nomura european strategy 16.4.12 509266

European Strategy

EUROPEAN STRATEGY

EQUITY RESEARCH

Outlook for the rest of the year

April 16, 2012

After European markets have given up much of their gains for the year, we think it is appropriate to take stock of our market view and how best to express it. We maintain a bullish outlook for European equities. The past few weeks have been a tough challenge for this position; however, the gap between the risk premium and the level of volatility is wide, which we think will support a rally in equities.

We do, however, recognise that sentiment is no longer as depressed as it was at the turn of the year, hence providing less scope for improvement.

We also acknowledge that we should have paid closer attention to our models, which indicated that sentiment had become moderately bullish in March. Given the sell-off over the past few weeks though, we would not want to reduce risk now.

Within the market we expect mean reversion to drive sector and factor performance. Thus we are overweight Cyclicals and Financials, underweight defensive sectors.

Within the Cyclicals we are adjusting our allocation more in favour of resources at the expense of Industrials; we are also trimming our weighting in Tech and adding to Banks.

An interesting feature of the past month has been the sharply increased willingness of investors to discriminate between European countries and stocks. This should be encouraging for active managers as it provides the ability to add value, as opposed to the highly correlated moves of last year.

This note includes a detailed discussion of the stock holdings that we think are the best way to express this top-down view. We also provide an analysis of our recommended portfolio. This has a beta of 1.2 that we think is appropriate at present. It also has high loadings on value and growth factors, but a negative loading on long-term momentum.

Research analysts

European Strategy

Inigo Fraser-Jenkins - NIplc [email protected] +44 20 7102 4658

Shanthi Nair - NIplc [email protected] +44 20 7102 4518

Mark Diver - NIplc [email protected] +44 20 7102 2987

Saurabh Katiyar [email protected] +44 20 7102 9135

Rohit Thombre [email protected] +44 20 710 25461

Robertas Stancikas - NIplc [email protected] +44 20 7102 3127

Gerard Alix Guerrini - NIplc [email protected] +44 20 7102 5079

Maureen Hughes - NIplc [email protected] +44 20 7102 4659

Global Strategy

Michael Kurtz - NIHK [email protected] +852 2252 2182

See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts.

Nomura | European Strategy April 16, 2012

2

Contents 3 Executive summary

3 Key calls

4 Market view

4 Valuations

6 Will fundamentals come back into focus?

9 Sentiment

10 Asset allocation

11 Risk factors

13 Themes

15 Sector allocation

27 European recommended portfolio

36 Characteristics of our recommended portfolio

37 Appendix

37 European recommended portfolio

38 European index targets

39 Investible themes

42 European valuation and profitability

45 Appendix A-1

Research analysts

European Strategy

Inigo Fraser-Jenkins - NIplc [email protected] +44 20 7102 4658

Shanthi Nair - NIplc [email protected] +44 20 7102 4518

Mark Diver - NIplc [email protected] +44 20 7102 2987

Saurabh Katiyar [email protected] +44 20 7102 9135

Rohit Thombre [email protected] +44 20 710 25461

Robertas Stancikas - NIplc [email protected] +44 20 7102 3127

Gerard Alix Guerrini - NIplc [email protected] +44 20 7102 5079

Maureen Hughes - NIplc [email protected] +44 20 7102 4659

Global Strategy

Michael Kurtz - NIHK [email protected] +852 2252 2182


3

Executive summary

We are maintaining our positive view on the European market and think the market will recover its losses of recent weeks. We believe that the disconnect between the high risk premium and low level of volatility makes equities attractive. The market faces a number of headwinds, in terms of a weak growth outlook exacerbated by the austerity programmes in many countries, ongoing political uncertainty and the impact of a delayed investment cycle from the prolonged crisis. However, we think that the supportive factors for the market will outweigh the negatives over the medium term, although it could be a rough ride at times.

The rally, which started in mid-December, ran out of steam in April as increased concerns have resurfaced in the euro area. With the benefit of hindsight, we believe it was a mistake to not pay more attention to the level of bullishness reflected in our sentiment indicator and pare back our view for the near term.

It is easier to form a positive view when valuations are cheap, sentiment is at a low ebb and a series of possible fundamental supports are in sight. Life is rarely so easy. Valuations are supportive but sentiment is mixed, with short-term sentiment actually fairly elevated. There is no ’silver bullet’ in place to fix the eurozone’s ills, but then that was always a chimera anyway. However, we think the trade-off between valuation, sentiment and fundamentals support a recovery and resumption of the rally.

Within the market we think that mean reversion of valuation will come to dominate sectoral and stylistic performance. Accordingly, we have a pro-cyclical and financial stance while we underweight sectors with stable earnings streams. Likewise, we like value and risk as factors and would underweight momentum and quality.

Although the latest sell-off reflects a distinctly bearish view, one aspect of this latest phase should be of benefit to all active investors. The market has shown a much higher degree of discrimination between both countries and stocks. For much of the past 18 months, Spain and Germany had actually moved within a broad relative trading range. That has been definitively broken. We also see a wide divergence of performance within the market at the stock level. This is encouraging as in 2010 and 2011 periods of market weakness were associated with highly correlated returns, leading to a flow from active into passive investing. A divergence of performance is good for active managers as it allows them to add value.

Key calls

• Bullish on overall market on 6-12 month view. This is based on valuation, sentiment, asset allocations and takes into account our macro outlook.

• Low correlation to continue, creating more opportunities for active managers

• Overweight Resources (Energy, basic materials). Valuations are below that implied by the corresponding commodities.

• Overweight Financials. Insurance offers a relatively inexpensive way of buying beta. Banks perceived failure risk greatly lessened by the LTRO.

• Underweight stability. We are not willing to pay the premium demanded for Consumer Staples, Healthcare and Utilities. The former is especially expensive. For healthcare the ‘patent cliff’ is showing up in the perennial earnings growth having halted.

• Overweight Germany. We have had a preference for Germany within Europe for some time. While the country no longer trades at a discount, it is only in line with the rest of Europe and we think it deserves to have a higher rating.

• Overweight value and risk factors. Underweight momentum and quality. Despite the underperformance of value stocks in April, we think that mean reversion will come to dominate factor performance. The stylistic view is not discussed in this report, for a detailed analysis of the case for factor mean reversion see Global Quantitative Research Monthly, 19 March 2012.

Shanthi Nair

+44 20 7102 4518

[email protected]

Inigo Fraser Jenkins

+44 20 7102 4658

[email protected]

Mark Diver +44 20 7102 2987 [email protected] Robertas Stancikas +44 20 7102 3127 [email protected] Rohit Thombre +44 20 7102 5461 [email protected]

mailto:[email protected]�






4

Market view

We believe that the European equity market is underpinned by supportive valuations and depressed sentiment, visible in longer-term allocations. However, the past two years have seen fundamentals take a back seat as macro concerns and sentiment have driven market movements and investors have not been willing to pay attention to the value on offer, while sovereign concerns have been predominant.

The upcoming quarter is also set to be a volatile one, as politics takes centre-stage again, given the elections in France, Greece and Germany, and the referendum in Ireland.

Given these headwinds, we would expect more near-term volatility. However, our medium-term view on the market is based on fundamentals and there are some tentative signs that investors are starting to take these factors into consideration.

Valuations

Valuation forms the basis for our longer-term view on the market and on this basis, the market is inexpensively valued on many metrics. We would accept though that valuation by itself is not a sufficient condition for the shorter-term direction of the market. We see valuation as being a long-term indication for market direction, over which we can impose shorter-term sentiment and fundamental-based views.

We can frame market valuation in a number of ways, but arguably the most central one would be a risk premium as asset allocation decisions are not normally taken in isolation for a given asset. In Figure 1 we show the European equity risk premium, which we plot against the level of implied volatility. Why implied volatility? Because we think this is a concise way of capturing the exogenous level of risk in equities. We also think that it is of particular use at this phase in the cycle. As we have shown in previous research1 we find that although increases in implied volatility and the risk premium tend to be co-incident, falls in implied volatility tend to precede falls in the risk premium.

Fig. 1: Equity risk premium and implied volatility

* 12-month forward earnings yield less real sovereign bond yield (10-year equity weighted European sovereign yield less current inflation rate)

Source: MSCI, IBES, Datastream, Nomura Strategy research

1 Please see ‘Value and Volatility’, 15 January, 2012

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We can also phrase the valuation in an absolute context. Perhaps the clearest way of doing this is to compare the price/book for the market with the ROE (Figure 2). This shows that the price/book is 25% below the average of the past 25 years while the ROE is slightly above average. This is not meaningfully affected if we remove Financials from the aggregate.

Fig. 2: European price/book and ROE

Source: Nomura Strategy research

Finally, probably the simplest valuation metric is PE. For what it is worth, the European market trades on a forward multiple of 10x, 24% lower than the historical average, while the trailing multiple is also 18% below its 38-year average.

Fig. 3: European PE


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Will fundamentals come back into focus?

Sovereign concerns have been crucial in determining the relative performance and valuations of European markets for the past few years. However, this has not been always the case.

As Figure 4 demonstrates, at the end of 2010, about 72% of the variation in the valuations of European countries could be explained by their respective countries’ government debt/GDP ratios. Prior to 2008, government debt/GDP ratios typically explained less than 10% of the valuation differentials, with European stock investors effectively ignoring the government debt position when valuing the region’s national stock markets.

Fig. 4: Correlation of government debt to GDP ratios and price to book valuations of European countries*

Source: FTSE, Nomura Strategy research.

*R2 of annual regression of cross-country price/book multiples and government debt/GDP ratios.

Interestingly, this correlation has decreased of late, moving to about 40% by the time of the ECB’s 3y long-term refinancing operations (LTRO) operation and to about 35% currently. Part of this movement could be just the impact of the removal of the immediate recapitalisation risk. However, we think this is also reflective of a wider recognition of the extent to which concerns have been priced in and therefore will result in a renewed focus on fundamentals.

Our view about the market is inextricably linked to the situation of the Financial sector. Here, we think the risks are lower than they were three months back. With two LTRO operations, we think the ECB has given the banking sector some breathing space. This is reflected in the drop in aggregate peripheral bond yields from 8.2% to 6.5% currently, although they have increased over the past four weeks.

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Fig. 5: Aggregate bond yield for the periphery*

Source: Datastream, Nomura Strategy research

*Market cap-weighted 10-year bond yields for Italy, Spain, Portugal, Ireland and Greece

We think that the stabilisation of markets will continue once the elections are out of the way and that the focus will return to fundamentals. In relative terms as well, we think the European market should provide a good recovery opportunity compared to other global regions where sentiment has turned more bullish more quickly.

Macro view Our positive view on the equity market over the medium term does not derive from a very positive growth outlook for the economy. Our economists expect that fiscal austerity and tighter credit conditions will tip the euro area into a mild recession and expect real GDP to contract by 0.6% this year and to move positive next year. However, they highlight that there are downside risks to these forecasts, albeit smaller than before.

Therefore, we remain watchful of any resurgence of tensions in the euro area that could tip the crisis into a worse outcome than our benign scenario of a mild recession. But we would emphasise that this is not our central case and we expect the recovery to resume by end-2012 and for the markets to look ahead to this outcome.

