The New Chinese Landscape A Chance For Europe

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23 March 2011

Economy

Beyond the cycle

www.sgresearch.com

The new Chinese landscape: a chance for Europe

An explosion in consumer demand in China The size of the urban Chinese middle class by 2015, i.e. double the

level observed in 2008.

Anticipated growth in demand for household goods and services by

2015, with +222% for durable goods.

The rise in Chinese household consumption between 2008 and 2015,

with +71% for food.

At the current rate, China will become the largest export market for all

European countries by 2020.

Weaker competition: EMU export prices to China rose by 45% from

2004 to 2010, and prices of imported Chinese products went up 41%.

Portion of European exports represented by China by 2020

Source: SG Cross Asset Research

Main sector positioning relative to new Chinese landscape Beneficiaries* Protected* At risk*

Automotive (high/mid-range) Automotive (premium) Telecoms equipment

Clothing Luxury Electrical equipment

Agri-food/Beverages Chemicals Industrial equipment

Pharmaceuticals Basic materials Renewable energies

media

Banking/Insurance * Strong demand and easing

competition * Strong demand and low exposure to competition * Strong demand but increasing

competition

x 3.3

x 3.3

x 2.3 x 4.5x 2.5 x 3.3

x 3.1x 3.5

x 1.9

0%

4%

8%

12%

16%

Germany France Italy Ndls Belgium Spain EMU 6 UK Sweden

2009 2020

400 million

+204%

+94%

Opportunities

Pricing power

Project leader

Véronique Riches-Flores (33) 1 42 13 84 04 vé[email protected]

With contributions from Philippe Barrier, Adrien de Susanne, Marie-Line Fort, Joseline Gaudino, Didier Laurens, Jean-Baptiste Roussille

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23 March 2011 2

Contents

3 The new Chinese landscape: a chance for Europe

3 Industrial revival in Europe after thirty years of decay

4 Industrials: heading for a sustainable rerating?

8 China: from an export machine to a consumption machine

9 Chinese middle class set to double by 2015

12 Sharp rise in demand

14 Auto… market set to double in size by 2020

17 Danone… or the westernisation of dietary lifestyles

19 China is losing grip – the unprecedented level of competition of the past decades has now gone

19 From international hyper-competition to an asymmetrical demand shock

20 European industry: a good deal has survived!

22 Seb… The Chinese experience from one decade to the next

24 Shift in Chinese demand: from yesterday’s champions to the beneficiaries of tomorrow

24 Exports to China rose by 20% per annum between 2001 and 2009

26 China set to become Europe s leading export market by 2020

27 A story about consumption rather than capital goods

29 Rail equipment: shattered dreams

30 Renewable energies: Chinese manufacturers in front!

31 ABB, Siemens, yesterday’s major beneficiaries of the Chinese demand boom…

34 Outlooks in terms of growth and profitability are now becoming more mixed

37 Gains should be more evenly balanced between the different sectors and European countries

38 What are the risks?

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23 March 2011 3


Industrial revival in Europe after thirty years of decay China’s transition from an export-performance-based model to a consumption-based model

paves the way for an industrial revival in Europe. The relative positioning of the lower value-

added industries has improved and the potential gains are more evenly distributed between the

various European economies.

The Chinese transition, a factor that should support European growth. That the

emerging markets are having an increasing influence on the earnings of European companies

is old news. SG Cross Asset Research has released various reports on this subject, the most

recent having just been published (on Emerging markets, the benefit for small & mid-caps).

While these changes now seem to be factored into company valuations, few economists seem

to have considered the extent to which this factor could support European industry and

economic growth in the future.

China is becoming less and less of a rival but more a vast market. The acceleration of

the Chinese transition from an export-performance-based model to a consumption-based

model is totally changing the global rules of play. Not only has China become a source of

unparalleled levels of growth in a new type of demand, that of consumer goods rather than

capital goods, but this growth is being accompanied by a substantial easing in international

price competitiveness.

Opportunities and profitability. Having been hit hardest by Chinese competition over the

last two decades, European industry, which accounts for 40% of global trade in manufactured

goods, is now best placed to take advantage of these changes. Europe is set to benefit in

terms of both opportunities and profitability. The structural outlook for exports has

significantly improved, as consequently has the outlook for Europe’s economic health in

general.

Valuations impacted in different ways depending on the industry. After years of relative

underperformance, industry should see a substantial improvement in market conditions as a

result of this new environment. In contrast, to past trends, the valuation of the traditional

consumer industries, automotive, clothing, food and pharmaceuticals, should benefit from an

unprecedented source of demand and a much easier competitive environment. Conversely,

progress made by China in the most strategic high tech industrial, energy, transport and

telecoms equipment sectors will probably make these areas of the Chinese market harder to

penetrate than they have been up until now. The best of the China story may well be ending

for these industries, which have up until now been the strongest performers, and their

valuations look set to suffer.

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Industrials: heading for a sustainable rerating? In 2010 the European industrial stocks were trading at close to 20x earnings, a record high

level not seen since 1973. The hardcore industrials aerospace, transport, industrial

equipment and chemicals put in an even stronger performance, with median P/E touching a

high of 22 over the course of the year, bringing the gap in valuation vs the overall market to an

exceptional level of six points.

Europe - Difference in performance of industrial stocks vs the market


Though clearly boosted by the performance of the German industrials, a significant

improvement in the valuations of industrial companies can be observed across most European

countries. At a P/E of more than 20 in the second half of 2011, hardcore French industrials, for

example, were trading at their highest multiple since the mid-1980s.

France:-P/E of industrial stocks

Source: Datastream, SG Cross Asset Research

8

6

4

2

0

2

4

6

8

Q11973

Q11976

Q11979

Q11982

Q11985

Q11988

Q11991

Q11994

Q11997

Q12000

Q12003

Q12006

Q12009

Core

Overall ind.

5

7

9

11

13

15

17

19

21

23

25

Q11973

Q11976

Q11979

Q11982

Q11985

Q11988

Q11991

Q11994

Q11997

Q12000

Q12003

Q12006

Q12009

Overall ind.

Core

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23 March 2011 5

In the near term, there is every chance that this trend will slow down. Not only is the

consolidation of the economic recovery leading to more diversified investment opportunities,

notably in services, insurance and banking, but also high input prices continue to weigh on the

margins at this stage, for both the industrials as well as the other sectors.

Business sentiment on input prices Implicit margins in services and industry

Sources : SG Cross Asset Research, PMI Market data

Nevertheless, in the longer term, the outlook for industry has improved enough to justify

a structural rerating of many sections of the European industrial landscape with,

however, significant sector rotation in comparison to past results.

Current P/E of the European industry, long-term average (1973-2010) and anticipated effects of the Chinese transition on the valuation in the medium term (3-5 years)


0.0

5.0

10.0

15.0

20.0

25.0

30.0

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Eng

Person

alPrd

Eltro/Elec

Eq

Hab

il.&

access.

S/W

&Co

mpSvs

TchH/W

&Eq

Aero/Defence

Beverages

Inds

Tran

spt

Chem

icals

GeneralInds

Auto

&Pa

rts

Gen

Retailers

Airlines

BasicResource

Semicon

ductors

Food

Rtl&

W

H/H

Gds,Hom

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FdProd

ucers

Paper

Toba

cco

Con&Mat

Pharm

Utilities

Tot.mkt

44.8

Long-termaverage

Q1 2011

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23 March 2011 6

Chinese transition Following a period of more than two decades, during which the Chinese economy has been

catching up with the developed nations, the transition from an export-led growth model to a

domestic growth model driven by private consumption is likely to have profound

consequences on the global

environment. Because we

are talking about China, and

therefore an industrial

competitor of unparalleled

proportions, whose entry

onto the global marketplace

has strongly influenced the

international competitive

environment for more than

20 years, the effects of this

transition are likely to be of

an unprecedented nature.

Aside from an incalculable

source of growth in

demand for industrial goods, the change in the Chinese growth model is likely to be

accompanied by a significant easing in the global competitive environment which is likely

to relieve producers in the rest of the world of the strain of the hyper-competition that has

weighed on them in the years that China s global market share was sky-rocketing. European

industry, which still accounts for a large portion of global production capacity, is

probably best placed to benefit from this radical change in environment characterised

by a sharp rise in opportunities and stronger profitability.

Thirty years of widespread industrial decline As the world s leading exporter of manufactured goods, Europe had the highest exposure to

increased competition from Asia in general, and China in particular, over the last three

decades. In conjunction with the extremely unfavourable currency conditions seen between

2002 and 2008 when the euro gained some 50% against the Asian currencies in real terms,

this competition ate away at the low value-added and low-technology industries that

continued to characterise various sectors of European activity. With the exception of Germany

which has been protected by a particularly high degree of specialisation in the capital

equipment sector which has accounted for half of the growth in global demand for

manufactured products in the 10 years leading up to the crisis, Europe has been heavily hit by

this situation. Since the beginning of the nineties, the portion of GDP contributed by industry

has decreased by between 5% and over 10%, depending on the country, while per-capita

growth in the value-added of the industrial sector has collapsed across the board.

While the most diversified economies have been able to partly compensate for these losses

through the development of services or through construction, particularly during the 15 years

of exuberant growth in the financial sector, Europe s structural growth potential has

substantially declined since the beginning of the 1980s, a trend that has become even more

worrying after the financial crisis, when the possibility of compensating these industrial losses

through tertiary activities looks to be largely compromised. This has understandably led to

growing pessimism over the outlook for Europe, as is reflected almost daily in downbeat

economic forecasts.

Chinese market share in global exports of manufactured goods, % in dollars


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23 March 2011 7

Contribution of the manufacturing industry to GDP, current prices in %

Contribution of finance and corporate services to GDP, current prices, %


However, the change in China’s influence on the international scene could be strong

enough to pull European industry away from a trajectory that has up until now been

considered unavoidable. After more than two decades of industrial decay during which the

developed countries came to rely on a single services sector as their main source of value

creation, the changes that are currently under way on the international scene are overturning

the established order.

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23 March 2011 8

China: from an export machine to a consumption machine

The development of

Chinese consumption has

absorbed all the efforts of

the ruling class since the

crisis erupted with

implications that are so

profound that they are

difficult to anticipate. With

the Chinese economy being

ripe for such a change,

economic policy momentum

is producing rapid and

spectacular effects on many

levels. Thus the Chinese

automotive market, barely

the size of the French

market 10 years ago, is now

nine times larger than the French market, and growing at a rate of more than 19 million

vehicles per annum, according to the latest figures. Today, the world’s largest automotive

market, China looks set to become the largest market for an increasingly large range of

products.

This new environment is already having very significant effects on the global climate.

According to our estimates, growth in consumer spending in emerging countries exceeded

the level recorded by the developed countries by 40% in 2010, with Chinese consumer

demand alone estimated to have equalled that of the US in terms of contributions to global

consumption growth.

Breakdown of global consumption in 2010, current $ Contribution to annual consumption growth in constant $ of 2008


Unsurprisingly, in this hierarchy we are once again struck by the export performance of the

European countries over the last 24 months of economic recovery, during which exports to

Otheradvanced

EMU

USA

Jap.

Brazil

India

China

Other EM

250

50

150

350

550

750

950

1150

1990 1995 2000 2005 2010

650

China

otherEM

USA

otherindus.

475

Car registrations


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23 March 2011 9

China have constituted the biggest almost the sole contributor to export growth in the

eurozone.

