whatifchinaslowsdown-whatifscenario

27 July 2015
Stratégie TypologieWhat if the slowdown in China is sharp and lasts?
 China is currently faltering, and a slump would upset world balances: recoupling
developed and emerging economies, a price drop in many commodities,
transformations in global industry. In this note we outline an adverse, but possible
scenario (GDP +4%), in which investment and consumer durable purchases would
be affected.
 The Chinese currency would not depreciate significantly. Keenness to
internationalise the currency is obliging the Chinese authorities to ensure its relative
stability. We expect a target of 6.35 vs. the $ (vs. ~6.11). But commodities would
be hard hit. Brent prices could slide by $15 to $17 compared with our 2016 baseline
scenario (57.3 $), with the re-emergence of a super contango, similar to 2008/09.
Iron ore prices would continue to fall, towards $40/tonne, more sharply than copper
or zinc prices. Gold would benefit somewhat with prices climbing to $1,300/oz.
 This scenario would be positive for fixed income markets with expansionist
monetary policies (Fed, ECB and satellite central banks) maintained for longer. Bull
flattening and the compression of sovereign spreads would be the order of the day.
Regarding equity markets, the scenario would corroborate our existing plays,
i.e. a preference for developed country stocks, with Europe to the forefront, and the
Value theme. In terms of cross-asset allocation, we would opt for a defensive
portfolio by reducing exposure to CVaR, and share and corporate bond pockets in
favour of greater exposure to Treasuries and gold.
 In terms of sector exposure, semiconductors would be directly and sharply affected
were an adverse scenario to materialise, with Infineon to the forefront (ca.40% of its
activity is in China). In the automotive sector it would be a reversal of fortunes to
which car makers Volkswagen and BMW would be the most exposed. Auto parts
makers (Faurecia, Plastic Omnium, Valeo), would be harder hit than tyre makers.
Capital goods stocks would also suffer, especially Schneider (15% of its sales are
generated in China). Then there are the industries that are indirectly exposed to the
Chinese market: for oil companies, the impact would be felt via oil prices and we
think that Shell would be hardest-hit. Oil companies’ E&P capex and margins would
be under heavy pressure, but we would still prefer asset-light profiles. Indeed, GTT
would still be our top pick among oil services companies. The pricing and product
mix would impact the tubes and equipment segment. The predictable fall in iron ore
prices calls for caution on ArcelorMittal. Last, apart from the spectre of rising
Chinese exports, tied to a drop in local demand, we would be more concerned about
the impact on the Asia region’s economy, which would primarily affect
LafargeHolcim and to a smaller extent HeidelbergCement and Italcementi. In the
Utilities sector, the indirect impact would primarily derive from downward pressure
on wholesale electricity and recycled raw materials prices with CEZ Fortum,
Vattenfall and E.ON most affected. Last, we think that European banks would be
well-shielded from an adverse scenario on the whole, as only Standard Chartered
and HSBC have substantial activities in China.
Economic Research
Patrick Artus +33 1 58 55 15 00
Sylvain Broyer +49 69 97153 357
Alicia Garcia Herrero +852 3900 8680
Commodities
Abhishek Deshpande +44 20 321 692 23
Nic Brown +44 20 321 692 39
Bernard Dahdah +44 20 32 16 91 31
Fixed Income and Forex Strategy
Nordine Naam +33 1 58 55 14 95
Strategy Fixed income
Cyril Regnat +33 1 58 55 82 20
Jean-François Robin +33 1 58 55 13 09
Strategy Equity
Sylvain Goyon +33 1 58 55 04 62
Strategy Cross-asset
Emilie Tetard + 33 1 58 19 98 15
Equity and Credit Research
Banks
Elie Darwish +33 1 58 55 84 32
Robert Sage +44 20 3216 91 70
Cars
Georges Dieng +33 1 58 55 05 34
Michael Foundoukidis +33 1 58 55 04 92
Oil
Baptiste Lebacq +33 1 58 55 29 28
Alain Parent +33 1 58 55 21 82
Anne Pumir +33 1 58 55 05 20
Industrials
Sven Edelfelt +33 1 58 55 29 03
Sandra Pereira +33 1 58 55 98 66
Utilities
Philippe Ourpatian +33 1 58 55 05 16
Ivan Pavlovic +33 1 58 55 82 86
Semi conductors
Maxime Mallet +33 1 58 55 37 71
Stéphane Houri +33 1 58 55 03 65
Global Markets research.natixis.com
Accès Bloomberg NXGR
Distribution of this report in the United States. See
important disclosures at the end of this report.

Global Markets Research I 2
Contents
1. Introduction 3
2. Slowdown in Chinese growth: empirical evidence, causes and structure 4
In the short/medium term: risk of subdued growth in China 4
What accounts for this weakening of the Chinese economy? 5
In the long term, decline in Chinese potential growth 7
Slowdown in growth in the short term: a mixed picture 8
Conclusion: The Chinese government will try to restore growth, but what would happen if the Chinese
economy slowed down markedly? 9
3. Immediate effects 12
Forex: CNY depreciation likely to be very limited 12
Oil: three scenarios are conceivable, each pointing to much lower prices 13
Basic metals: a sharply impacted market 15
Precious metals: gold is a winner, but just a little 19
4. Our strategic views 20
Fixed income strategy: lower rates, everywhere 20
Strategy equity: still our preference for Europe and Value 22
Cross-asset strategy: a more defensive strategy 25
5. Sectors affected by the slowdown in investment and consumer durable purchases 27
Semiconductors: the market would mature 27
Car makers: reversal of fortune 28
Auto Parts: harder-hit than tyre makers 29
Integrated oil: direct impact hit by oil prices 31
Oil services: deteriorating outlook for recovery 32
Tubes and equipment: pressure on pricing and the mix 33
Steel: pressure already visible … and it could increase 34
Other industrials: larger direct exposure 36
Cement: at little risk 37
Utilities : affected by prices decrease 40
Banks: almost all European well-shielded from Chinese risk 41

1. Introduction
China is a structural player for the global economy. Indeed, in 2010 it became the number two
economy and has tripled its economic expansion over twenty years to reach 15% of world GDP. On
a constant growth basis, it could even topple the US (a quarter of world GDP) from its number one
slot by 2030. By chalking up close to 20% of world investment since 2005, China has a sweeping
impact on the commodities market. Note, for example, that China now consumes 51% of world coal,
50% of copper and 11% of oil.
But the economy is unbalanced. In particular, domestic consumption is very low: barely 8% of world
consumption, versus 15% for the US, a massive gap relative to the total number of inhabitants (four
times greater than the US). Even though the authorities have made great progress in terms of
salaries/wages and currency revaluation, China now faces many obstacles to development
(overinvestment, an unsustainable debt level, bursting of the real estate bubble). To avoid the
‘middle income trap’ threat, the economy will have to be revamped, and this implies a clear, lasting
slowdown for growth.
A lasting slowdown for the Chinese economy would have major repercussions worldwide, well
beyond simple trade links with its geographic neighbours and commodity exporting countries. Its
current surpluses, relatively closed capital markets and a currency long maintained at an artificially
low level have made China a leading global financier. Having fed the commodities super cycle,
China has driven growth in emerging countries; by joining the WTO, it has lengthened geographical
production lines, helping raise world trade volumes. A change in regime for Chinese growth would
certainly upset these balances. It would contribute to a ‘recoupling’ of growth paces between
developed economies and emerging economies. It would impact the prices of many commodities
and imply many mutations for world industry.
Indeed, for many industrial groups, China’s and its neighbours’ surging growth has become a real
alternative to the structural lack of organic pace in Europe (car makers, capital goods, aerospace-
defence notably). A change in economic regime in China, combined with tenuous improvement in
growth potential in Europe, would clearly dent the perception, on equity and credit markets, of the
groups most exposed to this zone.
In this report, our experts identify which markets, sectors and companies would be hardest hit by a
shift in Chinese economic regime, and, of course, what strategic allocation to prefer if the adverse
scenario we describe in these pages materialises.
Sylvain Broyer
Thibaut Cuilliere
Stéphane Houri

2. Slowdown in Chinese growth:
empirical evidence, causes and
structure
The various available indicators confirm the growth slowdown in China. In the short/medium term, it
is due to the loss of industrial cost competitiveness, the exhaustion of construction stimulus
measures as a method to boost activity, and the declining effectiveness of the expansionary
monetary policy.
In the longer term, it is due to the decline in productivity gains as a result of the weakening of
investment and the distortion of the structure of the economy towards services, as well as population
ageing.
The nature of the slowdown is particular: it is barely affecting household consumption (with the
exception of cars), thanks to the rapid wage increases and the low level of inflation; it is primarily
concerning exports and corporate investment, especially investment in industrial machinery and
equipment. We must obviously take into account the fact that the Chinese authorities will continue to
combat the slowdown in growth.
In the short/medium term: risk of subdued growth in
China
If we look at official indicators, the Chinese economy is slowing down markedly.
Chart 1: China: GDP growth and manufacturing production (Y/Y as %)
Sources: Datastream, NBS, Natixis
But when we look at indicators that are normally correlated to growth (imports in volume terms
and electricity production, we realise that Chinese growth in all likelihood is markedly lower than that
shown by official figures.
Patrick Artus
Sylvain Broyer
Alicia Garcia Herrero
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Chart 2: China
Imports and real GDP (Y/Y as %) Electricity production and real GDP (Y/Y as %)
What accounts for this weakening of the Chinese
economy?
 First, the loss of industrial competitiveness due to the rapid increases in wages and labour
costs, themselves linked to the political determination to increase the weight of consumption in
GDP. The result of this loss of industrial competitiveness is offshoring of production to some
extent but especially a fall in exports, a decline in the weight of goods assembled in China
(processed goods) in exports and a stagnation or a fall in production in many industrial
sectors.
Chart 3: China
Nominal per capita wage and unit labour cost (as % per year) Household consumption (as % of real GDP)
Exports Total exports in value terms (Y/Y as %)
Sources: Datastream, China Customs, Natixis,NBS
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Nominal wage per capita Unit labour cost 34
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Total exports in value (yoy %)
Exports of assembled products as % of total exports
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Automotive Textiles
Steel Household equipment

 Second, the end of the Chinese government’s ability to use investment in construction
(housing, public infrastructure) to boost activity. Far too much has already been built and we can
currently see a slowdown in investment in construction and, which is an associated indicator, a
decline in cement production.
Chart 4: China
Housing construction*
(surface in millions of square meters)
Investment in construction
and cement production (Y/Y as %)
* seasonally adjusted series
 More generally, this shows the loss of effectiveness of monetary policy. Although it has
become more expansionary in the recent period, it is not jump-starting credit. Even credit
coming from shadow banking is slowing.
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Construction investment Cement production

