socgenchinaconstruction
TRANSCRIPT
Macro Commodities Forex Rates Equity Credit Derivatives
23 June 2011
Equity
Sector Review
www.sgresearch.com
Capital Goods Chinese construction bubble – Preparing for a potential burst
Overweight Construction in China - boom or bubble? The exponential growth of real estate and
infrastructure spending in China over the past decade has raised concerns over the
emergence of a construction bubble that could burst any time soon. Various data indicate
that China has ‚over built‛ over the past decade; China is consuming 1,400kg of cement per
head per annum, more than 4x higher than the world average and above the level consumed
by Spain ahead of its housing crisis. China is building almost 2 billion sqm of new housing
per annum, enough to accommodate 60 million people while around 20 million are migrating
to the cities every year. In terms of roads and railways, we found that China is also ahead of
its development curve. While we acknowledge the long-term prospects offered by the
Chinese economy and its urbanisation, we believe the current pace of construction activity is
unsustainable and a painful adjustment will come sooner or later. The recent weakness in
Chinese construction equipment data could be a first warning signal that the Chinese
construction growth story might not go on forever. Such concerns have been partly reflected
in the weakness of Chinese construction machinery stocks (-16%) and commodities (-13%
for main base metals on average) since early April.
Biggest near-term risk for capital goods lies in mining European capgoods companies have
a limited direct exposure to the Chinese construction market. The stocks with the strongest
exposure are Assa Abloy (9% of group sales), Volvo (8%) and Schneider (4%). The biggest
risk relates to the mining industry, in our view. Any construction downturn in China would
have severe consequences on commodity demand and prices, leading to lower capex plans
from miners. Stocks with the highest exposure to the mining industry are Sandvik (36% of
group sales) and Atlas Copco (26%). We now believe mining capex could peak at a record
high level in 2011 with latest consensus forecasts for the top five miners suggesting a decline
in capex post-2011.
Key recommendation Trading at a premium to the sector despite significant exposure to the
Chinese construction risk, Atlas Copco (rating lowered from Buy to Hold) and Sandvik (rating
lowered from Hold to Sell), now have unappealing risk/reward profiles. Although declining
construction equipment sales in China could hurt sentiment, we maintain our Hold rating on
Volvo but lower our TP to SEK110. Schneider would not be immune to a collapse in the
Chinese construction market; however, the shares remain good value with significant
exposure to the energy efficiency and industrial productivity themes.
Stock selection
Preferred
Siemens
Least preferred
Sandvik
Key recommendations
Price TP Reco P/E EV/EBIT Div. yield Comments
21/06 12m 12e (x) 12e (x) 11e
Atlas Copco 161 150 Hold 14.0 10.0 3.2 Sizeable exposure to mining capex and to China
Sandvik 108 90 Sell 12.4 9.5 3.9 Sizeable exposure to mining capex and highly sensitive to volume
Schneider 113 140 Buy 11.4 8.4 3.5 Exposed to Chinese construction but appealing play on energy efficiency
Volvo 106 110 Hold 9.1 6.5 3.3 Exposed to Chinese construction equipment but low valuation
Sébastien Gruter
Gaël de Bray, CFA
Adrien de Susanne
Colin Campbell
(33) 1 42 13 47 22 (33) 1 42 13 84 14 (33) 1 42 13 01 61 (44) 20 7762 5609
[email protected] [email protected] adrien.de [email protected] [email protected]
Societe Generale (‚SG‛) does and seeks to do business with companies covered in its research reports. As a result, investors should be
aware that SG may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a
single factor in making their investment decision. PLEASE SEE APPENDIX AT THE END OF THIS REPORT FOR THE ANALYST(S)
CERTIFICATION(S), IMPORTANT DISCLOSURES AND DISCLAIMERS AND THE STATUS OF NON-US RESEARCH ANALYSTS.
Capital Goods
23 June 2011 2
Contents
3 Sector – leading indicators
4 Investment summary
6 Key recommendations
8 Construction in China is running ahead of its development curve
8 China - A construction-led economy
10 Chinese construction bubble – Myth or reality?
12 Real estate – Long-term demand is there but how to sustain current development rates?
14 Infrastructure – Is there anything left to be built?
16 Cement consumption highlights significant ‚over construction‛
18 Early signs of weakness in China
18 Some weakness has emerged in construction equipment data
19 Share price performance reflects growing concerns
20 Sell-off in commodity indices
21 Monetary tightening and weak PMI data but IP and FAI remain strong
23 Focus on the Chinese construction equipment industry
23 The Chinese construction and mining equipment market
24 Overview of the main Chinese players
26 Moving up the value chain – The excavator example
27 Looking abroad for development as volume could stall in China
29 Who is exposed and to what extent?
29 Mining exposure is the biggest threat
30 China - Key driver of sales growth over the past few years
31 Chinese competition likely to intensify outside China
32 Forecasts edged down to reflect the increased uncertainty
Company profiles
34 Assa Abloy
36 Atlas Copco
38 Sandvik
40 Schneider
42 Volvo
44 Legrand
Capital Goods
23 June 2011 3
Sector – leading indicators
China PMI is weakening China FAI and IP growth (yoy, %)
40
42
44
46
48
50
52
54
56
58
60
Ma
y-0
5
Au
g-0
5
No
v-0
5
Fe
b-0
6
Ma
y-0
6
Au
g-0
6
No
v-0
6
Fe
b-0
7
Ma
y-0
7
Au
g-0
7
No
v-0
7
Fe
b-0
8
Ma
y-0
8
Au
g-0
8
No
v-0
8
Fe
b-0
9
Ma
y-0
9
Au
g-0
9
No
v-0
9
Fe
b-1
0
Ma
y-1
0
Au
g-1
0
No
v-1
0
Fe
b-1
1
Ma
y-1
1
Chinese PMI
is on a
downward
trend albeit
remaining
above the
critical mark
(50). May data
was slightly
better than
expected
0
5
10
15
20
25
30
35
40
Ma
y-0
6
Au
g-0
6
No
v-0
6
Fe
b-0
7
Ma
y-0
7
Au
g-0
7
No
v-0
7
Fe
b-0
8
Ma
y-0
8
Au
g-0
8
No
v-0
8
Fe
b-0
9
Ma
y-0
9
Au
g-0
9
No
v-0
9
Fe
b-1
0
Ma
y-1
0
Au
g-1
0
No
v-1
0
Fe
b-1
1
Ma
y-1
1
FAI yoy growth IP yoy growth
Despite
weakening PMI
data, Chinese
fixed asset
investment and
industrial
production
growth kept
surprising on the
upside over past
three months
Source: Datastream Source: National Bureau of Statistics
Chinese real estate growth (yoy, %) Excavator deliveries in China
10%
15%
20%
25%
30%
35%
40%
2003 2004 2005 2006 2007 2008 2009 2010 Q1 11
Growth in
Chinese real
estate has
averaged 25%
from 2003 to
2010.
-
4,000
8,000
12,000
16,000
20,000
24,000
28,000
32,000
36,000
40,000
44,000 A
pr-
01
Oc
t-0
1
Ap
r-0
2
Oc
t-0
2
Ap
r-0
3
Oc
t-0
3
Ap
r-0
4
Oc
t-0
4
Ap
r-0
5
Oc
t-0
5
Ap
r-0
6
Oc
t-0
6
Ap
r-0
7
Oc
t-0
7
Ap
r-0
8
Oc
t-0
8
Ap
r-0
9
Oc
t-0
9
Ap
r-1
0
Oc
t-1
0
Ap
r-1
1
Following a
surge in
excavator
deliveries over
the past three
years, weaker
data are
emerging (-12%
yoy in May)
Source: National Bureau of Statistics Source: CCMA
Chinese construction equipment market ($bn) Chinese CE market shares
0
10
20
30
40
50
60
70
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
The Chinese
construction
equipment
market has
grown by 25%
p.a. on average
and has reached
$60bn
according to
CCMA.
Caterpillar9% Volvo
7% Komatsu5%
Hitachi4%
Kobelco1%
Hunan Sunward
1%Liugong
5%
Lonking4%Sany Heavy
11%Shantui4%
XCMG8%
Zoomlion11%
XGMA3%
Other Chinese
18%
Others9%
The Chinese
construction
equipment
market is
dominated by
domestic
players and their
control of the
market has
tended to
increase.
Source: CCMA Source: SG Cross Asset Research
Exposure to China (2010 revenues) China - Contribution to group’s growth 04-10
0%
2%
4%
6%
8%
10%
12%
14%
16%
AB
B
SK
F
Sc
hn
eid
er
Atl
as
Vo
lvo
As
sa
Ab
loy
Sie
me
ns
Sa
nd
vik
Ph
ilip
s
Als
tom
Le
gra
nd
ABB, SKF,
Schneider and
Atlas Copco
derive more
than 10% of
their revenues
from China
0%
10%
20%
30%
40%
50%
60%
Vo
lvo
CE
Sc
hn
eid
er
SK
F
As
sa
Ab
loy
Atl
as
Sa
nd
vik
AB
B
Sie
me
ns
China has been
a key driver of
organic sales
growth for
European
capgoods
companies.
Source: SG Cross Asset Research, Company Data Source: SG Cross Asset Research, Company Data
Capital Goods
23 June 2011 4
Investment summary
Despite tightening measures, weakening PMI and much weaker construction equipment data
over the past couple of months, growth in industrial production and fixed asset investment in
China remained very healthy in May. In this unclear environment, we revisit the debate on the
outlook for the Chinese construction industry in this report and assess the likely
consequences that the bursting of a Chinese construction bubble would have on the
European capital goods industry.
Chinese construction is ahead of its development curve
Various data, such as cement consumption and the number of sqm built within a year,
indicate that China is running ahead of its development curve.
In 2010, China’s cement consumption exceeded 1,800mt, representing around 55% of
global consumption and about 25x more than US consumption. With average consumption of
1,400kg per head, China stands well above the world average ex-China of 300kg. History
shows that such high consumption is hard to sustain for a number of years and ultimately
leads to a construction crisis sooner or later.
With around 1.8bn square metres of new residential floor space completed in 2010, China
has built the equivalent of Spain’s housing floor space stock. This construction has already
provided accommodation for 60 million people while the urban population has only increased
by c. 20 million. If China were to keep its current construction rate over the next five years, the
9bn sqm new housing area built would provide accommodation for 300 million more people
by 2015. China would thus have the available floor space stock to accommodate an
urbanisation rate of 65-70%...IMF’s forecast for 2030!
Early signs of weakness in China
According to the China Construction Machinery Association, the excavator sales volume of
China's main construction machinery companies in May 2011 stood at about 14,000 sets,
down by c. 65% from March 2011. The sales volume of loaders and bulldozers also saw sharp
drops in May, with that of loaders plunging 45% from March, the largest drop since 2001. On
a 12-month rolling forward basis, the situation is not yet alarming but our analysis indicates
that we are likely to see a plateau at best and a sharp correction in a worst case scenario.
But no immediate trigger for a downturn
In our view, Chinese construction needs to slow down to avoid a large construction bubble.
However, as we have seen with the 12th five-year plan (planned building of 36 million units of
affordable housing between 2011 and 2015), the central government is unlikely to promote
such a policy as construction remains the easiest way to achieve its internal GDP growth
targets and reduce the risk of political unrest among its population. We therefore face
difficulties in determining the external trigger point that will lead to a slowdown or correction in
Chinese construction activity.
Chinese construction machinery companies looking overseas
In this report, we also analyse the Chinese construction equipment market and the emergence
of large domestic players which will increasingly be competing with the likes of Caterpillar,
Komatsu or Volvo within the next few years. Chinese companies are looking overseas to offset
a potential slowdown in their domestic market and the likely resulting overcapacity is creating
Capital Goods
23 June 2011 5
heightened competition in the global markets, particularly in other emerging markets. We
expect the largest Chinese manufacturers to become much more aggressive internationally
over the next few years, especially in emerging markets like India or Brazil. For instance, Sany
Heavy is planning to raise $3bn to finance its international expansion through an IPO on the
Hong Kong stock exchange. XCMG is following the same path by planning to raise $1.5-2bn
fresh equity. Fortunately, most of the capital goods companies we cover do not operate in the
construction equipment business (loaders, excavators, bulldozers, etc) where the competitive
risks look highest. But other industries are also likely to see intensifying Chinese competition in
the international markets if China’s economy slows down.
What are the implications for the European capital goods
companies?
The companies in our coverage universe generally have a limited direct exposure to China’s
construction market, the most exposed being Assa Abloy (9% of group sales), Volvo (8%),
Schneider (4%), Atlas Copco (3%) and Legrand (3%). We find that Japanese construction
equipment manufacturers, Hitachi and Komatsu, together with Kone, have more than 10%
exposure.
In our view, the biggest risk for engineering companies relates to their exposure to the mining
industry. A fall in Chinese construction activity would have a severe impact on global cement,
iron ore, coal and copper consumption which would likely lead to sharp reductions in global
mining capex programmes. Within our coverage, Sandvik and Atlas Copco both have a
sizeable exposure to the mining sector, deriving respectively 36% and 26% of their revenues
from this industry.
A fall in commodity prices would also have knock-on effects on the GDP outlook for countries
that derive a sizeable portion of their wealth from natural resources like in South America and
the Middle East/Africa.
A slowdown in the Chinese economy and capex-related industries is likely to create
overcapacity in the domestic market, prompting Chinese players to accelerate their expansion in
the overseas markets. The construction equipment industry is likely to be the hardest hit. Other
industries that are strategic and have a concentrated customer base should also see
increased competition.
In the following table, we rank each company in our universe, based on their exposure to the
areas most at risk in the event of a bursting of a Chinese construction bubble, including: 1) the
Chinese construction market itself, 2) the mining industry, and 3) emerging countries in
general. We also look at their resilience characteristics, including: 1) their cost structure
(variable vs fixed), 2) their aftermarket/service exposure, and 3) their backlog. Overall, we
estimate that companies such as Volvo and Sandvik would offer the highest risk profile in a
‘China construction collapse’ scenario and could be expected to trade at a discount if
uncertainties remain. On the other hand, companies such Legrand, Siemens and Smiths show
the highest resilience scores.
Capital Goods
23 June 2011 6
SG Capital Goods universe
Risk areas Resilience characteristics
Chinese
construction
Mining
industry
Emerging
markets
Cost
structure
Aftermarket/
service
Backlog/
visibility
Ranking
Volvo --- -- -----
Sandvik --- -- -----
Atlas -- --- --- +++ ++ ---
Vallourec --- ---
MAN -- --
Scania -- --
Philips - -- + --
SKF -- + -
ABB --- + + -
Nexans - -
Schneider -- -- ++ ++
Assa Abloy --- +++
GKN
Alstom --- + + ++ +
Invensys - + + +
Legrand - -- + +++ +
Siemens - + ++ ++
Smiths + ++
Source: SG Cross Asset Research
Key recommendations
Atlas Copco (HOLD from BUY, TP cut to SEK150) - Although Atlas has limited direct exposure
to the Chinese construction industry, its indirect exposure through the mining industry is
sizeable. Raising uncertainty around the Chinese construction activity led us to revise our
former optimistic scenario on mining capex and forecast a plateau in 2012 and a slight decline
in 2013. We have cut our forecasts and reduced our target price to SEK150 from SEK200.
Ongoing uncertainty around Chinese growth and weaker newsflow on mining capex are likely
to prevent the shares from expanding their premium any further as we had previously hoped.
We thus lower our rating to Hold.
Sandvik (SELL from HOLD, TP cut to SEK90) – Sandvik has only marginal exposure to the
Chinese construction market albeit the stock has by far the largest exposure to the mining
industry. As such any negative newsflow from China and on mining capex outlook is likely to
weigh on future price performance. In addition, we do not expect new management to
radically change Sandvik and its vertically integrated business profile. Sandvik remains overly
leveraged to volume outlook and therefore, in times of uncertainty, we believe the risk/reward
ratio is skewed to the downside. We have cut our forecasts to reflect more cautious
assumptions for the mining capex cycle and we reduced our target price to SEK90 from
SEK115.
Schneider (BUY, TP of €140) - Schneider derives around 12% of sales from China, of which
around 35% comes from the construction markets. Schneider’s presence in China is broad-
based, including product development, local production and commercial activity, with a vast
and diffuse distribution network. The group offers a complete range of low and medium
voltage products, secure power and industrial automation products in the country. While the
bursting of a construction bubble in China would directly affect around 4% of group sales, we
believe that Schneider’s exposure to the energy efficiency, industrial productivity and smart
grid themes should allow it a structural growth premium versus the sector average.
Capital Goods
23 June 2011 7
Volvo (HOLD, TP cut to SEK110) - Volvo’s direct exposure to the Chinese construction theme
mainly stems from its Construction Equipment (CE) division (21% of group revenues in 2010).
We estimate that, through its Volvo and Lingong brands, the group’s construction equipment
sales in China will reach 8% of revenues this year. Reflecting our forecast downgrade, we
have reduced our target price to SEK110 from SEK125. We maintain our Hold
recommendation on valuation grounds although we believe weakening sentiment on the
Chinese construction equipment industry is likely to keep weighing down the shares.
Legrand (BUY, TP of €35) - Legrand derives just 3% of sales from China. The low voltage
industry is characterised by a local market structure, a recurring and diffuse flow of activity
and the need to establish privileged relationships with numerous distributors and specifiers. In
such an environment, Legrand’s capacity for continuous innovation gives it solid pricing
power (+3% expected in 2011e). In 2010, Legrand also launched new ranges in wiring devices
(K5 and Meidian) and in audio & video door entry systems in China, which should help the
group gain market share in a more difficult environment. Moreover, a weakness in China
should be more than offset by a potential recovery in mature countries, where building market
volumes remain 23% below the pre-crisis level. Another accelerated book building from KKR
and Wendel (combined stake of 21.3%) would likely trigger a re-rating in our view, as the
perception of overhang would vanish and the free float be further enlarged.
Assa Abloy (HOLD, TP SEK170) – Following the acquisition of Panpan, Assa Abloy derives c.
9% of its revenues from the Chinese construction industry. The stock harbours the highest
direct exposure to the Chinese construction market within our coverage universe. Against this,
Assa Abloy still offers some leverage on the long awaited rebound in the US and European
construction markets, which should keep driving the shares going forward. In addition, Assa
Abloy offers a defensive business model investors are likely to appreciate in the event of a
bursting of a Chinese construction bubble. We therefore maintain our Hold rating on the stock
and our SEK170 target price remains unchanged.
Capital Goods
23 June 2011 8
Construction in China is running ahead of its
development curve
The outlook for the Chinese construction industry is dominating the current debates among
investors. Is the Chinese construction boom sustainable or could it burst? We believe that the
exuberance of the Chinese construction market is obvious. Various data, such as cement
consumption and the number of sqm built within a year, indicate that China is running ahead
of its development curve. Thus, Chinese construction needs to slow down to avoid a larger
construction bubble with many underperforming projects. However, as we have seen with the
12th five-year plan, the central government is unlikely to promote such a policy as
construction remains the easiest way to achieve its internal GDP growth targets and to reduce
the risk of political unrest among the population. We thus face difficulties in determining the
external trigger point that will lead to a slowdown or correction in Chinese construction
activity. Tighter monetary policy could be a trigger although so far it has had little effect on
prices or construction volumes.
China - A construction-led economy
China is undoubtedly a capex-led economy. Investments represented 46% of the country’s
GDP in 2009 while private consumption was only 36% of GDP. In comparison, in the US,
investments were 16% of GDP in 2009 and private consumption 71%. A developing country
like India has ratios of 58% consumption / 31% investment. Such reliance on investment is
unprecedented among larger nations and all countries that have experienced a significant
investment boom since WW2 have all gone through a recession sooner or later.
