BNP - Market Outlook 2011

Equity Strategy Market Outlook 2011
22 November 2010
Report
Equities - What else?
► A good year for European equities

We expect a favourable equity environment in 2011 with the DJ Stoxx 600 delivering
a total return of 15% and breaking out of its 2010 trading range.
► Earnings & valuations

Despite a slowdown in global GDP growth, we expect 16% earnings growth in
Europe, leaving modest upside to analyst forecasts. With valuations significantly
below long-term averages, equities should rise at least in line with earnings. We
assume no re-rating as uncertainty remains high.
► Monetary conditions & Risks

Liquidity conditions look as favourable as they can be with unprecedented monetary
easing. The ‘reach for yield’ should continue, with equities, as one of the highest
yielding asset classes, likely to take a growing share of flows. Downside risks include
unintended consequences of QE and a spill-over of sovereign stress to banks and/or
larger economies. On the other hand, Fed stimulus could inflate equities beyond what
would be justified, providing additional performance on top of our targets.
► Themes: Germany & Periphery

2011 should be the year that German consumers finally loosen their purse strings.
Rising real wages should provide the final piece of the puzzle. Selective investments
in the European periphery should become attractive on the back of labour cost cuts,
which should switch the focus from demand weakness to cost cutting potential.
► Themes: Commodity price inflation and fiscal austerity

Sectors with commodity input costs and limited exposure to emerging markets are at
risk of a margin squeeze (e.g. Construction, Retail, Autos). Those with strong brands
and emerging market sales should be able to cope (e.g. Food & Beverages). We
would avoid exposure to fiscal austerity (Defence, Healthcare and IT Services).
Bert Jansen
Paris: +33 1 44 95 98 55
bert.jansen@exanebnpparibas.com
Lars Kreckel
London: +44 207 039 9514
lars.kreckel@exanebnpparibas.com
www.exanebnpparibas.com/strategy
Please refer to important disclosures

at the end of this report.
Contents
Summary and investment conclusions ________________________ 3
Market Outlook___________________________________________ 6
Earnings Outlook and macro backdrop_____________________________________ 6
Valuation and index targets ____________________________________________ 14
Monetary conditions __________________________________________________ 22
Risks ______________________________________________________________ 29
Investment themes_______________________________________ 32
Growth vs Value – a polarised market ____________________________________ 32
Commodity price inflation ______________________________________________ 36
Konsum – Germany Shops_____________________________________________ 42
European periphery – waiting for cost cuts_________________________________ 57
Government exposure ________________________________________________ 63
Sector Outlook __________________________________________ 69

Sector allocation _____________________________________________________ 69
European large caps – top picks for 2011 _____________________ 71
Sector dynamics ________________________________________ 72
Appendices ___________________________________________ 121

Performance and headline index targets _________________________________ 121
Sector performance _________________________________________________ 122
Valuation: P/Es and DY; EPS and DPS growth ____________________________ 123
Valuation – MSCI sectors _____________________________________________ 124
2 Market Outlook 2011

Summary and investment conclusions
After a decent, but far from spectacular 2010, we expect European equities to break
out of their trading range and make new post-trough highs in 2011. We forecast a rise
of 12% for the MSCI Europe, which should deliver a total return of 15% including
dividends.
The global economy looks likely to slow next year, but 3.8% global GDP growth is
plenty for an upbeat equity outlook. We expect the US to slow down slightly, Europe to
post slightly higher growth and emerging markets to contribute the best growth rates
yet again. We assume consumer price inflation will be contained by persistent output
gaps, an average euro/dollar exchange rate close to spot and commodity prices in
2011 to be, on average, 10% higher than in 2010.
We expect the MSCI Europe to deliver 16% EPS growth in 2011e (14% ex Financials),
driven in equal measure by top-line growth and margin expansion. Unusually, our top-
down forecast is higher than bottom-up consensus (14% EPS growth), leaving some
room for positive revisions. We have extended our top-down EPS forecast to 2012e,
where we expect 11% average EPS growth.
With most valuation measures significantly below ex-bubble averages we expect

equities to rise at least in line with earnings. Beyond that we assume no meaningful re-
rating in an environment of economic uncertainty and structurally lower growth.
In our opinion, relative to other asset classes, equities present an attractive risk/reward
ratio. A dividend yield of nearly 4%, coupled with 12% dividend growth compares very
favourably with the yield on fixed income alternatives. In this environment, equities
could get a growing share of fund flows, given the mediocre returns to be expected
from bonds.
Monetary conditions should remain benign in 2011: zero interest rate policies from
most major central banks, quantitative easing by the Fed and decent economic and
earnings growth which should keep corporate bond yields low.
Of course no scenario is risk free. One obvious downside risk is an escalation of the
sovereign debt crisis beyond the smaller European peripheral countries and/or another
round of heavy losses in the banking sector. To us the more likely outcome is a drag on
potential growth rather than a solvency crisis. Rising inflation in emerging economies
could bring further policy tightening, leading to a larger than expected slowdown.
The upside risk to our base scenario could be a re-rating of equities. The Fed’s
unprecedented monetary stimulus could inflate asset prices beyond what would be
justified, which would provide additional upside to our index targets.

Themes & sectors
Growth vs Value – a polarised market
This year’s strong performance of growth stocks has led to an increasingly tricky trade-
off between mature Value and vibrant Growth as the valuation gap between the two
has widened to unprecedented levels.
In order to address the dilemma between Growth and Value, we have screened for
European stocks that offer a combination of the best of both worlds: above average
FCF growth, but at a reasonable price.
Commodity price inflation

The current environment is different from the 2006-08 economic boom, when
commodities also rose sharply. Companies are again faced with commodity cost inflation,
but this time have to cope with less top-line growth as a result of significantly lower
nominal GDP growth, due to the absence of inflation in the advanced economies.
Sectors or companies where commodities make up a large proportion of cost of goods

sold and have significant exposure to advanced economies are the most exposed,
including Construction, Food and General Retail and Automotive. Sectors less exposed
are Food & Beverages, thanks to their emerging market exposure and strong brands.
Mining should be the big winner of commodity price inflation; the correlation between
the CRB price index and the sector’s relative performance over the last five years has
been close to 90%.
Konsum – Germany Shops

After over a decade of disappointment and false dawns the scene seems set for
German consumers to finally increase spending. Healthy balance sheets suggest an
ability to consume more; after years of flat consumer spending pent-up demand has
built up; German economic growth should be among the most robust in Europe in the
next few years; export-driven growth is beginning to trickle down to consumers via a
rise in employment and consumer (and retail sector) confidence is near its 20-year
high. We argue the final piece of the puzzle, real wage increases lie just around the
corner. We will be watching the Christmas shopping season for the first signs of a
change in German consumer behaviour, but the real benefits should be seen in 2011.
Avoid government exposure

In response to pressure from the bond markets and to achieve the deficit targets in
their long-term budgets, most European governments have announced drastic fiscal
austerity measures to prevent their public deficits from spiralling out of control.
Sectors which are most exposed to government spending cuts are Construction &
Infrastructure, Defence, Healthcare and IT Services. We have compiled a list of stocks
which have above-average exposure to government deleveraging and limited emerging
market exposure. The basket has underperformed the market by 13% year-to-date, but
is not trading at a discount to the market.
European periphery – waiting for labour cost cuts

We see no reason to indiscriminately rush back into European periphery stocks. But we
see a good chance that at some stage in 2011 the time will come for selective
investments. Whereas periphery underperformance is currently driven by demand
weakness, we see scope for the focus to switch to potentially very earnings enhancing
unit labour cost cuts, only possible in countries in economic dire straits and with high
unemployment. We show which stocks would benefit most, combining the
characteristics of labour-intensive business models, a high proportion of the workforce
in periphery countries and low margins.

Sector allocation
Generally, we continue to prefer sectors with an above average FCF yield and
relatively steady FCF generation, such as Beverages, Media, Pharmaceuticals and
Telecoms. It is worth noting that most sectors with high FCF yield outperformed in
2010, including Media, Telecoms and Beverages.
We have no particular strong bias towards Cyclicals or non-Cyclicals in our sector

allocation. Cyclicals, in particular those with above average emerging market exposure,
remain appealing because of their superior growth prospects. But valuations, while still
reasonable in absolute terms, are on the high side when compared to the less vibrant
defensive plays. We maintain Outperform ratings on Mining and Oil & Gas as a play on
the asset boosting quantitative easing by the Fed.
In Consumer Cyclicals we maintain a cautious stance on sectors with limited exposure

to emerging markets. Consumer spending is likely to remain subdued in Europe under
the weight of fiscal austerity and commodity price inflation. The exception is German
consumer spending, which we expect to positively surprise (see above)
It is difficult to get particularly excited about Financials. Banks (=) offers good value, but
a sustained rerating vs the market looks unlikely because of Basel III constraints, such
as structurally lower ROE, subpar dividend growth and limited M&A potential without
the help of dilutive capital increases. Insurance suffers from mediocre earnings growth,
due to the combination of low interest rates and limited exposure to emerging markets.

Market Outlook
Earnings Outlook and macro backdrop

The earnings outlook forms one of the key components of any equity market forecast.
In this section we update and upgrade our 2011 EPS forecast for the Pan-European
market and also extend the forecast horizon to include 2012.
In short, we expect 16% EPS growth for the market in 2011 (14% excluding Financials)
and 11% in 2012.
Macro backdrop
Of course, our Economics team’s forecasts of how the global economy will develop
beyond the initial recovery phase lies at the heart of our top-down earnings forecast.
Broadly speaking, a double-dip in the global economy next year seems highly unlikely,
but potential growth in the developed world is likely to be below the average of past
cycles. This should result in lower average earnings growth over the coming years.
However, over the next two years, the sharp fall in real interest rates is likely to boost
economic activity.
Figure 1: Macroeconomic scenario – summary*

% Real GDP growth CPI
Euro zone UK US Emerging markets World Euro zone US
2010 1.6 1.6 2.6 6.8 4.4 1.5 1.5
2011 1.7 1.4 2.2 5.8 3.8 1.4 1.0
2012 1.7 1.5 2.6 6.0 4.2 1.7 1.3
* Year averages.
Source: Exane BNP Paribas estimates
For 2011 we expect world GDP growth to decrease slightly, from 4.4% to 3.8%. Within
that, we expect the US to make a smaller contribution than in 2010, as the benefits of
fiscal stimulus disappear and unemployment stays stubbornly high. Europe, on the
other hand, should post a slightly higher growth rate than in 2010, in-line with the
traditional time lag vis-à-vis the US.
For 2012, GDP growth in the euro zone is likely to be in line with 2011. The better
economic situation in peripheral countries should be offset by the impact of austerity
measures in the core countries of the euro zone. On the contrary, we expect a very
gradual fiscal consolidation in the USA. As a result, the gap between the USA and the
euro zone is likely to widen in 2012.
Global inflation is likely to be low over the medium term as the current period of private
debt reduction in developed countries should last 5 to 10 years. Unemployment rates in
developed countries are likely to remain high, limiting wage increases. Additionally we
expect credit demand to be subdued in the USA or more generally in countries where
household debt is high.
In the absence of progress in the real economy (e.g. innovation and rebalancing),
aggressive monetary policy put in place in developed countries, especially QE, brings a risk
of instability in the longer term. The global liquidity glut will persist (see Figure 2), which is
likely to lead to poor allocation of capital (e.g. bubbles.). Against this backdrop, inflation is
likely to increase in emerging countries and the commodity markets could continue to be
compelling for investors. Should a commodity bubble develop before the developed
economies have completed their deleveraging, this would hit households’ purchasing
power.

Figure 2: A growing liquidity glut worldwide
Global forex reserves, % of GDP
16.0
14.0
12.0
10.0
8.0
6.0
4.0
2.0
0.0
Q4 1986 Q4 1990 Q4 1994 Q4 1998 Q4 2002 Q4 2006 Q4 2010
Source: Exane BNP Paribas estimates, Thomson Datastream
Our top-down forecast

Using that macro-economic backdrop we arrive at an earnings growth estimate for the
European market excluding Financials of 14% in 2011. If we include Exane BNP
Paribas’s bottom-up forecast for Financials, the earnings growth rises to 16% in 2011.
We also extend our forecasts to 2012, where we estimate 11% EPS growth for the
market excluding Financials and also including Financials.
To arrive at these forecasts we have built an aggregated P&L of the MSCI Europe
excluding Financials using bottom-up consensus forecasts for all constituents. The result
can be seen in the table below, together with our own top-down forecasts (see Figure 3).
The sales growth and cost forecasts, arguably two variables where a top-down view is
particularly important, are based on our macro assumptions (discussed below). These
inputs then flow through the P&L using implicit bottom-up consensus assumptions for
depreciation. At the interest and tax expense line we again make a top-down adjustment.
In our opinion, this approach has the advantage of combining the strengths of a top-
down approach with those of a bottom-up approach. The top-down inputs use
consistent macro input factors across the market (e.g. currencies, commodity prices,
economic growth, inflation), which should neutralise the natural optimistic bias of
analysts for their companies. At the same time it tries to use bottom-up know-how in
factors such as depreciation and to a certain degree also on tax rates, where we
believe bottom-up knowledge of individual companies is essential.
Figure 3: Earnings forecast 2011 and 2012 – core scenario (MSCI Europe, excluding financials)
Consensus Consensus Exane Consensus Exane Consensus Consensus Exane Consensus Exane
BNPP BNPP BNPP BNPP
2010 2011 2011 2012 2012 2010 2011 2011 2012 2012
EURbn % growth
Sales 6,023 6,297 6,381 6,624 6,676 2% 4.6% 6.0% 5.2% 4.6%
COGS 4,952 5,112 5,187 5,356 5,374 10% 3.2% 4.7% 4.8% 3.7%
EBITDA 1,070 1,185 1,195 1,269 1,303 20% 11% 12% 7% 9%
Depreciation 332 355 355 367 367 (2%) 7% 7% 4% 4%
EBIT 738 830 840 901 935 33% 12% 14% 9% 11%
Interest & Tax 431 485 490 521 546 33% 13% 14% 7% 11%
Earnings 307 346 350 381 390 34% 12% 14% 10% 11%
EBIT margin (%) 12.3% 13.2% 13.2% 13.6% 14.0%

EBITDA margin (%) 17.8% 18.8% 18.7% 19.2% 19.5%
Source: Factset, Exane BNP Paribas estimates

Our 2011 assumptions
Our forecasts for 2011 earnings growth are founded on the following assumptions.
Figure 4: Main assumptions of our core scenario

Factor 2011 change (%) 2012 change (%)
Volumes 2.7 3.1
Selling prices 3.2 1.6
Input prices 4.1 2.2
Commodity prices* 10 0
FX (EUR)* unchanged over 2010 average 0
* Changes based on year averages.

Revenue growth
Top-line growth can come from two sources: volume growth and price increases. We
estimate both of these components using Exane BNPP Economists’ scenarios as a
starting point. We estimate that European companies will be able to expand top lines
by approximately 6% next year.
Volume growth
On aggregate, volume growth in the corporate sector is driven by real GDP growth. Our
Economists forecast a small acceleration in growth in Europe and a small deceleration
in the USA (see figure above). Most growth should once again be delivered by
emerging markets, where we expect real growth in excess of 6%. Using a regional split
of revenues (65% Europe, 10% US, 25% emerging markets) should provide the
European corporate sector with volume growth of approximately 2.7% next year.
Price increases
Forecasts for the price increases that the corporate sector is likely to be able to push
through have to be based on expectations for inflation. Our economists expect
consumer price inflation to remain subdued next year, at 1.6% in Europe, a mere 1.1%
in the USA and 5% in the emerging world. Of course not all companies sell directly to
consumers, so PPIs and commodity prices also form part of our price forecasts. We
assume PPIs to increase slightly more than CPIs and commodity prices to stabilise
close to current spot prices, implying a 10% year-on-year increase in 2011.
We calculate selling prices and input prices from the same components. The only
difference lies in the component weights. For input prices we use only PPIs and
commodity prices; for selling prices we mix in CPIs as well.
Fixed costs – operational leverage

We assume slightly decreased operational leverage compared with 2010. Aggressive
cost cuts by European companies have enhanced efficiency in the aftermath of the
recession. During the recession, fixed costs as a percentage of total costs rose to
approximately 32%, from a pre-crisis level of about 28%. With economic recovery,
variable costs naturally rise again and it should be expected that some of the
extraordinary cost cuts turn out to be cyclical rather than structural and are reversed.
We estimate operating leverage will decline somewhat in 2011, but at 31% fixed
costs/total costs remains higher than before the recession.

Margin expansion
As a result of the above, we expect EBIT margins for the European corporate sector to
expand by around 90bp next year.
Margin expansion should be possible. Top-line growth, thanks to the phenomenon of

operating leverage, the most important factor for margin expansion, should be a
healthy 6% next year. This should suffice for margin expansion despite some
acceleration of input costs and despite slightly diminished operating leverage.
It is important to keep in mind that higher input costs from, say, raw materials prices,
are not necessarily accompanied by lower margins. It depends very much on why
commodity prices are rising. If they are driven by strong demand, companies are also
likely to experience volume growth of their own and with fixed costs staying unchanged
operating leverage should boost margins. The best example of this was the record
breaking margin expansion across all sectors between 2003 and 2007 as the oil price
quadrupled.
We do not expect margin pressure from rising wages next year. Historically, US wage
inflation only tends to pick up once US unemployment rates fall to 6% or less, a far cry
from our forecast of 9% on average in 2011. With significantly above-trend
unemployment rates in large parts of Europe, wage inflation should also stay low on
this side of the Atlantic, with the possible exceptions of the stronger euro-zone
countries like Germany and the Nordics. (See our Investment Theme on German
consumer spending later in this report).
When discussing margin expansion in 2011, it is important to keep in mind that margins
are not yet at historical peaks. Margin expansion since the economic trough has been
impressive, but for the market excluding Financials, EBIT margins remain several
percentage points off the 2007 peak (see Figure 5). Using our forecasts from above we
estimate EBIT margins could expand to 13.2% next year, 40bp below the peak. And we
see peak margins as achievable over the coming years given decent volume growth.
The corporate sector seems to be escaping higher tax rates for the foreseeable future
and stubbornly high unemployment rates are keeping labour costs down.

Figure 5: Europe, excluding Financials - EBIT margins (%)
14
2011e
12
10
4
82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12
Source: Thomson Datastream, Exane BNP Paribas estimates
Interest expenses
We expect interest expenses to decline slightly next year.
Credit spreads have narrowed sharply and in our core scenario, of a continued gradual
normalisation of credit markets and quantitative easing, credit spreads should grind
lower but the room for additional yield compression over 2010 is small. Our core
scenario also suggests roughly unchanged government bond yields (on average 2.6%
for 10-year Bunds in 2011e).
Any impact from an improvement in corporate bond yields on 2011 earnings would be
further absorbed by the fact that fixed-rate interest expenses change only when debt is
refinanced. As a result, lower (or higher) corporate bond yields hit interest expenses
with a delay depending on the maturity structure of each company’s debt.
Tax
We expect tax expense to rise roughly in line with EBIT next year. Higher corporate
taxes seem unavoidable in the longer term, but should not be a topic before 2012 at the
earliest.
In the recent wave of austerity packages there has been a notable absence of
corporate tax increases. With unemployment still lingering uncomfortably above trend
levels in many countries, governments have been unwilling to increase the burden on
companies and building further barriers for new jobs. The British government’s decision
to cut corporate tax rates from 28% to 24% (1% reduction per annum over the next four
years) and similar plans in Japan show this trend.
Tax increases could become a topic of debate should the economy stabilise and
unemployment decline next year, but given the time-lag involved in such decisions any
increases are unlikely to be implemented before 2012, probably even later.

Currency
The Exane BNP Paribas forecast for EUR/USD next year is an average of 1.35. This
compares with an average so far this year of 1.33, so on our forex forecasts, currency
moves should be a negligible factor for European earnings in 2011.
As the uncertainty on currency forecasts is perhaps even greater than on economic

and earnings forecasts, it is important to be aware of the sensitivities of earnings to
currency moves. We estimate that a 10% change in the EUR/USD exchange rate
changes EBIT by approximately 3%.
A first look at 2012

While it may seem early to start talking about 2012 earnings prospects it is in fact an
important ingredient for any 2011 equity market outlook. 2012 earnings growth is
essential in coming up with a return forecast through end 2011, which boils down to the
development of forward earnings in the next twelve months (roughly equivalent to
2012e EPS growth) and what valuation (such as forward P/E ratio) one expects the
market will be willing to pay for those earnings at the end of 2011.
Of course, there is still a great amount of uncertainty attached to 2012 forecasts, but
our first take is based on the following assumptions:
– A small acceleration in global GDP growth, close to 2010 growth rates. This
assumption is based on current IMF forecasts, to which we have applied a small safety
discount.
– Stable inflation rates, only marginally above 2011 levels.
– We make no call on currencies and commodity prices beyond 2011, so assume
stability on both
Our assumptions give us a top-line growth target of 4.6%, slightly below current
consensus of 5.2%. This amount of top-line growth should again be sufficient to let
margins expand further, slightly exceeding 2007 peaks, and gives us an earnings
growth target of 11% for the Pan-European market excluding Financials. Given the
even greater uncertainty attached to Financial sector profits in 2012, we choose to
apply market-average growth rates instead of slightly higher consensus growth
expectations. So our total market EPS growth forecast remains at 11% for 2012.
Where could we be wrong?

While we are as confident as we can be in the correctness of our core earnings
scenario outlined above, we admit that there is a risk we could be wrong. To address
this risk we have designed two alternative scenarios, one more bullish than our core
scenario, the other more bearish.
For the more bullish scenario, we use the following assumptions. We assume a
stronger global economy than in the core scenario, with growth rates accelerating
slightly rather than slowing down. This assumes the economic recovery in developed
markets proves more self-sustainable with the boost of quantitative easing. The US
economy would maintain 2010 growth rates rather than slowing down and a slightly
larger acceleration in Europe. This would boost volume growth to 3.3%. Such an
economic scenario would likely also lead to higher commodity prices where we assume
20% appreciation, implying a 2011 average 10% above spot prices. This naturally lifts
selling and input prices, but due to the weight of the Resources sectors and operating
leverage remains a significant positive for 2011e market EPS.

Figure 6: Assumptions in the bullish scenario
Inputs Core (%) Bullish (%)
Volumes 2.7 3.3
Commodity prices 10 20
FX (EUR) Unch. Unch
Fixed costs 31 30
With the above bullish assumptions we arrive at a top-line growth forecast of 8.4%.
Greater volume growth meets increased operational leverage, so our EBIT margin
expansion forecast rises to 150bp. All of this filters down to a bottom-line increase
of 21%.
Figure 7: Bullish scenario for 2011 (MSCI Europe, excluding financials)

Consensus Exane BNPP Consensus Exane BNPP Consensus Consensus Exane BNPP Consensus Exane BNPP
2011 2011 2012 2012 2010 2011 2011 2012 2012
EURbn % growth
Sales 6,297 6,527 6,624 6,828 2% 4.6% 8.4% 5.2% 4.6%
COGS 5,112 5,277 5,356 5,467 10% 3.2% 6.6% 4.8% 3.6%
EBITDA 1,185 1,249 1,269 1,361 20% 11% 17% 7% 9%
Depreciation 355 355 367 367 (2%) 7% 7% 4% 4%
EBIT 830 895 901 994 33% 12% 21% 9% 11%
Interest & Tax 485 522 521 580 33% 13% 21% 7% 11%
Earnings 346 373 381 414 34% 12% 21% 10% 11%
EBIT margin (%) 13.2% 13.7% 13.6% 14.6%

EBITDA margin (%) 18.8% 19.1% 19.2% 19.9%
The bearish scenario differs from our core scenario in three main ways. We assume
less economic growth across all regions as the effects of austerity begin to bite and the
private sector struggles to offset the decline in government spending. This leaves us
with volume growth of only 2.3%. In line with a weaker economic environment we
assume commodity prices remain unchanged compared with the average of 2010,
implying a 10% decline for spot prices. We assume the same operational leverage as
in our core scenario. As an additional small stress we add the assumption of a slightly
stronger euro.
Figure 8: Assumptions in the bearish scenario

Inputs Core (%) Bearish (%)
Volumes 2.7 2.3
Commodity prices 10 Unch
FX (EUR) Unch. 5
Fixed costs 31 31
In this bearish scenario we arrive at a top-line growth forecast of 3.6%. Operational

gearing may be the same as in our core scenario, but with lower volume growth the
bearish scenario would see EBIT margins stay almost flat (+10bp). All of this filters
down to a bottom-line increase of 4%.

Figure 9: Bearish scenario for 2011 (MSCI Europe, excluding financials)
Consensus Exane BNPP Consensus Exane BNPP Consensus Consensus Exane BNPP Consensus Exane BNPP
2011 2011 2012 2012 2010 2011 2011 2012 2012
EURbn % growth
Sales 6,297 6,240 6,624 6,528 2% 4.6% 3.6% 5.2% 4.6%
COGS 5,112 5,103 5,356 5,287 10% 3.2% 3.0% 4.8% 3.6%
EBITDA 1,185 1,136 1,269 1,241 20% 11% 6% 7% 9%
Depreciation 355 355 367 367 (2%) 7% 7% 4% 4%
EBIT 830 770 901 874 33% 12% 4% 9% 13%
Interest & Tax 485 449 521 510 33% 13% 4% 7% 13%
Earnings 346 321 381 364 34% 12% 4% 10% 13%
EBIT margin (%) 13.2% 12.3% 13.6% 13.4%

EBITDA margin (%) 18.8% 18.2% 19.2% 19.0%
Room for consensus upgrades

So how do bottom-up consensus forecasts for earnings measure up to our forecasts?
Our EPS forecasts are 2% above current bottom-up consensus. This gap is more
remarkable than it seems.
It is highly unusual for our top-down forecast to be higher than bottom-up consensus.
This is the first time in several years this has happened. And usually it is a good
starting point to be cautious about analyst forecasts, as during the past 18 years
analysts have initially over-estimated earnings by 10% on average. Forecasts have often
been too high, even during earnings growth phases. During the bull market of the 1990’s,
for example, earnings grew from year to year but revisions tended to be to the downside
from an overly optimistic starting point (see Figure 10).
Analyst forecasts have fallen since the summer, perhaps somewhat too far. With
economic uncertainty rising, deteriorating macro-economic news flow from the US (e.g.
declining ISM), analysts have become more cautious about 2011 and 2012 earnings. For
the MSCI Europe, 2011 EPS estimates have been revised down by 4.5% since June and
it was a broad downgrade trend with 16 out of 24 sectors seeing significant forecast cuts.
But global growth should remain resilient next year and we believe downward revisions
have now gone too far, leaving room for upgrades as macro data improves and economic
growth comes through.
Figure 10: MSCI Europe: consensus forecast EPS (EUR)
140
120
2008
2011
100
2006
2007 2005
80
2010
2000 2004
60 1999 2009
2003
40
2001
1994 2002
20 1993
1990
1992
0
Jan 88 Jan 90 Jan 92 Jan 94 Jan 96 Jan 98 Jan 00 Jan 02 Jan 04 Jan 06 Jan 08 Jan 10
Source: Thomson Datastream, Exane BNP Paribas

Valuation and index targets
Absolute valuations – still attractive
Valuations of European equities have become more attractive in 2010, both in absolute
terms and relative to fixed income alternatives.
In absolute terms, forward-looking valuation ratios have shrunk as a result of significant

earnings upgrades among both Financials and most non-Financials, against more
modest gains in European headline indices (see Figure 11).
Figure 11: European equities - multiple contraction

Valuation ratios, 12-month forward (x)
14
12
10
0
P/E EV/EBIT P/CF P/Book EV/Sales
1 Jan 10 Latest
Source: Factset, Exane BNP Paribas
The 6% rise of the DJ Stoxx 600 index, for instance, is in sharp contrast with the
substantial earnings upgrades seen in 2010 (see Figure 12). As a result, the market’s
12-month forward P/E has shrunk from 12.6x at the beginning of the year to 10.8x,
which is a 14% discount to its 15-yr average (excluding the Great Bubble years 1998-
02) of 12.6x.
Figure 12: A year of significant earnings upgrades

Europe - consensus estimates 2010e EPS growth (%)
Jan 10 Nov 10
Financials 37 48
Non-Financials 21 34
Total 25 39
As a result of this multiple contraction, Europe’s forward P/E, EV/EBIT, P/CF and
P/Book are trading at 5-15% discounts to their long-term mean (we have excluded the
Great Bubble years of 1998-02 from the long-term averages).
The only ratio which is not trading at a discount is EV/Sales (1.1x, in line with its
historical average).

Figure 13: European equities – attractive on most counts
Valuation ratios – current as a % of 15-yr average* (12mth forward)
110
100
90
80
70
60
50
EV/Sales P/Book P/CF EV/EBIT P/E CAPE**
* Excluding the Great Bubble years 1998-02.

** Cyclically Adjusted P/E, based on 10yr average trailing EPS.
The Cyclically Adjusted P/E (‘CAPE’, based on price/10-year average EPS, trailing) is
the only valuation ratio which has risen in 2010 (from 13.9x in January to 14.5x in
November) because of its backward looking nature.
This, however, still leaves the European CAPE at a 26% discount to its long-term mean
(excluding the Great bubble years of 1998-02).
The US market CAPE, however, has risen above its long-term average (100 years)
once again (20x vs 18x), which suggests that the S&P500 is some 10% overvalued
(see Figure 14). This overvaluation is corroborated by another long-term indicator,
Tobin’s Q-ratio, which compares the stock market value with the underlying asset value
of companies. For US non-Financials, the current ratio (0.9x) is 20% above its long-
term average (0.75x).

Figure 14: Valuation Europe and USA
USA and Europe - Cyclically Adjusted P/E (Price/10yr trailing average EPS), x
50
45
40
35 long-term mean USA
30
25
20
15
10
5
00 10 20 30 40 50 60 70 80 90 00 10
USA Europe
Source: Datastream, Shiller, Exane BNP Paribas estimates
The chart above shows that Europe’s CAPE trades well below its own historical
average. It should be noted, however, that the significant discount to the US CAPE is
not very meaningful, for two reasons.
First, the valuation gap is to some extent explained by sector bias. For instance, in
Europe, Financials account for 22% of the DJ Stoxx 600, against 16% of the S&P500.
This lowers the European CAPE, given Financials’ discount to the market average. The
converse applies to Technology (usually trading at a premium), which accounts for 17%
of the S&P 500, against a mere 3% of the DJ Stoxx 600.
Second, historical averages of both markets are not comparable, simply because of
their different time frames: 100 years for the USA, vs a mere 27 years for Europe.
All in all, absolute valuations in Europe look attractive from an historical perspective. All
but one of the six valuation ratios that we monitor are trading at a discount to their
historical average. The US equity market, however, is we believe some 10%
overvalued, based on the market’s cyclically adjusted P/E (CAPE).
Relative valuations – more attractive than bonds

In relative terms, equity valuations have benefited from a further decline in corporate
and government bond yields in 2010.
In May 2010, for the first time in living memory, the average dividend yield exceeded
the average corporate bond yield in Europe (see Figure 15). This is highly unusual,
because shareholders usually have the benefit of rising dividends (historically,
dividends have been growing a bit less than GDP, but growing nevertheless), whereas
bondholders do not share this benefit.
This negative yield gap suggests that either investors take an unduly negative view on
future dividend growth, or, that bond markets are overvalued as a result of the asset
price-manipulating Fed.
Admittedly, the outlook for dividend growth in the mature, high yielding sectors,
including Financials, Oil & Gas, Telecoms and Utilities, is not what it used to be. But the
risk of widespread dividend cuts is highly unlikely, in our view.