Chart 5: China
Interest rate on loans and banks’
reserve requirement ratios (as %)
Total credit (Y/Y as %)
New loans (in RMB bn per month)
Sources: Datastream, PBOC, Natixis
In the long term, decline in Chinese potential growth
Chinese potential growth is declining because productivity gains are slowing down, and also
because of population ageing, which will be drastic from the 2020s because the only children will
join the labour force. It is possible that potential growth will only be around 4 to 5% out to the end of
this decade, and 2 to 3% in the next decade.
Chart 6: China
Per capita productivity (as % per year) Population aged 20 to 60 (as % per year)
Sources: Datastream, NBS, Natixis Sources: UNO, World Bank, Natixis
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1-year loan rate (lhs)
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The slowdown in productivity gains is explained by the slowdown in corporate investment and the
distortion of the Chinese economy towards services, where both the productivity level and
productivity gains are already weak.
Chart 7: China
Investment in machinery and equipment (Y/Y as %) Value added by sector (in volume terms, as % of real GDP)
Slowdown in growth in the short term: a mixed picture
The Chinese economy is currently characterised by rapid wage growth and a low level of inflation
due to the fall in commodity prices and the excess production capacity in industry.
Chart 8: China: Inflation (CPI, Y/Y as %)
Sources: Datastream, Natixis
So real wage growth remains rapid, which explains why household consumption remains
strong, with the exception of cars.
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Manufacturing Services

Chart 9:
Household consumption and retail sales
(in volume terms, Y/Y as %)
Car sales
(Y/Y as %)
Sources: Datastream, NBS, Natixis Sources: Datastream, CAAM, Natixis
In contrast, it is corporate investment that is weak as a result of the deterioration in cost
competitiveness and the stagnation of industrial production as well as very rapid leveraging of the
corporate sector.
Companies exposed to Chinese consumers are therefore much less affected than those exposed to
Chinese companies or investment.
Conclusion: The Chinese government will try to restore
growth, but what would happen if the Chinese economy
slowed down markedly?
We believe there is a serious risk that Chinese growth may weaken further:
 In the short/medium term as a result of the deterioration in competitiveness, the end of
construction-led stimulation of activity, and the loss of effectiveness of monetary policy;
 In the long term as a result of the fall in productivity gains and, subsequently, population ageing.
But we should nevertheless not forget that the Chinese government will continue to try to stimulate
growth.
 In a short-term perspective, with new infrastructure investments (New Silk Road project), an even
more expansionary monetary policy, and stock market support measures.
 In a long-term perspective, by favouring a rise up the value chain for the economy thanks to
spending on R&D and support for technological companies (Table 1 and Chart 10).
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Household consumption in volume
Retail sales in volume

Table 1: Total spending on R&D (as % of nominal GDP)
% United States Euro zone Japan China
1998 2.50 1.71 2.96 0.64
1999 2.54 1.76 2.98 0.75
2000 2.62 1.78 3.00 0.91
2001 2.64 1.80 3.07 0.96
2002 2.55 1.81 3.12 1.07
2003 2.55 1.81 3.14 1.13
2004 2.49 1.78 3.13 1.22
2005 2.51 1.78 3.31 1.31
2006 2.55 1.80 3.41 1.35
2007 2.63 1.81 3.46 1.39
2008 2.77 1.89 3.47 1.46
2009 2.82 1.99 3.36 1.66
2010 2.74 1.99 3.25 1.75
2011 2.76 2.04 3.38 1.84
2012 2.70 2.09 3.34 1.98
2013 2.73 2.09 3.47 2.08
Sources: OECD, Eurostat, Natixis
Chart 10: China: Investment in hi-tech equipment and other electronic equipment (Y/Y as %)
Lastly, given all the factors we have just discussed we could imagine a situation where Chinese
growth slows down more than what we currently expect in our baseline scenario (6% growth in 2015
and 2016 after taking into account the impact of the stock market collapse). China could find a
growth base of around 4 to 5% per year, which corresponds to potential GDP as we saw above.
In that case, what could be the result of such a slowdown?
We should expect the transformation of the Chinese growth model to continue, i.e. the weight of
consumption in GDP will continue to increase and that of investment will continue to decrease.
Assuming that this transformation will take place at more or less the same pace in the coming years,
consumption should then increase by 7% per year. Note that household spending on capital goods
(household equipment) and durable goods (cars) probably will grow more slowly than in the past and
less than other types of goods, because of credit restrictions.
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atixistal investment might grow no more than 3% per year. We believe residential construction will
slow down the most (to as low as 1% per year) for the same reasons, i.e. credit restrictions. The
non-residential part of construction is likely to remain somewhat stronger because of spending on
infrastructure, e.g. the new Silk Road project (3% per year). Corporate investment, lastly, is also
likely to slow down because of the overcapacity and the upgrade in the capital stock.
The table below compares such an adverse scenario with the average growth rates in China in the
2000-2013 period. We see that consumption would be unlikely to slow down substantially, as
opposed to investment.
Chart 11: China
Composition of domestic demand (% of GDP) Investment in fixed capital (% of GDP)
Sources: Datastream, Natixis Source: NBS
Table 2: An adverse growth scenario for China (growth rate per year, in real terms)
% 2000/2013 average 2015 scenario 2016 scenario Adverse scenario
GDP 9.9 6.0 6.0 4-5
Consumption 8.0 6.3 6.6 7
Government spending on consumption 9.1 6.4 6.6 4
Total Investment 12.3 4.4 4.6 3
o/x residential construction Na 1
o/w non-residential construction Na 3
o/w equipment and machinery Na 2
Source: Natixis
The countries most affected by a structural slowdown in the Chinese economy would primarily be
the economies in the Asia Pacific region, but also more distant countries that provide China with
commodities (Africa, OPEC, Chile, Brazil and Russia) and capital goods or durable consumer
goods, e.g. the euro zone and Norway.
Table 3: Exports to China (2014, as % of nominal GDP)
Japan South
Korea
Taiwan Singapore Malaysia Vietnam Indonesia Philippines Thailand Australia New Zealand United
States
Canada
2,7 10,1 28,8 16,7 8,6 9,5 2,0 2,9 6,6 5,7 4,2 0,7 1,0
Chili Argentina Brazil Mexico India Africa Euro zone CEEC UK Sweden Russia OPEC Norway
7,1 0,9 1,8 0,5 1,6 4,3 1,5 0,7 0,5 0,9 2,0 5,2 0,9
Sources: IMF, Natixis
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Government spending Private-sector consumption
investment

3. Immediate effects
Forex: CNY depreciation likely to be very limited
Following the sharp slump in equities during June and July, the PBoC has slightly increased its
Chinese yuan (CNY) fixing from a low of 6.1104 on 8 July to a high of more than 6.1175 on 18 July,
i.e. a change of +0.1% in the space of 10 days. Despite this small change, the increase in the
PBoC’s fixing has given rise to fears of a change of strategy by China. Yet the movement has
remained relatively small compared with previous episodes of risk aversion. Similarly, the CNH has
appreciated slightly against the CNY on expectations of PBoC action. On the other hand, CNY
forwards have appreciated, reflecting expectations the currency will depreciate.
Chart 12:
CNY and bands of fluctuation CNY 12m FWD and CNH/CNY premium/discount
Source: Bloomberg
How has the CNY behaved in previous major phases of economic slowdown? Following the Lehman
crisis, China’s GDP slowed markedly from a high of 11.2% in 2008 to 6.2% in the first quarter of
2009, while the USD/CNY exchange rate remained unchanged in the face of a sharply rising dollar
and significant capital outflows. In response, however, China put in place an economic stimulus
package.
The current situation is quite different to that in 2008. This time around, the slowdown in the Chinese
economy is linked to domestic factors. China’s economy is more indebted than in 2009, which limits
the use of fiscal stimulus. It is also more fragile as a result of the ongoing economic transition, and in
the event of a hard landing, one can assume that deflationary pressures would intensify. But a
depreciation of the CNY would hardly be beneficial, as it would only fuel the already large capital
outflows of the past few quarters. Moreover, it would not augur well to let the CNY depreciate
significantly, considering that China has requested its currency be included in the IMF’s Special
Drawing Rights (SDR) basket of currencies. Inclusion in the SDR basket is a major step for the
internalisation of the yuan.
The IMF reviews the monetary units in the SDR basket every five years. In 2010, China’s request
was rejected but this time, the Chinese authorities have taken a number of steps with a view to
internationalising their currency. The IMF is set to issue a final decision by the end of the year. The
question will be whether China’s capital markets are sufficiently open for the CNY to become a
reserve currency in the international monetary system on a level footing with the dollar, euro, sterling
Nordine Naam
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CNY FWD 12m Discount/Premium (rhs)

and yen. The likelihood of the CNY’s inclusion has increased, given that since 2010, the CNY has
become the second-most-used currency in global trade and the fifth for international payments.
Moreover, the Chinese authorities are planning to further open up the capital account in the coming
months with a view to making their currency convertible in the medium term. In this context, China is
unlikely to let its currency correct out to the end of the year. On the other hand, a gradual
depreciation of the CNY to as far as 6.35 or even 6.40 is possible as the dollar rises, once the IMF
has made its decision towards the year end.
Oil: three scenarios are conceivable, each pointing to
much lower prices
Chinese oil demand so far
Between 2006 and 2013, annual demand for oil products grew at 6% yoy on average in China, with
peak growth seen in 2010 at 12.7% yoy. However annual demand slowed significantly in 2014 due
to reforms made by the Chinese government to address overcapacity, pollution and a general
slowdown in the economic activity which led to oil products demand growing by only 1.7% yoy last
year. In the first 5 months of 2015, growth in oil product demand (excluding SPR demand) was quite
strong at 5.5% yoy mainly driven by consumer-driven fuels such as gasoline and jet kerosene and
some other light ends used in petrochemicals. According to the IEA’s medium term report, Chinese
demand for oil is expected to grow by a total of 1.7mbpd between 2014 and 2020, an average
annual growth of 280,000bpd.
Chart 13: China demand by product (1 000 b/d)
Sources: PIRA, ODI (2012 and 2013 Data)
Abhishek Deshpande
Other
Fuel Oil
Naphtha
Gasoline
Jet Kero
Gasoil/Diesel
0
2 000
4 000
6 000
8 000
10 000
12 000
2012 2013 2014 2015 2016