While we understand that this high share of investment is allowing China to catch up with
other developed countries, the length and magnitude of China’s boom gives cause for
concern. The key issue with such an enormous investment boom is the diminishing efficiency
of investments.
Breakdown of GDP by country: investment vs private
consumption
Share of investment in GDP since 1953: China vs Spain, South
Korea and Japan
0
10
20
30
40
50
60
70
80
90
100
China India Korea Russia Japan Euro Area Brazil United States
Gross fixed Household consumption
0
5
10
15
20
25
30
35
40
45
50
1953
1955
1957
1959
1961
1963
1965
1967
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
China Korea Spain Japan
Source: IMF Source: IMF
Capital Goods
23 June 2011 9
Construction – A key component of Chinese GDP growth
In 2010, we estimate China spent more than $1,000bn on construction (including residential
/non residential real estate and infrastructure), representing around 20% of its nominal GDP,
or almost twice the world average as the left-hand chart shows. Construction spending in
China grew at an outstanding rate of 17% per annum over the last 20 years, rising from $50bn
in 1990 to around $1,100bn. The scale of the Chinese construction market outpaced that of
the US last year and became the largest construction market worldwide with around 15%
share.
Construction as % of GDP – China stands well ahead China vs US construction spending (US$bn)
5%
7%
9%
11%
13%
15%
17%
19%
21%
Chin
a
India
Spain
Worl
d
Italy
UK
Fra
nce
Japan
Germ
any
US
0
200
400
600
800
1000
1200
1400
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
China US
Source: SG Cross Asset Research, IMF, Global Insight
A major driving force behind the surge in construction spending in China was the sharp
increase in the country’s urbanisation rate over the past two decades. Between 1990 and
2010, the urban population more than doubled and the urbanisation rate reached 47.5% in
2010 according to the latest data from the Chinese National Bureau of Statistics. Within the
12th five-year plan (2011-2015), the target is to increase this rate to 51.5% by moving c.
80 million people from rural areas to the cities.
Urbanisation - A major driving force behind high construction spending
20%
25%
30%
35%
40%
45%
50%
55%
0
100
200
300
400
500
600
700
800
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
2015 targ
et
Urban population Urbanization rate
Source: SG Cross Asset Research, Global Insight, National Bureau of Statistics
Capital Goods
23 June 2011 10
The new five-year plan should not break the trend but growth may slow
Contrary to initial expectations, the 12th five-year plan released in March did not signal any
major changes for the Chinese construction sector. The concept of the new plan has initially
been to move China away from an export and infrastructure-driven economy to a balanced
consumer demand-driven economy. In the guidance documents released in October 2010
there was a request for a dramatic social welfare reform to create a security network for the
people, increase consumer spending and balance exports with a local consumer-led
economy. The reality of the plan, released in March, does not deviate too much from previous
plans with lots of focus on infrastructure projects, a higher urbanisation rate and housing
building.
However, it appears that targets under the new plan, if achieved, should mean lower growth
rates for fixed asset investment and construction. Growth in fixed asset investment is
expected to slow down from 24.7% p.a., between 2005 and 2010, to 16.2% p.a. between
2011 and 2015. However, it is worth noting that this forecast is based on a targeted GDP
growth rate of just 7% over the same period. A growth rate of c. 20% in fixed asset
investment would therefore be likely if GDP growth were to be above the targeted figure as in
the 11th plan.
Chinese construction bubble – Myth or reality?
Within this section we set the scene by examining the opposing bear and bull arguments on
the Chinese construction bubble; myth or reality?
The Bears – Prices too high and oversupply
Price gains, rapid credit growth, oversupply and multiple property ownership are all cited as
evidence of a housing bubble by the bears. We detail the key arguments below:
Price overheating – The average apartment price to household income stands at 8x at a
national level. A usual level in developed economies is at 3-5x; prior to the financial crisis the
US and Spain were both at 6x. The bears thus believe migrants could no longer afford to live
in cities, urbanisation would stall, prices could fall and as a result real estate construction
spending is likely to shrink. However it is worth noting that this Chinese data is distorted by
large disparity between tier 1, 2 or 3 cities. For instance, Tier 1 cities like Shanghai or Beijing
have ratios of 17x and 22x respectively, while in several tier 3 cities the ratio stands below 3x.
Oversupply, available floor space, ghost cities – It is common to hear stories about ghost
cities in China. Built for 1 million people and currently inhabited by just a few thousand, the
new city of Ordos has been the flagship of the bears. Other examples like the world’s largest
retail mall at the Pearl River Delta with 99% of shops unleased are often cited as evidence of
the over-exuberance of the Chinese construction industry.
Reliability or lack of data called into questions – Bears often stress the low reliability or even
the lack of data supplied by the Chinese government bodies to fully assess the housing
situation in China. For instance, there is no housing vacancy statistics, which leads bears to
say that housing inventory might be too huge to be held publicly.
The bulls– Geographical disparity and low level of mortgage debt
The bulls often state that housing prices are unlikely to collapse, that central government has
still plenty of construction projects in the pipeline and finally that China is unique and making a
comparison with other nations’ history is therefore pointless:
Capital Goods
23 June 2011 11
Housing prices are unlikely to collapse - The bulls believe that housing prices are unlikely to
collapse and as such China should not experience the same situation as the US or Japan. The
dynamics displayed by lenders, borrowers and homeowners in China over the past two years
are very different to those observed in the US and Japan. A crucial starting point is the
recognition that China does not have a homogenous property market. Of the 7.3bn square
metres of floor space completed in China in the past five years, 45% was in commodity
building and 55% was non-commodity building. The importance of this fact is that it is only
the commodity building stock that is tradable and therefore price variable. The remaining 55%
is non-tradable being either state-owned, non-transferrable or simply having no marketable
price. Also, one of the most crucial dynamics in understanding the outlook for Chinese
housing prices is the very low level of mortgage debt held. Despite the dramatic pick-up in
housing market leverage over the past two quarters, the average level of mortgage debt held
at a national level is about 30%. The following table lists the main differences between the
housing situation in China vs the US or Japan pre-housing collapse.
Is China’s housing market as susceptible to correction as in the US or Japan?
China USA Japan
Pockets of excessive valuations in residential
property in certain cities. Underinvestment in
affordable economic housing.
Bubble largely concentrated in housing. Bubble concentrated in both housing and
commercial real estate.
Housing investment emerges as the most profitable
and least volatile asset class.
The belief in ever-increasing prices drove lending. A belief in ever increasing land prices.
The use of banks as fiscal agents saw an explosion
of bank lending in China.
Explosion of low-documentation lending and
greater penetration of the markets by non-bank
lenders.
Greater competition in the loans market saw small-
to medium-sized banks move into traditional
mortgage lending.
Borrowers must have a 30% down-payment for a
first home (40% for a second home) and mortgage
repayments cannot be greater than 50% of income.
No checks on borrowers within the “originate to
distribute” model. Securitisation was seen as
shifting risk.
No check on borrowers because of secure
collateral.
No teaser rates. Teaser rates for first two years created a time
bomb.
“Step interest rate loan” put in place to ease
income constraint.
China used its banks as fiscal agents to implement
policy stimulus. Actual liquidity flows have been
highly variable. The equity market has fallen over
the course of the lending spree whilst house prices
deviated to the upside from existing strong trend
long-run growth.
Monetary policy was held too low for too long after
the Tech-Wreck recession. Long bond yields fell
below fair value given high foreign participation in
UST market.
The Plaza Accord of 1985 saw the BoJ cut the
discount rate five times from 5.0% to 2.5% to help
exporters hit by the stronger yen. Financial excess
was created, which flowed into asset markets.
Source: SG Cross Asset Research
China is unique, comparison with developed countries is pointless – Bulls also highlight that
China is unique and could not be compared to other developed nations and their history. The
size of its population, the disparity between regions and the centralised nature of the
government makes China unique.
Central government has large infrastructure projects in the pipeline – Bulls often stress that
central government will support the construction industry. The affordable housing programme
or the large infrastructure projects already engaged should provide a sufficient floor to prevent
a potential collapse in the construction activity. Within the 12th five year plan, the Chinese
government plans to build 36 million units of affordable housing between 2011 and 2015. The
government’s affordable housing programme envisages 7 million units built per year on
average (ow 10 million in 2011 and 2012). However, the IMF forecasts there will be 380 million
more inhabitants in urban areas by 2030 (70% urbanisation rate). Assuming an average of 3-4
persons per new home, a new urban population of 380 million means 95-125 million new
homes to be built over the next 21 years. This means that China needs to build around 5
Capital Goods
23 June 2011 12
million (or 500m sqm per year) new homes every year to digest its rising urbanisation rate, i.e.
less than the 10 million affordable housing units targeted by the central government in 2011
and 2012.
China also has a lot of infrastructure
projects already under way. If China
were to sharply curtail lending
growth, half-finished projects would
turn into non-performing loans
souring the banking system. If central
government were to continue with a
generous liquidity policy, lending
would be towards increasingly
marginal investment and
infrastructure projects or ‚trophy‛
projects for which the economic
returns would be dubious.
With the vast expansion of China’s rail network already completed, our economists believe the
‚low hanging fruit‛ in terms of fiscally sound projects has already been picked. Still, as the
chart above shows, the skew of projects approved and for which funding has already
commenced is dramatically weighted towards future years. Approximately 65% of the total
fixed asset investment envelope that was approved by China occurs either during or after
2011, not before.
Real estate – Long-term demand is there but how to sustain
current development rates?
Soaring house prices in Chinese cities have driven widespread concerns over the emergence
of a large property bubble that could burst any time. The pace of Chinese real estate
construction is unprecedented, raising questions about the balance between supply and
demand for housing. Real estate investment growth averaged 25% over the past eight years
and growth even increased to 34% in Q1 2011.
Chinese real estate investment yoy growth
10%
15%
20%
25%
30%
35%
40%
2003 2004 2005 2006 2007 2008 2009 2010 Q1 11
Source: National Bureau of Statistics
China still has a lot of infrastructure to complete
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
2008 2009 2010 2011 2012 2013 2014 2015
0
0.05
0.1
0.15
0.2
0.25
Fixed Asset Investment, RMB
tn
65% occurs after 2011
81% occurs after 2010
Probability density
Source: SG Cross Asset Research/Economics
Capital Goods
23 June 2011 13
Rome was not built in a day but in China it takes less than two weeks!
Recently, the Economist released a report on China’s housing and came to the conclusion
that although there could be a short-term mild correction, strong underlying demand for
housing means that any correction will be short-lived. Higher urbanisation and steady growth
in incomes mean that demand for housing will remain strong for a long time.
However, this report also brings to the fore some alarming data in our view. The following
chart shows that China has built the entire European housing floor space stock (limited to
Czech Republic, Sweden, Portugal, Greece, Poland, Netherlands, Spain, UK, Italy, France and
Germany) in less than 10 years. Within 10 years, China has built slightly more than 16 billion
sqm of completed residential floor space, enough to provide accommodation for 600 million
people assuming 30 sqm per capita. Over the same period, the urban population increased by
just 185 million. With around 1.8 billion square metres of new residential floor completed in
2010, China has built the equivalent of Spain’s housing floor space stock. This construction
has already provided accommodation for 60 million people while the urban population only
increased by c. 20 million. If China were to keep its current construction rate within the next
five years, the 9 billion sqm of new housing built would provide accommodation for 300 million
more people. China would thus have the available floor space stock to accommodate an
urbanisation rate of 65-70%... the IMF’s forecast for 2030!
Cumulative new residential floor space in China vs floor space stock in Europe (in m sqm)
-
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,000
20,000
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 EU f loor space
stock
Source: SG Cross Asset Research, The Economists
Another key data point of this study highlights that with 31 sqm per capita and an average
personal disposal income of less than $2,000 China is more than 50% ‚overhoused‛
compared to the world average. Several studies have analysed the existing strong correlation
between floor space and income. This would mean that the last 10 years of new residential
construction building were unnecessary, once compared to Chinese people’s purchasing
power. The report gives several explanations to justify such a high ratio, including the
shrinking size of a Chinese household due to the one-child policy and lower building quality.
Although we understand the need for more housing construction as the rural population
gradually moves to the cities, we are concerned by its development pace. At the current
growth rate and assuming that the average number of people per household remains flat, the
residential floor space per head would reach 40 sqm by 2015, above that of the UK or
Capital Goods
23 June 2011 14
Germany while its urbanisation rate and living standards stand well below those of these
countries. This will make China even more disconnected from the trend line.
Household indicators (2010) – China in 2010 and 2015 vs. other countries
India UK Japan US China 2010 China 2015
Urban population (%) 30% 90% 67% 82% 48% 52%
Households (,000) 223,340 26,140 50,200 115,990 396,000 410,055
Average no. of people per household 5.3 2.4 2.5 2.7 3.3 3.3
Residential floor space per head (sqm) 10.5 35.5 33.3 64.6 31 40
Personal disposal income per head (US$) 1,110 23,970 26,080 35,970 1,870 3,012
Source: SG Cross Asset Research, Economist Intelligence Unit
Elevators & skyscrapers –Examples of real estate exuberance
To further highlight the exuberance of the Chinese real estate market, we looked at the
elevator industry. Sixty percent of the world’s new elevators go to China. The number of units
delivered reached more than 300,000 in 2010 against around 10,000 in 1990, a compound
growth rate of nearly 20%. The most surprising data is that, with an installed base of around
1.6 million units, the current delivery rate represents around a 20% increase in the installed
base per year. Such an increase in the installed base looks unsustainable in the mid-term.
Elevators – Unit delivery per year
-
50,000
100,000
150,000
200,000
250,000
300,000
350,000
400,000
Source: Kone
Real estate analysts often assess the pace of real estate construction by looking at the
number of skyscrapers built around the world. Today China can boast nearly half of all
skyscrapers due for completion worldwide in the next six years. Currently China has more
than 200 skyscrapers (defined as a building over 150 metres tall) under construction, which is
equivalent to the total number of skyscrapers in the US. In five years time, China is expected
to have 800 skyscrapers. Skyscrapers are often seen as a trophy building yielding low returns
and thus can be viewed as evidence of construction exuberance.
Infrastructure – Is there anything left to be built?
Following a review of the Chinese real estate market we now turn our focus to data on the
development of infrastructure in China. We conclude that a lot remains to be done…but also
that a lot has already been achieved and, as with real estate, China seems to be running
ahead of its development curve. The pace of infrastructure building in China has been
unprecedented and looks unsustainable in our view.
Capital Goods
23 June 2011 15
Roads – A lot has already been achieved
We first looked at the development of roads in China. We found that there are less than three
metres of road per inhabitant while the worldwide average stands at 14-15 metres per
inhabitant or 14 metres in the US. This data would suggest that there is still plenty of room for
further investment. However, when compared to the car fleet, China stands well ahead of
developed countries. Indeed, we find that China has almost 60 metres of paved roads per car
while a similar ratio for developed countries stands between 15m and 35m. Obviously, the
number of cars in China is expected to increase over-proportionally within the next few years,
albeit it is likely to be insufficient to bring China back to international standards.
Paved roads per capita (metres) Paved roads per car (metres)
0
5
10
15
20
25
30
35
40
45
50
Chin
a
India
Turk
ey
Russia
Germ
any
Italy
Bra
zil
Japan
Pola
nd
US
Fra
nce
Spain
Canada
Austr
alia
Sw
eden
-
10
20
30
40
50
60
70
China Spain France US Germany Italy
Source: SG Cross Asset Research, CIA Factbook
The development of China’s highways is even more impressive. The network has been built
from scratch at the end of the 1980s to reach nearly 74,000km in 2010. The Chinese highway
network is almost on a par with that of the US despite having four times less cars. Under the
12th five year plan the network is expected to expand by a further 34,000km, which is more or
less in line with the 33,000km of roads added under the 11th plan.
Development of Chinese highways since 1990
-
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
10,000
-
10,000
20,000
30,000
40,000
50,000
60,000
70,000
80,000
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
Total network (km) - LHS New build (km) - RHS
Source: National Bureau of Statistics
Capital Goods
23 June 2011 16
Railways – Investments seem to have peaked in 2010
The Ministry of Railways (MOR) announced that high-speed trains should connect all Chinese
provinces’ capitals and cities with more than 500,000 habitants by 2020, which represents
about 18,000km of high speed rail lines, compared with only 1,200km in 2008. By 2020,
China’s infrastructure should account for almost 50% of the world’s total high-speed rail lines.
Under the Chinese Mid- and Long-Term Railway Network Plan, investments in railway
infrastructure has grown rapidly, with an average annual investment seen at around
RMB600bn over 2009-2012e on average, up from RMB337bn in 2008 and RMB179bn in
2007. However, 2011 is seen as a turning point for spending on infrastructure. Facing
financing constraints and increased losses, MOR has decided to cut spending on
infrastructure from the planned RMB700bn to RMB600bn. It is clear that MOR has to face a
declining rate of return on new projects and many new lines appear to be under-utilised. We
would not be surprised to see further spending cuts. A recent New York Times article reported
that MOR has reduced the average operating speed on the new high speed line between
Beijing to Shanghai and on other lines as well. This action is aimed at cutting maintenance and
operating costs and improving safety. In addition the article reveals that the average ticket
cost for the Shanghai-Beijing line was around $60, a month’s salary in the rural areas.
High-speed rail (km) Chinese railway infrastructure spending (RMBbn)
-
2,000
4,000
6,000
8,000
10,000
12,000
China Spain Japan France Others Germany Italy Belgium
In operation In construction
89
155179
337
623
736
600 600
0
100
200
300
400
500
600
700
800
2005
2006
2007
2008
2009
2010
2011e
2012e
Source: International Union of Railways Source: MOR
Cement consumption highlights significant “over construction”
A final example of an over-exuberant Chinese construction market can be found in the
country’s cement consumption. In 2010, Chinese cement consumption exceeded 1,800
million tonnes, representing around 55% of worldwide consumption and about 25x the US
level of consumption.
Per capita, the picture looks even more worrying. Indeed with average consumption of
1,400kg per head, China stands well above the world average ex-China of 300kg and the US
consumption of 225kg per capita. The following chart on the right-hand side highlights the
strong correlation between GDP and cement consumption per capita based on US and
French historical data. It reveals that a country’s consumption per capita keeps on increasing
until it reaches $5,000 per capita.
Comparing Chinese cement consumption with that of the US is somewhat misleading since
cement consumption in the US is mostly used for infrastructure and little for residential
building. We believe Spain or France would provide more relevant comparables. French
Capital Goods
23 June 2011 17
cement consumption has a similar pattern than that of the US although it used more cement
per capita in the early stage of its development.
Spain represents an interesting example for assessing the outlook for Chinese cement
consumption. Indeed, Spain had an over-proportional consumption per capita for years before
it crashed with the financial crisis and the bursting of its construction bubble. Spanish annual
cement consumption peaked at nearly 1,300kg per capita in 2007, ahead of the financial
crisis. Four years later, Spanish consumption stands barely at around 500kg per capita, a
60% fall from its peak. Could China follow a similar pattern? Our analysis indicates that such
high cement consumption is unsustainable and all countries where cement consumption has
exceeded 1,000kg per capita for a number of years have gone through a construction crisis
sooner or later.
