Macquarie (22)

Tuesday, 27 March 2012
Bank of Queensland (Neutral)

RoE challenge remains
3
Michael Wiblin
Top Quant Alphas

MONADELPHOUS GROUP LTD. (MND AU) ILUKA RESOURCES LTD. (ILU AU) CAMPBELL BROTHERS LTD. (CPB AU) TELSTRA CORPORATION LTD. (TLS AU) SEVEN GROUP HDG.LTD. (SVW AU)
The BOQ capital raise and asset write-down largely remove questions around balance sheet quality. However, the fundamental challenge for the firm remains how it takes its RoE from low single digit levels to something around the cost of equity (c12%).
Suncorp (Underperform)
Red card from BOQ
10
Tim Lawson
Bottom Quant Alphas

AQUILA RESOURCES LIMITED (AQA AU) BENDIGO & ADEL.BK.LTD. (BEN AU) ALUMINA LTD. (AWC AU) MESOBLAST LTD. (MSB AU) AMCOR LTD. (AMC AU)
Source: Macquarie Research. Data as at 22/03/2012. Screening for all stocks in Australia and New Zealand with Market Cap over US$2bn.
Following the BOQ market update and capital raising, we review the potential read through to SUN. Why the BOQ update is not a direct read through to Suncorp: 1) the Suncorp Non Core Bank (NCB) has been closed to new business for 3.5yrs, 2) Suncorp, even under a BOQ type scenario, would not need to raise capital given its excess capital position (Suncorp surplus capital estimate $1.18bn, MRE estimate ~$845m), 3) BOQ's problems are concentrated in South East QLD while 58% of the SUN NCB is outside QLD, 4) Suncorp's loan book is 79.4% retail, BOQ loan book 73.7% retail.
TABCorp Holdings (Upgrade to Outperform)

Odds right for an in-play bet We refresh our views on TABCorp following a review of the state of the wagering market, as well as a number of the outstanding issues currently impacting investor sentiment towards the company.
14
Lachlan Fitt
CFS Retail Property Trust (Outperform)

Juicy stake sold CFX announced the sale of a 50% stake in Myer Brisbane for $366m, inline with book value. As anticipated, the group is embarking on an on-market share buyback for up to $150m of units on issue (~3%).
50
Rob Freeman
ESG
Ratings Replayed Environmental, social and governance (ESG) ratings can be a useful tool, one of a suite of tools for analysing the ESG performance of individual companies and integrating this information into financial analysis.
52
Aimee Kaye
Qantas (Outperform) China Commodities Call The China Diviner Dexus Property Group (Outperform) Premier Investments (Neutral) Horizon Oil (Outperform) European and UK economics Macquarie Commodities Comment Directors Cut
67 71 87 95 100 104 108 114 135
Please refer to the important disclosures and analyst certification on inside back cover of this document, or on our website www.macquarie.com.au/research/disclosures.
Macquarie Marquee Ideas / Diary

Macquarie Marquee Ideas Outperform - David Jones (DJS), TP $3.12, TSR 39.23% Outperform - RCR Tomlinson (RCR), TP $2.40, TSR 19.47% Outperform - Rio Tinto (RIO), TP $91.00, TSR 42.82% Outperform - Mermaid Marine (MRM), TP $3.62, TSR 18.93% Outperform - SAI Global (SAI), TP $5.37, TSR 14.07% Outperform - Seven Group Holdings (SVW), TP $10.91, TSR 15.95% Outperform - Newcrest (NCM), TP $38.00, TSR 31.41% Outperform - AGL Energy (AGK), TP $16.45, TSR 17.02% Outperform - CSL (CSL), TP $35.35, TSR 7.83% Outperform - CFS Retail Property Trust (CFX), TP $2.00, TSR 21.68% Outperform - Virgin Australia (VAH), TP $0.50, TSR 8.70% Corporate NUF 1H result, A$25.5m/A$17.7m IOF AGM LYL ex int div 12c Result figures are reported profit/Macquarie adjusted profit. Economics AUS RBA BOARD MEETING MINUTES, MAR (0030) RBA ASSISTANT GOVERNOR EDEY SPEAKS ON BANK FUNDING AT THE CARDS AND PAYMENTS AUSTRALASIA CONFERENCE 2012, SYDNEY (0305) US CONSUMER CONFIDENCE, MAR (1400) Feb: 70.8 All times are GMT.
Please refer to the important disclosures and analyst certification on inside back cover of this document, or on our website www.macquarie.com.au/research/disclosures.
AUSTRALIA
BOQ AU
Price (at 04:00, 23 Mar 2012 GMT) Volatility index 12-month target 12-month TSR Valuation GICS sector Market cap 30-day avg turnover Number shares on issue Investment fundamentals
Year end 31 Aug Net interest Inc Non interest Inc Underlying profit Reported profit Adjusted profit EPS adj EPS adj growth PER adj PER rel Total DPS Total div yield Franking ROA ROE Equity to assets EV/EBITDA P/BV m m m m m % x x % % % % % x x
Neutral A$7.30
Low/Medium A$ 6.85 % +1.4 A$ 6.22 A$m A$m m Banks 1,676 6.2 229.6
Bank of Queensland
Event
The BOQ capital raise and asset write-down largely remove questions around
- DCF (WACC 11.0%, beta 1.0, ERP 5.0%, RFR 7.0%)
balance sheet quality. However, the fundamental challenge for the firm remains how it takes its RoE from low single digit levels to something around the cost of equity (c12%). This is no easy task, given the ongoing intermittent pressures on funding, under-investment in systems and a deteriorating QLD economy.
Impact
191bp BDD hit sees 1H12 profits down substantially Due to rapidly
2011A 2012E 2013E 2014E 628.4 177.7 456.1 161.1 195.2 79.9 -5.6 9.1 0.74 54.0 7.4 100 0.5 8.2 6.4 -15.9 0.7 643.6 154.9 437.7 19.8 44.2 6.7 -91.6 109.3 8.84 54.0 7.4 100 0.1 1.7 7.1 -53.9 0.8 653.8 158.0 427.0 234.0 243.4 72.5 985.7 10.1 0.91 56.0 7.7 100 0.6 8.3 7.1 -9.7 0.8 680.3 160.9 433.9 240.0 249.4 72.2 -0.5 10.1 0.98 58.0 7.9 100 0.6 8.1 7.0 -9.3 0.8
rising impairments BOQ announced that it will raise $450m of capital (c30% of the share base). This will see core tier 1 move to 8.6%. As a part of the cleansing statement, BOQ released its preliminary results for 1H12. The bank will make a statutory loss of A$91m, which equates to a A$72m cash profit loss. The major difference is bad debts, where an A$328m charge has been taken including an A$160m overlay for QLD-related economic weakness. NIM increased 3bp (1.65% to 1.68%) in the tough funding environment and operating costs were relatively stable with a 1.7% increase.
Large capital raising removes balance sheet issues There is no doubt
BOQ AU vs ASX 100, & rec history
that the bad debt charge taken by BOQ in 1H12 (191bp) represents a step change in magnitude for BOQ but also the sector (major bank impairment reached c80-90bp at the height of the GFC). Hence in some ways a large capital raising (c30% of shares outstanding) was needed to keep the market satisfied that balance sheet issues had been removed from the picture. With the capital raising, BOQ now has impaired asset coverage of c100%, bringing it in to line with the majors.
However the challenge issued by the GFC still remains it is still
Note: Recommendation timeline - if not a continuous line, then there was no Macquarie coverage at the time or there was an embargo period.
Source: FactSet, Macquarie Research, March 2012 (all figures in AUD unless noted)
unclear how BoQ can earn at least its cost of equity While balance sheet issues have been removed, the fundamental challenge of earning a reasonable return remains for BOQ (and regional banks in general). We forecast that BOQ may be able to earn a RoE around 8% in FY13. This would justify a c0.75x Price to book multiple, placing the share price around A$6.42. Improving RoE will be no easy task, given the ongoing intermittent pressures on funding, under-investment in systems and a deteriorating QLD economy.
Earnings and target price revision

We revise our earnings down 35-94% on the basis of higher bad debts and
the capital raising. Our target price moves down from A$8.70 to A$6.85.
Price catalyst
Analyst(s)
Michael Wiblin, CFA +61 2 8232 6089 michael.wiblin@macquarie.com Elisa DiMarco +612 8237 6253 elisa.dimarco@macquarie.com
12-month price target: A$6.85 based on a DDM methodology. Catalyst: Upcoming strategy review
Action and recommendation

Maintain Neutral.
26 March 2012 Macquarie Securities (Australia) Limited
Please refer to the important disclosures and analyst certification on inside back cover of this document, or on our website www.macquarie.com.au/disclosures.
3
Macquarie Research
Bank of Queensland

What we liked
NIM increased 3bp (1.65% to 1.68%) in
Whatwedidntlike
Impaired assets up c30% HoH.
What else was interesting?

There appears to have been a
the tough funding environment. However outlook for 2H12 NIM is less certain given sector pressures.
Operating costs were relatively stable
with a 1.7% increase YoY, and flat HoH.

BOQ maintained commitment to yield
Increased natural disasters in South East QLD and decreased valuations in the same region and Northern NSW are the main culprits. Similarly, BDD expenses up 400% HoH.
Capital raising seems excessive in
significant decline in CRE prices post the FY11 result in October. This seems to indicate that there are accelerated risks to the downside.
Impaired loans continued to rise
investors with a 26c interim dividend.

Provision coverage post capital raising
terms of size (c30% of existing capital) and discount (c17%).

There is some indication that
sharply, c30% HoH. The increase was largely driven by the reduction in valuations in SE QLD.
We found it interesting that the BOQ
places BOQ in line with the majors at c100% impairment coverage.

Capital levels post capital raising place
BOQ at the top end compared to the majors, core tier 1 capital ratios for BOQ will rise to 8.6%.
The balance sheet and capital issues
additional spend in technology is required. This may increase operating costs in FY12 and FY13.
Momentum of balance sheet
management commented that they would turn on the broker channel. This seems odd given it tends to be a lower ROE product and the major issue for the regionals remains its funding structure.
Lead impairment indicators appear to
that arose in 1H12 will now be removed with the capital raising.
New CEO appears to be bringing in
growth is slowing. Loan growth, 1.5% HoH and deposit growth 3.9%.
The improvement in the NIM
be improving (30-89days past due). Other retail and leasing drove the 36bp decline in 30-89days arrears.
BOQ stated that it will have an
talent from the major banks (new CRO, new COO).
raises questions with respect to earnings sustainability given the sector saw marked declines in NIM over the same period (c310bp). Additionally, BOQs move away from high-yielding online deposits in pursuit of sustainable termed deposits this half is a oneoff kicker in that sense.
Despite the flat cost growth in
upcoming strategy day to talk through how it will improve RoE and the strategy going forward.
1H12, the cost to income ratio increased from 44.5-45% in 1H12.

Short-term wholesale still remains
high at 11% for a BBB rated bank.
26 March 2012
4
Macquarie Research
Bank of Queensland
Profit down due to bad debts.

As a part of the cleansing statement, BOQ released its preliminary results for 1H12. The bank will
make a statutory loss of A$91m, which equates to a A$72m cash profit loss, below MRE and consensus forecasts.
Fig 1
Preliminary profits miss MRE and consensus forecasts.

2H11 1H12 (Prelim) 326 77 403 -181 222 -328 -106 33 -72 -91 HoH growth (%) 2.4% -18.8% -2.4% -0.1% -4.3% 396.2% -163.9% -170.8% -165.8% -182.2% f1H12 MRE 319.9 96.5 416.5 -191.9 224.5 -67.7 156.9 -44.1 117.5 112.8 318.3 94.8 413.1 -181.2 231.9 -66.1 165.8 -46.6 109.4 110.7
Net Interest Income ($m) Non-interest income ($m) Total Operating Income ($m) Operating Expenses ($m) Normalised underlying profit tax ($m) Impairment Expense ($m) Normalised operating profit before tax ($m) Tax expense ($m) Normalised cash NPAT($m) Reported Profit ($m)
Source: Company data, Macquarie Research, March 2012
Costs were relatively controlled increasing 1.7% YoY, decreasing 0.1% HoH. As a result we revise our earnings down 35-94% on the basis of higher bad debts and the capital
raising. Our target price moves down from A$8.70 to A$6.85.
Fig 2 Earnings changes

Forecast Changes Old Cash EPS (Macq Basis) New Cash EPS (Macq Basis) % Change Old DPS New DPS % Change Old Cash NPAT (Macq Basis) New Cash NPAT (Macq Basis) % Change Source: Macquarie Research, March 2012 FY11 84 84 54 54 177 177 FY12 109 6 -94.1% 61 54 -11.5% 252 44 -82.5% FY13 120 78 -35.2% 69 56 -18.8% 288 243 -15.5% FY14 125 77 -38.3% 74 58 -21.6% 311 249 -19.8%
NIM increased 3bp (1.65% to 1.68%) in the tough funding environment, whilst the majors and BEN
NIM saw declines of 3-10bp in 1H12 (or 1Q12). BOQs primarily deposit-funded balance sheet was a key driver of the robust 1H12 NIM. Despite the banks keen efforts to reduce reliance on wholesale funding and pursue stable deposits, we do not think it likely that BOQ can hold-off margin impact in 2H12. We forecast a 10bp decline for FY12.
26 March 2012
5
Macquarie Research
Bank of Queensland
Fig 3 Resilient NIM in 1H12 forecasted 2H12 not likely to be the same
1.75% 1.70% 1.65% 1.60% 1.55% 1.50% 1.45% 1.40% FY11 Asset Mix 1.65% 5bp
3bp 1bp
2bp
1.68%
Funding & Capital
NPLs
Other
1H12
The major difference is bad debts, where a A$328m charge has been taken including an A$160m
overlay for QLD-related economic weakness, c400% greater than 2H11 and 1H12 MRE forecasts. Property valuations were hardest hit in the South-East QLD and Northern NSW properties. Residential developments and luxury homes saw the largest drop, with commercial real estate and other industrial developments impacted to a lesser degree.
Fig 4
700
Commercial real estate driving the 30% increase in impaired assets 1H12 HoH
99.2 600 500

$A(M)
- 8.7
579
444
27
17.8
400 300 200 100 0 2H11 Residential Lines of Credit CRE Leasing 1H12
Source: Company Data, Macquarie Research, March 2012
Large capital raising removes balance sheet issues

There is no doubt that the bad debt charge taken by BOQ in 1H12 (191bp) represents a step
change in magnitude for BOQ but also the sector the impairment (major bank impairment reached c80-90bp at the height of the GFC).
Hence in some ways a large capital raising (c30% of shares outstanding) was needed to keep the
market satisfied that balance sheet issues had been removed from the picture. With the capital raising, BOQ now has impaired asset coverage of c100%, bringing it in to line with the majors.
Following a c30% HoH increase in impaired assets, provision coverage has increased from 1.56%
to 2.72% of RWA or c100% of impaired assets. As a result BOQ is the best provisioned Australialisted bank.
26 March 2012
6
Macquarie Research
Bank of Queensland
Fig 5
Market leading coverage post capital raising

2H11 1H12 43% 32% 10% 1.18% 0.95% 0.54% 2.72% 1.5% 0.9% 96.9% 85.4% 27.1%
Specific provisions to Impaired Assets BOQ Average Majors BEN Collective Provisions to RWA BOQ Average Majors BEN Total Provisions to RWA BOQ Average Majors BEN Total Provisions to Impaired Assets BOQ Average Majors BEN Source: Company data, Macquarie Research, March 2012 57.1% 85.7% 26.6% 1.6% 1.6% 0.9% 0.39% 1.00% 0.57% 39% 31% 9%
1H12 saw a marked decline in capital for BOQ, 7.4% to c6.6% on a Basel III basis. The increased
provisioning and bad debt expenses shaved c0.44% off core tier 1 capital in 1H12. The commitment to paying dividends accounted for the remainder of the decline. The forthcoming capital raising will see capital rise to market-leading levels of c8.6%.
Fig 6 BOQ capital raising brings 1H12 to adequate capital levels
9% 9% 8% 8% 7% 7% 6% 6% 5% 2H11 Statutory Profit Reduction Dividends Paid 7.4% -0.44% -0.38% 6.6%
2.0%
8.6%
1H12 (ex. capital Capital raising & raising additional Dividends
1H12
However the challenge issued by the GFC still remains it is still unclear how BoQ can earn at least its cost of equity
While balance sheet issues have been removed, the fundamental challenge of earning a
reasonable return remains for BOQ (and regional banks in general). We forecast that BOQ may be able to earn a RoE around 8% in FY13. This would justify a c0.75x Price to book multiple, placing the share price around A$6.42. Improving RoE will be no easy task, given the ongoing intermittent pressures on funding, under-investment in systems and a deteriorating QLD economy.
26 March 2012
7
Macquarie Research
Bank of Queensland
Fig 7 RoE (%) BOQ lagging most other players
20 18 16 14 12 10 8 6 4 2 0 ANZ CBA NAB WBC BOQ BEN
Source: Bank data, Macquarie Research, March 2012
26 March 2012
8
Macquarie Research
Bank of Queensland
Year Ending 31 August
1H11
2H11
2011
1H12
2H12
2012
2013
2014
Bank of Queensland Neutral

Current Price Target Price
PER SHARE DATA Cash EPS (AUD) - Macq basis (basic) Growth Rate - Cash EPS (%) DPS (AUD) BVPS (stated) (AUD) NTA PS (AUD) Shares in issue (m)
35 -31.2 26 10.2 7.7 220
49 39.3 28 10.5 8.0 223
84 -12.0 54 10.5 8.0 221
-31 -137.1 26 9.9 7.4 228
38 -220.6 28 8.6 6.7 306
6 -92.3 54 8.6 6.7 267
78 1,104.9 56 8.6 6.8 313
77 -0.7 58 8.6 6.9 323
A$7.30
TSR = 1%
A$6.85
Reuters: BOQ.AX
Bloomberg: BOQ AU
VALUATION METRICS & PROFITABILITY P/E (Cash basic) 15.2 P/B (stated) 0.7 P/NTA 1.0 ROE (stated) (%) 4.1 ROA (stated) (%) 0.26 Dividend yield (%) 7.1 Dividend payout (%) 73.8 PROFIT & LOSS (AUD m) Net interest revenue Non-interest income Fees and commissions OMB revenue share Other Revenue Total Operating Income Total Operating Costs Employee costs Other costs Net Operating Income Bad debt expense Bad debts recovered Goodwill Pre-tax profit Tax Minority shareholders Other post tax items Stated net profit Extraordinary & Other items Hybrids distributions Movement in GRCL Goodwill Macquarie 'Cash' Earnings
9.0 0.7 0.9 8.8 0.56 7.7 57.1
8.7 0.7 0.9 6.5 0.41 7.4 64.1
-11.7 0.7 1.0 -7.2 -0.45 7.1 -83.2
9.7 0.9 1.1 8.2 0.54 7.7 74.3
113.2 0.9 1.1 0.7 0.05 7.4 837.1
9.4 0.8 1.1 8.2 0.56 7.7 72.0
9.5 0.8 1.1 8.2 0.55 7.9 75.2
20 15 10 5 0 5 10 1H11 2H11
Profitability & Leverage
1.2 0.8 0.4 0.0
2011
1H12 2H12
2012
2013
0.4 0.8
Leverage (x) ROA (RHS, %)
ROE (%)
12.0 10.0 8.0 6.0 4.0 2.0 0.0
Capital Adequacy & RWA Growth
10 8 6 4 2 0
310 83 57 -8 34 393 174 75 98 220 134 0 4 81 24 0 -7 50 5 0 20 3 77
318 95 57 -7 45 413 177 80 97 237 66 0 5 166 47 0 -9 111 5 0 -10 3 109
628 178 114 -15 79 806 350 155 195 456 201 0 8 247 70 0 -16 161 10 0 10 6 187
326 77 56 -8 28 403 176 78 98 227 328 0 5 106 -33 0 -18 -91 18 0 -3 5 -71
318 78 57 -8 29 395 184 81 103 211 45 0 5 161 50 0 0 111 0 0 0 5 115
644 155 114 -15 57 798 361 159 201 438 373 0 9 55 17 0 -18 20 18 0 -3 9 44
654 158 114 -16 61 812 385 170 215 427 77 0 9 340 106 0 0 234 0 0 0 9 243
680 161 113 -17 65 841 407 179 229 434 76 0 9 349 109 0 0 240 0 0 0 9 249
1H11 2H11 2011
1H12 2H12 2012
2013
BALANCE SHEET AND CAPITAL ADEQUACY (AUD m) Risk weighted assets 18,946 20,525 Interest-earnings assets 37,823 38,525 Total loans 33,154 34,065 Total deposits 29,014 29,627 Total Assets 39,171 39,901 Stated Shareholder Equity 2,473 2,574 Tier 1 capital 1,659 1,718 Tier 1 ratio (%) 8.8 8.4 ASSET QUALITY Coverage (%) Bad debt chg / Avg loans (%) KEY RATIOS AND GROWTH Growth in revenues (%) Growth in costs (%) Growth in PPOP (%) Growth in RWA (%) Growth in loans (%) Growth in deposits (%) Net interest margin (%) Cost income ratio (%) (normalised) 20,525 38,174 34,065 29,627 39,901 2,574 1,718 8.4 20,966 39,354 34,798 30,719 40,590 2,440 1,632 7.8 21,490 40,338 36,411 31,828 41,713 2,969 2,153 10.0 21,490 39,846 36,411 31,828 41,713 2,969 2,153 10.0 22,578 41,863 38,732 33,439 44,085 3,121 2,311 10.2 23,721 43,982 40,973 35,132 46,615 3,272 2,468 10.4
RWA Growth (RHS, %)
Tier 1 ratio (%)
Asset Quality
1.20 1.08 0.96 0.84 0.72 0.60 0.48 0.36 0.24 0.12 0.00 0.12 1H11 2H11 2011 1H12 2H12
50 40 30 20 10 0
35 0.82
35 0.39
44 0.60
69 1.91
77 0.25
40 1.07
35 0.22
35 0.20
Prov./ NPL's (RHS) (%)
Bad debt exp/ Loans (bp)
11.0 7.9 13.6 -0.3 2.2 3.3 1.65 44.1
5.1 1.7 7.8 8.3 2.7 2.1 1.64 42.7
15.7 10.5 20.0 8.0 5.0 5.5 1.65 43.4
-2.4 -0.1 -4.1 2.2 2.2 3.7 1.64 43.7
-1.9 4.7 -7.0 2.5 4.6 3.6 1.56 46.7
-0.9 3.1 -4.0 4.7 6.9 7.4 1.62 45.2
1.7 6.7 -2.5 5.1 6.4 5.1 1.56 47.4
3.6 5.8 1.6 5.1 5.8 5.1 1.55 48.4
DU PONT STYLE ANALYSIS (ROA vs ROE) Net interest income 1.60 Non-interest income 0.43 Total Operating Income 2.02 Operating Expense -0.89 Net Operating Income 1.13 Impairment Charge -0.69 Pre-tax Profit 0.44 Tax & Adjustments -0.02 Cash Profit (ROA) 0.42 Leverage (x) 15.4 Cash Profit (ROE) 6.4
1.61 0.48 2.09 -0.89 1.20 -0.33 0.86 -0.29 0.58 15.7 9.0
1.60 0.45 2.05 -0.89 1.16 -0.51 0.65 -0.15 0.50 16.0 7.9
1.62 0.38 2.00 -0.88 1.13 -1.63 -0.50 0.17 -0.33 16.1 -5.3
1.54 0.38 1.92 -0.90 1.02 -0.22 0.80 -0.22 0.58 15.2 8.9
1.58 0.38 1.96 -0.88 1.07 -0.91 0.16 -0.03 0.13 14.9 2.0
1.52 0.37 1.89 -0.90 1.00 -0.18 0.81 -0.23 0.59 14.3 8.4
1.60 0.45 2.05 -0.89 1.16 -0.51 0.65 -0.15 0.50 16.0 7.9
26 March 2012
9
AUSTRALIA
SUN AU
Underperform Price (at CLOSE#, 26 Mar 2012) A$8.12

Volatility index 12-month target 12-month TSR Valuation
- Sum of Parts
Suncorp
Red card from BOQ
Event
Following the BOQ market update and capital raising, we review the potential
A$ % A$
Low 8.20 +6.8 7.68
read through to SUN.
GICS sector Market cap 30-day avg turnover Number shares on issue Investment fundamentals
Year end 30 Jun Net interest Inc Non interest Inc Underlying profit Reported profit Adjusted profit EPS adj EPS adj growth PER adj PER rel Total DPS Total div yield Franking ROA ROE Equity to assets EV/EBITDA P/BV m m m m m % x x % % % % % x x
Insurance A$m 10,450 A$m 39.3 m 1,287
Impact
Why the BOQ update is not a direct read through to Suncorp: 1) the
2011A 2012E 2013E 2014E 910.0 128.0 470.0 453.6 653.6 51.3 -19.5 15.8 1.28 35.0 4.3 100 0.7 4.7 14.7 9.2 0.7 942.8 148.9 512.5 781.9 884.9 64.8 26.3 12.5 1.01 45.0 5.5 100 0.9 6.2 15.4 7.6 0.7 951.2 994.6 111.4 111.5 488.7 532.0 810.1 930.1 922.1 1,042.1 67.5 76.3 4.2 13.0 12.0 10.6 1.09 1.03 48.0 56.0 5.9 6.9 100 100 1.0 1.1 6.4 7.0 15.6 15.7 7.0 6.2 0.7 0.7
Suncorp Non Core Bank (NCB) has been closed to new business for 3.5yrs, 2) Suncorp, even under a BOQ type scenario, would not need to raise capital given its excess capital position (Suncorp surplus capital estimate $1.18bn, MRE estimate ~$845m), 3) BOQsproblems are concentrated in South East QLD while 58% of the SUN NCB is outside QLD, 4) Suncorps loan book is 79.4% retail, BOQ loan book 73.7% retail.
Why we remain cautious re Suncorp Bank: 1) Specific provision coverage
in the NCB is only 15.8%, collateral valuations may prove inflated given current difficult economic conditions or the wind down of this book may be protracted causing a funding drag, and 2) the 1H12 Suncorp Core Bank impairment charge of 4bps ($9m) in 1H12 is not sustainable.
SUN and BOQ: Provision comparison (last reported, $m)
Impaired Assets SUN Non Core Bank SUN Core Bank SUN Total Bank Implied SUN 'shortfalltoBOQ BOQ Major bank average RWA SUN Non Core Bank SUN Core Bank SUN Total Bank BOQ Implied SUN 'shortfall' to BOQ
Source: Macquarie Research, March 2012
Specific Provisions 342 45 387 604
SP/ Gross Impaired 15.8% 31.9% 16.8% 26.2% 43.0% 32.3% CP+GRCL / RWA 2.40% 0.85% 1.22% 1.51% 0.29%
2,163 141 2,304
SUN AU vs ASX 100, & rec history
579
249 Collective Prov+GRCL 160 182 342 312 80
6,660 21,307 27,967 20,500

EPS FY12E +0.3%, FY13E -2.2%, FY14E -4.9%. TP declines from $8.31 to
$8.20.
Price catalyst
Analyst(s)
Tim Lawson +61 2 8237 7332 Bryan Raymond +61 2 8232 2740 tim.lawson@macquarie.com bryan.raymond@macquarie.com
12-month price target: A$8.20 based on a Sum of Parts methodology. Catalyst: May 2012 strategy briefing

Underperform. We believe that the Suncorp Non Core Bank will continue to
be a drag on performance of the Suncorp group.
10
Macquarie Research
Suncorp
Suncorp: Non-core bank

Fig 1 Impairment charge stubbornly high Fig 2
16
Actual
250
Performing loan run-off masks NPLs

Actual Forecast Lease Finance Property Investment Development Finance Corporate
Impairment Charge (A$m) 300 Forecast
Non-Core Portfolio (A$bn)
14 12
200
10 8 6 4
150
100
50
2
0 1H10 2H10 1H11 2H11 1H12 2H12e 1H13e 2H13e 1H14e 2H14e 1H15e 2H15e
Fig 3 CashNIMreflectsfundingdragfromNPLs
Net Interest Margin
Fig 4 Specific provision and net impairedloans

Gross Impaired Assets (A$bn) 2.5
1.0% 0.5%
Actual
Forecast
Actual
Forecast
Specific Provisions Net Impaired Assets
0.0% -0.5%
2.0
1.5
-1.0% -1.5% -2.0%

0.5 1.0
-2.5% -3.0% 1H10 2H10
Reported Net Interest Margin Cash Net Interest Margin (adjusted for unwind interest discount) 1H11 2H11 1H12 2H12e 1H13e 2H13e 1H14e 2H14e 1H15e 2H15e
0.0 1H10 2H10 1H11 2H11 1H12 2H12e 1H13e 2H13e 1H14e 2H14e 1H15e 2H15e
Fig 5 Provision composition

Provisions (A$m)
Fig 6 Interest not brought to account

Accrued Interest not brought to account (A$m) 1200 Actual
1000
1000 900 800 700 600 500 400 300 200
Actual
Forecast
Forecast
Specific
Collective
GRCL
800
600
400
200
100 0 1H10 2H10 1H11 2H11 1H12 2H12e 1H13e 2H13e 1H14e 2H14e 1H15e 2H15e
Source (for all above): Company data, Macquarie Research, March 2012
26 March 2012
11
Macquarie Research
Suncorp
Suncorp Metway Ltd - Group

Year Ending 30 June
1H10 1H10A
2H10 2H10A
1H11 1H11A
2H11 2H11A
1H12 1H12A
2H12 2H12E
1H13 1H13E
2H13 2H13E
2010 2010A
2011 2011A
2012 2012E
2013 2013E
PROFIT & LOSS Banking + Interest Income + Non-Interest Income - Operating Expenses Underlying Performance - Loan Provisioning Banking Gross Profit General Insurance + Net Earned Premium - Net Claims Incurred - Underwriting Expenses Underwriting Result + Investment income on technical reserves +/- Discount rate adjustment Insurance Trading Result +/- Investment income on SHF's +/- Other income/expenses General Insurance Gross Profit Life Insurance Gross Profit Other Wealth Management Adjustments Consolidated Gross Profit Consolidated Pre-Tax Profit - Taxation Net Profit After Tax +/- Net Significant Items - Minority Interests Reported Profit - Net Significant items Less - Hybrid Security Distributions Adjusted 'Cash' Profit Cash EPS (adj.) Cash EPS growth (adj.) PE (adj.) DPS Dividend yield (net) Franking EFPOWA shares on issue KEY RATIOS Banking Loan Growth (incl. securitisation) Interest Margin Non Interest Income / Total Income Cost to Income Ratio (Banking) BDD / GLAA Tier 1 Capital Ratio Effective Tax rate (Group) General Insurance Insurance Trading Result NEP Growth Net Claims Ratio Underwriting Expense Ratio Combined Operating Ratio (COR) All Ords. Forecast (End Period)
$m $m $m $m $m $m
466 98 -277 287 -274 13
462 77 -269 270 -205 65
438 70 -279 229 -213 16
472 58 -289 241 -112 129
469 91 -291 269 -131 138
474 58 -288 243 -156 87
471 56 -287 240 -143 97
481 55 -287 249 -136 113
928 175 -546 557 -479 78
910 128 -568 470 -325 145
943 149 -579 512 -287 225
951 111 -574 489 -279 210
$m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m % x % % m
3,144 -2,235 -812 97 260 44 401 100 -10 491 181 4 -1 688 688 -229 459 -92 -3 364 92 21 477 35.1 203.5 11.6 15.0 3.7 100 1,360
3,166 -2,544 -858 -236 342 98 204 94 -15 283 207 0 10 565 565 -188 377 45 -6 416 -45 23 394 28.6 -18.3 14.2 20.0 4.9 100 1,376
3,266 -2,381 -795 90 169 97 356 87 -28 415 108 0 5 544 544 -180 364 -137 -4 223 137 0 360 28.3 -1.2 14.3 15.0 3.7 100 1,273
3,011 -2,361 -828 -178 339 -105 56 119 -27 148 156 0 6 439 439 -145 293 -63 0 230 63 0 293 23.0 -18.7 17.6 20.0 4.9 100 1,275
3,359 -2,706 -783 -130 373 -114 129 126 -29 226 235 0 0 599 599 -163 436 -47 0 389 47 0 436 31.9 38.8 12.7 20.0 2.5 100 1,365
3,462 -2,541 -786 135 138 121 394 84 -25 453 57 0 0 598 598 -149 449 -56 0 393 56 0 449 32.9 2.9 12.4 25.0 3.1 100 1,365
3,521 -2,587 -797 136 156 69 361 83 -46 398 127 0 0 622 622 -189 432 -56 0 376 56 0 433 31.7 -3.6 12.8 22.0 2.7 100 1,365
3,628 -2,651 -821 156 235 0 391 95 -33 453 140 0 0 706 706 -216 490 -56 0 434 56 0 492 35.9 13.2 11.3 26.0 3.2 100 1,365
6,310 -4,779 -1,670 -139 602 142 605 194 -25 774 388 4 9 1,253 1,253 -417 836 -47 -9 780 47 44 871 63.7 4.4 12.7 35.0 4.3 100 1,368
6,277 -4,742 -1,623 -88 508 -8 412 206 -55 563 264 0 11 983 983 -325 658 -200 -4 453 200 0 654 51.3 8.9 15.8 35.0 4.3 100 1,274
6,821 -5,247 -1,569 5 511 7 523 210 -54 679 293 0 0 1,197 1,197 -312 885 -103 0 782 103 0 885 64.8 -53.1 12.5 45.0 5.5 100 1,365
7,149 -5,239 -1,617 292 391 69 752 178 -79 851 267 0 0 1,327 1,327 -405 922 -112 0 810 112 0 923 67.5 -38.2 12.0 48.0 5.9 100 1,365
% % % % % % % % % % % % %
(2.0) 1.40 17.4 49.1 0.97 12.0 33.3 12.8 5.0 71.1 25.8 96.9 4,883
(3.5) 1.44 14.3 49.9 0.75 13.2 33.2 6.4 0.7 80.4 27.1 107.5 4,325
(2.7) 1.35 13.8 54.9 0.81 13.7 33.0 10.9 3.2 72.9 24.3 97.2 4,847
(6.9) 1.54 10.9 54.5 0.45 9.6 33.1 1.9 (7.8) 78.4 27.5 105.9 4,660
(1.9) 1.56 16.3 52.0 0.54 9.9 31.3 3.8 11.6 80.6 23.3 103.9 4,111 1H12A 46,028 93,045 53,917 78,872 14,133 14,133 3.1 0.47 6.11
(0.7) 1.61 10.9 54.2 0.66 10.3 25.0 11.4 3.1 73.4 22.7 96.1 4,449 2H12E 45,863 93,265 53,801 78,933 14,333 14,333 3.1 0.48 6.33
(0.1) 1.57 10.7 54.5 0.60 10.9 30.4 10.2 1.7 73.5 22.6 96.1 4,675 1H13E 45,953 93,821 53,685 79,355 14,467 14,467 3.0 0.46 6.51
(0.3) 1.64 10.3 53.5 0.58 11.5 30.6 10.8 3.1 73.1 22.6 95.7 4,675 2H13E 45,944 94,287 53,570 79,602 14,685 14,685 3.4 0.52 6.75
(5.4) 1.42 15.9 49.5 0.88 13.2 33.3 9.6 10.8 75.7 26.5 102.2 4,325 2010A 52,274 95,339 58,646 81,386 13,953 13,953 6.2 0.93 5.78
(9.4) 1.44 12.3 54.7 0.66 9.6 33.1 6.6 4.4 75.5 25.9 101.4 4,660 2011A 46,877 95,543 54,806 81,470 14,018 14,018 4.7 0.68 5.95
(2.5) 1.58 13.6 53.1 0.60 10.3 27.9 7.7 37.6 76.9 23.0 99.9 4,449 2012E 45,863 93,265 53,801 78,933 14,333 14,333 6.2 0.94 5.40
(0.4) 1.61 10.5 54.0 0.58 11.5 30.5 10.5 68.8 73.3 22.6 95.9 4,675 2013E 45,944 94,287 53,570 79,602 14,685 14,685 6.4 0.98 5.52
Share Price 12 Month Target Price Trading Upside / (Downside)
26/03/2012 $8.12 $8.20 +1.0%
BALANCE SHEET (year end $m) Gross Performing Loans Total Assets Interest Bearing Liabilities Total Liabilities Ord Shareholder Capital Total Shareholders' Funds ROE (ave) ROA (ave) NTA Per Share
26 March 2012
12
Macquarie Research
Suncorp
Suncorp General Insurance and Wealth Management