What if? scenario
The IMF currently forecasts Chinese GDP to slow down from 6.76% in 2015 to 6.3% in 2020.
According to Natixis, China is expected to grow by 6% in 2015 and 2016, below IMF estimates. If
GDP was to slow down to 4%, it would be 3 percentage points below the consensus.
Chart 14: China GDP – IMF forecasts (%)
Source: IMF
For Chinese oil demand, it really narrows down to industrial demand which is most directly related to
GDP slowdown. We have already seen a slowdown in Chinese diesel demand in 2014. Chinese oil
products demand on a very linear extrapolation of GDP with oil demand would slow rapidly to 0.6%
yoy in 2017 and then decline on a yoy basis from 2018 onwards if GDP was to slow down to 4% by
2020. However we know Chinese demand today has become significantly reliable on consumer
driven fuels such as gasoline and jet kerosene. Hence we consider three potential scenarios below.
Chart 15: China GDP vs total oil demand growth (%)
Sources: Natixis, IMF
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Annual growth in demand (%, rhs) Annual growth in demand wtih GDP slowdown to 4% (%, rhs)

Three potential scenarios in the future:
Assuming that gasoil + fuel oil demand declines with GDP, as seen in the linear extrapolation of
GDP with total oil product demand, we see three potential scenarios for demand for gasoline+jet
kerosene+ naphtha +other products (including light ends for petro chemicals):
 It keeps rising at the pace expected by IEA in 2016. Then we see oil product demand rising by
2.67% yoy on average between 2016 and 2020, assuming a 1% yoy decline in gasoil and fuel oil
demand.
 It grows at half the rate as expected by IEA in 2016. Total oil product demand will rise by only
1.1% yoy between 2016 and 2020, assuming 1% decline in gasoil and fuel oil demand.
 It grows at a quarter of the rate expected by IEA in 2016. Total oil product demand will grow by
0.4% yoy on average between 2016 and 2020, assuming a 1% yoy decline in gasoil and fuel oil
demand.
All of the scenarios above point to an even weaker pricing scenario than what we have assumed
with the return of Iranian oil. With the return of Iranian oil we were expecting crude oil stocks to
continue rising in 2016, putting pressure on oil prices as the call on OPEC will still be lower than
actual OPEC production by over 1m b/d even in 2016. Weak Chinese demand will further reduce
call-on-OPEC and lead to a further increase in crude and oil product stocks globally. In our central
scenario we were expecting Brent prices to average $56.7/bbl in 2015 and $57.3/bbl in 2016 and
then slowly recovering from 2017 onwards. But if Chinese demand were to weaken as early as
2016, then we can expect oil prices to range between $40-50/bbl in 2016 and then remain under
pressure i.e. between $50-60/bbl until 2017. We can very easily expect a super contango like 2008-
09 where oil will have to move to floating storage and spot prices will come under significant
pressure, as in order to justify oil on floating storage you need at least $1.1/bbl/month of contango.
Basic metals: a sharply impacted market
China is undergoing a seismic restructuring away from its old, unsustainable, investment-driven
economic model towards a more sustainable economic model based around consumption,
innovation and the influence of the price mechanism. This inevitably means slower growth in
demand for raw materials such as industrial metals, and more emphasis on new technology and
consumer-oriented industries, in particular when combined with the country’s new focus upon
environmental protection and the quality of the environment.
This was starkly illustrated earlier this year by the recognition that Chinese demand for steel had
peaked, causing steel and iron ore prices to collapse. Chinese steel output is now expected to fall by
1% in 2015 to around 814mn tonnes, according to the China Iron and Steel Association, with
demand expected to soften in tandem. From the perspective of the global iron ore, coking coal and
steel industry, this represents a key turning point, since growth in Chinese demand for and output of
steel has been a key driver behind the industry’s recent expansion.
From an economic development perspective, a peak in Chinese steel output would be a very
significant milestone. In long-term models of economic development, the steel intensity of economic
growth typically peaks ahead of other industrial metals as countries move up the industrial value-
added chain. In general, demand for energy and agricultural products continues to expand as per
capita income increases, even as demand for metals begins to fall.
Nic Brown

Chart 16: Commodity intensity of demand – the US as a case study
Sources: BHP, World Bank
Chart 17: China – Commodity intensity of demand, 2000/2014 (2005 = 100)
Source: Natixis
In China, centrally planned expansion of the metals industry has been used as a key exogenous
driver of economic growth. This makes it particularly difficult to know what will happen as China
morphs from its “old” growth model (unsustainable growth based on centrally planned investment)
into a new model (sustainable growth based on profit-maximising behaviour and consumer
demand).
This new aspirational economic model is already having a far-reaching effect upon the Chinese
economy and markets.
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Chart 18: HSBC China PMI SA
Source: Bloomberg
One by one, China’s heavy industries are undergoing major restructuring. In early-2014, temporary
cutbacks occurred in aluminium output as electricity prices were raised for less-efficient producers.
Later in the year, stainless steel producers also cut back, reducing demand for nickel sharply as they
ran down accumulated inventories.
This year, China’s authorities have focused upon the steel industry. After years of rapid growth,
China is now perceived to have reached “peak steel,” i.e. steel consumption per capita is expected
to fall over the coming years. As a result, iron ore and metallurgical coal markets face a period of
major consolidation as overcapacity erodes prices and profitability.
Conditions in China’s steel industry continue to deteriorate. While iron ore prices have staged a
small consolidation over the past three months, the steel industry still faces substantial excess
supply. Despite curbs on exports of born-based steel at year-end, Chinese steel exports increased
by 28% yoy during 2015H1. This exodus of surplus steel was not enough to prevent domestic steel
prices from falling by over 30% ytd. As a result, profitability in China’s steel industry has deteriorated
to a multi-year low.
With the rapid expansion in iron ore mining (and transportation) capacity undertaken by the world’s
large mining companies running headlong into an abrupt halt in Chinese demand for iron ore, prices
have already collapsed. From $140/tonne at end-2013, iron ore prices fell below $50/tonne in April
this year. If Chinese steel output does indeed fall by 2-3% per annum over the coming years, as
projected by CISA, it would be reasonable to think that iron ore prices can fall further. At current FX
rates, $40/tonne represents a point at which enough of the global mining industry might be forced to
close unprofitable operations in order to support prices. Forecasts for a worst-case scenario are
complicated by the fact that weakness in fundamentals results in a depreciation of FX rates for
producing countries, lowering the dollar price at which their mines break even.
Chinese apparent demand for nickel dropped by around 16% in 2014 as the stainless steel industry
went through a period of weak end-user demand and destocking. Reflecting the weakness of nickel
prices so far this year, restructuring in the stainless steel industry may be contributing to a second
year of abnormally low apparent demand, although destocking from accumulated inventories may
also be a contributory factor.
Given these developments, nickel prices have already collapsed to the point at which Asian ore and
NPI producers are holding back unprofitable output. Even with a further slowdown in China,
destocking in the stainless steel industry should soon come to an end, boosting apparent demand,
and lower output of NPI would force stainless steel producers to look elsewhere for nickel inputs. It
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is therefore unlikely that nickel prices will fall any further below recent lows of around
$11,000/tonne, even in a situation in which Chinese GDP growth slowed abruptly.
Chinese demand for lead fell by 3% in 2013 and a further 6% in 2014. This weakness in demand
reflects a combination of weaker demand for e-bikes as well as a structural shift away from lead-acid
batteries towards lithium-ion batteries. Over the coming years, this trend may be accentuated by an
increase in supply of recycled lead.
Our forecasts for lead already factor this negative outlook into our central scenario, in which we see
lead prices averaging $1,800/tonne this year. Were Chinese growth to slow abruptly, prices could
fall further, with $1,500/tonne a reasonable downside target.
Chinese demand for aluminium is expanding rapidly, but it is unlikely that this growth will be enough
to absorb the recent expansion in aluminium capacity. As a result, an increase in Chinese exports of
aluminium products is weighing upon global aluminium prices.
Within the global aluminium industry, costs of production range from around $1,400/tonne to
$1,900/tonne. With the collapse in aluminium premiums, many western producers already find
themselves producing at a loss, even as producers elsewhere continue to drive costs lower through
investment in new technology and cheaper energy inputs.
Were Chinese growth to slow abruptly, we would expect to see widespread shutdowns across the
global aluminium industry, supporting prices in the region of $1,700/tonne.
Chinese end-user demand for copper remains robust, but growth in apparent demand has
weakened perceptibly this year due to the absence of substantial purchases from China’s SRB. As a
result, copper prices fell to a multi-year low of $5,400/tonne in January.
This decline in copper prices is already percolating through the copper production chain, resulting in
slower mine output growth and, via lower TC/RCs, slower growth in output of refined copper. In our
lower case scenario, we would expect this natural reflex to become more exaggerated, thereby
limiting any potential downside in copper prices. Were Chinese growth to slow abruptly, we would
envisage copper prices stabilising somewhere around $5,300/tonne.
Zinc prices are currently benefiting from the imminent closure of Century and Lisheen, due to take
effect in September this year. The resultant shortfall in mined output is expected to have a significant
negative effect upon supply; hence our lower case scenario for zinc prices envisages a very modest
fall to around $1,825/tonne.