Extra EMU export breakdown of the eurozone


Chinese middle class set to double by 2015 Despite the progress already made, this rebalancing of Chinese consumption is probably still

only in its early stages. The increase in revenues, combined with relentless urbanisation and

major changes in the demographic structure of the country in recent years, has led to a

considerable rise in the Chinese middle class, and all indications suggest that this trend will

accelerate over the coming years (see report by Wei Hao Prosperity for the Proletariat or

Inflation for the Nation , published in October 2010).

Investigations on the subject carried out by the major research institutes mostly indicate a rise

to around 500 to 650 million people by 2020/25. However, with the definition of middle class

varying quite considerably, and verging on fantasy in some cases, we have tried to define the

income threshold at which changes in consumer behaviour become most marked. The

analysis we have carried out on the annual surveys conducted by the Chinese national bureau

of statistics (NBS) suggests that the most significant changes occurred when per-capita

income exceeded 16,000/18,000 yuan p.a. in 2008, which is equal to $2,450-2,650 at present.

When expressed in terms of purchasing power parity, based on an exchange rate of

3.8 yuan/USD in 2008 according to the IMF, this threshold equates to income of $4,200-4,700.

In 2008, 40% of the Chinese population fell into this category, characterised by average

disposable income of 27,000 yuan and average consumption expenditure of 17,900 yuan,

which is respectively 72% and 60% higher than the urban population as a whole. The

difference in the behaviour of the middle income category, compared with the low-

income population, is considerable, both in terms of savings and consumption.

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The middle classes account for 75% of Chinese household savings… The propensity to save is much higher among the more well-off segments of the population,

than among the lower income categories, with the apparent savings rate ranging from less

than 5%, among the poorest urban households, to more than 38% for the wealthiest 10%.

Thus a large part of the steady rise in the Chinese household savings rate over recent years

can be explained by changes in demographic structure and the improvement in living

standards.

…and 60% of urban consumer spending Consumer spending patterns vary significantly across the different revenue brackets. Above

the threshold that we consider to be middle class, the level of household equipment

ownership (e.g. refrigerator, colour television, telephone, etc.) is generally 50% higher than for

the lower income categories. Meanwhile, vehicle ownership is 30 times higher and air

conditioning/heating system ownership is 8 to 10 times higher, etc. (see overleaf). Aside from

the changes highlighted by the analysis of mass expenditure studies which essentially point to

a reduction in the proportion of the household budget devoted to food, in favour of transport

and telecommunications, the growth of the middle class has brought about a

considerable increase, as well as diversification, in demand for consumer goods and

services, which is fundamentally changing the needs of the Chinese economy and the

way in which it functions.

Breakdown of consumer spending for the less well-off urban households (1st decile) - 2008

Breakdown of consumer spending for the wealthiest 40% of urban households - 2008


Food48%

Clothing9%

Residence12%

HouseholdFacil ities,Articles andServices

4%

Health CareandMedicalServices

7%

TransportandCommunication

s8%

Education,CultureandRecreationServices

9%

MiscellaneousGoods andServices

3%

Food34%

Clothing10%

Residence10%

HouseholdFacil ities, Articles

and Services7%

Health Care andMedical Services

7%

TransportandCommunications

15%

Education,CultureandRecreationServices13%

MiscellaneousGoods andServices

4%

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Urban households’ per capita living expenditure breakdown by income group relative to average, in yuan (bars) and as % of total expenditure (RHS)


4,533 6,195 7,99410,345

13,31717,888

26,982

0

5000

10000

15000

20000

25000

30000

Firstdecile Seconddecile

secondquintile

Third quintile Fourthquintile

Ninth decile Tenth decile

Total consumptionexpenditure,yuan

0

20

40

60

2000

4000

6000

8000Food

0

5

10

15

0

500

1000

1500

2000

2500Clothing

0

5

10

15

0

1000

2000Residence

0

2

4

6

8

0

1000

2000HH facilities, articles and services

0

5

10

0

1000

2000Health care andmedical services

0

5

10

15

20

0

500

1000

1500

2000

2500Transport& communication

0

5

10

15

20

0

1000

2000Education, culture, recreational

This chart is based on survey results published by the Chinese National Statistics Bureau showing the breakdown of household spending by income group. The x axis shows average per capita spending for the entire population while the bars show the breakdown by income category. For example, transport & communication spending averages 1,358 yuan per capita per year for urban households as a whole, 424 yuan for the 10% lowest income category and 3,959 yuan for the wealthiest 10%. The right hand scale shows the percentage of total household spending represented by each item for each income group, amounting to respectively 8% (lowest income group) and 18%(highest) in the transport & communication example.

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23 March 2011 12

A middle class of four hundred million consumers by 2015 Based on the revenue growth projections and the expected development of the urban

population (from 600 million today to 700 million in 2015, assuming an inflexion in the

urbanisation trend in line with current government objectives), the middle class population is

expected to grow considerably over the next few years. According to our estimates, this

category will double between now and 2015, from 180-210 million people in 2008, to 380-

420 million. It is therefore expected to account for more than 60% of the urban

population within five years.

Annual growth in disposable income/cap, % Urban population repartition by income levels, 2008 and 2015 projections

Source: SG Cross Asset Research The above chart shows the estimated proportion of the middle class as a % of overall urban population. The shift to the right of the crossing point between the different areas and the grey line (between lower income population and middle class indicates the increasing share of the middle class.

Sharp rise in demand The implications of these anticipated developments are considerable.

Increase in savings capacity First and foremost the Chinese household savings rate should continue to be driven up by the

progression of an increasing proportion of the population towards the categories that have a

particularly high propensity to save.

Alongside the rapid increase

in the retired population

whose appetite for assets is

generally very high, this

trend should, all else being

equal, continue to fuel very

robust growth in demand for

savings instruments which,

in the event of inadequate

supply, is likely to turn

excessively towards other

available (reachable) assets,

particularly real estate.

3

1

1

3

5

7

9

11

13

15

78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14

Known

High Hyp.

Low hyp.

0

10000

20000

30000

40000

50000

60000

70000

80000

10095907050302010

low income class

upper income class

% of urban population

Annual income range/cap., yuan

2015

2008

High hyp.

Low hyp.

Population of 45-65 year olds as % of total


10

12

14

16

18

20

22

24

26

28

30

1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050

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23 March 2011 13

Breakdown of savings and consumer spending by income bracket – 2008-2015


Doubling of consumption, tripling of demand for household equipment Nevertheless, the most significant impact these changes are expected to have is on consumer

demand. Assuming expenditure remains constant in relation to standard of living, we estimate

that urban consumption would grow by 80% to 100% in real terms between now and 2015.

The increase will however be a lot more significant in certain specific categories of goods. The

progression of an increasing proportion of the population towards the levels of revenues that

correspond to the middle class should in particular lead to a considerable increase in demand

for household equipment, with our estimates suggesting an increase of 140% to 180% per

head, which corresponds to a potential increase of 180-220% on a national level. While

growth in expenditure on clothing, healthcare, education and leisure looks likely to be less

spectacular, at around 50-80% per head based on our preferred scenario, it nevertheless still

looks set to grow by 80-100% overall by 2015. Finally, while the food sector and transport and

communications look likely to see the least growth, they should nevertheless still record

increases of 70% and c. 50% respectively, based on current prices.

Growth in revenues and consumer spending of the urban population per capita and in total between 2008 and 2015, % Projections based on the SG central scenario* Risk scenario

Source: * see SG Monthly Country Notes – Staggered Policy Exits; SG Cross Asset Research

0

20000

40000

60000

80000

100000

120000

140000

2008 2015 2008 2015

10th dec.

9th dec.

4thQ.

3rdQ.

2ndQ.

2nd dec.

1stdec.

Savings

Consumption

0 50 100 150 200 250

Average Disposable income

Total Consumption Expenditures (yuan)

Food

Clothing

Residence

Household Facilities, Articles and…

Of which DurableConsumer Goods


Transportand Communications

Education, Culture and Recreation…

Population

Ofwhich urban

Per cap.

Total urban

%

0 50 100 150 200 250

Average Disposable income

Total Consumption Expenditures (yuan)

Food

Clothing

Residence

Household Facil ities, Articles and…

Of which DurableConsumer Goods


Transportand Communications

Education, Culture and Recreation…

Population

Ofwhich urban

Per cap.

Total urban

%

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Auto… market set to double in size by 2020 As living standards have improved, the Chinese auto market

has enjoyed spectacular growth in recent years. At 19 million

vehicles, it has become the world s largest market in less than

10 years, and is now significantly larger than the American or

European markets. However, despite this growth, the market

is still a lot smaller than can be envisaged long term. With a

fleet of 125 million vehicles, according to our estimates, or a

vehicle ownership rate of 70 for every 1,000 inhabitants, the

Chinese market is still well away from achieving a level that

can be considered as the start of standardisation. By

comparison, having been at a similar level as China today in

the early 1990s, vehicle ownership in South Korea and Brazil

had risen to 250 and 200 respectively per 1000 inhabitants by

2007.

If we assume that the increase in the vehicle ownership rate

observed over the last 10 years were to continue to 2020, an

assumption that is probably over-conservative, the number of

vehicles for every 1000 inhabitants would reach 170, which

implies a doubling in the market (260 million) and corresponds

to average annual growth of 18 million vehicles, a level already

achieved in 2010. Under a more optimistic scenario that

extends the trend seen over the last five years, the Chinese

automotive market would exceed 300 million by 2020, to

reach a vehicle ownership rate of 270/1000.

Change in vehicle ownership rate


Chinese capacity is far from being developed enough to cope

with this explosion in demand. While capacity was believed to

be in excess prior to the crisis, the recent acceleration in sales

leaves no doubt: the existing and planned production capacity

cannot match the anticipated demand. In 2009 the OECD

estimated that the sector would be 45% short of the required

capacity by 2015.

Emerging market demand now represents the auto

market’s only growth source

The rapid development of car sales in the emerging market

represents a genuine growth opportunity for the entire auto

sector. In the medium term, with the outlook for the mature

markets being as it is, growth will depend mainly on the

development of new markets, justifying the production and

commercial capacity that is being established in the emerging

markets by the major auto manufacturers.

Already in 2010, 53% of light passenger vehicle sales were

generated outside of the mature countries, compared with

38% in 2006. The portion represented by China stands at

24%, compared with 10% five years ago. Based on 7%

growth per annum over 2010-2020, with more buoyant growth

of 10% per annum over 2011-2015, the emerging markets

should account for close to two-thirds of global demand by

2020, with China representing 35%, well ahead of North

America (17%) and western Europe (20%).

Growth is being driven by the emerging markets – sales registered by the European automotive market, 000s


If we take a closer look we can see that the luxury market,

driven by the development of the middle classes, is likely to

remain stronger. The portion of total sales represented by the

luxury car segment remains low in comparison to mature

countries, and the catch-up effect is likely to continue. In

China for example, the luxury car market accounts for around

5% of the total, compared with 15% to 20% in the rest of the

world. A partial catch-up would justify growth more than 50%

higher than the level realised by the auto market as a whole in

the medium term, with the German manufacturers remaining

the best positioned in this niche.

0

50

100

150

200

250

97 99 00 01 02 03 04 06 07 08 09 10 11 13 14 15 16 17 18 20

Vehicles /1000 inhabitants

Trend observedover last 10 years

Trend observed overlast 5 years 0

20 000

40 000

60 000

80 000

100 000

120 000

North America

Western Europe

Japan

ROW

of which China

TOTAL

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23 March 2011 15

Proportion of premium models in total sales


There are two main risks to this scenario:

Political decisions or economic policy measures, which

could be introduced to rapidly slow consumption. Although

such measures could trigger a temporary decline, they

probably wouldn t change the 5-10 year growth outlook.