Year Ended: 30 June
Price:
1H12A
3,855 -128 3,727 -368 3,359 -3,757 1,051 -2,706 -434 -349 -783 -130 373 -114 129 88 38 -37 8 226 -64 162
$
FY13E
8,168 -181 7,987 -839 7,149 -7,325 2,086 -5,239 -890 -727 -1,617 292 391 69 752 201 -23 -110 31 851 -235 615
8.12
FY14E
8,526 -181 8,345 -876 7,469 -7,639 2,178 -5,461 -930 -754 -1,684 323 422 59 804 214 -23 -114 33 915 -255 661
Underwriting Accounts ($m)
FY09A
FY10A
7,027 -138 6,889 -579 6,310 -5,824 1,329 -4,495 -965 -705 -1,670 145 602 -142 605 191 3 -82 57 774 -217 557
1H11A
3,563 -16 3,547 -281 3,266 -3,141 760 -2,381 -447 -348 -795 90 169 97 356 93 -6 -43 15 415 -123 292
2H11A
3,717 -181 3,536 -525 3,011 -6,182 3,821 -2,361 -465 -363 -828 -178 339 -105 56 87 32 -46 19 148 -48 100
FY11A
7,280 -197 7,083 -806 6,277 -9,323 4,581 -4,742 -912 -711 -1,623 -88 508 -8 412 180 26 -89 34 563 -171 392
2H12E
3,915 -47 3,868 -406 3,462 -3,551 1,011 -2,541 -433 -353 -786 135 138 121 394 93 -9 -47 22 453 -126 327
FY12E
7,770 -175 7,595 -774 6,821 -7,308 2,062 -5,247 -867 -702 -1,569 5 511 7 523 180 29 -84 30 679 -190 489
Gross Written Premium 6,815 Movement in Unearned Premium -273 Gross Earned Premium 6,542 Reinsurance Expense -561 Net Earned Premium 5,981 Gross Claims Incurred -5,331 Reinsurance Recoveries 1,037 Net Claims Incurred -4,294 Acquisition Costs -1,079 Administration Costs -563 Underwriting Expenses -1,642 Underwriting Result 45 Investment income on technical reserves 733 Discount rate adjustment -316 Insurance Trading Profit 462 Normalised investment income on SHF's 129 Investment income market adjustment 1 Interest expense -115 Other net revenue 20 Pre-Tax Result 497 Income Tax Expense -157 AASB1023 Reported Result 340
Wealth management
Life risk Funds management Investment income on SHF's/other Wealth Management Result Non-Banking Profit Contribution
FY09A
92 44 0 117 457
FY10A
87 55 0 222 779
1H11A
16 33 12 61 353
2H11A
30 22 36 88 188
FY11A
46 55 48 149 541
1H12A
23 23 87 133 295
2H12E
25 17 -10 32 359
FY12E
48 40 77 165 654
FY13E
55 42 53 151 766
FY14E
84 45 58 186 847
Ratios (% )
GWP Growth Reinsurance Outwards NEP Growth Net Claims Ratio Underwriting Expense Ratio Combined Ratio Pre-tax Insurance Profit to NEP Paid/Incurred Average Investment Return Effective Tax Rate Payout Ratio - AASB1023 ROA ROE All Ords.
FY09A
6.0 8.6 2.0 71.8 27.5 99.2 7.7 96.1 8.0 31.6 209 2.2 9.0 3948
FY10A
3.1 8.4 5.5 71.2 26.5 97.7 9.6 94.0 7.2 28.0 95 3.1 9.2 4325
1H11A
2.1 7.9 3.9 72.9 24.3 97.2 10.9 98.2 4.5 29.6 86 2.9 7.0 4847
2H11A
5.1 14.8 (4.9) 78.4 27.5 105.9 1.9 102.4 8.1 32.4 159 1.0 2.5 4660
FY11A
3.6 11.4 (0.5) 75.5 25.9 101.4 6.6 100.2 6.4 30.4 104 1.9 4.9 4660
1H12A
8.2 9.9 2.8 80.6 23.3 103.9 3.8 91.5 9.0 28.3 42 1.6 4.2 4111
2H12E
5.3 10.5 15.0 73.4 22.7 96.1 11.4 91.5 3.6 27.8 75 3.1 8.4 4430
FY12E
6.7 10.2 8.7 76.9 23.0 99.9 7.7 91.5 6.1 28.0 39 2.3 6.2 4430
FY13E
5.1 10.5 4.8 73.3 22.6 95.9 10.5 91.6 4.5 27.6 75 2.8 7.6 4654
FY14E
4.4 10.5 4.5 73.1 22.5 95.7 10.8 91.6 4.6 27.8 73 2.8 8.0 4889
Balance Sheet ($m)

Assets Cash and Liquids Receivables Investments Intangibles Other Assets Total Assets Liabilities Borrowings Unearned Premiums Net Outstanding Claims Other Liabilities Total Liabilities Net Assets Shareholders' Funds Dividends to Holding Co. Premium Solvency Claims Solvency Prudential margins NTA
FY09A
765 1,570 10,589 1,190 1,030 15,144
FY10A
368 1,804 11,144 5,616 1,408 20,340
1H11A
153 1,955 11,476 5,553 940 20,077
2H11A
657 2,101 10,377 5,268 1,620 20,023
FY11A
657 2,101 10,377 5,268 1,620 20,023
FY12E
585 2,423 11,759 5,247 1,702 21,716
FY13E
633 2,760 12,331 5,229 1,788 22,741
GWP business mix - FY11A

Home 26% CTP 12% Other 2%
Motor 35%
729 3,527 6,059 1,083 11,398 3,746 3,746 712 41 42 686 2,556
689 3,670 6,335 1,270 11,964 8,376 8,376 527 43 44 701 2,760
689 3,665 6,376 957 11,687 8,390 8,390 250 43 44 718 2,837
689 3,854 6,317 1,485 12,345 7,678 7,678 159 38 38 697 2,410
689 3,867 6,325 1,464 12,345 7,678 7,678 409 37 38 686 2,410
689 4,042 6,770 2,238 13,739 7,978 7,978 190 39 40 747 2,731
689 4,223 7,212 2,485 14,610 8,131 8,131 462 40 40 800 2,902
Commercial 23%
Workers' comp 2%
Valuation summary ($m)

P&C DCF Bank DCF (mid case) Financial Services PER Consolidated value Shares on issue Value per share Share price target % upside/downside 6,373 2,436 1,073 9,882 1287 7.68 8.20 1%
$ $
26 March 2012
13
AUSTRALIA
TAH AU
Price (at 05:10, 26 Mar 2012 GMT) Volatility index 12-month target 12-month TSR Valuation
- Sum of Parts
Outperform A$2.67
A$ % A$ Low 3.00 +20.2 3.01
TABCorp Holdings
Odds right for an in-play bet
Event
We refresh our views on TABCorp following a review of the state of the
Year end 30 Jun Revenue EBIT Reported profit Adjusted profit Gross cashflow CFPS CFPS growth PGCFPS PGCFPS rel EPS adj EPS adj growth PER adj PER rel Total DPS Total div yield Franking ROA ROE EV/EBITDA Net debt/equity P/BV
Consumer Services A$m 1,903 A$m 13.3 m 712.8
wagering market, as well as a number of the outstanding issues currently impacting investor sentiment towards the company. Taking a view on the likely outcomes of these issues, we have increased our target price to $3.00/sh (from $2.85/sh) and raised our recommendation to Outperform.
Impact
Since the demerger, the investment case on TABCorp has been clouded by a
2011A 2012E 2013E 2014E m 2,947.5 2,979.8 1,964.7 1,878.5 m 562.5 595.1 371.8 365.8 m 534.8 340.8 178.2 178.6 m 486.3 340.8 178.2 178.6 m 610.6 474.5 335.8 335.2 92.5 66.2 45.5 44.5 % -16.3 -28.4 -31.3 -2.1 x 2.9 4.0 5.9 6.0 x 0.35 0.49 0.79 0.86 73.7 47.6 24.1 23.7 % -4.9 -35.5 -49.3 -1.7 x 3.6 5.6 11.1 11.3 x 0.29 0.45 1.00 1.09 43.0 23.0 20.0 19.0 % 16.1 8.6 7.5 7.1 % 100 100 100 100 % 12.1 19.5 11.3 11.2 % 20.8 25.9 12.3 11.8 x 3.8 3.8 5.3 5.4 % 67.5 78.5 76.5 65.7 x 1.5 1.4 1.3 1.3
TAH AU vs ASX 100, & rec history
number of issues. While the awarding of the new Victorian wagering licence was completed in 2011, uncertainty lingers on matters such as the High Courtsdecisiononracefieldslegislation,thepotentialamendmentof the Interactive Gambling Act 2001 (IGA) toallowonlinein-playbetting,thelikely compensation claim against the Victorian Government, the renegotiation of a pooling agreement with RWWA and the renewal of broadcast rights for Sydney and Victorian racing. We expect increased clarity on all of these matters within the next six months, which we believe will improve sentiment towards TABCorp. Taking a view on the likely outcomes of these issues, we have increased our target price to $3.00/sh (from $2.85/sh). Akeydriverofvaluationupsideisthepotentialforonlinein-playorlive betting to be permitted following a review of the IGA. The Government will complete its review of the IGA by the end of June 2012. We expect online live betting would generate an additional $180m in annual wagering industry revenuesbyFY16,ofwhichTABCorpssharecouldbe$45m.Thiswould translate into an additional $20.7m in variable contribution for TABCorp, increasing NPAT by 7% and valuation by 20cps. We have incorporated a 50% risk-weighting to this outcome in our updated target price. Underlying the potential upside from live betting, wagering market growth remains robust. Market net revenue growth during the December half was 2.9%, and while TABCorp is losing share as punters increasingly shift from retail based to online and mobile wagering platforms, user feedback suggests TABCorpsinvestmentinmobiletechnology has it well placed to capture the expected growth in mobile-based wagering over the coming years.

Broad modelling adjustments. We are adjusting our earnings per share by the
following: FY12 +1.0%, FY13 +2.2%, FY14 +3.5%. Target price increased to $3.00/sh (from $2.85/sh) and we upgrade to Outperform.
Price catalyst
12-month price target: A$3.00 based on a Sum of Parts methodology. Catalyst: High court decision on race fields (30 March), completion of review
Analyst(s)
Lachlan Fitt +61 2 8232 9390 Andrew Levy, CFA +61 2 8232 5165 lachlan.fitt@macquarie.com andrew.levy@macquarie.com
of the Interactive Gambling Act (June), update on potential Vic compensation (by August), finalisation of broadcast right renewal (by Dec 2012).

Upgrade to Outperform. TABCorp has sold off since the 1H12 result and is
currently trading below our underlying valuation. The potential introduction of online live betting is a positive catalyst, and resolution of a number of uncertainties will improve investor sentiment towards the company.
14
Macquarie Research
TABCorp Holdings
Analysis
Wageringmarketgrowthremainsrobust
AustraliaswageringmarketdeliveredrobustgrowthintheDecemberhalfacrossalllevels
turnover, gross revenue and net revenue (variable contribution). Within this, the incumbent TABs continued to lose market share to the online based corporate bookmakers (CBs). At the net revenue level (variable contribution), we estimate corporate bookmaker market share increased by 122bps to 23.3%. This share was taken from TABCorp (44.6% to 44.2%), Tatts (18.5% to 18.1%) and on-course bookmakers (2.3% to 1.9%).
Fig 1
Australian wagering market trends in 1H12

Turnover Gross revenue 3.1% Net revenue (VC) 3.6%
1H12 growth
3.0%
1H12 growth (ex. Tote Tas)
1.8%
1.6%
2.9%
Drivers:
+ve Growing penetration of sports betting; +ve Increased accessibility of wagering products (ie. mobile wagering apps, smartphone penetration); +ve Increased useability of mobile platforms; +ve Higher rebates driving higher wholesale turnover, in particular by Tote Tasmania; -ve Potential cannibalisation from the introduction of Trackside in NSW retail outlets.
-ve Shift from tote to fixed odds products at incumbent TABs reducing overall winrates; +ve More casual, retail punters choosing to bet with corporate bookmakers; +ve Corporate bookmakers consciously seeking to increase revenue yields with the backdrop of race fields legislation that could see their required contribution to the racing industry increase.
+ve TAB fixed odds win rates being maintained at 12-13%, resulting in higher VC margins on fixed odds vs tote products; +ve Market share shifts to corporate bookmakers based in jurisdictions with lower taxes and industry funding commitments.
TAH market share (ex. Tote Tas) 1H11 1H12 45.6% 45.7% 55.4% 55.1% 44.6% 44.2%
For TABCorp, despite losing market share, net revenue growth was above gross revenue growth
as lower fixed odds tax rates offset lower win-rates (vs the tote products). As we have written previously, a crucial factor in determining the sustainability of VC margin as turnover moves from tote to fixed odds will be TABCorpsabilitytomaintainwin-rates at ~13% on their fixed-odds books. In our modelling, we assume fixed odds win-rates in FY20 have reduced to 10.5%. butFY13growthforecastdowngradedto2%(from5%)followingthe sale of Tote Tasmania
Taking into account the expected changes to the wholesale market now that Tatts has taken
control of Tote Tasmania, we have reduced our market turnover growth forecast for FY13 from 5% to 2%. This has the effect of removing $725m of turnover from the market.
Our long-term market share assumptions remain broadly unchanged. By FY20, we see corporate
bookmaker market share of 38.3%, compared with 26.8% in FY11 and 18.8% five years ago.
26 March 2012
15
Macquarie Research
TABCorp Holdings
Regulationofin-playbettingonlineoffers 7% NPAT upside for TAH

The current review of the Interactive Gambling Act (2001) couldseetheprohibitiononin-playor
live betting online removed. Live betting is currently permitted in retail outlets and for telephone account holders, however the industry is calling for live betting to be technology agnostic. This would level the competitive playing field and also seek to ensure Australian punters are not betting onin-playproductswithoffshorewageringoperators.The Department of Broadband, Communications and the Digital Economy is expected to hand down its report on the IGA review by the end of June 2012.
If live betting online was permitted across all bet types (ie. simple win/lose/draw, as well as micro
events such as the next goal or try scorer),weestimateAustraliaswageringoperators could generate an additional $180m of annual revenue by FY16. Ofthis,weestimateTABCorpsshare could be $45m, which would translate into an additional $20.7m in variable contribution for TABCorp and increase NPAT by 7%. In this scenario, we estimate valuation upside for TABCorp of 20cps. Inalitein-playscenariowhereonlysimplewin/lose/drawbetswerepermitted,we estimate valuation upside of 10cps.
Fig 2
$m
Summary of the in-play online opportunity

2013e 537 12.8% 30 5.5% 7.5 0.8 10.1 7.0 4.2 7.5 3.4 1.3% 2014e 1,127 22.3% 62 5.5% 15.7 1.7 21.2 14.7 8.7 15.7 7.2 2.8% 2015e 2,044 34.3% 112 5.5% 28.4 3.1 38.4 26.7 15.8 28.4 13.1 4.7% 2016e 3,245 50.1% 178 5.5% 45.1 4.9 61.0 42.4 25.1 45.1 20.7 6.8%
Additional in-play turnover % of existing sports turnover forecast Additional in-play revenue Revenue yield Estimated split of additional revenue TABCorp (incl. Luxbet) Tatts Sportingbet/Centrebet Sportsbet Others Impact on TABCorp Additional revenue Additional VC % of existing NPAT Source: Macquarie Research, March 2012
TABCorp well positioned to capture growth in mobile wagering

Over the past 12 months, we have seen strong signs of take-up of mobile platforms in the
Australian wagering market, namely: TABCorpsmobile sales in August 2011 represented 6% of total account sales, with over 21,500 unique account customers (11% of total account customers) betting via a mobile device during the month; 20%ofSportingbetAustralias2Q12turnoverwasviamobile,upfrom13%in1Q12. Centrebet generates 13% of turnover from mobile, up from 5% in 1Q12; 40% of Sportsbets online customers are now transacting via mobile, up from 5% in May 2011.
Going forward, we see a number of factors supporting the ongoing adoption of mobile wagering
platforms, including: Rapid adoption of terminal betting within retail wagering outlets; Early indications of a structural shift to mobile platforms for personalised services over fixed internet platforms (ie. Netbanking); Improved offerings as corporates and competing tote operators develop new applications and products with improved front-end design; and Thepotentiallegalisationofin-playbettingonline.
26 March 2012
16
Macquarie Research
TABCorp Holdings
An important driver of which operators will be successful in capturing the growth in mobile turnover
is the performance of their applications. With this in mind, we reviewed the feedback offered by usersofwageringappsonApplesAppStoreandfound Centrebet currently has the top-rated app developed by the leading wagering operators, with 54.5% of respondents rating the app above average (4 or 5 stars). This compares with Sportingbet at 51.9%, Sportsbet at 42.4%, Betfair at 39.7%,TABCorpat39.2%andLuxbetat33.3%.TattsBetdoesntcurrentlyhaveaniPhoneapp.
For TABCorp, feedback has been improving in recent months as a new version of its app was
released that included vision and audio of Sky Racing 1 and Sky Racing 2. We see scope for further improvement from TABCorp on this front in coming months should user feedback for the addition of a bet slip (history of bets) be followed up in the next version.
Fig 3 % of respondents who rated the app above average (4 or 5 stars)

% 80% 70% 60% 50% 40% 30% 20% 1 0% 0% TA H Spo rtsbet C'bet Spo rtingbet B etfair iB etmate fo r Luxbet (P addyP o wer) B etfair 39.2% 42.4% 54.5% 51 .9% 39.7% 33.3% 69.3%
Fig 4 TABCorpscurrentversionperformingmuch better than previous versions

% 45% 40% 35% 30% 25% 20% 1 5% 1 0% 5% 0% 1star 2 star 3 star 4 star 5 star A ll versio ns (ex current versio n) Current versio n (v5.4) 1 7.8% 1 %1 .0% 2.1 1 1 5.2% 1 2.3% 1 7.8% 1 .5% 1 34.3% 26.8% 41 % .1
Source: Apple AppStore, Macquarie Research, March 2012
1-2% consensus downgrades likely in relation to RWWA pooling fees

WenoteconsensusforecastsforTABCorpsshareofEBITDAfromtheVictorianwageringlicence
are likely to require downward revisions due to our expectation of lower pooling fees from RWWA.
We expect TABCorp and RWWA to finalise their new pooling agreement shortly, at rates well
below the current agreements. We had previously assumed RWWA would pay a pooling fee of 1.5% of turnover, however our earnings estimates are now based on an average fee (across retail andwholesaleturnover)of0.83%.TheimpactofthisistoreduceTAHsshareofpoolingfees from RWWA by $4.9m pa, which is essentially all margin. We forecast the Victorian wagering licence to contribute EBITDA of $111.5m in FY14, below original guidance of $120m, and consensus of ~$115m. Valuation uncertainties from compensation, in-play betting, race fields and broadcast rights
The valuation drivers of TABCorp have become partly-focussed on a number of non-operational
issues that will play out over the course of 2012. These issues are: Potentiallegalisationofin-playbettingonline DBCDE to hand down a report by June 2012; Compensation from the Victorian Govt Vic pokies licence expires in August 2012. TABCorp believes it is entitled to up to $687m compensation following the change in industry structure announced in 2008; Race fields legislation decision from the High Court to be handed down on 30 March 2012; Renewal of TVN broadcast rights Sky Channel rebroadcast agreement with TVN expires on 31 December 2012.
Collectively these factors could have a valuation impact on TABCorp of between -36cps and
+109cps. On a risk-weighted basis, we see the overall impact at +8cps and have included this amount in our target price and valuation methodology.
26 March 2012
17
Macquarie Research
TABCorp Holdings
Fig 5
Risk-weighted valuation upside of 8cps

Low High Riskweighted impact +10cps 0cps -4cps +2cps +8cps
In-playbetting Compensation* Race fields Broadcast rights Combined valuation impact
0cps -22cps -14cps 0cps -36cps
+20cps +71cps +0cps +18cps +109cps
* Our current target price of $3.00/sh already includes a risk-weighted amount of 22cps for potential compensation from the Victorian government. Source: Macquarie Research, March 2012
Fig 6
TABCorp SOTP valuation

EV ($m) $/sh EBITDA FY13 ($m) Implied Multiple 6.6x 4.2x 54.0x 6.6x 9.4x 7.0x 7.3x 4.7x 5.5x
Wagering NSW Victoria Luxbet Wagering consolidation upside (67% risk-weighted) Total Wagering Media & International Total Wagering (incl. Media & Intl.) Gaming TABCorp Gaming Solutions (TGS) Keno Total Gaming Vic licence compensation (30% risk-weighted) Risk weighted outcomes - in-play, race fields, broadcast rights Corporate capex Enterprise value Net debt - 1 July 2012 Equity value Underlying equity value Source: Macquarie Research, March 2012
1,279 510 168 127 2,084 585 2,669 253 371 624 161 59 -137 3,377 -1,159 2,217 1,933
1.74 0.69 0.23 0.17 2.83 0.79 3.63 0.34 0.50 0.85 0.22 0.08 -0.19 4.59 -1.57 3.01 2.71
193 121 3 317 63 379 35 78 113
492
6.9x
Fig 7
Profile of key TABCorp licences

Licence expiry % of FY12 EBITDA 24.8% 18.8% n/a 0.2% 43.7% 8.6% 40.0% -0.7% 8.3% 47.7% % of FY14 EBITDA 37.9% n/a 21.3% 1.5% 60.7% 11.9% n/a 10.3% 17.0% 27.3%
Wagering NSW Current Victoria New Victoria Luxbet Total wagering Media & International Gaming Vic pokies TGS Keno - Queensland, NSW, Victoria Total gaming Source: Macquarie Research, March 2012
2097 Aug-12 2024 2015 ~10yr agreements (rolling tenders) Aug-12 Up to 10yr agreements 2022
26 March 2012
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Macquarie Research
TABCorp Holdings
Wagering market growthremainsrobustbutFY13growthforecast downgraded to 2% (from 5%) following sale of Tote Tasmania
Following the release of results from TABCorp, Tatts, Sportingbet plc (Sportingbet, Centrebet) and
PaddyPowerplc(Sportsbet,IASBet)wehavereviewedthetrendsinAustraliaswageringmarket for the December half. We estimate these operators collectively account for 78% of total industry turnover. The remaining 22% of the market is predominantly made up of RWWA (8%), Tote Tasmania (5%) and the third tier corporate bookmakers (5%).
The key takeways from this data are:
Wagering turnover will continue to be driven by the growing penetration of sports betting, and the increased accessibility of wagering products, in particular via mobile platforms; Acting as a partial offset to underlying turnover growth will be a decline in wholesale turnover as Tote Tasmania changes ownership. Taking the expected changes to the wholesale market into account, we have reduced our market turnover growth forecasts for FY13 from 5% to 2%; Turnover and revenue growth from major corporate bookmakers (CBs) Sportingbet and Sportsbet has significantly outpaced that of the incumbent tote operators TABCorp and Tatts during the December half. Given the timing of the spring carnival racing, we believe strong corporate bookmaker growth during the December half vs the incumbent operators indicates more casual,retail punters are choosing to bet online with these operators; Corporate bookmaker win-rates are increasing. In our view, increasing win-rates are being driven by increased acceptance of corporate bookmakers as a betting alternative by casual, retailpunters.Inaddition,CBsmaybeconsciouslyseekingtoincreasetheirrevenueyield withthebackdropofracefieldslegislationthatcouldseetheirrequiredcontributiontothe racing industry increase. Lastly, the consolidation of top-tier corporate bookmakers that creates greater scale would also be helping sustain higher win-rates; At the net revenue level (variable contribution), we estimate corporate bookmaker market share increased by 122bps to 23.3%. This share was taken from TABCorp (44.6% to 44.2%), Tatts (18.5% to 18.1%) and on-course bookmakers (2.3% to 1.9%).
Fig 8
Wagering market trends in 1H12

Turnover 3.0% 1.8% 3.9% 2.7% Gross revenue 3.1% 1.6% 4.3% 2.9% Net revenue (VC) 3.6% 2.9% 5.7% 5.0%
% ch vs pcp Total wagering market (excl. Trackside) Total wagering market (excl. Tote Tas, Trackside) Total wagering market (incl. Trackside) Total wagering market (incl. Trackside, excl. Tote Tas) Market share (excl. Tote Tas, Trackside) Tabcorp Tatts RWWA ACTTAB Total TABs Sportingbet / Centrebet Sportsbet Luxbet Tom Waterhouse.com Other CBs Total CBs On-course bookies Source: Company data, Macquarie Research, March 2012
45.7% 15.4% 8.6% 0.7% 70.4% 10.6% 8.3% 2.3% 1.2% 4.7% 27.1% 2.5%
55.1% 19.4% 10.4% 0.8% 85.7% 4.9% 5.1% 0.8% 0.6% 1.9% 13.3% 1.0%
44.2% 18.1% 11.0% 1.5% 74.8% 8.5% 8.9% 1.3% 1.0% 3.6% 23.3% 1.9%
26 March 2012
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Macquarie Research
TABCorp Holdings
Fig 9 Major corporate bookmakers outpacing TAB turnovergrowthintheDecemberhalf

% ch vs pcp 1 5% 1 .2% 1 1 0% 5% 0% 9.1 %
Fig 10
40% 35% 30%
andthisistranslatingintorevenuegrowth
% ch vs pcp 35.0% 28.1 %
1 .9%
0.3%
25% 20%
-5% -1 0% -1 5% -20% Tabco rp* Tatts -1 7.6% Luxbet Spo rtsbet Spo rtingbet**
1 5% 1 0% 5% 0% -5% -0.6% Tabco rp* Tatts Luxbet 1 .7%
1 2.2%
Spo rtsbet
Spo rtingbet**
* TABCorp represents core wagering only, and excludes Trackside and Luxbet. ** Sportingbet results are for the 6 months to 31 January 2012, and exclude the impact of the Centrebet acquisition. Source: Company data, Macquarie Research, March 2012
* TABCorp represents core wagering only, and excludes Trackside and Luxbet. ** Sportingbet results are for the 6 months to 31 January 2012, and exclude the impact of the Centrebet acquisition. Source: Company data, Macquarie Research, March 2012
Turnover growth robust at 3.0% (excluding Tote Tasmania growth was 1.8%)
Overall, based on the reported results and our assumptions for growth by the rest of the market,
we estimate total turnover growth in AustraliaswageringmarketintheDecemberhalf was a robust 3%.

Turnover growth is being driven by a number of factors, some of which are not sustainable. The
sustainable growth drivers include: Growing penetration of sports betting, The increased accessibility of wagering products (ie. mobile wagering apps, smartphone penetration); and The increasing useability of these mobile platforms (ie. ongoing improvements to app functionality).
We expect these drivers will continue to underpin growth in wagering turnover in coming years,
andmaybeaidedbythepotentialintroductionofin-playbettingforonlineoperators.
In addition to these enduring factors, turnover growth is also being driven by increased
rebate/wholesale activity, in particular by Tote Tasmania. Excluding the growth at Tote Tasmania, we estimate underlying market turnover growth of 1.8% (for the December half).
The wholesale segment of the market (currently $1.5-2.0bn in annual turnover) is highly price
sensitive, and therefore small changes in rebate levels can lead to large increases in turnover levels. Conversely, should rebates reduce now that Tatts have taken control of Tote Tasmania, we would expect wholesale turnover to shrink by at least ~50%. This will clearly act as a negative drag on market turnover growth over the next 18 months. Taking the expected changes to the wholesale market into account, we have reduced our market turnover growth forecast for FY13 from 5% to 2%.
Lastly, core wagering turnover is likely to have been cannibalised somewhat by the introduction by
TABCorp of Trackside (cartoon racing game) into retail outlets in NSW. Turnover on Trackside is excluded from our wagering market data, so there is no direct impact on the growth rates in that sense, however some punters may be shifting their allocated betting wallet from core wagering products to Trackside and hence reducing the growth of core wagering products. If we look at growth including Trackside, we estimate total wagering market turnover growth would be 3.9% (for the December half).
26 March 2012
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Macquarie Research
TABCorp Holdings
Fig 11
Australian wagering market turnover growth (excl. Trackside)
% ch vs pcp 12% 10% 8%
10.8% 9.2% 7.1% 6.0% 9.4% 8.5%
6% 4% 2% 0% FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 1H12e 2.8% 1.6% 3.4% 3.1% 3.8% 3.0%
Source: Australian Racing Board, Macquarie Research, March 2012
Fig 12
% share 50% 45% 40% 35% 30% 25% 20% 1 5% 1 0% 5% 0%
Turnovermarketshareshiftsin1H12
Fig 13
% share 50%
excludingToteTasmania
43.9% 43.4%
45.6%45.7%
1 1 H1
1 2 H1
45% 40% 35%
1 1 H1
1 2 H1
25.7% 25.6%
30% 25%
26.6%27.1%
15.0%14.6% 8.8%8.8% 3.8%5.0% 2.9%2.4%
20% 1 5% 1 0% 5% 0% TA H
15.6% 15.4% 9.1% 9.3% 3.0% 2.5%
TA H
TTS
To te Tas
Other to tes (RWWA , A CTTA B )
CB s
On-co urse bo o kies
TTS
CB s
Revenuegrowthdilutedbyshiftfromtotetofixedodds
On a gross revenue basis, we estimate market growth of 3.1% in the 6 months to 31 December
2011. Excluding Tote Tasmania, we estimate market growth of 1.6%, slightly below turnover growth (Fig 8).
There are a number of moving pieces that are currently impacting the translation of turnover
growth to revenue growth. These include: The ongoing shift of turnover from tote products to fixed odds products. Fixed odds products are inherently lower win-rate products (12-13% vs 16% for the tote), and therefore reduce the overall gross revenue margin. For TABCorp, this dynamic saw +1.9% turnover growth translate into -0.6% gross revenue growth, however as discussed below, lower revenue margins are offset by lower wagering taxes on fixed odds products, which results in a similar variable contribution (VC or net revenue) outcome.
26 March 2012
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Macquarie Research
TABCorp Holdings
Market share losses by incumbent TAB operators to corporate bookmakers. As turnover share moves from TAB operators that generate revenue yields of ~16% (on totes) and 1213% (on fixed odds), to corporate bookmakers generating yields of 6-8%, market revenue growth will be below turnover growth. Increasing win-rates at major corporate bookmakers Sportsbet, Sportingbet and Luxbet which is partially offsetting the trend described above. In our view, increasing winrates are being driven by increased acceptance of corporate bookmakers as a betting alternativebycasual,retailpunters.Thesepuntersaregenerallyseenashighermargin than the informed, regular punters that have bet with corporate bookmakers for a number of yearsnow.Inaddition,CBsmaybeconsciouslyseeking to increase their revenue yield with thebackdropofracefieldslegislationthatcouldseetheirrequiredcontributiontotheracing industry increase. Lastly, the consolidation of top-tier corporate bookmakers that creates greater scale would also be helping sustain higher win-rates.
Going forward, we anticipate the impact of the ongoing tote to fixed odds shift will continue to see
industry gross revenue growth lag turnover growth.
Fig 14
TABCorp core wagering gross revenue yield
Fig 15
% NGR 7.0% 6.0%
Corporate bookmaker win-rates on the way up
% gro ss revenue yield 1 8% 1 7% 1 6% 1 5% 1 4% 1 3% 1 2% 1% 1 1 0% 1 H09a 2H09a 1 0a H1 2H1 0a 1 1 H1 a 2H1 a 1 1 2a H1 1 6.9% 1 % 6.1 1 6.7% 1 % 6.1 1 6.5% 1 5.6%
6.0% 5.0%
5.8% 5.9% 4.6% 3.7% 2.4% 2.0%
1 % 6.1
5.0% 4.0% 3.0% 2.0% 1 .0% 0.0% 3.4%
4.5% 4.5%
Spo rtingbet FY09
Luxbet FY1 0 FY1 1 1 2 H1
Spo rtsbet
Fig 16
% share 60% 50% 40% 30% 20% 1 0% 0%
Grossrevenuemarketshareshiftsin1H12
Fig 17
% share 60%
56.4%
53.8% 51.8%
1 1 H1
1 2 H1
55.1%
1 1 H1
1 2 H1
50% 40% 30%

18.5% 18.2% 10.4% 10.5% 4.6%6.0% 1.2% 1.0% 11.5% 12.5%
20% 1 0%
19.3% 19.4% 10.9% 11.2% 12.1%13.3%
1.3%
1.0%
TA H
TTS
To te Tas
CB s
0% TA H TTS Other to tes (RWWA , A CTTA B ) CB s On-co urse bo o kies
26 March 2012
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Macquarie Research
TABCorp Holdings
Tote to fixed odds migration boosting net revenue today, but longer term risks exist
At the end of the day, the profitability of wagering operators is driven by the level of variable
contribution (VC) or net revenue that is generated. VC is influenced by a number of factors such as win-rates (mainly fixed odds related), wagering taxes, and industry funding commitments.
Over the past six months, we estimate industry net revenue has grown by 3.6%, or 2.9%
excluding Tote Tasmania. Within this, we estimate corporate bookmaker market share increased by 122bps to 23.3% during the December half. This share was taken from TABCorp (44.6% to 44.2%), Tatts (18.5% to 18.1%) and on-course bookmakers (2.3% to 1.9%).
Fig 18
% share 50% 45% 40% 35% 30% 25% 20% 1 5% 1 0% 5% 0%
Netrevenuemarketshareshiftsin1H12
Fig 19
% share 50%
43.0% 42.3%
1 1 H1
1 2 H1
45% 40% 35% 30%
44.6%
44.2% 1 1 H1 1 2 H1
21.2% 22.3% 17.9% 17.3% 12.0% 11.9% 3.6%4.3%
25% 20% 1 5%
2.3%1.9%
23.3% 22.0% 1 8.5% 1 % 8.1 1 2.5% 2.5% 1
1 0% 5% 0% TA H TTS Other to tes (RWWA , A CTTA B ) CB s On-co urse bo o kies 2.3% 1 .9%
TA H
TTS
To te Tas
CB s
For TABCorp, despite losing market share during the December half, net revenue growth was
above growth revenue growth as lower fixed odds tax rates offset lower gross revenue yields. As we have written previously, a crucial factor in determining the sustainability of VC margin will be TABCorpsabilitytomaintainwin-rates at ~13% on their fixed-odds products. This win-rate compares with its major competitors that currently generate yields of 6-8%.
SomeofthisdifferentialcanbeexplainedbyTABCorpsmarket share and retail presence,
however over time we expect market fixed odds win-rates will converge to 10-11%. We expect this will be driven by: IncreasedpenetrationoffixedoddswithinTABCorpscustomerbase,whichisadirectly comparable product to the fixed odds markets offered by corporate bookmakers; Greater acceptance of the mobile wagering platform that allows improved price-discovery amongst operators; Increased brand awareness and credibility of corporate bookmakers increasing the pressure on TABCorp to maintain market share; and New players entering the Australian wagering market (ie. Bet365, Unibet rebranding Betchoice).
To illustrate the impact on variable contribution of reduced fixed odds win rates, we have shown a
number of scenarios with differing fixed odds yields below. We estimate the migration from tote to fixed odds is dilutive to overall $ margin at a win-rate of 12.4%.
26 March 2012
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10
Macquarie Research
TABCorp Holdings
Fig 20
$ Turnover Revenue % yield
Impact of lower fixed odds win-rates on Tabcorp's margins

Tote Win/place 100.0 14.5 14.5% 3.2 22.0% 4.1 28.2% 7.2 7.2% Fixed odds 13% yield 100.0 13.0 13.0% 2.9 22.0% 2.6 20.0% 7.5 7.5% Fixed odds 11.5% yield 100.0 11.5 11.5% 2.5 22.0% 2.3 20.0% 6.7 6.7% Fixed odds 10% yield 100.0 10.0 10.0% 2.2 22.0% 2.0 20.0% 5.8 5.8%
Industry funding % of revenue Wagering tax (incl. GST) % of revenue Margin % of turnover
Note:BasedonTABCorpsNSWwageringlicence.Thisanalysisassumesothervariablecostssuchasvenue commissions and race fieldsfeesarebasedonturnover,andthereforeconstantinallscenarios. Source: Company data, Macquarie Research, March 2012
26 March 2012
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11
Macquarie Research
TABCorp Holdings
Regulationofin-playbettingonlinecanpotentiallyoffer7%NPAT upside for TAH in 2016

In-playorlivebettinginvolves wagering on outcomes after a game or event has commenced.
Outcomes can be as simple as the result of a match, or as detailed as who scores the next goal. In recent years, this aspect of gambling has grown in popularity, in particular throughout Europe where it now accounts for the majority of sports wagering turnover at a number of operators.
In Australia, the subject of live betting has been in focus as the Department of Broadband,
Communications and the Digital Economy (DBCDE) completes its review of the Interactive Gambling Act 2001 (IGA). A final report from the DBCDE is due by the end of June 2012.
The IGA currentlypreventswageringoperatorsfromacceptingonlinewagersonin-playmarkets
on sporting events. This is inconsistent with the rules for other distribution channels, such as retail outletsandtelephoneaccounts,wherein-playbetsarepermitted.Itisalsoinconsistentwitha numberofoffshorewageringoperatorsthatprovidein-playmarketstoAustraliancustomersvia their websites.
Accordingly, in public submissions on the IGA review a number of industry participants have called
for this technology inconsistency to be removed, and for the IGA to be amended to allow online operators licensed in Australia to accept live bets. The other alternative is that the Government enforces regulations to prevent offshore operators accepting bets from Australian punters.
In its report, the Parliamentary Joint Select Committee on Gambling Reform (JSCOGR) chaired
by Mr Andrew Wilkie MP recommended that the currentprohibitionononlinein-playbetting shouldremaininplace. The JSCOGR noted that whentheIGAwasintroduced,in-playbetting online was restricted due to concerns about new technology providing a platform for excessive bettingintheheatofthemomentduringasportingmatch. Thecommitteesaidtherisks associatedwithrapidin-playbettingatthetouchofabuttonanditsattractiontoyoungpeople remainsaconcerntothecommittee. However, the committee did soften its stance somewhat by also saying analternativetothe current ban that could be investigated in the context of research in this area might be to relax thebanonin-playbettingonlinebyallowingsimplebettypessuchaswhichteamwillwin a matchorwhichhorsewillwinarace,butcontinuingtorestrictin-playbettingonlineon micro-eventsordiscretecontingencieswithinanevent.
Forsimplicity,withinouranalysiswerefertotwopotentialscenariosofin-playbetting:
Fullin-play bothsimpleandmicrobetsarepermittedand Litein-play onlysimplebettypesareallowed.

