baird macro-economic perpsective

While acknowledging recent fears of a significant macroeconomic slowdown , Baird’sIndustrial, Business Services and Consumer analysts generally agree that the globaleconomy is transitioning from early cycle to the lower-growth middle stage of thebusiness cycle. As such, we see multiple ways to invest across these economicallysensitive end-markets. In this research report, we highlight our top Industrial, Services,and Consumer stocks that possess compelling risk/rewards amid the currentslow-growth, mid-cycle environment.

■ Slowdown or downturn? While macroeconomic risks have been building (startingwith the end of QE2 and ending with uncertainties surrounding the Greek debt crisis),our analysts largely agree that the current environment appears to be indicative of ashift to lower levels of growth observed during the middle portion of an economiccycle, with the sharp pullback in economic indicators influenced by supply chaindisruptions related to the Japan earthquake.

■ Uncomfortably soft labor market. The BLS Employment Report showed a slowdownin Nonfarm payroll growth from +232k in April to +54k in May, confirmed by the ADPReport, which showed private sector employment growth slowing from +177k in Aprilto +38k in May. Furthermore, the 4-week moving average of Initial Jobless Claims hasrisen solidly above the sub-400k level observed 1-2 months ago. Of note, while initialjobless claims rise preceding and during recessions, they have also historically risenduring prior mid-cycle slowdowns.

■ Continued reliance on the upper-income consumer. Employment for collegegraduates has increased on a y/y basis for 18 of the 20 last months, while employmentfor non-graduates has decreased for 17 of those 20 months. The above labordynamics coupled with higher gas prices favor companies catering to upper incomeconsumers.

■ The Industrial Cycle: what’s different this time? Behavior of key industrial sub-sectorsduring the current recovery has differed from prior cycles, particularly as constructionactivity has remained disengaged. Residential construction has lagged (historically oneof the earlier sectors to rebound), while traditional later-cycle areas such as miningactivity and natural resource extraction related equipment, have recovered morequickly than typical. Still, the current industrial up-cycle is relatively young measuredby historical standards such as months of Y/Y IP growth.

Document structure: the current note presents Top Ideas (page 2), Macro commentary(pages 3-8) and Sector-Specific comments (pages 9-42).

June 21, 2011 Baird Equity ResearchBaird

Economically Sensitive Investing in a Slow, Mid-Cycle Growth Environment

Team Baird Research

www.rwbaird.com

[Please refer to Appendix- Important Disclosuresand Analyst Certification]

2

Details

Price

Target

Current Price

(6/20/2011) Key Investment Points

JCI $63 $37.39

Cyclical margin and end market demand recovery plus secular growth and margin

expansion opportunities

CAT $148 $98.18

Large Late Cycle exposure, more aggressive growth strategy, achieving all of

Caterpillar's targets would imply $15-20 in EPS by 2015, or roughly 3-4x the prior peak

JEC $55 $41.27

Rising demand driven by investment in Oil & Gas infrastructure, backlog shows first

sequential improvement in two years

SWK $90 $68.83

Substantial exposure to construction markets suggests significant growth potential from

cyclical volume improvement. Cyclical growth should be leveraged by realization of

acquisition synergies from the merger with Black & Decker

ARG $78 $66.84

Mid-cycle dynamic is supportive of several key fundamental factors, with cyclical trends

increasingly positive, an improving pricing environment and acquisition activity expected to

accelerate

RBC $95 $64.27

Significant exposure to energy efficiency movement provides a secular theme and should

drive growth in excess of core industrial peers. Concerns over HVAC demand,

commodity inflation, and expiration of the high-efficiency HVAC tax credit should

moderate throughout 2011

FDX $117 $87.50

Well positioned to benefit from favorable parcel industry trends, supported by both the

growing industrial environment and more rational industry pricing

CLC $50 $44.72

Attractive aftermarket business mix, increasing penetration in emerging markets,

restructured I/E segment but more margin runway available

SFN $15 $8.77

Significant progress improving positioning into higher-margin, better secular growth sub-

sectors positions SFN for continued profitability growth assuming macro expansion

continues. Valuation attractive, especially on FCF basis with FCF/sh. regularly materially

exceeding EPS.

CTAS $35 $32.29

Accelerating top-line momentum is driving margin and earnings leverage as previous

investments in sales staff have begun to pay off; a recent bond offering coupled with

enhanced alliance agreements in CTAS# higher-growth hygiene business may provide

opportunity for additional EPS upside, beyond cyclical dynamics

G $19 $15.70

Mid-cycle corporate focus on organic-growth-enhancing expansion programs favors

Consulting and Offshore BPO. We think Genpact is well-positioned to benefit from this

growth # if market growth returns to pre-recession levels of 15-20%, we think 20%+

growth at Genpact is possible (from +13% in 2011E/2012E).

FCN $46 $36.41

Late cycle and countercyclical exposure. Roughly 55% of the business (Corporate

Finance and Restructuring at 32% and Forensic and Litigation Consulting at 23% of

revenues) is driven by financial distress in high yield borrowers as well as the litigation

and forensic accounting engagements that often follow cases of fraud or corporate

malfeasance

PNRA $150 $119.85

Near-term operating momentum (supported by internal drivers, higher-income customer

demographic), healthy long-term growth prospects

ZUMZ $35 $24.48

Footwear momentum, 57% of revenues non-apparel thus less exposed to commodity

driven cost increases

URBN $40 $28.97

Internal merchandising and execution improvement in C2H11/F2H12 would be

exaggerated by continued improvement in trends for higher-income consumers

TSCO $74 $63.46

Unique needs-based merchandise offering focused on traffic-driving C.U.E. (consumable,

usable, edible) items plus strong competitive position (4x the size of its next five

competitors combined) should continue to support healthy top-line trends even in a

challenging environment

ORLY $70 $63.00

We like O'Reilly for contrarian-minded investors noting: 1) an aging vehicle population, 2)

industry consolidation, 3) CSK-related growth, 4) a heavier commercial mix, and 5)

stronger cash flow through better inventory management

Consumer - Sector Specific commentaries pg 33 - 42

Business Services- Sector Specific commentaries pg 24 - 32

Industrials - Sector Specific commentaries pg 9 - 23

June 21, 2011 | Baird

Robert W. Baird & Co.

3

Macro Thoughts – Industrial Perspective

From a fundamental perspective, Baird’s Industrial analysts generally agree that the global economy istransitioning from early cycle to the middle stages of cyclical recovery. Aggregate general industrialindicators such as industrial production and capacity utilization generally bottomed in mid-2009 andhave improved steadily since, consistent with transition to a normal cyclical expansion (albeit at lowerabsolute levels relative to prior recoveries), and suggesting that industrial companies are transitioningto more normal, “mid-cycle” growth rates.

The PMI appears to have peaked, and is now moderating from the cycle highs, while continuing tosupport the prospect for additional growth. While the U.S. PMI posted a sharp sequential drop in May,the absolute reading remains at a healthy level (53.5). New orders also remained above the 50.0 level(while also reflecting a sharp sequential deceleration). Recent global shocks (Japan earthquake,Middle East unrest) coupled with an increasing inflation backdrop may have had a profound impact onthis sentiment indicator. At 22 months, the current PMI up-cycle (defined as readings over >50)remains relatively short compared to the average up-cycle of 31 months (since 1960).

Industrial Production continues to steadily improve on a y/y basis…but growth is decelerating.Industrial production (manufacturing ex-tech) has increased +11% (May 88.0) from the cyclical bottomin June 2009 (79.0) and now stands 13% below the prior peak (July 2007, 100.7). During the months ofMay, IP increased on a y/y basis for the 15th consecutive month. In the six previous cycles going backto the early 1970s, the average duration of growth has been 54 months, suggesting more growth liesahead. That being said, growth rates are moderating, as IP grew +3.4% y/y during the month of Mayafter increasing as rapidly as +8.3% in June 2010. Moreover, the pace of positive estimate revisions toIP have slowed, again reinforcing our belief the ‘second derivative” is leveling.



4

Fixed capital investment is rebounding. Global fixed investment (GFI) growth turned positive in 2Q10and averaged +5% in 2H10. GFI growth is forecasted to be approximately +5% in 2011 and+6% in2012. GFI growth troughed at -14.5% in 2Q09 versus -4% in 1Q02. In absolute terms, GFI peaked in4Q07 and troughed in 4Q09. The Blue Chip Economic Indicators forecast for non-residential fixedinvestment is currently +7.9% and +8.2% Y/Y growth for CY11/CY12E.

The Industrial Cycle: what’s different this time? While the overall industrial cycle appears to be fairlynormal, the ways in which key industrial sub-sectors have behaved during the current recovery hasdiffered from prior cycles, particularly as construction activity remains disengaged. The US residentialconstruction market has historically been one of the earlier sectors to rebound in an economicrecovery, yet housing starts fell 20% year/year in April (to near record-low SAAR), nearly two yearsafter the official end of the recent recession. Although May starts improved Q/Q, the Y/Y rate was stillnegative at 3.4%.



5

Indeed, the current recovery has occurred almost completely without a boost from domestic housingmarkets – itself a function of the heights of the housing bubble in the mid-2000s and the subsequentdeclines in home values. As a result, sales of product consumed directly in home construction haveremained weak even as areas such as construction-related-machinery have rebounded driven bypent-up replacement demand created by the depth of the downturn.

On the other hand, traditional later-cycle areas such as mining activity and natural resourceextraction-related equipment demand, have recovered more quickly than is typical in the early stagesof an upturn, reflecting the abbreviated up-cycle during the last recovery and the tight commoditymarket created by years of mining underinvestment observed since the 1980s. As an example, it tookthree full years beyond the official end of the 2001 recession (2004) before new mining equipmentorders at suppliers Joy Global and Bucyrus accelerated in earnest, whereas net orders rebounded atthe same suppliers as early as the 1Q10 (and have subsequently returned to peak), just 6-9 monthsafter the last recession’s official end (June-09).

Mid- and late-cycle opportunities. While Baird’s Industrial analysts project economic growth willcontinue, ongoing moderation in comparisons is viewed to be consistent with mid-cycle growth and asa signal that the initial, and powerful, short-cycle recovery has largely played out. A notable exceptionto the above statement can be found in Automotive, where Baird’s Automotive team projects theindustry is in the initial stages of a 4-5 year cyclical recovery in vehicle demand.

Broadly speaking, Baird’s industrial analysts are focusing on companies likely to benefit fromlonger-cycle project-oriented work in later-cycle markets, such as oil & gas, mining, power andinfrastructure, particularly in resource-heavy and emerging markets. Investment recommendationsare also focused on the construction market, particularly companies with non-residential constructionexposure, 3PLs and asset-based transportation names with secular themes, as well as companies thatcarry a higher aftermarket component to revenues (Filtration) that can provide defensivecharacteristic and still grow sales/EPS in slower growth economy. Engineering and constructioncompanies also continue to see strong order activity for “front-end” (e.g., design-heavy) project work,which bodes well for emerging later-cycle opportunities .

Macro Thoughts – Business Services Perspective

Our Business Services analysts also largely agree that the US economy is experiencing a shift towards amid-cycle slower-growth environment, evidenced in part by May’s economic data showing adeceleration in the rate of US economic and labor market growth, but also by anecdotal data pointssurrounding corporate budgets being directed towards the type of projects normally seen during themid-to-late portion of the cycle.

The Human Capital Services coverage team points out recent softness in the labor market. Notably,the closely followed BLS Employment Report showed a slowdown in Nonfarm payroll growth from+232k in April to +54k in May. The weakness in the BLS report was supported by the recent slowdownin the ADP-Macroeconomic Advisors Employment Report, which showed private sector employmentgrowth slowing from +177k in April to +38k in May.

Some investors may note that the BLS and ADP reports have only exhibited a sharp slowdown for onemonth, and the data series have historically been volatile and the recent slowdown occurred during aperiod that was arguably impacted by issues that may prove to be transitory (such as supply chaindisruptions stemming from the fall-out from the Japanese natural disasters). However, our HumanCapital Services team notes that other, more leading labor market indicators have softened in recent



6

months as well, the BLS and ADP reports exhibited broad-based weakness (one-month private sectordiffusion index in BLS series fell from 65.0 in April to 53.6 in May), and other leading macroeconomicdata points (that typically lead the lagging or co-incident labor market data) have been soft as well.

For example, temporary help employment, which has typically proven to be a leading labor marketindicator, has declined slightly on a seasonally adjusted sequential basis in three of the last fivemonths (per the BLS Employment Report). Furthermore, the 4-wk. moving average of Initial JoblessClaims has risen solidly above the sub-400k level observed 1-2 months ago, most recently coming in at425.5k. For perspective, as the chart below indicates, initial jobless claims declined materially in late2009 and early 2010 as the US economy exited the recession, similar to the early stages of priorrecoveries. Also, as illustrated by the chart below, while initial jobless claims rise preceding and duringrecessions, they have also historically risen during prior mid-cycle slowdowns.