Fig. 6: Key economic forecasts

Source: Nomura Economics Team

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2011 2012 2013

Real GDP GrowthEuro Area 1.5 -0.6 1.1

Germany 3.1 0.5 1.7France 1.7 -0.2 0.8Italy 0.4 -1.6 0.6Spain 0.7 -2 -1Netherlands 1.3 -0.8 1.7UK 0.7 0.8 1.6

InflationEuro Area 2.7 2.4 1.8UK 4.5 3.2 2.4

Policy RatesEuro Area 1 1 1UK 0.5 0.5 0.5

FX forecastsEuro 1.31 1.23 1.2British Pound 1.55 1.54 1.54


8

Earnings Based on these economic forecasts and the forecasts from our FX strategists of a weaker euro this year, we retain our earlier forecast for European earnings growth of 3.5% for this year. This leaves our numbers still slightly lower than current consensus, with the consensus numbers having moved lower from about 10% at the beginning of the year towards our numbers.

Fig. 7: Earnings forecasts


In late 2011, a large adjustment process had to take place for the street’s view of earnings as a European recession for 2012 was slowly incorporated into forecasts. There is now clear evidence that that process is behind us. The balance of analyst earnings revisions has also just turned positive for the first time since March 2011. While Europe is not the only region where this is happening, this has tended to lend support to market returns over 3, 6 and 12-month periods (Figure 8). These results are actually conservative as both the forward returns and the hit rates rise if we only count one first earnings revision observation in each cycle.

Fig. 8: Market returns after the first observation of positive earnings revisions

Figure shows the returns and hit rate of those returns for the European market after the first observation of a positive earnings revisions balance when the series moves out of negative territory. Source: Nomura Strategy research

With the major part of the adjustment in earnings over and with low valuations attached to European equities, we think there is substantial upside potential for European equities in the remainder of 2012. Our central case that policymakers will keep the eurozone intact by taking key steps towards fiscal union and GDP growth of -0.4% (western Europe) in 2012, with a positive growth rate of 1.2% in 2013, would be enough, in our view, to generate a substantial rally in European stock prices.

Fig. 9: Index targets


Nomura Consensus2012 2012

Europe ex UK 3.5 6.7

UK 3.1 1.5

Europe 3.4 5

3 Month 6 Month 12 Month

Return 5% 8% 16%

Hit rate 77% 92% 100%

End 2012 End 2012Current Level* End 2012 Price Return (%) Total Return (%)+

FTSE Europe** 145 165 14 18

FTSE Europe ex UK** 129 147 14 17EURO STOXX 50 2352 2700 15 17FTSE 100 (UK) 5710 6550 15 21

Dax 30 6743 7800 16 18CAC 40 3270 3700 13 16SMI 6125 6800 11 14AEX 311 350 13 15IBEX 7520 8650 15 21OMX 1050 1160 10 14MIB 14870 17250 16 20

* As of 12-Apr-2012** We use the FTSE All World Developed indices for Europe and Europe ex UK, in local currency terms+Euro terms


9

Sentiment

After the strong rally, which started in December, sentiment had moved up to fairly bullish levels in early March, consistent with a cautious stance. However, following the recent moves, sentiment appears to have started moving lower, although it still remains at fairly optimistic levels, in absolute terms.

As Figure 10 shows, our composite sentiment indicator, based on faster moving measures of sentiment including surveys, put-call ratios, positioning and mutual flows shows that sentiment is just above the neutral levels. The indicator has moved lower from the very bullish levels of 0.8 reached in mid-March to 0.31 currently.

Fig. 10: Composite sentiment indicator

Our composite sentiment indicator combines give different sentiment signals: Mutual flows, Nasdaq speculative positioning, Investors Intelligence survey, Put-call ratios and Implied to realised volatility. Source: Nomura Strategy research

Our composite sentiment indicator is our preferred measure of short-term sentiment and its impact on the market. There are signs that longer-term measures of sentiment are reassuringly at a lower ebb. Globally investors are still repatriating overseas equity holdings. This is a sign of risk aversion that has usually been a very effective contrarian indicator over a 6-12 month horizon (Figure 11).

Fig. 11: Cross-border equity flows*, 1987–Mar 2012

*Purchases of international equities by US, European & Japanese investors, excluding intra-regional continental flows. Cross border flows have been expressed as a percentage of domestic market capitalisation. The latest data points are estimated from EPFR equity mutual fund data. Sources: US Treasury, ONS, ECB (from Jan 1998),Bank of France, Bank of Japan, Bundesbank, Sveriges Riksbank, Nomura strategy research

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Asset allocation

In meetings with investors over the past year it has been evident that there is an entrenched negative view towards European equities. We see evidence for this in the foreign net purchases of European equities (Figure 12). This turned negative in June 2011 and stayed strongly negative for the remainder of the year.

Fig. 12: Foreign net purchases of euro area equities

Chart shows the 3-month moving average of foreign net purchases of euro area equities as an percentage of euro area market capitalisation (annualised) as reported by the ECB. The latest data point is January 2012, February and March points are estimated from cross-border net inflows into western European equity mutual funds as reported by EPFR.

Source: ECB, EPFR, Nomura Strategy research

In some ways an even more negative view is evident in the asset allocation of European institutions. UK institutions are now at the interesting stage of having equal allocations into equities and bonds (Figure 13). The only time when the bond allocation was higher than equity allocation was at the bottom of the market in March 2009.

Fig. 13: UK asset allocation of institutional investors: stocks and bonds

Source: ONS, Nomura Strategy research

Eurozone institutions have been allowing their equities allocation to fall too, having been net sellers of equities. This data is admittedly lagged with the latest data from Q3 2011 showing their equity allocations were just 12% of total financial assets, the lowest level for at least the past 12 years. Conversely, institutional bond allocations have increased strongly recently and now account for 39%. Allocations to cash within eurozone institutions are much higher than in other regions, but have been moving down and now represent 11.9 % of eurozone institutional total financial assets, down from 14.8% in Q1 2009.

We would be inclined to take a contrarian view on this cautious stance by institutions and regard it as positive. However, trying to second-guess the timing of asset allocation decisions by investors is tricky to say the least, so we would regard this as a longer-term support for the market.

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Risk factors

Our positive view on the European market is not without risks.

A risk that we would want to continue to monitor is the availability of credit to the non-financial corporate sector. The picture here has not been too encouraging of late, with the year-on-year growth rate of bank lending moving down even in Germany, (although still remaining positive), while it is shrinking outright in peripheral economies. As banks try to comply with regulatory pressures, there are likely to be incentives not to expand lending.

Fig. 14: Bank lending growth in the euro area

Note: Loans to private sector euro area residents and lending to non-financial private sector

Source: ECB, Datastream Nomura Strategy research,

Lending standards also appear to have tightened, which has negative implications for GDP growth, as Figure 15 shows. However, the latest figures from the ECB are before the second LTRO operation and thus it is too early to draw a conclusion of the impact of the operation here.

Fig. 15: Bank lending standards and GDP growth

* Proportion of Banks reporting tighter credit standards for firms expected over the next three months less those expecting a loosening. Source: ECB, EuroStat,, Nomura Strategy research

Growth surprise indices have indeed been moving down in Europe. This has been closely correlated with earnings revisions, which as we highlighted earlier, have moved positive recently. Continuing weakness in the growth surprise indicators is another factor we will be monitoring closely, as these could lead to weakening in earnings revisions.

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Fig. 16: Europe Growth Surprise Index and earnings revisions

Source: Nomura fixed income research

Another much-discussed risk is the impact of higher oil prices on an already weak economy and the impact this may have on inflation and subsequent monetary tightening. As we have pointed out in earlier reports, oil consumption is near levels where it would start affecting growth rates, but we would downplay this risk, with oil prices starting to move down.

Recent comments from the ECB have been surprisingly hawkish on inflation. Our economists expect headline inflationary pressures to persist throughout 2012, reflecting higher commodity prices, the effects of likely VAT hikes in Italy and France and robust wage growth. Under this scenario, they expect the ECB to maintain its policy rate of 1% throughout 2013 and only expect more LTROs or outright QE if the debt crisis re-intensifies. Ultimately, we do not think that the world faces a real inflationary risk in the near term.

Fig. 17: Oil consumption and oil prices

Source: B.P., Datastream, Nomura Strategy research

In terms of politics there are a number of key dates coming up that are important for the eurozone; the French election on 22 April, the Greek election on 6 May, regional elections in Germany on 13 May, and the referendum in Ireland on the fiscal compact on 31 May to name a few. As we have maintained, we do not expect that we will see a disorderly default or a break-up in the euro area. Apart from these, a sharper-than-expected slowing in China and the impact of the US fiscal situation could also have an impact on the fragile sentiment in the European market. .

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b-1

0

Fe

b-1

1

Fe

b-1

2

Correlation30 day equity/crude (Brent) correlation (LHS)

Oil consumption as a % of GDP (RHS)


13

Themes

Countries versus sectors: Are country effects more important than sector effects? Certainly in Europe that would seem to be the case. Among the European countries, we would highlight Germany as attractively valued relative to its profitability (Figure 18). Although the low valuations could be justified as indicating that the core countries would ultimately have to provide the backstop for the periphery, we think that if our expectation of a benign outcome materialises, then this market offers very attractive value.

Fig. 18: Country P/B and RoE

*Russia is not included in calculations. Source: MSCI, Datastream, IMF World Economic Outlook, Nomura Strategy research

Correlations: Another aspect to consider is that average stock correlations have moved down significantly from where they were three months back. This means that even though markets overall may be volatile, they offer a rich stock-picking environment for investors.

Fig. 19: Average stock correlations in Europe


M&A: Another theme that we have highlighted before, but think will be as valid this year is M&A. We think the M&A cycle will pick up, with corporates well placed in terms of the cost of funding relative to profitability, their cash levels and leverage ratios. The M&A basket we had published last year outperformed the market by 7.6% over the last year. We had recently revised the stocks in the basket and publish the stock basket 2. This basket trades at a discount relative to the market and, in our opinion, offers an attractive opportunity. The stock list can be viewed on Bloomberg: NMRAMNA6<index>.

2 Please see Bids please, 26 February 2012

Pric

e to

Bo

ok

ROE

Austria

Belgium

Czech Republic

Denmark

Finland

Germany

Greece

Ireland

Italy

NetherlandsPortugal

Spain

Sweden

Switzerland

United Kingdom

y = 0.0627x + 0.5803R² = 0.2561

0.0

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1.0

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2.0

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-09

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14

Fig. 20: Relative performance of M&A basket

Chart shows the performance of a basket of European stocks that our sector analysts consider could be potential takeover targets. The performance of the basket is shown relative to the FTSE ALL World Europe (ex financials) Index. The performance is shown on an equal weighted USD total return basis. Source: Nomura research, Bloomberg, FTSE All World, Exshare

Divestitures: As corporates look to increase value to their shareholders, we think they will look at divesting non-core businesses, especially where the conglomerates are valued at a discount. We highlight the stocks where we expect this to happen3. The stock list can be viewed on Bloomberg: NMRADVST<index>.