Stronger local competition in China. Local players are

currently focused on entry-range models. The risk is that they

will enter the mid-range hence the need to rapidly

consolidate positions. As usual, the real luxury market

(German cars) is beyond the reach of new entrants.

Structural change in margins (profitability)

The results achieved in these regions are generally high

following the initial start-up phase, a trend which tends to

increase the long-term profitability of the car makers.

Maintaining high margins in the emerging markets should lead

to better long-term results.

Financial analysis needs to play close attention to the various

levels of results here. Note that in China the carmakers cannot

own more than 50% of a Chinese company. This means that

they are obliged to set up joint ventures with local partners

and that they cannot fully consolidate this business in their

accounts. It is therefore necessary to look for their

contributions:

At the EBIT level, for exported vehicles and also parts sent

over for local assembly. BMW generates nearly 13% of its

volumes in China, i.e. 187,000 vehicles, and around 18% of

its revenues (SGe) which are largely derived from the export

of assembled vehicles (two-thirds in 2010) with a very high

product mix and a significant amount of parts sent over for

assembly. We estimate that China accounts for at least a

third of the group s EBIT, whereas the result posted by the

local joint venture currently seems very low.

In the equity associates line of the results (portion of net result

of local companies) which can be very high. For example,

Volkswagen sells 27% of its volumes in China, i.e. 1.9 million

vehicles, through two joint ventures that are very well

integrated locally (VW, Audi and now Skoda brands). Although

the group announced that it exports 600,000 engines and

gearboxes to China, the bulk of the earnings are generated by

the joint ventures. The portion of operating income retained by

VW was reported at 1.9bn, based on a double-digit margin in

2010.

Overall, for the German companies which are the most directly

exposed, the Chinese contributions have exceeded all targets,

going a long way to explaining why the 2010 results were

much higher than expected. Aside from local volume-price

effects alone, emerging market demand has helped to

saturate production units in a cost-cutting environment, and to

reinforce the pricing power of the better players. Thus in 2010

the published results were in line with previous cycle peak

levels before the traditional markets had even seen revenues

return to normal.

French brands gradually more visible

The performance of the French car manufacturers has also

significantly improved. China accounted for 376,000 units

sold by PSA in 2010, i.e. over 10% of total volumes,

representing an increase of 38%. The contribution of the

Chinese JV to the PSA s net income rose from 57m to

159m (14% of the total). As part of its strategy to reinforce

its presence in China, PSA plans to open a third production

unit in 2013 and has signed an agreement for a second joint

venture. Meanwhile, Renault has a limited direct presence in

China, barring a few exports from Korea. While Renault s

results remained weak in 2010 (operating margin of 2.8%),

43%-owned Nissan s contribution to the group s net income

rose from a loss of 0.9bn to a profit of 1.1bn. Over the last

12 months, Nissan generated a quarter of its sales, nearly

one million units (+40%) in China, while achieving a strong

margin of more than 8%.

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

0

200

400

600

800

1000

1200

1400

1600

1800

2009 2010 2011 2012 2013 2014 2015

Premium segment ('000 units)

part of total market (%)

B33374

The new Chinese landscape : a chance for Europe

23 March 2011 16

Market development, 2006-2020


Portion of the major carmakers’ results derived from China

(€m) Revenues EBIT Net income

Volkswagen 2010 estimates (March 2010)

106,300 2,570 1,575

In reality 128,675 7,141 6,835

BMW 2010 estimates (March 2010)

54,300 1600 1010

In reality 60,477 5,094 3,224

Daimler 2010 estimates (March 2010)

82,450 2,970 1,700

In reality 97,761 7,274 4,500

PSA 2010 estimates (March 2010)

51,770 905 605

In reality 56,060 1,736 1,134

Renault 2010 Estimates (March 2010)

34,550 730 620

In reality 38,971 1,099 1,420


Only a partial rerating has occurred so far

Thanks to the frequent earnings forecast upgrades, the auto

sector gained 50% in 2010, with the best players

(Volkswagen, BMW) up close to 90%.

Revenue multiples (EV/sales) have hardly risen above the

levels observed in March 2010 for the full-year estimates. They

merely take into account the current data. Meanwhile the

sector continues to trade at a low level in terms of earnings

multiples (P/E, EV/EBIT, EV/EBITDA), below the historical

averages of the companies concerned. We see two reasons

for the market caution:

On the one hand, the multiples applied to the emerging

markets have returned to normal levels (e.g. P/Es of around

10x) after having reached levels of 14x to 20x in the past.

On the other hand, investors are worried about the strength

of the results achieved in the new markets, which are less

cyclical than the mature markets but more volatile and more

sensitive to political decisions. The market seems be applying

an informal discount to the reported numbers.

Overall, after a period of scepticism the growth that we project

for these regions should convince the market that the results

currently being achieved are sustainable. In this context, our

preferred stocks remain Volkswagen and BMW, and then

Peugeot SA with the management making efforts to step up

expansion outside Europe (China, Russia and South America).

Philippe Barrier (33) 1 42 13 84 42

2006

N. AmericaW. EuropeJapanROW

2010 2020



B33374

a chance for Europe

23 March 2011 17

Danone… or the westernisation of dietary lifestyles

While China featured in the group s top three markets in 2007

(more than 10% of sales), problems with Wahaha

considerably reduced its exposure. The group has now

successfully recovered on its own in each of its segments. In

2010 China represented the 10th largest market (4% of

sales).

With a very old-fashioned approach to health, China is almost

a perfect market for Danone whose aim is to bring health to

the masses through better eating. Danone is present in China

in all three of its businesses: dairy products, water and infant

nutrition. Urban Chinese consumers, whose purchasing

power is steadily growing, and especially the under-30s and

the only-child generation, are increasingly favouring high

value-added products.

In terms of consumer behaviour and taste, China represents

a whole mosaic of different markets. The country is made

up of 30 autonomous regions and provinces with

populations sometimes exceeding 90 million (equivalent to a

country the size of Germany). Today more than 110 towns

have more than a million inhabitants. All in all, this calls for

powerful distribution networks, especially with traditional

retailers (small family-owned stores) still accounting for 70-

75% of sales.

Having built up 22 years of experience in the country, Danone

has adopted a step-by-step approach and adapted to the

specific features of each of these markets.

Danone s strategy in China is symbolised by three brands:

Dumex is China s leading super-premium brand of baby milk.

Twenty million children are born each year in china. The only-

child status elevates these children to the king of the family

which demands only the best products. The super premium

baby milk segment is the largest (40% of the market) and it is

this segment which drives the market. Following the recent

melamine scandal involving Chinese milk (2008), Chinese

mothers now tend to favour foreign products which were not

affected by the scandal. This is Danone s largest business in

China (>60% of sales).

The success of Dumex can be attributed to a dynamic sales

team but also to the independent distributors which reach out

to the 550 million urban Chinese people. The group is

extending its presence in the premium segment with its

Bébélac brand which has been launched in eight provinces.

Mizone (flavoured and vitamin enriched water) is driving the

group s growth in the Chinese bottled water market (35% of

sales). In a country where bottled water is still mostly

consumed outside the home, Danone has chosen to focus on

execution quality (marketing policy with campaigns on local

television channels). The group has so far only reached 600

million Chinese people, covering 14 provinces with a

presence in 300,000 points of sales. Its portfolio includes

Health and Evian (mineral water), Robust (purified water) and

Aquarius (HOD, Shanghai).

Consumption of food products, kg/person/year (red 2005, grey 2009)

Sources : Euromonitor, SG Cross Asset Research

Danone: geographical breakdown of sales (2009)


0

10

20

30

40

China Rus. USA Ita. Fra. NL

Yoghurt

0

20

40

60

80

100

120


Baby f ood

0

10

20

30

40

50

60


Milk powder (6 -36 months)

France11%

Other westernEurope9%

Spain8%

Germany5%UK

5%US8%

OtherAmericas

2%

Russia11%

Mexico5%

Indonesia5%

China4%

Argentina4%

Otheremerging

21%

Other developedcountries

2%

B33374


23 March 2011 18

Bio (Activia in Europe) carries the flag for the fresh dairy

products, in a country where milk consumption is strongly

encouraged by the authorities. This government initiative is

aimed at getting Chinese people to grow. It is true that eating

habits have a direct impact on the height of an individual. In a

Japanese family living in the United States it only takes a

single generation for family members to achieve a similar

height to the Americans. However, milk does not feature

heavily in Chinese cuisine. Children stop drinking milk at a

very young age when their digestive systems are not yet fully

grown. Thus, given that most adults are unable to digest milk

(lactose intolerance), dairy products (fermented milk

products) represent the best solution for increasing milk

consumption. Danone s development potential is very strong.

Based on its experience with Bright Dairy, the group started

out in the Shanghai and Canton regions. Bio is positioned in

the health niche (publication of a clinical study showing the

benefits of Bio for women suffering from constipation); while

it is estimated that 70% of Chinese people suffer from

digestive problems. Through its R&D centre in Shanghai, the

first to be opened by the group in Asia, Danone s researchers

are adapting the products to local tastes. The Bio range

therefore includes a variety of different flavours vanilla, nut,

aloe vera, etc and is altering the way in which yoghurt is

eaten in China, i.e. with a spoon, as opposed to with a straw

which is how it is traditionally consumed in the country. Bio is

the most dynamic brand in the digestive comfort segment,

which by itself accounts for 30% of the market, thanks to

considerable investment in advertising.

Danone has also expanded its presence in clinical nutrition,

its fourth business. The group has begun with enteral feeding

systems (nutrition delivered directly into the stock via a tube,

48% market share). The group s teams are working in close

partnership with the scientific community and the medical

profession to respond to consumer needs in this domain.

There is little doubt that Danone will continue to achieve

strong growth in this market.

Joseline Gaudino (33) 1 42 13 84 32

B33374


23 March 2011 19

China is losing grip – the unprecedented level of competition of the past decades has now gone

These changes are nothing new. We have ourselves largely anticipated them and detailed

their potential consequences for global consumption in the medium term. What is new is the

speed at which this transition is taking place. There is no doubt that neither China nor all of the

Asian countries combined would have the capacity to respond to such an increase in demand

at the rate at which it is taking shape. The faster the improvement in the standard of living, the

higher consumer demand is for quality and the higher the appetite is for branded products.

Thus the additional Chinese demand, which we had previously expected to be of limited

benefit to the developed nations, offers new opportunities based on the current

conditions.

From international hyper-competition to an asymmetrical demand shock Refocusing of Chinese manufacturers on their own market With a thriving domestic economy, Chinese companies no longer need to look beyond their

own borders to grow and seem to have already started to refocus on the home market. In

order to prevent bottlenecks the Chinese government has also recently eliminated a certain

number of export subsidies that were previously granted to companies. Their capacity to

conquer new market share in the developed countries has also gradually eroded as a result of

the increase in production costs and the rising quality requirements set by western

consumers. The period in which each new day brought consumers the world over a host

of new low priced products to replace their existing ones has now gone, and with it the

hyper-competitive conditions that came to characterise the last two decades.

The boom in Chinese demand seems to have already triggered a significant reduction in

international competitive pressure on European companies, a trend reflected both in the

export markets and on the domestic market.

EU 27 export prices of manufactured goods, indices EU 27 import prices of manufactured products by origin


B33374


23 March 2011 20

Thus, not only did global trade of manufactured products become tight between 2005 and

2008, but also, in spite of the impact of the crisis on demand, prices returned to their upward

trend very soon after the crisis. In this respect, the recovery in EU27 import prices of

manufactured products, regardless of whether they were of American, Japanese or Chinese

origin, is quite surprising. Another unexpected trend is the price increases implemented by

exporters on most of their markets, notably the Chinese market, which indicates a very

marked recovery in pricing power.