Cement consumption per capita (kg) Cement consumption per capita (kg) vs GDP per capita
-
200
400
600
800
1,000
1,200
1,400
1,600
1900
1904
1908
1912
1916
1920
1924
1928
1932
1936
1940
1944
1948
1952
1956
1960
1964
1968
1972
1976
1980
1984
1988
1992
1996
2000
2004
2008
US China Spain France
-
200
400
600
800
1,000
1,200
1,400
1,600
- 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 50,000
US China France Spain
GDP per capita (PPP, current $)
Cem
ent
cons
um
pti
on (k
g p
er
capit
a)
Maturity phase
Spanish construction bubble
Source: SG Cross Asset Research, US Geological Survey, Italcementi Source: SG Cross Asset Research, OECD, Cembureau
Capital Goods
23 June 2011 18
Early signs of weakness in China
Some weakness has emerged in construction equipment data
We have seen some weakness recently coming from China for construction equipment.
According to the China Construction Machinery Association (CCMA), the excavator sales
volume of China's main construction machinery companies in May 2011 stood at about
14,000 sets, down by c. 65% from March 2011. In addition, the sales volume of loaders and
bulldozers also saw sharp drops May, with that of loaders falling 45% from March, the largest
drop since 2001. Although the usual seasonal pattern may explain some of this weakness, it is
worth noting that we have seen a sharp slowdown in the yoy growth rates in April and May,
highlighting a worrying downward trend.
Monthly data of deliveries of excavators, loaders and bulldozers in China (units)
May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11
Excavator 16,264 11,734 8,939 8,756 11,528 12,350 14,323 13,427 10,922 20,279 43,063 27,334 14,288
Yoy chge 128% 83% 55% 41% 48% 42% 65% 55% 36% 136% 43% 25% -12%
Loader 22,389 17,510 15,823 15,461 17,685 15,283 15,535 18,463 14,128 16,304 39,988 28,692 22,805
Yoy chge 80% 35% 50% 40% 47% 37% 32% 21% 27% 87% 37% -3% 2%
Bulldozer 1,815 1,426 961 946 980 1,240 923 1,023 1,379 1,197 2,407 1,653 1,194
Yoy chge 147% 107% 55% 49% 21% 65% 22% 29% 78% 53% 71% 1% -34%
Source: CCMA
A primary reason for the slide stems from financing constraints in civil engineering. Another
possible reason comes from the irrationality of the Chinese construction equipment industry
as some local players used aggressive selling techniques (like zero down-payment mortgages)
to boost their market share. This type of behaviour seems to be increasing. At a recent
meeting in June, the head of CCMA expressed concern over aggressive sales techniques
which could lead to a price war in the entire industry.
On a 12-month rolling forward basis the situation is far from alarming, as shown by the
following charts. However, based on our analysis, we are likely to see a plateau at best and a
sharp correction in a worst case scenario.
Excavator deliveries 12M average Loader deliveries 12M average Bulldozer deliveries 12M average
-
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,000
Ja
n-0
7
Ap
r-0
7
Ju
l-0
7
Oc
t-0
7
Ja
n-0
8
Ap
r-0
8
Ju
l-0
8
Oc
t-0
8
Ja
n-0
9
Ap
r-0
9
Ju
l-0
9
Oc
t-0
9
Ja
n-1
0
Ap
r-1
0
Ju
l-1
0
Oc
t-1
0
Ja
n-1
1
Ap
r-1
1
-
5,000
10,000
15,000
20,000
25,000
Fe
b-0
7
Ma
y-0
7
Au
g-0
7
No
v-0
7
Fe
b-0
8
Ma
y-0
8
Au
g-0
8
No
v-0
8
Fe
b-0
9
Ma
y-0
9
Au
g-0
9
No
v-0
9
Fe
b-1
0
Ma
y-1
0
Au
g-1
0
No
v-1
0
Fe
b-1
1
-
200
400
600
800
1,000
1,200
1,400
Source: SG Cross Asset Research, CCMA
Capital Goods
23 June 2011 19
Share price performance reflects growing concerns
Following a massive outperformance of Chinese construction machinery stocks from 2005
(+690% over the past six years), we have seen a much weaker price performance since early
April. Driven by weaker construction equipment data and a weakening PMI as tightening starts
to produce some effects, Chinese construction machinery stocks have underperformed the
broader Chinese market by 6-7% since the end of March.
Absolute performance - Chinese construction machinery
stocks index
Relative performance - Chinese construction machinery stocks
index vs Shanghai composite index
0
500
1000
1500
2000
2500
09/0
6/0
5
09/1
2/0
5
09/0
6/0
6
09/1
2/0
6
09/0
6/0
7
09/1
2/0
7
09/0
6/0
8
09/1
2/0
8
09/0
6/0
9
09/1
2/0
9
09/0
6/1
0
09/1
2/1
0
09/0
6/1
1
0
1
2
3
4
5
6
7
8
9
Jun-0
5
Sep-0
5
Dec-0
5
Mar-
06
Jun-0
6
Sep-0
6
Dec-0
6
Mar-
07
Jun-0
7
Sep-0
7
Dec-0
7
Mar-
08
Jun-0
8
Sep-0
8
Dec-0
8
Mar-
09
Jun-0
9
Sep-0
9
Dec-0
9
Mar-
10
Jun-1
0
Sep-1
0
Dec-1
0
Mar-
11
Jun-1
1
Source: SG Cross Asset Research, Datastream
We have also seen a sharp contraction in P/Es of Chinese construction machinery stocks
since the start of the year. On average they now trade on 11x 12-months forward P/E
compared to 16x two months ago and an historical average of 17x. The stocks now trade at a
10-15% discount to their Western peers while they used to trade at a 10-20% premium
historically.
Chinese construction machinery (*) - 12M forward PE
0
5
10
15
20
25
30
35
40
Dec
-05
Mar-
06
Jun-0
6
Se
p-0
6
Dec
-06
Mar-
07
Jun-0
7
Se
p-0
7
Dec
-07
Mar-
08
Jun-0
8
Se
p-0
8
Dec
-08
Mar-
09
Jun-0
9
Se
p-0
9
Dec
-09
Mar-
10
Ju
n-1
0
Se
p-1
0
Dec
-10
Mar-
11
Source: SG Cross Asset Research, Datastream, * Includes Sany Heavy Industry, IMM, Lonking, Shantui, Liugong; Zoomlion, XGMA
Capital Goods
23 June 2011 20
Sell-off in commodity indices The increase in China’s demand for mineral resources associated with its urbanisation and
industrialisation, combined with the size of its population, has meant that China has been the
dominant contributor to growth in mineral resource demand over the past decade. China
represents more than half of global demand for metallurgical coal and iron ore as the following
left-hand side chart highlights. Therefore, China is a key driver of commodity prices and the
strength or weakness of the Chinese economy drives most commodity prices. We have
witnessed a recent sell-off in commodity prices on the back of negative sentiment around China.
China - A major driver of commodity demand Base metal index *
0%
10%
20%
30%
40%
50%
60%
70%
Met coal Iron ore Thermal coal Aluminium Copper Nickel
2002 2009
500
700
900
1100
1300
1500
1700
1900
2100
Jan-0
8
Mar-
08
May-
08
Jul-
08
Sep-0
8
Nov-
08
Jan-0
9
Mar-
09
May-
09
Jul-
09
Sep-0
9
Nov-
09
Jan-1
0
Mar-
10
May-
10
Jul-
10
Sep-1
0
Nov-
10
Jan-1
1
Mar-
11
May-
11
Source: BHP Billiton Source: Datastream * Includes LME Aluminium, Copper, Lead, Nickel and Zinc
A fall in Chinese construction activity would have a severe impact on global cement, iron ore,
coal and copper consumption. We now discuss the potential knock-out effect of a fall in
Chinese construction activity on these commodities/products:
Cement consumption to be hard hit – The impact on cement consumption is straight
forward. A hundred percent of cement consumption is used for construction (30% towards
property, 30% towards infrastructure and 40% towards other construction) and China
represents 55% of global consumption. The fall in cement consumption is likely to be over
proportional to the fall in Chinese construction activity as the more defensive renovation
market is usually less cement intensive. A 20% fall in Chinese construction activity could
easily lead to a 30%-40% fall in Chinese cement demand and therefore a 15-20% reduction in
global cement demand.
A new shock for steel and iron ore demand - We estimate the construction sector accounts for
up to 50-60% of the total steel consumption in China (around 600 million tons in total, 45% of
global steel consumption). Now, steelmakers use 1.6 tons of iron ore and 0.5 tons of coking coal
to make 1 ton of steel. Therefore, a 20% fall in Chinese construction activity would reduce global
steel demand by at least 4% and iron ore demand by at least 6%. In 2009, steel demand fell by
6.5% and on average prices halved between 2008 and 2009. Although iron ore consumption did
not fall in 2009 thanks apparently to China, average prices fell by 15%. In the event of a fall in
Chinese construction activity, iron ore prices would be under strong pressure bearing in mind
the large increase in production capacity expected to come on stream over the next five years.
Copper demand would be impacted to some extent – We estimate that about 30-35% of
copper demand is used by the construction industry and China accounts for nearly 40% of
global demand. Therefore, a 20% fall in Chinese construction activity would have at least a 2-
3% negative impact on global copper demand. Back in 2009, a 3% fall in copper demand led
to a 25% drop in the copper average price.
Capital Goods
23 June 2011 21
Monetary tightening and weak PMI data but IP and FAI remain
strong
China is trying to engineer a soft landing for an economy that has been flying at hypersonic
speed and still has plenty of rocket fuel left in the tanks. As the economy tracks lower,
policymakers also have to keep an eye on the corporates, local governments and the asset
bubbles that have been created by arguably the greatest quantitative easing experiment ever
undertaken. China pumped the equivalent of 50% of GDP into the economy over 2008-2010. To
date, monetary policy actions have barely kept up with the additional liquidity being generated
by China’s enormous stock of FX reserves – they haven’t even begun to drain the excess
liquidity that was created over the past two years.
Hence, it is not surprising that our economists’ Taylor rule analysis currently finds that China is
around 400bp behind the curve. They argue that this is the largest distortion in monetary
policy settings since the first part of 2008 when the PBOC was assessed as being nearly
600bp behind the curve. It was the over-tightening through the first part of 2008 (not just
interest rates, but reserve requirement ratios and administrative measures that included
aggressive credit controls and compulsory treasury purchases for targeted commercial banks)
that proved to be a significant contributory factor to the sharp slowdown in the Chinese
economy in the fourth quarter of 2008.
Tightening measures implemented by the central government have so far proved inefficient.
The reserve requirement ratio was hiked by 50bp in June, which takes it to an unprecedented
21.5% for major financial institutions. This is expected to lock up an additional CNY370bn of
liquidity. However, to put that into context, China’s bank lending was CNY680bn in the month
of March alone. China has raised the RRR five times so far this year and 11 times since the
beginning of this tightening cycle. In addition to greater administrative vigilance over bank
lending, particularly to the housing market and local governments, interest rates have risen
four times since October.
China’s version of quantitative easing China’s implied Taylor rule gap is extremely wide
0
5
10
15
20
25
30
35
40
45
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Increases in Money Stock as % of GDP
China's "QE"37
-10
-5
0
5
10
15
20
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
PBoC 1yr lending rate
Taylor rule implied policy rate
%
Source: SG Cross Asset Research
Will China over-tighten policy as growth continues to accelerate in 2011 forcing a much harder
than ‚soft‛ landing of the economy in 2012? Our economists now believe that the balance of
probabilities has shifted to this conclusion. The economy has already gotten away from the
People’s Bank of China while the Politburo is endorsing a ‚steady as she goes‛ approach to
tightening. Ultimately, they believe China will find itself in a process of policy catch-up, likely
Capital Goods
23 June 2011 22
to be triggered as inflation remains high. That policy catch-up, with history as a guide, is likely
to be overdone. If that happens, then the Chinese economy will inevitably overcool as a result.
Chinese PMI remains slightly above 50…
A slowdown is nonetheless obvious as recent PMI data stresses. Chinese PMI data started
falling at the end of last year but remain above 50, the critical point between expansion and
correction. However, with further tightening in sight as inflation is still not contained it is
possible to see PMI data crossing the 50 mark in H2, weighing on industrial stocks exposed to
the Chinese growth story.
Chinese monthly PMI from 2005
40
42
44
46
48
50
52
54
56
58
60
Ap
r-0
5
Ju
l-0
5
Oc
t-0
5
Ja
n-0
6
Ap
r-0
6
Jul-0
6
Oc
t-0
6
Jan-0
7
Ap
r-0
7
Jul-0
7
Oc
t-0
7
Ja
n-0
8
Ap
r-0
8
Ju
l-0
8
Oc
t-0
8
Ja
n-0
9
Ap
r-0
9
Jul-0
9
Oc
t-0
9
Jan-1
0
Ap
r-1
0
Jul-1
0
Oc
t-1
0
Ja
n-1
1
Ap
r-1
1
Source: Datastream
…while IP and FAI growth remains as strong as ever
Despite monetary tightening and weakening PMI data, Chinese economy is still flourishing.
Both growth in industrial production (IP) and Fixed Asset Investment remained very healthy in
May. Industrial production growth was better than expected, rising 13.3% yoy. Fixed asset
investment grew 25.8% yoy between January and May and 26.7% yoy in May alone. This was
the fourth positive surprise in a row from this series. Our economists believe that the
inconsistency between the strong investment figure and the soft monetary data reveals that
the fast development of the non-banking financial sector is playing a bigger and bigger role in
raising capital and funding economic activity.
China’s Fixed Asset Investment growth (yoy %) China’s industrial production growth (yoy %)
20
22
24
26
28
30
32
34
36
May-
06
Aug
-06
Nov-
06
Feb-0
7
May-
07
Aug
-07
Nov-
07
Feb-0
8
May-
08
Aug
-08
Nov-
08
Feb-0
9
May-
09
Aug
-09
Nov-
09
Feb-1
0
May-
10
Aug
-10
Nov-
10
Feb-1
1
May-
11
5
7
9
11
13
15
17
19
21
23
25
May-
06
Aug
-06
Nov-
06
Feb-0
7
May-
07
Aug
-07
Nov-
07
Feb-0
8
May-
08
Aug
-08
Nov-
08
Feb-0
9
May-
09
Aug
-09
Nov-
09
Feb-1
0
May-
10
Aug
-10
Nov-
10
Feb-1
1
May-
11
Source: Datastream Source: Datastream
Capital Goods
23 June 2011 23
Focus on the Chinese construction equipment
industry
Within this section, we describe the construction equipment market in China and its key
players. China now stands as the largest and the fastest growing construction equipment
market globally. The boom in construction equipment has led to the emergence of large
Chinese players which are gradually moving up the value chain and have ambitions to grow
internationally. Although they do not represent a short-term threat for the main Western
players, competition is only expected to get tougher and tougher in the mid-term. Last year
during a presentation, Caterpillar CEO said that the leading player in China will be the global
leader in 2020 and we fully agree with this statement.
So far, they have enjoyed little success internationally but we think that the strength of their
domestic market was a major impediment to this. As we foresee a slowdown in construction
equipment growth in China, international expansion would be key for Chinese companies to
keep their strong growth trajectory.
The Chinese construction and mining equipment market
According to the China Construction Machinery Association (i.e. CCMA), China’s construction
machinery industry revenue increased from $7bn in 2001 to an estimate of almost $60bn in
2010, which represents annualised growth of 25%, more or less in line with the growth in
Chinese fixed asset investment. China is by far the largest market for the construction &
mining equipment industry, in terms of volume as well as value.
China’s construction machinery industry ($bn)
0
10
20
30
40
50
60
70
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
25% CAGR
Source: CCMA
According to Komatsu data, China represents more than 35% of annual demand for the seven
biggest categories of construction equipment in 2011. Its share of the global market has
soared from just 10% back in 2005. In some market segments like wheeled loaders, China’s
domination is astonishing. According to Off-Highway Research, 60% of wheeled loaders in
2008 (so pre-crisis) were manufactured and sold by Chinese companies (75% if we include
SEM and Lingong which are respectively part of Caterpillar and Volvo).
Capital Goods
23 June 2011 24
Annual demand for 7 major construction equipment categories
(units)
2008 global market share of wheeled loaders (units)
0%
5%
10%
15%
20%
25%
30%
35%
40%
-
50,000
100,000
150,000
200,000
250,000
300,000
350,000
400,000
2003 2004 2005 2006 2007 2008 2009 2010 2011e
Japan Europe North America
China Others China share
Longlong15%
Liugong14%
XEMC12%
Xugong6%Chenggong
5%Foton4%
Changlin3%
Volvo14%
Komatsu5%
Caterpillar16%
CNH2%
JCB2%
Kawasaki2%
Source: Komatsu Source: Off-Highway Research
Overview of the main Chinese players
There are approximately 890 machinery manufacturers in China, mainly concentrated in the
Hunan, Shandong and Jiangsu provinces. The fragmented nature of the Chinese construction
equipment industry is due to the large number of small- and medium-sized enterprises. CCMA
promotes the consolidation of Chinese industry under the 12th five year plan.
Western manufacturers still dominate the high end segments
The top five Chinese players account for around one-third of the total market share. Domestic
brands are strong in segments with high demand for basic machine types like loaders or
forklift trucks. On the other hand, foreign brands usually dominate segments requiring more
advanced design and manufacturing techniques, like hydraulic excavators and drilling
machines.
We estimate foreign brands represent around a third of the market, with Caterpillar (including
SEM), Volvo Construction Equipment (including Lingong) and Komatsu standing as the largest
foreign players in the Chinese market. They respectively enjoy 9%, 7% and 5% market share
as the following chart shows.
Estimated market shares of the Chinese construction & mining equipment industry
Caterpillar
9%
Volv o7% Komatsu
5%
Hitachi4%
Kobelco1%
Hunan Sunward1%
Luigong5%
Lonking4%
Sany Heav y
11%
Shantui4%
XCMG8%
Zoomlion11%
XGMA3%
Other Chinese18%
Others9%
Source: SG Cross Asset Research, CCMA, Company Data
Capital Goods
23 June 2011 25
The main Chinese construction equipment companies often have a broad product portfolio
ranging from loaders to road and concrete machineries. Sany Heavy Industry, Zoomlion and
XCMG are almost full liners offering a complete product range for the construction industry.
Main Chinese construction equipment companies and their product portfolio
Loaders Excavators Material
Handling
Drilling
equipments
Road
machinery
Concrete
machinery
Bulldozers Mining
equipment
Sany Heavy X X X X X
Zoomlion X X X X X X X
XCMG X X X X X X
Liugong X X X
Shantui X X X X X X
Lonking X X X X
XGMA X X X X X
Hunan Sunward X X X X
IMM X
Shaanxi Construction X X
Dingsheng Tiangong X X X
Dagang X
XuanHua X X X X
Changlin X X X
Source: SG Cross Asset Research, Company Data
Despite strong domestic growth Chinese companies are still subscaled
In terms of scale, only seven companies exceed RMB10bn revenues (i.e. $1.5bn) as the
following chart highlights. Sany Heavy Industry, Zoomlion and XCMG are the three largest
companies with respective revenues of RMB34bn (i.e. $5bn), RMB32bn (i.e. $4.8bn) and
RMB25bn (i.e. $3.7bn). Chinese companies are therefore still lagging behind the global
players. Only six Chinese companies are within the top 20 and the revenues of the largest
Chinese company (i.e. Sany Heavy Industry) are six times lower than Caterpillar’s, the global
leader.