Fig. 21: Performance of divestiture basket

Chart shows the performance of a basket of European stocks that are considered potential candidates for spin-offs and divestitures. The performance is shown on an equal-weighted USD total return basis relative to market Source: Nomura research, FTSE All World, Exshare

3 Please see Unlocking the value in divestitures, 10 April 2011

85

87

89

91

93

95

97

99

101

103D

ec-

10

Jan

-11

Fe

b-1

1

Ma

r-11

Ap

r-11

Ma

y-11

Jun

-11

Jul-1

1

Au

g-1

1

Se

p-1

1

Oct

-11

No

v-11

De

c-11

Jan

-12

Fe

b-1

2

Index

68

72

76

80

84

88

92

96

100

104

Jan

-10

Fe

b-1

0

Ma

r-1

0

Ap

r-1

0

Ma

y-1

0

Jun

-10

Jul-1

0

Au

g-1

0

Se

p-1

0

Oct

-10

No

v-1

0

De

c-1

0

Jan

-11

Fe

b-1

1

Ma

r-11

Ap

r-11

Ma

y-11

Jun

-11

Jul-1

1

Au

g-1

1

Se

p-1

1

Oct

-11

No

v-11

De

c-11

Jan

-12

Fe

b-1

2

Ma

r-1

2

Index


15

Sector allocation

Our sector recommendation reflects an ultimately bullish view of European equity markets. There are some very wide spreads on sector valuations at the moment with a high premium demanded for defensive cash flows. The European sector that trades on the largest discount is, unsurprisingly Financials, but we would regard the multiples for resources and some other sectors with cyclical exposure as being depressed. We continue to think that the underlying driver over the balance of the year will be mean-reversion in these valuation spreads. It is this that runs through our sector views.

We are taking this opportunity to adjust the weighting within our cyclical exposure to reduce exposure to industrial cyclicals and increase resources exposure. Valuation and other factors favour resources and we want to express a fundamentally bullish long-term view of Chinese demand, whereas the earnings of European industrials have been surprisingly robust.

Resources We are increasing our Basic materials exposure to leave us with a portfolio weight of 16% versus a benchmark weight of 11%.

For the basic materials and energy sectors there is a useful comparison between the valuation of the sector and the ‘exogenous’ underlying commodity price that for us gives a framework for determining sector over/under valuation.

Starting from the industrial metals sector, Figure 22 shows that historically the relative performance of the sector was closely linked with the steel price. However, there has been a strong disconnect between the two series since 2011, and the sector appears to be pricing in a steel price materially below current levels.

Fig. 22: Price of steel and relative performance of Metals sector

Source: FTSE, Worldscope, Datastream, Nomura Strategy research

A similar picture can be seen when looking at sector valuations, where despite the steel price remaining relatively high, the sector is trading at a 50% discount to the market and is almost back to the lows seen at the end of 2008.

0

0.5

1

1.5

2

2.5

3

3.5

4

0

200

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Jan

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-00

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-01

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Jan

-05

Jan

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Jan

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IndexUS$/bnSteel Price Per Ton (LHS)

Relative Total Return - USD (RHS)


16

Fig. 23: Price of steel and relative valuation of Metals sector


Mining is another sector where we think it is instructive to draw comparisons between the pricing of underlying commodities and sector valuation. As shown in Figure 24, sector valuations have closely followed the CRB Metals Price Index since 2003. However, similarly to the Industrial Metals sector, mining stocks are now trading 12% below their average relative valuation and in line with valuations in previous recessions.

Fig. 24: Mining valuation and the CRB Index

Source: FTSE, Worldscope, Bloomberg, Nomura Strategy research

0

0.2

0.4

0.6

0.8

1

1.2

1.4

0

200

400

600

800

1000

1200Ja

n-9

0

Jan

-91

Jan

-92

Jan

-93

Jan

-94

Jan

-95

Jan

-96

Jan

-97

Jan

-98

Jan

-99

Jan

-00

Jan

-01

Jan

-02

Jan

-03

Jan

-04

Jan

-05

Jan

-06

Jan

-07

Jan

-08

Jan

-09

Jan

-10

Jan

-11

Jan

-12

RatioSteel Price Per Ton (LHS)

Relative PBK (RHS)

0.30

0.80

1.30

1.80

2.30

2.80

0

200

400

600

800

1000

1200

Jan

-88

Jan

-89

Jan

-90

Jan

-91

Jan

-92

Jan

-93

Jan

-94

Jan

-95

Jan

-96

Jan

-97

Jan

-98

Jan

-99

Jan

-00

Jan

-01

Jan

-02

Jan

-03

Jan

-04

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-05

Jan

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Jan

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Jan

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Jan

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RatioIndex CRB Price Index (LHS)

Relative PBK (RHS)


17

The above relationships are not as pronounced in the Energy sector. With the oil price currently near historical record levels and the sector enjoying healthy profitability, we find it surprising that the sector trades at such low multiples (Figure 25).

Fig. 25: Oil relative price/book

Source: FTSE, Worldscope, Nomura Strategy research

Fig. 26: Oil sector earnings and the oil price


In addition, with high oil prices being one of the highest risks to the outlook of the global economy, the energy sector can provide a useful hedge in the event of a further damaging rise in oil prices.

Our Oil and Gas research team would cite three themes that can drive the sector this year. Increased LNG demand, restructuring and exploration. The first two are also, to some degree, also shielded from the possibility of a lower oil price. Finally, as we have noted before (see our 2012 European Strategy Outlook), these sectors should benefit from the optionality in the event of a worse-than-expected global growth outlook. In this case, further quantitative easing measures are likely to emerge, which would support commodity prices.

0.70

0.80

0.90

1.00

1.10

1.20

1.30

1.40

1.50

1.60

1.70

Jan

-88

Jan

-89

Jan

-90

Jan

-91

Jan

-92

Jan

-93

Jan

-94

Jan

-95

Jan

-96

Jan

-97

Jan

-98

Jan

-99

Jan

-00

Jan

-01

Jan

-02

Jan

-03

Jan

-04

Jan

-05

Jan

-06

Jan

-07

Jan

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Jan

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Jan

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-11

Jan

-12

Ratio

0

20

40

60

80

100

120

0

100

200

300

400

500

600

700

800

Jan

-88

Jan

-89

Jan

-90

Jan

-91

Jan

-92

Jan

-93

Jan

-94

Jan

-95

Jan

-96

Jan

-97

Jan

-98

Jan

-99

Jan

-00

Jan

-01

Jan

-02

Jan

-03

Jan

-04

Jan

-05

Jan

-06

Jan

-07

Jan

-08

Jan

-09

Jan

-10

Jan

-11

Jan

-12

Europe Oil & Gas - 12mth Fwd Earnings (LHS)

Brent Crude Spot EUR (RHS)

http://intranet.nomuranow.com/research/globalresearchportal/getpub.aspx?pid=478112�


18

Other cyclicals We are reducing our exposure to Industrials to neutral. The sector has had a modest outperformance of 5% since its relative trough in September 2011. What concerns us is that valuations are high while earnings are close to previous cyclical highs at the same time. We find that the most important valuation factor for trading the sector is price/book4. This factor has the best correlation of forward returns with relative multiples. On this basis the sector is expensive with a 40% premium to the market, compared to usually trading in line with the market multiple over the past 25 years (Figure 27).

Fig. 27: Relative price/book of Capital Goods sector


Moreover, the sector’s earnings appear close to a cyclical high, the level of earnings being generated being only 5% below the recent cyclical peak. This is for a sector that, until the past five years had not been able to out-grow the market over a complete economic cycle (Figure 28). The sector has also recently seen relatively strong analyst upgrades both relative-to-market and also in absolute terms.

Fig. 28: 12-Month Forward Earnings Index for Capital Goods sector


4

See ‘Sizing up the Cyclicals’, European Strategy Weekly, 1 May 2006

0.5

0.7

0.9

1.1

1.3

1.5

1.7

Jan

-88

Jan

-89

Jan

-90

Jan

-91

Jan

-92

Jan

-93

Jan

-94

Jan

-95

Jan

-96

Jan

-97

Jan

-98

Jan

-99

Jan

-00

Jan

-01

Jan

-02

Jan

-03

Jan

-04

Jan

-05

Jan

-06

Jan

-07

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-08

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-11

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Ratio

50

100

150

200

250

300

Jan

-88

Jan

-89

Jan

-90

Jan

-91

Jan

-92

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-93

Jan

-94

Jan

-95

Jan

-96

Jan

-97

Jan

-98

Jan

-99

Jan

-00

Jan

-01

Jan

-02

Jan

-03

Jan

-04

Jan

-05

Jan

-06

Jan

-07

Jan

-08

Jan

-09

Jan

-10

Jan

-11

Jan

-12

Index


19

Transport We maintain exposure to the Transport sector. We would admit the sector is not cheap, on PE it trades at a 50% premium compared to a long-run average 7% premium, although on book it trades at a 7% discount to the market (in line with history). We would argue that the earnings level is still moderately depressed, which may bias the current PE upwards. The reason for maintaining the exposure is that the earnings have been growing, with a year-to-date growth of 12-month forward EPS of 10%, which compares favourably to a decline of 1.2% for the market overall (Figure 29). Our transport research team show that the upgrades are coming from supply control, pricing power and margin improvement, rather than any acceleration of the top line, but the upgrades are real and should continue gently, bar any major macro upset. Moreover, the sector does tend to respond quickly when recoveries do come.

Fig. 29: Index of 12-month forward EPS for Transport sector


Financials Within the Banks sector, the LTRO has removed much of the perceived failure risk that overhung the sector last year. Moreover, the impact the operation has had on fixed income markets and also broader macro developments have created good earnings momentum for the banks with capital markets businesses through FICC trading. The LTRO is also having a direct positive impact on earnings, especially for some southern European stocks. Coming at the market from a primarily valuation-driven standpoint as we do, it is hard to avoid a fundamentally positive view on the sector, trading at 0.75x tangible book. We are, however, aware of the possibility that the value on offer is illusory given the ongoing regulatory requirements of the sector in the form of stress tests in June 2012, Basle rules in 2013, changes in market structure and national resolution regimes (eg, the Vickers Report in the UK). These headwinds notwithstanding, we also see the very real negative sentiment expressed towards the sector when we meet with clients. It is this embedded negative sentiment that we think ultimately is more interesting as it has the scope for unwinding. We stay overweight.

5

10

15

20

25

Jan

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%


20

Fig. 30: Price/tangible book for European Banks sector

Source: WorldScope (Quarterly), FTSE, Exshare, Nomura Strategy research

The Insurance sector still suffers from being tarred with the Banks’ brush. We think this is misplaced as the situation is fundamentally different, particularly with respect to capital requirements. The other key driver for relative sector allocation is equity risk. However, given we have an ultimately positive view on the market we would like to get exposure to the in-built beta risk, especially at these entry valuations for the sector. More fundamentally, the sector has managed to out-grow the broader market in EPS terms by 9.9% over the past 12 months, yet despite this we do not see a sign that analysts have become overly optimistic on the sector (indeed they have only just moved into net upgrading territory with a modest upgrade of 2.8% in April).

Fig. 31: Insurance sector relative earnings growth and earnings revisions


0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0Ja

n-8

8

Jan

-89

Jan

-90

Jan

-91

Jan

-92

Jan

-93

Jan

-94

Jan

-95

Jan

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Jan

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Jan

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Jan

-99

Jan

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Jan

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10

20

30

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100

200

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600

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Jan

-89

Jan

-90

Jan

-91

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-92

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-94

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-95

Jan

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Jan

-97

Jan

-98

Jan

-99

Jan

-00

Jan

-01

Jan

-02

Jan

-03

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Jan

-05

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-12

Net earnings revisions %, (up-down)/total

Jan 1988 = 100 12M Fwd Earnings (LHS)

Earnings Revisions (RHS)


21

Rates have had a positive correlation with the relative performance of the sector for the past decade (the switch from a negative to positive correlation usually being explained by the driver moving from the asset to liability side of the balance sheet, Figure 32). Rates are probably unable to go materially lower from these levels, so eventually this will provide an additional reason to be long the sector as the NPV of liabilities decline.