Our Facilities Services coverage team points out that in spite of a softening overall employmentpicture, employment gains in uniform-wearing industry verticals are outpacing the broader economyfor the first time since late 2006/early 2007, presenting opportunities in the space.

Our BPO coverage team mentions anecdotal evidence surrounding the type of spending seen fromBPO’s client companies suggesting a mid-cycle shift as well. Broadly speaking, during the early stagesof a recovery (2009), clients normally reduce spending significantly. When spending resumed (early2010), it was largely focused on cost efficiencies, with a short payback focus. However, more recentlyclient spend has shifted toward revenue-generation types of programs, including new productintroductions, customer acquisition, and geographical expansion. This is indicative of companiesfocused on growth, consistent with the middle stage of the business cycle, a view also shared by theProfessional Services coverage team, which notes additionally that Regulatory and Corporatelitigation are showing early signs of growth typically seen in the mature portion of the business cycle.



7

Macro Thoughts – Consumer Perspective

The consensus view among our Consumer analysts is that we are still in the early stages of theconsumer recovery. Growth rates have moderated recently in some categories but it is unclearwhether slowing trends are a result of shorter-term factors (gas prices, weather, tougher comps) orlarger structural issues (depressed housing market, lingering unemployment). Given the relativeuncertainty, our Consumer analysts are generally focused on companies with more durable top-linedrivers (product cycle momentum, less cyclical end markets), internal profitability initiatives, andpricing power.

Consumer macro indicators have been improving; however, they are still below pre-recession levels,indicating potential for further upside to the recovery.

Consumer sentiment improved, but remains well below pre-recession levels. Consumer sentient(University of Michigan) in June decreased sequentially and y/y to 71.8 (vs. 76.0), remaining above therecession low of 56.3, but below the 20-year average of 88, and well below the 1997-2007 average of96.

Trends favor the higher-income consumer, as employment gains for college graduates outpaceemployment for non-graduates. Employment for college graduates has increased on a y/y basis for 18of the 20 last months (+2.3% six-month average), while employment for non-graduates has decreasedfor 17 of those 20 months (-0.5% six-month average). Additionally, the gap between the U6 rate andU3 rate has averaged 7.0% over the past six months, reflecting high levels of forced part-time workersand discouraged job seekers.

Source: U.S. Bureau of Labor Statistics

FIGURE 4: YEAR-OVER-YEAR EMPLOYMENT CHANGE

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May-05 May-06 May-07 May-08 May-09 May-10 May-11

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Non-College GraduatesCollege Graduates

Gas and food prices pressuring the lower-income consumer. Gasoline prices are currently trendingup +38% y/y and +21% sequentially (year-to-date), pressuring traffic and discretionary income(particularly for lower-income consumers). Looking forward, futures indicate gasoline prices willremain above year-ago levels in upcoming periods, although the recent pullback in oil/gasoline futuressuggests the year-over-year pressure in the second half of 2011 could be less severe than in the firsthalf of the year.



8

Source: Bureau of Economic Analysis, U.S. Department of Commerce; U.S. Energy Information Administration (average regular retail)

FIGURE 5: FOOD AND GASOLINE PRICES

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U.S. Gasoline PricesHistorical Spot PricesFuture Prices

While the impact of higher Gas prices is an area of concern for most of the Consumer research teams,our Restaurants team points out that responses to recent surveys of private restaurant chains aresuggesting that most operators still do not consider higher gasoline prices to be a meaningful issueimpacting consumer spending at this stage.



9

Sector Commentary - Global Automotive & Truck

David Leiker, [email protected] [email protected]

Believe recovery still early in Automotive. Automotive is still in the initial stages of likely a 4-5 yearcyclical recovery in vehicle demand. We believe auto supplier stocks are half way through the up cycleof outperformance, with most stocks potentially capable of doubling from current levels through2014/2015.

In the developed automotive markets (U.S. and Europe), light vehicle demand remains 15-30% belowprior-cycle peak levels; modeling a return to “trend,” not peak, demand levels drives 5-6% annualproduction growth through 2013/2014. The potential for a strong replacement cycle, returningmarkets back to/above last-cycle peak levels of demand, lends further upside to our estimates. Withinthe group, we are most attracted to ideas with secular growth opportunities to outpace the level ofend-market growth, in addition to margin expansion potential and attractive valuations.

Truck still well below prior peak. We believe the commercial vehicle stocks have another 2-3 yearsleft in an up cycle that typically doesn’t peak until incoming orders reach a cyclical peak. Both NorthAmerica and Europe are in the initial stages of a strong replacement cycle, with Europe ahead of NorthAmerica in terms of incoming orders translating to production by the truck manufacturers. The NorthAmerica commercial vehicle market is still 45% below prior-cycle peak demand levels, with annualizedproduction rates of 225,000 units well below the annualized order rates of 350,000 during previousmonths. A return to “trend” demand levels in these two markets drives 15% annual productiongrowth through 2013/2014.

Top Auto Ideas

GNTX (Outperform, Price Target $42)

■ GNTX positioned for +15-20% annual revenue growth over next 3-4 years, in our view, driven by acombination of cyclical recovery in end-market demand (5-6% annual growth) and 10-15% organicgrowth above end-market growth.

■ 10-15% annual organic revenue growth possible (+/- production) from the combination of growingauto-dimming mirror penetration (currently around 20%) and increasing content (addingfeatures/functionality to the mirror).

- Rear Camera Display shipments, at $65-100 of content, could increase from 1,250,000 units in2010 to over 8.0 million by 2015-2016 as the government mandates in-vehicle technology toimprove the rearward field of vision in vehicles to eliminate blind spots and prevent backoveraccidents.

- Additional technology delivering gains in content include SmartBeam (automatic control ofhigh/low beam head lamps) and driver assistance features (e.g., lane departure warnings, drivernotification, blind spot detection).

■ Margin expansion could be meaningful against double-digit revenue growth backdrop. Otherfactors supporting margin expansion include excellent cost management, a strong track record ofproductivity gains, and implementing value-added engineering actions.



mailto:[email protected]


10

■ Price target. Our $42 price target is based on 14.6 times our estimate of 2014 EBITDA, the medianof the valuation range during the "steady growth" period from 2000-2004.

■ Risks: 1) the pace/slope of end-market recovery; 2) adoption rates of auto-dimming mirrors andadvanced features; 3) a shift in mix between large and small vehicles; and 4) raw material andcomponent costs, primarily purchased electronics components.

JCI (Outperform, PT $63)

■ Cyclical margin and end-market demand recovery plus secular growth and margin expansionopportunities underpin our JCI recommendation.

■ Multiple areas for margin expansion. JCI’s three businesses all offer attractive margin expansionopportunities over the next several years, with the potential to expand segment margin by 200-300basis points from current levels through 2014:

- Power Solutions, the sale of higher-margin AGM batteries (2x the selling price and 3x the margindollars versus a traditional SLI battery), further vertical integration with internal recycling, andcapacity expansion in China could drive segment margin to 16.0-17.0% from current 13.0% level.

- Building Efficiency, an improved business mix (more product-centric offerings versuslower-margin service and building maintenance), productivity gains in the global service network,and operating leverage from residential HVAC could drive segment margin to 8.0-9.0% fromcurrent 5.0% level.

- Automotive Experience, higher-margin new business launches, increased vertical integrationfollowing recent seating structure and materials acquisitions, and improvements in Europe coulddrive segment margin to 6.0-7.0% from current 4.0% level.

■ M&A could supplement organic EPS. We estimate continued deployment of free cash flow towardsacquisitions, generating a 15% return on capital, could add $1.00 to our mid-cycle EPS estimates.

■ Price target. Our $63 price target is based on the stock trading at 10.5 times our estimate ofcalendar 2014 EBITDA, the median valuation of the S&P 500 Industrials, plus the present value ofequity income net of minority interest expense valued at 17.2x per share, discounted at 10% toreflect a 12-month time horizon

■ Risks: 1) the pace/slope of end-market recovery; 2) the pace/recovery of residential andnon-residential new construction markets (about 5-10% of total sales); 3) the costs associated withwinning/launching automotive new business; 4) raw material prices; and 5) acquisition-integrationrisks.

Truck Top Idea

PCAR (Outperform, PT $66)

■ Expecting cyclical recovery in developed markets (where PCAR has good exposure throughPeterbilt/Kenworth in North America and DAF in Europe), incremental initiatives to outgrow endmarkets, and secular margin expansion opportunities.

■ Rebound in operating leverage . As recovery gains steam and pricing improves, as has happened inpast cycles, we expect incremental margin to return to, or even exceed, historical levels.

■ History of up-cycle market share gains . PCAR has historically outgrown its end markets by 5-7percentage points over the course of a cyclical recovery, via market share gains andacquisitions/international expansion, while also growing profit margin by 100-200 basis points. Weexpect these trends to continue over the upcoming cycle, driven by market share gains (DAFvocational trucks, North America medium-duty), organic growth internationally (primarily in SouthAmerica), an improved cost structure, engine in-sourcing in North America, higher parts revenue (ahigher-margin offering), and Financial Services growth.



11

■ Price target. Our $66 target price is based on 8.3x our estimate of 2014 EBITDA, the medianvaluation range of the last cycle, discounted to reflect a 12-month horizon

■ Risks: 1) the pace/slope of cyclical end-market recovery; 2) commodity prices; 3) credit marketsand credit availability; 4) loan portfolio performance; 5) post-retirement liabilities; and 6) themaintenance of premium market position.



12

Sector Commentary – Diversified Industrial & Machinery

Robert F. McCarthy , [email protected] B. Weltzer, [email protected]

Machinery versus diversified industrials. The two halves of our coverage universe – machinery anddiversified industrials – can experience the economic cycle quite differently. Machinery manufacturersdeal in long-lived, capital equipment, where demand is ultimately driven by underlying activity levels(construction spending, for example), but factors like variable replacement cycles, tax incentives, theavailability of financing, and business confidence can significantly influence buying patterns.Diversified industrials typically focus more on products with less cyclical amplitude and that are tiedmore directly to actual activity levels. Construction fasteners and locksets would be two examples.

Seek leverage to late-cycle mining and nonresidential construction markets. We believe exposure tothe traditionally late-cycle markets for mining machinery and nonresidential construction offercompelling opportunities from this point in the currently developing up-cycle. While mining machineryorders have rebounded quickly, we see significant growth potential from here in the context of astunted up-cycle (through 2008), declining ore yields worldwide, and roughly 20 years of lowcommodity prices and associated underinvestment. Despite the relatively slow pace of the currenteconomic expansion in the developed economies, global mine capacity is already running in themid-90% range. The swift recovery in commodity prices signals the tightness of current supply and theneed for additional investments in capacity. Global mining sector capital spending may grow 30+% in2011 and another 20-25% in 2012; sustained high levels appear likely for three-to-five years.

We also see significant growth potential in US nonresidential construction markets, where spendinglevels in the US remain nearly 40% below the prior peak, despite little evidence of significantoverbuilding or a spending bubble during the last upturn. Dodge construction contract square footage(a measure of real activity), suggests that on a per-capita basis, the US has been meaningfullyunder-investing in nonresidential buildings in 2009 and 2010. While certain sectors of nonresidentialbuilding construction are intimately tied to residential construction activity (like retail stores and gasstations), a significant portion has little direct link and is already showing signs of recovery.Manufacturing construction contract square footage increased 69% year/year (L3M) in April, whilehotel and motel contracts were up 49% year/year.

CAT (Outperform, PT $148)

■ Large late-cycle exposure . Beyond machinery demand tied to nonresidential construction activity,other major later-cycle markets include oil & gas, energy infrastructure, power generation, andcommercial marine. Mining is traditionally the latest-cycle machinery market, but challenged by theEMD locomotive business. Clear majority of Caterpillar’s OE sales are to later-cycle markets.

■ More aggressive growth strategy . CAT acquired mining machinery maker BUCY purchased EMD(locomotives) and while planning to acquire MWM (gas engines). We estimate mining couldapproach 30% of CAT CY12 sales. Mining is CAT’s highest-margined machinery market by far.Accretion will be modest through 2012, but CAT projects meaningful synergies by 2013, reaching$400M by 2015. Our forecasts indicate CAT could repay all acquisition debt from operating cashflow by 2013.





13

■ Substantial financial targets. Beyond $8-10 of EPS in 2012, achieving all of Caterpillar's targetswould imply $15-20 by 2015, or roughly 3-4x the prior peak. Current (and new) executivemanagement team has established a 25% incremental operating margin objective; structuralimprovement in Machinery margins is an explicit objective.