Precious metals: gold is a winner, but just a little
Gold investment purchases in China occur when gold is seen as a buying opportunity (strong
fluctuation in the price). This contrasts with the west, where investors are also heavily influenced by
the opportunity cost of holding gold, and are therefore sensitive to yields and the wider economic
climate.
Indian demand for gold also has a different pattern. Indeed, demand for gold is mostly sensitive to
GDP growth and purchasing power. Purchasing the metal is intrinsically linked to festivals and
weddings.
 We would therefore suggest that Chinese investment demand for the metal would not be as
much affected by a drop in GDP growth as by fluctuations in the price of the metal itself.
That said, in a situation whereby cuts in interest rates and a devaluation in the RMB would occur,
this could potentially alter investor habits and encourage a safe haven flight but we think this is
not likely to be widespread.
 In the immediate aftermath, a potential slowdown in demand for jewellery is more likely to occur
as this demand is more sensitive to lower GDP and income growth. Chinese jewellery demand
for the metal represents over three quarters of total local demand and 20% of global demand for
the metal.
 China is the largest producer of the metal. From the local gold producer’s side we do not expect
that production should be affected.
 As for the international price of gold, fears of a US currency debasement have dissipated and so
we have seen the latter competing, if not replacing, gold as the main safe haven. Higher Fed
interest rates should make gold even less attractive. Earlier in June when the Shanghai gold
exchange fell sharply, we did not witness Chinese inflows of gold and the price of gold
denominated in dollars continued to drop.
Chart 19: Shanghai composite and gold price
Source: Bloomberg
In the event of a slowdown in the Chinese economy, local jewellery demand is expected to slow
down but not collapse, whereas investment demand for the metal is likely to continue to be more
focused on gold as a buying opportunity. That said, in the event of a currency devaluation (in efforts
to support growth), we could see a strong inflow into gold from local investors which would raise the
price of gold in RMB. This should also lift the price of gold denominated in dollars but not
considerably. Prices could reach $1,300/oz as the stronger dollar would also be counterbalancing
Chinese gold purchases.
Bernard Dahdah
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4. Our strategic views
Fixed income strategy: lower rates, everywhere
As we have seen above, the slowdown in Chinese growth will lead not only to lower growth rates in
developed and emerging countries, but also to lower inflation rates than those expected by
investors. This of course points to a lower interest-rate regime on a global scale for a prolonged
period.
A first effect for the market is that monetary policies will remain highly accommodating for
longer than currently expected. The US Federal Reserve, which is set to start hiking its policy
rates this year, could delay this decision until 2016. In particular, the Chinese growth slowdown
has led to an umpteenth downward revision in long-term levels of the Fed Funds rate, and
therefore lower dots than those the FOMC members currently expect.
The ECB would not be impervious to a significant Asian growth shock. With lower oil prices, the
profile of European inflation would be revised downwards markedly. In their scenario of Chinese
stress, our economists are forecasting inflation of just 0.9% in 2016 with an oil price of between 40
and 50 dollars per barrel, compared with 1.3% expected in our main scenario. In such a case it
would make sense for the central bank to decide to extend its QE, perhaps until the end of the
first half of 2017, and to begin tapering thereafter. This would of course mean much larger excess
reserves in the euro zone, potentially diverging some 700bn from the main scenario by end-2017.
Chart 20: Much more accommodating central banks
Federal Reserve dots vs. futures Size of the ECB’s balance sheet (EUR bn)
2015 2016 2017 Long term
Sept.-14 1.25 to 1.5 2.75 to 3 3.75 3.75
Dec.-14 1 to 1.25 2.5 3.5 to 3.75 3.75
Mar-15 0.5 to 0.75 1.75 to 2 3 to 3.25 3.75
Jun-15 0.5 to 0.75 1.5 to 1.75 2.75 to 3 3.75
New forecasts 0 to 0.25 0.75 to 1 1.75 to 2 3 to 3.25?
Sources: Bloomberg, Fed, Natixis
Cyril Regnat
Jean-François Robin
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Balance - Core scenario Balance - Risk scenario

Given this influx of liquidity, downward pressure on the euro would also have an impact on
European central banks, leading them to adopt even more accommodating policies. The
Danish National Bank, the SNB and Eastern European banks (Poland, Czech Republic, etc.) come
to mind in particular.
This context would of course provide significant support for bond markets and for sovereign issuers
in particular. The abundance of liquidity and an unconducive global economic context for risk-taking
(in particular as a result of the downward revision in growth levels) mean that the current
environment of low long-term interest rates will persist for a long time yet.
In the United States, given the deferment of the rate-hike cycle, we can therefore imagine a
downward shift in the yield curve, with 10-year interest rates returning to around 1.50-1.75%. At
the same time, under the effect of the additional liquidity and structurally lower inflation, German
rates would follow the same path, with 10-year Bunds returning to a range of 0.25-0.50%, which
is what we had at the start of the year. In contrast to the US yield curve, this would therefore mean a
significant flattening of core euro-zone yield curves through a fall in long-term interest rates.
This bull flattening configuration would probably be see spreads between the various issuers in
the euro zone continue to contract, as excessively low yields on core bonds lead investors to
extend their duration but also to position themselves in ever-riskier securities (search for yield + QE
effect).
Chart 21: Towards lower long-term interest rates in the United States and the euro zone
Yields on 2-year and 10-year US Treasuries 10-year Bunds and 5-year/5-year forward inflation
Source: Bloomberg, Natixis
With a longer-lasting European QE programme, one could also think that the matter of relative
liquidity of some sovereign euro-zone bonds would resurface or even intensify in some cases. The
ECB would then be likely to further extend its list of eligible issuers to offer additional substitutes.
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Strategy equity: still our preference for Europe and
Value
The slump in China’s financial markets has revived concerns about the country’s economic
growth. The former are not directly linked to the latter as China is a highly banked economy
and equity wealth effects on household consumer spending are still only marginal, but our
economists think that China’s economic growth could continue to slow down in the coming
years. They expect Chinese consumer spending to be only marginally affected, but
investment spending could come to an abrupt halt.
As far as investment strategies are concerned, we believe this risk underpins our arbitrage choices.
 Prefer equities in developed countries vs. emerging markets.
 Play the relatively favourable economic momentum in Europe. The slowdown in China could
reduce demand for commodities and thus drag commodity prices (including oil prices) further
downwards, which mostly benefits growth in the euro zone. The unknown element, however, is
how this additional drop in the oil price will influence the Fed’s decision to tighten its monetary
policy.
 Besides our preference for Europe, international themes would be penalised in favour of
Value themes (which are more domestics). We would clearly see the premium of growth stocks
narrowing ever faster, whereas stocks exposed to Europe would benefit from improved visibility
on the European economic cycle.
Before carrying out any precise quantification company-by-company, we asked our equity analysts
to examine their stock coverage and list the companies most exposed to China (i.e. those that could
potentially come under pressure) and also those most exposed to Europe (i.e. those that could be
relatively protected). The table below shows relative exposure rates and thus establishes a list of our
preferred stocks should China’s economy slow down significantly.
Sylvain Goyon

Table 4: Stocks most exposed to China
Stocks Sector Exposure to China Comment
Airbus Group Aero/Defence > 20% of commercial aircraft deliveries, i.e. 12%
of sales and 19% of EBIT (2015 estimates)
MTU AeroEngines Aero/Defence 8% of sales and EBIT (2015 estimates)
Rolls-Royce Aero/Defence 9% of sales and 8% of EBIT (2015 estimates)
Safran Aero/Defence 17% of sales and 20% of EBIT (2015 estimates) Potentially penalised by a negative wealth effect
Thales Aero/Defence 3% of sales and EBIT (2015 estimates) Not at risk
Zodiac Aerospace Aero/Defence 10% of sales and EBIT (2015 estimates)
Essilor Consumer goods 2% of sales and 7% of organic growth
ABI Brewers 3/4% of EBITA
Carlsberg Brewers 10% of EBITA
Heineken Brewers 4% of EBITA
SABMiller Brewers 5% of EBITA
ADP Concessions Chinese passengers account for 1% of traffic,
10% of retail sales (i.e. 1.5% of ADP’s sales)
Stock impact due more to general sentiment than
direct exposure
Peugeot Car makers 25% of sales volumes and 60/65% of earnings
(before tax)
Exposure to China (% of pre-tax profits) should
fall to 40/50% as Europe is set to grow more
rapidly
Volkswagen Car makers 36% of sales volumes and 50% of earnings
(before taxes)
BMW Car makers 21% of sales volumes and 35% of earnings
(before taxes)
SEB Retail 20% of sales, 15% of EBIT By far the company most exposed to China
EDF Energy Minority stake in 2 EPRs in China
Veolia Environnment/Suez Environment < 10% of sales
Faurecia Auto suppliers 30% of earnings
L'Oréal Food HPC 7% of sales
Intercontinental Hotels 12/13% of sales
Hermes Luxury 34.1% of sales in Asia ex-Japan Also exposed to Europe (35.1% of sales)
Kering Luxury 24.7% of sales in Asia ex-Japan Also exposed to Europe (31.4% of sales)
LVMH Luxury 29% of sales in Asia ex-Japan Also exposed to Europe (19% of sales)
Tod's Luxury 23% of sales Identically exposed to Europe (23% of sales)
JC Decaux Media 20% of sales But also 66% exposed to Europe
bioMérieux Midcaps pharma 3% of sales
Ingenico Payment 15% of sales
Ipsen Pharma 15% of sales
Novartis Pharma 20% of sales
Aixtron Semis 80% of sales
Infineon Semis 40% of sales
Melexis/STM Semis <40% of sales
Diageo Spirits 7% of EBITA 2/3% of sales but exposed via 33% stake in
Moet-Hennessy (10% of Diageo’s net profit)
Pernod Ricard Spirits 20% of operating profit At risk but less exposed than Remy Cointreau
Remy Cointreau Spirits 30% of group EBITDA Exposed mainly to the cognac market so
vulnerable to any slowdown
Kuoni Tour operator 5/10% of sales
Source: Natixis

Table 5: Main exposures to Europe
Stock Sector Exposure to Europe
Eiffage Concessions 98% of sales
Peugeot Car makers 63% of sales
Renault Car makers 62% of sales
Darty Retail 100% of sales and EBIT
Fnac Retail 95% of sales, 100% of EBIT
Veolia/Suez/Seché Environment
Faurecia Auto suppliers >50% of earnings
Beiersdorf Food HPC 37% of sales
Orpea/Korian Healthcare midcap 100% Europe
NH Hoteles Hotels 90% of sales
Solocal Media 100% France
Wirecard Payment 70% of sales
Rubis/OMV Oil Exposed to refining in Europe
Ipsen Pharma 65% of sales
Novartis Pharma 40% of sales
Enel Green Power/EDPR Renewables > 70% of EBITDA
Elior Catering 85% of sales
Elmos Semis 57% of sales
Micronas Semis 33% in Europe
KPN Telecoms 100% of sales
Numericable-SFR Telecoms 100% of sales
Iliad Telecoms 100% of sales
Swisscom Telecoms 100% of sales
Orange Telecoms 80% of sales
TeliaSonera Telecoms 75% of sales
Telecom Italia Telecoms 71% of sales
Vodafone Telecoms 67% of sales
Deutsche Telecom Telecoms 65% of sales
TUI/Thomas Cook Tour operator 90/95% of sales
Source: Natixis