2010 revenues of main Chinese construction & mining
equipment companies (RMB m)
2010 revenues from construction & mining equipment – Global
peer comparison (US$bn)
-
5,000
10,000
15,000
20,000
25,000
30,000
35,000
Sany
Heavy
Zoom
lion
XC
MG
Liu
gong
Shantu
i
Lonki
ng
XG
MA
Hunan S
unw
ard
Chang
lin
IMM
XuanH
ua
Shaanxi
C
onstr
uction
Din
gsheng
Tia
ng
ong
-
5
10
15
20
25
30
35
Cate
rpilla
r
Kom
ats
u
Volv
o C
E
Hitachi
Lie
bherr
Sandvi
k M
&C
Sany
Heavy
Zoom
lion
Atlas M
&C
XC
MG
Deere
Joy
Glo
bal
JC
B
Kobelc
o
CN
H
Liu
gong
Doosan I
nfr
acore
Tere
x
Shantu
i
Lonki
ng
Source: SG Cross Asset Research
Lower price and lower quality albeit good profitability
The average profitability of the top 10 Chinese companies is more or less in line with that of
the leading players in the developed countries. However, compared to Western
manufacturers, Chinese companies did not experience a downturn in 2008-2009 and therefore
Capital Goods
23 June 2011 26
their average profitability has kept on expanding in the meantime. With an average EBIT
margin of 15% in 2010, the profitability of the Chinese companies is 200-300bp higher than
that of the leading players in developed countries.
A key competitive advantage of the Chinese companies is obviously their cost base which
allows them to sell equipment at large discounts compared to Western manufacturers (from
30% up to 80% on some products). Zoomlion’s cost base is a fair reflection of the competitive
advantage of domestic brands, with production staff costs representing only 3% of its cost of
sales. The lower quality of products is also responsible for the price differential albeit as we
discuss later Chinese companies are quickly moving up the value chain.
Average EBIT margin – China vs developed countries A highly competitive cost base – Zoomlion’s example
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
16.0%
18.0%
2005 2006 2007 2008 2009 2010
China Average US, EU & Japan Average
Raw materials/compo
nents79%
Depreciation1%
Others2%
Staff costs3%
Sales & marketing
8% SG&A6%
R&D1%
Source: SG Cross Asset Research
Moving up the value chain – The excavator example
The Chinese excavator industry is a good example of how fast Chinese companies are moving
up the value chain. The hydraulic equipment used in excavators subjects hydraulic fluid to
extremely high pressures, which requires strong expertise and precision machinery. Since
China is a relative newcomer to this field, foreign companies have historically dominated the
Chinese market for excavators.
According to CCMA 2010 data, foreign brands had 70% of the Chinese excavator market in
terms of volume. However, it is worth noting that this market share has been on a downward
trend for the past few years as Chinese companies are successfully moving up the value
chain. Their market shares rose from 22% in 2006 to above 30% in 2010 as the chart on the
right-hand side shows. Data for the first three months of 2011 show an acceleration of this
trend with the share of Chinese manufacturers increasing to more than a third.
Chinese companies like Sany have successfully entered the excavator market by 1) entering
the small- to medium-size excavator market, and 2) importing hydraulic components from
Rexroth (part of Bosch group) or Kawasaki. Sany Heavy has thus seen its market share grow
from less than 2% in 2006 to more than 8% in 2010, just behind Kobelco.
Similarly, according to a May article in Reuters, XCMG is in talks to buy a 50% stake in two
hydraulic parts makers in Germany and Holland. This access to the latest hydraulic technology
would certainly boost the company’s competiveness and should allow it to gain market share
in the excavator market.
Capital Goods
23 June 2011 27
Excavators – 2010 market shares (units) Excavators - Evolution of market shares
Komatsu14%
Doosan13%
Hyundai11%
Hitachi11%
Kobelco9%
Sany Heavy Industry
9%
Caterpillar6%
Volvo5%
Yuchai5%
Liugong Machinery
3%
Futian Lovol3%
Hunan Sunward
3%
JCM2%
Xiagong2%
Sumitomo2%
Other3%
77.4% 78.1% 73.7% 71.8% 69.5%
22.6% 21.9% 26.3% 28.2% 30.5%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2006 2007 2008 2009 2010
Foreign Chinese
Source: CCMA Source: CCMA
Looking abroad for development as volume could stall in China
Fully aware that the sharp volume growth enjoyed over the last few years is unlikely to go on
forever, Chinese companies are looking abroad to be able to maintain their strong growth
trajectory. In 2010, China’s exports of construction machinery reached $9.3bn (up 35% from
2009 albeit still 25% down vs 2008), with the majority being components and low to medium-
end products. However, a portion of these exports (albeit unquantified) was accounted for by
foreign companies which are manufacturing parts or complete equipment in China and then
shipping them abroad.
Export of construction & mining equipments ($m) Breakdown of the export of construction & mining equipment
by value
-
2,000
4,000
6,000
8,000
10,000
12,000
14,000
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Excavator
4%
Loader9%
Bulldozer3%
Crane11%
Fork-lift truck5%
Grader / leveller3%
Road roller / tamping machine
3%
Lifting / handling machine
3%
Earth moving / grading machine
5%
Concrete machine
4%
Elevator / escalator
10%
Component35%
Other5%
Source: CCMA Source: CCMA
A relative lack of success internationally…so far
The Chinese construction equipment companies are still relatively undeveloped on a global
scale. The top three Chinese manufacturers have each reported only between $250-350m
revenues outside China as the following table shows. Sany Heavy has been the most
successful in increasing its non-domestic revenues from c. $220m to c. $325m between 2009
and 2010. However, it is interesting to note that the non-domestic revenues of these
companies are similar to their 2007 level. Clearly the export potential has shrunk during the
downturn, although we could have expected Chinese companies to outperform the broader
market.
Capital Goods
23 June 2011 28
One of the big issues in our view stems from the focus of Chinese companies over the past
few years on the strength of their domestic market. Indeed, their investments have been
skewed towards their domestic market to benefit from its exponential growth over the past
couple of years.
Non-domestic revenues of the top three Chinese companies ($m)
202
610
383272
239
577
218326
458
641
273 323
0
200
400
600
800
1000
1200
1400
1600
1800
2000
2007 2008 2009 2010
Zoomlion Sany XCMG
Source: Company Data
We expect the largest Chinese manufacturers to become much more aggressive
internationally over the next few years, especially in emerging markets like India or Brazil. For
instance, Sany Heavy is planning to raise $3bn to finance its international expansion through
an IPO on the Hong Kong stock exchange. XCMG is following the same path by planning to
raise $1.5-2bn new equity. A few days ago, XCMG announced it would invest $200m in Brazil
to establish a new plant. Zoomlion also raised equity last year to finance its international
expansion. The group (unrealistically?) aims to derive more than 50% of its revenues
internationally (vs only 6% in 2010).
Capital Goods
23 June 2011 29
Who is exposed and to what extent?
Mining exposure is the biggest threat
We have tried to assess the exposure of our coverage universe to the Chinese construction
market. We have estimated the companies’ direct exposure to this market as well as their
indirect exposure, through their mining equipment activities, since a slump in the Chinese
construction market would have a severe impact on commodity demand/prices and therefore
on the mining capex industry.
Overall, direct exposure to the Chinese construction market is relatively low, with most
industrial companies deriving less than 10% of their revenues from this market. We find that
only Japanese construction equipment manufacturers, Hitachi and Komatsu, together with
Kone, have more than 10% exposure as the following chart highlights.
Nonetheless, the biggest risk for engineering companies lies in their exposure to the mining
industry. Within our coverage, Sandvik and Atlas Copco both have sizeable exposure to
mining, deriving respectively 36% and 26% of their revenues from this industry. The following
chart shows the direct and indirect exposure of a few engineering companies. The list is
obviously not exhaustive.
Exposure to Chinese construction market and mining as % of 2010 sales
26%
1%12%
3% 1%9% 8% 12% 9%
4% 3%
100%
17%
36%24%
26% 27%18%
5%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Joy
Glo
bal
Hitac
hi
Sandv
ik
Kom
ats
u
Atlas C
opco
Mets
o
Ca
terp
illa
r
Volv
o
Kone
Assa A
blo
y
Schneid
er
Legra
nd
Chinese construction exposure Mining exposure
Source: SG Cross Asset Research, Company data
Mining capex could be sharply reduced
Driven by the strong rebound in commodity prices and greater optimism from miners, we have
seen a strong and quick rebound in mining capex from 2009 lows. We forecast global mining
capex to reach $125bn in 2011, surpassing the 2008 peak.
Now question marks remain for mining capex beyond 2011. Based on IBES forecasts for the
top five miners, capex should decline by 7% for 2012 and by a further 11% for 2013.
Consensus forecasts for Vale are the key driver behind the slide, with 2012 capex seen 20%
below the $24bn planned for 2011.
A significant slowdown in Chinese construction would be expected to drive commodity prices
lower and trigger new long-term plans from the miners. Indeed, their capex/production plans
are based on the assumption that Chinese appetite for commodities will remain firm in the
foreseeable future.
Capital Goods
23 June 2011 30
Mining capex vs base metal index ($bn) Net capex outlook for top five miners ($m) *
0
20
40
60
80
100
120
140
0
50
100
150
200
250
300
350
400
450
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011E
Global Mining capex US$bn (RHS)
MEG Base Metal Index (LHS)
-
10,000
20,000
30,000
40,000
50,000
60,000
70,000
2010 2011e 2012e 2013e
IBES SGe
+21%
+56%-7%
-11%
Source: SG Cross Asset Research, Metal Economics Group Source: SG Cross Asset Research, IBES, * Includes BHP Billiton, Rio Tinto, Vale, Xstrata, Anglo
American
A fall in commodity prices would obviously have knock-on effects on the GDP outlook for
countries that derive a sizeable portion of their wealth from natural resources, like Australia,
South Africa or Brazil.
China - Key driver of sales growth over the past few years
Unsurprisingly, China has been a key driver of sales growth for most capgoods companies
over the past few years. The following chart shows the contribution of China to the groups’
revenues between 2004 and 2010 (excluding acquisitions and FX). On average, higher
revenues in China accounted for c. 25% of the total revenue growth observed between 2004
and 2010. A third of Schneider’s revenue growth over the period was driven by China.
Atlas and Sandvik experienced a more moderate direct contribution from China, albeit this
was due to the sharp increase in revenues derived from the mining industry. Indeed, we
estimate higher mining revenues contributed respectively c.70% and c.50% to the revenue
growth seen at Sandvik and Atlas Copco between 2004 and 2010.
Contribution from China and Mining to group revenues between 2004 and 2010
0%
20%
40%
60%
80%
100%
120%
Sandv ik Atlas Volv o CE Schneider SKF Assa Abloy ABB Siemens
Contribution f rom China Contribution f rom Mining
Source: SG Cross Asset Research
Capital Goods
23 June 2011 31
Chinese competition likely to intensify outside China
Chinese companies are expected to look increasingly overseas to offset a potential slowdown
in their domestic market and the likely resulting overcapacity, creating heightened competition
in the global markets, particularly in other emerging markets. Fortunately, most capital goods
companies under our coverage do not operate in the construction equipment business (loaders,
excavators, bulldozers, etc) where the competitive risks look highest. But other industries would
also likely see intensifying Chinese competition in international markets if China’s economy
slows down. Generally speaking, we believe that capital goods companies are set to
experience growing competition from Chinese companies and price pressure when the
following conditions are in place:
1) The industry is “strategic”. For the Chinese government, which is currently building the
country’s infrastructure (power installed base, grid network, transportation network),
associated capital goods industries are strategic for the country’s development. This explains
why China has prevented foreign companies from entering freely into these markets, required
technology transfers and systematically favoured the development of local champions.
2) The customer base is highly consolidated, with only a handful of clients (utilities,
municipalities) by country. This gives customers stronger bargaining power. It also enables the
low-cost competition to address these markets more efficiently as their commercial efforts
can be focused on a small number of key clients. In contrast, in scattered markets such as the
low-voltage industry, it is very time-consuming and expensive for a new entrant to build up the
required commercial network to address all distributors and electricians.
3) Demand is characterised by big-ticket contracts (typically worth more than €15m). By nature,
the larger the contract, the greater the price sensitivity, as price increases represent a
significant additional amount of spending by the client. In contrast, when demand is
characterised by a flow of low-ticket items (switches, bearings, locks, etc.), the products sold
only represent a small cost component of customers’ total manufacturing or installation costs,
which limits price pressure.
Power, Rail and T&D clearly at risk – healthcare relatively immune in our view
As illustrated below, we believe that the power generation, rail transportation and T&D sectors
typically share these characteristics, making them particularly exposed to Chinese competition.
In theory, given China’s new focus on upgrading its healthcare architecture (with a $123bn
investment programme), the healthcare industry could be next on the list. However, unlike in the
power or rail markets, western companies have so far enjoyed relatively unimpaired access to
the Chinese market. The Chinese government seems to be more interested in quickly
modernising/building out its healthcare system than trying to build an industrial base in this area.
Global players have traditionally operated in the urban space (3,600 existing hospitals and 2,000
county hospitals under construction) and should now gradually benefit from China’s huge
investments outside urban areas (80,000 hospitals which should increasingly get access to basic
ultrasound and imaging systems).
Capital Goods
23 June 2011 32
Low-cost competition more likely to hit big ticket items with a consolidated customer base
Pricing power
Industries most at risk
Hig
h
LowHigh
Fossil Power Generation
TransportationNuclear
Wind Power
T&D
Cable
Auto Equipment
Automation
BearingsTooling
Mining equipment
Medical Equipment
Lo
w
Compressors
Co
ns
oli
da
tio
n o
f th
e c
us
tom
er
ba
se
Size of each contract
Ultra - low Voltage
Locks
Attractive but volatile
Pricing risks
Source: SG Cross Asset Research
Forecasts edged down to reflect the increased uncertainty
Given the mounting uncertainty on the outlook for Chinese construction, we have reduced our
forecasts for both the Chinese construction equipment and global mining equipment
industries;
Chinese construction equipment – We have reduced our forecasts for Chinese construction
equipment. We still forecast good growth for 2011 as a whole given the strength of the first
quarter. However, we now estimate deliveries could fall in 2012 and trend back to a more
normalised level following several years of over-proportional growth.
Construction equipments in China – Excavator, loader and bulldozer deliveries per annum
2006 2007 2008 2009 2010 2011e 2012e
Excavator 43,346 66,171 76,612 92,619 165,804 190,000 140,000
Yoy chge 50% 53% 16% 21% 79% 15% -26%
Loader 119,868 161,812 165,335 143,355 216,691 230,000 190,000
Yoy chge 13% 35% 2% -13% 51% 6% -17%
Bulldozer 6,087 7,382 8,776 8,580 13,911 14,500 11,500
Yoy chge 19% 21% 19% -2% 62% 4% -21%
Source: SG Cross Asset Research, CCMA
Mining capex – Mining capex will likely reach a record high level in 2011, a level which looks
unsustainable if we rely on IBES forecasts for the top five miners. In addition, growing
uncertainty on Chinese construction prompts us to assume a more cautious outlook for the
mining equipment industry. A sharp contraction in Chinese construction activity would be
likely to trigger further downgrades, whereas ongoing strength in Chinese FAI would lead to
upgrades to our new forecasts. We prefer to err on the side of caution as long as visibility on
the Chinese construction market remains low.
Global mining equipment industry
2008 2009 2010 2011e 2012e 2013e
New forecasts ($m) 45,400 31,780 38,000 52,300 54,000 50,000
yoy change 11% -30% 20% 38% 3% -7%
Old forecasts ($m) 45,400 31,780 38,000 53,500 59,000 63,000
New vs Old -2% -8% -21%
Source: SG Cross Asset Research
Capital Goods
23 June 2011 33
These revised forecasts for the Chinese construction and global mining industries led us to
downgrade our estimates for the most exposed companies to these industries. Atlas Copco
and Sandvik are the most impacted, with 2013e EPS downgrades of 13% for both stocks.
Volvo is likely to be impacted through its CE division. However, the negative impact on CE has
been offset by more optimistic truck delivery forecast following the strong May delivery data
released recently. Our EPS forecasts have thus been largely unchanged.
We have marginally lowered our forecasts on Assa Abloy by applying more a cautious forecast
on Chinese construction growth (9% of group revenues).
Finally, we have left unchanged our forecasts on Legrand and Schneider which derive just 3%
and 4% of sales respectively from the Chinese construction market.
Main changes to our forecasts – Assa Abloy and Atlas Copco
Assa Abloy Atlas Copco
2011e 2012e 2013e 2011e 2012e 2013e
Revenues - New forecasts 41,456 45,108 47,869 78,756 85,568 89,380
Revenues - Old forecasts 41,578 45,489 48,540 78,939 89,620 99,935
% change -0.3% -0.8% -1.4% -0.2% -4.5% -10.6%
SG adj. EPS - New forecasts 12.7 14.2 15.4 10.5 11.5 12.3
SG adj. EPS - Old forecasts 12.8 14.4 15.7 10.5 12.4 14.1
% change -0.4% -1.3% -1.9% -0.1% -7.2% -12.9%
Source: SG Cross Asset Research
Main changes to our forecasts – Sandvik and Volvo
Sandvik Volvo
2011e 2012e 2013e 2011e 2012e 2013e
Revenues - New forecasts 92,955 99,130 101,904 300,771 336,794 362,029
Revenues - Old forecasts 95,048 104,237 112,317 297,495 341,954 372,860
% change -2.2% -4.9% -9.3% 1.1% -0.9% -2.2%
SG adj. EPS - New forecasts 7.7 8.7 9.3 8.7 11.6 13.0
SG adj. EPS - Old forecasts 7.8 9.3 10.7 8.4 11.6 13.2
% change -1.3% -6.4% -13.4% 3.8% 0.4% -1.3%
Source: SG Cross Asset Research
Our forecasts for Atlas Copco, Sandvik and Volvo now differ materially from consensus which
still assumes steady growth in the companies’ end-markets, including both the Chinese
construction and the global mining equipment industries.
SG 2012e forecasts vs consensus SG 2013e forecasts vs consensus
-9%
-8%
-7%
-6%
-5%
-4%
-3%
-2%
-1%
0%Atlas Copco Sandvik Volvo
Revenues EBIT
-18%
-16%
-14%
-12%
-10%
-8%
-6%
-4%
-2%
0%Atlas Copco Sandvik Volvo
Revenues EBIT
Source: SG Cross Asset Research, Datastream
Capital Goods
23 June 2011 34
Machinery (Sweden)
ASSA ABLOY Rating reiterated Defensive appeal vs Chinese construction risk
Exposure to China Following the acquisition of Panpan (security doors), Assa Abloy now
derives c.9% of its revenues from the Chinese construction industry. The stock harbours the
highest direct exposure to the Chinese construction market within our coverage. The group’s
exposure to China has climbed from just 1% in 2004 via acquisitions and organic growth. We
calculate that China contributed c.25% of the group’s organic sales growth between 2004
and 2010. In China, Assa Abloy now offers a complete product range and has become the
largest lock company.
Chinese competition threat The Chinese lock industry is highly fragmented and as a result
no major competitors have yet emerged. Over the past few years, Chinese lock products
have made some inroads in emerging markets (notably in South East Asia and LatAm) albeit
with mixed success. Local standards and brand strength remain key barriers to entry within
the lock industry.
Target price & rating Despite its large direct exposure to the Chinese construction market,
Assa Abloy still offers some leverage on the long-awaited rebound in the US and European
non-residential construction markets, which should remain key drivers of the shares going
forward. In addition, Assa Abloy offers a defensive business model (low capital intensity and
high share of aftermarket) that investors are likely to appreciate in the event of a burst of the
Chinese construction bubble. We therefore maintain our Hold rating on the stock. Our
SEK170 TP is unchanged; it is derived on a DCF (8.5% WACC, 2% LT growth and 16%
normalised margin). We have marginally reduced our EPS forecasts by 1-2% for 2012 and
2013 to reflect a more cautious growth outlook in China. The shares trade on 11.6x P/E for
2012e, largely in line with the sector average. Key upside (downside) risk to the stock
achieving our TP would come from a rebound in US/EU non residential construction that is
stronger (weaker) than expected.