The 2011e operating cash flow covers, on average, more than twice the expected
corporate spending on capex and dividends. None of the European sectors have a
cash flow coverage ratio of less than 100%, even for Utilities (see Figure 16). There is,
in other words, no economic reason for dividend cuts, other than the bear case of a
double dip, which is not our base scenario.
This means that equities provide a fairly safe yield, in our view, that is higher than the
average yield on investment grade corporate bonds. The risk profile of equities is, of
course, not the same as that for bonds. But the latter are far from risk-free in an
environment of rising inflation expectations as a result of rising commodity prices and a
persistently bubble-blowing Fed. History shows that equities offer a better hedge
against inflation than bonds.
Figure 15: Equities look more attractive than bonds

Europe – dividend yield, corporate bond yield and 10y Bund yield (%)
1
00 01 02 03 04 05 06 07 08 09 10 11
Dividend yield (12m fwd) Corporate BY (inv gr.) 10y Bund yield
Source: Exane BNP Paribas, Thomson Datastream
Figure 16: Ample cash flow coverage for capex and dividends
European sectors – 2011e pre-tax operating cash flow/(Capex + Dividends), %
Beverages
IT Hardware
Pharma
Leis. & Hot.
Media
Capital Gds
Mining
Market
Aero. & Def.
Constr.
Chemicals
Luxury Gds
Food & HPC
Automotive
Gen'l Retail
Food Retail
Oil & Gas
Telecoms
Utilities
50 100 150 200 250 300 350

Quantitative easing and P/E expansion
The combination of below average valuations and low interest rates (including negative
real interest rates in the UK and the USA), thanks to the bubble-blowing Fed, make a
good case for P/E expansion.
The aim of QE2 is to boost asset prices and raise inflation expectations. The former is
supposed to encourage consumer spending as a result of a positive wealth effect. The
latter lowers real interest rates, which, in turn is supportive of economic growth.
By merely hinting at another round of quantitative easing at the end of August, the Fed
was able to drive down real interest rates. In the US and the UK, 5yr real bond yields
turned negative in October, while real bond yields in Germany, fell to a marginal 0.5%.
Figure 17: Real interest rates - from exceedingly low to negative

Real 5-year bond yields, based on index-linked bonds (%)
3.0
2.5
2.0
1.5
1.0 `
0.5
0.0
(0.5)
(1.0)
Jan 09 Jul 09 Jan 10 Jul 10 Jan 11
UK USA Germany
Source: Thomson Datastream
Negative real interest rates are supportive of economic growth, but quantitative easing
also provides a major boost to asset prices in general and real assets in particular.
Just consider the performance of equities, bonds, gold and commodities in the 10
weeks following Mr Bernanke’s first hint of another round of quantitative easing (QE2)
on 27 August. They all rose in value at the same time (see Figure 18), a rare
phenomenon that cannot be easily explained by factors other than the prospect of QE2.

Figure 18: Asset price inflation following the Fed’s first hint of QE2
Asset price gains in USD between 1 September and 1 November
Corp bonds (EUR, HY)

MSCI Emrg mkts
Commodities (CRB)
Oil (Brent)
MSCI Europe
MSCI World
S&P 500
Gold
EUR cash
Bunds
Corp bonds (EUR, inv gr.)
US Treasuries
USD cash
0 2 4 6 8 10 12 14
Source: Datastream
Nevertheless, we assume that a meaningful expansion of market P/Es is not

sustainable in 2011e. Here is why.
First, there is a lot of uncertainty regarding the effectiveness or unintended

consequences of quantitative easing, simply because there is no historical precedent
for such sustained monetary stimulus.
This uncertainty warrants a certain risk premium. The first round of quantitative easing,
worth USD1,700bn of asset purchases which ended in Q1 2010, did not have the
desired effect, so why would QE2, worth a third of QE1 (USD600bn) be more
successful? And even if it were, it would lead to uncertainty related to the Fed’s
inevitable exit strategy, thereby constraining the potential for P/E expansion.
Second, we believe US equities are overvalued, albeit modestly; the cyclically adjusted
market P/E (CAPE) is trading some 10% above its long-term average. This makes it
more difficult to argue for sustained multiple expansion, even in an environment of
negative real interest rates.
It is true that European equities are undervalued based on this measure, but we see no
reason for the strong correlation between the DJ Stoxx 600 and the S&P500 to cease
anytime soon.
History shows that, counter-intuitively, US market P/Es have been higher, on average,
when real interest rates were positive than when they were negative. The same
applies, more intuitively, to market P/Es and inflation: equity markets prefer low, but
positive inflation to deflation.

Figure 19: Cyclically Adjusted market P/E at different levels of real interest rates and inflation (1870-2010)
US equity valuations and real interest rates US equity valuations and inflation
< 0% >9%
0%-5% 6-9%
Real Bond Yield
US Inflation
5%-10% We are here 3-6%
10%-15% 0-3%
> 15% < 0% We are here
6 8 10 12 14 16 18 20 6 8 10 12 14 16 18 20
CAPE (x) CAPE (x)
Source: Shiller, Datastream, Exane BNP Paribas estimates
This does not mean that P/Es cannot expand. Financial markets can and do deviate
from their long-term averages all the time.
Indeed, it may well be that the trend in, rather than the level of real interest rates, which
is down, will push market P/Es higher in 2011e. This would leave more upside for
equities than our base scenario (provided, of course, that P/E expansion is not the
result of EPS downgrades!).
Conclusion and index targets

In conclusion, we expect a positive year for equities, with the headline indices rising
more or less in line with the expected growth in earnings. Low and falling real interest
rates should be supportive of real asset prices, including equities.
Nevertheless, we do not expect a sustained, meaningful rise in market P/Es. This is

because a) we think the S&P500 is overvalued (the US CAPE of 20x is some 10%
above its long-term average) and b) the big uncertainties related to QE2 warrant a
certain risk premium.
All in all, we expect a 12% gain, on average for European headline indices, which is in
line with 2012e EPS growth (2011e EPS growth is already discounted in today’s 12-
month forward P/E). This gives a total expected return of 15% by including an average
dividend yield of 3%.
This should easily beat the returns on fixed income alternatives, be it cash, corporate
bonds, US Treasuries or Bunds. P/E expansion, thanks to exceedingly low real interest
rates, cannot be excluded and would be a bonus on top of the 15% expected return.

Our 12-month index targets, based on the above assumptions, are summarised below.
Figure 20: Equity index targets – our 2011e guesstimates

Headline index targets 2011e for Europe and the S&P500
Index 1 Jan 10 18 Nov 10 % gain June 2011e June 11e Dec 2011e Dec 11e
YTD target upside (%) target upside (%)
DJ Stoxx 600 254 271 7 280 3 305 12
DJ Euro Stoxx 50 2,965 2,855 (4) 3,000 5 3,200 12
CAC 40 3,936 3,868 (2) 4,000 3 4,300 11
DAX 30* 5,957 6,832 15 7,300 7 8,000 17
FTSE 100 5,413 5,769 7 6,000 4 6,400 11
S&P 500 1,115 1,197 7 1,250 4 1,300 9
* Total return index.

Our index targets, which we review twice a year (at the interim stage and at the end of
the year), warrant a few comments.
First, our 6 and 12-month index targets of a year ago turned out to be spot on, at least
for the DJ Stoxx 600 and the S&P500 (275 and 1,200, respectively). We expected a 5-
10% market correction in H1 2010 (because of budget deficit concerns or disappointing
earnings), followed by a recovery in H2. This is exactly what happened: after a
mediocre H1 2010, all six equity headline indices hit our Y/E targets in November,
within plus or minus 2%.
Second, the usual caveat emptor applies. Index targets should always be taken with a
pinch of salt, for the forecast error is significant, especially with an asset price
manipulating Fed. History shows that equity markets are far more sensitive to monetary
policy than the real economy. This is why they often overshoot (both on the upside and
the downside) when unexpected changes in monetary conditions take place. The
extent of the overshooting is simply impossible to predict.
In other words, it is a difficult task to determine ‘fair value’ for equity markets at the best
of times and nigh impossible when the Fed is manipulating asset prices on an
unprecedented scale. And we haven’t even mentioned the difficulties in valuing stocks
as a result of the sovereign debt crisis in the eurozone. For instance, what is the risk
free rate to be used for a Spanish company which has more than 50%of its activities
outside Spain?
In conclusion, 2011 will doubtless be another bumpy ride. But the path of least
resistance for equities is up, in our view, driven by attractive valuations and exceedingly
loose monetary policy.

Monetary conditions
We expect monetary conditions to remain benign throughout 2011. In some ways one
could say the monetary backdrop for equity markets is likely to be as good as it gets:
zero interest rate policies (ZIRP) from most major central banks, quantitative easing
(QE) in the US keeping the long end of the yield curve down, decent economic and
earnings growth keeping corporate bond yields low and European equities arguably
offering some of the highest yields in financial markets.
Let’s look at some of the individual factors.
Central banks – liquidity is here to stay

The world’s main central banks, those in the developed world, bar Australia, are all
currently running extremely loose monetary policies, at least by historical standards.
One of the core views of Exane’s Economics team is that the sluggish pace of
economic recovery and persistent output gaps necessitate an extended period of low
real interest rates. Although the means of achieving this may change, interest rates
along the entire curve are likely to remain low throughout 2011 and probably for some
time beyond that.
ZIRP is here to stay

Exane’s economists’ forecast of ‘no rate hikes’ in the developed world in 2011 has
stood for over a year. Consensus has now caught up, but we see no reason to change
our forecast.
The fundamental argument remains convincing. Growth in most developed countries

remains well below potential. As a result of this output gap, inflation has also been low
and the Federal Reserve has abandoned for now its exit strategy. In fact, the zero-rate
bound is what has arguably kept the Fed from an even lower fed funds rate. The Taylor
rule suggests a negative fed funds rate would be appropriate in the current
circumstances, so as that is not possible, a lower for longer zero rate policy seems
likely.
In the euro zone and the UK, fiscal austerity measures add to pressures on central
banks to keep base rates low. For the UK in particular it seems likely that austerity
measures will weigh on growth and consumers’ disposable incomes for some time. To
offset these fiscal tightening measures monetary policy is likely to remain unusually
accommodative for an extended period of time.

Figure 21: No rate hikes on the agenda
Base rates, historical and Exane BNPP forecasts
6.0
5.0
4.0
3.0
2.0
1.0
0.0
Jan May Sep Jan May Sep Jan May Sep Jan May Sep Jan May Sep
07 07 07 08 08 08 09 09 09 10 10 10 11 11 11
FOMC ECB BoJ BoE
Source: Bloomberg, Exane BNP Paribas
QE2 – keeping a lid on the long end

With QE2 in the US on the agenda through at least the middle of next year, yields are
also likely to stay low at the long end of the yield curve. It is impossible to calculate the
precise impact of QE2 on bond yields and on the economy, but Exane’s economists
estimate the impact of the program could be equivalent to a 75bp decline in the fed
funds rate.
We find it likely that quantitative easing will be extended beyond the initial horizon of
June 2011. The Fed has deliberately left this option open in its most recent FOMC
statement, making the pace and size of asset purchases subject to regular review. As a
result we expect equity markets to remain highly sensitive to inflation and labour market
news flow. Given our economists’ forecasts of a US growth slowdown it seems likely
that economic data will allow asset purchases to be extended beyond mid 2011.
Credit stability
As equity strategists we shy away from making outright forecasts for credit markets, but
given our economic scenario, our top-down view of corporate earnings growth and the
prospects of continued central banks asset purchases, it seems most likely that
corporate bond yields will remain low.
Most factors suggest a stable credit environment, but with limited room for further
spread tightening. Global GDP growth of 3.8% and healthy balance sheets (see chart
below) make a significant increase in corporate default rates unlikely. As long as
companies can post positive earnings growth the risk of large-scale pressure on the
payment of coupons should also be low; we forecast 16% EPS growth for the pan-
European market. Asset purchases as part of further quantitative easing should drag
down yields and spreads in corporate bonds as well as investors’ reach for yield.

Figure 22: Healthy corporate balance sheets
Gearing – European market ex Financials (%) (D/E)
50
45
40
35
30
25
20
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Good environment for equities

All of the above provide a near perfect liquidity environment for equities.
The conclusion of the above is an environment of low (and possibly even negative) real
interest rates for the foreseeable future. On the one hand this should boost earnings
growth. By keeping borrowing costs low the Fed is attempting to encourage business
investment and thus boost economic growth potential. We estimate it takes three to
four quarters for the monetary stimulus to reach the real economy and although the
transfer mechanism may not be working perfectly in an environment of private sector
de-leveraging, history suggests a positive effect on economic growth rates.
At the same time, low real rates should boost equity valuations. Although the assets
purchased by the Fed are government bonds rather than equities we should expect
some spill-over effects into other asset classes. Bond buying pushes down bond yields,
making this asset class relatively unattractive and encouraging investors to reach for
yield in other more risky asset classes. So quantitative easing encourages risk taking
(good for equities) and pulls down yields (push up prices) along the entire risk
spectrum, including equities.
From an equity investor’s perspective one could perhaps even argue that the less
effective quantitative easing is in boosting the economy, the better it is for equities. If
less of the created liquidity finds its way into the real economy, possibly as the result of
a liquidity trap situation, the more liquidity will end up in risk assets (e.g. equities)
boosting valuations.
These fundamental arguments are also reflected in historic correlations. The two most
recent US quantitative easing programs were both associated with rising equity
markets. In the chart below we use the start of central bank guidance about quantitative
easing as the starting point, as that is when markets begin to price in QE. The chart
below also shows that there is no hard and fast rule that says what is good news for
bonds is bad news for equities. The correlation between these asset classes depends
on the reason for the bond yield decline. If, as is the case now, it is driven by low real
interest rate expectations it is good news for both asset classes.

Figure 23: QE boosts equities
Periods of QE announcement have resulted in rising equity markets and stable/lower bond yields
1650 5.5
1550
5.0
1450 QE2
1350 4.5
QE1
1250
4.0
1150
3.5
1050
950 3.0
850
2.5
750
650 2.0
Jan 07 May 07 Sep 07 Jan 08 May 08 Sep 08 Jan 09 May 09 Sep 09 Jan 10 May 10 Sep 10
S&P 500 (lhs) US 10yr yield (rhs)
Low base rates are equally beneficial for equities. As the chart below shows, this effect
is also borne out by historical data. Low rates accompanied and to a large degree
caused both the equity market rallies beginning in 2003 and 2009. It is, of course, not
so much the direction, as the level of base rates which matters (see chart below).
Figure 24: Low fed funds rate booster

Fed funds rate and S&P 500
6.0
1550
1450 5.0
1350
4.0
1250
1150
3.0
1050
950 2.0
850
1.0
750
650 0.0
Jan 01 Jan 02 Jan 03 Jan 04 Jan 05 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10
S&P 500 (lhs) Fed funds rate (rhs)
Tight credit spreads also provide a positive equity environment. Fundamentally, the
correlation is not surprising. Low credit spreads suggest low borrowing costs (as far as
low spreads are associated with low corporate bond yields), a clear positive for the
corporate sector.
Secondly, credit spreads are a measure of risk compensation in a risky asset class, just
as implied volatility is a measure of risk compensation in equities. So both should and
are closely correlated (see chart below). As low implied volatility is associated with high
share prices, credit spreads have been closely correlated with share prices.

Figure 25: Equities continue to be closely correlated with credit spreads
Correlated risk compensation
VDAX vs BBB spread Credit matters
120 300 100

7
100 275
6 200
250
80 5
300
4 225
60
400
3 200
40
2 500
175
20
1
150 600
0 0 Jan 09 Jul 09 Jan 10 Jul 10 Jan 11
99 00 01 02 03 04 05 06 07 08 09 10
DJ Stoxx 600 (lhs)
VDAX (lhs) BBB spread in % (rhs) Corporate credit spreads (Baa, inverted rhs,bp)
Source: Thomson DataStream, Exane BNP Paribas estimates
Fund flows – neutral for equities

While the liquidity environment is very supportive of long positions in equities, we see
limited scope for large fund flows from other asset classes into equities next year. This
is a potentially very bullish argument for equities, but one we think lies beyond 2011.
Fund flows have for some time been dominated by bonds. The data in the chart below
is for US mutual funds, but should be a good reflection of what has happened much
more broadly. Since 2009, as risk aversion has faded most of the flows out of money
market funds have ended up in bonds, both corporate and sovereign. The return of
principle rather than the return on principle has been the priority for investors. It is also
a reflection of regulation that forces many insurers to prefer bonds over presumably
much more risky equities.

Figure 26: Bonds have been king
Cumulative US mutual fund flows (USDbn)
800
600
400
200
-200
-400
-600
Jul 07 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10
Domestic equities Bonds Money-market International equities
Source: ICI, various sources, Exane BNP Paribas
With the valuation of equities relative to other asset classes close to historical lows, the
benefits of lower bond yields and quantitative easing should work particularly strongly.
The chart below shows the dividend yield of European equities significantly exceeds
the yields available from government and corporate bonds. On current forecasts the
average European stock yields 3.9%, compared with AA rated corporate bonds offering
3.2% and 10-year Bunds at 2.6%. The admittedly higher risk earnings yield for
European equities stands at an even more impressive 9.1%.
The further bond yields fall, the more attractive equities become to asset allocators and
the more difficult it becomes to justify a continuation of the current fund flow trend. One
can find more and more evidence of investors shifting out of bonds into equities (e.g.
Ageas Insurance), but it remains anecdotal evidence rather than a large trend.

Figure 27: Excellent relative value
Equity valuations (dividend yield) compared with other sources of yield
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
Jul 01 Jul 02 Jul 03 Jul 04 Jul 05 Jul 06 Jul 07 Jul 08 Jul 09 Jul 10
Dividend yield AA bond yield Bund 10yr yield
We would expect equities to get a growing share of fund flows in 2011 rather than a
real reversal of flows in the short term. History suggests that valuations are rarely the
catalysts for a change in trend. Assets can stay cheap or expensive for a long time. For
a real reversal to occur something needs to go wrong with the investment case for the
dominating asset class; something needs to deflate the bubble. It took a recession to
deflate the equity bubble built on the assumption of a new long-term growth paradigm.
It took increasing defaults on mortgages to deflate property prices.
For bonds such an event is most likely to be inflation, which would make a nominal
yield of 2.5% for government debt seem very unattractive and could potentially spark a
sharp sell-off in bonds. We expect inflation to remain contained at low levels for the
foreseeable future, so re-allocation out of bonds into equities seems too distant to bet
on it for 2011.

Risks
Quantitative easing
There are many uncertainties regarding quantitative easing, simply because there is no
historical precedent for such sustained stimulus. It remains to be seen whether the
positive wealth effect that the Fed is aiming for will boost US consumer spending and
whether investments will benefit even more from negative real interest rates.
There is also the risk of unintended consequences of QE2, such as trade restrictions
(as a result of further currency frictions), commodity price inflation (undermining
consumers’ purchasing power and eroding profit margins in sectors with limited pricing
power) and the creation of asset bubbles with potentially devastating consequences
(the Fed’s track record over the last 20 years has been impressive on this one).
There is also uncertainty as to what happens after QE2 expires at the end of June
2011. Will this be followed by a credible exit strategy, or, a third round of quantitative
easing in the event that QE2 does not have the desired effect? And how will the
markets react to QE3 in general and the US dollar in particular?
Quantitative tightening
There is the risk that China’s policy tightening, all but inevitable with food inflation
running at 10%, GDP growth close to 10% and negative real interest rates, will lead to
a hard landing rather than a mere slowdown.
Figure 28: China – a risk of quantitative tightening?

Chinese money supply, inflation and interest rates (% change yoy, except for deposit rate)
25
20
15
10
(5)
00 01 02 03 04 05 06 07 08 09 10 11
food inflation headline inflation real deposit rate (1yr)
It goes without saying that a hard landing in China would be unexpected and would not
be taken kindly by equity markets, considering that everyone seems to want to be
Overweight emerging markets or emerging market plays.
Escalation of the sovereign debt crisis

One of the risks is an escalation of the sovereign credit crisis that goes beyond the
smaller peripheral economies. We are not that worried about a possible bailout of
Ireland, which looks all but inevitable at the time of writing.

Figure 29: The unsustainable rise of the cost of sovereign debt
Eurozone – 10-year government bond yield minus 10yr Bund yield, bp
1000
900
800
700
600
500
400
300
200
100
0
Jan 09 Jul 09 Jan 10 Jul 10 Jan 11
GRE IRE PORT ESP
The EUR750bn that the European Financial stability Facility (EFSF) has at its disposal
(including the contribution from the IMF) is sufficient to refinance Greece, Ireland,
Portugal and Spain until 2013.
But this is of only modest comfort, given that bondholders are exposed to the risk of a
haircut as part of the new crisis resolution mechanism to be put in place after 2013.
The real risk for European equity markets is that the sovereign debt crisis will spread to
the larger peripheral countries, such as Spain. This would provide a major challenge
and could lead to fears of a fragmented eurozone and a more general rise in the risk-
free rate.
But since the introduction of the EFSF European headline equity indices have been
largely immune to the sovereign debt crisis (see figure below), benefiting from a weak
euro, lower eurozone interest rates for longer (the unintended consequences of the
crisis) and stronger-than-expected corporate earnings growth
Figure 30: The disconnection between sovereign debt and equities

Performance DJ Stoxx 600 and sovereign yield spread GIIPS vs Bunds
280 50
100
270
150
260 200
250
250
300
240 350
400
230
450
220 500
Jan 10 Mar 10 May 10 Jul 10 Sep 10 Nov 10
DJ Stoxx 600 (lhs) Yield spread 10y Bunds-GIIPS*, inverted rhs (bp)
* Non-weighted average of Greece, Ireland, Italy, Portugal and Spain.


Commodity price inflation and profit margins
One of the unintended consequences of quantitative easing is that of commodity price
inflation, which may have a larger impact on consumer spending (loss of purchasing
power) and/or corporate profit margins than is currently discounted.
The ability of companies to pass on cost inflation may prove to be more difficult than
during the credit-driven boom of 2003-2007 (oil prices trebled during that period without
meaningful consequences for corporate profitability) because of lower nominal GDP
growth in the absence of inflation.
This would have an adverse impact on profit margins which are expected to hit new
highs in virtually all sectors in 2011e (see Figure 31).
Figure 31: Profit margins heading for new highs

Europe – EBIT margins by sector (median, in %)*
35
30
25
20
15
10
0
Market
Aero.& Def.
Luxury Gds
Mining
Media
Automotive
Beverages
Software
Food & HPC
IT Hardware
General Rtl
Steel
Food Rtl
Telcos
Utilities
Constr
Capital Gds
Pharma
Chems
Leis. & Hotels
2010e 2011e Min Max
* Min and Max refer to period 1995-2009.

In our top-down earnings forecast for 2011e we have assumed commodity prices to be,
on average, 10% higher in 2011e than in 2010e. The negative impact of such a rise
should be more than offset by the positive impact of operating leverage and productivity
gains (i.e. ongoing restructuring efforts).
But if commodity prices were to rise significantly more than in our base scenario, this
would erode profit margins in certain sectors more than expected. Consumer
discretionary sectors would be particularly exposed as rising commodity prices would
also undermine consumers’ purchasing power.
For details regarding commodity price inflation and sector and stock repercussions,
refer to the section ‘Commodity price inflation’.

Investment themes
Growth vs Value – a polarised market

This year’s strong performance of growth stocks, mainly emerging market plays, has
led to a polarised market in terms of valuation. The gap between unexciting, mature
value plays and vibrant growth stories has widened to unprecedented levels.
In terms of EV/EBIT, the valuation premium for Growth vs Value has risen from 40% in
Q1 2009 to 100% today. Even allowing for superior EBIT growth in 2011e, the premium
is still an impressive 90%, based on consensus forecasts, i.e. 1.5x the 7yr average of
60%. Based on EV/Sales, Growth stocks are now trading at a 180% premium to Value,
double the historical average of 90% (see Figure below).
Figure 32: Valuation – ‘Vibrant’ Growth vs ‘Boring’ Value*

EV/EBIT, 12mth fwd EV/Sales, 12mth fwd
16.0 220% 3.5 280%
14.0 3.0 260%

200%
240%
Rel. 12m EV/EBIT
Rel. 12m EV/Sales

12.0 2.5
12m EV/Sales
12m EV/EBIT
180%
220%
10.0 2.0
200%
160%
8.0 1.5
180%
140%
6.0 1.0 160%
4.0 120% 0.5 140%

Jan 03
Jan 04
Jan 05
Jan 06
Jan 07
Jan 08
Jan 09
Jan 10
Jan 11
Jan 06
Jan 07
Jan 03
Jan 04
Jan 05
Jan 08
Jan 09
Jan 10
Growth/Value (rhs) Growth (lhs) Growth/Value (rhs) Growth (lhs)

Value (lhs) Value (lhs)
* Based on a portfolio of 10 European large caps each, equally weighted.(Small population due to survivor issues)
Source: Exane BNP Paribas estimates, Factset
The result is an increasingly tricky trade-off between cheap, mature Value plays (e.g.
Financials, Telecoms, Utilities and Pharmaceuticals) and vibrant but increasingly
expensive Growth in relative terms (mostly, but not limited to emerging market plays,
such as Luxury Goods and many Industrials).
It must be said that the strong performance of many Growth stocks has simply been led
by earnings upgrades and above-average EPS growth, rather than by a rerating. For
instance, Luxury Goods are currently trading at 12mth forward EV/EBIT of 10.4x, which
is a mere 0.2x more than at the beginning of the year, despite outperforming the market
by more than 40% year-to date.
Indeed, the upper lines in the Figure below above show that in absolute terms Growth
stocks are still less expensive, on average, than prior to the financial crisis.
Growth stories, therefore, continue to be tempting: reasonable valuations by historical

standards with superior growth prospects. But when compared to Value stocks, the
investment case becomes less easy: would you buy l’Oreal at a forward EV/EBIT of
15x or Sanofi-Aventis at less than 6x?

What about, say, Total and BG Group, trading at respectively 5x and 10x 12-month
forward EV/EBIT (and with a dividend yield of 6% vs 1%)?
Growth stocks should continue to outperform for as long as companies do not

disappoint consensus estimates. But there are two potential catalysts that could end
the outperformance of Growth vs Value.
First, Growth stocks have been a big beneficiary of falling bond yields, thanks to the
longer duration of future cash flows compared to that of value stocks. This comparative
advantage may be coming to an end in an environment of rising inflation expectations
which should put a floor on interest rates.
Second, year on year comparisons are likely to be a lot less favourable for growth
stocks in 2011e than in 2010e. For instance, 2010e EPS growth in Luxury Goods of
36% is 18 times that of Telecoms (2%). For next year, the ratio shrinks from 18x to
2.5x, based on current estimates (16.5% vs 6.5%).
FCF growth at reasonable prices

In order to address the dilemma between Growth and Value, we have screened for
European stocks that offer a combination of the best of both worlds: above average
FCF growth, but at a reasonable price.
We have used the following investment criteria for our stock selection among European
large caps (market cap > EUR3bn), excluding Financials.
– Sales growth 2011e of at least 5%, i.e. above the market average.
– 2011e CFPS growth of at least 10%, also above the market average.
– 2010e and 2011e FCF yield of at least 5%, i.e. comfortably above the average yield
on investment grade corporate bonds.
– 2010e Net debt/EBITDA of no more than 3x, i.e. a solid balance sheet.
The first two criteria aim to select stocks that offer above average top-line and CFPS
growth. This should give a sufficient buffer for companies to grow DPS and reduce the
risk of including high yielding value traps.
The third filter, a minimum FCF yield, prevents us from overpaying for the expected
growth. We have chosen 5% as the hurdle rate, which is comfortably above the
average Baa-rated corporate bond yield of around 4%.
The solvency criterion makes sure that companies are not financially overstretched.
The stocks which meet all of four selection criteria (but not necessarily rated
Outperform) are summarised in the figure below.
Comments
Most of the popular growth stocks and/or emerging market plays, such as LVMH, do
not qualify because of valuation considerations (FCF yield well below 5%). Conversely,
many value stocks don’t qualify because of a lack of top-line and/or CFPS growth.
Notice the absence of Telecoms and Utilities.

Figure 33: Above average FCF growth stocks at a reasonable price
European large caps meeting four investment criteria*
Company Mkt Cap 2011e 2011e 2010e 2011e 2010e
(EURm) Sales CFPS FCFY FCFY Debt/
growth (%) growth (%) (%) (%) EBITDA (x)
Anheuser-Busch InBev (=) 68,401 6 22 5.4 6.9 3.0
Atlas Copco (+) 18,868 11 13 8.7 6.8 0.1
Compass Group (+) 12,043 6 11 7.3 7.6 0.6
Deutsche Börse (+) 8,970 8 22 8.2 10.2 0.5
Heineken (+) 21,271 8 14 7.2 8.5 2.2
IMI (+) 3,112 7 15 7.2 7.6 0.5
Intercontinental Hotels Group (+) 3,719 6 16 7.0 7.7 1.5
JCDecaux (=) 4,454 6 15 5.7 6.3 1.0
K+S (=) 9,565 17 64 5.5 7.4 0.3
Luxottica (+) 9,283 6 12 5.6 5.5 2.1
Merck KGaA (=) 12,709 14 11 9.9 9.0 1.1
Millicom Intl Cellular (+) 7,160 11 15 6.3 7.6 0.7
Randstad Holding (-) 6,156 11 30 5.4 6.1 1.7
Reckitt Benckiser (=) 30,317 12 14 6.7 8.2 0.6
SAP AG (+) 43,647 10 14 8.0 7.0 0.0
Smiths Group (=) 5,449 8 15 8.5 6.0 1.6
* See text for details.

High and safe yields

In an environment of slowing earnings growth and limited scope for P/E expansion (our
base scenario for 2011; see Valuation section for details) dividends are likely to make
up an increased proportion of total equity returns.
Dividends are, over the long run, a big contributor to total equity returns. Over the last
100 years, for instance, dividends made up more than 40% of the total returns on US
equities, according to Shiller data. In a low growth world, with limited scope for capital
gains, this proportion can easily exceed 50%.
In addition to the limited scope for capital gains, the low yield on fixed income
alternatives are another reason why high-yielding stocks should do better in 2011 than
in 2010.
The yield on corporate and (solvent) government bonds has fallen to exceedingly low
levels and, at these levels, offer an unattractive risk/reward profile in an environment of
rising inflation expectations. With the Fed determined to raise inflation expectations,
German and US government bond yields have already risen over the last two months,
which, in turn put a floor under corporate bond yields.
This should shed a more favourable light on high-yielding stocks, as equities offer a
better hedge against inflation than bonds.
In order to benefit from the high-yielding theme, we have screened for stocks that offer
not only a high yield but also take into account the sustainability and potential for
dividend growth.
We have screened for Europe’s ten highest yielding large caps that meet the following
investment criteria.
– Sales and EBIT growth 2010e and 2011e >= 0%

– DPS growth 2011e > 0%
– DPS > 0 in each of the last five years
– Payout ratio 2010e and 2011e < 80%
– Net debt/EBITDA 2011e < 3x

For Financials, the same criteria apply, except for Debt//EBITDA and Sales and EBIT
growth. We have used EPS growth instead of EBIT growth.
The results are summarised below.
Figure 34: High and safe yields

High yielding European large caps which meet sustainability criteria*
Company DY 2010e DY 2011e DPS growth EPS growth Payout Payout
(%) (%) 2011e (%) 2011e (%) 2011e (%) 2010e (%)
SCOR (+) 6.0 6.5 9 10 51 52
Reed Elsevier NV (+) 5.1 5.7 13 12 58 57
Royal Dutch Shell (+) 5.2 5.6 7 18 50 55
Allianz (=) 4.9 5.2 7 7 40 40
Roche (+) 4.5 5.2 15 13 49 48
Tele2 B (=) 4.5 4.9 8 1 56 53
Wolters Kluwer (+) 4.4 4.8 11 9 47 47
Casino (=) 4.2 4.6 10 15 54 56
Fortum (+) 4.4 4.5 4 7 57 59
Repsol YPF (+) 4.3 4.5 5 24 42 50
Bouygues (+) 4.1 4.5 8 11 44 45
Securitas (=) 3.9 4.4 9 10 50 49
Merck KGaA (=) 2.4 4.3 79 17 34 23
Centrica (+) 4.0 4.3 6 5 52 51
Vinci (+) 4.0 4.2 5 7 50 51
* See text for details.