BasedontheexperienceofEuropeanoperatorsandassumingafullin-playscenario,we
estimate live betting could increase Australian wagering industry revenue by $180m by FY16. Ofthis,weestimateTABCorpssharecouldbe$45m,whichwouldtranslateintoanadditional $20.7m in variable contribution for TABCorp and increase NPAT by 7% in 2016. In this scenario, we estimate valuation upside for TABCorp of 20cps.
Fig 21
$m
Summary of the in-play online opportunity

2013e 537 12.8% 30 5.5% 7.5 0.8 10.1 7.0 4.2 7.5 3.4 1.3% 2014e 1,127 22.3% 62 5.5% 15.7 1.7 21.2 14.7 8.7 15.7 7.2 2.8% 2015e 2,044 34.3% 112 5.5% 28.4 3.1 38.4 26.7 15.8 28.4 13.1 4.7% 2016e 3,245 50.1% 178 5.5% 45.1 4.9 61.0 42.4 25.1 45.1 20.7 6.8%
Additional in-play turnover % of existing sports turnover forecast Additional in-play revenue Revenue yield Estimated split of additional revenue TABCorp (incl. Luxbet) Tatts Sportingbet/Centrebet Sportsbet Others Impact on TABCorp Additional revenue Additional VC % of existing NPAT Source: Macquarie Research, March 2012
26 March 2012
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12
Macquarie Research
TABCorp Holdings
Some cannibalisation expected, but overall turnover growth from in-play of $2-3bn
Theintroductionofin-playbettingviatheinternetwouldalmostcertainlygrowtotalturnoverand
revenueinAustraliaswageringmarket.Whiletherewouldinevitablybesome level of cannibalisation of existing wagering, from the examples we have seen (Unibet and Sportingbet shown below), there is little evidence to suggest that the ramp-up of in-play betting can not occur at the same time as maintaining the same level of underlying sports wagering.
There are likely to be several reasons for this, including:
Livebettingintroducingnewparticipantstothesportswageringmarketduetothesocial nature of simultaneously watching and gambling on a sporting event; and Existing punters allocating more of their gambling wallet to sports wagering, away from other forms of gambling such as pokies and keno.
Fig 22
GB P m 80
Unibet sports wagering gross revenue

Includes So ccer Wo rld Cup
Fig 23
GB P m 1 40 1 20
Sportingbet European sports gross revenue

Includes So ccer Wo rld Cup
In-play 70 60 50 40 30 20 28.8 1 0 0 2007 2008 3.1 36.9 9.0 P re-game
In-play P re-game
24.3 1 6.6
26.3
1 00 80 47.8 60 28.6 1 4.5 3.4 20.2 2005 33.9 39.0 44.6 44.5 54.4 45.7 66.8 73.2
40.4
44.5
40.9
40 20 0 8.7 2004
2009
201 0
201 1
2006
2007
2008
2009
201 0
201 1
At several European online operators, live betting now accounts for 60-70% of total sports
turnover and 40-60% of revenue. The majority of turnover in Europe is on soccer, which may be better suited to live betting due to the slower moving pace of the game, however we believe Australian centric sports (such as AFL and Rugby League) are also suited to the live betting environment. In addition, popular betting sportsinAustraliasuchascricket,tennisandgolfareverysuitedtoin-playbetting.
Using the European experience as a guide and taking into account the proportion of Australian
sportsturnoverviaretailoutlets(wherein-playisalreadypermitted), we would initially expect to seeAustralianoperatorsgenerateanadditional$1bnturnoverfollowingtheintroductionofinplaymarketsonline.Thisispremisedonafullin-playscenario(ie.simpleandmicrobets). Over time as the product matureswewouldexpectin-playturnovertogrowto$2-3bn by FY16 representing 30-50% of our existing sports turnover forecasts. IftheGovernmentapproveslitein-playbettingonly,weestimatetheturnoverupsidefrom live betting would be approximatelyhalfthatofthefullin-playscenario.
26 March 2012
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13
Macquarie Research
TABCorp Holdings
Fig 24
80% 70% 60% 50% 40% 30% 20% 1 0% 0% Dec-07
Unibet in-play as % of total

% o f to tal 80% 70% 60% 50% 40% 30% 20% 1 0% 0% Dec-08 % o f turno ver Dec-09 Dec-1 0 Dec-1 1 % o f gro ss revenue
Fig 25
80% 70% 60% 50% 40% 30% 20% 1 0% 0% 2006
Sportingbet in-play as % of total

% o f to tal 80% 70% 60% 50% 40% 30% 20% 1 0% 0% 2007 2008 % o f turno ver 2009 201 0 201 1 % o f gro ss revenue
% o f to tal
% o f to tal
Fig 26
A$bn 12 10 8
Live betting represents a potential market of $2-3bn turnover for Aust operators
In-play Pre-game 3.2 2.0
6 4 2 0 2008 2009 2010 2011 2012e 2013e 3.3 3.6 0.5 4.2
1.1 6.5
5.1
6.0
2.4
2.6
2.9
2014e
2015e
2016e
Revenue margins expected to be weaker due to fewer multiples on in-play markets

Revenue yields on in-playbettingareexpectedtobelowerthanstandalonesportsbetting,
primarilyduetothelackofmultispuntersplaceinalivebettingenvironment,vsthepre-game alternative. Due to the complexity of multis and the number of outcomes required to go a punters way in order to receive a payout, the margins on multis are considerably higher than standalone sportsbets.Bywayofexample,TABCorpsaverageyieldonsportsbettingis~11%.Withinthis we estimate the yield on multis is 22%, while standalone bets yield only 6%.
In addition, risk management on live betting is more difficult than on pre-game markets. Taking this into account, and based on the results from European operators, we estimate an
averagein-playrevenueyieldof5-6% for the Australian operators. We estimate the revenue opportunityforAustraliaswageringoperatorsfromfullin-playonlinebettingis$180mannually. This represents a 30% increase on our existing industry sports wagering revenue forecast for FY16. We note the Sportingbetin-playmarginof9.7%issignificantlyhigherthanUnibetand William Hill. The company puts this down to their experienced trading team, longer history in live betting and wider product offering. (See Fig 28)
26 March 2012
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14
Macquarie Research
TABCorp Holdings
Fig 27 TAB Sportsbet breakdown of win rates multis provide a boost

% yield 25% 21 .9% 20%
Fig 28 European in-play win-rates lower than pregame due to no multis in-play
% yield 1 2% 1 0.2% 1 0% 8% 1 .3% 1 9.7% 8.7%
1 5% 1 .1 1% 1 0% 6.0% 5%
6% 4% 2% 0%
4.6%
4.6%
0% M ultis No n-multis To tal
Unibet
Spo rtingbet P re-game In-play
William Hill
Fig 29
A$m 800 700 600 500 400 300 200 100 0
Live betting represents a revenue opportunity of $180m for Aust operators
In-play Pre-game 62.0 29.5 535.5 112.4
178.4
582.3
208.9
224.1
265.1
299.6
326.1
377.0
454.2
2008
2009
2010
2011
2012e
2013e
2014e
2015e
2016e
TABCorp expected to generate 25% share of online live betting, resulting in further $21m VC
Of the $180m additional revenue we estimate could be generated by 2016 from live betting online,
we expect TABCorp could generate around $45m, or 25%.

Other operators that are expected to benefit are Sportingbet and Sportsbet. We estimate market
share of 34% and 24% for these operators, respectively, based on their existing share of non-retail sports wagering.
26 March 2012
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15
Macquarie Research
TABCorp Holdings
Fig 30 Sports wagering market share total turnover (including retail)

Other bookies 8% Sportsbet 16% TABCorp (incl. Luxbet) 40%
Fig 31 Sports wagering market share non-retail turnover (online/phone)

Other bookies 12% Tabcorp (incl. Luxbet) 25%
Sportsbet 24%
Tatts 3% Other TABs 2%
Sportingbet/ Centrebet 24%
Tatts Other TABs 7% 5%
Sportingbet/ Centrebet 34%

Source: Australian Racing Board, Company data, Macquarie Research, March 2012
Source: Australian Racing Board, Company data, Macquarie Research, March 2012
For TABCorp, we estimate additional $45m revenue will translate into $20.7m in variable
contributionfor2016andwouldincreaseourvaluationby20cps.Inalitein-playscenariowe estimate valuation upside would be 10cps.
Fig 32
$m Revenue - NSW - Victoria - Luxbet Total VC - NSW - Victoria* - Luxbet Total
Estimated impact on TABCorp from in-play online betting

2013e 4.5 2.1 0.9 7.5 1.9 0.7 0.8 3.4 1.3% 2014e 9.4 4.5 1.8 15.7 3.9 1.5 1.8 7.2 2.8% 2015e 17.0 8.1 3.3 28.4 7.1 2.8 3.2 13.1 4.7% 2016e 27.0 12.9 5.2 45.1 11.2 4.5 5.0 20.7 6.8%
% of current NPAT Source: Macquarie Research, March 2012
*BasedonTABCorps50%shareofthenewVicwageringlicence.
26 March 2012
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16
Macquarie Research
TABCorp Holdings
TABCorp well positioned to capture growth in mobile wagering

In the face of intense competitive pressures and ongoing market share losses, as well as the
potentialforin-playbettingtobeexpanded,theincumbentoperatorsneedtocontinueinvesting in a range of distribution channels to provide wagering product to customers where they want it and when they want it.
Retail is currently the dominant distribution channel, with ~65%ofTABCorpsturnover(ex.Luxbet)
being transacted in retail outlets. This has reduced from 69% only two years ago, and over time, we expect the value of the retail distribution model will continue to diminish.
As we have written previously, we think the most critical driver of this diminishing value will be the
willingness of consumers to adopt account-based betting online, as opposed to cash-based betting in retail stores. While fixed internet products have been an enabler of this trend to date, we expect the momentum will be continued on a long-term view by the adoption of mobile internet platforms and betting applications. Over the past 12 months we have seen strong signs of take-up of mobile platforms in the Australian wagering market, namely: TABCorpsmobile sales in August 2011 represented 6% of total account sales, with over 21,500 unique account customers (11% of total account customers) betting via a mobile device during the month; 20%ofSportingbetAustralias2Q12turnoverwasviamobile,upfrom13%in1Q12. Centrebet generates 13% of turnover from mobile, up from 5% in 1Q12; 40% of Sportsbets online customers are now transacting via mobile, up from 5% in May 2011.
Going forward, we see a number of factors supporting the ongoing adoption of mobile wagering
platforms, including: Rapid adoption of terminal betting within retail wagering outlets. While these terminals accept cash and are not restricted to account-based betting, the high take-up rates in Victoria (47% of retail turnover) demonstrates a willingness of consumers to interact with web-based betting platforms to transact; Early indications of a structural shift to mobile platforms for personalised services over fixed internet platforms. By way of example, we note the rapid adoption of mobile banking at CBA, where mobile platforms now account for over 20% of NetBank logins (up from 14% a year ago). Further, we note 12% of smartphone users now access online banking more frequently on a mobile phone than a desktop or laptop computer (Source: Telstra Smartphone Index 2011); Improved offerings as corporates and competing tote operators develop new applications and products with improved front-end design; and Thepotentiallegalisationofin-playbettingonline.
At the same time, the structural shift to adopt the platforms that can deliver personalised mobile
wagering products will increase, evidenced by the rapid increase in smartphone penetration that is expected to grow from 46% of the mobile population last year to ~60% this year (Source: Telstra Smartphone Index 2011). Smartphone penetration amongst males, the core of wagering customers, is already over 50% of mobile users (vs female at 42%). Meanwhile tablet products are also being rapidly adopted.
AppStore feedback improving for TABCorp in recent months

Against this backdrop, a factor that will determine which wagering operators will be successful in
capturing the growth in mobile turnover is the performance of their applications. With this in mind, we have reviewed the feedback offered by users of wagering apps on ApplesAppStoreand found: Centrebet currently has the top-rated app developed by the leading wagering operators, with 54.5% of respondents rating the app above average (4 or 5 stars). This compares with Sportingbet at 51.9%, Sportsbet at 42.4%, Betfair at 39.7%, TABCorp at 39.2% and Luxbet at 33.3%.TattsBetdoesntcurrentlyhaveaniPhoneapp.Note the iBetmate app developed for use with Betfair was the top rated wagering app overall, with 69.3% of respondents rating it above average;
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Despite being the top-ratedappoverall,feedbackonCentrebetsapphasdeterioratedsince October 2011. The average rating up until 30 September 2011 was 3.8 (out of 5). Since then, the average rating of the Centrebet app has been only 2.2; TABCorpscurrentversionofits app (v5.4) has been rated above average by 58.9% of respondents (73 respondents in total). There have been 10 or fewer ratings for the current version of other operators apps, which we believe is too small a sample size to be meaningful; Over 50% off respondents rated the Betfair (56.2%), Sportsbet (54.2%) and Luxbet (52.4%) apps as below average (1 or 2 stars).
For TABCorp, we think the improved user feedback on the current version of its app shows the
company is making good progress on the functionality and performance of its mobile platform. The addition of live vision and audio to the app in late 2011 has likely aided this performance.
Looking forward, we see scope for further improvement from TABCorp in the mobile wagering
space should ongoing improvements continue to be implemented in response to user feedback. One such area that we noticed was a recurring theme in user feedback on the TABCorp app was theabsenceofabetslipthataggregatespuntersoutstandingbets.Anumberofrespondents noted that with the addition of this, the TABCorp app would have complete functionality.
Fig 33 % of respondents who rated the app above average (4 or 5 stars)

% 80% 70% 60% 50% 40% 30% 20% 39.2% 42.4% 54.5% 51 .9% 39.7% 33.3% 69.3%
Fig 34 % of respondents who rated the app below average (1 or 2 stars)

% 60% 50% 40% 30% 22.0% 20% 1 0% 54.2% 45.7% 34.8% 36.4% 56.2% 52.4%
1 0% 0% TA H Spo rtsbet C'bet Spo rtingbet B etfair iB etmate fo r Luxbet (P addyP o wer) B etfair
0% TA H Spo rtsbet C'bet Spo rtingbet B etfair iB etmate fo r Luxbet (P addyP o wer) B etfair
Fig 35 TABCorpscurrent version performing much better than previous versions

% 45% 40% 35% 30% 25% 20% 1 5% 1 0% 5% 0% 1star 2 star 3 star 4 star 5 star A ll versio ns (ex current versio n) Current versio n (v5.4) 1 7.8% 1 %1 .0% 2.1 1 1 5.2% 1 2.3% 1 7.8% 1 .5% 1 34.3% 26.8% 41 % .1
Fig 36 Feedback on Centrebet app has deteriorated post October 2011

A vge rating (o ut o f 5) 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1 .5 1 .0 0.5 P re Oct-1 1 A verage rating (o ut o f 5) (LHS) P o st Oct-1 1 Number o f respo ndents (RHS) 2.2 3.8 25 35 # respo ndents 40 35 30 25 20 1 5 1 0 5 0
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Valuation increased to $3.01/sh (from $2.84/sh)

Following a broad review of our TAH modelling, improved disclosure around the Luxbet business,
and the inclusion of risk weighted outcomes around in-play betting, race fields and broadcast rights, we have increased our valuation of TABCorp to $3.01/sh (from $2.84/sh). The table below also includes the implied EBITDA multiples from our DCF-based valuations.
Fig 37
TABCorp SOTP valuation

EV ($m) $/sh EBITDA FY13 ($m) Implied Multiple 6.6x 4.2x 54.0x 6.6x 9.4x 7.0x 7.3x 4.7x 5.5x
Wagering NSW Victoria Luxbet Wagering consolidation upside (67% risk-weighted) Total Wagering Media & International Total Wagering (incl. Media & Intl.) Gaming TABCorp Gaming Solutions (TGS) Keno Total Gaming Vic licence compensation (30% risk-weighted) Risk weighted outcomes - in-play, race fields, broadcast rights Corporate capex Enterprise value Net debt - 1 July 2012 Equity value Underlying equity value Source: Macquarie Research, March 2012
1,279 510 168 127 2,084 585 2,669 253 371 624 161 59 -137 3,377 -1,159 2,217 1,933
1.74 0.69 0.23 0.17 2.83 0.79 3.63 0.34 0.50 0.85 0.22 0.08 -0.19 4.59 -1.57 3.01 2.71
193 121 3 317 63 379 35 78 113
492
6.9x
Fig 38
TABCorp key valuation sensitivities

Base case 10.5% 61.3% 0.0% 20.0% 40.0% 10.0% $37.5m 8,500 2.5% Unit 1.0% 1.0% 1.0% 5.0% 5.0% 10.0% $5.0m 500 1.0% +/- unit 11cps 4cps 9cps 2cps 2cps 4cps 9cps 5cps 4cps
Sensitivity Wagering Fixed odd win rates (FY20) Total TAB share of wagering market (FY20) NSW wagering TGR (FY20) % of tote turnover retained in Victoria post FY24 % of fixed odds turnover retained in Victoria post FY24 Retail exclusivity risk weighting Media Annual cost of TVN rights (FY14 onwards) Gaming TGS machines under contract TGS TGR (FY20) Source: Macquarie Research, March 2012
2012 uncertainties from compensation, in-play betting, race fields and broadcast rights
The valuation drivers of TABCorp have become partly-focussed on a number of non-operational
issues that will play out over the course of 2012. These issues are: Potentiallegalisationofin-playbettingonline DBCDE to hand down a report by June 2012; Compensation from the Victorian Govt Vic pokies licence expires in August 2012. TABCorp believes it is entitled to up to $687m compensation following the change in industry structure announced in 2008;
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Race fields legislation decision from the High Court to be handed down on 30 March 2012; Renewal of TVN broadcast rights Sky Channel rebroadcast agreement with TVN expires on 31 December 2012.
Collectively these factors could have a valuation impact on TABCorp of between -36cps and
+109cps. On a risk-weighted basis, we see the overall impact at +8cps and have included this amount in our target price and valuation methodology.
Fig 39
Risk-weighted valuation upside of 8cps

Low High Riskweighted impact +10cps 0cps -4cps +2cps +8cps
In-playbetting Compensation* Race fields Broadcast rights Combined valuation impact
0cps -22cps -14cps 0cps -36cps
+20cps +71cps +0cps +18cps +109cps
* Our current target price of $3.00/sh already includes a risk-weighted amount of 22cps for potential compensation from the Victorian government. Source: Macquarie Research, March 2012
In-playbettingcouldadd20cps,7%NPATupsidefor2016
Asdiscussedpreviouslyinthisnote,weestimatetheintroductionofin-playbettingonlinecould
translate to additional revenue of $45m for TABCorp. This would flow to an additional $20.7m in variable contribution for TABCorp and increase NPAT by 7% in 2016. In this scenario, we estimate valuation upside for TABCorp of 20cps.
We include a 50% risk-weighting of this scenario in our valuation.
Compensation from the Victorian Govt offers upside

Following the change of gaming industry structure announced by the Victorian Labor Government
in 2008, there exists potential for TABCorp to receive a material compensation payment for the loss of their gaming licence. Legal proceedings are likely to be required to attempt to recover this amount.
While there are a number of factors that would determine the ultimate amount of compensation if
TAH are successful in their claims (such as the tax treatment of any payments), from a shareholder perspective the outcomes are essentially binary in that TAH is likely to either receive a significant payment, or nothing at all.
For TABCorp, if successful, pre-tax compensation is capped at $687m (~93cps). On a post-tax
basis, we see compensation in the range of $481549m.This equates to 63-72cps on a discounted basis (to today), or 2327% of our current base operating company valuation. We currently allocate a 30% risk-weighted amount to the top-end outcome in our $3.00/sh TAH target price (22cps).
For further reading on the potential compensation refer to Taking a punt on compensation,
TABCorp/Tatts Group, 6 October 2011. Race fields outcome likely to be neutral

With a final decision on the future of race fields fees to be handed down by the High Court of
Australia on Friday, 30 March 2012, there are a number of outcomes that could each have different valuation implications for TABCorp.
As a refresh, a summary of the arguments for each case (Betfair vs RNSW and Sportsbet vs
RNSW) are shown later in this note.

Based on the current agreements, TABCorp expects to pay ~$38m in race fields fees in FY12,
increasing to $55m pa from August 2012 when the new Victorian wagering licence commences.
Ahead of theHighCourtsdecision, we have looked at three potential scenarios for TABCorp:
Scenario 1: RNSW wins, no change to race fields fees (60% probability)
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Racing NSW win both cases, no change to the level of race fields fees. This would see TABCorp continue to be compensated for race field payments via the RDA arrangements. We see this scenario as the most likely outcome. From a competitive perspective we believe there is little that would change. The top tier corporate bookmakers appear to have been increasing their pricing over the past 6-12 months, and are therefore positioned to cope with turnover based race field fees. Under this scenario we estimate annual race field fees of $54.8m for TABCorp. Scenario 2:RNSWwins,racefieldsfeesincrease(25%probability) Racing NSW wins both cases, and all racing bodies increase race field fees to 2% of turnover. While TABCorp would continue to be compensated for NSW race field payments via the RDA arrangement, an increase in race field fees by other racing bodies (Racing Queensland, RWWA etc) would result in an increased cost burden for TABCorp. In this scenario, we see TABCorpsshareofracefieldfeesincreasingto$68.6m. Despite this, competitively we see this scenario as a minor positive for TABCorp as it would also increase the cost burden on its lower margin competitors. We ascribe some probability to this scenario eventuating (25%), however it is unlikely to be immediate. While the racing industry is ultimately seeking to increase funding levels, it must be conscious that pricing racing product too aggressively could result in some wagering operators cutting back promotion and concentrating on other events (ie. sports). Scenario 3: RNSW partial loss, compensation to TAH deemed unconstitutional (15% probability) RNSW successful against Betfair, but Sportsbet successful in proving the compensation arrangement between RNSW and TABCorp is unconstitutional. Given the results on the Betfair argument in previous hearings, we expect RNSW will be successful in the Betfair case. This outcome would allow race fields fees to be charged on the basis of a % of turnover. Should the High Court rule the compensation arrangement between TABCorp and Racing NSW is unconstitutional (Sportsbets argument), TABCorp may be required to pay race fields fees on top of RDA payments. Under this scenario weestimateTABCorpsshareofrace fields fee would theoretically be $109.4m. In saying that, this outcome would more than likely act as a catalyst for TABCorp to renegotiate the RDA with Racing NSW to remove its requirement to double-pay for access to product. We note this negotiation is not without risks for TABCorp, as the racing industry is likelytohavetheupperhandindiscussionsgivenTABCorpsrelianceontheindustryfor product. However, on a longer term view, the potential for a renegotiated RDA to shift some of the racing industrysrelianceforfundingfromTABCorptootherwageringoperatorswouldbea positive competitive outcome for TABCorp, in our view. Overall, while we a small possibility of Sportsbet being successful, assuming a renegotiation of the RDA, we believe TABCorp would be neutral from a financial perspective. Therefore, we see limited valuation impacts from this scenario.
The valuation impact of these scenarios are summarised below, and could have a direct valuation
impact vs our current valuation of up to -14cps. Our risk-weighted valuation impact of the scenarios is -4cps.
Fig 40
Scenario 1 2 3
Potential scenarios following the High Court's race fields decision

Annual race fields fees ($m post Aug 2012) $54.9m $68.6m $54.9m* Direct valuation impact (cps) 0cps -14cps 0cps -4cps Competitive impacts for TABCorp neutral minor +ve short-term ve, but long term potential +ve Risk-weighting 60% 25% 15%
Risk-weighted average
* Theoretically up to $109.4m, but as discussed we note the likely renegotiation of the RDA would place TABCorp in the same financial position as scenario 1. Source: Macquarie Research, March 2012
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Fig 41
Overview of Sportsbet and Betfair cases

Sportsbet Betfair Racing NSW, Harness Racing NSW Legislation not challenged
Overview Case against Main legislation challenged Legislation relied upon
State of NSW, Racing NSW, Harness Racing NSW Racing Administration Act 1998 (NSW) Racing Administration Regulations 2005 (NSW) Constitution ss 92, 109 Northern Territory (Self-Government) Act 1978 (Cth) s 49 The arrangements that existed between TAB, Racing NSW and Harness Racing NSW in addition to a turnover threshold for wagering operators had the effect of exempting the majority of intra-state operators (NSW based) frompayingtheracefieldsfee.Sportsbet argued this was contrary to s 49 of the Northern Territory (Self-Government) Act, which requires trade and commerce between the NT and the States to be absolutely free. By virtue of section 109 of the Constitution, Commonwealth acts prevail over inconsistent State acts.
Constitution ss 90, 92
Basis of argument
The imposition of a fee based on turnover was discriminatory against Betfair (as an inter-state operator) in favour of the NSW TAB (an intrastate operator). This breached section 92 of the Constitution which requires trade between the States to be absolutely free.
Current status
Sportsbet was granted leave to appeal to the Betfair was granted leave to appeal to the High High Court of Australia. The hearing was held Court of Australia. The hearing was held in in August/September 2011 and a decision is August/September 2011 and a decision is expected shortly. expected shortly. June 2010 Sportsbet (however only against RNSW and HRNSW, the application against the State of NSW was dismissed). June 2010 Racing NSW, Harness Racing NSW
Federal Court Judgement delivered In favour of
Reasoning
The Court concluded that RNSW and The judge agreed the race fields fee imposed HRNSW intended and understood at the time on Betfair discriminates against them in favour they decided to impose the fee on Sportsbet of the NSW TAB, however Betfair failed to that the NSW wagering operators, and demonstrate that the fee was protectionist in particularly the TAB, would not in substance nature. have to pay it. The Court concluded that whilst it may well be permissible to impose a fee on all wagering operators, regardless of their residence, as a matter of fact that is not what has happened and was not what was intended to happen. November 2010 State of NSW, Racing NSW, Harness Racing NSW November 2010 Racing NSW, Harness Racing NSW
Full Federal Court Judgement delivered In favour of Reasoning
The Full Court rejected the decision of the TheFullCourtagreedwiththeprimaryjudges primary judge, and ruled that, because the findings that Betfair had not made out a case fee imposed on the race field approval that a turnover fee deprived them of any applied to all operators, it was not competitive advantage (ie. was protectionist). discriminatory and protectionist. The Full Courtfoundthattheexistenceofarebate agreement between RNSW and the NSW TAB simply compensated the NSW TAB for a breach of its rights under the existing RDA.
Source: Federal Court judgements, Macquarie Research, March 2012
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Renewal of TVN broadcast rights

TABCorpsmediadivision,SkyChannel,currentlyhasarebroadcastagreementwiththeindustry
owned broadcaster, ThoroughVision (TVN). The current agreement expires in December 2012 and sees Sky Channel make an annual payment of ~$28m. Following the expiry of the rebroadcast agreement, there are a number of possible outcomes for TABCorp, including: Sky renewsrightsathighercost: Our base case assumption is Sky Channel agrees to pay an additional $10m per year for the rights to Victorian and Sydney races resulting in total annual rights payment to TVN of $37.5m. This assumption is based on the reported cost of the 10-year rights for Queensland thoroughbred racing acquired by Sky Channel recently, and our estimates on the relative contribution of Queensland racing vs Victorian/Sydney racing. Sky and TVN merge, TABCorp loses some control: The other plausible option for the racing industry is to extract a similar amount of value $37.5m pa from TABCorp via some form of merger between Sky Channel and TVN. While a merger could normally be viewed positively for TABCorp, we note the bargaining position of TABCorp is significantly reduced by the reliance of their broader wagering business on continued vision of Sydney and Victorian racing product. Accordingly, we expect TABCorp will need to pay an additional amount to TVN or give up a significant amount of control over the production and presentation of some racing product, or a combination of both. Split vision returns: Should Sky and TVN (and its shareholders) be unable to come to an agreement on the renewal of the broadcast rights or a merger, the industry is likely to return to astateofsplit-vision(ie.Victoria/SydneyracesonTVN,allotherracesonSky)thatwas witnessed in 2005/06. A return to split vision would (a) negatively impact wagering turnover, and (b) require Sky Channel to pass on discounts to subscribers to reflect the reduced racing product being shown on Sky.
Given our base case assumption is a $10m increase in annual rights payments, we see limited
valuation downside from this position. On the flipside, if TABCorp reached a new agreement with TVN for the same cost as the existing arrangement (ie. $28m pa), we estimate valuation upside of ~18cps. Taking into account the bargaining power of the racing industry in these negotiations, we believe this outcome to be unlikely, and attribute only a 10% risk-weighting to this eventuating.
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Wagering sector consolidation, a refresh of the scenarios

There has been ongoing speculation regarding potential consolidation between TABCorp and
Tatts for a number of years now. Overall, we believe consolidation in the wagering industry has
the potential to unlock ~$420m of value for participants (assuming regulatory approval was forthcoming).
Historically there has been a number of barriers to such consolidation, including:
Uncertainty over retail and licence exclusivity; Regulatory intervention (ACCC); Objections from Racing NSW to allowing NSW tote to pool with other States; TABCorpscomplexcorporatestructure Uncertainty over the future control of the Victorian wagering licence.
While the latter two barriers have now been removed, we don't see any consolidation activity
being imminent. We think consolidation is more likely to be at least 18 months away. This
timeframe would allow for: TABCorpsearnings to fully reflect recent investments and new products (Trackside, retail fixed odds, international tote gateway); the pokies licences to expire (August 2012); potential legal action to proceed against the Victorian Government in relation to compensation for the loss of the Vic pokies licences; and the balance sheet capacity of both TABCorp and Tatts to improve.
The major hurdle to any consolidation remains the ACCC, and how they would view the creation
ofanationaltotepool.TABCorpsbidtoacquireUNiTABin2006wouldhavecreatedanational toteoperatorandwasrejectedbytheACCC.WehaveoutlinedtheACCCsconcernsinthis transaction in the following table.
Fig 42
Issue
Summary of ACCC competition concerns: TABCorp acquiring UNiTAB (2006)

Details If TABCorp was the only tote operator, there would be limited competition when wagering licences came up for renewal. The ACCC was particularly concerned regarding the auction process for the Victorian wagering licence (completed in 2011). Due to a lack of scale, smaller totalisators elect to pool bets they take with other pools. The proposed acquisition of UNiTAB would have removed them as an alternative supplier of pooling services in the Australian market. Possible mitigators Following the NT licence in 2015, the next licence renewal would be the re-offering of the Victorian licence in 2024.
Competition for future wagering licences would be lessened
Supply of pooling services would be impacted
Undertakingintheformofnationalaccesspricing regulation, or a long-dated contractual arrangement between TAH/TTS and RWWA/ACTTAB. Either arrangement would set the prices a national tote was able to charge for pooling services.
Competition amongst totes
TheACCCnotedthatastotalisatorsdonotcontroltheodds In a broad sense, we believe this is still the case. The they offer (apart from marginally via changing take-out caveat being that as a greater amount of the TABs rates), the different odds on offer between pools do not business is being transacted online; we have seen TABs constitutealeverbywhichtotalisatorscanactivelycompete start to compete outside their retail boundaries (ie. witheachother.Therefore,theACCCconcludedatthetime TattsBet advertising for online customers in NSW). We thatUNiTABandTABCorp do not significantly compete estimate the TABs collective online market share is 45% directlyforpunters. compared with overall market share of ~70%. A move to a national tote would remove the online competition amongst the two tote operators; however the ACCC may be comfortable with this due to the online presence of a number of alternative betting operators (corporate bookmakers, Betfair). TheACCCconsideredthattheproposedacquisitiongives In our view, competition in the wagering market has rise to other competitionconcernsinwageringmarkets. changed significantly since the ACCC reviewed the Whilstthisstatementisessentiallyacatch-all,we proposed TABCorp/UNiTAB merger in 2006, and acknowledge the potential remains for a national tote pool to therefore the ACCC's view on the impact of a national tote be blocked by the ACCC on the grounds of the impact on pool on broader wagering market competition is likely to competition between totes, corporate bookmakers and haveshifted.In2006,thetoteoperatorsshareoftotal betting exchanges. wagering turnover was ~76%. This has fallen to ~70% today, and we forecast will be ~60% by 2020 as corporate bookmakers continue to grow.
Broader wagering market competition
Source: ACCC, Macquarie Research, March 2012
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Two possible consolidation scenarios TABCorp takes TattsBet, or Tatts takes all of TABCorp
On the following pages we have run the numbers on two of the potential consolidation options,
namely (a) TABCorp acquiring the TattsBet wagering division; and (b) Tatts acquiring all of TABCorp.
There is also the possibility of TABCorp bidding for all of Tatts, however given the valuation
differentials between TABCorp and Tatts scrip, and the relative size of Tatts vs TABCorp, we see a TABCorp bid for all of Tatts as highly unlikely.
Fig 43
A$m 1 ,400 1 ,200 1 ,000 800 600 400 200 0
TABCorp gearing profile

x EB ITDA 3.0x $ 1 59m ,1 $ 1 74m ,1 $1 ,068m $ 932m 2.2x 2.0x 1 .7x 1 .5x 1 .0x 0.5x 0.0x FY1 2e FY1 3e FY1 4e FY1 5e ND / EB ITDA FY1 6e Net debt $ 803m 2.5x 2.0x
Fig 44
A$m 1 ,400 1 ,200 1 ,000 800
Tatts gearing profile

x EB ITDA 3.0x $ 1 87m ,1 $1 ,078m $ 971 m $ 868m 2.1 x 1 .8x 1 .9x 1 .7x 1 .4x $ 756m 1 .5x 1 .0x 0.5x 0.0x FY1 2e FY1 3e FY1 4e Net debt FY1 5e ND / EB ITDA FY1 6e 2.0x 2.5x
1 .6x
1 .5x
600 400 200 0
Note:Fromaratingsagencyperspective,aportionofTABCorpsdebtthat is related to the recent hybrid issue will receive equity credit. Source: Company data, Macquarie Research, March 2012 Source: Company data, Macquarie Research, March 2012
$420m of value to be created from sector consolidation

Our estimate on the $420m of value arises from (a) deeper pools driving additional wagering
revenues, and (b) rationalisation of tote operating costs (and capex) as well as corporate costs.
This consolidation can occur at a number of levels, via the theoretical merging of:
TABCorpsNSWandVictoriantotepools this would create $74m of value arising from $6.5m of additional revenue and $5m of cost synergies; TABCorpsandTattstotepools (withseparatebackofficefunctions) creating $3.5m of incremental revenue, and removing a further $25m of IT-related costs delivering an incremental $190m of value; The wagering operations of TABCorp and Tatts creating an additional $156m of value by removing a further $10m costs from corporate administration functions.
Due to the complexities of agreements between the various State and Territory racing bodies,
State and Territory Governments and the wagering operators, the racing industry is likely to want a cut of any upside generated from sector consolidation.
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Fig 45
Estimated synergies / value creation from sector consolidation

TABCorp / TABCorp / UNiTAB MRE MRE MRE UNiTAB TAB / TAB assumption assumption assumption (2006) (2004) (2004) (merging (merging TAH(merging TAH pools) TTS pools) TAH-TTS operations)
Pools managed before bid Revenue synergies Net revenue Cost synergies Wagering operations and related IT Corporate administration Total cost synergies Capex synergies Total synergies One-off costs Capex required to achieve synergies Estimated value creation
2 4.4 12.3 6.2 18.5
1 9.7 35.7 17.1 52.8
1 10.0 14.8 15.2 30.0 6.5 5.0 5.0 10.0 30.0 30.0 3.0 43.0 60.0 264.0 10.0 30.0 10.0 40.0 10.0 60.0 60.0 420.0
22.9 51.2
62.5 ?
40.0 ?
11.5 5.0 74.0
Source: Bidder Statements, Macquarie Research, March 2012
Scenario 1: TABCorp acquisition of TattsBet: ~3% accretive in FY15, $1bn equity raising
Should consolidation in the wagering sector eventuate, we believe a TABCorp bid for the wagering
assets of Tatts is most likely. In this scenario, there would be a number of ACCC concerns, which we ultimately expect could be overcome. These are discussed in further detail earlier in this note.
In our modelling we have assumed:
A purchase price for TattsBet of $1,430m, made up of: o o o An underlying valuation for TattsBet of $1,061m; plus A 15% control premium; plus Half of the potential synergy value of $420m (ie. $210m).
The synergies detailed in the table above are fully achieved by FY15; Up-front capex of $60m is spent (in FY13/14 equally) to integrate the businesses and upgrade the TattsBet network; Target gearing of 2x ND/EBITDA in FY14 following the drop-off in earnings from Vic pokies. This is consistent with our current TABCorp gearing forecast; The balance of the acquisition being funded by TABCorp via a ~$1bn equity raising at $2.36/sh (15% discount to our underlying valuation of $2.71/sh); TABCorp maintains an 80% dividend payout ratio; and Transaction costs total 2% of the purchase price.
On this basis, we estimate EPS accretion of 2.7% and a post-tax ROIC of 10.1% in FY15.This
ROICisbroadlyconsistentwithTABCorpsWACC.BasedonourforecastsforflatEBITDAat TattsBet in FY16, EPS accretion drops to 0.8% in FY16.