Fig. 32: Correlation of Insurance sector relative performance and bond yields

Figure shows the rolling 24 month correlation coefficient between the return of the insurance sector relative to the market and changes in a Pan European aggregate bond yield Source: Nomura Strategy research

TMT We maintain an overweight exposure to Media. Here our favoured valuation factor for calling the sector relative to the market is free cash-flow yield5 and the sector currently yields 10.9%, fully 5.8 percentage points above that of the market (Figure 33). We also find that analysts have not been very aggressive in raising numbers for the sector of late. For some time now the issue for strategists has been to distinguish those parts of the sector that are challenged by technological change versus those parts that can continue to prosper. This leaves us with a preference for agencies and publishers.

Fig. 33: Free cash-flow yield of Media sector relative to the market


5

See ‘Sizing up the Cyclicals’, European Strategy Weekly, 1 May 2006

-0.8

-0.6

-0.4

-0.2

0

0.2

0.4

0.6

Jan

-90

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-91

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-97

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-99

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10 Yield


22

The Telecom sector has failed to lead the market in any meaningful way since 2008, while its earnings share has also been declining since then. A prima facie case could be made for the sector on the basis of its 8% dividend yield, but we maintain an underweight. We think there is too much dividend risk for the sector for this to be a meaningful case to support outperformance. Moreover, the sector is still suffering from price deflation, which, in our view, makes the relative earnings case for the sector weak at best (Figure 34). This is in part the result of the regulatory environment. Although much of this process is behind us the process still has a way to run (eg, in restrictions on voice and data roaming charges). We do, however, think that cases can be made for individual stocks in the sector, which we discuss below.

Fig. 34: Deflation in European Telecoms

Note: Year-on-year change in Telecom services pricing. Source: Datastream, Nomura Strategy research

We are maintaining our overweight in Tech, but reducing the size of the position with a 7% weight, relative to a benchmark weight of 3%. The sector in Europe has managed a good outperformance of 7.9% over the past year but it is hard to maintain that the sector is now objectively cheap given this outperformance. It is admittedly hard to determine what is an ‘average’ valuation for the sector given the impact of the bubble, but the sector now trades at the top of its ex bubble relative valuation range (Figure 35).

Fig. 35: Tech sector relative PE


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-10

-8

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-4

-2

0

2

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8

Oct

-99

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-01

Ap

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3

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-06

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7

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2

% y-o-y

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1.0

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4.0

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Jan

-89

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-95

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Ratio


23

The other complication with the sector from a strategist’s perspective is that, unlike the global sector, within Europe the sector is very diverse and yet small. This makes stock selection key. The prime reason for our sustained overweight and what stops a further cut to neutral is the potential to benefit from corporate expenditure. We think that this could be a key source of earnings growth for certain parts of the corporate sector.

Corporate capex is at a cyclical low point (Figure 36), and spending on Tech equipment by corporates has lagged. Meanwhile corporates do have cash to spend, the constraint has been management willingness to loosen the purse strings. As this is the theme that interests us from a top-down perspective, we express our position in the sector mainly though a software and services exposure.

Fig. 36: Global capex/sales ratio

Source: Worldscope, Nomura Strategy research

Staples We maintain a significant underweighting in Utilities through a confluence of negative factors: valuation, wanting to avoid ‘bond proxies’, policy risk and lack of cash coverage. The sector trades in line with the market on an earnings multiple that is a 14% PE premium to the 25-year average (Figure 37). We would not want to pay this premium unless we had a very strong aversion to holding beta risk, but we think there are more issues for the sector in addition to valuation.

Fig. 37: Relative PE for European Utilities sector


6

7

8

9

10

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-88

Jan

-89

Jan

-90

Jan

-91

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-93

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-95

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-97

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-98

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-99

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Ratio

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0.6

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1

1.1

1.2

1.3

1.4

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-88

Jan

-89

Jan

-90

Jan

-91

Jan

-92

Jan

-93

Jan

-94

Jan

-95

Jan

-96

Jan

-97

Jan

-98

Jan

-99

Jan

-00

Jan

-01

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-02

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-03

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Ratio


24

The sector is seeing significant downgrades to earnings both in absolute terms and relative to other sectors. This comes on top of a 20.0% fall in the aggregated EPS of the sector over the past three years.

Fig. 38: Earnings revisions for European Utilities sector


These downgrades reflect an environment where political risks remain high. In several countries (Germany, Italy) there has been a backlash against nuclear power. There is also the risk of a fiscal raid on the companies in the sector in countries where cash-poor governments are trying to raise revenue from the corporate sector. It also reflects a lack of ability to generate positive free cash flow that in turn has negative implications for dividend pay-outs.

The Consumer Staples sector has fewer fundamental headwinds than the Utilities in that earnings growth for the sector in aggregate has continued and has beaten that of the market by 8% in EPS terms over the past 12 months. Analysts have also maintained superior earnings revisions for the sector even as market-wise earnings revisions have recovered from a large negative number (note that this is unusual as the sector usually lags in such upswings). This has been typified by some large stocks in the sector seeing increasing earnings expectations over the past six months (Carlsberg forward EPS +3%, L’Oreal forward EPS +5%). Tobacco stocks have continued on their inexorable earnings trajectory (the log of aggregate EPS for the sector over the past 25 years is the closest thing that we have ever seen to a straight line in the 150,000 time series that we track on our database). Although for some sector heavyweights, the earnings momentum of recent years has interestingly lagged over the past six months (Unilever).

This positive earnings momentum means that even during the risk-on rally in early 2012, the sector moved in line with the market rather than underperformed. This does mean that valuations look stretched. We maintain a zero exposure to the sector in our recommended portfolio. The 40% PE premium that the sector has to the market is (by some degree) the highest of any sector. It is moreover high compared to a normal premium of 12% over the past 25 years. So our case against the sector is not in the main based on fundamentals (although in many cases we see the historical ability to achieve consistent growth with margin increase as increasingly difficult), but instead is predicated on the need for mean reversion of sector relative valuation this year.

-25

-20

-15

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0

5

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15

20

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Fig. 39: Relative PE of Consumer Staples sector


Healthcare We are underweight Healthcare, as with the other sectors with stable earnings streams it has seen its multiple bid up in the face of investor risk aversion. It is not as expensive as Consumer Staples (either relative to its own history or in absolute terms) so we do keep some allocation towards the sector in our portfolio, but from a strategy perspective the problems with the sector remain as they were at the beginning of the year. The premium valuation for the sector was always in the past justified by its ability to grow earnings over the cycle. The issues of the ‘patent cliff’ facing the sector have been well known for some time and it was perhaps surprising that despite this the sector still managed to grow aggregate EPS. However, the 30 year near-continuous growth in earnings seems to have come to an end, or at the least stalled. The sector has not managed to grow aggregate EPS since 2010 (Figure 40).

Fig. 40: 12-month forward EPS for European Healthcare sector


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26

In light of this change in the growth dynamics we struggle to justify a premium for the sector. Moreover, our Pharmaceuticals research team point out that the European sector trading at an 16% premium to NPV parity, is particularly unattractive compared to peers in other regions such as the US (Figure 41).

Fig. 41: NPV as percentage of EV for Healthcare sector

Source: Company data, Nomura estimates and Evaluate Pharma consensus data

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27

European recommended portfolio

Our European recommended portfolio is our main vehicle for expressing the market, sector and thematic views expressed here. It also holds us to account for the efficacy of our views. We discuss the case for our stock holdings below. We are making some changes to our recommended stocks and weightings.

We are keeping our cyclical exposure the same overall, but repositioning the weight with a greater emphasis on resources names and taking weight out of Industrials. Accordingly we are adding Antofagasta. We are taking profits in CRH and removing it from the portfolio. Also, to reduce our Industrials weight we are removing Meggitt. Within Energy we are adding Shell and removing BG and Repsol.

Within Tech we are adding Ericsson and removing STM. In Telecoms we add BT.

In the Banks we keeping our stock selection unchanged but adding weight to stocks with investment banking exposure

We are taking the opportunity of this note to review the case for the stocks in our recommended portfolio in a more detailed way. The comments on the individual stocks below largely reflect the views of our fundamental analysts, but with our own additions especially where the stock may reflect themes or characteristics that we prize from a top-down standpoint.

Basic Materials BHP Billiton

BHP, in our view, represents a truly diversified and high-quality exposure to the resources sector. The company offers less torque than a pure-play producer, yet offers attractive high-quality assets, low cash cost operations and growth to the wider resources sector.BHP has a deep portfolio of growth assets with a focus on brownfield expansion of existing leading businesses. Core areas of volume growth are in iron ore (Western Australia operations to 220Mtpa by FY14E and 350Mtpa by FY20E), oil & gas (to1.5Mboe/d by FY20E, driven by US shale gas) and met coal (>60Mtpa by FY17E).

Rio Tinto

RIO continues to be the preferred diversified miner offering exposure to both copper and iron ore, attractive near-term growth, balance sheet flexibility and an attractive valuation metrics, in our view. In addition to iron ore RIO seeks to build exposure to copper, while the tone for aluminium remains bearish. However, RIO is now prepared to add optionality through more frontier projects (eg, bulks in Mozambique and Guinea). The company, like BHP, is considering divestments but in the current market there is a limited pool of potential buyers and progress may take some time.

Antofagasta

Based on our analysis, we forecast a large copper deficit of 454kt in 2012 and 69kt in 2013. Even in a China ‘hard-landing’ scenario, where 2012 Chinese refined demand grows by 4% vs our current estimate of 8%, the copper market could still be in a material deficit in 2012 of around 150kt, which should be supportive for the copper price over the medium term. Despite this, copper equities have underperformed over the past 12 months and appear to be pricing in a pessimistic long-run price of c.USD 2.40/lb versus our long-term incentive price of USD 2.75/lb. We view Antofagasta as a good way to capitalise on a reversal of this trend. This is because it is a high-quality, long-life, low-cost tier 1 copper pure-play with a relatively lower risk profile given that close to 100% of the company’s portfolio is in Chile.


28

Thyssenkrupp

We believe TKA offers investors seeking exposure to a steel market recovery a more attractive risk-reward over the next 12 months. Weakness in Steel Europe is cyclical not structural, while the Steel Americas ramp-up has now passed the long-awaited inflection point and could approach EBITDA breakeven in the next year.

Investors should look through TKA’s near-term earnings softness:

The renegotiation of TKA’s half-year steel contracts in early January (at lower steel prices) temporarily clouds the underlying earnings power of its Steel Europe business until H2. This variance is not structural and in H2 2012 we expect TKA’s earnings to catch up with its peers.

In addition we believe that the stock offers attractive valuation:

Post-stainless spin-off, a proper assessment of TKA’s capital structure is required to calculate TKA’s Enterprise Value. On our estimates, TKA trades at 7.6x FY 11/12E EBITDA (6.7x ex-Steel Americas). This falls to only 5.3x by FY 12/13E – already below its mid-cycle level of c.6.0x.