■ Price Target and valuation. Our $148 price target is based on our estimate for normalized,mid-cycle earnings and a target multiple that is consistent with valuation metrics experienced atthe same point in past business cycles. We assume 2013 will be mid-cycle, when our $148 pricetarget assumes Caterpillar can achieve a 14x P/E multiple of our $11.70 estimate for normalizedEPS and/or an 8.5x EV/EBITDA multiple of our estimate for normalized EBITDA (~$13.7 billion) plusthe estimated future book value of Caterpillar’s finance subsidiary.

■ Risks include global economic growth; residential and nonresidential construction, quarrying andmining, power generation, industrial, oil and gas, marine, road construction, forestry, commercialvehicle industry fundamentals, acquisition regulatory approval and integration, and CPSimplementation.

MTW (Outperform, PT $28)

■ Potential inflection point reached in Crane . Crane orders surged 72% sequentially in 4Q10,generating a 1.25x book/bill ratio and bringing full-year orders even with 2010 Crane revenue. 4Qorders were ~40% above 2010's quarterly average; backlog expanded further in 1Q11, as ordersincreased sequentially and book/bill exceeded 1.55x.

■ Substantial deleveraging opportunity. High financial leverage from Enodis acquisition (1Q11: $2.0Bdebt; 81% D/TC; 6.1x debt/EBITDA), but Manitowoc targets $200 million of debt pay-down in 2011(supported by ~$100-million proceeds from 1Q11 divestiture of refrigerated display caseoperations). Cutting $200 million of debt at 5% adds ~$0.05 to annual EPS and shifts $1.50 ofper-share enterprise value to equity holders.

■ Building construction headwind easing. The global recession, plunging real estate values, andreduced global credit availability created huge declines in new nonresidential building investmentand drove significant Crane order cancellations, beginning in 4Q08. Net new Crane segment ordershave strengthened since that nadir and given backlog of $800 million at 3/31/11, we estimateManitowoc could deliver 10-13% Crane growth (=guidance) in 2011 without any growth in full-yearorders.

■ Price Target and valuation. Our $28 price target is based on our estimate for normalized, mid-cycleearnings and a target multiple that is consistent with valuation metrics experienced at the samepoint in past business cycles. We assume 2014 will be mid-cycle, when our $28 price targetassumes MTW can achieve a 15.0x P/E multiple of our $2.60 estimate for normalized EPS and/or an8.0x EV/EBITDA multiple of our estimate for normalized EBITDA (~$850 million).

■ Risks. Global economic growth; high financial leverage; residential and non-residential buildingconstruction activity, foodservice fundamentals; input costs; acquisition integration; and foreigncurrency fluctuations.

ETN (Outperform, PT $65)

■ Big and rapidly growing emerging markets exposure . Just 8% of sales in 2000, emerging marketswere 24% of Eaton’s 2010 sales, and intended to hit 30% by 2014. Growth rates generally exceed20%. Organic growth augmented by recent electrical acquisitions in South America and SouthAfrica, and a joint venture with Shanghai Aircraft Manufacturing Co. to support the COMAC C919.

■ Significant leverage to NAFTA heavy-duty truck cycle . Eaton is the primary OEM supplier ofheavy-duty truck transmissions, and the stock has historically outperformed while Class 8(heavy-duty) truck production is accelerating. Industry production is expected to surge ~60% in2011, but still remain ~30-40% below the 2006 peak. Truck segment to grow 31% in 2011,contribute ~40% of Eaton’s operating income growth.



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■ Significant later-cycle exposure . Eaton’s traditional electrical distribution products business isgeared towards nonresidential construction (and particularly industrial, energy, and powergeneration investment); plus, large data centers are now a core market. Certain fluid powermarkets are later-cycle; the Aerospace segment is ~60% commercial. Eaton estimates 20-25% ofsales are later-cycle; 15-20% non-cyclical (including airline aftermarket).

■ Up-cycle growth objectives appear achievable. Management believes an expanding geographicfootprint and significant investments in the global Electrical market have increased Eaton’snormalized organic market growth rate from +4% to +5% across the cycle, with Eaton targeting +7%market growth during the up-cycle (2009-2014). Developing markets growth expected to outpacedeveloped markets, driving 30% of sales by 2015 (up from 22% today) and adding 1.5% tonormalized growth, while innovation efforts contribute an addition 1.5% and acquisitions add 2-4%.Resultant 12-14% growth would essentially match Eaton’s performance during the prior cyclicalexpansion (+13% revenue CAGR) and appears to be a conservative target.

■ Price target and valuation. Our $65 price target is based on our estimate for normalized, mid-cycleearnings and a target multiple that is consistent with valuation metrics experienced at the samepoint in past business cycles. We assume 2013 will be mid-cycle, when our $65 price targetassumes ETN can achieve a 13.5x P/E multiple of our $5.40 estimate for normalized EPS and/or an8.5x EV/EBITDA multiple of our estimate for normalized EBITDA (~$3.2 billion).

■ Risks: Global economic growth; automotive, commercial vehicle, mobile equipment, industrialmachinery, HVAC, electrical equipment, power quality, and commercial and military aerospacefundamentals; acquisition pricing and integration; foreign exchange rates.



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Sector Commentary – Industrial Services

Andrew J. Wittmann, [email protected] P. [email protected]

Recommend E&C positions with leverage to later-cycle construction opportunities. Despite recentvolatility, we believe later-cycle opportunities are emerging for E&C companies, particularlyinternationally, supported by leading indicators of construction activity, capital budgets, and ourproprietary industry backlog model, which we believe suggest risk/reward favors an overweightposition. The graphic below illustrates that E&C industry backlog (a key driver of multiple expansion)has only recently posted positive growth, with our proprietary model suggesting further momentumahead.

As later-cycle opportunities emerge, E&C stocks should outperform earlier-cycle industrial stocksmore leveraged to utilization rate gains (earlier cycle). Thus, while a developed-nation slowdown isdamaging to earnings for the industrial space broadly, E&C exposure to the developing world,specifically Asia, the Middle East and in resource-driven economies like Canada and Australia, canoffer a cushion versus other industrials more heavily exposed to the U.S. and Western Europe.

Current valuation for the group reflects early/mid-cycle levels at roughly 7.0x EBITDA and 14.0xearnings. However, as back-end construction activity begins to turn (likely later this year and in to2012), we believe valuations will warrant modest multiple expansion and drive share outperformancefor the group. History suggests that, paradoxically, peak E&C multiples are often achieved closer tothe peak of the cycle rather than at the trough.

JEC (Outperform, PT $55): Top E&C Pick

■ Demand rising. Economic fundamentals are slowly improving and investment in Oil & Gasinfrastructure (~35-40% of revenue) continues to gain steam, driven by (still) high commodity pricesand returning aggregate demand.





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■ Tight customer relationships. We like Jacobs' relationship-based business model, focused onlong-term share gains from core customers, which we believe is not only lower risk, but also leavesJEC well positioned to capture share at earlier stages of the cycle as clients cautiously expand capexbudgets.

■ Backlog inflection point. Jacobs' F2Q11 backlog moved modestly higher sequentially - its firstsequential gain in two years - which we view as an early indication that greater earnings contentlies ahead paving the way to the next phase of the recovery – and we remain quite positive onJacobs' exposure to oil sands work (Canada) and its increasing traction in the Middle East, with thecompany's opportunity set potentially enhanced by last December's acquisition of Aker.

■ Price target and valuation. Our $55 price target assumes essential flat multiples of 9.5x our FTMEBITDA estimate (16.2x earnings), a modest premium to historical levels, but recognizing thecyclical bottom and more robust earnings outlook in F2012 (and F2013 in particular). The multipleis slightly above JEC's historical 8.7x average and at a slight premium to the E&C group, which webelieve is warranted given the company's industry-leading franchise and evidence of strengtheningfundamentals.

■ Risks include economically sensitive markets, acquisition integration risk, a highly competitiveindustry, and significant exposure to national government budgets.

PWR (Outperform, PT $25): Top Specialty Contractor Pick

■ Electric transmission capex beneficiary. While weather and regulatory delays continue to impactnear-term earnings potential, we continue to view PWR as a compelling stock ahead of theemerging capex cycle in electric transmission, particularly following the stock’s recent relativeunderperformance.

■ Eye on 2012. While we see some risk to near-term estimates and execution risk remains in 2H11,our thesis has always been underpinned by 2012 more than 2011, with recent data points stillsupportive of that outlook. We are also encouraged by recent insider buying on the open market bythe company's newly appointed CEO.

■ Price target and valuation. Our $25 price target assumes 8.5x FTM EBITDA, a discount to bothrecent and historical levels, recognizing the stock's higher risk and recent poor execution, balancedby what we see as a still-large opportunity set.

■ Risks. Highly competitive industry, state and federal regulatory changes, fixed-price contractexposure and acquisition integration risk.



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Sector Commentary – General Industrial & Building Products

Peter Lisnic, CFA, [email protected] K. [email protected]

Strong cash generation, ex-cyclical growth potential drive our recommendations . Within ourcoverage universe, stocks with the most attractive risk/reward profiles appear to be those withprimary end-market exposures closer to their respective cyclical bottoms. From a general industrialperspective, fundamentals appear to be approaching mid-cycle levels with growth expectations for2013 (and beyond) the primary determinant of potential equity upside, in our view.Construction-related markets appear to bottoming in nonresidential verticals, while the painfully slow“recovery” in residential markets continues, albeit well off from historically normal levels of demand.While longer-term risk/reward could be favorable in certain cases where residential exposure ismaterial, our posture remains defensive with our top ideas based on differentiated growth drivers,leveraged by eventual strong cyclical upside and strong free cash flow.

SWK (Outperform, PT $90)

■ Underappreciated cyclical leverage . Substantial exposure to construction markets suggestssignificant growth potential from eventual cyclical volume improvement. Cyclical leverage to beenhanced by realization of cost and revenue synergies from the merger with Black & Decker andgrowth opportunities afforded by strong free cash flow generation ($1B+ annually). Earnings powerexceeds $8.50 in our estimation with EPS CAGR exceeding 15%.

■ Cost, revenue synergies enhance leverage . Cost synergies from BDK merger on target with$460MM run-rate projected by end of 2013. Additionally, SWK estimates revenue synergies of$300-400MM from the Black & Decker acquisition by 2013, adding $0.35-$0.50 to structural EPSwhen fully realized.

■ $8.50/share in EPS power. Management is targeting sales of $15B and operating margin exceeding15%, implying earnings power in excess of $8.50/share. Target assumes sales CAGR of 10% from2010 to 2015 including acquisitions. Based on the company’s strong FCF profile, we believe SWKcan achieve its target without extending financial leverage markedly from current levels.

■ Price target and valuation. Our $90 price target is based on a 9.0x EV/EBITDA multiple applied toour 2012 EBITDA estimate (15.7x P/E multiple), modestly above the blended peer multiples (8.1xEV/EBITDA, 14.2x P/E), but we believe appropriate considering the company’s cyclical earningsgrowth potential and strong FCF profile.

■ Risks include: Execution risk surrounding the BDK integration, cyclicality of end markets, risingand/or volatile commodity costs, private-label competition, adverse foreign currency movements,and ability to find and successfully integrate acquisitions.

TNB (Outperform, PT $63)

■ Attractive mid/late cycle exposure . Shares appear attractive considering cyclical leverage toimproving construction and utility markets, strong free cash flow, and exposure to longer-termsecular growth in electrical infrastructure investment.

■ Solid execution in improving markets . TNB’s 2011 outlook assumes continued strength in industrialdemand, improving utility distribution demand, and early stages of recovery in nonresidentialconstruction markets. Operating margin in primary electrical business has already exceededprevious peak with volume still materially below previous-cycle high. Capital allocation appears to





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be a key company strength with recent bolt-on acquisitions initially appearing to be solidcontributors to growth and return profile of the business.

■ Strong FCF buttresses growth potential. Since 2005, free cash flow has averaged 130% of netincome. Acquisitions are the primary targeted use of capital with TNB seeking targets that provideleading brands and can be leveraged through the company’s distribution network. We estimateacquisition dry powder could approach $500MM with TNB maintaining net D/TC below 30% andnet debt-to-EBITDA below 2.0x.

■ Price target and valuation. Our $63 price target is based on an 8.0x EV/EBITDA multiple (14.5xcash-adjusted P/E) applied to our 2012 EBITDA estimate, slightly above the average EV/EBITDAmultiple accorded TNB’s electrical equipment peer group and we believe appropriate consideringTNB’s history of execution, and solid FCF.

■ Risks include: Cyclicality of construction and industrial end markets, protracted decline in utilityspending, rising and/or volatile commodity costs, and the ability to find and successfully integrateacquisitions.