For Tatts, this outcome would add 19cps to our valuation and leave the company in a net cash
position providing flexibility to pursue capital management and/or fund growth in the lotteries sector.
Overall, given the capital raising required by TABCorp is equivalent to ~55% of the current market
capitalisation, we believe it would be difficult for this transaction to be completed until TABCorps existing gearing levels have been materially reduced.
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Fig 46
$m Revenues
Pro-forma P&L for TABCorp acquisition of TattsBet

FY13e 2,736.5 740.1 27.0% 180.5 559.6 141.2 418.5 135.9 282.6 24.0 -0.6% FY14e 2,671.9 750.1 28.1% 179.5 570.6 132.1 438.5 143.6 294.9 24.7 4.3% FY15e 2,722.9 770.3 28.3% 177.3 593.0 122.8 470.2 153.1 317.1 26.3 2.7% FY16e 2,777.8 785.6 28.3% 177.1 608.4 110.3 498.2 161.5 336.7 27.5 0.8%
EBITDA EBITDA margin D&A Consolidated EBIT Interest EBT Taxes NPAT EPS Accretion to TABCorp
Fig 47
A$m 900 800 700 600 500 400 300 200 1 00 0
Combined group pro-forma EBITDA profile
Fig 48
Combined group pro-forma net debt / EBITDA

A$m 2.2x 2.0x 1 .8x 1 .5x 1 ,800 1 ,600 1 ,400 1 ,200 1 ,000 1 ,606 1 ,497 800 1 ,362 1 ,202 600 400 200
x EB ITDA 2.5x
35.0 1 75.7
45.0 1 82.7
50.0 1 83.3
50.0 1 84.1
2.0x
1 .5x
1 .0x
529.4
522.4
537.0
551 .4
0.5x
FY1 3e
FY1 4e Tabco rp TattsB et
FY1 5e Synergies
FY1 6e
0.0x FY1 3e FY1 4e Net Debt FY1 5e ND/EB ITDA FY1 6e
Scenario 2: Tatts acquisition of TABCorp: Cash/scrip deal ~10% accretive at $3.50/sh

If Tatts were to be the aggressor in sector consolidation, we believe they would need to take-out
the entire TABCorp business just taking the wagering assets would leave TABCorp as a subscale business.
The combination of the two companies would create an $8bn diversified gaming company with
exposure to the wagering, lotteries and keno markets in Australia. One potential hurdle to the deal wouldbetheACCCspreviousconcernsaboutensuringthereiscompetitionforfuturegaming licences that come up for sale or renewal.
In our modelling we have assumed:
A purchase price for TABCorp of $3.50/sh, representing a 30% premium to the current trading price. We assume a mix of cash and scrip would be provided to TABCorp shareholders in the ratio of 20/80% (ie. $0.70 cash, $2.80 scrip); The synergies detailed in the table earlier in this note are fully achieved by FY15. In addition, a further $10m of corporate/head office related synergies are captured by FY15; Up-front capex of $100m is spent (in FY13/14 equally) to integrate the businesses and upgrade the TattsBet network;
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Target gearing of 2.5x ND/EBITDA in FY14 following the drop-off in earnings from Vic pokies. This is above our current Tatts gearing forecast, however given Tatts does not maintain a credit rating we believe bank funding to this level could be achievable. This would allow $0.70/sh of the $3.50 offer price to be paid in cash; The balance of the acquisition being funded by Tatts via a scrip offer to TABCorp shareholders. Based on Tatts equity being worth $2.40/sh, the scrip entitlement would be 1.17 Tatts shares for every 1 TABCorp share; and Transaction costs total 2% of the purchase price.
On this basis, we estimate EPS accretion of 10.1% in FY15. Accretion is largely driven by the
~25% PER differential between Tatts and TABCorp scrip. Looking at the transaction on a ROIC basis and substituting capex for D&A, we estimate a post-tax ROIC of 9.0%, ~1% below Tatts weighted average cost of capital.
Fig 49
$m Revenues
Pro-forma P&L for Tatts acquisition of TABCorp

FY13e 5,033.8 1,076.8 21.4% 253.7 823.1 250.4 572.8 181.9 390.8 17.2 5.2% FY14e 4,881.9 1,075.3 22.0% 250.8 824.5 243.4 581.1 184.8 396.3 17.3 7.8% FY15e 4,992.9 1,111.8 22.3% 247.9 863.8 232.2 631.6 201.1 430.5 18.6 10.1% FY16e 5,109.6 1,138.7 22.3% 247.2 891.5 216.5 675.0 214.9 460.0 19.7 11.0%
EBITDA EBITDA margin D&A Consolidated EBIT Interest EBT Taxes NPAT EPS Accretion to Tatts
Fig 50
A$m 1 ,200 1 ,000 800 600 400 200 0
Combined group pro-forma EBITDA profile
Fig 51
Combined group pro-forma net debt / EBITDA

A$m 2.6x 3,000 2.5x 2.3x 2.0x 2,500 2,000 1 ,500 2,532 2,31 7 1 ,000 500 0 FY1 3e FY1 4e Net Debt FY1 5e ND/EB ITDA FY1 6e
x EB ITDA 3.0x
35.0
50.0
60.0
60.0
2.5x
529.4
522.4
537.0
551 .4
2.0x 1 .5x 1 .0x
2,795
2,679
51 2.4
502.8
51 4.8
527.3
0.5x 0.0x
FY1 3e Tatts
FY1 4e Tabco rp
FY1 5e Synergies
FY1 6e
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TABCorp Holdings
Key divisional forecasts

We have updated our TABCorp modelling in order to get a more detailed view of the variable
contribution drivers within the wagering business in particular NSW wagering, as well as to break-out the Luxbet business in more detail given recent improvements in disclosure.
Our updated forecasts on a divisional basis are summarised below. We discuss our forecasts for
the NSW wagering, Vic wagering and Luxbet businesses in further detail on the following pages.
Fig 52
A$m
TABCorp key division forecasts (FY11-16)

FY11a 1,569.1 125.8 1,077.4 169.6 2,941.9 286.8 59.8 279.6 60.6 686.8 219.5 52.8 241.4 48.8 562.5 FY12e 1,612.9 134.8 1,096.6 188.4 3,032.7 318.5 62.9 286.7 60.8 728.8 245.6 55.3 248.5 45.7 595.1 FY13e 1,458.4 142.3 207.5 218.0 2,026.1 315.3 62.5 73.4 78.2 529.4 225.4 54.1 41.0 51.2 371.8 FY14e 1,457.4 150.1 96.1 242.3 1,945.9 317.2 62.4 53.8 89.0 522.4 226.8 54.3 24.0 60.7 365.8 FY15e 1,480.7 158.3 99.7 248.9 1,987.5 321.9 67.4 55.8 91.9 537.0 229.4 59.5 28.5 64.5 381.9 FY16e 1,506.9 166.7 103.8 255.3 2,032.7 326.0 72.7 58.1 94.6 551.4 232.3 64.9 30.5 68.1 395.8
Revenue Wagering Media & International* Gaming/TGS Keno Total revenue EBITDA Wagering Media & International Gaming/TGS Keno Total EBITDA EBIT Wagering Media & International Gaming/TGS Keno Total EBIT * Net of intersegment revenue.
Fig 53
A$m 800 750 700 650 600 550 500 450 400 350 300
TABCorp EBITDA bridge - FY12 to FY13
728.8
39.7
1.1
16.4
6.4
6.2 17.8
2.0
4.6 5.0
529.4
253.0
FY1 2e
Vic gaming
TGS
Keno NSW/QLD
Keno - Vic
NSW wagering co re
NSW wagering T'side
Vic wagering
Luxbet
M edia underlying
M edia - TVN rights
FY1 3e
Fig 54
A$m 550 500
TABCorp EBITDA bridge - FY13 to FY14

529.4 19.1 38.7 2.0 2.5 7.6 4.8 5.0
8.8
2.4
4.6
522.4
450 400 350 300

FY1 3e Vic gaming TGS Keno NSW/QLD Keno - Vic NSW wagering co re NSW wagering T'side Vic wagering Luxbet M edia underlying M edia - TVN rights FY1 4e
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NSW wagering: Understanding the variable contribution drivers

A key driver of the earnings growth at TABCorp during the December half was a +10.5% jump in
variable contribution (VC) from the NSW wagering business. As we flagged at the 1H12 results, the introduction of Trackside into retail outlets in NSW during 2011 contributed over 60% of the VC growth,whileafurther15%camefromOtherrevenuesuchasself-service terminal rental to TAB outlets. Outside of these drivers, the VC from the core NSW wagering business tote and fixed odds grew by 2.5%, despite revenue growth of -0.4%, as higher margin fixed odds turnover substituted legacy tote turnover.
Fig 55
A$m 205 200 1 95 1 90 1 85 1 80 1 75 1 70 1 65 1 60
NSW wagering VC 1H11 to 1H12
Fig 56
A$m
NSW wagering VC 2H11 to 2H12
1 .9 1
3.0
201 .1
1 95 1 90 7.7 0.1
1 89.7
1 4.1 1 82.1
1 85 1 80 8.6 1 72.7
6.5
2.8
1 75 1 70
7.1
1 65 1 60 1 55 2H1 a 1
5.9
1 1 H1 a
To te
F/O Racing
F/O - Trackside Spo rts
Other
1 2a H1
To te
F/O Racing
F/O Spo rts
Trackside
Other
2H1 2e
We forecast strong VC growth will continue in 2H12 as the Trackside rollout continues to ramp-up,
while FY13 will see the final leg of this ramp-up in earnings from Trackside. Post that, we see the current growth drivers maturing, and expect VC growth will return to low-single digit levels from FY14 onwards.
As we have discussed earlier in this note, a key risk to TABCorp from the ongoing shift between
tote and fixed odds is the sustainability of current fixed odds win rates, and the impact lower winrates would have on absolute VC margin levels.
Fig 57
A$m 500 450 400 350 300 250 200 150 100 50 0 FY09a
Variable contribution of NSW wagering business

A$m 500 450 400 350 300 250 200 150 100 50 FY10a Totalisator FY11a FY12e FY13e Fixed odds - Sports FY14e FY15e Other 0 FY16e
FY12 VC expansion driven by Trackside
Fixed odds - Racing
Trackside
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Understanding this changing dynamic at the VC level is an important driver of earnings forecasts
for the NSW wagering licence. In order to sustain earnings growth above the level of VC growth, TABCorp will need to tightly manage operating costs. The ongoing shift to online and mobile platforms will help in this regard, however we expect the competitive intensity in the wagering market will keep marketing and promotion costs high, and offset any efficiency gains from technology improvements. Taking these factors into account, we forecast long-term opex within the NSW wagering business will increase in-line with CPI (3%).
Our full forecasts for the NSW wagering business are detailed in the following table.
Fig 58
$m
NSW wagering financial forecasts

FY11a 5,667.1 2.4% 936.1 0.7% 354.8 2.2% 37.9% 158.2 4.3% 16.9% FY12e 5,970.3 5.3% 976.3 4.3% 390.8 10.2% 40.0% 180.9 14.4% 18.5% FY13e 6,273.0 5.1% 1,009.3 3.4% 412.6 5.6% 40.9% 193.1 6.7% 19.1% FY14e 6,530.1 4.1% 1,030.2 2.1% 424.7 2.9% 41.2% 198.0 2.5% 19.2% FY15e 6,735.1 3.1% 1,045.3 1.5% 429.3 1.1% 41.1% 195.9 -1.1% 18.7% FY16e 6,920.0 2.7% 1,059.2 1.3% 438.4 2.1% 41.4% 197.9 1.0% 18.7%
Turnover % ch vs pcp Revenue % ch vs pcp Variable contribution % ch vs pcp % VC margin (of revenue) EBITDA % ch vs pcp % EBITDA margin
Vic wagering licence: $120m EBITDA looks a stretch

FromAugust2012,thestructureofTABCorpsVictorianwageringlicencewillundergoanumber
of significant changes.ThekeydifferenceisTABCorpsshareofthejoint-venture (with the Victorian racing industry) that will operate the licence will reduce from 75% to 50%. The other key differences are summarised in the table below.
Fig 59
Summary of Vic licence key terms

Existing licence New licence 50% 16.69% 13.47% 20.00% 26.5% of revenue 15.0% of revenue 15.0% of revenue 15.0% of revenue $72.6m, subject to indexation JV will bear race fields fees on nonVictorian product
TABCorp share of JV Tax rates (incl. GST) (% of revenue) Pari-mutuel Fixed odds Trackside Product fees Pari-mutuel* Fixed odds (racing) Fixed odds (sports) Trackside Program fee Race fields fees Minimum performance obligation FY13 FY14 FY15
75% 28.20% 20.00% 20.00% 18.8% of revenue 1.0% of turnover (~8% of revenue) nil nil $50m, subject to indexation (~$85m in FY10) Borne by Victorian racing industry
n/a $337m n/a $342m n/a Aggregate of $1bn by the end of FY15
* New licence includes 11.51% Victorian Racing Industry Benefit fee. This fee is subject to change with reference to the pari-mutuel tax rate. Source: Company data, Macquarie Research, March 2012
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When TABCorp acquired the licence for $410m in July 2011, the expected EBITDA contribution in
the first full financial year of operation (ie. FY14) was $120m. This earnings guidance was based on a continuation of pooling agreements with RWWA, Tote Tasmania and ACTTAB. Since the guidance was issued: Tatts acquired Tote Tasmania, and will therefore no longer pool into SuperTAB. We estimate TAH would have earned around $8m per annum in high margin pooling fees from Tote Tasmania; and We expect TABCorp and RWWA to finalise their new pooling agreement shortly, at rates well below the current agreements. We had previously assumed RWWA would pay a pooling fee of 1.5% of turnover, however our earnings estimates are now based on an average fee (acrossretailandwholesaleturnover)of0.83%.TheimpactofthisistoreduceTAHsshareof pooling fees from RWWA by $4.8m pa, which is essentially all margin.
Actingasaslightoffsettothesefactors,wehaveassumedTABCorparesuccessfulinwinning
backaportionofthewholesaleturnoverthatiscurrentlybetwithToteTasmania.Overall,we assume TAH retain 25% of the ~$700m wholesale turnover, which we estimate will generate EBITDA of $4.3m.
Takingthesefactorsintoaccount,wenowforecastTAHsshareofEBITDAfromtheVictorian
licence in the first full financial year (FY14) will be $111.5m.
Fig 60
$m
Forecast financials from the new Vic licence

FY14e 789.5 347.7 44.0% 222.9 28.2% 111.5 FY15e 792.4 0.4% 351.0 1.0% 44.3% 225.8 1.3% 28.5% 112.9 FY16e 801.6 1.2% 356.6 1.6% 44.5% 227.7 0.8% 28.4% 113.8 FY17e 806.7 0.6% 361.4 1.3% 44.8% 228.6 0.4% 28.3% 114.3 FY18e 811.5 0.6% 366.3 1.4% 45.1% 229.5 0.4% 28.3% 114.7 FY19e 812.3 0.1% 369.8 1.0% 45.5% 228.9 -0.3% 28.2% 114.4 FY20e 812.9 0.1% 373.4 1.0% 45.9% 228.2 -0.3% 28.1% 114.1
Revenue % ch vs pcp Variable contribution % ch vs pcp % VC margin (of revenue) EBITDA % ch vs pcp % EBITDA margin TAH share of EBITDA
Fig 61 Vic wagering EBITDA bridge Current licence to new licence (guidance) to new licence (MRE forecast)
160 140 120 100 80 60 40 20 0 FY12e Different licence terms Guidance for new licence Loss of TT pooling Retention of w holesale t'over Loss of RWWA pooling fees FY14e 16.8 8.0 4.8 A$m 136.8 120.0 4.3 111.5
Additional 4-5% retail turnover required to restore EBITDA to $120m in FY14

Following the loss of high-margin pooling revenue, if TABCorp is to achieve its guidance for
EBITDA of $120m from the new Vic licence, we estimate the TABCorp/Racing Vic JV would need to generate an additional:
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TABCorp Holdings
$210m of retail turnover, equivalent to ~4.5% of current turnover; or $350m of wholesale/rebate turnover, equivalent to ~50% of current Tote Tasmania wholesale turnover; or A combination of both.
In any case, we believe both outcomes noted above are unachievable given the ongoing pressure
ontheretailbusinessmodelandTABCorpsreluctancetodealwithaggregatorsinthewholesale market. Minimum industry funding commitments still achievable

An important feature of the structure of the new Victorian licence is the minimum performance
obligations (MPO) TABCorp has with the Victorian racing industry for the first three years. The obligations amount to $337m in FY13, $342m in FY14, and an aggregate amount of $1bn by the end of FY15.
Our analysis suggests that despite the lower than expected earnings from the licence, industry
funding commitments will be met with a buffer to the downside. We estimate that gross tote wagering revenue would need to fall 8-17% vs our current estimates to breach these commitments, and do not envisage it will come into play.
We understand TABCorp has protections under the MPO in the event of an unforeseen outcome,
such as another bout of Equine Influenza, a return to split vision or the loss of retail exclusivity.
Fig 62
9-18% buffer before breaching minimum performance obligations

FY13 FY14 $342m $360m -8% FY15 $321m* $360m -17%
Guaranteed industry funding amount (minimum payment level) Macquarie base case % ch in gross tote revenue to breach minimum payment level
$337m $361m -10%
*$1bn minimum aggregate amount for FY13-15. $321m in FY15 assumes minimum payment amounts met for FY13/FY14 Source: Company data, Macquarie Research, March 2012
Overall, the licence has been structured to protect legacy funding levels to the racing industry.
With the loss of income from the pokies licence, the make-good to the industry has mostly come through significantly lower wagering tax rates.
Fig 63
$m 400 350 300 250 200 150 100 50 0
Changing composition of Victorian industry funding under new licence

New licence $m 400 350 300 250 200 150 100 50 0 FY05 FY06 Fixed FY07 FY08 FY09 FY10 FY11 FY12e FY13e FY14e FY15e FY16e Variable (incl. race fields)
Wagering profit share
Gaming profit share
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Luxbet: Participating in corporate bookmaker growth

TABCorp validated the corporate bookmaker business model through the establishment of the
Luxbet brand in mid-2008. The entrance of TABCorp/Luxbet followed rapid growth in the corporate bookmaker market when collective CB market share had grown from 18.8% in 2006 to 25.1% in 2008. Luxbet currently captures 8% of turnover and 6% of gross revenue in the CB market.
TheLuxbetbusinessisconsistentwithTABCorpsoverallwageringstrategythatisbuilton
providing punters access to wagering product when they want it and how they want it. More specifically on strategy, TABCorp has two key objectives for the Luxbet business: CompetedirectlywithNTbookmakersonproduct,priceandservices(thesalesfocus)and IncreaseTABCorpprofitability(theprofitfocus).
Onthefirstpoint,Luxbetssalesfocusaimstoprovide punters with access to a corporate
bookmaker service, with a company that is strongly aligned with racing industry participants.
On the second point, Luxbet became EBITDA break-even in FY11 after two years of losses. Going
forward, the objective is to move Luxbet into sustained profitability. This has resulted in a focus on improving the revenue yield by turning away unprofitable turnover, while at the same time tightly managing the cost base.
Fig 64
A$m 600 500 400
Luxbet turnover (A$m)
Fig 65
A$m 25
Luxbet revenue and yield (A$m, % of turnover)

% yield 8% 20.7 21 .9 7% 6% 4.7% 5% 4% 3% 2% 1 %
559 477 471
20
1 5
300 200 1 00 0 FY09a FY1 0a FY1 a 1 FY1 2e 1 94

1 0 2.0% 5 3.8
1 .6 1 2.4%
3.7%
0 FY09a FY1 0a FY1 a 1 FY1 2e
0%
FollowingrecentimprovementsinthedisclosureofLuxbetsperformance,wehaveremodelledthe
business. Our updated forecasts are summarised in the table below. Based on these forecasts, we value Luxbet at $168m (23cps).
Fig 66
A$m
Luxbet financial forecasts

FY11a 559.0 17.2% 20.7 78.4% 3.7% 0.0 nmf 0.2% FY12e 471.3 -15.7% 21.9 5.9% 4.7% 1.1 nmf 5.1% FY13e 512.5 8.7% 26.4 20.4% 5.2% 3.1 177.6% 11.8% FY14e 573.6 11.9% 32.4 22.8% 5.7% 7.7 148.2% 23.9% FY15e 637.2 11.1% 39.2 20.9% 6.2% 13.1 69.2% 33.4% FY16e 705.5 10.7% 46.9 19.7% 6.7% 14.2 8.8% 30.4%
Turnover % ch vs pcp Revenue % ch vs pcp % yield EBITDA % ch vs pcp % margin
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Balance sheet/capex
TABCorp had net debt of ~$850m at 31 December 2011. The $410m payment for the new
Victorian wagering licence was made in January 2012 and we forecast net debt at 30 June 2012 to have increased to $1,159m. Over the next 18 months, TABCorp has $600m to refinance. $200m is due in October 2012, with a further $400m expiring in June 2013.
On a gearing basis, ND/EBITDA will end FY12 at 1.6x, increasing to an expected 2.2x when the
earnings from the Vic pokies licence drop off during FY13. Taking into account the equity credit TABCorp will receive for its recent hybrid issue, ND/EBITDA for credit rating agency purposes is ~0.5x lower.
To assist with balance sheet management, we expect TABCorp will continue to offer shareholders
a dividend reinvestment plan (DRP). We assume take-up of 25%, which will add a further ~15m shares per annum to the current share base to 730.1m for FY12.
Fig 66
A$m 1 ,400 1 ,200 1 ,000 800 600 400 200 0
TABCorp gearing profile

x EB ITDA 3.0x $ 1 59m ,1 $ 1 74m ,1 $1 ,068m $ 932m 2.2x 2.0x 1 .7x 1 .5x 1 .0x 0.5x 0.0x FY1 2e FY1 3e FY1 4e FY1 5e ND / EB ITDA FY1 6e Net debt $ 803m 2.5x 2.0x 1 .5x
Fig 67
SOI (m) 900 800 700 600 500 400 300 200 1 00 0
DRP will continue to increase share count
688.0
730.1
745.1
758.8
774.3
791 .0
1 .6x
FY1 a 1
FY1 2e
FY1 3e
FY1 4e
FY1 5e
FY1 6e
Note:Fromaratingsagencyperspective,aportionofTABCorpsdebtthat is related to the recent hybrid issue will receive equity credit. Source: Company data, Macquarie Research, March 2012
TABCorpscapexisexpectedtoremainhighinFY13astheTGSbusinessisestablished, and the
venue rollout for keno in Victoria ramps-up. Post FY13, we see capex of $120m pa on a long-run basis.
Fig 68
cps 40 30 20 1 0 0 -1 0 -20 -30
FCF/sh vs DPS
cps 32.1 27.0 1 4.3 40 31 .4 30 20 1 0 0 Includes payment fo r Vic wagering ($ 41 0m) and NSW Trackside ($ 75m) -25.4 FY1 2e FY1 3e FY1 4e FCF p/s FY1 5e DP S FY1 6e -1 0 -20 -30
Fig 69
A$m 1 60 1 40 1 20 1 00 80 60 40 20 0
TABCorp capex profile
$1 5m $1 0m $1 5m $ 20m $ 40m
$1 5m $ 30m $ 40m $1 3m $1 5m $ 28m $1 3m $1 5m $ 28m $1 3m $1 5m $ 28m
$ 33m
$ 59m
$ 53m
$ 55m
$ 55m
$ 55m
$ 57m
FY1 a 1
FY1 2e Wagering
FY1 3e Gaming/TGS
FY1 4e Keno
FY1 5e M edia
FY1 6e
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Tabcorp Holdings
Year End 30 June
Price: 1H12a 2H12e 1H13e 2H13e FY12e FY13e
$2.63 FY14e FY15e
Profit & Loss

Revenue Wagering Media Gaming Total revenue EBITDA Wagering Media Gaming Total EBITDA $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m cps cps cps x x % x x x x % %
837.1 69.7 639.8 1,546.6 169.3 32.5 181.3 383.1 33.8 32.4 316.9 0.0 0.0 316.9 42.6 274.3 85.0 0.0 85.0 189.3 0.0 189.3 189.3
1H12a
753.9 65.1 614.3 1,433.2 149.2 30.4 166.2 345.7 34.1 33.4 278.2 0.0 0.0 278.2 57.2 221.0 69.5 0.0 69.5 151.5 0.0 151.5 151.5
2H12e
772.0 73.5 250.4 1,096.0 171.9 32.4 85.8 290.1 39.7 38.7 211.8 0.0 0.0 211.8 51.1 160.7 52.5 0.0 52.5 108.2 0.0 108.2 108.2
1H13e
659.9 68.8 140.0 868.8 143.4 30.1 65.8 239.3 38.4 40.9 160.0 0.0 0.0 160.0 51.4 108.6 38.6 0.0 38.6 70.0 0.0 70.0 70.0
2H13e
1,591.0 134.8 1,254.1 2,979.8 318.5 62.9 347.5 728.8 67.9 65.8 595.1 0.0 0.0 595.1 99.8 495.3 154.5 0.0 154.5 340.8 0.0 340.8 340.8
FY12e
1,432.0 142.3 390.5 1,964.7 315.3 62.5 151.6 529.4 78.1 79.5 371.8 0.0 0.0 371.8 102.4 269.3 91.1 0.0 91.1 178.2 0.0 178.2 178.2
FY13e
1,425.0 150.1 303.4 1,878.5 317.2 62.4 142.8 522.4 76.6 80.1 365.8 0.0 0.0 365.8 93.4 272.3 93.8 0.0 93.8 178.6 0.0 178.6 178.6
FY14e
1,441.5 158.3 313.6 1,913.3 321.9 67.4 147.7 537.0 76.3 78.8 381.9 0.0 0.0 381.9 84.2 297.7 101.3 0.0 101.3 196.3 0.0 196.3 196.3
FY15e
Depreciation Amortisation
EBIT Consolidated Non-recurring Share of associates EBIT Net interest EBT Tax consolidated Tax on NRIs Total tax expense Profit after tax Minority interests Reported Profit Adjusted Profit
Cashflow analysis
EBITDA Increase in Working Capital Net Interest Paid Tax Paid Other Net Operating Cashflows Proceeds from Sale of PP&E Capex Acquisitions and Investments Other Net Investing Cashflows Dividends Paid Equity Movements (inc. DRP) Debt Movements Other Net Financing Cashflows Net Cashflow Net Exchange Rate Differences Change in Receivables Cash Balance
383.1 -8.4 -43.0 -94.8 -9.8 227.1 0.0 -67.6 -75.0 -1.6 -144.2 -130.7 65.5 0.0 -1.6 -66.8 16.1 0.0 0.0 163.2
1H12a
345.7 6.9 -57.2 -69.5 0.0 225.9 0.0 -82.4 -410.0 0.0 -492.4 -92.7 46.3 312.9 0.0 266.5 0.0 0.0 0.0 163.2
2H12e
290.1 -8.0 -51.1 -52.5 0.0 178.5 19.0 -75.0 -75.0 0.0 -131.0 -73.0 18.3 7.2 0.0 -47.5 0.0 0.0 0.0 163.2
1H13e
239.3 -15.8 -51.4 -38.6 0.0 133.5 0.0 -75.0 0.0 0.0 -75.0 -88.4 22.1 7.8 0.0 -58.5 0.0 0.0 0.0 163.2
2H13e
728.8 -1.5 -100.2 -164.3 -9.8 453.0 0.0 -150.0 -485.0 -1.6 -636.6 -223.4 111.8 312.9 -1.6 199.7 16.1 0.0 0.0 163.2
FY12e
529.4 -23.8 -102.4 -91.1 0.0 312.0 19.0 -150.0 -75.0 0.0 -206.0 -161.4 40.4 15.0 0.0 -106.0 0.0 0.0 0.0 163.2
FY13e
522.4 -11.5 -93.4 -93.8 0.0 323.7 0.0 -120.0 0.0 0.0 -120.0 -134.7 37.0 -106.0 0.0 -203.7 0.0 0.0 0.0 163.2
FY14e
537.0 15.9 -84.2 -101.3 0.0 367.3 0.0 -120.0 0.0 0.0 -120.0 -152.5 41.9 -136.7 0.0 -247.3 0.0 0.0 0.0 163.2
FY15e
Key ratios
DPS EPS Adjusted EPS PER Adjusted PER Dividend Yield EV / EBITDA EV / EBIT Net debt / EBITDA Gross debt / EBITDA RoA RoE
13.0 26.6 26.6 5.0x 5.0x 4.9% 3.5x 4.2x 1.1x 1.3x 20.7% 30.0%
10.0 21.0 21.0 6.3x 6.3x 3.8% 4.4x 5.5x 1.7x 1.9x 16.9% 22.1%
12.0 14.7 14.7 9.0x 9.0x 4.6% 5.3x 7.2x 2.0x 2.2x 12.9% 14.9%
8.0 9.4 9.4 13.9x 13.9x 3.0% 6.5x 9.7x 2.5x 2.7x 9.7% 9.5%
23.0 47.6 47.6 5.5x 5.5x 8.7% 4.2x 5.1x 1.6x 1.8x 19.5% 25.9%
FY12e
20.0 24.1 24.1 10.9x 10.9x 7.6% 5.8x 8.3x 2.2x 2.4x 11.3% 12.3%
FY13e
19.0 23.7 23.7 11.1x 11.1x 7.2% 5.8x 8.3x 2.0x 2.3x 11.2% 11.8%
FY14e
21.0 25.6 25.6 10.3x 10.3x 8.0% 5.4x 7.7x 1.7x 2.0x 11.8% 12.2%
FY15e
Performance analysis
Cash $m Receivables FY14 EBITDA by division Other $m Total Current Assets $m Property Plant & Equipment $m Gaming Goodwill $m 27% Intangibles $m Other $m Total Non-Current Assets $m Total Assets $m Payables $m Short-term Debt $m Other $m Total Current Liabilities $m Long-term Debt $m Media Other $m 12% Total Non-Current Liabilities $m Total Liabilities $m Net Assets $m Share Capital $m Retained profits/reserves $m Total Shareholders Funds $m
Balance Sheet
Cash Receivables Other Total Current Assets Property Plant & Equipment Goodwill Intangibles Other Total Non-Current Assets Total Assets Payables Short-term Debt Other Total Current Liabilities Long-term Debt Other Total Non-Current Liabilities Total Liabilities Net Assets Share Capital Retained profits/reserves Total Shareholders Funds
Wagering 61%
163.2 79.9 27.4 270.6 340.5 1,389.7 1,209.9 67.8 3,007.9 3,278.4 367.0 450.0 101.1 918.1 829.6 109.1 938.7 1,856.7 1,421.7 2,083.8 -662.1 1,421.7
163.2 54.9 23.4 241.6 393.4 1,389.7 1,205.4 67.8 3,056.3 3,297.9 314.2 450.0 101.1 865.3 844.6 109.1 953.7 1,819.0 1,478.8 2,124.2 -645.3 1,478.8
163.2 53.9 23.7 240.7 436.8 1,389.7 1,125.3 67.8 3,019.6 3,260.3 301.8 450.0 101.1 852.9 738.6 109.1 847.7 1,700.6 1,559.7 2,161.2 -601.5 1,559.7
163.2 56.6 23.8 243.6 480.6 1,389.7 1,046.5 67.8 2,984.5 3,228.2 320.6 450.0 101.1 871.7 601.9 109.1 711.0 1,582.7 1,645.5 2,203.1 -557.7 1,645.5
26 March 2012
49
36
AUSTRALIA
CFX AU
- Sum of Parts
Outperform A$1.79
Low A$ 2.01 % +19.9 A$ 2.01-2.09 Real Estate A$m 5,084 A$m 19.0 m 2,840
CFS Retail Property Trust

Juicy stake sold
Event
CFX announced the sale of a 50% stake in Myer Brisbane for $366m, inline
with book value. As anticipated, the group is embarking on an on-market share buyback for up to $150m of units on issue (~3%).
Year end 30 Jun Revenue EBIT Reported profit Adjusted profit Gross cashflow CFPS CFPS growth PGCFPS PGCFPS rel EPS adj EPS adj growth PER adj PER rel Total DPS Total DPS growth Total div yield Franking ROA ROE EV/EBITDA Net debt/equity P/BV m m m m m % x x % x x % % % % % x % x
Impact
CFX delivering on stated strategy at the 1H12 result. We are encouraged
2011A 2012E 2013E 2014E 699.3 463.7 532.6 350.3 350.3 12.7 1.5 14.1 1.15 12.7 1.5 14.1 1.11 12.7 1.5 7.1 0 8.2 6.4 15.5 38.0 0.9 730.5 415.7 389.7 372.6 372.6 13.2 3.4 13.6 1.10 13.2 3.4 13.6 1.07 13.2 3.5 7.3 0 6.2 6.4 14.6 36.9 0.9 731.2 499.2 379.2 379.2 379.2 13.7 4.0 13.1 1.10 13.7 4.0 13.1 1.08 13.7 3.9 7.6 0 5.7 6.4 14.7 41.7 0.9 782.2 534.2 388.6 388.6 388.6 14.1 3.1 12.7 1.12 14.1 3.1 12.7 1.10 14.1 3.2 7.9 0 5.9 6.4 13.7 43.5 0.9
that CFX is delivering on its stated strategy of selling down part stakes in regional centres and entire stakes in sub-regional centres. It is also positive that capital receipts are being applied to an on-market share buyback as opposed to simply being added to the development pipeline from which lower returns are likely in future periods, in our view. We anticipate coming sales will include the 1/3 stake in Myer Bourke St (slightly accretive due to low passing yield from Myer) and sub-regional assets (marginally dilutive in isolation).
Asset sale ~30bps dilutive, neutral when incorporating share
buyback. Considering the Myer Brisbane passing yield of ~7.5%, the sale is ~30bps dilutive to our FY13 estimates on a full year basis assuming debt pay down. Offsetting this we note that a $150m buyback (~3% of issued capital) at current levels is just over ~30bps accretive to our FY13 EPS estimate, thus today's announcement results in a minor net earnings upgrade. The earliest that the buyback can commence is 10 April 2012.
Sale at book value provides some valuation comfort. We believe
CFX AU vs ASX 200 Prop, & rec history
todays sale at book value (6.5% cap rate) provides some comfort in the valuations of top tier regional centres. We continue to expect good quality commercial assets to attract capital around book values with secondary assets to find it more difficult to attract buyer interest.
Gearing declines from 28.1% to 26.7% following initiatives. We note that
the sale of Myer Brisbane in isolation reduces group gearing (borrowings to total assets excluding the fair value of derivatives) to 24.9% (down ~320bps) with the $150m buyback only modestly increasing gearing to 26.7% overall.

FY12E: No change, FY13E: +0.1%, FY14E: +0.1%. TP +1cpu to A$2.01.
Price catalyst
12-month price target: A$2.01 based on a Sum of Parts methodology. Catalyst: Further asset sales including the 1/3 stake in Myer Bourke St and an
Analyst(s)
Rob Freeman +61 2 8237 1152 Paul Checchin +61 2 8232 4197 Ei Phyu Lwin +61 2 8232 2784 rob.freeman@macquarie.com paul.checchin@macquarie.com eiphyu.lwin@macquarie.com
increase in the share buyback to 5% of issued capital.

Today's announcement is consistent with our expectation outlined in CFS
Retail Property Trust Juicy stakes for sale (22 February 2012), delivering evidence of valuation support, capital discipline and modest earnings enhancement. CFX provides exposure to a high quality, predominately regional retail portfolio which should prove relatively resilient in the current difficult retail environment.
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CFS Retail Property Trust
Fig 1
CFX financial summary

FY10 611.4 0.6 9.6 621.6 118.2 164.8 31.7 314.7 306.9 312.2 306.9 12.5 3.3% 12.5 0.0% 2.02 2510.7 81.8 7515.0 42.2 7639.1 276.4 1502.4 5061.1 FY11 695.2 1.1 7.9 704.2 133.6 191.9 50.8 376.3 327.9 359.7 327.9 12.7 1.3% 12.7 1.6% 2.06 2839.6 64.9 8276.3 19.3 8360.5 281.7 1900.4 5835.8 FY12E 729.2 0.6 9.7 739.5 139.3 193.8 59.8 392.8 346.7 372.4 346.7 13.1 3.5% 13.1 3.5% 2.08 2827.6 71.9 8378.8 19.3 8470.0 288.7 2177.5 5886.8 FY13E 731.2 0.2 8.6 740.0 120.2 185.9 54.7 360.9 379.2 379.0 379.2 13.7 4.0% 13.7 4.0% 2.16 2755.8 71.9 8759.3 19.3 8850.5 290.6 2486.1 5956.6 FY14E 782.2 0.2 8.0 790.4 145.8 198.8 57.3 401.9 388.6 388.8 388.6 14.1 3.1% 14.1 3.2% 2.23 2755.8 71.9 9156.7 19.3 9247.9 201.8 2682.3 6153.4
Profit & Loss Gross Rental Interest Received GRM Total Revenue Interest Expense Property Expenses Other Expenses Total Expenses Trust NPAT Distribution Investment Fundamentals Net Trust Income EPU EPU - growth DPU DPU - growth NTA Per Unit Units on issue Balance Sheet Summary Current Assets Property Investments Other non-current assets Total Assets Current liabilities Debt Unitholders Equity
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AUSTRALIA
MacquariesESGratings
Stock BXB CSL WOW WES LLC ORG GPT TLS BHP CCL IAG QBE AMC ANZ WBC RIO TTS NCM CPB AMP SUN STO NAB ASX AGK ANN TAH MND OSH WPL EGP CBA SGP OST COH WOR BEN TOL TSE DXS IOF IPL UGL JBH PNA SEK RHC FMG AWC ESG Rating 93.2 92.6 89.5 87.4 85.0 84.8 84.0 83.2 82.9 82.0 81.7 80.8 80.8 80.7 80.7 80.6 80.0 80.0 80.0 80.0 79.8 79.4 79.3 79.2 79.2 79.2 78.1 78.0 77.5 77.5 77.1 77.0 76.9 76.8 76.7 76.7 76.3 76.2 75.6 75.0 75.0 74.8 74.8 74.8 74.7 74.3 74.2 74.1 73.5 Stock CPA CFX ILU GFF SHL AIO SYD JHX QRN SGM APA TCL BOQ MGR SKI TWE WDC CPU PDN WHC ORI OZL FXJ BLD CSR AGO PRU CTX GMG WRT CGF QAN CWN CQO PRY RMD DUE BSL SWM DOW MYR BLY MTS LYC DJS LEI HVN NWS ESG Rating 73.0 73.0 72.9 72.7 72.5 72.4 72.2 72.1 72.0 71.9 71.5 71.1 71.1 71.1 70.8 70.7 70.7 70.0 70.0 69.4 69.0 68.8 68.6 68.6 68.6 68.2 68.2 68.0 68.0 68.0 67.0 67.0 66.7 66.0 65.8 65.8 65.4 65.2 64.8 64.7 63.5 63.3 62.1 59.4 58.3 52.0 40.9 37.1 -
ESG
Ratings Replayed
Event
Environmental, social and governance (ESG) ratings can be a useful tool, one
of a suite of tools for analysing the ESG performance of individual companies and integrating this information into financial analysis. Building on our previously established methodology, thisnoteupdatesMacquariesESG ratings for 97 of the largest ASX-listed companies.
Impact
ESG ratings can provide a quick snapshot of ESG performance that can be
built upon for further analysis, an additional factor to build into quantitative models and link to different elements of financial performance, and a starting point for corporate engagement on ESG issues. However an understanding of an end-user alignment with the ratings methodology is crucial.
Macquarie has updated our proprietary ESG ratings for 97 of the largest
Australian-listed companies. Ratings have been compiled by the Macquarie Research Equities team in order to address the two biggest concerns with most ESG ratings non-disclosure and financial materiality. Specifically, ratings are compiled by stock specialists with a strong understanding of the financials and utilising only material information. With an average of 5 stocks per Macquarie analyst, this compares to an average of 100 companies per analyst across global ratings providers.
Outlook
Top Macquarie ESG-rated companies are BXB, CSL, WOW, WES, LLC,
ORG, GPT, TLS, BHP and CCL. While the weakest performers are NWS, HVN, LEI, DJS, LYC, MTS, BLY, MYR, DOW and SWM.
40stocks,outof97,havehadasignificantchangeinESGratingsinceour
last iteration in September 2011. Upgrades occurred for CCL, BXB, GFF, TWE, FMG, GPT, BEN, WOW, BOQ, TCL, JBH, WHC, STO, WBC, PDN, MGR, EGP, HVN, OSH, WPL, ANZ, TOL and WES. While downgrades occurred to SWM, BLD, CWN, DOW, UGL, BSL, TSE, CSR, AGO, LEI, AWC, RMD, WOR, MTS, QAN, SGM and AIO.
These changes are a result of updated ESG corporate disclosures, updated
*andrefertoasignificantincreaseordecreasein rating relative to September 2011 Source: Macquarie Research, March 2012
governance assessments, ad hoc ESG events, and in some instances, a change in analyst coverage (with further stock level detailed provided.) At a broader sectoral level, upgrades occurred across the food and beverage, and banking sectors. With downgrades to building and construction materials, metals processing, and commercial and professional services,
Moreover, a wide dispersal of ESG ratings in some sectors indicates a strong
Analyst(s)
Aimee Kaye +61 2 8232 9772 Gabby Hajj +61 2 8237 3897 aimee.kaye@macquarie.com gabby.hajj@macquarie.com
potential for companies to differentiatethemselvesonsustainablegrounds. This is the case for media, discretionary and nondiscretionary retailing, construction and engineering, and transport and logistics sectors.
Finally, these results are robust to altering the weighting methodology, with
only seven stocks significantly varying their relative positioning under a weighting change.
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ESG
ESG ratings the what, why and how

Environmental, social and governance (ESG) ratings have a chequered history. They can be a
useful tool, one of a suite of tools for analysing the ESG performance of individual companies and integrating this information into financial analysis. ESG ratings can provide: a quick snapshot of ESG performance that can be built upon with further analysis, an additional factor to build into quantitative models and link to different elements of financial performance, and a starting point for corporate engagement on ESG issues.
But while ESG ratings can be used effectively, they can also be abused. Put simply, the
informational and methodological quality of the ESG output is only as good as the informational and methodological input. It is thus important that end-user investor needs are aligned with the ratings process, and, more importantly, that several common ESG ratings pitfalls are avoided. Namely, ESG ratings ought to have a clear process for dealing with corporate non-disclosure and be based on the financial materiality of different ESG factors. Other common issues include ethical bias, reporting frequency and data standardisation.
To address these concerns, Macquarie has created proprietary ESG ratings for 97 of the largest
Australian-listed companies. These ratings have been compiled by the Macquarie Research Equities team, with ESG information assessed by the relevant analyst for that stock, and combined with an in-built question weighting system that focuses on ESG factors that are relevant for and material to each sector.
This approach addresses the dual concerns with most ESG ratings of non-disclosure and financial
materiality by being compiled by a stock specialist with a strong understanding of the financials and utilising only material information. This focus on involving financial analysts is fairly unique, and contrasts sharply with the methodology employed by most other organisations involved in compiling ESG ratings. Building on our previous report (ESG Ratingsrevealed,28September 2011), this is the 2nd iteration of these ratings.
Finally, it is worth noting that ratings ought to be utilised in conjunction with, rather than as a
replacement for, other forms of ESG integration such as directly pricing ESG factors such as carbon, staff turnover, industrial relations and project delay risks, governance, or the level of corporate disclosure. That is, ratings can be a useful tool for ESG integration, but over reliance on ratings at the expense of either financial information or a broader understanding of ESG risks can likewisebeaconcern.Inshort,MacquariesESGratingscomewiththeimportantcaveatthat theydonotcomprisetheentireESGanswer.
Fig 1 The evolution of ESG investing in Australia
ESG integration ESG thematic investing Positive screening and best in class investing Negative screening and ethical investing
Source: Macquarie Research, March 2012 Consideration of management quality and governance concerns in investment decision making Analysis of ESG thematic trends and financial implication Direct pricing of ESG risks and opportunities Increasing corporate ESG engagement Use of ESG ratings in collaboration with financial and other ESG analysis
Ongoing evolution in Australian ESG landscape
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Macquarie Research
ESG
Ratings and returns a still undetermined link