China’s grip has already weakened, and so too has the extraordinary level of

competitiveness that has characterised the global trade environment for the last 20

years. This constitutes an unexpected opportunity for European industry which still

accounts for a large portion of global manufacturing capacity.

European industry: a good deal has survived! In 2009 the eurozone still represented 35% of global manufactured goods exports. Europe as

a whole, including the Scandinavian countries and the UK, supplied up to 40% of international

demand.

Breakdown of the global manufactured goods market, 2009, %


Regardless of the business sector, eurozone manufacturers still hold prominent positions in all

regions in terms of world trade, representing:

More than 30% of global exports of industrial equipment, a sector that itself accounts for

more than 50% of global trade in manufactured goods;

More than 50% of the global chemicals market the weight of which was equal to more

than a sixth of all manufacturing exports in 2009;

More than 40% of all international automotive exports and over 35% of the global iron

and steel markets, with each recording considerable rates of expansion;

Others: 9.9

Brazil: 0.8Russia: 0.8

India: 1.4

ChinaMainland: 14.9

Hong Kong: 4.0

Jap.: 6.7

S. Korea: 4.3Ger.: 12.8

Fra.: 5.1

Ndl: 4.1

Bel.: 3.8Ire.: 1.3

Ita.: 4.5Spa.: 2.1

Por.: 0.4

Fin.: 0.7

Swe.: 1.4Den.: 0.8

UK: 3.4

USA: 10.6

Canada: 2.1

EMU : 34.8%

B33374


23 March 2011 21

25% of global textiles and clothing exports, sectors that have been by far the hardest hit

by increasing competition from new Asian producers since the beginning of the 1980s, in

which the positioning of certain countries, Spain in particular, has nevertheless improved over

recent years.

Thus the European countries could actually be far better positioned than is generally

perceived, to benefit from a new economic order which should bring an increase in

opportunities and a simultaneous easing of competitive pressure, to allow stronger

profitability and a recovery in market share, both at export and in the domestic markets.

Market shares in the main global manufactured products sectors (weight of the sector in terms of global exports of manufactured goods as a % in 2009)

Source: SG Cross Asset Research, EMU5

0%

5%

10%

15%

20%

25%

30%

35%

40%

1995 2000 2005

Machinery & transport eqmt (52%)

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

1995 2000 2005

Textile (2%)

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

1995 2000 2005

Clothing (4%)

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

1995 2000 2005

Auto (10%)

0%5%

10%15%20%25%30%35%40%45%50%55%60%

1995 2000 2005

EMU ow ger.

USA BRICs

Jap. S. Korea

Chemicals (16%)

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

1995 2000 2005

EMU ow Ger.USA BRICsJap. S. Korea

Iron & steel (3%)

B33374


23 March 2011 22

Seb The Chinese experience from one decade to the next Seb provides a good illustration of the change in the

functioning and influence of the Chinese economy vis-à-vis its

competitors. The small electrical household appliance market

was hit hard by competition from China and the enormous

number of 5 products that swamped the market at the

beginning of the 2000s. In 2003 the group mentioned in its

annual report that the weakness of the dollar had penalised

its competitiveness on the international level and favoured

growth in entry-range products manufactured essentially in

Asia .

Seb: Gross margin and $/€ trends

Sources: Seb, Datastream

Various companies found different ways of dealing with this

new competition. Most American and some European

companies chose to outsource their production and negotiate

with the Chinese manufacturers for their finished products. By

contrast, Seb decided to concentrate on the core and

upmarket segments where innovation rather than price is the

differentiating factor. Nevertheless the group was still forced

to conduct a major restructuring programme in its

manufacturing activities. Between 2002 and 2009, Seb

devoted 65m in revenues p.a. to restructuring or asset

depreciation.

This policy enabled the group to retain a large proportion of

its production in Europe (40% of total production) based on

highly satisfactory profitability conditions (the Rumilly

production unit manufactures 40 million saucepans, frying

pans and casserole dishes each year). This European

production aspect allows the group to stand out in the

industry as the last of the Mohicans as its chairman, Thierry

de la Tour d Artaise, likes to say.

Seb nevertheless also reinforced its presence in China when

the opportunity arose. The acquisition of Supor, negotiated in

August 2006 and finalised in August 2007, ranks as one of the

group s major transforming deals, alongside Rowenta, Arno,

Moulinex and All Clad. The Chinese cookware company has

market leading positions in the local small electric household

appliance market (no.4 in 2007, no.2 today) and has seen its

revenues triple since 2007. Supor still offers various synergies

as the Chinese middle class develops, generating new

consumer needs.

Seb: production capacity by region


Currently the second most important market in terms of

revenues (13% behind France which accounts for 19%),

China will most probably become the group s largest market

before long. Small electric household appliance penetration is

still very low in China, at 10 times lower than the level

observed in the developed countries. In China and in the

emerging markets in general, the sector is on the verge of a

very strong surge in development, similar to that seen in the

developed countries in the 1960s (growth of 11% p.a. in the

French market between 1959 and 1973). The Chinese small

0.50

0.60

0.70

0.80

0.90

1.00

1.10

1.20

1.30

1.40

38.0%

39.0%

40.0%

41.0%

42.0%

43.0%

44.0%

45.0%

46.0%

Gross margin $/€

Sourced products; 30%

Europe; 40%

China; 20%

SouthAmerica; 8% US; 2%

Sales of small household electricals, France

Source: INSEE

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

-1000

-500

0

500

1000

1500

2000

1959 1966 1973 1980 1987 1994 2001 2008

Consumption: small hhold elecs (€m in € 2000 terms), LH scale% change, RH scale

+5% p.a.+3% p.a.+11% p.a.

B33374


23 March 2011 23

electrical household appliance market currently consists of

rice cookers, pressure cookers and soya milk extractors but,

with Seb s help, Supor is gradually expanding its offering into

kettles and blenders, and hopes in time to introduce irons and

vacuum cleaners.

The development of the Chinese subsidiary has led the group

to invest heavily in its production capacity. We estimate that

the group has invested around 60m in its production sites in

China and effectively doubled its production capacity. By

2012 the Chinese production sites should have reached a

capacity of 70 million units (vs 100 million for the European

sites), which means that the proportion of total production

represented by China (currently 20%) is expected to steadily

grow.

Aside from the period in which the company was rocked by

emerging market crisis, Seb stands out for its good record in

terms of underlying EBIT (see graph on next page), having

recorded steady growth of 7.9% p.a. on average, compared

with 6.7% growth at the top-line, between 1995 and 2010. In

our view this growth reflects the group s capacity to generate

value added through innovation regardless of competitive

pressure, changing consumer spending trends, currency

movements and rising raw materials costs.

By contrast, EBIT, excluding restructuring charges and other

non-current charges, has been rather erratic, with growth

(+2.3% p.a. on average between 1995 and 2010) falling short

of the level recorded at the top line.

Meanwhile Seb s valuation multiples over this period have

tended to track the volatile EBIT trend, rather than the

underlying EBIT trend. The stock performance has therefore

reflected the market s fears surrounding the industrial

challenges faced by the group as a result of competition

from China.

Between 2006 and 2007, after the announcement of the

Supor acquisition, the stock entered a rerating phase, but

this was quickly reduced to nothing by the crisis and fears

over consumer spending.

In 2010 the group exceeded all initial estimates, recording

15% growth in revenues and 9.6% growth at constant

exchange rates.

The group s emerging market exposure (44% of 2010

revenues) currently represents a growth driver, with the

emerging countries generating top-line growth of 18% like-

for-like, compared with 4% for the developed nations. China

is recording growth of around 32%, Brazil 13% and Russia

12%. In 2010 the group improved its margins despite having

implemented price reductions on certain markets and a very

high level of investment in R&D, advertising and commercial

development.

Seb s valuation multiples have therefore risen back to their

2006/2007 levels, but they are still not at the levels observed

prior to the 2001 era.

Marie-Line Fort (33) 1 42 13 85 21

Seb: historical valuation multiples

Source: JCF-Factset

Seb: overview of long-term financial performance

Source: Seb

0.5

0.7

0.9

1.1

1.3

1.5

1.7

4.0

6.0

8.0

10.0

12.0

14.0

16.0

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

EV/EBIT (LH scale) EV/EBITDA (RH scale) EV/sales (RH scale)

Emerging market crisis Competition from Asian products Acquisition

of Supor

“Emerging market”rerating

0.050.0100.0150.0200.0250.0300.0350.0400.0450.0

0.0

500.0

1000.0

1500.0

2000.0

2500.0

3000.0

3500.0

4000.0

1995199619971998199920002001200220032004200520062007200820092010

Sales EBIT Underly ing EBIT

Emerging market crisisCompetition fromAsian products

Acquisitionof Supor

Emerging countries,growth

accelerator

B33374


23 March 2011 24

Shift in Chinese demand: from yesterday’s champions to the beneficiaries of tomorrow

The effects of this accelerated transition are difficult to predict, such is the impact they have

on the global economic scene. But how can Europe, with all its industrial potential, do

anything other than draw immense benefit from this future demand in a context that is

moreover a lot less competitive?

Exports to China rose by 20% per annum between 2001 and 2009 Between 2001 and 2009 exports from the six main EMU countries to China increased by more

than 20% per annum on average, more than twice the level of growth in exports to the rest of

the world (8.4%). The support represented by Chinese demand over these nevertheless very

difficult years in terms of competition and exchange rates was therefore already significant.

Momentum that has benefited all European countries… Contrary to received wisdom according to which only Germany has benefited from this trend,

the next graph shows that all European countries have been enjoying strong growth in

business with China,

even though their

presence on this market

may be markedly weaker

than Germany s. Thus,

average annual growth in

exports to China reached

27% in the Netherlands,

22% in the case of

Germany, but also 23%

in Spain, 19% in

Belgium, 18% in France

and more than 15 % for

Italy and the UK.

…and many sectors The industries that have benefitted from strong growth in business with China also turn out to

be far more varied than might often be believed. Aside from industrial machinery and

electrical/electronic goods, which still account for almost half of all EMU exports to China and

therefore represent the lion s share, the sales profile is actually very diversified.

Between 2001 and 2009, clothing exports from the eurozone grew at an average annual

rate of 29%, with 50% annual growth for Spain, 31% for Italy and 24% for France.

Growth in exports to China and ROW between 2001 and 2009, CARG, %, USD


0%

5%

10%

15%

20%

25%

30%

Ger. Fra. Ita. Ndls Bel. Spa. EMU 6 UK Swe. USA

To China

To RoW

B33374


23 March 2011 25

Average annual growth in exports to China and to the rest of the world, % p.a. in dollars


Meanwhile, Agrifood sales have increased by 30% per annum, with France and Italy

observing growth in excess of 35%;

Pharmaceuticals sales have grown by 32% per annum on average, with +38% for the

Netherlands, 34% for France and 31% for Germany.