Next events & catalysts Q2 results on 27 July.
Hold (12m)
Price 21/06/11 12m target
SEK165.5 SEK170.0
Sector
Weighting
Overweight
Preferred stock
Siemens
Least preferred stock
Sandvik
Type of investment
M&A
Defensive
1 year
Price MA 100
120
150
180
210
2010 2011
0
4.5
9
13.5
(m)
2010 2011
Source: SG Cross Asset Research
Assa Abloy
on www.sgresearch.com
Share data Financial data 12/10 12/11e 12/12e 12/13e Ratios 12/10 12/11e 12/12e 12/13e
RIC ASSAb.ST, Bloom ASSAB SS Revenues (SEKbn) 36.82 41.46 45.11 47.87 P/E (x) 14.6 13.0 11.6 10.7
52-week range 196.5-146.5 EBIT margin (%) 16.5 16.2 16.5 16.9 FCF yield (/EV) (%) 7.9 6.4 7.8 8.6
EV 11 (SEKm) 75,253 Rep. net inc. (SEKbn) 4.05 4.55 5.28 5.72 Dividend yield (%) 2.5 3.1 3.4 3.7
Market cap. (SEKm) 60,559 EPS (adj.) (SEK) 10.95 12.71 14.22 15.40 Price/book value (x) 2.9 2.6 2.3 2.0
Free float (%) 67.3 Dividend/share (SEK) 4.00 5.10 5.70 6.20 EV/revenues (x) 1.83 1.82 1.61 1.45
Performance (%) 1m 3m 12m Payout (%) 36.2 41.0 39.5 39.6 EV/EBIT (x) 11.5 11.2 9.7 8.6
Ordinary shares -6.2 -4.6 -3.6 Interest cover (x) 8.9 10.0 10.3 13.9 EV/IC (x) 2.0 1.8 1.7 1.6
Rel. Eurofirst 300 -2.9 -3.7 -7.3 Net debt/equity (%) 59.3 62.6 45.4 29.1 ROIC/WACC (x) 1.6 1.5 1.5 1.6
Prev. EPS change (22/06/11) 12.77 14.41 15.70 CAGR 10-13e: +12.0%
Sebastien Gruter
Gael de-Bray
Colin Campbell
(33) 1 42 13 47 22 (33) 1 42 13 84 14 (44) 20 7762 5609
[email protected] [email protected] [email protected]
Societe Generale (‚SG‛) does and seeks to do business with companies covered in its research reports. As a result, investors should be
aware that SG may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a
single factor in making their investment decision. PLEASE SEE APPENDIX AT THE END OF THIS REPORT FOR THE ANALYST(S)
CERTIFICATION(S), IMPORTANT DISCLOSURES AND DISCLAIMERS AND THE STATUS OF NON-US RESEARCH ANALYSTS.
Capital Goods
23 June 2011 35
Sales/division 10
0Eliminations -2%Entrance systems 11%
Global Technologies 14%
Asia Pacific 17%
America 26%
EMEA 35%
EBIT/division 10
0Eliminations -6%
Entrance systems 10%
Asia Pacific 14%
Global Technologies 14%
America 31%
EMEA 36%
Sales/region 10
Africa 2%
Latin America 2%Autralia/NZ 6%
Asia 15%
North. America 32%
Europe 43%
Major shareholders (%)
Investment AB Latour 7.0
Robur unit trusts 6.2
Alecta 4.2
Normalised data
EBITDA margin (%) 18.3
Normalised growth (%) 10.6
Machinery (Sweden) Price (21/06/11) 12m target
Assa Abloy HOLD SEK165.5 SEK170.0 Valuation* (SEKm) 12/06 12/07 12/08 12/09 12/10 12/11e 12/12e 12/13e
Nb. of shares basic year end/outstanding 365.9 365.9 365.9 365.9 365.9 365.9 365.9 365.9
Share price (average) 132.01 145.99 95.54 105.04 159.35 165.50 165.50 165.50
Average market cap. (SG adjusted) (1) 48,304 53,419 34,962 38,438 58,310 60,559 60,559 60,559
Restated net debt (-)/cash (+) (2) -13,560 -12,953 -14,271 -11,292 -10,626 -16,080 -13,535 -10,125
Value of minorities (3) 81 201 226 162 169 209 209 209
Value of financial investments (4) 163 209 356 430 1,595 1,595 1,595 1,595
Other adjustment (5)
EV = (1) - (2) + (3) - (4) + (5) 61,782 66,364 49,103 49,462 67,510 75,253 72,708 69,298
P/E (x) 17.5 16.2 10.7 11.7 14.6 13.0 11.6 10.7
Price/cash flow (x) 16.3 14.1 8.0 6.6 10.3 12.1 10.2 9.4
Price/free cash flow (x) 22.0 17.8 10.0 7.5 11.8 15.0 12.5 11.4
Price/book value (x) 3.7 3.6 1.9 2.0 2.9 2.6 2.3 2.0
EV/revenues (x) 1.98 1.98 1.41 1.41 1.83 1.82 1.61 1.45
EV/EBITDA (x) 10.8 10.4 7.6 7.7 9.6 9.6 8.4 7.4
Dividend yield (%) 2.5 2.5 3.8 3.4 2.5 3.1 3.4 3.7
Per share data (SEK)
SG EPS (adj.) 7.55 9.01 8.91 9.01 10.95 12.71 14.22 15.40
Cash flow 8.08 10.34 11.92 15.87 15.46 13.66 16.23 17.61
Book value 35.82 40.84 49.14 51.41 55.83 63.76 73.05 82.94
Dividend 3.25 3.60 3.60 3.60 4.00 5.10 5.70 6.20
Income statement (SEKm)
Revenues 31,138 33,549 34,918 34,963 36,823 41,456 45,108 47,869
Gross income 11,202 13,923 14,596 13,183 14,836 16,283 17,710 18,835
EBITDA 5,716 6,358 6,433 6,415 7,064 7,844 8,662 9,329
Depreciation and amortisation -898 -909 -921 -1,014 -995 -1,125 -1,200 -1,248
EBIT 4,818 5,449 5,512 5,401 6,069 6,719 7,463 8,081
Impairment losses 0 0 0 0 0 0 0 0
Net interest income -670 -849 -770 -634 -680 -672 -722 -582
Exceptional & non-operating items -1,529 0 -1,257 -1,039 -32 -250 0 0
Taxation -871 -1,241 -1,061 -1,081 -1,286 -1,296 -1,504 -1,823
Minority interests -10 -10 -25 -32 -35 -40 -46 -50
Reported net income 1,746 3,358 2,413 2,627 4,045 4,547 5,284 5,724
SG adjusted net income 2,860 3,413 3,374 3,360 4,084 4,738 5,300 5,740
Cash flow statement (SEKm)
EBITDA 5,716 6,358 6,433 6,415 7,064 7,844 8,662 9,329
Change in working capital -704 -25 -5 1,460 362 -300 -202 -276
Other operating cash movements -1,997 -2,471 -1,994 -1,963 -1,675 -2,468 -2,426 -2,505
Cash flow from operating activities 3,015 3,862 4,434 5,912 5,751 5,076 6,035 6,547
Net capital expenditure -739 -751 -829 -664 -708 -954 -1,083 -1,149
Free cash flow 2,276 3,111 3,605 5,248 5,043 4,123 4,953 5,398
Cash flow from investing activities -3,132 -1,376 -1,819 -1,171 -3,319 -8,479 -635 0
Cash flow from financing activities -1,189 -1,189 -1,317 -1,303 -1,068 -1,464 -1,866 -2,086
Net change in cash resulting from CF -1,273 598 -997 2,967 585 -5,820 2,451 3,312
Balance sheet (SEKm)
Total long-term assets 24,309 25,143 29,727 29,061 32,210 40,518 41,036 40,937
of which intangible 0 0 0 0 0 0 0 0
Working capital 3,996 4,666 5,042 3,633 3,473 3,351 3,553 3,830
Employee benefit obligations 1,297 1,156 1,182 1,182 1,078 1,078 1,078 1,078
Shareholders' equity 13,564 15,467 18,612 19,172 20,821 23,764 27,228 30,916
Minority interests 81 201 226 162 169 209 209 209
Provisions 973 896 1,591 1,954 4,067 3,817 3,617 3,517
Net debt (-)/cash (+) -12,390 -11,970 -13,088 -10,110 -12,448 -15,002 -12,457 -9,047
Accounting ratios
ROIC (%) 12.5 14.2 12.9 12.1 13.5 12.8 12.8 13.7
ROE (%) 12.5 23.1 14.2 13.9 20.2 20.4 20.7 19.7
Gross income/revenues (%) 36.0 41.5 41.8 37.7 40.3 39.3 39.3 39.3
EBITDA margin (%) 18.4 19.0 18.4 18.3 19.2 18.9 19.2 19.5
EBIT margin (%) 15.5 16.2 15.8 15.4 16.5 16.2 16.5 16.9
Revenue yoy growth (%) 12.0 7.7 4.1 0.1 5.3 12.6 8.8 6.1
Rev. organic growth (%) 8.9 7.1 0.4 -11.7 2.6 5.3 5.5 6.1
EBITDA yoy growth (%) 15.4 11.2 1.2 -0.3 10.1 11.0 10.4 7.7
EBIT yoy growth (%) 18.4 13.1 1.2 -2.0 12.4 10.7 11.1 8.3
EPS (adj.) yoy growth (%) 8.3 19.3 -1.1 1.1 21.5 16.1 11.9 8.3
Dividend growth (%) 0.0 10.8 0.0 0.0 11.1 27.5 11.8 8.8
Cash conversion (%) 81.8 93.8 91.9 123.3 103.8 90.6 96.2 96.6
Net debt/equity (%) 90.8 76.4 69.5 52.3 59.3 62.6 45.4 29.1
FFO/net debt (%) 30.8 32.9 32.2 41.6 48.0 36.5 47.6 68.4
Dividend paid/FCF (%) 52.3 42.3 36.5 25.1 29.0 45.3 42.1 42.0
In red: IFRS Data
* Valuation ratios for past years are based on average historical prices and market capitalisations
Capital Goods
23 June 2011 36
Machinery (Sweden)
ATLAS COPCO Rating downgrade Concerns over Chinese growth should limit further outperformance
Exposure to China Atlas Copco’s direct exposure to the Chinese construction theme is
rather limited, representing c.3% of group revenues in 2010 on our estimates. However, the
group’s indirect exposure is sizeable with the group deriving 26% of its sales from the mining
industry. Atlas Copco has mainly benefited from the Chinese growth story through its mining
equipment business. Indeed, we calculate that China contributed c.20% of Atlas Copco
organic sales growth between 2004 and 2010, while mining contributed c.55%. Atlas
Copco’s revenues from China increased from SEK1.5bn to SEK7.8bn between 2004 and
2010 and now represent some 11% of group revenues.
Chinese competition threat We believe that the risk from Chinese competition over the short
and medium term is rather limited thanks to Atlas Copco’s dominant market positioning,
multi-brand strategy, large dealer network and protected IP technology. However, in its
construction division, Atlas is only positioned in the high-end segment and thus seems more
exposed. Technology still gives the group a major edge, although Chinese competitors are
quickly moving up the value chain. In its mining business, Atlas’ low exposure to the coal
industry makes it less vulnerable to the Chinese competition.
Target price & rating Reflecting a more cautious outlook for mining capex, we have reduced
our EPS forecasts by 7% for 2012e and 13% for 2013e and cut our target price from
SEK200 to SEK150. Our TP is derived from a DCF inputting WACC of 9.6%, 2.5% LT growth
and a 21% normalised margin. Despite Atlas’ strong business model and excellent
management track record, we believe the growing uncertainty on Chinese growth and mining
capex outlook should prevent the shares’ premium from expanding further. We downgrade
the stock to Hold from Buy. On our new forecasts (standing 6% below the street), the shares
trade at 10.0x EV/EBIT for 2012e, a 20% premium to the sector average. The key upside
(downside) risks to the stock achieving our TP are from higher (lower) commodity prices and
stronger- (weaker-) than-expected growth in emerging markets.
Next events & catalysts Q2 results on 18 July
Hold (12m)
(from Buy)
Price 21/06/11 12m target
SEK160.9 SEK150.0
Sector
Weighting
Overweight
Preferred stock
Siemens
Least preferred stock
Sandvik
Type of investment
Growth
Counter consensus forecast
1 year
Price MA 100
90
120
150
180
2010 2011
0
6.5
13
19.5(m)
2010 2011
Source: SG Cross Asset Research
Atlas Copco
on www.sgresearch.com
Share data Financial data 12/10 12/11e 12/12e 12/13e Ratios 12/10 12/11e 12/12e 12/13e
RIC ATCOa.ST, Bloom ATCOA SS Revenues (SEKbn) 69.88 78.76 85.57 89.38 P/E (x) 14.3 15.3 14.0 13.1
52-week range 177.4-111.1 EBIT margin (%) 20.8 22.2 22.3 22.6 FCF yield (/EV) (%) 5.5 5.6 6.6 7.7
EV 11 (SEKm) 197,299 Rep. net inc. (SEKbn) 9.89 12.44 13.60 14.59 Dividend yield (%) 3.3 3.2 3.5 3.7
Market cap. (SEKm) 189,358 EPS (adj.) (SEK) 8.56 10.51 11.47 12.28 Price/book value (x) 5.1 6.4 5.1 4.3
Free float (%) 73.5 Dividend/share (SEK) 4.00 5.10 5.60 6.00 EV/revenues (x) 2.76 2.51 2.24 2.06
Performance (%) 1m 3m 12m Payout (%) 49.2 49.9 50.1 50.0 EV/EBIT (x) 13.5 11.3 10.0 9.1
Ordinary shares -1.9 -0.1 29.9 Interest cover (x) 17.6 21.9 23.9 25.2 EV/IC (x) 5.3 4.8 4.5 4.2
Rel. Eurofirst 300 1.6 0.9 24.9 Net debt/equity (%) 20.0 25.0 4.2 nm ROIC/WACC (x) 3.1 3.5 3.6 3.7
Prev. EPS change (22/06/11) 10.57 12.41 14.15 CAGR 10-13e: +12.8%
Sebastien Gruter
Gael de-Bray
Colin Campbell
(33) 1 42 13 47 22 (33) 1 42 13 84 14 (44) 20 7762 5609
[email protected] [email protected] [email protected]
Societe Generale (‚SG‛) does and seeks to do business with companies covered in its research reports. As a result, investors should be
aware that SG may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a
single factor in making their investment decision. PLEASE SEE APPENDIX AT THE END OF THIS REPORT FOR THE ANALYST(S)
CERTIFICATION(S), IMPORTANT DISCLOSURES AND DISCLAIMERS AND THE STATUS OF NON-US RESEARCH ANALYSTS.
Capital Goods
23 June 2011 37
Sales/division 10
0Eliminations -0%Industrial Technique 8%
Construction & Mining 41%
Compressor Technique 51%
EBIT/division 10
Industrial Technique 3%
Construction & Mining 37%
Compressor Technique 61%
Sales/region 10
Autralia/NZ 5%
Latin America 10%
Africa 12%
North. America 16%
Asia 21%
Europe 36%
Major shareholders (%)
Investor 15.0
ForeningsSparbanken 4.6
Alecta 3.5
Normalised data
EBITDA margin (%) 23.8
Normalised growth (%) 13.7
Machinery (Sweden) Price (21/06/11) 12m target
Atlas Copco HOLD SEK160.9 SEK150.0 Valuation* (SEKm) 12/06 12/07 12/08 12/09 12/10 12/11e 12/12e 12/13e
Nb. of shares basic year end/outstanding 839.4 839.4 828.1 828.1 828.1 828.1 828.1 828.1
Share price (average) 84.07 106.07 86.06 80.28 122.30 160.90 160.90 160.90
Average market cap. (SG adjusted) (1) 139,178 177,839 154,645 136,388 186,585 189,358 189,358 189,358
Restated net debt (-)/cash (+) (2) 12,364 -19,800 -23,247 -12,040 -7,428 -9,282 -3,189 4,034
Value of minorities (3) 92 116 141 162 180 218 259 302
Value of financial investments (4) 2,542 3,413 1,533 1,559 1,559 1,559 1,559 1,559
Other adjustment (5) 0
EV = (1) - (2) + (3) - (4) + (5) 124,364 194,343 176,500 147,031 192,634 197,299 191,246 184,068
P/E (x) 16.1 16.5 10.1 14.2 14.3 15.3 14.0 13.1
Price/cash flow (x) 11.5 16.5 11.7 9.7 19.6 17.3 17.3 11.8
Price/free cash flow (x) nm 23.3 17.2 6.8 15.2 18.1 15.9 13.9
Price/book value (x) 3.2 9.0 4.4 3.8 5.1 6.4 5.1 4.3
EV/revenues (x) 2.46 3.07 2.38 2.31 2.76 2.51 2.24 2.06
EV/EBITDA (x) 11.2 12.9 10.9 12.2 11.6 10.0 9.0 8.1
Dividend yield (%) 2.8 2.8 3.5 3.7 3.3 3.2 3.5 3.7
Per share data (SEK)
SG EPS (adj.) 5.23 6.43 8.52 5.66 8.56 10.51 11.47 12.28
Cash flow 7.32 6.41 7.37 8.29 6.22 9.33 9.33 13.69
Book value 25.98 11.81 19.43 20.98 23.97 25.20 31.29 37.69
Dividend 2.38 3.00 3.00 3.00 4.00 5.10 5.60 6.00
Income statement (SEKm)
Revenues 50,512 63,355 74,177 63,762 69,875 78,756 85,568 89,380
Gross income 17,174 20,907 24,478 21,042 26,407 30,762 33,282 35,353
EBITDA 11,057 15,037 16,144 12,052 16,663 19,678 21,362 22,756
Depreciation and amortisation -1,511 -1,596 -1,832 -2,171 -2,151 -2,192 -2,270 -2,570
EBIT 9,546 13,441 14,312 9,881 14,512 17,487 19,092 20,186
Impairment losses -127 -204 -248 -299 -347 -347 -347 -347
Net interest income -508 -2,382 -694 -819 -420 -281 -308 -64
Exceptional & non-operating items -83 -1,171 -258 -492 -250 0 0 0
Taxation -2,435 -3,118 -3,106 -1,995 -3,576 -4,383 -4,794 -5,142
Minority interests -24 -30 -33 -32 -30 -38 -41 -44
Reported net income 15,482 6,589 10,157 6,244 9,889 12,438 13,602 14,589
SG adjusted net income 6,579 7,911 10,402 6,887 10,411 12,785 13,949 14,936
Cash flow statement (SEKm)
EBITDA 11,057 15,037 16,144 12,052 16,663 19,678 21,362 22,756
Change in working capital -2,353 -2,326 -2,991 6,715 -1,730 -1,689 -1,295 -725
Other operating cash movements -4,165 -3,861 -4,012 -3,460 -3,513 -4,825 -5,272 -5,381
Cash flow from operating activities 4,539 8,850 9,141 15,307 11,420 13,165 14,795 16,650
Net capital expenditure -7,106 -3,262 -3,029 -1,055 -1,606 -2,346 -2,500 -2,619
Free cash flow -2,567 5,588 6,112 14,252 9,814 10,818 12,295 14,031
Cash flow from investing activities 21,636 -6,614 -1,364 -171 -1,666 0 0 0
Cash flow from financing activities -6,452 -27,344 -4,120 -3,652 -3,266 -10,939 -6,201 -6,809
Net change in cash resulting from CF 12,617 -28,371 628 10,429 4,882 -120 6,094 7,222
Balance sheet (SEKm)
Total long-term assets 13,216 22,710 23,916 27,302 26,866 28,647 28,700 28,577
of which intangible 0 0 0 0 0 0 0 0
Working capital 9,084 14,049 19,676 12,874 13,288 14,977 16,272 16,997
Employee benefit obligations 1,647 1,728 1,922 1,768 1,578 1,578 1,578 1,578
Shareholders' equity 32,677 14,524 23,627 25,509 29,141 30,641 38,041 45,822
Minority interests 92 116 141 162 180 218 259 302
Provisions
Net debt (-)/cash (+) 14,011 -18,072 -21,325 -10,272 -5,850 -7,704 -1,611 5,612
Accounting ratios
ROIC (%) 19.8 33.2 28.2 18.7 29.9 33.8 34.5 35.3
ROE (%) 53.0 27.9 53.2 25.4 36.2 41.6 39.6 34.8
Gross income/revenues (%) 34.0 33.0 33.0 33.0 37.8 39.1 38.9 39.6
EBITDA margin (%) 21.9 23.7 21.8 18.9 23.8 25.0 25.0 25.5
EBIT margin (%) 18.9 21.2 19.3 15.5 20.8 22.2 22.3 22.6
Revenue yoy growth (%) -4.2 25.4 17.1 -14.0 9.6 12.7 8.6 4.5
Rev. organic growth (%) 17.6 18.2 11.7 -21.7 12.4 20.1 9.0 4.5
EBITDA yoy growth (%) -13.1 36.0 7.4 -25.3 38.3 18.1 8.6 6.5
EBIT yoy growth (%) 1.5 40.8 6.5 -31.0 46.9 20.5 9.2 5.7
EPS (adj.) yoy growth (%) 3.7 23.0 32.4 -33.5 51.2 22.8 9.1 7.1
Dividend growth (%) 11.8 26.3 0.0 0.0 33.3 27.5 9.8 7.1
Cash conversion (%) 12.8 69.3 70.2 178.0 93.6 88.5 91.1 95.3
Net debt/equity (%) nm 123.4 89.7 40.0 20.0 25.0 4.2 nm
FFO/net debt (%) nm 48.2 53.1 76.7 170.5 161.7 nm nm
Dividend paid/FCF (%) nm 66.0 59.7 25.6 49.6 57.3 55.4 52.0
* Valuation ratios for past years are based on average historical prices and market capitalisations
Capital Goods
23 June 2011 38
Machinery (Sweden)
SANDVIK Rating downgrade Further underperformance driven by clouded outlook on mining capex cycle
Exposure to China Sandvik’s direct exposure to the Chinese construction theme is largely
inexistent (around 1% of group sales). However, the group is by far the most exposed stock
to the mining industry (more than one-third of group sales) within our coverage. As a result,
Sandvik has benefited from the Chinese growth story through its mining equipment business,
with mining contributing c.70% of the group’s organic sales growth between 2004 and 2010.