Comments
First, it is worth noting that only one Utility and one Telecom stock qualify. The dividend
yield may be above average in these sectors, but most stocks do not meet our
sustainability criteria (e.g. a payout above 80% or an expected drop in 2011e EBIT).
Second, there are thee Financials that make the mark, including one bank and two
insurers. Many banks don’t meet the criteria because of omitting a dividend payment in
2008.
Finally, there are, of course, many more stocks that meet our investment criteria, but
they offer a dividend yield below 4%, which is not meaningfully above the average yield
on corporate bonds.

Commodity price inflation
One of the aims of the Fed’s quantitative easing is to boost asset prices, which is
supposed to stimulate consumer spending thanks to a positive wealth effect. But one of
the inevitable consequences of money printing is commodity price inflation.
There are, of course other factors at play that drive commodity prices, such as the
insatiable demand from emerging markets, bad harvests or other supply constraints.
But it is no mere coincidence that commodity prices took off the moment Mr Bernanke
made clear at the end of August that the second round of quantitative easing (QE2)
was on its way (see Figure below).
Figure 35: Quantitative easing and commodity price inflation

Price increases in USD, % gain
Commodity YTD Since 2009 2008 5y hi Latest vs 10y
1 Sept. Hi (%)
Oil (Brent) 15 18 114 (61) 146 (39)
Natural Gas (26) 9 (1) (25) 722 (73)
Copper 21 17 156 (57) 8,959 (1)
Aluminium 11 17 46 (36) 3,271 (26)
Nickel 30 14 59 (55) 54,050 (56)
Gold 28 13 27 3 1,417 (1)
Lumber 35 34 21 (28) 452 (39)
Wheat 69 (3) (4) (45) 287 (23)
Corn 36 26 2 (11) 761 (26)
Coffee 45 14 43 (29) 257 (4)
Milk (7) (16) 32 (43) 22 (40)
Rice 0 29 (5) 13 2,446 (40)
Orange Juice 26 10 81 (52) 208 (25)
Barley 23 8 24 (44) 268 (31)
Cotton 102 61 55 (27) 149 (4)
Rubber 55 33 114 (48) 439.3 0
Soft commodities such as cotton, rice and rubber have risen by a third or more since 1
September. Even gas prices, which are still well down YTD, have risen since early
September. All of this year’s gain, and more, in oil prices were made after 1
September.
The prices of copper, gold, coffee, cotton and rubber hit all time highs this month. Last
but not least, the price of lumber has risen by a third in less than three months. This
can hardly be ascribed to a surging US housing market!
Admittedly, the price increases are less dramatic when converted into euros, but this is
not the case year-to-date, due to a lower euro now than at the beginning of the year.
No wonder that inflation expectations are on the rise, even though they are still low by
historical standards. This is not only reflected in falling real bond yields (the real yield
on 5yr Tips turned negative in October, which implies that the market expects future
inflation to be higher than nominal bond yields), there is also increasing evidence that
rising commodity prices are affecting corporate pricing and/or margins.
The following are just a few recent examples of announced price increases related to
rising commodity prices.
– Anheuser Bush and Starbucks have raised prices to offset rising commodity prices.
Carlsberg announced recently that it is planning to do the same in the near future.
– The UK retailer Next indicated a couple of months ago that clothing prices would
rise between five and eight per cent for the spring/summer season, reflecting the
increase in UK VAT to 20% in January 2011 and soaring cotton prices. The planned
price increase could hit total sales by 1-2 per cent, according to Next.

– Kingspan, a UK building product conglomerate announced in October dramatic
price increases of MDI, the main chemical input for its insulation products: +10% yoy in
H2 2010 and another 20% by January 2011. Kingspan would need to increase prices
by 4% to pass on the cost inflation.
– Continental, the German tyremaker, announced this month that it will raise prices by
up to 6.5% in North America as of January 2011. Michelin indicated that, at current
rubber prices, the 2011e ‘headwinds’ could be in the order of EUR600-700m without
price increases (i.e. equivalent to nearly half of 2010e EBIT).
– Geox indicated this month that ‘for the Spring/Summer 2011 season, trends in
currencies, raw material prices and labour costs in supplier countries suggest that
margins will come under pressure in the first half of 2011.
Both the timing and quantification of the impact of commodity prices on volumes and
profit margins is a challenging task because of factors such as hedging, long-term
contracts and the extent of a company’s pricing power.
For this year, the return of top-line growth, the lagged impact of last year’s margin-
boosting, cost-cutting measures and exceedingly favourable y-o-y comps virtually
guarantee a significant expansion in profit margins.
But 2011 is likely to be more challenging. This is because rising commodity prices tend
to have a lagged impact on margins and volumes and companies are faced with cost
inflation when top-line growth is slowing as a result of slowing GDP growth and lower
inflation. This is different from the 2006-08 economic boom when commodities also
rose sharply. Nominal GDP growth in the G7, for instance, is likely to barely exceed 3%
in 2011e, which is well below the 5% recorded in 2006 and 4% in 2007.
We expect commodity prices to stay firmly supported by the Fed’s quantitative easing
and ongoing buoyant demand from emerging markets.
It is, of course, difficult to tell by how much commodities will rise. What we can say is that,
in real terms, they could double before hitting the highs reached in the 1970s (see below).
Even if the CRB index were to stay, on average, at current levels for the remainder of
this year and the whole of next, this would still mean that commodity prices in 2011 will
be, on average, 10% higher than in 2010.
Figure 36: Commodity prices in real terms – still lots of upside potential
CRB commodity price index, deflated by US CPI
1100
1000
900
800
700
600
500
400
300
200
65 70 75 80 85 90 95 00 05 10

Figure 37: Commodity prices – unfavourable yoy comps 2011
CRB spot price index (1967 = 100)
650
2010 (495 YTD)

600
550
500 2009 (avge 409)
450
400
350
2008 (avge 491)
300
Jan Apr Jul Oct Jan
What are the implications for sectors and stocks with above average exposure to raw
materials?
Sectors or companies of which commodities make up a large proportion of cost of

goods sold (COGS) and, at the same time, have limited emerging market exposure are
the most exposed.
In the table below we have ranked by geographical exposure the European large caps
in the sectors which have significant exposure to rising commodity prices (Automotive,
Beverages, Food & HPC, General Retail, Chemicals and Construction). Those at the
top of the list (mostly exposed to advanced economies) are the relative losers in times
of raw materials cost inflation, while those on the bottom are the relative winners.

Figure 38: Commodity cost inflation – winners and losers
Stocks sensitive to commodity prices, sorted by geographical exposure
Stock Sector Stock Market Cap Developed Emerging Relative Performance
Rating (m) Countries (%) Countries (%) 3M 6M 12M
Hennes & Mauritz B General Retail - 40,520 100 0 (5) (5) 8
CRH Plc Building Materials & Infrastructure = 9,246 100 0 (18) (32) (29)
Wolseley Building Materials & Infrastructure + 4,689 99 1 13 16 32
Eiffage Building Materials & Infrastructure = 2,985 97 3 (8) (6) (13)
Inditex General Retail = 35,312 88 12 8 6 23
Renault Automotive + 12,425 84 16 20 (5) 25
Saint-Gobain Building Materials & Infrastructure + 18,203 84 16 8 2 (12)
Volkswagen Food & HPC + 62,841 82 18 1 (9) (1)
Continental Automotive = 11,406 81 19 16 3 43
Air Liquide Chemicals = 26,583 80 20 5 (4) 19
Peugeot SA Automotive + 6,908 79 21 27 10 16
Michelin Automotive - 9,708 79 21 (9) (21) 0
Solvay Chemicals - 6,316 79 21 1 (12) 1
BASF Chemicals = 52,015 78 22 22 8 34
Umicore Chemicals = 4,100 78 22 25 16 44
Imerys Mining = 3,492 78 22 5 (17) 7
Buzzi Unicem Building Materials & Infrastructure - 1,515 76 24 (3) (21) (35)
Wienerberger Building Materials & Infrastructure - 1,424 73 27 11 (9) (7)
Pernod Ricard Beverages = 16,742 72 28 0 (7) 3
Heidelberg Cement Building Materials & Infrastructure + 7,808 71 29 11 (8) (17)
Akzo Nobel IT Hardware + 2,354 67 33 16 (3) 4
Daimler Building Materials & Infrastructure = 9,246 67 33 (18) (32) (29)
Rémy Cointreau Beverages + 2,512 65 35 21 18 41
DSM Chemicals + 6,386 65 35 3 (0) 12
Diageo plc Beverages = 33,815 65 35 (3) (2) 12
Italcementi Building Materials & Infrastructure = 1,348 64 36 (7) (23) (46)
Porsche Automotive + 6,908 64 36 27 10 16
Carlsberg Beverages + 11,624 62 38 10 15 51
Linde Chemicals + 17,122 61 39 9 3 26
Danone Food & HPC + 28,403 60 40 4 1 3
Rhodia Chemicals = 2,188 59 41 36 14 64
Fiat Automotive = 15,828 57 43 30 4 13
Clariant Chemicals + 3,067 55 45 30 12 73
Nestlé Food & HPC = 139,619 55 45 4 2 20
Ciments Français Building Materials & Infrastructure + 2,448 54 46 4 (3) (20)
Anheuser-Busch InBev Beverages = 68,799 54 46 5 3 25
Unilever NV Food & HPC + 62,841 54 46 1 (9) (1)
Holcim General Retail - 40,520 51 49 (5) (5) 8
Lafarge Building Materials & Infrastructure = 12,736 47 53 11 (10) (28)
Heineken Beverages + 21,007 44 56 (0) (6) 7
Syngenta Chemicals - 20,082 34 66 13 (8) 17
SABMiller Beverages - 37,479 19 81 0 (5) 20

The next figure summarises the sensitivity of the main sectors exposed to hard and soft
commodity price inflation.
Main conclusions:
– Sectors or stocks which are exposed to consumer spending in the advanced
economies and with limited pricing power are most exposed, in our view. This includes
Food and General Retail and Automotive. This is because most companies in these
sectors might find it difficult to pass on the cost inflation without suffering a significant
impact on volumes. German carmakers benefit from a favourable geographical mix and
higher gross margins and should, therefore, be less affected than the French and
Italian carmakers. The tyre makers are also exposed because of their limited exposure
to emerging markets.
– Food & Beverages are less exposed, in our view, given their significant exposure to
emerging markets (45-50% of Sales for Unilever and Danone, for instance). For the
smaller companies, however, rising costs are likely to be more challenging. Food Retail
may find it difficult to pass on cost inflation, particularly for companies with substantial
exposure to Europe, such as Carrefour. Price negotiations with suppliers will be tough
as the retailers will fight to maintain a low average basket price for customers. In
difficult markets, price hikes are likely to be offset by larger promotions or a different
mix. The EBIT margin could be squeezed in a fiercely competitive environment.
– In Industrials, Mining should be the big winner of rising commodity prices. The
correlation between the CRB price index and the sector’s relative performance over the
last five years has been close to 90%. The oligopolistic nature of the industry means
strong pricing power, which should allow companies to pass on most of the cost
inflation.
– Construction is more sensitive than chemicals to rising commodity prices because
of the limited pricing power among the energy-intensive cement makers and a less
favourable geographical mix (e.g. CRH has no exposure to emerging markets).
– In Chemicals commodity cost inflation should be largely passed on amid tight
supply/demand. Significant price hikes are likely for agricultural products (fertilizers), of
which Yara and K+S should be beneficiaries. Companies close to the end-user are
likely to face a margin squeeze.

Figure 39: Commodity price inflation – sector sensitivities 2011e
Sector Commodity exposure Pricing Comments Winners (+)
power* and losers (-)
Automotive Car makers: 65% of COGS (of which 42% 4-5 Limited impact on luxury segment, thanks to Premium brands
Steel, 18% other metals, 30% plastics & geographical mix and higher margins. Mass (Daimler, BMW)
oil-related, 10% other, e.g. glass) market segment more sensitive because of lower less exposed than
profit margins. Tyremakers’s margins under mass market (eg
Tyremakers raw materials 42% of COGS,
pressure due to higher rubber prices and limited PSA, Renault) and
of which 52% is rubber
exposure to emerging markets. tyre makers.
Constr. & Building 20-25% of sales for cement makers (10% 4-5 Typical time lag between oil prices and industry’s Lafarge (-)
Materials for electricity and 10-15% for combustibles energy costs (mostly pet coke and coal) is ~9
Holcim (-)
depending geography) months. Many producers are increasingly using
alternative energy sources to mitigate the risk of Heidelberg Cement
rising commodity prices. (-)
Chemicals 40-60% of COGS, depending on business 2 Significant price hikes likely for agricultural BASF and Lanxess
segment. products (fertilizers). Higher commodity prices (oil, rubber, +)
Commodity and specialty chemicals are should be largely passed on, while overall Yara and K+S
most exposed. supply/demand remains tight. Companies close (fertilisers, +)
to the end-user are likely to face a margin
Akzo, Solvay and
squeeze.
Simryse (-)
Mining Raw materials 1 We expect, on average, higher commodity prices Xstrata

50% of Sales in 2011e than in 2010e, helped by buoyant (Copper, Coal, +)
demand and QE2. This should lead to a further Norsk Hydro
Energy (incl. fuel) 20% of COGS
expansion in EBIT margins. Stronger extracting (Alu, +)
currencies and renewed cost inflation (incl.
Rio Tinto
wages), however, should partly offset USD-
(iron ore & Alu, +)
denominated commodity price inflation.
Steel Iron ore and coal each 20% of COGS 2-3 Downside in steel prices is limited as spot prices ArcelorMittal
are below the marginal cost of production. We (iron ore +)
expect steel prices to converge towards the Salzgitter (-)
marginal cost of production in H1 2011, which
Voestalpine (-)
should reverse some of the margin squeeze in
Q4 2010.
Beverages Brewers: 67% of COGS (30% packaging, 2 Spirits less sensitive than beer because of higher Carlsberg (-)
30% commodities (e.g. barley, malt), 7% gross margins and lagged impact of cost Remy Cointreau (+)
energy (e.g. transport and electricity) inflation. Brewers should be able to pass on cost
Spirits: 50% of COGS (23% packaging and inflation, given degree of concentration and track
23% commodities, 4% energy) record, but at the expense of volume growth.
Food Mfg. Raw materials (20-25%) and packaging 2-3 Sector faced with sizeable input cost inflation in Danone (dairy +)
(10-15%) are typically 35% of Sales. 2011. Operational performance of three large caps Unilever
should be resilient, helped by strong brands and (edible oils, -)
exposure to emerging markets. For the smaller food
Northern Foods (-)
companies (weaker brands) cost inflation will be
challenging.
Food Retail Raw materials represent 15-90% of the 3 Price negotiations with suppliers will be tough as Carrefour (-)
retail price retailers will fight to maintain a low average
Tesco (+)
basket price for customers. In difficult markets,
price hikes are likely to be offset by larger
promotions or a different mix. EBIT margin could
be squeezed in a fiercely competitive
environment.
General Retail Raw materials and freight costs 50-65% of 4-5 Higher cotton prices and freight rates (Asia to H&M (-), Inditex (=)
COGS for clothing retailers Europe), plus wage inflation in emerging
countries, should squeeze 2011e gross margins
for clothing retailers such as H&M, Inditex and
Next, as cost inflation is unlikely to be fully
passed on.
* 1 = strong; 5= weak

Konsum – Germany Shops
Overview
Exposure to German consumers has been best avoided for the past decade. The charts
below illustrate how German retail sales have fallen marginally in real terms over the past
thirteen years and have also consistently underperformed nearly all other European
countries. Since 1997, German retail sales have declined by 1.9%, which contrasts
sharply with the 52% increase in France and even the European average of 18%.
After a decade of misery, there are signs that the fortunes of stocks exposed to
German consumers could be turning. The stage is set: healthy balance sheets suggest
an ability to consume more; after years of flat consumer spending pent-up demand for
discretionary and durable consumer goods has built up; German economic growth
should be among the most robust in Europe in the next few years; export-driven growth
is beginning to trickle down to consumers via a rise in employment and consumer (and
retail sector) confidence is near its 20-year high.
So far the macro improvement has not translated into a sustained increase in spending,
but if real wages begin to rise the final piece of the puzzle could slide into place. Recent
wage negotiations look promising in this respect. Wage increases have been pulled
forward and indefinite job guarantees have been given by a growing number of
companies. Greater job security and rising real incomes could release the pent-up
demand and excess savings mentioned above. We will be watching the Christmas
shopping season for the first signs of a change in German consumer behaviour, but the
real benefits should be seen throughout 2011.
Figure 40: Decade of pain - Retail trade

% change since 1997 Retail trade over time
Finland 120
Sweden 115
France 110
Ireland 105
Greece 100
UK 95
Spain 90
Denmark 85
Belgium 80
EU 15 75
Netherlands
70
Dec 96
Dec 97
Dec 98
Dec 99
Dec 00
Dec 01
Dec 02
Dec 03
Dec 04
Dec 05
Dec 06
Dec 07
Dec 08
Dec 09
Germany
Italy
(10%) 10% 30% 50% 70% EU 15 Germany UK
Source: Eurostat

Ability to spend
German consumers have long had the capacity to spend more should they want to. It
was not a lack of money that sparked the consumer strike. Indeed, after years of
frugality German consumer balance sheets are in rude health. The same is certainly
not true of consumers in other European countries, especially peripheral ones.
The German savings ratio is returning to historic highs in 2010. As uncertainty over
Germany’s economic future grew, culminating with Germany being labelled the ‘Sick
Man of Europe’, the savings ratio rose from 8.9% in 2000 to 10.5 in 2003. Since then
the Agenda 2010 reforms implemented under then-Chancellor Gerhard Schroeder put
Germany on a recovery path, but reforms initially benefited the corporate sector at the
expense of consumers’ wages and job security, further boosting the savings ratio to
12%. This stands in stark contrast to savings ratios in the UK and the US, highlighting
German consumers’ untapped potential.
Figure 41: Saving more than Anglo-Saxons

Savings ratios (as% of disposable income)
13
11
(1)
Dec 91 Dec 94 Dec 97 Dec 00 Dec 03 Dec 06 Dec 09
Germany UK US
As a result of this cautious behaviour, consumer balance sheets look healthy. German
consumers not only failed to jump on the leverage bandwagon that cut such a wide
swathe through most developed economies – but they have even paid back some of
the debts they did incur. Household liabilities peaked in 2003 and have since declined
by 6%. As disposable incomes continued to rise, the percentage of household debt to
disposable income has declined from 113% to 96% over the past decade.

Figure 42: Germans have paid back debt for seven straight years
Household liabilities
45,000 115
110
40,000
105
35,000
100
95
30,000
90
25,000
85
20,000 80
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Household liabilities (lhs) % of disposable income (rhs)
Source: Bundesbank, Exane BNP Paribas
This health is also reflected on the asset side of balance sheets. As liabilities declined
household assets continued to increase. Since 2003 gross assets increased by 19%,
and net assets (taking into account the decline in liabilities) increased by 36% to
EUR77,900 per household.
Figure 43: Net assets have grown and grown…now double disposable income
Household assets - liabilities
80,000 220
70,000 200
60,000 180
50,000 160
40,000 140
30,000 120
20,000 100
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Net assets per household (lhs) % of disposable income (rhs)
Another favourable factor is that Germany, unlike many of its European peers, has had no
property price bubble that will have to be digested over the coming years. German
property prices have been flat since the Reunification-related increase in the early 1990’s.
We have no strong views on German property prices going forward, but the risk reward
ratio on this factor seems much more favourable than in most other European countries.

Figure 44: No property bubble in Germany
Change in nominal property prices since 1995
180%
160%
140%
120%
100%
80%
60%
40%
20%
0%
(20%)
Spain UK Germany
Pent up demand – time to upgrade

Over the past years, pent-up demand has grown for discretionary durable goods and
services. Cutting back on such spending was the natural response to increased
uncertainty, as these purchases can easily be postponed. But buying a replacement
fridge, car or washing machine can only be delayed for so long. At some point they
either reach the end of their useful lives or the benefit of upgrading becomes greater
than that of waiting. Ultimately, in a worst-case scenario, consumption of such goods
should at least stabilise.
That said, we expect a more optimistic scenario to crystallise as we believe the recent
period is a blip rather than a new equilibrium, and that it is likely to be followed by a
period of catch-up spending to upgrade discretionary durable goods.
The car sector is a perfect example of pent-up demand. Between 2000 and 2008 the
proportion of German cars older than 10 years increased from 25% to 35% of all cars.
Figure 45: German cars getting older

Average age of German car fleet
0.4
0.4
0.4
0.3
0.3
0.3
0.3
0.3
0.2
0.2
0.2
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Under 10 years Over 10 years
Source: Eurostat, Exane BNP Paribas

The macro turnaround
Germany has transformed itself from the ‘sick man of Europe’ to an engine of European
economic growth. Having weathered painful reforms in 2003/04 the country is now in a
situation with many factors aligned in its favour.
Labour market reforms and painful nominal wage reductions in 2004 reduced unit
labour costs and created a highly competitive labour force and corporate sector. This
occurred at a time when much of Europe has gone in the opposite direction with the
periphery countries struggling with high unit labour costs.
Figure 46: Successful labour market reforms

Unit labour costs yoy (Germany)
4
Hartz labour market reforms & landmark Siemens
3 deal to extend working week without extra pay
(1)
(2)
(3)
(4)
Dec 95
Dec 96
Dec 97
Dec 98
Dec 99
Dec 00
Dec 01
Dec 02
Dec 03
Dec 04
Dec 05
Dec 06
Dec 07
Germany also boasts one of the largest exposures to emerging markets. As the second
largest exporter in the world its export strength is no secret. A total of 16% of exports
went to Eastern Europe in 2009, 10% to Asia ex Japan and 3% to Latin America.
Overall, our colleagues in the Economics team forecast further GDP weakness in
Greece, Ireland, Portugal and Spain (GIPS) next year, whereas Germany (as well as
France and the Nordic nations) should enjoy GDP growth rates in excess of 2%. They
also expect this growth advantage to last several years as the periphery countries cope
with the fallout from aggressive fiscal consolidation. The longer-term IMF forecasts in
the chart below show a structural change in Germany’s growth relative to the rest of
Europe, starting about one year after the introduction of the Agenda 2010 reform
package.

Figure 47: Structurally better (relative) growth
GDP growth gap (Germany – euro zone average)
2.0
1.5
1.0
0.5
0.0
(0.5)
(1.0)
(1.5)
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Source: IMF, Exane BNP Paribas
Dare to spend
There are a number of promising signs that German consumers are beginning to benefit
from Germany’s economic recovery. If this trend continues, as we expect, it could provide
the catalyst for some of the pent up demand to be released.
German consumers are a typical late-cycle play on the German economy. It normally takes
some time for export-led economic gains to trickle down to consumers. In the ‘ideal’ cycle,
as global economic growth recovers exporters are the first to feel the improvement. They
respond by investing domestically to meet increased export demand. With both the export
and domestic sides of the industrial economy improving, demand for workers and thus
hiring should pick up. At this stage consumers begin to fully participate in the economic
recovery as both the number of jobs and wages can rise.
The German labour market is showing signs of improvement. After reaching a post-war
record of 5.2 million unemployed in February 2005, unemployment has declined steadily
with only a relatively small set-back during the credit crunch. Total employment has now
reached a new record high at over 43m, despite the stable population.

Figure 48: No ‘jobless recovery’ in Germany
Total employment in Germany
40,500
40,000
39,500
39,000
38,500
38,000
37,500
37,000
Dec 93
Dec 95
Dec 97
Dec 99
Dec 01
Dec 03
Dec 05
Dec 07
Dec 09
The economic and employment recovery is beginning to boost consumer confidence,

fulfilling an important precondition for a pick up in consumer spending. Germans view of
their personal financial situation in twelve months’ time (see chart below) has returned to
positive territory and is within whispering distance of a 20-year high.
Figure 49: Most confident in 20 years

GfK – personal financial situation over the next 12 months
(1)
(3)
(5)
(7)
(9)
(11)
(13)
(15)
Jan 92
Jan 95
Jan 98
Jan 01
Jan 04
Jan 07
Jan 10
Jul 93
Jul 96
Jul 99
Jul 02
Jul 05
Jul 08

Figure 50: Impending trend reversal in Germany?
Willingness to buy – Germany Business confidence in retailing - Germany
5% 80 30 5%
4% 60 20 4%
10
3% 40 3%
0
2% 20 2%
(10)
-10
1% 0 1%
-20
(20)
0% (20)
-20 0%
-30
(30)
(1%) -40
(40) (1%)
-40
(40)
(2%) -60
(60) (50)
-50 (2%)
Q1 1992 Q1 1995 Q1 1998 Q1 2001 Q1 2004 Q1 2007 Q1 2010 Q1 1991Q1 1994Q1 1997Q1 2000Q1 2003Q1 2006Q1 2009
Consumer spending (volume, %, -lhs)

Willingness to buy (GfK, -rhs) IFO Retail (-lhs) Consumer spending (volume, %, -rhs)
Source: IFO, GfK, Exane BNP Paribas
So far, however, improved confidence has not translated into a real increase in spending.
Consumers may feel better about their own prospects over the next 12 months, but after
years of disappointment and job uncertainty it is perhaps unsurprising they are not yet sold
on the sustainability of the recovery. Retailers have posted positive top-line growth rates
for most of this year, but this is so far mostly a reflection of base effects after last year’s
slowdown in retail sales owing to the recession. However, retail sales offer only a partial
view on spending, as the figure does not include cars or any type of services, telcos or
other leisure activities. The gap between retail sales and total consumer spending reflected
in the Q2 GDP numbers is a signal that we should also track broader indices than retail to
get a full picture on consumer spending.
Figure 51: No real turnaround in retail sales yet

German retail sales yoy
(2)
(4)
(6)
(8)
Jan 95
Jan 96
Jan 97
Jan 98
Jan 99
Jan 00
Jan 01
Jan 02
Jan 03
Jan 04
Jan 05
Jan 06
Jan 07
Jan 08
Jan 09
Jan 10
Source: Destatis, Exane BNP Paribas

Catalysts – Wage negotiations and the holiday season
So what would it take to get Germans to believe in the sustainability of the economic
improvement and to change their long-held spending patterns? What would be early
indicators of such a change? We show two potential catalysts for German consumer
exposed stocks.
The most important catalyst for increased consumer spending would be an increase in
real wages and incomes. We noted the correlation between employment and retail
trade and the important link between the two is wages. Naturally, increased disposable
incomes and job security are vital for consumers to feel comfortable consuming today
rather than saving for a future rainy day.
After years of wage constraint, market forces seem aligned for real wage increases.
Demand for work is increasing as the economic recovery continues, both in export and
domestic markets. At the same time the supply of work is tightening, as we showed above
with employment levels increasing. That means employers will not be in the situation of
2004 where record unemployment allowed wage reductions despite economic growth.
Beyond the normal market forces there is also increased political pressure on the
corporate sector to share record profits with employees. Senior members of all parties
have publicly called on companies to allow significant wage increases. This is a marked
change from the calls for wage moderation of previous years.
Figure 52: Waiting for real wage inflation

Employee compensation per hour
6 120
5
4 115
3
110
2
1
105
0
(1)
100
(2)
(3) 95
(4)
(5) 90
Dec 95
Dec 96
Dec 97
Dec 98
Dec 99
Dec 00
Dec 01
Dec 02
Dec 03
Dec 04
Dec 05
Dec 06
Dec 07
Dec 08
Dec 09
Employee compensation per hour, absolute (rhs) Employee compensation by hour, yoy (lhs)
The real test of whether wages can rise in excess of inflation will come with the next rounds
of wage negotiations over the coming six months. In this context it is important to keep in
mind the time lag between economic recovery and wage recovery. Wage deals negotiated
at the bottom of the cycle, last year, were often set for more than one year, so most sectors
have not yet been able to negotiate wages against the backdrop of a stronger economy.
Nevertheless, recent news flow on wages has been encouraging. Despite having a wage
deal through April 2011, Bosch agreed to pull forward the scheduled wage increase to
February. Several other companies (e.g. ZF Friedrichshafen, Audi and Porsche) have
followed this template. Siemens has given its 128,000 German employees an indefinite job
guarantee. Without agreement of the workers’ council Siemens will not make
redundancies. Job reductions would have to be achieved via voluntary redundancy, early
retirement and regular retirement.

The table below gives an overview of upcoming wage negotiations to keep an eye on for
signs of more widespread real wage increases.
Figure 53: Catalyst: wage increases

Upcoming wage negotiations
Termination date of existing deal Union Sector Number of employees
November 2010 ver.di Private transport sector, North-Rhine-Westpahlia 139,800
IG Bau, ver.di Real Estate 70,000
December 2010 ver.di Public sector employees 634,300
NGG Hotel and Restaurants, some areas 110,600
ver.di Private transport sector, some areas 71,800
ver.di Deutsche Telekom 48,200
January 2011 IGM Volkswagen 91,000
February 2011 IG BCE Chemical sector, some areas 262,400
March 2011 IG Bau Construction sector 566,600
ver.di Retail sector, some areas 440,900
IG BCE Chemical sector, some areas 254,800
ver.di Printing sector 174,400
ver.di Insurance sector 161,500
ver.di Wholesale sector 127,000
April 2011 ver.di Retail sector, some areas 1,217,400
ver.di Wholesale sector, some areas 936,300
IGM Wood an plastics manufacturing sector, some areas 217,300
May 2011 ver.di Retail sector, some areas 183,900
IG BCE, ver.di Energy sector, incl. E.On 25,000
June 2011 ver.di Retail sector, some areas 168,100
Source: WSI-Tarifarchiv, Exane BNP Paribas
The next data point to watch is the upcoming holiday shopping season. This is
traditionally the most important part of the year for retailers, with a high proportion of
discretionary spending, and as such is a good barometer for changing consumer
spending patterns. The last two months of the year contribute about 19% of full year
sales in the Retail sector. For some of the more discretionary sub-sectors, which are
most likely to reflect changes in consumer sentiment and spending patterns, the ratio is
even higher (e.g. toys 30%, watches/jewellery 26%, books 25%).
The dependency on the holiday sales season becomes even clearer when looking at
profits. Given the same fixed cost base the increase in sales translates into a much
bigger increase in profits. For Douglas, 33% of sales and 65% of EBITDA are
generated in the holiday quarter.
Recent comments suggest cautious optimism on holiday season sales from German
retailers. Douglas’ CEO expects a significant increase in seasonal retail sales over last
year and believes the company will beat the sector average. Metro’s comments, which
also referred to ‘cautious optimism’ for the holiday sales period, mirrored this.
Micro leverage
Low margins mean small improvements in spending can have a disproportionate effect
on bottom lines. So German consumers do not have to start spending like British
consumers to make this theme work; even a small improvement in consumer spending
patterns would suffice to turn German retail into a Buy.
The lower the margin the more sensitive earnings are to changes in the top line. This
may sound like common sense, but the effect is often underestimated. The chart below
illustrates the effect. We show how two companies’ profits react to changes in the top
line. The only difference between the companies is that one operates on a 1% margin
and the other on a 4% margin. All else being equal, a sales increase of 1% adds 50%
to the profits of the 1% margin company, but only increases profits by 13% at the 4%
margin company. We assume a 50/50 split between fixed and variable costs.

