PEC’s Japan strategy:The cycle through 2017

Please refer to page 32 for important disclosures and analyst certification, or on our website www.macquarie.com/research/disclosures. ASIA The importance of the cycle: Our 12-month TOPIX TP of 1590 in conjunction with our broadly flat US$/¥ forecast implies that the blue line in the chart to the right needs to reach +20% The cycle is expected to drive a modest expansion of the TOPIX forward PER to 15.0x (our target multiple). Fig 37 puts this into a historical context The cycle, we believe, will drive upward earnings revisions in industrial sectors, whilst the increase in the global real interest rate, and nominal bond yields, becomes a headwind for sectors on PER premiums to the asset class Stock ideas, the Macquarie Marquee list of our analyst’s top stock ideas (6 of 8 are industrial companies), the 22-constituents of our Industrial recovery handbook are on page 2 To build confidence in the cycle through 2017, there are 31 charts over nine pages, pages 3-11 The August OECD LI was another solid data point, improving 7bp month on month to -37bp, with contributions from all three of US, Europe and Japan Analyst(s) Peter Eadon-Clarke +81 3 3512 7850 peter.eadon-clarke@macquarie.com Nara Song +81 3 3512 7878 nara.song@macquarie.com 12 October 2016 Macquarie Capital Securities (Japan) Limited PEC’s Japan strategy The cycle through 2017 Our 12-month TOPIX target is 1590, 15.0 times estimated EPS to 9/2018. We believe there are both fundamental factors and investor flow pressures that will result in outperformance of global cyclical sectors over domestic sectors. Please see the 5 October 2016 PEC’s Japan strategy: Accentuated sector rotation. TOPIX acts like a global cyclical, reflecting the heavy concentration of listed manufacturing companies and MNCs, chart below. OECD LI YoY versus TOPIX in US$ terms YoY Note: The OECD LI is a six-month lead indicator of OECD (advanced economies) real GDP growth. It troughed in February 2016 and has recovered for six months, page 3 Source: OECD, Factset, Macquarie Research, October 2016 The industrial cycle was, we believe, the cause of the 2014-16 deceleration in global growth, and will be the driver of the forecast 2017-18 recovery, below. To build confidence in the cycle’s durability we look at its underpinnings inside. Global real GDP growth; Macquarie’s the long grinding cycle forecast Note: The Total-16 is the IMF’s 10-advanced and 6 EM economies. Forecasts are Macquarie where available, alternatively the IMF – please see the 20 September 2016 The Global Macro Outlook 2017: Better, but still a grind, Fig.154. The country weights use market exchange rates, not PPP Source: IMF, Macquarie Research, October 2016 -80-60-40-20020406080100-8 -6 -4 -2 0 2 4 6 8 OECD LI (derived 6m annualised, LHS)Topix (US$, derived 6m annualised, RHS)%%2.602.772.692.532.192.622.712.682.630.01.02.03.04.05.020122013201420152016201720182019202016-TotalAverage 1980-2011, 3.0% p.aThe long grinding cycle, 2.5% p.aAverage 1980-2011,3.0% p.aThe long grinding cycle,2.5% p.a(Globalreal GDP growth) Macquarie Research PEC’s Japan strategy 12 October 2016 2 Stock ideas The Macquarie Marquee list is our best stock ideas driven bottom-up by our analysts, below. Industrial recovery ideas there are Nippon Steel SM, Mitsubishi Electric, Panasonic, Denso, Suzuki Motor and Mitsubishi Corp. Fig 1 The Macquarie Marquee List for Japan Stock Code Analyst name Rec C/P T/P To TP (%) Vol. Index Daiwa House Industry 1925 William Montgomery OP 2,666 4,200 57.5 Medium Hulic 3003 William Montgomery OP 988 1,800 82.2 Medium Nippon Steel SM 5401 Polina Diyachkina OP 2,136 2,600 21.8 Medium Mitsubishi Electric 6503 Damian Thong OP 1,338 1,600 19.6 Medium Panasonic Corporation 6752 Damian Thong OP 1,048 1,420 35.6 Medium Denso 6902 George Chang OP 4,198 4,900 16.7 Medium Suzuki Motor 7269 Takuo Katayama OP 3,521 3,900 10.8 Medium Mitsubishi Corp 8058 Polina Diyachkina OP 2,318 2,500 7.9 Medium Note: Prices are as of 7 October 2016. Please note that those shaded in blue are domestic stories, whilst those shaded in red are global industrial recovery ideas Source: FactSet, Macquarie Research, October 2016 Fig.2 has the current recommendation details and other financial data for the 22 companies showcased in the 3 August 2016 PEC’s Japan strategy: The industrial recovery handbook. This handbook remains the best source of charts and tables explaining the global cyclical thesis, in our opinion. Fig 2 The industrial recovery handbook basket Close Market Cap 6m Ave T/O PER Performance from indicated end date to latest Code Company Rating TP (¥) %Diff (¥) (US$bn) (US$mn) FY1 FY2 P/BV ROE 12/07 12/12 12/13 12/15 4063 Shin-Etsu Chemical OP 7,100 -5.4 7,504 31.3 85.8 19.6 18.2 1.6 7.5 6.9 43.5 22.2 13.4 5108 Bridgestone OP 4,800 21.6 3,948 31.0 103.5 11.5 10.6 1.4 13.3 98.6 77.5 -0.8 -5.4 5401 Nippon SSM OP 2,600 21.8 2,136 19.6 82.7 19.6 11.5 0.7 5.1 -69.1 1.7 -39.3 -11.6 5713 Sumito