BeforepresentingMacquariesratingmethodologyandresultsinmoredetail,thequestionneeds
to be asked do they work? Do ESG ratings provide a link to positive investment returns? The answer, unfortunately, is that the academic literature to date is inconclusive.
Some academic studies find that consideration of social factors, from diversity to employee
engagement, positively correlate with long-termsharepriceperformance.Macquariesown quantitative research (Quantamentals Socially ResponsibleInvesting,9March2011) finds a positive link between governance and stock volatility, with companies with strong governance outperforming during times of heightened risk aversion. While also finding outperformance of an index of employee engagement leaders versus laggards over a five-year period (ESG EverchangingEmployeeEngagement,6March2012).
However the link between ESG ratings and performance is still open for consideration and debate.
Yet it is also worth digging deeper into the existing literature. In doing so, the one message that becomes clear is that the method for constructing the rating and the investment technique used are vitally important. For example, the academic literature draws from a wide range of techniques, from negative screening, to best-in-class ESG ratings only investing, to thematic investing, with onlyasmatteringofintegrationtechniquesgivenitsshorterhistory(foramorecomplete discussion of differing methodologies, see ESG Ratingsrevealed,28 September 2011).
Moreover, the quality of the ESG input is not always assured. A particularly spurious study
focusedonthesharepriceperformanceofsustainableUSbanksduringthefinancialcrisis, where the assessment of sustainability was primarily based on whether or not the company recycled. While an alternative academic study found very little, and sometimes negative, correlation between governance ratings of different providers, suggesting that either the ratings are measuring very different aspects of corporate governance or that there is substantial measurement error.
With this in mind, the lack of strong academic evidence supporting the use of ESG ratings is
primarily a function of the evolution in the ratings and investment methodology itself. Indeed, it is worth keeping in mind that there remains no agreement among ESG ratings providers, other than the broadest and most inclusive of statements, of how to best rate companies.
Key challenges for ESG ratings disclosure and materiality

So if ESG ratings are not yet standardised, what are the key points of contention? In short, they
can be summarised as: treatment of non-disclosure, adjustment for sector-specific concerns with a potential ethical bias, proper interpretation of financial materiality in ESG risk and opportunity factors, and the frequency of updates. Each of these warrants further consideration.
By far the biggest source of contention for ESG ratings is how to cope with corporate non-
disclosure of key ESG information. This is especially the case in the Australian and Asian markets (Figure 2).
Fig 2 There are still a number of non-reporting companies in Australia

Quality of corporate ESG reporting am ong ASX100 com panies Poor or none 24% Excellent 19%
Basic 16% Average 20%
Solid 20%
26 March 2012
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Macquarie Research
ESG
The key question for investors when faced with non-disclosure is whether to assume the worst or
assume the average in construction of an ESG rating. This question has plagued investors and other participants in the ESG space for some time because neither option is intuitively satisfactory. To assume that a company is violating human rights because it does not explicitly state otherwise seems manifestly unreasonable although this is the approach taken by many ESG ratings providers. But to allow a company with a poor safety record to hide this from investors under the guise of not reporting any ESG information also creates perverse incentives. There is some logic totheideathatthosewhocanreport,do.
Besides being intuitively unconvincing, neither approach has compelling evidence either. If it was
the case that non-reporting reflected non-performance on ESG metrics, and given the lead times necessary for improving ESG metrics, then the first time a company discloses ESG information, its reporting should be quite poor. After all, the company would have had at most one year to improve from being worst practice. If, however, non-reporting companies were more similar to average ESG performance, then the first ESG disclosures should be just that average. And in the past 12 months there have been examples at either end of the spectrum.
We have argued before that non-disclosureremindsinvestorsthattheysimplydontknowwhat
theydontknow. Hence an appropriate action is to risk adjust non-reporters against best practice ESG reporters. However this risk adjustment for non-disclosure can occur outside of the ratings methodology.MacquariesESGratingsapproachside-stepstheissuetofocusonanalysts fundamental views.
The second key issue is a potential ethical or sectoral bias in ESG ratings. Put simply, companies
with low environmental (or social) exposure may inherently perform better on ESG ratings due to the nature of operations. Or conversely, companies with a high environmental exposure, regardless of how this exposure is addressed, may inherently perform worse on ESG ratings solely due to the nature of their operating activities. This is most common for the resources and financialsectors,andlinksinwiththeappropriatetreatmentofethicalconsiderations.
While there is certainly room for ethical ratings, and these are likely to be the most appropriate for
specific investment mandates, negative screening and ethical investors, it is nonetheless crucial thatmainstreaminvestorsunderstandthepotentialforethical considerations to drive ratings outcomes. For a mainstream investor, therefore, we view financial materiality as the key factor that ought to drive ESG ratings.Rather,Macquariesview on the materiality of factors for different sectors is outlined in the following sections.
26 March 2012
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Macquarie Research
ESG
The Macquarie ratings methodology a review with minor updates

Given the aforementioned concerns and caveats around ESG ratings, it is important to detail the
methodologybehindMacquariesownESGratings.Whilewehavepreviously outlined the conceptualbasis(seeESG Ratingsrevealed,28September2011), it is nonetheless worth reviewing the specifics.
In essence there are two key elements of a ratings framework thelistofESGquestionsandthe
different weightings applied to each sector. We consider each of these in turn, starting with the list ofESGanalystquestionsusedinMacquariesESGratings(Figure3).
Fig 3 ListofESGanalystquestionsusedinMacquariesESGratings
Governance Are a majority of the board independent directors? Is the Chair and CEO of the company the same person? Does the company undertake GRI (Global Reporting Initiative) reporting? How closely are management incentives and remuneration, particularly short-term and long-term incentive hurdles aligned with shareholder interests and corporate governance standards? Have there been any significant shareholder disputes or controversies over executive remuneration in the past 2 years? How would you rate the board's experience, expertise and track record to add value and protect shareholder interests? Have there been any significant shareholder disputes or controversies over the quality or effectiveness of management in the past 2 years? How would you rate the company's shareholder communication and corporate disclosure? How would you rate the company's internal risk and control mechanisms? Environmental How would you rate the 'environmental impact' of operating activities relative to industry peers, in terms of carbon pollution, other air pollutants, water pollution, land clearing and use, biodiversity loss and hazardous materials produced? How would you rate the 'environmental efficiency' of the company relative to industry peers? That is, how carbon, water, land and other resource intensive or efficient is the company relative to other industry peers? Has the company implemented, invested in or realised any significant environmental efficiency improvements in the past 3 years? How would you rate the company's environmental management practices, taking into account any track record of environmental incidents including pollutant releases, chemical or other spills, fines, compliance breaches, litigation? How would you rate the company's waste processing and/or hazardous materials handling? How would you rate the company's environmental supply chain management? That is, how much focus does the company provide to ensuring environmental efficiency and compliance in its supply chain? Does the company produce products, services or processes that assist customers in managing their own environmental needs? If so, how material are these factors to company earnings? Has the company undertaken any research on or preparations for the physical risks associated with climate change? Social How would you rate the company's alignment with and adherence to labour standards, taking into account any track record of human rights violations, workplace and industrial relations disputes, litigation, discrimination and harassment claims? How would you rate employee engagement and satisfaction at the company, taking into account staff turnover, remuneration and productivity, industrial relations disputes and performance on diversity metrics? How would you rate the company's occupational health and safety performance, taking into account any track record of safety incidents, injuries, deaths, non-compliance breaches, fines and litigation? How would you rate the company's community engagement and social licence to operate? How would you rate the company's performance on 'social' issues, such as labour standards, across its supply chain? Does the company have a Code of Conduct and ethics and procedures for enforcement, and is information on compliance against these standards disclosed? How would you rate the company's product safety systems and policies, taking into account any track record of product recalls, as well as product waste and disposal systems? How would you rate the company's data privacy systems and policies, taking into account any track record of hacks, litigation or other controversies? Does the company have policies and procedures regarding investment in controversial sectors (such as the military and forestry sectors), taking into account any controversial financing or investment decisions? Source: Macquarie Research, March 2012
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Macquarie Research
ESG
ThestartingpointforMacquariesESGratingsistheabove list of 26 ESG questions, covering the
fullspectrumofE,SandGissues. Each question is ascribed either a yes/no or 1-5 response and is completed by the relevant stock expert from the Macquarie Research Equities team. Analysts are also provided detailed commentary on each question, relevant ESG metrics and information including how these metrics compare to peers, and further guidance on how the 1-5 rating should be applied. An additional question on whether the company reports ESG information is used as a data check for whether answers are based on quantitative or qualitative assessments.
There has been one (minor) change to the list of ESG questions from the previous iteration.
Namely, both of the governance questions regarding significant shareholder disputes or controversies have been adjusted to reflect the previous two years, rather than the previous three. In our view, this more accurately reflects the length of time that investors may avoid, or remain more cautious, on a company due to prior governance controversies.
As mentioned previously, thefocusisoninvolvingMacquariesteamoffinancialanalysts due to
their detailed company and industry knowledge and ability to make an informed assessment on the financial materiality of qualitative and quantitative ESG information. This has the added advantage that each Macquarie analyst is able to more comprehensively consider their, on average, 4-5 stocks. This compares to a recent study of 21 global ESG ratings providers whereby the median number of companies covered and rated per analyst is approximately 100, with some analysts covering several hundred companies annually.
That said, having a sense of the relative performance across all 97 stocks, as well as consistency
in the ratings, is important. As such, all individual responses have then been cross-referenced against available ESG quantitative and qualitative information by an ESG specialist. This ensures that all questions are approached and answered in a consistent manner, and also serves to highlight any issues that may not have been otherwise addressed or incorporated by the stock analysts.
Having detailed the key questions, the issue becomes how these questions are weighted for each
company. Companies are first placed into one of 31 sectors (Figure 4), according to the primary operating activity. These sectors roughly, but not perfectly, follow the GICS classification but are adjusted for the similarity of ESG issues faced and classified according to primary operating activity. With some companies undertaking activities across a number of sectors, companies are ascribed a primary, and if relevant, a secondary sector.
Fig 4 ListofsectorsinMacquariesESGratings
Oil and gas Chemicals Building and construction
materials
Airlines Transport and logistics Infrastructure Other manufacturing auto,

electronics, etc
Healthcare equipment Healthcare services Pharmaceuticals and

biotechnology
Containers and packaging Mining Metals processing Paper and forestry products Construction and engineering Machinery and equipment Commercial and professional
services Source: Macquarie Research, March 2012
Banks Diversified financials Insurance Property development REITs and LPTs IT software and services Telecommunications Utilities
Textiles and apparel Hotels, leisure and gaming Media Discretionary retailing Nondiscretionary (consumer
staples) retailing
Food, beverage and tobacco
The weighting ascribed to each ESG question for each company is then determined by the
sector(s) in which the company operates. At a conceptual level, questions are weighted according to the materiality of the issue for that sector. Hence questions have a high, medium, or no weighting.
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Macquarie Research
ESG
In doing so, a number of questions are screened out for each sector such that the average
numberofeffectivequestionsforeachsectoris~17rather than 26. The question on preparedness for climate change, for example, is of high relevance for the infrastructure, insurance and property sectors, of moderate concern for the banking and financial sectors via the exposure of the loan book and investment portfolios, and not weighted for other sectors. Likewise, employee engagement is not weighted for the infrastructure and REIT sectors, and environmental management systems are not weighted in the media, financial, or retailing sectors.
Two changes to the sector question weightings have been made. First, the question on
occupational health and safety has been up-weightedtohighforthetransportandlogistics sector,frommediumpreviously.Whilethequestiononenvironmentalimpacthasbeenupweightedtohighforthepropertydevelopmentsector,frommediumpreviously.Bothofthese changes are to provide a more accurate assessment of the financial materiality of the ESG risks faced by these sectors.
Governance is strongly weighted across all sectors, in most cases contributing over 50% to the
overall rating (Figure 5). This is in line with strong empirical evidence on the link between governance and performance metrics. Environmental and social factors are broadly equally weighted across the entire market, although this varies significantly between sectors. That said, we also (below) provide details of ratings assuming a number of different weighting methodologies.
Fig 5 Relative environmental, social and governance weightings by sector

Oil and gas Chemicals Building and construction materials Containers and packaging Mining Metals processing Paper and forestry products Construction and engineering Machinery and equipment Commercial and professional services Airlines Transport and logistics Infrastructure Other manufacturing - auto, electronics, etc Textiles and apparel Hotels, leisure and gaming Media Discretionary retailing Nondiscretionary (consumer staples) retailing Food, beverage and tobacco Healthcare equipment Healthcare services Pharmaceuticals and biotechnology Banks Diversified financials Insurance Property development REITs and LPTs IT softw are and services Telecommunications Utilities E S G 0
20
40
60
80
100
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Ratings for Australia results and sectoral trends

The results of combining the responses to each question with the appropriate sectoral weightings
are summarised below (Figure 6).
Fig 6 Macquarie ESG ratings for Australian companies

1st quartile BXB CSL WOW WES LLC ORG GPT TLS BHP CCL IAG QBE AMC ANZ WBC RIO TTS NCM CPB AMP SUN STO NAB ASX AGK 93.2 92.6 89.5 87.4 85.0 84.8 84.0 83.2 82.9 82.0 81.7 80.8 80.8 80.7 80.7 80.6 80.0 80.0 80.0 80.0 79.8 79.4 79.3 79.2 79.2 2nd quartile ANN TAH MND OSH WPL EGP CBA SGP OST COH WOR BEN TOL TSE DXS IOF IPL UGL JBH PNA SEK RHC FMG AWC 79.2 78.1 78.0 77.5 77.5 77.1 77.0 76.9 76.8 76.7 76.7 76.3 76.2 75.6 75.0 75.0 74.8 74.8 74.8 74.7 74.3 74.2 74.1 73.5 3rd quartile CPA CFX ILU GFF SHL AIO SYD JHX QRN SGM APA TCL BOQ MGR SKI TWE WDC CPU PDN WHC ORI OZL FXJ BLD 73.0 73.0 72.9 72.7 72.5 72.4 72.2 72.1 72.0 71.9 71.5 71.1 71.1 71.1 70.8 70.7 70.7 70.0 70.0 69.4 69.0 68.8 68.6 68.6 4th quartile CSR AGO PRU CTX GMG WRT CGF QAN CWN CQO PRY RMD DUE BSL SWM DOW MYR BLY MTS LYC DJS LEI HVN NWS 68.6 68. 68.2 68.0 68.0 68.0 67.0 67.0 66.7 66.0 65.8 65.8 65.4 65.2 64.8 64.7 63.5 63.3 62.1 59.4 58.3 52.0 40.9 37.1
The bulk (76%) of ratings are between 65 and 85 (Figure 7), with only a minimal number of
outliers.
Fig 7 Frequency distribution of ESG scores

Number of stocks 12 10 8 6 4 2 0 Score frequency Mean = 73.2 St dev = 8.7 Scores w ithin 1 standard deviation
36
38
40
42
44
46
48
50
52
54
56
58
60
62
64
66
68
70
72
74
76
78
80
82
84
86
88
90
The top rated Macquarie ESG rated companies are BXB, CSL, WOW, WES, LLC, ORG, GPT,
TLS, BHP and CCL. While the weakest performers are NWS, HVN, LEI, DJS, LYC, MTS, BLY, MYR, DOW and SWM.
Strong or weak governance is a defining characteristic of these tail-end results (Figure 8).
However governance is also not the sole driver. Rather most of the top ESG rated stocks also performed well on environmental and social metrics as well. For example, BXBsresultincluded strong supply chain management and environmental efficiency, while WOWsresultincludedalso strong supply chain management and occupational health and safety.
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A similar pattern is observable for poorly-rated stocks. While governance is a key element, other
issues such as data privacy (NWS) and industrial relations disputes (LEI) also play a role.
Fig 8 Result drivers for top and bottom ESG rated stocks
Stock BXB CSL WOW WES LLC ORG GPT TLS BHP CCL SWM DOW MYR BLY MTS LYC ESG rating 93.2 92.6 89.5 87.4 85.0 84.8 84.0 83.2 82.9 82.0 64.8 64.7 63.5 63.3 62.1 59.4 Rating driver Strong performance on governance metrics, coupled with strong performance on environmental and social metrics, including OH&S, supply chain stewardship, environmental management and efficiency. Strong performance against all governance metrics, combined with strong product safety measures, waste management, environmental efficiency and solid employee engagement. Strong performance on governance metrics, coupled with strong supply chain stewardship and occupation health and safety performance. Strong performance on governance metrics largely drove the result. Strong performance on governance, environmental and social metrics, with a particular focus on green property development initiatives. Strong performance against all governance metrics, combined with above-average performance on environmental efficiency and management. Solid performance on most governance metrics, notwithstanding previous controversies (and still ongoing legal dispute) within the past 2 years. Combined with a strong focus on green property development initiatives. Strong performance on governance metrics, not withstanding previous controversies within the past 2 years, combined with solid performance on social metrics. Strong performance on governance and environmental metrics. Positive differential with RIO driven by fewer shareholder disputes, despite slightly stronger performance by RIO on community engagement and social licence to operate. Strong performance on governance metrics, and a significant gain across environmental efficiency, impact and investment, as well as occupational health and safety. Below average performance on governance indicators such as board independence, and corporate disclosure. Below average performance on governance indicators following recent shareholder disputes and controversies. Below average performance on governance, coupled with average performance on social metrics, notwithstanding recent improvements in supply chain stewardship. Average to below average performance across governance, environmental and social metrics. Below average performance on governance indicators, combined with average to below average performance on occupational health and safety and supply chain stewardship. Weak performance on governance indicators including CEO duality, and a history of shareholder disputes and controversies, as well as weaker social licence to operate, notwithstanding stronger performance on environmental metrics. Below average performance on governance indicators given board controversies in recent years, concerns over management quality and alignment with shareholder interests, not withstanding strong occupational health and safety gains. Below average performance on governance indicators in line with management gyrations and concerns over a lack of disclosure and transparency, combined with below average performance on social metrics given recent industrial disputes. Weak performance on governance indicators such as board independence, alignment with shareholder interests and corporate disclosure, and average to poor performance on environmental and social issues, such as within the supply chain. Weak performance on governance indicators such as CEO duality, board independence, alignment with shareholder interests and risk management, combined with weak performance on social metrics such as data privacy, compliance against company Code of Conduct, and social licence to operate.
DJS
58.3
LEI
52.0
HVN
40.9
NWS
37.1
Besides viewing the headline scores it is also instructive to consider the major changes that have
occurred since the last rating compilation in September 2011. 40 stocks, out of 97, have had a significant change in ESG rating over this time.
Considering only those changes greater than 2.0 in either direction, the major upgrades were to
CCL, BXB, GFF, TWE, FMG, GPT, BEN, WOW, BOQ, TCL, JBH, WHC, STO, WBC, PDN, MGR, EGP, HVN, OSH, WPL, ANZ, TOL and WES. Downgrades occurred to SWM, BLD, CWN, DOW, UGL, BSL, TSE, CSR, AGO, LEI, AWC, RMD, WOR, MTS, QAN, SGM and AIO.
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Fig 9 Drivers for largest ESG rating change

Stock CCL ESG rating 15.3 Rating change driver Updated sustainability reporting in late 2011 provided significant new insight into water sourcing and management, confirmation of environmental efficiency metrics, and a broader scope of occupational health and safety metrics that compared favourably to peers(forcommentaryseeESG - ESGReportingSeason10 24 January 2012) Upgrade to quantitative / objective governance question with the introduction of GRIlinked sustainability reporting, and run off of previous shareholder disputes beyond the 2 to 3 year mark. Upgraded assessment of the quality of internal risk management and controls. Modest upgrades to environmental impact and efficiency assessment, as well as employee engagement. Upgrade governance questions on board effectiveness, and also with the introduction GRI linked sustainability reporting. Improved indigenous liaison and social licence to operate following resolution of Solomon Hub dispute. Upgraded assessment of the quality of internal risk management and controls. Modest upgrades to environmental efficiency assessment, as well as employee engagement. Upgraded quantitative / objective governance questions following roll-off of previous dispute past the 2 year mark (previously 3 years). Upgrade assessment of governance quality following change in analyst coverage. Upgraded social assessment, particularly regarding supply chain stewardship and occupational health and safety. Combined with improved corporate strategy on organicorgreenproducts. Upgrade assessment of governance quality following change in analyst coverage. Upgraded assessment of executive remuneration alignment with shareholder interests given changes that followed recent shareholder disputes. Downgrade to assessment of social licence to operate following ongoing industrial relations disputes and investigation into potential corruption or bribery activity in the Middle East. Downgrade to occupational health and safety assessment to neutral given lack of comparable data disclosure in most recent sustainability reporting (for further commentaryseeESG - ESG Reporting Season Summary 7 November 2011) Downgrade to quantitative / objective governance question with the non-use of GRI linked sustainability reporting (although the broad quality of reporting remains unchanged,seeESG - ESG Reporting Season Summary 7 November 2011). Modest changes to occupational health and safety assessment to below-average against industry peers, following change in analyst coverage. Downgrade to quantitative / objective governance question following recent shareholder disputes over the quality and effectiveness of management. Lack of consistent environmental data, over a reliance on case studies, resulted in a number ofenvironmentalassessmentsbeingpulledbacktoneutral(formoredetailsseeESG - ESG Reporting Season Summary 7 November 2011) Downgrade to quantitative / objective governance question following recent significant no vote on company remuneration report. Compounded by downgrade in environmental impact and efficiency assessment to neutral. Downgrade to social assessment, with occupational health and safety performance pulled back to a neutral setting following poor quality reporting of safety policies and procedures to support headline metrics. Downgrade to environmental assessment to neutral, given non disclosure of environmental data. Downgrade to quantitative / objective governance question with the company no longer using GRI-linked sustainability reporting. Combined with modest downgrade to environmental efficiency investment assessment given the pull-back in sustainability reporting. Additional change in analyst coverage. Downgrade to quantitative / objective governance question following recent significant no vote on company remuneration report. Downgrade to quantitative / objective governance question on board independence.
BXB
10.4
GFF
8.7
FMG
7.1
TWE GPT BEN WOW BOQ TCL LEI
6.7 6.0 5.9 5.3 5.2 4.4 -4.0
AGO
-4.1
CSR
-4.3
TSE
-4.4
UGL
-4.4
BSL DOW
-4.4 -4.7
BLD
-5.7
CWN SWM
-5.7 -7.6
These changes are a result of a number of factors. First, over the past six months a significant
number of companies have released updated sustainability reports detailing their latest quantitative data, qualitative information and commentary on ESG performance. This includes information on: occupational health and safety, employee engagement, environmental performance, community engagement processes or other aspects of ESG.
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Just as significant as the incorporation of updated disclosed environmental and social data are
updated governance assessments, given the average ~50% weighting afforded to both qualitative and quantitative governance factors. Updates to these assessments have occurred over the past six months in light of: management or board changes, AGM results including the result of voting on the remuneration report, recent company financial reporting and guidance, and other events. Indeed, in addition to updated ESG reporting, ad hoc environmental, social or governance events can, and do, impact ESG ratings assessments.
Finally, it is worth noting that there have also been a number of companies where a change in
analyst coverage orarefinementintheanalystsapproachtoESGinformationmayhave contributed to a change in rating.
Fig 10 Change in ESG ratings

Number of stocks 40 No statistically significant change (betw een -2/+2 )
30
Change in ESG rating Sep 11 to Mar 12
20
10
0 <-10 10<5 5<2 2<0 0 0<2 2<5 5<10 >10

It is also instructive to compare the average ESG rating between sectors (Figure 10). A few
sectors pharmaceuticals and biotechnology, telecommunications and airlines have only one company in the sample group and should be discounted. But aside from these, there are a few notable results. Containers and packaging; nondiscretionary retailing; transport and logistics; banks; insurance; oil and gas; and commercial and professional services all perform well. While discretionary retailing; media; construction and engineering; building and construction materials; chemicals; and healthcare services all perform poorly.
In contrast to six months ago the major sectoral moves, excluding changes in composition of the
sector (new or old stocks added or removed) include: Improvers: food, beverage and tobacco; and banks; Regressors: building and construction materials; metals processing; and commercial and professional services.
Furthermore, some sectors show very little variation between companies. This is the case in the:
infrastructure; commercial and professional services; building and construction materials; and banking sectors. That is, there is very little separating different companies within each of these four sectors and as such there is unlikely to be much strategic opportunity at present for these companies to differentiate themselves from peers as being more sustainable. Or in other words, theESGopportunitybeingcapturedbyanyofthesecompaniesismarginal.
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Fig 11
ESG score by sector
Pharmaceuticals and biotechnology Containers and packaging Telecommunications Nondiscretionary (consumer staples) Transport and logistics Banks Insurance Oil and gas Commercial and professional services Hotels, leisure and gaming Food, beverage and tobacco Utilities Property development Diversified financials Healthcare equipment REITs and LPTs Mining Infrastructure Metals processing Healthcare services Chemicals Building and construction materials Airlines Construction and engineering Media Discretionary retailing 50
Average sector ESG rating
55
60
65
70
75
80
85
90
95
In other sectors there is a wide dispersal of results and likely a strong potential for companies to
differentiatethemselvestopeersonsustainablegrounds. This is the case in the: media; nondiscretionary retailing; discretionary retailing; construction and engineering; and transport and logistics sectors (Figure 12).
Fig 12 Blue oceans sectors with ESG differentiation

Infrastructure Building and construction materials Commercial and professional services Banks Chemicals Healthcare services Metals processing REITs and LPTs Hotels, leisure and gaming Food, beverage and tobacco Oil and gas Insurance Mining Diversified financials Property development Healthcare equipment Utilities Containers and packaging Transport and logistics Construction and engineering Discretionary retailing Nondiscretionary (consumer staples) Media 0
Less dispersed ESG scores => less differentiation on 'sustainability' criteria
Standard deviation of sector ESG scores
More dispersed ESG scores => greater differentiation on 'sustainability' criteria
10
12
14
16
18
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One ongoing point, given the aforementioned discussion over the appropriate course of action in
instances of non-disclosure, is that average sector level ESG disclosure does not directly map to average sectoral ESG performance (Figure 13). While questions such as GRI disclosure and broader financial reporting and disclosure form part of the governance questions and rating composition, this does not necessarily map to other factors such as perceived and evidenced environmental and social performance.
This adds further weight to the suggestion that the appropriate action in response to non-
disclosure is to risk-adjust non-reporters against best practice ESG reporters. But that this risk adjustment for non-disclosure can occur outside of the ratings methodology.
Fig 13
ESG disclosure versus sectoral performance not a direct map

Average sector ESG rating (LHS) % Proportion of stocks w ith ESG disclosure (RHS) 100 90 80 70 60 50 40 30 20 10
Index 95 90 85 80 75 70 65 60 55
Pharm. & biotech
REITs & LPTs
Contain. & pack.
Nondiscretion. retail
Discretionary retail
Hotels & gaming
Telecom.
50
Chemicals
Mining
Build. & constr. mat.
Food & bev.
Insurance
Com. & prof. serv.
Healthcare equip.
Metals proces.
Constr. & eng.
Property dev.
Trans. & logistics
Finally, while governance drives a significant proportion of the ESG ratings, it is also worth noting
the confidence intervals around each of the environmental, social and governance ratings. That is, how strong are analyst views on each of these factors? One manner for assessing this is to consider the mean and standard deviation for each subset of scores (Figure 14) considering only those that contribute towards the final rating that is, excluding zero-rated questions.
Fig 14 There is less conviction for harder-to-gauge social factors

ESG Questions Mean Standard deviation All 3.62 1.23 Governance 3.84 1.40 Environmental 3.23 0.97 Social 3.52 0.82
The result of this is a contrast between variability of ratings on governance and environmental
metrics versus the social metrics. Responses to the eight social questions err modestly above neutral, at 3.52 vs a neutral 3 out of 5. But more pertinently, the distribution of ratings is quite narrow, with a standard deviation of 0.82, compared to 1 or more for governance and environmental metrics.
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Healthcare serv.
Oil & gas
Utilities
Banks
Infrastructure
Div. finacnials
Airlines
Media
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ESG
Thisnarrowboundreinforcesourpreviouslyexpressedview(ESG Evaluating Employee
Engagement, 28 June 2011 andESG Ever-changingEmployeeEngagement,6April2012) that social metrics, such as employee engagement, remain an under-reported, under-researched and under-evaluated set of company metrics. Nonetheless, there remain a number of strong or poorly ratedcompaniesfromasocialviewpointwithinMacquariesESGratings. Indeed, encouragingly, the dispersion on social ratings has increased moderately over the past six months, to 0.82, from 0.79 previously. Changing the goalposts limited potential misalignment from weighting technique
As per our previous analysis, we again consider four other weighting systems for the potential
impact of question weighting on the ESG scores. Specifically we consider: Base weighting theexistingweightingmethodology,with~17activequestionsforeach sector (not zero weighted) and sector-specific question weightings.
Fig 15 The impact of different weighting methodologies on rating quartiles

Base BXB CSL WOW WES LLC ORG GPT TLS BHP CCL IAG QBE AMC ANZ WBC RIO CPB TTS NCM AMP SUN STO NAB AGK ASX ANN TAH MND WPL OSH EGP CBA SGP OST WOR COH BEN TOL TSE DXS IOF IPL UGL JBH PNA SEK RHC FMG AWC 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 All 1 1 1 1 1 1 1 2 1 1 1 1 1 1 1 1 1 2 1 1 2 1 2 1 2 1 3 1 1 2 3 2 2 2 1 2 3 1 2 3 3 2 3 2 2 3 2 2 2 Equal 1 1 1 1 1 1 1 1 1 1 1 1 2 1 1 1 1 1 1 1 1 1 2 1 2 2 2 2 1 1 2 2 1 2 2 3 3 3 2 2 2 2 3 2 2 2 2 2 2 Half gov 1 1 1 1 1 1 1 1 1 1 1 1 2 1 1 1 1 1 2 1 1 1 1 2 1 1 1 1 2 2 2 2 2 2 2 2 2 2 2 2 2 3 2 2 2 3 2 2 2 Sep2011 1 1 1 1 1 1 2 1 1 4 1 1 1 1 2 1 n/a 1 1 1 1 2 1 1 2 1 2 n/a 2 2 2 2 2 1 1 2 3 2 1 2 3 2 1 3 2 2 2 4 2 CFX CPA ILU GFF SHL AIO SYD JHX QRN SGM APA MGR TCL BOQ SKI WDC TWE CPU PDN WHC ORI OZL BLD CSR FXJ PRU AGO CTX WRT GMG CGF QAN CWN CQO RMD PRY DUE BSL SWM DOW MYR BLY MTS LYC DJS LEI HVN NWS Base 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 All 3 3 3 2 3 4 3 2 4 2 3 3 2 4 3 3 2 3 3 3 3 4 4 3 3 4 4 2 4 4 3 2 4 4 4 4 3 4 4 4 4 4 4 4 4 4 4 4 Equal 2 2 2 2 3 4 3 3 3 3 3 3 3 4 3 3 3 4 3 3 3 3 4 4 3 3 3 3 3 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 Half gov 2 2 3 3 3 3 3 3 3 3 3 3 4 3 3 3 3 3 3 4 4 3 3 4 4 4 3 3 4 4 3 4 3 4 4 4 4 4 4 4 4 4 4 4 4 4 4 4 Sep2011 3 3 3 4 3 2 3 3 2 2 3 3 4 4 3 3 4 3 4 4 3 3 2 3 3 n/a 3 3 4 4 n/a 3 3 4 3 4 4 3 3 3 4 4 4 n/a 4 4 4 4
Number represents each quartile group, so 1 = top quartile of 25 stocks, 2 = 2nd quartile of 25 stocks, etc Source: Macquarie Research, March 2012
All weighted all 26 questions are equally weighted, with no variation between sectors and a resulting 34.6% governance, 34.6% environmental and 30.8% social weighting across factors.
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Equal weighted onlytheactivequestionsusedinthebasescenario are used, but with the remaining ~17 questions all equally weighted. This differs from the base scenario in not distinguishingbetweenhighandmediumratedquestions. Half governance weighted similar to the base weighting but with the weighting applied to all governance questions halved. The net result is an average governance component of 42.1% of the score, rather than 58.6% previously.
The result of applying these alternative weightings to the stocks (Figure 15) is surprising for its
consistency. Put simply, a significant number of stocks remain in the same quartile group despite the change in weighting, and also despite the considerable flaws with some of these alternatives weightings. By considering the specific ranking of different stocks under different weighting methodology, only seven potential misalignments come to light. Specifically, AIO, AMC, BEN and UGL would all experience a significant deterioration in ESG rating should the weighting methodology be altered. While FMG, GFF and WPL would all experience a significant improvement.
Fig 16
Seven potentially misaligned stocks due to weighting methodology

Shift in ESG ranking (positions 1 through 97) from different w eighting m ethodologies
AIO AMC BEN UGL WPL FMG GFF -20 -15 -10 -5 0 5 10 15 Deterioration in ESG ranking
Improvement in ESG ranking
Overall, having only seven companies for which a change in weighting methodology impacts the
overall performance is a remarkably low level. Moreover, a detailed understanding of these changes serves a useful purpose, in reminding investors that it is just as much about understanding the factors driving ratings and ESG performance as it is about utilising the end rating.
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15
AUSTRALIA
QAN AU
- Sum of Parts
Outperform A$1.73
A$ % A$ Medium 2.20 +27.2 2.20
Qantas
Jetstar wagons circling China
Event
Qantas has announced that it has entered into a new strategic alliance
with China Eastern Airlines to create Jetstar Hong Kong. Pending

regulatory approvals, the new carrier should begin flying at the beginning of FY14.
Year end 30 Jun Revenue EBIT Reported profit Adjusted profit Gross cashflow CFPS CFPS growth PGCFPS PGCFPS rel EPS adj EPS adj growth PER adj PER rel Total DPS Total div yield Franking ROA ROE EV/EBITDA Net debt/equity P/BV
Transportation A$m 3,919 A$m 17.2 m 2,265
Impact
Encircling China. Importantly, the new airline furthersJetstarsstrategyof
2011A 2012E 2013E 2014E m 14,894 15,807 16,472 17,350 m 665 578 1,106 1,127 m 250 40 575 602 m 410 281 610 602 m 1,658 1,766 2,005 2,051 73.2 78.0 88.5 90.5 % 14.0 6.5 13.5 2.3 x 2.4 2.2 2.0 1.9 x 0.29 0.27 0.26 0.27 18.1 12.4 27.0 26.6 % 63.2 -31.5 117.3 -1.4 x 9.6 13.9 6.4 6.5 x 0.78 1.13 0.58 0.63 0.0 0.0 0.0 3.0 % 0.0 0.0 0.0 1.7 % nmf nmf nmf 100 % 3.3 2.7 5.1 5.1 % 6.8 4.5 9.4 8.6 x 3.8 3.5 2.9 2.8 % 41.2 49.7 49.3 38.8 x 0.6 0.6 0.6 0.5
gaining greater access to the fast growing Chinese leisure market (non Beijing, Shanghai specifically), and provides Qantas further scope for its Asian premium strategy, although that is unlikely to be the primary focus. While the Asian premium carrier strategy has gone into hibernation, the HK JV should provide stronger access into smaller Chinese markets in the meantime. In our view, the JV is a positive for Jetstar and more importantly QAN shareholders given the latent demand in China.
Capital light option. The ongoing deployment and expansion of Jetstar in
Asia provides the Qantas Group with a strong, albeit relatively capital light, option. The alliance will cost QAN a maximum of US$99m and will begin with a fleet of 3 A320s, with management saying that it should grow to 18 A320s by 2015, all lease-back. By creating the strategic alliance and capping the capitalisation, management are able to ring-fence the investment, providing investors a cheap option over Asian LCC growth.
Response remains to be seen. In our view, the announcement should elicit
QAN AU vs ASX 100, & rec history
a strong response from Cathay Pacific. Although the new Jetstar carrier is primarily focussed on the leisure markets, there will likely be some overlap withCathaysDragonAir. We doubt that Cathay would allow their incumbency in HK and regional flights into China via Dragon Air to be challenged. Jetstar also faces other challenges, namely slot constraints at HKIA and domestic Chinese airports, relatively high landing fees and other regulatory approvals.

No change.
Price catalyst
12-month price target: A$2.20 based on a Sum of Parts methodology. Catalyst: Further improvement in International business, regulatory approval
of both Jetstar Japan and Jetstar HK.

