PEC’s Japan strategy: The industrial recovery handbook

Please refer to page 68 for important disclosures and analyst certification, or on our website www.macquarie.com/research/disclosures. ASIA TOPIX and MSCI AC Asia-ex (in US$, indexed to 100 as of start 2011) Source: FactSet, Macquarie Research, August 2016 TOPIX, 2014 start to latest (in Yen) Note: High 1,691 10 August 2015 Source: FactSet, Macquarie Research, August 2016 Analyst(s) Peter Eadon-Clarke +81 3 3512 7850 peter.eadon-clarke@macquarie.com Nara Song +81 3 3512 7878 nara.song@macquarie.com 3 August 2016 Macquarie Capital Securities (Japan) Limited PEC’s Japan strategy The industrial recovery handbook Our 12-month TOPIX target is 1590 (unchanged), 15.0 times earnings per share to 9/2018 (previously 3/2018). Following the latest BOJ announcement (29 July 2016 The BOJ disappoints again) we have revised our exchange rate, inflation and TOPIX EPS forecasts (below & inside). The BOJ is increasing its annual equity ETF program to ¥6.0tr from ¥3.3tr. This appears to be a decision of consequence, please see from page 50. Please note that at TOPIX 1320 there’s over 20% upside to our TOPIX TP. We see opportunities in cyclical industrial sectors, and review each of the boxes below inside. The Macquarie Marquee list is our best stock ideas driven bottom-up by our analysts, Fig 5. Nippon Steel SM, Mitsubishi Electric, Panasonic, Denso, Suzuki Motor and Mitsubishi Corp are industrial recovery stock stories. A total of 22 stock ideas are presented on pages 2-3 and 24 to 45. The industrial recovery handbook Source: Macquarie Research, August 2016 Macro forecast changes: We are now forecasting the 2016 year-end US$-¥ to be 105 (previously 110) with all forward years similarly revised by US$-¥5. This takes about 0.1% off our CPI profile and around 3% off our estimated TOPIX EPS. A 10% move in the US$-¥ takes approximately 6% of TOPIX EPS. Japan: Macquarie’s key macroeconomic forecasts CY11 CY12 CY13 CY14 CY15 CY16E CY17E CY18E CY19E GDP (YoY, %) -0.5 1.7 1.6 -0.1 0.6 0.4 0.6 0.7 0.8 CPI (YoY, %) -0.3 0.0 0.4 2.7 0.8 -0.1 0.3 0.5 0.9 (**) Overnight call rate (*) 0.1 0.1 0.0 0.1 0.0 0.0 0.0 0.0 0.0 10-year JGB (*) 0.99 0.79 0.74 0.3 0.3 -0.1 -0.1 0.3 0.5 ¥/$ (*) 77.6 86.3 105.4 119.8 120.4 105 101 97 95 Note: CPI is the headline CPI ex fresh foods. (*): per period end, Macquarie forecasts. (**) The consumption tax rate increase to 10% from 8% is now scheduled for October 2019 Source: Bloomberg, Macquarie Research, August 2016 70809010011012013001/1107/1101/1207/1201/1307/1301/1407/1401/1507/1501/1607/16MSCI AC Asia ex JPTOPIX(Jan'11=100)1100120013001400150016001700Jan/14Jul/14Jan/15Jul/15Jan/16Jul/16TOPIX 1s t Sec tion Macquarie Research PEC’s Japan strategy 3 August 2016 2 The stocks come first Coincident with the June OECD LI report indicating a trough and infection in their lead indicator, we have been showcasing the industrial recovery opportunity in the reports below. Fig 1 The global industrial recovery story: 6 related reports 08 June 2016: The case for Japan’s auto sector Auto majors, Auto parts & Tires 15 June 2016: Manufacturing excellence now High quality managements 22 June 2016: Industrial recovery stories Mining & Resources ideas 13 July 2016: A single global equity market Global peer comparisons 20 July 2016: More industrial recovery stories 18 Outperform recommendations 27 July 2016 Follow the Money The expected return of major foreign buying Source: Macquarie Research, August 2016 Industrial recovery stock stories Early into an industrial recovery, we favour light cyclicals such as consumer durable autos and their supply chain (Fig 2 and Fig 3) to heavy cyclical capex sectors. We recommended the auto majors, auto parts and tire companies in the 8 June 2016 PEC’s Japan strategy: The case for Japan’s auto sector. Fig 2 Auto majors, auto parts and tires Code Company Rating TP (¥) %Diff Close (¥) Mkt. Cap (US$bn) Analyst 7203 Toyota Motor OP 7,300 26.8 5,759 165.1 Takuo Katayama 7267 Honda Motor OP 3,600 28.6 2,800 47.7 Takuo Katayama 7201 Nissan Motor OP 1,400 34.2 1,043 40.1 Takuo Katayama 6902 Denso OP 4,900 26.3 3,880 29.3 George Chang 7270 Fuji Heavy Industries N 4,200 6.5 3,943 29.1 Takuo Katayama 5108 Bridgestone OP 4,800 35.6 3,539 26.2 Polina Diyachkina 6201 Toyota Industries OP 6,200 40.6 4,410 13.1 George Chang 7269 Suzuki Motor OP 3,700 19.8 3,089 12.9 Takuo Katayama 7259 Aisin Seiki N 4,550 5.9 4,295 11.5 George Chang 7261 Mazda Motor OP 2,700 80.1 1,500 8.5 Takuo Katayama 6770 Alps Electric OP 2,700 30.8 2,064 3.8 George Chang 5334 NGK Spark Plug N 2,100 23.5 1,701 3.5 George Chang Note: Prices are as 29 July 2016. Outperform recommendations highlighted in grey Source: FactSet, Macquarie Research, August 2016 Seeking manufacturing operating leverage and quality management, the 15 June 2016 PEC’s Japan strategy: Manufacturing excellence now revisited our Manufacturing excellence theme, which is dominated by the auto sector and factory automation companies,