Figure 54: Magic ingredient – low margins
Sensitivity of profits to changes in top lines
200%
150%
Chg in profit from Sales=100

100%
50%
0%
(50%)
(100%)
(150%)
(200%)
94 96 97 99 100 102 103 105 106
Sales
Profit growth at 1% margin Profit growth at 4% margin
Source: Exane BNP Paribas
German retailers have some of the lowest margins in Europe, making them extremely
sensitive to changes in the top line. The above example is not as far from reality as it
may seem. Some companies, for example Praktiker with an EBITA margin of 1.9% in
2010, may be extreme examples, but even for the broader Retail sector the margin gap
between Germany and the rest of Europe is huge. On 2011 consensus estimates the
German sector will achieve a 3.7% EBIT margin, compared with 12.7% for the pan-
European sector.
Figure 55: Low margins = opportunity

EBIT margins 2011 (consensus)
14%
12%
10%
8%
6%
4%
2%
0%
German Retail German Retail ex Metro European Retail

Moderate expectations
Consensus expectations for consumer spending remain cautious. With the German
economy showing no signs of slowing down, economists have begun to upgrade their
forecasts, albeit from a very low level. The chart below shows the expected path of
German household spending in the next few quarters. It is striking that no acceleration
in spending appears to be priced in. Instead, future growth is expected to be roughly in
line with the lacklustre growth of recent years. In light of the fundamental improvements
discussed above, this seems to us to be a very conservative assumption.
Figure 56: Modest acceleration expected

Private consumption, reported and consensus forecast
140
130
120
110
100
90
80
Mar 91
Mar 93
Mar 95
Mar 97
Mar 99
Mar 01
Mar 03
Mar 05
Mar 07
Mar 09
Mar 11
Mar 13
Mar 15
Mar 17
Mar 19
Germany reported Germany consensus forecast US Japan
Valuations suggest investors are also still cautious on the German consumer recovery,
or at the very least that no great optimism about this theme is yet priced in. The
German Retail sector trades at a premium to the rest of the German market, which
suggests expectations of above-average earnings growth in the coming years.
Comparing the German sector to its European peers, however, shows it trading at a
small discount and a slightly larger discount than the historical average. This suggests
the market is looking for less earnings growth in Germany, which in turn implies less
optimism on top-line growth in Germany. Given the German sectors’ low margins, less
sales growth is needed to achieve the same earnings growth.

Figure 57: Good value
12m forward PE relative (German Retail vs MSCI Europe Retail)
1.4
1.3
1.2
1.1
1.0
0.9
0.8
0.7
0.6
Aug 03
Feb 04
Aug 04
Feb 05
Aug 05
Feb 06
Aug 06
Feb 07
Aug 07
Feb 08
Aug 08
Feb 09
Aug 09
Feb 10
Aug 10
Consensus analyst trends do not yet assume a significant German consumer recovery.
Analysts expect significantly lower top-line growth for the German sector than for their
European peers, but given the lower margins this still translates into greater earnings
growth, at least for 2011. Looking beyond the growth figures, however, shows that
consensus forecasts for the absolute level of EPS in 2011 and 2012 have been revised
down steadily over the past months. Forecasts for Europe, on the other hand, have
been revised up over the same period.
Figure 58: Low & High top-line expectations

Consensus sales growth expectations Consensus EPS growth expectations
7% 20%
18%
6%
16%
5% 14%
12%
4%
10%
3%
8%
2% 6%
4%
1%
2%
0% 0%
2011 2012 2011 2012
German Retail German Retail ex Metro European Retail German Retail German Retail ex Metro European Retail

Figure 59: Growth, yes, but analysts are still downgrading forecasts
Consensus EPS forecasts for German Retail sector (ex Metro)
50
45
40
35
30
25
Nov 08
Nov 09
May 08
May 09
May 10
Jan 08
Mar 08
Jul 08
Sep 08
Jan 09
Mar 09
Jul 09
Sep 09
Jan 10
Mar 10
Jul 10
Sep 10
F.Y. 2010 F.Y. 2011 F.Y. 2012
How to play it
Although this theme is a perfect example of how a macro view can filter down to a
specific investment recommendation, stock selection remains as important as ever. Not
all stocks are likely to benefit equally from this theme. As a rule of thumb, we look for
the following characteristics:
– Exposure to discretionary spending and to durable goods and services. Both have
been the most neglected in the past, hence have the greatest catch-up potential.
– Pure plays if possible. Not all companies in the German Retail sector are equally
dependent on the German market.
– Look for low margins. The lower the margin, the greater the sensitivity of earnings
to changes in the top-line.

Figure 60: Stocks with exposure to German consumers
Data overview
Market Cap. P/E 2011 Price/Book EBIT margin EPS CAGR Sales CAGR % of sales Recommendation
(EURm) (x) 2011 (x) 2011 (%) 2010-13 (%) 2010-13 (%) in Germany
Daimler 72,469 14.0 1.9 7.7 8.7 4.1 25 =
Volkswagen 48,591 10.0 1.1 5.7 5.9 2.8 28 +
Deutsche Telekom 44,573 13.3 1.2 14.1 4.8 (1.3) 43 +
Hennes & Mauritz 38,984 18.7 7.5 22.8 7.9 10.9 25 -
BMW 35,019 10.2 1.4 8.5 0.5 2.7 23 -
Metro 17,352 14.3 2.5 3.7 15.8 4.7 40 -
Henkel 16,698 14.2 2.2 12.7 10.7 4.0 18 +
Continental 12,000 10.5 1.8 9.2 25.4 6.3 29 +
Beiersdorf 11,340 20.1 3.2 11.9 9.6 3.9 18 =
Commerzbank 7,435 13.0 0.7 n.a. 5.0 0.8 90
Deutsche Lufthansa 7,348 11.8 1.1 4.0 21.9 5.1 n.a.
Esprit Holdings 5,185 13.9 3.1 14.8 7.8 8.6 44
ProSiebenSat.1 Media 4,705 11.1 4.0 27.0 3.0 3.1 69 +
Axel Springer 3,578 11.9 2.2 15.4 5.9 3.8 79
Hugo Boss 3,176 17.8 8.5 15.1 8.7 6.4 23 +
United Internet 3,132 13.9 5.3 15.6 17.6 8.8 45 =
Fielmann 2,809 20.8 4.9 18.0 9.1 5.8 81 -
TUI 2,035 10.3 0.9 3.8 36.2 3.0 22
Douglas 1,581 16.1 2.0 4.7 10.8 4.3 65 =
Deutsche Euroshop 1,381 17.8 1.1 84.6 11.6 3.2 100
GfK 1,151 11.0 1.7 13.2 7.5 4.4 26
Gerry Weber International 791 12.3 3.1 13.6 11.7 6.7 60
Sky Deutschland 787 4.3 (16.0) n.a. 12.5 100
Hornbach-Baumarkt 719 10.8 4.3 1.5 8.1 63
Delticom 639 22.4 9.5 9.8 23.5 16.0 35 +
Beter Bed 426 13.4 6.2 10.3 21.1 7.4 51
Praktiker 418 13.4 0.5 2.4 183.4 3.6 71 +
Air Berlin 333 20.1 0.5 2.1 n.a. 8.7 n.a.
Pfleiderer 192 0.3 4.2 n.a. 5.2 28 =
A.S. Creation Tapeten 102 8.9 7.8 13.1 4.4 33
Leifheit 93 15.2 4.3 (8.6) 4.4 42
Loewe 83 14.6 1.0 3.2 n.a. 3.0 60
Source: Bloomberg, Factset, Exane BNP Paribas

European periphery – waiting for cost cuts
Country allocation made a comeback in 2010 and rotation out of the European
periphery into Germany and the Nordic countries has been the main theme. We see no
reason to rush back into periphery stocks generally for 2011, but see opportunities for
selective investments in the region should unit labour costs in these countries begin to
decline.
Regional rotation
The country effect has been particularly evident within Europe. The performance gap
between the best and worst European markets is at its widest level in a decade (see
left-hand chart below). Since October 2010, Greece has fallen 46%, whereas Germany
is unchanged and Sweden has gained 16% in euro-terms or 6% in local currency terms
(see right-hand chart below).
Figure 61: Performance gap in Europe

Best – worst country performer (EU 15, yoy) Country stock market performance (rebased and in EUR)
0.9 1.3
0.8 1.2
0.7 1.1
0.6 1.0
0.5 0.9
0.4 0.8
0.3 0.7
0.2 0.6
0.1 0.5
Sep 09 Dec 09 Mar 10 Jun 10 Sep 10
0.0
Jul Jul Jul Jul Jul Jul Jul Jul Jul Jul
01 02 03 04 05 06 07 08 09 10 Germany Spain Greece Sweden
Source: Thomson Datastream, Exane BNP Paribas estimates
Valuation – not cheap enough

Periphery stocks have de-rated, but relative valuations are still far from extreme. Our
basket of stocks with periphery exposure has de-rated from a 40% price-to-book
premium to the MSCI Europe to a 9% discount (see below). Yet, up until 2003 the
discount often reached 18%.
But while valuations are beginning to look attractive, they are never by themselves a
sufficient reason to buy. There is no historical correlation between valuations and short-
term returns; stocks can stay cheap for a long time. It takes a catalyst to crystallise
the value.

Figure 62: Cheap, but not cheap enough
Price-to-book relative of our Periphery stock basket (vs MSCI Europe)
1.4
1.2
1.0
0.8
Aug 97 Aug 98 Aug 99 Aug 00 Aug 01 Aug 02 Aug 03 Aug 04 Aug 05 Aug 06 Aug 07 Aug 08 Aug 09 Aug 10
Growth gap
GDP growth is unlikely to provide such a catalyst. Our colleagues in the Economics
team forecast recessions in Greece, Ireland, Portugal and Spain next year, whereas
Germany and the Nordic nations should enjoy GDP growth rates in excess of 2%. They
also expect this growth disadvantage to last several years, estimating an average drag
on growth rates in the periphery countries throughout the (4-5 year) adjustment period
between 0.9 and 2% each year (see chart below).
Figure 63: Large adjustment needed in the euro-zone periphery

Annual average impact on growth of necessary adjustments (points of GDP)
0.0
(0.5)
(1.0)
(1.5)
(2.0)
(2.5)
Italy
Ireland
Germany
Greece
Portugal
Spain
France
USA
UK
Belgium
Denmark
For equity investors, excessive sovereign debt and inferior GDP growth translate
directly into more muted earnings growth. As a rough estimate, to quantify the effect of
inferior domestic GDP growth we use our 2010 pan-European earnings model.
Assuming 40% of the average company’s sales are domestic, a 1% reduction in
volume growth for this isolated segment of sales takes about 2% off our EPS estimate.

Assuming the same sensitivities across Europe with all else remaining unchanged and
the 2.8% growth advantage our economists expect for Germany over Spain, would give
a 5.5% EPS advantage to the average German company over the average Spanish
company. A second effect is increased borrowing costs for companies based in
indebted countries. The difference in CDS spreads between Germany and Spain has
opened up to 135bp.
Figure 64: Median corporate CDS by country (5yr senior, bp)
300
250
200
150
100
50
0
Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct
07 07 07 07 08 08 08 08 09 09 09 09 10 10 10 10
Germany Spain
Looking for a catalyst

What could be a catalyst to return to periphery investments? We would look for signs of
labour market reforms and unit labour cost cuts.
It is important to keep in mind that it is folly to base investment decisions on GDP

forecasts. There is no historical correlation between GDP growth and a country’s stock
market performance. Long-term studies (Dimson/Marsh) have shown that, if anything,
the correlation is negative.
The reason for this seemingly counter-intuitive correlation is that companies in weak
GDP countries are often the ones able to achieve the greatest efficiency gains. So far,
the focus has almost entirely been on top lines driven by domestic demand weakness,
but an earnings boost from labour cost cuts can be equally large. It is important not to
forget the power of operational leverage. If a company with a slim margin of 1% and a
balance between fixed and variable costs can reduce the former by 2% it doubles its
profits (see figure below).

Figure 65: Don’t underestimate the power of leverage
Change in profit through change in fixed costs
120%
Chg in profit from unchanged sales

70%
20%
(30%)
(80%)
(130%)
2.4% 1.8% 1.2% 0.6% 0.0% -0.6% -1.2% -1.8% -2.4%
Fixed costs in %
Profit growth at 1% margin Profit growth at 4% margin
German role model

Germany, everyone’s favourite market at the moment, is perhaps the best recent
example of how this effect can work. In 2003, Germany was called the sick man of
Europe by The Economist as the country was saddled with record unemployment and
some of the highest labour costs in Europe. But it was this economically challenging
situation that made the Agenda 2010 reforms possible. This programme infused greater
flexibility into the rigid labour market and companies were subsequently able to increase
weekly working hours for no extra pay (see figure below). This also marked the turning
point in Germany’s competitiveness, economic fortunes and stock market relative
performance.
Figure 66: Role reversal

Unit labour cost index
115
110
105
100
95
90
85
80
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Germany Spain
Source: OECD, Exane BNP Paribas

How to play it
Although this theme is a perfect example of how a macro view can filter down to a
specific investment recommendation, stock selection remains as important as ever. Not
all stocks are likely to benefit equally from this theme. As a rule of thumb, we look for
the following characteristics:
– Labour intensive business models. We screen for high ratios of personnel costs
– High proportion of workforce based in periphery countries
– Low margins. The lower the margin, the greater the effect of wage cost reductions
on the bottom line.
– Exporters. This may be rare, but the ideal company is one which benefits from
domestic labour cost reduction, but which is not effected by the weakness of domestic
demand because it sells into strong global markets. Such companies combine the best
of both worlds.
We show overleaf a broad list of stocks with the aforementioned criteria as a guide to
how sensitive individual companies are likely to be to changes in unit labour costs.

Figure 67: Stocks that could benefit from wage cuts in Euro periphery countries
Company Home market Sector Market cap % of Personnel EBIT Exane
(EURm) employees costs 2009 / margin Stock
in periphery Sales 2011 2011 Rec.
INDITEX Spain Consumer, 36,976 50% 13.1% 17.3% =
Cyclical
TELECOM ITALIA SPA Italy Communications 20,289 83% 12.7% 21.9% =
FIAT SPA Italy Consumer, 14,906 42% n.a. 4.2% =
Cyclical
ACS ACTIVIDADES CONS Y SERV Spain Industrial 11,776 77% 24.2% 7.2% -
PORTUGAL TELECOM SGPS SA-REG Portugal Communications 9,328 50% 18.8% 15.6% -
MEDIASET SPA Italy Communications 6,390 100% 10.6% 19.3% =
FERROVIAL SA Spain Industrial 5,908 50% 29.4% 12.8% n.a.
FINMECCANICA SPA Italy Industrial 5,599 59% 24.6% 8.0% +
ACCIONA SA Spain Industrial 3,951 76% 17.5% 9.0% =
CIMPOR-CIMENTOS DE PORTUGAL Portugal Industrial 3,363 29% 20.5% 25.3% =
IBERIA LINEAS AER DE ESPANA Spain Consumer, 3,042 96% 27.4% 2.1% n.a.
Cyclical
HELLENIC TELECOMMUN ORGANIZA Greece Communications 2,828 Vast Majority 21.8% 14.8% n.a.
PROSEGUR COMP SEGURIDAD-REGD Spain Consumer, Non- 2,762 42% 53.9% 11.0% =
cyclical
PUBLIC POWER CORP Greece Utilities 2,756 Vast Majority 19.0% 17.2% n.a.
GRIFOLS SA Spain Consumer, Non- 2,474 39% 11.2% 24.6% +
cyclical
FOMENTO DE CONSTRUC Y CONTRA Spain Industrial 2,449 64% 26.6% 6.0% =
OBRASCON HUARTE LAIN S.A. Spain Industrial 2,317 29% 13.0% 14.6% +
INDRA SISTEMAS SA Spain Technology 2,286 70% 41.5% 11.0% -
ABENGOA SA Spain Industrial 1,785 41% 12.3% 10.7% n.a.
SACYR VALLEHERMOSO SA Spain Industrial 1,421 77% 16.1% 7.7% +
GAMESA CORP TECNOLOGICA SA Spain Industrial 1,208 40% 10.9% 3.4% -
PIAGGIO & C. S.P.A. Italy Consumer, 942 64% 15.1% 9.0% +
Cyclical
CAMPOFRIO FOOD GROUP SA Spain Consumer, Non- 750 43% 18.2% 5.7% -
cyclical
BREMBO SPA Italy Consumer, 530 35% 15.6% 6.6% =
Cyclical
VIDRALA SA Spain Industrial 496 85% 21.5% 17.6% +
INTERPUMP GROUP SPA Italy Industrial 458 61% 18.8% 14.9% +
PROMOTORA DE INFOM SA -PRISA Spain Communications 434 54% 22.2% 15.9% =
VOCENTO SA Spain Communications 433 100% 44.0% 3.5% -
IMMSI SPA Italy Consumer, 302 100% for the 15.4% 6.7% +
Cyclical holding
FLUIDRA SA Spain Industrial 288 71% 19.5% 6.4% -
BARON DE LEY Spain Consumer, Non- 228 100% 10.5% 33.8% +
cyclical
Source: Exane BNP Paribas estimates, Bloomberg and company reports

Government exposure
Sovereign deleveraging
In response to pressure from the bond markets and to achieve the deficit targets in
their long-term budgets, most European governments have announced drastic fiscal
austerity measures to prevent their public deficits from spiralling out of control.
Not all European countries are, of course, in the same fiscal situation. The smaller
peripheral economies (e.g. Ireland, Portugal and Greece) face a more challenging task
than Germany and most Nordic countries (see the figure below). Also, the effectiveness
and impact on growth of fiscal tightening also varies, depending on the country’s
savings rate, the openness of its economy and the size of the public sector.
Figure 68: A rising mountain of debt

Government debt Europe and USA – 2011e and change since 2007 (% of GDP)
150
GRE
140
130
Gross debt/GDP (2011e, %)
120 ITA
110
BEL
100 USA IRE
FRA
90 Eurozone
PORT UK
80
70 GER NL SPAIN
60
FIN
50
0 10 20 30 40 50 60 70 80 90
Change in Gross debt/GDP ratio (2007-11e, %- points)
Source: IMF
Our Economics team has estimated the amplitude of measures required to meet the
official deficit reduction targets. In Europe, these targets have been set to allow a slight
reduction in the ratio of public debt to GDP within the next three to five years.
The measures required to meet the deficit targets average four percentage points of
GDP. To meet their objectives, the governments of Greece (16 percentage points of
GDP), the UK (5.3 points), Ireland (11 points) and Spain (7 points) will have to make
swingeing cuts to reduce their public deficits. Germany would only need 0.9 points.
History shows that major fiscal adjustments tend to rely more on cost cutting than on
tax hikes. This is because excessive tax hikes are a disincentive for private investment
and spending and can curb the economy’s growth potential in the long term. This
explains why governments, so far, have been very reluctant to raise corporate income
taxes. Witness Ireland’s determination to protect its 12.5% corporate tax rate.
But both sources of leverage, spending cuts and tax increases, have been and will be
used, which means that the adjustment does not exclusively target the weakest
categories of households.

Figure 69: Deficit reductions split between spending cuts and tax hikes
25.0
20.0
15.0
10.0
5.0
0.0
(5.0)
Italy (93)
Cyprus (1994)
Switzerland (2000)
Germany (1989)
Germany (2000)
Israel (83)
Sweden (87)
Sweden (00)
Ireland (89)
United States (00)
N.Zealand (95)
Japan (90)
Canada (99)
Spain (2006)
UK (00)
Portugal (85)
Greece (95)
Finland (00)
Belgium (98)
Denmark (86)
Lower public spending Higher fiscal receipts
Source: IMF
Sectors exposed to spending cuts

So, which sectors and companies are most exposed to the end of governments’
largesse?
As discussed above, there are two ways to reduce budget deficits: 1) cut spending or
2) increase revenues.
Sectors which are exposed to government spending cuts are those selling their
products or services directly to the government (e.g. Construction, Infrastructure,
Defence, Media, Telecoms and IT Services) or are dependent on government in some
other way, such as for subsidies (e.g. renewable energy and healthcare).
Pharmaceuticals
Pharmaceuticals warrant a few specific comments, given the sector’s high sensitivity to
government spending. The comments below are a summary of our sector team’s view
regarding Europe’s healthcare austerity measures.
Concerns about healthcare austerity measures in Europe are understandable, but

overdone, in our view. Our sector team estimates the measures represent a c.3%
negative impact on total EU Pharma revenues in 2010-2011, which is already factored
into companies’ guidance.
The negative pricing environment has been a feature of the Pharma industry for years
and is definitely not new (see Figure 70). Several measures to restrict healthcare
spending (mostly public funding to the magnitude of 70-90%) have been implemented
since the late 1990s. As from the mid 2000s, the pricing trend has been negative, by
roughly 2% pa.

Figure 70: Pharma volume and price trends in EU – 2003-2009
6% 6%
5% 5%
4% 4%
0.9%
3% 5.6% 3%
0.1% 4.8% 4.8%
2% 3.7% 2%
3.2%
1% 1.9% 2.1% 1%
0% 0%
(1%) (0.6%) (0.8%) (1%)
(2%) (1.5%) (2%)

(1.8%) (1.6%)
(3%) (3%)
2003 2004 2005 2006 2007 2008 2009
Volume Price Growth total
Source: IMS, Eurostat, Exane BNP Paribas
In this context, the recent sovereign debt crisis in Europe and rising budget deficits led
most European countries to simultaneously pursue this effort. Unsurprisingly, countries
with the largest public deficits, e.g. Greece and Spain, have taken the most far-
reaching measures. Among the tools at governments’ disposal to contain healthcare
expenses, the easiest and quickest way has been to restrain prices via a combination
of price cuts, reference pricing systems and mandatory rebates.
Pharma companies are in our view well prepared to absorb such price pressure,
notably through regional and product diversification. Big Pharma companies have
consistently decreased their exposure to Europe, from 40% to 34% of total sales in
2009, following increased exposure to emerging markets (25% on average for Large
Pharma). In addition, Pharma companies have become more diversified (OTC,
generics, vaccines, animal health), thereby reducing their exposure to prescription
products.
Many European countries have already taken measures to reduce their healthcare
system deficit. Within the top 5 EU Pharma markets, Germany has been the most
aggressive with a rebate on branded drugs increasing to 16% from 6% and a price
freeze for three years. In France, the government recently announced its main cost-
containment targets in its preliminary 2011 budget. Total healthcare savings are
expected to be up to EUR2.5bn, of which EUR625m for Pharma, meaning that 75% of
the savings will not come from Pharma.
Sectors exposed to tax increases

We do not believe corporate tax rates will increase significantly in developed
economies, at least not in the next two years. An increase nonetheless appears
possible in the medium term, once fiscal adjustments have been taken. And even if tax
systems were changed, the changes would be gradual and would have a minor impact
on net earnings, well within the margin of error of consensus estimates.
Tax rates vary widely from sector to sector, as well as within the same sector (see
Figure below), because of geographic exposure, specific sector aspects such as the
North Sea tax for Oil & Gas, tax subsidies in renewable energy, financial leverage, and
specific expenses unrelated to earnings (e.g. France’s local business tax). The intra-
sectoral dispersion of total tax is particularly high in Insurance.

Figure 71: Total tax rate in Europe, average and dispersion by sector (%)
Total average tax rate*, Standard Total average tax rate in Standard
2004-2009 deviation 2010 deviation
Aerospace & Defense 23 9 29 11
Automotive 31 13 28 11
Banks 25 12 29 16
Beverages 27 9 27 8
Bldg Mat. & Infrastr. 30 12 29 15
Capital Goods 25 8 26 10
Chemicals 32 26 30 5
Food & HPC 25 11 26 6
Food Retail 29 17 30 12
General Retail 29 5 28 6
Healthcare 34 14 32 9
IT Hardware 27 15 25 13
IT Services 24 6 24 7
Insurance 26 73 28 6
Leisure & Hotels 20 27 25 17
Media 26 12 29 13
Mining 28 9 30 11
Pharmaceuticals 24 11 22 27
Real Estate 10 9 3 13
Software 29 11 25 11
Steel 18 8 25 10
Telecoms 26 13 26 11
Utilities 29 8 30 7
Oil & Gas 47 16 47 17
* Tax as a percentage of pre-tax earnings; earnings after goodwill write-offs and adjusted for non-recurring items
(e.g., capital gains).
It is difficult to draw any meaningful sector conclusions from the data. For example, the
fact that a total income tax rate is particularly low or, on the contrary, high, does not
necessarily mean that it will end up returning to the mean. The Oil & Gas sector has the
highest tax rate, but it is unlikely that the various sovereign surcharges will be cut any
time soon.
Another way to assess the exposure to fiscal austerity is the sector’s geographical
mobility.
We have calculated the average foreign exposure for 13 European sectors, taking into
account not only sales, but also employment and assets, for 65 European large caps.
Specifically, we created a foreign exposure index, made up of foreign assets over total
assets, foreign sales over total sales, and foreign employment over the total labour
force.
Sectors for which the bulk of sales, jobs and assets are domestic will find it difficult to
optimise corporate income tax than those with a high proportion of foreign assets.
As illustrated in the chart below, sectors with the highest domestic exposure include
Utilities, Retail, Automotive Basic Resources, and Oil & Gas. Excluding Automotive and
Retail, these sectors are already subject to specific taxes or surcharges that are difficult
to cut. Such is the case with the North Sea oil tax, the nuclear tax in Germany, and the
mining tax in Australia.

Figure 72: Europe - foreign exposure index*, by sector
Capital Gds
Consumer Gds
Food & Bev.
Aerosp. & Def.
Construction
Chemicals
Pharma
Telecoms
Oil & Gas
Basic Res.
Automotive
Retail
Utilities
50 60 70 80 90
* Non-Financials, based on the average of foreign assets to total assets, foreign sales to total sales, and foreign
employment to total employment.
Source: Exane BNP Paribas, UNCTAD
Corporate taxes are an opaque and complicated issue (e.g. Ernst & Young’s 2009
global tax guide has 342-pages on the petrochemical industry alone) and, therefore the
impact of any changes in corporate tax rates is very difficult to quantify. One problem,
for instance, is that, generally, tax as per the P&L account is rarely the same as that
shown in the Cash Flow Statement.
In any event, the impact of a change in corporate income tax or other taxes would be
relatively insignificant for most European large caps. The average tax rate in Europe is 20%.
This means that, all things being equal, a five-point increase by half of all the countries to
which European companies are exposed would reduce net earnings by around 3% (a very
unlikely scenario, in our view; witness Ireland’s determination to protect its 12.5% tax rate)
Such earnings dilution falls well within the margin of error of the consensus earnings
estimates (over the past 15 years, the average gap between consensus earnings estimates
and actual earnings has been 9%).

Stocks
We have compiled a list of stocks which have above-average exposure to government
deleveraging and have, at the same time, limited emerging market exposure (see table
below). The basket has underperformed the market by 13% year-to-date, but is not
trading at a discount to the market average (see chart below).
Figure 73: Exposure to government deleveraging

European large caps with large government exposure
Company Sector Comment
BAE Systems Aerospace & Defence 98% of sales Defence related
Cobham Aerospace & Defence 72% of sales Defence related
Buzzi Unicem Construction Sales exposure to public works: 18% Western Europe, 9% North America
Italcementi Construction Sales exposure to public works: 20% Western Europe, 4% North America
Roche Healthcare Above-average exposure to hospital spending on highly priced cancer and immunology drugs
Smith & Nephew Healthcare 65% of sales from public & private health insurance
Synthes Healthcare 75% of sales from public & private health insurance
Cap Gemini IT Services 28% of sales related to public sector (16% to UK public sector), 4% excl. outsourcing
Indra IT Services 61% of sales to public sector
Logica IT Services 31% of sales related to public sector (12% to UK public sector), 7% excl. outsourcing
Steria IT Services 39% of sales related to public sector, including outsourcing and (18% to UK public sector)
OPAP Leisure & Hotels 34% government stake + government exposure via concession
Pearson Media Approx. 20% of sales from school textbooks, mostly US
Cable & Wireless Telecoms 13% of sales is non-contracted to UK public sector
Figure 74: Government exposure

Performance and valuation of Government exposure basket
180
160
140
120
100
80
Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10
Relative performance (rebased) Relative P/E, 12m fwd (%)
Source: Factse, Exane BNP Paribast

Sector Outlook
Sector allocation
Cyclicals
We have no particular strong bias towards Cyclicals or non-Cyclicals in our sector
allocation. Cyclicals, in particular those with above average emerging market exposure,
remain appealing because of their superior growth prospects. A weak euro, thanks to
Europe’s sovereign debt crisis, is also a positive. But valuations, while still reasonable
in absolute terms, are on the high side when compared to the less vibrant defensive
plays.
Figure 75: Cyclicals vs non-Cycicals

EV/Sales, 12-month forward
12m EV/Sales Rel. 12m EV/Sales

2.0x 60%
1.8x 58%
56%
1.6x
54%
1.4x 52%
1.2x 50%
1.0x 48%
46%
0.8x
44%
0.6x 42%
0.4x 40%
Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10
Rel. 12m EV/Sales MSCI Europe - Cyclicals (lhs) MSCI Europe - Non Cyclicals (lhs)
In addition, the prospect of further quantitative tightening in China, this time including
more frequent rate hikes (the recent rate hike of 25bp was the first one in nearly three
years), may prove a major headwind for emerging market plays. The economic impact
of policy tightening might be trivial, but financial markets, and Cyclicals in particular, are
far more sensitive to monetary policy than the real economy.
Indeed, what makes sector allocation so difficult is the opposing forces of quantitative
tightening in emerging markets and quantitative easing in the USA.
All in all, we maintain an Outperform rating on Mining and Oil & Gas as a play on the
asset boosting quantitative easing by the Fed. We are more selective among
Industrials after their stellar performance in 2010. Certain segments in Construction
(cement makers) and in Chemicals (companies close to the end-user) are likely to face
a squeeze on gross margins as a result of commodity cost inflation.
In Consumer Cyclicals we maintain a cautious stance on sectors with limited exposure

to emerging markets. Consumer spending is likely to remain subdued in Europe under
the weight of fiscal austerity and in the USA under the weight of further deleveraging.
The exception is German consumer spending, which we expect to positively surprise,
thank to the lagged impact of Germany’s export boom, rising wages and falling
unemployment.