Cross-asset strategy: a more defensive strategy
A slowdown in China would have repercussions on the global recovery and trigger a rise in risk
aversion. This means that a more defensive profile should be chosen in a portfolio allocation,
with a reduction in the level of CVaR5% (Conditionnal Value At Risk of 5%) from 8% (core scenario)
to 5%. The direct consequence would be a reduction in the proportion of equities and credit
compared with our current allocation. Equities, for example, which are favoured in our core scenario,
would be reduced from 43.5% of the portfolio to 27.5%.
Conversely, there would be global flows repatriated to sovereign bonds (which would be
increased to 49% of the portfolio), especially as in such a scenario, the accommodating monetary
policies would have to be continued. As usual in this type of risk regime, the big winner would
therefore be US Treasuries (despite sales from China, as we have seen recently) and 10-year
interest rates would return to the 1.50-1.75% region
1
. The current interest rate level would make US
bonds very attractive in total return terms in the event of another fall. But the Bund’s risk-free asset
status would also come into full effect, while we would play a curve flattening and look for the
longest maturities in view of the QE/liquidity effect.
Subsequently, we would play a rebalancing towards Spanish and Italian bonds, which on the
whole are benefiting from a favourable ECB monetary policy (especially a continuation of the QE
programme) and from the search for yield, given the ever lower yield levels on core paper.
Emerging countries together with industrial commodities (base metals and energy) would be
the first to suffer from a slowdown in Chinese activity. That would translate into a loss of
momentum for the region (without counting India, Asia already accounts for more than 30% of our
emerging equities index), but also a weakening for exporter countries, while the decline in Chinese
demand would automatically put pressure on commodity prices
2
.
On the other hand, we would take a long gold bet. Risk aversion combined with lower interest
rates and accommodating monetary policies encourage gold buying even though Chinese demand
as such probably would be affected (nevertheless with possible switches from buyers of Chinese
equities who have got their fingers burnt). Our strategists have a target of $1,300 for gold.
Lastly, in geographical terms, the scenario calls for a refocus on Europe, with companies that on
the whole would benefit from the fall in energy commodity prices
3
, banks that have little direct
exposure
4
, not to mention the fact that European risky assets would continue to benefit from the
continuation of the QE programme. So for equities and credit as a whole, European companies
continue to account for 26% of our portfolio and for the majority of its CVaR.
1 Read the recommendations of our fixed income strategists
2 Read the recommendations of our commodities strategists
3 Read les recommendations of our equities strategists
4 Read the recommendations of our bank analyst
Emilie Tetard

Table 6: Proposal for an asset allocation in a scenario of slowdown in Chinese activity
% Natixis Portfolio - Central scenario Natixis Portfolio - China crisis Tactical reco
Equities 43.5 27.5 UW
Equities US 11.5 7.0
Equities UK 7.5 3.0
Equities Emerging
European equities 24.5 17.5
EuroStoxx 50 16.0 10.0
Equities Mid Caps Europe 3.5 3.5
Equities Switzerland 5.0 4.0
Commodities 15.0
GSCI Energy UW
GSCI Precious metals 15.0 OW
GSCI Industrial metals UW
Sovereign Bonds 38.5 47.0 OW
Sov. Bonds Ger-Fr 1-3 years 2.0 3.0
Sov. Bonds Ger-Fr 7-10 years 4.5 9.0 OW
Sov. Bonds It-Spa 1-3 years 15.0 4.0
Sov. Bonds It-Spa 7-10 years 16.0 16.0
US Treasuries 7-10 years 1.0 15.0 OW
EUR Inflation indexed
Corporate Bonds 17.0 10.5 UW
Credit € IG Fin. 4.5 2.5
Credit € IG Non Fin. 7.0 5.0
Credit US IG Non Fin. 2.5 2.0
Crédit € High Yield 3.0 1.0
Crédit US High Yield UW
Cash € 1.0
Risk Statistics
CVaR 5% (monthly, %) 8 5 ↘
Volatility (annualized, %)
5% chg. (monthly, %)
NB: Weights are rounded to 1 decimal place. OW = Overweight, UW = Underweight, N = Neutral.
Source: Natixis

5. Sectors affected by the slowdown in
investment and consumer durable
purchases
In terms of sector exposure, semiconductors would be directly and sharply affected were an adverse
scenario to materialise, with Infineon to the forefront (ca.40% of its activity is in China). In the
automotive sector it would be a reversal of fortunes to which car makers Volkswagen and BMW
would be the most exposed. Auto parts makers (Faurecia, Plastic Omnium, Valeo), would be
harder hit than tyre makers. Capital goods stocks would also suffer, especially Schneider (15% of
its sales are generated in China). Then there are the industries that are indirectly exposed to the
Chinese market: for oil companies, the impact would be felt via oil prices and we think that Shell
would be hardest-hit. Oil companies’ E&P capex and margins would be under heavy pressure, but
we would still prefer asset-light profiles. Indeed, GTT would still be our top pick among oil services
companies. The pricing and product mix would impact the tubes and equipment segment. The
predictable fall in iron ore prices calls for caution on ArcelorMittal. Last, apart from the spectre of
rising Chinese exports, tied to a drop in local demand, we would be more concerned about the
impact on the Asia region’s economy, which would primarily affect LafargeHolcim and to a smaller
extent HeidelbergCement and Italcementi. In the Utilities sector, the indirect impact would primarily
derive from downward pressure on wholesale electricity and recycled raw materials prices with CEZ
Fortum, Vattenfall and E.ON most affected. Last, we think that European banks would be well-
shielded from an adverse scenario on the whole, as only Standard Chartered and HSBC have
substantial activities in China.
Semiconductors: the market would mature
The recent slump by the stock market in China and the imbalance inherent in its growth model,
which was bound to correct, is prompting fears of a slowdown in investment in the private sector.
The group with the most exposure in our universe is Infineon. Against this backdrop, we prefer
ASML, Dialog, ams and ASMi.
If China’s growth does slow to 4/5% (vs. nearly 10% in the past), it would have a negative impact on
the structural growth of the semiconductors market, given the way the country has grown in
importance in the last decade. In ten years, the semiconductors market has already shifted from
long-term growth of 15% to only 6/7%. This slowdown could continue, to the tune of around 1 to 2
points, notably in automotive (slower volume growth, weaker advance in electronics content),
industrials (lower spending on transport and energy infrastructure and plant equipment although the
New Silk Road initiative limits the downside risk) and even in the wireless segment (China is now a
major market for equipment makers such as Apple). The semiconductors market could thus move in
line with world GDP growth, becoming a mature market.
In our stock universe, the group with the most exposure to this risk is Infineon, with close to
40% of its sales generated in China, particularly in the industrial segment. While we are not
concerned about the fiscal Q3 figures (calendar Q2), the guidance over the coming quarters could
be under pressure. From structural growth of around 8%, the group could see its potential reduced
to 6%, which could have consequences for its outlook for improvement in earnings beyond the
current level and therefore for its valuation. Nonetheless, we are maintaining our Buy rating at
Maxime Mallet
Stéphane Houri

this stage despite the risk of volatility. Indeed, the valuation is low and its solid positioning in
industry (world leader) and automotive (world no. 2), should enable it to outperform the
semiconductors market over the next few years.
By contrast, a number of groups seem to be relatively immune to this slowdown, particularly
ASML which offers the best long-term visibility in the sector, thanks to its de facto monopoly position
in the upcoming generations of EUV lithography machines. Dialog should continue to take
advantage of growth in iPhone volumes and from product and client diversifications. Looking beyond
the likely loss of the NFC booster contract with Apple, growth for ams should be driven by the ramp-
up of biosensors that measure cholesterol, alcohol, blood sugar (diabetics) and blood oxygenation
levels. Technological transitions (10nm then 7nm) and the ramp-up of ALD (Atomic Layer
Deposition), in the face of other deposition techniques, should shield ASMi from a broad-based
slowdown in growth, including in China.
Car makers: reversal of fortune
No car makers will be spared to an adverse growth scenario for China, affecting investment
and durable goods purchases, but Volkswagen and BMW seem the most exposed.
A more marked economic slowdown would inevitably have a significant effect on Chinese
automotive demand, which is clearly already in a normalisation phase. After a decade of strong
growth (+24% per year between 2000 and 2010), the Chinese light vehicle market grew just 8% per
year in 2011/2014. 2015 looks set to be a lacklustre year with a fall of 2.3% in June (base effects
and statistical distortions) and limited growth expected for the full year (+2.5%). In our baseline
scenario, we assumed medium-term growth slightly lower than that in GDP, of around 5/6% over
2016/2018e. An adverse scenario (including credit restrictions that would curb the support provided
by the recent development of automotive financing) would call into question the prospect of growth
in demand and could lead to an unprecedented decline, of around 1%/year over this period. This
may look severe in that the Chinese market is anything but uniform and continues to be driven by
Tier3/Tier 5 cities, which have above-average growth potential.
Sector impact: ‘not all of them died, but all were hit’. With the exception of FCA, which has very
little presence in China, and Renault (indirect effect via Nissan), no car makers would be spared by
this new situation. In this scenario, the BMW and Volkswagen groups would be the most severely
affected, with a theoretical impact of around -13% and -9% on 2016/17 EPS estimates. Estimates for
PSA would be lowered by around -7% in the same period, and those for Daimler by around 5.5%.
Such a scenario would unquestionably be bad news for European car makers, for which
China has become one of their main markets and a key contributor to their profitability, and
even to their cash flow (via the dividends paid by Chinese JVs). The valuation of the Chinese
JVs would of course be affected.
China currently accounts for 36% of global volumes at Volkswagen, 25% at PSA, 21% at BMW,
18% at Mercedes, but just 4% at FCA and 1% at Renault whose exposure is mainly indirect via
Nissan, which generates 23/24% of its global sales in China. In terms of estimated profitability
(which includes the share in the earnings of Chinese JVs, the margins on imported vehicles and
parts, as well as royalties), the hierarchy is roughly the same, with more than 50% of profit before
tax coming from China at Volkswagen, nearly 50% in the case of PSA (automatic effect of the
weakness of Europe in the short term, this percentage being set to fall sharply in the medium term),
25% at Daimler and 35% at BMW. As regards cash flow, Volkswagen is certainly the most
Georges Dieng