Arkema

We believe Arkema is the most undervalued group in the chemicals sector at 9x 2012E P/E vs 14.1x for the sector and 10.5x for average industrial chemicals.

In our view, the market has not yet rewarded the company for its structural improvement because of concerns that the earnings recovery was mainly driven by cyclical factors. Since 2005, Arkema has improved its EBITDA margin from 6.2% to 17.5% (proforma) thanks to fixed cost reductions, mix improvement and value-creating portfolio management (vinyl, cerexagri urea-formaldehyde resin disposals vs Dow, Total and Coatex coating resin acquisitions).

In addition, we believe more structural improvement is yet to come:

Arkema should generate significant synergies in its coating resin division following the Total Coating integration.

The performance products division should continue to enjoy mix improvement.

The tax rate is likely to decline thanks to a progressive recognition of deferred tax assets from the vinyl disposal.

Capital Goods Amec

We believe that a strong 2011 earnings result and announced GBP 400mn share buyback reaffirms AMEC’s impressive EPS outlook (we forecast 26% 2011-13E CAGR). The stock also offers an attractive valuation relative to the sector (2013E P/E of 11.8x; sector average P/E 2013E is 11.7x and EPS growth is 12%).

We believe that the scale of the share buyback leaves sufficient scope for more acquisitions and we expect the company to target bolt-ons in natural resources (we are confident in AMEC’s ability to execute in 2012).

Siemens

Siemens fulfils two goals in our portfolio, maintaining a diversified industrial sector weight and also giving us exposure to Germany. The stock trades in line with the European market multiple on earnings of 11x, and yet over the past 25 years has averaged a 22% premium. It also trades in line with the non-financial sector book multiple. Although the stock has a very much cyclical earnings stream, this has become progressively more growth-like as well. Analysts have been downgrading forecasts on the stock continuously for 12 months and have yet to put in upgrades; this has coincided with an 8% underperformance relative to the sector and 14% underperformance relative to the market.


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Thales

Thales brings an aerospace and defence element into our cyclical exposure. Although some other stocks in the subsector are less expensive on PE (eg, BAE), Thales has been generating positive earnings growth over the past year. It also trades on just 1.5x book, which is at the bottom of its 20-year trading range.

Consumer Cyclicals Daimler

Daimler is trading at a 12% discount on price to book value to the broader European market, which we consider attractive. It should benefit from a growing EM exposure and it also offers a significant 28% ROE premium to the European market. Finally, the stock offers an attractive dividend yield of 4%.

Deutsche Lufthansa

Lufthansa has placed a direct target on improved profitability with its latest plan, SCORE, with the aim of improving profits by EUR 1.5bn over the next three years. Without further details, it is difficult to assess how effective the profit improvement will be.

However, we are encouraged by the focus and targeting of profit improvements (rather than a cost-cutting number that may not be seen in the profit-and-loss account) and the fact that any gains from capacity growth will be removed from the calculated improvements.

We viewed Lufthansa’s capacity growth in 2011 as excessive. With 2012 capacity growth plans revised down to 1.7%, we are more comfortable with Lufthansa’s current capacity growth plans.

Fuel is the biggest risk to the network carriers, enjoying the benefits of a more disciplined capacity picture, but longer term we believe Lufthansa remains better placed to survive a high fuel price than many weaker peers, and should thus enjoy the benefits of an industry capacity shake-out further down the line.

Deutsche Post

The least expensive of the logistics stocks with “self-help” driving half the growth. The real opportunity for the subsector comes when top-line growth resumes, to which they have high gearing.

Energy ENI

Downsizing its stake in Galp and providing clear plans to ultimately exit heralds what we believe are the first stages of a long-awaited restructuring. It should help promote our view that ENI is transitioning from a European-bias gas conglomerate to a global upstream operator offering a competitive growth and returns profile. With greater evidence of a transformational process, more valuation support from larger resource numbers in Mozambique, the opportunity for more exploration success and a balance sheet deleveraging quicker than anticipated, we argue a narrower valuation discount to SoP and relative target P/Es is warranted.

OMV

The stock has outperformed in recent months, but is still inexpensive and trading at a notable discount to peers. The shares have been unloved, but past issues around Libya, the balance sheet, Petrom and exposure to refining are well flagged and in some cases now represent tailwinds. With the steps put in place by management to turn around the company, we remain more positive than the market on: 1) Libya – production continues to return and should benefit 1H 12 earnings; 2) Exploration – the portfolio is under-appreciated and contains more high-impact prospects than in the past; 3) The ability of management to unlock medium-term shareholder value via its three strategic pillars of upstream growth, integrated gas and restructuring.


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Saipem

Our positive outlook for gas capex favours Saipem owing to its new state-of-the-art vessels (FDS2 and Castorone), which possess unique pipe-laying capability (importantly the installation of wide diameter pipe in deepwater) required for large and complex gas developments. Petrobras’ requirement to transport gas produced on its pre-salt developments back to shore via pipe-trunkline should put Saipem in good stead for upcoming awards.

Also, we believe that Saipem should benefit from relatively large contract awards (>USD 1bn) in Iraq from H2 2012, where we believe it is well positioned based on its legacy presence and strong relationships in the country (not least with ENI), as well as its solid reputation in the region.

Shell

Looking at Shell through a number of lenses gives us confidence:

Execution, technology and bias to gas suggest it is the best placed of the European mega-caps to offer competitive growth rates on a 10-year view.

In that context, we maintain that the valuation is not particularly demanding – trading at 7.8x 2012E P/E (a 5% premium) and a dividend yield of 5.2%. While relative performance may not match what we saw in 2010 and 2011, we believe that the company is well positioned to outperform its Big Oil peers in Europe and that it remains attractive in the context of large-cap global oils. With 10% underperformance relative to the market YTD, we see this as an attractive entry point.

Finally, from a purely quantitative perspective, the stock is also our top pick in the Energy sector in the European Multifactor model.

Banks Barclays

Our preferred pick in the UK banking sector. The group is generating an RoTE of 7%, well ahead of its domestic banking peers. Its commercial banking operations are customer-deposit funded and have relatively modest asset quality risks, largely in the periphery of Europe, but which are small in the group context. In the short term, earnings estimates may also benefit from positive revisions, given the improved capital markets experience in Q1. Although Barclays is our preferred UK stock, we also see relatively limited upside potential. The group does need to build capital. In the long term, the main negative we see for the group is the uncertainty over the returns available in investment banking, particularly after the implementation of the ICB recommendations. We estimate BarCap’s effective RoE on a Basel 3 capital basis was c.6% last year. Until the market is more positive towards the long-term profitability of the capital markets industry, we believe the shares are unlikely to be significantly re-rated.

BNP Paribas

In the short run, deleveraging costs, capital build and election uncertainty could keep a lid on French bank returns and multiples, although by late 2012 regulations should become clearer and the operational flexibility between better and less well capitalised peers could drive differing earnings momentum. In 2013 and beyond, while BNP Paribas has a footprint largely in the developed markets in Europe, its strong management and good risk control have delivered consistent market share and book value per share growth throughout the crisis, unlike many peers, and this combined with a potential to re-rate nearer to 1x book could deliver shareholder returns even in an environment of weak growth. Into 2014, BNP Paribas has some more options – using better capital ratios than peers to drive faster organic growth if repricing and cost control has driven industry ROEs back into the 12-15% range (large acquisitions being dis-incentivised by GSIFI rules), or more aggressively buying back stock if not."


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HSBC

HSBC’s latest full-year results showed weaker momentum at the group level. However, emerging market operations showed robust growth with pre-provision profits up double digits. We also believe that the revenue headwinds will moderate and that the group’s cost measures are still likely to generate progressive positive operating leverage over the next three years. This should allow improved operating momentum. With the shares at little over TBV and c.8x 2012E underlying EPS, while offering a 4.5% yield, we remain positive towards the shares.

HSBC’s full-year results helped little in terms of catalysing our bull case in absolute terms, which is based around our preference of emerging growth economies over developed western economies. Although we see downgrade risk in the sector, we believe this remains much lower at HSBC. With minimal balance sheet restructuring needs, a strong capital base and a dividend yield close to 5%, we see value in HSBC at current valuations. We also view the reclassification of renegotiated loans at HFC as an accounting issue and envisage a further stabilisation in trends, with the US economy continuing to strengthen.

We remain concerned about costs as the group cost/income ratio for 2011 was 61%, excluding own debt, and management has admitted that the target range of 48-52% that it set for 2013 may have to become an absolute cost target as revenue has remained essentially flat at the group level.

Swedbank

Using our week-by-week analysis of mortgage rates, it is clear that front-book relative to back-book margins in Sweden remain significantly higher on fixed rate mortgages and with tighter regulatory requirements (ie, higher capital and liquidity buffers held against mortgages) driving the repricing, we expect the trend to continue and drive net interest income higher. Given that Swedbank holds a 26% share of the SEK 2.1trn Swedish household mortgage market, the company is highly geared to any uplift in mortgage margins resulting from a secular shift in pricing. On our numbers, a 10bp margin uplift will add 3% to Swedbank’s NII.

In addition, company management has put in place plans to reduce costs (primarily headcount driven in Sweden and the Baltics) by SEK 1bn in 2012 on a cost base of SEK 17.1bn (ex restructuring and compensation), which we believe is achievable and something that should lead to consensus earnings upgrades if targets are met.

Given the company’s strong balance sheet (core tier 1 ratio at Q4 11 under Basel 2.5 was 15.7%), earnings dilution risk is low relative to peers. A 2012E dividend yield of 5.4% on a 50% pay-out policy should offer fundamental support to the shares, as would a buyback programme, which potentially could be resumed in 2013

UBS

From a top-down perspective we want to have investment banking exposure. The post LTRO improvement in banks with capital markets businesses is a theme that could persist. We believe that UBS will sustain a premium to TBV owing to its high ROTE and strong balance sheet.


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Unicredito

Italian banks have recently underperformed the sector owing to a mix of disappointing Q4, sovereign issues resurfacing (especially in Spain) and weaker macro data (both in the EU and US). Political disagreement concerning the reform of the labour market (which we expect will be approved) has also been negative for sentiment on Italy, but this has improved thanks to the new government. After the sell-off, we see large cap Italian banks trading at more reasonable valuations. At a PTBV12E of 0.4x we find Unicredit interesting (Neutral, TP EUR4.6) on restructuring potential (for which visibility is increasing) and exposure to a more stable CEE area. From a top-down perspective we are particularly interested in the valuation, both relative to the market and also relative to Italian peers.

Insurance

Aviva

Aviva’s 2011 FY earnings were better than expected, with IFRS operating profit before tax of GBP 2,503m beating consensus of GBP 2,414m, and operational cash generation (OCG) posting a stronger beat with GBP 2.1bn, compared to consensus of GBP 1.6bn.The main drivers of this are operational jaws, with cash revenues increasing and new business strain and expenses falling.

Aviva increased its dividend by 2% to 26p, below the consensus expectation for a 5% increase. We think this is a sensible step given the stock’s high pay-out ratio and somewhat lower-than-sector average solvency levels. Aviva’s cash cover has risen to its highest level in 2011 of 2x. Aviva’s management was optimistic that it expects dividend growth in future years.

We think that the stock is attractively valued, trading on a 2012E P/E of 6.4x and 2012E P/NAV of 1x.

