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Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
Lehman   Stagflation Report Final
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Lehman Stagflation Report Final

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  • 1. Performance in Stagflation Lehman Brothers | Title PLEASE SEE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES, INCLUDING FOREIGN AFFILIATE DISCLOSURES, ON PAGES 157–158 Falling Growth and Rising Inflation in Asia The relentless demand for resources is creating a need for large-scale investment in agriculture, water, and alternative energy Investors confront the reality of rising inflation and slowing growth Regional Research Team May 2008 Lehman Brothers does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Customers of Lehman Brothers in the United States can receive independent, third-party research on the company or companies covered in this presentation, at no cost to them, where such research is available. Customers can access this independent research at www.lehmanlive.com or can call 1-800-2-LEHMAN to request a copy of this research. This research report has been prepared in whole or in part by research analysts who are not registered/qualified as research analysts with FINRA.
  • 2. Lehman Brothers | Equity Research EXECUTIVE SUMMARY Describing Asian stagflation Our definition of stagflation in an Asian context can be described as significantly slowing growth and rising inflation. We have both of these in every single country in Asia, without exception. These stagflationary forces produce: (1) capital shortages, (2) rising costs, (3) diminishing aggregate demand, (4) margin squeeze and (5) rising taxes. In this environment, the characteristics of the likely winners, in our view, include (1) low debt, (2) pricing power, (3) captive buyers, (4) control of input prices, (5) makers of consumer staples and (6) “sin” stocks. Winners and losers The countries which are implementing significant price control and/or large subsidy program risk economic destabilization. These countries include India, China, the Philippines and Indonesia. Countries which allow market forces to determine prices – and therefore which allow supply and demand to recalibrate effectively and quickly – are the likely winners. These include Hong Kong, Singapore, Thailand and Taiwan. Countries which should also benefit are those which have large agricultural sectors. Malaysia wins on this score. Korea stands as an outlier in that it is highly dependent on hard and soft commodities, is heavily indebted, produces large-scale capital goods and is vulnerable to an economic slowdown in the West. Sector winners and losers Sectors which stand to benefit in a world of stagflation are iron ore, plantations, coal, telecom, properties and selected utilities. Other consumer sectors include tobacco, alcohol, gambling and health care. Sectors which are likely to be affected poorly by stagflation are lower margin, high-debt businesses, such as container shipping, shipbuilding, low margin technology businesses, autos, high-end and discretionary consumer goods, basic materials, price-controlled oil & gas, and selected construction materials. Currencies We also highlight countries with large current account surpluses and large budget surpluses which can withstand the economic pressures from falling growth and rising prices. These include CNY, MYR, SGD and TWD. Countries with troublesome current account deficits and budget deficits are threatened by excessive subsidies. These include Indonesia, India and the Philippines. Stagflation Portfolio The following portfolio shows stocks which we believe will be winners under a stagflationary environment. EV/ 3 Mth Ave P/E P/B Div Yield EBITDA Lehman Current Mkt Cap Liquidity ROE Net Debt/ Altman Company Ticker Rating Price US$mn (US$mn) FY08E Assets Z-Score FY08E FY08E FY08E FY08E Industry Sector Cheung Kong Infra 1038 HK Utilities 1-OW 31.8 9,248 9.0 13 -2% 5.3 55.6 13.9 1.8 3.8 Hong Kong Electric 6 HK Utilities 1-OW 45.2 12,724 27.5 15 2% 3.5 9.4 12.8 1.9 4.4 China Mobile 941 HK Telecom 1-OW 132.5 379,182 477.7 28 -27% 10.1 10.8 20.6 5.4 2.1 Sun Hung Kai 16 HK Property 1-OW 138.0 45,174 178.8 6 10% NA 27.0 26.3 1.7 1.8 CNOOC 883 HK Oil & Gas E&P 2-EW 13.9 94,145 237.9 28 -16% 10.1 9.7 14.3 3.7 2.6 Shenhua 1088 HK Energy 1-OW 35.0 14,379 153.4 20 3% 1.9 2.0 20.4 4.0 1.7 Rio Tinto RIO AU Mining 0-NR 145.3 64,535 197.2 40 44% 1.4 4.8 15.7 4.9 1.2 IOI IOI MK Palm Oil 0-NR 7.1 13,801 31.3 26 7% 7.5 14.7 21.6 5.0 2.4 EGCO EGCO TB Utilities 2-EW 95.5 1,547 1.8 18 8% 3.4 8.8 6.4 1.1 5.7 HK and Shanghai Hotels 45 HK Hotels 1-OW 13.5 2,544 1.8 5 5% 2.9 12.0 20.1 0.9 1.5 Ranbaxy RBXY IS Pharmaceuticals 1-OW 466.3 4,355 4.6 24 44% 3.2 18.0 24.7 5.7 2.0 KT&G 033780 KS Consumer 1-OW 82500.0 11,019 31.2 23 -3% 11.3 10.7 14.8 3.3 NA Melco 200 HK Equit Conglomerates 0-NR 11.6 1,891 7.5 4 11% 5.6 82.7 43.5 1.4 0.1 Average 50,350 104.6 27 6% 8.6 11.9 19.3 4.6 2.1 Source: BES, Worldscope, Lehman Brothers estimates Prices as of May 7, 2008 Paul Schulte and regional team Lehman Brothers Asia Limited May 2008 3
  • 3. Lehman Brothers | Equity Research COUNTRY SUMMARY Country Lehman Brothers Comments In a stagflation scenario Top Gainers Top Losers Australia Australian institutional processes and flexible, yet aggressive, policy settings Telstra Bluescope Steel (David are likely to soften inflationary impacts, in our view. The demand side of the PrimeAg Fairfax Media Langford) stagflation equation may prove to be the toughest issue for Australian policy makers. As a result, we believe that more attractive investment exposures are likely to be provided by those companies which enjoy: (i) limited exposure to input cost inflation (e.g., materials and labor); and (ii) product sets with a high degree of substitutability for higher priced products in a cost- conscious environment. China China is trying to deal with rising inflation by appreciating the currency and COSL Guangzhou (Cheng Khoo) keeping rates high. We believe growth is likely to slow down somewhat in R&F China Shenhua 2008 and again in 2009. Inflation risks are to the upside. Minsheng Bank Hong Kong We expect Hong Kong’s internal consumption to slow, unemployment to rise, HK Electric Giordano (Ivan Lee) and input cost (in terms of energy, labor, rental, etc.) to rise quickly. This is Hutchison Shangri-la Hotel not positive, especially for the consumer, hotel, manufacturing, gaming, Whampoa financial, and export sectors, mainly due to Hong Kong’s fairly open economy, close linkage with China’s economy, and because its currency is pegged to the US dollar. However, housing prices will likely continue to benefit from a negative interest rate environment, in our view. Also, we expect regulated utilities, whose earnings are tied to capex instead of tariff and fuel cost, and conglomerates with diversified earnings streams to have earnings resilient performance. India We do not believe that India will be hit significantly by stagflation and we Ranbaxy Larsen and (Prabhat think growth will remain strong in relative terms. In our view, the negative Toubro Hindustan Lever Awasthi) impact will be felt by interest rate-sensitive stocks or by companies not in a Tata Motors position to pass on cost pressures to consumers. Korea In Korea, we expect defensive industries such as telco and tobacco to be the KT Hanjin Shipping (Zayong Koo) least affected while other consumer related and export related industries KT&G LG Display would be adversely affected. However, we believe Samsung Electronics although the industry in which it operates is likely to be hurt by stagflation, the company is nevertheless well positioned globally to actually benefit from the downturn. Taiwan We believe Taiwan’s export-oriented economy is likely to underperform TSMC AUO (Kent Chan) compared with its Asian peers owing to its high dependence on technology, Taiwan Cement Nanya Tech excessive competition, and its dependence on imported oil. The domestic economy (property, telecoms, and insurance) and asset reflation stocks would continue to rise, potentially like they did after the inflation shock in the 1970s, in our view. May 2008 4
  • 4. Lehman Brothers | Equity Research SECTOR SUMMARY Sector Comments Top Gainers Top Losers Auto The auto sector could be a likely loser since auto demand is tied to Denway Hyundai Motor (Zayong Koo) economic conditions and the level of disposal income that consumers enjoy. In a slower growth environment and with higher inflation, non- essential high-cost items such as cars could face some pressure. Banks Banks are mirrors of the underlying economy. We believe none of the Nil Huaxia Bank (Lucy Feng) Chinese banks could survive well in a severe economic downturn. Furthermore, players with weak fundamentals, poor risk management, and less prudent lending procedures will suffer more. Conglomerates Because of their business diversification, the earnings of Hutchison Shanghai Industrial (Benjamin Lo) conglomerates have a higher degree of defensiveness than many Whampoa other single-industry-focused companies. All conglomerates are also cash-rich and some are industry leaders in their core businesses. We, therefore, maintain an overall positive stance on conglomerates under a stagflation scenario. Consumer China retail softlines and department stores/broadlines are more Parkson People’s Food (Phoebe Wong, resilient in the current high inflationary cycle, while F&B might not fare KT&G Lotte Shopping Hong Taik as well because of their high exposure to soft commodities and thin Chung) margins, in our view. In the Korean retail space, we favor discount stores to department stores. Among Korean consumer staple names, we expect top-tier players that can prove strong market leadership and experience steady consumer demand to generate stable earnings. Info Tech Most IT manufacturers are likely to employ a low pricing policy to spur Samsung Hon Hai (James Kim) demand and sustain fab utilization rates. However, we believe that a Electronics rapid rise in material costs and labor expenses will make it very difficult for IT companies to post meaningful profits. With the exception of a few segments, we believe there will be few winners among IT manufacturers when faced withising inflation and slowing growth. Media/Internet The media/Internet sector in Asia-Pacific will weather the stagflation Focus Media Fairfax Media (Paul Wuh) storm better than many other industrial sectors. We focus on media companies that: (1) have a subscription model that is unlikely to face lost revenues in an economic downturn and can raise prices if needed to counter inflation (such as, cable TV and satellite TV companies); (2) have relatively low operating costs and are able to easily scale their businesses to meet changing business environments (such as Internet gaming and e-commerce); (3) are relatively low cost to advertisers and are success-based (such as Internet portal/search companies). Metal and We believe inflation-driven upstream sectors (i.e., coal) should remain China Shenhua Chalco Mining (Oliver the winners given their strong pricing power, while downstream sectors Du) with relatively weak pricing power, such as aluminum and copper smelters, would be the losers. Oil & Gas We expect the physical oil demand to decline. In the near term, we Sinopec Honam (Cheng Khoo) expect the tight supply situation to continue, which could further boost oil prices. However, by the end of 2008 and especially in 2009, as new capacities come into the market, we believe oil prices are likely to decline. Property (Paul Housing and low-end retail, we believe, should prove the most resilient SHKP HK Land Louie, Min as they cover basic needs; office and high end-retail are likely to fare Chow Sai) the worst. At the country level, performance should be tied to existing supply levels. Hong Kong with the lowest expected housing supply for the next four years should prove the most defensive, in our view. Telecom In our opinion, the telecom services sector will do much better than Chunghwa Bharti (Paul Wuh) other industries in a period of stagflation. However, revenue growth for Telecom telecom operators in developing markets like China, India, and SE Asia will be affected more than those in developed markets. Transportation We believe the shipping sector would be a likely loser since demand is Nil Evergreen (Andrew Lee) driven by global economies and shipping lines bear higher costs because carriers struggle to pass on higher costs to customers. Further, given that shipping is a highly fragmented industry, carriers are mainly price takers. Utilities and In a stagflation environment, defensive and regulated utilities that are HK Electric KEPCO Renewable cash rich, have strong cash flow, and have fixed returns tied to a Energy (Ivan regulated asset base tend to outperform, in our view. Lee) May 2008 5
  • 5. Lehman Brothers | Equity Research Table of Contents Executive Summary 3 Country Summary 4 Sector Summary 5 Regional Strategy 9 Effects on equities from rising inflation and slower growth.................................................9 Country Analysis 15 Australia’s Brief Stagflation 16 Tight policies limit local stagflation risk ............................................................................16 China Stagflation Scenario 20 Can the government tame rising inflation and rescue slowing growth? .....................................20 HK Stagflation Scenario 31 Effects of rising inflation and slower growth .....................................................................31 India and Stagflation 36 Tight policies limit local stagflation risk ............................................................................36 Korea Stagflation Scenario 39 Effects of rising inflation and slower growth .....................................................................39 Taiwan Stagflation Scenario 45 Can politics offset rising inflation and slower growth? ............................................................45 Sector Analysis 53 Auto and Auto Parts 54 Effects of rising inflation and falling growth .....................................................................54 Banks 57 China Banks .......................................................................................................................57 India Banks.........................................................................................................................59 Taiwan Banks .....................................................................................................................61 Cement 62 India Cement ......................................................................................................................62 Conglomerates 64 Effects of rising inflation and slower growth .....................................................................64 Consumer 67 India Consumer ..................................................................................................................67 China/Hong Kong Consumer .............................................................................................69 Korean Consumer...............................................................................................................71 May 2008 6
  • 6. Lehman Brothers | Equity Research Electrical Equipment 73 India Electrical Equipment .................................................................................................73 IT Industry 75 Effects of rising inflation and slower growth .....................................................................75 Metal & Mining (China) 78 Effects of rising inflation and slower growth .....................................................................78 Materials (Taiwan) 80 Effects of rising inflation and slower growth .....................................................................80 Media/Internet 81 Effects of rising inflation and slower growth .....................................................................81 Oil and Gas 84 Effects of rising inflation and slower growth .....................................................................84 Oil Refining 87 Effects of rising inflation and slower growth .....................................................................87 Petrochemicals 89 Effects of rising inflation and slower growth .....................................................................89 Pharmaceuticals 91 India Pharmaceuticals.........................................................................................................91 Property 92 Reverting to basic needs for shelter....................................................................................92 India Real Estate.................................................................................................................98 Taiwan Property ...............................................................................................................100 Semiconductors – Foundry & SATS 101 Effects of rising inflation and slower growth ...................................................................101 Semiconductors – Memory 102 Effects of rising inflation and slower growth ...................................................................102 Technology – Hardware 104 Effects of rising inflation and slower growth ...................................................................104 Technology – Display 105 Effects of rising inflation and slower growth ...................................................................105 Technology – IC Design 107 Effects of rising inflation and slower growth ...................................................................107 Telecommunications Services 108 Effects of rising inflation and slower growth ...................................................................108 May 2008 7
  • 7. Lehman Brothers | Equity Research Transportation – Shipping 112 Effects of rising inflation and slower growth ...................................................................112 Utilities/Power/Renewable Energy 117 Effects of rising inflation and slower growth ...................................................................117 Valuation Methodologies 123 Asia Research Roster 138 Coverage Universe 140 Companies under Coverage in Asia, by Country (as of May 14, 2008) ...........................140 Companies under Coverage in Asia, by Sector (as of May 14, 2008)..............................148 May 2008 8
  • 8. Lehman Brothers | Equity Research REGIONAL STRATEGY Effects on equities from rising inflation and slower Paul Schulte growth LBAL, Hong Kong Tel: (852) 2252 -1409 paul.schulte@lehman.com INTRODUCTION: LOWER GROWTH AND HIGHER INFLATION Justin Lau The world is slowly moving away from a systemic meltdown and toward some LBAL, Hong Kong normalcy. Much of this has been accomplished through the intermediation of central Tel: +852 2252 1420 banks. The introduction of a facility on March 20 to lend directly to investment banks for justin.lau@lehman.com the first time in the history of the Federal Reserve helped greatly in calming markets. These moves by the Fed – and more recently by the Bank of England – have been made Chris Leung, CFA in conjunction with a sharp reduction in interest rates. There have been three LBAL, Hong Kong consequences of this activity. Tel: +852 2252 6183 1. Rising liquidity chris.w.leung@lehman.com There has been a sharp and sudden increase in risk appetite and a sharp rise in liquidity. As risky or worthless assets are taken out of the market by central bank intervention, Shubhankar Das those assets most at risk often go up the most. So, values of risky assets may go up in LBAL, Hong Kong price. Government bonds would go down in price as investors sell risk-free government Tel: +852 2252 1424 bonds and dive back into risky bonds. shubhankar.das@lehman.com 2. Lower growth The above scenario should be great for growth. It makes growth go down less. But the problem is that much of this liquidity being created is not finding its way back to asset creation. It is being bottled up on the balance sheet of banks which are themselves dealing with bad asset liquidation and capital constraints. They are being forced to shed assets from their balance sheet and write off losses against capital. They are being forced to find alternative sources of liabilities (deposits). This is because banks must bring down excessively high loan/deposit ratios at the same time that they are writing off bad assets. So, the asset base must shrink even while liquidity is replenishing the system. We present below the base case set forth by our economics team together with the worst case scenario provided by the strategy team. Figure 1: Slower growth/rising inflation – base case and worst case scenarios GDP (% y-o-y) CPI (%y-o-y) Base Case Worst Case Scenario Base Case Worst Case Scenario Lehman Economics Team Lehman Stategy Team Lehman Economics Team Lehman Stategy Team 2008 2009 2008 2009 2008 2009 2008 2009 US 1.2 0.6 -0.9 -0.4 na na na na Australia 2.5 2.0 1.1 0.9 3.1 2.2 3.1 3.2 China 9.8 8.0 6.1 5.9 5.5 2.8 6.7 6.9 Hong Kong 4.3 6.2 0.3 0.2 5.0 5.5 5.0 5.5 India 7.5 8.5 5.1 4.6 6.9 4.7 6.9 7.1 Indonesia 5.2 7.0 2.7 2.3 10.0 8.0 9.0 9.5 Malaysia 5.0 6.2 2.4 2.2 3.5 4.5 3.9 4.5 Philippines 5.0 7.0 2.6 2.4 7.8 5.5 8.5 8.9 Singapore 4.2 7.0 2.4 2.1 6.0 4.8 6.0 6.1 South Korea 4.1 5.2 2.1 2.0 4.5 3.5 4.1 4.3 Taiwan 3.9 5.7 2.9 2.6 3.8 3.5 3.8 3.9 Thailand 4.2 6.7 2.6 2.5 6.5 4.5 6.0 6.2 Asia ex-Japan 7.3 7.3 4.1 3.8 5.7 3.8 5.7 5.9 Source Lehman Brothers research May 2008 9
  • 9. Lehman Brothers | Equity Research 3. Higher inflation All this liquidity is not creating more assets. It is supporting the shrinking of assets in an attempt to keep a balance sheet cleansing event from turning into a depression. The cost we are paying for this dynamic is excessive liquidity with low growth. Inflation’s classic definition is too much money chasing too few assets. This is as classic an inflationary phenomenon as it gets. So, liquidity, like lava bursting from a volcano, will roll down the mountain, seeking a path of least resistance to those areas where it is needed most: in the shortages. The greatest shortage of liquidity in the world is in agriculture. The food inflation problem has been brewing since 2004, but was rising right in the midst of the credit crisis. So, this liquidity is creating inflation in an area which had chronic shortages already. This food inflation has spread quickly and has created generally high inflation all over Asia. Oil is part of this as well. Oil shortages are receiving the liquidity as well. We think these price rises are a symptom of inflation, not the other way around. EFFECT ON EBIT: SHRINKING MARGINS? With rising costs in food and energy, the CPIs of many Asian countries are rising quickly. This is because the CPI has a very large proportion of food and energy in the baskets relative to the West. In many cases, it is 30-50%. So, price changes are accelerating quickly. In addition, many governments are responding to sharp increases in food, fertilizers, and oil with price caps and/or subsidies. We believe these policy responses are unhelpful and lead to more inflation. This is because price caps, for instance, lead consumers to consume more, given the perception that prices are unusually low. This also leads to a cutback in production given the perception that producers are not being given a fair price for the goods they sell. So, everyone loses. There are three effects on margins. In the meantime, high fertilizer costs spill into higher food prices. Higher oil spills into high coal prices. The chain reaction goes on. 1. Rising cost of labor As food and energy prices increase, the employees at corporates demand higher wages given that lifestyle costs are rising sharply. So, SG&A expenses rise. We are seeing this all across Asia, as wage growth begins to rise in earnest. Wage rises are a response to rising prices. In many parts of Asia, inflation is rising to multi-decade highs. Figure 2: Asia CPI % y-o-y Headline CPI 8 Core CPI 6 4 2 0 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Source: Lehman Brothers research May 2008 10
  • 10. Lehman Brothers | Equity Research 2. Rising cost of goods The costs associated with production given rising energy costs are felt throughout the industrial food chain. Cost of energy also goes up dramatically. So, input costs rise. Growth, while falling, is still high in many parts of Asia. As a result, an increasing number of companies have expressed confidence for the first time in many years to pass through price increases to end users. Steel producers are passing prices through to buyers of steel. This is best seen in the rise of the Producer Price Index. Figure 3: Japan’s domestic corporate goods prices % y-o-y 5 4 3 2 1 0 -1 -2 -3 -4 Jan-90 Jan-94 Jan-98 Jan-02 Jan-06 Source: CEIC, Lehman Brothers research 3. Rising cost of money In the midst of a waning credit crisis, the sharp rise in liquidity is not reaching into the cost of money. The cost of money has actually risen. This is because banks are trying to recapitalize and at the same time shed bad assets. Concentrating on lending is the last thing on their minds. So, while the cost of money is now down to 2% in the US, for instance, the cost of a loan has barely budged. This also reaches into the world of working capital. Working capital is also more expensive although rates are now a lot lower. So, financing costs are higher and new money is harder to come by. There will, of course, be exceptions. For example, we think price makers (monopolies, plantations, oil producers) will make a windfall here. The middle man loses. Lower-end retail wins. Banks which are healthy win big. Unhealthy banks lose altitude and are in danger of crashing. Those banks which try to pick up cheap assets too early can get dragged down. EFFECT ON CASH FLOW: EFFECT ON CAPEX GIVEN FALLING CASH FLOWS AND CAPITAL SHORTAGE? In an environment of restrained lending, rising costs, and increasing wages, corporates may face three hurdles. 1. Working capital is working harder and may turn negative Inflation drives up the cost of doing business. Some corporates will be able to pass on these costs. Others will not. Those with less pricing power or those which sell low- margin goods or middlemen are most at risk for a cash squeeze. (Our stagflation portfolio favours companies that are most decidedly out of this area). Rising working capital tends to be associated with an aversion to corporate activity or high cash levels that have yet to be put to work. On the liabilities side, slowing payments (short-term liabilities rising faster than short-term assets) in a world of liquidity but with hesitant banks is not at all surprising to us. May 2008 11
  • 11. Lehman Brothers | Equity Research 2. Rising cost of funds for capex One of our preferences in our portfolios has been for companies with cash flow sufficient to cover capex. In a world of hesitant banks, the cost of finishing a project will very likely rise. The assumptions for viability in projects included interest costs which were a lot lower a year ago. We estimate that interest costs are up, on average, from Libor +150 to Libor +300 to 500. This is a significant increase in interest expense and eats into cash flow. 3. Cutbacks in capex or cancellation of projects The dangerous part of a global slowdown is that companies which are in the middle of major expansion are in danger of not finishing a very expensive project. The anticipation of completion is the source of earnings. In the event of cessation of funding in a half- finished project, the problems are quite serious. With a great deal of money spent, the value of the asset is essentially still zero. Companies in this sort of condition are either forced to sell an impaired asset or are forced into bankruptcy proceedings. WHAT HAPPENED IN THE 1970S? In the early 1970s, the US was in the middle of an unwinnable and increasingly expensive war. It was funding large budget deficits. It was facing high commodity prices. The US – and other countries – imposed price controls to deal with inflation. If this sounds familiar, it is because it is familiar. Many investors agree that analogies to the 1970s are appropriate. As Mark Twain, however, said, “History does not repeat itself. It rhymes.” History will likely play itself out differently, but with many similarities. There are three similarities we see. 1. Inflation hit suddenly and hard Inflation reared its head in a small way from the early 1970s and then hit all of a sudden. When it did, it hit hard and took a long time to go away. Interest rates in 1980 were still 21%. Government bond yields peaked at 14%. Gold, oil, agricultural commodities, and general prices soared. These conditions are eerily similar. 2. Growth slowed While nominal growth was quite high given that inflation was in the high single digits, real growth slowed dramatically. Wages can grow with inflation, but pretty soon, they can no longer keep up. As a result, real wages fall and spending drops. Interest rates would soar and the cost of borrowing becomes prohibitive. Tax revenues from slowing economic activity would have to rise and deficits rise. Taxes would rise more. Real take- home income then falls. A vicious cycle is born. 3. Inflation expectations rose The hard part of price increases is that they are born of expectations. As people expect prices to rise, prices rise. We have been living in a world for many years where we have expected prices to go down. So, we delay expenditure and wait for prices to fall further. As inflation grabs hold, we come to expect prices to rise and we rush our purchases. We grab onto those types of investments which are seen as an inflation hedge. We eschew fiat money. We seek out commodities, land, precious metals, and rare jewels. A plethora of books have been written on this subject. Suffice to say that it takes much data (and much time) for people to change their expectations on higher prices once higher prices begin their gallop. May 2008 12
  • 12. Lehman Brothers | Equity Research HOW CAN THE GOVERNMENT HELP EASE THE PAIN? Whether we like it or not, governments in the world are now deciding the price of assets as much as investors are. The decision of the Federal Reserve in March to lend to investment banks essentially put a ceiling on the price of debt for these banks. We think governments can do three things to help. 1. Price controls and subsidies We are facing a shortage of oil, a shortage of coal, and a shortage of food. Governments can help by accelerating the development of alternative energy. They can introduce conservation programs in terms of emissions regulation. They can place price caps on retail prices or they can introduce subsidy programs which compensate producers and make the consumer feel less pain at the cash register. While many insist that subsidies and price controls are destructive in the longer term, they quell social unrest and prevent riots. The problem is that they almost guarantee inflation as they incentivize consumers to consume more and cause producers to produce less. 2. Crash investment programs One of the results of high prices is the need for governments to pay for investment programs for products which are price inelastic. Goods with inelastic prices must be bought independent of price (basic necessities and staples). So, governments have a responsibility to rush the production of these goods to people and so need to step in and jump start programs such as oil exploration, cattle production, and farming. 3. Tax and regulatory relief Governments are famous for changing rules mid-stream. In an environment of rising costs, governments can act to reduce costs by turning a blind eye to restrictive immigration policy. In an environment of bad debt and economic stagnation, they may turn a blind eye to strict marking to market of that bad debt. They may allow banks to alter classification. In a coal shortage, some countries may reduce strict safety standards. In an oil shortage, countries may bend rules on oil drilling in wildlife preserves. Governments can reduce taxes on corporates which are large employers in a period of high unemployment. In other words, governments change valuations of companies and, indeed, cash-flows in the blink of an eye with market-friendly policies which can improve profitability. Conversely, governments which want to quell civil unrest may stick it to some corporates which make staples such as food and gasoline. Price controls can destroy shareholder value in the blink of an eye. We believe we are living in a world of unprecedented intervention by governments. This is an added risk for markets. Figure 4: Stagflation portfolio EV/ 3 Mth Ave P/E P/B Div Yield EBITDA Lehman Current Mkt Cap Liquidity ROE Net Debt/ Altman Company Ticker Rating Price US$mn (US$mn) FY08E Assets Z-Score FY08E FY08E FY08E FY08E Industry Sector Cheung Kong Infra 1038 HK Utilities 1-OW 31.8 9,248 9.0 13 -2% 5.3 55.6 13.9 1.8 3.8 Hong Kong Electric 6 HK Utilities 1-OW 45.2 12,724 27.5 15 2% 3.5 9.4 12.8 1.9 4.4 China Mobile 941 HK Telecom 1-OW 132.5 379,182 477.7 28 -27% 10.1 10.8 20.6 5.4 2.1 Sun Hung Kai 16 HK Property 1-OW 138.0 45,174 178.8 6 10% NA 27.0 26.3 1.7 1.8 CNOOC 883 HK Oil & Gas E&P 2-EW 13.9 94,145 237.9 28 -16% 10.1 9.7 14.3 3.7 2.6 Shenhua 1088 HK Energy 1-OW 35.0 14,379 153.4 20 3% 1.9 2.0 20.4 4.0 1.7 Rio Tinto RIO AU Mining 0-NR 145.3 64,535 197.2 40 44% 1.4 4.8 15.7 4.9 1.2 IOI IOI MK Palm Oil 0-NR 7.1 13,801 31.3 26 7% 7.5 14.7 21.6 5.0 2.4 EGCO EGCO TB Utilities 2-EW 95.5 1,547 1.8 18 8% 3.4 8.8 6.4 1.1 5.7 HK and Shanghai Hotels 45 HK Hotels 1-OW 13.5 2,544 1.8 5 5% 2.9 12.0 20.1 0.9 1.5 Ranbaxy RBXY IS Pharmaceuticals 1-OW 466.3 4,355 4.6 24 44% 3.2 18.0 24.7 5.7 2.0 KT&G 033780 KS Consumer 1-OW 82500.0 11,019 31.2 23 -3% 11.3 10.7 14.8 3.3 NA Melco 200 HK Equit Conglomerates 0-NR 11.6 1,891 7.5 4 11% 5.6 82.7 43.5 1.4 0.1 Average 50,350 104.6 27 6% 8.6 11.9 19.3 4.6 2.1 Note: Prices as of May 7, 2008 Source: IBES, Worldscope, Lehman Brothers estimates May 2008 13
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  • 14. Lehman Brothers | Equity Research COUNTRY ANALYSIS May 2008 15
  • 15. Lehman Brothers | Equity Research AUSTRALIA’S BRIEF STAGFLATION Tight policies limit local stagflation risk David Langford LBAUL, Sydney Tel:+612 8062 8440 HOW WOULD STAGFLATION IMPACT AUSTRALIA? david.langford@lehman.com Lehman Brothers Asia is exploring the risks to Asia Pacific markets in the scenario of falling global growth, resulting in slower Asian growth, but in the face of rising input Stephen Roberts costs. In our view, Australia could witness a brief period of stagflation, where inflation is LBAUL, Sydney high and relatively sticky and economic growth is weakening. However, we believe a Tel:+612 8062 8431 lengthy period of stagflation is unlikely because of the Reserve Bank of Australia’s stephen.roberts@lehman.com (RBA) commitment to deliver sufficiently tight monetary conditions to ensure that domestic spending growth and inflation fall. Australia Research Team Unlike many of its Asian neighbors and major trading partners, Australia benefits from a Tel:+612 8062 8000 de-regulated financial system. The characteristics of this system include a freely floating exchange rate and an independent central or reserve bank. The RBA is free to use its cash interest rate to tighten or loosen monetary conditions as it deems necessary. The RBA has a formal 2-3% inflation target that it has agreed (with the Federal Treasurer) to achieve over the course of the economic cycle. Thus, despite the relatively greater acceleration of inflation in most Asian economies when compared with Australia over the past 12 months, the RBA stands almost alone in lifting its cash rate aggressively and allowing its currency to appreciate freely to dampen rising inflation. We consider that Australia is different from Asia in the manner in which policy has responded to rising inflation. In our view, while a consequence of comparatively tighter Australian monetary conditions will be to deliver the “stag” part of stagflation, we expect the “flation” part to recede. The rise of stagflation among Australia’s major Asian trading partners represents a material risk for many Australian companies, in our view. Asia receives around 70% of Australian exports and almost all of Australia’s exports of coal and metal ores. Weakening Asian growth, as a consequence of trying to contain high inflation, could dampen raw material prices significantly, in our view. We believe that attempts to calibrate Australian policy settings at a time when Asian growth may turn in an unpredictable fashion, runs the risk of double trouble for Australian economic growth prospects. Domestic spending is weakening owing to tight monetary policies. We consider that this impact may be further reinforced by an erratic pull-back in Asian demand and commodity prices. May 2008 16
  • 16. Lehman Brothers | Equity Research WINNERS AND LOSERS Figure 5: Winners and losers (Australia) Winners Ticker Price TP Rating Comments • Telstra’s large infrastructure/sunk cost base limits exposure Telstra TLS.AX A$4.52 A$5.40 1-OW to margin squeeze from a rising cost base, in our view. Telecommunications • Upgraded IT/customer care systems are likely to reduce its exposure to increasing labor costs. • Telstra’s products are believed to be attractive substitutes for businesses and consumers when cutting costs (e.g. phone services/video conf replaces travel) • Inflation-sensitive labor represents ~14% of Austar’s FY08E Austar AUN.AX A$1.35 A$1.65 1-OW total cost base. Programming costs (~48% of Austar’s Subscription Television FY08E total costs) are subject to long-term contracts, we Services believe. We expect the outcome of these factors to be margin strength. • We consider subscription TV services to be price inelastic and a cheap entertainment alternative for cost-conscious consumers. • Austar’s set-top box costs (capex) are subject to declining prices, driven by ongoing technology improvements. • Waste management is an essential/non-discretionary Transpacific TPI.AX A$8.35 A$12.50 1-OW service, we believe. Waste Management Services • We understand that long-term customer contracts (~35% of FY08E revenues) include CPI adjustment clauses. We expect this structure to provide Transpacific a level of immunity from margin squeeze. • PrimAg owns Australian agricultural land and produces soft PrimeAg Australia PAG.AX A$1.99 A$2.25 1-OW commodities. Agricultural Commodities • We expect the company to be a significant beneficiary of food price inflation. Losers Ticker Price TP Rating Comments • Project cost inflation already represents a difficulty for future WorleyParsons WOR.AX A$39.50 $40.00 2-EW growth. Cost pressures may intensify particularly in labor- and Hydrocarbon Engineering commodity-based materials categories. Services • Around 85%+ of Bluescope’s EBIT is derived from sales of Bluescope Steel BSL.AX A$10.61 A$9.35* 3-UW commodity-grade flat steel products at international Flat Steel Products benchmark prices. • Lower Asian growth may result in reduced steel demand (Asia has been a key driver of global steel demand) and therefore, lower international steel prices. • Bluescope Steel’s earnings are highly leveraged to falling international steel prices. • Print advertising and circulation represents ~85% of Fairfax’s Fairfax Media FXJ.AX A$3.34 A$3.80** 2-EW FY08E revenue base. We expect a stagflationary environment to Newspaper and Online weaken ad growth and accelerate the secular trend to cheaper Publisher online alternatives. • Labor costs comprise ~41% of Fairfax’s FY08E total cost base. Accordingly, labor-intensive content requirements and the shift of advertising online are likely to result in margin squeeze, we believe. May 2008 17
  • 17. Lehman Brothers | Equity Research • Babcock & Brown BNB.AX A$15.38 A$16.20 2-EW Infrastructure investments employ significant gearing, which creates earnings and cash flow risk in a high inflation/interest Brokers and Asset Managers rate environment, we believe. • We expect principal trading gains to be nominally supported by inflation. But the after-tax real gain will be much lower, we believe, because the tax system does not distinguish between real and nominal gains. • Macquarie Group MQG.AX A$60.75 A$62.80*** 2-EW Infrastructure investments employ significant gearing, which creates earnings and cash flow risk in a high inflation/interest Brokers and Asset Managers rate environment, we believe. • We expect principal trading gains to be nominally supported by inflation. But the after tax real gain will, we believe, be much lower because the tax system does not distinguish between real and nominal gains. Source: Lehman Brothers research. Prices as of May 7, 2008. * The 12-month target price for Fairfax Media was cut to A$3.80 (from A$4.30) on 14 May 2008. ** The 12-month target price for Bluescope Steel was revised to A$9.35 (from A$9.25) on 13 May 2008. *** The 12-month target price for Macquarie Group was revised to A$62.80 (from A$59.20) on 15 May 2008 DOWNSIZING THE ENGINE ROOM? Investment spending, in all forms, has been one of the strongest growing segments of the Australian economy. We believe that strong growth has taken place across the spectrum, from public sector infrastructure spending to business investment spending. In 2007, the Australian economy grew 3.9% in real terms, but investment spending was up 8.7%. We believe that the combination of (1) Asian stagflation resulting in weakening commodity demand; and (2) tight domestic monetary policy aimed at softening domestic spending is likely to result in jaundiced growth in investment spending. Apart, from the negative short-term impact on economic growth, Australia’s longer-term potential growth rate is also likely to suffer, in our view. Current Australian Federal Treasury estimates put the country’s long-term potential growth rate at around 3.5% per annum. However, we estimate that the long-term growth rate could fall to less than 3% per annum on a material reduction in the pace of growth in investment spending. WHAT HAPPENED IN THE 1970S? In our view, Australia’s experience of stagflation in the past was caused by inappropriate and ineffective monetary and fiscal responses to the oil price shock of the early 1970s. There are many reasons for why we believe the current run-up in key commodity prices will not trigger a re-run of the 1970s. First, we believe that it is more difficult for a commodity price shock to trigger second-round inflation effects in wage claims that help to develop an upward inflationary spiral. In the 1970s, Australia had near-automatic wage indexation, which meant that the latest quarterly rise in inflation fed almost directly into higher wages – i.e., four wage increases a year after each CPI reading. Second, monetary policy was largely ineffective in the 1970s because of bank lending, deposit and interest controls, and a fixed exchange rate regime. Third, the exchange rate could only help to contain inflation periodically – i.e., on occasions when the dollar was formally re-valued. Finally, fiscal policy was very loose, notwithstanding strong supply- side pressures on inflation from higher commodity prices. HOW CAN THE GOVERNMENT HELP EASE THE PAIN? The government can only ease the pain by ensuring that the period of stagflation is as brief as possible. Leaving the central bank to deal with inflation and providing it with the independence and policy armory to do the job is a good start, in our view. We also May 2008 18
  • 18. Lehman Brothers | Equity Research believe that prudent fiscal policy (Federal Budget surpluses at or above 1% of GDP) should contain domestic inflationary pressures. CONCLUSION We consider that Asian stagflation represents a material risk to the Australian economy and corporate earnings growth. However, we believe that Australian institutional processes and flexible yet aggressive policy settings are likely to soften inflationary impacts. In our view, the demand side of the stagflation equation may prove to be the toughest issue for Australian policy makers. As a result, we believe that more attractive investment exposures are likely to be provided by those companies which enjoy: (1) limited exposure to input cost inflation (e.g., materials and labor); and (2) product sets with a high degree of substitutability for higher priced products in a cost-conscious environment. May 2008 19
  • 19. Lehman Brothers | Equity Research CHINA STAGFLATION SCENARIO Can the government tame rising inflation and rescue Cheng Khoo slowing growth? LBAL, Hong Kong Tel: +852 2252 6180 cheng.khoo@lehman.com HOW WOULD STAGFLATION IMPACT CHINA? Paul Schulte During a high inflationary period that coupled with slowing global and domestic LBAL, Hong Kong economic growth, we think Chinese companies and the stock market would not be Tel: +852 2252 1409 shielded from a downturn. The Chinese government is in a difficult position. It seems the paul.schulte@lehman.com most logical course of action is to allow the currency to appreciate. In doing so, it: (1) imports deflationary pressures; (2) reduces trade surplus; and (3) reduces the enormous reserves. In essence, importing deflationary pressures and reducing inflationary domestic China Research Team liquidity is just about the only thing China can do, in our view. Interest rates could be raised further, but we believe that would be using the wrong tool. In our view, China’s problems are due to insufficient upstream raw material supply and an excess capacity in selected downstream manufacturing industries, in our view. Ironically, we have to ask whether there has been sufficient investment in China. With fixed capital investment running at 25% per year, we also expect nominal growth at about 19%–20%. Is one way out of the supply-driven inflationary burst an even higher level of capital investment, especially in water and agriculture? The government recently increased its investment in agriculture by 30%, to around US$43 billion. It is also running up large subsidy bills as it keeps consumers from feeling the full brunt of international price increases of most commodities. Our favourite theme for the next few years is agricultural investment. China needs to revolutionize its agricultural sector, including its water supply. When it targets to achieve something, its policies tends to succeed. This, we believe, represents the most promising sector for investors over the coming years. Biofuels, genetically modified (GM) seeds, irrigation, and new labor in rural areas are vital for China to get to the next level. Earnings and margins outlook. We are already seeing the effects on margins in many forms. (1) Many exporters’ margins are eroded by the appreciating renminbi. Other companies are under severe pressure due to price caps on products. The renminbi has appreciated by more than 9% against the dollar in the past few months, eliminating any profits for low-margin businesses. (2) These price caps – actually, for most products in the HSCEI – decimate margins as international prices rise. Consider the case of the biggest oil refining company Sinopec – were it not for a subsidized check, many of them would have already been in the red in 1Q08. Ironically, these price caps themselves are inflationary as they discourage future expansion in plant and equipment, and, therefore, are likely to produce lower installed capacity over time. This is a concern for us. (3) The normal margin pressure comes from input prices going up while wages are also rising. So, we can see many companies with rising land costs, rising energy costs, rising labor costs, and rising capital costs. Market performance. In January, we downgraded China from an overweight because we saw inflationary pressures spilling out all over. We also saw China’s inflation-free growth beginning to show wear and tear. The costs of land, labor, and capital are all moving up dramatically. This is a phenomenon that we strongly believe is a reflection of shortages and, hence, we are sceptical about the issue of overcapacity. So, China is seeing its liquidity seep out of the economy as the government becomes reinvigorated by the need to control inflation. We also think there is a need for a vast “Green Revolution” or “New Deal” to deal with chronic food shortages and water shortages, among others. This necessary, but very expensive, bonanza of spending is, in itself, also inflationary. Hence, we expect a pause in growth as large capital investments are implemented, which do not yield strong results. May 2008 20
  • 20. Lehman Brothers | Equity Research We would consider upgrading China if we saw signs of inflation peaking. However, we do not see that any time soon. Our sector and company selections follow. WINNERS AND LOSERS Figure 6: Winners and losers (China) Winners Ticker Price Target price Rating Comments • COSL 2883.HK HK$15.56 HK$21.0 1-OW Low earnings risk • China Shenhua 1088.HK HK$34.95 HK$57.0 1-OW Extremely tight supply and asset injections • Price controls a risk • Hutchison Whampoa 0013.HK HK$78.00 HK$93.8 1-OW Cash rich; industry leader; diversified Losers – Company Ticker Price Target price Rating Comments • Guangzhou R&F 2777.HK HK$21.00 HK$31.04 2-EW High gearing of 265%. • A-share listing not assured in current unfriendly environment. • Minsheng Bank 600016.SS RMB8.22 RMB9.85 2-EW Relatively weaker management; insufficient risk management during a downturn. • CSCL 2866.HK HK$3.49 HK$2.9 3-UW Leveraged to changes in inflation and costs Prices as of May 7, 2008 Source: Lehman Brothers estimates LOWER GDP GROWTH WITH HIGHER INFLATION Lehman Brothers’ China economist Mingchun Sun currently forecasts single-digit GDP growth of 9.8% in 2008 for China, which indicates a decline from a growth rate of 11.6% in 2006 and 11.9% in 2007. Expecting deteriorating conditions exacerbated by overinvestment, which is resulting in overcapacity situation in many sectors, he recently downgraded the 2009 GDP forecast from 8.5% to 8%. In terms of inflation, Sun forecasts a full-year 2008 CPI to reach 5.5%, up from 4.8% in 2007, but much lower than the 1Q08’s level of 8%, indicating that 2H08 inflation will likely ease from a high base effect in 2H07. The easing trend then continues into 2009 with a FY09E CPI of 2.8%. Figure 7: China real GDP growth vs CPI China Real GDP Growth vs CPI (YoY % Change) 16 30 14 25 Real GDP growth 12 CPI (RHS) 20 10 15 8 10 6 5 4 0 2 0 -5 1985 1988 1991 1994 1997 2000 2003 2006 2009E Source: CEIC, Lehman Brothers estimates May 2008 21
  • 21. Lehman Brothers | Equity Research However, in this report, the equity strategy team explores the impact of equities in light of a more negative scenario of a GDP growth rate of only 6.1% in 2008 and 5.9% in 2009 and escalating inflationary environment with a CPI of 6.7% in 2008 and rising further to 6.9% in 2009. By applying higher inflation assumptions, we are exploring the negative impact of real GDP growth. We analyze the risks to revenue growth and profit margins in combination with higher input cost in the various sectors. IMPACT ON REVENUE The market is currently debating whether a slowdown in the US/developed economies would impact the Asian and Chinese economies. Irrespective of the global economic slowdown, Chinese exporters have already started to feel the pinch of rising costs and competitive pressures. These include an appreciating currency, reduced VAT export rebates (and in some cases an increase in export tariffs), removal of favourable policies for processing trade; increasing cost pressure from rising prices of land, labour, energy and raw materials; and tighter standard on product quality, labour conditions, and environmental protection. In terms of trend, export growth has already slowed, especially in volume terms. As global demand weakens, export growth is very likely to be hit further. We think domestic consumption is unlikely to be strong enough to offset weakness in exports. Furthermore, as export growth slows, we expect income growth to decline while high inflation stands to erode the purchasing power of households and be a drag on real spending. During a period of slowing GDP growth, demand normally enters a downward trend, and excess capacity becomes a problem as operating rates decline. This is especially true in sectors that are experiencing an overcapacity situation. Producers have to lower prices in light of the heightened competition. With the global economy expected to slowdown considerably more in 2H08, we expect exports to decline in 2H08, intensifying through 2009. About one quarter of China’s total industrial production is exported, even though some sectors are more dependent on exports than others, such as mobile phones and color TVs. EFFECT ON EBIT: MARGIN SHRINKAGE? As external demand weakens, we think inventories are likely to pile up as soon as in 3Q08, after the Olympics. A strong inventory is being built up in some areas such as fuel and consumer products in anticipation of high demand during the Olympics. We believe firms will probably compete on price despite rising cost, which will likely depress margins. Profit margins are still trending around their highest levels since 1999, but seem to have reached a plateau. The number of loss-making enterprises is currently rising at 8.5%, up from 0.3% in 2007. Figure 8: China net profit margin China Net Profit Margin (%) 12 10 8 6 4 2 0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Source: Worldscope, Lehman Brothers research May 2008 22
  • 22. Lehman Brothers | Equity Research With significantly lower economic growth and a rising cost base, we expect corporate earnings to come under pressure. According to consensus (IBES) estimates for Chinese corporations, analysts are projecting slowing EPS growth of 17.6% for 2008 and 16.6% for 2009, down from 32% in 2006. However, only four sectors (capital goods, retailing, diversified financials, and insurance) have negative earnings growth projections for 2008, while only one sector (diversified financials) has negative earning growth estimate in 2009(–10%). In our worst-case scenario, we expect potential downside to this set of earnings estimates. Instead of a majority of the sectors showing earnings growth, we expect the reverse to happen especially for those that are export focused and are facing overcapacity. Figure 9: China EPS growth estimates EPS growth (%) 2007 2008E 2009E China 32.3 17.6 16.6 Energy 7.6 18.7 9.6 Materials 4.8 24.9 14.2 Capital goods 38.6 -3.7 22.7 Transportation 155.2 12.7 9.7 Auto & components 38.4 19.2 16.1 Consumer durables 23.2 11.5 20.5 Consumer services 34.9 34.6 25.8 Retailing 52.0 -22.5 23.7 Food bev & tobacco 26.2 24.5 24.2 Household products 42.9 19.0 25.7 Banks 47.0 39.8 19.2 Diversified financials 360.6 -41.7 -10.0 Insurance 103.3 -17.2 17.3 Real estate 53.0 26.0 37.3 Software & services 24.1 17.1 30.7 Technology hardware & equip 61.0 15.5 15.3 Telecom 19.0 25.1 15.7 Utilities 10.0 1.3 18.2 Source: IBES We believe weaker corporate earnings and rising bankruptcies will increase unemployment and undermine the ability of the firms to repay loans. While bank non- performing loans (NPLs) have declined in recent years, they rose slightly in 4Q07. In addition, we are concerned that a credit cycle may kick in, and Chinese banks could face increased new NPL formation, particularly in risky sectors such as property, manufacturing, and exporters. We think that the weakening earnings will likely be reflected in the stock market as P/E ratios climb. Despite falling by about 30% this year, the Shanghai Stock Exchange A- share Index at a P/E of 27.3 is still expensive compared to the other market index P/Es. May 2008 23