dependent on China since, with a pay-out of 80% and a cash flow of €3bn in 2014 (and the same in
2015), the dividend paid by the Chinese JVs represents 50% of its FCF and covers the annual
dividend payment of VW AG one and a half times.
Against the backdrop of a deterioration in purchasing power, the recent phenomenon of a shift
in market share in favour of local players (thanks to their offensive in the affordable SUV segment) is
likely to gain strength, thereby weighing on the volumes of the international JVs. Concerning the
premium segment, which is currently penalised by the anti-corruption/anti-ostentation campaigns,
the situation is more uncertain, but the pressure on high-margin imported vehicles is likely to be
maintained (BMW being the most vulnerable).
Moreover, this slowdown in demand would increase pricing pressures, already tangible since
Q2 15, which would be fuelled by the fall in utilisation rates (currently over 100% at PSA, VW and
probably Mercedes). It would also aggravate the already fragile situation of a number of dealers
(particular those that were recently established and are exclusively dependent on sales of new cars),
requiring widespread implementation of the financial support measures that recently affected BMW
in particular.
What counter-measures? The race for growth had hitherto pushed cost and productivity issues into
the background. The ongoing normalisation, and even more so an adverse scenario, would make
them a priority for car makers, like the action plans launched by PSA in cooperation with Dongfeng
(industrial efficiency, “deep” localisation) and those envisaged by Volkswagen, which acknowledges
that it pays 40% more for certain parts than in Germany (!!). Capacity-widening investment plans will
inevitably be recalibrated (particularly at VW, which planned to lift capacities from 4 million vehicles
in 2016 to 5 million by 2019). Conversely, we do not expect car makers to make widespread use of
Chinese capacities to re-export to Europe or the USA (specific features of certain long wheelbase
models).
Faced with faltering Chinese growth, how resilient will car makers be? With the North
American market nearing a cycle high (which we expect in 2016), Europe, which is faring better than
expected, will be the pillar of growth in 2015/2016. The French car makers Renault and Peugeot
look to be the best placed to take advantage (>60% of their sales). While PSA’s situation looks
paradoxical (highly exposed to both China and Europe), it should be underlined that most of the
expected recovery and upwards revisions to estimates stems from the faster-than-expected
recovery in the outlook in Europe. Conversely, German car makers are likely to be particularly hard
hit, with a risk of a 9% downward revision to 2016/17 estimates. BMW (-13%) and VW (-9%) appear
to be the most vulnerable in this context.
Auto Parts: harder-hit than tyre makers
As part of a scenario of much sharper economic slowdown in China, original equipment
suppliers would clearly be more impacted than tyre makers, but probably much less so than
car makers.
In the parts universe, unsurprisingly the most sensitive would be OE suppliers, exposed to
variations in production and hence more cyclical, while the least exposed would be tyre makers,
very insensitive to OE in China and benefiting from the recent surge in the number of cars on the
road (115 million vehicles in 2015 vs. 19 million 10 years ago). They could also indirectly profit from
the market slowdown if consumers postpone their purchases. Hence and as part of this scenario,
we would recommend positioning on tyre makers (Michelin) at the expense of OE suppliers
(Faurecia, Valeo or Plastic Omnium, even Continental to a lesser extent). Remember,
Michael Foundoukidis

moreover, that Pirelli is currently subject to a takeover bid (Chinese) and that Nokian is barely
exposed to China.
With the Chinese auto market slowing for some months already, plus a shift in its mix towards local
OEMs and at the expense of International JVs, a steeper economic slowdown would clearly
have a substantial impact on the auto market and hence on production.
In this context, we have assumed: 1/ stabilisation in auto production in 2016/17 (and not a fall)
given the fact that consumption would still be the main growth driver (+7%/year in our adverse
macro scenario, i.e. the least impacted contributor versus investment or public spending); 2/
ongoing deterioration in the mix in favour of locals given the budgetary constraints that could
weigh on households.
Undeniably, stabilisation of auto production would be bad news for the auto sector as the
country has been by far (>60%), the main locomotive for sector growth worldwide and profits in the
last few years.
OE suppliers may benefit from their more balanced geographic earnings profile than at car
makers (there is no major distortion in favour of China). Moreover, Europe, the main trigger for
earnings improvement in 2015, is firmer than expected and external factors (oil, forex) still
positive. In addition, we do not expect a significant shift in these dynamics in 2016 and
Europe is likely to remain the main growth driver for the sector in 2016.
The weight of China at OE suppliers is much weaker than at OEMs. They generate between
8%e (Plastic Omnium) and 12%e of their sales (Valeo) in China. On the operating level and except
for Faurecia (more linked to its current weakness in other markets), the weight of China (from 10%e
for POM to 18%e for Valeo), though higher than the contribution to sales, remains low relative to that
for some car makers, notably German ones for which almost half of earnings stems from their
Chinese businesses. The situation is still clearly more marked at tyre makers which all generate
under 10% of their sales in China.
Productivity and flexibility on the menu. Hitherto a secondary issue, given the sharp growth in the
last few years, the improvement to productivity (costs management, process, automation, etc.)
would become a priority for most players in this adverse scenario, whether car makers or suppliers,
and underpin the profitability (Autoliv mentioned these efforts on 17/07, underpinning our opinion).
Moreover, parts suppliers have greater flexibility in their industrial bases and could scale down their
capacities, if need be, much more readily and quickly than OEMs (as we saw in Europe and North
America in 2008/09).
The local OEMs offer an opportunity medium term. Next, the exposures of OE suppliers to local
car makers are likely to increase in years to come (at the CMD Valeo mentioned an exposure of
over 30% in its order book … i.e. will transfer to its sales in 2/3 years), Faurecia has recently signed
a significant agreement with Dongfeng, etc.) and thus allow parts suppliers to better manage this
slowdown as market share gains at locals could partly offset the slowdown for the market. Moreover,
in a context of stiffening standards, mentioned above, local players, very exposed to SUVs, will have
greater need of technological depollution solutions proposed by international OE suppliers which
could thus profit from these mix trends (faced with non-existent local competition on these products).
Overall, and as part of this scenario, we would cut our estimates by some 10% for parts
suppliers for 2016/17: -8% for Plastic Omnium -10% for Valeo and -12% for Faurecia while
estimates for tyre makers would be broadly unchanged.

Integrated oil: direct impact hit by oil prices
Downward impact on crude: Slowing Chinese growth, which in our economists’ scenario of
structural weakening could decline to around 4% out to 2020, could result in oil prices falling to
around $50/60/bbl. While the average sensitivity of integrated oil groups is around 1.8% of
attributable net profit for a $1/bbl, ENI is the most sensitive.
Table 7: Sensitivity of earnings to a $1/bbl shift for crude
Shell BP Total ENI Repsol OMV
Oil price Sensitivity:
+1$/b
$320m
post-tax
$300m pre tax
$180m post taxe
$310m pre tax,
$170m post tax
€280m pre tax
€140m post tax
€30m pre tax
€18m post tax
€40m pre tax
€24m post taxe
Gearing end of
2013e 13.9% 20.5% 31.9% 22.0% 14.3% 33.6%
Crude scenario
2014 99.96
EBIT 2014 20,818 9,074 11,574 2,421 2,238
Net profit 2014 22,562 12,136 12,837 3,711 2,010 1,133
$1/bbl chg % EBIT 1.4% 3.4% 2.4% 1.2% 1.8%
$1/bbl chg % Net 1.4% 1.5% 1.3% 3.8% 0.9% 2.1%
Sources: Companies, Natixis
Volumes threatened in LNG. In the LNG sphere, China represents 8.1% of world demand with
growth estimated at 10.6% in 2014. LNG now amounts to 14.6% of gas consumption in the country.
The economic slowdown is likely to weigh on electricity and hence gas demand. However, the
development of gas usage also responds to energy and environmental diversification
considerations. From this perspective, the impact of the economic slowdown could be limited.
New declines in investments and operating costs in sight. Already faced with a negative price
climate since H2 14, oil groups are thus likely to press on and amplify opex and caped reduction
policies that we detailed in our year-start report ‘What if oil stays low long-term’. The decline in
investments is estimated at -15% internationally and over -35% in the US in 2015 by Schlumberger,
i.e. an overall slide of over 20%. Signs of new investment reductions have recently set in at major
players: at end-June 2015, Petrobras communicated a 37% fall for its capex over 2015/2019
including 50% in exploration; ConocoPhillips stated in mid-July 2015 that it intends to reduce its
investments in deep offshore, notably in the Gulf of Mexico to balance out its 2017 cash flows and
allow an increase of 1cts/quarter for its dividend; finally, the press mention a further reduction in
investments at Shell after the $2bn slide announced in Q1 15. The quarterly publications will offer an
occasion to summarise the situation on achievements and prospects in terms of cost cutting and
investments.
Limited exposure to international oil companies (IOCs). Given the legal and regulatory climate,
international oil groups have limited exposure to production in China and this is mainly focused in
offshore (Bohai Bay basin for ConocoPhillips) and on non-conventional resources. Implantations
have been made, however, in downstream (lubricants, bitumen) and, above all, in chemicals to profit
from the dynamic consumption. Aside from the exposure in China, large petrochemical platforms
have been developed in the zone (Singapore, Taiwan, Korea) to serve the Chinese market.
Anne Pumir

Table 8: Exposure to China for the main oil groups
2014
production
(in bpd)
% of total
production
2014 refining
capacity
(in kboepd)
% of total
refining
capacity
2014 ethylene
capacity
(in Mt)
% of total
ethylene
capacity
2014 PTA
capacity
(in Mt)
% of total
PTA
capacity
Royal Dutch Shell 25,000 0.8% 0.475 8.2%
BP 3.3,(1) 64.7% 1.8 26.9%
Total 12,000 0.6% 49,000 2.2%
ENI 9,000 0.5%
ExxonMobil 67,000 1.3% 0.3 3.3%
Chevron 16,000 0.6%
ConocoPhillips 40,000 2.5%
Total 102,000 2.4% 116,000 0.8%
1 Olefins and derivatives capacity
Shell the most determined in China. In the sample of majors, Shell is the group that has focused
most on expanding in the country by forging partnerships with the three Chinese majors (CNPC,
Sinopec and CNOOC) in China and abroad (Australia and Brazil notably) by investing over $1bn in
2013 in the country. Shell is also one of the main suppliers of LNG to China, a position still
reinforced by the merger underway with BG: according to Wood Mackenzie, Shell and BG together
wold represent 13% of Chinese LNG imports and this would reach 28% in 2017.
Opportunities in China? However, China seems to be making headway in the reform plan for its oil
industry. The reforms, which mainly apply to the onshore sector, chiefly concern the gradual opening
of exploration and development to private enterprises, deregulation for natural gas imports, access
of third parties to oil and gas infrastructures. At this stage, the SOE (State Owned Enterprise) reform
does not slate extra incentives for foreign investments but these are likely to be associated via
‘mixed/hybrid’ holdings which allow the injection of capital and limit recourse to debt. The groups
already present in the county could thus be able to increase their exposure.
Oil services: deteriorating outlook for recovery
Slowing Chinese growth and ensuing slide for crude would most likely result in an accentuation of
the scenario for the oil services sector that we laid out in the year-start Cross Expertise report ‘What
if oil stays low long-term?’:
 Increased pressure on E&P capex for oil companies: they are expected to fall 20% in 2015e,
and this contraction would then continue in 2016 (-10%?) and 2017.
 Postponement of the recovery for demand for the most early-cycle businesses, such as
seismic, and launches of new developments postponed, notably in offshore, where marginal
costs are higher. We slated a business recovery as of 2017, this would then be pushed out to
2018, but on low bases.
 The Chinese services groups (COSL, COOEC), faced with the slowdown for their domestic
market, could seek to redeploy outside the country, as was the case for Korean engineering
players in the Middle East in 2008/2009.
 Maintained pressure on margins, which will lead to new restructuring and new asset write-offs.
Some groups look clearly exposed to this risk: CGG, PGS, Bourbon, Saipem, SBM Offshore.
Alain Parent