Analyst(s)
Russell Shaw, CFA +61 2 8232 7124 russell.shaw@macquarie.com David McGregor +61 2 8237 8032 david.mcgregor@macquarie.com
With the continuing turnaround in the mainline international business,
investors are increasingly looking to the domestic strength of QAN. In our view, the continued growth of Jetstar, specifically in Asia provides investors with a growth option which is currently being given little value. Maintain Outperform.
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Qantas
Slowly circling China

Qantas has announced that it has entered into a new strategic alliance with China Eastern
Airlines to create Jetstar Hong Kong. Pending regulatory approvals, the new carrier should begin
flying at the beginning of FY14.
Jetstar will take a 50% economic and operational interest in the JV, whereby both parties will
contribute US$99m each into the structure. The carrier will begin with a fleet of 3 A320s, with management saying that it should grow to 18 A320s by 2015, all from QAN current order book and all utilising a sale-and-lease-back type option in order to keep capital costs low. Management have said that the carrier should be in the air by mid 2013, meaning regulatory approvals will need to be finalised in around 12 months.
Continues growth trend around China. The announcement of the HK LCC effectively continues
a trend of increasing connectivity into and out of China. Following on from bases in Singapore, Vietnam and Japan, hubbing in Hong Kong will allow Jetstar to fill-out some of its existing network while providing strong connectivity on emerging leisure routes in China, i.e. ex-Beijing and Shanghai.
Fig 1
Recent investments in expanding the Jetstar brand

Capital Invested (A$m) Stake (%) 50% 42% 30% 49% 95 63 37.5 50
Jetstar Hong Kong Jetstar Japan Jetstar Pacific Jetstar Asia Source: Company data, Macquarie Research, March 2012
Management control? Although Jetstar will have a 50% economic interest in the new
carrier, in our view Management should have a strong degree of control given its ability to appoint key management. Previously Jetstar have been able to appoint a number of key staff, including the COO, CFO, Head Pilot and Chief of Ground Staff in the Pacific (Vietnam) business. Importantly QAN Management stated that part of the agreement will require a joint flying committee, which will protect current China Eastern routes in particular Beijing and Shanghai.
ImportantlythenewventurewillfurtherconsolidateJetstarsroutemaptoandfromChina,as
well as providing synergies with the current Jetstar Asia business in terms of ground handling andservicestaff,aswellasengineers.Wedontyet have complete clarity on the extent of this given China Eastern will also have people on the ground. Fig 2 Current China sectors run by Jetstar Asia
Origin Singapore Singapore Singapore Singapore Singapore Singapore Singapore Singapore Route SIN-CAN SIN-HAK SIN-HGH SIN-HAN SIN-KWL SIN-NGB SIN-PEN SIN-SWA Weekly frequency 7 4 4 4 2 4 7 3
Destination Guangzhou Haikou Hangzhou Hanoi Guilin Ningbo Penang Shantou Source: Company data, Macquarie Research, March 2012
Capital light option. The new Jetstar HK airline willbeginwith3A320sinmid-calendar 2013,
growing toaforecast18A320sby2015.AlltheplaneswillcomefromQANscurrentdelivery schedule, via an effective sale-and-lease-back arrangement which means a capital light, offbalance sheet outcome. By capping the capitalisation at US$99m, management are able to ringfence the investment, providing investors a large potential upside with little downside. While we expect some early losses, US$99m should be enough to sustain the business until the upward trendoftheJcurvekicksin.
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As of 31 December 2011 QAN had 125 A320sonorder through to FY20, of which we suspect
roughly half are for replacement, with the residual providing flexibility to the group. We anticipate the HK portion will come out of the growth orders.
Not replacing the Asian premium carrier. Management reiterated that the Asian premium
strategy is not dead, but may take more time to pad out given the lack of viable partners and the requirement for a capital light deployment. In our view, this may take some time given it will most likely require internally generated funds, and greater capacity and slot availability into the key markets of China and India.
Regulatory/competitive risks remain

The regulatory process should take ~12 months given the new carrier will need a new AOC
amongst other approvals. Importantly Management would have some experience in the process; however the strategic partner in China Eastern should provide the expertise here.
HKIA slots a potential short term constraint. Hong Kong International Airport (HKIA) last week
announced that it will be embarking on a third runway implementation strategy, likely to take until 2020. This will rapidly increase capacity, allowing for further growth at the port. In the near term, the majority of the slots are full or close to full, meaning that QAN will have to operate within the existing slot constraints. Management have said that there are 2 smaller step ups in slot capacity prior to the third runway opening which may provide some breathing room for Jetstar HK.
In our view, given the primary focus is the leisure market, there may be less time-sensitivity from
customers, meaning that Jetstar HK could utilise slots usually not taken by premium/business travellers through the airport. Further, HKIA has seen relatively benign growth for years, partly due to capacity constraints as well as its overall size. Jetstar HK provides a strong growth option, albeit small, to the airport, which may allow for negotiations around superior slots.
Management should have little issues negotiating slots at the destination airports given China
Eastern should have prior developed relationships.

High landing fees. Management have said that the new carrier will have a cost base close to
50% of that of its rivals, allowing it to price its fares at around 50% of current prices, with the upside being in the ancillary revenues generated on the side. However, HKIA has some of the most expensive landing fees in the region, given the current capacity demand. Given the higher input charges Jetstar HK will need to rely on ancillary revenues in order to generate an adequate return commensurate with its other regional operations. As in the table below, the landing fees, even when spread across 180 passengers, can still cause a material change to an LCC fare.
Fig 2
Airport
RelativelandingfeesforA320scomparedotherinternationalairports
Approx. landing fee (US$) 4,761 3,610 3,312 2,993 2,811 849
New York (JFK) Paris (CDG) Hong Kong (HKG) Seoul (ICN) Singapore (SIN) London (LHR) Source: Macquarie Research, March 2012
Making new friends, potentially losing others. Jetstar Hong Kong will be the first low-cost
carrier to hub out of Hong Kong, with QAN ostensibly making use of China Eastern's traffic rights. Cathay Pacific, the incumbent premium carrier in HK, has elected not to set up an LCC of its own to date. Clearly, using Hong Kong as a base to link into China will compete directly with Cathay's Dragon Air services and is unlikely to go down well with one of QAN's major alliance partners. That said, at present QAN codeshares on more routes with China Eastern over Shanghai that it does with Cathay over Hong Kong, providing further credence to the choice of partner.
26 March 2012
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Macquarie Research
Qantas
In our view, the announcement should elicit a strong competitive response from Cathay Pacific,
who should have a few levers to pull including price and capacity. Cathay Pacific has two major shareholders on the register, namely Swire Pacific Limited (44.97%), a conglomerate listed and based in HK (although 41.27% of Swire Pacific is owned by Swire Group, listed in the UK) and Air China Ltd (29.99%). Given the size of the holdings and subsequent control, we suspect that both SwireandChinaAirwouldopposetoJetstarsentrance,andshouldmovetoattempttoremain the incumbent. QAN have stated that their target market, being completely leisure, will not impede to a large extend on the premium incumbents; however their response remains to be seen.
Fig 5
QANTAS
QAN financial snapshot

30 Jun Dec-10 Jun-11 Dec-11 Jun-12 2010 2011 2012 2013 2014
Profit & Loss Sales Qantas Mainline Jetstar Other Revenue Total Revenue Growth EBITDAR Margin - Non-Cancellable Leases - Depreciation & Amortisation EBIT Continuing Non recurring EBIT Margin - Net Interest Expense Underlying PBT Actual Pre-tax Profit Tax Tax Rate (Continuing) Reported Profit Adjusted Profit EPS (adj abnormals, one offs) EPS Growth CFPS DPS EV/EBITDAR EV/EBITA (adj for leases) PE (adj) Price/BV Yield EFPOWA Cashflow Analysis EBITDA - Inc. in Working capital - Net Interest Paid - Tax refunded (paid) Net Cash in Op Activities + Asset Sales - Capex & Acquisitions Net cash in investing - Dividends Paid + Equity Movements + Debt Movements Net cash in financing Net Increase in Cash + Adjusting Figure (inc. net exch. diff.) Net Cash/Borrowing movement Balance Sheet Cash Fixed Assets Other Assets Total Assets Short Term Debt Long Term Debt Shareholders Funds RoFE (%) Return on Equity (%) Book value Assumptions Average currency Average Jet Fuel price Group load factor Group yield
$m $m $m $m $m % $m $m $m $m $m % $m $m % $m $m % x x x x % m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m
5,008 1,258 1,325 7,591 10.6% 1,253 16.5% 283 606 459 -95 364 4.8% 42 417 322 83 26% 239 308 13.6 69% 37.4 0.0
4,619 1,174 1,510 7,303 6.4% 998 13.7% 900 643 206 -134 72 1.0% 71 135 1 -9 -655% 10 103 4.5 49% 28.8 0.0
5,123 1,476 1,449 8,048 6.0% 1,176 14.6% 1,013 762 281 -144 137 1.7% 79 202 58 16 28% 42 143 6.3 -54% 35.5 0.0
4,953 1,443 1,363 7,759 6.2% 1,107 14.3% 984 723 297 -200 97 1.3% 107 191 -9 -7 80% -2 138 6.1 34% 31.8 0.0
8,915 2,011 2,846 13,772 -5.4% 1,977 14.4% 525 1,199 452 -199 253 1.8% 75 377 178 62 35% 116 251 11.09 54% 57.9 0.0 4.7 12.3 13.4 0.67 0.0 2,265 1,452 -201 -89 129 1,307 87 -1,688 -1,601 -4 -16 378 381 87 0 87 3,704 13,032 3,174 19,910 619 5,099 5,981 6.8% 5.0% 2.64
9,627 2,432 2,835 14,894 8.1% 2,251 15.1% 566 1,249 665 -229 436 2.9% 113 552 323 74 23% 249 410 18.1 63% 66.2 0.0 4.4 10.5 8.7 0.65 0.0 2,265 1,685 133 -149 2 1,692 140 -2,429 -2,389 -1 -65 575 508 -189 -20 -209 3,496 14,149 3,214 20,858 577 5,454 6,151 7.9% 7.5% 2.72 0.98 109 80.1% 11.3
10,076 2,919 3,004 15,999 7.4% 2,283 14.3% 564 1,485 578 -344 234 1.5% 186 393 49 9 18% 40 281 12.4 -32% 67.3 0.0 4.5 12.5 12.1 0.64 0.0 2,265 1,720 129 -200 7 1,661 120 -2,210 -2,134 0 -16 425 525 52 -1 51 3,342 14,819 3,178 21,339 654 5,796 6,250 6.7% 5.3% 2.76 1.05 127 79.9% 11.4
10,136 3,184 3,153 16,472 3.0% 2,990 18.2% 539 1,394 1,106 -50 1,056 6.4% 248 859 809 233 29% 576 610 27.0 117% 87.0 0.0 3.9 8.0 6.1 0.59 0.0 2,265 2,451 56 -323 -233 1,951 33 -2,209 -2,176 0 0 0 0 -225 0 -225 2,976 15,657 3,185 21,819 654 5,679 6,801 10.1% 9.7% 3.00 1.10 133 80.0% 11.9
10,444 3,509 3,397 17,350 5.3% 3,119 18.0% 545 1,448 1,127 0 1,127 6.5% 288 839 839 236 28% 603 602 26.6 -1% 90.5 3.0 3.7 7.6 6.1 0.55 1.7 2,265 2,575 300 -343 -236 2,295 47 -1,664 -1,617 0 0 0 0 678 0 678 2,976 15,883 3,211 22,071 654 5,141 7,263 10.4% 9.0% 3.21 1.09 140 80.0% 11.9
2,265 970 -158 -68 -7 743 56 -1,033 -1,077 0 -64 41 -20 -354 -14 -368
2,265 715 291 -81 9 949 84 -1,396 -1,312 -1 -1 534 528 165 -6 159
2,265 899 -32 -48 0 823 42 -1,499 -1,501 0 -16 425 525 -153 -1 -154
2,265 821 161 -152 7 838 78 -711 -633 0 0 0 0 205 0 205
US$/A$ US$/bbl % A/RPK
0.86 83 80.8% 10.9
26 March 2012
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GLOBAL
Shanghai Futures Exchange Cash price Copper Aluminium Zinc Lead Stocks Copper Aluminium Zinc Lead Open interest RMB/t 59,600 16,005 15,450 15,580 ton 223,632 366,218 383,651 33,013 Contracts 51,714 33,984 16,376 504 RMB/t Week on week % change -0.85 -0.25 -1.90 -1.49 %change -1.60 0.62 -0.96 -7.19 change -10074 -3674 -3964 -392 % change -2.41 -1.87 % change 0.34 -0.28 0.20 -0.48 % change 0.3 0.5
China Commodities Call

Itsnotthatbadoutthere
InthisweeksChina Commodities Call we have a series of reports that all
point to the view that conditions in China are not as bad as some of the more bearish market watchers are suggesting. Our proprietary steel sector survey has revealed a positive shift in end-user demand, trade and apparent consumption data for January and February, suggesting that China has had a positive impact on global commodity prices over the last few months, and analysis of Chinese steel data suggests the lower-end estimates for production run rates have been wrong.
Steel survey analysis Real demand is coming back

The March results have shown a significant improvement in end-user
Copper Aluminium Zinc Lead Other prices (from SMM) Cash price
Nickel 133,700 Tin 170,250 Steel prices (From Mysteel) Cash price RMB/t HR coil (3mm) CR coil (1mm) Galvanised (1mm) Rebar (20mm) Iron ore import (from TSI) CFR N. China port 62%Fe 58%Fe Exchange rate US$/Rmb 4,395 5,255 5,030 4,180 $/t 145.2 135.4
ordering, suggesting that the seasonal recovery that had been lacking in the February data has finally come through. There are also signs of improving confidence at the mills with production plans and raw material purchasing plans both more positive. Inventory of both steel and raw materials is not low but it is not dangerously high either.
Chinadatafailstorevealaslowdownindemandfor metals and steel

Latest data for the first two months of 2012 show relatively strong demand
across most commodities from China, belying the fears of a significant slowdown in consumption. Part of the reason appears to be that Chinese buyers have decided to restock metals at low prices, which may mean that the slowdown in apparent demand is ahead of us, even though there appear to be increasing signs of a nearbytroughinreal consumption. Chinese strong net trade balance with the rest of the world has been a significant support for global metal prices over the past 35 months.
6.31
Chinese steel data NBS vsCISA:theyvebothbeen wrong

WhenChinasNationalBureauofStatisticsreleased steel production data for
Source:LME, Comex, Nymex, SHFE, Metal Bulletin, Reuters, LBMA, Macquarie Research, March 2012
Analyst(s)
Macquarie Capital Securities Limited Graeme Train +86 21 2412 9035 graeme.train@macquarie.com Angela Bi +86 21 2412 9086 angela.bi@macquarie.com Bonnie Liu +86 21 2412 9008 bonnie.liu@macquarie.com Andrew Dale +852 3922 3587 andrew.dale@macquarie.com Macquarie Capital (Europe) Limited Jim Lennon +44 20 3037 4271 jim.lennon@macquarie.com
JanFebthisyearof685mtpa,itseemedtocontrastsharplywithCISAshighfrequency data over the same period of ~620mtpa. The debate raged over which number to believe, with bulls and bears each finding validation for their views. Now CISA has released a high-frequency update for early-March that suggests production of 693mtpa, seemingly in line with NBS data for January and February.
In this report we reiterate our view that the NBS production number was
wrong for 4Q11 (first published in Commodities Comment Under-reporting of Chinese steel: a reoccurring Q4 phenomenon, 17 February 2012) and is more likely to be right for 1Q12, while the CISA data was too low for January and February 2012. We also show that the CISA data was wrong in JanFeb because the NBS number was wrong in 4Q11 and that as we move further into the year we should be in for a period of more reliable production data.
26 March 2012 Please refer to the important disclosures and analyst certification on inside back cover of this document, or on our website www.macquarie.com.au/disclosures.
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Macquarie Research
Steel survey analysis Real demand is coming back

The March results have shown a significant improvement in end-user ordering suggesting that the
seasonal recovery that had been lacking in the February data has finally come through. There are also signs of improving confidence at the mills with production plans and raw material purchasing plans both more positive. Inventory of both steel and raw materials is not low, but it is not dangerously high either. We are encouraged by the results, and while they may not indicate much beyond the usual seasonal recovery at the moment, we believe the stage is set for a cyclical recovery to follow.
Fig 1 End-user orders particularly construction and infrastructure have turned positive
Net change in orders at mills - end use sectors
30 20 10 0 -10 -20 -30 -40 Jul-11
Construction Machinery White goods
Infrastructure Autos Shipbuilding
Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12
Source: Macquarie Steel Sector Survey, March 2012
Production plans: On average, the mills appear to have pulled production back moving into
March, perhaps a reflection of disappointing end-use orders over February. The smaller mills, however, did increase the pace of output. More interesting, for the first time since September mills are indicating that they plan to raise production over the next month.
Fig 2
Production increased in February

What is your current capacity utilisation rate? - % basis
Fig 3 Production expectations, however, are neutral

How do you expect production to change over the next m onth? 100 90 80 70 60 50 40 30
To tal Large M ills (>1 0mtpa) M edium M ills (5-1 0mtpa) Small M ills (<5mtpa) Increasing expectatio ns o f rising pro ductio n
100% 98% 96% 94% 92% 90% 88% 86% Jul-11

Total Large Mills (>10mtpa) Medium Mills (5-10mtpa) Small Mills (<5mtpa)
20 10 0
Increasing expectatio ns o f falling pro ductio n
Aug-11 Sep-11 Oct-11
Nov-11 Dec-11 Jan-12 Feb-12 Mar-12
Jul-11
Aug-11
Sep-11
Oct-11
Nov-11
Dec-11
Jan-12
Feb-12
Mar-12
Orders at mills and traders: Traders have seen a very strong turnaround in orders with almost
every trader surveyed indicating orders were higher in March than in February. The recovery at mills has been more muted, with responses moving to the neutral position, although this is still the strongest result since September.
26 March 2012
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Macquarie Research
Fig 4
Traders have seen a sharp turnaround in orders

Have sales volum es increased or decreased?
Fig 5 Mills have seen orders stabilise

Have dom estic orders increased or decreased over the last m onth?
100 90 80 70 60 50 40 30 20 10 0 Jul-11 Aug-11 Sep-11 Oct-11

To tal Large Traders (>1 mtpa) M edium Traders (0.5-1 mtpa) Small Traders (<0.5mtpa)
Increasing no . o f traders seeing sales rise
100 90 80 70 60 50 40 30 20 10
Increasing no . o f mills seeing o rders rise
Increasing no . o f traders seeing sales fall
0
Mar-12
Increasing no . o f mills seeing o rders fall
Nov-11 Dec-11
Jan-12
Feb-12
Jul-11
Aug-11 Sep-11
Oct-11
With orders increasing, traders have been able to reduce the volume of inventory they are holding.
More traders are reporting low inventory levels in March than in February, and the Mysteel data on the level of trader inventory has shown volumes falling, and the pace of the decline is picking up.
Fig 6
More traders reporting low inventory in March

Is inventory higher or lower than normal?
Fig 7 Mysteel data shows inventory volumes falling

Reported trader inventory
9.00
Reported trader inventory (m t)
100 90 80 70 60 50 40 30 20 10 0 Jul-11 Aug-11 Sep-11 Oct-11

To tal Large Traders (>1 mtpa) M edium Traders (0.5-1 mtpa) Small Traders (<0.5mtpa)
Increasing no . o f traders with lo w invento ry
8.50 8.00 7.50 7.00 6.50 6.00 5.50 5.00 4.50 4.00
Nov-10 May-10 May-11 Nov-11 Jul-10 Jan-10 Jan-11 Jul-11 Mar-10 Mar-11 Jan-12 Sep-10
Increasing no . o f traders with high invento ry
Nov-11
Dec-11
Jan-12
Feb-12
Mar-12
Rebar
HRC
The figure below shows our estimate of total deliverable steel inventory (inventory held at traders,
mills and on SHFE) on a weeks-of-consumption basis. While it is unusual to have seen such a strong build in January, the excess volume of inventory in the system is not unusually high for the time of year.
Fig 8 Steel inventory levels are in line with seasonal norms

13 12
Weeks of inventory
Deliverable steel inventory (weeks of use)
80% 70% 60% 50%
11 10 9 8 7
Jul-10 Jun-10 Nov-10 Jun-11 Jul-11 May-10 May-11 Nov-11 Jan-10 Jan-11 Aug-10 Aug-11 Mar-10 Mar-11 Dec-10 Dec-11 Feb-10 Feb-11 Jan-12 Oct-10 Apr-10 Apr-11 Oct-11 Sep-10 Sep-11 Feb-12
40%
YoY
30% 20% 10% 0% -10% -20% -30%
Deliverable inventory/AC
YoY
Source: Mysteel, Macquarie Research, March 2012
26 March 2012
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Sep-11
Mar-12
Macquarie Research
Raw materials: Iron ore inventory has flatlined on a days-of-use basis for the past month, at
around 31 days. At this level, mills do not need to come to market and buy aggressively, but equally, it is not enough of a buffer to stop mills having to buy more as they increase steel output. Indeed, in line with rising production plans, mills are indicating that they plan to increase purchasing activity in the coming month. This should allow for continued upward drift in the iron ore price, even if the trajectory is not aggressive.
Fig 9
45
Iron ore inventory at 50 smaller mills- days of use
Mill iron ore inventory has stabilised

Iron ore inventory (days of use) and spot prices
200 190 180 170 160 150 140 130
Spot iron ore prices - 62% Fe, CFR China, $/t
Fig 10 Mills are signalling that they plan to increase ore purchasing
100 90 80 70 60 50 40 30 20 10 0
To tal Large M ills (>1 0mtpa) M edium M ills (5-1 0mtpa) Small M ills (<5mtpa) Increasing no . o f mills planning to reduce purchases
Do you plan to increase or decrease iron ore purchases?

Increasing no . o f mills planning to raise purchases
40
35
30
25
Iron ore inventory - days of use Spot iron ore prices
120 110 100
20
Jul-11
May-11
Jan-11
Jul-11
Mar-11
Jan-12
Sep-10
Nov-10
Sep-11
Source: Mysteel, TSI, Macquarie Research, March 2012
Nov-11
Mar-12
Mills are indicating that they have started to destock coking coal, having built up reasonably high
levels over 4Q11. Purchasing plans for coking coal are neutral, with the larger mills that have historically been more active on the import market suggesting they still plan to reduce buying. The outlook is therefore likely to be pretty stagnant for coking coal prices, at least until destocking is complete.
Fig 11 Coking coal inventory has started to fall

100 90 80 70 60 50 40 30 20 10 0 Jul-11
To tal Large M ills (>1 0mtpa) M edium M ills (5-1 0mtpa) Small M ills (<5mtpa) Increasing no . o f mills with rising invento ry
Fig 12
100 90 80 70 60 50 40 30 20 10 0
Purchasing plans for coking coal are stable

Do you plan to increase or decrease coking coal purchases?
Increasing no . o f mills planning to increase purchases
Is coking coal inventory rising or falling?

Increasing no . o f mills with falling invento ry
To tal Large M ills (>1 0mtpa) M edium M ills (5-1 0mtpa) Small M ills (<5mtpa) Increasing no . o f mills planning to decrease purchases
Jul-11
Aug-11 Sep-11
Oct-11
Nov-11 Dec-11
Jan-12
Feb-12
Mar-12
Source: Mysteel, TSI, Macquarie Research, March 2012
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Macquarie Research
Chinadatafailstorevealaslowdownindemandformetalsandsteel
While there is undoubtedly a slowdown taking place in Chinese economic growth as a result of
domestic policy tightening and weaker export growth, the impact on commodities demand has been negligible, according to a detailed analysis of the latest data on production and trade released this week. Due to the January Chinese New Year holiday, some of the data for January was only released this week, so we only now have a complete picture.
What the data fails to show is a sharp slowdown in Chinese demand for metals. Indeed, base
metals demand actually reaccelerated towards the end of last year and has remained strong in the first two months of this year. There has been a more pronounced slowdown ex-China and, if anything, China has been a significant support for commodity prices. A lot of this has to do with stocking/destocking in China for much of 2011 China was a net de-stocker, but by the end of the year had become a major and growing buyer again (starting at a time of relatively weak prices).
Fig 13 YoY changes in base metals demand in China and the rest of the world to February 2012 (3MMA)
60% 50%
% change yoy - 3MMA
Fig 14 YoY changes in steel demand in China and the rest of the world to February 2012 (3MMA)
60% 50%
40% 30% 20% 10% 0% -10% -20% -30%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
% change yoy - 3MMA
40% 30% 20% 10% 0% -10% -20% -30% -40%
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
China
World Ex-China
China
World Ex-China
Source: CNIA, Chinese Customs, Macquarie Research, March 2012
Source: NBS, WSA, Chinese Customs, Macquarie Research, March 2012
Fig 15 Year-on-year changes in apparent demand in Jan-Feb 2012

% change YoY 30% 25% 20% 15% 10% 5% 0% -5% Aluminium -2.5% Copper -3.4% Nickel -2.0% Steel 7.6% 3.8% 7.7% 2.4%
`
27.0%
10.4% 3.5%
2.4%
1.2%
Zinc China Ex-China
Lead
Source: CNIA, INSG, ILZSG, ICSG, IAI, Macquarie Research estimates, March 2012
26 March 2012
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2012
Macquarie Research
Historically, we have seen China emerge as a re-stocker of base metals at a time of weak prices
and ahead of a recovery in real demand (2009 was the most obvious, but the surge in Chinese apparent demand is clear from Figure 13) many times in the past. For steel, the slowdown is more apparent but fears of a sharp collapse (down 15% or so as had been implied by misleading and wrong CISA data) have proved to be unfounded (see Figure 14).
Fig 16 Chinese apparent demand bymajorcommodity(000t)

2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 Apparent demand Aluminium Copper Nickel Zinc Lead Tin Aluminium semis Copper semis Steel (mt, crude steel eqv.) Stainless steel (crude eqv.) Coke (mt) All Coal (mt) % change YoY Aluminium Copper (before SRB) Nickel Zinc Lead Tin Aluminium semis Copper semis Steel (mt, crude steel eqv.) Stainless steel (crude eqv.) Coke (mt) All Coal (mt) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2011 2010 YTD % chang e YTD Y-o-Y 7.6 22.2 10.4 7.7 2.4 13.7 18.9 16.9 3.8 27.3 4.6 6.8
1379 1168 1499 1421 1919 1710 1662 1643 1668 1493 1408 1543 507 441 644 711 685 784 726 700 886 670 830 582 63 48 55 50 63 50 63 60 66 63 59 64 402 383 450 412 430 466 438 416 497 525 483 524 349 214 378 390 332 403 347 385 407 404 410 435 12.1 11.6 13.0 14.4 14.0 14.3 12.8 15.7 19.0 19.9 17.0 12.2 1503 1675 1565 1780 1243 2068 1882 1846 1934 2055 1943 1872 622 762 1018 1103 1100 1128 998 1140 1108 1028 1048 1149 58 56 63 63 64 62 63 62 60 57 53 55 990 33 295 953 1238 1084 1061 33 252 35 306 20.8 -0.3 4.6 6.4 27.0 -0.9 11.6 19.1 11.9 18.4 9.6 4.7 35 310 6.8 8.2 12.9 -7.3 30.2 -6.4 37 333 34.3 -7.3 73.5 -2.9 6.4 -3.0 959 38 323 14.9 20.5 18.5 -1.4 18.5 -4.3 27.7 15.5 7.4 3.1 13.8 9.9 943 1022 1013 1116 1049 1163 37 337 38 340 37 324 15.7 28.3 43.6 7.8 0.5 29.8 18.9 26.0 18.3 0.3 16.1 12.0 36 338 8.6 28.1 34.0 17.0 2.2 62.2 35.1 16.9 11.3 24.6 11.8 8.3 33 367 35 327
2740 2547 1159 948 122 111 845 785 577 563 27.0 23.7 3777 3178 1618 1384 118 114 2475 1944 69 585 66 547
3.6 3.6 2.7 35.3 35.1 10.7 7.0 12.3 12.5 -14.5 4.2 -2.9 23.0 180.6 -11.9 34.3 8.8 9.1 -4.1 9.8 8.3 -0.5 22.9 12.4
9.3 10.1 9.9 8.4 26.8 29.8 -3.8 -13.5 -4.7 0.9 1.6 12.1 24.2 11.2 14.8 2.9 18.0 10.9 17.5 26.8 16.4 9.5 20.6 8.8
11.5 13.5 38.7 -6.1 32.5 16.8 2.0 7.4 -3.5 4.6 15.7 -18.7 8.8 6.2 2.8 27.8 2.4 4.9 1.6 13.1 3.6 4.1 2.0 5.3
15.6 -21.7 21.2 17.8 7.7 7.0 6.9 8.0 10.2 7.7 9.3 13.4
As Figure 16 shows, despite reports of sharp demand showdown in infrastructure spending,
construction activity and year-on-year falls in appliance manufacture, apparent demand growth remained positive for all the commodities we look at. Even the apparent demand for aluminium and copper semis was growing strongly, according to the data, despite reports recently of a sharp falls in utilisation of capacity at semis manufacturers. Why the discrepancy? Two factors spring to mind: 1) when reports of low capacity utilisation are made, no account is often made for the fact that capacity has often risen dramatically over the past year; 2) China is a big country, and while demand in the main urban areas is particularly weak, that is not the whole of China.
This would not be the first time over the past ten years when external observers have been
panickedbyanecdote.WhileChinesedataisbynomeansperfect,theconsistencyofabetter performance across a whole range of commodities is compelling. Yes, there is a slowdown, but it is by no means as dramatic as some had (and still do) fear.
The other factor to bear in mind for the global commodity markets is that China is also exporting
less metal-containing semi-finished commodities and, hence, when the net trade of primary metal products plus semis is calculated, China is having a bullish impact on global markets.
We would highlight big falls in stainless steel (containing nickel and ferrochrome) and aluminium
semis exports in Figures 17 and 18:
26 March 2012
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Macquarie Research
Fig 17 China'snettradeinbasemetals(000t)
2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 2012 2012 Net imports base metals Aluminium (refined & alloy) Aluminium (semis) Total above (Al content) Copper (refined) Copper (semis) Nickel (finished, ni content) Zinc (refined) Lead (refined) Tin (refined) Alumina Bauxite Aluminium scrap Copper concentrate Copper scrap Zinc concentrate Lead concentrate Nickel Concentrate % change YoY Aluminium (refined & alloy) Aluminium (semis) Total above (Al content) Copper (refined) Copper (semis) Nickel (finished, ni content) Zinc (refined) Lead (refined) Tin (refined) Alumina Bauxite Aluminium scrap Copper concentrate Copper scrap Zinc concentrate Lead concentrate Nickel Concentrate Jan 34 -169 -135 223 26 22 Feb 18 -114 -96 138 23 16 Mar 18 -202 -183 155 27 21 Apr 6 -201 -195 116 25 20 May 3 -287 -284 129 19 19 Jun 0 -251 -251 174 21 16 Jul -11 -252 -262 190 18 26 Aug 10 -225 -215 235 29 22 Sep 10 -186 -176 274 29 23 Oct 9 -185 -176 296 19 28 Nov 0 -180 -180 342 24 25 Dec 46 -168 -122 407 22 28 Jan 33 -164 -131 335 8 24 Feb 68 -152 -84 375 24 20 2011 2010 YTD 101 -316 -215 709 33 43 % chnge YTD Y-o-Y 51 -282 -231 97.0 12.0 -6.9
361 96.3 49 -34.0 38 13.7
30 16 32 11 22 20 14 23 28 25 25 54 47 39 -2 -1 0 1 0 0 0 0 1 0 1 0 0 1 0.7 0.3 0.6 0.3 0.7 1.1 0.7 1.4 3.6 4.0 4.2 3.2 1.6 3.7 343 225 133 131 113 72 59 35 80 261 227 201 447 276 2971 2169 3577 4138 4502 3491 3743 3852 4478 3086 4594 4580 3121 4666 221 150 256 257 337 301 305 274 232 228 226 212 202 195 571 387 451 466 466 595 453 672 563 517 673 563 602 628 365 246 387 378 399 422 432 382 418 377 433 447 229 403 296 206 225 225 236 184 245 338 246 194 261 279 186 195 163 89 101 135 84 89 90 141 160 118 136 138 89 167 21 16 26 30 20 19 35 13 27 20 30 20 19 23 8.5 42.9 55.0 27.1 -27.7 -131.9 43.2 46.7 45.6 62.1 33.3 -104.3 -14.8 77.3 69.8 - 627.7 1059. -86.5 9489. 7 1476. 7 1 76.2 43.2 52.8 35.6 17.4 19.5 68.9 36.7 46.6 29.7 19.1 -15.2 -2.5 285.2 -2.9 34.1 -3.0 -12.4
86 46 86.2 1 -2 -125.4 5.3 1.0 421.0 723 567 27.3 7787 5140 51.5 397 371 6.9 1230 958 28.3 632 611 3.5 382 502 -24.0 256 252 1.7 42 37 15.7
72.6 105.8 43.1 107.2
14.3 -36.9 -53.9 -61.8 -52.7 -18.2 -14.7 -12.1 14.4 75.1 48.7 85.8 50.1 170.7 -2.1 -21.8 -32.9 -30.4 -48.6 -39.9 -38.2 -22.7 -23.2 -41.6 -28.5 -27.1 -67.9 4.3 25.5 4.0 11.9 17.5 151.2 -16.8 23.9 4.5 38.2 42.8 70.2 36.4 6.7 23.7 57.7 98.5 154.3 -58.1 -15.1 2.4 -52.8 -34.0 -1.2 15.8 11.2 -48.1 -100.7 -179.1 -90.6 -68.9 -82.9 -89.5 -57.5 -83.2 -39.5 -83.0 -57.5 -84.6 -45.2 -2.3 -50.1 -5.3 167.2 1221. 2 -49.2 -45.3 -73.7 -15.0 -75.4 -49.5 -78.2 -85.8 -74.1 -41.9 65.8 11.9 39.0 73.4 83.6 21.4 24.2 53.2 42.5 73.2 34.8 30.7 32.5 52.8 73.4 55.0 55.8 31.8 37.4 25.3 -4.5 -31.7 -16.6 -23.4 -2.8 9.1 -3.7 41.6 -17.7 9.5 8.1 -11.2 6.1 1.8 22.0 19.3 14.2 -4.0 2.4 19.9 -12.8 -36.8 17.3 6.5 5.5 -13.5 25.5 12.0 -40.7 -32.2 50.8 -12.7 -0.7 49.3 2.2 -26.0 -25.7 -20.1 -27.0 -36.0 0.0 0.0 48.4 -11.8 147.8 108.9 48.4 -41.3 8.5 33.0 26.7 68.3 56.3 142.7 35.4 -124.6 -101.4 -185.9 375.7 408.0 125.9 1103. 9 -16.9 -50.8 30.3 22.8 75.6 46.5 5.1 115.1 12.2 9.7 -8.8 30.1 21.7 16.1 5.4 62.2 8.7 2.8 -37.2 63.9 -7.6 9.2 -37.2 -5.1 -20.5 6.3 -45.6 88.6 198.7 4.3 -8.0 47.6
Source: Chinese Customs, Macquarie Research, March 2012
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Fig 18 Chinese net trade in steel and bulk commodities

Net imports steel/bulks All steel (mt, crude eqv.) Stainless steel (crude eqv.) Iron ore (mt, 62% Basis) Steel scrap (mt) Coke (mt) Thermal coal (mt) Anthracite coal (mt) Thermal & anthracite (mt) Coking coal (mt) All coal (mt) % change YoY All steel (mt, crude eqv.) Stainless steel (crude eqv.) Iron ore (mt, 62% Basis) Steel scrap (mt) Coke (mt) Thermal coal (mt) Anthracite coal (mt) Thermal & anthracite (mt) Coking coal (mt) All coal 2011 Jan 1471 -93.1 69.0 0.46 -0.2 7.9 1.8 9.6 5.5 15.1 2011 Feb 2011 Mar 2011 Apr 2011 May 2011 Jun 2011 Jul 2011 Aug 2011 Sep 2011 Oct 2011 Nov 2011 Dec 2741 -86.6 64.1 0.80 -0.1 12.8 2.7 15.5 5.0 20.6 87 46 10 39 -70 62 10 49 -8 29 2011 YTD 5474 -159 124 0.80 -0.1 18.5 4.3 22.8 8.3 31.2 2010 YTD 2977 -173 118 0.71 -0.4 10.8 2.3 13.1 7.0 20.1
1506 3584 3587 3762 2518 3467 3038 3080 -80.3 -143.8 -118.0 -175.4 -159.0 -179.3 -167.9 -148.2 48.8 0.25 -0.2 2.9 0.6 3.5 1.5 5.0 59.5 0.61 -0.8 2.7 1.7 4.4 2.1 6.5 52.9 0.31 -0.5 3.8 3.3 7.1 2.6 9.7 53.3 0.63 -0.4 7.2 3.4 10.5 2.1 12.7 -4 172 3 74 -4 77 131 91 -47 33 51.1 0.52 -0.3 6.4 3.3 9.6 3.4 13.0 -45 99 8 61 -41 15 81 31 -3 20 54.5 0.78 -0.2 9.4 3.1 12.5 4.1 16.6 4 425 7 55 -71 33 106 46 31 42 59.1 0.52 -0.2 9.7 2.6 12.3 3.0 15.3 107 174 32 -3 18 59 64 60 -22 33 60.6 0.70 -0.1 11.2 2.8 14.0 3.9 17.9 67 98 15 43 -43 49 77 53 -10 33
2794 3123 -90.3 -113.1 49.9 0.56 -0.1 7.9 2.5 10.3 4.2 14.6 56 19 9 117 -64 42 88 51 -1 31 64.2 0.63 -0.1 13.4 2.7 16.1 5.1 21.2 102 4 12 46 -83 97 96 97 15 68
-10 6 1611 -5886 48 -25 633 -22 41 -15 7 -8 -1 -46 399 -61 -44 -59 -51 -56
102 20 -629 31936 1 -17 1645 -63 -14 -53 -43 -50 -4 -44 103 -33 60 -8 -35 -18
Fig 19 Collapse in Chinese net exports of aluminium and aluminium semis augurs well for global market adjustment
mt annualised metal/alloy/semis
4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5
Nov-10
Nov-11
Jan-10
Jan-11
May-10
May-11
Mar-10
Mar-11
Sep-10
The final feature of the JanuaryFebruary data we would wish to highlight is the still-strong growth
in reported production for most metals, especially mined zinc and lead. The reliability of some of this data is questionable but for the most part highlights trends accurately.
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Sep-11
Jan-12
Jul-10
Jul-11
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Fig 20 Reported and Estimatedproductionofselectedcommodities(000t)