Sandvik’s revenues from China increased from SEK1.5bn to SEK5.5bn between 2004 and
2010 and now represent some 7% of group sales. A bursting of the Chinese construction
bubble would predominantly impact Sandvik through its mining equipment business.
Chinese competition threat Sandvik’s exposure to Chinese competition is limited, although
we expect the group to face increasing competitive pressure in its Materials Technology and
Mining businesses (notably for coal). In respect of coal, Sandvik took steps to protect its
business by forming a JV with Shandong for roadheaders.
Target price & rating Reflecting a more cautious outlook on mining capex, we have reduced
our EPS forecasts by 6% for 2012e and 13% for 2013e and cut our target price from
SEK115 to SEK90. It is derived from a DCF inputting WACC of 9.6%, 2.5% LT growth and a
14% normalised margin. Since we do not expect new management to radically change the
group’s vertical integration, Sandvik should remain overly leveraged to volume outlook and
therefore, in times of uncertainty, we believe the risk/reward ratio is skewed to the downside.
This, allied to the overhang stemming from the low visibility on Chinese growth/mining capex
outlook means that underperformance is likely to continue. We downgrade our rating from
Hold to Sell. On our new forecasts (standing 8% below the Street), the shares trade at 9.5x
EV/EBIT for 2012e, a 15% premium to the sector average. The key upside risk to our TP
would come from higher commodity prices.
Next events & catalysts Q2 results on 19 July.
Sell (12m)
(from Hold)
Price 21/06/11 12m target
SEK108.3 SEK90.0
Sector
Weighting
Overweight
Preferred stock
Siemens
Least preferred stock
Sandvik
Type of investment
Overvalued
Growth
Counter consensus forecast
1 year
Price MA 100
70
95
120
145
2010 2011
0
7.5
15
22.5
(m)
2010 2011
Source: SG Cross Asset Research
Sandvik
on www.sgresearch.com
Share data Financial data 12/10 12/11e 12/12e 12/13e Ratios 12/10 12/11e 12/12e 12/13e
RIC SAND.ST, Bloom SAND SS Revenues (SEKbn) 82.66 92.96 99.13 101.90 P/E (x) 16.7 14.1 12.4 11.7
52-week range 134.9-85.9 EBIT margin (%) 13.5 15.3 16.0 16.3 FCF yield (/EV) (%) 6.9 4.8 6.6 6.9
EV 11 (SEKm) 156,678 Rep. net inc. (SEKbn) 6.61 8.95 10.13 10.75 Dividend yield (%) 3.2 3.9 4.3 4.6
Market cap. (SEKm) 128,475 EPS (adj.) (SEK) 5.85 7.69 8.74 9.25 Price/book value (x) 3.3 3.2 2.8 2.6
Free float (%) 63.2 Dividend/share (SEK) 3.10 4.20 4.70 5.00 EV/revenues (x) 1.73 1.69 1.55 1.48
Performance (%) 1m 3m 12m Payout (%) 55.7 55.7 55.0 55.2 EV/EBIT (x) 13.6 10.8 9.5 9.0
Ordinary shares -7.2 -7.8 3.1 Interest cover (x) 6.5 9.3 10.7 12.8 EV/IC (x) 2.4 2.3 2.2 2.1
Rel. Eurofirst 300 -3.9 -6.9 -0.8 Net debt/equity (%) 61.1 55.6 42.5 32.2 ROIC/WACC (x) 1.3 1.7 1.8 1.8
Prev. EPS change (22/06/11) 7.79 9.33 10.68 CAGR 10-13e: +16.5%
Sebastien Gruter
Gael de-Bray
Colin Campbell
(33) 1 42 13 47 22 (33) 1 42 13 84 14 (44) 20 7762 5609
[email protected] [email protected] [email protected]
Societe Generale (‚SG‛) does and seeks to do business with companies covered in its research reports. As a result, investors should be
aware that SG may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a
single factor in making their investment decision. PLEASE SEE APPENDIX AT THE END OF THIS REPORT FOR THE ANALYST(S)
CERTIFICATION(S), IMPORTANT DISCLOSURES AND DISCLAIMERS AND THE STATUS OF NON-US RESEARCH ANALYSTS.
Capital Goods
23 June 2011 39
Sales/division 10
Other 0%
Seco tools 7%
Materials technology 21%
Tooling 29%
Mining & Construction 43%
EBIT/division 10
0Other -5%
Seco tools 10%
Materials technology 14%
Tooling 39%
Mining & Construction 42%
Sales/region 10
Latin America 7%Africa 10%
Autralia/NZ 10%
North. America 15%
Asia 17%
Europe 41%
Major shareholders (%)
AB Industrivarden 10.4
JP Morgan Chase Bank 9.8
State Street Bank and Trus Co 6.3
Normalised data
EBITDA margin (%) 19.0
Normalised growth (%) 8.2
Machinery (Sweden) Price (21/06/11) 12m target
Sandvik SELL SEK108.3 SEK90.0 Valuation* (SEKm) 12/06 12/07 12/08 12/09 12/10 12/11e 12/12e 12/13e
Nb. of shares basic year end/outstanding 1,186.3 1,186.3 1,186.3 1,186.3 1,186.3 1,186.3 1,186.3 1,186.3
Share price (average) 85.74 125.02 82.31 64.58 97.69 108.30 108.30 108.30
Average market cap. (SG adjusted) (1) 101,716 148,311 97,645 76,615 115,883 128,475 128,475 128,475
Restated net debt (-)/cash (+) (2) -13,630 -26,840 -32,130 -29,140 -21,949 -23,025 -19,849 -16,730
Value of minorities (3) 7,897 6,132 5,291 4,398 6,763 6,823 6,844 7,421
Value of financial investments (4) 2,315 3,779 4,352 1,645 1,645 1,645 1,645 1,645
Other adjustment (5) 0 0 0 0 0 0 0
EV = (1) - (2) + (3) - (4) + (5) 120,928 177,504 130,714 108,507 142,950 156,678 153,523 150,980
P/E (x) 13.2 16.2 12.4 nm 16.7 14.1 12.4 11.7
Price/cash flow (x) 12.4 27.1 10.1 6.2 9.4 12.2 9.7 8.9
Price/free cash flow (x) 25.2 305.2 33.9 9.5 12.9 21.3 15.0 14.0
Price/book value (x) 3.9 5.2 2.7 2.6 3.3 3.2 2.8 2.6
EV/revenues (x) 1.67 2.06 1.41 1.51 1.73 1.69 1.55 1.48
EV/EBITDA (x) 7.9 10.0 7.5 15.8 9.0 8.4 7.5 7.1
Dividend yield (%) 3.8 3.2 3.8 1.5 3.2 3.9 4.3 4.6
Per share data (SEK)
SG EPS (adj.) 6.48 7.73 6.63 -0.35 5.85 7.69 8.74 9.25
Cash flow 6.89 4.62 8.15 10.38 10.38 8.88 11.20 12.11
Book value 22.04 24.12 30.00 24.43 29.25 33.81 38.22 42.18
Dividend 3.25 4.00 3.15 1.00 3.10 4.20 4.70 5.00
Income statement (SEKm)
Revenues 72,289 86,338 92,654 71,937 82,657 92,955 99,130 101,904
Gross income 25,205 30,362 31,092 17,066 29,527 34,079 36,911 38,968
EBITDA 15,044 17,471 16,538 5,263 15,215 18,042 19,845 20,645
Depreciation and amortisation -2,976 -3,077 -3,444 -4,049 -4,038 -3,843 -3,944 -4,048
EBIT 12,068 14,394 13,094 1,214 11,177 14,200 15,901 16,597
Impairment losses 0 0 0 0 0 0 0 0
Net interest income -955 -1,397 -2,217 -2,061 -1,616 -1,427 -1,382 -1,191
Exceptional & non-operating items 0 0 -300 -2,625 -148 80 0 0
Taxation -3,006 -3,404 -2,741 876 -2,470 -3,406 -3,848 -4,083
Minority interests -406 -478 -364 -56 -338 -495 -537 -576
Reported net income 7,701 9,115 7,472 -2,652 6,605 8,952 10,135 10,747
SG adjusted net income 7,684 9,171 7,870 -411 6,944 9,123 10,364 10,976
Cash flow statement (SEKm)
EBITDA 15,044 17,471 16,538 5,263 15,215 18,042 19,845 20,645
Change in working capital -2,920 -6,567 -1,348 11,632 49 -2,876 -1,513 -1,189
Other operating cash movements -3,954 -5,428 -5,519 -4,583 -2,951 -4,633 -5,049 -5,094
Cash flow from operating activities 8,170 5,476 9,671 12,312 12,313 10,534 13,283 14,362
Net capital expenditure -4,133 -4,990 -6,788 -4,212 -3,332 -4,490 -4,690 -5,190
Free cash flow 4,037 486 2,883 8,100 8,981 6,044 8,593 9,172
Cash flow from investing activities -1,191 -5,493 -843 -1,981 -1,215 -1,000 0 0
Cash flow from financing activities -2,912 5,286 724 -3,926 -1,187 -3,969 -5,417 -6,053
Net change in cash resulting from CF -66 361 2,992 2,193 6,579 1,075 3,176 3,119
Balance sheet (SEKm)
Total long-term assets 27,581 36,099 42,947 46,354 47,109 49,027 49,593 50,554
of which intangible 1,095 2,492 2,641 2,641 2,641 2,641 2,641 2,641
Working capital 20,614 29,040 34,562 20,985 19,898 22,774 24,287 25,476
Employee benefit obligations 3,180 3,100 2,735 2,735 2,735 2,735 2,735 2,735
Shareholders' equity 26,146 28,614 35,588 28,984 34,693 40,112 45,345 50,039
Minority interests 1,052 1,209 1,137 970 1,233 1,293 1,314 1,890
Provisions 2,158 830 1,204 742 132 132 132 132
Net debt (-)/cash (+) -13,630 -26,840 -32,130 -29,140 -21,949 -23,025 -19,849 -16,730
Accounting ratios
ROIC (%) 19.4 19.1 13.8 1.3 12.9 15.9 16.9 17.0
ROE (%) 31.0 33.3 23.3 -8.2 20.7 23.9 23.7 22.5
Gross income/revenues (%) 34.9 35.2 33.6 23.7 35.7 36.7 37.2 38.2
EBITDA margin (%) 20.8 20.2 17.8 7.3 18.4 19.4 20.0 20.3
EBIT margin (%) 16.7 16.7 14.1 1.7 13.5 15.3 16.0 16.3
Revenue yoy growth (%) 14.1 19.4 7.3 -22.4 14.9 12.5 6.6 2.8
Rev. organic growth (%) 12.0 14.0 9.1 -27.9 15.4 19.0 6.3 2.8
EBITDA yoy growth (%) 24.4 16.1 -5.3 -68.2 nm 18.6 10.0 4.0
EBIT yoy growth (%) 28.6 19.3 -9.0 -90.7 nm 27.0 12.0 4.4
EPS (adj.) yoy growth (%) 28.8 19.3 -14.2 -105.2 nm 31.4 13.6 5.9
Dividend growth (%) 20.4 23.1 -21.2 -68.3 nm 35.5 11.9 6.4
Cash conversion (%) 64.8 37.6 62.0 918.5 105.3 77.4 87.7 87.8
Net debt/equity (%) 50.1 90.0 87.5 97.3 61.1 55.6 42.5 32.2
FFO/net debt (%) 81.3 47.2 36.0 14.0 50.7 57.4 73.6 91.9
Dividend paid/FCF (%) 95.5 976.4 129.6 14.6 40.9 82.4 64.9 64.7
* Valuation ratios for past years are based on average historical prices and market capitalisations
Capital Goods
23 June 2011 40
Electrical Equipment (France)
SCHNEIDER Rating reiterated Compelling valuation and energy-efficiency theme overshadow Chinese construction risk
Exposure to China Schneider derives around 12% of its sales from China, around 35% of
which come from the construction markets. The group’s sales in China grew from €415m in
2004 to €2,269m in 2010 and we estimate that this country alone contributed to one-third of
the group’s organic sales growth over the period. Schneider’s presence in China is broad-
based, including product development, local production and commercial activity, with a vast
and diffuse distribution network. Schneider has 10% of its workforce in China, and this
China-based headcount should be further reinforced by the recent acquisition of Leader
Harvest (750 employees in the medium-voltage drives segment). In China, Schneider offers a
complete range of low- and medium-voltage products, as well as secure power and
industrial automation products. The group is also active in the low-end market through a 50-
50 JV (created in 2007) with the Delixi Group, focusing on the needs in the Chinese low-
voltage market via a distinct market approach.
Chinese competition threat Most of Schneider’s businesses (low voltage, discrete
automation, building automation, secure power) are characterized by high entry costs and
solid barriers to entry. Schneider has one of the most deeply rooted networks in China and is
increasingly active in the tier-2 and -3 cities. The group should also continue to benefit from
structurally strong growth for energy-efficient solutions in the industrial markets.
Target price & rating We reiterate our Buy rating with a DCF-based TP of €140 (norm. EBITA
margin 15%, WACC 8.4%, LT growth rate 2.5%). With the Luminous, Telvent and Leader
Harvest deals, we believe management has further underlined its willingness to grow
externally through small-/medium-sized deals focused on emerging markets and energy
efficiency. This should alleviate investors’ concerns about a potential large-scale and value-
destroying acquisition and help the shares to re-rate. Risks to our TP: a slowdown in
emerging markets.
Next events & catalysts H1 results on 29 July. We expect H1 sales to rise by 21%, including
10.6% organic growth and an 11.2% consolidation effect. H1 EBITA is forecast at €1,537m,
up 25%, with a margin of 14.8%, up 50bp.
Buy (12m)
Price 21/06/11 12m target
€113.3 €140.0
Sector
Weighting
Overweight
Preferred stock
Siemens
Least preferred stock
Sandvik
M&A
1 year
Price MA 100
70
90
110
130
2010 2011
0
1.5
3
4.5
(m)
2010 2011
Source: SG Cross Asset Research
Schneider
on www.sgresearch.com
Share data Financial data 12/10 12/11e 12/12e 12/13e Ratios 12/10 12/11e 12/12e 12/13e
RIC SCHN.PA, Bloom SU FP Revenues (€bn) 19.58 22.34 24.85 26.41 P/E (x) 12.5 13.2 11.3 10.2
52-week range 123.2-80.2 EBIT margin (%) 15.0 15.9 16.3 16.6 FCF yield (/EV) (%) 6.1 6.3 7.5 8.6
EV 11 (€m) 38,089 Rep. net inc. (€bn) 1.72 2.14 2.51 2.80 Dividend yield (%) 3.6 3.5 4.0 4.9
Market cap. (€m) 30,813 EPS (adj.) (€) 7.19 8.61 10.04 11.10 Price/book value (x) 1.7 1.9 1.8 1.6
Free float (%) 81.8 Dividend/share (€) 3.20 4.00 4.50 5.50 EV/revenues (x) 1.42 1.71 1.42 1.29
Performance (%) 1m 3m 12m Payout (%) 49.7 50.1 47.9 52.6 EV/EBIT (x) 11.6 10.7 8.7 7.8
Ordinary shares 0.3 -2.7 22.8 Interest cover (x) 8.4 9.1 11.9 17.4 EV/IC (x) 1.6 1.6 1.4 1.4
Rel. Eurofirst 300 3.6 -2.1 17.3 Net debt/equity (%) 18.3 36.8 17.4 8.4 ROIC/WACC (x) 1.2 1.3 1.3 1.4
Prev. EPS change (22/06/11) 8.69 9.90 10.99 CAGR 10-13e: +15.5%
Gael de-Bray
Adrien de-Susanne
Colin Campbell
(33) 1 42 13 84 14 (33) 1 42 13 01 61 (44) 20 7762 5609
[email protected] [email protected] [email protected]
Societe Generale (‚SG‛) does and seeks to do business with companies covered in its research reports. As a result, investors should be
aware that SG may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a
single factor in making their investment decision. PLEASE SEE APPENDIX AT THE END OF THIS REPORT FOR THE ANALYST(S)
CERTIFICATION(S), IMPORTANT DISCLOSURES AND DISCLAIMERS AND THE STATUS OF NON-US RESEARCH ANALYSTS.