0%5%

10%15%20%25%30%35%

Agriculture,liveanimals,

mea

t,freshfood

Processedfoods,

beveerages,tob

acco

Fuels&chem

icals

Tann

ing,essentialopils,

perfum

es,cosmetics,

soap

s

Leathera

ndleather

good

s,skins,furskins

Woo

d,pu

lpofwood,

cork,pap

er,books

Textile

s

Appa

reland

footwear

Basicmaterials,cem

ent,

glass,iro

n&steel,

precious

Machine

ry,electrica

ndelectroniceqmt,nuclear

reactor

Tran

sport,railw

ay,

aircraft,spacecraft,

ships,boats

Furniture,prefabricated

build

ings

Others

Germany

China

RoW

5%0%5%

10%15%20%25%30%35%40%


mea

t,freshfood

Processedfoods,

beveerages,tob

acco

Fuels&chem

icals

Tann

ing,essentialopils,

perfum

es,cosmetics,

soap

s

Leathera

ndleather

good

s,skins,furskins

Woo

d,pu

lpofwood,

cork,pap

er,books

Textile

s

Appa

reland

footwear

Basicmaterials,cem

ent,

glass,iro

n&steel,

precious

Machine

ry,electrica


reactor

Tran

sport,railw

ay,


ships,boats


build

ings

Others

France

5%0%5%

10%15%20%25%30%35%40%


mea

t,freshfood

Processedfoods,

beveerages,tob

acco

Fuels&chem

icals

Tann

ing,essentialopils,

perfum

es,cosmetics,

soap

s

Leathera

ndleather

good

s,skins,furskins

Woo

d,pu

lpofwood,

cork,pap

er,books

Textile

s

Appa

reland

footwear

Basicmaterials,cem

ent,

glass,iro

n&steel,

precious

Machine

ry,electrica


reactor

Tran

sport,railw

ay,


ships,boats


build

ings

Others

Italy

0%5%

10%15%20%25%30%35%


mea

t,freshfood

Processedfoods,

beveerages,tob

acco

Fuels&chem

icals

Tann

ing,essentialopils,

perfum

es,cosmetics,

soap

s

Leathera

ndleather

good

s,skins,furskins

Woo

d,pu

lpofwood,

cork,pap

er,books

Textile

s

Appa

reland

footwear

Basicmaterials,cem

ent,

glass,iro

n&steel,

precious

Machine

ry,electrica


reactor

Tran

sport,railw

ay,


ships,boats


build

ings

Others

EMU 6

B33374


23 March 2011 26

China set to become Europe’s leading export market by 2020 Quite apart from the effective size of the Chinese market, it is its growth momentum which

looks set to completely transform the structure of the European export market. If we were to

assume that growth in exports to China will remain at the level seen over the last 10 years,

which is undoubtedly a minimalist scenario in view of the development of Chinese demand,

China would absorb up to 9% of Europe’s exports in 2020, making it the largest export market

for the eurozone. In the case of Germany, this proportion would reach 15%, i.e. by far the

highest level among the European countries. At the same time, the level could also approach

8% in the case of France and the UK, which is still three to four times higher than the level

observed in 2009.

Share of exports to China in the different sectors of country’s exports, % in USD, 2009


Beyond the indisputable domination of the transport and aerospace industries which, all else

being equal, could derive up to 30% of their revenues from China by 2020 45% in the case

of Germany and 27% for France in the capital goods and steel industries, China would

account for more than 13% of business. Meanwhile, China would be expected to account for

a fifth of France s agri-food business and 19% of its textiles business, while Italy should

generate 10% of its clothing sales in China (see overleaf).

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

Agriculture,live

anim

als,m

eat,fresh

food

Processedfood

s,beveerages,toba

cco

Fuels&chem

icals

Tann

ing,essential

opils,perfumes,

cosm

etics,soap

s

Leatheran

dleather

good

s,skins,furskins

Woo

d,pu

lpofw

ood,

cork,pap

er,boo

ks

Textiles

Apparelan

dfootwear

Basicmaterials,

cement,glass,iron

&steel,precious

Machinery,elec

tric

andelectron

iceqmt,

nuclearreactor

Tran

sport,railway,

aircraft, spa

cecraft,

ships,bo

ats

Furniture,

prefab

ricated

buildings

Others

GER

FRA

BEL

NDL

ITA

SP

B33374


23 March 2011 27

Simulated growth in the portion of total exports represented by China by 2020


A story about consumption rather than capital goods Things probably won t work out like that. Growth in European exports to China has until

recently, i.e. in the midst of a Chinese investment boom, consisted mainly of sales of

machines and capital goods in China, the main beneficiaries having been Japan, Korea and

Germany.

Top Chinese imports between 2001 and 2009, annual growth rates in %, and USD

Annual average growth rate, %

Annual average growth, USDbn

Share in Chineseimports, 2009,%

Electrical, electronic equipment 20.2 23.5 24.7Mineral fuels, oils, distillation products, etc 27.7 13.3 14.0

Machinery, nuclear reactors, boilers, etc 15.0 10.4 10.9

Ores, slag and ash 42.1 8.2 8.6

Optical, photo, technical, medical apparatus 27.2 7.2 7.5

Plastics and articles thereof 15.6 4.2 4.4

Organic chemicals 19.0 3.4 3.6

Copper and articles thereof 25.2 3.1 3.2

Vehicles other than railway, tramway 25.8 3.0 3.1

Oil seed, oleagic fruits, grain, seed, fruit, etc 25.8 2.2 2.3


x 3.3

x 3.3

x 2.3 x 4.5x 2.5 x 3.3

x 3.1x 3.5

x 1.9

0%

4%

8%

12%

16%

Ger. Fra. Ita. Ndls Bel. Spa. EMU 6 UK Swe.

2009 2020

B33374


23 March 2011 28

Simulated weight of China in the exports of the various sectors in 2020*

*Assuming that the rate of export to China and the rest of the world remains unchanged vs the average level observed over 2001-2009 Source: SG Cross Asset Research

0%5%

10%15%20%25%30%35%40%45%50%

Agricultu

re,live

animals,

mea

t,freshfood

Processedfoods,

beveerages,tob

acco

Fuels&chem

icals

Tann

ing,essentialopils,

perfum

es,cosmetics,

soap

s

Leathera

ndleather

good

s,skins,furskin

s

Woo

d,pu

lpofwood,

cork,pap

er,books

Textile

s

Appa

reland

footwear

Basicmaterials,cem

ent,

glass,iro

n&steel,

precious

Machine

ry,electrica

ndelectroniceqmt,nu

clear

reactor

Tran

sport,railw

ay,


ships,boats

Furnitu

re,prefabrica

ted

build

ings

Others

Germany

20202009

0%

5%

10%

15%

20%

25%

30%

Agricultu

re,live

animals,

mea

t,freshfood

Processedfoods,

beveerages,tob

acco

Fuels&chem

icals

Tann

ing,essentialopils,

perfu

mes,cosmetics,

soap

s

Leathera

ndleather

good

s,skins,furskins

Woo

d,pu

lpofwood,

cork,pap

er,books

Textile

s

Appa

reland

footwear

Basicm

aterials,cem

ent,

glass,iro

n&steel,

precious

Machine

ry,electric

and

electroniceqmt,nu

clear

reactor

Tran

sport,railw

ay,


ships,boats

Furnitu

re,prefabrica

ted

build

ings

Others

France

0%2%4%6%8%

10%12%14%

Agricultu

re,live

animals,

mea

t,freshfood

Processedfoods,

beveerages,tob

acco

Fuels&chem

icals

Tann

ing,essentialopils,

perfu

mes,cosmetics,

soap

s

Leathera

ndleather

good

s,skins,furskins

Woo

d,pu

lpofwood,

cork,pap

er,books

Textile

s

Appa

reland

footwear

Basicm

aterials,

cement,

glass,iro

n&steel,

precious

Machine

ry,electric

and

electroniceqmt,nu

clear

reactor

Tran

sport,railw

ay,


ships,boats

Furnitu

re,prefabrica

ted

build

ings

Others

Italy

0%5%

10%15%20%25%30%35%

Agricultu

re,live

animals,

mea

t,freshfood

Processedfoods,

beveerages,tob

acco

Fuels&chem

icals

Tann

ing,essentialopils,

perfu

mes,cosmetics,

soap

s

Leathera

ndleather

good

s,skins,furskins

Woo

d,pu

lpofwood,

cork,pap

er,books

Textile

s

Appa

reland

footwear

Basicm

aterials,

cement,

glass,iro

n&steel,

precious

Machine

ry,electric

and

electroniceqmt,nu

clear

reactor

Tran

sport,railw

ay,


ships,boats

Furnitu

re,prefabrica

ted

build

ings

Others

EMU 6

B33374


23 March 2011 29

Rail equipment: shattered dreams China continues to make substantial investment with the aim of

expanding its rail network from 80,000km in 2008 to 120,000km

by 2020. There are currently many infrastructure projects under

way as well as rail equipment orders (track equipment and

rolling stock). China is favouring its own industries as much as

possible, but awarding some contracts or parts of contracts to

international companies, where it lacks the technological

capability and/or production capacity.

Nearly two years ago in our first report on the rail equipment

sector (“China and environmental concerns: two powerful

growth drivers”), we said that China was likely to constitute a

powerful growth driver for the rail industry. A year ago, we

brought out a new report (“A more cautious stance on the

growth outlook for railway equipment stocks”) in which we

expressed fears that China would not represent the opportunity

it was hoped to be and that it could even constitute a threat in

the medium term. It is still difficult to work out how much of a

risk/opportunity China represents. Although the country’s needs

are immense and it will need to call on western expertise to

some extent (technology, production capacity), it is also

showing a strong desire to compete in the international

markets. Thus CRCC (China Railway Corporation Corp.) and

two major rolling stock manufacturers (CSR and CNR) have won

a number of international contracts in 2009.

Does China still represent an opportunity?

This question is a legitimate one, given that the National

Commission for Development and Reform published a circular

in mid-2009 indicating that “domestic products must be

purchased for the government investment programme, unless

there are no such products available…”. The railways minister

thus indicated that he would be favouring Chinese companies in

the first instance. This explains why the European Chamber of

Commerce in China became alarmed about the contract award

procedures in markets which are in fact reserved for Chinese

companies.

We believe that to a certain extent the products produced by

the companies we cover still enter into the category of products

not available from Chinese suppliers. For example, it would

seem likely that the Chinese could fairly quickly develop air

conditioning systems, a domain in which a number of players

are present (Faiveley, world number one) and which doesn’t

carry an important safety implications. By contrast, developing

a breaking system seems a more distant threat (Faiveley, world

number two), as this feature is critical for safety and the

competition is less dense. Despite everything, this field of

opportunity could become limited fairly quickly.

Call on western companies for internal needs, if necessary

TGV Bombardier, Knorr-Bremse machinery, Vossloh

fastenings… Having imported Japanese and German

technology to develop the first generation of high-speed trains

(CRH2 and CRH3), the Chinese signed a contract with

Bombardier Transport in the autumn of 2009 to develop a new

generation (speed 380km/h), which the Canadian constructor

must split 50/50 with its Chinese partner CSR. Meanwhile,

Knorr-Bremse, Faiveley’s main competitor, won the biggest

contract in its history in 2009, valued at €500m. Finally, Vossloh

signed a contract for the Beijing-Shanghai line (€180m) in June

2009 and a further major contract (€140m) in August 2010,

which attest to the strength of its Chinese positioning.

Investment on the decline?

Regardless of our questions over the appetite (or otherwise) of

the Chinese for western products we also need to bear in mind

the time-line for the Chinese investment programme. We could

see investment peak over the coming years, before starting to

decline (in 2015? towards 2020?) as the investment programme

draws to a close. This explains why the Chinese companies

have already started to prepare for international expansion (in

search of growth sources beyond 2015).

Some investors believe that the Chinese railway companies do

not represent a threat to the western companies on the

international markets because their production capacities will

be saturated by domestic demand. We fear this may be a little

too hasty and we note the involvement of several Chinese

players on a number major projects (see table below).

The two major Chinese rail manufacturers, CSR and CNR, are

very active abroad. Also, it seems significant that Saudi Arabia

didn’t hesitate to place an order for the Mecca underground

with CNR, even though China doesn’t have a reputation for

quality and Saudi Arabia probably doesn’t have the toughest

budget constraints.