Production Aluminium Copper Nickel Zinc Lead Tin Alumina Copper concentrate Zinc concentrate Lead Concentrate Aluminium semis Copper semis Crude steel (mt) Stainless steel (crude eqv.) Iron ore (mt, 62% Basis) Coke (mt) Coal (mt) % ch. YoY Aluminium Copper Nickel Zinc Lead Tin Alumina Copper concentrate Zinc concentrate Lead Concentrate Aluminium semis Copper semis Crude steel (mt) Stainless steel (crude eqv.) Iron ore (mt) Coke (mt) Coal (mt) 2011 Jan 1315 382 40.3 387 351 11.4 2725 77 214 110 1672 596 57 1083 23 33 280 2011 Feb 1351 431 32.4 375 215 11.3 2553 94 216 142 1788 739 54 1033 25 33 247 2011 Mar 1445 443 33.3 446 378 12.4 2960 102 302 171 1767 991 59 1382 25 35 300 3.7 20.9 0.4 3.4 26.0 6.2 17.6 21.4 18.6 24.7 14.6 21.7 9.0 35.7 11.1 9.6 7.2 2011 Apr 1289 431 29.6 427 389 14.1 2985 106 323 169 1982 1077 59 1202 29 35 300 -7.4 11.3 9.9 -1.2 29.7 6.7 18.4 16.1 14.5 13.8 2011 2011 May Jun 1787 440 43.8 418 332 13.2 3009 104 360 209 1530 1081 60 1236 30 37 320 26.0 14.5 53.1 -7.6 7.0 1.3 24.2 7.7 15.0 41.1 1560 459 34.2 447 403 13.2 3100 115 395 226 2319 1107 60 1118 32 38 310 9.5 13.5 48.6 5.8 18.7 -4.4 29.4 15.5 9.8 15.4 31.7 17.5 11.9 10.7 36.1 13.8 9.5 2011 Jul 1585 452 36.9 423 347 12.1 2959 108 353 195 2133 979 59 1122 33 37 320 11.9 16.4 29.0 5.1 -4.4 8.3 23.5 15.4 12.0 18.9 28.7 12.9 15.5 18.1 29.1 18.0 9.6 2011 Aug 1641 499 37.8 410 385 14.3 2977 109 373 199 2071 1112 59 1189 29 38 325 18.2 30.1 51.5 -5.6 1.5 14.2 24.0 8.7 20.9 15.1 19.8 28.9 13.8 19.7 9.2 20.6 7.8 2011 Sep 1623 458 43.6 453 407 15.4 2774 111 389 223 2119 1080 57 1161 25 37 306 23.9 18.0 46.6 -0.6 0.7 15.9 16.3 14.0 23.3 32.2 21.3 28.2 16.5 7.1 2011 Oct 1533 449 34.4 474 404 15.9 2669 107 421 233 2241 1010 55 1206 23 36 323 18.7 20.7 27.5 2.4 1.8 33.0 18.4 3.4 47.8 38.7 35.2 19.1 9.7 24.2 2011 Nov 1466 429 33.7 451 409 12.8 2638 108 435 231 2123 1023 50 1162 21 33 346 2011 Dec 1501 453 36.7 465 434 9.1 2621 123 449 253 2040 1127 52 1250 21 35 306 2012 Jan 1486 434 40.0 372 267 9.8 3008 95 276 187 1911 671 57 1317 22 35 254 2012 Feb 1548 438 39.0 403 309 11.8 2833 104 300 197 2182 914 56 1317 23 34 299 14.6 1.5 20.4 7.4 44.0 4.7 11.0 9.8 39.0 39.0 22.0 23.7 3.3 27.4 2011 YTD 3035 872 79 775 576 21.7 5841 199 577 384 4094 1585 113 2633 44 69 553 2010 % ch. YTD YoY 2666 813 73 763 566 22.7 5278 172 430 251 3460 1335 111 2117 48 66 527 13.8 7.3 8.7 1.6 1.8 -4.7 10.7 15.8 34.0 52.6 18.3 18.7 1.6 24.4 -7.9 4.6 5.0
-6.5 3.1 9.1 57.0 41.0 14.3 -4.9 12.5 12.5 -14.7 9.1 11.5 8.8 6.7 1.6 10.9 -4.8 -29.0 8.7 115.0 24.8 164.5 -12.3 37.4 9.4 9.2 4.4 8.0 9.2 9.8 9.3 21.0 22.9 16.1
22.5 20.4 13.0 6.0 5.3 13.8 13.7 5.4 -0.8 -1.9 -0.9 -4.0 -3.5 4.0 -24.0 -7.3 -37.1 -14.0 14.5 6.5 10.4 -8.0 10.4 23.0 23.8 24.3 9.5 7.5 -0.2 25.0 16.7 29.7 2.8 14.3 1.2 6.2 28.9 70.2 14.3 12.6 0.0 21.5
19.6 -11.4 23.4 20.5 7.1 7.8 18.5 17.8 33.8 8.0 11.4 35.0 9.3 12.7
-1.0 -17.5 -17.4 -21.8 16.1 11.8 2.4 2.0 11.0 7.5 2.5 4.0
-5.1 -10.4 4.1 5.0 -9.2 21.0
Source: CNIA, NBS, Macquarie Research estimates (for nickel, iron ore and stainless steel), March 2012
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Fig 21
Selected Chinese end-use indicators a mixed picture

Jan-Feb 2012 Jan-Feb 2011 100,939 70,042 3,949,008 2,976,048 972,690 543,146 2,315 593 2,908 19,652 11,840 9,159 2,321 43,708 % change YoY 45% -14% 35% 33% 44% 28% 11% -14% -5% -5% 12% -6% -19% -3%
Construction Activity Indicators ('000 sq m) Floor space completed Floor space sold Floor space under construction of which: Residential Non-Residential Real estate investment (RMB Mn) Output of Autos ('000 units) Passenger Vehicles Commercial Vehicles Total White goods ('000 units) Air Conditioners Refrigerators Washing machines Freezers Selected Appliances Source: NBS, Macquarie Research, March 2012
69,515 81,429 2,914,730 2,240,488 674,241 425,037 2,094 691 3,058 20,731 10,526 9,721 2,863 45,045
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Chinese steel data NBS vsCISA:theyvebothbeenwrong

WhenChinasNationalBureauofStatisticsreleasedsteelproductiondataforJanFeb this year of
685mtpa,itseemedtocontrastsharplywithCISAshigh-frequency data over the same period of ~620mtpa. The debate raged over which number to believe, with bulls and bears each finding validation for their views. Now CISA has released a high-frequency update for early-March, which suggests production of 693mtpa, seemingly in line with NBS data for January and February.
In this report we reiterate our view that the NBS production number was wrong for 4Q11 (first
published in Commodities Comment Under-reporting of Chinese steel: a reoccurring Q4 phenomenon, 17 February 2012) and is more likely to be right for 1Q12, while the CISA data was too low for January and February 2012. We also show that the CISA data was wrong in JanFeb because the NBS number was wrong in 4Q11 and that as we move further into the year we should be in for a period of more reliable production data.
Fig 22 The focus has been on NBS vs CISA steel data

750
Annulised crude steel output, mtpa
Fig 23 butwethinkNBSwaswrongin4Q11and CISA is wrong in 1Q12

China total crude steel production 750
Crude steel production, mtpa
Macq estimte crude output Reported crude output - NBS
CISA vs NBS steel production data
700 650 600 550 500
700 650 600 550 500

1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12E
CISA estimate NBS reported
Jun-10
Aug-10
Jun-11
Aug-11
Dec-10
Dec-11
Feb-11
Feb-12
Apr-11
Oct-10
Oct-11
The NBS publishes a crude steel production number that should in theory cover almost every steel
producer in the country. The data is reported directly by the companies to the local NBS bureau, which then sends the data up the chain to a provincial bureau and on to Beijing.
CISA, meanwhile, collects production statistics on a ten-day basis and a monthly basis from its
member mills. Typically, these mills account for 8083%ofChinastotaloutput.ThemonthlyCISA data is published on a mill-by-mill basis, while the ten-day data is published in aggregate form, along with an estimate from CISA of what total China production was over the period.
In our view, the monthly CISA data on production at its member mills is the most reliable of all the
production data sets the fact that the data is published on a mill-by-mill basis means that there should be a good level of accountability in the data, and it is also easier to spot errors in the data.
The NBS production meanwhile has been prone to under-reporting in recent years, particularly in
4Q. In the Commodities Comment of 17 February we ran through in some detail where these under-reporting errors arose in summary, non-CISA mills, particularly in Hebei, appear to disappear completely from the NBS production data at the end of the year (see Figures 24 and 25).
This is a problem that seems to disappear in the first quarter of the year, hence the apparent
sharp ramp-up in output in the reported data for January and February.
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Fig 24 Output of non-CISA mills in Hebei disappears completely at the end of the year (apparently)
200
Fig 25 In fact, Hebei-based CISA mills appear to produce more than 100%ofHebeistotaloutput
Hebei based CISA mill crude steel output as % of reported Hebei output 120% 110% 100% 90% 80%
180 160 140 120 100
70%
80 60
Reported Hebei province output Reported output of Hebei based CISA mills
60%
Nov-09
Nov-10
May-09
May-10
May-11
Sep-09
Sep-10
Sep-11
Nov-11
Jul-09
Jul-10
Jan-09
Jan-10
Mar-09
Mar-10
Jan-11
Mar-11
Jul-11
50%
Nov-09
Nov-10
May-09
May-10
May-11
Sep-09
Sep-10
Source: CISA, NBS, Macquarie Research, March 2012
Source: NBS, CISA, Macquarie Research, March 2012
The figure below shows our estimates of production and consumption of steel after adjusting for
under-reporting. We also include the JanuaryFebruary NBS data, which we believe to be reasonably accurate, as it is only a modest sequential increase from our 4Q11 estimated run rates (see Commodities Comment, 12 March 2012, for more details on why we prefer a higher number).
Fig 26 Official production data vs our estimates and the impact on apparent consumption
In million tonnes NBS data Reported crude steel output Reported crude steel output - annualised YoY Net semis imports Net finished imports Apparent consumption (crude basis) Apparent consumption (crude basis) - annualised YoY Inventory Change Real consumption (end user purchasing) Real consumption (end user purchasing) - annualised YoY Macquarie estimates Crude steel output Crude steel output- annualised YoY Net semis imports Net finished imports Apparent consumption (crude basis) Apparent consumption (crude basis) - annualised YoY Estimated inventory change Real consumption (end user purchasing) Real consumption (end user purchasing) - annualised YoY 1Q10 157.9 640.2 24.4% 0.2 -4.5 153.0 620.6 21.2% 34.0 119.0 482.8 25.3% 157.9 640.2 24.4% 0.2 -4.5 153.0 620.6 21.2% 34.0 119.0 482.8 25.3% 2Q10 165.3 663.1 18.6% 0.0 -10.4 153.8 616.8 8.1% -5.8 159.5 640.0 7.3% 165.3 663.1 18.6% 0.0 -10.4 153.8 616.8 8.1% -5.8 159.5 640.0 7.3% 3Q10 151.3 600.4 -1.5% 0.2 -6.1 144.7 573.9 -6.0% -8.9 153.6 609.2 15.6% 157.6 625.2 2.6% 0.2 -6.1 150.9 598.8 -1.9% -8.9 159.8 634.1 20.4% 4Q10 152.0 603.0 3.1% 0.2 -4.5 147.2 583.9 2.7% -12.1 159.3 631.9 11.8% 158.7 629.8 3.6% 0.2 -4.5 153.9 610.7 3.3% -12.1 166.0 658.7 12.0% 1Q11 172.6 699.9 9.3% 0.2 -6.1 166.0 673.2 8.5% 33.0 133.0 539.5 11.7% 172.6 699.9 9.3% 0.2 -6.1 166.0 673.2 8.5% 33.0 133.0 539.5 11.7% 2Q11 179.2 718.8 8.4% 0.1 -9.0 169.3 679.1 10.1% -24.4 193.8 777.2 21.4% 179.2 718.8 8.4% 0.1 -9.0 169.3 679.1 10.1% -24.4 193.8 777.2 21.4% 3Q11 174.8 693.3 15.5% 0.2 -8.8 165.1 655.2 14.2% 0.7 164.4 652.4 7.1% 176.8 701.6 12.2% 0.2 -8.8 167.2 663.5 10.8% 0.7 166.5 660.7 4.2% 4Q11 156.7 621.8 3.1% 0.2 -8.0 148.0 587.3 0.6% -10.9 159.0 630.8 -0.2% 165.4 656.0 4.2% 0.2 -8.0 156.7 621.6 1.8% -10.9 167.6 665.0 1.0% Jan-Feb 12 112.6 685.1 2.2% 0.1 -5.0 107.1 651.7 -2.0% 39.5 67.6 411.1 -7.0% 112.6 685.1 2.2% 0.1 -5.0 107.1 651.7 -2.0% 39.5 67.6 411.1 -7.0% 518.9 15.2% 573.2 14.6% 4.6 -5.7 571.4 26.0% 46.8 524.6 16.4% 591.4 14.0% 639.5 11.6% 0.5 -25.5 611.6 7.0% 7.2 604.4 15.2% 650.2 9.9% 694.0 8.5% 0.7 -31.9 659.2 7.8% -1.7 661.0 9.4% 2009 567.5 13.4% 4.6 -5.7 565.7 24.7% 2010 626.5 10.4% 0.5 -25.5 598.6 5.8% 2011 683.3 9.1% 0.7 -31.9 648.5 8.3%
Source: NBS, China Customs, Mysteel, Macquarie Research, March 2012
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Sep-11
Nov-11
Jul-09
Jul-10
Mar-09
Mar-10
Mar-11
Jan-09
Jan-10
Jan-11
Jul-11
12
Macquarie Research
The result of having under-reporting in the NBS data but not in the CISA mill production is that
CISA mills end up appearing to take an unusually large share of national output. This has a knockon effect on the CISA estimates of national output in its ten-day numbers.
Fig 27 CISA mills share of reported NBS output rises at times of under-reporting
CISA mills share of NBS reported steel production
95% 90% 85% 80% 75% 70%
May-09
May-10
May-11
Mar-09
Mar-10
Nov-09
Nov-10
Mar-11
Sep-09
Sep-10
Although it publishes a number for total China production on a ten-day basis, CISA actually has no
method for collecting production data from its non-member mills. It therefore has to estimate the production from non-members, and it does this by looking back at the share of CISA mills output in the reported NBS data from one or two months previously. The chart in Figure 28 shows the CISA mills share of NBS reported output against the share of CISA mill output assumed by CISA when calculating total national output on a ten-day basis a clear lagged relationship.
Fig 28 CISA base their estimate for high frequency total China production on the historical relationship between CISA and NBS data
95% 90% 85% 80% 75% 70%
CISA mills % of monthly NBS production CISA mills % of CISA high-freq production data
May-11
Sep-11
Nov-11
Jan-09
Jan-10
Jan-11
Jul-09
Jul-10
Jul-11
Source: CISA, NSB, Macquarie Research, March 2012
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1-10 Mar 12
Nov-10
Mar-11
Nov-11
Jul-10
Aug-10
Jul-11
Aug-11
Jun-10
Jan-11
Jun-11
Feb-11
Jan-12
Apr-11
Sep-10
Dec-10
Sep-11
Dec-11
Feb-12
Oct-10
Oct-11
13
Macquarie Research
As NBS data was under-reportedin4Q11,theCISAmillsshareofoutputappearedunusually
high over the period. CISA has then carried this error forward into its January and February estimates of total China production by assuming that CISA mills are producing a much-higher share of output than they were. This has resulted in CISA underestimating non-CISA output over January and February, resulting in an estimate for total China production that was considerably below the actual.
To underscore the point, on Monday CISA released its estimate for production over 110 March.
The total China production estimate jumped to 693mtpa from an estimate of 613mtpa for endFebruary.TheprincipalreasonfortheriseinCISAsestimatewasa sharp jump in their estimate of the proportion of production taken by non-CISA mills in line with the rolling off of underreporting in the NBS data in January and February.
Fig 29 CISAsestimateoftotalChinaoutput rebounds strongly in March lagging the NBS data
Fig 30 Although output data from its member mills has been much more stable
Now that the under-reporting issues have passed out of both the NBS and CISA data, we should
be in for a period of more reliable production statistics (at least until 4Q, when we will have to see). As a general rule, however, we find the CISA mill production data to be the most reliable and believe any national level estimate should be taken with caution and cross checked.
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Macquarie Research
Fig 31 ProductiontradeandapparentdemandforChinasmainmining,metalandsteelproducts(000tunless otherwise specified)

Production Aluminium Copper Nickel Zinc Lead Tin Alumina Copper concentrate Zinc concentrate Lead Concentrate Aluminium semis Copper semis Crude steel (mt) Stainless steel (crude eqv.) Iron ore (mt, 62% Basis) Coke (mt) Coal (mt) Net imports base metals Aluminium (refined & alloy) Aluminium (semis) Total above (Al content) Copper (refined) Copper (semis) Nickel (finished, ni content) Zinc (refined) Lead (refined) Tin (refined) Alumina Bauxite Aluminium scrap Copper concentrate Copper scrap Zinc concentrate Lead concentrate Nickel Concentrate Net imports steel/bulks All steel (mt, crude eqv.) Stainless steel (crude eqv.) Iron ore (mt, 62% Basis) Steel scrap (mt) Coke (mt) Thermal coal (mt) Anthracite coal (mt) Thermal & anthracite (mt) Coking coal (mt) All coal (mt) Apparent demand Aluminium Copper (after SRB) Nickel Zinc Lead Tin Aluminium semis Copper semis Steel (mt, crude steel eqv.) Stainless steel (crude eqv.) Coke (mt) All Coal (mt) 2011 Jan 1315 382 40.3 387 351 11.4 2725 77 214 110 1672 596 57 1083 23 33 280 Jan 34 -169 -135 223 26 22 30 -2 0.7 343 2971 221 571 365 296 163 21 Jan 1471 -93.1 69.0 0.46 -0.2 7.9 1.8 9.6 5.5 15.1 Jan 1379 507 63 402 349 12.1 1503 622 58 990 33 295 2011 Feb 1351 431 32.4 375 215 11.3 2553 94 216 142 1788 739 54 1033 25 33 247 Feb 18 -114 -96 138 23 16 16 -1 0.3 225 2169 150 387 246 206 89 16 2011 Mar 1445 443 33.3 446 378 12.4 2960 102 302 171 1767 991 59 1382 25 35 300 Mar 18 -202 -183 155 27 21 32 0 0.6 133 3577 256 451 387 225 101 26 2011 Apr 1289 431 29.6 427 389 14.1 2985 106 323 169 1982 1077 59 1202 29 35 300 Apr 6 -201 -195 116 25 20 11 1 0.3 131 4138 257 466 378 225 135 30 2011 May 1787 440 43.8 418 332 13.2 3009 104 360 209 1530 1081 60 1236 30 37 320 May 3 -287 -284 129 19 19 22 0 0.7 113 4502 337 466 399 236 84 20 2011 Jun 1560 459 34.2 447 403 13.2 3100 115 395 226 2319 1107 60 1118 32 38 310 Jun 0 -251 -251 174 21 16 20 0 1.1 72 3491 301 595 422 184 89 19 2011 Jul 1585 452 36.9 423 347 12.1 2959 108 353 195 2133 979 59 1122 33 37 320 Jul -11 -252 -262 190 18 26 14 0 0.7 59 3743 305 453 432 245 90 35 2011 Aug 1641 499 37.8 410 385 14.3 2977 109 373 199 2071 1112 59 1189 29 38 325 Aug 10 -225 -215 235 29 22 23 0 1.4 35 3852 274 672 382 338 141 13 2011 Sep 1623 458 43.6 453 407 15.4 2774 111 389 223 2119 1080 57 1161 25 37 306 Sep 10 -186 -176 274 29 23 28 1 3.6 80 4478 232 563 418 246 160 27 2011 Oct 1533 449 34.4 474 404 15.9 2669 107 421 233 2241 1010 55 1206 23 36 323 Oct 9 -185 -176 296 19 28 25 0 4.0 261 3086 228 517 377 194 118 20 2011 Nov 1466 429 33.7 451 409 12.8 2638 108 435 231 2123 1023 50 1162 21 33 346 Nov 0 -180 -180 342 24 25 25 1 4.2 227 4594 226 673 433 261 136 30 2011 Dec 1501 453 36.7 465 434 9.1 2621 123 449 253 2040 1127 52 1250 21 35 306 Dec 46 -168 -122 407 22 28 54 0 3.2 201 4580 212 563 447 279 138 20 Dec 2741 -86.6 64.1 0.80 -0.1 12.8 2.7 15.5 5.0 20.6 Dec 1543 582 64 524 435 12.2 1872 1149 55 1163 35 327 2012 Jan 1486 434 40.0 372 267 9.8 3008 95 276 187 1911 671 57 1317 22 35 254 Jan 33 -164 -131 335 8 24 47 0 1.6 447 3121 202 602 229 186 89 19 2012 # Feb 1548 438 39.0 403 309 11.8 2833 104 300 197 2182 914 56 1317 23 34 299 Feb 68 -152 -84 375 24 20 39 1 3.7 276 4666 195 628 403 195 167 23 2011 YTD 3035 872 79 775 576 21.7 5841 199 577 384 4094 1585 113 2633 44 69 553 YTD 101 -316 -215 709 33 43 86 1 5.3 723 7787 397 1230 632 382 256 42 YTD 5474 -159 124 0.80 -0.1 18.5 4.3 22.8 8.3 31.2 YTD 2740 1159 122 845 577 27.0 3777 1618 118 2475 69 585 2010 % ch. YTD YoY 2666 13.8 813 7.3 73 8.7 763 1.6 566 1.8 22.7 -4.7 5278 10.7 172 15.8 430 34.0 251 52.6 3460 1335 111 2117 48 66 527 18.3 18.7 1.6 24.4 -7.9 4.6 5.0
YTD Y-o-Y 51 97.0 -282 12.0 -231 -6.9 361 96.3 49 -34.0 38 13.7 46 86.2 -2 -125.4 1.0 421.0 567 27.3 5140 51.5 371 6.9 958 28.3 611 3.5 502 -24.0 252 1.7 37 15.7 YTD Y-o-Y 2977 83.9 -173 -8.6 118 5.5 0.71 12.6 -0.4 -65.9 10.8 71.1 2.3 86.1 13.1 73.8 7.0 19.0 20.1 54.7 YTD Y-o-Y 2547 7.6 948 22.2 111 10.4 785 7.7 563 2.4 23.7 13.7 3178 1384 114 1944 66 547 18.9 16.9 3.8 27.3 4.6 6.8
Feb Mar Apr May Jun Jul 1506 3584 3587 3762 2518 3467 -80.3 -143.8 -118.0 -175.4 -159.0 -179.3 48.8 59.5 52.9 53.3 51.1 54.5 0.25 0.61 0.31 0.63 0.52 0.78 -0.2 -0.8 -0.5 -0.4 -0.3 -0.2 2.9 2.7 3.8 7.2 6.4 9.4 0.6 1.7 3.3 3.4 3.3 3.1 3.5 4.4 7.1 10.5 9.6 12.5 1.5 2.1 2.6 2.1 3.4 4.1 5.0 6.5 9.7 12.7 13.0 16.6 Feb 1168 441 48 383 214 11.6 1675 762 56 953 33 252 Mar 1499 644 55 450 378 13.0 1565 1018 63 1238 35 306 Apr 1421 711 50 412 390 14.4 1780 1103 63 1084 35 310 May 1919 685 63 430 332 14.0 1243 1100 64 1061 37 333 Jun 1710 784 50 466 403 14.3 2068 1128 62 959 38 323 Jul 1662 726 63 438 347 12.8 1882 998 63 943 37 337
Aug Sep 3038 3080 -167.9 -148.2 59.1 60.6 0.52 0.70 -0.2 -0.1 9.7 11.2 2.6 2.8 12.3 14.0 3.0 3.9 15.3 17.9 Aug 1643 700 60 416 385 15.7 1846 1140 62 1022 38 340 Sep 1668 886 66 497 407 19.0 1934 1108 60 1013 37 324
Oct Nov 2794 3123 -90.3 -113.1 49.9 64.2 0.56 0.63 -0.1 -0.1 7.9 13.4 2.5 2.7 10.3 16.1 4.2 5.1 14.6 21.2 Oct 1493 670 63 525 404 19.9 2055 1028 57 1116 36 338 Nov 1408 830 59 483 410 17.0 1943 1048 53 1049 33 367
Note: Apparent demand = production plus net imports adjusted for reported (and SRB) stock changes. Annual data is for the most part the sum-of monthly data o may not incorporate revisions to annual data. Source: CISA, CNI-A, China Metals, NBS, Ecowin, Macquarie Research, March 2012
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Fig 32
KeymacroeconomicandsectorindicatorsforChinassteel,coalandmetalsindustries(YoY%change)
2010 10.3% 14.4% 15.8 53.8 20.6% 3.3% 5.5% 26.2% 23.4% 31.6% 38.8% 12.3 52.9 17.2% 4.9% 6.6% 43.2% 19.9% 37.7% 51.4% 14.9% 12.4 52.2 15.7% 4.9% 7.2% 32.5% 11.6% 1.3% 19.8% Jan-11 Feb-11 Mar-11 9.7% 14.8% 12.6 53.4 16.6% 5.5% 7.3% 42.5% 17.4% 35.8% 27.4% 13.4% 12.7 52.9 15.3% 5.3% 6.8% 43.2% 17.1% 29.8% 22.0% 13.3% 13.0 52.0 15.1% 5.5% 6.8% 40.4% 16.9% 19.3% 28.4% Apr-11 May-11 Jun-11 9.5% 15.1% 13.2 50.9 15.9% 6.4% 7.1% 40.8% 17.7% 17.9% 19.0% 14.0% 13.3 50.7 14.7% 6.5% 7.5% 39.8% 17.2% 20.3% 23.0% 13.5% 13.2 50.9 13.5% 6.2% 7.3% 37.7% 17.0% 24.4% 30.4% Jul-11 Aug-11 Sep-11 9.1% 13.8% 12.7 51.2 13.0% 6.1% 6.5% 16.5% 17.7% 17.0% 21.1% 13.2% 12.1 50.4 12.9% 5.5% 5.0% 28.4% 17.0% 15.8% 29.1% 12.4% 11.3 49.0 12.7% 4.2% 2.7% 28.4% 17.3% 13.8% 22.6% Oct-11 Nov-11 Dec-11 8.9% 12.8% 10.5 50.3 13.6% 4.1% 1.7% 27.7% 18.1% 13.3% 12.1% 11.4% 9.9 50.5 12.4% 4.5% 0.7% 25.0% 14.9% -0.5% -15.0% 11.4% 50.5 13.0% 3.2% 0.0% 29.7% 14.9% 18.3% 40.3% Jan-12 Feb-12 2012 YTD 9.2% 11.4% 9.9 50.8 12.7% 3.9% 0.4% 21.5% 14.9% 8.1% 6.8%
Growth % change year-on-year Macro-economic indicators GDP (Gross domestic product) Industrial production OECD lead indicator PMI Money supply growth (M2) Consumer price index (inflation) Ex-factory price index (PPI) Fixed asset investment - total urban Retail sales Exports Imports Sector indicators Fixed asset investment in: Coal mining/processing Iron ore mining Non-ferrous mining Steel Non-ferrous melting/rolling Metal product manufacturing Power and thermal supply Real estate Floor space of buildings under construction (3MMA) Floor space of buildings sold (3MMA) Power/coal indicators Electric power production of which thermal Production of power generating equipment Cement production Fertilizer production Pig iron production Production of metal-containing products Copper semis Aluminium semis Air conditioners Washing machines/refrigerators/freezers Power cables Electric motors Electric driven tools Electrical instruments Computers Colour TVs Transport production Cars (sedans) Trucks Buses Motor cycles Large and Medium Tractors Railway engines Civil Steel Boats and ships
35.4% 27.1% 27.8% 6.1% 33.2% 37.9% 4.4% 33.3% 26.9% 10.1%
-43.4% 35.4% 16.5% 10.7% 8.4% 17.8% 1.3% 32.5% 33.2% 12.6%
-43.4% 35.4% 16.5% 10.7% 8.4% 17.8% 1.3% 32.5% 35.7% 12.1%
6.1% -7.2% 16.5% 10.5% 23.4% 21.5% 11.3% 29.8% 35.2% 14.9%
13.1% 49.5% 16.0% -0.4% 11.8% 14.3% 0.6% 34.8% 29.4% 5.0%
19.2% 6.2% -10.8% 8.2% 58.7% 36.5% 6.8% 37.6% 14.1% 7.6%
33.2% 29.5% 38.5% 40.1% 40.5% 20.1% -3.4% 27.5% 18.3% 11.6%
31.1% 12.9% 22.4% 31.8% 44.3% 8.2% 0.5% 41.0% 20.3% 21.1%
25.5% 26.9% 14.8% 25.3% 33.1% 12.5% -2.1% 33.9% 20.3% 19.6%
35.0% 17.2% 25.0% 28.2% 33.8% 10.8% 15.1% 28.9% 17.2% 12.9%
26.8% 8.7% 42.9% 10.2% 33.2% 44.0% 2.6% 29.4% 11.1% 3.8%
31.2% 41.9% 18.6% 16.0% 48.0% 36.4% 4.2% 23.3% 8.0% -0.3%
9.4% 7.7% 61.2% -13.2% 56.5% 38.0% -9.0% 17.5% -5.9% -6.2%
23.0% 38.6% 38.5% 21.2% 19.1% 13.3% 14.7% 31.4% 27.1% -6.1%
23.0% 38.6% 38.5% 21.2% 19.1% 13.3% 14.7% 31.4% 31.6% -8.7%
23.0% 38.6% 38.5% 21.2% 19.1% 13.3% 14.7% 31.4% 35.5% -14.0%
14.0% 11.9% -6.4% 13.8% 1.2% 8.3%
8.2% 6.2% 60.4% 0.8% -9.2% 4.9%
15.0% 14.1% 97.8% 5.2% -3.8% 6.3%
13.7% 12.1% 21.7% 21.0% -10.2% 5.0%
10.5% 11.1% 11.6% 15.1% -11.9% 6.5%
10.9% 13.9% -5.5% 13.1% -4.5% 4.4%
14.5% 19.5% 21.9% 13.4% 1.1% 10.3%
12.6% 20.8% 12.7% 11.0% -2.5% 15.7%
9.1% 17.2% 25.9% 8.7% -5.8% 10.5%
10.7% 21.0% 26.1% 11.6% -3.5% 14.0%
9.4% 16.7% -7.7% 11.9% -9.2% 8.9%
7.5% 9.8% 12.8% 6.5% -11.6% -2.2%
9.8% 12.6% 1.4% 3.2% -13.7% 2.9%
-5.1% -5.5% -13.6% -12.4% 11.7% 4.0%
19.4% 19.9% -23.0% 29.5% 18.1% 5.7%
6.1% 6.1% -18.6% 5.7% 15.0% 4.9%
11.7% 25.6% 30.7% 27.3% 26.7% 23.0% 3.4% 36.1% 32.5% 13.2%
-4.7% 43.4% 51.1% 11.1% 7.1% 49.4% 49.4% 49.4% 49.4% 49.4%
1.7% 18.2% 41.1% 6.4% 1.0% 20.5% 9.2% 34.0% 7.3% -8.5%
3.5% 37.3% 41.1% 15.3% 23.1% 11.3% 20.9% 31.2% 28.1% 3.0%
-10.2% 36.3% 32.5% 13.0% 14.9% 8.1% 1.9% 36.1% 42.1% 5.7%
1.5% 32.3% 29.4% 14.9% 28.9% 7.5% 2.3% 2.4% 31.6% 6.7%
4.5% 34.3% 37.6% 18.1% 36.7% 12.9% 15.3% 21.6% 42.5% 10.0%
3.8% 25.8% 28.7% 13.0% 15.3% 8.1% 10.9% 6.2% 48.2% 19.5%
9.5% 25.3% 36.5% 7.0% 18.6% 1.5% 14.9% 29.5% 50.3% 20.2%
15.8% 22.7% 4.5% 10.7% 10.1% 2.9% 6.0% 35.5% 43.4% 9.0%
10.8% 16.1% -3.8% 12.5% 7.8% -0.1% 6.7% 16.3% 25.0% 2.8%
5.6% 16.2% -1.0% 3.9% 12.6% -3.8% 0.5% 13.2% 38.1% 16.8%
-0.3% 3.4% 4.5% 10.5% 8.9% -0.5% -7.2% -13.0% 61.8% 22.9%
-4.8% -5.9% 28.5% -9.6% -17.9% 9.8% 6.6% 23.9% 90.0% 42.6%
51.7% 18.0% 28.5% 14.0% 1.6% 9.8% 6.6% 23.9% 90.0% 42.6%
21.3% 5.5% -5.2% 0.9% -8.4% -9.8% -19.2% 5.1% 18.6% -0.2%
26.8% 25.0% 18.9% 1.5% 7.2% 41.8% 54.2%
17.3% 6.0% 9.2% -14.0% 12.4% 75.5% 45.9%
7.2% -1.7% 4.0% -2.3% 9.4% 34.0% -16.5%
10.6% 2.3% 21.2% -8.5% 9.5% 34.1% 20.7%
3.4% -15.6% 5.6% -13.5% 55.5% -23.4% 41.7%
5.6% -21.5% -2.6% -8.8% 33.3% -0.5% 56.3%
17.6% -20.7% -11.9% -14.2% 28.4% 22.0% 6.7%
14.8% -30.3% -27.6% 10.0% 13.4% 50.8% 58.8%
17.4% -17.8% 2.1% 23.1% 17.4% -5.4% 31.5%
10.2% -16.4% -12.0% 15.0% -0.4% -7.1% 57.6%
6.9% -21.8% -7.6% 12.3% 17.1% -14.7% 6.0%
1.4% -17.7% -9.6% 16.2% 58.6% -29.9% -1.7%
-5.1% -19.3% -12.2% -11.6% -2.2% -26.5% 77.2%
-28.2% -36.7% -21.5% -6.8% -4.6% -36.3% -10.6%
31.4% 18.3% 16.4% 12.9% 21.5% -41.8% 55.8%
-4.4% -12% -5.2% 2.4% 7.7% -39.2% 11.6%
Note: Some monthly numbers (especially for December) often include revisions to prior numbers and may not make sense Source: NBS, OECD, Ecowin, Dragonomics, Macquarie Research, March 2012
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CHINA
The China Diviner

Macro monthly
Why are Beijing taxis so hard to find?
These days, it takes perseverance, luck, and sharp elbows to find an empty
cab in Beijing. If you do spy one, someone else may get to it first. If you happen to be the quickest, then in all probability the driver wont take you, speeding past with a vigorous shaking of the head. Perhaps you finally get lucky and find a car, only to get caught in an enormous traffic snarl.
Photo of the month: Beijing taxis on Changan Avenue, Jamie Zhou, MSG SRO
Congestion is clearly one reason for taxi scarcity. This is partly an illness of
INSIDE
Story in charts Economic outlook Macq forecasts Back-page charts 2 4 6 8
affluence, with demand for transport rising: car ownership in Beijing is up fivefold since 2003. Supply hasnt grown as fast. Road length has only doubled. The metro network is up to 336km, but still trails that of other big cities.
Another reason you cant find a taxi is they are too cheap fares have been
RECENT REPORTS Macro Monday

Equities and the economy Be careful what you wish for Finally the slowdown Not enough yet Getting the policy put 9-Jan-12 19-Dec-11 28-Nov-11 14-Nov-11 7-Nov-11
largely static, while Beijing incomes have risen 10%pa. Meanwhile, the supply oftaxishasntchangedatallonpaper,and may effectively even have shrunk. Driver earnings have been dented by rising costs like fuel, and the need to pay rental fees to the government-regulated firms that own most Beijing cabs. Low pay is hardly the way to encourage taxi drivers onto the road.
All this says much about the economy. Take congestion all that car buying
The China Diviner

Consumer confidence - February Consumer confidence - January Understanding inflation Consumer confidence - November The Beijing buzz 14-Mar-12 8-Feb-12 3-Feb-12 15-Dec-11 16-Nov-11
suggests consumptionisntweak,andwhileinfrastructurespending has been strong, Beijing is far from building bridges to nowhere. Second, the need for deregulation, now a priority for many economists. That includes price reform, which relates to a third point, repressed inflation. Infrastructure building seems easier for officials than structural reforms. Maybe the incoming leadership will change that. But until it does, Beijing taxis will remain in short supply.
Economic outlook: decoupling, of a sort

Fixed supply and low prices rationing doesnt just characterise the market
Macro Monthly
The shoe that didnt fall far Risks start to shift Clearing the credit constraints Its all about investment The next shoe to fall 21-Feb-12 30-Jan-12 7-Dec-11 30-Sep-11 21-Aug-11
for taxis. This is also the framework Beijing has used to manage credit, albeit with some complications. Just how much economic activity a particular loan will buy depends on prices. With PPI inflation having decelerated so much in recent months, lending in real terms has picked up, accelerating even in January and February when nominal lending was considered weak.
Often, official rationing leads to black markets. For taxis, unlicensed cabs are
Analyst(s)
Paul Cavey +852 3922 3570 Chen Shao +86 21 2412 9041 paul.cavey@macquarie.com chen.shao@macquarie.com
now appearing in Beijing. Unofficial supply is even more obvious for credit. Indeed, our impression from speaking to bankers in recent weeks is that Beijing is having increasing difficulty controlling credit, with official loan but even social finance data now understating total lending. Three specific factors are driving this process. The LDR ceiling and restrictions on lending to property make it more difficult for banks to make formal loans. But lending to real estate sector developers is attractive, because they are willing to pay rates higher than the benchmark. Banks are also under pressure from savers to supply investment products that offer better returns than one-year deposits.
Market interest rates are now falling. That could reflect weaker demand from
26 March 2012 Macquarie Capital Securities Limited
the economic slowdown that clearly has happened. However, there is now a risk that it reflects a monetary cycle that is starting to pick-up again. If true, that would support stronger economic growth in 2H12, but also inflation.
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Macquarie Research
The China Diviner
Story in pictures: Why are Beijing taxis so hard to find?