  • 23. Lehman Brothers | Equity Research EFFECT ON CASH FLOW: EFFECT ON CAPEX, GIVEN FALLING CASH FLOWS AND CAPITAL SHORTAGE? As earnings decline, we believe cash flows will constrict and companies will have less incentive to invest in new capacities especially in areas that already have overcapacity. Furthermore, the high interest rate and credit tightening situation is making it difficult for companies to borrow funds. The falling stock market is also not conducive for fund raising, which is already evident in the much reduced activity. HOW CAN THE GOVERNMENT HELP EASE THE PAIN? China is steered in every direction by government policies depending on its focused goals. Since 2004, the government has been trying to cool down the overheating economy by introducing credit-tightening measures by a series of rate hikes and raising bank reserve requirement ratios (RRR). Figure 10: China policy rate vs RRR China RRR vs 1Y Base Lending Rate 9 14 13 9 12 8 1Y Base Lending Rate 11 8 RRR (RHS) 10 7 9 7 8 6 7 6 6 5 5 1997 2000 2003 2006 Source: Lehman Brothers research At the same time, by controlling prices of electricity, oil products, food, etc, it is trying to combat rising inflation, which started to become a concern in 2H07. Ultimately, the government is concerned about social issues, and consequently, political stability. High inflation, unemployment, stock market losses, and severe negative growth are all concerns. With slowing economic growth, the government’s policy priority could quickly change from combating inflation to boosting employment. Our economist expects no more rate hikes this year despite still high consumer product inflation (CPI) inflation in 1H08 and that the pace of RMB appreciation to slow significantly in 2H08 (to 6.7 CNY/US$ by year-end). Meanwhile, the government could also expand fiscal policy, especially by strengthening welfare programs to boost consumption. Timing, however, is the essence. May 2008 24
  • 24. Lehman Brothers | Equity Research SECTOR SUMMARIES Auto and Auto Parts We believe that, in a scenario of lower growth and higher inflation, the auto sector would be a likely loser. With auto demand generally driven by global economic growth and disposable income, a slowdown in the global economy would have an adverse impact on high-ticket items such as automobiles, in our view. In addition, cost inflation driven by higher inputs (e.g., gasoline) as well as limited financing could put further pressure on demand. We expect China auto demand to experience 15% growth in 2008 and 12% in 2009, on our base-case GDP growth of 9.5% and 8%, respectively. However, under our worse-case GDP growth of 6.5% in 2008 and 6.9% in 2009, we forecast that auto demand growth will fall to 10% in 2008 and 10% in 2009. We believe the auto industry faces possible overcapacity problems in the next couple of years. DF PSA and Beijing Hyundai announced aggressive capacity expansion in China last year to catch the last fastest-growing auto market on the earth. Moreover, national leading automakers such as Shanghai Auto (600104 CH, 3-Underweight), Dongfeng Motor (489 HK, 1-Overweight), Brilliance (1114, 3-Underweight), announced ambitious new product development and capacity expansion programs in order to compete with global original equipment manufacturers (OEM) in their home market. We expect the problem to start emerging sometime in 2009 if most of current announced plans could be completed. This means that the firms may face fierce price competition, margin pressure, and even survival challenges in 2010. We believe the relatively winning China auto stocks are Denway (203 HK, 1- Overweight) and Weichai (2338 HK, 1-Overweight), which focus on luxury vehicles as demand will be supported by industry structure change of product mix favouring luxury vehicles. The relative losers will likely be Brilliance (1114 HK, 3-Underweight) and Dongfeng (489 HK, 1-Overweight) as they are focusing on products that have overcapacity. Banks The Chinese banks witnessed another strong earnings growth in 1Q08, with banks under our coverage recording net profit growth of 77%–187% YoY. However, we will be much more conservative on the banks’ earnings outlook under a heightened scenario of rising inflation and slower growth. We are wary that a domestic economic slowdown may have already surfaced since overall earnings growth of all A-share listed companies stood at 31.3% in 1Q08 versus 80.2% in 1Q07. We believe sector margin peaked (avg 3.22%, 70bp higher than regional banks) in 1Q08, thanks to the ongoing asset re-pricing after the six rate hikes in 2007 as well as enhanced loan pricing capability. Credit risk continues to represent the single-largest threat to the safety and stability of Chinese banks, in our view. In general, we find that the exposure of Chinese banks to credit losses is becoming increasingly manageable given the rising loan-loss provisioning and much-improved capitalization. However, there is a risk that asset quality trends may reverse if the US enters into recession and China’s economic slowdown continues. In a worst-case scenario, our Asia ex-Japan strategy team estimated Asia ex-Japan’s aggregate GDP growth to fall to 5.4%, and China’s GDP to drop to 6.7% while CPI rise to 6.1% in full-year 2008. Under such scenario, we estimate sector credit growth could slowdown to 12.8% YoY from current level of 16.2% YoY (March 2008). Banks are mirrors of the underlying economy. We believe none of the Chinese banks could survive well in a severe economic downturn. Furthermore players with weak fundamentals, poor risk management and less prudent lending procedures will suffer more. May 2008 25
  • 25. Lehman Brothers | Equity Research We identified Huaxia Bank (600015.SS, 3-Underweight, PT: RMB9.00), Minsheng Bank (600016.SS, 2-Equal weight, PT: RMB9.85) and Shenzhen Development Bank (000001.SZ, 1-Overweight, PT: RMB31.84) as the biggest losers under the scenario of rising inflation and slower growth. Conglomerates Conglomerates, by definition, are diversified in nature and will not be totally immune to stagflation. Nonetheless, it is also this business diversification that gives their earnings a higher degree of defensiveness than many other single-industry-focused companies. All conglomerates are also cash-rich, and some are industry leaders in their core businesses. We therefore maintain an overall positive stance on conglomerates under a stagflation scenario. The biggest risk to conglomerates is price controls by the government, especially on products and services that affect the household, such as utilities, food, energy prices. Conglomerates with the biggest exposure to the utility sector is Beijing Enterprises (60% of its NAV is from Beijing Gas). Consumer Among the key consumer segments, we believe China retail softlines and department stores/broadlines are more resilient in the current high inflationary cycle; whereas food & beverages (F&B) should fare less in light of the more vulnerable nature due to their high exposure in soft commodities and thin margins, even though industry leaders should be better protected by scale advantage and pricing power. In the worst-case scenario, we estimate that earnings growth of China department stores/retailers will decrease by 3–5 percentage points to 19%–44% from our current growth forecast of 22%–49% in 2008 and by 5–7 percentage points to 10%–29% from our current forecast of 15%–36% in 2009, respectively. As for F&B, we expect the dairy, processed meat, and tissue paper segments to have the biggest earnings downside risk. Our sensitivity analysis suggests that every 10% rise in the cost of raw milk, pork, and pulp would lower respective operating margins by 4%, 4%, and 3%. As for Hong Kong retailers, given the nature of their heavy cost exposure in rentals, our earnings growth expectations (at 4%–20% for FY08–FY09E) could be easily wiped out should a rental hike revive in the worst-case scenario. In our coverage universe, we believe Parkson Retail, Li Ning, China Mengniu, China Yurun, ctrip, and Li & Fung are the more defensive plays in the currently high inflationary cycle, while Intime, People’s Food, and Bright Dairy are likely to lose out. Media/Internet In general, we believe that the media/Internet sector in the Asia-Pacific region will be better than other sectors in dealing with a period of stagflation. Media companies often require a large fixed upfront investment, but have relatively lower incremental costs to support revenue streams. Furthermore, since media generally faces less tariff controls than the telecom industry, rates are more adjustable in periods of higher inflation. However, the media sector has numerous subsectors – some of which will be better able to weather an environment of stagflation than others, in our view. For example, we believe that media companies whose revenue is primarily based on a subscription model versus an advertising revenue model will do better in a period of stagflation. This group will include online gaming companies, cable TV, and satellite TV companies. For media companies that rely on advertising revenue, companies that have lower cost to advertisers will be in a competitive advantage, in our opinion. In this group, we believe that Internet portals that rely on advertising will do better in a period of stagflation than traditional media companies that operate TV and radio stations or that publish newspapers. May 2008 26
  • 26. Lehman Brothers | Equity Research Nevertheless, all media companies that rely on advertising revenue will likely experience some negative impact during a period of slower growth due to weaker advertising budgets. We believe that the traditional print media companies will do worse in a period of stagflation given their higher fixed and variable operating costs. Given the above conclusions, we believe that the following media companies will outperform during a period of stagflation: Kingsoft, The9, NCsoft, Neowiz Games. Austar, Starhub. Sohu.com, sina.com, NHN, Ctrip.com, Focus Media, and Clear Media. Metals and Mining With different supply/demand dynamics, we believe the effect on gross margin and EBIT margin should be analyzed on a case-by-case basis for different commodity sub- sectors. Being an upstream sector and enjoying both domestic and global tight supply, the Chinese coal sector should enjoy relatively stronger pricing power, which allows coal producers to pass through most of the cost hike pressure and to maintain margins. Domestic 2008 thermal coal contract price jumped 15% YoY, underpinned by supply tightness and sustained railway transportation bottleneck. Further potential upside for 2009 domestic contract price remains, given the deep discount (more than 20%) to the spot prices. Downstream sectors, particularly for copper smelters and aluminium, will likely experience margin squeeze as the raw material cost and labour cost are expected to increase in an inflationary environment. We believe domestic oversupply will constrain their ability to pass through the cost increase. With continued progress to phase out the inefficient capacity and accelerating industry consolidation, steel and cement companies should be able to increase end-product (steel product/cement) prices and offset most of the cost increase. Winners: We think the coal sector should be the winner, underpinned by the shutdown of small coal mines in China, sustained railway transportation bottleneck, and extremely tight supply in Asia-Pacific seaborne-traded coal market. China Shenhua Energy (1088 HK, 1-Overweight) remains our top pick in the sector given its resilient organic growth, steady increase in coal contract price, and likely value-accretive coal mine asset injections from its parent company. Losers: Aluminium producers would likely be the losers due to cost pressure and domestic oversupply, which limits domestic aluminium price upside. Chalco (2600 HK, 3-Underweight) would likely suffer due to cost pressure (bauxite, energy, and power) and limited upside in domestic aluminium prices. Oil and Gas Demand alone does not impact oil prices; the supply situation also plays an important role. Over the past decade, limited new supply has created a tight situation. In particular, non-OPEC supplies have lagged demand growth, leading to a drawdown in inventories and OPEC spare capacity. However, by end-2008 and in 2009, we are expecting large new fields in Saudi to come on-stream. Hence, our view is that oil price prices will remain high for most of 2008, but will likely fall sharply by end-2008 and in early-2009. We expect EBIT to grow in 2008 for most pure oil companies such as CNOOC Ltd. (883.HK, 2-Equal weight) owing to high oil prices, although the magnitude of EBIT expansion is likely to be muted by the impact of local currency appreciation and cost escalation. May 2008 27
  • 27. Lehman Brothers | Equity Research The Chinese integrated companies such as Petrochina and Sinopec, which also have downstream refining exposure, are currently suffering from high oil prices but constrained from raising oil product prices. We believe EBIT could improve with the expected decline in crude oil prices in 2009 even if the government does not relax oil product price controls. This will likely more than offset the gradual increase in production cost. Meanwhile, fearing product shortages, the government is using other regulatory measures such as import VAT rebate to help these companies. In a severe economic downturn, coupled with a high inflationary environment, we expect physical oil demand to decline although there could be demand for oil papers to hedge against inflation. In the near term, we expect the tight supply situation to continue, which could further boost oil prices. However, by the end of 2008 and especially in 2009, as new capacities come on-stream, we believe that oil prices are likely to decline. In the near term, we believe a pure oil company such as CNOOC Ltd is likely to outperform in light of the expectation that oil prices could escalate further. However, over the next 12-18 months, we believe that integrated oil companies such as Sinopec and Petrochina will outperform when crude prices decline. A clear winner will likely be COSL, an oil service company, the earnings of which we expect to be relatively uncorrelated to immediate oil price movements, and which we believe will continue to benefit from high capex spending by oil companies. Utilities – Power China IPPs’ earnings are sensitive to tariff, coal price, utilization rate, and interest rate, in the order of their impacts. Lower GDP growth would mean not only lower power demand and utilization, but also a lower coal price, as 60% of coal demand is driven by power demand. The skyrocketing spot coal price this year – the Qinhuangdao standard spot coal price already reached RMB895 per ton in 1Q (spot raw coal price at RMB640 per ton), similar to the New Castle price, due to unexpected snowstorms in China and a strong regional coal price due to supply shortage – has been a key concern for IPPs’ profitability for 2008–09. We believe that slowing power demand and subsequent softening of coal price should be viewed positively because this is likely to enhance margins significantly. Our sensitivity analysis shows that, for every 1% drop in the coal price, listed IPPs’ average earnings for 2008E–10E would rise 4%, and this compares with a 3% earnings decline for each 1% fall in utilization hours. Unlike the oil and gas sector, in which the government could easily provide one-off subsidies (such as VAT and windfall tax rebates) to the two oil majors, the power sector is fragmented, and this would likely restrict the government’s relief policy to just a tariff hike (or a 17% VAT rebate on tariff). Power tariffs have not been increased since end- 2006, while the coal price has risen by 30% since then. According to the “coal-tariff linkage” 70% pass-through policy, the on-grid power tariff would have to rise 14% in the next review. This compares with our base-case assumption of a 3%–5% tariff hike in 3Q, which means IPPs margins would nevertheless be eroded. If coal prices do not soften, the biggest losers would be IPPs such as Huaneng, Huadian, Datang, CR Power, and China Power International. Utilities – Gas Distribution and Water In terms of the China water and gas distribution sector, it is worth mentioning that Chinese government does not only control the retail price but also the input cost to the operators. Therefore, price control does not impact the water and downstream gas companies at all, but that may limit potential upside from tariff hikes for water utilities. In addition, we believe residential demand for these necessities (especially for water) will not significantly slow, when a country is going through urbanization and when natural gas remains 30% cheaper (per heat content) than other sources of energy, such as coal gas, electricity, etc. However, we expect demand for natural gas from commercial and industry users, which have been the major driver for demand growth over the past couple years, to slow when economic activities slow. May 2008 28
  • 28. Lehman Brothers | Equity Research In the downstream gas and water sector, we prefer water over gas during periods of stagflation, despite limited potential upside from water tariff hike. In particular, we like China Water Affair (855.HK, 2-Equal weight, TP HK$3.00) and China Everbright International (257.HK, 1-Overweight, TP HK$4.70). We think gas distributors such as Xinao Gas (2688.HK, 1- Overweight, TP HK$17.30), Zhengzhou Gas (3928 HK, 1- Overweight, TP HK$1.50), HK & China Gas (3.HK, 3-Underweight, TP HK$17.06) and Beijing Enterprise (392 HK, 1-Overweight, TP HK$42.70) could suffer as a result of lower demand from commercial and industrial users and frozen tariffs. Property/Asset Reflation In a scenario of low growth and high inflation, we believe housing would prove to be the most resilient asset class, followed by low-end retail. The office market should be the most vulnerable. The main impact of a slowdown could be a delay in demand (not extinguishing demand). Short-term supply is the key to holding the resilience of the various markets. The tighter the supply picture, the more room there is for demand to be cut before rents and prices have to adjust. Ranked from the lowest to highest supply, we see Hong Kong housing, Hong Kong office, Singapore office, Singapore housing, and then the China housing market. Due to their high gearings and tight cash position, a potential delay in demand could have more dire consequences on the Chinese developers. If demand proves weaker than expected and contract sales lower, we believe highly geared developers will have little choice but to dilute their NAVs by either taking on a JV partner or some equity issuance. There are no winners under this scenario in the China property space, in our view, and we think the biggest loser is Guangzhou R&F (2777.HK, 2-Equal weight). It is a highly geared developer with a net debt:equity ratio of 140%. Including outstanding land premium of Rmb10 billion, the net debt:equity ratio is near 265%. R&F is dependent on good contract sales and potential A-Share listing to strengthen its cash flow, both of which are difficult if inflation in China continues to stay high. Telecommunications We believe that telecom services would be hurt less than other sectors during a period of slower growth and higher inflation as they are a relatively low-cost and important part of life for a majority of the people in the region. In addition, in a period of slow growth, businesses and consumers looking to reduce costs may use more telecom services (through more phone calls/video conferences) while reducing travel. However, we believe that revenue growth for telecom operators in the developing markets such as China would suffer a greater impact than for those in developed markets – especially as they depend on growth from new low-end subscribers in rural areas (where telephony expenses could represent up to 7%–10% of disposable income). In China, we believe that slower economic growth coupled with higher inflation could result in a negative impact on revenue growth due to weaker subscriber growth and a sharper decline in average revenue per user (ARPU). For example, according to CEIC data, residents in rural China spend 46% of their disposable income on food and 7% on transport, post, and telecom services. If food prices continue to increase, we believe that telecom services could be an expenditure that is reduced. Telecom usage reduction (both for voice and SMS) will result in lower ARPU. On the other hand, we do not believe that there will be any upward adjustments to mobile tariffs due to inflation. In fact, mobile phone rates have continued to decline in China with the average tariffs (revenue/MOU) down more than 17% in FY07 for China Mobile. Telecom operators that would do worse in an environment of stagflation include high- growth companies such as China Mobile and China Unicom. May 2008 29
  • 29. Lehman Brothers | Equity Research Transportation/Shipping We believe that in a scenario of lower growth and higher inflation, shipping sector would be a likely loser. With container demand driven by global economic growth, consumption, and disposable income, we are already forecasting global container demand to slow, and we have a cautious view on the container sector. This is driven not only by slowing global demand but also by cost inflation pressures (such as bunker fuel cost, terminal handling charges and inland transportation costs), as container carriers struggle to pass through the higher costs to customers. The net effect is pressure on margins. Under our worst-case scenario, margins would come under further pressure with declining freight rates from a mixture of slowing demand and excess supply, while container shipping carriers are already struggling to pass through higher costs. Given the current shortage in bulk shipping capacity, we believe the bulk sector will be affected only from 2H09 when the sector switches to excess supply. We believe lower growth and higher inflation will likely exacerbate the problems now faced by the container lines and could even lead to losses. In our opinion, there are no winners but only losers in the shipping sector. Furthermore, we believe the government is unlikely to assist shipping lines. Within China shipping sector, being the only pure container play in China, we believe CSCL (2866.HK, 3-Underweight) will be the largest potential loser in a scenario of slowing growth and rising inflation as the company is most leveraged to changes in freight rates and costs due to low profitability and low margins. CONCLUSION In an environment of severely slowing economic growth and much-higher-than-expected inflation, we think the China equity stock market would likely tumble, especially if the market is expecting corporate earnings growth to be still strong in 2008E and 2009E, which is unlikely to be the case in our worst-case scenario. More than in other countries, we think government policies (monetary and fiscal policies), including interest rates and the reserve requirement ratio, currency policies, price caps and tariffs, etc., are crucial to the potential outcome of our stagflation scenario. The timing as to when these policies will be implemented is essential in whether the government can tame rising inflation and rescue slowing growth. May 2008 30
  • 30. Lehman Brothers | Equity Research HK STAGFLATION SCENARIO Effects of rising inflation and slower growth Ivan Lee LBAL, Hong Kong Tel: +852 2252 6213 HOW WOULD STAGFLATION IMPACT HONG KONG? ivan.lee@lehman.com The US sub-prime problem is looming large, and alongside the continued weakness in the US dollar, falling global economic growth, and a quick washout of wealth effect HK Research Team from the stock and property markets, we believe Hong Kong is likely to enter into a phase of stagflation. This is also underpinned by our views of an economic slowdown, a persistent high inflation and the low likelihood of easing of macro administrative controls in China, which we think will affect ‘hot’ money flowing into Hong Kong and mainlanders’ expenditure in Hong Kong. We expect Hong Kong’s internal consumption to slow, unemployment to rise and input costs (in terms of energy, labor and rental, among others) to increase rapidly. This is not a positive backdrop, especially to the consumer, hotel, aviation, manufacturing, gaming, financial and export sectors, due mainly to Hong Kong’s fairly open economy, its close linkage to China’s economy, and the pegged currency to the US. Potential losers could include SaSa (178.HK, 1-Overweight), Giordano (709.HK, 2-Equal weight), Shangri-la Hotel (69.HK, 2-Equal weight), and Galaxy (27.HK, 1-Overweight). Housing prices, however, will continue to benefit from a negative interest rate environment, in our view. Nonetheless, this is not without risk, as when unemployment continues to rise and the economic confidence level continues to weaken, we believe the appetite for long-term investment may turn sour although affordability is at an all-time high. Other risks may also surface should the US decide to hike rates to curtail inflation, which will be followed by Hong Kong, and when the US dollar recovers. As such, we would be more positive on the economy housing segment than on the front-running high- end property segment. We suggest overweighting SHKP (16.HK, 1-Overweight) and Sino Land (83.HK, 1-Overweight). We expect regulated utilities, whose earnings are tied to capex instead of tariff and fuel cost, and conglomerates with diversified earnings streams to have earnings resilient performance. In particular, we believe utilities and consumer staples (like telephony) will outperform because of their demand and price inelasticity. We believe regulated power utilities, such as HK Electric (HKE) (6.HK, 1-Overweight), CLP (2.HK, 2-Equal weight), and Cheung Kong Infrastructure (CKI) (1038.HK, 1-Overweight), will be winners. Telecom operators such as PCCW (8.HK, 2-Equal weight) and Smartone (315.HK, 2-Equal weight) will also perform well due to their inelastic demand in voice and cable services. We believe there is not much that the Hong Kong government can do to counter the inflationary pressure and slipping economy, given the government’s minimal intervention policy, currency peg and the non-government controlled utilities sector. Nevertheless, we think that the government will likely expedite infrastructure investment and reduce the tax rate further to revive the economy. Still, we believe any impact could be short-lived. May 2008 31
  • 31. Lehman Brothers | Equity Research Figure 11: Factors affecting the Hong Kong market Hong Kong Consumption reduced Weak US stock market HK Stock market to correct drag down Economic growth reduced Unemployment to increase US sub-prime Slow US economic growth Export stimulate reduced inflation Reduced demand for property Weak US dollar Weak HK dollar import inflation Inflation USD-HKD peg Lower US interest rate Lower HK interest rate Negative interest rate Asset price to increase Source: Lehman Brothers research Figure 12: Winners and losers in a stagflation scenario Winners – Company Ticker Price Target Price Rating Comments • HK Electric 6.HK HK$45.20 HK$52.0 1-OW 90% of earnings generated from Hong Kong scheme of control (SOC), which allows a 9.99% ROA • Net cash in 2008E; 5% dividend yield • High earnings and capex visibility, upside from potential overseas M&A • CLP 2.HK HK$60.2 HK$62.0 2-EW 70% of earnings generated from Hong Kong SOC • Under-geared balance sheet; 5% yield • HK$3 bn development funds act as earnings cushion to any adverse market condition • Hutchison Whampoa 13.HK HK$78.05 HK$93.8 1-OW Well-diversified earnings base • Exposure to resilient sectors – oil, port, and housing • Cheung Kong 1038.HK HK$31.75 HK$34.0 1-OW 85% of earnings attributed from regulated assets in HK, Australia, and Infrastructure the UK • HK$1.5 bn net cash inflow per year; Net cash in 2008E; 4% dividend yield • Potential upside from M&A • PCCW 8.HK HK$4.95 HK$5.1 2-EW Similar to the situation of mobile operators, Hong Kong has six fixed- line operators, so it is unlikely fixed-line operators will increase tariffs. • Indeed, we believe fixed-line operators may be even more defensive than mobile operators in a stagflation environment because fixed-line operators are less dependent on VAS and more on monthly tariffs. We believe mobile operators generate higher margins on VAS services. • Smartone 315.HK HK$8.85 HK$7.6 2-EW Even in an inflationary environment, we believe it is unlikely that Hong Kong mobile operators will increase mobile tariffs. For the past many years, mobile tariffs in Hong Kong have been on a downward trend due to intensive competition among mobile operators. • Under our worst-case scenario, we believe mobile subscribers may cut their usage of value-added services (eg, MMS, color ring tones, etc). In Hong Kong, the tariffs for VAS are still at a relatively high level when compared with other countries. Given that voice service has become quite an essential part of subscribers’ daily life, we believe it is unlikely that mobile subscribers will cut voice usage. • SHKP 16.HK HK$138.0 HK$200.5 1-OW Hong Kong’s second-largest housing provider (22% market share) and largest shopping mall owner (10 mn sq ft) should show resilience performance to a downturn. • Furthermore, with net debt:equity ratio of only 14%, SHKP has a strong balance sheet to weather any short-term slowdown. • Sino Land 83.HK HK$21.20 HK$29.8 1-OW Highest leverage to Hong Kong housing and retail. Every 10% increase in housing and retail boost would NAV by 8.2%. • Most near-term catalysts in the form of upcoming pre-sales. The Palazzo and Lake W are both triggers for NAV and earnings upgrades. May 2008 32
  • 32. Lehman Brothers | Equity Research Comments Losers – Company Ticker Price Target Price Rating • Giordano 709.HK HK$3.40 HK$3.33 2-EW High margin to leverage rental cost change • Vulnerable on top-line squeeze amid their more cyclical nature • Sa Sa 178.HK HK$2.98 HK$3.93 1-OW Ditto • HK Land HKL SP US$4.82 US$5.95 1-OW Property stock with the highest proportional exposure to the office market. • HK and SG offices make up 87% of HK Land’s NAV. That said, with existing vacancy at a very low 1.1% in Central, there is ample cushion before HK Land should need to trade rents for occupancy. • HK & China Gas 3.HK HK$19.84 HK$17.06 3-UW Limited upside to HK Towngas tariff and demand amid stagflation • Property earnings nearing an end • Excessive valuation at 34x recurring gas P/E, the most expensive gas utilities in the world • Shangri-la Hotel 69.HK HK$22.40 HK$19.9 2-EW Near-term RevPAR growth risks as weaker demand will likely hurt occupancy levels. • On the other hand, the subdued new hotel room supply in the next few years in HK luxury hotel segment should help preserve hotel operators’ pricing power. • Fair valuations – stock is fairly valued at 9% premium to SOTP of $19.9/share. Our TP of $19.9 is based on par to SOTP. • Galaxy 27.HK HK$5.69 HK$8.5 1-OW Lower visitor arrivals may slow gaming revenue growth, although we have yet to witness this YTD, thanks to strong growth in VIP market. • Potential margin compression for casino operators due to higher effective junket commissions. • Stock is trading at 24% discount to NAV of $7.7/share. We see long- term value from a large undeveloped Cotai site, and also potential short-term market share boost from proposed Jumbo VIP facility. Our TP of $8.5 is the sum of NAV and a Cotai land option value of $0.80. Source: Lehman Brothers Research; Pricing as of 7 May 2008 PROPERTY Under our worst-case scenario of low growth and high inflation, we believe housing should prove to be the most resilient asset class followed by low-end retail. The office market should be the most vulnerable. Housing – Covers basic needs for security. The need for shelter and shortages in available units are likely to drive up rents. Unless we are to envision a world where there is mass emigration, we think demand for shelter should prove very resilient. Retail – Under a recessionary scenario, low-end retail typically outperforms as consumers tighten their budget. Still, we believe that the more important distinction lies in retail mix management as a good mall should be able to adjust its trade mix. Office – For developed and service-based economies such as Hong Kong and Singapore, we think a slowdown in economic activity should affect the office market the most. In the worst-case scenario, we believe housing and low-end retail should be the most resilient as they cover basic needs. Office and high end-retail are likely to fare the worst. At the country level, performance should be tied to existing supply levels. Hong Kong, which has the lowest expected housing supply for the next four years, should prove to be the most defensive, in our view. May 2008 33
  • 33. Lehman Brothers | Equity Research UTILITIES Hong Kong power utilities would fare the best amid stagflation, in our view, given their high earnings visibility, under-geared balance sheet and strong cash flow despite rising inflation and fuel costs. This is because earnings are based on capex (with a fixed 9.99% return on net fixed asset under “scheme of control [SOC]”), not on tariff, and fuel costs are passed through. However, we believe that Hong Kong gas company, HK & China Gas (3 HK, 3- Underweight) could be affected because it is non-regulated, and its tariff in Hong Kong could be frozen for a longer period of time due to rising inflation and an already lucrative return (31% on net fixed asset), while demand for gas in Hong Kong and China will likely also slow when GDP growth starts to turn south. This is especially true in China, where a majority of gas demand growth is driven by commercial and industrial users. FINANCIALS We think stagflation should be neutral to the Hong Kong banks’ net interest margin, but will lead to increased cost pressure (i.e. staff cost & office overheads). Banks that have a better record of controlling cost, such as Hang Seng Bank (0011.HK, 1-Overweight) and Wing Hang Bank (0302.HK, 1-Oveweight) should manage the situation better, in our view. Slowing economic growth would erode profitability of small and medium enterprises. Local banks which have a higher exposure to the SME loans, will likely see increases in loan loss provision. On loan growth, we believe the effect would be relatively neutral – a slower economy should lead to slower credit growth, but this could be offset by a higher property-related loan growth. Overall, we believe stagflation would be slightly negative on Hong Kong banks. TELECOMMUNICATION For countries such as Hong Kong, we believe the impact from potential stagflation is more likely to be felt via a lower usage of value-added services (VAS) than higher mobile tariffs. Over the past few years, Hong Kong mobile operators have been lowering the tariffs of voice services. However, tariffs of VAS (color ring tones, etc) still stay at relatively high levels. If the domestic economy slows, we believe it is possible that mobile subscribers will cut back on their usage of VAS. Given voice service is a core part of mobile telephony, we believe it is unlikely to decline because of slower economic growth. CONSUMER While a mild inflationary environment is a welcome factor to drive healthier earnings growth in the consumer sector due to the better leverage from both pricing and sales perspective, any severe inflationary pressure may post a reverse outcome amid heightening margin risk as operators are squeezed to absorb part of the cost hike to share the burden with their suppliers. For Hong Kong retailers, given the nature of their heavy cost exposure into rental, our earnings growth expectations (at 4%-20% for FY08-09E) could be easily wiped out should rental hikes revive in a worst-case scenario. Overall, in our Hong Kong consumer-related stocks universe, we believe that Li & Fung (0494.HK, 1-Overweight) is the most defensive play against our inflation topic, thanks to its commission-driven business model, which is on a cost-plus basis, while Giordano and Sa Sa are more sensitive to it. May 2008 34
  • 34. Lehman Brothers | Equity Research CONGLOMERATE In a stagflation environment, those companies that have: (1) a pricing power to pass on rising costs, (2) a control in input costs, and (3) strong recurring cash flows and healthy balance sheets, will be the likely winners. As a result, we believe those conglomerates that possess industry leadership (hence pricing power), scarce resources (hence input cost control), larger exposure to infrastructure (recurring cash flows), and cash-rich balance sheets, should weather stagflation better than others. In terms of sector exposure amongst the conglomerates, we believe Hong Kong housing should be the most resilient to stagflation, followed by energy and transportation infrastructure. Low-end manufacturing, airlines and office market should be the least defensive. Conglomerates, by definition, are diversified in nature and will not be totally immune to stagflation. Nonetheless, it is also because of this business diversification that gives their earnings a higher degree of defensiveness than many other single-industry-focused companies. All the conglomerates are also cash-rich, and some are industry leaders in their core businesses. We therefore maintain an overall positive stance on conglomerates under a stagflation scenario. SHIPPING AND TRADE We believe that under a scenario of lower growth and higher inflation, the shipping sector will be the likely loser. With container demand driven by global economic growth, consumption and disposable income, we forecast global container demand to slow and we have a cautious view on the container sector. This is driven by not only slowing global demand but also cost inflation pressures (such as bunker fuel cost, terminal handling charges, and inland transportation costs) since container carriers struggle to pass through the higher costs to customers. The net effect is margins pressure. We believe lower growth and higher inflation will exacerbate the problems currently facing the container lines and could even lead to losses. May 2008 35
  • 35. Lehman Brothers | Equity Research INDIA AND STAGFLATION Tight policies limit local stagflation risk Prabhat Awasthi LBSPL, India Tel: +91 22 40374180 HOW WOULD STAGFLATION IMPACT INDIA? prabhat.awasthi@lehman.com Lehman Brothers Asia is exploring the potential risks to Asia-Pacific markets in a scenario of slowing global growth, resulting in slower Asian growth, but in the face of India Research Team rising input costs. The current inflationary risks in India are the result of rising Tel: +91 22 40374037 commodity and food prices. Indian inflation has already seen a significant increase: from a low of 3.07% in October 2007, wholesale price inflation in India moved to 7.57% on April 19, 2008. The Indian central bank, the Reserve Bank of India (RBI), started a tightening policy in October 2006 in the wake of serious asset inflation. This policy continues and has been joined by a series of fiscal measures, such as cuts in import duty for edible oil, steel and cement, etc., which are causing inflation to rise. We believe that inflation will remain high for some more time, due largely to the base effect. In our view, the government, especially due to the proximity of elections, is unlikely to let many cost increases be passed on to consumers, but will likely absorb them by increasing fiscal deficit. Crude price increases have not been passed on to customers in the form of increases in the prices of diesel, petrol, LPG or kerosene. Increases in fertilizer costs have not been passed on to farmers for the same reasons. This would mean a swelling of deficit for the government. The ballooning of fiscal deficit is one of the primary risks we perceive at a time when monetary conditions are tight. This essentially means a tight environment for interest rates going forward. One of the major reasons for India’s premium expansion has been the reduction in fiscal deficit, a process which could be derailed in the short term due to inflationary headwinds. The sectoral impact is likely to be less obvious than a straightforward extrapolation of high interest rates onto sectors sensitive to them. We believe that further increases in interest rates to consumers will remain limited as they have already risen considerably. We also believe a significant slowdown in investment spending is unlikely, given that corporates are flush with cash and there are significant shortages in key sectors, such as steel and power. The risks are significant for part of the banking sector, companies with a high proportion of fixed-price contracts and companies with high energy usage without the ability to pass on increased costs. We believe that the following sectors will be the most affected: • Public sector banks • Infrastructure companies with a high proportion of fixed-price contracts • Automobile companies • Cement companies Beneficiaries in a weak economic environment laced with inflation can only be relative. Classic defensive sectors, such as pharmaceuticals and fast-moving consumer goods (FMCG), will be the least affected, in our view. May 2008 36
  • 36. Lehman Brothers | Equity Research WINNERS AND LOSERS Figure 13: Winners and losers (India) Winners Ticker Price (INR) TP (INR) Rating Comments • Ranbaxy RANB.NS 466 603 1-OW We expect the slowdown in Indian GDP growth in CY08 to result in a proportional slowdown in the growth of the Indian pharmaceutical market. However, the Indian market contributes just 19% of Ranbaxy’s revenue. • A slowdown in India’s GDP growth to 6.5% would imply only a 1% adverse impact on our CY08 EPS estimate for Ranbaxy. • Ranbaxy has a strong product pipeline and front-end presence in 49 countries, providing healthy core business performance. It also has strong earnings support from potential exclusivity related upsides in CY09 and CY10, in our view. • Nicholas NICH.BO 336 524 1-OW Domestic formulations contribute close to 50% of the company’s sales. A Piramal slowdown in India’s GDP growth to 6.5% would imply a 3% adverse impact on our FY09 EPS estimate for Nicholas Piramal. • Its CRAMS business is gaining traction and is expected to contribute increasingly more to EBITDA margins. This business would not be affected by a slowdown in India’s GDP growth in CY08, according to our estimates. • The adverse impact on NP’s TP due to a GDP growth slowdown would be only 1%, which would still imply 53% potential upside from current levels. • Hindustan HLL.BO 252 293 1-OW We expect the home and personal care (HPC) categories to remain largely Unilever insulated from new competition. • We expect margins to expand in an inflationary environment on account of reduced competitive intensity and aggressive pricing action. • The impact of a slowdown is likely to be minimal on volumes. However, in an extreme downturn, people may down trade, in our view. • Bharti Airtel BRTI.BO 816 1,110 1-OW Defensive business model. Sells low ticket necessities. • Low penetration and strong growth. • Asset owner available at reasonable price. Losers Ticker Price (INR) TP (INR) Rating Comments • Larsen & LART.NS 2,993 5,003 1-OW Potential order inflow slowdown due to economic slowdown. Toubro • Margins could be adversely affected by rising raw material costs. • Trading at a relatively higher multiple than other construction companies, hence risk of de-rating of P/E multiple. • State Bank SBI.NS 1,769 1,900 3-UW We believe a macro slowdown will disproportionately impact asset quality, of India especially in the small and medium enterprises (SME) segment, which has been a focus area for the bank and which has been clocking higher growth in the past two years. • Our concern on SBI is that management seems to be pursuing strong asset growth at a time of heightened risk in the asset quality environment. • Regulatory risks. • CRR continues to be RBI’s tool for targeting inflation. A hike in CRR is a significant tax on the banking system (state-owned banks may not be able to recover costs by raising lending yields, given the government policy environment and limited pricing power). • The recently announced government farm loan waiver has led to a spike in State Bank’s agricultural bad debts and the risk of moral hazard continues, more so in a weak economic outlook. • Tata Motors TAMO.NS 680 976 1-OW A GDP slowdown would be likely to result in a sharp decline in the sales of commercial vehicles. • Margins could also come under pressure due to unfavorable product mix. • Ambuja GACM.NS 111 100 3-UW The stock is currently trading at an EV per ton of US$216, which we believe is Cements expensive, given the deteriorating fundamentals of the Indian cement sector. We believe the sector will see overcapacity and a price correction even in the base-case scenario. • In the stagflation scenario, a price correction could be much more severe than our forecast of 10% and given the increase in input prices, profitability could decrease significantly from the current operating margin of 28%. May 2008 37
  • 37. Lehman Brothers | Equity Research • In such a scenario, we expect the company to trade at a replacement cost valuation of US$90 per ton. Source: Lehman Brothers estimates (Prices as of May 7, 2008) DOWNSIZING THE ENGINE ROOM? India’s capital spending has been growing at a rapid clip and has been the primary reason for the acceleration in GDP growth. WHAT HAPPENED IN THE 1970S? We believe a comparison with 1970s would not be appropriate at this time, given that the Indian economy was protected by high tariffs and capacity controls in the 1970s. India did not have a well-developed capital market, and the public sector controlled most of the economy. The impact on Indian GDP growth was felt with a lag – FY72 was a flat-growth year and FY73 was a recession year. HOW CAN THE GOVERNMENT HELP EASE THE PAIN? The government has been using fiscal measures alongside monetary measures to reduce the inflationary impact on consumers. Unfortunately, some of these measures mean that true market economics are not reflected in the economy. If the inflation period is prolonged, we expect the government to start passing on some of the suppressed price increases (especially those relating to crude oil and fertilizers) in small doses. However, we do not expect this anytime soon, given the proximity of the elections. CONCLUSION India’s positive in the event of stagflation is the investment cycle, which is predicated on significant demand-supply gaps. The RBI has been extremely vigilant and has not allowed the build-up of excesses in the system. We do not believe that India would be affected significantly in a stagflation scenario and growth would remain strong in relative terms, in our view. The negative impact would likely be felt by interest rate- sensitive stocks or by companies that are not in a position to pass on cost pressures to consumers, in our view. May 2008 38
  • 38. Lehman Brothers | Equity Research KOREA STAGFLATION SCENARIO Effects of rising inflation and slower growth Korea Research Team Seoul Based HOW WOULD STAGFLATION IMPACT KOREA? Zayong Koo LBIE, Seoul We are exploring the risks to the Korean market in the scenario of falling global growth, Tel: 822.2116.7550 resulting in slower Asian growth – but in the face of rising input costs. In general, we zayong.koo@lehman.com believe most Korean industries would be adversely affected by rising inflation and slower growth, as many of these are export driven, and much of their inputs (e.g., raw James Kim materials) are imported. LBIE, Seoul As global growth, especially US growth, decelerates, we would expect Korea’s export- Tel: +822.2116.7570 driven industries, such as autos, discretionary consumer electronics (e.g., mobile phones, james.kim@lehman.com LCD TVs, etc.) and semiconductors (via PCs) to face great challenges. Domestic industries –retail, travel, and even utilities – are also likely to be adversely affected by Mark Yoon such a stagflation environment. LBIE, Seoul Tel: +822.317.5159 On the other hand, such an environment would also likely increase the demand for mark.yoon@lehman.com necessities like food and beverages. As a result, consumer demand would likely increase at discount stores, where food and beverages account for more than half the total sales. CW Chung In addition, we would expect relatively inelastic consumer demand for consumer staples LBIE, Seoul like cigarettes. Tel: 852.2116.7558 The Korean economy entered a slowdown in 1Q08, and the leading composite economic cwchung@lehman.com index slowed in February, suggesting further economic weakening. Our economics team expects the Bank of Korea (BOK) to cut rates by 100bp in 2H08 to counter slowing Stanley Yang growth in the economy. However, with a market-oriented new president having taken LBIE, Seoul Tel: +822.317.5168 office, it is our view that he will focus on revitalizing the domestic economy as soon as stanley.yang@lehman.com possible to minimize the length of such stagflation. Michelle Cho LBIE, Seoul Tel: +822.2116.7559 michelle.cho@lehman.com Hong Taik Chung LBIE, Seoul Tel: +822.317.5148 hongtaik.chung@lehman.com Jee Hoon Park LBIE, Seoul Tel: +822.2116.7567 jeehoon.park@lehman.com HK-Based Andrew Lee LBAL, Hong Kong Tel: 852.2252.6197 andrewkw.lee@lehman.com Ivan Lee LBAL, Hong Kong Tel: +852.2252.6213 ivan.lee@lehman.com May 2008 39
  • 39. Lehman Brothers | Equity Research WINNERS AND LOSERS Figure 14: WINNERS AND LOSERS (Korea) Winners Ticker Price Target Price Rating Comments • KT 030200.KS KRW45,250 KRW46,700 2-EW Telecom spending is very defensive to macro economic downturn. Telecommunication • Inflationary costs pressure is also limited. • KT&G 033780.KS KRW82,500 KRW101,000 1-OW Cigarette demand is almost inelastic with regard to economic turnarounds. Consumer • Significant earnings are backed by export cigarette business and 100%-owned subsidiary Korea Ginseng. • Profitability will improve on increasing imported leaf tobacco. • Extraordinary shareholder friendly measures. • Samsung Electronics 005930.KS KRW741,000 KRW920,000 1-OW Strong cost competitiveness. • Tech – Semiconductors Highest ASP in the industry. • Strong financial structure. Losers Ticker Price Target Price Rating Comments • With container demand driven by global economies, Hanjin Shipping 000700.KS KRW43,350 KRW39,000 2-EW consumption, and disposable income, shipping lines are the likely losers. Transportation • Among the listed Asian container stocks, Hanjin has one of the highest exposures to the transpacific route. • If demand weakened significantly more than expected, it Honam Petrochem 011170.KS KRW88,900 KRW165,000 1-OW would exacerbate the existing negative environment caused by oversupply. Petrochemical • Honam’s product suite remains concentrated on ethylene derivatives, where we expect overcapacity to be most severe. • Rising fuel costs, a deprecating won, and limited chances KEPCO 015760.KS KRW33,950 KRW26,900 3-UW of securing a tariff hike amid high inflation imply downside risks to FY08 earnings. Utilities • Slowing down of power demand (assuming growth slows down) may exert further pressure on the deteriorating bottom line. • Sensitive to economic environment. Kia Motors 000270.KS KRW13,500 KRW17,500 1-OW • The domestic market is small and highly reliant on Autos overseas markets, with over 50% of its exports going to developed markets. • Input costs are rising. • Lower sales volumes would increase fixed costs and raise incentive levels, resulting in a margin squeeze. • Demand slowdown from the US/EU regions, especially for LG Display* 034220.KS KRW48,500 KRW54,000 2-EW TV panels, could significantly limit earnings growth. • Tech – Hardware Increased capex in 2008, combined with a demand slowdown, could lead to serious oversupply in the LCD industry in 2009. • Lower operational efficiency. LIG Insurance 002550.KS KRW20,850 KRW24,500 2-EW • Weaker underwriting capabilities and sustainability of Non-life Insurance customer retention efforts. • Lesser exposure to health-related long-term insurance products (that has greater growth potential) than others. • Over-extended shipbuilding capacity expansion STX Shipbuilding 067250.KS KRW37,650 KRW30,000 3-UW (especially in overseas markets) could bite during down cycle. Shipbuilding • Undiversified business scope, with 100% of revenues from ordinary cargo ships, puts vulnerable earnings at risk. *Note: Closing price as of May 7, 2008; Source: Lehman Brothers research. *The investment rating for LG Display was downgraded to 2-EW and the 12-month target price was cut to W54,000 (from W65,000) on 15 May 2008 May 2008 40
  • 40. Lehman Brothers | Equity Research EFFECT ON EBIT: SHRINKING MARGINS? In the lower growth and higher inflation scenario, margins for most industries would be under greater pressure, with declining prices from a mixture of slowing demand and excess supply. The situation is further exacerbated by higher input costs, and it is becoming increasingly difficult to pass this on fully to end consumers. However, the magnitude of margin pressure for certain industries, such as tobacco and banks, would likely be minimal. We believe Korea’s leading tobacco player, KT&G, would maintain its profitability given stable domestic cigarette demand, growing exports, and declining raw material costs, due to greater usage of relatively cheap imported tobacco leaves. We believe that banks’ margins are relatively well protected. Since we expect banks to refrain from aggressive loan growth, we believe they can command better pricing power for loans. Banks had not been able to fully price in the rise in interest rate until now due to heated lending competition. Hence, even if the central bank cuts rates aggressively in 2H08, we believe that banks will enjoy better spreads from interest earnings assets and interest-bearing liabilities. WHAT HAPPENED IN THE 1970S? The 1970s for Korea was still a period of strong growth and low per capita GDP, with average GDP growth persisting at over 8% and per capita GDP at less than US$2,000. In addition, the manufacturing sector’s contribution to GDP started to rise, accounting for over 17% of real GDP, up from 14% in the 1960s and 9% in 1953. This was largely driven by export-oriented industries. The real turmoil for Korea arose only in 1980 during the second oil shock (which contracted Korea’s GDP by over 4%) and post the assassination of the late President Chung Hee Park, who was instrumental in the industrialization of Korea in the 1960s and 1970s. Figure 15: Korea GDP Growth 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 *Growth (%) 8.8% 7.5% 4.2% 12.1% 6.7% 4.1% 12.4% 10.8% 10.4% 6.1% -4.2% *Based on Real GDP/Source: Bank of Korea HOW CAN THE GOVERNMENT HELP EASE THE PAIN? The government’s measures to boost the domestic economy (e.g., reducing income taxes, comprehensive real estate taxes, special consumption taxes, lower interest rates, etc.) could help from the macro perspective. In addition, Korean financial regulators increased loan loss reserve standards for banks in 2006 and 2007 to strengthen asset quality. However, given the current strong asset quality of Korean banks, which boast historically low NPS ratios of 50-100bp and high NPL coverage of more than 150%, we believe the reserve standards could also be eased. SECTOR SUMMARIES Autos We believe that under a scenario of lower growth and higher inflation, the auto sector would be a likely loser. With auto demand generally driven by global economic growth and disposable income, a slowdown in global economy would have an adverse impact on high ticket items such as automobiles, in our view. In addition, cost inflation driven by higher input (e.g., gasoline) costs and limited financing could, in our view, put further pressure on demand. May 2008 41