No export competition yet on “me too” products

The reluctance of some western manufacturers to produce

products in China for the Chinese market is attributable to the

risk that they might then find themselves competing against

Chinese players who would subsequently produce similar

products on the international markets. We thought that China

could start to export products based on western technology as

early as 2010. However, this did not turn out to be the case.

B33374

https://www.sgresearch.com/p/en/3/0/2321/capital-goods_fundamental-report(20080527)_101.html?sid=25ea9b8230c962d8201f424721d6f9b6

https://www.sgresearch.com/p/en/3/0/2321/capital-goods_fundamental-report(20080527)_101.html?sid=25ea9b8230c962d8201f424721d6f9b6

https://www.sgresearch.com/p/en/3/0/2321/5F7734FDB9FEA05FC12575E500613B8C.html?sid=100eb65e5ea09ac30efff2f9336668c8

https://www.sgresearch.com/p/en/3/0/2321/5F7734FDB9FEA05FC12575E500613B8C.html?sid=100eb65e5ea09ac30efff2f9336668c8


23 March 2011 30

Saudi TGV: the Chinese consortium was the big favourite to

win the Saudi call for tenders for the TGV between Mecca and

Medina. This consortium which was expected to submit an offer

based on Siemens ICE technology, ultimately did not

participate in the process.

Fastenings: Vossloh has won a number of major contracts

in Libya and Kazakhstan for its fastening systems. Nevertheless

we had though these countries could potentially fall for a

Chinese offer.

Margins undoubtedly under pressure in the medium term?

While the competitive environment in the railway equipment

market was relatively balanced a few years ago, with a limited

number of players enjoying a period of strong margin growth, it

seems unlikely that this situation will last.

Sooner or later the extra growth linked to Chinese demand

will dry up. Competition is also likely to grow stronger, as the

Chinese players enter the international arena. Western

companies are therefore likely to suffer in the medium to long

term, with margins weighed down structurally, compared with

the levels achieved in recent years.

International contracts for rolling stock

Country Market Supplier Amount Date

Saudi Arabia 10 locomotives CSR nd Jul. 2010

Malaysia Underground CSR €480m Jul. 2010

India Underground CSR nd Jun 2010

Pakistan Carriages CNR €83m Jan. 2010

Argentina Buenos Aires underground

CNR €365m Jan. 2010

Brazil Underground (234 cars, Rio de Janeiro)

CNR $300m Dec. 2009

Turkey Tramway CSR €40m Nov. 2009

Iran 6 locomotives CNR na Sept. 20 9

New Zealand 20 locomotives CNR na Jul. 2009

Saudi Arabia 17 underground trains (204 cars) CNR na Jun 2009

Jean-Baptiste Roussille (33) 1 42 13 99 78

Renewable energies: Chinese manufacturers in front! The development of a Chinese middle class will lead to a

considerable rise in electricity demand as a result of

increasing production capacity. One of the main objectives of

the Chinese government in the field of energy is to preserve

its independence. The development of renewable sources of

energy has become a major part of this policy, alongside the

construction of thermal power stations.

For many years the Chinese authorities have supported the

development of the local wind turbine and solar PV

industries. Currently in the low value-added solar panel

industry, Chinese players are exporting heavily, having calved

out the lion s share (70%) of the market for themselves. Their

development has led to increased pressure on prices and

margins for European players such as Q-Cells and

Solarworld. The continued rise in production capacities does

not bode well for margins in the medium term. Additionally, if

the Chinese government decided to introduce measures to

support internal demand, it would be the Chinese companies

that would benefit.

In the wind power market, internal demand has been heavily

supported and China has become the leading company in

terms of wind turbine production capacity, with its own

production covering around 80% of demand. For non-

Chinese manufacturers (Vestas, General Electric, Gamesa)

the issue of domestic Chinese demand is clearly a thing of

the past since even the Chinese turbine makers (Goldwind,

Sinovel) are seeking to win market share outside China.

Nevertheless, in contrast to solar panels, the cost of

transporting wind turbines limits the interest of producers

located in China. The need for production capacity to be

located close to demand is likely to limit the capacity of the

Chinese manufacturers to put pressure on production costs,

which should in turn protect the operating margins of non-

Chinese players.

Overall the development of Chinese demand is likely to offer

limited economic opportunity for the European solar panel

manufacturers. For the turbine makers, the opportunity of

winning market share in China is limited but their operating

margins should be safe.

Didier Laurens (33) 1 42 13 50 78

B33374


23 March 2011 31

ABB, Siemens, yesterday’s major beneficiaries of the Chinese demand boom… The sharp rise in Chinese demand in recent years has been

characterised mainly by a strong surge in demand for capital

goods which has provided a significant boost to foreign

companies up until today. For example, ABB generated $4.4

billion in revenues in China in 2010. Its presence in China has

represented a strong growth driver in recent years, with the

company recording annual growth of nearly 30% between

1998 and 2008. Over the same period, the portion of the

group s revenues represented by China has risen from 1% to

14%.

ABB revenues in China ($bn)


These companies have nevertheless become major

competitive targets for local companies which have built up an

increasing presence and are becoming much more powerful,

even in activities characterised by high technology contents. In

fact, these activities are now considered as strategic by the

Chinese government which has significantly encouraged their

development in the last few years. The key sectors here are

energy generation, rail transport and T&D equipment.

Exposure to Chinese competition by segment


The companies concerned are therefore Alstom and ABB, but

also Siemens, although to a lesser extent as its portfolio is

much more diversified. Other segments could also gradually

become more strategic and are therefore in danger of

encountering stronger competition from local players in the

near future (healthcare, energy efficiency, mining, etc.).

For the moment this increase in competition is limited mainly to

China. However, Chinese capital goods manufacturers are

going to encounter a slowdown in domestic demand in the

coming years. They will therefore undoubtedly seek to develop

their export activities in order to avoid reaching overcapacity

on the local market. This new competition not only benefits

from government support and from low-cost labour, but also

from critical mass thanks to the size of the domestic market,

and the support of the Chinese banks which enable the

Chinese players to offer their customers attractive financing

conditions. All these factors make the Chinese companies very

strong competitors for the European companies in the

emerging markets.

The Chinese players have many advantages on the export market


Adrien de Susanne (33) 1 42 13 01 61

0.3 0.4 0.5 0.6 0.8

1.8 2.0

2.4

2.9

3.4

4.1 4.3 4.4

-

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

(Md$)

Pricing power

Industries most at risk

Hig

h

LowHigh

Fossil Power Generation

TransportationNuclear

Wind PowerT&D

Cable

Auto Equipment

Automation

BearingsTooling

Mining equipment

Medical Equip.

Low

Compressors

Con

solid

atio

n of

the

cust

omer

bas

e

Size of each contract

Ultra -low voltageLocks

Attractiv e but v olatile

Pricing risks

Chinesecompanies

Ability to offer financing to the client

Critical size

due to large dom

estic market

Cost advantage

Unl

imite

d ac

cess

to

cap

ital

B33374


23 March 2011 32

The explosion in consumer

demand on the one hand

and the increasing

specialisation/ramp-up in

quality of Chinese products

is likely to significantly

change the breakdown of

Chinese imports in the

future. Under these

conditions, yesterday’s

most prosperous sectors

won’t necessarily be the

best positioned for the

future.

A more competitive environment in the strategic sectors Chinese industry has considerably improved in recent years as reflected by the almost

systematic progress achieved by Chinese exporters in terms of their level of specialisation in

the high technology sectors, and their simultaneous withdrawal from activities characterised

by a lower technology content. Often considered as strategic, high tech sectors currently

benefit from conditions which support their very rapid development and which are increasingly

preventing foreign companies from penetrating in the energy and transport segments of the

capital goods sector.

Degree of specialisation of Chinese exporters and technology content (*) 1995-2009

(*) The number of asterisks is representative of the technological intensity of each sector based on the CTCI classification Source: SG Cross Asset Research

-15

-10

-5

0

5

10

15

Man

ufac

ture

s

Tele

com

. equ

ipm

ent

Clot

hing

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troni

c dat

a pr

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ent

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ort e

quip

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m e

quip

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t

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les

Phar

mac

eutic

als

Food

Auto

mot

ive p

rodu

cts

Iron

and

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l

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icals

Inte

grat

ed ci

rcui

ts a

nd e

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c com

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nts

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t equ

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ent a

nd o

ther

mac

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er M

anuf

actu

res

2009

2000

1992

****

****

****

****

***

** ***

***

***

*** ****

*

EMU6: Top 10 sectors for exports to China (80% of total sales), 2009


35%

17%12%

7%

6%

6%

5%

4%3%

3%

2%Machinery, nuclear reactors,boilers, etc

Electrical, electronicequipment

Vehicles other thanrailway, tramway

Optical, photo, technical, medical, etc apparatus

Aircraft, spacecraft, and parts thereof

Plastics and articles thereof

Copper andarticles thereof

Organic chemicals

Pharmaceutical products

Articles of ironor steel

Iron and steel

B33374


23 March 2011 33

The new players are in the consumer goods sector New Chinese demand for consumer goods is huge and the sun that has shone on the best

performing sectors of the last few years now looks likely to shine on the consumer goods

sector. The European companies whose specialisations are more in line with the new

requirements of the Chinese population, namely a middle class looking for quality and

branded goods, look a lot more likely to benefit from the current transition.

In this area, those that look likely to benefit from the surge in Chinese demand are not limited

to just a couple of segments, such as cars and luxury goods. Behind these two major

beneficiaries, a whole range of sectors should see growth over the coming years, including

middle-sized companies in sectors ranging from the small household electrical equipment

discussed earlier in the report (see page 22), to clothing, food and pharmaceuticals, i.e. most

of the sectors of European industry that have suffered over the last two decades.

B33374


23 March 2011 34

Outlooks in terms of growth and profitability are now becoming more mixed European companies are likely to see significant changes in the conditions they encounter on

the Chinese market, depending on their sector of activity. Our analysis had led us to divide the

50 European countries with the greatest exposure to the Chinese market into three categories.

The “protected” group of stocks which includes growth sectors whose activities are

structurally supported by the Chinese demand trend and whose results are less sensitive to

the competitive context. In this group we find companies in the chemicals, metals and utilities

sectors, for which the outlook in terms of earnings growth on the Chinese market remains very

solid, with profitability set to remain the same as that generated in other markets. The luxury

companies and the top-of-the-range auto markets also benefit from very solid growth

prospects and from the protection that their branding brings in terms of pricing power. By

contrast the profitability they generate in the Chinese market is higher than in their domestic

markets. The majority of these sectors are already trading at relatively high levels which may

be justified, but it implies limited additional upside.

The “exposed” group, made up of companies whose golden era of Chinese

development is probably now over, i.e. companies that are facing the emergence of new

competitors in all sectors that are considered strategic by the Chinese authorities. This group

consists of the capital goods, transport – rail transport in particular – aerospace and

renewable energies sectors, but also cement. Although the demand outlook for these sectors

remains relatively solid in the short term, thanks to the exceptionally strong growth in demand,

the competitive context is weighing on their profitability outlook, both on the Chinese market

and internationally where the major Chinese players have now become formidable rivals.

These sectors are generally overvalued and are likely to derate towards their historical

averages.