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Sector Commentary – Industrial Distribution & Services

David J. Manthey, [email protected] L. [email protected]

We remain positive on the group in a moderately expanding industrial economy. We expectcontinued expansion in US industrial activity and believe we are in the “big middle” of the businesscycle. Historically, this is the point in the cycle when industrial supply stocks have outperformed.Periods of underperformance are infrequent due to secular positives, and are typically late in thecycle. We are also increasingly constructive on companies with exposure to non-residentialconstruction, given our outlook for flattening trends in 2011 and a possible modest recovery in 2012.Overall this should be a good time frame for the group – watch for catalysts and valuationopportunities as cyclical factors are positive or less negative for nearly every stock on our list.

ARG (Outperform, PT $78)

■ Thesis. We rate ARG Outperform. Mid-cycle dynamic is supportive of several key fundamentalfactors, with cyclical trends increasingly positive, an improving pricing environment and acquisitionactivity expected to accelerate. Ongoing SAP implementation also provides a meaningful catalyst.

■ Price target and valuation. Our $78 price is based on 9x EV/C2012E EBITDA, a slight premium tothe five-year average of 8.6x NTM EV/EBITDA.

■ Risks. Key risks include general US economic conditions, demand/pricing, SAP implementation,opening/operating ASUs, shareholder base turnover

GWW (Outperform, PT $170)

■ Thesis. We rate GWW Outperform. Overall, mid-cycle is an advantageous point in the cycle forindustrial supply stocks. Adding to positive cyclical dynamics is the ongoing “cultural renaissance”at the company, which is driving a more aggressive, growth-oriented approach and sustainablyhigher margins and returns driven underscored by the implementation of LEAN and 5S techniques.As such, we believe the stock deserves a premium relative to its historical valuation.

■ Price target and valuation. Our $170 price target represents 9x EV/2012E EBITDA, a premium(which we believe is warranted) to the historical NTM average of 8.3x.

■ Risks. Fundamental risks include macroeconomic conditions, ability to expand margins, pricingpower, benefits from product expansion, sales force additions, global sourcing and internationaloperations.





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Sector Commentary –Process Controls

Michael Halloran, [email protected] [email protected]

Favor companies benefitting from secular growth opportunities. We believe that marketoutperformance by pure cyclical stocks is largely over, and that prevailing market uncertainty andbroadly souring of sentiment remain broad-based headwinds for industrial stocks. Consequently, ourstock recommendations focus on secular drivers over cyclical drivers, and late-cycle exposure overearly-cycle exposure. On this premise, our top picks remain RBC and GDI (see comments below).

From a purely cyclical standpoint, we believe ABB (Outperform, PT $32) is the best way to invest inthe late-cycle acceleration and sentiment shift within the Process Controls space, followed by FLS(Outperform, PT $142) and CFX (Neutral, PT $24).

RBC (Outperform, PT $95)

■ Buyers on 2012 earnings power of $6.50+ (including AO Smith EPC acquisition) and 2015 earningspower of $7.00-$8.50+/share organically ($9.00+ inorganically). Significant exposure to energyefficiency movement provides a secular theme and should drive growth in excess of core industrialpeers. Concerns over HVAC demand, commodity inflation, and expiration of the high-efficiencyHVAC tax credit should moderate throughout 2011.

■ Price target and valuation. Our $95 price target assumes forward multiples of 8.4x EV/EBITDA and14.3x earnings versus historical average multiples of 7.7x and 12.9x, respectively. Potential forfurther multiple expansion over time with crisp execution of five-year plan.

■ Risks. Industrial activity, highly competitive industry and integration of current and futureacquisitions.

GDI (Outperform $100 PT)

■ Corporate transformation and secular themes drive impressive earnings power . Continuedstructural margin improvement, improving industrial end markets, and significant leverage to shaleoil and gas drilling trends should drive near-term earnings upside. Longer-term marginimprovement story still not fully reflected in stock price; 2012 EPS power is well north of $6.00.Early stages of transformation from a low-margin, average-growth industrial company to ahigh-margin, new market/product-oriented company should drive valuation multiple expansion.

■ Price target and valuation. Our $100 price target assumes forward multiples of 10.6x EV/EBITDAand 16.6x earnings versus historical average multiples of 7.8x and 13.3x, respectively.

■ Risks. Exposure to highly cyclical markets, pricing pressure from lower cost countries.





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Sector Commentary – Transportation & Logistics

Jon A. Langenfeld, [email protected] J. Hartford, [email protected] [email protected]

Favor 3PLs and asset-based names with secular themes as cycle matures . We identify three keyelements signifying a transition from cyclical recovery to slow-growth expansion in the Transportationand Logistics sector:■ Duration of cycle. Currently in 30th consecutive month of ISM diffusion index recovery from

trough, versus 40-month average duration of cycle over past 50 years.■ Moderating demand. Demand growth moderating across modes in 2011 following 2009/2010

cyclical recovery, consistent with a maturing cycle. Moderation in international airfreight and oceanfreight, domestic truckload, and rail car loadings a function of strengthening prior-year growthcomparisons and normalizing freight demand and inventory restocking activity.

■ Recent underperformance among early cyclicals. Asset-based truckers underperforming thebroader market (Russell 2000 Index) after early-cycle outperformance, consistent with mid- andlate-cycle performance.

We would position investors for rotation into mid- and late-cycle names as cycle matures; favor 3PLsand asset-based names with secular themes (pricing, margin expansion).

FDX (Outperform, PT $117)■ Industry trends more favorable . Well positioned to benefit from favorable parcel industry trends,

supported by both the growing industrial environment and more rational industry pricing.■ Catalysts: include F12 guidance, which should remove investor overhang and reflect building

earnings power.■ Price target and valuation. Our $117 target price equates to 14.6x F13E EPS (vs 17x average

2004-2006), slightly below its average multiple.■ Risks. Economic sensitivity, constrained growth in domestic express market, operates in a highly

competitive industry which could be subject to price competition and deteriorating profitability.

UNP (Outperform, PT $120)

■ Our favorite rail idea. We see a host of beneficial factors underlying our UNP thesis: strongestcommodity group, capable of mid-single-digit volume growth; largest legacy repricing opportunity,providing above-market pricing growth potential over next cycle; and management’s 65-67%operating ratio target by 2015 should prove conservative.

■ Price target and valuation. Our $120 price target reflects roughly 14x forward estimates, one yearout, a valuation multiple more in line with the S&P 500's average (15.5x 10-year average).

■ Risks. Competes in mature, cyclical industry, improving ROC key to thesis, potential liabilityexposure for hazardous materials movement, truckload competition in Intermodal, highly regulatedindustry potentially subject to further regulation, unionized workforce cost inflation/servicedisruptions.






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RRTS (Outperform, PT $19)■ Unique asset-light model. LTL brokerage (65% of revenue) offering well positioned to gain market

share given its low-cost model, and LTL pricing dynamics improving. Though the stock remains a“show me” story, narrowing of valuation gap to 3PL peers provides further upside opportunity.

■ Price target and valuation. Our $19 price target reflects 17.5x forward estimates, one year out vs.18-20x for its 3PL peer group.

■ Risks. Acquisition risk, reliance on third-party capacity, unique LTL brokerage margins withpotential for margin squeeze (price in LTL, buy in TL), economic sensitivity, highly competitivemarket, limited public company experience.



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Sector Commentary – Advanced Industrial Equipment

Richard C. Eastman, [email protected] W. Mason, [email protected]

Favor stocks possessing margin expansion ability, defensive elements . Our AIE coverage list generallyenjoys strong business fundamentals in the mid- to latter part of the business cycle. R&D budgets,which are significant drivers for our Test and Measurement and Analytical Instrument companies, canexperience attractive growth as end demand solidifies.

Rising industrial production/capacity utilization also spurs growth in productivity projects, and newcapacity for our Automation companies, while rising production and utilization in general aids ouraftermarket-driven Filtration companies.

Near term, as investors adjust to what we view as mid-cycle slowing (mean reversion), we believe arotation to more defensive growth could prove most beneficial to Filtration companies (CLC, PLL). Wealso favor MSA, which has exposure to employment growth (personal occupational safety) as a way tocapitalize on an eventual recovery in employment growth. Additionally, we find each of these stocksparticularly compelling because of specific, targeted underlying margin expansion efforts that couldpropel EPS growth above the normal mid-cycle trend.

CLC (Outperform, PT $51)

■ Attractive aftermarket business mix . CLC derives ~80% of sales from disposable filtration products.We expect the business will perform well in a low-growth environment. CLC has an expectation(and history) of growth +2-3pp above GPD.

■ Increasing penetration in emerging markets , especially China (where CLC targets +30% growth),further supports CLC overall growth objectives.

■ Restructured I/E segment, but more margin runway . Following a multi-year restructuring andupgrading of it Industrial/Environmental (I/E) filtration operations, CLC has already raised themargin goal for this segment from 10% to 15% (Q2: 12%). If CLC tracks toward 15% by 2014, webelieve CLC would generate attractive incremental profitability in the mid- to later portion of thebusiness cycle.

■ Balance sheet can create value. CLC currently possesses ~$105M of net cash, providing the abilityto also create value in a slower growth environment, via M&A, share repurchases.

■ Price target and valuation. Our current price target of $51 is based on 10X our FY12E EV/EBITDA,versus CLC's historical 8X-11X trading range. The shares currently trade at the low end of thehistoric EV/EBITDA multiple range, or 8X FY12E EBITDA.

■ Risks for CLC include the economy, ongoing success with productivity improvement programs,periodic patent litigation between industry participants.

PLL (Outperform, PT $62)

■ Leading industry scale. PLL is the largest filtration/separations pure play by revenues, holding anapproximate 7% market share. Pall has a tradition of participation in higher-value-added nichemarkets, product innovation, aggressive international expansion, and strong distribution.





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■ Growth opportunities. PLL’s strong market position in the Life Sciences less influenced by cyclicalmacro-economic considerations. PLL should benefit from new medical opportunities includingblood prion removal filters, bacterial detection systems for platelets, and hospital critical careproducts. Biopharma growth should be driven by higher volumes of producedbiotherapeutics/vaccines, adoption of single-use/disposable production technologies and emergingmarket customer growth. PLL's Industrial business has benefited from a cyclical recovery inmicroelectronics markets and general economic improvement. Demand in the commercialaerospace aftermarket has returned to growth military systems/consumables positioned for strongFY12. Other secular growth markets for PLL include Asia and municipal and industrial watermarkets/systems.

■ Strategic growth plan aims for higher margins . PLL’s four-year (FY10-13) financial plan targets EBITmargin of 19.5%-22.0%. Execution to date against the plan has been noteworthy from 13.9%starting point (FY09A) to current 17.4% (F3QA). Further, margin expansion expected from acombination of regionalized HQ structure, value-based pricing and SG&A leverage. Coupled withfurther reduction in tax rate, PLL’s FY13 targets equate to $3.77-$4.77 EPS, or +14%-28% CAGRfrom FY11E $2.89.

■ Price target and valuation. Price target of $62 assumes shares trade at 10X our CY-12E EBITDAforecast, within PLL's normalized five- and 10-year 9X-13X EV/EBITDA range.

■ Risks. Global macro-economy, in particular industrial production/utilization, FX, and execution ofplanned margin expansion initiatives.

MSA (Outperform, PT $44)

■ Beneficiary of eventual employment recovery. MSA manufactures/sells high-end safety equipmentto protect employees (employment driven). Industrial markets (process, oil & gas, power, non-resconstruction, aggregates, other) now about ~70% sales. MSA aims for sales growth of 10%+(including General Monitors acquisition) from these core markets. We remain cautious on FireService spending due to U.S. funding concerns; however, with help from international demand FireService sales appear to be bumping along a bottom, “stabilizing.” MSA Military sales will improvethis year due to sales of ACH3’s against a 12-15 month backlog.

■ Earnings power substantial. MSA delivered ~14% operating margin in CY05 largely resulting from arich sales mix. We believe a realistic OP% opportunity/goal is a return to 14%; however, continuedprogress on streamlining/realigning the cost structure , principally in Europe, will be key tooffsetting a more normalized forecast sales mix. Sales volume, leverage will also contribute.Achieving 14% GAAP OP% (sales CAGR +7%, four-year goal) would equate to about $3.50 in EPS inCY14.

■ General Monitors (GMI) attractive strategic fit . GMI adds leadership in fixed based gas detectionproducts, technology/sensor, sales synergy with MSA portable gas detection products, sales andearnings accretion.

■ Past M&A activity/multiples validate attractiveness of Safety/Personal Protection market .Several notable transactions support interest in the space: MMM’s $1.2B purchase of Aearo (‘07,11X LTM EBITDA) and HON’s $1.2B purchase of Norcross (’08, 12X LTM EBITDA) and $1.4B purchaseof Sperian (’10, 11X LTM EBITDA).

■ Price target and valuation. Our $44 price target assumes shares trade at 9.5X our CY12EEV/EBITDA, the midpoint of MSA's seven-year 7X-13X EV/EBITDA trading range, reflectingexpectations for improved operating margin in 2012, balanced by caution over CY11 U.S. FireService spending and continued progress on restructuring.