  • 41. Lehman Brothers | Equity Research Consumer We believe low growth and higher inflation are likely to exert a negative impact on the Korean consumer sector, suggesting a potential slowdown in domestic consumption due to lower employment and real wage growth. However, we expect to see a mixed outlook for individual players given diverse consumer sub-markets. Financials Despite the central bank’s efforts to support economic growth, we believe it will be tough for commercial banks to comply, given their difficult funding environment. The loan-to-deposit ratios of major nationwide commercial banks are all above 100%, which means that banks will have to rely mostly on market funding to support any sizable loan growth. However, given that market funding bears higher cost versus deposits, loan growth supported by market funding will mean NIM contraction for banks. We believe banks will be prudent when it comes to increasing loans, given NIM control is a major issue for banks at this stage. Internet In general, we believe the Korean Internet/Gaming sector will be better than other sectors in dealing with a period of stagflation. We believe online gaming companies whose revenues are primarily based on a subscription model versus an advertising revenue model will do better in a period of stagflation. However, we believe an economic downturn is likely to have some negative impact on an Internet portal’s top- line growth, due to advertisers’ cut in overall advertisement budgets. Metals A weak economy, coupled with higher input costs, is, in our opinion, likely to exert pressure on steel makers, especially since they cannot fully pass on the higher costs in this stagflation environment. We believe this is the scenario that has plagued the Korean steel makers in recent times. Non-Life Insurance Under a scenario of lower growth and higher inflation, we think there is a likelihood of downside risks to insurers but the magnitude of downside could be limited, in our view. An economic downturn accompanied by inflation could work adversely for insurers because of possible claim cost escalation along with diminished demand for insurance. At the same time, insurers cannot pass the potential claim cost escalation on to policyholders when there is an increase in inflationary pressures, as insurance premiums are included in Consumer Price Index (CPI) baskets. Therefore, we believe a scenario of stagflation could hurt both the growth and profitability of insurers. However, the insurance underwriting cycle responds to supply and demand inputs with a number of drivers affecting the equation. Several factors, including economic activity, inflation and demographics could impact the demand for non-life insurance; thus the scope for downside risks could be contained if one of these factors nearly outweighs the others, in our view. Shipbuilding We believe the shipbuilding industry would benefit from 3–4 years’ worth of orderbook outstanding, in that it provides a cushion of locked-in revenue stream for that time horizon. However, we believe cost inflation in the form of rising steel prices, wage rates, and a weaker US dollar (i.e., a higher FX rate) could materially erode profitability on outstanding orderbooks (most orders have prices fixed in US dollars, without cost pass- through or escalation clauses). Moreover, the aforementioned topline visibility is unlikely to insulate shipbuilding stocks from macro headwinds leading to a slowdown in orderflows (exacerbating the May 2008 42
  • 42. Lehman Brothers | Equity Research ongoing cyclical order downturn, coming off a prolonged upturn in the last four years), which is a major driver for share prices. In our view, if capital shortage (leading to ship financing market crunch) and capex cutbacks by ship buyers induce them to start cancelling outstanding orders, it could mitigate revenue visibility and also lead to sharp de-rating on this predominantly sentiment-driven sector. Technology – Hardware In a prolonged stagflation scenario ignited by the US credit crisis, we believe the LCD industry would face two key issues: one, panel demand from the US and European regions could slow down rapidly, especially for TV panels; two, increased capex in 2008 (up almost 60% YoY), combined with the demand slowdown, could lead to serious oversupply in 2009. Considering that we regard TVs as the key future growth driver for the overall LCD sector and developed countries make up a major portion of global TV demand, the US/EU economic slowdown could pose a material threat for the display industry. However, we note that the US broadcasting system’s move to digital from analog in February 2009 could limit the downside. Also, strong CRT replacement demand from emerging markets could, in our opinion, offset the overall global demand slowdown to some extent. However, in a prolonged stagflation, we believe overall demand slowdown is likely to negatively impact most panel makers’ profitability, especially at the advent of an industry-wide oversupply in 2009. Technology – Semis We believe that a combination of high inflation and economic recession would result in slower demand for memory, particularly for NAND flash, as flash demand contribution from the US and Europe is much greater than that for DRAM. Also, NAND flash- equipped applications are designed for entertainment, which is more susceptible to an economic slowdown. At the same time, we believe that slower NAND flash consumption would also be negative for the DRAM market. This is because we should see increased DRAM supply if the NAND flash market becomes weak, as production should shift from NAND flash to DRAM. However, we think a recession would affect memory makers differently. While a severe recession may impede the sector recovery as a whole, it would accelerate industry restructuring, strengthening the position of first-tier makers, in our view. Unlike other industries, the semi memory industry is characterized by a huge gap in cost competitiveness and funding ability between first- and second-tier makers. Telecommunications Overall, we believe that telecom services will be affected less than other sectors during a period of slower growth and higher inflation. Telecom services are relatively low-cost and an important part of life for a majority of the people in the region. In addition, in a period of slow growth, businesses and consumers looking to reduce costs may use more telecom services (more phone calls/video conferences) while reducing travel, in our view. However, we believe Korean telcos could be under pressure due to a tariff cut driven by regulatory dynamics, where inflation pressure translates into wireless tariff cut pressure given that telecom spending roughly represents 6% of CPI baskets in Korea. Transportation We believe that, in a scenario of lower growth and higher inflation, players in the shipping sector could be likely losers. With container demand driven by global economic growth, consumption, and disposable income, we are already forecasting a slowdown in global container demand, and our view on the container sector is cautious. Our view is driven not only by slowing global demand but also by cost inflation pressures (such as bunker fuel cost, terminal handling charges, and inland transportation costs) as container carriers struggle to pass through higher costs to customers. The net effect is margin pressure. We believe lower growth and higher inflation would exacerbate the problems currently faced by the container lines and could even lead to losses. May 2008 43
  • 43. Lehman Brothers | Equity Research Utilities Lower growth with higher inflation would imply downside risks to power demand growth plus limited scope for securing a tariff hike, in our view. If this comes against a backdrop of rising fuel costs (mainly coal), we believe it would imply shrinking margins at the operating level. CONCLUSION Overall, stagflation is not a desired environment in any country or region. It leads to lower sales, higher input costs, and ultimately a margin squeeze. Governments try to implement policies to minimize the impact, but there are limitations to what they can do when the weakened environment transcends their borders. In Korea, we expect defensive industries such as telco and tobacco to be the least affected, while other consumer-related and export-related industries would be harder hit. However, we believe Samsung Electronics is well positioned globally to actually benefit from the downturn, although the industry in which it operates is likely to be hurt by stagflation. May 2008 44
  • 44. Lehman Brothers | Equity Research TAIWAN STAGFLATION SCENARIO Can politics offset rising inflation and slower growth? Kent W.B. Chan LBAL, Hong Kong Tel: +852.2252.1408 HOW WOULD STAGFLATION IMPACT TAIWAN? kent.chan@lehman.com • In an environment of slowing global growth and high INFLATION, Taiwan’s Josephine Ho export-oriented economy stands to underperform relative to its Asian peers owing LBAL, Hong Kong to its high dependence on technology, excessive competition, and its Tel: 8862 8723 1663 josephine.ho@lehman.com dependence on imported oil. The domestic economy and asset reflation stocks would continue to rise, potentially like they did after the inflation shock in the John Hsu 1970s. LBSTL, Taiwan Tel: 8862 8723 1627 • john.hsu@lehman.com Margin risks are high from (1) potentially lower utilization at capital intensive industries (semiconductors, TFTs, materials) and (2) rising input costs, both of Sarah Hung, CFA which Taiwan may not able to pass on due to the competitive nature of its key LBSTL, Taiwan industries, which may create downside risks for earnings in LEH’s worst-case Tel: 8862 8723 1618 scenario. sarah.hung@lehman.com • Domestic oriented companies would continue to outperform and rising inflation Yolanda Wang could further support the property sector and asset reflation stocks, while telecoms LBSTL, Taiwan and insurance/select banks could outperform, particularly exporters as the market Tel: 8862 8723-1623 look for domestic spending and increases in fixed asset investment. yolanda.wang@lehman.com • Winners and Losers: Despite risks to earnings, the financial risks should be Alex Yang limited due to healthy (over capitalized) balance sheets; outperformers would LBSTL, Taiwan include global leaders, brand winners, property plays and select financials, and Tel: 8862-8723-1619 alex.yang@lehman.com defensives; losers are abundant in the export sector, but led by low-margin tech assemblers and consumer goods exporters. Danny Chu LBAL, Hong Kong Tel: +852.2252.6209 danny.chu@lehman.com Andrew Lee LBAL, Hong Kong Tel: 852 2252 6197 andrewkw.lee@lehman.com Yong Liang Por LBAL, Hong Kong Tel: 852 2252 6220 yongliang.por@lehman.com Felix Pan LBSTL, Taiwan Tel: +8862.8723.1614 felix.pan@lehman.com Zona Chen LBSTL, Taiwan Tel: + +8862.8723.1628 zona.chen@lehman.com Maggie Huang LBSTL, Taiwan Tel: + +8862.8723.1631 maggie.huang@lehman.com May 2008 45
  • 45. Lehman Brothers | Equity Research WINNERS AND LOSERS IN A STAGFLATION SCENARIO Figure 16: WINNERS AND LOSERS (Taiwan) Winner-Company Ticker Rating Target Price Comments • TSMC 2330.TW 1-OW NTD 76.0 We believe industry leaders like TSMC will be the winners in a slowing economy with inflation, as industry leaders are usually R&D innovators for advanced technology. • Taiwan Cement 1101.TW 1-OW NTD 61.0 Taiwan Cement will be the winner of Chinese cement industry consolidation and capacity increase in 2008. • Cathay FHC 2882.TW 1-OW NTD 97.7 Companies with higher real estate exposure, such as Cathay may see smaller impact as appreciation of real estate is likely to offset part of their loss in the business. • China Trust 2891.TW 1-OW NTD 30.1 Banks with higher consumer banking exposure, such as Chinatrust will likely to perform better. • Chunghwa Telecom 2412.TW 2-EW NTD 84.0 The potentially lower MOU from mobile subscribers may be partially offset by its steady fixed-line and broadband business. • Acer 2353.TW 1-OW NTD 80.2 Acer will be better off under stagflation than Dell and Asus based on its higher exposure to low-end segment. However, the revenue growth will be slower too based on slower high-end demand. • Ju Teng 3336.HK 1-OW HKD 5.15 The only winner is consumer NB component vendor like plastic casing vendor, Ju Teng based on that they can transfer more of rising cost to clients and stronger demand from industry growth. May 2008 46
  • 46. Lehman Brothers | Equity Research Loser- Company Ticker Rating Target Price Comments • ProMOS 5387.TWO 2-EW NTD 7.3 We view second tier makers like ProMOS as the eventual losers in the memory industry. • Sunplus 2401.TW 3-UW NTD 50.0 Sunplus with higher global consumer demand and less room for cost reduction is clearly a loser • Asustek Computer 2357.TW 1-OW NTD 135.0 For desk top ODMs and MB vendors like Asustek will be the losers under stagflation, as they have greater exposures to desktop and motherboards which will be replaced by low-end NBs. • High Tech Corp 2498.TW 1-OW NTD 841.0 HTC will suffer as it has larger exposure to high-end handset products. • Foxconn Tech 2354.TW 3-UW NTD 140.0 As a metal casing supplier, Foxconn Tech’s products are exposed to high-end NBs. • Catcher 2474.TW 3-UW NTD 100.5 As a metal casing supplier, Catcher’s products are exposed to high-end NBs. • Formosa Chemical 1326.TW 3-UW NTD 62.0 FCFC faces more headwinds as aromatic margins are likely to and Fibre continue being the most adversely affected by a combination of record crude prices, weakening end-demand and increasing supply. • Evergreen Marine 2603.TW 3-UW NTD 18.9 Evergreen is the most leveraged to changes in freight rates and costs due to low profitability and low margins. Source: Lehman Brothers research May 2008 47
  • 47. Lehman Brothers | Equity Research WE HAVE ALREADY CUT OUR 2008E EPS, BUT WHAT ABOUT 2009? Lehman Brothers Asia is exploring the risks to the Asia Pacific market in a scenario of falling global growth, resulting in slower Asian growth, but when asked, most analysts say they have already cut their 2008 numbers, and 2009 global growth will be better….right? What if 2009 is not better, but worse? Add on to that the risk of deflation, with slower unit demand, and the cocktail becomes disturbing quite quickly, especially for a capital intensive exporter like Taiwan. We are concerned that despite Lehman’s 17% cut to 2008 profit estimates in our Taiwan universe of stocks, we still increased 2009 estimates by 6% so far this year; hence, if stagflation were to hit in 2009, there could still be MORE downside risk to our estimates. Figure 17: Earnings Revisions vs. Taiex, 1998-2008 TaiEX (RHS) Up/Downgrade Momentum (LHS) 0.60 12700 0.40 10700 0.20 0.00 8700 -0.20 6700 -0.40 4700 -0.60 -0.80 2700 6/30/1988 2/28/1989 10/31/1989 6/29/1990 2/28/1991 10/31/1991 6/30/1992 2/26/1993 10/29/1993 6/30/1994 2/28/1995 10/31/1995 6/28/1996 2/28/1997 10/31/1997 6/30/1998 2/26/1999 10/29/1999 6/30/2000 2/28/2001 10/31/2001 6/28/2002 2/28/2003 10/31/2003 6/30/2004 2/28/2005 10/31/2005 6/30/2006 2/28/2007 10/31/2007 Source: I/B/E/S and Lehman Brothers Despite the seemingly steep cut to I/B/E/S estimates for Taiwan (please see chart above) we explore the risks in a worst-case scenario where stagflation hits Taiwan and the region. Although domestic Taiwan would likely continue it outperformance vs exporters and tech, risks of a short-term market sell-off would be high as seen in the initial inflation shock in 1974. Below we explore the risks. LOWER GDP GROWTH WITH HIGHER INFLATION Lehman Brothers Asia is exploring the risks to the Asia Pacific market in a scenario of falling global growth, resulting in slower Asian growth, but in the face of rising input prices. Lehman Brothers economists project 2008 GDP growth of 3.9% in 2008 and rebounding to 5.7% in 2009 on 3% inflation, in expectations that fiscal policy and domestic spending may result in better growth after a weak year in 2008, and where tech earnings remain resilient, despite the deterioration of the export markets, most notably the U.S. However, we wonder WHAT IF growth fails to reaccelerate and deteriorates in 2009, primarily based on slower global growth but also due to rising inflation? May 2008 48
  • 48. Lehman Brothers | Equity Research Our equity strategy team chose to explore a more negative scenario to global growth, applying higher inflation assumptions: negatively impacted real GDP growth in 2008, if growth were to fall to 2.9%, and more importantly falling again to 2.6% in 2009 with inflation closer to 4%. We analyze the risks by sector. However, in such an environment, we see Taiwan underperforming, especially its low-margin technology assembly and manufacturing stocks, which would could see a fall in product demand. However, the more capital intensive portions of its manufacturing sectors, semiconductors, steel, and petrochemicals, would likely face lower utilization and higher input costs. As such, the export oriented portion of Taiwan would likely face margin and profit pressure exacerbated by the slowing demand, in our view. EFFECT ON REVENUES: LOWER UNIT SALES? As global growth, and especially U.S. growth, decelerates, unit shipment growth is likely to face challenges and will likely impact Taiwan’s export driven tech sector, particularly discretionary consumer electronics such as mobile phones and LCD TVs, though we have not seen signs of this yet. Our house view calls for global PC unit growth of 12% in 2008 and 10% in 2009, 12% and 8% for handsets, and 38% and 25% for LCD TV growth. The risk is that not only will unit shipment growth decelerate but average selling prices (ASPs) may also fall as consumers spend more frugally. Although we have not yet seen lower unit shipment guidance, the risks of deceleration remain a key risk and concern to Taiwan market EPS where tech accounts for nearly half of the market’s EPS. Our concerns are that this deceleration is felt in 2H08 and into 2009, and meanwhile, as unit shipments and ASPs slow, we may see rising input costs, resulting in a margin squeeze. Figure 18: Historical inventory level of US tech companies 220 Days 200 180 160 140 120 100 Q2 03 Q3 03 Q4 03 Q1 04 Q2 04 Q3 04 Q4 04 Q1 05 Q2 05 Q3 05 Q4 05 Q1 06 Q2 06 Q3 06 Q4 06 Q1 07 Q2 07 Q3 07 Q4 07 Q1 08 EMS Semis PC Source: Company data, Lehman Brothers An additional risk to unit shipments are rising technology inventories, most notably in the U.S. PC space, which is persistently higher in 2007 into 1Q08. We also note that PC inventories drive demand for semiconductors and peripherals, and historically lead EMS and semi sector inventories. Although inventory levels are still below 2001 post-bubble levels, the increase is disconcerting at a time when demand is expected to slow. And a suddenly disappointing global growth outlook in 2009 combined with rising inventory is a cocktail for lower utilization and thus, lower profit margins. May 2008 49
  • 49. Lehman Brothers | Equity Research EFFECT ON EBIT: MARGIN SHRINKAGE? Margins go down in our scenario, and the question is whose margins will fall the most. The combination of slowing unit demand, falling capacity utilization, and rising input costs hit everyone in the manufacturing sector. Although the capital intensive (high operating leverage) companies, semis and materials, may see less impact potentially from rising marginal input prices, the risks of lower utilization is equally damning. While global leaders like a TSMC might gain market share in a falling market, players without dominant technology or low pricing power or excessive competition, stand to lose the most, in our view. The hardware sector would face adverse challenges in this environment, with rising input prices on falling unit demand. As such, one would expect to see the domestic portion of the economy outperforming. While financials, consumer and asset reflation stocks might see slower growth, relative to exporters, these sub- sectors would likely outperform, especially on the margin front, in our view. WHAT HAPPENED IN THE 1970S? During the period of severe inflation in the 1970s, Taiwan’s underlying stock market (TaiEx) performed remarkably well, after the initial inflation shock to CPI between 1973 and 1974, which coincided with a period of negative U.S. growth. However, after this initial shock, from 1974 to 1983, the market rose nearly three-fold, despite the persistent rise of inflation. Although we do not have company data back to the ‘70s, this may have been due to the potential increase in exports, as Taiwan began to emerge as a consumer goods manufacturer in the ‘70s through to the ‘80s (possibly from Japanese outsourcing) particularly in plastics. Eventually, this rise in CPI and gains in the stock market led to the asset bubble of the 1980s (coinciding with Japan) which eventually burst along with Japan again into the 1990s. Figure 19: 1973-1983 TaiEx vs US CPI, Taiwan CPI and US Real GDP Growth TaiEX TWN CPI Growth Rate 65% 800 US CPI Growth Rate US Real GDP Growth Rate 700 55% 600 45% 500 35% 400 25% 300 15% 200 5% 100 -5% - Mar-73 Mar-74 Mar-75 Mar-76 Mar-77 Mar-78 Mar-79 Mar-80 Mar-81 Mar-82 Mar-83 Source: CEIC; Bloomberg; Lehman Brothers HOW CAN THE GOVERNMENT HELP EASE THE PAIN? To combat inflation, the government may consider a policy of strengthening the New Taiwan Dollar (NT$), as our economists highlight that the NT$ is one of the most under- valued currencies in the region and has shown continuous weakness over the last five years. While Taiwan is largely self-sufficient, it does import wheat and oil, thus, should it see external demand fall, the risks associated with a strong NT$ may not be as painful as rising costs for select commodities, particularly oil. Meanwhile, with a projected fiscal surplus potentially in 2008, and hopes around the KMT campaign promise to support investment of NT$4 trillion in Taiwanese infrastructure in the next eight years (half May 2008 50
  • 50. Lehman Brothers | Equity Research funded by the private sector). Otherwise, we could expect to see the newly elected executive branch invest in infrastructure and urban gentrification throughout Taiwan, especially in key cities, to offset slower growth and revive the local economy via domestic consumption. Figure 20: NT$ vs US$ Figure 21: Taiwan Annual Surplus/Deficit (NT$ mn) 36.0 NT$/US$ TW: Governm e nt Surplus or Deficit: ANNUAL NTD m n 35.0 100000 0 34.0 -100000 33.0 -200000 32.0 -300000 31.0 -400000 30.0 -500000 -600000 29.0 May-03 May-04 Nov-07 Mar-08 Jan-03 Sep-03 Jan-04 Sep-04 Jan-05 Jun-05 Oct-05 Feb-06 Jun-06 Oct-06 Feb-07 Jul-07 -700000 1967 1972 1977 1982 1987 1992 1997 2002 2007 Source: Bloomberg, Lehman Brothers Source: CEIC Meanwhile, with rising inflation, and potentially lower interest rates from the U.S, we would expect to see the property market and asset reflation stocks improve. With cash- rich Taiwanese depositors facing our scenario of 4% inflation, and 10-year bond yields at 2.5% and six month deposit rates at 2%, real interest rates would hover around -1.5-2% and potentially push further investment into physical assets or gold. This combined with the likelihood of governmental stimulus spending, we could see outperformance by the materials, property and asset reflation stocks continue, as we have seen so far in 2008. CONCLUSION In the face of surprisingly weaker-than-expected global growth and higher-than-expected inflation, Taiwan’s economy and thus, stock market, would initially underperform vs regional markets, in our opinion. However, financial/solvency risks are low, saving and forex reserves are high, and with a new presidential administration focused on domestic reinvestment and closer economic ties with China, Taiwan could surprise to the upside even if exports slow more than expected. Although the make up of the Taiwanese economy is more externally oriented today, we do not expect to see the same growth in the stock market as we saw from the late 1970s into the early 1980s. However, with upside in the currency, domestic fixed asset investment and leveraging trade and investment with China, there is a large portion of the domestic economy that remains untapped and could grow as the external economy shrink, in our view. We think Taiwan, and the TaiEx, though initially a potential underperformer relative to other Asian economies with less exposure to exports, could potentially see the domestic side of the economy surge faster and further than anyone can analyze at this time, and which has realistically consolidated and been dormant since the early 1990s. May 2008 51
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  • 52. Lehman Brothers | Equity Research SECTOR ANALYSIS May 2008 53
  • 53. Lehman Brothers | Equity Research AUTO AND AUTO PARTS Effects of rising inflation and falling growth Zayong Koo Korea Autos & Regional Coordinator INTRODUCTION: LOW GROWTH AND HIGH INFLATION LBIE, Seoul In an environment of low growth and high inflation, we believe the auto sector will be a Tel: 822 2116 7550 loser. Since auto demand is generally driven by global economic growth and high zayong.koo@lehman.com disposable income, a slowdown in the global economy is likely to have an adverse effect on high ticket items such as automobiles, in our view. Cost inflation that is driven by Prabhat Awasthi higher inputs (for example gasoline) as well as limited financing could also put India Autos additional pressure on demand. LBSPL, India We expect certain markets to have less of an impact than others, depending on the Tel: 9122 4037 4180 vehicle penetration levels and the markets served. For example, main markets for prabhat.awasathi@lehman.com automakers in China and India are normally their own local markets, which, even, in our worst case scenario, are estimating between 5%-6% growth in both 2008 and 2009. Yankun Hou Korea, on the other hand, would be the most affected because its vehicle penetration rate China Autos is the highest among the three major auto-producing countries (250 vehicles per 1,000 in LBAL, Hong Kong Korea versus 33 vehicles per 1,000 in China versus 8.5 vehicles per 1,000 in India), and Tel: 852 2252 6234 our worst case scenario GDP growth rate is the lowest, at only 2%. In addition, more yankun.hou@lehman.com than 50% of Korea’s exports are slated for developed markets such as the US and Europe, where the effects of low growth and high inflation could be severe had the exports been more to developing markets. We believe demand for autos in China will experience 15% growth in 2008 and 12% in 2009, higher than our base case scenario GDP growth of 9.5% and 8%, respectively. However, under our worse case scenario GDP growth of 6.5% in 2008 and 6.9% in 2009, we estimate auto demand growth will fall to 10% in 2008 and 10% in 2009. Moreover, we believe the China auto industry will face overcapacity problems in the next couple of years. DF PSA (not listed) and Beijing Hyundai (not listed) announced aggressive capacity expansions in China last year. Moreover, leading national automakers such as Shanghai Auto (600104 CH, 3-Underweight), Dongfeng Motor (489 HK, 1-Overweight) and Brilliance (1114 HK, 3-Underweight) have announced ambitious new product developments and capacity expansions to compete with global original equipment manufacturers (OEM) in their home markets. We believe the problem will start emerging in 2009 if most of the current announced plans are completed. This means firms may face strong price competition, margin pressures and even survival challenges in 2010. If firms were to remain under margin pressures and competition heightens, we think those companies that survive would emerge as leading automakers in China, with an even stronger profile. EFFECT ON EBIT: MARGIN SHRINKAGE? In an environment of low growth and high inflation, automakers would suffer margin pressures because they are likely to provide more incentives to increase sales. We believe higher incentives are more likely to be implemented in the developed markets, such as the US and Europe. In addition, weaker sales may lead to higher fixed costs due to lower capacity utilization rates. This coupled with higher raw material costs (for example steel) is likely to put a squeeze on margins for automakers. May 2008 54
  • 54. Lehman Brothers | Equity Research EFFECT ON CASH FLOW: EFFECT ON CAPEX GIVEN FALLING CASH FLOWS AND CAPITAL SHORTAGE? With EBIT margins under pressure, we also expect slow growth/high inflation environment to have an adverse effect on cash flow. Since the Asian automakers are still in the phase of capacity expansion, falling cash flow as well as capital shortage resulting from weakened demand could hamper their ability to continue their growth stage, including developing new products. As a result of falling cash flow and capital shortage, capex spending could be delayed, which could affect the Asian automakers’ ability to capture market share when market improvement occurs because it takes around two years to build a new factory and between 2-3 years to develop new products. This could put the automakers under cash flow pressures behind the curve of those with a stronger financial position. WHAT HAPPENED IN THE 1970S? Most Asian auto stocks were not listed in the 1970s except for a few Korean auto companies. Hence, it is very difficult to draw any parallels during this period. HOW CAN THE GOVERNMENT HELP EASE THE PAIN? In an environment where growth is slow and inflation persists, governments from all around the world are likely to offer assistance by way of lowering consumption and fuel taxes, and other road subsidies, besides lowering rates on auto financing. We had seen similar actions by the Korean government to spur auto demand in 2001 and 2004 when it announced a temporary cut in the special excise tax for autos by 1%-2% percentage points in both 2001 and 2004, depending on the engine displacement size. The Chinese government has been subsidizing gasoline price for decades, which has substantially distorted the pricing system. The reform gasoline price system is one of the most important tasks for the current cabinet. The earliest window for gasoline price reform would be late 2008 after the consumer price index (CPI) starts trending down. We believe increasing gasoline prices and/or imposing a tax on gasoline directly can adversely affect vehicle demand, which is one of the main reasons why we have a cautious view on the sector. At the same time, the Chinese government could possibly launch a few new regulations to support automakers to develop an economy car with greater fuel efficiency and one which is more environmentally friendly, to reduce the gasoline burden on consumers. The Indian government too may offer some incentives to the industry, by cutting excise duties on cars and commercial vehicles. But, we believe the benefits from such an act will be marginal for passenger vehicle consumption, given low income growth. This may also not result in any benefits for commercial vehicles because buying is more dependent on expected freight volume growth, which may slow with slowing GDP. CONCLUSION We believe the auto sector will likely be a loser due to auto demand being tied to the economic conditions and the level of disposal income that the consumers enjoy. In a slow growth environment and during times of high inflation, non-essential high cost items such as cars could face some pressures. May 2008 55
  • 55. Lehman Brothers | Equity Research WINNERS AND LOSERS IN A STAGFLATION SCENARIO Within the Asian auto sector, we believe the winners will likely be China and India auto stocks because they are dependent on the domestic markets where growth is still robust despite a slowdown. In China, we believe the winners will be Denway (203 HK, 1- Overweight) and Weichai (2338 HK, 1-Overweight) because we expect them to benefit from the booming industry structural demand, namely a change in product mix. The losers in a stagflation scenario will likely be Brilliance (1114 HK, 3-Underweight) and Dongfeng (489 HK, 1-Overweight) as they are actively expanding their capacity. In India, we prefer Maruti Suzuki (MSIL IN, 1-Overweight). In our view, the biggest losers in a stagflation scenario will be the Korean auto makers such as Hyundai Motor (005380 KS, 1-Overweight), Kia Motors (000270 KS, 1-Overweight) and Ssangyong Motor (003620 KS, 1-Overweight) because their local market is small, and they are highly dependent on the overseas markets. May 2008 56
  • 56. Lehman Brothers | Equity Research BANKS China Banks EFFECTS OF RISING INFLATION AND SLOWER GROWTH Lucy Feng LBAL, Hong Kong Tel: +852-2252-6174 Expect weakening earnings outlook lucy.feng@lehman.com Chinese banks witnessed another round of strong earnings growth in 1Q08, with banks, under our coverage, recording net profit growth of 77%–187% YoY. However, we would have a far more conservative earnings outlook for banks in a scenario of rising inflation and slower growth. We are wary that a domestic economic slowdown may have already surfaced, as the overall earnings growth of all A-share listed companies stood at 31.3% in 1Q08 versus 80.2% in 1Q07. Downward margin trend We believe the sector margin peaked (average: 3.22%, 70bp higher than regional banks) in 1Q08 on account of (1) the ongoing asset re-pricing following the six rate hikes in 2007 and (2) enhanced loan pricing capability. However, we think the sector NIM will likely head downhill in the medium to long term. Credit quality outlook – what happened in the 1997 Asia financial crisis? Credit risk continues to be the single largest threat to the safety and stability of Chinese banks, in our view. In general, we find that the exposure of Chinese banks to credit losses is becoming increasingly manageable, given rising loan-loss provisioning and much-improved capitalization. However, there is a risk that asset quality trends may reverse if the US enters into a recession and the slowdown in China’s economy continues. In a worst-case scenario, our Asian ex-Japan strategy team forecasts the following: (1) Asia ex-Japan’s aggregate GDP growth to fall to 5.4% (2) China’s GDP may drop to 6.7% while the CPI may rise to 6.1% in 2008. In such a scenario, we estimate credit growth of the sector would likely slow to 12.8% YoY from the current 16.2% YoY in March 2008. In addition, we are concerned that a credit cycle may kick-in and Chinese banks may face severe new NPL formations, particularly in risky sectors, such as property, manufacturing, and exporters. Nevertheless, it is still difficult to forecast the magnitude and scale of new NPL formation, without the support of a thorough macro data point analysis. A relevant data point that investors can refer to is the NPL ratio of Chinese banks, post the Asian financial crisis. At that time, the new NPL formation ratio of joint-stock banks peaked to 5.5%–7.5%. CONCLUSIONS In general, the fundamentals of China banks have improved significantly over the past three years of reforms, restructuring and IPOs. However, as the newly listed Chinese banks have not passed through any full credit cycle, their book quality was never tested in an economic downturn. Banks are mirrors of the underlying economy. We believe none of the Chinese banks would survive well in a severe economic downturn. Further, players with weak fundamentals, poor risk management and less prudent lending procedures will suffer more, we believe. May 2008 57
  • 57. Lehman Brothers | Equity Research WINNERS AND LOSERS We have identified Huaxia Bank (600015SS, 3-Underweight), Minsheng Bank (600016SS, 2-Equal weight) and Shenzhen Development Bank (000001SS, 1- Overweight) as potential losers in a scenario of rising inflation and slower growth. Figure 22: Valuation comparison of H-share and A-share Chinese banks Ticker Rating Target Price Price Mkt. Cap EPS BVPS DPS P/E (x) P/B (X) ROAE (%) ROAA(%) Div. Y (US$mn) 07A 08E 09E 07A 08E 09E 07A 08E 09E 07A 08E 09E 07A 08E 09E 07A 08E 09E 07A 08E 09E 07A 08E 09E ICBC-H HK.1398 1-OW 8.08 6.10 290,613 0.25 0.35 0.46 1.63 1.96 2.26 0.02 0.16 0.21 22.2 15.6 11.88 3.36 2.79 2.41 16.2% 19.5% 21.8% 1.02% 1.27% 1.51% 0.29% 2.88% 3.79% BOC-H HK.3988 2-EW 3.84 3.95 165,800 0.22 0.29 0.37 1.66 1.84 2.08 0.04 0.10 0.13 16.0 12.1 9.5 2.14 1.92 1.70 14.0% 16.8% 19.0% 1.10% 1.29% 1.48% 1.13% 2.82% 3.68% CCB-H HK.939 1-OW 8.86 6.97 210,916 0.30 0.45 0.58 1.81 2.21 2.63 0.23 0.18 0.23 21.1 14.0 10.7 3.46 2.83 2.37 18.4% 22.2% 24.0% 1.15% 1.48% 1.71% 3.64% 2.85% 3.72% BCOM-H HK.3328 1-OW 12.52 10.84 68,785 0.43 0.61 0.78 2.72 3.00 3.27 0.10 0.24 0.31 22.6 16.0 12.5 3.57 3.24 2.97 18.2% 21.3% 24.9% 1.07% 1.33% 1.51% 0.99% 2.50% 3.20% CMB-H HK.3968 1-OW 35.53 31.80 67,114 1.04 1.61 2.30 4.62 6.06 7.98 0.12 0.48 0.69 27.5 17.7 12.4 6.17 4.70 3.57 24.8% 30.1% 32.8% 1.36% 1.66% 2.04% 0.42% 1.69% 2.42% CITIC Bank-H HK.998 2-EW 5.63 4.93 33,844 0.21 0.33 0.42 2.15 2.38 2.66 0.02 0.10 0.15 20.7 13.6 10.5 2.05 1.85 1.66 14.4% 14.4% 16.7% 0.97% 1.17% 1.30% 0.42% 2.21% 3.33% H share sector mean 139,512 0.33 0.48 0.65 2.03 2.43 2.88 0.09 0.18 0.24 21.1 14.6 11.2 3.33 2.78 2.37 17.1% 20.4% 22.7% 1.09% 1.36% 1.59% 1.37% 2.71% 3.57% ICBC-A(3) SS.601398 Not rated na 6.28 290,532 0.25 0.35 0.46 1.63 1.96 2.26 0.02 0.16 0.21 25.5 18.0 13.6 3.86 3.20 2.77 16.2% 19.5% 21.8% 1.02% 1.27% 1.51% 0.25% 2.51% 3.30% BOC-A(3) SS.601988 Not rated na 5.00 165,753 0.22 0.29 0.37 1.66 1.84 2.08 0.04 0.10 0.13 22.6 17.0 13.4 3.02 2.72 2.40 14.0% 16.8% 19.0% 1.10% 1.29% 1.48% 0.80% 2.00% 2.61% CCB-A(3) SS.601939 Not rated na 7.77 210,856 0.30 0.45 0.58 1.81 2.21 2.63 0.23 0.18 0.23 26.3 17.4 13.4 4.30 3.52 2.95 18.4% 22.2% 24.0% 1.15% 1.48% 1.71% 2.92% 2.29% 3.00% BCOM-A(3) SS.601328 Not rated na 9.89 68,766 0.43 0.61 0.78 2.72 3.00 3.27 0.10 0.24 0.31 23.0 16.3 12.7 3.63 3.30 3.02 18.2% 21.3% 24.9% 1.07% 1.33% 1.51% 0.98% 2.46% 3.15% CMB-A(3) SS.600036 Not rated na 32.63 67,096 1.04 1.61 2.30 4.62 6.06 7.98 0.12 0.48 0.69 31.5 20.3 14.2 7.06 5.38 4.09 24.8% 30.1% 32.8% 1.36% 1.66% 2.04% 0.37% 1.48% 2.12% CITIC Bank-A(3) SS.601998 Not rated na 6.82 33,835 0.21 0.33 0.42 2.15 2.38 2.66 0.02 0.10 0.15 32.0 20.9 16.2 3.17 2.86 2.57 14.4% 14.4% 16.7% 0.97% 1.17% 1.30% 0.27% 1.43% 2.16% SPDB(4) SS.600000 1-OW 35.48 29.32 23,756 1.26 1.74 2.20 6.50 10.01 11.28 0.15 0.16 0.40 23.2 16.8 13.3 4.51 2.93 2.60 20.7% 24.2% 20.7% 0.69% 1.10% 1.16% 0.51% 0.55% 1.35% Industrial Bank(2) SS.601166 Not rated na 37.05 26,512 1.75 2.38 2.98 7.78 9.60 12.18 0.32 0.46 0.59 21.2 15.6 12.5 4.76 3.86 3.04 31.2% 23.7% 24.2% 1.17% 1.20% 1.13% 0.86% 1.23% 1.59% Minsheng SS.600016 2-EW 9.85 8.22 22,143 0.44 0.40 0.51 3.47 3.80 4.02 - 0.05 0.10 18.8 20.4 16.0 2.37 2.16 2.04 18.2% 13.4% 13.2% 0.77% 0.90% 0.97% 0.00% 0.61% 1.25% Huaxia SS.600015 3-UW 9.00 13.24 7,958 0.50 0.66 0.84 3.16 3.59 4.14 0.11 0.23 0.29 26.5 20.0 15.7 4.19 3.69 3.20 16.7% 19.6% 21.8% 0.40% 0.43% 0.49% 0.83% 1.75% 2.22% SZDB SS.000001 1-OW 31.84 26.89 8,826 1.25 1.78 2.44 5.67 8.93 11.32 - 0.18 0.24 21.5 15.1 11.0 4.74 3.01 2.38 27.0% 24.9% 24.1% 0.86% 1.11% 1.28% 0.00% 0.66% 0.91% Bank of Nanjing(2) SS.601009 Not rated na 15.44 4,059 0.62 0.67 0.84 5.41 5.86 6.53 0.30 0.21 0.26 24.9 23.1 18.4 2.85 2.64 2.37 14.5% 11.3% na 1.40% 1.32% na 1.94% 1.36% 1.68% Bank of Ningbo(2) SS.002142 Not rated na 14.18 5,073 0.38 0.52 0.68 3.21 3.68 4.26 0.08 0.17 0.21 37.3 27.4 21.0 4.42 3.85 3.33 17.0% 15.8% 17.7% 1.44% 1.81% 1.61% 0.59% 1.18% 1.46% Bank of Beijing(2) SS.601169 Not rated na 15.92 14,189 0.63 0.74 0.96 4.28 4.80 5.88 0.12 0.13 0.28 25.3 21.5 16.6 3.72 3.31 2.71 18.3% 16.3% 19.1% 1.07% 1.32% 1.33% 0.75% 0.82% 1.76% A share sector mean 67,811 0.41 0.58 0.77 2.43 2.98 3.53 0.10 0.19 0.25 25.3 17.9 13.7 4.01 3.33 2.84 17.7% 20.4% 22.4% 1.07% 1.33% 1.53% 1.04% 2.07% 2.76% Note: (1)Closing price of May 7, 2008 (2) For banks Lehman does not cover, we use Bloomerg Estimates as consensus (3) For SPDB (SS.600000) we have factored in the new share issuance of 800mn and bonus shares issuance of 1.3bn in 2008. (4) For SZDB (SS.000001) we have factored in the A share full listing plan which every 10 tradable shares can receive 1 bonus share and 1.5 warrants at a strike price of RMB 19.00. (5) For Minsheng (SS. 600016) we have factored in a 3.6bn new shares issuance in 2008, which accounted for 20% of the bank's enlarged share capital base. Source Company data, Lehman Brothers estimates May 2008 58
  • 58. Lehman Brothers | Equity Research India Banks EFFECTS OF RISING INFLATION AND SLOWER GROWTH Srikanth Vadlamani LBSPL, India Banking is a macro sector, closely linked to the state of the overall economy and would Tel: +91 22 40374191 be affected by deterioration in the macro environment, especially in the case of the srikanth.vadlamani@lehman.com Indian banking sector, on account of rapid asset growth over the past few years. We believe the key risk to Indian banking from an economic downturn will be through its impact on asset quality. The past few years have seen Indian banks rapidly building up loan books. We estimate that, on a net basis, around 50% of the current loan book may have been added over the past three years; on a gross basis, which is the more relevant number, in our view, this proportion is likely to be even larger. In addition, growth over the past two years has been driven by SMEs and mid-corporates. This is the segment most leveraged to an economic downturn, and, hence, enhances the risk profile of Indian banks. However, we also note that corporate balance sheets are now much better able to withstand a downturn compared with the conditions in 1998-2000 (which was the last time we had major corporate asset quality issues). Key metrics, in terms of debt-equity ratios and interest coverage ratios, are still close to historical lows. On balance, in the base-case scenario for economic growth, we expect asset quality to deteriorate, but only to the historical mean asset quality levels for the sector. We believe that this level of asset quality deterioration is manageable, and is factored into the price of public sector banks (which are likely to be impacted the most, in our view). In the worst-case scenario for economic growth, however, we believe the impact on asset quality will be non-linear, and we would expect to see a rapid deterioration in asset quality. Continued high inflation would be a negative for banks, in our view. It would imply high interest rates, which is a negative from demand and asset-quality perspectives. More importantly, the RBI has been trying to combat inflation through liquidity management, for which the cash reserve ratio (CRR) has been an important tool. High CRR levels are a direct tax on banks’ margins and are a negative factor. EFFECT ON PROFITABILITY We expect profitability to be under pressure in a high inflation scenario, as banks may have to absorb the costs of maintaining tight liquidity. In addition, corporate fee income growth has been a key driver of non-interest income, which is likely to be affected in the event of a slowdown. EFFECT ON FUNDING/CAPITAL A major part of Indian banks’ funding is through stable retail deposits. We do not expect any funding problems for Indian banks. In addition, most banks are well capitalized, and are unlikely to require capital from the markets for the next one to two years. HOW CAN THE GOVERNMENT HELP EASE THE PAIN? As discussed, one of the RBI’s tools to target inflation has been CRR, which is a negative for banks. Government policies, such as the recently announced farm waiver, are also a negative for banks, in our view. We would characterize the regulator’s role as neutral to negative for the banking sector, in the event of stagflation. May 2008 59
  • 59. Lehman Brothers | Equity Research CONCLUSION We believe that banks will be negatively affected in a stagflationary environment. In our view, the negative impact in a worst-case scenario would be disproportionately high compared with the base-case scenario, on account of asset-quality issues. WINNERS AND LOSERS The key losers in a stagflationary environment would be public sector banks including SBI, in our view. The major winner in a stagflationary environment would be ICICI Bank, as the transformation of its liabilities profile would take place independent of the unfolding economic environment. We also believe that HDFC would be a beneficiary as its growth would be the least impacted by the systemic slowdown, its asset quality continues to be driven by strong risk management, and unlike banks, it would not be affected by potential CRR hikes. Figure 23: Base-case and worst-case scenarios Company Ticker Price (INR) Rating FY09E EPS (INR) FY10E EPS (INR) Base case Worst case % chg Base case Worst case % chg ICICI Bank ICBK.NS 919 1-OW 41.7 37.2 -11 53.3 47 -12 HDFC Bank HDBK.NS 1542 1-OW 49.3 47 -5 68.4 65 -5 HDFC HDFC.NS 2732 1-OW 79.1 78.5 -1 94.9 92.2 -3 SBI SBI.NS 1769 3-UW 159 137 -14 178 149 -16 Punjab National Bank PNBK.NS 539 1-OW 69.4 65.1 -6 83.1 76.9 -7 Canara Bank CNBK.NS 244 1-OW 42.6 39.5 -7 49.9 44.5 -11 Bank of Baroda BOB.NS 318 1-OW 42.2 38.5 -9 51 44.6 -13 Union Bank of India UNBK.NS 174 1-OW 27.1 25.7 -5 30.7 28.5 -7 Indian Overseas Bank IOBK.NS 149 1-OW 26.8 25 -7 32 28.8 -10 Edelweiss Capital EDEL.NS 819 1-OW 43.2 39.1 -9 55.9 47.4 -15 Source: Lehman Brothers estimates (Prices as of May 7) May 2008 60
  • 60. Lehman Brothers | Equity Research Taiwan Banks BANKS AND FINANCIALS Sarah Hung, CFA LBSTL, Taiwan Effects of rising inflation and slower growth Tel: 8862 8723 1618 Introduction: Lower growth and higher inflation Sarah.hung@lehman.com A stagflation scenario is negative to financials as their business is highly reliant upon the economic situation. However, given a specific domestic recovery from new government’s accession, we think the financial sector will perform better than the exporting sector in Taiwan due to their domestic business concentration. And with a steep yield curve and negative real interest rates, there may be more debt issuance/demand, potentially offsetting the impact of lower consumer spending as growth decelerates. Effect on ebit: margin shrinkage? Financials will likely see limited impact from inflation in accounting for banks/financials, as their assets and liabilities are in monetary terms. However, given an inflation premium, the interest spread may widen versus the current situation, and the search for alternative investments in the face of negative real interest rates may stimulate more investment and mortgage lending, particularly in the consumer property sector. Effect on cash flow: effect on capex given falling cash flows and capital shortage? We expect limited impact on banks as they hold mostly monetary assets and owe monetary liabilities. Insurance companies may benefit in some ways as they hold more property assets, which may see an upward valuation reversion, this could somewhat offset the negatives from weak business under a weak economy. What happened in the 1970s? There are limited records for Taiwan financials from the 1970s, as at the time, most financial institutions in Taiwan were state-owned and there was full-control of pricing as well as full financial support from the government. Winners and losers Inflation may result in an increase in interest rates. For insurance, if the interest rate goes up, it is positive to insurance on the asset side, as their investment rates will go up; however, inflation would decrease sales of insurance policies at the same time, even though the increase in the interest rate would lower the price of insurance policies—they will likely buy policies if the yield curve steepens in ordinary situation but not under expectations of inflation, as the purchasing power of long-term monetary instruments would be largely decreased. We think insurance companies will be better off amid a stagflation scenario versus banks, due to their real estate holdings, but they are still unlikely to be pure winners in the scenario, in our view, given their exposure to banking operations and the equity markets as well. For banks, in an increasing interest rate environment, their interest spreads my increase at the same time. However, under a stagflation environment (low GDP growth and high inflation), banks will likely suffer from weak demand from the corporate side and consumer side, more than the technical gains from the spread increase due to inflation, in our view All financials will be mostly negatively impacted in the scenario, in our view. Companies with higher real estate exposure, such as Cathay FHC (2882.TW; 1- Overweight) and Shin Kong FHC (2888.TW; 1-Overweight) may see smaller impact as appreciation of real estate is likely to offset part of their business losses. Banks with higher consumer banking exposure, such as Chinatrust FHC (2891.TW; 1-Overweight) will likely perform better. May 2008 61
  • 61. Lehman Brothers | Equity Research CEMENT India Cement EFFECTS OF RISING INFLATION AND SLOWER GROWTH Satish Kumar LBSPL, India Cement demand growth is linked to GDP growth. Specifically, demand growth is Tel: +91 22 40374183 affected by the change in gross fixed capital formation. At present, our cement demand satish.kumar@lehman.com growth assumptions are 10% for FY09 and FY10. If GDP growth were to slow down to our stagflation prediction of 5.1% in 2008 and 4.6% in 2009, demand growth would also witness a sharp slowdown, in our view. The cement sector is going through some rough times, since companies cannot pass on increased raw material prices to consumers. Even if cement demand increases by 10% in FY09E and FY10E, the sector would witness overcapacity and a steep correction in cement prices in fiscal 2H09. In a stagflation scenario, falls in prices, and, subsequently, profitability, could be much steeper than the 10% correction we are currently building in. EFFECT ON EBIT: SHRINKING MARGINS? The only raw material that cement companies source from outside is coal. Coal prices have increased significantly over the past five months and in case of an inflationary scenario we could expect these prices to be higher still. Cement companies would be affected depending on the amount of increase that can be passed on to consumers. Even in a strong demand scenario, companies have been unable to pass on input price pressures because of regulatory checks on prices. In a weak demand scenario, companies will be unable to pass on any of this cost pressure and EBIT margins would fall sharply from current levels of 30%, in our view. EFFECT ON CASH FLOW: EFFECT ON CAPEX, GIVEN FALLING CASH FLOWS AND CAPITAL SHORTAGE? Cash flows will contract as margins decrease. The cement sector has planned significant capex over the next two years. Nearly 70 million tons of new capacity is expected to come online in the next two years. In our view, a shortage of cash flow could affect capex in FY10 but not in FY09, since most of the capacity scheduled to come online in FY09 has been ordered. HOW CAN THE GOVERNMENT HELP EASE THE PAIN? We believe the government can ease the pain by not subjecting the sector to further regulatory controls. The cement sector has witnessed constant regulatory action over the past one year in the form of the elimination of import duty, an increase in excise duty, the elimination of counter veiling duty (CVD), and price rationing, in some cases, to rein in the prices of cement. These regulations have restricted companies’ ability to pass on hikes in input costs to end-consumers even in the prevalent strong demand scenario. CONCLUSION In conclusion, we believe that in the event of stagflation, the environment for cement companies would turn from bad to worse. We would recommend staying away from the sector in such a scenario. In terms of valuation, we believe that fundamentally stocks should not trade below their replacement cost value. However, if the fall in prices, and, hence, profitability is very steep, stocks could trade below replacement cost values as well. May 2008 62
  • 62. Lehman Brothers | Equity Research Figure 24: Base-case and worst-case scenarios Rating Price Ticker Base case (Current) Stagflation (INR) Target price Valuation of cement Worst-case Valuation of cement asset (INR) asset in US$ per ton price (INR) in US$ per ton ACC 3-UW 738.2 ACC.NS 698 115 560 90 Ambuja Cements 3-UW 111.5 GACM.NS 100 176 50 90 Shree Cement 2-EW 955.2 SHCM.NS 1,070 130 1,110 90 India Cement 3-UW 165.9 ICMN.NS 207 165 95 90 UltraTech 3-UW 742.5 ULTC.NS 735 110 580 90 Cement Grasim Industries 2-EW 2336.5 GRAS.NS 2,474 115 1,829 90 Source: Lehman Brothers estimates (Prices as of May 7) WINNERS AND LOSERS We have worked out the worst-case valuation for stocks, which, in our view, is the replacement cost valuation for cement stocks. We have worked with a replacement cost of US$90 per ton. Thus, in terms of potential downside, clearly there is very high potential downside for Ambuja Cement and India Cement, while ACC and Grasim Industries have relatively lower potential downside. Figure 25: Potential downside Country Potential downside from current price in a stagflation scenario (%) ACC -24.1 Ambuja Cements -55.1 Shree Cement 16.2 India Cement -42.7 UltraTech Cement -21.9 Grasim Industries -21.7 Source: Lehman Brothers estimates May 2008 63
  • 63. Lehman Brothers | Equity Research CONGLOMERATES Effects of rising inflation and slower growth Benjamin Lo LBAL, Hong Kong (852) 2252 6208 INTRODUCTION: LOWER GROWTH AND HIGHER INFLATION benjamin.lo@lehman.com In a stagflation environment, companies with the following attributes will emerge likely winners: (1) pricing power to pass on rising costs, (2) control over input costs, (3) strong recurring cash flows and (4) healthy balance sheets. As a result, those conglomerates with industry leadership (hence pricing power), scarce resources (hence input cost control), wider exposure to infrastructure (recurring cash flows), and cash-rich balance sheets, should be able to better withstand stagflation than others, in our view. In terms of sector exposure among the conglomerates, we believe the Hong Kong housing sector should be the most resilient to stagflation, followed by energy and transportation infrastructure. Low-end manufacturing, airlines and the office market should be the least defensive. IMPACT ON EBIT: MARGIN SHRINKAGE? Rising raw material and operating costs exert varying degrees of margin pressure on different industries. Those conglomerates with higher exposure to infrastructure projects have relatively more resilient earnings, due to the larger proportion of fixed costs, such as depreciation. For instance, we assume that the variable operating costs of Chinese port operators (such as China Merchants) will increase by 30% this year, and yet given the high proportion of fixed costs (60% of total costs), EBIT margins would still expand by 1 percentage point if revenue growth exceeds 16% (based on less than 15% throughput growth and a 3-5% tariff increase). Separately, rising borrowing costs are also not a major concern for cash-rich and infrastructure-focused conglomerates, in our view. Figure 26: Sample P&L for a more mature container Figure 27: A sample P&L for a growing container terminal in China terminal in China 2007 2008 YoY% 2007 2008 YoY% Revenue 100.0 125.0 25% Revenue 100.0 117.0 17% Cash cost (variable) (33.3) (43.3) 30% Cash cost (variable) (20.0) (26.0) 30% Cash cost (fixed) (10.0) (10.0) 0% Cash cost (fixed) (16.7) (16.7) 0% EBITDA 70.0 81.0 16% EBITDA 50.0 65.0 30% EBITDA margins 70% 69% EBITDA margins 50% 52% Depreciation (20.0) (21.0) 5% Depreciation (20.0) (21.0) 5% EBIT 50.0 60.0 20% EBIT 30.0 44.0 47% EBIT margins 30% 35% EBIT margins 50% 51% Source: Lehman Brothers estimates Source: Lehman Brothers estimates May 2008 64
  • 64. Lehman Brothers | Equity Research IMPACT ON CASH FLOWS: EFFECT ON CAPEX GIVEN FALLING CASH FLOWS AND CAPITAL SHORTAGE? Given the generally strong balance sheets and steady cash flows from infrastructure projects, most conglomerates have either net cash or comfortable gearing levels. Therefore, the conglomerates in our universe do not plan to slow capex this year. In fact, investors would be eager to see them improve their inefficient capital structure by reinvesting surplus cash into core businesses. Figure 28: End-2007 net debt-to-equity comparison – generally healthy for conglomerates (% ) 40 30 20 10 0 (1 0 ) (2 0 ) Shanghai Citic Pacific Cosco Pacific Enterprises Wham poa* HK & Shanghai Mandarin Swire Pacific Shangri-La Asia China Merchants Industrial Shun Tak Oriental Hutchison Beijing Hldgs (Int'l) Hotels * excluding loans from minority shareholders Source: Company data, Lehman Brothers WHAT HAPPENED IN THE 1970S? Most conglomerates in our coverage universe either did not exist in the 1970s, or had an absolutely different asset mix, as compared with their current structure. Nevertheless, since the Asian financial crisis of 1997-98 when companies suffered from over-extended balance sheets and over-optimistic projections, the conglomerate managements have become much more cautious while deploying their capital, to the extent that they receive investor criticism for being too conservative and inefficient in managing their capital structures. In addition, the conglomerates under our coverage have increased their exposure to various types of infrastructure projects as a foundation of their recurring cash flows. As a result, they may emerge as winners in snatching up attractively valued assets while their competitors face cash flow issues. May 2008 65