AXA

AXA remains one of our top pick in the insurance sector. We think AXA has a good platform to deliver earnings growth in the medium term with:

i) An enlarged Asian franchise

ii) Improving P&C underwriting profitability, and

iii) Disciplined management of higher risk savings business, e.g. variable annuities.

Legal and General

Legal & General is our top UK insurance pick. Given the strategic shift towards capital-light products, it has the highest net positive exposure in the sector to the Retail Distribution Review, due to come into effect in January 2013, which will force IFAs to move their focus away from life insurance savings products and towards purer asset management.

The company also has strong solvency levels of 238% vs the sector average of 199% and its high cash cover level (2.6x in 2010) offers considerable scope for dividend growth – we forecast 22% growth in 2012.

It has limited exposure to GIIPS, representing just 6.2% of NAV ex-goodwill.

At a 2012E P/E of just 7.5x vs the UK sector at 10x, we believe the company to be attractively valued.

Swiss Life

For Swiss Life, 2011 was focused on strengthening the balance sheet. The company increased policyholder participation liabilities to CHF 5.2bn, as well as embedded values. Together with the execution of cost cutting and improving profits by sources, we believe this bodes well for future profitability. Moreover, as uncertainty on solvency should get resolved soon, we believe Swiss Life may start increasing its dividend payout.


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Swiss Life shares are trading inexpensively on 0.5x P/EV and 0.4x P/NAV for 2012E despite the stronger balance sheet and more diversified profit generation. We therefore believe that the shares offer an attractive risk return profile, but that investors may want to see further profit improvements and new profitability targets, which we expect will be unveiled in November.

Zurich Financial Services

Zurich reported full-year 2011 results with robust underlying earnings. The underlying combined ratio improved by 2ppts in 2011; price increases achieved and envisaged should help improve this further, and we expect a combined ratio of 96.9% for 2012E. The full consolidation of Santander’s LatAm business should further boost earnings in 2012E. As such, we believe the earnings outlook for Zurich remains promising.

We believe the shares premium valuation is justified given that cash generation remains strong, price increases in non-life are accelerating and the solvency still appears superior in a sector context.

Healthcare

Novartis

We see Novartis bucking the trend of generic erosion given its ability to replace its soon-to-be-generic blockbusters (Diovan and Gleevec) with innovative products such as Gilenya (MS) and Afinitor (Breast Cancer). Addressing genuine unmet medical needs should support the company’s diversified growth while many peers face intense generic competition.

Following a detailed appraisal of recent late-stage clinical data, we argue that the market under-estimates the number of hormone positive breast cancer patients eligible for Novartis’s drug Afinitor and ignores its potential to compete in the Herceptin ‘add-on’ market in HER2-positive disease. We forecast 2015 total Afinitor sales (all indications) of USD 3bn, versus consensus forecasts of USD 1bn.

For Gilenya, we forecast that the new tablet form of medicine will result in peak sales in 2015 of USD 3.5bn, compared with consensus expectations at USD 2bn (based on EvaluatePharma) as we see penetration of Gilenya into the 40% of MS patients currently taking no drug, as well as those switching from existing injectible therapies.

Finally, we believe that the stock valuation is attractive as it trades at 2012E P/E of 9.1x vs the sector at 10.2x, yet offers an 8.1% 2010-15E EPS CAGR vs the sector at 2.7%

Media

Reed Elsevier

The near-term investment case for Reed rests on the delivery of low-single-digit organic growth with modest margin expansion from cost efficiency, in turn driving mid- to high single-digit EPS growth with a dividend yield of approximately 4%. Potential upside could come from:

i) Cyclical recovery

ii) Re-rating on solid execution and owing to disposals of underperforming businesses

Valuation at a 2012E P/E of c.10.5x looks favourable and growth in the core S&T and Risk businesses continues to be better than most areas in professional publishing.


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WPP

Currently, clients spend 17% of total advertising spend on digital and consumers are spending about a third of their time online, including mobile. Given that WPP’s share of digital revenue in 2011 was 30%, with a target to move this to 35-40% within five years, the company is in a strong position to benefit from this structural shift, which is likely to drive margins higher. Digital also provides agencies with the opportunity to capture a larger share of the client wallet as they can provide services beyond pure search and display advertising. As well as this, WPP is well placed to benefit from advertising growth in emerging markets with the business currently having a 15%, 25% and 50% share of the Chinese, Brazilian and Indian markets, respectively.

Technology

SAP

SAP trades at 15.9x CY’12E EPS, above its two-year average, but below its five-year average. We think the valuation is justified given that the company has produced a stable earnings stream historically.

In addition, we think that HANA technology can provide a catalyst for future outperformance. It is a disruptive new technology and expands the market for SAP in several directions, as a database, but also as enabling new technology that makes possible new apps that require real-time performance. We estimate that SAP can get to double-digit licence revenue growth this year entirely from the success of HANA, so this is a key product, and we are at the higher end of Street estimates at EUR 500mn for HANA this year.

Ericsson

The scale of the Q4 earnings miss surprised, but the drivers behind it are well understood, in our view. Moreover, we expect the impact of these drivers to abate in H1 and reverse in H2. We thus believe that we are at or near the gross margin trough for Ericsson. A turnaround in gross margins could, in our view, translate into a strong stock performance in H2 2012 and / or 2013. Turnaround drivers include:

i) US catch-up spend after M&A-induced weak H2 2011 spending

ii) Maturing network modernisation contracts, resulting in higher margin capacity expansion

iii) Declining network roll-out revenues as modernisation peaks

iv) A rising share of software in the revenue of new products It is unclear to us whether Q1 or Q2 are likely to see the bottom in gross margins. Strong US catch-up spending could provide a short-term boost to Q1, resulting in lower gross margins in Q2, postponing visibility into the margin turnaround until the Q4 2012 results are reported. While the timing is uncertain, we remain confident that a turnaround will take place.

Capgemini

From a top-down perspective we want exposure to services aspects of the sector. The company should benefit from increases in corporate capex.


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Telecoms

BT

We see a significant opportunity for BT to take market share in UK broadband – we expect share to rise from 29.5% currently, to 32% in FY 16. In addition to this, UK consumers cite speed as their main concern with regards to broadband and given that BT has significant exposure here, a move towards higher broadband speeds is likely to lead to a pick-up in fibre adoption, which should have a large positive impact on BT’s access division, Openreach. Meanwhile, mobile carriers will increasingly depend on BT for access to Wi-Fi / backhaul infrastructure to manage their capacity demands and thus we see potential for BT to become a meaningful and growing part of the mobile value chain.

Deutsche Telekom

We continue to see DT as a relative Buy in the telecoms sector context:

i) We see DT’s asset mix as superior to peers, with a more stable macro and competitive domestic backdrop.

ii) Contrary to FT or TEF, DT kept its dividend commitment stable at EUR 0.70+0.08 of buy-back, a 9% total yield, which accounts for 55% of FCF or 78% on a fully taxed basis, despite higher US capex.

iii) Valuation is attractive vs the sector at 12.3% and 12.6% in 2012-13, respectively (including the LTE roll-out) despite higher domestic visibility.

Telenor

Telenor offers exposure to robust structural growth in its Asian markets. With regard to Bangladesh and Pakistan, penetration rates are just 35% and 55%, respectively, and Telenor is targeting operating leverage benefits from strong revenue growth. Meanwhile, penetration in Thailand and Malaysia has reached a mature level but healthy performance is likely to continue as a result of strong demand for data over mobile networks. In addition, in its Nordic markets Telenor could be the first to benefit as smartphone penetration reaches the lower-ARPU customer segments, for which smartphone economics are more favourable than for high-ARPU segments. Valuation and yield remain attractive in the sector context and given Telenor’s growth profile.


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Characteristics of our recommended portfolio

Finally, we also provide some analysis of the overall characteristics of our recommended portfolio. The beta of the portfolio is 1.2, which we think is appropriate for our current market view. We also show that it has high positive loading on value and growth factors (Figure 42). We anticipate that the growth loading will decrease somewhat following our reduced exposure to Tech, but will still remain positive through the Resources overweight. We have a large negative loading on momentum and size (ie, the portfolio is overweight small caps). This is appropriate as momentum is an expensive factor that we see at most risk of a near-term downward correction.

Fig. 42: Recommended portfolio factor characteristics

Figure shows the results of a regression of the return of our European recommended portfolio relative to the market on a selection of long-short style factors. Regression is based on daily returns over past year. The factor portfolios are the relative return of top/bottom quartiles screened on the respective factors with a quarterly rebalancing. Growth is a blend of expected growth and internal growth (ROE*(1-payout ratio), value is a blend of PE, price/book and dividend yield and momentum is a blend of long term price and earnings momentum. Source: Nomura Quantitative Strategy

Variable Coefficient t-StatisticConstant 0.00 0.35Growth 0.19 6.54Momentum -0.11 -3.21Size -0.11 -3.32Value 0.12 3.49

Adjusted R-squared 0.51


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Appendix

European recommended portfolio

Price (LC) Mkt Cap

Calendarised EPS y/e

Dec1Price/

earnings DateRel Perf.

since

Rel Perf. Over Analyst

Sector Stock Currency 12 Apr 12 US$m 2011a/e 2012e 2013e Dec 12 (x) Added Added week Rating2

Basic Industries ANTOFAGASTA GBP 11.40 7,171 1.3 1.7 1.9 6.7 13 Apr 12 N/A N/A BuyARKEMA EUR 69.01 5,582 -0.3 5.3 6.8 13.1 14 Oct 11 31 3 BuyBHP BILLITON GBP 19.07 64,235 4.3 4.3 4.3 4.5 2 Dec 11 -7 1 BuyRIO TINTO PLC GBP 34.87 78,865 7.3 8.1 9.1 4.3 11 Dec 09 15 1 BuyTHYSSENKRUPP AG EUR 17.94 9,120 -1.9 0.9 2.2 20.7 14 Oct 11 -23 0 Buy

Capital Goods AMEC PLC GBP 10.97 5,802 0.6 0.7 0.9 14.7 3 Dec 10 5 -2 BuySIEMENS AG EUR 73.01 87,935 7.7 7.3 7.9 10.1 14 Oct 11 -7 0 Not RatedTHALES SA EUR 27.00 3,530 2.5 3.0 3.4 9.1 8 Oct 10 -2 1 Not Rated

Consumer Cyclicals DAIMLER AG EUR 41.77 58,408 5.5 5.2 6.0 8.0 2 Dec 11 22 -2 Not RatedDEUTSCHE LUFTHANSA EUR 10.23 3,085 0.3 0.1 0.8 195.2 9 Sep 11 -19 1 BuyDEUTSCHE POST EUR 14.37 17,087 1.0 1.4 1.3 10.5 9 Sep 11 32 2 Buy

Energy ENI EUR 16.47 58,952 1.9 2.0 2.1 8.1 21 Oct 11 -6 -4 BuyOMV AG EUR 25.22 5,436 3.4 5.1 5.3 4.9 21 Oct 11 -10 0 BuyROYAL DUTCH SHELL GBP 21.74 93,175 4.6 4.4 4.5 5.0 13 Apr 12 N/A N/A BuySAIPEM EUR 37.57 16,148 2.1 2.5 3.0 14.8 2 Dec 11 6 -2 Buy