Non-Cyclicals
Generally, we continue to prefer sectors with an above average FCF yield and
relatively steady FCF generation, such as Beverages, Media, Pharmaceuticals and
Telecoms. It is worth noting that most sectors with high FCF yield one year ago
outperformed the market, including Media, Telecoms and Beverages. The exception
was Pharmaceuticals, which slightly underperformed the market (see Figure below).
Figure 76: FCF yield and performance

European sectors – FCF yield 2011e and relative performance YTD
10 30
25
8
20
6
15
10
4
5
2
0
0 -5
Telcos Pharma Auto Media Mining Beverages
2011e FCF yield (%, lhs) Relative performance (%, rhs)

We maintain our Underperform stance on Utilities because of the sector’s low FCF yield
(less than 2% in 2011e) and pedestrian CFPS and EPS growth in 2011e (less than 5%,
on average).
Financials
In Financials, we can’t get particularly excited about Banks. The sector offers good
value, which explains our Neutral stance. However a sustained rerating vs the market
looks unlikely, given structurally lower ROEs, subpar dividend growth and limited M&A
potential without the help of dilutive capital increases because of Basel III constraints.
Insurance suffers from the combination of a low interest rate environment and limited
exposure to emerging markets. The result is structurally low ROEs (10%, on average,
in the next few years) and mediocre earnings growth: less than 5% per annum in the
next three years, according to our sector team.
Figure 77: Sector weightings

Outperform Neutral Underperform
Beverages Aerospace & Defence Automotive
IT Hardware Banks Capital Goods
Media Chemicals General Retail
MedTech Construction & Bldg Mat. Insurance
Mining Food & HPC Leisure & Hotels
Oil & Gas Food Retail Paper
Pharmaceuticals IT Services Utilities
Software Luxury Goods
Telecoms Real Estate
Steel
Support Services

European large caps – top picks for 2011
Figure 78: Exane analyst top picks for 2011

Market cap Share price Target price P/E (x) 2011e EPS growth 2011e EV/EBIT 2011e (x) FCF Yield 2011e
(EURm) (%) (%)
ArcelorMittal 37,862 34.2 42.0 10.4 118.8 10.1 6.3%
BG Group 48,183 1222.0 1420.0 16.6 4.4 11.1 NS
BT Group 14,999 165.0 220.0 8.8 8.9 8.2 11.0%
Clariant 3,064 18.5 21.0 10.3 5.0 6.5 7.9%
Danone 28,634 47.0 53.0 15.8 9.8 12.0 5.8%
Deutsche Bank 37,527 40.4 57.0 6.3 8.2 NA NS
Ericsson 24,564 72.1 105.0 9.3 20.5 4.3 11.8%
Fortum 18,422 20.7 25.0 12.7 6.7 11.3 2.4%
Heineken 21,650 36.5 47.0 11.9 16.9 9.9 8.3%
Henkel Pref 18,298 47.1 47.0 14.7 14.0 10.1 6.3%
Infineon 4,751 6.6 8.0 12.5 -13.5 7.8 3.5%
ING Group 29,988 7.9 10.7 5.4 46.3 NS NS
Intercont'l Hotels Group 3,829 1141.0 1350.0 16.8 14.4 11.9 7.5%
Kingfisher 6,723 244.7 300.0 11.6 15.8 8.0 6.9%
Klépierre 4,835 25.9 31.0 13.7 NS NS NS
LVMH 56,547 119.4 134.0 18.8 18.9 12.7 4.0%
Philips 21,297 22.9 29.0 12.1 14.5 6.9 5.9%
Reed Elsevier NV 6,526 9.4 12.0 9.9 12.2 8.3 9.9%
Rémy Cointreau 2,609 53.8 55.0 17.5 21.6 13.5 4.6%
Repsol YPF 24,085 19.8 22.0 9.4 24.1 7.4 12.0%
Rio Tinto 101,868 4230.0 5000.0 7.1 36.1 5.5 8.6%
Saint-Gobain 19,030 37.4 43.0 10.7 41.3 8.9 7.2%
Sanofi-Aventis 65,200 50.0 65.0 7.5 -2.3 5.8 12.5%
SGS 9,158 1638.0 1850.0 18.9 7.6 13.3 3.6%
Synthes 10,667 122.5 150.0 14.7 10.1 8.8 6.3%
Telenor 18,578 92.5 112.0 12.0 32.2 11.1 6.7%
Tesco 39,335 426.7 495.0 11.2 11.6 9.0 3.2%
Volkswagen 54,591 122.7 139.0 10.0 17.2 6.5 11.4%
Xstrata 44,262 13.2 15.0 10.2 6.4 6.6 7.5%
Yara Intl ASA 10,781 305.0 336.0 11.1 28.8 8.0 6.1%

Sector dynamics
Aerospace & Defence ___________________________________ 73
Automotive ____________________________________________ 75
Banks ________________________________________________ 77
Beverages_____________________________________________ 79
Building Materials & Infrastructure ________________________ 81
Capital Goods__________________________________________ 83
Chemicals _____________________________________________ 85
Food & HPC ___________________________________________ 87
Food Retail ____________________________________________ 89
General Retail__________________________________________ 91
Healthcare Providers & Services __________________________ 93
Healthcare_____________________________________________ 94
Insurance _____________________________________________ 95
IT Hardware ___________________________________________ 97
Leisure & Hotels________________________________________ 99
Luxury Goods_________________________________________ 101
Media________________________________________________ 103
Mining _______________________________________________ 105
Oil & Gas_____________________________________________ 107
Pharmaceuticals ______________________________________ 109
Real Estate ___________________________________________ 111
Steel ________________________________________________ 113
Support Services ______________________________________ 115
Telecom Operators ____________________________________ 117
Utilities ______________________________________________ 119

Aerospace & Defence Sector weighting: Neutral (=)
MSCI benchmark weighting: 0.9%
Stock selection Relative performance vs MSCI Europe (rebased)
Stock Stock Mkt cap CAPE* EV/EBITDA Net debt/ 120
rating (EURm) 10Y (x) 11e (x) EBITDA
11e (x)
115
☺ Safran (+58.6%)*
Favourite stocks Thales (-22.5%)*
Safran + 9,005 32.9 7.0 0.3 110
BAE Systems + 14,124 11.1 4.7 NC
Stocks to avoid 105
EADS - 14,620 12.5 6.1 NC
100
95
90
85
Jan 09 Apr 09 Jul 09 Oct 09 Jan 10 Apr 10 Jul 10 Oct 10
* Cyclically adjusted P/E * Best and worst performers in 2010, based on Exane BNP Paribas
Source: Exane BNP Paribas estimates universe. Relative performance in brackets.
Sector – Valuation* Key issues

(x) 2010e 2011e 2011e On the commercial aerospace side, we expect Q4 2010/Q1 2011 to signal the beginning
rel. mkt
of the rise of aftermarket activities, on the back of sustained strong air traffic and airlines
CAPE 12.7 12.0 69%
EV/EBITDA
profits. This will have a positive impact on the margins of equipment suppliers and
6.3 5.7 81%
DY (%) 2.8 3.2 93% engine makers. Production of new aircraft is increasing across the board, typically with
low margins. The 787 and A350 development schedules will likely be further deferred,
leading to additional cost overruns. Ever-present fluctuations in the EUR/USD will of
Sector – Growth*
course impact this sector segment.
% ch. 2010e 2011e Hist.
Avg
Sales
In defence, underlying budgets will remain under pressure in Europe, while they are
3.8 3.8 9.3
EBIT 8.0 11.7 17.0 expected to be flat in the US. In this context, the pace of any reduction in military
EPS 7.4 19.6 21.2 spending will be driven by military operations in Afghanistan and the eventual drawdown
of forces there. Every single defence group focuses on export markets for growth,
leading to increased competition and amplifying already strong margin pressure.
Sector – Profitability*
Margins (%) 2010e 2011e 2011e
vs
M&A will help differentiate between groups inside the sector, between those who can
peak (BAE Systems, Zodiac, Rheinmetall, Safran, possibly EADS) and those who can’t
EBITDA 10.6 11.8 82% (Thales, Finmeccanica). Governance issues will also drive market sentiment on EADS
EBIT 7.4 8.6 94% and Finmeccanica, with upcoming management reshuffle for both companies.
Net 4.3 6.7 76%
* median ratios
Valuation
Sector – Solvency** Defence valuations are low, but will likely remain so for some time. Indeed, we have
(x) 2009 2010e 2011e likely entered a 10-year down-cycle, after a 10-year up-cycle. This depresses the overall
Net Debt/EBITDA 0.3 0.4 0.2 sector valuations, but there remains some upside for the aftermarket stocks, with above-
Interest Cover (37) 10 12 par growth expected.
Gearing (%) 11% 12% 6%
** based on aggregated figures
Stocks
NC = Net Cash
NA = Not Applicable Our preference still goes to aftermarket stocks, led by Safran. MTU will also benefit from
Source: Exane BNP Paribas estimates this trend, as well as Zodiac (once the end of the speculative case has been fully
digested). 787 difficulties will negatively impact market sentiment for all suppliers,
Olivier Brochet
(+33) 1 44 95 98 83
including Rolls-Royce, Zodiac, MTU and Safran but this will be a positive for margins.
olivier.brochet@exanebnpparibas.com We believe EADS will likely be hurt by further delays on the A350. Governance issues
will increase the risk premium on the stock, as well as on Finmeccanica. Thales’
Tristan Sanson mutation is slowly happening while BAE Systems is in the process of repositioning itself
(+33) 1 42 99 24 04
tristan.sanson@exanebnpparibas.com
on growth areas in the defence market.
aerodefence@exanebnpparibas.com

Aerospace & Defence - Valuation and Earnings Dynamics*
EV/Sales

3.0x 80%
2.5x 70%
2.0x 60%
1.5x 50%
1.0x 40%
0.5x 30%
0.0x 20%
déc- déc- déc- déc- déc- déc- déc- déc- déc- déc- déc- déc- déc-
98 99 00 01 02 03 04 05 06 07 08 09 10
Rel. 12m EV/Sales Aerospace & Defence (lhs) MSCI Europe Ex Financials (lhs)
EV/EBIT
12m EV/EBIT Rel. 12m EV/EBIT

120%
19.0x
110%
17.0x
100%
15.0x
90%
13.0x
80%
11.0x
9.0x 70%
7.0x 60%
5.0x 50%
3.0x 40%
98 99 00 01 02 03 04 05 06 07 08 09 10
Rel. 12m EV/EBIT Aerospace & Defence (lhs) MSCI Europe Ex Financials (lhs)
12-month forward EPS
12m EPS Rel. 12m EPS

120%
36.0
110%
31.0 100%
26.0 90%
80%
21.0
70%
16.0
60%
11.0 50%
98 99 00 01 02 03 04 05 06 07 08 09 10
Rel. 12m EPS Aerospace & Defence (lhs) MSCI Europe Ex Financials rebased (lhs)
*Based on consensus estimates for Exane BNP Paribas covered stocks universe.
Source: Exane BNP Paribas, Factset Estimates, MSCI

Automotive Sector weighting: Underperform (-)
11e (x) 120 ☺ VW Pref. (+70.6%)*
Porsche SE (+2.5%)*
115
Favourite stocks
Renault + 12,455 7.6 0.5 0.2 110
Peugeot + 6,904 7.3 1.4 0.1
Volkswagen Pref + 51,907 18.2 3.0 NC 105
Stocks to avoid
100
Scania - 12,657 26.1 6.4 NC
Michelin - 9,884 14.1 5.3 0.7
95
BMW - 35,696 17.5 3.3 NC
90
85
80

(x) 2010e 2011e 2011e Next year should be a contrasting picture for car markets. We expect China and the US
rel. mkt
to remain relatively strong (around 10% growth), but Europe and Brazil relatively weak.
CAPE 17.8 16.1 93%
EV/EBITDA
Pricing will be an important issue since the industry will have to deal with higher raw
4.9 4.7 66%
DY (%) 1.8 2.3 67% material price (negative impact expected between EUR300 and EUR500m).
Emission regulation will also have an impact since OEMs must add new features to
Sector – Growth*
comply with them (stop & start, hybridisation) and to downsize engines. The challenge
% ch. 2010e 2011e Hist.
Avg for the OEMs is to pass on these extra costs to the customers.
Sales 18.5 6.0 1.2
EBIT 94.5 16.1 18.0 In China, everybody is increasing capacity to keep up with demand and to localise more
EPS NA. 14.1 23.0 to limit import duties.
Sector – Profitability* Valuation

Margins (%) 2010e 2011e 2011e The success of the GM’s IPO revives market’s interest in a sector which looks cheap
vs
peak compared to others. However, there is now a large discrepancy between premium
EBITDA 11.5 11.8 93% makers (BMW, Daimler) which have fully benefited from China and product momentum,
EBIT 7.2 7.5 82% and mass makers which have no pricing power. Suppliers are in the middle, but might
Net 4.2 4.9 69% need some time to pass through cost inflation.
* median ratios
Stocks
Sector – Solvency**
(x) 2009 2010e 2011e
VW pref (+) remains our top pick as the group is exposed to all markets and segments.
Net Debt/EBITDA 0.5 NC NC Its profitability is improving thanks to the success of the new models, Audi and to the
Interest Cover 5 10 14 implementation of the new modular approach. This positive trend should continue as the
Gearing (%) 9% (7%) (12%) product momentum will remain strong and the pay back of recent investment materialise.
** based on aggregated figures Out TP, based on our 2012 estimates is EUR139. But a medium term valuation (2015)
NC = Net Cash
would point to EUR178.
NA = Not Applicable
Source: Exane BNP Paribas estimates Renault (+) is also one of our picks since we believe that the management is now
addressing the group’s main issues such as brand positioning and overcapacity. The
group valuation is compelling and our SOTP points to EUR50, leaving 15% upside.
PSA (+) is doing well thanks to strong product momentum. This should drive positive
earning surprises when the group posts its FY numbers. However, there are still some
major strategic questions about the medium term. Our TP is EUR35 (+10%).
Finally, cost inflation is back on the menu and we see Michelin as the most at risk on this
Thierry Huon topic. Besides, we believe that it is too early to play the new ‘growth’ story as the benefits
(+33) 1 44 95 41 06 of the capex plan will only kick in post 2012. In between, headwinds should be
thierry.huon@exanebnpparibas.com
automotive@exanebnpparibas.com significant.

Automotive - Valuation and Earnings Dynamics*
EV/Sales

3.0x 70%
2.5x 60%
2.0x 50%
1.5x 40%
1.0x 30%
0.5x 20%
0.0x 10%
Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11
Rel. 12m EV/Sales Automotive (lhs) MSCI Europe Ex Financials (lhs)
EV/EBIT
390%
34.0x
340%
29.0x
290%
24.0x
240%
19.0x
190%
14.0x 140%
9.0x 90%
4.0x 40%
Rel. 12m EV/EBIT Automotive (lhs) MSCI Europe Ex Financials (lhs)

31.0
100%
26.0
80%
21.0
60%
16.0
40%
11.0
6.0 20%
1.0 0%
Rel. 12m EPS Automotive (lhs) MSCI Europe Ex Financials rebased (lhs)

Banks Sector weighting: Neutral (=)
130
Stock Stock Mkt cap CAPE* P/BV 11e ROE 11e
rating (EURm) 10yr (x) (%)
(x) 120
Favourite stocks
Deutsche Bank + 37,824 10.4 0.7 12.0 110
Société Générale + 31,129 7.5 0.8 11.7
Barclays plc + 40,715 6.1 0.6 10.3
100
Stocks to avoid
Dexia - 5,571 3.1 0.5 7.9
Standard Chartered - 52,904 22.7 1.8 13.6 90 ☺ RBS (+46.05%)*
UBS AG - 47,967 12.8 1.1 14.9 Dexia (-31.9%)*
80
70

(x) 2009 2010e 2011e
CAPE
The forthcoming regulatory framework (Basel 3) has been significantly softened during
7.0 7.2 7.5
P/BV 0.7 0.8 0.7 2010. Final rules will be unveiled by the end of 2010, but are unlikely to materially
change the picture. Among the issues that will weigh on the sector in 2011, the
sovereign risk, which underpins the macro risk (precisely when the decline in cost of risk
Sector – Growth*
is set to boost the sectors profitability) and the shape of the yield curve, will be key. The
% ch. 2010e 2011e Hist.
Avg impact of central banks’ exit strategies on the inter-bank funding market as well as more
EPS (6.9) 23.9 13.2 broadly on banks’ wholesale funding will also be closely watched.
DPS 33.3 19.2 8.6
Valuation
Sector – Profitability* Exane universe is trading at around 1.05x BV for an estimated across-the-cycle RoE of
(%) 2010e 2011e 2011e 12% (after governments’ bank taxes). Assuming a 10% CoE, the theoretical value of the
vs
Peak sector could thus embed a 20% upside. However, with the aforementioned issues, we
ROE 8.7 10.7 52% believe it is unlikely that the sector will trade at its theoretical value.
* median ratios
Stocks
Sector – Solvency* SocGen (+, EUR55): the set of Q3 results confirms that the earnings recovery is well
(%) 2009 2010e 2011e underway. Moreover, it gave credibility to guidance disclosed by management a few
Tier 1 Ratio 10.8 11.8 11.8 months ago: 1/ breakeven in Russia 2) contribution from legacy assets to results in line
* median ratios with expectations and reduced exposure, 3) confirmation of the gradual fall in the LLPs.
Deutsche Bank (+, EUR57): with IB momentum having normalized, a re-rating is now
required for the stock to outperform. The two concerns that prevented it are removed
with the DPB deal: capital adequacy and overdependence on IB. The bank is trading at a
Elie Darwish compelling 0.7x P/BV for an 11.5% ROE in 2011.
(+33) 1 42 99 50 13
elie.darwish@exanebnpparibas.com
Dexia (-, EUR3.4): the restructuring plan is on track but there remains lot to do. We
banks@exanebnpparibas.com believe that even on a 0.5x P/BV, it is early to return to the stock given the low level of
ROE expected over the next few years. Assuming that the AFS reserve has remained
Ian Gordon flat since the end of Q2, the valuation would be close to zero.
(+44) 207 039 9407
ian.gordon@exanebnpparibas.com
StandChart (-, GBP18.31): Strong growth will continue, driven by Global Markets within
its Wholesale Banking division. However, it is adversely impacted on liability spreads by
Eric Hazart "lower for longer" interest rates and on asset spreads by increased competition in Asia
(+33) 1 44 95 35 68 (in contrast to expanding asset spreads in the UK). Also, core tier 1 has risen from c.6%
eric.hazart@exanebnpparibas.com pre-crisis to pro-forma 11% today, so returns are under pressure. We expect RoEs of
banks@exanebnpparibas.com
c.13% in 2011/12e against historic delivery of, and notional targeting of, "high-teens"
returns. These challenges will mitigate against a further re-rating in the near term.

Banks - Valuation and Profitability*
P/E
12m P/E Rel. 12m P/E
23.0x 180%
21.0x
160%
19.0x
17.0x 140%
15.0x
120%
13.0x
11.0x 100%
9.0x
80%
7.0x
5.0x 60%
Rel. 12m P/E Banks (lhs) MSCI Europe (lhs)
P/BV
12m P/BV Rel. 12m P/BV

4.0x 110%
3.5x 100%
3.0x 90%
2.5x 80%
2.0x 70%
1.5x 60%
1.0x 50%
0.5x 40%
0.0x 30%
Rel. 12m P/BV Banks (lhs) MSCI Europe (lhs)
ROE
12m ROE Rel. 12m ROE

18.0% 120%
16.0%
100%
14.0%
80%
12.0%
10.0%
60%
8.0%
40%
6.0%
4.0% 20%
Rel. 12m ROE Banks (lhs) MSCI Europe (lhs)

Beverages Sector weighting: Outperform (+)
rating (EURm) 10Y (x) 11e (x) EBITDA ☺ Carlsberg (+39.3%)*
11e (x) 135 Pernod Ricard (+1.4%)*
Favourite stocks 130

Heineken + 21,360 18.9 7.6 1.7
Rémy Cointreau + 2,570 28.7 12.3 1.9
125
Carlsberg + 11,399 22.7 7.8 1.4
Stocks to avoid
120
SABMiller - 37,639 31.5 8.8 1.2
Vranken-Pommery
Monopole - 227 14.9 11.6 8.3 115
110
105
100

(x) 2010e 2011e 2011e
rel. mkt High government debt and unemployment coupled with fiscal austerity packages are
CAPE 23.4 21.7 125% likely to weigh on consumer expenditure in advanced economies. The key theme in the
EV/EBITDA 10.4 9.4 132% sector will continue to be exposure to emerging markets with supportive demographics
DY (%) 2.2 2.3 67% and consumer expenditure trends as well as self-help restructuring situations. On
balance, the brewers continue in our view to offer a better way to play these themes than
Sector – Growth* spirits. We estimate that the European brewers generate on average 60% of their EBIT
% ch. 2010e 2011e Hist. from EMs, which compares with on average 35% for the European-listed spirits
Avg
companies. Meanwhile, opportunities still exist for further consolidation in the sector,
Sales 3.0 4.4 10.8
both in spirits, an industry which still remains highly fragmented, and beer.
EBIT 9.1 7.6 14.1
EPS 18.2 13.2 10.2
Risks to our positive sector stance and preference for the brewers are mainly the
concerns over rising commodity prices. However, we estimate that input cost pressures
Sector – Profitability* remain at reasonable levels, at an average of around +8% in 2011e. Considering the
Margins (%) 2010e 2011e 2011e
vs
high degree of industry concentration in beer, price increases of 2-3% (as needed to
peak protect gross margins) appear feasible.
EBITDA 29.9 30.2 101%
EBIT 24.3 24.7 92%
Net 15.8 18.0 103% Valuation
* median ratios Free cash flow yields in the sector are at attractive levels, especially when compared
with the strong earnings growth prospects of the sector. Overall, we expect European
beverages to generate annual earnings growth that will average 19% over the 2010-12e
(x) 2009 2010e 2011e
period. This ranks as the fastest growth rate amongst the defensive sectors under our
Net Debt/EBITDA 3.1 2.6 2.0
Interest Cover 4 5 7
coverage. While Beverages have already outperformed the market by 50% since early
Gearing (%) 113% 91% 67% 2008, we expect this outperformance to continue, as the sector continues to offer
** based on aggregated figures investors an attractive combination of pricing power, earnings visibility, good free cash
NC = Net Cash flow yields and strong earnings growth.
NA = Not Applicable
Stocks
Among the European brewers, Heineken and Carlsberg remain our sector team’s top
stock picks. As a Key Buy recommendation, Heineken offers major value to be unlocked
Javier Gonzalez Lastra through the ongoing cost savings program (TCM) and the FEMA acquisition in Mexico. In
(+44) 207 039 9431
spirits, our preference is for Rémy Cointreau. The company is enviably positioned for
javier.gonzalez-lastra@exanebnpparibas.com
growth, with the highest exposure in the sector to Chinese consumption (c. 40% of
exanebeveragesteam@exanebnpparibas.com FY10/11 EBIT). Improving sales mix as a result of rising Asian demand offers significant
upside on operating leverage.

Beverages - Valuation and Earnings Dynamics*
EV/Sales

4.0x
260%
3.5x
3.0x 240%
2.5x 220%
2.0x
200%
1.5x
180%
1.0x
160%
0.5x
0.0x 140%
Rel. 12m EV/Sales Beverages (lhs) MSCI Europe Ex Financials (lhs)
EV/EBIT

14.0x 160%
13.0x 150%
12.0x 140%
11.0x 130%
10.0x 120%
9.0x 110%
8.0x 100%
7.0x 90%
6.0x 80%
Rel. 12m EV/EBIT Beverages (lhs) MSCI Europe Ex Financials (lhs)

27.0 120%
25.0
110%
23.0
100%
21.0
19.0 90%
17.0
80%
15.0
70%
13.0
11.0 60%
Rel. 12m EPS Beverages (lhs) MSCI Europe Ex Financials rebased (lhs)

Building Materials & Infrastructure Sector weighting: Neutral (=)
110
Stock Stock Mkt cap CAPE* EV/EBITDA Net debt/
rating (EURm) 10Y (x) 11e (x) EBITDA 108
11e (x)
106
Favourite stocks
Saint-Gobain + 18,178 10.5 5.8 1.3 104
Heidelberg Cement + 7,686 9.0 6.9 2.8
SacyrVallehermoso + 1,422 5.1 16.9 24.9 102
Stocks to avoid 100

Brisa - 2,857 17.9 9.8 4.1
Grupo ACS - 10,288 18.7 6.6 6.7 98
Lafarge = 12,555 7.7 7.1 3.2
96 ☺ Wolseley (+42.3%)*
Sacyr (-43.6%)*
94
92
90

(x) 2010e 2011e 2011e
rel. mkt The demand outlook for the building materials sector is very uncertain and visibility is
CAPE 10.3 10.5 60% low. Emerging markets should remain strong, but challenges remain in developed
EV/EBITDA 7.9 7.1 101% markets – most notably fiscal retrenchment and a sluggish private sector. Cement prices
DY (%) 3.9 4.1 120% are also under pressure because of low utilisation rates (developed markets) and new
entrants (emerging markets) and this could pressure margins at a time when input costs
Sector – Growth* are rising. Balance sheets for many of the majors are strained. Stock selectivity will be
% ch. 2010e 2011e Hist. key in these challenging conditions.
Avg
Sales 2.1 3.0 10.4
EBIT 4.5 8.7 10.9 Valuation
EPS 2.3 10.5 11.3
The building materials sector is trading on a 2011e EV/EBITDA of 7.1x. This is slightly
above the mid cycle average of 7.0x EV/EBITDA and already prices in an element of
Sector – Profitability* recovery, in our view. Our preference is for the lightside names. These are less exposed
Margins (%) 2010e 2011e 2011e to cuts in public budgets, have more pricing power than the cement majors and are more
vs
peak able to manage input costs (energy costs are less significant than in cement).
EBITDA 19.3 20.5 97%
EBIT 11.9 12.3 81%
Net
Stocks
5.3 6.5 52%
* median ratios Our top pick is Saint Gobain (+, TP EUR43). The group is well positioned to benefit from
better trends in Northern Europe (Germany, France, UK, Nordics) and recent price
Sector – Solvency** momentum has been strong. The group has also set new ambitious targets for 2015, and
(x) 2009 2010e 2011e the focus on ROCE should ensure strong capital discipline. Catalysts are better FY10
Net Debt/EBITDA 4.4 4.0 3.6 results on 24 February (driven by Q4 top line in Distribution and better margins in
Gearing (%)
Innovative Materials); ongoing announcements of new investments in emerging markets
135% 124% 114%
** based on aggregated figures or energy efficient projects; and progress on the previously announced Packaging IPO.
NC = Net Cash Amongst the cement names our preferred stock is Heidelberg Cement, due to its
NA = Not Applicable regional exposure and improving returns profile.
Paul Roger
(+44) 203 430 8415
paul.roger@exanebnpparibas.com
infrastructure@exanebnpparibas.com

Building Materials - Valuation and Earnings Dynamics*
EV/Sales

3.0x 130%
2.5x 120%
110%
2.0x
100%
1.5x
90%
1.0x
80%
0.5x 70%
0.0x 60%
Rel. 12m EV/Sales Building Materials & Construction (lhs)
MSCI Europe Ex Financials (lhs)
EV/EBIT

14.0x 150%
13.0x 140%
130%
12.0x
120%
11.0x
110%
10.0x
100%
9.0x
90%
8.0x
80%
7.0x 70%
6.0x 60%
Rel. 12m EV/EBIT Building Materials & Construction (lhs) MSCI Europe Ex Financials (lhs)

130%
34.0
120%
110%
29.0
100%
24.0
90%
80%
19.0
70%
14.0 60%
Rel. 12m EPS Building Materials & Construction (lhs)
MSCI Europe Ex Financials rebased (lhs)

Capital Goods Sector weighting: Underperform (-)
11e (x) ☺ SKF (+53.1%)*
115 Vestas (-47.8%)*
Favourite stocks
GEA Group + 3,529 29.6 7.6 0.0 110
Philips + 21,492 43.1 5.5 NC
IMI + 3,215 29.5 7.2 0.1
Stocks to avoid 105
ABB - 34,614 28.6 8.2 NC
SKF - 8,738 23.4 7.3 NC
Areva CI - 12,224 25.0 16.0 4.3 100
95
90

(x) 2010e 2011e 2011e
rel. mkt The Capital goods sector should continue to benefit from the high level of fixed
CAPE 24.6 24.0 138% investment in emerging countries. The comparable base for growth will however become
EV/EBITDA 8.7 7.9 111% quite challenging as the year progresses. Growth opportunities will be quite differentiated
DY (%) 2.5 3.0 86% between those companies that can continue to capture growth in Emerging markets with
business models offering high entry barriers, good channels to market and a high level of
Sector – Growth* service/consumable and those companies that will have to fight growing competition
% ch. 2010e 2011e Hist. from emerging players on the international scene.
Avg
Sales 6.6 5.5 6.0
EBIT 32.8 15.2 10.9 Valuation
EPS 20.3 15.9 14.0
The capital goods sector trades on 12 m forward EBIT of 9.8x a 15% premium to the
Exane coverage universe. This premium is in line with the average relative valuation
Sector – Profitability* over the last 5 years. This premium has been supported by an 50% recovery in EPS
Margins (%) 2010e 2011e 2011e expectations over the last 12 months.
vs
peak
EBITDA 14.5 14.6 89% Stocks
EBIT 13.2 12.4 96%
Net 8.7 9.1 77% We like GEA’s exposure to EM (39%) and process industries (68%) which has the
* median ratios greatest capex recovery over 2010-15. the GEA restructuring program should drive
margins up to 11% in 2012.
(x) 2009 2010e 2011e We like Philips refocused portfolio around Lighting, Healthcare and Consumer. We see
Net Debt/EBITDA 0.6 0.5 0.3 Philips achieving a 10% EBITA margin in 2010 and the company targets GDP+2%
Gearing (%)
organic growth and 10-13% EBITA% over 2010-2013. Growth will be supported by the
16% 14% 8%
** based on aggregated figures LED revolution in Lighting and strong EM exposure (34%). Valuation is very attractive on
NC = Net Cash 0.7x EV/sales11e
NA = Not Applicable
Source: Exane BNP Paribas estimates IMI has an attractive exposure to the O&G market, and regulatory driven demand in
Buildings via a portfolio focused on consumables. IMI is structurally improving returns
and margins through portfolio adjustment & restructuring. We expect EBIT margins to
reach levels significantly above the pro forma levels reached in the last cycle (17.9% in
2011e versus 13.4%).
Olivier Esnou
(+33) 1 44 95 68 87
olivier.esnou@exanebnpparibas.com
capitalgoods@exanebnpparibas.com

Capital Goods - Valuation and Earnings Dynamics*
EV/Sales

3.0x 120%
110%
2.5x
100%
2.0x
90%
1.5x 80%
70%
1.0x
60%
0.5x
50%
0.0x 40%
Rel. 12m EV/Sales Capital Goods (lhs) MSCI Europe Ex Financials (lhs)
EV/EBIT

15.0x 150%
14.0x
140%
13.0x
12.0x 130%
11.0x
120%
10.0x
110%
9.0x
8.0x 100%
7.0x
90%
6.0x
5.0x 80%
Rel. 12m EV/EBIT Capital Goods (lhs) MSCI Europe Ex Financials (lhs)

150%
28.0
140%
23.0 130%
120%
18.0
110%
100%
13.0
90%
8.0 80%
Rel. 12m EPS Capital Goods (lhs) MSCI Europe Ex Financials rebased (lhs)

Chemicals Sector weighting: Neutral (=)
130
rating (EURm) 10Y (x) 11e (x) EBITDA ☺ Lanxess (+90.1%)*
11e (x) 125 AkzoNobel (-8.8%)*
Favourite stocks
120
Clariant + 3,032 11.2 4.9 NC
Linde + 16,895 24.8 7.3 1.6
Yara Intl ASA + 10,189 22.2 5.8 0.8 115
Stocks to avoid
Solvay - 6,256 12.5 4.9 NC 110
Syngenta - 19,179 26.7 9.8 0.2
AkzoNobel = 10,095 13.7 6.7 0.5
105
100
95

(x) 2010e 2011e 2011e We turn somewhat more cautious on diversified chemicals but more positive on
rel. mkt
agrochemicals – hence our Neutral view. After having been ahead of the curve in terms
CAPE 23.6 20.0 115%
EV/EBITDA 8.2 6.7 95%
of estimates, consensus has now increased towards our numbers and we are now in line
DY (%) 2.2 2.7 78% for the next 12 months.
We are increasingly concerned for diversified chemicals (50% of market cap covered)
Sector – Growth*
after a major rebound in sales and operating results in 2010. We see no potential for
% ch. 2010e 2011e Hist. earnings growth in 2011. Indeed utilization rates have risen dramatically following an
Avg upturn in demand, particularly in emerging markets, and restocking, to c.85%, leaving
Sales 13.1 4.8 6.3 little headroom for a further increase. Prices have been strong, reflecting tight
EBIT 30.2 3.9 13.6
supply/demand, and could be a further support in 2011. But margins, helped also by
EPS 34.4 8.5 8.8
currencies and the last effect from cost cutting efforts, might have peaked in 2010. At 8x
EV/EBIT and 12x P/E 2011e, valuations are now fair, assuming little earnings growth
Sector – Profitability* next year.
Margins (%) 2010e 2011e 2011e
vs Demand for Agrochemicals (25% of market cap covered) should be strong in 2011
peak following a rebound in soft commodity prices. Bad weather in some regions (notably
EBITDA 17.7 18.2 88% drought in Eastern Europe), but also lower-than-expected production in Europe and in
EBIT 13.1 13.0 89% the US due to a late start have sent prices for soft commodities (corn, whet, soybean)
Net 7.6 8.7 59%
almost 50% higher over the past six months. This should support farmer demand into the
* median ratios
new season. On the pricing and margin side, we see a clear difference between
fertilizers, where supply should remain tight offering nice upside potential, and crop
(x) 2009 2010e 2011e
protection, where competition remains intense and operating leverage lower.
Net Debt/EBITDA 1.7 1.0 0.8 Industrial gases and flavour & fragrances (25%) are still the most expensive sub-sectors
Interest Cover 10 12 15 within chemicals, trading at a wide 30% premium on 2011e EV/EBIT. However both sub-
Gearing (%) 52% 38% 27%
sectors offer good visibility on growth, which is priceless in our view given peak margins
NC = Net Cash
in a broader cyclical space. We thus like growth in industrial gases driven by
NA = Not Applicable industrialisation and in flavours & fragrances driven by consumption in emerging
Source: Exane BNP Paribas estimates markets.
Valuation
The sector trades at 9.5x (market cap-weighted) EV/EBIT, a 12% premium to the market.
Diversified chemicals valuation remains attractive but earnings could lack momentum.
Matthias Cornu Stocks
(+33) 1 42 99 24 29
matthias.cornu@exanebnpparibas.com Clariant remains our top pick with a still low utilization rate (mid 70’s), further self-help
opportunities; and potential improvements in pricing power and portfolio transformation.
chemicals@exanebnpparibas.com We also like Lanxess within diversified chemicals. Yara remains the best play within
agrochemicals while Linde and Givaudan offer a nice play on EM exposure.