  • 65. Lehman Brothers | Equity Research HOW CAN THE GOVERNMENT HELP EASE THE PAIN? The biggest risk facing conglomerates, in our view, is government price controls, especially on products and services that affect households, such as utilities, food and energy. A conglomerate with the highest exposure to the utility sector is Beijing Enterprises (60% of its NAV is from Beijing Gas). On the other hand, natural gas, as an environmentally friendly alternative energy source, is being encouraged by the government through the accelerated build-out of a gas pipeline network and gas-fired power plants. This should ensure structurally growing demand for natural gas and, hence, is a long-term positive for Beijing Enterprises, we believe. CONCLUSION Conglomerates, by definition, are diversified and will not be totally immune to stagflation. Nonetheless, this business diversification gives their earnings a higher degree of defensiveness than many other single-industry-focused companies. The conglomerates under our coverage are also cash-rich, and some are industry leaders in their core businesses. We, therefore, maintain an overall positive stance on conglomerates in a stagflation scenario. WINNERS AND LOSERS Figure 29: Winners and losers (Conglomerates) Name Ticker Price Rating TP NAV 07-10E EPS 08E P/E 07 Net debt (cash) 08E Yield Comments (7-May) (HK$) (HK$) Cagr (%) (x) / equity (%) (%) WINNERS Well-diversified exposure to relatively resilient sectors of Hutchison Whampoa 13 HK 78.05 1-OW 93.8 115.7 (7.4) 28.3 26.0 2.4 oil, ports and housing Strong quot;Peninsulaquot; hotel brand and prime residential HK&S Hotels 45 HK 13.54 1-OW 14.3 18.0 13.6 20.3 7.0 1.5 investment properties Natural gas is being encouraged by Chinese Beijing Enterprises 392 HK 31.25 1-OW 42.7 40.7 26.0 20.9 (8.5) 1.9 government; Beijing Gas enjoys automatic pass-through LOSERS Despite being cash-rich, SIHL has little pricing power Shanghai Industrial 363 HK 32.00 3-UW 25.7 32.1 10.4 16.8 (13.7) 2.8 and control of input costs Source: Bloomberg, Company data, Lehman Brothers estimates May 2008 66
  • 66. Lehman Brothers | Equity Research CONSUMER India Consumer EFFECTS OF RISING INFLATION AND SLOWER GROWTH Manish Jain LBSPL, India The fast-moving consumer goods sector has shown close links to overall economic Tel: +91 22 40374186 growth over the past few years. Growth in the sector has been on a structural upturn over manish.jain@lehman.com the past five years, due largely to a strong macroeconomic environment. However, we believe that the impact of an economic slowdown would be minimal on the Jamil Ansari sector, chiefly because these home and personal care (HPC) products typically have a LBSPL, India small share of the wallet, and, hence, spending on these products is usually the last to be Tel: +91 22 40374192 affected. It is usually the high-involvement consumer discretionary items that are jamil.ansari@lehman.com expected to be affected immediately by such a slowdown. Lifestyle changes are unlikely unless the situation reaches extremes, in our view. Hence, the impact of slower economic growth is likely to be limited to the extent of consumer down-trading to lower value items in respective categories. Inflation, unlike popular perception, has been beneficial for these consumer companies. Increases in raw material prices enable them to increase end-product prices aggressively because of: (1) decreased intensity of competition and (2) strong industry-wide focus on improving margins. We expect larger consumer goods companies to benefit in an inflationary environment as this enables margin expansion. EFFECT ON EBIT: SHRINKING MARGINS? In an inflationary environment, the impact on operating margins is positive due to aggressive pricing action. For instance, in CY07, margins in the soap and detergent category for Hindustan Unilever increased by 250 bp following a 74% YoY increase in palm oil prices. We expect this trend to continue and believe that consolidated margins will improve by 110 bp in CY08E and 100 bp in CY09E. However, lower volume growth and an inferior product mix would have a negative impact on these companies, in our view. EFFECT ON CASH FLOW: EFFECT ON CAPEX, GIVEN FALLING CASH FLOWS AND CAPITAL SHORTAGE? Consumer goods companies are characterized by low asset intensity and high operating cash flows. Thus, a slowdown in growth owing to an overall economic slowdown should have an insignificant impact on the cash flows of these companies. The capex required in these businesses is a small proportion of the revenue generated and is unlikely to be impacted by a slowdown, in our view. Even in the worst-case scenario, if earnings were to come under pressure, there would be no major impact on the cash flow position of these companies, in our view. HOW CAN THE GOVERNMENT HELP EASE THE PAIN? Apart from aggressive pricing, another key reason the sector benefits in a high inflation period is that there are usually a series of measures implemented by the government, which benefits these consumer companies. For instance, import duty on palm oil was cut last year from about 45% to 20%. Further excise duty cuts and peak customs duty cuts also tend to ease the pressure. May 2008 67
  • 67. Lehman Brothers | Equity Research CONCLUSION In conclusion, we reiterate that being defensive plays, an economic slowdown has a negligible impact on companies in this sector. Low involvement usually means that if consumer spending is under pressure, these products are the last to be affected. Furthermore, inflation is likely to be beneficial for these companies as aggressive pricing action would more than offset any pressure from raw material cost increases, in our view. WINNERS AND LOSERS Given the stability of revenue growth, we believe that the consumer goods stocks as a basket will likely outperform in a choppy macroeconomic environment. A slowdown in the economy would have a minimal impact on the bottom line of these companies. Hindustan Unilever is our top pick, given the likely earnings surprise, strong brand portfolio, and impressive distribution network. We reiterate our 1-Overweight ratings on Asian Paints, Marico and Tata Tea. However, we remain concerned on the lower long- term growth prospects for ITC’s cigarette business and reiterate our 3-Underweight rating on the stock. Figure 30: Base-case and worst-case scenario Company Ticker CMP (INR) Rating FY09E EPS FY10E EPS Base case Worst case % change Base case Worst case % change Hindustan Unilever * HLL.BO 252 1-OW 9.6 9.2 (4.2) 11.5 11.1 (3.5) Asian Paints ASPN.NS 1274.45 1-OW 52.8 49.9 (5.5) 62.9 60.5 (3.8) Marico MRCO.NS 66.45 1-OW 3.4 3.3 (2.9) 4.2 4.1 (2.4) Tata Tea TTTE.BO 914.95 1-OW 71.1 67.3 (5.3) 79.5 72.1 (9.3) Godrej Consumer GOCP.NS 136.65 1-OW 7.7 7.4 (3.9) 9.1 8.9 (2.3) Dabur DABU.NS 106.9 3-UW 4.4 4.2 (4.5) 5.0 4.9 (2.1) *= calendar year ending Source: Lehman Brothers estimates (Prices as of May 7) May 2008 68
  • 68. Lehman Brothers | Equity Research China/Hong Kong Consumer EFFECTS OF RISING INFLATION AND SLOWER GROWTH Phoebe Wong LBAL, Hong Kong Tel: 22521403 Our view of the impact phoebe.wong@lehman.com A mild inflationary environment is a welcome factor to drive healthy earnings growth in the consumer sector, in our view, due to the better leverage from both pricing and a sales Candy Huang perspective. However, any significant inflationary pressure may result in the reverse, LBAL, Hong Kong amid heightening margin risk, as operators are squeezed to absorb a part of the cost hike Tel: 22521407 to share the burden with their suppliers. Among the key consumer segments, we believe candy.huang@lehman.com China retail softlines and department stores/broadlines are more resilient in the current high inflationary cycle, whereas F&B should fare less well given that they are more Christine Peng vulnerable owing to their high exposure to soft commodities and thin margins, though industry leaders should be better protected due to advantages of scale and pricing power, LBAL, Hong Kong we believe. Tel: 22526191 christine.peng@lehman.com Earnings and margin Downside risk In a worst case scenario, we estimate the earnings growth of China department stores/retailers to decline by 3–5 percentage points to 19%–44% in 2008 from our current growth forecast of 22%–49%, and by 5–7 percentage points to 10%–29% in 2009 from our current forecast of 15%-36%. For the F&B sector, we expect the dairy, processed meat and tissue paper segments to face the highest earnings downside risk. Our sensitivity analysis suggests that every 10% increase in the cost of raw milk, will reduce the operating margins on milk, pork and pulp by 4%, 4% and 3%, respectively. As for Hong Kong retailers, given the nature of their heavy cost exposure to rentals, our earnings growth expectations (at 4%–20% for FY08-09E) could be easily wiped out in the case of a rental hike, in a worst case scenario. Overall, in our Hong Kong consumer- related stocks universe, we think Li & Fung is the most defensive play against our inflation topic, due to its commission-driven business model which is on a cost-plus basis. EFFECT ON CAPEX, GIVEN DECLINING CASH FLOWS AND CAPITAL SHORTAGE? Capex has far less impact on the consumer sector, compared with other sectors, as most segments, particularly retail, are cash-rich and are based on asset-light business models. This apart, operating cash flows may worsen due to higher working capital outflow on account of rising raw material/merchandise costs. WINNERS AND LOSERS In our coverage universe, we believe that Parkson Retail, Li Ning, China Mengniu, China Yurun, Ctrip and Li & Fung are the more defensive plays in the current high inflationary cycle, while Intime, People’s Food, and Bright Dairy are likely to lose. May 2008 69
  • 69. Lehman Brothers | Equity Research Figure 31: Valuation comparison of our coverage universe Company Code Price REC Net profit growth P/E (x) Yield (%) EV/EBITDA (x) 7-May-08 08E 09E 08E 09E 08E 09E 08E 09E HK consumer Esprit 330HK 92.00 1-OW 30.3% 20.9% 16.7 13.8 4.79 6.15 Li & Fung 494HK 31.10 1-OW 46.8% 27.5% 28.1 22.0 2.9 3.7 Sa Sa 178HK 2.98 1-OW 33.2% 18.9% 11.5 12.6 6.7 8.0 Lifestyle 1212HK 16.90 2-EW 16.0% 18.4% 27.1 23.0 1.5 1.7 Giordano 709HK 3.40 2-EW 7.2% 4.3% 16.0 15.4 6.6 6.8 China retail China Resources Enterprise 291HK 29.50 1-OW 23.8% 17.2% 27.7 23.6 1.8 2.3 Li Ning 2331HK 21.95 1-OW 49.1% 35.7% 29.7 21.9 1.3 1.8 Belle 1880HK 8.30 1-OW 47.6% 36.4% 27.2 19.9 0.9 1.3 Parkson 3368 HK 72.50 1-OW 47.2% 29.9% 37.2 29.1 1.3 1.7 Golden Eagle 3308 HK 7.87 1-OW 22.8% 29.3% 27.9 21.6 1.1 1.4 Intime 1833 HK 6.07 3-UW 15.0% 23.4% 23.6 18.8 1.3 1.6 Avg 28.9 13.9 0.7 1.0 China supermarkets Lianhua 980 HK 10.88 1-OW 21.5% 16.0% 19.2 16.6 1.6 1.8 Times 1832 HK 3.57 1-OW 65.5% 21.3% 18.7 14.3 1.6 2.1 Avg 19.0 15.4 1.6 2.0 F&B China Foods 506 HK 4.26 2-EW 44.8% 39.4% 22.7 16.3 1.54 2.14 14.59 10.89 People’s Food PFH SP 1.15 1-OW 13.3% 22.4% 11.68 9.54 2.16 2.72 6.18 4.82 China Yurun Food 1068 HK 13.40 1-OW 15.0% 20.5% 20.7 17.2 1.21 1.46 14.41 11.84 China Mengniu 2319 HK 24.55 1-OW 25.8% 19.0% 27.6 23.2 0.73 0.86 12.63 9.80 Tingyi 322 HK 10.38 1-OW 34.0% 26.1% 28.6 22.7 2.17 2.38 13.25 10.41 Tsingtao Brewery 168.HK 23.10 1-OW 39.7% 32.2% 37.2 28.1 2.69 3.56 12.59 9.79 Avg 24.7 19.5 1.75 2.19 Prices as of 7 May 2008 Source: Lehman Brothers, Bloomberg May 2008 70
  • 70. Lehman Brothers | Equity Research Korean Consumer EFFECTS OF RISING INFLATION AND SLOWER GROWTH HongTaik Chung LBIE, Seoul 822-2116-7561 introduction: Lower growth and higher inflation hongtaik.chung@lehman.com Low growth and higher inflation will likely have a negative impact on the Korean consumer sector, suggesting a potential slowdown in domestic consumption, due to lesser employment and low growth in real wages. Nonetheless, we expect a mixed outlook for individual players, given the diverse consumer sub-markets. For instance, such an environment will likely increase the demand for necessity items such as food and beverages. Consequently, consumer demand for discount stores in which food and beverages account over half of total sales, will likely increase during an inflationary environment. Particularly, we expect solid demand for private labels, which offer relatively cheap prices than ordinary items. On the other hand, we expect adverse consumer demand for department stores which carry a relatively large portion of apparels and accessories. Meanwhile, we expect largely inelastic consumer demand, regardless of economic turnarounds for consumer staple categories like cigarettes. EFFECT ON EBIT: MARGIN SHRINKAGE? We find a correlation between the trend in department stores’ same-store sales growth and GDP growth. Under our base case scenario assumptions, we estimate same-store sales growth of 3%-plus YoY and 1%-plus YoY for HDS and Lotte Shopping, respectively in 2008E. However, in a worst case scenario, we estimate their same-store sales will likely decline to 1% and -1%, respectively. As a result, we estimate the EBIT margin to shrink by 0.4% percentage points and 0.3% percentage points, from the current forecast of 8.9% (HDS) and 7.4% (Lotte Shopping), respectively assuming Lotte’s other divisions such as discount store and supermarket post stable earnings. Meanwhile, we believe Korea’s leading tobacco player KT&G is likely to maintain its profitability, given stable domestic cigarette demand, rising exports, and declining raw material costs owing to the higher usage of relatively cheap imported leaf tobacco. EFFECT ON CASH FLOWS: EFFECT ON CAPEX GIVEN FALLING CASH FLOWS AND CAPITAL SHORTAGE? Given the rising cost of funds for capex, retailers with aggressive new store opening plans will likely face some challenges, in our view. We believe domestic oligopolistic department store players such as Lotte Shopping and HDS have aggressive store opening plans lined up from this year, hurting overall earnings visibility. Meanwhile, we estimate Shinsegae to be able to generate FCF for the first time from 2009, given its secured land sites for new discount stores and fewer plans for opening new department stores. WHAT HAPPENED IN THE 1970S? Most consumer stocks were not listed in the 1970s. Besides, department stores had a very insignificant presence, with no existence of discount stores. HOW CAN THE GOVERNMENT HELP EASE THE PAIN? We think the government may try to boost domestic consumption through additional measures such as income tax and real-estate holding tax cuts, apart from monetary expansionary policies. May 2008 71
  • 71. Lehman Brothers | Equity Research CONCLUSION In the retail space, we favor discount stores to department stores despite concerns about discount store saturation in the long term. Among consumer staple names, we expect the top-tier players, who have strong market leadership and experience, and steady consumer demand, to generate stable earnings. For instance, we believe KT&G will be better insulated in a challenging environment. Also, CJCJ could pass on the cost burden to consumers by increasing average selling prices, given its strong market leadership in oligopolistic sub-markets. We believe that Hite Brewery too will likely be able to pass on any potential cost burden by raising the average selling price, in a stable duopoly market, despite the fact that beer sales fluctuate in line with consumption trends. Figure 32: Korean consumer players – Valuation comparison Company Shinsegae HDS Lotte Shopping GSHS CJHS KT&G Hite Brewery CJCJ Code 004170 KS 069960 KS 023530 KS 028150 KS 035760 KS 033780 KS 000140 KS 097950 KS Rating 1-Overweight 1-Overweight 2- Equal Weight 2- Equal Weight 2- Equal weight 1-Overweight 1-Overweight 1-Overweight Price (Won, May 7th 2008) 650,000 100,000 365,000 66,100 66,700 82,500 123,000 245,000 12-month price target (Won) 770,000 112,000 370,000 72,000 65,000 101,000 165,000 303,000 Upside potential (%) 18.5 12.0 1.4 8.9 (2.5) 22.4 34.1 23.7 Market cap (Wbn) 12,259 2,266 10,601 434 733 11,834 2,711 2,983 Market cap ($bn) 12.0 2.2 10.4 0.4 0.7 11.6 2.7 2.9 P/E (x) 2007 19.5 12.9 15.3 7.7 17.5 17.8 16.2 N/A 2008E 16.8 12.1 14.2 9.0 13.3 15.8 14.3 17.5 2009E 14.7 11.5 13.2 8.9 12.0 14.7 12.1 14.3 P/B (x) 2007 3.0 1.7 1.3 1.3 1.6 3.8 2.0 N/A 2008E 2.5 1.5 1.2 1.3 1.5 3.6 1.9 3.6 2009E 2.2 1.3 1.1 1.2 1.4 3.1 1.7 3.1 EV/EBITDA (x) 2007 12.7 12.3 9.5 3.7 12.0 13.2 12.8 N/A 2008E 11.6 11.3 9.1 4.9 10.5 12.2 11.2 12.3 2009E 10.2 10.7 8.4 4.7 10.4 11.5 10.2 10.8 EV/Sales (x) 2007 1.5 1.4 1.0 0.2 0.5 4.9 3.8 N/A 2008E 1.4 1.3 1.0 0.2 0.5 4.6 3.4 1.3 2009E 1.3 1.3 0.9 0.2 0.4 4.3 3.1 1.2 EBITDA margin (%) 2007 9.9 11.2 10.8 4.7 4.3 36.9 29.7 N/A 2008E 10.3 11.5 10.6 4.2 4.6 37.4 30.0 10.5 2009E 10.7 11.8 10.8 4.2 4.3 37.6 30.7 11.2 ROE (%) 2007 16.3 14.2 8.7 14.6 5.6 21.4 10.7 N/A 2008E 16.2 13.2 8.5 11.7 8.1 22.5 11.5 22.1 2009E 15.9 12.3 8.4 11.5 8.8 22.1 12.6 23.2 EPS growth (% y-y) 2007 4.6 (0.6) (8.8) (6.1) (33.0) 12.9 39.6 N/A 2008E 21.9 7.0 7.8 (14.3) 31.9 12.8 13.7 N/A 2009E 14.9 4.8 7.4 0.9 10.4 7.6 17.7 N/A Net debt-to-equity ratio (%) 2007 87.6 10.8 Net cash Net cash 10.2 Net cash 69.6 70.6 3-yr EPS CAGR (%) 13.6 3.7 1.8 (6.7) (0.8) 11.1 23.1 17.7 DPS (Won) 2008E 1,500 800 1,600 3,000 1,200 2,800 1,600 5,000 Dividend yield (%) 2008E 0.2 0.8 0.4 4.5 1.8 3.4 1.3 2.0 Prices as of May 7th 2008 Note: Excluding Samsung Life Stake for Shinsegae and excluding amortization costs for Lotte Shopping, GSHS, CJHS, and Hite Brewery Source: Company data, Lehman Brothers estimates May 2008 72
  • 72. Lehman Brothers | Equity Research ELECTRICAL EQUIPMENT India Electrical Equipment EFFECTS OF RISING INFLATION AND SLOWER GROWTH Satish Kumar LBSPL, India We believe that engineering stocks under our coverage would be significantly affected Tel: +91 22 40374183 by a slowdown in GDP growth to 5.1% in 2008 and 4.6% in 2009. In addition, if slower satish.kumar@lehman.com growth is accompanied by higher inflation, these companies could be doubly affected as they are large users of ferrous and non-ferrous metals. Engineering stocks are trading at a significant premium to the broader market and any significant deceleration in growth could lead to the shrinking of high multiples. In this scenario, we would prefer Bharat Electronics (BAJE.NS, 1-Overweight) as the company’s revenue growth is dependent on India’s defence expenditure, which, we believe, would remain strong, even if there is a slowdown in GDP growth. EFFECT ON EBIT: SHRINKING MARGINS? EBIT margins would be affected by an increase in the prices of metals – both ferrous and non-ferrous. The actual impact would depend on: • The percentage of the company’s business that comes from pass-through contracts, i.e., contracts with price-escalation clauses. • The raw material sourcing strategy of the company, i.e., whether the company buys through long-term or short-term contracts. EFFECT ON CASH FLOW: EFFECT ON CAPEX, GIVEN FALLING CASH FLOWS AND CAPITAL SHORTAGE? Engineering companies do not require large amounts for capex. They are not short of cash, owing to the high growth they have seen over the past five years. In addition, they are also debt free, so raising funds would not be a problem, in our view. Thus, we would not expect see a slowdown in capex owing to shortage of funds. There could be a delay in capex, not because of a shortage of funds but because of lower visibility on growth, if there is a protracted slowdown. HOW CAN THE GOVERNMENT HELP EASE THE PAIN? The government could help by making speedy decisions on infrastructure projects. Companies in the electrical equipment sector derive a significant part of their revenue from the power sector. Thus, speedy and timely execution of power projects could help offset the impact of an industrial slowdown. CONCLUSION In conclusion, in our stagflation scenario, we believe engineering stocks would be badly hit. These stocks are trading at high multiples because of high expected growth. A slower growth scenario would mean a de-rating of multiples and this, coupled with a slowdown in earnings, could mean that the stocks would take a beating. We have worked out worst- case valuations for the stocks under our coverage for a possible stagflation scenario. Under our worst-case scenarios, we have reduced both revenue growth and margin assumptions. The resulting lower growth could lead to a contraction of P/E multiples for these stocks. May 2008 73
  • 73. Lehman Brothers | Equity Research For our stagflation scenario analysis, we have reduced our revenue growth and margin assumptions for 2008 and 2009. We have calculated DCF-based prices under two scenarios of expected risk premium (ERP) – 5% and 6%. We have assumed a risk-free rate of 8% to calculate the cost of equity. Figure 33: Stagflation scenario analysis Rating Price (INR) Ticker Equity BETA Base case (INR) Stagflation (INR) ERP = 5% ERP = 6% ERP = 5% ERP = 6% ABB 1-OW 1087.0 ABB.NS 0.9 1,464 1,185 750 650 BHEL 2-EW 1785.4 BHEL.NS 1.3 1,538 1,329 964 871 Crompton Greaves 1-OW 252.1 CROM.NS 1.1 385 327 186 157 Bharat Electronics 1-OW 1229.8 BAJE.NS 0.9 2,125 1,899 1,417 1,265 Source: Lehman Brothers estimates (Prices as of May 7) WINNERS AND LOSERS In a stagflation scenario, from the stocks under our coverage, we would prefer Bharat Electronics, as the stock is least leveraged to slower GDP growth and its driver is Indian defence expenditure, which we believe will be largely unaffected by a slowdown in GDP growth. Our least preferred stocks would be BHEL, followed by ABB. Figure 34: Potential downside from current price Potential downside from current price (%) ERP = 5% ERP = 6% ABB -31.0 -40.2 BHEL -46.0 -51.2 Crompton Greaves -26.2 -37.7 Bharat Electronics 15.2 2.9 Source: Lehman Brothers estimates May 2008 74
  • 74. Lehman Brothers | Equity Research IT INDUSTRY Effects of rising inflation and slower growth James Kim LBIE, Seoul Tel: 822 2116 7570 INTRODUCTION: STAGFLATION IS DETRIMENTAL FOR THE ASIAN IT james.kim@lehman.com INDUSTRY With so much uncertainty in the global economy, we analyze the outlook for the Asian CW Chung IT industry in the event of a prolonged economic slowdown. If we were to experience a LBIE, Seoul period of prolonged stagflation, the overall Asian IT industry would show a significant Tel: 852 2116 7558 slowdown in demand as well as deterioration in profitability. cwchung@lehman.com In 2008, we expect the US consumer electronics market to decrease in size. The home appliance market, in particular, should contract by about 20% year on year. The John Hsu consumer integrated circuit (IC) market will also likely be a loser, in our view, given our LBSTL, Taiwan expectation a prolonged economic setback. We think the TV market should also Tel: 8862 8723 1627 experience a slowdown in demand, even with the US broadcasting system’s full John.hsu@lehman.com digitalization in early 2009. We also expect distinct contraction in corporate PC demand because companies are likely to delay investments due to an unfavourable macro Alex Yang environment. If we were to see a severe and prolonged stagflation for the rest of 2008 LBSTL, Taiwan and 2009, the negative impact would not only apply to the US market, but also to the Tel: 8862-8723-1619 global electronics market. alex.yang@lehman.com Most IT makers will likely employ a low pricing policy to spur demand and sustain Yolanda Wang production line utilization rates. However, we believe a rapid rise in material costs and LBSTL, Taiwan labour expenses will make it difficult for IT companies to post meaningful profits. With the exception of a few segments, we think that there will be very few winners among IT Tel: 8862 8723-1623 manufacturers in an environment of rising inflation and slowing growth. yolanda.wang@lehman.com However, we think the worst-case scenario for Korean handset makers, such as Samsung Electronics (005930.KS, 1-Overweight) and LG Electronics (066570.KS, 2-Equal Weight), is not as gloomy vis-à-vis other regional IT manufacturers. Even though the high-end handset market should also contract when faced with an economic depression, weak performance by Motorola (MOT, 1-Overweight) and Sony Ericsson (not rated) should enable Korean makers to easily increase market share. Korean handset makers’ profitability should also improve somewhat because they have significantly improved their cost structure and design capability since 2007. In addition, foreign exchange trends are also working in favour of Korean exporters compared with their Japanese and Taiwanese counterparts. We think the Korean Won will likely remain weak against the US dollar, while the Japanese Yen and the Taiwanese dollar should remain relatively strong. For the memory industry, we think a severe economic slowdown should accelerate the memory industry’s restructuring where the position of first-tier makers such as Samsung Electronics and Hynix (000660.KS, 1-Overweight) should be strengthened. For the PC market, we expect low-end notebooks to replace high-end desktops and other notebooks. Lastly, we think the display industry could experience worse-than-expected oversupply in 2009. May 2008 75
  • 75. Lehman Brothers | Equity Research EFFECT ON EBIT: WE EXPECT OVERALL WEAK MARGINS Prolonged stagflation would bring about a slowdown in overall IT demand. This, then, would negatively impact overall industry supply/demand dynamics, in our view. In turn, average selling prices would fall rapidly, causing makers’ margins to deteriorate. Component makers in Taiwan could experience a rapid fall in margins, while display makers’ profitability could remain stable through to fiscal year 3Q08 based on a shortage in the industry. From fiscal year 4Q08, however, we expect display makers’ margins to show a significant drop based on industry oversupply and rapidly falling ASPs. We view the memory sector to be an exception, however. We believe the memory industry has already hit bottom in fiscal year 1Q08, and that it would be difficult for makers’ margins to deteriorate further from current levels. While a severe recession may slow a sector recovery as a whole, this could accelerate industry restructuring where the position of first-tier makers is strengthened, in our view. Unlike other industries, the semi-memory industry is characterized by a huge gap in cost competitiveness and funding ability between first- and second-tier makers. Korean handset makers’ margins should be able to sustain double-digit margins, in our view. We think Motorola and Sony Ericsson’s weakness should enable Samsung Electronics and LG Electronics to increase their market share. EFFECT ON CASH FLOW: MAKERS LIKELY TO CUT CAPEX Overall, IT players will be forced to reduce capex, in our view, if an economic setback causes demand to slow and ASPs to fall rapidly. The memory industry should see an acceleration of industry restructuring that has already started. We note that foundries have already cut capex by about 30% to 50% in 2008, and we expect this trend to continue. LCD makers, however, will likely stick to their original fab expansion plans in 2008 (capex to be up about 60% year on year in 2008). However, we think expected oversupply in 2009 combined with a potential economic slowdown should prompt LCD makers to lower capex levels in 2009. WINNERS AND LOSERS Winners: • Korean handset makers competitors’ weakness and favourable F/X trend • First-tier memory makers accelerated industry restructuring • Notebook casing makers low-end notebook demand boost Losers: • IC design weaker demand, especially for consumer IC products • General electronics component makers rapid ASP fall and higher material costs • Handset component makers in Taiwan who supply to non-Korean handset makers • LCD makers 2009 industry oversupply May 2008 76
  • 76. Lehman Brothers | Equity Research Figure 35: Asia IT Sector – winners and losers in a prolonged stagflation Winners 33 Mkt Cap Absolute Performance (%) P/E P/B ROE Company Ticker Currency Rating Shr Price (US$ mn) 1m 3m 1yr 07 08E 09E 07 08E 09E 07 08E 09E 12.8 11.9 10.6 1.8 2.2 1.9 Samsung Electronics 005930.KS KRW 1-OW 741,000 118,830 14.0 20.9 26.2 15% 19% 19% 13.2 9.0 10.1 2.3 2.7 2.2 LG Electronics 066570.KS KRW 2-EW 153,500 21,639 11.6 64.5 134.4 18% 37% 14% 36.2 n/a 7.5 1.4 1.5 1.3 Hynix Semiconductor 000660.KS KRW 1-OW 28,300 12,689 3.1 8.6 (15.0) 4% -3% 18% 16.6 15.1 12.4 3.7 3.3 3.1 TSMC 2330.TW TWD 1-OW 68.0 57,329 5.6 10.7 (1.1) 22% 23% 23% 7.1 4.8 3.2 1.3 1.1 0.9 Ju Teng 3336.HK HKD 1-OW 2.9 366 14.9 16.3 46.2 22% 26% 31% 21.9 15.8 12.0 8.5 7.4 6.0 High Tech Corp 2498.TW TWD 1-OW 830.0 15,648 22.6 38.6 87.3 44% 50% 55% 9.5 8.3 n/a 2.2 2.2 n/a n/a Inventec Appliance Corp 3367.TW TWD 2-EW 66.7 1,013 10.2 19.3 15.0 27% 28% 17.2 15.6 12.4 4.4 4.0 3.5 Silitech Technology 3311.TW TWD 1-OW 117.0 580 26.6 31.2 (14.5) 28% 27% 30% Losers Mkt Cap Absolute Performance (%) P/E P/B ROE Company Ticker Currency Rating Shr Price (US$ mn) 1m 3m 1yr 07 08E 09E 07 08E 09E 07 08E 09E 11.6 9.9 n/a 1.4 1.2 n/a n/a Sunplus 2401.TW TWD 3-UW 40.5 742 1.1 18.4 (38.6) 19% 17% n/a n/a n/a 0.7 0.9 1.0 ProMOS 5387.TWO TWD 2-EW 8.1 1,794 0.1 2.4 (40.2) -10% -20% -8% 26.8 17.7 13.9 2.7 4.0 3.4 Foxconn Tech 2354.TW TWD 3-UW 177.0 4,419 (6.8) (1.7) (39.1) 13% 18% 27% 17.9 11.9 10.8 2.0 1.9 1.6 Asustek Computer 2357.TW TWD 1-OW 100.0 12,264 8.0 19.2 29.6 14% 18% 17% 11.3 n/a n/a 2.8 n/a n/a n/a n/a Hon Hai Precision 2317.TW TWD 1-OW 165.0 34,144 (7.0) (4.1) (17.8) 29% 9.2 13.1 9.0 2.1 2.1 1.6 Catcher 2474.TW TWD 3-UW 110.0 1,960 (14.1) 16.3 (48.7) 29% 17% 22% 8.7 6.3 12.5 1.6 1.3 1.2 AU Optronics 2409.TW TWD 1-OW 62.7 16,084 13.0 17.9 16.5 19% 21% 9% 13.2 4.7 10.5 2.1 1.5 1.4 LG Display 034220.KS KRW 1-OW 48,500 16,913 3.9 18.7 21.6 18% 37% 14% 8.2 5.2 15.8 1.3 1.1 1.0 Chi Mei Optoelectronics 3009.TW TWD 1-OW 43.5 9,630 4.7 12.8 16.0 16% 20% 6% 10.9 5.2 103.7 1.0 0.8 0.8 Chunghwa Picture Tubes 2475.TW TWD 1-OW 10.1 2,795 5.5 7.0 22.0 9% 15% 1% Pricing as of 7 May 2008 Source: Bloomberg, Company data, Lehman Brothers estimates May 2008 77
  • 77. Lehman Brothers | Equity Research METAL & MINING (CHINA) Effects of rising inflation and slower growth Oliver Du LBAL, Hong Kong Tel: 852 2252 1402 INTRODUCTION: LOW GROWTH AND HIGH INFLATION oliver.du@lehman.com According to our China economist, Mingchun Sun, China’s GDP growth will be 9.8% and 8.5% in 2008 and 2009, respectively; below 10% growth for the first time in six Nick Wang years because of weak exports and a likely profit margin squeeze by Chinese companies. LBAL, Hong Kong On the other hand, we expect the consumer price index (CPI) to remain at a high of 5.5% Tel: 852 2252 1598 in 2008, primarily due to a surge in food prices. We also expect it to decline sharply to nick.wang@lehman.com 2.8% in 2009 once the food supply shortage alleviates. If the scenario worsens and China’s GDP growth drops dramatically to 6.1% and 5.9% in 2008 and 2009, respectively, and CPI soars to 6.7% and 6.9% in 2008 and 2009, respectively, we expect: (1) lower-than-expected economic growth to result in a soft demand for various commodities, which may be moderated by supply tightness; and (2) higher-than-expected inflation to drive up costs for Chinese metal & mining companies. EFFECT ON EBIT: MARGIN SHRINKAGE? With different supply-demand dynamics, the effect on gross margin and EBIT margin should be analyzed on a case-by-case basis for different commodity sub-sectors. Since metals & mining is an upstream sector and enjoys both domestic and tightening global supply, we believe the Chinese coal sector will enjoy strong pricing power, which may allow coal producers to pass on most of their cost hikes to maintain margins. The domestic thermal coal contract price in 2008 jumped 15% year on year, underpinned by tightness in supply and a sustained bottleneck in the country’s railway transportation. Further potential upside for the domestic contract price in 2009 remains, in our view, given the deep discount (more than 20%) in spot prices. Downstream sectors, particularly sectors for copper smelters and aluminium, will experience margins squeeze because we expect raw material and labour costs to increase in an inflationary environment. Domestic oversupply may constrain their ability to pass on costs increases. Since we expect continued progress to phase out inefficient capacities and acceleration in industry consolidation, we think steel and cement companies should be able to increase end-product (steel product and cement) prices and offset most costs increases. EFFECT ON CASH FLOW: EFFECT ON CAPEX GIVEN FALLING CASH FLOWS AND CAPITAL SHORTAGE? Chinese metals & mining companies generally enjoy a solid balance sheet, underpinned by strong demand, a solid commodity prices trend and strong operating cash flows for the past few years. Particularly, we expect top industry players to expand their capacities or continue their M&A activities funded by a strong balance sheet and the government’s preferential bank loan support to top industry leaders. HOW WILL THE GOVERNMENT HELP EASE THE PAIN? Faster RMB appreciation should lower costs of imported raw materials. We think the Chinese steel sector should particularly benefit from RMB appreciation because global iron ore prices soared by 71% in 2008, following a 9.5% rise in 2007. We estimate imported iron ore, on an adjusted iron content basis, will account for 58% of China’s total iron ore requirement in 2008. Assuming a 7% RMB appreciation, we estimate our 2008 earnings estimates will change by 2.8% for Angang Steel (347 HK, 1-Overweight), May 2008 78
  • 78. Lehman Brothers | Equity Research 4.2% for Baosteel (600019 CH, 2-Equal Weight), 8.7% for Maanshan Iron & Steel (323 HK, 3-Underweight). We do not expect much of an earnings impact from the Chinese coal, cement, aluminium and copper sectors. Also, to maintain a stable GDP growth rate, we expect the Chinese government to maintain resilient fixed asset investment (FAI) growth in 2008, which should serve to partially offset a likely weak exports performance this year. A continued resilient FAI bodes well for the commodities demand, in our view. CONCLUSION We believe a potential and dramatic slowdown in Chinese GDP growth will negatively affect demand for commodities, and, hence, prices. However, global supply shortage/disruptions coupled with years of underinvestment in mining should offset the demand weakness. Also, potentially resilient FAI growth encouraged by the Chinese government to offset exports weakness should also lend support for commodities, in our view. The impact of inflation, driven by costs hikes on margins of different commodity sub- sectors, depends on whether each sector is able to pass on price increase. Upstream sectors (i.e. coal) should remain winners, given their strong pricing power. Downstream sectors with weak pricing power, such as aluminium and copper smelters, will be losers, in our view. WINNERS AND LOSERS Winner: The coal sector should be the winner, in our view, underpinned by the shutdown of small coal mines in China, a sustained bottleneck in the country’s railway transportation and an extremely tight supply in the Asia Pacific seaborne-traded coal market. China Shenhua Energy (1088 HK, 1-Overweight) remains our top pick in the sector, given its resilient organic growth, a steady increase in coal contract price and the possibility of value-accretive coal mine asset injections from its parent company. Losers: The aluminium producers are likely to be losers because costs pressures and a domestic oversupply scenario would limit potential upside of domestic aluminium prices. We believe Chalco (2600 HK, 3-Underweight) is likely to suffer due to costs pressures (bauxite, energy and power), and we think there is limited upside in domestic aluminium prices. Figure 36: China metals & mining valuation comparison Company Ticker Price Mkt. cap REC P/E (x) P/B (x) EPS growth (%) ROE Div yield (%) (USD mn) 08E 09E 08E 09E 08E 09E 08E 09E 08E 09E Shenhua 1088.HK HKD34.95 89,350 1-OW 19.1 16.4 4.6 3.8 48.5 16.1 24.0 23.4 1.8 2.1 Energy China Coal 1898.HK HKD16.04 24,191 1-OW 19.4 14.4 5.5 4.3 44.7 35.3 28.4 29.8 1.3 1.7 Yanzhou Coal* 1171.HK HKD14.70 9,246 1-OW 11.3 10.3 2.6 2.2 78.3 10.2 22.6 21.2 2.7 2.9 Angang 347.HK HKD20.00 18,607 1-OW 13.2 11.0 2.2 1.9 21.6 20.2 16.4 17.6 3.0 3.6 Baosteel 600019.SS CNY12.95 30,157 2-EW 16.4 13.5 2.4 2.1 8.7 21.9 14.4 15.8 2.7 3.3 Magang 323.HK HKD5.16 4,281 3-UW 12.0 12.3 1.4 1.3 8.9 -2.2 11.9 10.8 3.5 2.8 Chalco 2600. HK HKD13.10 22,771 3-UW 13.5 14.8 2.4 2.2 6.5 -8.7 18.0 14.8 2.2 2.0 Jiangxi Copper 358.HK HKD18.18 7,424 3-UW 10.3 10.1 2.3 1.9 21.6 2.1 23.0 19.9 2.1 2.2 Anhui Conch 914. HK HKD63.90 12,800 1-OW 20.5 16.5 6.2 4.7 76.9 24.7 30.2 28.6 0.7 0.9 CNBM 3323. HK HKD18.36 4,997 1-OW 19.8 13.4 2.8 2.3 126.4 48.0 14.1 17.5 0.4 0.6 Average 16.1 13.8 3.2 2.7 38.7 16.6 19.7 19.4 1.9 2.1 Source Bloomberg, Lehman Brothers estimates. Pricing as of 7 May 2008. *The investment rating forYanzhou Coal was upgraded to 1-OW and the 12-month target price was raised to HK$20.00 (from HK$15.00) on 15 May 2008 May 2008 79
  • 79. Lehman Brothers | Equity Research MATERIALS (TAIWAN) Effects of rising inflation and slower growth Josephine Ho LBAL, Hong Kong Tel: 8862 8723 1663 INTRODUCTION: LOWER GROWTH AND HIGHER INFLATION josephine.ho@lehman.com Cement: cement consumption is a function of FAI (fixed asset investment) and GDP growth, so lower growth and higher inflation is likely to weaken cement consumption. However, due to controlled supply landscape in Taiwan and the ongoing consolidations in China, we expect cement prices to remain high in 2008 and 2009. Steel: steel consumption is a function of FAI (fixed asset investment) and GDP growth, so lower growth and higher inflation is likely to weaken steel consumption. While cost hikes have been putting pressure on margins for steel makers, we believe profit/ton should be sustained given the global steel supply discipline in 2008. EFFECT ON EBIT: MARGIN SHRINKAGE? Cement: we expect margin declines despite cost-push price increases. However, overall bottom-line earnings should remain healthy for Taiwan Cement (1101.TW, 1- Overweight) given the capacity ramp-up in China and continued efforts to reduce non- core assets. Asia Cement (1102.TW, 1-Overweight) is likely to have higher earnings downside risks, as (1) it saw no capacity increase in 2008, and (2) earnings volatility from U-Ming Marine (2606.TW, 1-Overweight). Steel: margins are likely to be under pressure in 2008. However, global supply discipline should allow steel makers to raise prices and to pass on cost increases, thus maintaining profit/ton. We therefore expect China Steel’s earnings and dividend yield to sustain in 2008. EFFECT ON CASH FLOW: EFFECT ON CAPEX GIVEN FALLING CASH FLOWS AND CAPITAL SHORTAGE? We expect little impact to Taiwan cement and steel companies’ cash flows and capex as we forecast their earnings should be supportive due to industry structural changes. Additionally, these companies have very low net gearings (between 10% and 40%). HOW CAN THE GOVERNMENT HELP EASE THE PAIN? TWD appreciation against USD could help ease cost pressure but the impact is likely to be marginal. Any government intervention, likely to be price control, will be negative to cement and steel companies in Taiwan, in our view. Taiwan is a net importer all its raw materials, including iron ore, coking coal, and thermal coal; thus, it has no control over costs. Government intervention in the form of fixing prices would inevitably lead to margin pressures, in our view. CONCLUSION While we think margins would inevitably slide due to higher ASP, we believe structural changes in the cement and steel industry (more concentrated supply landscape resulting from industry consolidation) should allow cement and steel producers to sustain their profitability per ton. Our preferred stock is Taiwan Cement (1101.TW; 1-Overweight) owing to its significant China capacity increase in 2008. May 2008 80
  • 80. Lehman Brothers | Equity Research MEDIA/INTERNET Effects of rising inflation and slower growth Paul Wuh LBAL, Hong Kong Tel: (852) 2252-6182 INTRODUCTION: LOW GROWTH AND HIGH INFLATION paul.wuh@lehman.com In general, we believe the media/internet sector in the Asia-Pacific region will be better than other sectors at dealing with stagflation. Media companies often require a large fixed upfront investment but have low incremental costs to support revenue streams. Furthermore, since the media sector generally faces fewer tariff controls than the telecom industry, rates are more adjustable in periods of high inflation. However, the media sector has numerous subsectors – some of which will be better able to weather an environment of stagflation than others, in our view. For example, we believe media companies whose revenue is primarily based on a subscription model (versus an advertising revenue model) will do better in a period of stagflation. This group would include online gaming companies, cable TV, and satellite TV companies. For media companies that rely on advertising revenue, companies that offer low costs to advertisers will have a competitive advantage, in our opinion. In this group, we believe internet portals that rely on advertising will do better than traditional media companies that operate TV and radio stations or that publish newspapers, in a period of stagflation. Nevertheless, all media companies that rely on advertising revenue will experience some negative impact during a period of slow growth due to weak advertising budgets. EFFECT ON EBIT: MARGIN SHRINKAGE? As with telecom services, the media sector generally has a large fixed/sunk cost in building out the distribution, but the incremental costs are low. Again, the impact on EBIT depends on subsectors within media. First, we expect newspaper companies to do worse in a period of stagflation, given the high costs of producing a newspaper (paper, ink, etc.) and distribution (higher gasoline costs). However, new advertising media companies have low incremental costs. For example, companies such as Focus Media (FMCN, 1-Overweight) in China have already deployed their digital frames and can change the advertising content in the frames with little variable costs. For internet gaming companies, variable costs are dependent upon the number of subscribers – with new servers added only as the popularity of a game increases. There will be higher costs related to wages for game developers and other employees, but this is a small part of the cost structure for these companies. For cable TV companies, there is also a large fixed-cost component to roll out the service, but the incremental operating costs are low. Finally, for internet portal and e-commerce companies, there are also minimal incremental expenses that would increase during a period of stagflation. May 2008 81
  • 81. Lehman Brothers | Equity Research EFFECT ON CASH FLOW: EFFECT ON CAPEX GIVEN FALLING CASH FLOWS AND CAPITAL SHORTAGE? As with other service industries, we believe the media industry will not face a major drop in cash flow in an environment of stagflation. We also believe companies such as cable TV operators could decide to postpone upgrades to their networks if subscription growth slows during a period of stagflation. This would actually lead to higher returns on capital for these companies. As for capex and capital needed for other media companies, we do not think there will be any major shortfall. Much of the incremental spending is success-based and will only be deployed when the number of users increases, in our view. For the new outdoor media companies, such as Focus or Air Media, the incremental rollout or upgrade plans for digital frames could be postponed during a period of economic slowdown. This may result in slower longer-term growth but offer high short- term returns. HOW CAN THE GOVERNMENT HELP EASE THE PAIN? Although some media companies face regulatory scrutiny in terms of content, there is less regulation in terms of pricing media services versus telecom services. As such, we believe there are fewer measures that governments can adopt during a period of stagflation to assist media companies. CONCLUSION As with telecom services, we believe the media/internet sector in the Asia-Pacific region will weather the stagflation storm better than many other industrial sectors. In particular, we would focus on media companies that: (1) have a subscription model that is unlikely to face loss of revenue in an economic downturn and can raise prices if needed to counter inflation (such as cable TV and satellite TV companies), (2) have low operating costs and are able to easily scale their businesses to meet changing business environments (such as internet gaming and e-commerce), and (3) are low cost to advertisers and success-based (such as internet portal/search companies). On the other hand, we believe the traditional print media companies will do worse in a period of stagflation, given their higher fixed and variable operating costs. WINNERS AND LOSERS We believe the following media companies will outperform during a period of stagflation: • Online gaming companies: Kingsoft (3888.HK, 1-Overweight), The9 (NCTY, 1- Overweight), NCsoft (036570.KQ, 1-Overweight, covered by Stanley Yang) and Neowiz Games (095660.KQ, 1-Overweight, covered by Stanley Yang). • Cable TV companies: Austar (AUN.AX, 1-Overweight, covered by David Langford) and Starhub (STAR.SI, 1-Overweight). • Internet and internet search portals: NHN (035420.KQ, 1-Overweight, covered by Stanley Yang). • E-commerce: Ctrip.com (CTRP, 1-Overweight, covered by Candy Huang). • Outdoor new media: Focus Media (FMCN, 1-Overweight) and Clear Media (100.HK, 1-Overweight). May 2008 82
  • 82. Lehman Brothers | Equity Research Several media companies that could lose out in a stagflation environment include Fairfax Media (FJX.AX, 2-Equal Weight, covered by David Langford) in Australia, as newspaper companies rely on print advertising for a large percentage of their revenue. Figure 37: Selected companies’ valuation Market cap Price & EPS EPS 07-09E P/E PEG Name Ticker Rating (US$mn) Currency Price 2008E 2009E EPS CAGR 2008E 2009E 2008E 2009E Internet Alibaba 1688 HK Not rated 9,418 HKD 14.54 0.25 0.36 35% 57.9 40.3 1.7 1.2 Tencent 700 HK Not rated 12,428 HKD 54.05 1.63 2.25 40% 33.1 24.0 0.8 0.6 Baidu BIDU Not rated 12,258 USD 359.13 4.10 6.60 63% 87.6 54.4 1.4 0.9 Sina SINA Not rated 2,542 USD 46.49 1.41 1.76 34% 33.0 26.5 1.0 0.8 Sohu SOHU Not rated 2,699 USD 71.52 2.43 3.14 87% 29.4 22.8 0.3 0.3 Weighted Average 49% 55.8 37.5 1.2 0.8 Online games Shanda SNDA Not rated 2,422 USD 33.83 2.08 2.46 15% 16.3 13.8 1.1 0.9 Perfect World PWRD Not rated 1,623 USD 29.05 2.21 2.64 69% 13.2 11.0 0.2 0.2 Giant GA Not rated 4,129 USD 16.05 0.78 1.01 18% 20.5 15.9 1.1 0.9 NetEase NTES 2-EW 2,963 USD 23.23 1.37 1.42 2% 17.0 16.4 9.4 9.1 The9 NCTY 1-OW 522 USD 21.39 2.00 2.73 41% 10.7 7.8 0.3 0.2 Kingsoft 3888 HK 1-OW 450 HKD 3.08 0.28 0.42 50% 11.0 7.3 0.2 0.1 Weighted Average 22% 17.0 14.3 2.9 2.7 Media Clear Media 100 HK 1-OW 461 HKD 6.91 0.44 0.49 35% 15.7 14.1 0.5 0.4 Focus Media FMCN 1-OW 5,138 USD 39.91 2.06 2.68 31% 19.4 14.9 0.6 0.5 VisionChina VISN Not rated 1,137 USD 16.63 0.58 0.84 176% 28.9 19.9 0.2 0.1 Weighted Average 55% 20.7 15.7 0.5 0.4 Note: Pricing as of 7 May 2008 Source Lehman Brothers estimates for rated companies and Bloomberg estimates for non-rated companies May 2008 83
  • 83. Lehman Brothers | Equity Research OIL AND GAS Effects of rising inflation and slower growth Cheng Khoo LBAL, Hong Kong Tel: 2252 6180 INTRODUCTION: LOWER GROWTH AND HIGHER INFLATION cheng.khoo@lehman.com There is a chicken and egg relationship between oil prices and inflation. Since oil is a major energy source and a major input cost across all industries, high oil price is a Gordon Wai contributor to inflation. On the other hand, inflation causes crude oil production cost to LBAL, Hong Kong escalate. Furthermore, oil, not unlike gold, is viewed by many as a natural hedge during Tel: 2252 6176 inflationary periods. gordon.wai@lehman.com Our worst case scenario of a severe economic recession (where US growth is -0.9% in 2008 and -0.4% in 2009, while Asian growth slows to 4.1% in 2008 and 3.8% in 2009) would likely lead to a slowdown in global oil demand. So far in 2008, we have already witnessed a slowdown in US oil demand partly due to the high price and partly due to the economic slowdown. However, demand in Asia (China, in particular) and the Middle East has shown strong growth. In these economies, the governments are subsidizing prices, which essentially removes the impact of price elasticity. Additionally, China is building up inventory, which we think will continue until mid-2008. We believe an impactful global demand slowdown is unlikely until the end of 2008, and become more severe in 2009. Demand alone does not impact oil prices; the supply situation also plays an important role. Over the past decade, limited new supply has created a tight situation. In particular, non-OPEC supplies have lagged demand growth, leading to a drawdown in inventories and OPEC spare capacity. However, by end-2008 and in 2009, we are expecting large new fields in Saudi Arabia to come on-stream. Hence, our view is that oil price prices will remain high for most of 2008 but will fall sharply by end-2008 and in early-2009. EFFECT ON EBIT: SHRINKING MARGINS? We expect EBIT to grow in 2008 for most pure oil companies (CNOOC Ltd., PTTE&P) owing to high oil prices although the magnitude of EBIT expansion is likely to be muted by the impact of local currency appreciation and cost escalation. International crude oil is priced in US dollars. In this inflationary environment and given current US monetary policy, local currencies are likely to continue to appreciate against the US dollar. In 2009, we expect the decline in earnings to be greater than the decline in oil prices if inflationary problems escalate. Most oil companies listed in Asia (such as Petrochina, Sinopec, PTT, ONGC, and Reliance) are integrated and have exposure to downstream refining and marketing businesses. These companies also come under regulatory controls imposed by their governments. Their EBIT will depend on changes in regulatory policies. For Chinese integrated companies currently suffering from high oil prices but constrained from raising oil product prices, we believe EBIT could improve with the expected decline in crude oil prices in 2009 even if the government does not relax oil product price controls. This will more than offset the gradual increase in production cost, in our view. Meanwhile, fearing product shortages, the government is using other regulatory measures such as import VAT rebate to help these companies. May 2008 84
  • 84. Lehman Brothers | Equity Research EFFECT ON CASH FLOW: EFFECT ON CAPEX GIVEN FALLING CASH FLOWS AND CAPITAL SHORTAGE After enjoying several years of strong profits, oil companies are flooded with cash and are finding it challenging to spend more than they earn; hence, there has been a gradual improvement in net gearing across the board and many companies are net cash. These companies intend to gear up to a reasonable level and hence we do not expect capex to fall off in the next two to three years. WHAT HAPPENED IN THE 1970s? There were two distinct periods of high inflation in the 1970s – one in the early 1970s and another more severe one in the late 1970s. During both these periods, the stock market (Dow) declined. In the first downturn, oil stocks underperformed the Dow. However, during the second downturn, oil stocks outperformed the market significantly, because the second inflationary period was the result of a commodity price rally and oil prices, in particular, were extremely high, benefitting oil companies. Figure 38: Stock price, oil price, and inflation during the 1970s-80s stock price inflation and oil price 200% 1600% 1400% 150% 1200% 100% 1000% 800% 50% 600% 0% 400% 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 200% -50% 0% -100% -200% Aggreated performance of XOM, BP, CVX, RDSA Dow Crude Oil-WTI (RHS) Inflation (RHS) Source: Datastream HOW CAN THE GOVERNMENT HELP EASE THE PAIN? As mentioned briefly above, the oil sector is subject to significant regulatory control, as it is considered a strategic sector manufacturing products that influence economic activities. The government can either cause a lot of pain to the companies by controlling prices and taxing them or it can help them out by lifting price controls and reducing taxes/tariffs. Most of all, governments strive to strike a balance between ensuring supply sufficiency and controlling inflation. CONCLUSION In a severe economic downturn coupled with a high inflationary environment, we expect physical oil demand to decline although there could be demand for oil papers to hedge against inflation. In the near term, we expect the tight supply situation to continue, which could further boost oil prices. However by the end of 2008 and especially in 2009, as new capacities come on-stream, we believe that oil prices are likely to decline. May 2008 85
  • 85. Lehman Brothers | Equity Research Figure 39: LB crude oil (Brent) price forecast US$/bbl 2006 2007 2008E 2009E 2010E Long term Q1 61.85 58.11 96.31 80.00 Q2 69.85 68.73 110.00 85.00 Q3 70.09 74.91 110.00 90.00 Q4 59.71 88.84 95.00 75.00 Year Avg 65.38 72.65 103.00 83.00 83.00 70.00 Source: Bloomberg, Lehman Brothers estimates WINNERS AND LOSERS In the near term, we believe pure oil companies such as CNOOC Ltd and PTTE&P are likely to outperform in light of expectations that oil prices could escalate further. However, over the next 12-18 months, we believe that integrated oil companies such as Sinopec and Petrochina will outperform when crude prices decline. We think a clear winner would be COSL, an oil service company, the earnings of which we expect to be relatively uncorrelated to immediate oil price movements. We believe it can continue to benefit from high capex spending by oil companies. Figure 40: Valuation comparison of select companies Sh price Target Price Potential Mark. cap PE (x) PBV (x) ROE (%) Yield (%) Reuters Rating (loc curr) (loc curr) Upside (%) (US$ bn) 2008E 2009E 2008E 2009E 2008E 2009E 2008E 2009E Petrochina 0857.HK 1-OW HK$ 11.46 HK$ 15.80 38% 446.8 11.3 11.3 2.2 1.9 20% 17% 4.0% 4.0% Sinopec 0386.HK 1-OW HK$ 8.14 HK$ 10.50 29% 142.7 9.1 7.6 1.7 1.4 19% 19% 2.8% 2.9% Reliance Ind. RIL.BO 1-OW Rs 2,682.4 Rs 3,800.0 42% 94.3 20.3 16.0 3.8 3.2 21% 22% 0.8% 1.0% CNOOC 0883.HK 2-EW HK$ 13.88 HK$ 13.50 -3% 79.5 13.0 12.5 3.4 2.7 26% 22% 3.0% 3.1% ONGC ONGC.BO 1-OW Rs 1040 Rs 1500 44% 53.8 10.8 10.1 2.5 2.2 25% 23% 3.6% 3.7% PTT PTT.BK 1-OW Bt 348 Bt 388 11% 30.7 10.3 10.8 2.0 1.8 22% 22% 3.9% 3.7% PTT E&P PTTE.BK 2-EW Bt 179 Bt 154 -14% 18.5 15.5 15.3 4.4 3.7 32% 26% 2.6% 2.6% COSL 2883.HK 1-OW HK$ 15.56 HK$ 21.00 35% 14.0 21.5 17.0 3.3 2.7 15% 16% 1.1% 1.4% Average 14.0 12.6 2.9 2.5 22% 21% 2.7% 2.8% Prices as of 7 May 2008 Source: Company data and Lehman Brothers estimates May 2008 86