Though the direct exposure to China of groups in our sample is very slight, it is interesting to raise
the specific case of GTT, tributary of future LNG demand. China indeed represents 8.1% of world
LNG demand (2014), and the LNG contributes to the tune of 14% of gas consumption in the country.
The economic slowdown is likely to drag on electricity demand and hence of gas, but this also looks
dictated by energy and environmental diversification considerations (substitution for coal), which is
likely to limit the impact on an economic slowdown on Chinese LNG demand.
This Chinese slowdown scenario does not prompt us to alter our sector hierarchy, and we
maintain our preference for ‘asset light’ profiles. GTT remains our top pick. We steer clear of
the most fragile financial structures (CGG, PGS, SBM Offshore, Bourbon).
Tubes and equipment: pressure on pricing and the mix
We do not think the tubes sector will emerge unscathed from a structural let-up in the
Chinese economy and in investment in particular, even though the Chinese market is not one
of the sector’s primary outlets.
Amid the slowdown in the pace of Chinese growth and to respond to a more challenging
environment and based on oil prices of $40/50 in 2016 and $50/60 in 2017, oil companies are likely
to once again cut their investment spending. The North American market, which is the biggest
consumer of tubes and the quickest to react, should once again see spending on the part of E&P
companies being revised down.
Pressure on drilling: we think that despite the numerous cost cuts over the past few years, the rig
count on the North American market could fall by a further 20% on current levels.
Chart 22: Development costs depending on the permit ($/b)
Source: Rystad Energy
Amid this, after a very bleak 2015, orders are not likely to recover in early 2016. In the event of a
potential stock replenishment at distributors, negotiations would likely leave very low margins for
tube manufacturers. Moreover, 2016 will see the coming on-stream of Tenaris’ new US plant
(600,000 tonnes), further upsetting the market’s balance.
Baptiste Lebacq
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Bakken Eagle Ford Permian Delaware Permian Midland Niobrara

Chart 23: North American market balance (Mt)
Heading for further asset impairments? This change in the market’s balance could prompt
companies to book impairment charges on the North American market. As a reminder, Vallourec’s
asset impairments in 2014 did not affect this region (but rather the new Brazilian plant and its
European ones). All players in our sample could then be impacted by accounting adjustments, even
Schoeller Bleckmann which has already booked impairment charges after the acquisition of
Resource Well Completion end-2014.
Also pressure in the rest of the world: in the rest of the world, the pace of new projects could be
slowed down, such as the development of the Vaca Muerta field in Argentina. Only the Middle East
might be a safe haven. Indeed, despite the fall in oil prices from their all-time high, the rig count has
slid by just 6% (401 rigs) in the region and it even increased 16% in Saudi Arabia (with 121 rigs in
operation in June 2015).
A real risk of downtrading: in onshore drilling, there is a risk that players could switch to less
premium tubes to reduce costs. For instance, in the last Abu Dhabi tender invitation, the NOC
awarded some of the tube supply contracts to the Chinese company TPCO. Indeed, this last had in
the past been pre-selected for a previous contract.
Steel: pressure already visible … and it could increase
Though the Chinese market accounts for a large share of world steel consumption, big
European players have only limited access to it (ArcelorMittal generates around 1% of its
sales in China). If a slowdown of the Chinese market therefore has only a small direct impact
on the activity of these groups, it may however affect the global market outlook. Besides the
pressure driving exports, it should be noted that the strength of Chinese demand determines
not only trends in raw materials prices (iron ore and coal) but also in steel prices.
A decline in steel consumption in China…
For the first time since 1995, Chinese apparent demand for steel fell in 2014 (-3.3%) due to
government efforts in particular to curb artificial activity in the real estate market and the slowdown in
the outlook for the automotive market (see the Auto section). This situation is likely to last according
to the World Steel Association, which, in April 2015, forecast a decline of 0.5% in apparent demand
for steel in China in both 2015 and 2016. The World Steel Association is more cautious than
Sandra Pereira
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US Steel Tenaris Vallourec TMK-Ipsco TPCO Benteler demand

ArcelorMittal, which, at its Q1 15 results publication, still expected a small increase in apparent steel
demand in 2015 (between 0.5% and 1.5% versus between +1.5% and +2.5% previously). In the
medium term, the World Steel Association does not expect a significant recovery.
…resulting in a rise in exports …
With overcapacity in China still at a high level (the ratio of production to production capacities stood
at 70% in 2014 versus 75% in 2013 and 77% in 2012 by our estimates), the slowdown in Chinese
demand therefore resulted in a rise in Chinese steel exports (+28% in the first five months of the
year), which now represent nearly 13% of production in the first five months of 2015 (versus 11.5%
in 2014 and 8% in 2013). At the publication of its Q1 15 results, ArcelorMittal mentioned that it had
suffered a deterioration in its operating performances in the USA against the backdrop of stronger
competition from imports from China. In the first three months of the year, imports of Chinese steel
into the USA grew 29%.
Chart 24: Growth of steel consumption and production in China (‘000t) and growth in Chinese steel exports (‘000t)
Sources: Bloomberg, WSA, Natixis
…and pricing pressures
This pressure to export is particularly strong as the price difference between flat steel in China and
that in North America ($151/t) makes importing steel from China particularly attractive, and moreover
represents a risk for flat steel prices in the USA and to a lesser extent in Europe. In this respect, it
should be noted that a number of complaints have been filed by the European steel association,
Eurofer, for dumping relating to imports of certain types of steel from China.
The fall in steel prices also stems from the fall in raw materials prices. The slowdown in apparent
demand for steel has resulted in a fall in consumption of iron ore in China, weighing heavily on iron
ore prices, which fell by nearly 49% at the end of 2014 (fall of 30% on average over the full year), as
mining groups did not adjust their production. This decrease continued in 2015 with a further fall of
23% to $54/t.
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Chart 25: Steel prices (HRC) per region and iron ore prices compared to ArcelorMittal EBITDA expectations
Sources: Bloomberg, Natixis
The threat of a more pronounced slowdown than expected therefore raises fears of:
 An increase in the pressures driving Chinese steel exports for at least as long as it takes the
Chinese steel industry to rationalise production. In this respect, it should be noted that the
Chinese government has presented a plan aimed at reducing the steel production capacities of
its blast furnaces by 80 million tonnes by 2017, which will probably not be sufficient. These
measures are also part of the pollution reduction process initiated by the Chinese government in
2013.
 But also, a further fall in iron ore prices, which could slide to $40/t according to our economists.
Caution recommended on ArcelorMittal
The fall in iron ore prices and the deterioration in performances on the US market had led
ArcelorMittal to lower its EBITDA target, which is now for between $6bn and $7bn (versus between
$6.5bn and $7bn previously, and $7.3bn at the end of 2014). The weakness of iron ore prices had
moreover led S&P to lower the group’s rating by one notch to BB at the start of February 2015 after
the rating agency cut its estimates for iron ore prices to $65 per tonne in 2015 and 2016. While the
further reduction since then in S&P’s iron ore price forecasts, which are now for a price of $45/t,
$50/t and $55/t in the period 2015/2017, did not lead to any further negative action on the group’s
rating, a greater erosion in prices could put pressure on the group’s operating performances, as
illustrated by the chart above on the right, which shows the close correlation between EBITDA
estimates and iron ore prices, and therefore its rating, other things being equal. In 2014,
ArcelorMittal’s mining division accounted for 18% of its EBITDA (compared with 29% in 2013).
Other industrials: larger direct exposure
The slowdown in industrial activity in China is also likely to affect the activity of industrial
gases groups, which are directly exposed to this market. Respectively number 2 and 3 on the
market behind Chinese group Yingde Gases, German industrial gases group Linde generated just
under 8% of its sales in China in 2014 while its French counterpart, Air Liquide, does not disclose its
direct exposure. While the slowdown of the Chinese economy is likely to weigh on the industrial
gases market, it should be buoyed by growth drivers that are not correlated to economic activity:
 The rebalancing of the Chinese industrial sector;
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Consensus EBITDA 14 Consensus EBITDA 15
Iron ore price ($/t) (rhs)

 The increase in on-site outsourcing of production, which is likely to rise from 42% in 2014 to 50%
in 2019 (in line with the global average);
 Growing energy needs in a more demanding regulatory climate as regards environmental
protection, resulting in big opportunities for industrial gases producers. Indeed, industrial gases
are at the heart of manufacturing processes for cleaner and renewable energies (conversion of
fossil energies, for example).
Chart 26: Outlook for the industrial gases market in China and organic growth in activity for Schneider by region
Sources: Yingde Gases, Schneider, Natixis
The issuer in our sample that it most exposed to China is capital goods manufacturer
Schneider, which in 2014 generated 15% of its sales in China. The group already suffered in
2012 from a slowdown in its activity on the Chinese market, as the chart on the right above shows,
with a decrease in organic growth in activity in Asia Pacific. While the situation has since stabilised
at a low level (still affected by the weakness of the residential market, including in Tier 2 and Tier 3
cities, and the slowdown in manufacturing activity), Schneider experienced an overall slowdown in
organic growth in activity in emerging countries in 2014, with the rate of growth converging with that
in mature countries. A sharper slowdown of the Chinese economy would therefore be negative for
the group.
Cement: at little risk
The threat from China needs to be put into perspective as far as Europe’s cement companies
are concerned, because 1/ these companies have little exposure to China, at just 2% of
EBITDA in LafargeHolcim’s case, 2/ cement travels badly, do imports account for just 2.8% of
global cement consumption. If demand slows down, Chinese exports could double (30/40 Mt)
but we think these imports will be limited to traditional importing countries. Chinese cement
companies could step up their efforts to expand internationally, as Anhui Conch is doing.
Setting aside the risk of an increase in Chinese exports, we are more concerned about the
impact on the region’s economy.
By nature, cement is not very exportable because it is heavy and sensitive to humidity. Cement
trading amounted to just 117 Mt in 2014, i.e. 2.8% of global consumption of 4.1bnt (4.7% of Chinese
cement consumption of 2.4bnt). We would divide cement-exporting countries into several categories:
Sven Edelfelt
4.7 5.1 5.8 6.5 7.2 7.9 8.6 9.3 10.1 10.8 11.6 12.4
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Q1-15
Emerging countries Mature countries Asia/Pacific