Chemicals - Valuation and Earnings Dynamics*
EV/Sales

3.0x 120%
2.5x 110%
2.0x 100%
1.5x 90%
1.0x 80%
0.5x 70%
0.0x 60%
Rel. 12m EV/Sales Chemicals (lhs) MSCI Europe Ex Financials (lhs)
EV/EBIT

13.0x 130%
12.0x
120%
11.0x
110%
10.0x
9.0x 100%
8.0x
90%
7.0x
80%
6.0x
5.0x 70%
Rel. 12m EV/EBIT Chemicals (lhs) MSCI Europe Ex Financials (lhs)

150%
36.0
140%
31.0 130%
120%
26.0
110%
21.0 100%
90%
16.0
80%
11.0 70%
Rel. 12m EPS Chemicals (lhs) MSCI Europe Ex Financials rebased (lhs)

Food & HPC Sector weighting: Neutral (=)
11e (x) ☺ ABF (+34.1%)*
110 Unilever NV (-5.8%)*
Favourite stocks
Unilever NV + 62,729 15.4 9.1 0.8 105
Henkel Pref + 17,892 25.0 8.2 0.6
Danone + 28,314 22.6 9.7 0.7
Stocks to avoid 100
Parmalat - 3,354 22.8 5.1 NC
Beiersdorf AG = 10,444 28.3 9.6 NC
ABF = 8,555 21.1 7.8 0.6 95
90
85

(x) 2010e 2011e 2011e
rel. mkt The ability of the sector to recover input cost inflation, whilst maintaining volume
CAPE 23.8 22.4 129% momentum will be the key theme for the sector in FY11. With pricing likely to lag cost
EV/EBITDA 9.8 9.2 131% increases and private label resurgence likely, the earlier part of the year may be testing
DY (%) 2.7 2.8 80% from a trading perspective.
Sector – Growth*
Valuation
% ch. 2010e 2011e Hist.
Avg Food is trading broadly in-line with its average post tech-boom P/E. While HPC is trading
Sales 9.9 4.6 4.5 at a modest discount, this likely reflects future earnings growth at both L’Oreal and
EBIT 16.2 7.5 6.7
Reckitt Benckiser being below historical levels. Relative to market P/E, both sectors are
EPS 18.0 9.1 10.6
trading at historical highs (excluding the market implosion in FY08).
Stocks
Margins (%) 2010e 2011e 2011e
vs Our favoured stocks are an eclectic mix. Henkel is our preferred HPC name as we see
peak
EBITDA
much scope for self-help and c.50% of the business is adhesives and therefore not
16.5 16.6 101%
EBIT 13.7 13.5 100% exposed to what will likely be a tough developed world HPC market. In Food, our
Net 8.9 9.4 65% preferred large cap pick is Danone as given increasing global milk production we believe
* median ratios it will face lower cost inflation than peers in FY11. Premier Foods is a special situation
where we believe de-leveraging of liabilities offers very material upside.
(x) 2009 2010e 2011e Our least preferred HPC stock is Beiersdorf. While M&A speculation will provide share
Net Debt/EBITDA 0.8 0.3 0.3 price underpinning, we believe that trading will remain poor for much of FY11. In Food,
Gearing (%)
our least preferred large cap stock is Nestle. While it is a fantastic company, given
27% 11% 11%
** based on aggregated figures FY10’s out performance we believe that this is now priced in and we struggle to see a
NC = Net Cash catalyst for further out performance.
NA = Not Applicable
Jeff Stent
(+44) 207 039 9469
jeff.stent@exanebnpparibas.com
foodhpc@exanebnpparibas.com

Food & HPC - Valuation and Earnings Dynamics*
EV/Sales

3.0x 180%
2.5x 170%
160%
2.0x
150%
1.5x
140%
1.0x
130%
0.5x 120%
0.0x 110%
Rel. 12m EV/Sales Food & HPC (lhs) MSCI Europe Ex Financials (lhs)
EV/EBIT

16.0x 180%
15.0x 170%
14.0x 160%
13.0x
150%
12.0x
140%
11.0x
130%
10.0x
120%
9.0x
8.0x 110%
7.0x 100%
6.0x 90%
Rel. 12m EV/EBIT Food & HPC (lhs) MSCI Europe Ex Financials (lhs)

34.0 120%
32.0
110%
30.0
28.0
100%
26.0
24.0 90%
22.0
80%
20.0
18.0
70%
16.0
14.0 60%
Rel. 12m EPS Food & HPC (lhs) MSCI Europe Ex Financials rebased (lhs)

Food Retail Sector weighting: Neutral (=)
Stock Stock Mkt cap CAPE* EV/EBITDA Net 120
rating (EURm) 10Y (x) 11e (x) debt/
☺ Jeronimo Martin (+52.4%)*
EBITDA
115 Delhaize Group (-3.3%)*
11e (x)

Carrefour + 25,582 15.0 6.4 1.6
Tesco + 38,931 18.8 6.5 1.1 105
Morrison Wm + 8,617 22.0 5.7 0.5
Ahold + 11,740 23.1 4.6 0.0
100
Stocks to avoid
Sainsbury J - 8,128 20.2 6.2 1.4
Metro - 17,463 21.6 6.6 1.4 95
JeronimoMartins = 6,938 58.5 10.1 0.4
90
85

(x) 2010e 2011e 2011e
rel. mkt Food inflation is back, pushed by raw materials prices, and we think this will be a major
CAPE 21.1 21.6 125% theme in 2011. In the current economic context, inflation is likely to be retailers’ worst
EV/EBITDA 7.2 6.4 90% enemy in the most depressed markets like Spain, Greece, Ireland or some regions of the
DY (%) 2.5 2.8 81% USA as it will be particularly difficult to pass it on to customers. And even if it is passed
on, it is likely to be compensated by higher promotions or a different mix. Retailers will
Sector – Growth* strive to keep the average basket price low and meet the needs of customers affected by
% ch. 2010e 2011e Hist. lower purchasing power. This would mean that, globally, few possibilities are left to
Avg
maintain or improve margin, such as restructuring and fixed cost savings. In Europe, our
Sales 7.2 6.0 11.1
favourite markets are Germany, Poland, Russia, Belgium, France and the UK. The most
EBIT 12.6 10.9 10.8
EPS 11.5 15.1 8.1
difficult markets are likely to be Spain, Greece, Italy and Portugal. On the East coast of
the USA, New England is the only good place to be.
Sector – Profitability* The second important factor is likely to be M&A, particularly in the markets severely hit
Margins (%) 2010e 2011e 2011e
vs
by the crisis and still fragmented, such as the USA, Greece, or Spain. The companies
peak that have the best balance sheets are likely to make the most of this situation and
EBITDA 7.4 7.6 92% accelerate their growth.
EBIT 4.9 4.9 82%
Net 2.9 3.4 89%
* median ratios Valuation
The sector is currently enjoying a 10% premium to the market (ex financials). It seems
Sector – Solvency** that some restructuring cases have been well played by the market, driving multiples to a
(x) 2009 2010e 2011e
higher level. The British market seems neglected on consumption fears.
Gearing (%) 57% 50% 41% Stocks
NC = Net Cash Our favourite stocks are Tesco and Morrison in the UK; both remain at attractive
NA = Not Applicable valuations and benefit from the oligopolistic structure of the British market. Carrefour is
Source: Exane BNP Paribas estimates still an interesting bet on the ability of the new hypermarket format to recover share in
mature markets. As for Ahold, its very solid balance sheet will help it make the most of
the consolidation of the US market and enhance growth in the next few years.
Philippe Suchet
(+33) 1 42 99 25 20
philippe.suchet@exanebnpparibas.com
foodretail@exanebnpparibas.com

Food Retail - Valuation and Earnings Dynamics*
EV/Sales

3.0x 60%
55%
2.5x
50%
2.0x
45%
1.5x 40%
35%
1.0x
30%
0.5x
25%
0.0x 20%
Rel. 12m EV/Sales Food Retail (lhs) MSCI Europe Ex Financials (lhs)
EV/EBIT

16.0x 150%
15.0x 140%
14.0x
130%
13.0x
12.0x 120%
11.0x 110%
10.0x 100%
9.0x
90%
8.0x
7.0x 80%
6.0x 70%
Rel. 12m EV/EBIT Food Retail (lhs) MSCI Europe Ex Financials (lhs)

110%
27.0
100%
25.0
23.0 90%
21.0 80%
19.0
70%
17.0
60%
15.0
50%
13.0
11.0 40%
Rel. 12m EPS Food Retail (lhs) MSCI Europe Ex Financials rebased (lhs)

General Retail Sector weighting: Underperform (-)
rating (EURm) 10Y (x) 11e (x) EBITDA ☺ Inditex (+28.6%)*
11e (x)
Celesio (+1.1%)*
150
Favourite stocks
Kingfisher + 6,724 21.6 5.6 NC
140
Celesio + 3,164 10.0 7.0 2.4
Stocks to avoid
Hennes & Mauritz - 40,499 35.4 12.0 NC 130
Inditex = 36,110 38.8 10.8 NC
120
110
100

(x) 2010e 2011e 2011e
rel. mkt Cost inflation, including higher commodity prices and wage inflation in emerging markets
CAPE 17.8 18.4 106% is likely to squeeze the gross margins of the H&M and, to a lesser extent, Inditex which
EV/EBITDA 7.0 6.4 91% make up the bulk of the sector’s market capitalisation. There is, for instance, a significant
DY (%) 3.7 4.0 117% risk that cotton prices will stay high in 2011 because of historically low stock levels,
according to US Dept. of Agriculture. Raw materials, wages and freight costs make up
Sector – Growth* 70-75% of COGS, which will be difficult to fully pass on to the consumer in the advanced
% ch. 2010e 2011e Hist. economies.
Avg
Sales 5.7 3.8 9.6
This implies that, despite continuing buoyant top-line growth at both H&M and Inditex,
EBIT 9.5 5.1 11.9
EPS 13.7 8.9 14.6
gross profit margins are to shrink from their record highs, giving back the bulk of the
gains made in 2010e. As a result, EPS should grow by a mere 5-10% in 2011e, a rise
unworthy for companies valued as growth stocks.
Margins (%) 2010e 2011e 2011e
vs Valuation
peak
EBITDA 16.6 17.1 98% As a result of the growth status of Inditex and H&M, General Retail looks expensive
EBIT 12.4 12.8 87% relative to the market average. On EV/EBIT, the sector trades at a significant premium to
Net 8.3 8.7 74% the market, close to its 10-year high reached in early 2007.
* median ratios
Sector – Solvency** Stocks

(x) 2009 2010e 2011e Our favourite stock is Kingfisher, a constituent of our Key Ideas list. The shares look
Net Debt/EBITDA 0.3 0.0 NC undervalued in our view, given the degree to which future earnings growth will be the
Gearing (%)
fruit of the self-help work that the company has already done. With a FCF yield of 6%, a
11% 2% (4%)
** based on aggregated figures P/Book of 1.1x (half of its market cap is in real estate), against EPS growth of 16% in
NC = Net Cash 2011e and 12% in 2012e, the shares look attractive.
NA = Not Applicable
Philippe Suchet
(+33) 1 42 99 25 20
philippe.suchet@exanebnpparibas.com
generalretail@exanebnpparibas.com

General Retail - Valuation and Earnings Dynamics*
EV/Sales

3.0x 120%
2.5x 110%
2.0x 100%
1.5x 90%
1.0x 80%
0.5x 70%
0.0x 60%
Rel. 12m EV/Sales General Retail (lhs) MSCI Europe Ex Financials (lhs)
EV/EBIT

16.0x 150%
15.0x
140%
14.0x
13.0x 130%
12.0x
120%
11.0x
110%
10.0x
9.0x 100%
8.0x
90%
7.0x
6.0x 80%
Rel. 12m EV/EBIT General Retail (lhs) MSCI Europe Ex Financials (lhs)

130%
26.0
120%
24.0
22.0 110%
20.0 100%
18.0
90%
16.0
80%
14.0
70%
12.0
10.0 60%
Rel. 12m EPS General Retail (lhs) MSCI Europe Ex Financials rebased (lhs)

Healthcare Providers & Services Sector weighting: Outperform (+)
120
rating (EURm) 10Y (x) 11e (x) EBITDA ☺ Fresenius SE (+23.1%)*
11e (x) Qiagen (-16.8%)*
115

Synthes + 10,755 23.2 7.2 NC
Qiagen + 3,085 30.9 9.4 NC
Grifols + 2,049 18.6 8.0 4.1 105
Stocks to avoid
100
Sonova - 5,951 40.6 13.1 NC
William Demant - 3,237 35.5 14.24 0.82
Straumann - 2,438 27.3 11.62 NC 95
90

(x) 2010e 2011e 2011e The MedTech sector has shown good momentum in 2010, outperforming the MSCI
rel. mkt
index by nearly 10% YTD. The best performers in the sector have been FMC (positive
CAPE 33.8 30.3 175%
EV/EBITDA
outcome of US bundling scheme) and Fresenius SE (APP’s tremendous growth has
9.3 8.3 118%
DY (%) 1.4 1.6 46% reassured), helped by strong visibility on earnings growth and favourable events.
Hearing aid manufacturers (Sonova, William Demant) have also performed well,
benefiting from a stronger-than-expected US volume rebound (partly fuelled by Veterans
Sector – Growth*
Affairs’ change in regulation). The worst performers have been dental implant makers
% ch. 2010e 2011e Hist.
Avg (Nobel Biocare, Straumann), as prospects of a return to double-digit market growth have
Sales 8.4 8.4 16.0 faded somewhat, with such growth now not expected until (at best) 2012. Orthopaedic
EBIT 8.2 8.7 20.7 (Synthes, S&N) and Diagnostic names (Biomerieux, Diasorin) have suffered from weak
EPS 9.0 12.5 23.6 Q2-Q3 figures, with people deferring/skipping visits to physicians, as the economy failed
to materially improve.
Entering 2011, the key issues will be the potential renegotiation (repeal?) of the US
Margins (%) 2010e 2011e 2011e
vs Healthcare Reform (after the Republican victory in the mid-term elections), the impact of
peak austerity measures on European healthcare budgets, and the ability of MedTech
EBITDA 29.8 30.8 100% companies to rapidly increase their exposure to attractive emerging countries.
EBIT 24.2 25.3 100%
Net 13.7 16.8 85%
* median ratios Valuation
The sector’s valuation looks attractive, both in absolute (11x EV/EBIT 12-month forward,
Sector – Solvency** i.e. 10% below the 8-year average) and relative terms (20% premium to MSCI vs an 8-
(x) 2009 2010e 2011e year average premium of 25%). In the long term, the sector is driven by major
Net Debt/EBITDA 1.8 1.5 1.0 demographic factors (ageing, obesity, diabetes), and benefits from significant barriers to
Interest Cover 8 8 10 entry. Yet, marked differences in valuation multiples across sub-segments (hearing aid
Gearing (%) 70% 54% 36%
manufacturers 15-16x EV/EBIT 2011e vs Orthopaedic names 8-9x) plead for selectivity.
NC = Net Cash
NA = Not Applicable Stocks
Source: Exane BNP Paribas estimates We retain our defensive bias for 2011, as the risk of earnings downgrades seems much
higher for Cyclical names (Sonova, William Demant, Straumann). Hence, among our
preferred stocks is Synthes, which combines a cheap valuation, dominant positions in its
two main activities and an attractive geographic exposure. We also like Qiagen for its re-
rating potential, as the current valuation does not reflect the prospects for double-digit
EPS growth and our non-consensual view that Roche is not a big threat to Qiagen’s
Julien Dormois dominance in the HPV testing market. Lastly, we also recommend Grifols (strong
(+33) 1 44 95 69 49
julien.dormois@exanebnpparibas.com
multiples expansion ahead, once the anti-trust decision on Talecris deal is passed),
Fresenius SE (ample room for further re-rating as APP’s potential is not fully discounted),
medtech@exanebnpparibas.com and Rhoen-Klinikum.

Healthcare - Valuation and Earnings Dynamics*
EV/Sales

4.0x 210%
3.5x 200%
190%
3.0x
180%
2.5x
170%
2.0x
160%
1.5x
150%
1.0x
140%
0.5x 130%
0.0x 120%
Rel. 12m EV/Sales Healthcare Providers & Services (lhs)
MSCI Europe Ex Financials (lhs)
EV/EBIT

16.0x 170%
15.0x 160%
14.0x 150%
13.0x
140%
12.0x
130%
11.0x
120%
10.0x
110%
9.0x
8.0x 100%
7.0x 90%
6.0x 80%
Rel. 12m EV/EBIT Healthcare Providers & Services (lhs) MSCI Europe Ex Financials (lhs)

180%
36.0
160%
31.0
140%
26.0
120%
21.0
16.0 100%
11.0 80%
Rel. 12m EPS Healthcare Providers & Services (lhs)
MSCI Europe Ex Financials rebased (lhs)

Insurance Sector weighting: Underperform (-)
Stock Stock Mkt cap CAPE* P/BV 11e ROE 11e 100
rating (EURm) 10yr (x) (%)
(x)
95
Favourite stocks
Aviva + 13,178 7.2 1.0 13.8
90
ING + 29,980 4.1 0.6 12.7
Swiss Re + 11,589 9.2 0.6 NC
Stocks to avoid 85
Munich Re - 20,836 13.9 0.8 NC
Prudential - 18,414 17.8 2.2 NC
80
☺ Legal & General (+24.21%)*
Axa (-21.2%)*
75
70

(x) 2009 2010e 2011e
CAPE
In 2011, Solvency II will be back on the agenda. While H2 2010 was dedicated to the
9.7 10.0 9.6
P/BV 0.9 1.0 0.9 internal calculations of the so-called QIS V (Quantitative Impact Study, providing input to
P/EV 0.8 0.8 0.8 the finalisation of the Solvency II Framework Directive), results will start to be disclosed
as soon as H1 2011. The main consequence is that investors will be in a better position
to assess insurance companies’ capital position. The disclosure of the outcome of
Sector – Growth*
% ch. 2010e 2011e Hist.
calculations will not be mandatory. Given the example of Basel III, we expect the market
Avg to put significant pressure on companies not disclosing sufficient information.
EPS 4.4 (0.1) 10.5
DPS 5.0 2.0 4.1 The clarification of Solvency II should open the door to some M&A activity as most
groups with solid balance sheets are currently waiting for the new regulation to be settled
to go for acquisitions, either transformational or even bolt on. Some companies could
start to discover that they are in a relatively difficult position (this is unlikely for listed
Margins (%) 2010e 2011e 2011e
vs players) and then decide to buy more reinsurance as a capital substitute.
peak
ROE 10.1 9.6 60% Interest rate evolution will be key. Recent inflation data in the US should limit upside
* median ratios potential while the absolute low level of rates create an asymmetric risk reward for bond
investors.
Valuation
Valuations are undemanding. The sector trades at P/BV10E of 1x for an expected ROE
of 10.6%. Book values, however, are currently inflated by unrealized gains on bonds.
The sector’s average dividend yield is 4.2%, ranging from 0% (ING) to 6.2% (Aviva).
Stocks
ING remains our top pick in the sector. We believe that the group is in a good position to
cope with the new regulations (bank and insurance). The disposal process should also
gain some momentum, providing some news flow. The base case scenario is a dual IPO
process for insurance activities.
Swiss Re is a strong cash generation and turnaround story combined with a positive
Thomas Jacquet, CFA
+33 1 42 99 51 96 reinsurance outlook (pricing is unlikely to be as bad as expected by the market).
thomas.jacquet@exanebnpparibas.com Aviva is our only buy in the UK. We find the consensus too bearish. The offer received
for the non life division reflects a more positive outlook. We welcome the potential
insurance@exanebnpparibas.com
disposals in minor countries.

Insurance - Valuation and Profitability*
P/E

15.0x 100%
13.0x 90%
11.0x 80%
9.0x 70%
7.0x 60%
5.0x 50%
3.0x 40%
Rel. 12m P/E Insurance (lhs) MSCI Europe (lhs)
P/BV

4.0x 90%
3.5x 85%
80%
3.0x
75%
2.5x 70%
2.0x 65%
1.5x 60%
55%
1.0x
50%
0.5x 45%
0.0x 40%
Rel. 12m P/BV Insurance (lhs) MSCI Europe (lhs)
ROE

18.0% 120%
17.0%
110%
16.0%
100%
15.0%
14.0% 90%
13.0%
80%
12.0%
70%
11.0%
10.0% 60%
Rel. 12m ROE Insurance (lhs) MSCI Europe (lhs)

IT Hardware Sector weighting: Outperform (+)
11e (x) 110
☺ ARM (+99.6%)*
105 Nokia (-17.8%)*
Favourite stocks
Infineon + 4,751 -17.2 3.9 NC 100
ASML + 10,299 65.7 4.8 NC
Ericsson + 24,052 21.0 3.0 NC 95
Stocks to avoid 90
Nokia - 27,568 8.6 5.3 NC
ARM = 5,301 83.4 24.1 NC 85
80
75
70
65

(x) 2010e 2011e 2011e The semiconductor sector should continue to grow in 2011 albeit at a slower pace. We
rel. mkt
do not see any signs of inventory build-up and expect supply constraints for some
CAPE 18.9 20.8 120%
EV/EBITDA
applications (namely Automotive) to last until H1 11.
5.0 4.8 68%
DY (%) 1.8 1.9 53%
The consumer electronics segment is undergoing a major transformation. Smartphones
are emerging as the key growth category of mobile phones, while the PC market’s
Sector – Growth*
growth is depressed by the rapid emergence of tablets. By 2015, smartphones will
% ch. 2010e 2011e Hist.
Avg represent over 70% of mobile phone units, while tablets may displace up to 70% of
Sales 25.9 5.4 8.2 notebook PC sales.
EBIT 85.0 22.5 39.7
EPS 78.2 21.3 20.7 New category leaders are emerging due to these category shifts, putting incumbent
vendors and their component suppliers under significant pressure. Both smartphones
and tablets are emblematic of the consumer’s interest in mobile broadband connectivity,
Margins (%) 2010e 2011e 2011e putting pressure on rapidly saturating mobile networks in developed economies.
vs
peak
We expect the semiconductor equipment industry to continue to grow as the record
EBITDA 24.2 26.9 91%
EBIT 15.5 17.7 87%
capacity cuts over the last two years have resulted in an unsustainable situation and in a
Net 8.3 13.0 80% need for new fabs that should be built in the course of 2011/2012.
* median ratios
Valuation
Sector – Solvency** The sector has faced a massive de-rating and is now trading at a 12-month forward P/E
(x) 2009 2010e 2011e
of 10.2x, its lowest level since 1998 (20x historically). Looking at EV/Sales, the sector is
Net Debt/EBITDA NC NC NC
also nearly trading at its lowest level since 1998, at 1.8x vs 3.2x historically.
Gearing (%) (21%) (24%) (33%) Paradoxically, the sector has never been so profitable (highest EBIT margin since 2000)
** based on aggregated figures and has never been so cash rich (20% of market capitalization in net cash). At this stage,
NC = Net Cash despite low cash returns to shareholders and a dubious track record of shareholder
NA = Not Applicable value creation in technology hardware, we believe that the de-rating of the sector
observed over the past ten years has now run its course.
Alexander Peterc
(+44) 207 039 9413
Stocks
alexander.peterc@exanebnpparibas.com In semiconductors our favourite stock is Infineon. We believe that its new risk profile is
mispriced and expect a further re-rating of the stock. Our highest conviction in the sector
Jerome Ramel is Apple, the biggest beneficiary of both the smartphone and tablet booms. On the
(+44) 207 039 9484
network equipment side, we believe that Ericsson is still a very good bet for 2011, while
jerome.ramel@exanebnpparibas.com
we remain sceptical on Nokia’s ability to remain competitive in smartphones as long as it
ithardware@exanebnpparibas.com clings to its inefficient operating system roadmap.

IT Hardware - Valuation and Earnings Dynamics*
EV/Sales

4.0x
220%
3.5x
3.0x 200%
2.5x 180%
2.0x
160%
1.5x
140%
1.0x
120%
0.5x
0.0x 100%
Rel. 12m EV/Sales IT Hardw are (lhs) MSCI Europe Ex Financials (lhs)
EV/EBIT

220%
22.0x
200%
20.0x
18.0x 180%
16.0x 160%
14.0x
140%
12.0x
120%
10.0x
100%
8.0x
6.0x 80%
Rel. 12m EV/EBIT IT Hardw are (lhs) MSCI Europe Ex Financials (lhs)

270%
48.0 250%
43.0 230%
38.0 210%
33.0 190%
28.0 170%
23.0 150%
18.0 130%
13.0 110%
8.0 90%
Rel. 12m EPS IT Hardw are (lhs) MSCI Europe Ex Financials rebased (lhs)

Leisure & Hotels Sector weighting: Underperform (-)
115
Stock Stock Mkt cap CAPE* EV/EBITDA Net debt/ ☺ TUI (+36.4%)*
rating (EURm) 10Y (x) 11e (x) EBITDA Lottomatica (-20.8%)*
11e (x) 110

InterContinental H. + 3,734 26.2 9.3 0.9
Sol Melia + 1,221 28.6 9.1 3.9
100
Thomas Cook + 2,153 8.1 4.2 1.1
Stocks to avoid
95
Autogrill - 2,393 20.7 6.2 2.2
Kuoni = 968 10.8 4.2 NC
Sodexo = 6,568 24.3 8.6 1.8 90
85

(x) 2010e 2011e 2011e Leisure
rel. mkt After a challenging 2010 for Leisure & Hotels because of austerity measures and the
CAPE 20.6 19.7 114% volcanic ash cloud, we believe that the sector should face easier comps in 2011 and
EV/EBITDA 9.0 8.3 118%
DY (%)
therefore should prove relatively resilient. We expect capacity to remain under control, a
2.6 2.8 81%
positive in terms of pricing power, as price sensitivity is likely to remain a key consumer
trend. Tour operators should also be supported by continued strategic refocus: asset-
Sector – Growth*
% ch. 2010e 2011e Hist.
light models, direct distribution and differentiated content. Cruise operators could also
Avg benefit from an upturn in consumer spending, although substantial capacity increases
Sales 5.7 5.9 8.4 and oil/forex volatility might impact earnings estimates.
EBIT 12.0 11.3 13.9
EPS 6.5 11.0 14.6
Hotels
RevPARs have strongly recovered in 2010 to date as business demand revived. Having
moved back in most regions towards previous peak occupancy levels, we believe that
Margins (%) 2010e 2011e 2011e 2011 should see ADR improvements, although some groups have remained cautious on
vs corporate rate renegotiations. Hence, the magnitude of the recovery appears unclear,
peak
being dependent in Europe and the US on corporate demand, and inflation concerns on
EBITDA 20.2 20.5 92%
EBIT
the main cost items could drag down operating leverage. Real estate transactions should
12.0 12.8 82%
Net 4.9 5.0 33% continue to be a key theme for 2011, as liquidity remains high and interest rates low,
* median ratios fuelling further re-rating based on undervalued asset prices.
Catering
(x) 2009 2010e 2011e
Employment trends are set for only gradual recovery, weighing on volumes growth, but
Net Debt/EBITDA 2.2 2.1 1.6 this should be offset by accelerated outsourcing trends. Despite modest top-line growth
Interest Cover 5 8 9 in 2011e, catering offers margin growth potential, with solid FCF generation and limited
Gearing (%) 58% 53% 45% downside risks in a still challenging economic environment. The main source of concern
** based on aggregated figures lies in raw material costs and forex volatility. Passenger traffic recovery should drive the
NC = Net Cash
top line (hence margins) in concessions, though Dufry remains more appealing in our
NA = Not Applicable
view, thanks to its emerging markets exposure and substantial contract wins.
Valuation
Hotel stocks have largely re-rated in 2010 thanks to an upturn in RevPARs driven by
business travel revival. They now trade above mid-cycle multiples, which could limit the
upside, although there is still scope for real estate appreciation. Tour operators are more
appealing to us as they trade way below 12-13x their historical 12M forward P/Es.
Improvements in bookings could be among the catalysts for multiple expansion.
Matthias Desmarais
(+33) 1 44 95 58 60
matthias.desmarais@exanebnpparibas.com
Stocks
Our favourite Hotel stocks remain IHG for its cash generative and value creative profile,
leisureservices@exanebnpparibas.com and Sol Melia for its undervalued asset base. Among tour operators, we favour Thomas
Cook and TUI Travel for internal restructuring measures and FCF recovery at affordable
valuations. Compass remains our top pick in Catering.