  • 86. Lehman Brothers | Equity Research OIL REFINING Effects of rising inflation and slower growth Michael Lo LBAL, Hong Kong +852 2252 6225 INTRODUCTION: LOWER GROWTH AND HIGHER INFLATION michael.lo@lehman.com In our opinion, lower global growth along with higher inflation is negative for refiners regionally. Lower global growth rates will likely reduce consumption growth of oil Cheng Khoo products, and hence, margins of refiners. Gasoline demand will likely be the worst hit, in LBAL, Hong Kong our view, with the US being the largest consumer. Furthermore, rising inflation will +852 2252 6180 likely keep oil prices at high levels thereby pushing up feedstock costs, and squeezing cheng.khoo@lehman.com margins of refiners. This is especially true for countries such as China and India that have pricing controls on end-products. EFFECT ON EBIT: MARGIN SHRINKAGE? We estimate refining margins will likely decline by 30% YoY in FY08-09 on the back of deteriorating supply and demand fundamentals globally. In our view, global supply growth of 2.6% in 2009 will likely outstrip demand growth of 1.6% during the same period. The add-on effect of a weaker global economy will likely worsen our expectation of margin deterioration. In our base case scenario, we expect global demand growth for oil products to soften to 1.4%, and gasoline to be the worst hit as the US is the largest consuming nation. This could lead to a 5%–10% correction to our Singapore refining margin estimates for 2009. In a worst case scenario, we expect global demand growth to decline to only 0.8% YoY in FY08-09 and refining margins to decline an estimated 20%–30% from our original forecast. The most significant change will come from a reduction in gasoline demand growth, which we estimate will decline to 0.7% YoY in FY08-09, from an estimated 1.5% on account of a much weaker US economy. Figure 41: GDP and global consumption growth Figure 42: Consumption by region 2007E 100% 10.0% 90% 8.0% 32% 36% 37% 80% 43% 6.0% 70% 4.0% 13% 60% 15% 15% 2.0% 50% Others 16% 13% 0.0% Asia 40% 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 19% 25% -2.0% Europe 18% 30% US -4.0% 42% 20% 29% -6.0% 24% 23% 10% Global GDP growth% oil consumption growth% -8.0% 0% light distillates middle distillates heavy oil total consumption Source: Datastream Source: Datastream May 2008 87
  • 87. Lehman Brothers | Equity Research EFFECT ON CASH FLOWS: EFFECT ON CAPEX GIVEN FALLING CASH FLOWS AND CAPITAL SHORTAGE? We believe the decline in cash flows due to weaker-than-expected earnings, will have a minimal impact on capex plans for two key reasons: Firstly, the long lead time in building a new refinery (three–four years) implies that refineries, scheduled to be operational over the next two to three years, have already been financed and are currently under construction. We think that these projects will likely proceed as planned. Secondly, most new refineries in Asia will be built out of China and India by national companies which face no capital shortage. Moreover, we think China is set to rectify its current refining capacity shortage and will likely add new refining capacity, in line with its long-term demand growth goal to ensure balanced demand-supply. HOW CAN THE GOVERNMENT HELP EASE THE PAIN? The governments of China and India are battling inflationary pressures arising from soaring oil prices, by controlling the prices of end-products. Though this could lower inflation, the subsidies on oil products are a burden for the country and domestic refiners. Other Asian countries with hefty taxes on oil products are reducing tax rates in order to control the impact of high oil prices on the domestic economy and inflation. CONCLUSION We believe that a period of slow growth, coupled with inflation, is negative for refiners regionally. Refiners in countries where the prices of end-products are controlled will likely be the worst hit. WINNERS AND LOSERS In our opinion, refiners with a diversified revenue stream will likely be the least affected on account of deteriorating refining margins. We prefer refiners with E&P exposure, as high oil prices will likely help sustain earnings during a period of high inflation. Of our refining stocks universe, we believe that Reliance Industries (RIL IN, 1-Overweight) will likely be the least affected given its diversified business mix. Figure 43: Comparing valuation of select companies Sh price Target Price Potential Mark. cap PE (x) PBV (x) ROE (%) Yield (%) Reuters Rating (loc curr) (loc curr) Upside (%) (US$ bn) 2008E 2009E 2008E 2009E 2008E 2009E 2008E 2009E Petrochina 0857.HK 1-OW HK$ 11.46 HK$ 15.80 38% 446.8 11.3 11.3 2.2 1.9 20% 17% 4.0% 4.0% Sinopec 0386.HK 1-OW HK$ 8.14 HK$ 10.50 29% 142.7 9.1 7.6 1.7 1.4 19% 19% 2.8% 2.9% Reliance Ind. RIL.BO 1-OW Rs 2,682.4 Rs 3,800.0 42% 94.3 20.3 16.0 3.8 3.2 21% 22% 0.8% 1.0% PTT PTT.BK 1-OW Bt 348 Bt 388 11% 30.7 10.3 10.8 2.0 1.8 22% 22% 3.9% 3.7% Formosa Petrochemical 6505.TW 2-EW NT$ 90.90 NT$ 82.00 -10% 27.5 12.9 17.2 3.2 3.4 25% 16% 7.0% 4.3% SK Energy 096770.KS 1-OW W 118,000 W 210,000 78% 10.5 7.5 8.0 1.4 1.3 21% 17% 1.7% 1.7% S-Oil 010950.KS 2-EW W 68,500 W 74,000 8% 7.5 9.5 15.0 2.1 2.1 21% 14% 7.5% 7.5% SK Holdings 003600.KS 1-OW W 152,000 W 298,000 96% 7.0 6.7 6.4 1.4 1.2 24% 20% 1.3% 1.3% Shanghai Petrochem 0338.HK 1-OW HK$ 3.18 HK$ 3.55 12% 6.6 11.3 7.4 0.9 0.8 8% 11% 3.5% 5.4% Thai Oil TOP.BK 1-OW Bt 70.50 Bt 98.0 39% 4.5 6.9 10.0 1.7 1.6 27% 17% 7.0% 4.8% GS Holdings 078930.KS 1-OW W 39,950 W 78,000 95% 3.6 5.2 7.4 1.1 1.0 23% 14% 2.8% 2.8% PTT Aromatics & Refining PTTAR.BK 1-OW Bt 36.00 Bt 57.00 58% 3.4 7.4 11.1 1.4 1.3 20% 12% 5.4% 3.6% Average 9.9 10.7 1.9 1.7 21% 17% 4.0% 3.6% Note: Pricing as of 7 May 2008 Source Company data and Lehman Brothers estimates May 2008 88
  • 88. Lehman Brothers | Equity Research PETROCHEMICALS Effects of rising inflation and slower growth Yong Liang Por LBAL, Hong Kong Tel: 852 2252 6220 INTRODUCTION: LOW GROWTH AND HIGH INFLATION yongliang.por@lehman.com We believe the sector will be severely impacted in an environment of low growth and high inflation. Since chemicals are primarily bulk commodities, manufacturers may find Cheng Khoo it difficult to raise end-product pricing in an environment of weakening demand. The LBAL, Hong Kong situation is likely to be exacerbated once significant new supply comes online from the Tel: 852 2252 6180 Middle East and Asia, beginning from end-2008. This, we believe, will signal the cheng.khoo@lehman.com beginning of a down-cycle. EFFECT ON EBIT: MARGIN SHRINKAGE? We expect margins to be significantly impacted. Crude oil prices have doubled over the past 12 months, leading to higher prices of naphtha, the primary chemical feedstock in Asia. Meanwhile, we have observed faltering demand for products, such as polyester. While margins for olefin derivatives have held up well so far, we estimate a significant deterioration in margins by next year. For example, we estimate the ethylene-naphtha spread to halve from USD497 per tonne in 2008 to USD249 per tonne in 2009. EFFECT ON CASH FLOW: EFFECT ON CAPEX GIVEN FALLING CASH FLOWS AND CAPITAL SHORTAGE? In most cases, chemical companies have positioned themselves for the downturn, having concluded the bulk of capex over the past two years. They have mainly been successful in de-gearing balance sheets, and, hence, we do not expect a significant deterioration in their financial health, even with the downturn. WHAT HAPPENED IN THE 1970S? There is no direct comparison with the 1970s. During the previous downturn in 2001, ethylene demand growth fell to just 1.2%, compared with its ten-year historical growth rate of around 3.6%. HOW CAN THE GOVERNMENT HELP EASE THE PAIN? Governments will be unable to alleviate the situation because prices are set by the market. CONCLUSION We believe these conditions can serve to accelerate the arrival of the downturn. While margins currently remain at reasonable levels, we think the confluence of rising costs, slowing demand and impending overcapacity will likely erode margins. WINNERS AND LOSERS We do not expect any companies to benefit – the only issue is which company is best placed to weather the downturn. In this respect, in an environment of low growth and high inflation we believe that earnings of companies such as Formosa Plastics (1301.TW, 2-Equal weight) and LG Chem (011590.KS, 1-Overweight) will be more resilient because of their diversified and strong product stream. In contrast, in an environment of low growth and high inflation Honam (011070.KS, 1-Overweight) and Formosa Chemicals (1326.TW, 3-Underweight) are likely to be negatively impacted due to their dependence on olefin and aromatic derivatives. May 2008 89
  • 89. Lehman Brothers | Equity Research Figure 44: Select companies’ valuation Sh price Target Price Potential Mark. cap PE (x) PBV (x) ROE (%) Yield (%) Reuters Rating (loc curr) (loc curr) Upside (%) (US$ bn) 2008E 2009E 2008E 2009E 2008E 2009E 2008E 2009E Nanya Plastics 1303.TW 2-EW NT$ 72.5 NT$ 78.0 8% 18.1 11.6 11.0 1.9 1.9 17% 17% 7.8% 8.2% Formosa Plastics 1301.TW 2-EW NT$ 85.60 NT$ 82.00 -4% 16.0 10.8 13.1 1.9 1.9 18% 15% 7.3% 6.1% Formosa Chemical & Fibre 1326.TW 3-UW NT$ 75.40 NT$ 62.00 -18% 13.6 11.1 13.6 1.6 1.6 14% 12% 7.7% 6.3% LG Chem 051910.KS 1-OW W 107,500 W 106,500 -1% 7.9 7.7 9.0 1.9 1.7 22% 16% 2.9% 2.4% PTT Chemical PTTC.BK 2-EW Bt 111 Bt 138 24% 5.2 8.1 10.4 1.6 1.5 20% 15% 5.9% 4.6% Honam Petrochemical 011170.KS 1-OW W 88,900 W 165,000 86% 2.8 5.5 16.6 0.8 0.8 17% 5% 1.1% 1.1% Source Company data, Lehman Brothers estimates. Pricing as of 7-May 2008 May 2008 90
  • 90. Lehman Brothers | Equity Research PHARMACEUTICALS India Pharmaceuticals EFFECTS OF RISING INFLATION AND SLOWER GROWTH Saion Mukherjee LBSPL, India Tel: 91 22 40374184 Historically, growth in the Indian pharmaceutical market (IPM) has mirrored broader Saion.mukherjee@lehman.com GDP growth (IPM grows at about 1.5x GDP growth). So, if GDP growth is lower in FY09, we anticipate corresponding lower growth for IPM. Although the Indian pharma Prasanth MLNPP sector is likely to be adversely affected by such a slowdown, we expect the impact to be limited, given the high proportion of revenue generated from markets outside India. LBSPL, India Tel: 91 22 40374197 HOW CAN THE GOVERNMENT HELP EASE THE PAIN? mlnpp.prasanth@lehman.com Modern medicine penetration is just at around 30% in India. In a stagflationary scenario, we would expect the government to ease pressure on drug prices through measures such as excise duty cuts. CONCLUSION The pharmaceutical sector has companies with wide-ranging dependencies on the domestic market. We expect the adverse impact of a possible slowdown to be lower on contract manufacturing companies and generic companies (with lower domestic market revenue contribution). The impact would likely be much higher on MNC pharma companies and certain domestic pharma companies, which derive most of their revenue from the domestic market. WINNERS AND LOSERS Among the companies under our coverage, we estimate the slowdown would cause only a 1-3% adverse impact on our FY09 EPS estimates. Revenue contributions from the domestic market are at 15-50% for these companies. The corresponding change in target price is likely to be 1-3%, according to our estimates. Figure 45: Stagflation scenario – 6.5% GDP growth in FY09/CY08 Ticker Sensitivity Our target Change Sensitivity Our Change (%) Sensitivity Our current Change analysis – price (INR) analysis – current analysis – EBITDA (%) (bp) FY09 EPS FY09 EPS EBITDA margins price (INR) (INR) estimates margins forecast (INR) FY09E (%) FY09E (%) Ranbaxy RANB.NS 597 603 -1 19.8 20.0 -1 16.0 16.1 (9) Sun Pharma SUN.NS 1,301 1340 -3 71.1 72.8 -2 47.8 48.1 (28) Dr Reddy’s REDY.NS 601 618 -3 31.8 32.5 -2 16.6 16.8 (18) Cipla CIPL.NS 190 192 -1 10.9 11.1 -1 22.6 22.7 (7) Nicholas Piramal NICH.BO 518 524 -1 20.8 21.4 -3 20.0 20.3 (30) Source: Lehman Brothers estimates May 2008 91
  • 91. Lehman Brothers | Equity Research PROPERTY Reverting to basic needs for shelter Paul Louie LBAL, Hong Kong Tel:+852 2252 6189 MASLOW’S HIERARCHY OF NEEDS paul.louie@lehman.com Abraham Maslow’s psychological theory of a ‘hierarchy of needs’ proposes that lower- level physiological needs must first be met before higher-level psychological and esteem Min Chow Sai needs. Food, water, and air are the most basic needs, followed by safety and the need for LBAL, Hong Kong shelter. In the worst-case scenario of low growth and high inflation, we believe housing Tel:+852 2252 1412 should prove to be the most resilient asset class, followed by low-end retail. The office msai@lehman.com market should be the most vulnerable. Jackie Choy Housing – It covers the basic need for security of body. The need for shelter and a LBAL, Hong Kong shortage of available units are likely to drive up rents. Unless we were to envision a Tel:+852 2252 6226 world where there is mass emigration, demand for shelter should prove very resilient. jackie.choy@lehman.com Retail – In recessionary scenario, low-end retail typically outperform as consumers tighten their budget. That said, we believe the more important distinction lies in retail mix management because a good mall should be able to adjust its trade mix in a down market. Office – For developed and service-based economies such as Hong Kong and Singapore, a slowdown in economic activity should impact the office market most. CORRELATION TO GDP GROWTH Historically, home prices in Hong Kong and Singapore have shown only a limited correlation with real GDP growth, at 0.62 and 0.65, respectively. On the other hand, office rents have been tied more closely in Hong Kong, with a 0.85 correlation, and less closely in Singapore, with a 0.23 correlation. Figure 46: Correlation between GDP growth, home prices and office rents Change in Volatility (Standard deviation) Correlation with Real GDP Growth Period HK Home Prices 22% 0.620 1990-Now HK Office Rents 17% 0.850 1995-Now HK Retail Rents 7% 0.880 1995-Now SG Home Prices 13% 0.650 1991-Now SG Office Rents 13% 0.230 1991-Now SG Retail Rents 8% 0.270 1991-Now Source: Lehman Brothers estimates Strictly by the numbers, if GDP growth were to pull back to worst-case levels, this would suggest that office rents could fall as much as 15% in Hong Kong and 3% in Singapore. Note, however, the mild decline in Singapore’s case because, even in our worst-case scenario, we expect GDP growth to be still 2%–3%. In the scenario where Singapore slides into a prolonged recession, we think office rents will be flat in 2008E- 09E, but could fall 20% in 2010E. SUPPLY TIGHTNESS KEY TO POTENTIAL DEMAND LAG The main impact of a slowdown should be a delay in demand (not extinguishing demand). Short-term supply is the key to holding the resilience of the various markets. The tighter the supply picture, the more room there is for demand to be cut before rents and prices have to adjust. Ranked from the lowest to the highest supply, we see Hong Kong housing, Hong Kong office, Singapore office, Singapore housing, and then the China housing market. May 2008 92
  • 92. Lehman Brothers | Equity Research Figure 47: Property supply in 2008 and 2009 vs historical average Com pletions Surplus/Deficit to Avg 2008 2009 Vs. Metric 2008 2009 HK Housing (units) 10,634 11,215 10 Yr Avg 23,751 -55% -53% HK Central Grade A Office (m sf) 0.26 - 10 Yr Avg 0.82 -68% -100% HK Overall Grade A Office (m sf) 5.79 1.37 10 Yr Avg 2.45 136% -44% SG Private Housing (units) 11,000 16,000 10 Yr Avg 7,350 50% 118% SG Office (sq m) 99,000 168,000 10 Yr Avg 104,000 -5% 62% China Housing* (m sqm) 12.10 18.90 3 Yr Avg 5.30 128% 257% Note: China housing proxied by China Overseas, CR Land, Guangzhou R&F, Shimao, Agile Source Lehman Brothers estimates BALANCE SHEET KEY TO WEATHERING THE STORM: (1) HK, (2) SG, (3) CHINA In general, Hong Kong property companies have the strongest balance sheet to weather the worst-case scenario. Hong Kong property companies have a net debt:equity ratio of only 19%, versus 81% (47% if SC Global is excluded) for Singapore and 63% of China property companies. Figure 48: Net debt:equity ratios HK Developers/Landlords HK REITS China Developers SG Developers/REITs Net Debt- Net Debt- Net Debt- Net Debt- Code Name Code Name Code Name Code Name Equity Equity Equity Equity 0101.HK HLP na 0405.HK GZI Reit -30% 2007.HK Country Garden na CATL.SI Capitaland -47% 0014.HK Hysan -8% CRCT.SI CRCT (S$) -33% 0917.HK New World China -26% KLAN.SI Keppel Land -40% 0001.HK Cheung Kong -14% 0823.HK Link Reit -36% 0337.HK SPG Land -29% CTDM.SI City Development -48% 0016.HK SHKP -14% 2778.HK Champion Reit -37% 0688.HK China Overseas -30% SCGO.SI SC Global -320% 0012.HK Hend Land -15% 0808.HK Prosperity Reit -57% 0813.HK Shimao -36% BSES.SI Bukit Sembaw ang -89% 0083.HK Sino Land -22% 1109.HK China Res Land -49% CDLT.SI CDL Hosp. Trust -21% 0041.HK Great Eagle -22% 0754.HK Hopson -58% CMIT.SI Cambridge REIT -50% HKLD.SI HK Land -24% 3383.HK Agile -60% KASA.SI K-REIT -36% 0017.HK NWD -26% 2337.HK Shanghai Forte -95% 0004.HK Wharf -27% 3900.HK Greentow n China -103% 2777.HK Guangzhou R&F -140% Average -19% Average -38% Average -63% Average -81% Source: Company data, Lehman Brothers estimates May 2008 93
  • 93. Lehman Brothers | Equity Research WHAT HAPPENED IN THE 1970S? As the Asian property market was only in its infancy in the 1970s, we turn to the US to look at how property stocks performed in a “stagflationary” environment. For six years after the end of 1976, property stocks outperformed the Dow Jones Industrial Average by more than 70%. Figure 49: 1970s inflation era 175.0 16.0 14.0 155.0 12.0 135.0 10.0 115.0 8.0 6.0 95.0 4.0 75.0 2.0 55.0 0.0 Nov-72 May-73 Nov-73 May-74 Nov-74 May-75 Nov-75 May-76 Nov-76 May-77 Nov-77 May-78 Nov-78 May-79 Nov-79 May-80 Nov-80 May-81 Nov-81 May-82 Listed Property Index (LHS) Dow Jones Indust (LHS) CPI Inflation (RHS) Source: Worldscope, IBES, Lehman Brothers estimates TWO KEY RISKS Overall, the very low supply in the housing and office market should provide a good buffer against a general slowdown in economic activity. However, that said, we see two main risks to property in a stagflationary environment: (1) government intervention and (2) 1980s style rate hike. 1. Government intervention. With costs rising, we believe there will be an increasing call especially among low income earners to safeguard their housing needs. There is a risk for a big push for the return and build out of public housing. The main risk lies in a policy that is unclear with substantial overlap between public and private housing, in which the private sector gets crowded out by an overly ambitious public housing program. 2. Massive rate hikes to curtail inflation. If inflation continues unchecked, we worry about a repeat of the massive rate hikes similar to those in the early 1980s when the Fed Funds rate was raised to as high as 19% in June 1981. Property is most correlated with real rates and if the Fed Funds were to approach double digit, real rates should return to positive territory and we should see a switch from property back to cash. STOCK IMPACT: EARNINGS FOR HK, LIQUIDITY FOR CHINA, RNAV FOR SG Hong Kong: As we highlighted in our note “Sanity Check 4: Point of maximum disgust” dated March 27, 2008, if demand/take-up were to pull back by 10% and vacancy to climb 5%, we estimate an average FY08 earnings drop of 7%. In a somewhat counterintuitive finding, small land-bank developers suffer more as they have pre-sold fewer of their properties. May 2008 94
  • 94. Lehman Brothers | Equity Research Figure 50: Earnings sensitivity to delayed consumption FY 08 Net Profit (HK$m) FY 09 Net Profit (HK$m) Year End Base Case Bear Case Change Base Case Bear Case Change Cheung Kong Dec 31 10,963 10,900 -1% 14,995 14,973 0% Henderson Land Jun 30 5,004 4,347 -13% 5,247 5,742 9% SHKP Jun 30 13,765 12,605 -8% 16,394 16,976 4% New World Dev Jun 30 4,895 4,614 -6% 4,451 4,590 3% Sino Land Jun 30 3,244 3,150 -3% 4,049 3,978 -1.8% Hang Lung Properties Jun 30 6,008 4,939 -18% 6,397 7,260 14% Developers average 43,881 40,556 -8% 51,533 53,520 4% Wharf Dec 31 5,470 5,088 -7% 6,233 6,175 -1% Hysan Dec 31 950 898 -5% 1,012 957 -5% Great Eagle Dec 31 1,095 979 -11% 1,293 1,173 -9% Hongkong Land (US$) Dec 31 450 424 -6% 727 697 -4% Landlords average 11,021 10,269 -7% 14,208 13,743 -3% Overall average 54,902 50,825 -7% 65,741 67,263 2% Source: Lehman Brothers estimates China: Due to their high gearings and tight cash position, a potential delay in demand could have more dire consequences on the Chinese developers. If demand proves weaker than expected and contract sales lower, we believe highly geared developers (see Figure 48) will have little choice but to dilute their NAVs by either taking on a JV partner or some equity issuance. Singapore: As we highlighted in our report “Overall tight housing market to prolong up- cycle into 2010E” dated April 30, 2008, in the worst-case scenario, we expect home prices to fall 5% in 2008E, flat in 2009E, and 30% in 2010E; office rents to be flat over 2008E-09E and fall 20% in 2010E. In the worst-case scenario, we believe the most diversified developer CapitaLand will be the least affected with a 7%–8% cut in its RNAV, while a pure residential developer such as Bukit Sembawang will be the most affected with a 53% cut in its RNAV. Figure 51: RNAV sensitivity to worst case end-08E RNAV (S$) end-09E RNAV (S$) Base Case Worst Case Change Base Case Worst Case Change CapitaLand 7.12 6.61 -7% 7.43 6.87 -8% City Developments 16.85 14.24 -15% 18.70 15.62 -16% Keppel Land 9.12 8.43 -8% 9.45 8.61 -9% Bukit Sembaw ang 15.43 7.30 -53% 15.43 7.30 -53% SC Global 3.75 2.13 -43% 3.77 2.15 -43% Source: Lehman Brothers estimates CONCLUSION In a worst-case scenario, we believe housing and low-end retail should prove the most resilient as they cover basic needs. Office and high-end retail are likely to fare worst. At the country level, performance should be tied to existing supply levels. Hong Kong, with the lowest expected housing supply for the next four years, should prove the most defensive. May 2008 95
  • 95. Lehman Brothers | Equity Research WINNERS AND LOSERS Winners SHKP (16 HK, 1-Overweight) – Hong Kong’s second-largest housing provider (22% market share) and largest shopping mall owner (10 million sqft) should show resilient performance in a downturn. Furthermore, with a net debt:equity ratio of only 14%, SHKP has a strong balance sheet to weather any short-term slowdown, in our view. CapitaLand (CAPL SP, 1-Overweight) – South-east Asia’s largest developer is well- diversified in terms of business segments and geographical regions, and is therefore defensive against near-term volatility in a specific business/area – every 10% change in Singapore home prices and office rents translates into just a 1% change each in its RNAV. Net debt:equity of 47% and a strong liquidity position of S$4.4 billion in cash as of end-07 (20% of market cap in cash) put CapitaLand in a comfortable position in the current market. Losers HK Land (HKL SP, 1-Overweight) – It is the property stock with the highest proportional exposure to the office market. HK and SG offices make up 87% of HK Land’s NAV. That said, with existing vacancy at a very low 1.1% in Central, there is ample cushion for HK Land, should it need to trade rents for occupancy. Guangzhou R&F (2777 HK, 2-Equal weight) – A highly geared developer with net debt:equity ratio at 140%. Including outstanding land premium of Rmb10 billion, net debt:equity ratio is near 265%. R&F is dependent on good contract sales and potential A- Share listing to strengthen its cash flow, both of which are difficult if inflation in China continues to stay high. CDL Hospitality Trusts (CDREIT SP, 2-Equal weight) – 87%–88% of FY08E- FY09E gross revenue is derived from Singapore hotels. Although 25%–27% of FY08E- FY09E gross revenue is fixed, in the scenario when RevPAR declines 15% in 2008E and 2009E (vs our current projection of 15% and 10% growth, respectively) – back in 1Q98 and 1Q99 when real GDP growth in Singapore last dropped to 2%–3%, hotel occupancy fell to 71% and RevPAR fell 15% YoY – we estimate that FY08E DPU will be cut 25% from S$0.11 to S$0.08 and FY09E DPU will be cut 41% from S$0.11 to S$0.07. Fair value will be cut by 25% from S$2.22 to S$1.66. May 2008 96
  • 96. Lehman Brothers | Equity Research Figure 52: Peer comparison table Valuation and recom m endation NAV Curr End-09 Grow th Prem / Prem / Target Share Mkt cap NAV NAV (Now to (Disc) to (Disc) to Target Price Potential HK Property Developers Price (HK$) (US$m n) (HK$) (HK$) End-09) Curr End-09 disc. (HK$) upside Rec 0001.HK Cheung Kong 123.20 36,584 119.5 157.8 32% 3% -22% 7.5% 169.00 37% 1-OW 0012.HK Henderson Land 60.35 15,030 67.6 72.5 7% -11% -17% -10% 65.00 8% 2-EW 0016.HK SHKP 138.00 45,369 140.7 164.8 17% -2% -16% 25% 205.00 49% 1-OW 0017.HK New World Dev 21.05 9,888 27.4 30.8 12% -23% -32% -10% 27.50 31% 2-EW 0083.HK Sino Land 21.20 12,464 19.2 25.9 35% 10% -18% 15% 29.80 41% 1-OW 0101.HK Hang Lung Properties 31.00 16,464 25.3 30.7 21% 22% 1% 5% 32.30 4% 2-EW NAV Curr End-09 Grow th Prem / Prem / Target Share Mkt cap NAV NAV (Now to (Disc) to (Disc) to Target Price Potential HK Property Investors Price (HK$) (US$m n) (HK$) (HK$) End-09) Curr End-09 disc. (HK$) upside Rec 0004.HK Wharf 41.95 13,165 54.8 63.4 16% -23% -34% -5% 60.00 43% 1-OW 0014.HK Hysan 23.35 3,159 39.2 43.7 12% -40% -47% -20% 35.00 50% 1-OW 0041.HK Great Eagle 24.70 1,903 47.8 55.2 15% -48% -55% -20% 44.00 78% 1-OW HKLD.SI HK Land (US$) 4.82 11,063 6.8 7.5 10% -29% -36% -20% 5.95 23% 1-OW Enterprise Spread on Total Share Mkt cap Value 10 year Fair Value Potential potential HK REITs Price (HK$) (US$m ) (HK$m ) NTA P/NTA 2008 Yield EFN (bps) (HK$) upside return Rec 0823.HK Link REIT 18.98 5,201 52,746 13.62 39% 4.2% 142 20.54 8% 12% 1-OW 0405.HK GZI REIT 2.94 377 4,206 3.20 -8% 7.5% 471 3.37 15% 22% 2-EW 0808.HK Prosperity REIT 1.59 260 3,763 2.50 -36% 8.0% 527 1.97 24% 32% 1-OW CRCT.SI CapitaRetail China (S$) 1.43 436 845 1.06 35% 5.0% 218 3.57 150% 155% 1-OW 2778.HK Champion REIT 3.97 1,426 18,302 6.98 -43% 9.4% 669 5.25 32% 42% 1-OW Prem / Curr Optim ised With Rm b Prem / (Disc) to Target Target Share Mkt cap NAV NAV Apprec'n (Disc) to Optim ised Prem ./ Price Potential China Developers Price (HK$) (US$m n) (Rm b) (Rm b) (HK$) Curr NAV NAV (Disc.) (HK$) upside Rec 0688.HK China Overseas Land 16.10 15,223 9.5 12.4 13.6 52% 16% 23% 16.78 4% 2-EW 1109.HK China Resources Land 15.26 6,501 15.1 17.7 19.4 -9% -22% 0% 19.40 27% 1-OW 2777.HK Guangzhou R&F 21.15 8,738 20.2 25.7 28.2 -6% -26% 10% 31.04 47% 2-EW 3900.HK Greentow n 9.20 1,809 18.5 18.7 19.6 -55% -56% -20% 15.57 69% 1-OW 0337.HK SPG Land 3.91 520 7.0 7.0 7.3 -50% -50% -15% 6.24 60% 1-OW Current End-08E Prem / Prem / Target Share Mkt cap RNAV RNAV (Disc) to (Disc) to Target Price Potential Singapore Developers Price (S$) Shares (m ) (US$m n) (S$) (S$) Curr End-08E Prem /Disc (S$) Upside Rec BSES.SI Bukit Sembaw ang Estates 9.48 108 705.4 14.8 15.4 -36% -39% 0% 15.40 62% 1-OW CATL. SI CapitaLand 6.70 2,806 12,965.5 6.6 7.1 1% -6% 15% 8.20 22% 1-OW CTDM.SI City Developments 11.96 909 7,500.2 15.7 16.8 -24% -29% 0% 16.90 41% 1-OW KLAND.SKeppel Land 6.00 720 2,980.0 7.0 9.1 -15% -34% 14% 10.40 73% 1-OW SCGO.SI SC Global Developments 1.47 395 400.4 3.6 3.8 -60% -61% 0% 3.80 159% 1-OW Enterprise Spread on Total Share Mkt cap Value 10 year Fair Value Potential potential Singapore REITs Price (S$) (US$m ) (S$m ) NAV P/NAV 2008 Yield SGS (bps) (S$) upside return Rec KASA.SI K-REIT Asia 1.43 690 1,468 2.26 63% 5.9% 361 2.17 52% 58% 1-OW CMIT.SI Cambridge Industrial Trust 0.71 419 880 0.77 92% 8.5% 620 0.88 24% 32% 1-OW CDLT.SI CDL Hospitality Trusts 2.05 1,256 1,965 1.61 127% 5.1% 282 2.22 8% 13% 2-EW Prices as of May 7, 2008 Source: Lehman Brothers estimates May 2008 97
  • 97. Lehman Brothers | Equity Research India Real Estate EFFECTS OF RISING INFLATION AND SLOWER GROWTH Manish Gunwani LBSPL, India Tel: 91 22 4037 4182 A stagflation scenario would result in lower disposable income, thus directly affecting manish.gunwani@lehman.com demand for residential property in India and indirectly affecting demand for retail mall space. We believe a lower GDP growth rate would also slow down the expansion of the Aatash Shah corporate sector in India, which could affect demand for commercial property. The Indian IT/ITES sector contributes 60-70% of commercial space demand and any LBSPL, India prolonged slowdown worldwide would likely result in low off-take of IT special Tel: 91 22 4037 4194 economic zones (SEZs) and IT parks, in our view. aatash.shah@lehman.com At the same time, rising inflation may prompt higher interest rates, which would likely be a double blow for the sector. EFFECT ON EBIT: SHRINKING MARGINS? Higher inflation could result in higher costs for developers. However, we believe this will not affect margins to a great extent because we are building in the assumption of 5% growth in the cost for developers every year. In addition, costs are low compared with product prices, and companies are currently reporting EBIT margins of 45-70%. If costs increase 10% and product prices are kept constant, EBIT margins could change by 200 bp-300 bp, but developers are unlikely to suffer significantly, in our view, as they already have high margins. EFFECT ON CASH FLOW: EFFECT ON CAPEX, GIVEN FALLING CASH FLOWS AND CAPITAL SHORTAGE? We believe that in such an environment developers will not launch new projects and might even delay existing under-construction projects. If projects have to be completed, lack of sales to self-fund construction could result in developers leveraging themselves to a large extent at a rising cost of funds. HOW CAN THE GOVERNMENT HELP EASE THE PAIN? Low growth in income and high interest rates are a double blow for the sector and also for buyers looking for homes. Currently, it takes about a year for any project to be approved and a reduction in approval time would result in lower overheads for developers. The government could also consider reducing stamp duties for buyers and providing mortgages at lower rates for first-home buyers. Tax incentives for corporates could result in better take-up of commercial space. CONCLUSION A stagflation scenario will result in real estate stocks underperforming, in our view. Real estate stocks in India are valued on an NAV basis and trade at varying multiples to NAV. While we believe that real estate stocks should trade at a premium to NAV given our long-term structural view of the sector, the market might not share our enthusiasm. In such a situation, stocks would trade at best at NAV for large caps and for mid- and small-cap stocks even at a discount to NAV. May 2008 98
  • 98. Lehman Brothers | Equity Research WINNERS AND LOSERS We prefer Puravankara Projects Ltd. (PPRO.BO, 1-Overweight) in such a scenario as the valuations are highly attractive. Even in a stagflationary scenario, where we have assumed no new launches for FY09E and FY10E, kept prices constant until FY10E, increased costs by 10% each in FY09E and FY10E, reduced nominal GDP growth rate in the beyond NAV period, and increased discount rates by 100bp, the NAV of Puravankara is still 14% above the current market price. DLF Ltd’s (DLF.NS, 1- Overweight) and Unitech Ltd’s (UNTE.NS, 1-Overweight) NAVs in a stagflation scenario are lower than the current market price by 37% and 55%, respectively. Thus according to our sensitivity analysis for stagflation, Unitech shows the highest potential downside while Puravankara shows the lowest. Figure 53: NAV and target price sensitivity to stagflation (INR per share) Ticker Rating Current market Current target Sensitivity to stagflation price price Target price (%) NAV (%) DLF Ltd DLF.NS 1-OW 653 1,088 (29) (33) Unitech Ltd UNTE.NS 1-OW 305 386 (42) (45) Puravankara Projects Ltd PPRO.BO 1-OW 290 610 (29) (28) Source: Lehman Brothers estimates (Prices as of May 7) May 2008 99
  • 99. Lehman Brothers | Equity Research Taiwan Property INTRODUCTION: LOWER GROWTH AND HIGHER INFLATION Josephine Ho LBAL, Hong Kong Property is generally perceived as an inflation hedge. Rental yield in Taiwan is Tel: 8862 8723 1663 extremely low, at some 2% for residential and about 5% for commercial, and CPI year- josephine.ho@lehman.com on-year growth reached 3.59% in 1Q08 (the full-year average was 1.8% in 2007). With the anticipated return on property (rental yield + inflation = anticipated return on property) in Taiwan at 5.6% to 8.6%, investors are buying property as an inflation hedge. The degree of property value appreciation in Taiwan has been lagging behind other major countries in the region due to the slow domestic economy. EFFECT ON EBIT: MARGIN SHRINKAGE? For most Taiwanese developers, margins have sustained on the continued rise in housing prices. The cost of land has gone up sharply, but developers have been able to pass it on to the home buyers so far, especially at high-end luxury residential projects. HOW CAN THE GOVERNMENT HELP EASE THE PAIN? Various government-led economic stimulants, including closer ties with China, banking regulation reform, and the TWD4.0 trillion (USD131bn) infrastructure “I-Taiwan” 12 Projects, are expected to revive the local economy via domestic consumption. That said, we see little risk of significant rate hikes in Taiwan, as the new administration, led by the KMT from May 20, 2008, on a four-year term, is likely to keep interest rates relatively low, to encourage investment and consumption. A revived domestic economy should help improve the average income and release some pressure from inflation. CONCLUSION We view Taiwan Fertilizer (1722.TW; 3-Underweight) as the premiere asset play in Taiwan. Additionally, investment in its fertilizer related business, Al Jubail, is bearing fruit – the 85% share price appreciation year-to-date (vs an 11% rise in the Taiex over the same period). However, we believe that Taiwan Fertilizer’s current share price implies that its property values in Nangang (a developing business park with little infrastructure in place) are valued at only a 4% discount to the property price in Sinyi district (an established business area), which is hard to justify, in our view. We thus advise to take profits on Taiwan Fertilizer. May 2008 100
  • 100. Lehman Brothers | Equity Research SEMICONDUCTORS – FOUNDRY & SATS Effects of rising inflation and slower growth John Hsu LBSTL, Taiwan Tel: 8862 8723 1627 INTRODUCTION: LOWER GROWTH AND HIGHER INFLATION john.hsu@lehman.com In a low growth and high inflation scenario, foundries and backend players will definitely suffer, in our view. Although IDM customers might release more outsourcing orders to foundries and backend suppliers to reduce in-house production costs, the potential order increase might not offset the negative impact of a demand slowdown. In addition, end demand will likely shift to low-end/low-price products, which may lead to unfavourable product mixes, thus reducing margins, in our view. EFFECT ON EBIT: NARROWER PROFIT MARGINS We believe that high inflation will lead to increased material prices and production costs for foundries and semiconductor assembly and test services (SATS) suppliers – the negative impact would dampen upstream players’ profit margins severely, in our view. In addition, upstream semi players would likely have a hard time maintaining their revenue growth and margin levels amid a slowing economy, as capacity utilization is difficult to maintain when end demand slows. EFFECT ON CAPEX: EVEN MORE CAUTIOUS Starting late-2007, the major foundries began to announce plans to reduce their 2008 capex budgets by 30-50%, compared to 2007, in order to maintain healthy competition within the industry. Meanwhile, backend suppliers have also become more cautious about their capacity expansion, for similar reasons. Amid an economic slowdown, we believe that semi-upstream players will become even more cautious towards expansion, due to concerns about slow end demand. EFFECT ON CASH FLOW: GREATER RELIANCE ON INTERNAL CASH FLOW We believe that semi-upstream players will rely more on internal cash flows for future capacity expansions or R&D expenses in a low growth and high inflation environment. We believe their future expenditure levels will be limited to cash generated from operations. CONCLUSION Amid an inflation or stagflation scenario, we believe that foundries will relatively outperform within the semiconductor upstream space, followed by packaging and testing suppliers (backend) and then the IC substrate makers. WINNERS AND LOSERS We believe industry leaders such as TSMC (2330.TW; 1-Overweight) will be the winners in a scenario of slowing economy with inflation, as industry leaders are usually R&D innovators for advanced technology. In addition, industry leaders tend to have wider profit margins that mitigate the negative impact of inflation. We believe the potential losers in a scenario of slowing economy with inflation are IC substrate suppliers, such as PPT (2446.TW; 1-Overweight) and Nanya PCB (8046.TW; 2-Equal weight), as soaring material costs will likely narrow their profit margins. May 2008 101
  • 101. Lehman Brothers | Equity Research SEMICONDUCTORS – MEMORY Effects of rising inflation and slower growth CW Chung LBIE, Seoul Tel: 852 2116 7558 INTRODUCTION: LOWER GROWTH AND HIGHER INFLATION cwchung@lehman.com Under the scenario of high inflation combined with economic recession, we believe it would naturally result in slower demand for memory, particularly for NAND flash, as flash demand contributions from the US and Europe are much greater than that for DRAM. In addition, NAND flash-equipped applications are designed for entertainment purposes, which are more susceptible to economic slowdowns. At the same time, we believe that lower NAND flash consumption would also be a negative for the DRAM market. This is because we should see increased DRAM supply if the NAND flash market becomes weak, as production should shift from NAND flash to DRAM, in our view. However, we believe that a recession would affect memory makers very differently. While a severe recession may slow the sector recovery as a whole, it should accelerate industry restructuring, where the position of first-tier makers could strengthen, in our view. Unlike other industries, the semi memory industry is characterized by a huge gap in cost competitiveness and funding ability between the first and second-tier makers. EFFECT ON EBIT: MARGIN SHRINKAGE? At this point, second-tier DRAM makers are generating margins of between –50% and –80%. If the market situation worsens from current levels, we view industry production cuts, spending cuts, and accelerated consolidation as inevitable. While we may expect a slower recovery speed or a delay in industry recovery, even if the market situation weakens, we do not expect profitability to worsen from current levels. EFFECT ON CASH FLOW: EFFECT ON CAPEX GIVEN FALLING CASH FLOWS AND CAPITAL SHORTAGE Memory makers’ free cash flow has seen a huge decline over the past two years. While negative cash flow was initially due to excessive spending, memory makers’ cash flow situations have continued to worsen with the recent deterioration in EBITDA margins. As such, we believe that these makers have no choice but to cut spending. If fundraising becomes more difficult, we believe that this would aggravate the position of second-tier players even more and accelerate industry restructuring. HOW CAN THE GOVERNMENT HELP EASE THE PAIN? As semi memory is an important sector for both Korea and Taiwan, the respective governments have several methods to support memory makers should they face funding difficulties. However, we believe both governments have limited ability to provide direct support in terms of increasing makers’ competitiveness vis-à-vis their peers. CONCLUSION The memory sector is in the early stages of recovery after an industry downturn instigated by excessive investment, resulting in oversupply. Although an economic recession may lead to a slower recovery for the industry, we believe this would facilitate eventual industry restructuring centred on first-tier makers. May 2008 102
  • 102. Lehman Brothers | Equity Research WINNERS AND LOSERS Potential winners in the memory sector include first-tier makers such as Samsung Electronics (005930.KS, 1-Overweight), Hynix Semiconductor (000660.KS, 1- Overweight) and Elpida Memory (6665.T, 1-Overweight), who have greater cost competitiveness, market shares and funding ability versus the second-tier makers. We have the view that second-tier makers will be the eventual losers in the memory industry. May 2008 103
  • 103. Lehman Brothers | Equity Research TECHNOLOGY – HARDWARE Effects of rising inflation and slower growth Alex Yang LBSTL, Taiwan Tel: 8862-8723-1619 INTRODUCTION: LOWER GROWTH AND HIGHER INFLATION alex.yang@lehman.com Rising inflation coupled with consumption recession will cause demand to slow, especially for desktop and mid- to high-end notebooks, in our view. However, we expect low-end notebooks and ultra low-priced notebooks (internet device) to replace mid- to high-end NB PC and desktop PC, with more market share gains. Previously, market watchers assumed ultra-low-cost PCs (Internet Device) would account for 10% of the total NB PC market in 2H08. If stagflation occurs, the market share of this sub-sector could go up even further, in our view. For each unit shipped to replace a mid-to-high-end NB or DT PC, it means a vendor loss of at least US$100 per unit, and possibly reaching US$500 per unit. Similarly, stagflation will result in weakening demand for high-end handsets. EFFECT ON EBIT: MARGIN SHRINKAGE? For the labor-intensive sector, PC makers, handset original design manufacturers (ODMs), and component vendors may find their margins compressed due to rising raw material prices, labor costs and other manufacturing costs. Besides, the slower demand reduces manufacturing scale, which also squeezes gross margins. EFFECT OF CASH FLOW: EFFECT ON CAPEX GIVEN FALLING CASH FLOWS AND CAPITAL SHORTAGE? Stagflation will result in lower capex, but we expect minimal impacts on the operations of hardware companies given that these companies have lower maintenance costs compared with the semiconductor sector. CONCLUSION We believe that ODMs and component vendors related to DT PC, the mid- to high-end NB segments, and the smartphone segments will suffer the most under stagflation. WINNERS AND LOSERS Losers DT ODMs and mother board (MB) manufacturers such as Hon Hai (2317.TW, 1- Overweight) and Asustek (2357.TW, 1-Overweight) will be the losers under stagflation. Metal component vendors of NB PC, such as Foxconn Tech (2354.TW, 3-Underweight) and Catcher (2474.TW, 3-Underweight), will suffer because of higher exposure to the mid- to high-end NB and consumer segments, in our view. NB ODMs will suffer slightly given the transition from high-end NB demand to low-end NB demand, in our view. Winner The only winner is consumer NB component vendor, such as plastic casing vendor Ju Teng (3336.HK, 1- Overweight), which has the ability to transfer rising costs to clients as compared to its competitors due to stronger demand from industry growth. Smartphone and mobile handset components manufacturers such as HTC (2498.TW, 1- Overweight) and IAC (3367.TW, 2-Equal weight) will suffer the most, in our view. As for component vendors like Silitech (3311.TW, 1-Overweight), we believe they will have less of an impact because of compensation from low-end phone orders. May 2008 104
  • 104. Lehman Brothers | Equity Research TECHNOLOGY – DISPLAY Effects of rising inflation and slower growth James Kim LBIE, Seoul Tel: (822) 2116-7570 INTRODUCTION: WEAKER DEMAND + MASSIVE CAPEX = OVERSUPPLY james.kim@lehman.com Under a prolonged stagflation scenario triggered by the US credit crisis, the LCD industry faces two key issues: (1) panel demand from the US and European regions will Yolanda Wang likely slow rapidly, especially for TV panels, in our view, and (2) increased capex in LBSTL, Taiwan 2008 (up 64% YoY to US$18.8 trillion), combined with a slowing demand, could lead to Tel: (8862) 8723-1623 serious oversupply in 2009. Considering that we regard TVs as the key future growth yolanda.wang@lehman.com driver for the overall LCD sector and that developed countries make up a major portion of global TV demand, an economic slowdown in the US/EU could pose a material threat to the display industry, in our view. However, we note that the move from analog to digital in February 2009 by the US broadcasting system could limit the downside. In addition, strong CRT replacement demand from emerging markets should somewhat offset an overall global demand slowdown. However, in a prolonged stagflation, we think that it is inevitable that an overall demand slowdown will adversely affect the overall profitability of most panel makers, especially at the advent of industry-wide oversupply in 2009. EFFECT ON EBIT: WE EXPECT MARGIN TO CONTRACT SIGNIFICANTLY Year to date, the LCD industry continues to face supply tightness. However, the recent aggressive pricing strategy adopted by some global top-tier TV makers to gain more market shares could weigh on LCD TV panel prices till 2009, in our view. This, combined with our global stagflation scenario, should cause the average selling price (ASP) of TV panel to come down by more than 25%. IT panel prices could also rise less than expected. As such, the above 20% operating profit level enjoyed by LCD makers in 1Q08 could drop to below 10% from 4Q08, in our view. As we expect an oversupply in 2009, LCD makers’ operating margins should continue to remain below 10% in 2009. A seasonal fall in LCD panel prices in 1H09 could turn out to be the worst LCD pricing environment since 2007. EFFECT ON CASH FLOW: WE EXPECT 2009 CAPEX TO DECREASE YOY We think the LCD industry will face a shortage in 2008, enabling makers to enjoy high profit margins and ample cash surplus. Owing to the increased cash levels, we expect LCD makers to maintain their original line expansion schedules in 2008 (capex up 58% YoY in 2008). However, this should lead to oversupply in 2009 and deteriorating profitability. On the back of margin contraction in 2009, we expect LCD makers to reduce capex in 2009. CONCLUSION Even under our worst-case scenario, LCD makers should be able to show healthy profitability through to 3Q08 on an industry-wide shortage. However, starting from 4Q08, makers’ margins should worsen sharply on rapid ASP fall and 2009 oversupply, in our view. May 2008 105
  • 105. Lehman Brothers | Equity Research WINNERS AND LOSERS Overall, we believe the LCD industry is unable to weather the storm in a prolonged economic recession. Under our worst-case scenario, cost savings would unlikely offset the rapid falling ASP of panels. However, if we have to pick a winner in the display sector, we think AUO (2409.TW, 2-Equal weight) will stand out as a winner in the short term, as the company supplies to aggressive top-tier TV makers, such as Sony and Samsung. In the long term, we think LG Display (LGD) (034220.KS, 2-Equal weight) should emerge as a winner because of the support it received from LG Electronics (066570.KS, 2-Equal weight) and the latter’s aggressive share gains in the global TV market. May 2008 106
  • 106. Lehman Brothers | Equity Research TECHNOLOGY – IC DESIGN Effects of rising inflation and slower growth Yolanda Wang LBSTL, Taiwan Tel: (8862) 8723-1623 INTRODUCTION: SLOWER DEMAND = FURTHER MARGIN CONTRACTION yolanda.wang@lehman.com During stagflation (high inflation combined with an economic recession), we believe that demand for IC, especially for consumer IC products, will slow. As such, companies are likely to engage in pricing competition, which could cause margins to contract further. We view this as a negative for Taiwan’s fabless companies. For 2008, we expect most Taiwan fabless companies to witness top line growth with margin contractions since they aim to maintain market shares during a downturn. Slower demand or declining revenue will further aggravate the degree of margin contraction, in our view. NEGATIVE ON OPERATING MARGIN, IN OUR VIEW IC design houses are unable to control capacity, so cost reduction is one avenue to help counter stagflation since it is difficult for them to cut raw material prices. However, cost reduction via technology migration takes time to deliver results. Furthermore, rising R&D expense will likely hurt profit margins. Therefore, if stagflation lasts longer than one year, we think it is inevitable that profit margins of IC design houses will face significant erosion. HOW CAN THE GOVERNMENT HELP EASE THE PAIN? As IC design is an important sector for Taiwan, we believe that the Taiwan government may have several measures (such as providing subsidies, tax credit or a lower tax rate) to support the fabless companies. Nonetheless, we believe impacts from these measures are likely to be limited, as subsidies and/or new tax/monetary policy implemented would not be able to mitigate effectively the pricing competition faced by most fabless companies. The average selling price for IC design house will be highly dependent on global demand and supply rather than on the government policies or subsidies, in our view. CONCLUSION IC design houses, as a whole, in our view, will be losers in times of stagflation when consumer demand slows. Product prices will likely decline and companies with inferior cost-cutting capability will lose more compared with its peers, in our view. WINNERS AND LOSERS Sunplus (2401.TW, 3-Underweight) with higher global consumer demand and less room for cost reduction would be a loser, in our view. May 2008 107
  • 107. Lehman Brothers | Equity Research TELECOMMUNICATIONS SERVICES Effects of rising inflation and slower growth Paul Wuh LBAL, Hong Kong Tel: (852) 2252-6182 INTRODUCTION: LOWER GROWTH AND HIGHER INFLATION Paul.Wuh@lehman.com We believe that telecom services will be affected less than other sectors during a period of slower growth and higher inflation. Telecom services are relatively low-cost and an important part of life for a majority of the people in the region. In addition, in a period of slow growth, we believe businesses and consumers looking to reduce costs may use more telecom services (more phone calls/video conferences) while reducing travel. However, we believe that the impact of a period of higher inflation/slower growth will be greater on the revenues of operators in developing markets than on the revenues of operators in developed markets across the region. In terms of phone tariffs, we believe that telecom operators are unlikely to raise rates due to competitive forces and regulatory restrictions. This restriction on raising tariffs could also exert some pressure on real revenue growth for operators in both developed and developing markets in the region. Developing market: In China, India, Indonesia, and other countries in SE Asia, we believe that slower economic growth coupled with higher inflation could have a negative impact on revenue growth due to weaker subscriber growth and a sharper decline in ARPUs. While many low-income mobile subscribers are willing to spend a larger percentage of their disposable income on telecom services as compared with users in developed markets, at some point, they may have to cut back on phone services. In addition, much of the incremental new user growth in these countries is from rural areas where there is less income to buy a mobile phone and pay for the monthly service. For example, according to CEIC data, residents in rural China spend 46% of their disposable income on food and 7% on transport, post, and telecom services. If food prices continue to increase, we believe that spend on telecom services could be reduced. Telecom usage reduction (both for voice and SMS) would result in lower ARPUs. On the other hand, we believe that upward adjustments to mobile tariffs due to inflation are unlikely. In fact, mobile phone rates have continued to decline in China with average tariffs (revenue/MOU) down over 17% in FY07 for China Mobile. Finally, if inflation accelerates and the average selling price (ASP) of mobile handsets increases (instead of falling by 10% to 20% per annum, historically), the affordability of a mobile phone could be affected, resulting in fewer new subscribers signing up for the service. (Alternatively, more new subscribers would sign up for more inexpensive phones made by local vendors). Developed markets: In developed markets in the Asia-Pacific region, we believe stagflation will affect revenue growth for the telecom services sector much less because it represents a much smaller percentage of disposable income for customers in these countries. Overall, we estimate that telecom services represent less than 2% of per capita disposable income in developed markets in the region. Furthermore, given that telecom services are considered a necessity in developed markets, we believe that there would be little, if any, negative revenue impact from a higher level of inflation or slower growth. If unemployment increases due to a recession in the region, mobile ARPUs are likely to increase as those looking for employment in developed markets are more likely to use their mobile phones. With respect to tariff regulations, we believe it is unlikely that a short period of stagflation will bring about major policy changes. This could change if the problem were to become more long term. The Korean telecom regulator could require more mobile tariff cuts in an inflationary environment to ensure that telecom spending remains within a certain percentage of the CPI basket. May 2008 108
  • 108. Lehman Brothers | Equity Research EFFECT ON EBIT: MAINLY DUE TO HIGHER WAGES For telecom operators in both the developing and developed markets, we believe that the impact of slower growth/higher inflation would be evident in higher personnel costs. This is a significant factor, given that telecom operators tend to have large employee bases, and some countries have strong labor unions representing telecom employees. On the other hand, telecom services have a higher proportion of fixed/sunk costs compared with other industries. Therefore, while there will be some margin pressure, it could be comparatively less painful. EFFECT ON CASH FLOW: EFFECT ON CAPEX GIVEN FALLING CASH FLOWS AND CAPITAL SHORTAGE? Although we believe that EBIT margins could be under pressure and revenue growth is likely to slow in an environment of higher inflation/slower growth, we also expect cash flow to see some downward pressure. Of course, with inflation, the value of the cash on the balance sheet would also drop. In developing markets, where wireless operators are still expanding coverage, we believe that inflation could result in scaled-back build out plans as the cost for the infrastructure build out increases. As a result, we might have to lower our growth projections for these operators. In developed markets, capital expenditure for next generation networks could be scaled back during a period of slower growth. Difficulty in funding fund capital expansion and longer technology upgrade cycles could result in an enhanced return to invested capital in the short term but would lower our longer-term DCF valuations. Many of the telcos in developed market also have significant dividend payouts from their high levels of free cash flow. If these operators face pressure due to higher costs and slower revenue growth due to inflation or slower growth, dividends could be reduced. Moreover, if telecom operators in the region believe that the higher level of inflation is a multi-year phenomenon, they could choose to accelerate capex spending—especially since many telecom operators in the region have net cash positions with little or no debt. HOW CAN THE GOVERNMENT HELP EASE THE PAIN? As mentioned above, we believe that telecom regulators could help if inflationary pressures result in higher wages and input costs by allowing telecom operators to raise tariffs. If all telecom operators in a market are allowed to raise tariffs by the core CPI level, this would help offset some competitive pressures. On the other hand, allowing for higher tariffs due to inflation could lead to an inflationary spiral that the regulators are trying to avoid. CONCLUSIONS Although there are some negatives from slower growth and higher inflation, we believe that the telecom services sector will do much better than other industries in a period of stagflation. Even in a period of stagflation, we believe that customers will continue to use telephony services—especially as it has become an integral part of the lives of a large percentage of the population in the region. Some believe that businesses and consumers will increase their use of telephony services to lower expenses. However, we believe that revenue growth for telecom operators in developing markets like China, India, and SE Asia will be more impacted than those in developed markets— especially because they depend on growth from new low-end subscribers in rural areas (where telephony expenses could represent up to 7% to 10% of disposable income). May 2008 109