 Countries that are natural or regular exporters because they have built up their cement
industries (perhaps partially) with the aim of exporting the product, e.g. Turkey, Greece and
Germany.
 Countries that are being undermined by poor domestic demand and temporarily focusing on
exporting their cement production, e.g. Spain, Thailand, South Korea and Japan.
 Countries that temporarily find themselves with surplus capacity. The rate at which new
capacity comes on stream can result in a surplus of cement lasting several years. This is the
case in Iran, Vietnam and certain Persian Gulf countries.
Table 9: The world’s biggest cement-exporting countries
Mt Cement and clinker exports
2012 2013 2014
Iran 13.60 18.80 19.40
Vietnam 8.70 16.10 17.00
China 13.60 14.60 15.00
United Arab Emirates 10.60 12.88 13.50
Turkey 13.60 12.40 12.50
South Korea 8.88 9.00 10.30
Spain 6.19 7.00 9.59
Japan 9.70 8.70 8.50
Thailand 11.47 7.99 8.23
Pakistan 8.32 8.29 8.05
India 2.76 4.47 5.95
Greece 4.25 4.76 5.65
Germany 7.02 6.32 5.60
Portugal 2.92 4.95 5.42
Canada 4.11 3.48 3.76
Taiwan 3.69 4.26 3.50
Italy 1.77 2.44 2.50
Belgium 2.57 2.60 2.40
Malaysia 2.67 2.50 2.37
Caribbean 1.91 1.98 2.16
Sources: ICR, Natixis
The threat from Chinese exports needs to be put into perspective as they amounted to just
15 Mt in 2014. Cement markets have high entry barriers, especially in emerging countries where
cement is sold by the bag (between 60% and 70%, depending on the country) and therefore needs
to go through a distributor. Meanwhile, a lot of China’s cement is considered to be of inferior quality
to that produced by European cement companies.
If demand slows down, we think Chinese exports could rapidly jump to between 30 Mt and
40 Mt (a level already reached in 2007). Certain plants near the coast could easily revive their
exporting activity, but these exports would be limited to countries that are traditional importers or
neighbours (countries equipped with infrastructure such as cement grinders). Bear in mind that
China exported between 22 Mt and 36 Mt in 2005/2008, mostly to the USA, a country that has a
structural cement deficit (imports in 2007 amounted to 38.5 Mt, i.e. 31% of cement consumption, vs.
6 Mt today).

Chart 27: China’s cement exports/imports (Mt)
Sources: Bloomberg, ICR, companies, Natixis
Certain Chinese companies could be tempted to adopt a more aggressive international
expansion strategy. Anhui Conch is still the only company with plans to expand internationally, so
far consisting exclusively of building new capacity (Myanmar, Indonesia and Vietnam). Chinese
companies have similar levels of production capacity to Lafarge or Holcim on a standalone basis, i.e.
around 200 Mt (CNBM, Anhui Conch), Heidelbergcement, i.e. around 130 Mt (Jidong Development),
or Italcementi, i.e. around 70 Mt (China Resources). Chinese companies might want to limit their
exposure to their depressed domestic market and diversify their portfolios by 1/ adding new capacity
(we estimate that it takes about 4/5 years to build a new plant, including the time needed to obtain
the operating licence), 2/ generating external growth, as Latam companies are doing. However, their
financial resources might be undermined by a lasting slowdown in their domestic market, which
would hinder such plans.
LafargeHolcim, and to a lesser extent, HeidelbergCement and Italcementi are currently the
companies most exposed to emerging Asia (see map below). LafargeHolcim’s production
capacity in Asia accounts for 42.1% of its total capacity (162.5 Mt) and 21.9% ex-India (68 Mt), of
which 8% in China (31 Mt). Meanwhile, HeidelbergCement’s Asian exposure stands at 22.6%
(29 Mt), consisting mainly of its Indonesian subsidiary Indocement which accounts for 16.0% of its
capacity (20.5 Mt). The Chinese operations of European cement companies are limited to
observation posts in subsidiaries owned jointly with a partner and therefore not consolidated. In
LafargeHolcim’s case, Lafarge’s assets are being taken over purely as part of the merger with
Holcim. We think the new group could seek to merge Lafarge’s former subsidiary with Holcim’s
(currently booked as a JV and not consolidated).
Setting aside the risk of an increase in Chinese exports, we are more concerned about the
impact on the region’s economy. The region’s demand for cement could prove disappointing for
the cement companies operating there.
0%
1%
2%
3%
4%
0
5
10
15
20
25
30
35
40
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
YTD2015
Exports Share of exports in production (rhs)
-10%
0%
10%
20%
0
500
1 000
1 500
2 000
2 500
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
YTD2015
Consumption Variation production (rhs)
Variation consumption (rhs)

Chart 28: Cement companies operating in Asia
Note: figure in brackets corresponds to % of EBITDA and production capacity/Australia: Cement Australia controlled by LafargeHolcim-
HeidelbergCement joint venture (the group gives capacity at 100% in the registration document)
Sources: Bloomberg, ICR, companies, Natixis
Utilities : affected by prices decrease
The scenario of a severe slump in Chinese growth would affect European utilities in four different
ways and in decreasing order of importance: 1/ wholesale electricity prices via the fall in coal prices,
2/ recycled raw materials prices, 3/ Chinese investment in the nuclear and renewables segments in
Europe and 4/ investment in the Chinese nuclear segment.
Firstly, such a scenario would further depress coal prices, negatively affecting electricity
prices on the different wholesale markets in Europe. Despite the government’s various initiatives
underway to “decarbonise” the Chinese economy and which are likely to structurally affect the
aggregate consumption of this fuel in the years ahead, China still represents 40% of the global coal
market. It still consumes 3 billion tonnes of the fuel, 300 million of which are imported. Therefore, a
sharp let-up in Chinese growth would worsen the market’s overcapacity and the downward pressure
on prices that has been perceptible for the past four years (1-year forward prices have fallen from
$120/tonne in early 2011 to $58/tonnes currently). As coal-fired electricity generation is now a
“marginal” technology on most European wholesale markets, any further downward pressure on coal
prices would also be a drag on electricity prices. Such a scenario would firstly impact those
electricity companies exposed to market risk and with more rigid cost structures, given their
predominantly of nuclear, hydro and/or lignite-fired capacities. This category includes CEZ, Verbund,
Fortum, Vattenfall and E.ON. Given the importance of their coal-fired capacities, RWE and
southern-European electricity companies (EDP, Enel and Iberdrola) would be less affected by this
phenomenon as falling electricity prices on wholesale markets are partly offset by lower coal
sourcing costs, which in themselves depend on the global market situation. For an electricity
Philippe Ourpatian
Ivan Pavlovic
With the participation
of Orith Azoulay
LafargeHolcim 68.2 Mt (8%)
HeidelbergCement 5.6 Mt (2%)
Italcementi 5,5 Mt (2.8%)
HeidelbergCement 7.4 Mt
HeidelbergCement 20.5 Mt (19%)
HeidelbergCement 2.4 Mt (>1%)
LafargeHolcim 5.7 Mt (>1%)
HeidelberCement 2.7 Mt
Italcementi 5.8 Mt (10%)

company such as Fortum, every €1/MWh fall in prices would have a €50m impact on EBITDA, i.e.
4% of the consolidated level forecast for 2015 by the Bloomberg consensus.
This scenario would, moreover, have a negative impact secondary raw materials prices to
which Suez Env. and Veolia Env. are exposed via their Waste division’s recycling activities.
Paper, scrap metal and pasteboard prices, which are set locally, are based on global factors. The
volatility of secondary raw material prices can dent the recycling margin and even push them into
negative territory. This is the specific case of Suez Env. insofar as this company buys waste
destined for recycling from its industrial clients. Although the impact of a fall in secondary raw
materials prices is a direct one, it must be put into perspective for the two environmental services
specialists. In 2014, downward pressure on secondary raw materials price (-12% on paper prices
according to Copacel and -6% on scrap metal according to the French Steel federation) knocked off
€7m from Suez Env.’s EBITDA (1% of the Waste division’s total). For Veolia Env., this low pricing
environment had a 0.6% impact on the Waste division’s sales (€8.5bn, i.e. 36% of consolidated
sales).
Furthermore, this scenario could affect Chinese investment in the European electricity
sector. In the nuclear field, this could compromise the involvement of the two Chinese electricity
companies CGN and CNCC in plans to build the two EPR reactors at Hinkley Point in the UK.
Remember that according to the broad outline of the plans EDF announced in October 2013, the two
companies were expected to acquire a 30 to 40% interest in the project structure designed to hold
the two planned reactors. If they pulled out, this would force EDF to seek new partners to fund this
project, which could be tricky amid the current global energy climate. The potential shelving of the
project would above all be negative for Areva. It would affect the potential for the EPR’s commercial
development, which has already been hit by the difficulties encountered on the OL3 projects in
Finland and in Flamanville in France. Moreover, the scenario of a severe downturn in China could
affect the partnership between EDP and CTG (China Three Gorges) and the latter’s participation in
the Portuguese’s electricity company’s investment in renewables.
All in all, in our universe of coverage, CEZ Fortum, Vattenfall and E.ON emerge as the issuers
that could potentially be the hardest hit by the indirect effects of a sharp Chinese downturn.
Suez Env. and Veolia Env. would also be affected were this scenario to materialise, but to a
far more marginal extent.
Banks: almost all European well-shielded from Chinese
risk
Disposals of European banks’ stakes in Chinese banks has been the name of
the game
We believe the European banking sector is well shielded when it comes to direct exposures to the
slowing Chinese economy. Few banks are operationally active in the area on a significant scale
other than Standard Chartered and HSBC whose risk weighted asset allocation at end 2014 was
as follows.
Elie Darwish
Robert Sage

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