Leisure & Hotels - Valuation and Earnings Dynamics*
EV/Sales

3.0x 140%
130%
2.5x
120%
2.0x 110%
100%
1.5x
90%
1.0x 80%
70%
0.5x
60%
0.0x 50%
Rel. 12m EV/Sales Leisure & Hotels (lhs) MSCI Europe Ex Financials (lhs)
EV/EBIT

16.0x 160%
15.0x 150%
14.0x
140%
13.0x
12.0x 130%
11.0x 120%
10.0x 110%
9.0x
100%
8.0x
7.0x 90%
6.0x 80%
Rel. 12m EV/EBIT Leisure & Hotels (lhs) MSCI Europe Ex Financials (lhs)

27.0 110%
25.0
100%
23.0
21.0 90%
19.0
80%
17.0
15.0 70%
13.0
60%
11.0
9.0 50%
Rel. 12m EPS Leisure & Hotels (lhs) MSCI Europe Ex Financials rebased (lhs)

Luxury Goods Sector weighting: Neutral (=)
11e (x) 170 ☺ Burberry (+71.6%)*
PPR (+32.9%)*
Favourite stocks
LVMH + 55,340 32.1 10.2 0.4 150
Richemont A + 22,604 33.7 10.5 NC
PPR + 14,714 16.0 7.7 1.5
Stocks to avoid
Burberry - 5,204 40.5 10.6 NC 130
HermèsInternational - 15,638 60.6 18.5 NC
Swatch Group B = 14,797 31.4 10.2 NC
110
90

(x) 2010e 2011e 2011e
rel. mkt Although consensual, the emerging markets theme has remained the key sector driver in
CAPE 35.7 32.5 187% 2010. We estimate that emerging markets now represent c.1/3 of total luxury demand.
EV/EBITDA 12.0 10.3 145% This should be supportive for the high-single-digit top line scenario we foresee for the
DY (%) 1.7 2.0 57% next five years. We estimate that China has already surpassed Japan as the number 1
clientele for brands such as Louis Vuitton, Burberry or Gucci, and we believe that the
Sector – Growth* next leg of China’s growth still lies ahead thanks to the compelling outlook for retail
% ch. 2010e 2011e Hist. expansion in the country. In fact, there are fewer than 40 stores in Mainland China for
Avg
the main Chinese brands, compared to more than 160 cities with more than 1m
Sales 18.3 9.6 4.0
inhabitants. We are therefore confident that Chinese demand can continue to grow in the
EBIT 35.6 14.4 9.9
EPS 35.8 17.0 14.4
high double digits for another four years at least. This, combined with high pricing power
for global brands, should pave the way for sustainable market share and margin gains in
the long run, more than offsetting a still depressed consumer outlook in Japan.
Margins (%) 2010e 2011e 2011e Valuation
vs
peak Although it now trades at a relative peak to the market (c.40% and 70% premium to the
EBITDA 24.8 25.6 101% market on an EBITDA and CAPE basis), we still believe that current valuation levels
EBIT 20.5 21.2 94% remain attractive by historical standards (12.5x EV/EBIT vs 14.5x historical average).
Net 15.3 16.4 99% This fails to fully reflect the strong trends in emerging markets, sound FCF and balance
* median ratios sheets, and un-rivalled pricing power.
Sector – Solvency** Stocks

(x) 2009 2010e 2011e Even after its strong rally, LVMH remains a top pick to play the strong underlying trends
Net Debt/EBITDA 0.5 0.3 0.1 at Louis Vuitton, where we expect top line to continue to advance at a double digit
Gearing (%)
growth pace again in 2011E. Among the watchmakers we continue to prefer Richemont,
12% 9% 2%
** based on aggregated figures as we think the market fails to capture the upside from retail expansion at Cartier,
NC = Net Cash together with its unrivalled pricing power. For a different story, we are buyers of PPR, as
NA = Not Applicable we are confident that its transformation from a disparate conglomerate into a pure play
Source: Exane BNP Paribas estimates Luxury / Lifestyle group can bring significant value creation for shareholders, although
the consensus is still sceptical.
Edouard Crowley
(+44) 207 039 9438
edouard.crowley@exanebnpparibas.com
Leopold Authie
(+44) 207 039 9503
leopold.authie@exanebnpparibas.com
luxurygoods@exanebnpparibas.com

Luxury Goods - Valuation and Earnings Dynamics*
EV/Sales

4.0x
180%
3.5x
3.0x 160%
2.5x
140%
2.0x
1.5x 120%
1.0x
100%
0.5x
0.0x 80%
Rel. 12m EV/Sales Luxury Goods (lhs) MSCI Europe Ex Financials (lhs)
EV/EBIT

14.0x 140%
13.0x 130%
12.0x
120%
11.0x
10.0x 110%
9.0x 100%
8.0x 90%
7.0x
80%
6.0x
5.0x 70%
4.0x 60%
Rel. 12m EV/EBIT Luxury Goods (lhs) MSCI Europe Ex Financials (lhs)

150%
36.0
140%
31.0
130%
26.0 120%
110%
21.0
100%
16.0
90%
11.0 80%
Rel. 12m EPS Luxury Goods (lhs) MSCI Europe Ex Financials rebased (lhs)

Media Sector weighting: Outperform (+)
Stock Stock Mkt cap CAPE* EV/EBIT Net debt/ 115
11e (x) ☺ ProSieben (+150.7%)*
110 Mediaset (-19.3%)*
Favourite stocks
Publicis + 7,055 18.8 8.3 0.5
105
Reed Elsevier NV + 6,526 12.5 8.3 1.4
Lagardère + 3,836 8.9 6.5 2.2
ProSiebenSat.1 + 4,365 23.5 8.0 2.8
100
Stocks to avoid
TF1 - 2,567 14.6 9.4 NC
Pearson - 8,826 21.1 9.6 NC 95
Sanoma - 2,639 16.7 13.9 2.3
90
85

(x) 2010e 2011e 2011e
rel. mkt Facing a low GDP growth environment, cyclical/advertising driven stocks will not benefit
CAPE 19.5 18.1 104% anymore in FY11 from an easy cyclical rebound. The ability to grow the top-line will
EV/EBIT 9.4 8.4 84% come from 1/ digital/superior mix 2/ emerging markets exposure 3/ late cyclicality.
DY (%) 4.1 4.4 126%
Pre-crisis long-term issues to hit harder in 2011: directories and print newspapers have
Sector – Growth* to cope with perpetual print usage decline and difficulties switching to online model, FTA
% ch. 2010e 2011e Hist. TV need to adapt to new connected devices and audience fragmentation from greater
Avg
DTT and pay-TV penetration in most EU countries.
Sales 5.2 2.9 7.4
EBIT 7.7 10.8 11.3
EPS 11.0 12.2 7.9
The downturn forced most companies to cut costs aggressively, often beyond market
expectations. Yet, cost-cutting stories will fade in 2011 as opportunities to reduce
expenses shrink and risk of losing market share widens.
Margins (%) 2010e 2011e 2011e
vs Valuation
peak
EBITDA 22.8 24.7 86% Following 10 years of market underperformance, the sector has regained momentum
EBIT 18.6 19.3 85% (5% outperformance YTD). Yet, the sector looks still affordable, trading 10% below the
Net 8.8 10.5 57% market on EV/EBIT11. In light of reasonable EPS growth (+10% in FY11), above market
* median ratios average dividend yield (4.5%) and relatively low leverage (1.1x Net Debt / EBITDA in
FY11), we view the discount as unjustified.
(x) 2009 2010e 2011e
Net Debt/EBITDA 1.8 1.3 1.0 Stocks
Gearing (%)
Publicis (+) and WPP (+) combine structurally sound business models, digital and
70% 52% 42%
** based on aggregated figures emerging markets exposure, cheap valuation (c.8.5x EBITA11) and earnings
NC = Net Cash momentum.
NA = Not Applicable Reed Elsevier (+) offers catch-up potential owing to the late-cyclical nature of its assets
Source: Exane BNP Paribas estimates (Events, Legal) and reasonable market expectations
Lagardère (+) is the best way to play the expanding e-book market, with positive
impacts on margins.
The buoyant consumer spending trends in Germany on top of stringent cost control are
likely to sustain ProSiebenSat.1 (+) re-rating.
Charles Bedouelle
(+44) 207 039 9482
charles.bedouelle@exanebnpparibas.com Pearson (-) positive momentum is likely to abate in FY11 as budgetary pressures in
North America are likely to trigger negative earnings revisions.
media@exanebnpparibas.com

Media - Valuation and Earnings Dynamics*
EV/Sales

4.0x 180%
3.5x 170%
3.0x 160%
2.5x 150%
2.0x 140%
1.5x 130%
1.0x 120%
0.5x 110%
0.0x 100%
Rel. 12m EV/Sales Media (lhs) MSCI Europe Ex Financials (lhs)
EV/EBIT

14.0x 130%
13.0x
120%
12.0x
110%
11.0x
10.0x 100%
9.0x
90%
8.0x
80%
7.0x
6.0x 70%
Rel. 12m EV/EBIT Media (lhs) MSCI Europe Ex Financials (lhs)

120%
15.0
110%
13.0
100%
11.0
90%
9.0
80%
7.0 70%
5.0 60%
Rel. 12m EPS Media (lhs) MSCI Europe Ex Financials rebased (lhs)

Mining Sector weighting: Outperform (+)
220
rating (EURm) 10Y (x) 11e (x) EBITDA ☺ Antofagasta Plc (+46.1%)*
11e (x) Norsk Hydro (-15.7%)*
200
Favourite stocks
Xstrata + 44,332 15.4 5.1 0.3 180
Norsk Hydro + 9,629 14.4 6.2 0.4
Rio Tinto + 105,284 22.3 4.9 0.0
Stocks to avoid 160
BHP Billiton = 174,252 26.7 7.1 0.0
Lonmin = 3,870 29.2 16.9 1.2
140
120
100

(x) 2010e 2011e 2011e
rel. mkt China remains the main driving force behind the direction of metal markets. The year
CAPE 25.9 22.8 131% 2011 will be the first in the new 5-year plan which in our view should remain intensive in
EV/EBITDA 7.3 5.2 74% metals: at below USD5,000 GDP per capita China is still far off the USD15,000 level at
DY (%) 1.3 1.4 41% which metals intensity tends to peak and recycling kicks in. Chinese policy aims to
rebalance growth from the coast to Tier 2 cities, accelerate social housing starts and
Sector – Growth* stimulate consumer demand, all of which bodes well for base metals and steel
% ch. 2010e 2011e Hist. consumption. From a cyclical standpoint the picture remains constructive too: China is
Avg
past two quarters of de-stocking that followed the April tightening measures. The country
Sales 33.5 9.7 13.2
is still busy fighting hot money but remains behind the curve with credit growth still
EBIT 89.8 34.4 27.8
EPS 90.6 32.5 30.9
exceeding targeted GDP growth of a minimum of 7.5% in its new 5-year plan.
QE2 together with a weaker USD (arbitrage impact) were among the non-fundamental
Sector – Profitability* factors that helped trading sentiment on traded metals on the LME in recent weeks, but
Margins (%) 2010e 2011e 2011e
vs
this could last for another six months under our macroeconomic scenario. In areas where
peak prices have gone vertical we expect some volatility but still to remain at a high level.
EBITDA 40.9 42.6 90% Bottom line: the supply response is still constrained and both supply and demand remain
EBIT 33.1 34.7 85% largely inelastic for a metal like copper. We expect the copper market to remain tight not
Net 21.3 24.2 75%
just for two years but for five or six. Thermal coal should surprise on the upside too, with
* median ratios
Indian imports in FY11e adding to Chinese net imports topping 100mt already. Energy
efficiency closures in China – the first we have seen – are providing some support to the
aluminium market. Iron ore should remain underpinned by Chinese low grade-high cost
(x) 2009 2010e 2011e
capacity for another two years, but some capacity additions should change the picture
Interest Cover 22 27 35 after that.
Gearing (%) 30% 21% 9%
NC = Net Cash Valuation
NA = Not Applicable Valuations do not look overly stretched yet at about 5x EV/EBITDA FY11e for our
preferred plays. Plays on industrial metals are already valued on long-term prices,
meaning the extra profits likely to be generated over the next 3-4 years are free.
Stocks
Xstrata is one of our favourite plays, with risks on the upside for both copper and coal
Sylvain Brunet
+33 1 42 99 50 84 (accounting for 80% of EBIT). Vale and Rio Tinto’s leverage to iron ore should still
sylvain.brunet@exane.com benefit from short-term tightness. Norsk Hydro’s earnings in FY11e should record the
first contribution from the group’s low cost Qatar plant and reflect the acquisition of
metals@exanebnpparibas.com
Vale’s alumina assets.
Mining - Valuation and Earnings Dynamics*
EV/Sales

5.0x
270%
4.5x
4.0x 250%
3.5x
230%
3.0x
210%
2.5x
2.0x 190%
1.5x
170%
1.0x
150%
0.5x
0.0x 130%
Rel. 12m EV/Sales Mining (lhs) MSCI Europe Ex Financials (lhs)
EV/EBIT

140%
12.0x 130%
120%
10.0x 110%
100%
8.0x
90%
80%
6.0x
70%
4.0x 60%
50%
2.0x 40%
Rel. 12m EV/EBIT Mining (lhs) MSCI Europe Ex Financials (lhs)
92.0
82.0 330%
72.0
280%
62.0
230%
52.0
42.0 180%
32.0
130%
22.0
12.0 80%
Rel. 12m EPS Mining (lhs) MSCI Europe Ex Financials rebased (lhs)

Oil & Gas Sector weighting: Outperform (+)
11e (x) ☺ Saipem (+31.6%)*
110 BP (-24.6%)*
Favourite stocks
BG Group + 49,980 28.9 8.7 1.1 105
Repsol YPF + 24,231 9.4 4.3 1.4
Tullow Oil + 12,958 134.6 15.6 1.1
Stocks to avoid 100
Eni - 59,227 8.2 3.3 0.8
Neste Oil - 2,966 9.6 6.9 2.9
Statoil - 49,903 11.2 2.7 0.5 95
90
85

(x) 2010e 2011e 2011e
rel. mkt 2010 was of course a difficult year for the Oil & Gas sector. The BP oil spill dominated
CAPE 11.0 12.2 70% performance patterns in the middle of the year and was the main source of the sector’s
EV/EBITDA 7.3 6.6 93% 7% underperformance through 2010. But the focus on BP hides the fact that excluding
DY (%) 2.2 4.6 133% this event the sector’s performance was roughly in line with the broader, rising market.
Sector – Growth* Looking into 2011, we see no reason to change our Outperform rating on the Oil & Gas
% ch. 2010e 2011e Hist. sector. In a world of quantitative easing it should benefit from two effects. Central bank
Avg
asset purchases are pushing down bond yields, making this asset class relatively
Sales 22.5 3.9 9.8
unattractive and encouraging investors to reach for yield in other more risky asset
EBIT 33.9 12.1 17.9
EPS 26.0 11.0 15.8
classes. This should benefit equities as a whole, and especially high yielding stocks.
With a dividend yield a third higher than the equity market average, Oil & Gas fits the bill.
Despite this year’s obvious dividend disappointment, dividends are fundamentally well
Sector – Profitability* covered for most Oil Majors, in our opinion. The second effect of quantitative easing is a
Margins (%) 2010e 2011e 2011e
vs
boost for real assets, such as commodities, as a hedge against potential future inflation.
peak The oil price has risen almost 20% since talk of quantitative easing began.
EBITDA 19.7 22.7 77%
EBIT 14.0 16.2 68% Oil & Gas sector earnings should grow 11% next year, on Exane BNPP estimates. This
Net 7.5 8.2 83%
is less than our top-down forecast of total market earnings growth (16%). Given low
* median ratios
sector valuations (see below), however, we do not see this earnings gap as problematic
or a cause for underperformance.
(x) 2009 2010e 2011e
Net Debt/EBITDA 0.8 0.8 0.7 Valuation
Gearing (%) 32% 36% 32% On most valuation measures the Oil & Gas sector looks attractive. The dividend yield is a
** based on aggregated figures third higher than the market average and the cyclically adjusted P/E ratio is about a third
NC = Net Cash lower than the market average. On a forward P/E basis, Oil & Gas is one of the cheapest
NA = Not Applicable sectors in the market. The valuation discount should sufficiently protect against
underperforming earnings, whilst we see modest re-rating potential on a dividend basis.
Stocks
Our top picks in the sector are BG and Repsol. Both will benefit from exposure to Brazil,
Alexandre Marie
with the ongoing development of very large fields such as tupi (BG 25%) and Guara (BG
(+44) 207 039 9427
alexandre.marie@exanebnpparibas.com 30%, Repsol 25%) as well as further planned exploration and appraisal drilling. Repsol
should also benefit from the continued improvement in fuel and gas prices in Argentina,
energy@exanebnpparibas.com widening margins for its subsidiary YPF.

Oil & Gas - Valuation and Earnings Dynamics*
EV/Sales

3.0x 120%
2.5x 110%
100%
2.0x
90%
1.5x
80%
1.0x
70%
0.5x 60%
0.0x 50%
Rel. 12m EV/Sales Oil & Gas (lhs) MSCI Europe Ex Financials (lhs)
EV/EBIT

12.0x 100%
11.0x
90%
10.0x
9.0x
80%
8.0x
7.0x 70%
6.0x
60%
5.0x
4.0x
50%
3.0x
2.0x 40%
Rel. 12m EV/EBIT Oil & Gas (lhs) MSCI Europe Ex Financials (lhs)

150%
39.0
140%
34.0 130%
29.0 120%
110%
24.0
100%
19.0
90%
14.0 80%
Rel. 12m EPS Oil & Gas (lhs) MSCI Europe Ex Financials rebased (lhs)

Pharmaceuticals Sector weighting: Outperform (+)
11e (x) ☺ Novo Nordisk (+65.3%)*
110 Merck KGaA (-13.9%)*
Favourite stocks
105
UCB + 4,783 19.9 10.0 1.7
Sanofi-Aventis + 64,665 11.0 5.2 NC
Roche + 91,781 17.2 7.9 0.4 100
Stocks to avoid
AstraZeneca - 50,323 14.1 4.0 NC 95
Shire Plc - 9,726 25.5 10.3 NC
Elan - 2,400 -9.7 23.0 5.3
90
85
80

(x) 2010e 2011e 2011e
rel. mkt The healthcare reforms in the US and Europe negatively weighed on the pharma sector
CAPE 20.2 18.3 105% performance in 2010 and we believe this is likely to improve in 2011, as all companies
EV/EBITDA 8.2 8.0 113% already factor into their guidance the impact of price reductions. Emerging markets
DY (%) 3.0 3.8 108% should more than ever attract the attention of investors, with the implementation of a
broad public healthcare coverage plan in China (emerging markets are expected to
Sector – Growth* contribute half of global pharma growth by 2030, of which one third for China). Also
% ch. 2010e 2011e Hist. positive pipeline results in the second part of 2010 (Bayer’s Xarelto in thrombosis,
Avg
Novartis’ Gilenya in multiple sclerosis, GSK’s Benlysta in lupus, etc) should somewhat
Sales 11.6 3.3 11.8
reassure investors regarding pharma companies’ ability to develop future blockbusters in
EBIT 15.0 8.6 17.0
EPS 10.1 10.1 16.7
diseases with high unmet medical need despite the current lack of R&D innovation.
Valuation
Margins (%) 2010e 2011e 2011e Pharma currently trades at a 5% discount to the market on 12-month forward P/E (10.3x
vs
peak vs 10.8x respectively), still far from the 5-year historical premium average of 15%. This
EBITDA 37.1 37.2 101% fails to fully reflect the positive trends in emerging markets, sound FCF yield (9.2% vs
EBIT 32.0 32.9 114% 6.0% for the market) and dividend yield (4.4% vs historical average of 2.6%).
Net 22.3 24.1 102%
* median ratios
Stocks
Our top picks among large pharmas are Roche and Sanofi which both trade at material
Sector – Solvency** discounts of 10-20% to sector multiples for unjustified reasons in our view. We expect
(x) 2009 2010e 2011e Roche’s re-rating to be driven by the ongoing cost-cutting programme, below-average
Net Debt/EBITDA 0.5 0.6 0.3 exposure to generics and faster 2010-15e EPS CAGR (7.5% vs 3.5% for peers). Sanofi
Gearing (%)
is likely to acquire US biotech Genzyme for up to USD75 per share (i.e. remaining
23% 25% 11%
** based on aggregated figures disciplined), and should benefit from the gradual improvement of its diversified profile.
NC = Net Cash Also, we buy Novartis, trading in line with peers on 2011e P/E, despite a more attractive
NA = Not Applicable profile, research portfolio and solid 2010-15e EPS CAGR of 4% vs 3% for large pharma.
Source: Exane BNP Paribas estimates Within Specialty pharma, our top pick is UCB which is a growth story (15% 2010-15e
EPS CAGR vs 6% for peers) with limited risk as its three main growth drivers are newly
launched products (Cimzia, VImpat, Neupro). Within the biotech segment, we like
Stallergènes, a fast growing profitable player in the niche market of allergy
desensitization, expanding towards Asia and the US. Within generics, we prefer Stada
Vincent Meunier
and Teva.
(+33) 1 42 99 24 42
vincent.meunier@exanebnpparibas.com
pharma@exanebnpparibas.com

Pharmaceuticals - Valuation and Earnings Dynamics*
EV/Sales

5.0x
4.5x 290%
4.0x
3.5x 270%
3.0x
250%
2.5x
2.0x
230%
1.5x
1.0x 210%
0.5x
0.0x 190%
Rel. 12m EV/Sales Pharmaceuticals (lhs) MSCI Europe Ex Financials (lhs)
EV/EBIT

15.0x 160%
14.0x 150%
13.0x 140%
12.0x 130%
11.0x 120%
10.0x 110%
9.0x 100%
8.0x 90%
7.0x 80%
6.0x 70%
Rel. 12m EV/EBIT Pharmaceuticals (lhs) MSCI Europe Ex Financials (lhs)

31.0 150%
29.0 140%
27.0
130%
25.0
23.0 120%
21.0 110%
19.0 100%
17.0
90%
15.0
13.0 80%
11.0 70%
Rel. 12m EPS Pharmaceuticals (lhs) MSCI Europe Ex Financials rebased (lhs)

Real Estate Sector weighting: Neutral (=)
NOPAT FFO 110
Stock Stock Mkt cap Premium/(Discount)
yield yield
rating (EURm) to NNAV 11e
11e 11e
105
Favourite stocks
Klépierre + 4,864 5.6 7.2 (17.7)
Icade + 3,900 5.6 5.8 (15.2) 100
Beni Stabili + 1,323 5.2 5.6 (39.2)
Stocks to avoid
95
PSP - 2,227 3.8 4.8 (11.1)
Corio - 4,302 5.1 6.9 (12.4)
90
☺ Icade (+16.7%)*
SEGRO (-11.6%)*
85
80

(%) 2010 2011e Hist. Long-term corporate bond yields are a key driver for the real estate sector. Our
Avg
economists expect long-term bond yields to remain low for quite some time, which
NOPAT Yield 5.0 5.3 5.6
FFO Yield 6.0 6.0 5.6 should provide prolonged support to real estate stock valuations.
Premium
(disc.) to
NNAV (4.3) (11.9) (18.8) The current low bond yield environment has attracted increased interest in direct
properties from long-term investors such as insurance companies. This should continue
to support property values. So far interest has been concentrated on the prime end of the
Sector – Growth*
market, which we expect to continue in 2011. We believe that rents in secondary location
% ch. 2010e 2011e Hist.
Avg could continue to be under pressure while prime rents have now stabilised or are even
NOPAT 1.9 5.6 15.6 growing in some niche markets, such as London offices.
FFO 3.9 6.1 17.9
On a more negative note, the sector is still characterised by a substantial amount of
debt, a large part needing refinancing within the coming 24 months. Overall, the lower
2010e 2011e availability of debt and adjustments to lending terms will have a negative impact on the
ROCE/WACC 74.3 77.3 real estate sector. We believe that prime properties will be more easily refinanced that
* median ratios secondary properties, supporting our previous point that prime should continue to
Source : Exane BNP Paribas estimates outperform secondary.
Valuation
Following the decline in bond yields, our NOPAT yield valuation model, which takes into
account the long-term relationship between listed real estate stocks and long-term real
corporate bond yields, suggests that the real estate sector is attractive compared to
bonds. Currently, the European listed real estate sector is trading on a NOPAT yield of
5.2%, 380bp above the European long-term real corporate bond yield of 1.4%. This
400bp spread is some way above the average spread between these two yields between
1989 and October 2010 (120bps). Nonetheless, as a number of other sectors within the
equity markets also appear attractive relative to bonds, we remain Neutral.
Stocks
Klépierre- Klépierre offers the most attractive valuation amongst pan-European
shopping centre companies. We believe that current fears on the Hungarian and Spanish
portfolios (resp 3% and 9% of group revenues) are exaggerated while investors
underestimate the potential value-creation from the Scandinavian portfolio (14%).
Valerie Guezi Icade – We see considerable upside in the like-for-like portfolio, driven by a declining
(+44) 207 039 9505 vacancy rate over the short term and a recovery in development margins over the
valerie.guezi@exanebnpparibas.com
medium term, and further rental growth will come from the EUR750m pipeline.
realestate@exanebnpparibas.com

Real Estate – Valuation and Profitability*
P/E

230%
27.0x 210%
190%
22.0x
170%
17.0x 150%
130%
12.0x
110%
7.0x 90%
Rel. 12m P/E Real Estate (lhs) MSCI Europe (lhs)
P/BV

4.0x 90%
3.5x 80%
3.0x
70%
2.5x
60%
2.0x
50%
1.5x
40%
1.0x
0.5x 30%
0.0x 20%
Rel. 12m P/BV Real Estate (lhs) MSCI Europe (lhs)
ROE

70%
17.0%
60%
15.0%
13.0% 50%
11.0%
40%
9.0%
30%
7.0%
20%
5.0%
3.0% 10%
Rel. 12m ROE Real Estate (lhs) MSCI Europe (lhs)

Steel Sector weighting: Neutral (=)
rating (EURm) 10Y (x) 11e (x) EBITDA 140
11e (x)
130
Favourite stocks
ArcelorMittal + 38,014 8.3 6.1 1.6
ThyssenKrupp + 11,001 11.8 6.1 1.3
120
Tenaris + 19,384 22.1 7.9 NC
Stocks to avoid
Voestalpine - 5,155 11.4 5.5 2.5 110
Vallourec = 8,917 17.4 8.1 0.5
☺ Vallourec (+15.9%)*
100 ArcelorMittal (-23.7%)*
90

(x) 2010e 2011e 2011e Steel prices surged through most of H1 10, fuelled by the end of destocking in Western
rel. mkt
markets and then some restocking, in the context of fast-rising raw material costs and
CAPE 11.7 11.4 66%
EV/EBITDA
relatively good supply discipline at the global level. The positive trend in steel prices
9.0 6.6 93%
DY (%) 2.3 2.3 67% came to a halt however in April, with tightening measures in China and the ensuing
uncertainty about whether authorities would be able to engineer a soft landing. This,
together with high starting inventory levels in the country triggered a period of heavy
Sector – Growth*
destocking. The weakness in China inevitably put pressure on international steel prices
% ch. 2010e 2011e Hist.
Avg while production costs showed no signs of abating, hence a severe margin squeeze in
Sales 14.9 16.6 10.2 H2 10 for those steelmakers mostly exposed to spot contracts.
EBIT 17.1 49.1 31.2
EPS 0.3 43.5 34.0 China is now into its sixth straight month of destocking despite continued robust
economic growth and indications that the country’s next 5 year plan will remain metal
intensive. Steel inventories in Western markets are low. Current spot prices stand well
Margins (%) 2010e 2011e 2011e below marginal costs and in some cases barely above average costs. Raw materials
vs costs have shown renewed strength of late. There is no significant price differential
peak
between China and other markets. Also, the steelmaking industry as a whole has been
EBITDA 13.2 14.2 53%
EBIT 6.5 8.7 36%
implementing supply discipline again in recent months. Given all this, we believe that
Net 4.4 5.3 32% steel spot prices are set to recover by the end of Q1 11, with increases of 10%-20%
* median ratios depending on regions, simply to catch up with estimated production cash costs at
marginal players. A changing momentum in prices should positively impact apparent
Sector – Solvency** demand, therefore allowing for a sequential improvement in utilisation rates. We estimate
(x) 2009 2010e 2011e that global steel consumption should grow at 5-6% yoy in 2011, including growth of 4-5%
Net Debt/EBITDA 2.0 1.9 1.3 in Western economies, arguably from a still depressed base in the latter compared with
pre-crisis levels. Beyond the “technical” sequential recovery in prices and volumes that
Gearing (%) 31% 36% 31%
we forecast by the end of Q1 11, the Western steel industry will continue to grapple with
NC = Net Cash overcapacity for 2-3 years. With overcapacity also a feature in a number of key customer
NA = Not Applicable industries, pricing power will likely be a recurring theme.
Valuation
European carbon steel companies currently trade at between 0.75x (ArcelorMittal,
ThyssenKrupp, Salzgitter) and 1x EV/CE (Voestalpine). At the low end of this range,
valuations already look somewhat beyond the earnings potential in 2011e, but do not yet
discount normalised earnings potential.
Vincent Lepine Stocks

(+33) 1 42 99 50 52
vincent.lepine@exanebnpparibas.com
Within our coverage universe, ArcelorMittal should be the greatest beneficiary of the
expected recovery in spot prices by end Q1, given the group’s contract portfolio.
metals@exanebnpparibas.com Upstream vertical integration remains a key competitive advantage in our view.

Steel - Valuation and Earnings Dynamics*
EV/Sales

3.0x 100%
90%
2.5x
80%
2.0x
70%
1.5x 60%
50%
1.0x
40%
0.5x
30%
0.0x 20%
Rel. 12m EV/Sales Steel (lhs) MSCI Europe Ex Financials (lhs)
EV/EBIT
16.0x 170%
14.0x 150%
12.0x 130%
10.0x 110%
8.0x 90%
6.0x 70%
4.0x 50%
2.0x 30%
Rel. 12m EV/EBIT Steel (lhs) MSCI Europe Ex Financials (lhs)

55.0
50.0
320%
45.0
40.0 270%
35.0
30.0 220%
25.0
170%
20.0
15.0
120%
10.0
5.0 70%
Rel. 12m EPS Steel (lhs) MSCI Europe Ex Financials rebased (lhs)

Support Services Sector weighting: Neutral (=)
130
rating (EURm) 10Y (x) 11e (x) EBITDA ☺ Bureau Veritas (+48.0%)*
11e (x) 125
G4S (-2.9%)*
SGS N + 9,219 31.7 9.8 NC

G4S + 4,163 17.6 7.3 1.9 115
Adecco R + 8,624 17.3 7.6 NC
Stocks to avoid 110
Randstad Holding - 6,244 20.2 9.4 1.1
Edenred = 3,770 24.2 14.2 4.1 105
100
95

(x) 2010e 2011e 2011e Testing, Inspection & Certification (TIC)
rel. mkt TIC has been our favourite sub-segment in 2010 owing to its structural growth profile
CAPE 20.2 19.6 113% (mainly led by tightening regulations, outsourcing). Growth prospects for 2011 remain
EV/EBITDA 11.1 9.1 129% sound: we expect a return to high single-digit sales growth organically and further
DY (%) 2.3 2.7 77%
margins gains (on productivity gains and positive business/geographic mix. In addition
M&A opportunities are also likely to resurface given the group’s strong financial leeway
Sector – Growth* and full acquisition pipeline in still fragmented markets. Hence, despite tremendous
% ch. 2010e 2011e Hist. share price performance, we see further upside on improving earnings momentum.
Avg
Sales 8.6 8.1 10.0
Staffing
EBIT 12.2 10.3 12.2 Staffing markets have strongly recovered in 2010 to date. Despite tougher comps from
EPS 10.4 14.1 11.8 Q4 10 onwards, we expect end staffing markets to remain solid thanks to a sustained
search for more flexibility by corporates and return to solid growth in professional
staffing. Profitability-wise, in the next upcycle we expect the groups’ margins to beat
Margins (%) 2010e 2011e 2011e previous peak cycle levels (above 5.5% EBITA margins for generalist staffers) given tight
vs cost control (part of capacity cuts not replaced) and positive business mix (higher
peak
exposure to professional staffing or emerging markets for permanent recruiters).
EBITDA 19.4 19.3 101%
EBIT 16.8 16.5 101%
Security
Net 3.5 10.7 110% We expect the Security services segment (manned guarding, electronic systems and
* median ratios cash services) to return to gradual mid single-digit sales growth by 2011, driven by
increasing wealth (GDP correlated), safety concerns, and continuing outsourcing trends
Sector – Solvency** in emerging countries/new segments (seaport, energy). As a late-cyclical sector (6-12
(x) 2009 2010e 2011e months lag versus the macro environment), the global security market is only starting to
Net Debt/EBITDA 2.0 1.6 1.1 stabilise in Europe, with the first signs of a pick-up in the US. We should thus see
Interest Cover 8 9 12 supportive earnings momentum as the year progresses.
Gearing (%) 113% 82% 58%
** based on aggregated figures Valuation
NC = Net Cash Testing stocks have strongly re-rated in 2010 (+25/+55% abs.) reflecting strong multiples
NA = Not Applicable expansion, improving earnings momentum and M&A upside (for BV) They now trade in
line with the sector historical average, which could limit the upside, although there is still
scope for upward EPS revision. Staffers are more appealing to us as they trade below
their historical 12M forward EV/Sales and EV/EBIT. Security services stocks are cheap
relative to historical performance, reflecting the late cyclical features of the industry and
the negative impact on the top line of low inflation.
Stocks
Our favourite testing stock in 2011 would be SGS to play its aggressive 2014 strategic
Laurent Brunelle plan focusing on organic development. Among Security Services, we favour G4S given
(+33) 1 42 99 84 66
laurent.brunelle@exanebnpparibas.com
its strong exposure to niche and emerging markets and historically low valuation, mostly
factoring in its exposure to struggling government exposure. Adecco remains our top
leisureservices@exanebnpparibas.com pick in Staffing on compelling valuation and further margin upside (owing to its more
efficient business model and its higher exposure to professional staffing).