  • 109. Lehman Brothers | Equity Research For telecom companies in developed markets, given that telephony represents less than 2% of disposable income for these markets, we do not expect a major slowdown in revenue growth during a period of stagflation. On the expense front, both developed and developing market telecom operators will face higher wage pressures and some higher input costs. However, these expenses are relatively limited compared with those faced by other industries, in our opinion. Furthermore, as telecom services have a relatively high proportion of fixed/sunk costs, the industry would have lesser exposure to an inflating cost base than other industries. WINNERS AND LOSERS Overall, we believe that in an environment of stagflation, share prices for telecom services companies should outperform those of companies in other sectors. Within the telecom sector, we believe that investors should focus on telecom companies in developed markets—especially in markets where telecom regulators take a more laissez-faire attitude. In addition, we would focus on companies that have a high free cash flow and an attractive dividend yield. In a period of stagflation, we would consider companies such as Far EasTone, Chunghwa Telecom, Taiwan Mobile, Telstra, LG Telecom, and KT. Telecom operators that would suffer during stagflation include high-growth companies in developing markets such as China Mobile, China Unicom, Bharti, Indosat, PT Telkom, and Reliance Communications. May 2008 110
  • 110. Lehman Brothers | Equity Research Figure 54: Valuation comparison 7-May-08 EV/EBITDA Dividend Yield FCFE Yield P/E Mkt. Cap. In Ticker US$mn 2008E 2009E 2008E 2009E 2008E 2009E 2008E 2009E Reco'n Current Price Mobile 1-OW Advanc TB THB 92.00 8,602 5.5 5.3 6.8% 8.1% 8.3% 8.9% 12.9 12.4 AIS 1-OW Bharti IN INR 816.15 37,293 10.0 7.9 1.4% 2.5% 2.5% 4.9% 17.4 13.8 Bharti 1-OW 941 HK HKD 132.50 339,197 10.3 8.6 2.3% 2.8% 3.0% 4.5% 21.1 18.0 China Mobile China Unicom 1-OW 762 HK HKD 16.62 31,748 6.2 5.6 1.6% 1.8% 6.5% -0.6% 24.7 22.4 1-OW DIGI MK MYR 25.00 5,883 7.9 7.1 4.8% 5.3% 5.4% 6.1% 15.7 14.1 DiGi.com 1-OW 4904 TT NT$50.20 6,347 6.1 5.9 5.6% 5.7% 9.0% 9.0% 15.0 14.8 Far Eastone HTIL 2-EW 2332 HK HKD 10.92 6,659 6.3 4.9 0.8% 1.1% 4.3% 6.0% 23.7 19.0 2-EW IDEA IN INR 104 6,583 10.6 8.2 0.0% 0.9% -4.5% 1.6% 21.2 17.0 Idea Cellular 1-OW ISAT IJ IDR 6,300 3,702 4.9 4.5 3.4% 3.6% -2.6% 3.1% 14.6 13.8 Indosat KTF 2-EW 032390 KS KRW 28,750 5,402 4.0 3.5 2.4% 2.4% 5.9% 8.5% 17.8 11.9 1-OW 032640 KS KRW 9,400 2,540 4.2 3.8 0.0% 0.0% 1.8% 8.6% 8.0 7.5 LG Telecom 2-EW M1 SP SGD 1.94 1,240 5.6 5.6 9.9% 10.0% 7.0% 7.2% 10.1 10.0 Mobile One 1-OW RCOM IN INR 540.05 26,625 10.0 7.4 0.9% 1.5% -1.1% 5.8% 17.0 13.5 Reliance SK Telecom 2-EW 017670 KS KRW 209,000 16,534 4.9 4.6 4.5% 3.8% 9.0% 10.8% 11.9 10.0 2-EW 315 HK HKD 8.85 659 3.7 3.5 3.3% 3.3% 8.0% 7.3% 30.5 29.9 Smartone 2-EW 3045 TT NT$55.70 6,909 6.5 6.3 5.4% 5.8% 8.5% 7.6% 14.9 13.8 Taiwan Mobile DTAC 2-EW DTAC SP USD 1.52 3,559 6.7 6.0 2.6% 3.8% 2.1% 3.8% 13.5 11.9 Asian Mobile Median 6.2 5.6 2.6% 3.3% 5.4% 6.1% 15.7 13.8 Asian Mobile Average 6.7 5.8 3.3% 3.7% 4.3% 6.1% 17.1 14.9 Integrated Chunghwa 2-EW 2412 TT NT$78.00 24,568 6.3 6.1 5.9% 6.1% 8.1% 8.0% 15.1 14.7 3-UW 906 HK HK$24.80 21,560 5.1 4.8 2.1% 2.0% 9.0% 9.1% 17.2 17.8 China Netcom 3-UW 728 HK HK$5.40 57,129 5.8 5.5 1.5% 1.6% 7.3% 7.2% 18.0 18.0 China Telecom Hanaro Telecom 1-OW 033630 KS HK$8,650 2,165 4.5 3.7 0.0% 0.0% 34.2% 23.3% 28.9 9.0 2-EW 030200 KS KRW 45,250 8,736 3.6 3.4 4.4% 4.4% -1.3% 14.0% 10.6 8.6 KT 1-OW 015940 KS KRW 20,250 1,601 5.0 4.0 3.2% 4.2% 4.2% 10.1% 13.6 8.2 LG Dacom MTNL 3-UW MTNL IN INR 106 1,616 3.3 2.6 5.5% 7.7% 15.2% 18.8% 9.1 7.8 2-EW 8 HK HK$4.95 4,287 7.3 7.0 2.5% 2.8% 11.6% 18.8% 15.8 14.4 PCCW 2-EW TLKM IJ IDR 8,750 19,074 5.4 4.9 5.4% 6.7% 9.8% 13.2% 11.2 9.7 PT Telkom 1-OW ST SP SGD 3.82 44,355 7.9 7.4 5.1% 6.3% 5.9% 6.6% 13.8 12.7 Singapore Tel Starhub 1-OW STH SP SGD 3.01 3,753 8.2 7.7 6.2% 7.5% 7.4% 8.3% 14.4 13.3 1-OW T MK MYR 3.68 3,967 2.4 2.2 14.3% 16.7% 13.6% 19.0% 5.3 4.8 Telekom Malaysia 1-OW TLS AU AUD 4.52 42,183 6.6 6.2 6.4% 6.9% 6.3% 8.0% 14.9 13.9 Telstra Telecom New Zealand 2-EW TEL NZ NZD 3.85 8,967 4.9 5.0 7.7% 7.0% 6.2% 6.2% 9.7 10.7 1-OW TRUE TB THB 4.94 692 4.7 4.0 0.0% 0.0% 17.6% 24.8% -10.8 46.4 True Corporation Integrated Median 5.1 4.9 5.1% 6.1% 8.1% 10.1% 13.8 12.7 Integrated Average 5.4 5.0 4.7% 5.3% 10.3% 13.0% 12.5 14.0 Prices as of 7 May 2008 Source Company data, Lehman Brothers estimates May 2008 111
  • 111. Lehman Brothers | Equity Research TRANSPORTATION – SHIPPING Effects of rising inflation and slower growth Andrew Lee LBAL, Hong Kong Tel: 852 2252 6197 INTRODUCTION: LOWER GROWTH AND HIGHER INFLATION andrewkw.lee@lehman.com We believe that, in a scenario of lower growth and higher inflation, the shipping sector would be a likely loser. With container demand driven by global economic growth, consumption, and disposable income, we are already forecasting global container demand to slow, and we have a cautious view on the container sector. This is driven by not only by slowing global demand but also by cost inflation pressures (such as bunker fuel cost, terminal handling charges, and inland transportation costs), as container carriers struggle to pass through the higher costs to customers. The net effect is pressure on margins. We believe lower growth and higher inflation will likely exacerbate the problems now faced by the container lines and could even lead to losses. We believe there is likely to be a time lag before slower economic growth affects bulk shipping because of: (1) Asia lacking natural resources and relying on imports from resource-rich regions (such as Australia and Latin America) and (2) shortage of capacity (vessels). However, with the potential switch from current attractive demand imbalance to oversupply from end-1H09, we believe any slowdown in demand will likely put freight rates under increasing pressure. Furthermore, as demand is also driven by industrialisation, we expect slowing exports to lead to slowing bulk imports. EFFECT ON EBIT: MARGIN SHRINKAGE? In a lower growth and higher inflation scenario, margins would come under further pressure with declining freight rates from a mixture of slowing demand and excess supply, while container shipping carriers are already struggling to pass through higher costs. Given the current shortage in bulk shipping capacity, we believe the bulk sector will be affected only from 2H09, when the sector switches to excess supply. EFFECT ON CASH FLOW: EFFECT ON CAPEX, GIVEN FALLING CASH FLOWS AND CAPITAL SHORTAGE? Although the supply of vessels (both bulk and container) is expected to increase more than 60% in the next few years (based on Clarksons), we believe this is unlikely to result in cancellation of new vessels because the balance sheet and gearing have significantly improved. For example, the container sector’s average gearing level was only 31% in 2007 compared with 163% in 2003. Likewise, the Asian bulk sector gearing was 227% in 2003 compared with only 11% in 2007. WHAT HAPPENED IN THE 1970S? Asian shipping stocks were de-listed in the 1970s. In the previous down-cycles, container shipping lines were loss-making, as earnings were driven primarily by long haul routes of Asia-Europe and Asia-US. HOW CAN THE GOVERNMENT HELP EASE THE PAIN? We believe the governments around the world are unlikely to assist shipping lines. May 2008 112
  • 112. Lehman Brothers | Equity Research CONCLUSION We believe the shipping sector will be a likely loser because demand is driven by global economies, and shipping lines bear the higher costs because carriers struggle to pass through the higher costs to the customer. Furthermore, given that shipping is a highly fragmented industry, carriers are mainly price takers. NO WINNERS, ONLY LOSERS FOR SHIPPING Within the container shipping sector, we believe Evergreen and Yang Ming would be the largest potential losers in a scenario of slowing growth and rising inflation because both stocks are most leveraged to changes in freight rates and costs due to low profitability and low margins. Figure 55: 2008 net profit sensitivity to a 1% change in Figure 56: 2008 net profit sensitivity to a 1% change in overall rates bunker prices 40% 7% 35% 6% 30% 5% 25% 4% 20% 3% 15% 2% 10% 1% 5% 0% 0% Wan Hai Wan Hai OOIL HMM Hanjin OOIL Hanjin CCH HMM NOL CSCL Yang Ming NOL CSCL Yang Ming Evergreen Evergreen Source: Lehman Brothers estimates Source: Lehman Brothers estimates Figure 57: Container revenue breakdown Figure 58: Container volume breakdown Transpacific Asia Europe Intra Asia Others Transpacific Asia Europe Intra Asia Others COSCON 33% 24% 20% 23% COSCON 25% 24% 46% 5% CSCL 44% 28% 13% 15% CSCL 25% 24% 47% 4% Evergreen 50% 18% 20% 12% Evergreen 41% 18% 30% 11% Hanjin 59% 29% 7% 5% Hanjin 54% 30% 11% 5% HMM 60% 24% 16% 0% HMM 60% 24% 17% -1% NOL 55% 24% 21% 0% NOL 43% 25% 32% 0% OOIL 43% 20% 24% 13% OOIL 31% 17% 43% 9% Wan Hai 17% 6% 68% 9% Wan Hai 11% 4% 85% 0% Yang Ming 48% 29% 18% 5% Yang Ming 38% 25% 33% 4% Source: Company data, Lehman Brothers estimates Source: Company data, Lehman Brothers estimates Likewise, for the bulk shipping sector, Korea Line is the most leveraged to changes in bulk freight rates because the company has the highest exposure to the spot market. We estimate that roughly 70% of Korea Line’s revenue is generated from the spot market. Hence, Korea Line would be the largest loser among Asian bulk carriers in a scenario of slower growth and rising inflation. May 2008 113
  • 113. Lehman Brothers | Equity Research Figure 59: 2008 net profit sensitivity to a 5% change in BDI Figure 60: Breakdown of spot vs long-term contracts 100% 20.0% 80% 60% 15.0% 40% 70 60 60 50 50 50 20% 35 10.0% 28 6 0% Pacific Basin Sincere U-Ming China Cosco STX Pan Ocean Korea Line TTA Precious MBC 5.0% 0.0% China Sincere MBC U-Ming Precious Pacific Thoresen STX Pan Korea COSCO Basin Thai Ocean Line Spot Long term Source: Lehman Brothers estimates Source: Lehman Brothers estimates May 2008 114
  • 114. Lehman Brothers | Equity Research Figure 61: Asian bulk shipping valuation comparison 7-May-08 Stock tickers, ratings and price targets Listing Current Price Pot. upside/ Market cap Avg daily t/o Stock currency Ticker Rating price target (downside) (US$ m) (US$ m) China Cosco HK$ 1919 HK 1-Overweight 24.25 26.50 9% 31,783 92.2 Korea Line Won 005880 KS 1-Overweight 212,500 335,000 58% 2,383 31.4 Malaysian Bulk Carriers RM MBC MK 1-Overweight 4.30 5.50 28% 1,364 1.5 Pacific Basin HK$ 2343 HK 1-Overweight 14.76 20.40 38% 2,954 30.6 Precious Shipping Thb PSL TB 3-Underweight 25.25 31.00 23% 829 1.5 Sincere Navigation NT$ 2605 TT 2-Equalweight 61.20 79.00 29% 971 10.2 STX Pan Ocean S$ STX SP 2-Equalweight 3.80 3.90 3% 5,758 27.1 Thoresen Thai Thb TTA TB 1-Overweight 48.50 80.00 65% 985 19.7 U-Ming NT$ 2606 TT 1-Overweight 102.50 134.00 31% 2,884 40.2 Balance sheet analysis Return on ROFV/WACC Target Current Net debt/ Fixed Current Stock fleet value WACC spread EV/Fleet EV/Fleet equity asset t/o ratio China Cosco 13.4% 9.2% 4.2% 1.8 x 1.5 x -14% 2.2 x 0.9 x Korea Line 18.1% 9.9% 8.2% 2.0 x 1.3 x 70% 1.9 x 1.2 x Malaysian Bulk Carriers 18.8% 10.8% 8.0% 1.9 x 1.4 x -21% 0.6 x 5.8 x Pacific Basin 17.5% 10.3% 7.3% 1.8 x 1.5 x 1% 1.6 x 5.5 x Precious Shipping 12.5% 12.4% 0.2% 1.0 x 0.8 x -25% 0.8 x 4.2 x Sincere Navigation 5.9% 7.3% -1.4% 0.8 x 0.5 x 66% 0.5 x 1.3 x STX Pan Ocean 15.6% 10.9% 4.7% 1.5 x 1.3 x -6% 5.3 x 1.5 x Thoresen Thai 20.7% 11.4% 9.3% 1.9 x 0.9 x 31% 1.1 x 2.1 x U-Ming 11.8% 8.9% 2.9% 1.4 x 0.9 x -28% 0.9 x 3.6 x Bulker average 14.9% 10.1% 4.8% 1.6 x 1.1 x 8% 1.7 x 2.9 x Traditional multiples Pre-exceptional P/E Dividend Yield Stock 2006 2007E 2008E 2009E 2006 2007E 2008E 2009E China Cosco 139.0 x 12.2 x 9.5 x 9.1 x 0% 2% 3% 3% Korea Line 44.1 x 7.8 x 6.7 x 10.1 x 0% 0% 1% 1% Malaysian Bulk Carriers 16.7 x 10.1 x 8.4 x 10.1 x 7% 9% 9% 7% Pacific Basin 25.1 x 8.3 x 6.8 x 9.5 x 3% 8% 7% 5% Precious Shipping 3.5 x 7.4 x 5.3 x 6.0 x 13% 8% 8% 7% Sincere Navigation 24.5 x 12.7 x 9.3 x 8.5 x 8% 7% 5% 6% STX Pan Ocean 23.7 x 9.6 x 7.8 x 11.8 x 1% 3% 4% 3% Thoresen Thai 11.8 x 7.3 x 3.9 x 5.4 x 3% 3% 6% 5% U-Ming 21.8 x 9.9 x 6.2 x 7.3 x 5% 6% 10% 8% Bulker average 34.5 x 9.5 x 7.1 x 8.6 x 4% 5% 6% 5% P/B ROE Stock 2006 2007E 2008E 2009E 2006 2007E 2008E 2009E China Cosco 9.3 x 3.0 x 2.4 x 2.0 x 7% 25% 25% 22% Korea Line 4.7 x 3.6 x 2.1 x 1.6 x 9% 46% 31% 16% Malaysian Bulk Carriers 2.7 x 2.6 x 2.5 x 2.5 x 7% 9% 9% 7% Pacific Basin 6.1 x 3.4 x 2.8 x 2.1 x 21% 41% 41% 23% Precious Shipping 1.1 x 1.7 x 1.5 x 1.4 x 30% 24% 28% 23% Sincere Navigation 2.6 x 3.1 x 3.0 x 2.9 x 11% 24% 33% 34% STX Pan Ocean 5.9 x 3.0 x 2.2 x 2.0 x 24% 27% 28% 17% Thoresen Thai 2.6 x 1.9 x 1.3 x 1.2 x 22% 26% 34% 22% U-Ming 4.3 x 2.2 x 1.8 x 1.6 x 20% 23% 28% 22% Bulker average 4.4 x 2.7 x 2.2 x 1.9 x 17% 27% 29% 21% Source Company data, Lehman Brothers estimates May 2008 115
  • 115. Lehman Brothers | Equity Research Figure 62: Asian container shipping valuation comparison 7-May-08 Stock tickers, ratings and price targets Listing Current Price Pot. upside/ Market cap Avg daily t/o Stock currency Ticker Rating price target (downside) (US$ m) (US$ m) China Cosco HK$ 1919 HK 1-Overweight 24.25 26.50 9% 31,783 92.2 CSCL HK$ 2866 HK 3-Underweight 3.49 2.90 -17% 5,231 31.0 Evergreen Marine NT$ 2603 TT 3-Underweight 28.30 18.90 -33% 2,706 25.3 Hanjin Shipping Won 000700 KS 2-Equalweight 43,350 39,000 -10% 3,087 35.9 Hyundai Merchant Won 011200 KS 3-Underweight 43,500 31,400 -28% 5,749 8.7 NOL S$ NOL SP 2-Equalweight 3.51 3.70 5% 3,771 13.6 OOIL HK$ 316 HK 1-Overweight 51.75 63.00 22% 4,155 10.7 Wan Hai NT$ 2615 TT 2-Equalweight 26.85 24.90 -7% 1,812 8.9 Yang Ming NT$ 2609 TT 3-Underweight 23.60 14.10 -40% 1,826 13.8 Balance sheet analysis Return on ROFV/WACC Target Current Net debt/ Fixed Current Stock fleet value WACC spread EV/Fleet EV/Fleet equity asset t/o ratio China Cosco 13.4% 9.2% 4.2% 1.8 x 1.5 x -14% 2.2 x 0.9 x CSCL 9.9% 9.6% 0.3% 1.0 x 1.2 x -19% 1.6 x 1.5 x Evergreen Marine 5.2% 7.9% -2.7% 0.6 x 0.7 x 2% 3.0 x 0.8 x Hanjin Shipping 6.6% 7.6% -1.0% 0.8 x 0.8 x 62% 1.9 x 0.9 x Hyundai Merchant 7.3% 7.9% -0.6% 0.9 x 1.2 x 75% 1.6 x 2.2 x NOL 13.1% 9.8% 3.3% 1.4 x 1.3 x 3% 3.3 x 1.2 x OOIL 11.4% 8.8% 2.7% 1.4 x 1.0 x 16% 1.7 x 2.4 x Wan Hai 8.3% 8.3% 0.0% 1.0 x 1.1 x 55% 1.5 x 1.6 x Yang Ming 5.7% 7.8% -2.1% 0.7 x 0.8 x 57% 2.2 x 1.3 x Container average 9.0% 8.5% 0.5% 1.1 x 1.1 x 26% 2.1 x 1.4 x Traditional multiples Pre-exceptional P/E Dividend Yield Stock 2006 2007E 2008E 2009E 2006 2007E 2008E 2009E China Cosco 139.0 x 12.2 x 9.5 x 9.1 x 0% 2% 3% 3% CSCL 24.6 x 6.4 x 11.3 x 12.5 x 1% 4% 2% 2% Evergreen Marine n.m. 10.6 x 18.2 x 45.8 x 0% 0% 3% 2% Hanjin Shipping 99.1 x 20.7 x 20.5 x 19.9 x 2% 2% 2% 2% Hyundai Merchant 67.4 x 33.9 x 34.2 x 50.6 x 1% 1% 1% 2% NOL 6.8 x 6.4 x 7.3 x 9.6 x 2% 4% 3% 2% OOIL 10.3 x 7.2 x 11.3 x 12.0 x 18% 18% 3% 2% Wan Hai 29.9 x 13.7 x 14.2 x 13.3 x 4% 8% 3% 4% Yang Ming 98.7 x 14.0 x 16.5 x 19.4 x 1% 5% 3% 3% Container average 59.5 x 13.9 x 15.9 x 21.3 x 3% 5% 3% 2% P/B ROE Stock 2006 2007E 2008E 2009E 2006 2007E 2008E 2009E China Cosco 9.3 x 3.0 x 2.4 x 2.0 x 7% 25% 25% 22% CSCL 1.3 x 1.2 x 1.1 x 1.0 x 5% 12% 10% 8% Evergreen Marine 1.4 x 1.2 x 1.1 x 1.0 x -7% 11% 6% 2% Hanjin Shipping 1.3 x 1.2 x 1.1 x 0.9 x 1% 6% 5% 4% Hyundai Merchant 2.8 x 2.6 x 2.5 x 2.5 x 4% 8% 7% 5% NOL 1.8 x 1.4 x 1.3 x 1.2 x 23% 20% 15% 11% OOIL 1.5 x 1.0 x 0.8 x 0.7 x 15% 13% 7% 6% Wan Hai 1.9 x 1.6 x 1.7 x 1.6 x 6% 12% 12% 12% Yang Ming 1.3 x 1.1 x 1.0 x 0.9 x 1% 8% 6% 5% Container average 2.5 x 1.6 x 1.4 x 1.3 x 6% 13% 10% 8% Source Company data, Lehman Brothers estimates May 2008 116
  • 116. Lehman Brothers | Equity Research UTILITIES/POWER/RENEWABLE ENERGY Effects of rising inflation and slower growth Ivan Lee LBAL, Hong Kong 852.2252.6213 HONG KONG ivan.lee@lehman.com Lower growth and higher inflation Hong Kong power utilities (Hongkong Electric Company (HKE, 6 HK, 1-Overweight, TP – HK$52.0), CLP Holdings (CLP, 2 HK, 2-Equal weight, TP – HK$62.0), and Cheung Kong Infrastructure (CKI, 1038 HK, 1- Overweight, TP – HK$34.0) are the most defensive sector for stagflation, in our view, given their high earnings visibility and strong cash flow, despite rising inflation and fuel costs. This is because earnings are based on capex (with a fixed 9.99% return on net fixed asset under the Scheme of Control [SOC]), not on tariff, and fuel costs are passed through. Being a mature economy, Hong Kong’s power (peak) demand growth has been very stable at 1-3% per year over the past decade. Also, Hong Kong power utilities are either net cash or under-geared (10-30%) and always generate positive free cash flow. Therefore, their capex plans will not be affected amid the prevailing credit crunch environment. Instead, their expansions through M&A could speed up because more quality assets are now available at distressed prices. However, we believe that the Hong Kong gas company, HK & China Gas (3 HK, 3- Underweight, TP – HK$17.06), could be affected because it is non-regulated, and its tariff in Hong Kong could be frozen for a longer period of time due to rising inflation and an already lucrative return (31% on net fixed asset), while the demand for gas in Hong Kong and China will also be slowing when GDP growth starts to turn south. This is especially true for China, where the majority of gas demand growth is driven by commercial and industrial users. CHINA Lower growth and higher inflation China independent power producers’ (IPP) earnings are sensitive to tariffs, coal price, utilization rate, and interest rate, in the order of their impacts. Lower GDP growth would not only mean lower power demand and utilization, but also a lower coal price because 60% of coal demand is driven by power demand. Skyrocketing spot coal price this year (Qinhuangdao standard spot coal price already reached RMB895 per ton in 1Q [spot raw coal price at RMB640 per ton], similar to Newcastle price, due to unexpected snowstorms in China and strong regional coal price due to supply shortage) has been a key concern to IPPs’ profitability for 2008-09. We believe that slowing power demand and subsequent softening of coal price should be viewed positively because this is likely to enhance margins significantly. Our sensitivity analysis shows that for every 1% drop in coal price, listed IPPs average earnings for 2008E-10E would be lifted by 4%, and this compares with a 3% earnings decline for each 1% fall in utilization hour. Effect on ebit: margin shrinkage? However, higher inflation would mean price controls would persist and interest rates would stay high for a longer period of time. This compares to our base-case assumption of a 3% tariff hike in 3Q (or in the form of VAT rebate), with the bulk of the increase going to industrial users, while residential tariff remains unchanged. Our sensitivity analysis shows that listed IPPs’ average earnings for 2008E-10E will likely be affected by 17%, if tariffs are frozen from now on.. May 2008 117
  • 117. Lehman Brothers | Equity Research Effect on cash flow: effect on capex, given the falling cash flows and capital shortage? It is reported by the China Electricity Information Network that 70% and 15% of the power plants in China were in loss and would face cash flow deficits during 1Q08, given a 20% rise in coal price, frozen tariffs, and power-line suspension. In addition, a number of small and inefficient power plants have been forced to suspend production due to insufficient cash flow to cover variable costs. If demand growth were to slow further and tariffs were to be frozen for a longer period of time, we would see continued losses in the sector going to 2H08 and 2009, even though listed IPPs should be able to maintain a tiny profit, given their better-then-average asset quality. Nevertheless, listed IPPs’ near-term capex (for power plants commissioning in 2008 and 2009) will not likely be affected since most of the resources have been allocated, but longer-term capex plan may be shelved, in our view. However, this will likely result in a higher negative free cash flow, higher gearing, and negative EVA, further dragging down the profitability and investors’ appetite for the sector, and, hence, capital inflow to the sector. If that persists, we expect power shortages to resume sooner than later. How can the government help ease the pain? Unlike the oil and gas sector, in which the government can easily provide one-off subsidies (such as VAT and windfall tax rebates) to the two oil majors, the fragmented structure of the power sector would likely restrict the government’s relief policy just to a tariff hike (or a VAT [17%] rebate on tariff). Power tariffs have not been increased since end-06, while coal prices have risen by 30% since then. According to the “coal-tariff linkage” 70% pass-through policy, on-grid power tariff would have to rise by 14% in the next review. This compares with our base-case assumption of a 3% tariff hike in 3Q, which means IPPs’ margins would nevertheless be eroded. In terms of the China water and gas distribution sector, it is worth mentioning that the Chinese government does not only control the retail price but also the input cost to the operators. Therefore, price control does not impact the water and downstream gas companies at all, but this could limit potential upside from tariff hikes for water utilities. In addition, we believe residential demand for these necessities (especially for water) will not significantly slow, when a country is going through urbanization and when natural gas remains 30% cheaper (per heat content) than other sources of energy, such as coal gas, electricity, etc. However, we expect demand for natural gas from commercial and industry users, which have been the major driver for demand growth over the past couple years, to slow when economic activities slow. KOREA Lower growth and higher inflation Lower growth with higher inflation would imply potential downside risks to power demand growth plus limited scope for securing a tariff hike. When the above comes with a backdrop of rising fuel costs (mainly coal), it would imply margin shrinkage at the operating level. We believe KEPCO (015760 KS, 3-Underweight, TP – W26,900) remains the most susceptible to risks presented by the above phenomenon. For KOGAS (036460 KS, 3-Underweight, TP – W54,500), we do not see big downside to demand unless KEPCO decides to offtake lower LNG for its power facilities. Effect on ebit: margin shrinkage? The only positive aspect for KEPCO, in our view, is strong power demand growth, which contributes to healthy operating leverage. Every 1% contraction in demand, with costs remaining the same, would bring down its operating profit by 1.4-1.5%, according to our estimates. We presently forecast demand growth of 5.0% for FY08 on 4.3% GDP growth. May 2008 118
  • 118. Lehman Brothers | Equity Research Effect on cash flow: effect on capex, given falling cash flows and capital shortage? For KEPCO, capex pipeline still remains strong at W8.5-9 trillion. Moreover, Korea still operates under single-digit reserve margins, implying that there could be potential risks to the upside to KEPCO’s capex. A risk to demand growth would further put pressure on operational cash flows, and we believe KEPCO may have to resort to debt to fund its incremental capex in the event of a demand downturn. We currently expect capex spending to the tune of W8.6 trillion and even at 5% demand growth, KEPCO would still be free cash flow negative, according to our estimates. For KOGAS, the impact on the cost front is likely to be minimal, given that the tariff mechanism incorporates material cost pass-through to KEPCO and the city gas companies. However, demand downturn could hurt core LNG earnings. How can the government help ease the pain? For KEPCO, government intervention is indispensable in the form of tariff hike (which KEPCO, in principle, deserves, in our view). Tariff hikes could be a possibility, but given the inflationary conditions, the government is already talking about tariff cuts in certain segments (such as residential). Hence, we believe an overall tariff hike may be difficult to pull off and a scenario of falling demand may worsen an already deteriorating financial position, in our view. On the whole, given that the tariff-setting mechanism for KEPCO is entirely at the discretion of the government, the government will have to play its part through a tariff hike to ensure that KEPCO is not unduly affected by rising fuel costs and capex. SOUTH-EAST ASIA Lower growth and higher inflation Lower growth with higher inflation would imply downside risks to power demand growth plus limited scope for securing a tariff hike. When the above comes with a backdrop of rising fuel costs (mainly coal), it would imply margin shrinkage at the operating level. We believe Tenaga (TNB MK, 2-Equalweight, TP – RM8.30) in Malaysia remains the most susceptible to risks presented by the above phenomenon. For Thailand, the capacity schedule for the next three to four years has already been lined up and the IPPs, EGCO (EGCO TB, 2-Equal weight, TP – THB106) and Ratchaburi Electricity (RATCH TB, 2-Equal weight, TP – THB42) have pass-through mechanisms and guaranteed 19% ROE from EGAT, thereby securing their bottom lines to a large extent. For Indonesia, higher oil prices would present enhanced opportunity for Perusahaan Gas (PGAS IJ, 1-Overweight, TP – IDR19,400) to move its customers to gas from oil, given that its current gas price is still at a steep discount to the subsidised oil price. Effect on ebit: margin shrinkage? The only positive aspect for Tenaga is strong power demand growth, which contributes to its healthy operating leverage. Every 1% contraction in demand, with costs remaining the same, would bring down its operating profit by 2.4%, according to our estimates. We presently forecast 6.5% demand growth for FY08 on 5% GDP growth. During 1H08, power demand grew 7.7% YOY. Effect on cash flow: effect on capex, given falling cash flows and capital shortage? We expect Tenaga’s capex to come down in the coming years owing to modest generation capex (in view of the prevailing high reserve margin of around 40%). We expect the company to spend around RM4 billion as capex this year, which we expect to fall going into FY09. In spite of contractions in operating margin, we do not expect May 2008 119
  • 119. Lehman Brothers | Equity Research Tenaga to face serious issues with respect to its ability to meet its capex. For Thai IPPs, given their modest expansion plans beyond FY10-FY11, we expect operational cash flows to be sufficient to fund their capex. Perusahaan Gas will also be nearing the end of its capex cycle once SSWJ pipeline is online by October 2008. So, the impact to Perusahaan gas and Thai IPPs, EGCO and RATCH, will be limited, but Tenaga will be adversely affected, in our view. How can the government help ease the pain? For Tenaga, government intervention is indispensable, in our view. Tariff hikes could be one possibility, but given the inflationary conditions, it may be difficult to pull off, we believe. In order to cushion the impact of rising coal costs, the government could offer some subsidy to Tenaga so that financial impact to it is minimal in spite of no tariff hike. On the whole, given that the utilities sector is regulated and tariff-setting mechanism for most of the economies in South-East Asia is still at the hands of the governments, the governments will have to play their part in ensuring that the utility companies are not unduly affected by current phenomenon. INDIA Lower growth and higher inflation Lower growth with higher inflation would imply downside risks to power demand growth plus limited scope for higher tariffs. With respect to Indian utilities, since most of the capacity pipeline has already been firmed up, we see minimal downside risks to earnings, given that India is still in a power shortage situation. We expect companies such as NTPC (NATP IN, 2-Equal weight, TP – INR224.0) to be relatively insulated, given that they execute mostly regulated projects (where returns are based on capex and tariff incorporates pass-through with respect to fuel, interest, etc). For Reliance Infrastructure (formerly known as Reliance Energy, RLEN.BO) (RELI IN, 2-Equal weight, TP – INR960), Reliance Power (RPWR IN, not rated), and Tata Power (TPWR IN, 2-Equal weight, TP – INR940), most of their projects would be coming online over the next three to four years, and, hence, the immediate impact will also likely be neutral. Effect on ebit: margin shrinkage? Most of the capacity additions in India have been on the regulated route (meaning projects enjoy post-tax ROE of 14% excluding incentives) with tariffs being fixed accordingly. Hence, for companies such as NTPC, the impact on EBIT is likely to be minimal. For companies such as Tata Power, Reliance Infrastructure and Reliance Power, existing assets comprise mainly regulated ones, although the ones in the pipeline comprise ultra mega power projects (UMPP), which have levelised tariffs, and merchant power plants (mainly for Reliance Power). Given the long time horizon over which these projects will come online, the immediate impact on EBIT is likely to be minimal for them as well, in our view. Effect on cash flow: effect on capex, given falling cash flows and capital shortage? Since tariffs under regulated projects take into account the capex (and a debt:equity of 70:30), tariffs ensure a steady recovery of capital. Given that NTPC is also adding capacity only at a distributed pace over 2007-12, we believe operational cash flows can support their capacity expansion. With respect to Reliance Power, we believe that funds raised from its recent IPO should help meet initial capex requirements. May 2008 120
  • 120. Lehman Brothers | Equity Research How can the government help ease the pain? The government’s role would mainly come in respect of merchant power plants where the rates are relatively higher compared with regulated projects. In the event of stagflation, higher power rates may be difficult to sustain, and, hence, the government could step in to provide some kind of direction. Also, given that recently there has been a thrust on using imported coal by private players, some kind of regulation on coal prices could help, especially in the case where the impact of fuel costs cannot be wholly passed on in the form of higher tariffs. On the whole, with India looking to build a decent portfolio in merchant power (hitherto, the portfolio was comprised mainly of regulated projects), we believe the role of the government will be all the more important in respect of setting guidelines to provide some kind of direction to merchant rates so that, on one hand, customers do not end up paying too much, while at the same time, utilities having merchant portfolios make decent returns. CONCLUSION In a stagflation environment, we would like defensive and regulated utilities, which are cash rich (high dividend yield), have strong cash flow (to make dividend payments and capex), and have a fixed return tied to regulated asset base (capex), have a well-defined capex plan and a 100% fuel cost pass-through. These are typical attributes of Hong Kong power utilities (HKE, CLP, and CKI), Thai utilities (EGCO and RATCH) and Indian regulated utilities (NTPC), which have limited exposure to UMPPs and merchant power projects. In particular, we like HKE, CKI, EGCO, and RATCH, as more than 80% of their earnings are represented by regulated assets with fixed returns, while HKE and CKI are also in net cash. We think potential upside to HKE and CKI will also come from: (1) a higher dividend payout; (2) potential bargain asset hunting opportunities amid the prevailing credit crunch environment; and (3) NAV enhancements when capital structure improves. In the downstream gas and water sector, we prefer water over gas during periods of stagflation, despite the limited potential upside from water tariff hike. In particular, we like China Water Affair (855.HK, 2-Equal weight, TP – HK$3.00) and China Everbright International (257.HK, 1-Overweight, TP – HK$4.70). We think gas distributors such as Xinao Gas (2688.HK, 1-Overweight, TP – HK$17.30), Zhengzhou Gas (3928 HK, 1- Overweight, TP – HK$1.50), HK & China Gas (3.HK, 3-Underweight, TP – HK$17.06), and Beijing Enterprise (392 HK, 1- Overweight, TP – HK$42.70), could suffer as a result of lower demand from commercial and industrial users and frozen tariffs. In Korea, we believe KEPCO is a potential loser in the event of a demand downturn, while the impact to KOGAS could be neutral to slightly negative (assuming KEPCO cuts down on its offtake of LNG from KOGAS). In South East Asia, Perusahaan Gas could be a winner by virtue of its selling price (for gas) being lower than subsidised oil. Tenaga could be losing out, if the government cannot provide it a tariff hike or some other arrangement such as a subsidy, etc. In India, we believe the impact will be neutral over a one-year period to NTPC, Tata Power and Reliance Infrastructure. However, NTPC seems to have a better stand, given that the majority of its portfolio is represented by regulated projects (where returns are based on capex and tariff incorporates pass-through with respect to fuel, interest, etc.) with limited exposure to UMPPs and merchant power plants. May 2008 121
  • 121. Lehman Brothers | Equity Research WINNERS AND LOSERS Figure 63: WINNERS AND LOSERS Share Target price price Mkt cap Company Type BBG ticker (local $) (local $) Rating (US$m) Curcy EPS (local $) EPS growth (%) PER (x) Price to book (x) Yield (%) 08f 09f 10f 08f 09f 10f 08f 09f 10f 08f 09f 10f 08f 09f 10f Winners HKE Integrated 6 HK 45.20 52.00 1-OW 12,370 HKD 3.82 2.88 2.89 10% -25% 0% 11.8 15.7 15.6 1.9 1.9 1.8 4.7% 5.1% 5.1% CKI Integrated 1038 HK 31.75 34.00 1-OW 9,178 HKD 2.45 2.23 2.46 16% -9% 10% 12.9 14.2 12.9 1.7 1.6 1.5 3.9% 4.2% 4.6% CLP Integrated 2 HK 60.20 62.00 2-EW 18,591 HKD 4.28 3.52 3.72 -3% -18% 6% 14.1 17.1 16.2 2.2 2.2 2.1 4.7% 4.7% 4.9% EGCO IPP EGCO TB 95.50 106.00 2-EW 1,551 THB 16.22 17.33 19.46 2% 7% 12% 5.9 5.5 4.9 1.0 0.8 0.7 6.8% 10.0% 11.2% Ratchiburi, IPP RATCH TB 45.25 42.00 2-EW 2,024 THB 4.47 5.17 5.58 11% 16% 8% 10.1 8.7 8.1 1.4 1.2 1.0 5.0% 5.8% 6.2% Petronas Gas Gas PTG MK 10.30 10.70 2-EW 6,267 MYR 0.55 0.56 0.57 -13% 1% 1% 18.7 18.5 18.2 2.6 2.5 2.4 3.7% 3.8% 3.8% Perusahaan Gas Gas PGAS IJ 13,550 19,400 1-OW 6,703 IDR 748 867 1,072 116% 16% 16% 18.1 15.6 12.6 6.8 5.1 3.9 1.4% 1.6% 2.0% Losers HKCG Gas 3 HK 19.84 17.06 3-UW 16,958 HKD 0.84 0.68 0.74 -43% -19% 8% 23.6 29.1 26.9 4.1 3.9 3.6 1.9% 1.9% 2.0% Tenaga Integrated TNB MK 7.10 8.28 2-EW 9,461 MYR 0.80 0.67 0.68 -16% -17% 1% 8.9 10.7 10.5 1.1 1.0 0.9 5.2% 5.4% 5.6% Kepco Integrated 015760 KS 33,950 26,900 3-UW 20,815 KRW 2,850 3,299 3,551 -21% 16% 8% 11.9 10.3 9.6 0.5 0.5 0.4 2.6% 3.0% 3.2% Datang IPP 991 HK 5.19 6.60 1-OW 7,812 CNY 0.30 0.35 0.46 -4% 16% 31% 15.4 13.3 10.1 1.9 1.8 1.6 3.2% 3.6% 4.8% Huaneng IPP 902 HK 6.35 8.90 1-OW 9,816 CNY 0.37 0.53 0.69 -27% 42% 30% 15.4 10.8 8.3 1.4 1.3 1.2 3.6% 5.1% 6.7% Huadian IPP 1071 HK 2.66 3.83 1-OW 2,054 CNY 0.11 0.20 0.29 -49% 88% 44% 22.5 11.9 8.3 1.0 0.7 0.7 1.6% 3.5% 5.6% CR Power IPP 836 HK 20.00 18.50 1-OW 10,644 HKD 1.12 1.42 1.56 30% 27% 10% 16.0 12.6 11.5 2.4 2.1 1.9 1.9% 2.4% 2.6% China Power Int'l IPP 2380 HK 2.74 4.30 1-OW 1,267 CNY 0.20 0.23 0.23 31% 13% 1% 12.1 10.7 10.6 0.9 0.9 0.8 3.4% 3.8% 3.9% Xinao Gas Gas 2688 HK 14.24 17.40 1-OW 1,844 CNY 0.62 0.74 0.88 21% 19% 20% 20.5 16.2 13.5 2.4 2.0 1.7 1.5% 2.2% 2.6% Beijing Enterprises Integrated 392 HK 31.25 42.70 1-OW 4,564 HKD 1.50 1.72 2.04 47% 15% 19% 20.9 18.2 15.3 1.8 1.6 1.5 1.9% 2.2% 2.6% Sources: Lehman Brothers estimates; Share prices as of 7 May 2008 EARNINGS SENSITIVITY FOR THE CHINESE IPPS: ON COAL, TARIFF AND UTILIZATION Figure 64: Earnings sensitivity for the Chinese IPPs 1% rise in utilisation hours 1% rise in tariff 2007f 2008f 2009f 2010f Avg 2007f 2008f 2009f 2010f Avg Datang 0% 5% 4% 3% 3% Datang 0% 7% 6% 5% 4% Huaneng 0% 5% 4% 3% 3% Huaneng 0% 11% 8% 6% 6% Huadian 0% 8% 5% 4% 4% Huadian 0% 31% 19% 13% 16% CR Power 0% 2% 1% 1% 1% CR Power 0% 4% 5% 5% 3% CPI 0% 3% 2% 2% 2% CPI 0% 11% 11% 11% 8% Avg 3% Avg 8% 1% rise in coal price If no 3% tariff hike in July-2008 2007f 2008f 2009f 2010f Avg 2007f 2008f 2009f 2010f Avg Datang 0% -3% -3% -2% -2% Datang 0% -10% -17% -13% -10% Huaneng 0% -6% -4% -3% -3% Huaneng 0% -16% -23% -18% -14% Huadian 0% -19% -11% -8% -9% Huadian 0% -46% -51% -36% -33% CR Power 0% -2% -2% -2% -2% CR Power 0% -6% -12% -13% -8% CPI 0% -7% -7% -7% -5% CPI 0% -16% -32% -33% -20% Avg -4% Avg -17% Our base case has assumed 3% tariff hike in 3Q08 Source: Lehman Brothers estimates May 2008 122
  • 122. Lehman Brothers | Equity Research VALUATION METHODOLOGIES Security Valuation Methodology Acer We believe the fair value for Acer should be the average diluted earnings multiple, 16x, for the last cycle, since we expect Acer to maintain its growth momentum for the next two years. Based on the diluted 2008 EPS estimate, NT$ 5.01, we derive a target price of NT$ 80.2 for Acer. Advanced Info Services Our discounted cash flow valuation (DCF) uses a 10.4% WACC and a terminal growth rate of 2%. Aluminum Corp of China We use discounted cash flow (DCF) analysis to derive our fair value and price target of Chalco of HK$9.6. We use a seven-year unleveraged free cash flow (FCF) model and assume a terminal growth rate of 2%, given that we expect Chalco to continue to grow its alumina and aluminum volume, in both the domestic and overseas markets. In deriving our weighted average cost of capital (WACC) of 9.7%, we assume a cost of equity of 13.3%, an after-tax cost of debt of 3.0% and a target debt-to-capital ratio of 35%. In deriving our terminal values, we capitalize our terminal-year free cash flow assumption, adjusted for long-run capex, over our WACC assumption less our estimate of terminal growth. Ambuja Cements We have valued the company on the basis of long term expected return on its cement assets. Long term growth rate and pre tax WACC have been assumed as 6% and 11.5% respectively. Angang Steel H-share Our 12-month price target (PT) of HK$28.5 incorporates two parts: (1) Angang’s existing business, which is worth of HK$24.6 based on 15x 08e P/E or 0.7x PEG (2007-09E) and (2) potential NAV enhancement from likely steel-asset injection of Benxi Steel from Angang Group, its parent company. we applied a peer group average EV/tonne of RMB6,380 – the average of its domestic peers. We calculate that Benxi Steel will add around HK$3.9 per share for Angang. Anhui Conch We derive our 12-month price target of HK$100 based on EV/tonne of cement capacity at US$174 and estimated cement capacity of 124.8mt for 2009. Our EV/tonne of US$174 is calculated based on our forecasted EBITDA/tonne of US$12.4/t as a result of cement price increase and 14x EV/EBITDA multiple. Our EV/tonne of US$174/t is still lower than the average EV/tonne over US$232/t commanded by Indian cement producers. Ashok Leyland We have valued Ashok Leyland based on DCF of Free Cash Flow to Equity(FCFE). We have assumed a terminal growth rate of 6% and discount rate of 13% for this purpose. Asustek Computer We have used EV/IC analysis to derive our valuation of ASUSTeK. We have assumed ASUSTeK’s beta to be 0.88. This results in a WACC assumption of 9.7%. Based on forward-looking invested capital and EBIT numbers and EV mn, we set our target price at NT$135 for ASUSTeK shares Our target price of NT$65 is based on the mid-cycle average P/B of 1.25x. AU Optronics Austar United Communications We adopt a 12 month DCF valuation methodology. Our PT is based on a WACC of 9.7% and terminal Limited growth rate of 3.0%. We assume a risk free rate of 6.4%, 1.0 equity beta, 1.5% credit premium and 5.5% equity market risk premium for our WACC calculations. Babcock & Brown Limited Our 12-month target price is derived using target P/E. Our target P/E is derived using a global peers comparison. The target P/E of 8.1x is 10% below is the median FY08E trading P/E of 9x for global investment banks under Lehman Brothers’ equity research coverage. The current methodology is adopted on 28 March 2008; prior to that we used a dividend discount model (DDM) -based valuation. Bank of China (H-shares) We used the Gordon growth model to derive our target of HK$3.84, assuming a sustainable ROE of 15.2%, a COE of 11.5%, and 7.6% long-term growth. Bank of Communications Gordon Growth Valuation Methodology. Our 12-month price target HK$12.52 is based on target multiple of 3.57x P/BV and 2008E PB of RMB 3.00. Our target PB/V ratio is based on 17.6% long-term ROE, 11.25% COE, and 8.8% long-term growth and a long term pay out ratio of 50%. Baoshan Iron & Steel Our price target of Rmb14.0 is based on a P/E multiple of 17.7x 2008e EPS of Rmb0.79. This is in line with Baosteel’s historical one-year forward P/E average. Beijing Enterprises In our view, NAV (or sum-of-the-parts value) remains the best valuation methodology for asset-intensive and diversified conglomerates. We value BEHL’s different businesses based on what we believe to be the most appropriate valuation benchmark for each of them. Our 2008E NAV of HK$49.5bn comprises HK$39.5bn for infrastructure/utility division (based on DCF), HK$8.6bn for brewery division (based on 15x forward EV/EBITDA), and HK$1.4bn for all other businesses (based on market values or book values). Our TP is based on 2008E NAV plus a HK$2/sh acquisition premium. We expect a gradual re- rating given a more focused business portfolio and the expected significant improvement in earnings quality following the acquisition of Beijing Gas. May 2008 123
  • 123. Lehman Brothers | Equity Research Security Valuation Methodology Belle International Holdings Limited Our price target of HK$9.55 is based on a multiple of 24.1x our FY09 EPS estimate of HK$0.385, a 20% premium to the major peers’ average. Bharti Airtel Limited We derive our price target using a base DCF, a towerco upside and a TRAI recommendation downside. Both our base DCF, towerco upside & TRAI reco downside is derived using an 11% WACC and a terminal FY03/2016 growth rate of 3%. For our towerco upside, we have also used a 10% holdco discount. Bluescope Steel Limited Our A$9.35 12-month price target is derived using a DCF valuation. We have employed a WACC of 10.75% and a terminal free cash flow growth rate of 2.5% p.a. Bukit Sembawang Estates Target price at parity to end-08E RNAV Cambridge Industrial Trust We employ a SOTP valuation methodology to arrive at our fair value of S$0.88 per share; of this S$0.82 or 93% is from our five-year DDM valuation of the current portfolio and S$0.06, or 7% of fair value, is derived from our 10-year DDM valuation of potential acquisitions of S$90mn a year over the next three years. We have assumed a cost of equity of 7.2% (risk free rate of 3%, beta of 1.05 and equity-risk premium of 4%) and terminal yield of 6.8% in our DDM valuation. CapitaLand Our target price for CapitaLand is pegged at a 15% premium to our end-CY08E RNAV estimate. CapitaRetail China Trust We value CRCT using a sum of the parts approach. On its existing portfolio, we use a 10-year dividend discount model based on beta of 0.5 and terminal yield of 7.0%. On its future acquisition pipeline, we present value the yield accretion on future asset acquisition based on entrance yield of 7.5%. Catcher Technology Our price target of NT$100.5 is derived from a multiple of 12x our 2008 fully diluted EPS estimate of NT$8.38. 12x is Cather’s average P/E multiple in the past five years and a conservative multiple for hardware component names, in our view. We believe it is a reasonable valuation methodology because we believe that Catcher can maintain its long-term growth momentum with existing product lines and diversify its portfolio in the next three years. The conservative multiple has factored in the uncertainty risk of new product lines. Cathay Financial Holding Co. Our valuations of Taiwan financial holding companies are based on sum-of-the-parts valuations of their subsidiaries. Among subsidiaries, life insurance subsidiaries are valued at embedded value (EV) and actuarial value (AV), and banks are valued on a target P/B multiple derived from the equation of (ROE- g)/(k-g), where ROE stands for normalized sustainable ROE, g stands for longer-term growth expectation, and k stands for require rate of return. Enterprise value is derived from the target P/B multiple and FY07 book value forecast, adjusted for off-balance-sheet items, including unrealized gains/losses. Our ROE assumptions for CUB and Cathay Century are 13%, with a cost of capital of 8.0%, and a growth rate at 3%. For Cathay Life, we assume a 10.7% cost of capital and apply embedded value and actuarial valuation methodology to value the life insurance operation. Our valuation indicates a target P/B of 4.0x our FY08 NPL adjusted BVPS estimate of NT$24.4 or 2.5x its fully adjusted BVPS estimate of NT$39.1. CDL Hospitality Trust Target price of S$2.22, based on a sum-of-the-parts (SOTP) valuation methodology – S$1.83 or 82% of our fair value is attributed to a 5-year Dividend Discount Model (DDM) valuation of CDLHT’s existing property portfolio, and S$0.39 or 18% of our fair value is attributed to a 10-year DDM valuation of potential acquisitions in the pipeline. Cost of equity of 6%, based on a beta of 0.75, equity risk premium of 4% and risk-free rate of 3%. Terminal yield of 6.3%. Champion REIT Our HK$5.25 price target is based on a 10-year dividend discount model using 5.0% risk-free rate, 5.0% market risk premium, beta of 0.5 and a terminal yield of 5.5% China Shenhua Energy Our price target of HK$57 includes two parts – (1) existing business by using sum-of-the-parts valuation based on DCF analysis; (2) our estimated NAV enhancement from coal mine assets to be injected. For existing business, we use DCF analysis to separately value Shenhua’s coal and power operation to get the fair value, assuming a long-term coal price of US$45/tonne and terminal growth rate of 2%. Our WACC assumption is 8.9% based on cost of equity at 14.1%, cost of debt at 3.8%. To value coal mine assets to be injected, we apply regional peers’ comparable EV/tonne of reserve at US$8.5/t based on the parent company’s scheduled injection of coal reserves of 2,992mt into Shenhua. Cheung Kong Our HK$169.00 is based on 7.5% premium to Cheung Kong’s end-09E NAV (premised on HK$93.80 price target for Hutchison Whampoa, which is computed is based on the sum of 2008E ex-3G NAV of HK$82.8/sh and 3G fair value of HK$11/sh (representing 33% of 3G NAV of HK$33/sh, to reflect our estimate of 33% probability of corporate activities to unlock the 3G value). Our ex-3G NAV of HK$82.8/sh comprises HK$23.1/sh from properties/hotels (using a mix of DCF, yield basis and per room valuation), HK$35.4/sh from container terminals (using DCF), HK$9.7/sh from retail/manufacturing (using P/E), HK$34.2/sh from infrastructure/energy (using market value and Lehman’s target price), and HK$8.7/sh from listed telecom assets (using market value and Lehman’s target price). Chi Mei Optoelectronic Corp To derive our target price of NT$45, we apply the mid-cycle average of 1.15x price to 4Q-forward book multiple of the benchmark to our adjusted book value estimate. May 2008 124
  • 124. Lehman Brothers | Equity Research Security Valuation Methodology China CITIC Bank (H Share) We have used the Gordon Growth model (target P/BV = (sustainable ROE – long-term growth)/ (cost of equity – long-term growth) to derive our fair P/BV, assuming a cost of 11.25%, a long-term growth rate of 7.8%, and a payout ratio of 50%. Our target price of HKD 5.63 is based on end-2008E BVPS of RMB 2.38. China Coal We derive our 12-month price target of HK$32.0 for China Coal (27.5 x 09e P/E), close to our fair value for Shenhua (1088 HK, 1-OW), representing P/E multiple of 28.6x. Compared to Shenhua, despite China Coal’s smaller production scale (80mt vs. Shenhua’s 152mt for ‘07) and lower margins, China Coal enjoyed a higher ROIC at 38% vs. Shenhua’s 24% for 2008. We have also cross-checked with its peers by using EV/tonne of coal reserve. If we incorporate China’s acquired coal reserve associated with its coal-based chemical projects and the reserve held by its parent, China Coal’s EV/tonne of reserve would trade at US$4/t, undemanding compared to the global peer average of US$8.5/t. China Construction Bank Our price target of HK$8.86 is based on our long-term ROE assumption of 18.4%. We used a Gordon growth model to derive our fair price to book value multiple. Other valuation assumptions include a cost of equity of 11.5% and a long-term growth rate of 9.2%. China COSCO Our target price is based on sum-of-the-parts valuation. We apply a modified EV/invested capital (IC) multiple to arrive at our fair value, calculated as ROIC/WACC adjusted for terminal growth. If a company is creating value by generating positive economic returns where ROIC > WACC, we ascribe a multiple greater than 1x to the IC. The key difference in our methodology is that we apply this metric to a shipping company, where we can value its assets (i.e. its fleet) using secondhand market transactions instead of accounting-based invested capital, which tends to be distorted by different accounting policies and historical costs. We believe this should provide a better reflection of a shipping company’s asset value and returns. Within our sum-of-the-parts valuation, we use return on fleet value estimates, which are based on expected returns for FY08E-FY09E of 10.9%, against a relatively conservative WACC of 9.2%. We assume long-term growth of 1.5%, which represents the average annual global fleet developmentro 1991-2005. We assume maintenance capex of 4% of fleet value, which reflects the amount of ongoing investment to maih current fleet aging profile. Our EV/FV valuation factors in a fleet value target multiple of 1.2x. China Everbright International Our valuation is based on the discount cash flow methodology, employing a WACC of 9.50% with no Limited terminal growth rate. China Foods We base our 12-month price target of HK$5.1 based on sum-of-the-parts methodology. We use 2009E EV/EBITDA multiple of 14x to value the Great Wall wine business on the back of estimated 33% and 31% EBITDA growth in 2008 and 2009, respectively. We use a 2009E EV/EBITDA multiple of 10x to value CBL, the Coca-Cola bottling business, projecting a 15% EBITDA CAGR during 2006-09. China Mengniu We use the 2-stage DCF methodology (assuming a terminal growth rate of 3% and a WACC of 11%) to value Mengniu. We think only the DCF valuation can capture Mengniu’s strong operating cash flow generation, expanding market share in the fast growing China dairy sector and expected margin improvements. China Merchants Bank (H-shares) Our price target of HKD35.53 is derived from the Gordon growth model which we use for Asian emerging-market banks, assuming a sustainable ROE of 18.0%, COE of 10.8%, and long-term growth of 9.0%. China Merchants Hldgs (Int’l) Our NAV is based on a sum-of-the-parts methodology, for which we adopt separate valuation benchmarks to assess the fair values of each different operating unit. Specifically for ports, which are typically of long-term nature and have relatively predictable and stable cash flows, we use discounted cash flow (DCF) analysis. Our price target of HK$49.50 is based on par to 2008 NAV of HK$119bn (HK$115.8bn for ports, HK$12.6bn for the remaining businesses, and subtracting HK$9.4bn head- office’s net debt), or HK$49.5 per share. China Minsheng Bank Co. We used the Gordon Growth Model to derive our fair value P/B multiple. Our target price of Rmb 9.85/share is based on 2.59x end-2008E adjusted BVPS (post money), assuming 16.2% sustainable ROE, 11.25% COE, and 8.1% terminal growth. China Mobile Limited Our DCF valuation uses a risk-free rate of 6%, equity risk premium of 6.5% and a cost of equity of 13.8%, and a WACC of 10.1%. Our DCF also assumes a long-term growth rate of 1.5%. China National Building Materials We apply a sum-of-the-parts valuation given CNBM’s four different business segments. For CNBM’s cement operation, we apply EV/tonne of US$121/t, 30% discount to our target EV/t for Anhui Conch (914 HK, 1-OW) given Anhui Conch’s higher profitability. We also assume 108m tonnes of attributable cement capacity at end-2008 for CNBM. To value other business segments, we apply average P/E multiple of industry peers. May 2008 125
  • 125. Lehman Brothers | Equity Research Security Valuation Methodology China Netcom Group Our 12-month target price of HK$16.0 is based on a discounted cash flow (DCF) methodology. Our DCF valuation uses a risk-free rate of 6%, an equity risk premium of 6.5%, a cost of equity of 15.1%, growth to perpetuity of 0.5%, and a WACC of 10.5%. China Oilfield Services Ltd Our price target of HK$21 is derived from (ROIC-g/WACC-g) – ROACE: 24%; WACC: 9% and long-term growth rate of 5%. Our WACC of 9% is based on a risk free rate of 4.6%; risk premium of 5.6%; cost of debt of 2.7%; cost of equity of 10.2% and beta of 1.0. China Overseas Land Our price target is based on 23% premium to China Oversea’s forward NAV of HK$12.40. This 23% premium reflects China Overseas surplus returns on its market value NAV over its cost of equity. China Power International The target price is based on 13x 2009E P/E China Resources Enterprise Our price target of HK$31.4 is derived from a sum-of-parts valuation, on a premium of 25% of our NAV estimate of HK$25.1, to reflect the rising exposure to the consumer sector, the ability to execute, and the potential corporate activity. China Resources Land Our HK$19.40 price target for CR Land is based on 0% premium to its forward optimised NAV. This includes potential value from another round of asset injection from parent China Resources Holdings. China Resources Power Our price target for CR Power is based on a 13x of FY09 P/E. China Shenhua Energy Valuation Methodology: Our price target of HK$57 includes two parts – (1) existing business by using sum-of-the-parts valuation based on DCF analysis; (2) our estimated NAV enhancement from coal mine assets to be injected. For existing business, we use DCF analysis to separately value Shenhua’s coal and power operation to get the fair value, assuming a long-term coal price of US$45/tonne and terminal growth rate of 2%. Our WACC assumption is 8.9% based on cost of equity at 14.1%, cost of debt at 3.8%. To value coal mine assets to be injected, we apply regional peers’ comparable EV/tonne of reserve at US$8.5/t based on the parent company’s scheduled injection of coal reserves of 2,992mt into Shenhua. China Shipping Container Lines We apply a modified EV/invested capital (IC) multiple to arrive at our fair value, calculated as ROIC/WACC adjusted for terminal growth. If a company is creating value by generating positive economic returns where ROIC > WACC, we ascribe a multiple greater than 1x to the IC. The key difference in our methodology is that we apply this metric to a shipping company, where we can value its assets (i.e. its fleet) using secondhand market transactions instead of accounting-based invested capital, which tends to be distorted by different accounting policies and historical costs. We believe this should provide a better reflection of a shipping company’s asset value and returns. Our return on fleet value estimate is based on expected returns for FY08E-FY09E of 9.9%, against a conservative WACC of 9.6%. We assume long-term growth of 1.5%, which represents the average annual global fleet development from 1991-2005. We assume maintenance capex of 4% of fleet value, which reflects the amount of ongoing investment to maihe current fleet aging profile. Our EV/FV valuation factors in a fleet value target multiple of 1.0x. China Telecom Our 12-month target price of HK$4.30 is based on a discounted cash flow (DCF) methodology. Our DCF valuation uses a risk-free rate of 6%, an equity risk premium of 6.5%, a cost of equity of 14.5%, and a WACC of 10.5%. China Unicom Ltd. We use a discounted cash flow (DCF) model valuation and have assumed a WACC of 10.9% and a FCF growth to perpetuity of 1%. Our DCF also uses a risk-free rate of 6% and an equity risk premium of 6.5%. China Water Affairs Group Limited Our 12-month price target of HK$3.00 is based on a discounted cash flow (DCF) valuation methodology, assuming a weighted average cost of capital (WACC) of 13.5% and a terminal growth rate of 0%. China Yurun Food We use a two-stage DCF valuation methodology to calculate our price target of HK$12.8 for Yurun. We think DCF best captures the company’s strong operating cash flow generation, and we expect its free cash flow will turn positive from 2009. We use a WACC of 10.9% and a 3% terminal growth rate to capture the long-term growth of food & beverage consumption in China. Chinatrust Financial Holding Co. The valuation of Taiwan financial holding companies are sum-of-the-parts valuations of their subsidiaries. Among subsidiaries, life insurance subsidiaries are valued at embedded value (EV) and actuarial value (AV), banks are valued based on a target P/B multiple derived from the equation of (ROE-g)/(k-g), where ROE stands for normalized sustainable ROE, g stands for longer-term growth expectation and k stands for require rate of return. Enterprise value, at the same time, is derived from the target P/B multiple and FY07 forecast book value, adjusted for off-balance sheet items including unrealized gains/losses. Our valuation for CTCB, the major subsidiary of CFHC, is based a long-term ROE of 15%, a growth rate of 3.5%, and a cost of capital of 8.5%. The target price implies an target P/adj. book multiple of 2.27 times FY08 forecast NPL adjusted book NT$16 per share. Chunghwa Picture Tubes With the current healthy industry conditions, we think it is fair to apply a cycle-average price-to-book of 1.4x for the derivation of the stock’s target price. Coupled with the trailing 4Q book value NT$11.1 per share, we calculate our target price of NT$15.19 for the stock. May 2008 126