Positioning of European companies relative to the new China landscape (*) PROTECTED AT RISK

Structural growth in demand and low exposure to competition Strong demand growth but increasing exposure to competition % rev. 2010 % rev. 2015 % rev. 2010 % rev. 2015

Automobiles BMW 12% 15% Communications Equip. Ericsson 7% 8%

Text., Apparel & Lux. Gds Hermes Int. 20% 20% Communication Equip. Alcatel-Lucent 10% 10%

Text., Apparel & Lux. Gds LVMH 14% 18% Communication Equip. Nokia 12% 11%

Text., Apparel & Lux. Gds Richemont 30% 35% Electrical Equipment ABB 12% 13%

Chemicals Rhodia 8% 13% Electrical Equipment Schneider 9% 10%

Chemicals Air Liquide 4% 8% Electrical Equipment Alstom 6% 6%

Chemicals BASF SE 8% 12% Machinery Atlas Copco 15% 17%

Chemicals Linde AG 4% 7% Machinery SKF 12% 13%

Chemicals Akzo Nobel NV 8% 11% Machinery Vallourec 11% 12%

Chemicals Clariant 6% 9% Machinery Sandvik 8% 9%

Chemicals Arkema 5% 8% Industrial Conglomerates Siemens 6% 7%

Metals & Mining BHP Billiton plc 25% 27% Renewable energies Vestas 15% 15%

Water Utilities Veolia Environnement

7% 10%

Source: (*) Among the 50 companies the most exposed to the Chinese market according to their 2010 revenue origin as defined in Emerging markets, the benefit for small & mid-

caps);; SG Cross Asset Research

B33374




23 March 2011 35

The best-positioned sectors that are taking off or catching up, thanks to the recent

change in Chinese policy on consumption growth and to a very sharp improvement in

profitability. The mid- and high-range auto manufacturers, the parts makers, but also the

household appliance and clothing manufacturers, who are traditionally more sensitive to the

competitive environment and who have up until now been heavily penalised by the ramp-up in

demand for low cost products, should now benefit from a less competitive environment and a

Chinese market that is easier to penetrate. In view of these prospects, companies in these

sectors generally seem undervalued and are likely to sustain a rerating beyond their historical

average multiples. The experience of the larger companies probably tells us a lot about the

trends that are likely to influence European exports in the medium term now that the

environment has become less competitive. In contrast to the general belief that only

companies based in China can access this market, the analysis of export performances

generally supports the trends observed on the ground by the larger companies.

In the clothing sector, the experience of companies like Inditex, H&M and Etam give a

good illustration of the ramp-up of Chinese demand. Generally representing between 2% and

3% of current revenues, our analysts expect most companies in the sector to see revenues

derived from this market double over the coming 3-5 years with an identical improvement at

the EBIT level. This firmly supports our projected growth trend in real expenditure on clothing,

as presented on page 13 of this report. In the present context, the development of the

Chinese market offers some compensation for the risks arising from rising production costs,

with the bulk of production often being located far away in low-labour-cost countries.

In Agri-food, the experiences of Danone and Nestlé encapsulate most of the change in

behaviour triggered by the improvement in living standards of a population that has developed a

strong taste for coffee and yoghurts in less than a decade (this theme is discussed in greater

detail on page 17). France, which is very well positioned in the wines and spirits market and now

occupies a very strong position in the Chinese market, accounting already for 60% of the

sector s Chinese imports, could derive more than 20% of its exports from this market by 2020.

Clothing/urban household expenditure, CNY Consumption of dairy products/urban households, CNY

Source: SG Cross Asset Research Source: SG Cross Asset Research

Pharmaceutical products are a different story, with this market having had very limited

exposure to China up until now. The macroeconomic analysis nevertheless suggests that

things could rapidly change in the coming years. Although China accounted for less than 1%

of pharmaceutical exports in 2009, the European countries nevertheless supplied more than

half of China s pharmaceutical imports which recorded growth of 32% per annum on average

between 2001 and 2009. With the market expected to double in size by 2015, Chinese sales

volumes look likely to remain very strong over the coming years, with China becoming a key

destination for French and German exporters.

0

200

400

600

800

1000

1200

1400

1600

1800

2000

90 92 93 94 95 97 98 99 00 02 03 04 05 07 08 09 10 12 13 14 15

BeijingShanghai National avg

Rural

0

50

100

150

200

250

300

350

400

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

Beijing

Shanghai

National avg

B33374


23 March 2011 36

Healthcare spending/urban households, CNY Origin of and growth in Chinese pharmaceutical exports

Source: SG Cross Asset Research Source: SG Cross Asset Research

Media and marketing companies look well placed to benefit from the robust growth in

advertising on the back of the sharp rise in consumption.

Banks and insurance companies, whose growth is predominantly linked to the development

of the middle class, should also do well.

We are tempted to add to this group a certain number of companies that do not feature among

the top 50 companies with the strongest presence in the Chinese market, but are likely to benefit

from the growth of this market in the future or from the easing of competition on other markets.

The best positioned companies to benefit from the change in Chinese landscape

The BENEFICIARIES

Of the rise in demand and easing competitive environment Aerospace & Defence Rolls-Royce 6% 10% Auto Components Valeo 9% 14%

Auto Components Autoliv 6% 11%

Auto Components Faurecia 7% 12%

Auto Components Pirelli 5% 8%

Auto Components Michelin 8% 10%

Automobiles Daimler 10% 14%

Automobiles Peugeot Citroen PSA 10% 14%

Automobiles Volkswagen (Pref.) 7% 8%

Text., Apparel & Lux. Gds Adidas 7% 10%

Beverages Anheuser-Busch InBev 12% 14%

Beverages Pernod Ricard 8% 10%

Food Products Danone 5% 7%

Household Durables Groupe SEB 19% 24%

Distributors Inchcape 8% 12%

Media JCDecaux 4% 9%

Media Vivendi 4% 7%

Personal Products Beiersdorf 6% 8%

Personal Products L'Oréal 6% 6%

Commercial Banks Standard Chartered 15% 17%

Commercial Banks HSBC 17% 13%

Insurance Assic Generali spa 7% 7%

Pharmaceuticals Sanofi-Aventis 2% 14%

Personal Products Essilor na na

Personal products Luxottica na Na

Personal products Inditex na na

Source: Companies;; SG Cross Asset Research (Emerging markets, the benefit for small & mid-caps)

0

200

400

600

800

1000

1200

1400

1600

1800

90 92 93 94 95 97 98 99 00 02 03 04 05 07 08 09 10 12 13 14 15

Beijing

Shanghai

FR

DE 18%

IT 7%

SP 3%

BE 4%

ND 2%SW 3%

UK6%

USA 14%

JAP 5%

RoW 29%

0

1

2

3

4

5

6

7

0

10

20

30

40

50

1 2 3 4 5 6 7 8 9

Amount, $bn (RHS)

AnnualChange, %

Preferred companies among the 200 largest capitalisations in the DJ STOXX that do not feature within the top 50 European countries present in China.

Among the 50 companies the most exposed to the Chinese market according to their 2010 revenue origin

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Gains should be more evenly balanced between the different sectors and European countries

Estimating the potential gains to be derived from the change in the influence of the Chinese

economy on the European economies would be very hazardous at this stage. Nevertheless

this report draws a number of conclusions:

Easing competition. The competitive pressure exerted by China on the low and medium

value-added segments of European industry over the last 10 years have eased considerably

since the mid-2000s and even more since the financial crisis of 2008, notably due to the

emergence of a new source of demand.

Real exchange rate adjustment. From this perspective, the recent rise in inflation in the

emerging Asian countries constitutes a relatively encouraging trend for Europe and to a

certain extent: the longer the inflation differential lasts, the more significant the rebalancing will

be in terms of real exchange rates and therefore competitiveness.

Rotation in demand. Having mainly focused on capital goods and transport, the demands

of the Chinese economy is gradually likely to shift, as the middle classes expand, towards

consumer/household products. By 2015 real consumer spending is expected to double

spending on cars and household equipment could triple, while spending on clothing or

pharmaceuticals will probably rise by more than 50%.

Opportunities. Given what has been observed over the last 10 years, the predominance of

European industry in the global export of manufactured products and the positioning of

European industry across the broader field of consumer segments, the Chinese market seems

to offer considerable development potential for European exporters. The chances of seeing

China rise to become the leading export market for every European country by 2020 are very

high.

More evenly balanced gains between European countries The range of companies that

can be expected to benefit from this environment now seems a lot wider than in the past. In

this context, the advantage enjoyed by Germany as a result of its high degree of specialisation

in the capital goods, transport and telecommunications sectors could gradually fade.

Meanwhile, other European economies should see their relative positioning improve.

Support to structural growth. These changes in the environment are encouraging for

European growth in the medium term. In the present context of great uncertainty over the

future of the monetary union, even a modest improvement in the region s growth potential

should not be ignored. The improvement in potential growth is in reality the only hope Europe

has to dispel its sovereign issues in the long run and to reduce the growth distortions that

currently exist between the various countries of the eurozone, which is ultimately what is

needed for the European monetary union to be preserved.

Over the last two decades few occasions have given rise to hopes of a structural consolidation

of growth in Europe. The conclusions of this report are undeniably welcome. According to our

estimates, annual structural growth in the eurozone could be boosted by a contribution of

between 0.25 points and 0.40 points from China over the 2010-2020 period. This is quite a

substantial support in proportion to current estimates of potential GDP growth accounting for

between one-sixth and one-third higher than the level of potential growth that is typically

indicated.

By noting the importance of specialisation, our analysis allows us to put into perspective the

disappointment expressed as a result of the EU competitiveness pact which was considered

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23 March 2011 38

by many as an agreement at best. In actual fact, in view of the factors highlighted in this

report, the objectives sought by the advocates of such a pact probably already seem a lot less

imperative than is generally considered.

What are the risks? Having relied heavily on the American economic environment, the outlook for Europe now

largely depends on the economic development which is taking shape on the opposite side of

the planet. This transition significantly alters the risks. In this respect, questions over the future

of Chinese growth in a context of rising inflation are very much a current concern. This

situation justifies the risk scenario presented in this report. We note however that the inflation

risk should not have much of an impact on the expected growth in the Chinese middle class

by 2015. Nevertheless, it is possible that inflation could lead the government to step up its

revenue redistribution policy at some stage. Thus, high inflation over a long period would be

more of a threat in terms of its impact on the breakdown of expenditure or its impact on the

savings trend. Such a scenario could weigh on discretionary household spending, especially

luxury goods. All else being equal, these changes are likely to take time to emerge.

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23 March 2011 39

IMPORTANT DISCLOSURES Air Liquide SG is acting as sole consultation coordinator on Air Liquide's consent solicitation on four bonds.

Air Liquide SG acted as Joint dealer manager of Air liquide's bond exchange offer.

Alstom SG acted as joint bookrunner in Alstom's senior bond issue.

Alstom SG acted as financial advisor to Alstom for the acquisition of Areva T&D.

Alstom SG is a lender to Alstom Group.

Anheuser-Busch InBev SG acted as co-manager of ANHEUSER BUSH IN BEV's HG bond issue.

Anheuser-Busch InBev SG acted as joint bookrunner of Anheuser-Busch Inbev's bond issue (4% 26/04/18 EUR).

Anheuser-Busch InBev SG acted as co-manager of Anheuser-Bush Inbev's senior bond issue

Arkema SG acted as joint bookrunner in Arkema's senior bond issue.

Assic Generali spa SG makes a market in Generali Assicurazione warrants

Danone SG acted as Joint Dealer Manager and Joint Bookrunner in Danone's combined exchange offer and tender offer.

Etam Développement SGSP was managing a liquidity contract on behalf of Etam Developpement

Faurecia SG acted as sole lead manager and sole bookrunner for the placement of Faurecia's shares by One Equity Partner

Faurecia SG was sole bookrunner and sole global coordinator for the placement of Faurecia's shares.

Michelin SG acted as joint lead manager in Michelin's rights issue.