P
R
E
M
I
U
M
L
I
S
T
Capital Goods
23 June 2011 41
Sales/division 10
CST 2%Buildings 7%IT 14%
Industry 18%
Power 59%
EBIT/division 10
CST 2%Buildings 4%IT 13%
Industry 19%
Power 62%
Sales/region 10
Others 18%
Asia 24%
North. America 25%
Europe 33%
Major shareholders (%)
Capital research 8.2
CDC 4.2
Employees 4.1
Normalised data
EBITDA margin (%) 16.6
Normalised growth (%) 4.5
Electrical Equipment (France) Price (21/06/11) 12m target
Schneider BUY €113.3 €140.0 Valuation* (€m) 12/06 12/07 12/08 12/09 12/10 12/11e 12/12e 12/13e
Nb. of shares basic year end/outstanding 227.7 245.3 247.4 262.8 272.0 272.0 272.0 272.0
Share price (average) 82.84 96.02 68.34 60.48 89.97 113.30 113.30 113.30
Average market cap. (SG adjusted) (1) 18,861 23,553 16,910 15,892 24,468 30,813 30,813 30,813
Restated net debt (-)/cash (+) (2) -2,569 -5,579 -5,530 -3,855 -3,817 -7,088 -4,187 -2,723
Value of minorities (3) 558 576 492 756 1,140 1,443 1,589 1,907
Value of financial investments (4) 520 704 674 482 911 927 945 965
Other adjustment (5) -490 -794 -497 -891 -786 -328 -328 -328
EV = (1) - (2) + (3) - (4) + (5) 20,978 28,211 21,761 19,130 27,728 38,089 35,316 34,150
P/E (x) 13.9 13.9 9.0 15.2 12.5 13.2 11.3 10.2
Price/cash flow (x) 11.6 10.9 6.5 5.6 10.5 11.6 10.2 8.9
Price/free cash flow (x) 16.6 14.9 9.0 7.2 13.7 15.2 13.3 11.3
Price/book value (x) 2.2 2.3 1.6 1.4 1.7 1.9 1.8 1.6
EV/revenues (x) 1.53 1.63 1.19 1.21 1.42 1.71 1.42 1.29
EV/EBITDA (x) 8.8 9.5 6.8 8.3 8.0 9.0 7.7 7.0
Dividend yield (%) 3.6 3.4 5.0 3.4 3.6 3.5 4.0 4.9
Per share data (€)
SG EPS (adj.) 5.96 6.93 7.63 3.98 7.19 8.61 10.04 11.10
Cash flow 7.16 8.83 10.45 10.74 8.59 9.78 11.08 12.71
Book value 38.28 41.52 44.08 44.75 54.36 58.96 64.15 69.90
Dividend 3.00 3.30 3.45 2.05 3.20 4.00 4.50 5.50
Income statement (€m)
Revenues 13,730 17,309 18,311 15,793 19,580 22,339 24,845 26,405
Gross income 5,679 7,099 7,415 6,221 7,738 8,935 10,062 10,773
EBITDA 2,394 2,977 3,209 2,306 3,448 4,080 4,563 4,876
Depreciation and amortisation -375 -416 -455 -483 -517 -529 -506 -503
EBIT 2,019 2,562 2,754 1,823 2,931 3,551 4,057 4,373
Impairment losses 0 0 0 0 0 0 0 0
Net interest income -121 -266 -314 -384 -347 -389 -341 -251
Exceptional & non-operating items 0 0 0 0 0 0 0 0
Taxation -535 -600 -555 -293 -566 -716 -866 -967
Minority interests -37 -38 -41 -42 -76 -87 -105 -126
Reported net income 1,310 1,583 1,682 852 1,720 2,136 2,511 2,796
SG adjusted net income 1,323 1,640 1,833 986 1,893 2,317 2,700 2,985
Cash flow statement (€m)
EBITDA 2,394 2,977 3,209 2,306 3,448 4,080 4,563 4,876
Change in working capital -333 -121 -72 813 -206 -331 -363 -226
Other operating cash movements -472 -767 -628 -454 -980 -1,117 -1,219 -1,230
Cash flow from operating activities 1,588 2,090 2,509 2,665 2,262 2,632 2,981 3,419
Net capital expenditure -481 -560 -693 -576 -528 -632 -682 -723
Free cash flow 1,107 1,529 1,816 2,089 1,734 2,000 2,299 2,697
Cash flow from investing activities -735 -5,317 -587 -103 -1,749 -2,646 0 0
Cash flow from financing activities -547 666 -783 -125 89 -923 -1,100 -1,233
Net change in cash resulting from CF -174 -3,121 446 1,861 74 -1,569 1,199 1,464
Balance sheet (€m)
Total long-term assets 10,181 14,193 15,221 15,077 17,913 20,489 20,443 20,442
of which intangible 1,493 3,714 3,991 3,919 4,258 5,511 5,402 5,313
Working capital 2,273 2,819 2,706 2,164 2,908 3,239 3,603 3,829
Employee benefit obligations 1,159 996 1,463 1,491 1,504 1,504 1,504 1,504
Shareholders' equity 8,717 10,185 10,906 11,757 14,785 16,036 17,447 19,010
Minority interests 122 129 145 131 204 291 396 522
Provisions 660 786 860 1,052 1,592 1,592 1,592 1,592
Net debt (-)/cash (+) -1,798 -4,918 -4,553 -2,812 -2,736 -6,007 -3,106 -1,642
Accounting ratios
ROIC (%) 11.7 11.9 10.9 7.1 10.7 11.3 12.1 12.9
ROE (%) 15.4 16.8 16.0 7.5 13.0 13.9 15.0 15.3
Gross income/revenues (%) 41.4 41.0 40.5 39.4 39.5 40.0 40.5 40.8
EBITDA margin (%) 17.4 17.2 17.5 14.6 17.6 18.3 18.4 18.5
EBIT margin (%) 14.7 14.8 15.0 11.5 15.0 15.9 16.3 16.6
Revenue yoy growth (%) 17.6 26.1 5.8 -13.8 24.0 14.1 11.2 6.3
Rev. organic growth (%) 10.7 13.9 6.6 -15.7 9.3 9.5 7.1 6.3
EBITDA yoy growth (%) 23.8 24.4 7.8 -28.1 49.5 18.3 11.8 6.9
EBIT yoy growth (%) 28.0 26.9 7.5 -33.8 60.8 21.2 14.2 7.8
EPS (adj.) yoy growth (%) 30.1 16.2 10.2 -47.9 80.9 19.7 16.6 10.6
Dividend growth (%) 36.4 10.0 4.5 -40.6 56.1 25.0 12.5 22.2
Cash conversion (%) 87.3 93.1 97.5 151.7 90.3 87.4 86.4 89.5
Net debt/equity (%) 20.3 47.7 41.2 23.7 18.3 36.8 17.4 8.4
FFO/net debt (%) 67.6 37.8 42.3 42.3 66.4 42.0 80.2 134.3
Dividend paid/FCF (%) 60.1 51.1 45.6 25.1 49.3 53.5 52.3 54.5
* Valuation ratios for past years are based on average historical prices and market capitalisations
Capital Goods
23 June 2011 42
Machinery (Sweden)
VOLVO 12m target downgrade Weakening Chinese construction equipment data likely to weigh on the share
Exposure to China Volvo’s direct exposure to the Chinese construction theme mainly stems
from its Construction Equipment (CE) division (21% of group revenues in 2010). We estimate
that, thanks to its Volvo and Lingong brands, the group’s construction equipment sales in
China should account for 8% of the group’s revenues this year. Volvo is also indirectly
exposed to the Chinese construction theme via its mining business (mostly hydraulic
excavators and trucks). Volvo’s revenues in China increased from SEK6bn (3% of group
revenues) to almost SEK23bn (9% of group revenues) between 2004 and 2010. The bulk of
the growth came from CE and the successful integration of Lingong (acquired in 2007). We
calculate that more than half of Volvo CE’s organic sales growth between 2004 and 2010
came from China.
Chinese competition threat Volvo does not face a significant threat from Chinese
competition within its Truck and Construction Equipment businesses in the short term.
However, in both industries, Chinese players are eager to play a bigger role internationally
with a particular focus on emerging markets. At CE, Volvo has developed a dual-brand
strategy to target the medium- and high-end markets, allowing the group to compete on a
level playing field with the Chinese players. In its Truck business, no real strategy has been
implemented to contain rising Chinese competition risk.
Target price & rating Driven by a more cautious outlook on the Chinese construction
equipment market, albeit partly offset by higher truck delivery forecast (following the strong
May delivery data), we have reduced our EPS forecasts by just 1% for 2013e. Reflecting
increased risks relating to Chinese growth, we have reduced our DCF-derived (WACC of
10%, LT growth of 2% and normalised margin of 8%) target price to SEK110 from SEK125.
We maintain our Hold rating on valuation grounds (the stock is trading on 6.5x EV/EBIT for
2012e vs 7.4x for Scania and MAN) although we believe weakening sentiment on the
Chinese construction equipment industry is likely to hurt the shares. Key downside (upside)
risk to the stock achieving our TP would come from lower (stronger) operating leverage at
Trucks.
Next events & catalysts Q2 results on 22 July.
Hold (12m)
Price 21/06/11 12m target
SEK105.5 SEK110.0
Sector
Weighting
Overweight
Preferred stock
Siemens
Least preferred stock
Sandvik
Type of investment
Change in management
Undervalued
1 year
Price MA 100
60
85
110
135
2010 2011
0
20
40
60
(m)
2010 2011
Source: SG Cross Asset Research
Volvo
on www.sgresearch.com
Share data Financial data 12/10 12/11e 12/12e 12/13e Ratios 12/10 12/11e 12/12e 12/13e
RIC VOLVb.ST, Bloom VOLVB SS Revenues (SEKbn) 257.37 294.21 329.46 354.16 P/E (x) 16.0 12.1 9.1 8.1
52-week range 121.7-82.1 EBIT margin (%) 6.9 9.0 10.3 10.5 FCF yield (/EV) (%) 9.5 13.0 16.7 19.4
EV 11 (SEKm) 230,583 Rep. net inc. (SEKbn) 10.87 17.72 23.55 26.43 Dividend yield (%) 2.9 3.3 4.4 4.9
Market cap. (SEKm) 215,536 EPS (adj.) (SEK) 5.36 8.74 11.62 13.04 Price/book value (x) 2.4 2.5 2.1 1.8
Free float (%) 62.4 Dividend/share (SEK) 2.50 3.50 4.60 5.20 EV/revenues (x) 0.59 0.78 0.67 0.59
Performance (%) 1m 3m 12m Payout (%) 0.0 28.6 30.1 35.3 EV/EBIT (x) 13.4 8.7 6.5 5.7
Ordinary shares -8.0 -1.5 10.5 Interest cover (x) 5.5 10.7 19.6 35.4 EV/IC (x) 1.6 1.5 1.5 1.5
Rel. Eurofirst 300 -4.7 -0.5 6.3 Net debt/equity (%) 33.3 17.2 4.3 nm ROIC/WACC (x) 0.7 1.1 1.4 1.6
Prev. EPS change (22/06/11) 8.42 11.57 13.21 CAGR 10-13e: +34.5%
Sebastien Gruter
Colin Campbell
(33) 1 42 13 47 22 (44) 20 7762 5609
[email protected] [email protected]
Societe Generale (‚SG‛) does and seeks to do business with companies covered in its research reports. As a result, investors should be
aware that SG may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a
single factor in making their investment decision. PLEASE SEE APPENDIX AT THE END OF THIS REPORT FOR THE ANALYST(S)
CERTIFICATION(S), IMPORTANT DISCLOSURES AND DISCLAIMERS AND THE STATUS OF NON-US RESEARCH ANALYSTS.
Capital Goods
23 June 2011 43
Sales/division
0other -1%
Volvo Aero 3%Volvo Penta 3%
Financial Services 3%
Buses 8%Construction Equipment 20%
Trucks 63%
EBIT/division
0other -1%Financial Services 1%Volvo Aero 2%Volvo Penta 3%
Buses 4%Construction Equipment 34%
Trucks 56%
Sales/region
East. Europe 5%Others 7%
Latin America 11%
North. America 18%
Asia 25%
W. Europe 34%
Major shareholders (%)
Renault SA 6.8
Capital Group Funds 5.4
Industrivarden 4.2
Normalised data
EBITDA margin (%) 11.0
Normalised growth (%) 2.4
Machinery (Sweden) Price (21/06/11) 12m target
Volvo HOLD SEK105.5 SEK110.0 Valuation* (SEKm) 12/06 12/07 12/08 12/09 12/10 12/11e 12/12e 12/13e
Nb. of shares basic year end/outstanding 1,368.1 1,369.1 1,370.1 1,370.1 1,370.1 1,370.1 1,370.1 1,370.1
Share price (average) 75.31 118.38 73.80 53.49 85.54 105.50 105.50 105.50
Average market cap. (SG adjusted) (1) 106,915 168,717 109,928 80,590 126,549 215,536 215,536 215,536
Restated net debt (-)/cash (+) (2) 22,104 -4,250 -29,763 -41,489 -24,694 -15,045 -4,514 6,069
Value of minorities (3) 284 579 630 629 1,011 1,457 2,050 2,712
Value of financial investments (4) -1,096 1,562 1,301 1,456 1,456 1,456 1,456 1,456
Other adjustment (5) -11,090
EV = (1) - (2) + (3) - (4) + (5) 86,191 171,984 139,020 121,252 150,798 230,583 220,645 210,723
P/E (x) 5.9 8.6 15.0 nm 16.0 12.1 9.1 8.1
Price/cash flow (x) 8.3 23.9 8.8 5.4 7.3 8.2 8.2 5.5
Price/free cash flow (x) 8.0 37.6 nm 27.2 10.8 10.3 8.2 7.2
Price/book value (x) 1.8 2.9 1.8 1.6 2.4 2.5 2.1 1.8
EV/revenues (x) 0.35 0.62 0.47 0.58 0.59 0.78 0.67 0.59
EV/EBITDA (x) 2.8 5.2 5.0 nm 4.7 5.7 4.6 4.1
Dividend yield (%) 13.3 4.2 2.7 0.0 2.9 3.3 4.4 4.9
Per share data (SEK)
SG EPS (adj.) 12.79 13.75 4.90 -7.26 5.36 8.74 11.62 13.04
Cash flow 9.07 4.96 8.37 9.92 11.65 12.86 12.86 19.03
Book value 42.94 40.59 41.45 32.76 36.07 42.31 50.43 58.87
Dividend 10.00 5.00 2.00 0.00 2.50 3.50 4.60 5.20
Income statement (SEKm)
Revenues 248,135 276,795 295,836 208,487 257,373 294,205 329,461 354,158
Gross income 55,893 62,635 62,322 28,909 59,893 70,985 80,291 84,493
EBITDA 30,810 33,057 27,978 -1,133 31,808 40,170 48,136 52,006
Depreciation and amortisation -11,000 -12,474 -13,524 -15,200 -13,974 -13,607 -14,151 -14,858
EBIT 19,810 20,583 14,454 -16,333 17,834 26,564 33,985 37,147
Impairment losses 0 0 0 0 0 0 0 0
Net interest income -100 -675 -1,842 -3,560 -2,487 -1,728 -978 -293
Exceptional & non-operating items 0 0 0 0 0 0 0 0
Taxation 3,981 6,528 -3,638 5,775 -4,168 -7,202 -9,572 -10,688
Minority interests 50 96 -74 -33 -346 -446 -593 -662
Reported net income 26,042 27,679 9,941 -14,717 10,865 17,720 23,552 26,427
SG adjusted net income 25,895 27,864 9,941 -14,717 10,865 17,720 23,552 26,427
Cash flow statement (SEKm)
EBITDA 30,810 33,057 27,978 -1,133 31,808 40,170 48,136 52,006
Change in working capital 1,765 -9,993 -23,304 16,900 -84 -2,017 -3,354 -3,380
Other operating cash movements -6,699 -4,674 -3,905 -880 -6,623 -8,398 -9,840 -10,058
Cash flow from operating activities 25,876 18,390 769 14,887 25,101 29,755 34,942 38,568
Net capital expenditure -13,000 -12,005 -15,199 -10,900 -9,000 -9,000 -9,000 -9,000
Free cash flow 12,876 6,385 -14,430 3,987 16,101 20,755 25,942 29,568
Cash flow from investing activities -5,600 -11,023 9,536 -8,700 0 0 0 0
Cash flow from financing activities -6,075 8,410 7,034 -4,200 0 -5,068 -7,095 -9,324
Net change in cash resulting from CF 1,201 3,772 3,168 -9,113 16,101 15,688 18,848 20,244
Balance sheet (SEKm)
Total long-term assets 124,039 162,487 196,381 174,282 170,868 166,262 161,111 155,253
of which intangible 8,045 25,436 32,886 30,556 29,642 29,642 29,642 29,642
Working capital 24,813 42,719 60,665 39,631 39,715 41,732 45,085 48,465
Employee benefit obligations 8,692 9,774 11,705 8,051 7,510 7,510 7,510 7,510
Shareholders' equity 86,904 82,202 84,010 66,405 73,110 85,762 102,220 119,323
Minority interests 284 579 630 629 1,011 1,457 2,050 2,712
Provisions
Net debt (-)/cash (+) 22,104 -4,250 -29,763 -41,489 -24,694 -15,045 -4,514 6,069
Accounting ratios
ROIC (%) 13.5 11.6 6.2 -6.8 8.1 12.4 16.2 18.2
ROE (%) 31.5 32.7 12.0 -19.6 15.6 22.3 25.1 23.9
Gross income/revenues (%) 22.5 22.6 21.1 13.9 23.3 24.1 24.4 23.9
EBITDA margin (%) 12.4 11.9 9.5 -0.5 12.4 13.7 14.6 14.7
EBIT margin (%) 8.0 7.4 4.9 -7.8 6.9 9.0 10.3 10.5
Revenue yoy growth (%) 7.3 11.6 6.9 -29.5 23.4 14.3 12.0 7.5
Rev. organic growth (%) 8.0 4.0 4.0 -39.0 25.9 20.5 12.0 7.5
EBITDA yoy growth (%) 18.4 7.3 -15.4 nm nm 26.3 19.8 8.0
EBIT yoy growth (%) 22.9 3.9 -29.8 nm nm 48.9 27.9 9.3
EPS (adj.) yoy growth (%) 133.6 7.5 -64.3 -248.0 173.8 63.1 32.9 12.2
Dividend growth (%) nm -50.0 -60.0 -100.0 na 40.0 31.4 13.0
Cash conversion (%) 70.0 60.7 -65.5 -52.6 128.1 112.6 108.2 110.2
Net debt/equity (%) nm 5.1 35.2 61.9 33.3 17.2 4.3 nm
FFO/net debt (%) nm nm 75.6 2.6 101.9 207.6 nm nm
Dividend paid/FCF (%) 47.2 318.4 nm 102.8 0.0 24.4 27.3 31.5
* Valuation ratios for past years are based on average historical prices and market capitalisations
Capital Goods
23 June 2011 44
Electrical Equipment (France)
LEGRAND Rating reiterated A market characterised by high entry costs and favourable pricing trends
Exposure to China Legrand derives just 3% of its sales from China but the group claims to
hold the number one position in wiring devices following the acquisition of TCL Electrical in
2005. Legrand has one of its largest industrial production facilities in the country, supplying
the local residential market and exporting wiring devices to the UK, the Middle East and the
US; 13% of the group’s R&D workforce is also based in China.
Chinese competition threat The Chinese ultra-low voltage market is highly fragmented
(>1,000 local participants) and the distribution network is scattered and very specialised. As
a result, we think acquisitions of local, small-scale manufacturers are required to enlarge the
group’s access to the Chinese market, and thus should represent a growth opportunity over
time. Note also that Legrand launched new ranges in wiring devices (K5 and Meidian) and
audio & video door entry systems in China in 2010, which should help the group gain market
share. Generally speaking, the low voltage industry is characterised by a local market
structure (varies in terms of national standards and aesthetic preferences), a recurring but
diffuse flow of activity and the need to establish privileged relationships with numerous
distributors and specifiers. In such a protected environment, Legrand’s capacity for
continuous innovation gives it solid pricing power (+3% SGe 2011) in our view.