Financials - Banks BARCLAYS PLC GBP 2.23 43,418 0.2 0.4 0.5 5.1 4 Nov 11 21 2 NeutralBNP PARIBAS EUR 32.08 44,050 8.0 9.0 9.8 3.6 16 Apr 10 -40 -2 BuyHSBC HOLDINGS PLC GBP 5.48 155,758 0.9 1.0 1.2 5.3 4 Nov 11 0 -1 BuySWEDBANK AB SEK 100.30 14,349 12.2 10.9 11.4 9.2 4 Nov 11 10 0 BuyUBS AG CHF 11.80 49,549 2.0 2.5 2.7 4.7 17 Sep 10 -30 -2 BuyUNICREDITO ITALIANO EUR 3.23 18,515 0.2 0.2 0.3 13.2 16 Apr 10 -79 -2 Neutral

Financials - InsuranceAVIVA PLC GBP 3.13 14,524 0.5 0.6 0.6 5.7 31 Jul 09 -11 -1 BuyAXA EUR 11.27 34,433 1.4 1.9 2.1 6.0 9 Jan 09 -54 -3 BuyLEGAL & GENERAL GROUP PLC GBP 1.25 11,688 0.1 0.1 0.2 8.8 11 Dec 09 84 -2 BuySWISS LIFE CHF 102.00 3,586 21.5 20.6 22.6 5.0 13 Jan 12 13 -3 BuyZURICH FINANCIAL SERVICES A CHF 219.50 35,470 25.8 27.2 26.5 8.1 11 Dec 09 42 0 Buy

Healthcare MERCK KGAA EUR 82.23 6,998 3.0 4.0 4.5 20.7 4 Sep 09 18 -1 BuyNOBEL BIOCARE HLDG CHF 10.66 1,452 0.4 0.5 0.6 22.0 3 Dec 10 -29 -2 BuyNOVARTIS AG CHF 50.00 136,089 3.8 4.8 5.0 10.4 9 Jan 09 -1 0 Buy

Media REED ELSEVIER GBP 5.39 10,446 0.5 0.5 0.5 10.9 4 Sep 09 21 0 BuyWPP PLC GBP 8.60 17,256 0.7 0.7 0.8 11.6 3 Dec 10 22 2 Buy

Technology CAPGEMINI SA EUR 31.54 6,435 3.2 2.5 2.8 12.7 22 Jul 11 -15 0 Not RatedERICSSON SEK 66.50 29,684 3.8 2.3 5.0 28.7 13 Apr 12 N/A N/A BuyILIAD S.A. EUR 100.05 2,885 5.2 1.8 2.6 55.6 23 Oct 09 21 0 BuySAP AG EUR 50.67 61,370 2.8 3.1 3.5 16.4 23 Oct 09 39 0 Buy

Telecoms BT GROUP GBP 2.20 27,078 0.2 0.2 0.2 10.2 13 Apr 12 N/A N/A BuyDEUTSCHE TELECOM EUR 8.73 37,620 0.8 0.7 0.8 12.3 4 Sep 09 -11 0 BuyTELENOR ASA NOK 103.60 14,886 4.9 8.1 9.3 12.9 8 May 09 134 0 Buy

Portfolio perf. (Euro Return, %)4 1 WK 1 MTH YTD 12 MTH 2011 2010 2009 2008 5 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995Nomura Strategy Recommend Portfolio -0.9 -2.8 10.4 -9.5 -16.6 5.3 49.4 -20.7 -4.5 20.9 21.7 7.7 22.5 -34.0 -21.2 14.7 67.4 26.4 43.2 35.7 17.8FTSE-World Europe Index -0.7 -2.6 6.1 -4.1 -8.5 11.7 33.2 -20.4 3.6 17.2 23.0 9.4 12.6 -31.7 -17.3 -2.9 25.4 18.6 40.5 24.7 11.2

Please note that the trade ideas within this report in no way relate to the fundamental ratings applied to European stocks by Lehman Brothers equity research.

1 EPS Estimates are based on Nomura Estimates (for stocks under coverage), IBES (for stocks not currently under coverage)

4 Return history presented as price return in Euro Terms from before 2006. Returns from 2007 to present are on a Total Return basis.

Please turn to the back cover for an explanation of Nomura's rating system.

Past performance is not a guarantee of future results.

2 Analyst rating refers to Nomura research department rating3 Sector rating refers to Nomura research sub sector department rating

5 Ending 12th September 2008

Changes in European recommended portfolio

Stock Rating Price CurrencyAdded

Antofagasta PLC Buy 11.4 GBPRoyal Dutch Shell Buy 21.85 GBPEricsson Buy 66.5 SEKBT Group PLC Buy 2.19 GBP

RemovedCRH PLC Not Rated 15.29 EURBG group PLC Buy 14.07 GBPRepsol Buy 17.47 EURMeggitt PLC Not Rated 4.07 GBPSTMicroelectronics Buy 5.49 EUR


38

European index targets

Benchmark Recommended Weighting Recommendation

Basic Industries 11 16 OverweightCapital Goods 8 8 NeutralConsumer Cyclicals* 10 9 NeutralConsumer Staples 14 0 UnderweightEnergy 12 15 OverweightFinancials 19 29 Overweightof which: Banks 12 18 Overweight

Insurance 6 11 OverweightOther 2 0 Underweight

Healthcare 11 5 UnderweightMedia 2 6 OverweightTechnology 3 7 OverweightTelecoms 6 4 UnderweightUtilities 5 2 Underweight


*Combination of Cyclical Consumer Goods and Cyclical Services excluding Media.

European recommended sector allocation

Pan-European equity market forecasts for 2012

End 2012Current Level* End 2012 Price Return (%)

FTSE Europe** 145 165 14FTSE Europe ex UK** 129 147 14EURO STOXX 50 2352 2700 15FTSE 100 (UK) 5710 6550 15Dax 30 6743 7800 16CAC 40 3270 3700 13SMI 6125 6800 11AEX 311 350 13IBEX 7520 8650 15OMX 1050 1160 10MIB 14870 17250 16

* As of 12-Apr-2012

+Euro terms


** We use the FTSE All Wolrd Developed indices for Europe and Europe ex UK, in local currency terms

European earnings* growth forecasts

Projected Nomura Consensus2011 outcome 2012 2012

Europe ex UK 8.7% 3.5% 6.7%

UK 9.5% 3.1% 1.5%

Europe -3.5% 3.4% 5.0%

* EPS growth

Source: FTSE, Nomura Strategy research


39

Investible themes

Source: Bloomberg

For details of the investible products based on these themes and how to trade them please contact the Quantitative Solutions Group on +44 (0) 20 7103 9988 or [email protected]. Our investible themes and style portfolios are listed on Bloomberg at NMRA<Go>. Bloomberg codes are listed, w here applicable, w ith each theme below .

Our investible themes and style portfolios are listed on Bloomberg at NMRA<Go>. We show live tradable prices for these themes. Option 1 show s the long/short return of our key style portfolios, option 2 show s the returns of the top and bottom quartiles of the full range of styles and allow s access to the constituents.

Investible themes are available under option 3 as show n below .


40

-

-

-

Source: FTSE World, Worldscope, IDC/Exshare, Nomura Strategy research

-

-


-

-

-


Divestiture Basket

Within overall M&A activity we think divestitures deserve special attention. We believe we could see divestitures and spin-offs increase during the rest of the year as companies seek to increase value for their shareholders.

The basket consists of 19 European stocks that Nomura sector analysts consider potential candidates for spin-offs and divestitures.

See European Strategy Weekly, Unlocking the value in divestitures, 10 April 2011.

Chart shows the performance of a basket of European stocks that are considered potential candidates for spin-offs and divestitures. The performance is shown on an equal-weighted USD total return basis relative to market.

Chart shows the performance of a basket of European stocks that we consider could be potential takeover targets based on a screening that takes into account valuation and the attractiveness of the companies as a strategic asset for potential buyers. The performance of the basket is shown relative to the FTSE ALL World Europe Index. The performance is shown on an equal-weighted USD total return basis.

M&A Basket II

Unlike previous cycles M&A activity has not played a major role in the post-2009 market recovery. Howerever, we think this is likely to change during 2012 and beyond.

We identify companies that we think are potential targets to be bid for. For more details of the basket please see Strategy Weekly, "Bids please", 26 February 2012.

Organic Growth Basket II

Chart shows the performance of a basket of European stocks that we consider could be potential takeover targets based on a screening that takes into account valuation and the attractiveness of the companies as a strategic asset for potential buyers. The performance of the basket is shown relative to the FTSE ALL World Europe (ex financials) Index. The performance is shown on an equal-weighted USD total return basis.

We expect the market to reward companies that can invest in profitable internal growth opportunities.

We have refreshed the constituents of our original Organic Growth basket, which we closed on 9 June 2011.

To derive the basket, we look for European companies with ROCE > 10%, where capex / depreciation (2010) ratio is greater than 1.5 and where capex is expected to grow in the next few years. We also looked for expected EPS growth in the next 3 years in excess of 10% pa, giving a total of 51 constituents.

68

72

76

80

84

88

92

96

100

104

Jan-10May-10Sep-10 Jan-11May-11Sep-11 Jan-12

Index

85.0

87.0

89.0

91.0

93.0

95.0

97.0

99.0

101.0

103.0

Dec-10 Apr-11 Aug-11 Dec-11

Index

97.0

99.0

101.0

103.0

105.0

107.0

109.0

111.0

113.0

115.0

Dec-10Feb-11Apr-11Jun-11Aug-11Oct-11Dec-11Feb-12

Index


41

-

-

-

-


-

-

-


Trade On Trade Off Return

Emerging Market Exposed Basket NMRAEQEM 20/02/2009 31/07/2009 27.60% Return relative to FTSE World European index in USD

Government Spending basket NMRAFISC 23/01/2009 15/01/2010 37.80% Return relative to FTSE World European index in USD

Organic Growth Basket I 06/12/2010 09/06/2011 -0.30% Return relative to FTSE World European ex Financials index in USD

European Q-GAARP Basket 08/01/2010 03/12/2010 -5.33% Long/Short

Capital Structure Arbitrage Basket 09/10/2009 03/12/2010 -6.24%

Dividend Theme Basket 19/02/2010 03/12/2010 -6.63% Return relative to FTSE World European index in USD

European M&A Basket 28/01/2011 24/02/2012 7.60% Return relative to FTSE World European index in USD

Closed trades

European Multifactor Model

Chart shows the relative performance of attractive relative to unattractive styles according to our style selector model with styles rebalanced each month.

A quant-driven model that selects attractive and unattractive stocks each quarter.

Uses a broad range of factors with regressions used to assign coefficients to factors based on the efficacy of factors in each sector.

Incorporates a non-linear interaction term that captures the level of agreement between value and momentum.

European Style Selector

Chart shows the performance of our long-short European multifactor stock selection model. The performance is on a USD total return basis with a 5-day implementation lag at each quarter end. Sectors are equally weighted and stocks equally weighted within sectors. The portfolios have been rebalanced quarterly.

A quant-driven model that selects attractive and unattractive styles each quarter.

Uses the valuation of style factors and the recent momentum of style factors to rank styles each month.

See European Multifactor Model , 3 November 2008.

See European Style Selector , 5 June 2009.