Pernod Ricard SG is acting as Mandated Lead-Arranger and Bookrunner for the financing of the acquisition by Pernod Ricard of Vin & Sprit Group

Peugeot Citroen PSA SG acted as joint bookrunner in PSA Peugeot Citroen's bond issue (4% 28/10/13 EUR & 5% 28/10/16 EUR).

Peugeot Citroen PSA SG is acting as sole lead manager and sole bookrunner for the placement of Faurecia shares by One Equity Partner

Pirelli SG acted as joint bookrunner in Pirelli's bond issue (5.125% 22/02/16 EUR).

Renault SG acted as joint bookrunner in Renault's bond issue (tap) (5.625% 30/06/15 EUR).

Renault SG acted as exclusive financial advisor to Renault in the financial restructuring of Avtovaz.

Rhodia SG holds between 5% and 10% of Rhodia as a result of its trading activites

Rhodia SG holds a 50% stake in Orbeo, a joint-venture active in emissons markets equally owned by Rhodia

Sanofi-Aventis SG is acting as joint bookrunner in Sanofi-Aventis' USD bond issue.

Sanofi-Aventis SG is acting as financial advisor to Sanofi Aventis in its take over of Genzyme and initial mandated lead arranger in the acquisition

credit facility.

Schneider SG acted as Joint Dealer Manager in Schneider's bond tender offer.

Schneider SG acted as financial advisor to Alstom for the acquisition of Areva T&D.

Standard Chartered SG acted as joint bookrunner of Standard Chartered's bond issue.

Total SG provided an opinion to Total as to the fairness of the planned disposal of one of its businesses.

Veolia Environnement SG acted as joint bookrunner of VEOLIA Environnement's bond issue (2021)

Veolia Environnement SG is acting as joint dealer manager of Veolia Environnement's bond exchange offer.

Veolia Environnement SG is acting as financial advisor to CDC for the merger of Transdev with Veolia Transport.

Vestas SG acted as Joint Lead Managers and Bookrunners of Vestas' inaugural bond issue (4.625 23/03/15 EUR).

Vivendi SG will act as joint lead manager and joint bookrunner in Canal + France's potential IPO.

Vivendi SG acted as sole Structuring advisor and Joint Dealer Manager in Vivendi's bond tender offer

Vivendi SG acted as joint bookrunner of Vivendi's senior bond issue (4% 31/03/17 EUR).

Volkswagen (Pref.) SG acted as co bookrunner for Volkswagen's right issue.

SG and its affiliates beneficially own 1% or more of any class of common equity of ING Group, Nokia, Rhodia.

SG or its affiliates act as market maker or liquidity provider in the equities securities of ABB, Adidas, Air Liquide, Alcatel-Lucent, Alstom, Anheuser-Busch InBev,

Assic Generali spa, Atlas Copco, BASF SE, BMW, Beiersdorf, Clariant, Daimler, Danone, Ericsson, Essilor, Gamesa, Hennes & Mauritz, ING Group, Inditex, K&S,

L'Oréal, LVMH, Linde AG, Michelin, Nestlé, Nokia, Pernod Ricard, Peugeot Citroen PSA, Pirelli, Renault, Richemont, Sanofi-Aventis, Schneider, Siemens, Total,

Vallourec, Veolia Environnement, Vivendi, Volkswagen (Pref.).

SG or its affiliates expect to receive or intend to seek compensation for investment banking services in the next 3 months from Air Liquide, Alcatel-Lucent, Alstom,

Anheuser-Busch InBev, Assic Generali spa, BHP Billiton plc, Danone, Essilor, Etam Développement, Faurecia, Groupe SEB, JCDecaux, L'Oréal, LVMH, Pernod

Ricard, Peugeot Citroen PSA, Pirelli, Renault, Rhodia, Sanofi-Aventis, Siemens, Total, Valeo, Veolia Environnement, Vivendi.

SG or its affiliates have received compensation for investment banking services in the past 12 months from Air Liquide, Alstom, Anheuser-Busch InBev, Arkema,

Danone, Etam Développement, Faurecia, Michelin, Pernod Ricard, Peugeot Citroen PSA, Pirelli, Renault, Sanofi-Aventis, Schneider, Standard Chartered, Veolia

Environnement, Vestas, Vivendi, Volkswagen (Pref.).

SG or its affiliates managed or co-managed in the past 12 months a public offering of securities of Alstom, Anheuser-Busch InBev, Arkema, Faurecia, Michelin,

Peugeot Citroen PSA, Pirelli, Renault, Standard Chartered, Veolia Environnement, Vestas, Vivendi, Volkswagen (Pref.).

SGAS had a non-investment banking non-securities services client relationship during the past 12 months with ABB, Alcatel-Lucent, Anheuser-Busch InBev,

Arkema, BASF SE, BMW, Daimler, Faurecia, HSBC, ING Group, LVMH, Michelin, Nissan Motor Co, Nokia, Peugeot Citroen PSA, Renault, Rhodia, Rolls-Royce,

SKF, Sanofi-Aventis, Schneider, Siemens, Standard Chartered, Total, Vallourec, Veolia Environnement, Vivendi, Volkswagen (Pref.).

SGAS had a non-investment banking securities-related services client relationship during the past 12 months with Assic Generali spa, HSBC, ING Group, Standard

Chartered.

SGAS received compensation for products and services other than investment banking services in the past 12 months from ABB, Alcatel-Lucent, Anheuser-Busch

InBev, Arkema, Assic Generali spa, BASF SE, BMW, Daimler, Faurecia, HSBC, ING Group, LVMH, Michelin, Nissan Motor Co, Nokia, Peugeot Citroen PSA,

Renault, Rhodia, Rolls-Royce, SKF, Sanofi-Aventis, Schneider, Siemens, Standard Chartered, Total, Vallourec, Veolia Environnement, Vivendi, Volkswagen (Pref.).

SGCIB received compensation for products and services other than investment banking services in the past 12 months from ABB, Air Liquide, Akzo Nobel NV,

Alcatel-Lucent, Alstom, Anheuser-Busch InBev, Arkema, Assic Generali spa, Autoliv, BASF SE, BHP Billiton plc, BMW, Daimler, Ericsson, Essilor, Etam

Développement, Faiveley, Groupe SEB, HSBC, Hermes International, ING Group, JCDecaux, K&S, L'Oréal, LVMH, Linde AG, Michelin, Nestlé, Nissan Motor Co,

Nokia, Pernod Ricard, Pirelli, Renault, Rhodia, Richemont, Rolls-Royce, Sandvik, Sanofi-Aventis, Schneider, Siemens, Standard Chartered, Total, Valeo, Vallourec,

Veolia Environnement, Vestas, Vivendi, Vossloh.

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23 March 2011 40

GLOBAL ECONOMICS Head of Global Economics

Michala Marcussen (44) 20 7676 7813 [email protected]

Euro area

Klaus Baader

James Nixon

Vladimir Pillonca

Michel Martinez (44) 20 7676 7609 (44) 20 7676 7385 (44) 20 7676 7863 (33) 1 42 13 34 21 [email protected] [email protected] [email protected] [email protected]

United Kingdom

Brian Hilliard (44) 20 7676 7165 [email protected]

Americas

Stephen Gallagher

Aneta Markowska

Alejandro Cuadrado

Rudy Narvas (1) 212 278 44 96 (1) 212 278 66 53 (1) 212 278 73 13 (1) 212 278 76 62 [email protected] [email protected] [email protected] [email protected]

Brian Jones (1) 212 278 69 55 [email protected]

Asia Pacific

Glenn Maguire

Takuji Okubo

Wei Yao

Joseph Lau (852) 2166 5438 (81) 355 49 5560 (852) 2166 5437 (852) 2166 5441 [email protected] [email protected] [email protected] [email protected]

Thematic Research

Véronique Riches-Florès (33) 1 42 13 84 04 [email protected]

Research Associates Lydia Boussour Martin Rose Mehreen Khan Ramzi Berrima

David Tam Samuel Slama

IMPORTANT DISCLAIMER: The information herein is not intended to be an offer to buy or sell, or a solicitation of an offer to buy or sell, any securities and including any expression of opinion, has been obtained from or is based upon sources believed to be reliable but is not guaranteed as to accuracy or completeness although Société Générale (“SG”) believe it to be clear, fair and not misleading. SG, and their affiliated companies in the SG Group, may from time to time deal in, profit from the trading of, hold or act as market-makers or act as advisers, brokers or bankers in relation to the securities, or derivatives thereof, of persons, firms or entities mentioned in this document or be represented on the board of such persons, firms or entities. SG is acting as a principal trader in debt securities that may be refered to in this report and may hold debt securities positions. Employees of SG, and their affiliated companies in the SG Group, or individuals connected to then, other than the authors of this report, may from time to time have a position in or be holding any of the investments or related investments mentioned in this document. Each author of this report is not permitted to trade in or hold any of the investments or related investments which are the subject of this document. SG and their affiliated companies in the SG Group are under no obligation to disclose or take account of this document when advising or dealing with or for their customers. The views of SG reflected in this document may change without notice. To the maximum extent possible at law, SG does not accept any liability whatsoever arising from the use of the material or information contained herein. This research document is not intended for use by or targeted at retail customers. Should a retail customer obtain a copy of this report they should not base their investment decisions solely on the basis of this document but must seek independent financial advice. Important notice: The circumstances in which materials provided by SG Fixed & Forex Research, SG Commodity Research, SG Convertible Research and SG Equity Derivatives Research have been produced are such (for example because of reporting or remuneration structures or the physical location of the author of the material) that it is not appropriate to characterise it as independent investment research as referred to in European MIF directive and that it should be treated as a marketing material even if it contains a research recommendation (« recommandation d’investissement à caractère promotionnel »). However, it must be made clear that all publications issued by SG will be clear, fair, and not misleading. Analyst Certification: Each author of this research report hereby certifies that (i) the views expressed in the research report accurately reflect his or her personal views about any and all of the subject securities or issuers and (ii) no part of his or her compensation was, is, or will be related, directly or indirectly, to the specific recommendations or views expressed in this report. Notice to French Investors: This publication is issued in France by or through Société Générale ("SG") which is authorised by the CECEI and regulated by the AMF (Autorité des Marchés Financiers). Notice to UK investors: This publication is issued in the United Kingdom by or through Société Générale ("SG") London Branch which is regulated by the Financial Services Authority ("FSA") for the conduct of its UK business. Notice To US Investors: This report is intended only for major US institutional investors pursuant to SEC Rule 15a-6. Any US person wishing to discuss this report or effect transactions in any security discussed herein should do so with or through SG Americas Securities, LLC (“SGAS”) 1221 Avenue of the Americas, New York, NY 10020. (212)-278-6000. THIS RESEARCH REPORT IS PRODUCED BY SOCIETE GENERALE AND NOT SGAS. Notice to Japanese Investors: This report is distributed in Japan by Société Générale Securities (North Pacific) Ltd., Tokyo Branch, which is regulated by the Financial Services Agency of Japan. The products mentioned in this report may not be eligible for sale in Japan and they may not be suitable for all types of investors. Notice to Australian Investors: Société Générale Australia Branch (ABN 71 092 516 286) (SG) takes responsibility for publishing this document. SG holds an AFSL no. 236651 issued under the Corporations Act 2001 (Cth) ("Act"). The information contained in this newsletter is only directed to recipients who are wholesale clients as defined under the Act. IMPORTANT DISCLOSURES: Please refer to our websites: http://www.sgresearch.socgen.com/compliance.rha http://www.sgcib.com. Copyright: The Société Générale Group 2011. All rights reserved.

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The New Chinese Landscape A Chance For Europe

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