Target price & rating Building market volumes in mature markets remain 23% below pre-
crisis levels but are showing early signs of improvement. We reiterate our Buy rating and
DCF-based target price of €35 (growth 2%, normalised margin 19%, WACC 8.4%). Risks to
our TP: KKR and Wendel (combined stake of 21.3%) may decide to sell additional shares in
the market.
Next events & catalysts Q2 results on 28 July. We expect Q2 sales to rise by 6.6% including
5.6% organic growth, 3.7% consolidation effects and 2.6% negative currency effects. EBITA
is seen at €227m, up 7% yoy, with a margin of 21.3%, unchanged from last year’s record-
high level. Management should reiterate its FY guidance for 5% organic growth and a margin
of at least 20%.
Buy (12m)
Price 21/06/11 12m target
€28.4 €35.0
Sector
Weighting
Overweight
Preferred stock
Siemens
Least preferred stock
Sandvik
Type of investment
Undervalued
M&A
Pricing power
1 year
Price MA 100
20
24
28
32
2010 2011
0
2.5
5
7.5
(m)
2010 2011
Source: SG Cross Asset Research
Legrand
on www.sgresearch.com
Share data Financial data 12/10 12/11e 12/12e 12/13e Ratios 12/10 12/11e 12/12e 12/13e
RIC LEGD.PA, Bloom LR FP Revenues (€bn) 3.89 4.25 4.61 4.91 P/E (x) 15.4 13.9 12.2 11.0
52-week range 32.0-23.5 EBIT margin (%) 20.2 20.8 21.5 22.0 FCF yield (/EV) (%) 7.9 6.5 8.0 9.2
EV 11 (€m) 8,759 Rep. net inc. (€m) 419 520 602 677 Dividend yield (%) 3.5 3.7 4.1 4.4
Market cap. (€m) 7,459 EPS (adj.) (€) 1.63 2.03 2.32 2.59 Price/book value (x) 2.4 2.5 2.2 2.0
Free float (%) 73.2 Dividend/share (€) 0.88 1.05 1.15 1.25 EV/revenues (x) 2.03 2.06 1.83 1.64
Performance (%) 1m 3m 12m Payout (%) 55.0 52.9 50.0 48.4 EV/EBIT (x) 11.2 9.9 8.5 7.5
Ordinary shares -4.8 0.3 5.5 Interest cover (x) 7.1 13.5 15.8 24.1 EV/IC (x) 2.4 2.2 2.1 2.0
Rel. Eurofirst 300 -1.7 1.0 0.8 Net debt/equity (%) 43.8 39.2 26.3 13.9 ROIC/WACC (x) 1.8 1.9 2.0 2.2
Prev. EPS change (22/06/11) 2.04 2.31 2.58 CAGR 10-13e: +16.6%
Gael de-Bray
Adrien de-Susanne
Colin Campbell
(33) 1 42 13 84 14 (33) 1 42 13 01 61 (44) 20 7762 5609
[email protected] [email protected] [email protected]
Societe Generale (‚SG‛) does and seeks to do business with companies covered in its research reports. As a result, investors should be
aware that SG may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a
single factor in making their investment decision. PLEASE SEE APPENDIX AT THE END OF THIS REPORT FOR THE ANALYST(S)
CERTIFICATION(S), IMPORTANT DISCLOSURES AND DISCLAIMERS AND THE STATUS OF NON-US RESEARCH ANALYSTS.
Capital Goods
23 June 2011 45
Sales/division 10
North. America 14%
Italy 15%
Other Europe 19%
France 24%
Others 27%
EBIT/division 10
North. America 9%
Other Europe 13%
Others 20%
Italy 24%
France 34%
Sales/region 10
North. America 14%
Italy 15%
Other Europe 19%
France 24%
Others 27%
Major shareholders (%)
KKR 10.5
Wendel 10.5
Employees 5.0
Normalised data
EBITDA margin (%) 25.5
Normalised growth (%) 5.9
Electrical Equipment (France) Price (21/06/11) 12m target
Legrand BUY €28.4 €35.0 Valuation* (€m) 12/06 12/07 12/08 12/09 12/10 12/11e 12/12e 12/13e
Nb. of shares basic year end/outstanding 269.7 271.0 262.8 263.1 263.1 263.1 263.1 263.1
Share price (average) 22.00 24.70 17.08 16.16 25.06 28.35 28.35 28.35
Average market cap. (SG adjusted) (1) 5,933 6,693 4,489 4,251 6,594 7,459 7,459 7,459
Restated net debt (-)/cash (+) (2) -1,898 -2,010 -2,006 -1,469 -1,334 -1,321 -1,013 -648
Value of minorities (3) 24 9 12 9 13 12 10 9
Value of financial investments (4) 38 34 18 7 33 33 33 33
Other adjustment (5)
EV = (1) - (2) + (3) - (4) + (5) 7,818 8,678 6,489 5,722 7,909 8,759 8,449 8,083
P/E (x) 14.8 14.2 11.6 12.9 15.4 13.9 12.2 11.0
Price/cash flow (x) 9.5 9.7 7.8 5.8 9.0 12.1 10.3 9.1
Price/free cash flow (x) 12.0 12.0 10.4 6.4 10.4 15.0 12.4 10.9
Price/book value (x) 2.7 3.1 2.1 1.8 2.4 2.5 2.2 2.0
EV/revenues (x) 2.09 2.10 1.54 1.60 2.03 2.06 1.83 1.64
EV/EBITDA (x) 10.1 9.9 7.5 7.7 8.3 8.3 7.3 6.5
Dividend yield (%) 2.3 2.8 4.1 4.3 3.5 3.7 4.1 4.4
Per share data (€)
SG EPS (adj.) 1.48 1.73 1.48 1.26 1.63 2.03 2.32 2.59
Cash flow 2.33 2.55 2.20 2.78 2.80 2.35 2.76 3.10
Book value 8.01 7.85 8.30 9.08 10.38 11.48 12.62 13.95
Dividend 0.50 0.70 0.70 0.70 0.88 1.05 1.15 1.25
Income statement (€m)
Revenues 3,737 4,129 4,202 3,578 3,891 4,250 4,605 4,915
Gross income 1,855 2,068 2,132 1,877 2,093 2,282 2,491 2,674
EBITDA 773 877 860 745 950 1,049 1,152 1,239
Depreciation and amortisation -157 -153 -162 -166 -166 -165 -160 -157
EBIT 616 724 698 579 784 884 992 1,081
Impairment losses 0 0 0 0 0 0 0 0
Net interest income -192 -66 -148 -102 -111 -65 -63 -45
Exceptional & non-operating items 0 0 0 0 0 0 0 0
Taxation -83 -175 -143 -131 -227 -263 -297 -334
Minority interests -3 -2 -2 -2 -1 -1 -2 -2
Reported net income 252 421 350 290 419 520 602 677
SG adjusted net income 370 465 388 333 437 544 622 693
Cash flow statement (€m)
EBITDA 773 877 860 745 950 1,049 1,152 1,239
Change in working capital -37 18 -19 242 76 -93 -53 -28
Other operating cash movements -154 -211 -263 -250 -277 -328 -360 -379
Cash flow from operating activities 582 684 578 738 749 628 739 831
Net capital expenditure -125 -133 -148 -72 -104 -121 -127 -137
Free cash flow 456 552 430 666 645 507 612 695
Cash flow from investing activities -88 -270 -132 -5 -289 -262 0 0
Cash flow from financing activities -114 -417 -263 -107 -181 -232 -303 -329
Net change in cash resulting from CF 254 -135 35 554 176 13 308 366
Balance sheet (€m)
Total long-term assets 4,394 4,460 4,449 4,365 4,641 4,824 4,763 4,719
of which intangible 1,840 1,784 1,773 1,770 1,768 1,735 1,710 1,692
Working capital 439 417 445 296 269 361 414 442
Employee benefit obligations 155 125 144 129 137 137 137 137
Shareholders' equity 2,160 2,128 2,180 2,389 2,731 3,020 3,321 3,670
Minority interests 9 3 6 5 5 5 5 5
Provisions 102 81 63 172 205 205 205 205
Net debt (-)/cash (+) -1,743 -1,885 -1,862 -1,340 -1,198 -1,185 -876 -511
Accounting ratios
ROIC (%) 12.4 14.5 13.5 11.4 15.3 16.0 17.2 18.6
ROE (%) 18.7 19.6 16.2 12.7 16.4 18.1 19.0 19.4
Gross income/revenues (%) 49.6 50.1 50.7 52.5 53.8 53.7 54.1 54.4
EBITDA margin (%) 20.7 21.3 20.5 20.8 24.4 24.7 25.0 25.2
EBIT margin (%) 16.5 17.5 16.6 16.2 20.2 20.8 21.5 22.0
Revenue yoy growth (%) 15.1 10.5 1.8 -14.9 8.7 9.2 8.4 6.7
Rev. organic growth (%) 7.8 8.6 -0.1 -13.9 3.6 6.7 6.4 6.7
EBITDA yoy growth (%) 16.9 13.5 -2.0 -13.3 27.5 10.4 9.8 7.5
EBIT yoy growth (%) 21.1 17.5 -3.7 -17.0 35.5 12.7 12.2 9.0
EPS (adj.) yoy growth (%) 71.2 16.9 -14.9 -14.9 29.9 24.5 14.2 11.5
Dividend growth (%) 22.6 40.0 0.0 0.0 25.7 19.3 9.5 8.7
Cash conversion (%) 107.8 100.4 101.7 160.0 108.1 94.5 98.0 99.3
Net debt/equity (%) 80.4 88.4 85.2 56.0 43.8 39.2 26.3 13.9
FFO/net debt (%) 26.2 31.7 28.3 34.9 45.9 54.6 78.2 132.7
Dividend paid/FCF (%) 29.6 32.9 41.7 27.5 35.7 54.2 49.2 47.1
* Valuation ratios for past years are based on average historical prices and market capitalisations
Capital Goods
23 June 2011 46
APPENDIX
COMPANIES MENTIONED
ABB (ABBN.VX, Hold)
Alstom (ALSO.PA, Sell)
Anglo American (AAL.L, Hold)
Assa Abloy (ASSAb.ST, Hold)
Atlas Copco (ATCOa.ST, Hold)
BHP Billiton (BLT.L, Hold)
Caterpillar (CAT.N, No Reco- )
GKN (GKN.L, Buy)
Invensys (ISYS.L, Hold)
Legrand (LEGD.PA, Buy)
MAN (MANG.DE, Buy)
Nexans (NEXS.PA, Hold)
Philips (PHG.AS, Buy)
Rio Tinto (RIO.L, Buy)
Sandvik (SAND.ST, Sell)
Schneider (SCHN.PA, Buy)
Siemens (SIEGn.DE, Buy)
SKF (SKFb.ST, Buy)
Vale (VALE.N, Buy)
Volvo (VOLVb.ST, Hold)
Wendel (MWDP.PA, Buy)
Xstrata (XTA.L, No Reco)
Scania AB (SCVb.ST, Buy)
ANALYST CERTIFICATION
Each author of this research report hereby certifies that (i) the views expressed in the research report accurately reflect his or
her personal views about any and all of the subject securities or issuers and (ii) no part of his or her compensation was, is, or
will be related, directly or indirectly, to the specific recommendations or views expressed in this report: Gaël de Bray, Adrien
de Susanne, Colin Campbell.
Historical Price: ASSA-ABLOY (ASSAb.ST) 2008/2009 Change 2010/2011 Change
49
69
89
109
129
149
169
189
06/08 09/08 12/08 03/09 06/09 09/09 12/09 03/10 06/10 09/10 12/10 03/11
Price Target MA100 Change Reco
25/07/08 New Target: 88.0 22/04/10 New Target: 133.0
20/10/08 New Rating: Sell 15/07/10 New Rating: Hold
20/10/08 New Target: 60.0 15/07/10 New Target: 171.0
19/01/09 New Target: 55.0 28/10/10 New Target: 160.0
02/04/09 New Target: 52.0 30/11/10 New Rating: Sell
23/04/09 New Target: 80.0 13/01/11 New Target: 170.0
30/07/09 New Target: 97.0 29/04/11 New Rating: Hold
29/10/09 New Target: 105.0
Source: SG Cross Asset Research
Capital Goods
23 June 2011 47
Historical Price: Atlas Copco (ATCOa.ST) 2008/2009 Change 2010/2011 Change
46
66
86
106
126
146
166
186
206
06/08 09/08 12/08 03/09 06/09 09/09 12/09 03/10 06/10 09/10 12/10 03/11
Price Target MA100 Change Reco
21/10/08 New Target: 57.0 14/01/10 New Target: 111.0
24/10/08 New Target: 55.0 29/04/10 New Target: 117.0
03/02/09 New Target: 52.0 19/07/10 New Target: 125.0
28/04/09 New Target: 78.0 05/10/10 New Rating: Buy
23/10/09 New Target: 91.0 05/10/10 New Target: 145.0
20/11/09 New Target: 95.0 25/10/10 New Target: 165.0
13/01/11 New Target: 200.0
03/02/11 New Target: 190.0
21/04/11 New Target: 200.0
Source: SG Cross Asset Research
Historical Price: Legrand (LEGD.PA) 2008/2009 Change 2010/2011 Change
10
15
20
25
30
35
06/08 09/08 12/08 03/09 06/09 09/09 12/09 03/10 06/10 09/10 12/10 03/11
Price Target MA100 Change Reco
23/07/08 New Target: 17.5 12/01/10 New Rating: Buy
08/09/08 New Target: 17.0 12/01/10 New Target: 23.0
20/10/08 New Rating: Sell 05/02/10 New Target: 24.0
20/10/08 New Target: 11.0 07/05/10 New Target: 28.0
07/05/09 New Target: 13.5 05/11/10 New Target: 32.0
30/07/09 New Rating: Hold 10/01/11 New Target: 35.0
30/07/09 New Target: 15.5
17/09/09 New Target: 18.8
28/10/09 New Target: 20.0
06/11/09 New Target: 21.0
Source: SG Cross Asset Research
Historical Price: SANDVIK (SAND.ST) 2008/2009 Change 2010/2011 Change
33
53
73
93
113
133
06/08 09/08 12/08 03/09 06/09 09/09 12/09 03/10 06/10 09/10 12/10 03/11
Price Target MA100 Change Reco
21/07/08 New Target: 73.0 12/01/10 New Target: 100.0
29/10/08 New Target: 39.0 05/05/10 New Target: 120.0
20/11/08 New Target: 35.0 05/10/10 New Rating: Sell
30/04/09 New Rating: Buy 05/10/10 New Target: 90.0
30/04/09 New Target: 68.0 10/01/11 New Target: 115.0
20/07/09 New Target: 74.0 03/02/11 New Rating: Hold
02/11/09 New Target: 90.0
Source: SG Cross Asset Research
Capital Goods
23 June 2011 48
Historical Price: Schneider (SCHN.PA) 2008/2009 Change 2010/2011 Change
38
58
78
98
118
138
06/08 09/08 12/08 03/09 06/09 09/09 12/09 03/10 06/10 09/10 12/10 03/11
Price Target MA100 Change Reco
25/07/08 New Target: 75.0 12/01/10 New Target: 74.0
29/09/08 New Target: 67.0 19/02/10 New Target: 77.0
20/10/08 New Target: 52.0 22/04/10 New Target: 84.0
18/12/08 New Target: 48.0 23/07/10 New Target: 90.0
08/06/09 New Rating: Buy 02/08/10 New Target: 95.0
08/06/09 New Target: 60.0 18/11/10 New Target: 105.0
03/08/09 New Rating: Hold 10/01/11 New Rating: Buy
14/09/09 New Target: 67.0 10/01/11 New Target: 135.0
01/12/09 New Target: 70.0 08/03/11 New Target: 140.0
Source: SG Cross Asset Research
Historical Price: VOLVO 'B' (VOLVb.ST) 2008/2009 Change 2010/2011 Change
28
48
68
88
108
128
06/08 09/08 12/08 03/09 06/09 09/09 12/09 03/10 06/10 09/10 12/10 03/11
Price Target MA100 Change Reco
30/03/09 New Rating: Hold 16/04/10 New Target: 93.0
30/03/09 New Target: 39.0 26/04/10 New Target: 110.0
27/04/09 New Rating: Sell 10/01/11 New Rating: Hold
27/04/09 New Target: 43.0 10/01/11 New Target: 125.0
06/10/09 New Rating: Buy 07/02/11 New Target: 120.0
06/10/09 New Target: 79.0 25/03/11 New Target: 115.0
28/04/11 New Target: 125.0
Source: SG Cross Asset Research
SG RATINGS
BUY: expected total return of 10% or more over a 12 month
period.
HOLD: expected total return between -10% and +10% over a 12
month period.
SELL: expected total return of -10% or worse over a 12 month
period.
Sector Weighting Definition:
The sector weightings are assigned by the SG Equity Research
Strategist and are distinct and separate from SG research analyst
ratings. They are based on the relevant MSCI.
OVERWEIGHT: sector expected to outperform the relevant broad
market benchmark over the next 12 months.
NEUTRAL: sector expected to perform in-line with the relevant
broad market benchmark over the next 12 months.
UNDERWEIGHT: sector expected to underperform the relevant
broad market benchmark over the next 12 months.
Equity rating and dispersion relationship
48%
40%
13%
50%
39%
48%
0
50
100
150
200
250
Buy Hold Sell
Companies Covered Cos. w/ Banking Relationship
Source: SG Cross Asset Research
Capital Goods
23 June 2011 49
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IMPORTANT DISCLOSURES
Alstom SG acted as joint bookrunner in Alstom's senior bond issue.
Alstom SG acted as financial advisor to Alstom for the acquisition of Areva T&D.
Alstom SG is a lender to Alstom Group.
Caterpillar SG acted as joint bookrunner in Caterpillar Financial Services' senior bond issue.
Caterpillar SG acted as joint bookrunner of Caterpillar's bond issue.
Legrand SG acted as joint bookrunner in legrand's bond issue (4.375% 21/03/18 EUR).
MAN SG is acting as Mandated Lead Arranger of the acquisition facilities set up by MAN for the acquisition of
Brazil-based Volkswagen Truck & Bus
Rio Tinto SG acted as financial advisor to Apollo in acquiring together with the Fonds Stratégique
d'Investisssement (FSI) 61% stake in Alcan Engineering Products from Rio Tinto
Schneider SG acted as Joint Dealer Manager in Schneider's bond tender offer.
Schneider SG acted as financial advisor to Alstom for the acquisition of Areva T&D.
Vale SG is acting as financial adviser to Vale S.A. in respect of its offer to acquire Metorex Limited.
Wendel SG acted as joint bookrunner in the WENDEL's senior bond issue.
Wendel SG acted as joint bookrunner in Wendel's senior bond issue (tap) (4.875% 26/05/16 EUR).
Xstrata SG is acting as co-bookrunner in Glencore's IPO.
Director: A senior employee, executive officer or director of SGAS and/or SGCIB is a director and/or officer of Alstom.
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of SGAS and may not be subject to the FINRA restrictions on communications with a subject company, public appearances and trading securities held
in the research analyst(s)’ account(s): Sébastien Gruter Société Générale Paris, Gaël de Bray Société Générale Paris, Adrien de Susanne Société
Générale Paris, Colin Campbell Société Générale London
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Capital Goods
23 June 2011 50
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