■ Risks. Industrial business cycle, government security subsidies, variations in secular growth rate,product liability.



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Sector Commentary – Human Capital

Mark S. Marcon, [email protected] P. Meuler, [email protected] R. [email protected]

Most staffing/recruiting stocks appear to have largely (although not fully) discounted a mid-cycleslowdown, but not a recession.■ The median stock performance of covered staffing/recruiting stocks has been -16% YTD (vs. S&P

500 +3%), with ten of the twelve covered names underperforming the broader S&P 500 index YTD.Similarly, over the LTM, the median performance among our formally covered staffing/recruitingnames has been +1% (vs. +18% for the S&P 500).

■ While recent economic data has been disappointing and indicates meaningful deceleration,staffing/recruiting stocks have also been declining recently, and appear to be largely (althougharguably not fully) discounting a mid-cycle slowdown at current levels with the stocks currentlytrading at lower than typical mid-cycle multiples against our C’12E estimates despite our C’12estimates generally assuming operating margins that are both below the prior cyclical peak andbelow what we believe the companies are capable of generating during this cycle (assuming themacroeconomic expansion continues).

Multiples could remain pressured as long as macroeconomic data remains soft.

While we believe that most staffing/recruiting stocks appear to have discounted a mid-cycleslowdown to a large extent, and valuations appear attractive assuming that the economic expansionwill continue, multiples could remain depressed and staffing/recruiting stocks could continue tounderperform the broader market if economic data points remain weak. Therefore we continue tolook for a favorable inflection in the leading economic indicators to become more aggressive onstaffing/recruiting stocks.

Additionally, our Human Capital Services team feels that the probability of a recession or elongatedslower growth period is rising.■ Leading indicators, such as the Manufacturing ISM (including the new orders sub-component),

regional ISMs, and the ECRI Weekly Leading Index, suggest the potential for further deceleration inthe rate of economic growth in coming months.

■ Hence, in the view of our Human Capital Services team, it appears increasingly clear that the USeconomy has at least entered a mid-cycle slowdown, and it also appears that the probability of arecession over the NTM is rising as well. Additionally, even if the economy emerges from a“mid-cycle slowdown,” it may enter a period of sub-par intermediate-term growth as theincremental benefits of monetary and fiscal stimulus wear off (in line with the “New Normal” viewarticulated by PIMCO, Rogoff, etc., prior to QE2).

SFN and TBI attractively valued if the economic slowdown proves to be temporary, in our view. SFNand TBI are among the most attractively valued stocks among the comp group and their stocks haveexperienced some of the greatest declines recently. Given cyclical sensitivity, any improvement ineconomic data could serve as a catalyst.






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SFN (Outperform, PT: $15)

■ Significant progress in improving positioning and execution – management successfullyrepositioned SFN to more attractive staffing/recruiting sub-sectors both organically and viaacquisition (increasing exposure to professional staffing, small and medium sized accounts,perm/RPO, and MSP), positioning the company for continued strong profitability growth as long aseconomic/labor market recovery continues.

- Focus on profitability growth is highlighted 17% yoy gross profit growth in 1Q11 (vs. 8% revenuegrowth) with EBITDA more than doubling yoy.

- Well positioned for further margin expansion -- temp pricing/gross margins are at an early stageof firming, perm/RPO growth remains strong, and SFN is delivering on its goal of limiting SG&Agrowth to ~50% of opex growth.

- While macro is clearly a key risk, given SFN’s improved positioning in higher margin, bettersecular growth sub-sectors, coupled with the company’s focus on gross margin and achievingopex leverage, management’s 5% mid-term EBITDA margin appears achievable assuming norecession.

■ Valuation attractive, especially on cash flow basis .

- 2012E capex ~$10 million ($0.20/share) below D&A.

- Cash tax shield yields ~5% cash tax rate vs. ~41% effective book rate into 2014.

- Our $0.84 '12E EPS estimate equates to ~$1.50 on “cash EPS" basis.■ Price target. Our $15 price target reflects 8x EV/’12E EBITDA (EV includes PV of tax shield).■ Risks: macroeconomic/labor market cyclical sensitivity, potential loss of large contract(s) including

mortgage servicing work, continued underperformance in IT business, and potential that SFNcompletes an acquisition at an uneconomical price.

TBI (Outperform, PT: $20)

■ Continued cyclical recovery coupled with favorable secular trends toward the increasing usage oftemporary staffing driving strong revenue growth – 1Q11 revenue grew 24% yoy organically(excluding Boeing, where revenue is down meaningfully yoy, but has been roughly stable on asequential basis for the last three quarters).

■ Attractive mix of business positions TBI for long-term revenue growth with margin expansion . TBIhas favorable long-term growth opportunities with high incremental margins as the clear leader inday labor staffing and via expanding the footprint of recently acquired brands.

■ Management's 7% intermediate-term EBITDA margin target (higher if pricing/mix improve)seems achievable, in our view, driven by 15-18% incremental margins given its positioning tocapture cyclical + secular industry growth and TBI’s potential to expand its brands, coupled withopex leverage and further efficiency gains.

■ Return to normalized incremental margins in H2-11 a potential catalyst . While incrementalmargins are expected to be somewhat depressed in 2Q11E due to a tough comp (resulting fromsome investment being delayed from 2Q10 to 3Q10), we expect a return to more normalizedincremental margins driving solid margin expansion in 2H11E.

■ Price target and valuation. $20 price target reflects 16x '12E EPS on a cash-adjusted basis($3.48/sh. net cash), a slight discount to the 17.5x average NTM P/E multiple that TBI traded atduring a similar stage in the last cycle given the potential for relatively slower growth and lowermargins given TBI's benefit from the residential construction boom last cycle.

■ Risks: macroeconomic sensitivity, concentration in largest account, workers compensation risks,ability to attract and retain workers.

Should the current economic softness prove to be more negative than a mid-cycle slowdown , wewould expect our recurring revenue stream companies, including ADP (Outperform, PT: $59) and PAYX(Outperform; PT $34) to potentially outperform the broader market.



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ADP (Outperform, PT: $59)

■ Key metrics improving; nearing/hitting additional inflection points. ADP invested in itstechnology/solutions and largely maintained producer/servicing headcount throughout therecession. While it’s business model is relatively cyclically resilient, it does lag somewhat. Assumingcontinued macro recovery, ADP appears well positioned for continued improvement in key metrics.

- Client retention continues to improve; new sales are strong; client employment yoy growthaccelerating in the US; and, cross sales remain strong.

- Margin expansion has been masked thus far; however, every segment is experiencing organicmargin expansion, and consolidated margin improvement should become more apparent as ADPanniversaries investments/acquisitions.

- Float income nearing inflection point, with balance growth now roughly offsetting continuingdecline in ADP's effective interest rate.

■ Well positioned for solid multi-year EPS growth – management recently provided a credible planfor 12-15% EPS CAGR over next five years, driven by 8-10% organic revenue growth, 1-2% growthfrom acquisitions, ~50 bps annual margin expansion, slightly lower tax rates, and continued sharebuybacks.

- Key growth driver is new sales in less mature areas that have already demonstrated promise suchas HR BPO (PEO, ASO, COS), international markets, and adjacent to core areas such as benefits,time & attendance, talent management, and digital marketing in Dealer.

■ Price target and valuation. Risk/reward appears attractive at current levels, in our view. $59DCF-supported price target reflects 20.2x our $2.92 F'13E EPS (average NTM P/E from C'05-C'07:21.2x).

- While ADP benefits from a macro recovery, given its relatively resilient business model, we wouldexpect its fundamental and stock performance to outperform the broader market on a relativebasis, should the US economy enter another recession or go through a prolonged period ofsub-par growth.

■ Similarly, we would also expect ADP’s competitor PAYX (Outperform, $34 PT) stock toOutperform if the economic trajectory proves to be worse than a mid-cycle slowdown. Our PAYXprice target reflects conservative 10-year DCF analysis (5% FCF CAGR, 9.4% discount rate, and2.25% terminal growth rate). PAYX’s risks include increasing competition, cyclical exposureincluding the rate of new business formation, and exposure to interest rates and Muni investments.



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Sector Commentary – Facility Services

Andrew J. Wittmann, [email protected] P. [email protected]

Facility Services: Defensive Sector with Upside from Further Employment Gains.

■ Business cycle context for uniform stocks . Historically, the uniform sector has been an effectiveway to invest in early-cycle stocks (the stocks historically bottom 12 months before an employmentinflection) or to play a rapid job creation (stocks also tend to outperform mid to late cycle when therate of job growth is at its highest). Indeed, uniform stocks have historically outperformed thebroader market by 19% over the 13-24 months following the bottom in YOY employment gains. Forperspective, current cycle employment bottomed in September 2009 (19 months ago).

■ Employment growth showing continued momentum in uniform-wearing industries . Recentemployment gains are now more consistent with mid-cycle levels with YOY growth rates inuniform-wearing employment industry verticals (which we refer to as the Baird Add/Stop Index)now outpacing the broader economy for the first time since late 2006/early 2007. This is a criticaldata point as uniform employment has lagged broader employment categories throughout therecovery until recently. Employment gains at existing uniform-rental accounts is highly profitable,with incremental margins from higher route density and improved utilization rates likely to driveearnings growth above investor expectations.





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CTAS (Outperform, PT: $35) - Top Large Cap Pick

■ Accelerating top-line momentum, driving margin and earnings leverage as previous investmentsin sales staff have begun to pay off. Although rising commodity costs remain a source of caution(though have recently moderated), with broad-based top-line improvement, increasing capitalallocation towards M&A, and moderating pricing pressure, we believe CTAS offers lower-riskleverage to a slowly improving employment market.

■ A $500M bond offering in May could also provide meaningful accretion (we estimate up to $0.12in F2012) from share repurchases or other capital deployments and we are encouraged by recentefforts to expand the company’s higher-growth hygiene/chemicals business through strategicpartnerships with established industry suppliers (e.g., Diversey).

■ Price target and valuation. Our $35 price target assumes modest (essentially flat) multipleexpansion to 7.7x FTM EBITDA, below the company’s historical average of 9.2x but which webelieve more fully reflects the industry’s challenging fundamentals and a slower growth rate, withdownside supported by the company’s $500M share repurchase authorization.

■ Risks include a highly competitive market, employment trends, energy and scrap paper pricefluctuations.

GKSR (Outperform, PT: $40) - Top Small-Cap Pick

■ We believe Street estimates, broadly under appreciate GKSR's underlying earnings growthpotential from even modest top-line growth . Furthermore, G&K reported better-than-expectedF3Q11 earnings in May, driven by strong top-line results (above both our and consensus estimates)and much better-than-expected margin expansion.

■ Investors are gaining confidence in management's targeted “10/10” plan to achieve 10%operating margins and ROIC by F2014, which we believe should unlock material value creation overthe next several years. Combined with solid cash flow, and a likely increase in return of capital toshareholders (likely through a dividend increase later this summer), we see relative upside to thestock, particularly following the stock’s recent pullback.

■ We believe investors are best served by taking a multi-year look at GKSR ’s ability to create valueby bridging the profitability gap versus peers over time. In addition, we believe outsized earningsgrowth potential at GKSR relative to peers continues to justify a growth multiple for the stock.



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■ Price target and valuation. Our $40 price target therefore assumes the stock is able to hold current(premium) multiples of ~8.0x EBITDA and ~17.9x earnings, which are modestly above peers butnear the stock's historical average.

■ Risks to our price target include a highly competitive industry, employment trends, energy pricefluctuations and acquisition integration.



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Sector Commentary – BPO

David J. Koning, [email protected] Wojs, [email protected]

Mid-cycle corporate focus on organic-growth-enhancing expansion programs favors Consulting andOffshore BPO.

ACN (Outperform, PT $66)

Benefits from shift to mid/late-cycle. Accenture’s end-to-end model is a true differentiator – theconsulting business combined with systems integration, ADM, and BPO is quite unique in themarketplace.■ We estimate that approximately 40-50% of Accenture’s revenue stream is exposed to middle-cycle

work, including consulting (we estimate ~20%), BPO (~10%), and a portion of discretionary systemsintegration work (~10-20%), and believe this is much higher than its Indian-based IT peers (wherewe estimate exposure to these three types of work is more like 15%).

■ Consulting, BPO, and systems integration require more up-front investment, have longer paybackcycles, and are truly transformational processes. While these processes are focused on costefficiencies, they are also driven by clients’ desire to drive incremental revenue growth.Additionally, there is evidence that billing rates have started to increase recently, signaling thatdemand is returning to the marketplace.

