 - only to find a legacy of high client expectations andforecast track record to exceed. After all, Vonnie Chan had beendictating the woes of the Hang Seng for two years in a row and believeit or not, the CLSA Feng Shui Index has a track record of being ‘largely Philip Chowright’ throughout its history. So before we go into 2011, how did we (852) 26008693stack up in the year of the Tiger? philip.chow@clsa.comPredictions for 2010 fairly accurate. We were in the money formost of the months having accurately predicted the run in the HangSeng from June and once again in September. Commodity prices ranhard. Gold didn’t break US$2,000/oz but we were “directionally” correct.Just as we believe we got it all right under our watchful celestial eyes,it turned out the Metal Tiger did not have a fat tail after all. At the timeof writing, shells were falling on the unsuspecting island of Yeonpyeongand the Hang Seng dived 600 points on the day. Without certainty onhow junior Kim even looks like or his date of birth, Feng Shui, Right about the June and September runsunfortunately, has no telling what he will do. Feng Shui Index relative to Hang Seng Index 27,000 +5The Rabbit is no more predictable than the Tiger. We will bid the Hang Seng Index +4 25,000volatile Metal Tiger farewell on 4 February 2011. While it has been a Feng Shui Index (RHS) +3fun ride in 2H10 in general, most will lament the bumpy ride in the final 23,000 +2few months. The last time we had a Metal Rabbit was in 1951, when 21,000 +1the Dow was largely volatile throughout the year and hobbling between 0 19,000a trading band of 15%, despite ending slightly up. Markets were -1sceptical, with seemingly no end to the conflict in the Korean peninsula. 17,000 -2The threat of an atomic exchange loomed, while scars from World War 15,000 -3II a decade before were still fresh. Fortunately, not all other Rabbit Feb 10 Mar 10 Apr 10 May 10 Jun 10 Aug 10 Sep 10 Oct 10 Nov 10 Dec 10 Jul 10years saw equally unexciting stockmarkets - Dow in 1963, and HangSeng in 1975 and 1999 all ended the year up. Still, there was onedisturbing exception - the 1987 crash. The bunny, by default, is an Source: Bloomberg, CLSA Asia-Pacific Marketsecstatic yet unpredictable animal.Watch out for our 2011 Feng Shui guide. Having incorporated thefeedback/requests of one-too-many Feng Shui patrons, we add anumber of new features to our 2011 Feng Shui guide, with much extrawork devoted to the fortunes of different sectors and whether thisstacks up to our sector research views. The most popular sections - HKproperty-market trend and celebrity fortunes - will of course includemore meat than ever. Stay tuned and Kung Hei Fat Choi.16 December 2010 29
    • Asia Themes 2011Asia - REVIEWHow did our 2010 predictions fare?Our bigger-picture views were fairly accurate.Below are the key predictions in our Asia Themes 2010, bulleted as theywere on on page 3 of last year’s report. We italicise those that did notquite pan out (about one-third). Our general themes for the region weremuch more accurate but at the country level the ratio of successfulpreditions falls. The moral? Focusing on the bigger picture appears morereliable, and you can expect brokers’ country views to be biased in acertain direction. Amar Gill (65) 65122337Macro and global - From Beijing to Washington amar.gill@clsa.com1) US consumption and employment remain weak, monetary policy loose and liquidity ample for risky assets including Asian equities.2) Governments will continue to play an active role with increasing risk of controls to resist the flood of capital.3) Economic growth will be stronger; inflation will revive.4) China heads toward a current-account deficit. [Not quite but the current-account surplus has narrowed.]5) The USA needs to attract capital will require further dollar weakness. [DXY is up 4% YTD owing mainly to euro weakness.]6) The yuan will recommence its appreciation but at a gradual pace.Sectors - From banks to technology7) Banks will see improving margins but may need more capital.8) Consumer spending rises with incomes and improving confidence.9) Further upside for resources, eg, coal, gold; watch for M&As.10) CPO is set to push higher in 1H10, with rising Chindia® demand, seasonal patterns [CPO price rallied in 2H10]. Dollar strengthened, yuan resumed its rise Rmb/dollar and dollar index11) Anticipation of higher prices could spike steel prices in 1Q10. 7.4 (Rmb) 9012) Low real interest rates support the property sector, but expect further 7.3 7.2 administrative measures to control price escalation. 7.1 85 7.013) Tech sector to see enterprise-demand revival [although consumer 6.9 80 demand wobbled], rising share of China sales and Japan outsourcing 6.8 6.7 75 to the rest of Asia. Rmb/US$ 6.6 DXY (RHS) 6.5 7014) Momentum post-Copenhagen for renewable equipment [solar-panel Dec 07 Aug 08 Apr 09 Dec 09 Aug 10 demand strong but wind ex-China stagnated] and operators, electric vehicles and nuclear power. Source: Bloomberg, CLSA Asia-Pacific MarketsMarkets - From North Asia to India15) China emerging as the No.1 market, providing upside for its leading CPO up mainly in 2H10 companies. Prices of crude palm oil and crude oil16) Unloved Japan has upside potentially driven by yen weakness. 160 (US$/bbl) (US$/m t) 1,600 140 1,40017) Cleaner corporate structures in Korea could lower its discount. 120 1,200 100 1,00018) Taiwan to benefit from M&As from China, and FAI pickup. 80 800 60 60019) Singapore’s casino openings will impact the domestic economy. 40 400 WTI crude 20 20020) Indonesia’s momentum to be sustained by commodity prices. 0 CPO (RHS) 0 Dec 07 Aug 08 Apr 09 Dec 09 Aug 1021) India’ investment cycle kicks in leading to earnings upgrades [upgrades have not been major]. Source: Bloomberg, CLSA Asia-Pacific Markets30 16 December 2010
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