Support Services - Valuation and Earnings Dynamics*
EV/Sales

3.0x 90%
85%
2.5x
80%
75%
2.0x
70%
1.5x 65%
60%
1.0x
55%
50%
0.5x
45%
0.0x 40%
Rel. 12m EV/Sales Support Services (lhs) MSCI Europe Ex Financials (lhs)
EV/EBIT

15.0x 150%
14.0x
140%
13.0x
130%
12.0x
11.0x 120%
10.0x 110%
9.0x
100%
8.0x
90%
7.0x
6.0x 80%
Rel. 12m EV/EBIT Support Services (lhs) MSCI Europe Ex Financials (lhs)

110%
26.0
24.0 100%
22.0
20.0 90%
18.0
80%
16.0
14.0
70%
12.0
10.0 60%
Rel. 12m EPS Support Services (lhs) MSCI Europe Ex Financials rebased (lhs)

Telecom Operators Sector weighting: Outperform (+)
11e (x) ☺ Tele2 B (+37.2%)*
105 Orascom (-18.5%)*
Favourite stocks
BT Group + 15,082 11.0 4.0 1.3 100
Telenor + 18,891 20.0 5.5 0.5
Deutsche Telekom + 43,313 17.8 4.8 1.9
95
KPN + 17,995 17.8 5.3 1.9
Stocks to avoid
Portugal Telecom - 8,663 17.2 5.9 2.0 90
Telecom Italia = 18,373 8.3 3.9 2.3
Iliad = 4,308 39.9 6.3 1.0
85
80

(x) 2010e 2011e 2011e
rel. mkt
Telecom operators have outperformed in 2010, driven by 1) their defensive nature (high
CAPE 18.1 17.8 103% and sustainable dividends), 2) a return to growth in mobile, in particular in emerging
EV/EBITDA 6.0 5.5 78% markets, but also in some mature European markets thanks to accelerating smartphone
DY (%) 5.2 5.6 161% adoption, and 3) some specific ‘self-help’ stories such as BT.
Looking at 2011, we remain believers in the defensiveness of telcos and we still favour
Sector – Growth*
exposure to mobile in emerging markets (notably Asia and Africa).
% ch. 2010e 2011e Hist.
Avg
In Europe, given the more optimistic consensus view on mobiles (as demonstrated by
Sales 0.9 2.0 5.7
EBIT 0.4 4.7 12.8
the excellent performance of Vodafone in 2010), we are constructive but increasingly
EPS 1.8 6.6 20.9 selective: the growth in Nordic markets is well discounted and the Southern markets are
likely to remain very depressed due to the macro backdrop and competitive pressure
(Spain, Portugal, Italy), so we believe that the best place in Europe to play the
accelerating mobile data growth is now Germany. Fixed-line trends remain very country-
Margins (%) 2010e 2011e 2011e
vs specific but on a sector-wide basis the most interesting theme remains cable.
peak
EBITDA 37.5 36.5 81% Valuation
EBIT 22.5 21.9 81%
Net 16.9 13.7 64% The sector’s discount on P/E has vanished but European incumbents remain uniquely
* median ratios attractive on FCF yield and dividend yield. We believe that their FCF is sustainable, and
so are the dividends, in most cases (on average dividends represent c.70% of FCF).
(x) 2009 2010e 2011e Stocks
Interest Cover
- BT: we expect FCF upgrades thanks to cost cutting and a progressive improvement in
8 8 9
Gearing (%) 95% 85% 77% the revenue trend (reflecting BT’s gradually improving competitive position in the UK
** based on aggregated figures fixed-line market), plus large upside on the pension deficit front.
NC = Net Cash
NA = Not Applicable - Deutsche Telekom: exposure to the attractive German mobile market, cost cutting
Source: Exane BNP Paribas estimates protecting the domestic fixed-line EBITDA, while T-Mobile US, which is in a difficult
situation, remains an undervalued option.
- Telenor and Millicom are our favourite emerging market plays, and KPN remains one
of the most defensive stocks with a very attractive valuation and cash return policy.
- On the other hand we are cautious on Southern European incumbents, notably

Telecom Italia, as well as Portugal Telecom and Telefonica, which we downgraded
Antoine Pradayrol recently.
(+44) 207 039 9489
antoine.pradayrol@exanebnpparibas.com - In France, we remain cautious on France Telecom and Iliad given the increasing
competitive pressure in the telecom market ahead of Iliad’s mobile entry in 2012.
telecoms@exanebnpparibas.com
- Finally Virgin Media is our favourite play in European cable.

Telecom Operators - Valuation and Earnings Dynamics*
EV/Sales

4.0x 200%
3.5x
190%
3.0x
180%
2.5x
2.0x 170%
1.5x
160%
1.0x
150%
0.5x
0.0x 140%
Rel. 12m EV/Sales Telecom Operators (lhs) MSCI Europe Ex Financials (lhs)
EV/EBIT

14.0x 140%
13.0x
130%
12.0x
120%
11.0x
10.0x 110%
9.0x
100%
8.0x
90%
7.0x
6.0x 80%
Rel. 12m EV/EBIT Telecom Operators (lhs) MSCI Europe Ex Financials (lhs)

190%
20.0
180%
18.0 170%
160%
16.0
150%
14.0
140%
12.0 130%
120%
10.0
110%
8.0
100%
6.0 90%
Rel. 12m EPS Telecom Operators (lhs) MSCI Europe Ex Financials rebased (lhs)

Utilities Sector weighting: Underperform (-)
11e (x) 100 ☺ Severn Trent (+35.4%)*
EDP Renovaveis (-42.4%)*
Favourite stocks 95
National Grid + 22,962 14.3 8.1 4.2
Fortum + 18,333 18.2 8.7 2.5
90
Enel + 38,154 9.4 5.9 2.5
Stocks to avoid 85
RWE - 26,446 11.3 6.9 2.3
E.ON - 43,339 9.9 7.4 2.7
Iberdrola - 31,484 15.1 7.7 3.1 80
75
70
65

(x) 2010e 2011e 2011e
rel. mkt The rebound in electricity and gas consumption should be moderate in 2011, as the
CAPE 15.3 14.9 86% increase led by further economic progress should be mitigated by 1) continuing efforts to
EV/EBITDA 8.0 7.9 111% improve energy efficiency, and 2) a likely return to more normal weather (Q1 10 was
DY (%) 5.6 5.7 165% extremely cold). Forward hedging is progressively fading away and, in our view,
consensus 2011e EPS will have to be revised down by c. 8% on average for utilities
Sector – Growth* exposed to power generation, due to lower achieved electricity prices. The robustness of
% ch. 2010e 2011e Hist. balance sheets will be tested, as free cash flows are likely to remain below debt
Avg
maturities and dividend commitments over the next two years.
Sales 6.3 4.3 11.8
EBIT 7.1 6.2 13.7
EPS 0.0 4.7 14.5 Valuation
The sector remains expensive on a 12M EV/EBITDA, at close to a 10% premium,
Sector – Profitability* whereas it was trading at a c.10% discount in the last period of overcapacity. On a yield
Margins (%) 2010e 2011e 2011e basis, it appears attractive (c.50% premium, close to an all-time high), but dividends
vs
peak should trend down on the back of negative earnings momentum (decreasing achieved
EBITDA 27.8 27.1 62% electricity price).
EBIT 17.8 17.2 58%
Net 9.5 9.7 53%
* median ratios
Stocks
Our bearish view on power prices in most regions leads us to keep favouring
Sector – Solvency** infrastructure utilities. Our favourite stock is National Grid.
(x) 2009 2010e 2011e
Net Debt/EBITDA 2.9 2.9 2.9 Within the power generation space, we favour names where the regulatory and political
Gearing (%)
environment is less intrusive, and where power prices have more upside potential.
111% 114% 114%
** based on aggregated figures Fortum and ENEL fit the bill. In contrast, RWE and E.On still have more downside in our
NC = Net Cash view.
NA = Not Applicable
Benjamin Leyre
(+33) 1 42 99 24 72
benjamin.leyre@exanebnpparibas.com
utilities@exanebnpparibas.com

Utilities - Valuation and Earnings Dynamics*
EV/Sales

4.0x 180%
3.5x 170%
3.0x 160%
2.5x 150%
2.0x 140%
1.5x 130%
1.0x 120%
0.5x 110%
0.0x 100%
Rel. 12m EV/Sales Utilities (lhs) MSCI Europe Ex Financials (lhs)
EV/EBIT

14.0x 150%
13.0x 140%
12.0x
130%
11.0x
120%
10.0x
110%
9.0x
100%
8.0x
7.0x 90%
6.0x 80%
Rel. 12m EV/EBIT Utilities (lhs) MSCI Europe Ex Financials (lhs)

33.0 150%
31.0
140%
29.0
27.0 130%
25.0
120%
23.0
110%
21.0
19.0 100%
17.0
90%
15.0
13.0 80%
Rel. 12m EPS Utilities (lhs) MSCI Europe Ex Financials rebased (lhs)

Appendices
Performance and headline index targets
Headline index targets

Index 1 Jan 10 18 Nov 10 % gain YTD June 11e June 11e Dec 11 target Dec 11e
target upside upside
DJ Stoxx 600 254 271 7 280 3 305 12
DJ Euro Stoxx 50 2,965 2,855 (4) 3,000 5 3,200 12
CAC 40 3,936 3,868 (2) 4,000 3 4,300 11
DAX 30* 5,957 6,832 15 7,300 7 8,000 17
FTSE 100 5,413 5,769 7 6,000 4 6,400 11
S&P 500 1,115 1,197 7 1,250 4 1,300 9
* Total return index.
Headline index performance

Country Index Level Performance over (%)
1 month 3 months 6 months 1 year Since 31 Dec. 2009
Germany DAX 302 6,832 5 10 11 18 15
France CAC 40 3,868 1 6 7 1 (2)
Switzerland SMI 6,613 2 4 2 4 1
Netherlands AEX 346 1 6 5 8 3
Italy S&P MIB 20,880 (2) 2 3 (11) (10)
Sweden OMX 1,106 1 5 11 15 16
Spain IBEX 10,325 (5) (1) 7 (14) (14)
Portugal PSI Général2 2,790 1 6 11 (4) (4)
UK FTSE100 5,769 0 9 9 8 7
Belgium BEL 20 2,671 (0) 6 7 6 6
Euro Euro Stoxx 276 1 6 7 2 0
Europe Stoxx 271 2 5 8 9 7
Euro 50 Euro Stoxx 50 2,855 0 5 6 (2) (4)
Europe 50 Stoxx 50 2,588 1 3 5 2 0
USA S&P 500 1,197 1 9 7 8 7
USA Dow Jones 11,181 0 7 6 7 7
USA Nasdaq 100 2,135 1 15 13 18 15
Japan Nikkei 225 10,014 5 8 (2) 3 (5)
Headline index performance (LT)

Country Index Level Performance over (%)
1 year 3 years 5 years 10 years
2
Germany DAX 30 6,832 18 (10) 33 1
France CAC 40 3,868 1 (30) (15) (37)
Switzerland SMI 6,613 4 (22) (11) (19)
Netherlands AEX 346 8 (31) (17) (49)
Italy S&P MIB 20,880 (11) (46) (39) (56)
Sweden OMX 1,106 15 1 20 (2)
Spain IBEX 10,325 (14) (35) (2) 5
Portugal PSI Général2 2,790 (4) (33) 13 9
UK FTSE100 5,769 8 (8) 5 (10)
Belgium BEL 20 2,671 6 (34) (21) (15)
Euro Euro Stoxx 276 2 (32) (12) (33)
Europe Stoxx 271 9 (25) (10) (29)
Euro 50 Euro Stoxx 50 2,855 (2) (33) (17) (42)
Europe 50 Stoxx 50 2,588 2 (29) (21) (47)
USA S&P 500 1,197 8 (18) (4) (13)
USA Dow Jones 11,181 7 (15) 4 5
USA Nasdaq 100 2,135 18 4 27 (27)
Japan Nikkei 225 10,014 3 (34) (32) (31)
2
Dividend reinvested.

Sector performance
European sector performances3

Sector Performance over (%)
1 week 1 month 3 months 1 year YTD
Automobiles & Components 3.8 11.2 28.0 39.4 41.8
Banks (0.1) (3.0) (5.1) (10.5) (4.6)
Capital Goods 0.8 2.8 9.2 21.2 19.9
Chemicals (0.3) 4.0 14.0 28.9 20.6
Commercial Services & Supplies (1.5) 0.3 5.4 23.0 15.8
Constr Mater 3.1 12.9 4.6 (12.2) (17.0)
Consumer Durables & Apparel (0.2) 3.5 19.1 54.2 48.5
Consumer Services (0.2) 3.3 7.0 21.0 15.8
Diversified Financials (0.9) (1.6) (2.1) (0.9) 3.0
Energy (2.1) 3.0 7.1 (0.2) (2.3)
Food & Staples Retailing 2.2 2.7 4.7 13.3 10.9
Food Beverage & Tobacco 0.8 4.5 5.2 23.0 16.2
Health Care Equipment & Services 1.2 2.5 0.9 16.7 10.0
Household & Personal Products (0.1) 5.3 10.5 21.8 12.6
Insurance (0.2) 0.2 2.9 0.8 0.6
Media (1.2) (0.2) 3.2 14.8 8.9
Metals & Mining (3.5) 6.8 18.3 22.6 15.8
Pharmaceuticals & Biotechnology 1.3 (0.2) 3.5 10.7 3.6
Real Estate (1.8) (2.2) 7.3 0.9 5.6
Retailing 1.6 (1.3) 4.4 18.7 20.9
Semiconductors & Semiconductor 5.3 4.8 15.3 31.4 19.0
Software & Services (0.6) (2.8) 2.4 11.7 11.0
Technology Hardware & Equipment (1.1) (4.1) 1.3 (8.0) (2.3)
Telecommunication Services (1.0) 0.2 3.8 8.4 6.5
Transportation 0.1 1.6 5.7 12.8 9.6
Utilities 0.8 2.9 2.6 (3.5) (7.4)
Source: Factset
US sector performances3
Sector Performance over (%)
1 week 1 month 3 months 1 year YTD
Automobiles & Components (1.8) 11.8 27.8 51.2 46.3
Banks (3.0) 4.8 4.0 1.0 5.5
Capital Goods (0.8) 1.0 8.9 14.5 15.5
Commercial Services & Supplies (0.8) (1.6) 5.6 3.4 2.4
Consumer Durables & Apparel (0.3) 1.5 13.7 22.6 20.0
Consumer Services (2.0) 6.2 16.2 28.4 29.3
Diversified Financials (1.9) 2.7 4.9 (8.0) (2.8)
Energy (1.5) 5.1 17.2 5.2 8.5
Food & Staples Retailing (0.4) 0.8 9.4 0.4 2.0
Food Beverage & Tobacco (0.1) 0.4 6.1 12.2 12.6
Health Care Equipment & Services (2.0) 1.8 8.2 4.6 (0.5)
Household & Personal Products (0.0) (0.7) 3.8 0.5 3.8
Insurance (1.2) (1.5) 6.0 10.4 12.8
Materials (3.4) 1.5 11.6 9.5 9.2
Media 0.0 4.0 11.8 24.9 20.4
Pharmaceuticals & Biotechnology (0.7) (3.3) 4.2 0.8 (1.3)
Real Estate (3.5) (3.3) 3.5 20.7 17.1
Retailing (1.4) 3.5 16.8 20.6 18.5
Semiconductors & Semiconductor (0.4) 8.4 13.4 10.3 3.0
Software & Services (1.9) 0.7 13.9 5.9 2.3
Technology Hardware & Equipment (2.4) (2.6) 11.5 11.7 9.3
Telecommunication Services (1.0) 0.3 6.2 13.7 6.5
Transportation 0.0 1.7 11.3 25.4 25.2
Utilities (1.2) (3.2) 1.4 6.1 0.2
Source: Factset

Valuation: P/Es and DY; EPS and DPS growth
By index
P/E (x) EPS growth (%)
2010e 2011e 2012e 12m forward 2010e 2011e 2012e
MSCI Europe 12.2 10.7 9.6 10.8 39 14 12
MSCI Europe Large Cap 11.7 10.3 9.3 10.4 38 13 11
MSCI Europe Mid Cap 15.5 13.0 11.2 13.3 50 19 16
MSCI Europe Small Cap 16.7 12.4 10.4 12.8 88 35 19
MSCI Euro 11.2 10.0 9.0 10.1 36 12 12
CAC 40 11.4 10.2 9.1 10.3 45 12 12
SBF 250 12.1 10.6 9.4 10.7 51 14 13
DAX 30 11.8 10.9 9.7 11.0 65 9 12
IBEX 35 10.4 9.5 8.5 9.6 4 10 12
FTSE 100 12.3 10.4 9.3 10.6 44 18 12
SMI 12.9 11.7 10.7 11.9 33 10 9
MSCI USA 14.4 12.7 11.2 12.9 38 14 13
Dividend yield (%) Dividend growth (%)

2010e 2011e 2012e 2010e 2011e 2012e
MSCI Europe 3.5 3.9 4.3 9 11 11
MSCI Europe Large Cap 3.7 4.1 4.5 9 11 11
MSCI Europe Mid Cap 2.8 3.1 3.4 12 11 11
MSCI Europe Small Cap 2.5 2.9 3.3 19 15 12
MSCI Euro 4.1 4.4 4.9 11 8 11
CAC 40 4.0 4.4 4.8 11 9 9
SBF 250 3.8 4.1 4.5 11 9 9
DAX 30 3.5 3.7 4.0 20 6 9
IBEX 35 5.8 6.1 6.8 6 7 10
FTSE 100 3.1 3.6 4.0 (1) 15 12
SMI 3.2 3.6 3.9 16 11 9
MSCI USA 1.9 2.0 2.3 7 8 14
By group1
Weighting P/E (x) EPS growth (%)
(%) 2010e 2011e 2012e 2010e 2011e 2012e
Energy 10.9 9.8 8.8 7.8 44 12 12
Cyclicals1 38.7 14.4 12.1 10.7 97 19 13
Defensives1 27.9 12.3 11.7 11.0 9 6 7
Financials 20.1 10.7 8.8 7.6 48 21 17
Technology 2.3 16.1 13.2 11.7 51 22 13
Market excl. Basic Res and Financials 72.8 12.7 11.5 10.5 31 10 10
Market excl. Energy 89.1 12.5 11.0 9.8 39 14 12
Market excl. Financials 79.9 12.7 11.4 10.3 36 11 10
Market excl. Oil ex Fin 69.0 13.3 11.9 10.9 35 11 10
Market 12.2 10.7 9.6 39 14 12
Weighting Dividend yield (%) DPS growth (%)

(%) 2010e 2011e 2012e 2010e 2011e 2012e
Energy 10.9 3.9 4.7 5.0 (19) 23 5
Cyclicals1 38.7 2.6 2.9 3.2 23 13 11
Defensives1 27.9 4.3 4.5 4.8 11 6 7
Financials 20.1 3.5 4.0 4.8 12 13 20
Technology 2.3 2.6 2.7 3.0 5 6 11
Market excl. Basic Res and Financials 72.8 3.7 4.0 4.3 7 10 8
Market excl. Energy 89.1 3.5 3.8 4.2 14 9 12
Market excl. Financials 79.9 3.5 3.9 4.2 8 10 8
Market excl. Oil ex Fin 69.0 3.5 3.7 4.1 14 8 9
Market 3.5 3.9 4.3 9 11 11
1
Cyclicals = Automobiles & Components, Capital Goods, Chemicals, Commercial Services & Supplies, Construction Materials, Consumer Durables
& Apparel, Consumer Services, Media, Metals & Mining, Retailing, Telecommunication Services, Transportation
Defensives = Food & Staples Retailing, Food Beverage & Tobacco, Health Care Equipment & Services, Household & Personal Products,
Pharmaceuticals & Biotechnology, Utilities
Technology = Semiconductors & Semiconductor Equipment, Software & Services, Technology Hardware & Equipment

Valuation – MSCI sectors
P/E and EPS growth 1

P/E (x) EPS growth (%)
2010e 2011e 2012e 2010e 2011e 2012e
Market (MSCI Europe) 12.2 10.7 9.6 39 14 12
Automobiles & Components 12.2 10.0 8.2 NS NS 22
Banks 12.1 8.8 7.2 228 37 22
Capital Goods 15.1 12.8 11.3 55 17 14
Chemicals 14.9 13.7 12.6 57 8 9
Commercial Services & Supplies 16.9 15.0 13.2 18 13 14
Constr Mater 16.9 13.2 10.4 (8) 28 26
Consumer Durables & Apparel 20.8 17.8 15.8 51 17 12
Consumer Services 15.2 13.4 11.9 8 13 12
Diversified Financials 9.9 8.4 7.5 NS 18 12
Energy 9.8 8.8 7.8 44 12 12
Food & Staples Retailing 14.2 12.4 11.1 15 14 12
Food Beverage & Tobacco 15.8 14.4 13.0 17 10 11
Health Care Equipment & Services 18.1 16.0 14.3 14 13 12
Household & Personal Products 17.4 16.5 14.9 26 5 11
Insurance 9.1 8.4 7.7 16 9 9
Media 12.5 11.6 10.7 10 7 9
Metals & Mining 12.4 9.5 8.7 157 30 10
Pharmaceuticals & Biotechnology 11.0 10.2 9.9 9 7 3
Real Estate 18.0 17.0 15.7 1 6 8
Retailing 16.0 14.5 12.9 25 10 12
Semiconductors & Semiconductor Equipt 14.7 13.3 12.5 NS NS 6
Software & Services 16.7 14.4 12.8 15 15 13
Technology Hardware & Equipment 16.3 12.3 10.5 6 33 17
Telecommunication Services 10.6 10.3 9.8 5 3 5
Transportation 14.6 12.7 10.9 312 15 17
Utilities 10.9 11.2 10.4 (1) (2) 8
1
MSCI classification
Source: Factset
Dividend yield and DPS growth1

Dividend yield (%) DPS growth (%)
2010e 2011e 2012e 2010e 2011e 2012e
Market (MSCI Europe) 3.5 3.9 4.3 9 11 11
Automobiles & Components 2.1 2.8 3.3 257 29 20
Banks 3.0 3.5 4.5 22 18 26
Capital Goods 2.9 3.2 3.5 23 12 10
Chemicals 2.7 3.0 3.2 18 9 9
Commercial Services & Supplies 2.3 2.6 2.9 13 11 12
Constr Mater 3.1 3.3 3.8 (3) 7 18
Consumer Durables & Apparel 1.5 1.8 2.1 38 19 13
Consumer Services 3.2 3.3 3.7 (2) 5 12
Diversified Financials 2.2 2.4 3.5 (1) 8 46
Energy 3.9 4.7 5.0 (19) 23 5
Food & Staples Retailing 3.1 3.4 3.9 12 11 13
Food Beverage & Tobacco 3.1 3.4 3.7 15 9 10
Health Care Equipment & Services 1.5 1.6 1.8 10 12 12
Household & Personal Products 2.3 2.5 2.7 16 7 10
Insurance 4.8 5.3 5.8 16 11 8
Media 4.4 4.6 4.9 4 5 6
Metals & Mining 1.6 2.0 2.2 51 28 11
Pharmaceuticals & Biotechnology 4.0 4.3 4.6 13 8 6
Real Estate 5.0 4.8 5.0 4 (4) 5
Retailing 3.5 3.9 4.4 23 10 12
Semiconductors & Semiconductor Equipt 1.5 1.6 1.8 62 10 13
Software & Services 1.7 2.0 2.2 9 17 12
Technology Hardware & Equipment 3.7 3.9 4.2 3 3 10
Telecommunication Services 6.2 6.6 7.0 9 6 7
Transportation 2.6 2.9 3.2 6 11 13
Utilities 5.7 5.7 5.9 4 (0) 4
1
MSCI classification
Source: Factset

Analyst location
As per contact details, analysts are based in the following locations: London, UK for telephone numbers commencing +44; Paris, France +33; Brussels, Belgium +32;
Frankfurt, Germany +49; Geneva, Switzerland +41; Madrid, Spain +34; Milan, Italy +39; New York, USA +1; Singapore +65; Zurich, Switzerland +41
Rating definitions
Stock Rating (vs Sector)
Outperform: The stock is expected to outperform the industry large-cap coverage universe over a 12-month investment horizon.
Neutral: The stock is expected to perform in line with the industry large-cap coverage universe over a 12-month investment horizon.
Underperform: The stock is expected to underperform the industry large-cap coverage universe over a 12-month investment horizon.
Sector Rating (vs Market)
Outperform: The sector is expected to outperform the DJ STOXX50 over a 12-month investment horizon.
Neutral: The sector is expected to perform in line with the DJ STOXX50 over a 12-month investment horizon.
Underperform: The sector is expected to underperform the DJ STOXX50 over a 12-month investment horizon.
As at 04/10/2010 Exane BNP Paribas covered 577 stocks. The stocks that, for regulatory reasons, are not accorded a rating by Exane BNP Paribas are excluded from
these statistics. For regulatory reasons, our ratings of Outperform, Neutral and Underperform correspond respectively to Buy, Hold and Sell; the underlying
signification is, however, different as our ratings are relative to the sector.
42% of stocks covered by Exane BNP Paribas were rated Outperform. During the last 12 months, Exane acted as distributor for BNP Paribas on the 3% of stocks with
this rating for which BNP Paribas acted as manager or co-manager on a public offering. BNP Paribas provided investment banking services to 9% of the companies
accorded this rating*.
38% of stocks covered by Exane BNP Paribas were rated Neutral. During the last 12 months, Exane acted as distributor for BNP Paribas on the 0% of stocks with this
rating for which BNP Paribas acted as manager or co-manager on a public offering. BNP Paribas provided investment banking services to 5% of the companies
accorded this rating*.
20% of stocks covered by Exane BNP Paribas were rated Underperform. During the last 12 months, Exane acted as distributor for BNP Paribas on the 1% of stocks
with this rating for which BNP Paribas acted as manager or co-manager on a public offering. BNP Paribas provided investment banking services to 3% of the
companies accorded this rating*.
* Exane is independent from BNP Paribas. Nevertheless, in order to maintain absolute transparency, we include in this category transactions carried out by BNP
Paribas independently from Exane. For the purpose of clarity, we have excluded fixed income transactions carried out by BNP Paribas.
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See www.exane.com/disclosureequitiesuk for details. Complete disclosures, please see www.exane.com/compliance
Exane is independent of BNP Paribas (BNPP) and the agreement between the two companies is structured to guarantee the independence of Exane's research,
published under the brandname « Exane BNP Paribas ». Nevertheless, to respect a principle of transparency, we separately identify potential conflicts of interest with
BNPP regarding the company/(ies) covered by this research document.

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BNP - Market Outlook 2011

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Equity Strategy Market Outlook 2011

Equities - What else?

► A good year for European equities

► Earnings & valuations

► Monetary conditions & Risks

► Themes: Germany & Periphery

► Themes: Commodity price inflation and fiscal austerity

Please refer to important disclosures

Summary and investment conclusions ________________________ 3

Sector Outlook __________________________________________ 69

European large caps – top picks for 2011 _____________________ 71

Sector dynamics ________________________________________ 72

Appendices ___________________________________________ 121

2 Market Outlook 2011

With most valuation measures significantly below ex-bubble averages we expect

3 Market Outlook 2011

Commodity price inflation

Sectors or companies where commodities make up a large proportion of cost of goods

Konsum – Germany Shops

Avoid government exposure

European periphery – waiting for labour cost cuts

4 Market Outlook 2011

We have no particular strong bias towards Cyclicals or non-Cyclicals in our sector

In Consumer Cyclicals we maintain a cautious stance on sectors with limited exposure

5 Market Outlook 2011

Earnings Outlook and macro backdrop

Figure 1: Macroeconomic scenario – summary*

6 Market Outlook 2011

Source: Exane BNP Paribas estimates, Thomson Datastream

Our top-down forecast

EBIT margin (%) 12.3% 13.2% 13.2% 13.6% 14.0%

Source: Factset, Exane BNP Paribas estimates

7 Market Outlook 2011

Figure 4: Main assumptions of our core scenario

* Changes based on year averages.

Fixed costs – operational leverage

8 Market Outlook 2011

Margin expansion should be possible. Top-line growth, thanks to the phenomenon of

9 Market Outlook 2011

Source: Thomson Datastream, Exane BNP Paribas estimates

10 Market Outlook 2011

As the uncertainty on currency forecasts is perhaps even greater than on economic

A first look at 2012

Where could we be wrong?

11 Market Outlook 2011

Source: Exane BNP Paribas estimates

Figure 7: Bullish scenario for 2011 (MSCI Europe, excluding financials)

EBIT margin (%) 13.2% 13.7% 13.6% 14.6%

Source: Factset, Exane BNP Paribas estimates

Figure 8: Assumptions in the bearish scenario

Source: Exane BNP Paribas estimates

In this bearish scenario we arrive at a top-line growth forecast of 3.6%. Operational

12 Market Outlook 2011

EBIT margin (%) 13.2% 12.3% 13.6% 13.4%

Source: Factset, Exane BNP Paribas estimates

Room for consensus upgrades

Figure 10: MSCI Europe: consensus forecast EPS (EUR)

Source: Thomson Datastream, Exane BNP Paribas

13 Market Outlook 2011

In absolute terms, forward-looking valuation ratios have shrunk as a result of significant

Figure 11: European equities - multiple contraction

Source: Factset, Exane BNP Paribas