92.0

94.0

96.0

98.0

100.0

102.0

104.0

106.0

108.0

Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

Index

95

100

105

110

115

120

125

Dec-07 Dec-08 Dec-09 Dec-10 Dec-11

Index


42

European valuation and profitability

12 month Forward PE1

Current Values Post 1990 Average

UK Europe EEMEA UK Europe EEMEA5

Basic Industries 11.6 8.1 9.9 8.9 Basic Industries 12.8 11.9 12.4 11.5

Capital Goods 11.3 10.7 11.2 10.0 Capital Goods 15.6 11.6 14.3 7.4

Consumer Cyclicals 11.3 13.6 11.8 11.3 Consumer Cyclicals 15.3 12.6 13.9 9.6

Consumer Staples 15.1 13.4 14.3 17.0 Consumer Staples 16.9 12.8 14.7 12.3

Energy 8.4 8.0 8.2 4.9 Energy 13.7 14.2 13.9 7.6Financials2

7.5 9.2 8.0 8.9 Financials212.9 12.2 12.6 10.0

of which: Banks 7.4 8.9 7.9 8.5 of which: Banks 11.6 11.4 11.4 9.8

Insurance 6.9 8.7 7.3 10.7 Insurance 16.2 15.0 15.5 10.4

Healthcare 12.2 9.9 11.5 8.8 Healthcare 18.0 17.0 17.6 17.0

Technology 14.8 17.6 15.1 15.7 Technology 21.4 18.6 20.6 13.2

Media 9.7 11.6 10.5 19.6 Media 17.8 18.6 18.0 34.9

Telecoms 9.1 10.0 9.4 9.8 Telecoms 19.5 15.9 16.8 13.7

Utilities 9.4 12.1 10.1 8.9 Utilities 14.4 10.2 11.8 12.5

Market 10.3 9.8 10.1 7.8 Market 14.2 12.6 13.5 9.5

Enterprise Value / Sales








NA NA NA NA Financials2NA NA NA NA

of which: Banks NA NA NA NA of which: Banks NA NA NA NA

Insurance NA NA NA NA Insurance NA NA NA NA



Media 1.4 1.6 1.5 4.7 Media 1.7 2.2 1.9 2.5



Market ex Financials 1.2 1.1 1.1 1.2 Market ex Financials 1.1 1.4 1.2 1.5

Enterprise Value / EBITDA








NA NA NA NA Financials2NA NA NA NA

of which: Banks NA NA NA NA of which: Banks NA NA NA NA

Insurance NA NA NA NA Insurance NA NA NA NA



Media 5.7 7.7 6.3 22.1 Media 8.0 10.6 8.9 1.1



Market ex Financials 6.4 6.1 6.3 5.2 Market ex Financials 6.8 7.7 7.1 6.21 Ratios reflect earnings before goodwill amortisation2 Financials excluding Real Estate5 Post 2000 average for EEM EA region

Source: FTSE, Worldscope, IBES, Nomura Strategy research

Eur ex UK

Eur ex UK

Eur ex UK

Eur ex UK

Eur ex UK

Eur ex UK


43

Return on Capital Employed4 (ROE4 Financials)Current Values Post 1990 Average






Energy 11.3 15.0 13.3 13.2 Energy 12.6 12.4 12.5 17.9

Financials1,26.7 9.0 7.3 16.2 Financials1,2

9.7 11.8 10.1 16.2

of which: Banks25.8 8.9 6.7 16.8 of which: Banks2

9.3 14.4 10.3 17.9

Insurance29.3 10.9 9.6 15.6 Insurance2

11.4 11.5 11.4 15.1



Media 13.4 14.7 14.2 14.3 Media 12.2 16.0 13.8 12.2




Enterprise Value / Capital Employed (P/BV Financials)







Energy 1.1 1.2 1.1 0.8 Energy 1.6 1.9 1.7 1.4

Financials1,30.6 0.9 0.7 1.5 Financials1,3

1.8 1.7 1.7 2.1


1.6 2.0 1.7 2.3


2.7 1.9 2.4 1.8



Media 1.2 1.5 1.3 2.6 Media 2.1 2.8 2.3 2.0




1 Financials excluding Real Estate

2 Return on equity used for Financials.

3 Price to book value used for Financials.

4 RO E and RoCE calculated pre goodwill and pre exceptionals.

5 Post 2000 average for EEM EA region

Source: FTSE, Worldscope, IBES, Nomura Strategy research

Eur ex UK

Eur ex UK

Eur ex UK

Eur ex UK


44


45

Appendix A-1

Analyst Certification

We, Inigo Fraser-Jenkins and Shanthi Nair, hereby certify (1) that the views expressed in this Research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of our compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.


46

Important Disclosures Online availability of research and conflict-of-interest disclosures Nomura research is available on www.nomuranow.com, Bloomberg, Capital IQ, Factset, MarkitHub, Reuters and ThomsonOne. Important disclosures may be read at http://go.nomuranow.com/research/globalresearchportal/pages/disclosures/disclosures.aspx or requested from Nomura Securities International, Inc., on 1-877-865-5752. If you have any difficulties with the website, please email [email protected] for help. The analysts responsible for preparing this report have received compensation based upon various factors including the firm's total revenues, a portion of which is generated by Investment Banking activities. Unless otherwise noted, the non-US analysts listed at the front of this report are not registered/qualified as research analysts under FINRA/NYSE rules, may not be associated persons of NSI, and may not be subject to FINRA Rule 2711 and NYSE Rule 472 restrictions on communications with covered companies, public appearances, and trading securities held by a research analyst account. Any authors named in this report are research analysts unless otherwise indicated. Industry Specialists identified in some Nomura International plc research reports are employees within the Firm who are responsible for the sales and trading effort in the sector for which they have coverage. Industry Specialists do not contribute in any manner to the content of research reports in which their names appear. Marketing Analysts identified in some Nomura research reports are research analysts employed by Nomura International plc who are primarily responsible for marketing Nomura’s Equity Research product in the sector for which they have coverage. Marketing Analysts may also contribute to research reports in which their names appear and publish research on their sector. Distribution of ratings (US) The distribution of all ratings published by Nomura US Equity Research is as follows: 39% have been assigned a Buy rating which, for purposes of mandatory disclosures, are classified as a Buy rating; 0% of companies with this rating are investment banking clients of the Nomura Group*. 54% have been assigned a Neutral rating which, for purposes of mandatory disclosures, is classified as a Hold rating; 0% of companies with this rating are investment banking clients of the Nomura Group*. 7% have been assigned a Reduce rating which, for purposes of mandatory disclosures, are classified as a Sell rating; 0% of companies with this rating are investment banking clients of the Nomura Group*. As at 31 March 2012. *The Nomura Group as defined in the Disclaimer section at the end of this report. Distribution of ratings (Global) The distribution of all ratings published by Nomura Global Equity Research is as follows: 46% have been assigned a Buy rating which, for purposes of mandatory disclosures, are classified as a Buy rating; 40% of companies with this rating are investment banking clients of the Nomura Group*. 43% have been assigned a Neutral rating which, for purposes of mandatory disclosures, is classified as a Hold rating; 45% of companies with this rating are investment banking clients of the Nomura Group*. 11% have been assigned a Reduce rating which, for purposes of mandatory disclosures, are classified as a Sell rating; 21% of companies with this rating are investment banking clients of the Nomura Group*. As at 31 March 2012. *The Nomura Group as defined in the Disclaimer section at the end of this report. Explanation of Nomura's equity research rating system in Europe, Middle East and Africa, US and Latin America The rating system is a relative system indicating expected performance against a specific benchmark identified for each individual stock. Analysts may also indicate absolute upside to target price defined as (fair value - current price)/current price, subject to limited management discretion. In most cases, the fair value will equal the analyst's assessment of the current intrinsic fair value of the stock using an appropriate valuation methodology such as discounted cash flow or multiple analysis, etc. STOCKS A rating of 'Buy', indicates that the analyst expects the stock to outperform the Benchmark over the next 12 months. A rating of 'Neutral', indicates that the analyst expects the stock to perform in line with the Benchmark over the next 12 months. A rating of 'Reduce', indicates that the analyst expects the stock to underperform the Benchmark over the next 12 months. A rating of 'Suspended', indicates that the rating, target price and estimates have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstances including, but not limited to, when Nomura is acting in an advisory capacity in a merger or strategic transaction involving the company. Benchmarks are as follows: United States/Europe: Please see valuation methodologies for explanations of relevant benchmarks for stocks (accessible through the left hand side of the Nomura Disclosure web page: http://go.nomuranow.com/research/globalresearchportal);Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia, unless otherwise stated in the valuation methodology. SECTORS A 'Bullish' stance, indicates that the analyst expects the sector to outperform the Benchmark during the next 12 months. A 'Neutral' stance, indicates that the analyst expects the sector to perform in line with the Benchmark during the next 12 months. A 'Bearish' stance, indicates that the analyst expects the sector to underperform the Benchmark during the next 12 months. Benchmarks are as follows: United States: S&P 500; Europe: Dow Jones STOXX 600; Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia. Explanation of Nomura's equity research rating system in Japan and Asia ex-Japan STOCKS Stock recommendations are based on absolute valuation upside (downside), which is defined as (Target Price - Current Price) / Current Price, subject to limited management discretion. In most cases, the Target Price will equal the analyst's 12-month intrinsic valuation of the stock, based on an appropriate valuation methodology such as discounted cash flow, multiple analysis, etc. A 'Buy' recommendation indicates that potential upside is 15% or more. A 'Neutral' recommendation indicates that potential upside is less than 15% or downside is less than 5%. A 'Reduce' recommendation indicates that potential downside is 5% or more. A rating of 'Suspended' indicates that the rating and target price have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstances including when Nomura is acting in an advisory capacity in a merger or strategic transaction involving the subject company.

http://www.nomuranow.com/�

http://go.nomuranow.com/research/globalresearchportal/pages/disclosures/disclosures.aspx�

http://go.nomuranow.com/research/globalresearchportal�


47

Securities and/or companies that are labelled as 'Not rated' or shown as 'No rating' are not in regular research coverage of the Nomura entity identified in the top banner. Investors should not expect continuing or additional information from Nomura relating to such securities and/or companies. SECTORS A 'Bullish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a positive absolute recommendation. A 'Neutral' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a neutral absolute recommendation. A 'Bearish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a negative absolute recommendation. Target Price A Target Price, if discussed, reflect in part the analyst's estimates for the company's earnings. The achievement of any target price may be impeded by general market and macroeconomic trends, and by other risks related to the company or the market, and may not occur if the company's earnings differ from estimates.


48

Disclaimers This document contains material that has been prepared by the Nomura entity identified at the top or bottom of page 1 herein, if any, and/or, with the sole or joint contributions of one or more Nomura entities whose employees and their respective affiliations are specified on page 1 herein or identified elsewhere in the document. Affiliates and subsidiaries of Nomura Holdings, Inc. (collectively, the 'Nomura Group'), include: Nomura Securities Co., Ltd. ('NSC') Tokyo, Japan; Nomura International plc ('NIplc'), UK; Nomura Securities International, Inc. ('NSI'), New York, US; Nomura International (Hong Kong) Ltd. (‘NIHK’), Hong Kong; Nomura Financial Investment (Korea) Co., Ltd. (‘NFIK’), Korea (Information on Nomura analysts registered with the Korea Financial Investment Association ('KOFIA') can be found on the KOFIA Intranet at http://dis.kofia.or.kr ); Nomura Singapore Ltd. 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