  • 126. Lehman Brothers | Equity Research Security Valuation Methodology Chunghwa Telecom Co. Ltd. Our 12-month target price is based on a DCF valuation with a WACC of 11.2%, a cost of equity of 14.1% and a long-term FCF growth rate of 0%. City Developments Target price pegged at parity to end-08E RNAV CJ Home Shopping Our price target is calculated by a sum-of-the-parts valuation, applying 3.5x 2008E EBITDA (KRW 84.7bn) and W500,000/subscriber value for its SO holdings. We apply 15x 2008E P/E (NP 08E: KRW 16bn) to MBC Dramanet, the program provider, 1x 2008E EV/sales (Sales 08E: KRW 1,575bn) to its China subsidiary, 0.5x 07 net asset value (W38bn) of BSI, and book value for other stake holdings. Clear Media We apply DCF valuation, with WACC of 11.6% and terminal growth rate of 2%. CLP Holdings Our target for CLP is derived by DCF, assuming a 2009 tariff cut of 20%, a 2009 SOC return of 9.99%, a WACC of 8.75% and a terminal growth rate of 1.5%. CNOOC We use two methodologies to value CNOOC: (1) EV/CE; and (2) sum of the parts (DCF). Our preferred valuation methodology for CNOOC is an absolute valuation approach, which links its returns to share price, as we believe share prices are driven by asset returns (returns on capital. Our target price of HK$13.5 is based on average 08-09E ROACE/WACC (32.3%/11%). Our WTI oil price forecasts are US$93/bbl for 2008E, US$83/bbl for 2009E, US$75/bbl for 2010E and LT oil price estimates of US$60/bbl. Datang International The target price is based on 13x 2009E P/E Digi.Com Berhad We value DiGi using a DCF with 8.8% WACC and 2% terminal growth rate Electricity Generating PCL DCF, using a WACC of 9.19% and zero terminal growth rate. Esprit Holdings Our price target of HK$135.0 is based on a PEG of 1x (implied 1-yr fwd PER of 22.0x). Evergreen Marine We apply a modified EV/invested capital (IC) multiple to arrive at our fair value, calculated as ROIC/WACC adjusted for terminal growth. If a company is creating value by generating positive economic returns where ROIC > WACC, we ascribe a multiple greater than 1x to the IC. The key difference in our methodology is that we apply this metric to a shipping company, where we can value its assets (i.e. its fleet) using secondhand market transactions instead of accounting-based invested capital, which tends to be distorted by different accounting policies and historical costs. We believe this should provide a better reflection of a shipping company’s asset value and returns. Our return on fleet value estimate is based on expected returns for FY08E-FY09E of 5.2%, against a WACC of 7.9%. We assume long-term growth of 1.5%, which represents the average annual global fleet development from 1991-2005. We assume maintenance capex of 4% of fleet value, which reflects the amount of ongoing investment to mainn the currentfleet aging profile. Our EV/FV valuation factors in a fleet value target multiple of 0.6x. Fairfax Media Limited We base our target price of A$3.80 on a 12-month discounted cash flow methodology that assumes a 9.9% WACC and a 0.5% terminal free cash flow growth. Our WACC is based on a 6.3% risk free rate, a 1.0 equity beta, a 1.5% credit premium, and 30% debt to total capital. Far EasTone Telecommunication Our 12-month target price is based on a DCF valuation with a WACC of 11.2%, a cost of equity of 14.1% and a long-term FCF growth rate of 0%. Focus Media Holding Limited We use a DCF valuation with a WACC of 11.5% and terminal growth rate of 3%. Formosa Chemical and Fibre We value FCFC using a sum-of-the-parts methodology. We value FCFC’s core business at a 2008E EV/IC of 1.0x (WACC of 9% and ROIC of 9.4%), investments in Formosa companies at our price target, mark its other listed investments to market, and value its unlisted investments at cost. Formosa Petrochemical We value FPCC using an asset-based approach, linking equity valuation to ROCE. Our price target of NT$82 is derived from a target EV/CE of 2.2x, which assumes a 2008E-2009E average ROCE of 16.5% and a WACC of 7.6%. Formosa Plastics Our price target of NT$82 is derived by a sum-of-the-parts analysis, which values FPC’s core business at 1.7x EV/IC (average 08E-09E ROIC of 15.0%; WACC of 8.5%); investments in the Formosa Group at our price targets, other listed investments at market price, and unlisted investments at book value. Foxconn Technology We have concerns that Foxconn Tech may not be able to recover to its previous peak valuation multiple based on the rising risks of labor and material cost and volatility from Nintendo’s EMS business. There is a gap before the company’s next catalyst materializes. As such, we have assigned a diluted earnings multiple of 14x to Foxconn Tech to derive its long-term fair value since 14x is often used as a hardware component player’s fair valuation. Foxconn Technology We have concerns that Foxconn Tech may not be able to recover to its previous peak valuation multiple based on the rising risks of labor and material cost and volatility from Nintendo’s EMS business. There is a gap before the company’s next catalyst materializes. As such, we have assigned a diluted earnings multiple of 14x to Foxconn Tech to derive its long-term fair value since 14x is often used as a hardware component player’s fair valuation. May 2008 127
  • 127. Lehman Brothers | Equity Research Security Valuation Methodology Galaxy Entertainment Group Our PT is the sum of ‘08E NAV (HK$7.70), dominated by gaming assets valued at 7.2x ‘10E EV/EBITDA; and a Cotai land option value ( HK$0.80), which is estimated proportional to the gaming assets value estimated for GalaxyWorld Phase I based on the gaming area proposed for GalaxyWorld Phase I and Phases II-IV respectively. Giordano International Our price target of HK$3.33 is based on a PER of 15.7x FY08E EPS of HK$0.212, at a 5% premium to peers (the reflection of an M&A premium). Golden Eagle Retail Group Our target price of HKD8.2 per share is based on 20x 2009E P/E multiple (EPS RMB0.337), in line with domestic peers average. We also expect the US$1=RMB6.4 by end-2009. Our DCF valuation suggests a fair value of HKD12.5 (terminal growth:3%, discount rate:9.5%) Great Eagle Our HK$44.00 price target is based on a 20% discount to Great Eagle’s end-09 NAV of HK$55.20. Greentown Our 15.57 price target is based on 20% discount to Greentown’s current NAV of HK$18.48 plus 5% Rmb appreciation. The 20% discount reflects Greentown’s average 2008 and 2009 return on assessed NAV and its costs of equity. GS Holdings Our price target of W78,000 is based on a sum-of-the-parts valuation methodology. We use the market value of GS Home Shopping, the implied value of GS Caltex based on our calculation of ROCE/WACC of 15%/11.5%, and the book value of GS Retail (W339bn), GS EPS (W101bn), and GS Sports (W2bn). GS Home Shopping Our price target is calculated by a sum-of-the-parts valuation, applying 3.3x 2008E EBITDA, and applying W500,000/subscriber value for its SO holdings with 30% discount. Our price target is equivalent to 11x 2008E P/E or 9x 2008 P/E when excluding amortization costs related to SO acquisitions. Guangzhou R&F Our HK$31.04 price target is based on 10% premium to R&F’s forward optimised NAV of Rmb25.7 and factored in a 10% appreciation in Rmb. GZI Real Estate Investment Trust Our HK$3.37 price target is based on a 10-year dividend discount model using 5.0% risk-free rate, 7.5% market risk premium and a beta of 0.5. Hanaro Telecom Our target price is based on DCF valuation, with a WACC of 9.94% and terminal growth rate of 2% after 2010E. Hang Lung Properties Limited Our HK$32.30 price target is based on 5% premium to our HLP end-09E NAV of HK$30.7 per share. Hanjin Shipping We apply a modified EV/invested capital (IC) multiple to arrive at our fair value, calculated as ROIC/WACC adjusted for terminal growth. If a company is creating value by generating positive economic returns where ROIC > WACC, we ascribe a multiple greater than 1x to the IC. The key difference in our methodology is that we apply this metric to a shipping company, where we can value its assets (i.e. its fleet) using secondhand market transactions instead of accounting-based invested capital, which tends to be distorted by different accounting policies and historical costs. We believe this should provide a better reflection of a shipping company’s asset value and returns. Our return on fleet value estimate is based on expected returns for FY08E-FY09E of 6.6%, against a conservative WACC of 7.6%. We assume long-term growth of 1.5%, which represents the average annual global fleet development from 1991-2005. We assume maintenance capex of 4% of fleet value, which reflects the amount of ongoing investment to main the current fleet aging profile. Our EV/FV valuation factors in a fleet value target multiple of 0.8x. Henderson Land Our HK$65.0 price target is based on 10% discount to Henderson Land’s end-09 NAV of HK$72.49 Hero Honda We have valued Hero Honda by discounting free cash flow to equity (FCFE). For this purpose we have used discount rate of 13% and a terminal growth rate of 4%. High Tech Computer We believe HTC’s earnings multiple can be traded back to last upcycle average, 16x. Using 16x our 2008 our diluted 2008 EPS estimate of NT$ 52.59 as a reasonable valuation, we derive the target price as NT$ 841. Hindustan Unilever Limited We have used a P/E multiple based valuation methodology. We have valued HUL at 29x current year’s earnings, which is at a 24% premium to the average multiple of our coverage universe. We believe that the premium is justified due to: a) strong brand portfolio of the company, b) the large size and enhanced liquidity in the stock, c) the historically high multiples that the company has traded in the past and d) the strong ROE and high dividend yield that the stock offers. Hite Brewery Our share price target of KRW165,000 is based on a sum-of-the-parts valuation and is equivalent to 19x our 2008 adjusted EPS estimate of KRW8,508. We begin with a DCF-based operating value of KRW128,830 per share and add to this a holding equity value, adjusted to Hite’s holding stake with a 30% discount, of KRW31,034, and a value for other subsidiaries (also at a 30% discount) of KRW4,676. May 2008 128
  • 128. Lehman Brothers | Equity Research Security Valuation Methodology Hon Hai Precision We carried out our valuation using EV/IC analysis. We assumed Hon Hai’s beta to be 1.24 and the tax rate to be 20%. This resulted in a WACC assumption of 8.4%. By this method, we have derived a fair share price of NT$242 for Hon Hai. Honam Petrochemical We value Honam on a sum-of-the-parts valuation methodology. Based on our NAV valuation of Honam petrochemical, we believe the company is undervalued compared to our fair value of W165,000 per share. We value the company’s core business on an ROIC/WACC analysis of 12%/10% and equity investments are added to derive our target price of W165,000 per share. Hong Kong & China Gas We use a DCF analysis with a WACC of 8.2% and a terminal growth rate of 3%. Hongkong & Shanghai Hotels Our PT is based on sum-of-the-parts, with HSH’s hotel operations valued at a global peer average of 12x 08E EV/EBITDA, and its investment properties valued at a 40% discount to 2008E NAV. Hongkong Electric Our target for HKE is derived by DCF, assuming a 2009 basic tariff cut of 20%, a 2009 SOC return of 9.99%, a WACC of 7.4%, and a terminal growth rate of 1%. Hongkong Land Our US$5.95 target price is based on 20% discount to end-2009 NAV estimate of US$7.48. Huadian Power International The target price is based on 13x 2009E P/E Huaneng Power International The target price is based on 13x 2009E P/E Huaxia Bank We used the Gordon Growth Model to derive our fair value P/B multiple. Our target price of Rmb 9.00/share is based on 2.51x mid-2008E BVPS, assuming 16.5% sustainable ROE, 11.5% COE, and 8.2% terminal growth. Hutchison Telecommunications Intl Our price target is based on a SOTP DCF using a WACC of 8-11% and a terminal year exit multiple of 3-5x for its various operations. We also apply a 30% holdco discount on its operations and a 10% discount on its cash balance. Hutchison Whampoa Our TP is based on the sum of 2008E ex-3G NAV of HK$82.8/sh and 3G fair value of HK$11/sh (representing 33% of 3G NAV of HK$33/sh, to reflect our estimate of 33% probability of corporate activities to unlock the 3G value). Our ex-3G NAV of HK$82.8/sh comprises HK$23.1/sh from properties/hotels (using a mix of DCF, yield basis and per room valuation), HK$35.4/sh from container terminals (using DCF), HK$9.7/sh from retail/manufacturing (using P/E), HK$34.2/sh from infrastructure/energy (using market value and Lehman’s target price), and HK$8.7/sh from listed telecom assets (using market value and Lehman’s target price). Hynix Semiconductor Inc. Our price target of W38,000 is based on 1.9x our mean 2008 and 2009 BPS estimate of W20,356. Hysan Development Our price target of HK$35.00 is based on applying 20% discount to end-09E NAV of HK$43.70. Hyundai Department Store Our 12-month price target of W112,000 is equivalent to 13.5x 2008E P/E with EPS of W8,363. We calculate our target by summing the company’s W1.9t operating value (applying 8.7x 08E EBITDA) and W840bn equity-holdings value (applying 30% discount to estimated value) and subtracting its net debt (W196b). Idea Cellular Limited We value IDEA Cellular using a DCF with 11.3% WACC and 3% terminal growth rate Indosat We derive our price target using a 20% discount on Telkomsel ‘08 EV/EBITDA for Indosat’s mobile business and a 5.2x ‘08 EV/EBITDA for its fixed-line business. Industrial & Comml Bank of China(H) We have used the Gordon growth model to derive our target 2008E P/B, based on the following estimates: sustainable ROE of 18.6%, cost of equity of 11.5%, and terminal growth of 9.3%. Other assumptions include a US$/Rmb exchange rate of 7.1 by the end of 2008. Intime Department Store (Group) Our sum-of-the-parts valuation of Intime’s equity suggests a valuation of HKD5.2 per share, representing 16.1x 2009E earnings of RMB0.298. To value its core recurring business, we use 15.3x 2009EP/E, which is at a 40% discount to its domestic peer group To value its A-share investment, we use 25x 2009E EPS, in line with A-share-listed consumer stocks. Inventec Appliances Corp In view of the continued risks, we maintain our previous conservative valuation methodology of a 10x forward earnings multiple. Based on the NT$ 7.95 of 2008E EPS estimates, we derive our TP of NT$ 79.5 and we maintain our 2-EW rating. Jiangxi Copper Our price target of HK$17.0 would represent 9.7x 2008e P/E, relatively in line with Jiangxi Copper’s historical 1-year forward P/E average of 9.5x. Our 2008 EPS forecast is Rmb1.58 and HK$/Rmb exchange rate of 0.9. Ju Teng International We use a P/E valuation methodology. We believe that it would be fair to use a forward earnings multiple of 10x for Ju Teng, which is a discount to its Taiwan-listed competitors, as this takes into consideration the company’s lower liquidity and smaller market capitalization. Applying a 10x multiple to our average 2007/2008 EPS estimate of HK$0.53, we derived our 12-month price target of HK$5.3 Kia Motors Corporation Our 12-month price target is W17,500 for Kia Motors based on 5.2x our one-year forward CFPS of W3,357 representing mid-year earnings as we believe the company is coming out of a trough valuation. May 2008 129
  • 129. Lehman Brothers | Equity Research Security Valuation Methodology Kingsoft Corp. Inc. Our 12-month price target of HK$3.90 is based on 14x FY08E EPS of HK$0.28. The average FY08 P/E for Chinese online gaming companies is 13.9x. We believe that using a P/E multiple is the best valuation methodology for the gaming sector, given the cyclical and uncertain nature of the industry. Korea Electric Power Corp. DCF with a WACC of 9.7% and a terminal growth rate of 2%. Korea Line Our target price is based on sum-of-the-parts. We apply a modified EV/invested capital (IC) multiple to arrive at our fair value, calculated as ROIC/WACC adjusted for terminal growth. If a company is creating value by generating positive economic returns where ROIC > WACC, we ascribe a multiple greater than 1x to the IC. The key difference in our methodology is that we apply this metric to shipping company, where we can value its assets (i.e. its fleet) using secondhand market transactions instead of accounting-based invested capital, which tends to be distorted by different accounting policies and historical cost. We believe this should provide a better reflection of a shipping company’s asset value and returns. Our return on fleet value (ROFV) estimate is based on expected returns for FY08E-FY09E of 18.1%, against a conservative WACC of 9.9%. We assume long-term growth of 1.5%, which represents the average annual global bulk fleet development from 1991-2005. We assume a maintenance capex estimate of 4% ofleet value, which reflects the amount of onvtment to maintain the current fleet aging profile Our EV/IC valuation factors in a fleet value multiple of 2.0x. K-REIT Asia DDM valuation using fully-diluted DPU forecasts from FY08E to FY12E, cost of equity of 5.6% (beta 0.65, risk-free 3%, equity risk premium 4%) and terminal yield of 4.9%. KT Our target price is based on a sum-of-the-parts valuation. The parent company value is derived from DCF analysis using a 9.69% WACC and a -1.0% terminal growth rate of FCF after 2010. KT&G Our 12-month price target of W101,000 is based on a sum-of-the-parts valuation and is equivalent to 18.3x 2008E P/E of W5,511 or 4.3x 2008E P/B (24% ROE). KTF Our price target for KTF is based on DCF methodology, for which we use a 10.00% of WACC and a 0% terminal growth rate after 2010. Larsen & Toubro We have valued L&T using a sum-of-the-parts (SOTP) analysis. Our core E&C business (L&T standalone) valuation is based on a dividend discount methodology. We estimate the one-year forward value of the E&C business at INR4,010 per share. To this value, we have also added values for L&T Infotech, L&T Finance, Capital and Infrastructure Finance, L&T IDPL, the housing company for L&T’s BOT projects, L&T’s ECC and EC&P’s subsidiaries and associates, manufacturing associates, foreign subsidiaries, as well as value for L&T’s holding in Ultratech Cement. Hence, we estimate our one-year forward target price at INR5,003 per share. LG Chem Based on our EV/CE analysis of 18%/9%, we value LG Chem at W8.9tri or W106,500 per share. LG Dacom We raise our target price by 8% to W27,900 from W25,800 on the back of upwardly revised earnings forecasts of PWC. Our price target of W27,900 is based on a 10% discount to the sum of Dacom’s discounted cash flow (DCF) and 45% of the DCF value of Powercom (PWC). LG Display Co., Ltd Our target price of W54,000 is based on 1.8x 2008E BVPS of W30,313. LG Electronics Inc. Our target price is based on our global basis sum-of-the-parts valuation. We employ global basis (global = parent + LGE’s overseas subsidiaries) figures, as a major portion of LGE’s business is operated globally. For our sum-of-the-parts valuation, we split the company into its three major business divisions: Home Appliance, Display & Media and Telecom Equipment (including Handset), and compared each with its global peers. We applied a discount to the peer average ‘08E EV/EBITDA multiple to account for factors such as relatively low brand equity. From this analysis, we arrived at our global basis firm value, which we then reduced by the company’s net debt of W4.9tn (global basis). We then added back the value of LGE’s investment holdings to arrive at our total equity value. This yields a fair value of between W176000 and W163,000. We have taken the median of this range as our target price. LG Telecom Our target price of KRW10,600 is based on our DCF valuation for which we apply a 9.9% WACC and a 0% terminal growth rate after 2014. Li & Fung Our price target of HK$35.3 is based on rolling forward PER of 29.0x, on an unchanged 20% premium to the 3-year trading average. Li Ning Our price target of HK$25.0 is based on a forward PEG of 0.84x, implying a PER of 26.2x EPS FY09E estimate of RMB0.928. Lianhua Our price target of HK$13.00 for Lianhua is based on a multiple of 22.9x 2008E EPS of RMB0.52, in line with its historical 3-year average 12-month forward P/E. We assume a 5% appreciation in the renminbi against the US dollar for 2008E. Our fair value represents 14.5x 2008E ex-cash P/E and 5.5x 2008E EV/EBITDA. Lifestyle International Holdings Our price target of HK$17.6 is derived by a sum-of-the-parts valuation. Limited May 2008 130
  • 130. Lehman Brothers | Equity Research Security Valuation Methodology LIG Insurance We derive our price target of W24,500 with a two-stage Gordon Growth Model, assuming a sustainable ROE of 14.5%, COE of 11.3% and terminal growth rate of 5%. Link REIT Our price target for Link is based on a 10-year DDM using 5.0% risk free rate, 5.0% risk premium, beta of 0.5 and a terminal yield of 7.25%. Lotte Shopping Our 12-month target price is calculated by the sum-of-the-parts valuation by summing its operating value (W9.3trn) and equity-holdings (W1.5trn after applying 30% discount to our estimated value) value and subtracting its net debt (W56b). When deriving the operating value, we apply 7.8x 2008E EBITDA multiple, which reflect global peers’ average. Maanshan Iron & Steel Our 12-month PT of HK$5.0 is based on 11.5x 2008E P/E multiple, 20% higher than its historical average one-year forward P/E multiple, given Magang’s capacity expansion in high-end flat products. Our target 2008 P/E multiple of 11.5x for Magang is lower than our target 2008 P/E multiple of 19.2x for Angang H-shares and 17.5x for Baosteel. We believe the discount is justified given Magang’s relatively commodity-grade focused product mix and the lack of asset injection or M&A activity ahead. Macquarie Group Limited Our price target of A$62.80 is based the average per share valuations of the dividend discount model (A$61.78) and relative dividend yield valuation of A$63.89. Our DDM assumes a risk-free rate of 6%, an equity-risk premium of 5.5% and beta of 1.5. Sustainable ROE is assumed to be 19.5% and assumed dividend payout is 55%. For the past 10 years, MQG’s dividend yield was on average 0.8% below that of the average of the four major Australian commerical banks. Mahanagar Telephone Nigam We use DCF with WACC at 11.8% and a terminal year growth rate of 2%. Malaysian Bulk Carriers Target price is based on sum-of-the-parts. We apply a modified EV/invested capital (IC) multiple to arrive at our fair value, calculated as ROIC/WACC adjusted for terminal growth. If a company is creating value by generating positive economic returns where ROIC > WACC, we ascribe a multiple greater than 1x to the IC. The key difference in our methodology is that we apply this metric to a shipping company, where we can value its assets (i.e. its fleet) using secondhand market transactions instead of accounting-based invested capital, which tends to be distorted by different accounting policies and historical cost. We believe this should provide a better reflection of a shipping company’s asset value and returns. Key assumptions include a return on fleet value (08E-09E) of 18.8%, a WACC of 10.8%, and a long- term growth rate of 1.5%. Our EV/IC valuation factors in a fleet value multiple of 1.9x. Maruti Suzuki India Limited We have discounted Free Cash Flow to Equity (FCFE) to arrive at our target price. Our target price of INR1,042 builds in a terminal growth rate of4% and 4% CAGR in free cash flow to equity (FCFE) in the long run, after an intermediate stage earnings CAGR of 12.6% from FY08E to FY20E. MobileOne We value M1 using a DCF with 8.4% WACC and 0% terminal growth rate. Nan Ya Plastics Our share price target of NT$78 is derived by our sum-of-the-parts analysis, valuing NYP’s core business at 2.2x EV/IC (2008E-2009E average ROIC of 19.0%; WACC of 8.5%), investments in the Formosa Group at our price targets, other listed investments at market price, and unlisted investments at book value. Nan Ya Plastics Our share price target of NT$78 is derived by our sum-of-the-parts analysis, valuing NYP’s core business at 2.2x EV/IC (2008E-2009E average ROIC of 19.0%; WACC of 8.5%), investments in the Formosa Group at our price targets, other listed investments at market price, and unlisted investments at book value. NetEase We derive our price target by applying 15x 2008PE to 2008 EPS estimate of US$1.37 New World Development Our HK$27.50 price target is based on 10% discount to NWD’s end-09E NAV of HK$30.70. Nicholas Piramal India Ltd We value NP using the sum-of-parts valuations, determining the worth of its (1) base business, excluding the innovation R&D entity and (2) 18% stake in the innovation R&D entity. We value the base business using dividend discount model (DDM) to arrive at our Mar 2009 price target of INR 508/share. Our end-FY09 price target of INR 508/share implies a multiple of 18.6x FY10E earnings. We value the innovation R&D facility separately. NP has decided to hive off the innovation R&D entity effective 1st April 2007. We value the R&D entity value at US$ 488mn (end-FY09), or INR 91/share. Therefore, 18% stake in this entity would add INR 16/share to the base business value of INR 508/share, giving a end- FY09 price target INR 524/share. Oil and Natural Gas Corp We have valued ONGC based on ROIC/WACC (19%/11%) analysis and further added value of its overseas oil and gas reserves and other investments to derive our price target. May 2008 131
  • 131. Lehman Brothers | Equity Research Security Valuation Methodology Pacific Basin Target price is based on sum-of-the-parts. We apply a modified EV/invested capital (IC) multiple to arrive at our fair value, calculated as ROIC/WACC adjusted for terminal growth. If a company is creating value by generating positive economic returns where ROIC > WACC, we ascribe a multiple greater than 1x to the IC. The key difference in our methodology is that we apply this metric to a shipping company, where we can value its assets (i.e. its fleet) using secondhand market transactions instead of accounting-based invested capital, which tends to be distorted by different accounting policies and historical costs. We believe this should provide a better reflection of a shipping company’s asset value and returns. Our return on fleet value estimate is based on expected returns for FY08E-FY09E of 17.5%, against a conservative WACC of 10.3%. We assume long-term growth of 1.5%, which represents the average annual global bulk shipping fleet development from 1991-2005. We assume maintenance capex of 4% of fleet vich reflects the amount of ongoing inent to maintain the current fleet aging profile. Our EV/FV valuation factors in a fleet value target multiple of 1.8x. Parkson Retail Group Our price target of HKD93 per share is based on 35x 2009E P/E (EPS of RMB2.31) and assumes 14.5% RMB appreciation against the US dollar for 2008-09E. This represents a 30% premium to the valuation for domestic peers and branded China consumer universe to justify the company’s favourable industry, faster estimated earnings growth, and plenty of potential share price catalysts. PCCW Our 12-month target price is based on sum-of-the-parts valuation methodology. For the fixed-line business, we use a WACC of 10% and long term terminal growth rate of 0%. PCCW Our 12-month target price is based on sum-of-the-parts valuation methodology. For the fixed-line business, we use a WACC of 10% and long term terminal growth rate of 0%. People’s Food We use a DCF valuation methodology to calculate our price target of SGD1.24 for PF.We think DCF best captures the company’s strong operating cash flow generation, and we expect it to remain free cash flow positive in the future. We use a WACC of 13.2% and a 3% terminal growth rate to capture the long-term growth of food & beverage consumption in China. We are using the book value of Pine Agritech to calculate our target price because we do not expect management to sell the stakes in the near future. Perusahaan Gas Negara We use a discounted cash flow (DCF) methodology to value Perusahaan Gas, as we believe it best captures the company’s stable earnings profile. We use a weighted average cost of capital (WACC) of 9.0% and a 2.5% terminal growth rate. Our 12-month price target is set at INR19,400. PetroChina The valuation methodology we use to derive our target price for Petrochina is based on ROACE/WACC = EV/CE. This preferred valuation methodology for PetroChina is an absolute valuation approach, which links returns to share price, as we believe share prices are driven by asset returns (returns on capital). This also captures the market risk premium as well as considers the financial structure of the company. Our target price of HK$15.8 derived from the sum of (i) HK$12.10 per share (based on average 08E- 09E ROACE/WACC (19.8%/10.3%) and LT growth rate: 1.5%) and (ii) HK$3.7 of our estimated oil and gas new discoveries’ value. Our oil price (Brent) forecasts are US$93/bbl for 2008E, US$83/bbl for 2009E, US$75/bbl for 2010E and LT oil price forecast of US$60/bbl. PetroChina The valuation methodology we use to derive our target price for Petrochina is based on ROACE/WACC = EV/CE. This preferred valuation methodology for PetroChina is an absolute valuation approach, which links returns to share price, as we believe share prices are driven by asset returns (returns on capital). This also captures the market risk premium as well as considers the financial structure of the company. Our target price of HK$15.8 derived from the sum of (i) HK$12.10 per share (based on average 08E- 09E ROACE/WACC (19.8%/10.3%) and LT growth rate: 1.5%) and (ii) HK$3.7 of our estimated oil and gas new discoveries’ value. Our oil price (Brent) forecasts are US$93/bbl for 2008E, US$83/bbl for 2009E, US$75/bbl for 2010E and LT oil price forecast of US$60/bbl. Petronas Gas DCF methodology with a WACC of 10.8% and a terminal growth rate of 2%. Precious Shipping Our target price is based on sum-of-the-parts. We apply a modified EV/invested capital (IC) multiple to arrive at our fair value, calculated as ROIC/WACC adjusted for terminal growth. If a company is creating value by generating positive economic returns where ROIC > WACC, we ascribe a multiple greater than 1x to the IC. The key difference in our methodology is that we apply this metric to a shipping company where we can value its assets (i.e. its fleet) using secondhand market transactions instead of accounting-based invested capital, which tends to be distorted by different accounting policies and historical cost. We believe this should provide a better reflection of a shipping company’s asset value and returns. Our return on fleet value (ROFV) estimate is based on expected returns for FY08E-FY09E of12.5%, against a WACC of 12.4%. We assume long-term growth of 1.5%, which represents the average annual global bulk fleet development from 1991-2005. We assume a maintenance capex estimate of 10% of fleet value which reflects our view of how much the comnould theoretically be reinvesting back into fleet renewal to reduce the current fleet aging profile. Alternatively, the fleet would become obsolete. Our EV/IC valuation factors in a fleet value multiple of 1.0x. May 2008 132
  • 132. Lehman Brothers | Equity Research Security Valuation Methodology PrimeAg Australia Limited Our 12 month price target of A$2.25 is derived using a discounted cash flow valuation. We empoy a WACC of 10% and terminal growth rate of 3%. ProMOS We apply a cycle trough P/B multiple of 0.86x for ProMOS as our benchmark valuation to derive our target price. Combining the P/B benchmark and our updated 4Q-forward book value of NT$8.5 (2Q09), we derive our target price of NT$7.3 for ProMOS. Prosperity Real Estate Investment Our HK$1.97 target price is based on a ten-year dividend discount model using 5.0% risk-free rate, Trust 5.0% market risk premium, beta of 0.5 and a terminal yield of 5.7% PT Telkom We derive our Telkom DCF using a 12.2% WACC (on a 9% 10-yr risk-free rate) and a 3% terminal FY12/2015E growth rate for both the mobile and the non-mobile businesses. PTT Aromatics & Refining Our price target of Bt57 is based on a target EV/CE of 1.5x (derived from a 2008E ROCE of 14.7%, WACC of 9.8% and ‘g’ of zero) and valuing its new expansion projects at 1x replacement value. PTT Chemical Our price target of Bt138 is based on a 2008E EV/IC multiple of 1.7x (ROIC 18.1%, WACC 10.4%), Bt7.9 valuation of PTT Polyethylene, listed investments at market value and unlisted investments at book. PTT Exploration & Production Our price target of Bt154 is based on a field-by-field DCF using a WACC of 8.9%. The long-term growth rate is 0% and ROACE (2008E) is 21%. PTT PCL We mark PTT’s listed investments to market, and value the remainder of its businesses as follows: PTT’s natural gas business on a DCF (WACC of 10% and g of zero), oil marketing business at book, and unlisted investments at book value. Ranbaxy Laboratories Ltd We use a dividend discount model as detailed below to value the base business. To arrive at the base business earnings, we make the following adjustments: a) subtract the upside related to one-off exclusivity gains; b) subtract the upside related to one-off notional gains on FCCB; and c) add back NCE R&D spend. RBXY will be hiving off its innovation research entity. Hence, the assumption of adding back the innovation research spends after adjusting for the tax benefit is justified, in our view. The key assumptions of our dividend discount model are: (1) Explicit forecast for the CY08-09 period. (2) Adjusted profit growth to slow down from 25% in CY10E to 7% in the terminal year CY19E. This implies an adjusted profit CAGR of 18% over CY10- 19 (3) Long-term adjusted RoE of 25% compared with 23.5% in CY09 (4) Discount rate of 13% (5) Terminal growth rate of 7%. (2) Based on the dividend discount model, we arrive at Mar-09 price of the base business of INR 441/share. To this, we add INR 140/share as one-off exclity gains. We build in value of INR 22/share for innovation R&D, which should be hived off in a separate entity. This gives us Mar-09 price target of INR 603/share. Earlier, we were treating FCCB as debt and were not building in conversion. Accordingly, we were earlier subtracting the FCCB liability from the valuation. However, now with increase in our target price and strong earnings growth we expect conversion of the FCCB. Therefore, we are now treating FCCB as equity and are using fully diluted number of share for computing per share value. Ratchaburi DCF with a WACC of 8.97% and zero terminal growth rate Reliance Communications Ltd We are using a DCF methodology with WACC at 11.0% and a terminal year growth rate of 3%. Reliance Industries We valued RIL’s core business based on an ROIC-growth/WACC-growth (21%/9%) analysis as we believe share prices are driven by asset returns. We further add the value of assets which are not captured in our core valuation methodology to derive our target price. Sa Sa International Our price target of HK$3.93 is derived from one-year forward PER of 16.6x, on par with that of its peers, to reflect its market leadership and sustainable high dividend payout policy, despite a discount for being more cost-sensitive. Samsung Electronics Our price target of W920,000 is based on 2.5x our mean 2008 and 2009 BPS estimate of W367,848. SC Global Developments Target price pegged at parity to end-08E RNAV Shanghai Industrial In our view, NAV (or sum-of-the-parts value) remains the best valuation methodology for asset-intensive and diversified conglomerates. We value SIHL’s different businesses based on what we believe to be the most appropriate valuation benchmark for each of them. Our 2008E NAV of HK$34.4bn (from HK$45.3bn) or HK$32.1/share (from HK$42.5/share) comprises HK$11.8bn (from HK$14.3bn) for consumer products (based on P/E multiples and Lehman’s target price), HK$7.0bn (from HK$7.9bn) for infrastructure (based on DCF and investment cost), HK$2.1bn (from HK$3.6bn) for pharmaceutical (based on P/E multiple), HK$7.9bn (from HK$10.5bn) for property (based on sum-of-the-parts), HK$2.0bn (from HK$2.6bn) for information technology (based on market value and investment cost), and HK$3.6bn (from HK$6.3bn) head-office net cash. Our price target is based on 20% discount (from 5%) to 2008E NAV. Such discount is fair in our view, given the challenges for SIHL to achieve market leadership at its various businesses, and its overall modest ROE outlook. May 2008 133
  • 133. Lehman Brothers | Equity Research Security Valuation Methodology Shanghai Pudong Development We used the Gordon growth model to derive our fair value P/BV multiple. Our target price of RMB Bank 35.48/share is based on 3.86x our end-2008E adjusted BVPS (post money) assuming a 18.2% sustainable ROE, an 11.25% COE, and 9.1% terminal growth. Shangri-La Asia Ltd Our PT is based on sum-of-the-parts, with SLA’s hotel operations valued at a historical average of 14x 08E EV/EBITDA, and its investment properties valued at a 40% discount to 2008E NAV. In arriving at our 2008E EBITDA estimate, we have assumed RevPAR growth 5% – 13% for SLA’s various hotels depending on their locations, and a largely flat EBITDA margin. Shenzhen Development Bank We used the Gordon growth model to derive our fair value P/B multiple. Our target price of Rmb 31.84/share is based on 3.56x end-2008E BVPS of RMB 8.93, assuming 17.6% sustainable ROE, 11.25% COE, and 8.8% terminal growth. Shinsegae We set our target price at W770,000, based on the sum-of-the-parts valuation. The target price is calculated by summing up the operating value (W11trn), which is derived by DCF valuation and equity holding value (W3.4trn after applying 30% discount to estimated value except Samsung Life Insurance). Shinsegae holds a 14% stake in Samsung Life Insurance, and we reflect its value based on 1.8x Mar 07FY P/B. In our valuation, we assume a WACC of 8.0% (cost of equity at 10.8% and cost of debt at 5.1%), terminal growth of 4% and beta of 0.9. Silitech Technology We conduct ROIC/WACC to derive the fair value of Silitech, as we believe that this methodology can eliminate and screen out short-term uncertainties and focus on long-term value. We have assumed Silitech’s beta to be 0.96 and the tax rate to be 20%. This has led to a WACC assumption of 8.2%. Using EV/IC analysis, we have calculated a fair share price of NT$126 for Silitech. Sincere Navigation Our target price is based on sum-of-the-parts. We apply a modified EV/invested capital (IC) multiple to arrive at our fair value, calculated as ROIC/WACC adjusted for terminal growth. If a company is creating value by generating positive economic returns where ROIC > WACC, we ascribe a multiple greater than 1x to the IC. The key difference in our methodology is that we apply this metric to a shipping company where we can value its assets (i.e. its fleet) using secondhand market transactions instead of accounting-based invested capital, which tends to be distorted by different accounting policies and historical cost. We believe this should provide a better reflection of a shipping company’s asset value and returns. Our return on fleet value (ROFV) estimate is based on expected returns for FY08E-FY09E of 5.9%, against a WACC of 7.3%. We assume long-term growth of 1.5%, which represents average annual bulk fleet development from1991-2005. We assume a maintenance capex estimate of 4% of fleet value, which reflts the amount of ongoing investment to maintae current fleet aging profile. When we calculate the ROFV/WACC spread adjusted for growth, we arrive at a multiple of 0.8x. Sincere Navigation Our target price is based on sum-of-the-parts. We apply a modified EV/invested capital (IC) multiple to arrive at our fair value, calculated as ROIC/WACC adjusted for terminal growth. If a company is creating value by generating positive economic returns where ROIC > WACC, we ascribe a multiple greater than 1x to the IC. The key difference in our methodology is that we apply this metric to a shipping company where we can value its assets (i.e. its fleet) using secondhand market transactions instead of accounting-based invested capital, which tends to be distorted by different accounting policies and historical cost. We believe this should provide a better reflection of a shipping company’s asset value and returns. Our return on fleet value (ROFV) estimate is based on expected returns for FY08E-FY09E of 5.9%, against a WACC of 7.3%. We assume long-term growth of 1.5%, which represents average annual bulk fleet development from1991-2005. We assume a maintenance capex estimate of 4% of fleet value, which reflts the amount of ongoing investment to maintae current fleet aging profile. When we calculate the ROFV/WACC spread adjusted for growth, we arrive at a multiple of 0.8x. SingTel We value Singtel using a sum-of-the-parts and discounted-cash-flow methodology. We base its associate stakes in Bharti, Telkomsel and AIS at our target price. We value its local business on DCF with 8% WACC and 0.5% TGR. We value Optus on DCF with 8.0% WACC and 1% TGR. Sino Land Our HK$29.80 price target is based on a 15% premium to Sino Land’s end-09E NAV of HK$25.90. Sinopec The valuation methodology we use to derive our target price for Sinopec is based on ROACE/WACC = EV/CE. This preferred valuation methodology for Sinopec is an absolute valuation approach, which links returns to share price, as we believe share prices are driven by asset returns (returns on capital). This also captures the market risk premium as well as considers the financial structure of the company. Our target price of HK$10.5 derived from the sum of (i) HK$8.40 per share (based on an average 08E-09E ROACE/WACC (15.4%/9.5%) and (ii) HK$2.1 of our estimated oil and gas new discoveries’ value. Our oil price (Brent) forecasts are US$93/bbl for 2008E, US$83/bbl for 2009E, US$75/bbl for 2010E and LT oil price forecast of US$60/bbl. Sinopec Shanghai Petrochemical Our price target of HK$3.55 is derived from ROACE/WACC (11%/10.5%). Our WACC calculation of 10.5% assumes a risk-free rate of 4.58%, a risk premium of 7.5%, a cost of debt of 5.8%, a cost of equity of 11.5%, and a beta of 0.92. May 2008 134
  • 134. Lehman Brothers | Equity Research Security Valuation Methodology SK Energy Based on our EV/IC analysis, applied to our 2008 earnings estimates, we value SK Energy operating business at W121,765bn. We further add our valuation for SK Incheon at W3,777bn based on EV/CE. In total, we value SK Energy at W19,490bn or W210,000/share. SK Holdings SK Holding’s NAV is derived based on our fair value for SK Energy of W245,000/share and SK Telecom W230,000/share plus market valuation for other subsidiaries listed subsidiaries. SK Telecom SKT’s target price is based on a sum-of-the- parts valuation for which we use a DCF method for the parent company, with 10.79% WACC, and terminal growth rate of -1.0% after 2014E. SmarTone Our 12-month target price is based on a discounted cash flow model. We are using a WACC of 11.9% and a terminal growth rate of 0%. S-Oil Corporation We valued S-Oil at W74,000/share based on our EV/CE valuation formula with ROCE/WACC of 24%/11%. SPG Land Our HK$6.24 price target is based on 15% discount to SPG’s current NAV of Rmb6.99 plus 5% Rmb appreciation. The 15% discount reflects SPG’s 2009 return on assessed NAV and its costs of equity. StarHub Ltd We value StarHub using a DCF with 8.1% WACC and 0.5% terminal growth rate. State Bank of India We value SBI using sum-of-the-parts (SOTP) valuation, valuing the banking and non-banking businesses separately. Our 12 month forward SOTP fair value is INR 1900. We value the parent using a three-stage dividend discount model (DDM) with explicit forecasts up to FY10E, intermediate growth phase between FY10E-FY28E and terminal phase beyond that. We are building an intermediate growth of 16%p.a over FY10E-FY19Eand 10%p.a. over FY20E-FY28E and a sustainable RoE of 15.5%. We are building in a 5% terminal growth in earnings. Using this methodology, we arrive at a 12-month fair value of INR 1590 for the banking business. We value the subsidiaries at a combined INR310. Of this the largest subsidiary, life insurance is valued at 20xFY10E NBAP, which imlpies a value of INR 238/shr. STX Pan Ocean For STX Pan Ocean our target price is based on sum-of-the-parts with return on fleet value (ROFV) estimate based on expected returns for FY08E-FY09E of 15.6%, against a WACC of 10.9%. We assume long-term growth of 1.5%, which represents the average annual fleet development from 1991- 2005. We assume a maintenance capex estimate of 4% of fleet value, which reflects the amount of ongoing investment to maintain the current fleet aging profile. Our EV/IC valuation factors in a fleet value multiple of 1.5x. STX Shipbuilding Our W30,000 price target is based on risk-adjusted 3-stage DCF approach, using a 16% WACC to arrive at our base-case fair value of W51,033 then applying a 41% risk-adjustment discount. Sun Hung Kai Properties Our HK$205.00 price taget is based on 25% premium to SHKP’s end-09E NAV of HK$164.8. Sunplus Technology Co. Ltd. The target price of NT$50 is based on FY08 EPS of NT$4.13 and the historical floor multiple of 12x. Taiwan Cement Our price target is based on a sum-of-the-parts, where we take the value of its cement business (based on EV/tonne of USD140/tonne and capacity of 20.25mn tonnes) less net debt, and then add the value of its investments (based on 15% conglomerate discount to both market value for listed companies and book value for non-listed companies). The discount is lower than Asia Cement due to less cyclical earnings. Taiwan Mobile Our 12-month target price is based on a DCF valution with a WACC of 11.2%, a cost of equity of 14.1% and a long-term FCF growth rate of 0%. Tata Motors We have valued Tata Motors by Sum of Parts methodology. For this purpose we have done a DCF for the standalone business and a multiple based valuation for other key subsidiaries. For DCF we have used a terminal growth rate of 6% and discount rate of 13%. Telecom Corporation of New We apply a 12 month DCF based valuation for TEL. Our calculations factor 6.5% risk free rate, 6.0% Zealand equity risk premium, 0.9 equity beta and 10.1% WACC. Telekom Malaysia Bhd We use a sum-of-the-parts methodology, with a WACC varying between 8% and 14% and terminal exit multiples between 4.5x and 5.0x. Telstra Discounted cash model (DCF) that assumes a WACC of 9.6% and a terminal growth rate of 0.5%. Tenaga Nasional DCF based on WACC of 9.7% and terminal growth rate of 2%. Thai Oil Our valuation is derived from a fair EV/CE multiple of 2.0x, which assumes a ROCE of 21.5%, WACC of 10.6% and long-term growth rate of 0%. The9 Limited Our $30 12-month target price is based on 15x FY08 earnings of $2/share, which is in-line with the average for Chinese online gaming companies’ FY08 P/E multiples. We do not include The9’s $9.40/share in cash in our valuation. May 2008 135
  • 135. Lehman Brothers | Equity Research Security Valuation Methodology Thoresen Thai Our target price is based on a sum-of-the-parts valuation. We apply a modified EV/invested capital (IC) multiple to arrive at our fair value, calculated as ROIC/WACC adjusted for terminal growth. If a company is creating value by generating positive economic returns where ROIC > WACC, we ascribe a multiple greater than 1x to the IC. The key difference in our methodology is that we apply this metric to a shipping company where we can value its assets (i.e., its fleet) using second-hand market transactions instead of accounting-based invested capital, which tends to be distorted by different accounting policies and historical cost. We believe this should provide a better reflection of a shipping company’s asset value and returns. Our return on fleet value (ROFV) estimate is based on expected returns for FY08E-09E of 20.7%, against a conservative WACC of 11.4%. We assume long-term growth of 1.5%, which represents the average annual fleet development from 1992 to 2006. Note that our ROFV could be conservative, ae assume an aggressive maintenance capex estimate of 10%. In our view, a high maintenance capex assumption is necessary if we are to assume that the company wishes to continue as a going concern. Our EV/IC valuation factors in a fleet value multiple of 1.9x. Times We value Times at 14.5x 2009E P/E, in line with the average for China grocery chain store operators. Our target valuation suggests 0.6x PEG and 6.5x 2009E EV/EBITDA. Tingyi We use a DCF valuation methodology to calculate our price target of HK$12.0 for Tingyi. We think DCF best captures the company’s strong operating cash flow generation, and we expect it to remain free cash flow positive in the future. We use a risk-free rate of 4.5%, an equity-risk premium of 7.5% and a beta of 1.1. We factor a long-term debt weight of 25%, a capital weight of 75%, and an after-tax cost of debt of 6.6%. This gives us a WACC of 11.2%. We use a 3% terminal growth rate to capture the long- term growth of food & beverage consumption in China. Total Access Communication We are using DCF (Discounted Cash flow) method to arrive at the target price. Our WACC and terminal growth rate assumptions are 10.2% and 2.0% respectively Transpacific Industries Limited We value TPI on a SOTP EV/EBIT multiple of 13.3 times. This is in line with domestic peer company comparisons. We have assigned a higher multiple for the company’s defensive earnings and a lower multiple to its more cyclical divisions. Our target price implies a FY08E P/E multiple of 20.6x. True Corporation We value True Corp using a sum-of-the parts discounted-cash-flow methodology. We value wireless business on DCF with 12.2% WACC and 2% TGR. We value Wireline business on DCF with 12.2% WACC and 0% TGR and we value Pay TV business on DCF with 12.2% WACC and 3% TGR. TsingTao Brewery (H share) We use a DCF valuation methodology to calculate our price target of HK$23.6 for TB. We think DCF best captures the company’s strong operating cash flow generation, and we expect it to remain free cash flow positive from 2009 onwards. We use a risk-free rate of 4.5%, an equity-risk premium of 7.5% and a beta of 1.1. We factor a long-term debt weight of 25%, a capital weight of 75%, and an after-tax cost of debt of 5.6%. This gives us a WACC of 11%. We use a 3% terminal growth rate to capture the long-term growth of food & beverage consumption in China. TSMC We raise our 12-month TP to NT$76, 3.7x our ‘08 estimated BVPS (NT$20.3), the peak level PB valuation in the ‘05-’07 cycle. TVS Motor We have valued the company by discounting free cash flow to equity (FCFE). For this purpose we have taken a terminal growth rate of 4% and a discount rate of 13% U-Ming Marine Our target price is based on sum-of-the-parts. We apply a modified EV/invested capital (IC) multiple to arrive at our fair value, calculated as ROIC/WACC adjusted for terminal growth. If a company is creating value by generating positive economic returns where ROIC > WACC, we ascribe a multiple greater than 1x to the IC. The key difference in our methodology is that we apply this metric to a shipping company, where we can value its assets (i.e. its fleet) using secondhand market transactions instead of accounting-based invested capital, which tends to be distorted by different accounting policies and historical cost. We believe this should provide a better reflection of a shipping company’s asset value and returns. Our return on fleet value (ROFV) estimate is based on expected returns for FY08E-FY09E of 11.8%, against a WACC of 8.9%. We assume long-term growth of 1.5%, which represents the average annual fleet development from 1991-2005. We assume a maintenance capex estimate of 4% of fleet value, which reflcts the amount of ongoing investment to maintain the current fleet aging profile. Our EV/IC valuation factors in a fleet value multiple of 1.4x. Wharf (Holdings) Ltd. Our HK$60.00 price target is based on 5% discount to Wharf’s end-09 NAV of HK$63.35. WorleyParsons Limited Our price target is derived from 24x our FY09E EPS forecast of AUD 1.66. Our P/E target multiple is at a 13% premium to the Lehman Brothers target P/E multiple for the E&C sector global average. Our valuation premium is due to WOR’s minimal exposure to fixed price contracts relative to its peers. Xinao Gas Our HK$17.30 target price is based on our DCF value, which is based on the NAV at the end of 2008. Our model does not incorporate any unannounced project or acquisition that has not been approved. A 10.5% WACC is derived at a 15.4% cost of equity and a 50% long-term debt to capital ratio. We roll over FCF to 2022 with a 0% terminal growth rate. May 2008 136
  • 136. Lehman Brothers | Equity Research Security Valuation Methodology Yanzhou Coal Mining Co Ltd Our 12-month price target of HK$20.0 is based on our -year DCF analysis. Our WACC assumption is 9.7%, incorporating a cost of equity at 12.2% and a cost of debt at 3.8%. Our terminal growth rate assumption is 2% given Yanzhou Coal’s long reserve life (59 years) and likely continued M&A efforts. On our PT, it would represent 15.3x 08e P/E and 14.2x 09e P/E. Zhengzhou Gas We have used a DCF methodology to derive a fair value of HK$1.51, rounded to HK$1.50. We have assumed a terminal growth rate of 0%, a one-year forward foreign exchange rate of HK$1.12 per RMB and a WACC of 10.8% (debt cost 7%, raw beta: 0.90 adjusted to 0.93, a risk-free rate of 5.0%, a risk premium of 8% and a long-term debt-to-equity ratio of 30%). May 2008 137