Why do we like the stock?■ Well positioned to take advantage of key macro trends . These include cloud, mobility,

geographical expansion, customer acquisition, cost efficiencies. As mentioned above, thecompany’s end-to-end offering is a true differentiator (several Indian-based IT peers are trying toemulate) and Accenture has one of the largest global delivery networks. We think this will drivesolid demand over the next 12-18 months.

■ Strong fundamentals expected to continue . Management preliminarily expects 7-10% constant-FXgrowth in F2012 (we model +7%). While this shows deceleration from F2011 levels (currently+11-14%), we note that management has been quite conservative with its initial year-out guidancepreviously.

■ Margin expansion offers upside. Accenture has been focused on driving margin expansion, and wethink this could be the key to unlocking more value in the stock. Each 100bps of margin expansionis a $0.25 benefit to annual EPS.

■ Superior brand. The company has extensive C-level relationships with many of the world’s largestcompanies. We believe Accenture is a trusted partner with its clients.

■ Strong FCF/balance sheet. Accenture currently has roughly $6/share in cash (no debt) on itsbalance sheet, and expects to generate over $2.5 billion in FCF in F2011. ACN has historically been aheavy repurchaser of its own stock, while also paying a semi-annual dividend.

■ Price target and valuation. At 15X F2012E EPS (August 2012 year-end), we think risk/reward isattractive for solid high-single-digit growth. With some margin expansion and usage of strong FCF,we think 15%+ EPS is possible over the next few years. Our $66 price target reflects 17X C2012E EPS(five-year average 15X) – we think faster growth and margin expansion afford ACN a highermultiple than it has been given historically. Over the next 18 months, we think reasonableupside/downside is $82 and $53 respectively.

■ Risks. Include pricing pressure, economic sensitivity, brand reputation, FX movements, supply sideconstraints (wage inflation, employee attrition), protectionism.





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G (Outperform; PT $19)

Benefits from shift to middle-cycle. BPO work tends to be mid/late-cycle, as it requires upfrontinvestments and requires large organizational change to be successful. Clients typically spend less ondiscretionary BPO work until they are comfortable with their company’s own positioning.■ We continue to hear positive datapoints from public peers and industry consultants that the BPO

market has begun to improve.■ We expect this momentum to continue, and think Genpact can benefit from an improving market

as a well-positioned, market-leading provider of offshore BPO services, including finance &accounting, HR outsourcing, and procurement. While Genpact will benefit, we think EXLS and WNSstand to benefit from a BPO market recovery as well.

Why do we like the stock?■ Improving BPO market. As was mentioned above, datapoints from several public peers and

industry consultants suggests that the BPO market is improving, and can be sustainable. We thinkGenpact is well positioned to benefit from this growth – if market growth returns to pre-recessionlevels of 15-20%, we think 20%+ growth at Genpact is possible (from +13% in 2011E/2012E).

■ Poor investor sentiment . Despite three recent upgrades, sell-side sentiment is still more negativethan positive on Genpact, especially when looking at IT Services stocks (which are generally muchmore liked by the Street). We think sustainable BPO market momentum will improve sentiment.

■ Estimate upside possible. We think guidance is conservative, specifically around revenue growth,margin expansion through the year, and assumptions around Headstrong.

■ Price target and valuation. At 17X NTM EPS, we think valuation is attractive for a potential 20%+grower with market leadership, a strong management team, and a solid balance sheet. We thinkreasonable risk/reward over the next year is $14 and $21, respectively. Our $19 price target reflects11X C2012E EBITDA (similar to our multiple for EXLS’ price target).

■ Risks. Include pricing pressure, economic sensitivity, FX movements, supply side constraints (wageinflation, employee attrition), protectionism.



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Sector Commentary – Professional Services (Specialty Consulting)

Daniel R. Leben, [email protected] (Mig) [email protected]

FCN (Outperform, PT $46),

Attractively valued high-end consulting firm with exposure to Restructuring, Litigation and Disputes.

■ Late-cycle and countercyclical exposure . Roughly 55% of the business (Corporate Finance andRestructuring at 32% and Forensic and Litigation Consulting at 23% of revenues) is driven byfinancial distress in high yield borrowers as well as the litigation and forensic accountingengagements that often follow cases of fraud or corporate malfeasance.

■ Valuation remains low, history suggests that multiples expand as the economic cycle matures.The stock currently trades at 7.8x our 2011E EV/EBITDA compared to the historical 12.3x TTMaverage with current valuation fairly close to the low points observed over the last 8-9 years. Our$46 price target represents 7.8x 2012E EV/EBITDA, in line with the valuation observed over the lastyear, but a discount to the historical average

■ Expectations are low, comps are getting progressively easier . Additional valuation expansion ispossible if revenues in the Corporate Finance/Restructuring segment show signs of stability,coupled with continued growth in Litigation and Economic consulting. The Bankruptcy andRestructuring business remains challenged by a relatively easy global borrowing environment;however, we recognize that expectations for this business remain very low with comps gettingprogressively easier into 2011. We continue to recommend FCN, as we believe this remains anattractive entry point in a high quality franchise

■ Risks. Risks include foreign exchange risk to our estimates and the event-driven nature of thebusiness that can create shifts in revenue and earnings from quarter to quarter





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Sector Commentary – Restaurants

David E. Tarantino, [email protected] R. [email protected] A. [email protected]

Cautiously optimistic outlook. Our proprietary restaurant industry traffic model suggests restaurantdemand trends can hold up well during the balance of the year, although we acknowledge thatvisibility to further improvement has been reduced somewhat by the recent softness inhousing/employment data. We expect demand trends going forward to be supported by increasedconsumer confidence driven by a firmer employment picture, the federal payroll tax reduction (beganin January 2011, adding $110+ billion stimulus) and better credit conditions which can more thanoffset the projected drag from higher gasoline prices and sluggish housing market dynamics.

Recommending selective exposure. We continue to recommend some exposure to restaurant stocks,as we think group valuations can be supported by further signs of solid same-store traffic trends inupcoming periods. Additionally, continued interest in the restaurants space from private equity firmscould help stocks within the group could find support at EV/EBITDA multiples near the 7-8X averagefor recent transactions. We favor companies which we believe are capable of sustaining strongrelative top-line trends (through excellent value propositions and/or internal drivers) and invokingpricing actions (to combat cost inflation), as these factors may be needed to drive healthy earningsgrowth and stock outperformance in the balance of 2011 and into 2012.

PNRA (Outperform, PT $150)■ Our Outperform rating is based on the company’s near-term operating momentum (supported by

internal drivers, higher-income customer demographic), healthy long-term growth prospects,strong balance sheet and cash flow characteristics, and valuation (PEG near/below level seen bycomparable growth companies historically).

■ Attractive growth prospects . Over the next 3-5 years (on average), we expect PNRA to increasesales 8-12% and EPS 15-20% annually via unit expansion (with opportunity to nearly double the sizeof system; targeting 5-7% annual growth), solid comps (+3-4% annually), margin improvement, andshare repurchases.

■ Near term catalysts. In the near term, potential catalysts include quarterly EPS results at or abovehealthy consensus expectations, as well as possible signs of cash deployment (buybacks, franchiseacquisitions). We believe healthy same-store sales trends in recent quarters have been fueled by animpressive pipeline of internal drivers (menu innovation, loyalty program, marketing, Via Paneracatering) that can continue to support results going forward. Based on these factors, we have highconviction in our 2011 EPS estimate of $4.50 (+24%), which assumes comps +5.5% and EBIT margin+10 bp.

■ Price target and valuation. Our $150 price target incorporates a target PEG of 1.5, consistent withthe historical valuation seen by other large-cap consumer companies with comparable growthprofiles (top-quartile). The 1.5 target PEG translates to a target NTM P/E of 26-27X, cash-adjustedNTM P/E of 24X, and trailing EV/EBITDA near 13X. We believe a premium valuation is justified bythe company’s near term operating momentum, solid long-term growth prospects, robust ROIC,






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strong balance sheet, and healthy cash flow characteristics.■ Risks include managing growth, competition, economic factors, health/dietary concerns, input

costs, franchise operations, and acquisitions.

DRI (Outperform, PT $57)■ Attractive valuation . We consider DRI a good value at the current levels as we believe higher

valuation metrics can be justified by the company’s solid long-term growth prospects and extendedtrack record of delivering healthy relative performance.

■ Healthy near-term expectations . We are confident in our EPS estimates for F2011 (projected +19%on comps +1.4%) and F2012 (modeling +13% on comps +2.8%). Factors expected to support solidearnings growth in upcoming periods include building momentum at LongHorn and Red Lobster,better trends at Olive Garden, and an improved industry demand picture. Additionally, DRI appearspoised to increase the pace of shareholder payouts in upcoming periods.

■ Attractive long-term outlook . We expect DRI to grow revenue 7-9% and EPS 10-15% annuallythrough unit development (targeting 5% annually), modest comps (supported by effectivemarketing, solid unit-level execution, and other initiatives), and margin improvement (via G&Aleverage and productivity enhancements).

■ Price target. Our price target of $57 is based on a target EV/EBITDA of 8X, near the two-yearaverage for DRI.

■ Risks include managing growth, competition, economic factors, input costs, health or dietarychanges, and financial leverage.

We also have Outperform ratings on BWLD, CAKE, CBOU, CMG, MCD, and TXRH, as we think thesecompanies can meet or exceed healthy 2011 estimates, even if macro conditions fail to improvemeaningfully from recent levels. All else equal, a continuation of the recent industry same-store salestrendline should allow these chains to achieve our full-year estimates.

Potential economic downside scenario. Our analysis of historical data suggests restaurant industryvaluations are tied closely to same-store traffic trends. As such, any meaningful deceleration in thepace of economic activity (and related slowdown in restaurant traffic trends) could result in lowergroup valuations on reduced estimates. Important factors for consideration in any potential downsidescenario would include relative brand positioning, characteristics of the business model (with highoperating margin and greater franchise mix generally reducing earnings volatility), and balancesheet/cash flow metrics (as healthy cash balances could support meaningful share buybacks for somechains).



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Sector Commentary – Active/Outdoor

Mitch Kummetz, [email protected] N. [email protected]

The Action Sports market is in early recovery stage with guys apparel posting strong performance(which we expect to continue), while the girls portion appears to have bottomed, with the movetowards fast fashion muting the girls recovery. Our covered companies (VLCM, ZQK, PSUN) echo ourremarks; our Boardsport Report results (done through our survey work on independentsurf/skate/snow retailers) are also consistent with the aforementioned view.

Brown shoe. We’ve seen a deceleration in comp performance (1H10 to 1Q11) from BWS, DSW andSCVL as well as our independent retail checks, which coupled with the poor seasonal categoryperformance, could adversely impact spring 2012 prebooks. We remain cautiously optimistic on theoutlook for boots in fall/winter. Aside from seasonal performance, companies remain cautious onback-half performance as rising food and gas prices take a bigger chunk out of consumers’discretionary budget and unemployment remains elevated.

Athletic/apparel category: the trend remains strong in footwear, most recently driven by thelightweight running and basketball shoe segments; apparel has also performed well. Performancefrom both vendors (ADS, NKE, UA) and retailers (FL, FINL) support the current cycle momentum andsuggest a further reacceleration in sales growth. We believe this performance, coupled with furthernew product roll-outs over the balance of the year, bodes well for the remainder of FY11. We furtherbelieve that the athletic space is least susceptible to margin pressure coming from increased productcosts as consumers are willing to pay a premium price for perceived premium products (managementteams from both ADS and UA support this view; we have already seen increased ASPs across bothfootwear and apparel through 1H11 in our SportsOneSource data).

Key elements in our positioning are elevated inflation pressures on input costs and uncertaintysurrounding the consumers’ acceptance to higher prices in the back half of the year. With that beingsaid, we are most positive on companies that have one or more of the following characteristics: 1)participating in current product cycle with momentum, 2) limited exposure to cotton in the coststructure, and/or 3) the ability to pass along costs through higher prices.

DECK (Outperform, PT $109)■ Ability to pass along higher input costs. We think DECK has the ability to pass along its higher

product costs (primarily sheepskin) through increased prices, particularly with the UGG brand. Forexample, in 4Q10, DECK’s gross margin increased 440bp with a majority of the increase due toincreased UGG wholesale margins. We believe a similar story will play out in the back half of FY11as well.

■ Price target. Our price target is $109, based on 12x our FY12 EBITDA forecast of more than $315million. The company’s peer group currently trades at an EV/EBITDA(NTM) multiple of more than9x. DECK has historically traded at a premium to the group.

■ Risks include health of the economy, consumer sentiment, consumer tastes/preferences,competition, weather, fluctuating product costs, and ability to procure top-grade sheepskin.





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WWW (Outperform, PT $46)

■ Growth driven by new product rollout. We are positive on the Merrell brand’s new barefootcollection and believe a further rollout of additional SKUs and distribution for both fall 2011 andspring 2012 can support incremental top-line growth. The collection marks the brand’s foray intothe minimalist running category. According to SportsOneSource, the category’s trailingthirteen-week sales are up 162% for the week of May 29. Moreover, the company’s higher-marginOutdoor Group (which includes Merrell) continues to outpace the overall company, contributing tohigher overall gross margins.