  • 137. Lehman Brothers | Equity Research ASIA RESEARCH ROSTER INVESTMENT STRATEGY & MACRO FINANCIAL SERVICES Japan Economics Global Chief Economist Walter Altherr .........................813.6440.1662 ....................walter.altherr@lehman.com Paul Sheard .......................... 1.212.526.0067...........................psheard@lehman.com Takayuki Hayano...................813.6440.1389 ............... takayuki.hayano@lehman.com Non-Japan Asia Junsuke Senoguchi....................813.6440.1676 .............junsuke.senoguchi@lehman.com Robert Subbaraman ................. 852.2252.6249.............................. rsuba@lehman.com Miwako Tani ........................813.6440.1634 .....................miwako.tani@lehman.com Mingchun Sun ...................... 852.2252.6248.............................minsun@lehman.com Non-Japan Asia Young Sun Kwon .................. 852.2252.1370................. youngsun.kwon@lehman.com Michelle Cho ..........................822.2116.7559 .................... michelle.cho@lehman.com Stephen Roberts .................... 61.2.8062. 8431..................stephen.roberts@lehman.com Jee Hoon Park .........................822.2116.7567 ................... jeehoon.park@lehman.com Japan Lacey Cho..............................822.317.5141 ........................ lacey.cho@lehman.com Kenichi Kawasaki.................... 813.6440.1420...............kenichi.kawasaki@lehman.com Lucy Feng...............................852.2252.6174 .........................lucy.feng@lehman.com Hiroshi Shiraishi .................... 813.6440.1427............................hshirais@lehman.com Kenneth Fong ........................852.2252.6196 ....................kenneth.fong@lehman.com Non-Japan Asia Strategy Sarah Hung ..........................8862.8723.1618 ...................... sarah.hung@lehman.com Paul Schulte.......................... 852.2252.1409...................... paul.schulte@lehman.com Timothy Mak .........................61.2.8062. 8449 ..................... timothy.mak@lehman.com Shubhankar Das .................. 852.2252.1424.................shubhankar.das@lehman.com India Japan Strategy Srikanth Vadlamani ...............91.22.4037.4191 ............ srikanth.vadlamani@lehman.com Hidenao Miyajima ................ 813.6440.1380..............hidenao.miyajima@lehman.com Deepak Reddy ...................91.22.4037.4190 ................. deepak.reddyr@lehman.com CUSTOM PRODUCTS HEALTH CARE Non-Japan Asia Justin Lau................................ 852.2252.6697.......................... justin.lau@lehman.com Non-Japan Asia Philip Lo .............................. 852.2252.6617...........................philip.lo@lehman.com Christine Peng .........................852.2252.6191 .................. christine.peng@lehman.com Jibo Ma............................... 852.2252.6619........................... jibo.ma@lehman.com Pharmaceuticals Japan Japan Suni Kim ................................ 813.6440.1351........................... suni.kim@lehman.com Toshihide Yoda .......................813.6440.1674 ............................. tyoda@lehman.com Yukigi Naka .........................813.6440.1668 ......................yukigi.naka@lehman.com SMALL & MID-CAP RESEARCH India Saion Mukherjee ..................91.22.4037.4184 ............... saion.mukherjee@lehman.com Non-Japan Asia MLNPP Prasanth .................91.22.4037.4197 ................ mlnpp.prasanth@lehman.com Josephine Ho........................ 8862.8723.1663.................... josephine.ho@lehman.com India INDUSTRIAL Manish Gunwani ................. 91.22.4037.4182................manish.gunwani@lehman.com Manish Jain....................... 91.22.4037.4186...................... manish.jain@lehman.com Automotive Aatash Shah ..................... 91.22.4037.4194......................aatash.shah@lehman.com Non-Japan Asia Jamil Ansari....................... 91.22.4037.4192...................... jamil.ansari@lehman.com Zayong Koo .............................822.317.5145 ..................... zayong.koo@lehman.com Lydia Shin...............................822.517.5146 ........................ lydia.shin@lehman.com AGRICULTURE Yankun Hou............................852.2252.6234 ......................yankun.hou@lehman.com Japan Non-Japan Asia Tsuyoshi Mochimaru .................813.6440.1338 ........... tsuyoshi.mochimaru@lehman.com Bradley Clibborn.................... 61.2.8062.8447................bradley.clibborn@lehman.com Emi Ohbu.............................813.6440.1647 ........................ emi.ohbu@lehman.com CONSUMER Rie Serizawa ........................813.6440.1624 .................... rie.serizawa@lehman.com India Retail Prabhat Awasthi ..................91.22.4037.4180 ............... prabhat.awasthi@lehman.com Non-Japan Asia Kapil Singh........................91.22.4037.4199 .......................kapil.singh@lehman.com Christine Peng ........................ 852.2252.6191................... christine.peng@lehman.com Building Materials & Construction Phoebe Wong........................ 852.2252.1403...................phoebe.wong@lehman.com India Hong Taik Chung...................... 822.317.5148................. hongtaik.chung@lehman.com Satish Kumar ........................91.22.4037.4183 ...........................satishku@lehman.com Candy Huang ........................ 852.2252.1407.................... candy.huang@lehman.com Abhinav Sharma .................91.22.4037.4198 .........................abhinsha@lehman.com Japan Saion Mukherjee ..................91.22.4037.4184 ............... saion.mukherjee@lehman.com Yasuyuki Sasaki ...................... 813.6440.1681................. yasuyuki.sasaki@lehman.com Tanuj Shori ........................91.22.4037.4028 ....................... tanuj.shori@lehman.com Consumer Chemicals India Mikiya Yamada.......................813.6440.1645 .......................miyamada@lehman.com Manish Gunwani ................. 91.22.4037.4182................manish.gunwani@lehman.com Yusuke Inoue.........................813.6440.1695 ....................yusuke.inoue@lehman.com Osamu Iwasawa ...................813.6440.1648 ............... osamu.iwasawa@lehman.com Conglomerates ENERGY/POWER Non-Japan Asia Oil & Gas Benjamin Lo ............................852.2252.6208 ........manchuenbenjamin.lo@lehman.com Non-Japan Asia Perveen Wong ......................852.2252.6254 ..................perveen.wong@lehman.com Cheng Khoo .......................... 852.2252.6180...................... cheng.khoo@lehman.com Sylvia Chan ..........................852.2252.1414 .................. sylviasw.chan@lehman.com Michael Lo............................. 852.2252.6225........................ michael.lo@lehman.com General Yong Liang Por ..................... 852.2252.6220...................yongliang.por@lehman.com Non-Japan Asia Gordon Wai........................ 852.2252.6176...................... gordon.wai@lehman.com Martin Baker .........................61.2.8062. 8444 .................... martin.baker@lehman.com Martin Baker ........................ 61.2.8062. 8444..................... martin.baker@lehman.com Machinery -Japan Tsutomu Kijima ........................813.6440.1678 .................. tsutomu.kijima@lehman.com Power & Utilities Non-Japan Asia Koji Takahashi.......................813.6440.1526 ...................koji.takahashi@lehman.com Ivan Lee................................. 852.2252.6213........................... ivan.lee@lehman.com Machinery -Korea Evan Li ................................ 852.2252.1405.............................evan.li@lehman.com Mark Yoon ...............................822.317.5159 .......................mark.yoon@lehman.com Metals and Mining Clarisse Pan ......................... 852.2252.6264......................clarisse.pan@lehman.com Japan Non-Japan Asia Masanori Maruo..................... 813.6440.1370................ masanori.maruo@lehman.com Oliver Du ...............................852.2252.1402 ......................... oliver.du@lehman.com Miharu Kiuchi ....................... 813.6440.1659.................... miharu.kiuchi@lehman.com Zayong Koo .............................822.317.5145 ..................... zayong.koo@lehman.com Lydia Shin...............................822.517.5146 ........................ lydia.shin@lehman.com EQUITY SPECIALIST Bradley Clibborn ....................61.2.8062.8447 ............... bradley.clibborn@lehman.com India Japan Prabhat Awasthi ..................91.22.4037.4180 ............... prabhat.awasthi@lehman.com Christopher Schreiber............... 813.6746.7608.......... christopher.schreiber@lehman.com Alok Kumar Nemani ............91.22.4037.4193 .............alokkumar.nemani@lehman.com Shipbuilding Non-Japan Asia Zayong Koo ........................ 822.317.5145..................zayong.koo@lehman.com Mark Yoon .......................... 822.317.5159....................mark.yoon@lehman.com Transportation Non-Japan Asia Andrew Lee ............................852.2252.6197 .................. andrewkw.lee@lehman.com May 2008 138
  • 138. Lehman Brothers | Equity Research INTERNET & MEDIA TELECOMMUNICATIONS Game Software Telecom Services Mia Nagasaka....................... 813.6440.1644.................. mia.nagasaka@lehman.com Non-Japan Asia Internet Paul Wuh ...............................852.2252.6182 .........................paul.wuh@lehman.com Non-Japan Asia Lei Tang ...............................852.2252.6134 ........................... lei.tang@lehman.com David Langford ...................... 61.2.8062.8440.................. david.langford@lehman.com Danny Chu.............................852.2252.6209 ....................... danny.chu@lehman.com Thomas Kierath ................. 61.2.8062.8448.................. thomas.kierath@lehman.com Stanley Yang ............................822.317.5168 .................... stanley.yang@lehman.com Japan Sophia Yoon...........................822.317.5165 .................... sophia.yoon@lehman.com Keiichi Yoneshima ................... 813.6440.1635.............. keiichi.yoneshima@lehman.com David Langford.......................61.2.8062.8440 ................. david.langford@lehman.com Azusa Ejiri ........................... 813.6440.1686........................ azusa.ejiri@lehman.com Thomas Kierath ..................61.2.8062.8448 ..................thomas.kierath@lehman.com Media Japan Non-Japan Asia Tetsuro Tsusaka........................813.6440.1393 ..................tetsuro.tsusaka@lehman.com David Langford ...................... 61.2.8062.8440.................. david.langford@lehman.com Thomas Kierath ................. 61.2.8062.8448.................. thomas.kierath@lehman.com India MANAGEMENT Prabhat Awasthi .................. 91.22.4037.4180................ prabhat.awasthi@lehman.com Global Head of Equity and Fixed Income Research Kapil Singh ....................... 91.22.4037.4199....................... kapil.singh@lehman.com Ravi Mattu ............................1.212.526. 0206 ............................. rmattu@lehman.com QUANTITATIVE RESEARCH Head of Equity and Fixed Income Research in Asia Hua He .................................813.6440.1434 ................................ hhe@lehman.com Japan Co-Deputy Head of Research, Non-Japan Asia Fumiyuki Takahashi.................. 813.6440.1640............. fumiyuki.takahashi@lehman.com Kent Chan .............................852.2252.1408 ..................... kent.chan@lehman.com Hiroko Tada......................... 813.6440.1684...................... hiroko.tada@lehman.com Co-Deputy Head of Research, Non-Japan Asia Hongsong Chou..................... 813.6440.2712................. hongsong.chou@lehman.com Cheng Khoo ...........................852.2252.6180 ..................... cheng.khoo@lehman.com Yingchuan Wang.................. 813.6440.2670...... dorithyyingchuan.wang@lehman.com Head of Research, Japan Koichiro Chiwata ....................813.6440.1660 ...............koichiro.chiwata@lehman.com REAL ESTATE Head of Research, India Property Prabhat Awasthi ..................91.22.4037.4180 ............... prabhat.awasthi@lehman.com Non-Japan Asia Head of Research, Australia Paul Louie .............................. 852.2252.6189........................ paul.louie@lehman.com David Langford.......................61.2.8062.8440 ................. david.langford@lehman.com Jackie Choy ......................... 852.2252.6226...................... jackie.choy@lehman.com Product Manager in Non-Japan Asia Min Chow Sai........................ 65.6433.6959.....................sai.minchow@lehman.com Terri Ellis ................................852.2252.6164 .................... teresa.ellis@lehman.com India Sunayana Agarwal ................852.2252.1415 ............sunayana.agarwal@lehman.com Manish Gunwani ................. 91.22.4037.4182................manish.gunwani@lehman.com Product Manager in Korea Zayong Koo .............................822.317.5145 ..................... zayong.koo@lehman.com TECHNOLOGY Communication Equipment & Components Non-Japan Asia James Kim................................ 822.317.5143........................ james.kim@lehman.com John Kim................................ 822.317.5169.......................... john.kim@lehman.com Computer Hardware and Display Industry Non-Japan Asia James Kim................................ 822.317.5143........................ james.kim@lehman.com John Kim................................ 822.317.5169.......................... john.kim@lehman.com Electronic Components Japan Masaru Koshita....................... 813.6746.7620..................masaru.koshita@lehman.com Eric Lee ................................. 813.6440.1627............................eric.lee@lehman.com Information Technology India Harmendra Gandhi .............. 91.22.4037.4181............. harmendra.gandhi@lehman.com Sarvottam Kumar................ 91.22.4037.4188................ sarvottam.kumar@lehman.com Semiconductors Non-Japan Asia John Hsu.............................. 8862.8723.1627...........................john.hsu@lehman.com Yolanda Wang .................... 8862.8723.1623.................. yolanda.wang@lehman.com Alex Yang............................ 8862.8723.1619........................ alex.yang@lehman.com CW Chung............................ 822.2116.7558..........................cwchung@lehman.com Felix Pan............................ 8862.8723.1614.......................... felix.pan@lehman.com Japan Steven Myers.......................... 813.6440.1636.....................steven.myers@lehman.com Keiji Takeda........................... 813.6440.1638...................... keiji.takeda@lehman.com May 2008 139
  • 139. Lehman Brothers | Equity Research COVERAGE UNIVERSE Companies under Coverage in Asia, by Country (as of May 14, 2008) MarketCap Absolute Relative Company Ticker Analyst Entity Country Rating Price USD (MN) 12M % 12M % Australia Austar United Communications Limited AUN.AX Langford,David LBAUL, Sydney 1,623.97 1 1.32 -8.16 -1.88 Australia Babcock & Brown Limited BNB.AX Mak,Timothy LBAUL, Sydney 4,909.39 2 15.99 -46.95 -43.32 Australia Bluescope Steel Limited BSL.AX Clibborn,Bradley LBAUL, Sydney 7,604.39 3 10.74 -13.46 -7.54 Australia Fairfax Media Limited FXJ.AX Langford,David LBAUL, Sydney 4,822.81 2 3.42 -32.68 -28.07 Australia Macquarie Group Limited MQG.AX Mak,Timothy LBAUL, Sydney 16,410.82 2 64.15 -28.32 -23.42 Australia OneSteel Limited OST.AX Clibborn,Bradley LBAUL, Sydney 5,182.38 1 6.33 0.64 7.52 Australia PrimeAg Australia Limited PAG.AX Clibborn,Bradley LBAUL, Sydney 270.43 1 1.94 0.00 0.00 Australia Seek Limited SEK.AX Langford,David LBAUL, Sydney 1,470.74 1 5.48 -27.42 -22.45 Australia Telstra TLS.AX Langford,David LBAUL, Sydney 43,772.51 1 4.53 -7.55 -1.23 Australia Transpacific Industries Limited TPI.AX Baker,Martin LBAUL, Sydney 2,258.58 1 8.44 -37.44 -33.16 Australia WorleyParsons Limited WOR.AX Baker,Martin LBAUL, Sydney 8,978.58 2 41.58 41.91 51.62 China Aluminum Corp of China 2600.HK Du,Oliver LBAL, Hong Kong 6,866.89 3 13.58 24.13 1.99 China Angang Steel H-share 0347.HK Du,Oliver LBAL, Hong Kong 3,034.82 1 21.80 33.75 9.90 China Anhui Conch 0914.HK Du,Oliver LBAL, Hong Kong 13,612.85 1 67.80 85.75 52.62 China Bank of China (H-shares) 3988.HK Feng,Lucy LBAL, Hong Kong 39,181.65 2 4.02 0.50 -17.43 China Bank of Communications 3328.HK Feng,Lucy LBAL, Hong Kong 31,877.89 1 10.78 27.88 5.07 China Baoshan Iron & Steel 600019.CH Du,Oliver LBAL, Hong Kong 35,036.00 2 14.01 5.50 16.59 China Beijing Enterprises 0392.HK Lo,Benjamin LBAL, Hong Kong 4,577.90 1 31.35 36.90 12.48 China Bright Dairy & Food Co., Ltd 600597.SS Peng,Christine LBAL, Hong Kong 1,536.97 3 10.33 -8.75 0.85 China Brilliance China Automotive 1114.HK Hou,Yankun LBAL, Hong Kong 677.53 3 1.44 -22.58 -36.39 China CITIC Pacific 0267.HK Lo,Benjamin LBAL, Hong Kong 9,971.35 1 35.40 12.03 -7.95 China CITIC Securities Co., Ltd. 600030.SS Feng,Lucy LBAL, Hong Kong 34,626.77 2 36.57 35.90 38.90 China CNOOC 0883.HK Khoo,Cheng LBAL, Hong Kong 83,839.21 2 14.76 108.77 71.53 China COSCO Pacific 1199.HK Lo,Benjamin LBAL, Hong Kong 4,179.32 1 14.52 -27.25 -40.23 China China CITIC Bank (H Share) 0998.HK Feng,Lucy LBAL, Hong Kong 7,870.78 2 4.95 -22.78 -36.55 China China COSCO 1919.HK Lee,Andrew Kam Wing LBAL, Hong Kong 8,139.23 1 24.60 162.54 115.71 China China Coal 1898.HK Du,Oliver LBAL, Hong Kong 8,603.37 1 16.34 87.17 53.79 China China Construction Bank 0939.HK Feng,Lucy LBAL, Hong Kong 207,127.88 1 7.19 46.14 20.07 China China Everbright International Limited 0257.HK Li,Evan LBAL, Hong Kong 1,286.74 1 3.20 25.49 3.11 China China Foods 0506.HK Peng,Christine LBAL, Hong Kong 1,485.23 2 4.15 -21.25 -35.30 China China Mengniu 2319.HK Peng,Christine LBAL, Hong Kong 4,589.51 1 25.10 -6.52 -23.19 China China Merchants Bank (H-shares) 3968.HK Feng,Lucy LBAL, Hong Kong 10,546.16 1 30.90 50.73 23.85 China China Merchants Energy Shipping 601872.SS Lee,Andrew Kam Wing LBAL, Hong Kong 4,456.85 3 9.09 -22.57 -14.43 China China Merchants Hldgs (Int'l) 0144.HK Lo,Benjamin LBAL, Hong Kong 11,123.16 1 36.05 -2.30 -19.73 China China Minsheng Bank Co. 600016.SS Feng,Lucy LBAL, Hong Kong 21,692.15 2 8.07 -13.54 -4.45 China China Mobile Limited 0941.HK Chu,Danny LBAL, Hong Kong 340,302.93 1 132.50 79.66 47.62 China China National Building Materials 3323.HK Du,Oliver LBAL, Hong Kong 5,373.08 1 18.98 74.45 43.33 China China Netcom Group 0906.HK Chu,Danny LBAL, Hong Kong 21,649.89 3 25.30 31.91 8.38 China China Oilfield Services Ltd 2883.HK Khoo,Cheng LBAL, Hong Kong 3,030.50 1 15.40 87.58 54.12 China China Overseas Land 0688.HK Louie,Paul LBAL, Hong Kong 15,636.74 2 15.74 49.05 22.47 China China Power International 2380.HK Lee,Ivan LBAL, Hong Kong 1,225.05 1 2.65 -33.42 -45.29 China China Resources Land 1109.HK Louie,Paul LBAL, Hong Kong 7,375.77 1 14.26 38.99 14.20 China China Resources Power 0836.HK Lee,Ivan LBAL, Hong Kong 10,117.82 1 19.02 23.99 1.87 China China Shenhua Energy 1088.HK Du,Oliver LBAL, Hong Kong 14,379.35 1 33.00 50.69 23.81 China China Shipping Container Lines 2866.HK Lee,Andrew Kam Wing LBAL, Hong Kong 1,702.46 3 3.54 30.96 7.60 China China Shipping Development 1138.HK Lee,Andrew Kam Wing LBAL, Hong Kong 4,386.69 3 26.40 59.42 30.99 China China Techfaith Wireless Comm Tech Ltd CNTF.P Wang,Yolanda LBSTL, Taiwan 254.68 3 5.88 -22.63 -17.11 China China Telecom 0728.HK Chu,Danny LBAL, Hong Kong 57,278.15 3 5.52 24.05 1.92 China China Unicom Ltd. 0762.HK Chu,Danny LBAL, Hong Kong 29,262.81 1 16.74 43.08 17.56 China China Water Affairs Group Limited 0855.HK Li,Evan LBAL, Hong Kong 446.66 2 2.81 -42.65 -52.88 China China Yangtze Power 600900.SS Lee,Ivan LBAL, Hong Kong 19,690.83 2 14.65 -0.61 9.84 China China Yurun Food 1068.HK Peng,Christine LBAL, Hong Kong 2,448.61 1 12.50 40.92 15.79 China Clear Media 0100.HK Wuh,Paul LBAL, Hong Kong 459.85 1 6.84 -17.09 -31.88 China Cosco Shipping 600428.SS Lee,Andrew Kam Wing LBAL, Hong Kong 3,770.68 3 40.30 84.02 103.38 China Ctrip.com International Ltd CTRP.C Huang,Candy LBAL, Hong Kong 4,072.17 1 62.34 72.93 85.27 China Datang International 0991.HK Lee,Ivan LBAL, Hong Kong 3,754.79 1 5.09 2.62 -15.68 China Denway Motors Limited 0203.HK Hou,Yankun LBAL, Hong Kong 4,019.82 1 4.17 22.65 0.77 China Dongfeng Motor Group Co Ltd 0489.HK Hou,Yankun LBAL, Hong Kong 1,493.84 1 4.08 -5.99 -22.76 China Focus Media Holding Limited FMCN.OQ Wuh,Paul LBAL, Hong Kong 4,876.30 1 39.47 1.21 8.43 China Geely Automobile Holdings 0175.HK Hou,Yankun LBAL, Hong Kong 666.84 2 1.00 -14.53 -29.78 China Golden Eagle Retail Group 3308.HK Huang,Candy LBAL, Hong Kong 1,817.40 1 7.80 30.00 6.81 China Great Wall Motor Co 2333.HK Hou,Yankun LBAL, Hong Kong 499.13 1 9.42 -11.63 -27.39 China Greentown 3900.HK Louie,Paul LBAL, Hong Kong 1,888.29 1 9.58 -36.81 -48.08 China Guangzhou R&F 2777.HK Louie,Paul LBAL, Hong Kong 2,972.15 2 20.50 3.33 -15.10 China Hengan International 1044.HK Peng,Christine LBAL, Hong Kong 4,029.50 3 27.50 1.48 -16.62 China Hongguo International HGUO.SI Peng,Christine LBAL, Hong Kong 153.77 1 0.54 -62.06 -59.51 China Huadian Power International 1071.HK Lee,Ivan LBAL, Hong Kong 2,014.86 1 2.61 -41.61 -52.03 China Huaneng Power International 0902.HK Lee,Ivan LBAL, Hong Kong 9,273.86 1 6.00 -31.97 -44.11 China Huaxia Bank 600015.SS Feng,Lucy LBAL, Hong Kong 8,144.97 3 13.58 0.52 11.09 China Industrial & Comml Bank of China(H) 1398.HK Feng,Lucy LBAL, Hong Kong 65,170.72 1 6.12 42.00 16.67 China Inner Mongolia Yili 600887.SS Peng,Christine LBAL, Hong Kong 2,163.08 3 22.74 -24.45 -16.51 China Intime Department Store (Group) 1833.HK Huang,Candy LBAL, Hong Kong 1,361.61 3 5.90 -10.61 -26.55 China Jiangxi Copper 0358.HK Du,Oliver LBAL, Hong Kong 3,248.30 3 18.26 35.86 11.63 China LDK Solar LDK Pan,Clarisse L LBAL, Hong Kong 3,736.75 2 35.94 0.00 0.00 China Lenovo Group Ltd 0992.HK Yang,Alex LBSTL, Taiwan 7,069.44 2 6.19 94.65 59.94 China Li & Fung 0494.HK Wong,Phoebe LBAL, Hong Kong 13,064.12 1 29.50 12.17 -7.84 China Li Ning 2331.HK Wong,Phoebe LBAL, Hong Kong 3,256.51 1 24.45 50.00 23.25 China Lianhua 980.HK Huang,Candy LBAL, Hong Kong 283.45 1 10.68 6.16 -12.77 China Maanshan Iron & Steel (H) 0323.HK Du,Oliver LBAL, Hong Kong 1,281.99 3 5.77 -14.90 -30.08 China NetEase NTES.OQ Wuh,Paul LBAL, Hong Kong 3,116.17 2 24.43 36.10 45.81 Source: Lehman Brothers estimates; 1 = Overweight, 2 = Equalweight, 3 = Underweight, 4 = Rating suspended May 2008 140
  • 140. Lehman Brothers | Equity Research MarketCap Absolute Relative Company Ticker Analyst Entity Country Rating Price USD (MN) 12M % 12M % China PT Davomas Abadi TBK DAVO.JK Peng,Christine LBAL, Hong Kong 326.94 1 245.00 -18.33 -30.98 China Parkson Retail Group 3368.HK Huang,Candy LBAL, Hong Kong 5,184.85 1 72.55 34.35 10.39 China People's Food PFFH.SI Peng,Christine LBAL, Hong Kong 982.32 1 1.20 -42.31 -38.43 China PetroChina 0857.HK Khoo,Cheng LBAL, Hong Kong 29,485.84 1 10.90 7.28 -11.85 China Prime Success 0210.HK Peng,Christine LBAL, Hong Kong 976.49 1 4.65 -20.78 -34.91 China Shandong Weigao 8199.HK Peng,Christine LBAL, Hong Kong 645.84 1 14.50 2.40 -15.86 China Shanghai Automotive Co. 600104.SS Hou,Yankun LBAL, Hong Kong 13,723.98 3 14.67 -6.98 2.81 China Shanghai Industrial 0363.HK Lo,Benjamin LBAL, Hong Kong 4,245.63 3 30.80 30.23 7.00 China Shanghai Pudong Development Bank 600000.SS Feng,Lucy LBAL, Hong Kong 25,086.62 1 31.03 37.86 52.37 China Shenzhen Development Bank 000001.SZ Feng,Lucy LBAL, Hong Kong 9,134.19 1 27.89 0.14 -1.81 China Sinopec 0386.HK Khoo,Cheng LBAL, Hong Kong 16,114.39 1 7.49 -7.19 -23.74 China The9 Limited NCTY.OQ Wuh,Paul LBAL, Hong Kong 701.47 1 23.94 -43.14 -39.08 China Tianjin Capital Environmental 1065.HK Li,Evan LBAL, Hong Kong 134.70 3 3.09 -42.46 -52.72 China Times 1832.HK Huang,Candy LBAL, Hong Kong 392.20 1 3.50 0.00 0.00 China Tingyi 0322.HK Peng,Christine LBAL, Hong Kong 7,237.02 1 10.10 14.51 -5.91 China TsingTao Brewery (H share) 0168.HK Peng,Christine LBAL, Hong Kong 1,931.71 1 23.00 54.78 27.17 China Weichai Power 2338.HK Hou,Yankun LBAL, Hong Kong 690.92 1 42.60 -5.23 -22.13 China Xinao Gas 2688.HK Lee,Ivan LBAL, Hong Kong 1,804.71 1 13.94 28.84 5.86 China Xingda International 1899.HK Hou,Yankun LBAL, Hong Kong 311.02 2 1.75 -60.67 -67.69 China Yanzhou Coal Mining Co Ltd 1171.HK Du,Oliver LBAL, Hong Kong 3,861.76 2 15.38 50.20 23.41 China Yingli Green Energy YGE Pan,Clarisse L LBAL, Hong Kong 3,089.31 1 24.34 0.00 0.00 China Yue Yuen 0551.HK Peng,Christine LBAL, Hong Kong 5,023.13 2 23.55 -15.59 -30.65 China ZTE Corp. 0763.HK Wuh,Paul LBAL, Hong Kong 944.32 1 32.85 26.35 3.81 Hong Kong ASM Pacific 0522.HK Hsu,John LBSTL, Taiwan 3,095.13 1 61.80 14.44 -5.97 Hong Kong BOC Hong Kong Holdings Ltd. 2388.HK Asia,Equity Research LBAL, Hong Kong 27,653.30 2 20.40 3.87 -14.66 Hong Kong Bank of East Asia 0023.HK Asia,Equity Research LBAL, Hong Kong 9,391.74 1 44.20 -6.16 -22.90 Hong Kong Belle International Holdings Limited 1880.HK Wong,Phoebe LBAL, Hong Kong 9,675.56 1 8.94 0.00 0.00 Hong Kong CITIC 1616 Holdings Ltd 1883.HK Tang,Lei LBAL, Hong Kong 535.03 1 2.11 -37.94 -49.01 Hong Kong CLP Holdings 0002.HK Lee,Ivan LBAL, Hong Kong 19,127.65 2 61.95 9.07 -10.39 Hong Kong Champion REIT 2778.HK Choy,Tsun Kit (Jackie) LBAL, Hong Kong 1,438.24 1 4.09 -8.50 -24.82 Hong Kong Cheung Kong 0001.HK Louie,Paul LBAL, Hong Kong 36,288.43 1 122.20 15.94 -4.74 Hong Kong Cheung Kong Infrastructure 1038.HK Lee,Ivan LBAL, Hong Kong 9,248.51 1 32.00 10.73 -9.02 Hong Kong China Communications Services Corp. Ltd. 0552.HK Chu,Danny LBAL, Hong Kong 1,640.35 1 6.42 30.22 7.00 Hong Kong China High Speed Transmn 0658.HK Pan,Clarisse L LBAL, Hong Kong 2,266.65 1 14.20 0.00 0.00 Hong Kong China Resources Enterprise 0291.HK Wong,Phoebe LBAL, Hong Kong 8,506.48 1 27.80 -1.42 -19.00 Hong Kong Comba Telecom System 2342.HK Wuh,Paul LBAL, Hong Kong 237.57 1 2.17 -45.20 -54.98 Hong Kong Dah Sing Banking Group Ltd. 2356.HK Asia,Equity Research LBAL, Hong Kong 1,819.94 1 15.24 -11.81 -27.54 Hong Kong Dah Sing Financial Holdings 0440.HK Asia,Equity Research LBAL, Hong Kong 1,824.45 2 56.90 -16.39 -31.30 Hong Kong Esprit Holdings 0330.HK Wong,Phoebe LBAL, Hong Kong 14,836.53 1 93.10 -2.10 -19.56 Hong Kong Foxconn International Holdings 2038.HK Yang,Alex LBSTL, Taiwan 10,640.49 2 11.76 -50.38 -59.23 Hong Kong GZI Real Estate Investment Trust 0405.HK Louie,Paul LBAL, Hong Kong 376.94 2 2.94 -3.61 -20.80 Hong Kong Galaxy Entertainment Group 0027.HK Wong,Perveen LBAL, Hong Kong 2,876.20 1 5.70 -22.13 -36.02 Hong Kong Giordano International 0709.HK Wong,Phoebe LBAL, Hong Kong 669.31 2 3.50 -10.49 -26.45 Hong Kong Great Eagle 0041.HK Louie,Paul LBAL, Hong Kong 1,934.34 1 24.95 -18.60 -33.12 Hong Kong HSBC Holdings Plc 0005.HK Asia,Equity Research LBAL, Hong Kong 205,865.00 1 135.30 -7.90 -24.32 Hong Kong Hang Lung Properties Limited 0101.HK Louie,Paul LBAL, Hong Kong 16,368.07 2 30.80 25.97 3.50 Hong Kong Hang Seng Bank 0011.HK Asia,Equity Research LBAL, Hong Kong 39,317.33 1 160.40 45.16 19.27 Hong Kong Henderson Land 0012.HK Louie,Paul LBAL, Hong Kong 16,335.33 2 59.35 10.11 -9.53 Hong Kong Hong Kong & China Gas 0003.HK Lee,Ivan LBAL, Hong Kong 16,972.51 3 19.86 28.05 5.21 Hong Kong Hongkong & Shanghai Hotels 0045.HK Wong,Perveen LBAL, Hong Kong 2,543.68 1 13.76 3.15 -15.25 Hong Kong Hongkong Electric 0006.HK Lee,Ivan LBAL, Hong Kong 12,724.36 1 46.50 16.54 -4.25 Hong Kong Hongkong Land HKLD.SI Choy,Tsun Kit (Jackie) LBAL, Hong Kong 11,453.17 1 4.99 3.96 10.95 Hong Kong Hutchison Telecommunications Intl 2332.HK Wuh,Paul LBAL, Hong Kong 6,687.88 2 10.90 -31.88 -44.03 Hong Kong Hutchison Whampoa 0013.HK Lo,Benjamin LBAL, Hong Kong 43,155.14 1 78.95 2.20 -16.03 Hong Kong Hysan Development 0014.HK Louie,Paul LBAL, Hong Kong 3,059.48 1 23.00 6.98 -12.10 Hong Kong Ju Teng International 3336.HK Yang,Alex LBSTL, Taiwan 397.46 1 3.10 59.79 31.29 Hong Kong Kingsoft Corp. Inc. 3888.HK Wuh,Paul LBAL, Hong Kong 571.16 1 4.18 0.00 0.00 Hong Kong Lifestyle International Holdings Limited 1212.HK Wong,Phoebe LBAL, Hong Kong 3,631.82 2 16.60 24.58 2.36 Hong Kong Link REIT 0823.HK Louie,Paul LBAL, Hong Kong 5,179.48 1 18.90 5.47 -13.34 Hong Kong New World Development 0017.HK Louie,Paul LBAL, Hong Kong 9,962.19 2 20.80 5.93 -12.96 Hong Kong Orient Overseas International 0316.HK Lee,Andrew Kam Wing LBAL, Hong Kong 4,248.38 1 52.95 -19.65 -33.98 Hong Kong PCCW 0008.HK Chu,Danny LBAL, Hong Kong 4,250.11 2 4.89 -2.59 -19.96 Hong Kong Pacific Basin 2343.HK Lee,Andrew Kam Wing LBAL, Hong Kong 2,720.71 1 13.38 50.34 23.52 Hong Kong Prosperity Real Estate Investment Trust 0808.HK Louie,Paul LBAL, Hong Kong 255.02 1 1.59 -3.64 -20.82 Hong Kong SPG Land 0337.HK Choy,Tsun Kit (Jackie) LBAL, Hong Kong 522.81 1 3.93 -31.05 -43.35 Hong Kong Sa Sa International 0178.HK Wong,Phoebe LBAL, Hong Kong 541.00 1 3.06 15.91 -4.77 Hong Kong Semiconductor Mfg Intl Co. (SMIC) 0981.HK Hsu,John LBSTL, Taiwan 1,334.49 3 0.56 -47.66 -57.00 Hong Kong Shangri-La Asia Ltd 0069.HK Wong,Perveen LBAL, Hong Kong 8,111.97 2 21.95 3.78 -14.73 Hong Kong Shun Tak Holdings 0242.HK Wong,Perveen LBAL, Hong Kong 3,047.20 1 10.14 -7.82 -24.26 Hong Kong Sino Land 0083.HK Louie,Paul LBAL, Hong Kong 13,234.00 1 21.25 19.52 -1.80 Hong Kong Sinopec Shanghai Petrochemical 0338.HK Khoo,Cheng LBAL, Hong Kong 878.28 1 2.94 -50.51 -59.33 Hong Kong SmarTone 0315.HK Chu,Danny LBAL, Hong Kong 662.19 2 8.98 -0.22 -18.02 Hong Kong Solomon Systech 2878.HK Wang,Yolanda LBSTL, Taiwan 148.92 2 0.48 -53.43 -61.74 Hong Kong Standard Chartered Plc 2888.HK Asia,Equity Research LBAL, Hong Kong 50,732.20 1 280.20 13.44 -6.79 Hong Kong Sun Hung Kai Properties 0016.HK Louie,Paul LBAL, Hong Kong 45,174.01 1 137.40 45.24 19.34 Hong Kong Swire Pacific Ltd 0019.HK Lo,Benjamin LBAL, Hong Kong 11,210.36 2 95.50 5.82 -13.06 Hong Kong TPV Technology Co. 0903.HK Wang,Yolanda LBSTL, Taiwan 1,340.50 1 5.37 0.75 -17.22 Hong Kong Towngas China Company 1083.HK Lee,Ivan LBAL, Hong Kong 878.44 2 3.50 -17.04 -31.84 Hong Kong Wharf (Holdings) Ltd. 0004.HK Louie,Paul LBAL, Hong Kong 14,564.42 1 41.25 35.30 11.17 Hong Kong Wing Hang Bank 0302.HK Asia,Equity Research LBAL, Hong Kong 3,993.56 1 105.60 14.78 -5.69 Source: Lehman Brothers estimates; 1 = Overweight, 2 = Equalweight, 3 = Underweight, 4 = Rating suspended May 2008 141
  • 141. Lehman Brothers | Equity Research MarketCap Absolute Relative Company Ticker Analyst Entity Country Rating Price USD (MN) 12M % 12M % Hong Kong Zhengzhou Gas 3928.HK Lee,Ivan LBAL, Hong Kong 78.37 1 1.11 -2.63 -20.00 Hong Kong Zhongyu Gas 8070.HK Lee,Ivan LBAL, Hong Kong 182.01 2 0.73 -40.16 -50.84 India ABB India ABB.NS Kumar,Satish LBSPL, India 5,307.94 1 1062.55 24.05 0.02 India ACC Ltd ACC.NS Kumar,Satish LBSPL, India 3,021.17 3 683.00 -21.26 -36.51 India Ambuja Cements GACM.NS Kumar,Satish LBSPL, India 4,003.62 3 111.55 -9.79 -27.26 India Ashok Leyland ASOK.NS Awasthi,Prabhat LBSPL, India 1,204.27 2 38.40 2.26 -17.54 India Asian Paints ASPN.NS Jain,Manish LBSPL, India 2,788.62 1 1233.25 56.40 26.11 India Bajaj Auto BJAT.NS Awasthi,Prabhat LBSPL, India 3,047.67 1 675.85 -52.11 -61.39 India Bank of Baroda BOB.NS Vadlamani,Srikanth LBSPL, India 2,534.06 1 295.10 9.34 -11.84 India Bharat Electronics BAJE.NS Kumar,Satish LBSPL, India 2,330.69 1 1235.85 -25.30 -39.77 India Bharat Heavy Electricals Ltd (BHEL) BHEL.NS Kumar,Satish LBSPL, India 20,071.24 2 1739.30 41.61 14.18 India Bharti Airtel Limited BRTI.BO Wuh,Paul LBAL, Hong Kong 36,743.79 1 821.25 -0.34 -19.64 India Canara Bank CNBK.NS Vadlamani,Srikanth LBSPL, India 2,252.49 1 233.05 1.26 -18.35 India Cipla Ltd CIPL.NS Mukherjee,Saion LBSPL, India 3,803.08 3 207.55 -1.68 -20.72 India Crompton Greaves CROM.NS Kumar,Satish LBSPL, India 2,004.79 1 232.00 2.77 -17.14 India DLF Ltd. DLF.NS Gunwani,Manish LBSPL, India 24,716.45 1 615.00 0.00 0.00 India Dabur India DABU.NS Jain,Manish LBSPL, India 2,023.59 3 99.35 10.45 -10.94 India Dr Reddy's Laboratories Ltd REDY.NS Mukherjee,Saion LBSPL, India 2,475.61 2 624.40 -4.12 -22.69 India Edelweiss Capital Ltd EDEL.NS Vadlamani,Srikanth LBSPL, India 1,342.59 1 760.05 0.00 0.00 India Exide Industries EXID.NS Jain,Manish LBSPL, India 1,415.37 1 75.05 70.30 37.31 India Godrej Consumer GOCP.NS Jain,Manish LBSPL, India 827.50 1 136.00 -0.34 -19.65 India Grasim Industries GRAS.NS Kumar,Satish LBSPL, India 4,794.41 2 2218.50 -9.91 -27.36 India HCC HCNS.NS Mukherjee,Saion LBSPL, India 788.02 1 130.45 35.67 9.40 India HCL Technologies HCLT.NS Gandhi,Harmendra LBSPL, India 4,605.00 1 293.60 -11.12 -28.34 India HDFC HDFC.NS Vadlamani,Srikanth LBSPL, India 17,800.85 1 2658.20 58.23 27.58 India HDFC Bank HDBK.NS Vadlamani,Srikanth LBSPL, India 12,386.89 1 1482.20 48.82 20.00 India Hero Honda HROH.NS Awasthi,Prabhat LBSPL, India 3,756.04 2 797.90 15.62 -6.77 India Hindustan Unilever Limited HLL.BO Jain,Manish LBSPL, India 12,612.48 1 245.65 27.91 3.14 India ICICI Bank ICBK.NS Vadlamani,Srikanth LBSPL, India 23,288.67 1 887.85 2.05 -17.72 India ITC Limited ITC.BO Jain,Manish LBSPL, India 20,029.06 3 225.45 39.17 12.21 India IVRCL Infra. IVRC.NS Mukherjee,Saion LBSPL, India 1,335.37 1 427.70 36.21 9.83 India Idea Cellular Limited IDEA.BO Wuh,Paul LBAL, Hong Kong 6,375.18 2 104.30 -8.59 -26.29 India India Cements ICMN.NS Kumar,Satish LBSPL, India 1,023.33 3 154.00 -16.28 -32.50 India Indian Overseas Bank IOBK.IN Vadlamani,Srikanth LBSPL, India 1,925.17 1 149.90 26.39 1.91 India Infosys Technologies INFY.NS Gandhi,Harmendra LBSPL, India 23,541.23 1 1747.20 -12.74 -29.64 India Larsen & Toubro LART.NS Mukherjee,Saion LBSPL, India 19,397.16 1 2814.75 66.78 34.47 India Mahanagar Telephone Nigam MTNL.BO Wuh,Paul LBAL, Hong Kong 1,506.68 3 101.45 -33.97 -46.76 India Marico Limited MRCO.NS Jain,Manish LBSPL, India 912.35 1 63.55 9.47 -11.73 India Maruti Suzuki India Limited MRTI.NS Awasthi,Prabhat LBSPL, India 5,245.26 1 770.15 -4.19 -22.74 India NTPC NTPC.BO Lee,Ivan LBAL, Hong Kong 37,376.56 2 192.30 23.07 -0.76 India Nagarjuna Constructions NGCN.NS Mukherjee,Saion LBSPL, India 1,113.18 1 206.35 21.28 -2.21 India Nicholas Piramal India Ltd NICH.BO Mukherjee,Saion LBSPL, India 1,703.10 1 345.65 30.38 5.13 India Oil and Natural Gas Corp ONGC.BO Lo,Michael LBAL, Hong Kong 50,275.09 1 997.10 9.96 -11.34 India Punjab National Bank PNBK.NS Vadlamani,Srikanth LBSPL, India 3,683.35 1 495.55 -7.44 -25.37 India Puravankara Projects Ltd. PPRO.BO Gunwani,Manish LBSPL, India 1,319.81 1 262.25 0.00 0.00 India Ranbaxy Laboratories Ltd RANB.NS Mukherjee,Saion LBSPL, India 4,268.22 1 485.10 22.87 -0.93 India Redington India REDI.NS Gunwani,Manish LBSPL, India 644.94 1 351.35 95.63 57.74 India Reliance Communications Ltd RLCM.BO Wuh,Paul LBAL, Hong Kong 26,549.63 1 545.65 13.16 -8.76 India Reliance Energy RLEN.BO Lee,Ivan LBAL, Hong Kong 7,440.26 2 1381.25 170.09 117.78 India Reliance Industries RIL.BO Lo,Michael LBAL, Hong Kong 85,719.66 1 2501.45 54.32 24.44 India Satyam Computer SATY.NS Gandhi,Harmendra LBSPL, India 7,849.29 1 495.95 7.49 -13.33 India Shree Cement SHCM.NS Kumar,Satish LBSPL, India 741.79 2 903.25 -14.07 -30.71 India State Bank of India SBI.NS Vadlamani,Srikanth LBSPL, India 24,830.08 3 1668.00 46.62 18.22 India Sun Pharmaceutical Industries Ltd SUN.NS Mukherjee,Saion LBSPL, India 6,617.02 1 1355.25 37.01 10.48 India Suzlon Energy Limited SUZL.BO Lee,Ivan LBAL, Hong Kong 9,984.95 1 282.95 11.50 -10.10 India TVS Motor TVSM.NS Awasthi,Prabhat LBSPL, India 231.27 2 41.30 -33.76 -46.59 India Tata Consultancy Services TCS.NS Gandhi,Harmendra LBSPL, India 20,894.08 1 905.70 -27.50 -41.54 India Tata Motors TAMO.NS Awasthi,Prabhat LBSPL, India 6,051.10 1 665.85 -6.74 -24.81 India Tata Power TTPW.BO Lee,Ivan LBAL, Hong Kong 6,288.76 2 1348.00 130.51 85.86 India Tata Tea TTTE.BO Jain,Manish LBSPL, India 1,349.93 1 926.00 16.32 -6.21 India Tech Mahindra TEML.NS Gandhi,Harmendra LBSPL, India 2,583.94 1 902.60 -41.01 -52.44 India Ultratech Cement ULTC.NS Kumar,Satish LBSPL, India 1,954.74 3 666.10 -18.75 -34.49 India Union Bank of India UNBK.NS Vadlamani,Srikanth LBSPL, India 1,914.73 1 160.80 35.18 9.00 India Unitech Ltd. UNTE.NS Gunwani,Manish LBSPL, India 10,541.21 1 275.45 17.95 -4.89 India Wipro WIPR.NS Gandhi,Harmendra LBSPL, India 17,021.23 1 494.20 -9.14 -26.74 Indonesia Indosat ISAT.JK Wuh,Paul LBAL, Hong Kong 3,536.88 1 6050.00 -11.03 -24.81 Indonesia PT Telkom TLKM.JK Wuh,Paul LBAL, Hong Kong 18,869.47 2 8700.00 -10.77 -24.59 Indonesia Perusahaan Gas Negara PGAS.JK Asia,Equity Research LBAL, Hong Kong 7,289.21 1 14750.00 43.90 21.61 Japan ALPS ELECTRIC 6770.T Lee,Eric LBJ, Tokyo 1,944.48 2 1127.00 -3.01 22.27 Japan Acom 8572.T Altherr,Walter LBI, New York 4,869.39 1 3210.00 -26.38 -7.18 Japan Advantest 6857.T Myers,Steven LBJ, Tokyo 5,357.57 2 2825.00 -47.20 -33.43 Japan Aeon 8267.T Sasaki,Yasuyuki LBJ, Tokyo 11,204.56 1 1473.00 -34.09 -16.91 Japan Aiful 8515.T Altherr,Walter LBI, New York 3,066.85 3 1927.00 -42.48 -27.48 Japan Amada 6113.T Kijima,Tsutomu LBJ, Tokyo 3,619.97 1 945.00 -36.00 -18.90 Japan Aozora Bank 8304.T Senoguchi,Junsuke LBJ, Tokyo 4,625.99 1 295.00 -31.87 -14.11 Japan Asahi Kasei 3407.T Yamada,Mikiya LBJ, Tokyo 7,944.11 2 596.00 -26.51 -7.35 Japan Astellas Pharma Inc. 4503.T Yoda,Toshihide LBJ, Tokyo 21,206.40 2 4300.00 -17.94 3.45 Japan Bank of The Ryukyus 8399.T Tani,Miwako LBJ, Tokyo 405.30 1 1085.00 -56.25 -44.84 Japan Bank of Yokohama 8332.T Senoguchi,Junsuke LBJ, Tokyo 9,731.98 2 747.00 -18.45 2.81 Japan Brother Industries, Ltd. 6448.T Takeda,Keiji LBJ, Tokyo 3,792.61 2 1438.00 -12.74 10.01 Source: Lehman Brothers estimates; 1 = Overweight, 2 = Equalweight, 3 = Underweight, 4 = Rating suspended May 2008 142
  • 142. Lehman Brothers | Equity Research MarketCap Absolute Relative Company Ticker Analyst Entity Country Rating Price USD (MN) 12M % 12M % Japan Canon 7751.T Myers,Steven LBJ, Tokyo 70,084.64 1 5530.00 -20.55 0.17 Japan Canon Marketing Japan 8060.T Takeda,Keiji LBJ, Tokyo 2,928.85 1 2040.00 -14.47 7.83 Japan Capcom 9697.T Nagasaka,Mia LBJ, Tokyo 1,997.21 1 3150.00 66.67 110.12 Japan Chubu Electric Power 9502.T Maruo,Masanori LBJ, Tokyo 17,692.87 2 2390.00 -34.34 -17.22 Japan Chugai Pharmaceutical 4519.T Yoda,Toshihide LBJ, Tokyo 7,998.61 1 1504.00 -49.45 -36.27 Japan Chugoku Electric Power 9504.T Maruo,Masanori LBJ, Tokyo 8,004.32 2 2270.00 -11.33 11.79 Japan Chuo Mitsui Trust Holdings 8309.T Senoguchi,Junsuke LBJ, Tokyo 6,691.28 2 713.00 -39.32 -23.50 Japan Circle K Sunkus 3337.T Sasaki,Yasuyuki LBJ, Tokyo 1,294.02 2 1580.00 -23.67 -3.77 Japan CyberAgent 4751.T Yoneshima,Keiichi LBJ, Tokyo 954.78 1 152000.00 104.85 158.26 Japan Daicel Chemical Industries 4202.T Yamada,Mikiya LBJ, Tokyo 2,233.42 1 644.00 -15.93 5.99 Japan Daiei 8263.T Sasaki,Yasuyuki LBJ, Tokyo 1,000.77 1 859.00 -35.75 -19.00 Japan Daihatsu Motor 7262.T Mochimaru,Tsuyoshi LBJ, Tokyo 4,911.32 2 1210.00 28.86 62.45 Japan Daiichi Sankyo Co. 4568.T Yoda,Toshihide LBJ, Tokyo 19,557.45 1 2800.00 -20.68 0.00 Japan Daikin Industries 6367.T Kijima,Tsutomu LBJ, Tokyo 14,734.38 2 5290.00 20.50 52.60 Japan Dainippon Sumitomo Pharmaceutical 4506.T Yoda,Toshihide LBJ, Tokyo 3,183.80 2 842.00 -34.01 -16.81 Japan Daiwa Securities Group Inc 8601.T Altherr,Walter LBI, New York 13,802.36 1 1034.00 -24.85 -5.26 Japan DeNA 2432.T Yoneshima,Keiichi LBJ, Tokyo 3,523.88 2 763000.00 98.70 150.50 Japan E-Trade Securities 8701.Q Yoneshima,Keiichi LBJ, Tokyo 3,453.23 3 105000.00 -20.45 0.28 Japan Eisai 4523.T Yoda,Toshihide LBJ, Tokyo 10,795.19 2 3830.00 -32.40 -14.30 Japan Elpida Memory 6665.T Myers,Steven LBJ, Tokyo 4,969.81 1 4030.00 -19.08 2.02 Japan FUJIFILM Holdings 4901.T Takeda,Keiji LBJ, Tokyo 19,464.12 1 3980.00 -21.19 -0.64 Japan FamilyMart 8028.T Sasaki,Yasuyuki LBJ, Tokyo 3,518.19 1 3790.00 22.26 54.13 Japan Fanuc 6954.T Kijima,Tsutomu LBJ, Tokyo 25,264.08 3 11100.00 -1.86 23.73 Japan Fuji Fire & Marine Insurance Co Ltd 8763.T Altherr,Walter LBI, New York 1,542.89 2 344.00 -33.20 -15.79 Japan Fuji Heavy Industries 7270.T Mochimaru,Tsuyoshi LBJ, Tokyo 3,489.16 3 469.00 -15.80 6.15 Japan Fujitsu 6702.T Myers,Steven LBJ, Tokyo 15,107.60 2 768.00 2.67 29.44 Japan Fukuoka Financial Group 8354.T Tani,Miwako LBJ, Tokyo 4,093.51 2 501.00 -41.90 -26.70 Japan GMO Internet 9449.T Yoneshima,Keiichi LBJ, Tokyo 687.53 2 720.00 -15.79 6.16 Japan H2O Retailing 8242.T Sasaki,Yasuyuki LBJ, Tokyo 1,575.66 2 802.00 -28.33 -9.64 Japan Hino Motors 7205.T Mochimaru,Tsuyoshi LBJ, Tokyo 3,494.55 1 640.00 -2.44 23.00 Japan Hirose Electric 6806.T Koshita,Masaru LBJ, Tokyo 4,632.29 2 12180.00 -11.68 11.35 Japan Hiroshima Bank 8379.T Tani,Miwako LBJ, Tokyo 3,238.34 1 545.00 -19.62 1.34 Japan Hitachi 6501.T Myers,Steven LBJ, Tokyo 22,949.21 2 717.00 -19.17 1.91 Japan Hitachi Chemical 4217.T Yamada,Mikiya LBJ, Tokyo 4,415.28 1 2230.00 -15.05 7.10 Japan Hitachi Construction Machinery 6305.T Kijima,Tsutomu LBJ, Tokyo 7,277.48 2 3560.00 -8.95 14.78 Japan Hokkaido Electric Power 9509.T Maruo,Masanori LBJ, Tokyo 4,439.64 1 2170.00 -27.91 -9.11 Japan Hokuriku Electric Power 9505.T Maruo,Masanori LBJ, Tokyo 5,119.41 2 2445.00 -7.03 17.20 Japan Honda Motor 7267.T Mochimaru,Tsuyoshi LBJ, Tokyo 57,888.70 1 3320.00 -18.63 2.59 Japan Ibiden 4062.T Koshita,Masaru LBJ, Tokyo 6,994.59 1 4880.00 -23.63 -3.72 Japan Index Holdings 4835.Q Yoneshima,Keiichi LBJ, Tokyo 512.58 3 23110.00 -36.60 -20.07 Japan Internet Initiative Japan 3774.T Yoneshima,Keiichi LBJ, Tokyo 665.59 1 340000.00 -12.60 10.19 Japan Isuzu Motors 7202.T Mochimaru,Tsuyoshi LBJ, Tokyo 8,304.43 2 515.00 -11.97 10.98 Japan JSR 4185.T Yamada,Mikiya LBJ, Tokyo 5,653.64 1 2325.00 -12.43 10.40 Japan KDDI 9433.T Tsusaka,Tetsuro LBJ, Tokyo 29,834.64 1 700000.00 -31.37 -13.48 Japan KOEI 9654.T Nagasaka,Mia LBJ, Tokyo 1,074.47 3 1647.00 -14.75 7.47 Japan Kansai Electric Power 9503.T Maruo,Masanori LBJ, Tokyo 21,956.44 2 2400.00 -23.81 -3.95 Japan Komatsu 6301.T Kijima,Tsutomu LBJ, Tokyo 30,181.56 2 3180.00 4.95 32.31 Japan Konami 9766.T Nagasaka,Mia LBJ, Tokyo 5,075.52 2 3890.00 28.38 61.85 Japan Konica Minolta Holdings 4902.T Takeda,Keiji LBJ, Tokyo 8,968.01 2 1775.00 11.71 40.83 Japan Kubota 6326.T Kijima,Tsutomu LBJ, Tokyo 9,189.49 1 752.00 -22.71 -2.56 Japan Kuraray 3405.T Yamada,Mikiya LBJ, Tokyo 4,806.27 2 1321.00 -2.15 23.36 Japan Kyocera 6971.T Koshita,Masaru LBJ, Tokyo 18,307.34 3 10070.00 -14.66 7.59 Japan Kyorin 4569.T Yoda,Toshihide LBJ, Tokyo 841.86 2 1182.00 -26.77 -7.67 Japan Kyushu Electric Power 9508.T Maruo,Masanori LBJ, Tokyo 10,296.58 2 2285.00 -31.99 -14.26 Japan Lawson 2651.T Sasaki,Yasuyuki LBJ, Tokyo 4,098.34 3 4330.00 -0.92 24.92 Japan Lopro Corp 8577.T Altherr,Walter LBI, New York 91.09 1 84.00 -53.59 -41.49 Japan Marui Group 8252.T Sasaki,Yasuyuki LBJ, Tokyo 2,810.19 2 928.00 -32.56 -14.98 Japan Maruman & Co.,Ltd. 7834.OJ Altherr,Walter LBI, New York 57.75 2 572.00 -21.75 -1.35 Japan Matsui Securities 8628.T Yoneshima,Keiichi LBJ, Tokyo 1,929.27 1 754.00 -20.21 0.59 Japan Mazda Motor 7261.T Mochimaru,Tsuyoshi LBJ, Tokyo 6,200.84 2 460.00 -30.20 -12.00 Japan Mediceo Paltac Holdings Co Ltd 7459.T Yoda,Toshihide LBJ, Tokyo 4,220.12 2 1826.00 -15.70 6.80 Japan Millea Holdings Inc 8766.T Altherr,Walter LBI, New York 33,333.88 2 4360.00 -6.84 17.45 Japan Minebea 6479.T Kijima,Tsutomu LBJ, Tokyo 2,404.95 1 634.00 -7.31 16.85 Japan Mitsubishi Chemical Holdings 4188.T Yamada,Mikiya LBJ, Tokyo 10,435.08 2 729.00 -31.10 -13.13 Japan Mitsubishi Electric 6503.T Myers,Steven LBJ, Tokyo 23,669.61 1 1160.00 5.36 32.83 Japan Mitsubishi Motors 7211.T Mochimaru,Tsuyoshi LBJ, Tokyo 8,578.13 3 163.00 -13.30 9.31 Japan Mitsubishi Rayon 3404.T Yamada,Mikiya LBJ, Tokyo 2,058.34 2 361.00 -53.54 -41.43 Japan Mitsubishi Tanabe Pharma 4508.T Yoda,Toshihide LBJ, Tokyo 6,866.34 2 1287.00 -23.03 -2.96 Japan Mitsubishi UFJ Financial Group 8306.T Senoguchi,Junsuke LBJ, Tokyo 108,895.09 2 1055.00 -21.27 -0.74 Japan Mitsui Chemicals 4183.T Yamada,Mikiya LBJ, Tokyo 4,597.10 1 613.00 -35.13 -18.22 Japan Mitsui Sumitomo Insurance Group Holdings 8725.T Altherr,Walter LBI, New York 17,136.31 2 4280.00 -15.25 6.85 Japan Mixi Inc. 2121.T Yoneshima,Keiichi LBJ, Tokyo 1,119.26 3 780000.00 -3.11 22.15 Japan Mizuho Financial Group 8411.T Senoguchi,Junsuke LBJ, Tokyo 55,989.09 2 517000.00 -33.46 -16.12 Japan Monex Beans Holdings 8698.T Yoneshima,Keiichi LBJ, Tokyo 1,551.00 2 69600.00 -31.76 -13.98 Japan Murata Mfg. 6981.O Koshita,Masaru LBJ, Tokyo 11,195.77 2 5230.00 -37.89 -21.69 Japan NEC 6701.T Myers,Steven LBJ, Tokyo 10,126.48 2 525.00 -16.53 5.23 Japan NEC Electronics 6723.T Myers,Steven LBJ, Tokyo 2,552.62 1 2175.00 -22.74 -2.59 Japan NGK SPARK PLUG 5334.T Koshita,Masaru LBJ, Tokyo 2,916.48 3 1337.00 -30.00 -11.75 Japan NHK Spring 5991.T Koshita,Masaru LBJ, Tokyo 1,992.33 1 859.00 -23.58 -3.65 Japan NSK 6471.T Kijima,Tsutomu LBJ, Tokyo 4,887.70 2 933.00 -23.90 -4.06 Source: Lehman Brothers estimates; 1 = Overweight, 2 = Equalweight, 3 = Underweight, 4 = Rating suspended May 2008 143
  • 143. Lehman Brothers | Equity Research MarketCap Absolute Relative Company Ticker Analyst Entity Country Rating Price USD (MN) 12M % 12M % Japan NTN 6472.T Kijima,Tsutomu LBJ, Tokyo 3,362.05 2 752.00 -24.27 -4.53 Japan NTT 9432.T Tsusaka,Tetsuro LBJ, Tokyo 74,494.13 1 498000.00 -12.01 10.92 Japan NTT DoCoMo 9437.T Tsusaka,Tetsuro LBJ, Tokyo 67,797.48 1 159000.00 -24.29 -4.55 Japan Namco Bandai Holdings 7832.T Nagasaka,Mia LBJ, Tokyo 3,346.10 1 1375.00 -30.17 -11.96 Japan Nidec 6594.O Koshita,Masaru LBJ, Tokyo 10,650.48 1 7730.00 9.96 38.62 Japan Nihon Inter Electronics 6974.T Myers,Steven LBJ, Tokyo 70.52 1 235.00 -60.90 -50.70 Japan Nikon 7731.T Myers,Steven LBJ, Tokyo 12,395.03 2 3260.00 9.03 37.45 Japan Nintendo 7974.T Nagasaka,Mia LBJ, Tokyo 78,488.09 1 58300.00 50.65 89.92 Japan Nissan Motor 7201.T Mochimaru,Tsuyoshi LBJ, Tokyo 41,241.90 2 960.00 -25.64 -6.25 Japan Nitto Denko 6988.T Yamada,Mikiya LBJ, Tokyo 8,190.06 2 4960.00 -8.82 14.95 Japan Nomura Holdings Inc 8604.T Altherr,Walter LBI, New York 32,787.13 1 1755.00 -29.52 -11.14 Japan Olympus 7733.T Takeda,Keiji LBJ, Tokyo 8,584.77 2 3330.00 -28.54 -9.91 Japan Ono Pharmaceutical 4528.T Yoda,Toshihide LBJ, Tokyo 6,178.49 2 5380.00 -18.11 3.24 Japan Osaka Gas Company 9532.T Maruo,Masanori LBJ, Tokyo 7,835.24 2 382.00 -14.92 7.26 Japan Promise 8574.T Altherr,Walter LBI, New York 4,242.23 2 3310.00 -15.13 7.00 Japan Rakuten 4755.Q Yoneshima,Keiichi LBJ, Tokyo 7,593.52 1 61100.00 29.18 62.85 Japan Resona Holdings 8308.T Senoguchi,Junsuke LBJ, Tokyo 20,366.82 3 188000.00 -33.80 -16.55 Japan Ricoh 7752.T Takeda,Keiji LBJ, Tokyo 12,897.74 1 1822.00 -31.12 -13.16 Japan Rohm 6963.O Koshita,Masaru LBJ, Tokyo 7,654.38 2 6780.00 -35.55 -18.75 Japan SBI Holdings, Inc. 8473.T Yoneshima,Keiichi LBJ, Tokyo 3,568.81 1 30200.00 -21.66 -1.24 Japan SFCG Co. Ltd 8597.T Altherr,Walter LBI, New York 1,362.62 1 11710.00 -46.26 -32.25 Japan SMC 6273.T Kijima,Tsutomu LBJ, Tokyo 8,175.16 2 11970.00 -17.90 3.50 Japan Sanken Electric 6707.T Lee,Eric LBJ, Tokyo 821.65 2 689.00 -43.10 -28.27 Japan Santen Pharmaceutical 4536.T Yoda,Toshihide LBJ, Tokyo 2,199.95 1 2665.00 -16.19 5.65 Japan Seiko Epson Corp. 6724.T Takeda,Keiji LBJ, Tokyo 4,777.09 3 2560.00 -26.22 -6.99 Japan Seven & I Holdings 3382.T Sasaki,Yasuyuki LBJ, Tokyo 29,630.33 1 3260.00 -6.05 18.44 Japan Shikoku Electric Power 9507.T Maruo,Masanori LBJ, Tokyo 6,930.13 3 3000.00 3.81 30.87 Japan Shin-Etsu Chemical 4063.T Yamada,Mikiya LBJ, Tokyo 26,321.42 2 6410.00 -18.55 2.68 Japan Shinko Electric Ind. 6967.T Koshita,Masaru LBJ, Tokyo 1,957.64 1 1524.00 -31.20 -13.26 Japan Shinsei Bank 8303.T Senoguchi,Junsuke LBJ, Tokyo 8,732.43 3 446.00 -16.64 5.10 Japan Shionogi 4507.T Yoda,Toshihide LBJ, Tokyo 6,873.90 1 2060.00 -5.72 18.86 Japan Shizuoka Bank Ltd 8355.T Senoguchi,Junsuke LBJ, Tokyo 8,469.18 2 1255.00 -0.87 24.97 Japan Showa Denko 4004.T Yamada,Mikiya LBJ, Tokyo 3,783.97 2 319.00 -23.50 -3.56 Japan SoftBank 9984.T Tsusaka,Tetsuro LBJ, Tokyo 20,693.12 3 2015.00 -20.36 0.41 Japan Sompo Japan Insurance Inc 8755.T Altherr,Walter LBI, New York 10,550.34 2 1124.00 -24.87 -5.28 Japan Square Enix 9684.T Nagasaka,Mia LBJ, Tokyo 3,774.18 1 3450.00 7.81 35.92 Japan Sumitomo Chemical 4005.T Yamada,Mikiya LBJ, Tokyo 9,989.61 2 635.00 -15.89 6.03 Japan Sumitomo Mitsui Financial Group 8316.T Senoguchi,Junsuke LBJ, Tokyo 61,001.81 2 830000.00 -24.55 -4.87 Japan Sumitomo Trust & Banking 8403.T Senoguchi,Junsuke LBJ, Tokyo 13,833.38 2 869.00 -25.73 -6.36 Japan Suruga Bank 8358.T Tani,Miwako LBJ, Tokyo 3,718.12 1 1477.00 -1.30 25.10 Japan Suzuken 9987.T Yoda,Toshihide LBJ, Tokyo 3,660.47 2 4100.00 -4.65 20.21 Japan Suzuki Motor 7269.T Mochimaru,Tsuyoshi LBJ, Tokyo 13,820.14 1 2680.00 -15.46 6.58 Japan T-ZONE HOLDINGS,INC. 8073.Q Altherr,Walter LBI, New York 467.64 2 1485.00 -38.76 -22.80 Japan TDK 6762.T Koshita,Masaru LBJ, Tokyo 8,953.02 2 7270.00 -26.64 -7.51 Japan THK 6481.T Kijima,Tsutomu LBJ, Tokyo 2,881.18 2 2265.00 -19.40 1.62 Japan Tadano 6395.T Kijima,Tsutomu LBJ, Tokyo 1,335.24 1 1085.00 -37.03 -20.61 Japan Taisho Pharmaceutical 4535.T Yoda,Toshihide LBJ, Tokyo 6,057.27 3 1989.00 -12.57 10.22 Japan Taiyo Yuden 6976.T Lee,Eric LBJ, Tokyo 1,346.65 2 1176.00 -55.20 -43.20 Japan Takashimaya 8233.T Sasaki,Yasuyuki LBJ, Tokyo 3,473.96 3 1105.00 -24.00 -4.19 Japan Takeda Pharmaceutical Co. 4502.T Yoda,Toshihide LBJ, Tokyo 49,943.91 1 5910.00 -23.05 -2.99 Japan Takefuji 8564.T Altherr,Walter LBI, New York 3,072.44 3 2195.00 -47.61 -33.96 Japan Teijin 3401.T Yamada,Mikiya LBJ, Tokyo 3,593.51 2 384.00 -43.11 -28.28 Japan Tohoku Electric Power 9506.T Maruo,Masanori LBJ, Tokyo 10,967.55 1 2295.00 -19.76 1.16 Japan Tokyo Electric Power 9501.T Maruo,Masanori LBJ, Tokyo 33,169.23 1 2580.00 -33.85 -16.60 Japan Tokyo Electron 8035.T Myers,Steven LBJ, Tokyo 11,568.17 1 6740.00 -22.44 -2.22 Japan Tokyo Gas Company 9531.T Maruo,Masanori LBJ, Tokyo 10,681.77 2 410.00 -32.12 -14.42 Japan Tokyo Tomin Bank 8339.T Tani,Miwako LBJ, Tokyo 894.41 2 2350.00 -44.31 -29.80 Japan Toray Industries 3402.T Yamada,Mikiya LBJ, Tokyo 8,670.19 3 651.00 -20.90 -0.28 Japan Toshiba 6502.T Myers,Steven LBJ, Tokyo 27,223.91 1 885.00 -2.96 22.34 Japan Toshiba TEC 6588.T Takeda,Keiji LBJ, Tokyo 1,957.85 3 715.00 4.23 31.40 Japan Tosoh 4042.T Yamada,Mikiya LBJ, Tokyo 2,547.92 1 446.00 -26.77 -7.67 Japan Toyota Motor 7203.T Mochimaru,Tsuyoshi LBJ, Tokyo 173,005.70 2 5280.00 -27.87 -9.06 Japan Uny 8270.T Sasaki,Yasuyuki LBJ, Tokyo 2,032.73 2 1130.00 -20.65 0.04 Japan Verisign Japan 3722.T Yoneshima,Keiichi LBJ, Tokyo 381.80 2 88300.00 -29.92 -11.65 Japan Yahoo! JAPAN 4689.T Yoneshima,Keiichi LBJ, Tokyo 26,361.46 2 45850.00 6.88 34.74 Japan Yamaha Motor 7272.T Mochimaru,Tsuyoshi LBJ, Tokyo 5,566.97 2 2045.00 -34.24 -17.10 Japan Zeon 4205.T Yamada,Mikiya LBJ, Tokyo 1,249.14 1 543.00 -52.62 -40.27 Japan kabu.com Securities 8703.T Yoneshima,Keiichi LBJ, Tokyo 1,335.01 1 144000.00 -18.18 3.15 Malaysia Digi.Com Berhad DSOM.KL Wuh,Paul LBAL, Hong Kong 5,898.44 1 24.80 18.10 24.68 Malaysia MISC Berhad MISC.KL Lee,Andrew Kam Wing LBAL, Hong Kong 10,810.14 1 9.50 -2.56 2.87 Malaysia Malaysian Bulk Carriers MBCB.KL Lee,Andrew Kam Wing LBAL, Hong Kong 1,315.39 1 4.30 31.74 39.09 Malaysia Petronas Gas PGAS.KL Asia,Equity Research LBAL, Hong Kong 6,053.02 2 10.00 7.53 13.53 Malaysia Telekom Malaysia Bhd TLMM.KL Wuh,Paul LBAL, Hong Kong 3,873.96 1 3.54 10.75 16.93 Malaysia Tenaga Nasional TENA.KL Asia,Equity Research LBAL, Hong Kong 9,080.60 2 6.85 -41.95 -38.71 New Zealand Telecom Corporation of New Zealand TEL.NZ Langford,David LBAUL, Sydney 5,370.70 2 3.89 -18.05 0.68 Singapore Bukit Sembawang Estates BSES.SI Sai,Min Chow LBAL, Hong Kong 737.67 1 9.44 -20.67 -15.34 Singapore CDL Hospitality Trust CDLT.SI Sai,Min Chow LBAL, Hong Kong 1,177.02 2 1.97 -1.45 5.18 Singapore Cambridge Industrial Trust CMIT.SI Sai,Min Chow LBAL, Hong Kong 408.92 1 0.71 -22.83 -17.64 Singapore CapitaLand CATL.SI Sai,Min Chow LBAL, Hong Kong 13,532.31 1 6.62 -21.66 -16.39 Singapore CapitaRetail China Trust CRCT.SI Louie,Paul LBAL, Hong Kong 652.47 1 1.46 -52.60 -49.41 Source: Lehman Brothers estimates; 1 = Overweight, 2 = Equalweight, 3 = Underweight, 4 = Rating suspended May 2008 144
  • 144. Lehman Brothers | Equity Research MarketCap Absolute Relative Company Ticker Analyst Entity Country Rating Price USD (MN) 12M % 12M % Singapore China Energy Limited CENR.SI Por,Yong Liang LBAL, Hong Kong 526.27 1 0.58 -56.39 -53.46 Singapore City Developments CTDM.SI Sai,Min Chow LBAL, Hong Kong 7,704.82 1 11.70 -30.77 -26.11 Singapore K-REIT Asia KASA.SI Sai,Min Chow LBAL, Hong Kong 670.22 1 1.43 -48.74 -45.29 Singapore Keppel Land KLAN.SI Sai,Min Chow LBAL, Hong Kong 2,976.83 1 5.70 -39.36 -35.28 Singapore Mandarin Oriental Int'l Ltd MOIL.SI Lo,Benjamin LBAL, Hong Kong 2,130.17 2 2.15 -3.15 3.36 Singapore MobileOne MONE.SI Wuh,Paul LBAL, Hong Kong 1,289.52 2 1.99 -9.96 -3.90 Singapore Neptune Orient Lines NEPS.SI Lee,Andrew Kam Wing LBAL, Hong Kong 4,001.81 2 3.76 3.20 8.30 Singapore SC Global Developments SCGO.SI Sai,Min Chow LBAL, Hong Kong 427.18 1 1.49 -42.14 -38.24 Singapore STATS ChipPAC Ltd STTSY.PK Hsu,John LBSTL, Taiwan 1,733.95 2 8.43 -30.56 -25.70 Singapore STX Pan Ocean STXP.SI Lee,Andrew Kam Wing LBAL, Hong Kong 5,501.27 2 3.69 125.00 140.13 Singapore SingTel STEL.SI Wuh,Paul LBAL, Hong Kong 42,964.69 1 3.73 9.71 17.08 Singapore StarHub Ltd STAR.SI Wuh,Paul LBAL, Hong Kong 3,649.34 1 2.95 -0.34 6.37 Singapore Wilmar International WLIL.SI Por,Yong Liang LBAL, Hong Kong 22,938.13 1 4.96 64.24 75.28 South Korea Ace Digitech 036550.KQ Kim,James LBIE, Seoul 445.79 3 20300.00 9.43 18.11 South Korea CJ Cheil Jedang 097950.KS Chung,HongTaik LBIE, Seoul 2,696.92 1 250500.00 0.00 0.00 South Korea CJ Home Shopping 035760.KQ Chung,HongTaik LBIE, Seoul 683.97 2 65100.00 4.16 12.42 South Korea Daegu Bank 005270.KS Cho,Michelle LBIE, Seoul 1,904.71 2 15100.00 -1.63 -14.33 South Korea Daewoo Shipbldg & Marine Eng. 042660.KS Yoon,Mark LBIE, Seoul 7,656.01 2 41900.00 3.33 -10.01 South Korea Display Manufacturing Service 068790.KQ Chung,CW LBIE, Seoul 170.87 2 9000.00 6.51 14.95 South Korea Dongbu Insurance 005830.KS Cho,Michelle LBIE, Seoul 2,453.62 1 36300.00 36.98 19.30 South Korea Finetec 033500.KS Yoon,Mark LBIE, Seoul 186.88 2 13050.00 -26.69 -20.87 South Korea GS Holdings 078930.KS Lo,Michael LBAL, Hong Kong 3,499.45 1 39450.00 -13.77 -24.90 South Korea GS Home Shopping 028150.KQ Chung,HongTaik LBIE, Seoul 412.28 2 65800.00 -15.75 -9.07 South Korea Halla Climate Control 018880.KS Koo,Zayong LBIE, Seoul 1,090.58 1 10700.00 4.90 -8.64 South Korea Hana Financial Group 086790.KS Cho,Michelle LBIE, Seoul 9,000.35 1 44500.00 -3.16 -15.66 South Korea Hanaro Telecom 033630.KS Yang,Stanley LBIE, Seoul 1,947.97 1 8650.00 -10.36 -3.26 South Korea Hanjin Heavy I&C 097230.KS Yoon,Mark LBIE, Seoul 2,322.90 1 51400.00 0.00 0.00 South Korea Hanjin Shipping 000700.KS Lee,Andrew Kam Wing LBAL, Hong Kong 3,424.09 2 45050.00 9.88 -4.30 South Korea Hankook Tire 000240.KS Koo,Zayong LBIE, Seoul 2,193.97 2 15100.00 0.33 -12.62 South Korea Hankuk Carbon 017960.KS Yoon,Mark LBIE, Seoul 175.18 1 6220.00 -45.20 -52.27 South Korea Hite Brewery 000140.KS Chung,HongTaik LBIE, Seoul 2,448.65 1 121000.00 -3.97 -16.36 South Korea Honam Petrochemical 011170.KS Lo,Michael LBAL, Hong Kong 2,913.92 1 95800.00 -2.24 -14.86 South Korea Hynix Semiconductor Inc. 000660.KS Chung,CW LBIE, Seoul 12,890.98 1 29400.00 -6.52 -18.58 South Korea Hyundai Department Store 069960.KS Chung,HongTaik LBIE, Seoul 2,046.62 1 94500.00 -4.16 -16.53 South Korea Hyundai Heavy Industries 009540.KS Yoon,Mark LBIE, Seoul 25,395.01 2 350000.00 28.21 11.66 South Korea Hyundai Marine & Fire 001450.KS Cho,Michelle LBIE, Seoul 1,843.56 2 21600.00 72.80 50.50 South Korea Hyundai Merchant Marine 011200.KS Lee,Andrew Kam Wing LBAL, Hong Kong 5,564.56 3 43800.00 41.06 22.86 South Korea Hyundai Mipo 010620.KS Yoon,Mark LBIE, Seoul 4,429.81 3 232000.00 -2.73 -15.28 South Korea Hyundai Mobis 012330.KS Koo,Zayong LBIE, Seoul 7,814.52 1 95400.00 17.78 2.58 South Korea Hyundai Motor Company 005380.KS Koo,Zayong LBIE, Seoul 18,598.34 1 88600.00 37.15 19.45 South Korea Industrial Bank of Korea 024110.KS Cho,Michelle LBIE, Seoul 7,426.53 1 19200.00 5.49 -8.12 South Korea Jusung Engineering 036930.KQ Chung,CW LBIE, Seoul 627.05 2 20250.00 72.34 86.00 South Korea KT 030200.KS Yang,Stanley LBIE, Seoul 12,125.23 2 46150.00 8.97 -5.09 South Korea KT&G 033780.KS Chung,HongTaik LBIE, Seoul 11,018.04 1 82000.00 18.50 3.20 South Korea KTF 032390.KQ Yang,Stanley LBIE, Seoul 5,335.76 2 29000.00 -4.76 -17.05 South Korea Kia Motors Corporation 000270.KS Koo,Zayong LBIE, Seoul 4,475.25 1 13500.00 16.38 1.36 South Korea Kookmin Bank 060000.KS Cho,Michelle LBIE, Seoul 21,259.53 1 66200.00 -21.19 -31.36 South Korea Korea Electric Power Corp. 015760.KS Lee,Ivan LBAL, Hong Kong 20,532.72 3 33500.00 -15.51 -26.42 South Korea Korea Exchange Bank 004940.KS Ch