■ Price target. Our $46 price target is based on an Enterprise Value of 10x our FY12 EBITDA forecastof more than $210 million. The company’s peer group currently trades at an EV/EBITDA(NTM)multiple of 9x. WWW has historically traded at a slight premium to the group, and we believe that apremium is justified due to the company’s strong near-term outlook.

■ Risks include health of the economy, consumer sentiment, consumer tastes/preferences,competition, weather, fluctuating product costs, and foreign currency exposure.

ZUMZ (Outperform, PT $35)

■ Footwear momentum, lower exposure to rising apparel costs . The company enjoys strongmomentum in its footwear business as well as in accessories and men’s concepts, as it reported adouble-digit comp in 1Q (on top of an 11.9% comp for FY10). We believe the company is poised toexceed our 6% comp which we have built into our model for the balance of the year. Moreover,while ZUMZ expects apparel product costs to be up 10%-15% in the back half, apparel onlyaccounts for 43% of sales. The other 57% of sales is comprised of products for which costs are notgoing up as much.

■ Price target. Our $35 price target is based on an enterprise value of 11x our FY12 EBITDA forecastof roughly $84 million. The peer group currently trades at roughly 7x, but ZUMZ has historicallytraded at a significant premium to the group. Additionally, we believe that our valuation is basedon conservative estimates.

■ Risks include health of the economy and consumer sentiment, dependence on emerging brands,ability to attract and retain action sports oriented sales associates and weather.



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Sector Commentary – Softline Retail

Erika K. Maschmeyer, [email protected] R. [email protected]

Anticipate choppy, gradual growth to continue. While the pace of softline retail growth hasmoderated in April-May (reflecting slower growth, traffic hindered by gas prices, unfavorable weather,inflationary headwinds), trends remain strong for retailers that cater to higher-income customers(sustained employment gains). An improving employment outlook for less educated workers, couldprovide a catalyst for the next stage of the recovery, particularly if the housing market were tostabilize (albeit not likely over the near-term). Despite considerable improvement from the recessiontrough, jobless claims, the unemployment rate, and consumer sentiment/confidence all have amplerunway to improve (still less favorable than pre-recession levels).

Favor high-growth/higher-end, plus recent underperformers. While we anticipate greater volatilityfor softline retailers in the back half due to unprecedented inflationary pressure, we recommendselective exposure to the group, with valuations generally more attractive after the recent pullback.We continue to favor high-quality retailers with compelling growth drivers that are gaining marketshare, particularly those catering to higher-income consumers, as we believe this group will be bestable to pass along higher input costs. In addition, we see potential for investors to seek out"underappreciated" names that have underperformed and that offer greater potential for multipleexpansion (and less downside risk in a pullback).

URBN (Outperform, PT $38)

■ Thesis centered on merchandising and comps improvement in F2H12 . Anticipating 2Himprovement, supported by improved merchandising, high-quality management additions(including new GMM and CEO Glen Senk’s incremental involvement at Urban; Creative Director atAnthropologie), technology investments (supporting efficiency, allocation), strength for FreePeople, BHLDN expansion, as well as significantly easier comparisons for comps (5% in F2H11 vs.13% in F1H11) and margins (operating margin +355 bp in 1H11 and -147 bp in 2H11).

■ However, favorable trends for higher-income consumers could augment internal drivers .Accessories (including cosmetics, handbags, footwear, and jewelry) have generally outperformedapparel in the broader softline retail industry throughout the recovery as consumers have lookedfor efficient manners to update wardrobes (opposed to buying complete outfits). While URBN hasbeen increasing the penetration of non-apparel assortments to capitalize on this secular trend,continued wealth and employment gains for higher-income consumers could accelerate theirwillingness to purchase complete outfits, aiding the women’s apparel business.

■ We believe current valuation presents a compelling entry point , with runway for all concepts inNorth America and substantial international potential, differentiated concepts, strong balancesheet, and substantial revenue and margin drivers. While near-term trends will likely remainchoppy, we anticipate improvement in 2H11, supported by management changes/additions,improved merchandising, technology investments, and easier comparisons. Our price target of $38reflects a target multiple of 17X our NTM EPS in 12 months, below high-growth peers and historicalaverages.

■ Risks include managing rapid growth (including international), consumer spending trends,merchandising (fashion risk), competition, seasonality, and higher sourcing costs.





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KSS (Outperform, PT $65)

■ Anticipate continued market share gains. Catalysts include comp acceleration in 2H11, particularlyafter bad weather in April-May; upside to low expectations (amid fears of weakness formiddle-income consumer) which should be supported by consistent execution, newprivate/exclusive brands (fall 2011), and incremental buybacks. Kohl's concept offers consumers anattractive combination of convenient shopping for well-known brands at competitive values. Webelieve KSS is well positioned, given its value orientation and off-mall stores (consistently generatebetter traffic than regional malls).

■ KSS offers an attractive combination of defensive characteristics and leverage to a recovery . KSShas demonstrated ability to drive traffic in a tough climate (comps +0.4% vs. -7.2% average forJCP/M/DDS in 2009), but also has opportunity to improve operating margins (13% long-term target;10.6% in 2010; prior peak of 11.6% in 2006) if the recovery continues. Margin drivers includeincremental exclusive brands, productive small-format stores, and leveraging online infrastructure.

■ Attractive valuation . We recommend purchase, as we consider the company’s fundamentals soundand the valuation compelling. KSS recently traded at a 10.8X NTM P/E, below historical levels (25%below two-year average). Our price target of $65 reflects a target NTM P/E of 12.5X (below thetwo-year average of 14.4X).

■ Risks include managing growth, promotional competition, seasonality, economic factors, moredifficult comparisons than peers, and slower spending for the moderate consumer (headwindsfrom employment, gas and food prices).

VRA (Outperform, PT $46)

■ Scarce retail growth story, with substantial global growth prospects (significant opportunity in U.S.,recently entered Japan), a strong management team, and differentiated positioning in an attractivecategory. Founded in 1982, VRA is a real brand with staying power, with potential for substantialexpansion in the U.S., as well as internationally (sales +27% to $366 million in F2011). Comp driversinclude a young store base, category/line extensions, and growing brand awareness (supportingstrong traffic; aided by targeted email marketing in F2012).

■ Opportunity for margin expansion (+470 bp to 20.6% in F2011; modeling flat in F2012 on highercosts) through gross margin improvements (inventory management, channel mix) and SG&Aleverage on a growing retail footprint (although pressured in the near term by growth investmentsand public company costs). In F2012, VRA expects to partially offset sourcing pressures (cottonprices up ~30%) through price increases (+5% on half of signature styles) and incrementalsupply-chain efficiencies (supported by Dongguan sourcing office).

■ Price target of $46 reflects a 27X NTM+1 EPS (1.35X PEG on our estimates vs. 1.1X peer average).VRA trades on a forward P/E of 26.8X, on the low end of the post-IPO range of 38X-26X (33.4Xaverage).

■ Risks include managing rapid growth (including international), consumer spending trends,merchandising (fashion risk), indirect retailer relationships, competition, seasonality, and highersourcing costs.



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Sector Commentary – Hardline & Broadline Retail

Peter S. [email protected] E. [email protected] J. [email protected]

We believe consumers are in the early stage of recovery and that consumer spending trends willgradually improve over time. That said, several structural headwinds remain in place (deleveraging,increased frugality) and recent data on employment and housing suggest that the economic recoveryhas hit a soft patch. With job growth key to the sustainability of consumer spending and home pricesagain rolling over, we are a bit more cautious as to the near-term pace of recovery in demand trends.When combined with rising food/high gas prices, we think spending on discretionary items couldsuffer as consumers allocate a greater percentage of disposable income to these necessities.

As such, we expect comp momentum to generally slow across the group to a LSD pace over thesecond half of the year as compared to M-HSD rates experienced over the past 12-18 months, thoughwould point out the likelihood for continued (and perhaps even greater) bifurcation in spendingbehavior between the low/middle and high-end consumer. In fact, retail sales results for the month ofMay generally lend support to this view, with high-end retailers posting the strongest results, whilecomps missed expectations at many discount/department stores catering to lower/mid-tierconsumers.

Key positioning elements. In light of our overall view of the macro and consumer, we recommendexposure to retailers with identifiable top-line and/or margin drivers, as well as those positioned tobenefit from key macro trends (like food inflation and high gas prices). Our top ideas include COST(large cap), TSCO (mid cap), and VSI (small cap).

COST (Outperform, PT $91) – top Large-Cap idea

■ Top-line drivers . Exposure to higher income consumers, ability/willingness to pass through foodinflation (boosting average ticket), and partial benefit from high gas prices (through increased clubtraffic), suggest top-line trends should remain amongst the best in retail.

■ Ability to weather pullback in spend. COST’s deep value positioning and defensive sales mix(food/sundries 55% of sales) should allow the company to weather any pullback in discretionaryspending. With margins rising and a potential membership fee increase on tap this year,fundamental momentum appears sustainable in our view.

■ Price target. Our $91 price target assumes shares trade at a 45% premium to our estimate of thePV of COST’s MFI stream plus net cash, modestly above the stock’s five-year average of 38% yetbelow the pre-financial crisis average of 55%-60%.

■ Risks include food deflation, decline in membership renewal rates, foreign currency fluctuations,meaningful exposure to California, and increased penetration of lower-margin gas.






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TSCO (Outperform, PT $74) – top Mid-Cap idea

■ Top-line drivers . Unique needs-based merchandise offering focused on traffic-driving C.U.E.(consumable, usable, edible) items plus strong competitive position (4x the size of its next fivecompetitors combined) should continue to support healthy top-line trends even in a challengingenvironment.

■ Sustainable high-teens EPS growth should contribute to premium valuation . Visible HSD% unitgrowth, multiple early-stage drivers of gross margin, entrenched operating discipline, and a newfocus on returning excess cash to shareholders though increased share buyback activity suggestsustainable high-teens EPS growth and rising ROIC over the next several years. With true "growth"a scarce commodity across retail, we believe this profile deserves a premium valuation.

■ Price target. Our $74 price target assumes shares trade at 23x FY12E EPS, a premium to the stock'sfive-year average forward multiple of ~16x. With high-growth consumer/retail peers commandingaverage PEG's of ~1.4x, this 23x target multiple (1.3x PEG) appears sustainable given strongfundamentals and upward bias to estimates.

■ Risks include inflationary pressures, seasonality/weather, and ability to manage growth in newmarkets.

VSI (Outperform, PT $43) – top Small-Cap idea

■ Top line helped by secular tailwinds: Fundamentals at VSI should remain amongst the best in all ofretail, as strong secular tailwinds (aging US population, increased focus on active/healthy lifestyles)are complementing sound execution of the company’s consistent/predictable business model,which provides good visibility into continued MSD comp trends.

■ High EPS growth potential. With significant new store growth potential (targeting 10% annual unitgrowth), material margin expansion opportunities, and continued deleveraging of the balancesheet, EPS appears poised to grow 20%-plus over the next few years.

■ Price target. Our $43 price target assumes shares trade at a 26x FY12E EPS or a 1.3x PEG, a modestdiscount to the current 1.4x PEG commanded by high growth retail/consumer peers.

■ Risks include FDA and FTC regulatory oversight, exposure to fad products, product liability claims,irrational pricing, and managing rapid growth.



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Sector Commentary – Consumer Discretionary / Automotive Services

Craig Kennison, [email protected] Altschwager, [email protected] [email protected]

Retail demand of big ticket discretionary products remains in the early stages of recovery followinga deep downturn. Some categories (RVs, utility vehicles, used cars) have enjoyed a modest recovery,while others (boats, ATVs, motorcycles) have yet to post positive growth. Many manufacturers ofdurable consumer goods are seeing moderating wholesale demand after a robustinventory-cycle-driven recovery over the past 12-18 months – with further growth now dependent onthe pace of retail demand.

Credit easing – but impact muted. The availability of credit has been improving on the wholesale andretail level – a major driver to a recovery in spending on big-ticket consumer goods. However, may bereluctant to borrow until the economy improves – especially employment and housing trends.

Spring trends. High gas prices, unfavorable weather, and softening consumer confidence haveweighed on retail trends as the 2011 selling season. While most discretionary categories remain wellbelow “mid-cycle” levels the shape of the recovery looks flatter than past cycles.

Defensive categories doing well. Auto part retailers performed well through the recession. Comps arepoised to slow a bit this year due to tough 2010 comparisons – but overall consumer demand remainsstrong. An aging vehicle population, more frugal consumer, and industry consolidation providedurable drivers for the category.

Outlook. In light of the flatter recovery our dealer checks have uncovered, we are focused on 1)companies with strong internal drivers, or 2) more defensive revenue streams

HOG (Outperform, PT: $50)■ Compelling restructuring story led by credible CEO. Key achievements: 1) improving scarcity value

of brand by reducing dealer inventory (used bike values are appreciating); 2) negotiating favorablelabor contracts with unions (total restructuring savings in excess of $300M annually); and 3)growing internationally (adding 20% to international dealer base).

■ Cyclical rebound to drive incremental profits . With 50% incremental gross margin and significantlylower fixed costs, Harley is poised to drive significant margin expansion as the economy improves.

■ Recent checks show Harley is on brink of growth. Our mid-quarter checks indicate that U.S. Harleydealers are on the brink of retail growth for the first time since 2006 - an important inflection point.






43

■ Price target and valuation. Our $50 price target is based on approximately 16-17x our 2012 outlook(ex-restructuring charges). The multiple is consistent with the historical range as the turnaroundstory unfolds and shipments recover.

■ Risks. Harley-Davidson sells a highly discretionary product and is sensitive to consumer confidence,economic trends, tax policy, credit markets, competitive pressures, labor negotiations, productcycles, and regulation.

ORLY (Outperform, PT: $70)

■ Quality low-beta growth. We like O'Reilly for contrarian-minded investors noting: 1) an agingvehicle population, 2) industry consolidation, 3) CSK-related growth, 4) a heavier commercial mix,and 5) stronger cash flow through better inventory management.

■ Gas prices and miles driven. The stock has underperformed YTD as investors harvest gains andshed exposure to higher gas prices. The number of miles driven fell 1.4% in March as consumersdrove less to conserve fuel. This is a clear headwind for the auto part retailers, but the risk alreadymay be priced into the stock.

■ The O'Reilly Factor. We've included our analysis of an emerging cash flow story we call “TheO'Reilly Factor.” We believe investors have not fully recognized the potential for O'Reilly togenerate significant cash flow from operations (inventory productivity + vendor financing) andfinancing (more financial leverage), driving further share repurchase activity and sustainable EPSgrowth. The plan relies on vendor use of factoring now that O'Reilly debt is unsecured.Management plans to raise the accounts payable ratio to 60-70% in a couple years - an impressiveaccomplishment with room to expand (AutoZone sets the standard today at 104%).

■ Price target and valuation. Our price target for O'Reilly is $70, based primarily on our analysis of itshistorical price/earnings ratio relative to its same-stores sales growth rate. We expect O'Reilly topost 4-6% comps over the next few quarters, supporting a 14-18x multiple of earnings.

■ Risks include the CSK integration, DIFM strategy, energy prices, miles driven and competition.



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Appendix - Important Disclosures and Analyst Certification

Covered Companies Mentioned

All stock prices below are the June 17, 2011 closing price.

Accenture (ACN - $53.96 - Outperform)Airgas, Inc. (ARG - $66.84 - Outperform)Alliance Data Systems Corporation (ADS - $89.77 - Outperform)Automatic Data Processing, Inc. (ADP - $52.40 - Outperform)Barnes Group Inc. (B - $23.44 - Neutral)Bucyrus International, Inc. (BUCY - $91.63 - Neutral)Buffalo Wild Wings, Inc. (BWLD - $60.23 - Outperform)Caribou Coffee Company Inc. (CBOU - $12.87 - Outperform)Caterpillar Inc. (CAT - $98.18 - Outperform)Chipotle Mexican Grill, Inc. (CMG - $276.05 - Outperform)Cintas Corporation (CTAS - $32.29 - Outperform)CLARCOR Inc. (CLC - $44.72 - Outperform)Costco Wholesale Corp. (COST - $81.25 - Outperform)Darden Restaurants, Inc. (DRI - $47.16 - Outperform)Deckers Outdoor Corporation (DECK - $80.60 - Outperform)Eaton Corporation (ETN - 47.41 - Outperform)ExlService Holdings, Inc. (EXLS - $22.07 - Outperform)Fastenal Company (FAST - $33.09 - Outperform)FedEx Corporation (FDX - $87.50 - Outperform)Flowserve Corporation (FLS - $104.90 - Outperform)FTI Consulting, Inc. (FCN - $36.41 - Outperform)G&K Services, Inc. (GKSR - $31.68 - Outperform)Gardner Denver, Inc. (GDI - $79.13 - Outperform)Gartner Inc. (IT - $38.00 - Neutral)Genpact Limited (G - $15.70 - Outperform)Gentex Corporation (GNTX - $28.27 - Outperform)Gladstone Commercial Corporation (GOOD - $17.42 - Neutral)Grainger, W.W., Inc. (GWW - $146.04 - Outperform)Harley-Davidson, Inc. (HOG - $36.98 - Outperform)J.C. Penney Company, Inc. (JCP - $35.19 - Neutral)Jacobs Engineering Group Inc. (JEC - $41.27 - Outperform)Johnson Controls, Inc. (JCI - $37.39 - Outperform)KeyCorp (KEY - $8.20 - Neutral)Kohl's Corporation (KSS - $51.06 - Outperform)Lowe's Companies, Inc. (LOW - $23.11 - Outperform)Manitowoc Company Inc. (MTW - $15.10 - Outperform)McDonald's Corporation (MCD - $82.69 - Outperform)Mine Safety Appliances Company (MSA - $35.67 - Outperform)Nike Inc. (NKE - $83.23 - Outperform)O'Reilly Automotive, Inc. (ORLY - $63.00 - Outperform)PACCAR Inc. (PCAR - $47.87 - Outperform)Pacific Sunwear of California, Inc. (PSUN - $2.51 - Neutral)Pall Corporation (PLL - $54.02 - Outperform)Panera Bread Company (PNRA - $119.85 - Outperform)Paychex, Inc. (PAYX - $29.67 - Outperform)Quanta Services Inc. (PWR - $18.91 - Outperform)Quiksilver Inc. (ZQK - $4.64 - Neutral)RBC Bearings Incorporated (ROLL - $38.02 - Neutral)Regal Beloit Corporation (RBC - $64.27 - Outperform)Roadrunner Transportation Systems, Inc. (RRTS - $14.09 - Outperform)Ryder System, Inc. (R - $52.61 - Neutral)



45

Sealed Air Corporation (SEE - $22.90 - Neutral)SFN Group (SFN - $8.77 - Outperform)Stanley Black & Decker, Inc. (SWK - $68.83 - Outperform)Texas Roadhouse, Inc. (TXRH - $16.54 - Outperform)The Cheesecake Factory Incorporated (CAKE - $30.04 - Outperform)Thomas & Betts Corporation (TNB - $50.73 - Outperform)Tractor Supply Company (TSCO - $63.46 - Outperform)TrueBlue, Inc. (TBI - $14.57 - Outperform)Under Armour Inc. (UA - $71.87 - Neutral)Union Pacific Corporation (UNP - $101.80 - Outperform)Urban Outfitters, Inc. (URBN - $28.97 - Outperform)Vera Bradley, Inc. (VRA - $38.54 - Outperform)Vitamin Shoppe, Inc. (VSI - 43.50 - Outperform)WNS (Holdings) Limited (WNS - $8.88 - Neutral)Wolverine World Wide, Inc. (WWW - $39.83 - Outperform)Zumiez, Inc. (ZUMZ - $24.48 - Outperform)(See recent research reports for more information)

Robert W. Baird & Co. Incorporated and/or its affiliates expect to receive or intend to seek investment banking related compensationfrom the company or companies mentioned in this report within the next three months.Investment Ratings: Outperform (O) - Expected to outperform on a total return, risk-adjusted basis the broader U.S. equity marketover the next 12 months. Neutral (N) - Expected to perform in line with the broader U.S. equity market over the next 12 months.Underperform (U) - Expected to underperform on a total return, risk-adjusted basis the broader U.S. equity market over the next 12months.Risk Ratings: L - Lower Risk - Higher-quality companies for investors seeking capital appreciation or income with an emphasis onsafety. Company characteristics may include: stable earnings, conservative balance sheets, and an established history of revenue andearnings. A - Average Risk - Growth situations for investors seeking capital appreciation with an emphasis on safety. Companycharacteristics may include: moderate volatility, modest balance-sheet leverage, and stable patterns of revenue and earnings. H -Higher Risk - Higher-growth situations appropriate for investors seeking capital appreciation with the acceptance of risk. Companycharacteristics may include: higher balance-sheet leverage, dynamic business environments, and higher levels of earnings and pricevolatility. S - Speculative Risk - High-growth situations appropriate only for investors willing to accept a high degree of volatility andrisk. Company characteristics may include: unpredictable earnings, small capitalization, aggressive growth strategies, rapidly changingmarket dynamics, high leverage, extreme price volatility and unknown competitive challenges.Valuation, Ratings and Risks. The recommendation and price target contained within this report are based on a time horizon of 12months but there is no guarantee the objective will be achieved within the specified time horizon. Price targets are determined by asubjective review of fundamental and/or quantitative factors of the issuer, its industry, and the security type. A variety of methodsmay be used to determine the value of a security including, but not limited to, discounted cash flow, earnings multiples, peer groupcomparisons, and sum of the parts. Overall market risk, interest rate risk, and general economic risks impact all securities. Specificinformation regarding the price target and recommendation is provided in the text of our most recent research report.Distribution of Investment Ratings. As of May 31, 2011, Baird U.S. Equity Research covered 657 companies, with 52% ratedOutperform/Buy, 47% rated Neutral/Hold and 1% rated Underperform/Sell. Within these rating categories, 12% ofOutperform/Buy-rated, and 6% of Neutral/Hold-rated companies have compensated Baird for investment banking services in the past12 months and/or Baird managed or co-managed a public offering of securities for these companies in the past 12 months.Analyst Compensation. Analyst compensation is based on: 1) The correlation between the analyst's recommendations and stockprice performance; 2) Ratings and direct feedback from our investing clients, our sales force and from independent rating services;and 3) The analyst's productivity, including the quality of the analyst's research and the analyst's contribution to the growth anddevelopment of our overall research effort. This compensation criteria and actual compensation is reviewed and approved on anannual basis by Baird's Research Oversight Committee. Analyst compensation is derived from all revenue sources of the firm,including revenues from investment banking. Baird does not compensate research analysts based on specific investment bankingtransactions.A complete listing of all companies covered by Baird U.S. Equity Research and applicable research disclosures can beaccessed athttp://www.rwbaird.com/research-insights/research/coverage/research-disclosure.aspx .You can also call 1-800-792-2473 or write: Robert W. Baird & Co., Equity Research, 24th Floor, 777 E. Wisconsin Avenue, Milwaukee,WI 53202.



http://www.rwbaird.com/research-insights/research/coverage/research-disclosure.aspx

46

Analyst Certification. The senior research analyst(s) certifies that the views expressed in this research report and/or financial modelaccurately reflect such senior analyst's personal views about the subject securities or issuers and that no part of his or hercompensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in the researchreport.DisclaimersBaird prohibits analysts from owning stock in companies they cover.This is not a complete analysis of every material fact regarding any company, industry or security. The opinions expressed here reflectour judgment at this date and are subject to change. The information has been obtained from sources we consider to be reliable, butwe cannot guarantee the accuracy.ADDITIONAL INFORMATION ON COMPANIES MENTIONED HEREIN IS AVAILABLE UPON REQUESTThe Dow Jones Industrial Average, S&P 500, S&P 400 and Russell 2000 are unmanaged common stock indices used to measure andreport performance of various sectors of the stock market; direct investment in indices is not available.Baird is exempt from the requirement to hold an Australian financial services license. Baird is regulated by the United StatesSecurities and Exchange Commission, FINRA, and various other self-regulatory organizations and those laws and regulations maydiffer from Australian laws. This report has been prepared in accordance with the laws and regulations governing United Statesbroker-dealers and not Australian laws.Copyright 2011 Robert W. Baird & Co. IncorporatedOther DisclosuresUK disclosure requirements for the purpose of distributing this research into the UK and other countries for which Robert W. BairdLimited holds an ISD passport.This report is for distribution into the United Kingdom only to persons who fall within Article 19 or Article 49(2) of the FinancialServices and Markets Act 2000 (financial promotion) order 2001 being persons who are investment professionals and may not bedistributed to private clients. Issued in the United Kingdom by Robert W. Baird Limited, which has offices at Mint House 77 MansellStreet, London, E1 8AF, and is a company authorized and regulated by the Financial Services Authority. For the purposes of theFinancial Services Authority requirements, this investment research report is classified as objective.Robert W. Baird Limited ("RWBL") is exempt from the requirement to hold an Australian financial services license. RWBL is regulatedby the Financial Services Authority ("FSA") under UK laws and those laws may differ from Australian laws. This document has beenprepared in accordance with FSA requirements and not Australian laws.

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