Fig 1 Are taxis all stuck on roads?
Particularly at rush hour these days, it takes much perseverance, luck, and sharp elbows to find an empty taxi in Beijing. If you do spy one, likely someone else will get to it first. If you happen to be the quickest (or more aggressive), then in all probability the driver will refuse to take you, claiming hes going a different way. Perhaps after an hour or so you finally lock onto a car that is both empty and has a driver willing to work. You slip onto the third ring road and immediately get caught in an enormous traffic snarl. That points to the first reason for taxis scarcity: congestion. Our traffic heat map is for a Wednesday morning, with orange and red representingmoderatelyandseriously congested. In last year IBMs Global Commuter Pain Survey Beijing scored 95, admittedly below MexicoCitys108(wewontbebecomingMexicoeconomists)butmuch worse than cities like Moscow (65), Singapore (44) and London (just 23). Source: BMCT, Macquarie Research, March 2012
Fig 2 Growing demand for transportation

thd 5,000 4,000 3,000 2,000 1,000 2003 2004 2005 2006 2007 2008 2009 2010 Number of motor-vehicles (L) Metro traffic (R) mn passenger-journey 1,600 1,400 1,200 1,000 800 600 400 200
This congestion reflects inefficiencies in traffic management, but it also reflects raw demand and supply. The number of cars in Beijing has tripled since 2003. It is easy to attribute that to government spending all those VandWJplatesarejustthemostvisiblesignofofficialdom there but household car ownership has also risen five-fold, fuelled by a 10%pa increase in incomes. Travel rises with economic growth, and particularly in Beijing, where the urban area has grown by 17% since 2003. There is simply more need to get around. Supply justhasntkeptpacewith this demand growth. The government has spent heavily on roads, but the total length has only doubled since 2003. Metro development has been faster, with the length of lines tripling to 336km. But that is still less than in other cities, such as New York (381km), London (436km) and Tokyo (577km).
Source: CEIC, Beijing Yearbook, Macquarie Research, March 2012
Fig 3 means fares are becoming too low

Daily expense for a 5km communting trip, Rmb 50 40 30 20 10 0 2003 2004 2005 2006 2007 2008 2009 2010 Monthly expense as % of average wage, %
This demand-supply imbalance is even more pronounced when it comes to taxis. As is usually the case around the world, the taxi business is a protected industry in Beijing, with both prices and supply regulated by the government. That is a problem, because officials are always wary about raising prices for just about anything. In Beijing, the taxi flag-down fare has stayed at Rmb10 for years, and the mileage charge has only risen from Rmb1.6/km in 2006 to Rmb2/km today. Assuming a commuting trip of 5km every day, then regular taxi expenses have almost halved relative to average incomes since 2003. So another reason you cant find a taxi is because they are simply too cheap. Not only are you waiting for one, but so are thousands of other people in the city for the simple reason that they can afford to do so.
Source: CEIC, Macquarie Research, March 2012
Fig 4
thd 70 65 60 55 50 45 40
butsupplyisfixed
Beijing Shanghai Number of taxis nationwide (R) thd 1,000 980 960 940 920 900 880 860 2003 2004 2005 2006 2007 2008 2009 2010
In fact, our estimates probably understate the relative cheapness of taxis today, because they make allowance for changes in quality.Thisisntto say that taxi riding in Beijing has become a particularly pleasant experienceoverthelastfewyears.Butitisntnearlyasgrimasitusedto be, with the government at least having the goodness to get rid of those awful Xiali vehicles, small to begin with, with space squeezed even further by the cages used for driver protection. That change, which makes it even more difficult to justify such low fares, is the only noticeable adjustment on the supply side. Just as prices are fixed, so is supply. In common with Shanghai which has a similar taxi quota the total number of taxis in Beijing has hardly changed in the last few years, remaining at 66,646.
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The China Diviner
Fig 5 Cost-push pressures from fuel expense

Rmb 14 12 10 8 6 4 2 Flagdown fare + fuel surcharge Beijing gasoline price (R) Rmb thd / ton 14 12 10 8 6 4 2
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Fig 6
3,000 2,500 2,000 1,500 1,000 500 0
rising wages
Minimum wage in Beijing Average wage
Jan-12
That would be bad enough, but the supply-side shortages are clearly worsened by the frequent reluctance of taxi drivers to pick up passengers. Part of this is practical: the municipality of Beijing is huge, covering 1,390 sq km, and cars are usually shared between drivers. So shift swaps can be lengthy, with drivers making long journeys home, to swap with their partners who have to make the same lengthy trek back in. But even when they are cruising (or usually crawling) the streets of Beijing, it is hardly surprisingthattaxidriversarentthemostenthusiastic of employees. Not only are their fares fixed, but costs are rising. Most obvious is fuel. That already ate up 30% of taxi revenue in 2006, and petrol prices have become yet more expensive since, a rise that has more than offset the impact of the Rmb1-2 per journey fuel surcharges imposed in 2009.
Jul-03
Jul-04
Jul-05
Jul-06
Jul-07
Jul-08
Jul-09
Jul-10
Jul-11
Rmb / month
The result is a reduction in the profitability of driving a taxi, a loss which is even more noticeable in a relative sense. After all, income growth in other industries has remained strong. The result should be a reduction in the attractiveness of driving a taxi. This could become reflected in on-the-job shirking the wave of the hand and vigorous shaking of the head as the empty taxi you thought was yours speeds on past. It could also trigger strikes, with taxi drivers staging protests in 70 cities in recent yeas. Finally, drivers will just do something else instead. Ten years ago, drivers hailingfromShanghaisurbanareaswerebeing replaced by those from neighbouring counties, and now the latter are being substituted by drivers from other provinces. Such a process should be playing out in Beijing too.
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Fig 7
% 50 40 30 20 10 0
and administrative outlays

Beijing taxi driver total revenue in 2006 Self-hired drivers Company-hired drivers
Maintenance
Depreciation
Source: You Chenli, Macquarie Research, March 2012
Fig 8
Rmb 140 120 100 80 60 40 20 0
so by how much should fares be hiked?

How much does a 5km ride cost?
Net earnings
With no change in the profitability of driving a taxi, even those drivers from outside, while willing to accept the lower wages for now, would lose interest. So ultimately, something has to give. If fuel costs and labour costscantbetackled,thenperhapsthegovernmentcanworkonthe biggest cost for taxi drivers: the rent they have to pay for the privilege of driving a car. Most taxis in Beijing are owned by companies, and rented out to drivers. The significance of this system for driver incomes is obvious: back in 2006, a typical driver owning his own car took home 42% of his income, while a driver renting his car had to hand over the same proportion to the company. Some redistribution of income from the companies that the local government has licensed to oligopolise the domestic taxi industry would go a long way to raise taxi driver incomes.
Taxes and fees
Company share
Fines
Oil
Wage
Readers might detect a level of personal frustration here. Hopefully, that is forgivable: anyone who spends a lot of time in Beijing does tend to develop strong views about transport. But our taxi story is motivated by more than angst, telling much that is useful about the economy. First of all, the basic causes of congestion all those cars suggest to us that at leastinBeijing,consumptionisntweak,and while infrastructure spending has been strong, the city is still a very long way from building bridges to nowhere. Second, the importance of deregulation, with almost all economists now wanting action against oligopolies mandated or owned by the state. That relates to the third point, repressed inflation. Taxi fares, which we think need to rise by at least 20-30% in Beijing, are just one example of controlled prices in China. Where does this leave us? Infrastructure building seems easier for governments than structural reforms of vested interests or prices. Maybe the incoming leadership will change that. But until it does, taxis in Beijing will remain in short supply.
New York
Singapore
Source: Taxi Fare Finder, Macquarie Research, March 2012
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Economic outlook: decoupling, of a sort

Expecting growth to slow Our base case for the economy for 2012 has been for a more noticeable slowdown in growth early in the year on the back of the monetary and property tightening of 2011. We expected that to result in an official PMI of around 46-47. Policy loosening would then kick in, with cuts in the RRR (one by Chinese New Year, and one more before the end of 1Q) and some easing of property policy. That would support an economic recovery in 2H12, and GDP growth of 8-8.5% in the year as a whole. There are of course alternative scenarios. One is more bearish, in the form of the commonlydiscussed but poorly-defined hard landing. For us, such a downturn would combine elements of 2008 a sharp slowdown in growth and 1998 adownturnthatcantbequicklyreversedas structural problems like NPLs emerge to weigh on the economy. This bear case is still one that worriesmanyinvestors,andunfortunatelyisariskthatcantbecompletelydismissed,withboth lending and import data weak in the last couple of months. One possible trigger would be a worsening of the problems in Europe, particularly a sharp fall in the Euro. The context would likely be another step-down in EU growth, a development that would clearly be bad news for Chinese exports. But a weaker Euro would also greatly complicate Chinese exchange rate and monetary policy. It would probably be difficult for Beijing to hold the RMB peg against the USD, but depreciation would be very damaging for Sino-US relations. Even if Beijing ultimately held the line on the RMB, the concern that it might not would encourage capital outflows, squeezing domestic liquidity. Thereisalsoathird,morepositivescenario.Atleastinthesensethattheyhaventallbeenuniformly bad, it seems to us that it is in this direction that recent data points have been pointing. December construction data wereterrible,butotherindicatorswerent,atleastintheformofIndustrial Production and the PMIs. While lending figures in January and February appear a bit weak, PMIs have held up. There are some early signs that growth may have further slowed down in March, but again it doesnt feel like a collapse, with the seasonal rebound in orders recently coming back for some downstream users (heavy machinery and auto) of commodities. so why are growth numbers still reasonable? The implications, that the economy is enjoying a soft-ish landing even without much obvious loosening, and that other sectors are somehow managing to decouple from property, might be difficulttoaccept.Themostcommonresponseweveheardisitisalljusttiming,thatthelagsoflast yearspolicyarejustabouttopushtheeconomyoffacliff.Ofcourse,thisisarisk.However,the effect of property tightening is already evident in that 25% contraction in real estate construction in December, a fall-offthatwedimagineshouldhaveareal-time impact on IP and overall sentiment. As for monetary tightening, Chinese New Year should have been crunch time, but if SME and developer attempts to collect cash to pay workers and SMEs really were causing macro problems, the January MNI survey and flash HSBC PMI both of which involved data collection in the first half of the month should have come in much weaker.
Fig 9 Decoupling of a sort

60 50 40 30 20 10 0 -10 -20 Jan-08 Oct-08 Jul-09 Apr-10 Jan-11 Oct-11 butsomedecouplingin2011 A broad-based slowdownin2008 Construction, % YoY, RHS IP, % YoY, LHS 35 30 25 20 15 10 5 0
Fig 10
95 75 55 35 15 -5
because of monetary easing

Loans, constant prices, sa, % MoM annualised, LHS Loans, nominal, % MoM annualised, RHS 40 35 30 25 20 15 10 5 0
Apr-03 Apr-04 Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11
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Iftimingdoesnt explain things, then it seems to us three other dynamics could be at work. First, real monetary loosening is already quite advanced. Some improvement in credit conditions was of course the message of the uptick in the headline YoY change in nominal loans into December. The degree of monetary easing is even more obvious after a couple of adjustments are made. First, taking out the producer price inflation that affects just how much activity the nominal loans are able to purchase. Second, seasonally adjusting this real number and then annualising the MoM growth rates, a change that gives a better sense of the changing momentum of lending. On this basis growth in lending by the end of last year was back to a 20% run-rate, up from just 0% at the height of the tightening at the beginning of 2011. In any case, our impression from speaking to bankers in recent weeks is that the official lending data, and even the bigger social finance figures, now understate just how much funding is available in the economy. Three factors are driving this process. Official regulations are making it harder for banks to make official loans: smaller banks in particular are butting up against the 75% ceiling for the Loan:Deposit Ratio (LDR), while all banks are under pressure to lend less to the property sector. At the same time, lending is still attractive, particularly to property developers which these days seem to be willing to pay rates higher than the benchmark. Banks are also under pressure from savers to supply investment products that offer better returns than one-year deposits. Market interest rates in China now do seem to be falling, and while that could reflect weaker demand from the economic slowdown that clearly has happened, there is now the risk that it reflects a monetary cycle that is starting to pick-up again. The other likely driver of the better than expected economic outturn is strong consumption. That is the message of the retail sales data, which accelerated quite noticeably at the end of 2011. Admittedly, we have doubts about the quality of that data series, but it does make intuitive sense againstthebackdropofastilltightlabourmarketcompaniesarentcomplainingofanexcessof workers, but rather that wages are still rising quickly. This is partly driven by continued growth in exports, which in turn has been helped by a recovery in growth in sales to the US offsetting the continued slippage in shipments to the EU. But it is also a structural phenomenon, as the number of young people entering the labour force starts to shrink in absolute terms. The tightness of the labour market is a big difference from 2008, and feeds into the third possible driver of better-than-expected economic performance: industrial upgrading. As wages rise, companies start to invest in machinery to replace labour. If the experience of other East Asian economiesisanyguide,thereshouldalsobeashiftinthestructureofChinasexportsawayfrom labour-intensive goods like clothing towards more capital-intensive products such as machinery. Theseareofcoursestructuralchangesthatdonthappenovernight.However,thesetrendsare perhaps one reason why investment in export-driven industries was so strong in 2011. In any case, evenifthisupgradinghasntyetbecomeamajormacrodriver, it is going to be an important sectoral phenomenon throughout the next few years.
Fig 11
recovering consumption
Nominal Real
Fig 12
and perhaps, industrial upgrading

Consumer goods Taiwan Korea Capital goods China
Retail sales, % YoY 24 22 20 18 16 14 12 10 Jan-07 Oct-07 Jul-08 Apr-09 Jan-10 Oct-10 Jul-11
% of total exports 60 50 40 30 20 10 0 Japan
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19 65 19 72 19 79 19 86 19 93 20 00 19 82 19 89 19 96 20 03 20 10 19 86 19 93 20 00 20 07 19 96 20 03 20 10
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Fig 13
Annual indicators and forecasts

2004 2005 2006 2007 2008 2009 2010 2011 2012F 2013F
Activity Constant prices, y/y % chg Published GDP Macq GDP Domestic demand Private consumption Government consumption Fixed investment Contribution to real GDP growth, ppts Domestic demand Private consumption Government consumption Fixed investment Stocks Net exports Current prices GDP (US$bn) - y/y % chg GDP (Rmb bn) - y/y % chg Investment FCF:FAI ratio FAI, nominal, Rmb bn Export-intense industry Intermediaries Infrastructure Transport Utilities Real estate Rural FAI, y/y % chg Export-intense industry Intermediaries Infrastructure Transport Utilities Real estate Rural Consumption Household incomes, % chg, real Urban Rural Household savings, % of income Urban Rural
10.1 14.8 12.1 8.9 7.3 14.7 12.0 3.6 1.0 7.4 1.1 2.9 1,943 17.7 16,080 17.7 0.92 5,862 415 1,263 1,711 662 1,049 1,485 64 27.6 34.9 37.0 25.5 21.0 28.5 29.4 20.3
11.3 13.7 9.3 9.4 16.1 8.6 8.9 3.6 2.0 3.3 -0.4 4.7 2,284 17.6 18,713 16.4 0.84 7,510 606 1,744 2,194 848 1,346 1,794 82 28.1 46.1 38.1 28.3 28.1 28.3 20.8 27.9
12.7 17.5 13.8 11.3 13.9 15.0 12.8 4.2 1.8 6.8 0.7 4.7 2,788 22.0 22,224 18.8 0.80 9,347 856 2,197 2,682 1,088 1,594 2,194 110 24.5 41.3 25.9 22.2 28.3 18.4 22.3 33.9
14.2 16.0 13.5 11.1 12.2 14.6 12.1 3.9 1.5 6.7 0.8 3.9 3,496 25.4 26,583 19.6 0.76 11,741 1,161 2,907 3,098 1,235 1,863 2,913 147 25.6 35.6 32.3 15.5 13.5 16.9 32.8 33.1
9.6 13.4 12.9 9.2 9.8 15.3 11.3 3.1 1.2 7.0 1.0 2.1 4,534 29.7 31,490 18.5 0.74 14,817 1,478 3,834 3,796 1,475 2,321 3,586 226 26.2 27.3 31.9 22.5 19.5 24.6 23.1 53.8
9.2 10.3 18.5 10.3 15.0 29.3 16.2 3.3 1.7 11.1 -0.6 -5.9 5,070 11.8 34,632 10.0 0.70 19,414 1,910 4,757 5,399 2,198 3,201 4,401 337 31.0 29.3 24.1 42.2 49.0 37.9 22.7 49.5
10.4 12.0 9.5 6.5 13.0 10.3 9.0 2.1 1.6 5.3 0.4 3.1 5,825 14.9 39,431 13.9 0.66 24,141 2,543 5,841 6,388 2,616 3,772 5,872 397 24.4 33.1 22.8 18.3 19.0 17.8 33.4 17.6
9.2 9.1 10.0 10.3 8.0 10.2 9.2 3.2 1.0 5.0 0.3 0.0 7,004 20.2 45,246 14.7 0.62 29,887 3,733 7,658 6,548 2,509 4,043 7,734 679 23.8 46.8 31.1 2.5 -4.1 7.2 31.7 71.3
8-8.5 8.3 9.1 9.3 8.0 9.6 8.5 2.9 1.0 4.6 0.1 -0.1 8,297 18.5 51,026 12.8 0.58 36,401 4,782 9,649 7,426 2,714 4,712 8,933 856 21.8 28.1 26.0 13.4 8.2 16.6 15.5 26.0
8-8.5 8.4 8.7 9.0 7.0 9.1 8.1 2.8 0.8 4.4 0.1 0.3 9,841 18.6 58,063 13.8 0.55 43,955 5,523 12,665 8,292 2,849 5,443 10,505 1,079 20.8 15.5 31.3 11.7 5.0 15.5 17.6 26.0
7.0 7.8 23.8 25.6
9.4 8.9 24.3 21.5
10.4 8.6 26.0 21.1
11.9 10.1 27.5 22.1
8.1 8.6 28.8 23.1
9.6 9.0 28.6 22.5
7.7 11.2 29.5 26.0
7.0 14.0 30.5 25.2
7.5 10.0 30.7 25.0
7.5 8.5 30.4 26.0
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Fig 14
Annual indicators and forecasts

2004 2005 4.9 1.8 8.2 8.1 -1.2 763 24.5 28.5 33.4 628 13.6 17.6 27.5 134 5.9 134 5.9 117 5.1 11 0.5 819 35.8 16 -31 -1.4 11.8 16.3 12.8 1.5 2006 3.0 1.5 8.0 7.8 -0.7 970 24.2 27.2 34.8 752 16.0 19.7 27.0 218 7.8 233 8.3 124 4.5 21 0.8 1,066 38.3 17 -88 -3.2 17.5 17.0 14.6 1.9 2007 3.1 4.8 7.6 7.4 0.6 1,220 19.2 25.8 34.9 905 12.9 20.3 25.9 315 9.0 354 10.1 160 4.6 17 0.5 1,528 43.7 20 -35 -1.0 21.0 16.7 16.4 1.9 7.5 4.1 2008 6.9 5.9 6.9 6.8 -0.4 1,435 8.2 17.6 31.6 1,074 3.4 18.7 23.7 361 8.0 412 9.1 175 3.9 54 1.2 1,946 42.9 22 -116 -2.6 9.0 17.8 18.0 1.1 5.3 2.3 2009 -5.4 -0.7 6.8 6.8 -2.2 1,204 -10.7 -16.1 23.7 954 2.5 -11.1 18.8 250 4.9 261 5.2 114 2.3 44 0.9 2,399 47.3 30 122 2.4 25.0 27.0 33.0 1.2 5.3 2.3 2010 5.5 3.3 6.77 6.6 -1.7 1,581 29.4 31.4 27.1 1,327 26.4 39.1 22.8 254 4.4 305 5.2 137 2.4 57 1.0 2,847 48.9 26 63 1.1 22.0 18.0 19.7 2.7 5.8 2.8 2011 6.0 5.4 6.46 6.3 -2.2 1,814 11.9 14.7 26.0 1,605 15.7 20.9 23.0 209 3.0 258 3.7 171 2.5 83 1.2 3,181 45.6 24 -13 -0.2 18.0 16.0 14.6 3.0 6.6 3.5 2012F 4.0 3.5 6.15 6.0 -2.0 2,032 8.7 12.0 24.6 1,862 11.0 16.0 22.5 170 2.1 224 2.7 197 2.4 108 1.3 3,381 40.9 22 -113 -1.4 18.0 16.0 16.0 2.8 6.6 3.5 2013F 3.5 4.5 5.9 5.7 -1.6 2,276 8.7 12.0 23.3 2,104 10.8 13.0 21.5 172 1.8 250 2.6 227 2.3 135 1.4 3,581 36.6 20 -142 -1.5 15.0 14.0 16.0 3.2 6.8 3.8
Prices PPI (ann avg % chg) CPI (ann avg % chg) Exchange rate (US$/Rmb, ann avg) Exchange rate (US$/Rmb, year end) Fiscal and external balance Budget balance (% of GDP) Merchandise exports (fob) (US$bn) - y/y % chg volume - y/y % chg value (% of GDP) Merchandise imports (fob) (US$bn) - y/y % chg volume - y/y % chg value (% of GDP) Merchandise trade balance (fob) (US$bn) (% of GDP) Current account balance (US$bn) (% of GDP) Inwards foreign direct investment (US$bn) (% of GDP) Outwards foreign direct investment (% of GDP) Foreign exchange reserves (ex gold, US$bn) (% of GDP) Months' Import Coverage Other capital flows, net (US$bn) (% of GDP) Liquidity and market rates Narrow money supply (%, Dec-Dec) Broad money supply (%, Dec-Dec) Loan growth (%, Dec-Dec) Overnight rate (%, year end) 1-year lending rate (%, year end) 1-year deposit rate (%, year end rate) Key assumptions Current account Return on fx holdings Return on inwards FDI
6.1 3.9 8.3 8.3 -1.3 593 35.3 35.4 30.5 534 28.1 35.8 27.5 59 3.0 69 3.5 55 2.8 2 0.1 610 31.4 14 85 4.4 14.1 14.9 14.4 1.9
3.0 3.9
4.3 9.3
4.7 8.0
5.0 8.4
4.8 8.0
4.1 9.2
4.6 9.6
3.0 6.0
3.0 6.0
3.2 6.5
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Fig 15 Growth has further slowed down

Industrial Production, YoY % 25 20 15 10 5 0 JanFeb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2008 2009 2010 2011 2012
Fig 16
65 60 55 50 45 40 35
Jan-08
but PMIs seem to have held up

Official PMI HSBC/Markit PMI
Jan-09
Jan-10
Jan-11
Source: CEIC, Markit, Macquarie Research, March 2012
Fig 17 Inflation expectation has fallen significantly

100 90 80 70 60 50 Macq Consumer Price Expectation Index PBC Depositor Future Price Expectations
Fig 18
% 10 8 6 4 2 0
so have market interest rates

1y AAA bond yield Acceptance bill discounting rate 3m SHIBOR
May-07
May-08
May-09
May-10
May-11
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Sep-07
Sep-08
Sep-09
Sep-10
Source: PBC, CEIC, Macquarie Research, March 2012
Source: Wind, Macquarie Research, March 2012
Fig 19 Housing market has some weakness

3m MA, YoY % 100 80 60 40 20 0 -20 -40 Residential sales Primary housing price index - RHS YoY % 16 12 8 4 0 -4
Fig 20
100 90 80 70 60 50
but a bottom may still be found

Short term housing price outlook Long term outlook
May-10
May-11
Mar-08
Mar-09
Mar-10
Mar-11
Mar-10
Mar-11
Jun-08
Jun-09
Jun-10
Jun-11
Jan-11
Sep-11 Oct-11
Sep-08
Sep-09
Sep-10
Sep-11
Sep-10
Sep-11
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
Nov-10
Fig 21 Monetary easing remains underway

YoY % 50 40 30 20 10 0 Rmb loan stock Real loan stock growth
Fig 22
70 60 50 40 30
as reflected in better credit availability

MNI credit availability
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-08
Jan-09
Jan-10
Jan-11
Nov-11 Jul-11
Source: MNI, Macquarie Research, March 2012
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Jan-12
Apr-08
Oct-08
Apr-09
Oct-09
Apr-10
Oct-10
Apr-11
Oct-11
Apr-08
Oct-08
Apr-09
Oct-09
Apr-10
Oct-10
Apr-11
Jul-08
Jul-09
Jul-10
Jul-11
Jul-08
Jul-09
Jul-10
Jan-12
Jul-10
Jul-11
Jan-12
Ja n09 Ap r-0 9 Ju l-0 9 O ct -0 9 Ja n10 Ap r-1 0 Ju l-1 0 O ct -1 0 Ja n11 Ap r-1 1 Ju l-1 1 O ct -1 1 Ja n12
Jan-12
Apr-08
Oct-08
Apr-09
Oct-09
Apr-10
Oct-10
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Jul-11
AUSTRALIA
DXS AU
- Sum of Parts
Outperform A$0.86
Low A$ 0.94 % +15.6 A$ 0.94-0.97 Real Estate A$m 4,162 A$m 18.3 m 4,839
Dexus Property Group

Many options but ball in DXS court
Event
A recent press report (AFR, 23 March 2012) suggested that DXS may be interested
in acquiring CPA and we accordingly comment on the possibility.
Impact
DXS will be awash with cash following the likely sale of the groups $1.3bn US
Year end 30 Jun Revenue EBIT Reported profit Adjusted profit Gross cashflow CFPS CFPS growth PGCFPS PGCFPS rel EPS adj EPS adj growth PER adj PER rel Total DPS Total DPS growth Total div yield Franking ROA ROE EV/EBITDA Net debt/equity P/BV m m m m m % x x % x x % % % % % x % x
2011A 2012E 2013E 2014E 474.1 448.4 553.0 358.0 374.3 7.7 1.7 11.1 0.91 7.4 0.8 11.6 0.92 5.2 1.6 6.0 0 8.0 7.2 14.9 40.3 0.8 513.0 480.4 321.7 370.1 384.6 7.9 2.7 10.8 0.88 7.6 3.3 11.2 0.88 5.3 3.1 6.2 0 6.7 7.2 11.0 38.7 0.8 509.3 476.5 353.6 371.3 388.1 8.0 0.9 10.7 0.90 7.7 0.3 11.2 0.93 5.4 0.6 6.2 0 6.0 7.0 12.9 25.9 0.8 498.5 465.6 358.0 374.3 391.7 8.1 0.9 10.6 0.94 7.7 0.8 11.1 0.96 5.4 0.8 6.3 0 6.0 6.9 13.2 25.2 0.8
DXS AU vs ASX 200 Prop, & rec history
industrial portfolio and we believe the press article suggesting interest in CPA is not entirely far fetched, particularly given our long held view that Commonwealth Bank may not be long term holders of its listed real estate platform. We see a hostile takeover of CPA as unlikely and whilst any transaction can take several forms, we briefly comment on four scenarios: Full cash takeover + equity raising. With limited strategic/synergy and earnings/cashflow benefits and a takeover that would likely have to occur at aroundCPAsNTA, the requirement for DXS to raise equity at a discount to its NTA would likely see a de-rateinDXSsshareprice(thinkbacktoMGR acquisition of WOT). Full cash takeover + office only. A complete strategy turnaround involving the sale of the Australian industrial portfolio as well as the US would negate the need to raise equity to acquire CPA and would be an overall strategic positive for DXS provided all sales also occur at around book value. The resultant DXS would largely be a pure Australian office trust with ~$7.6bn of assets. NTA for NTA merger. The key variable here is the merger ratio agreed. A merger of equals would be beneficial to the group trading at the bigger discount to NTA - currently DXS. Hard to see why CPA unit holders would accept this and DXS would potentially need to supplement their equity with cash for such a move to be successful. DXS only buy the management rights. Of course depending on the price paid for the management rights, this could be a value enhancing deal for DXS. Although again itshard to see the upside for CPA unit holders and hence why it would be supported by them, unless such a deal was combined with a privatisation with 3rd party investors.

No change.
Price catalyst
12-month price target: A$0.94 based on a Sum of Parts methodology. Catalyst: Sale of US industrial portfolio in CY12

Darren Steinberg has only recently commenced as CEO and is no doubt weighing
Analyst(s)
Paul Checchin +61 2 8232 4197 Ei Phyu Lwin +61 2 8232 2784 Rob Freeman +61 2 8237 1152 paul.checchin@macquarie.com eiphyu.lwin@macquarie.com rob.freeman@macquarie.com
up all options and considerations as to where to take the Group. Whilst a CPA takeover is possible, theballisinDXSscourtandtherearemanywayscorporate activity can eventuate which does not necessarily require the issue of DXS equity. That said, we maintain our view that for DXS, buying back DXS stock at a discount to NTA is better for DXS than buying a lower quality portfolio of assets at NTA and thus do not think such a takeover should be executed absent i) acquisition at a discount to NTA commensurate to which DXS trades, ii) a merger of equals preventing a value transfer from DXS to CPA, iii) reinvestment of sale proceeds which negates the requirement to raise equity or iv) use of third party wholesale equity.
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Considering the options

SaleofDXSsentireUSportfoliowouldseegearingreduceto~16% and thus provide DXS with
capacity to acquire assets, undertake a share buyback or capital distribution or some combination of all three.
Pressspeculation(AFR,23March2012)hassuggestedthatDXSsnewCEO, Darren Steinberg,
may be interested in acquiring CPA. We consider below some of the options. Full cash takeover of CPA funded with equity raising
Commonwealth Property Office (CPA AU, A$0.98, Underperform, TP: A$0.99) has net tangible
assets of ~$2.7bn and thus a cash takeover of CPA would require DXS to raise equity. On our estimates, assuming a takeover at NTA ($1.13ps) and ~$50m consideration for the management rights (50% margin and 6x multiple), DXS would need to raise ~$1.4bn of equity to maintain gearing at ~30%.
This would result in ~6-8% earnings dilution and ~6% NTA dilution after allowing for the
achievement of ~$10m of cost savings post the acquisition and thus is unlikely to be well received bythemarket.IndeedoneonlyneedstolookatthemarketreactionstoMGRsacquisitionof WOT to see what the market thinks of issuing equity below NTA to buy assets at NTA.
Fig 1 CashfundedacquisitionwouldbeearningsandNTAdilutiveatCPAsNTA
Post-US sales 7.6 7.6 1.01 16.1% Post-CPA bid & $1.4bn equity raising 7.1 7.0 0.95 30.0% Increment al change (6.0%) (7.9%) (5.7%) 1,389
Current FY13 forecast EPS FY14 forecast EPS December 2011 NTA Gearing cps cps $ bps 7.7 7.7 1.01 29.0%
Change (1.5%) (1.4%) -% (1,288)
Note: Our current EPS forecasts assume the sale of the Central portfolio in FY13 Source: Macquarie Research, March 2012
Strategically there would be some scale benefits from increasing the office footprint however given
DXS already has a $4.6bn office portfolio, most of these scale benefits would already be being achieved and we expect any incremental benefit would be limited. In fact we note the likely dissatisfactionwithcombiningDXSshigherqualityportfoliowithCPAs lower quality office portfolio.
Under this scenario investors would be best positioned long CPA and short DXS.
Full takeover and become a pure office REIT

DXSscurrentonbalancesheetexposureisbroadly60%office,22%Australianindustrialand
17% US industrial. Given the likely (and expected) sale of the US industrial portfolio, DXS will become an Australian office and industrial REIT. With limited scale in the Australian industrial sector it may make sense to subsequently divest the Australian industrial portfolio as well.
Sale at book value would bring a further ~$1.5bn in the door and put DXS in a net cash position,
providing it with the capacity to fund an acquisition of CPA without the need to raise further equity.
Fig 2 Sale of all industrial would provide the capital to buy CPA
Post-US & Australian sales 7.4 7.5 1.01 Net cash PostCPA bid 7.5 7.3 0.99 33.0% Incremental change 2.1% (2.3%) (1.7%) N/A Total change (1.8%) (5.8%) (1.7%) 400
Change (3.7%) (3.6%) -% N/A
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Whilst dilutive to earnings, given the higher yield from the industrial portfolio, the pure focus on
Australian office could result in a re-rate of the stock, albeit the stock will become more cyclical. Other key assumptions we make are a $7m pa overhead cost saving post the sale of the Australian industrial portfolio and $10m pa of cost synergies on merger with CPA.
This scenario would be positive for both CPA and DXS, although clearly CPA would be the
outperformer in the near term. NTA for NTA merger

The outcome will depend on the merger ratio agreed. A merger of equals would be beneficial to
the group trading at the bigger discount to NTA - currently DXS @ 14.9% vs CPA @ 13.7% discount.
Fig 3 100% Scrip bid, merger of equals at NTA

Current FY13 forecast EPS FY14 forecast EPS December 2011 NTA Gearing cps cps $ bps 7.7 7.7 1.01 29.0% Post-US sales 7.6 7.6 1.01 16.1% Change (1.5%) (1.4%) -% (1,288) Post-CPA bid 7.3 7.3 1.00 16.1% Incremental change (3.9%) (4.5%) (1.1%) (4)
Whilst currently this would be a good outcome for DXS unit holders given its stock is trading at the
larger discount, earnings will be diluted as again a transition from industrial to office occurs. We would envisage CPA unit holders would seek some merger premium which again would be to the detriment of DXS unit holders, through the application of a merger ratio that results in value for CPA unit holders. Such an outcome would be received in a similar vein to the MGR/WOT and CPA/Grocon deals in our view.
Under the scenario of an NTA for NTA merger of equals, investors would be best
positioned long DXS and short CPA, however we note that any change to the merger ratio would change this outcome.
Also, in the case above, DXS would be left in an under geared position. We therefore also
determine the financial implications of using bid consideration of cash and DXS scrip at a ratio of 50/50.ThepositivespreadbetweenborrowingcostsandCPAsearningsyield results in more limited earnings dilution.
Fig 4 Dilution limited if consideration is 50/50 cash/scrip

Current FY13 forecast EPS FY14 forecast EPS December 2011 NTA Gearing cps cps $ bps 7.7 7.7 1.01 29.0% Post-US sales 7.6 7.6 1.01 16.1% Change (1.5%) (1.4%) -% (1,288) Post-CPA bid 7.4 7.4 1.00 30.0% Increment al change (1.6%) (3.6%) (1.3%) 1,391
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Macquarie Research
No takeover and buy back stock at a discount

The above three scenarios all involve DXS acquiring CPA at NTA. Of course with DXS stock
trading at a ~15% discount to NTA it is questionable as to why the best use of proceeds is not to buy back DXS stock. Indeed, a buyback would be earnings, cashflow and NTA accretive and we believe the best use of proceeds.
Fig 5 Share buy back accretive to earnings and NTA

Current FY13 forecast EPS FY14 forecast EPS December 2011 NTA Gearing Cps Cps $ Bps 7.7 7.7 1.01 29.0% Post-US sales 7.6 7.6 1.01 16.1% Change (1.5%) (1.4%) -% (1,288) Post-10% buyback 7.8 7.8 1.03 22.5% Incremental change 3.0% 2.4% 1.6% 640
Furthermore, DXS would still have capacity to go and make acquisitions even after the buyback of
10% of units on issue.

This is our central case which supports our current Outperform recommendation on DXS.
Just buy management rights, maybe view to privatise with third party equity
Following the potential sale of the US industrial portfolio, DXS could undertake an on market share
buyback for 10% of units on issue and still have capital of ~$700m to deploy, whilst comfortably maintaining gearing of ~30%.
Thus a further scenario that could be executed is that DXS acquire the management rights of
CPA. Assuming a 50% margin and an acquisition multiple of 6x we estimate consideration of ~$50m would need to be provided.
Under this scenario investors would be best positioned long DXS and short CPA.
Fig 6
Acquisitionofmanagementrightsvalueenhancingbutwillcomedowntoprice
Postmanagement rights acquisition 7.7 7.7 1.00 16.9%
Post-US sales 7.6 7.6 1.01 16.1%
Change (1.5%) (1.4%) -% (1,288)
Incremental change 1.3% 1.2% (1.1%) 83
AlthoughitshardtoseetheupsideforCPAunitholdersandhencewhyitwouldbesupportedby
them, unless such a deal was combined with a privatisation to be funded by third party equity. This scenario would be a good outcome for both DXS and CPA although excess returns would clearly rest with the stock to be privatised, namely, CPA, in the short term.
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Macquarie Research
DXS- ESSENTIALS SUMMARY Income Net rental income Funds mgmt income Development profits Property revaluations & FV adjustments Other income Total income Expenses Interest expense Trust & other expenses Total expenses Profit before tax Tax expense OEI Reported net profit after tax Less adjustments to derive dist. Income Reported distributable income Per share data EPS EPS growth DPS DPS growth Cashflow statement Cash flow from operations EBITDA Net interest Change in working capital Tax paid Other Net operating cash flow Cash flow from investing Asset sales Asset purchases Capex- Maintenance Capex - development Other Net investing cash flow Cash flow from financing Issue of equity Debt movement Distributions paid Other Net financing cash flow Net cash flow Balance sheet Total current assets Total non current assets TOTAL ASSETS Total current liabilities Total non current liabilities TOTAL LIABILITIES TOTAL EQUITY A$m A$m A$m A$m A$m A$m A$m A$m A$m A$m A$m A$m A$m A$m A$m A$m A$m A$m A$m A$m A$m A$m A$m A$m A$m A$m A$m A cps % A cps % A$m A$m A$m A$m A$m A$m A$m A$m A$m A$m A$m A$m A$m A$m A$m
FY10A
FY11A
FY12F
FY13F
FY14F
484 6 (270) 5 225 191 33 223 2 (30) 0 31 319 350 7.3 (29.5%) 5.1 (30.1%)
467 4 3 192 3 669 53 40 93 576 21 2 553 (195) 358 7.4 0.8% 5.2 1.6%
503 6 5 62 8 583 196 48 245 338 15 2 322 48 370 7.6 3.3% 5.3 3.1%
503 4 2 6 516 108 49 156 359 3 2 354 18 371 7.7 0.3% 5.4 0.6%
492 5 2 7 505 92 49 142 364 4 1 359 16 376 7.7 0.8% 5.4 0.8%
488 (187) 43 1 (4) 340 589 (311) (79) (109) 91 90 (234) (210) (90) (444) (14) 159 7,712 7,871 483 2,381 2,865 5,006
460 (168) (32) 0 (20) 239 171 (104) (102) (192) (227) 15 246 (241) (15) 5 17 213 7,775 7,988 585 2,096 2,681 5,307
494 (159) 3 (2) 8 344 185 (39) (100) (84) (38) 8 (261) (0) (253) 53 251 7,946 8,198 276 2,451 2,726 5,437
492 (129) (3) 360 630 (89) 541 (630) (260) (890) 10 262 7,406 7,667 276 1,827 2,103 5,564
480 (114) (4) 362 (89) (89) (262) (262) 11 273 7,495 7,767 276 1,827 2,103 5,665
26 March 2012
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AUSTRALIA
PMV AU
- Sum of Parts
Neutral A$5.55
Low A$ 5.70 % +9.2 A$ 5.35-5.60 A$m A$m m Retailing 861 0.7 155.2
Premier Investments
Just a very good cost performance
Event
Review of forecasts and outlook post 1H result release and results lunch.
PMV reported 1H12 NPAT of $38.5m down 2.3% (Macq E $34.4m). EBIT from Premier Retail of $51.1m was down 2.3% (Macq E $45m)
Year end 31 Jul Revenue EBIT Reported profit Adjusted profit Gross cashflow CFPS CFPS growth PGCFPS PGCFPS rel EPS adj EPS adj growth PER adj PER rel Total DPS Total div yield Franking ROA ROE EV/EBITDA Net debt/equity P/BV m m m m m % x x % x x % % % % x % x
Impact
The three key discussion points to come from the PMV result were firstly, how
2011A 2012E 2013E 2014E 880.5 65.7 40.5 51.5 73.2 47.1 -14.6 11.8 1.14 33.2 -21.0 16.7 0.96 36.0 6.5 100 4.5 4.3 7.7 -14.6 0.7 845.8 75.7 57.3 57.3 77.2 49.3 4.6 11.3 1.24 36.6 10.4 15.2 1.00 36.0 6.5 100 5.2 4.8 7.1 -14.6 0.7 878.2 88.6 66.2 66.2 84.6 54.0 9.6 10.3 1.39 42.2 15.3 13.1 1.18 36.0 6.5 100 6.1 5.5 6.3 -15.8 0.7 901.2 95.8 71.2 71.2 88.9 56.7 5.1 9.8 1.41 45.4 7.6 12.2 1.21 38.0 6.8 100 6.5 5.9 6.0 -17.6 0.7
much further is there to go and how sustainable are the benefits of the margin improvement program which was key the driver of the better than expected 1H12 result? Part of this is likely a timing issue related to the acceleration of cost initiatives given the weaker retail environment. Rental growth has been contained, even allowing for the benefits of onerous lease provisions while the focus on store labour efficiency and productivity is being realised. Gross margin reduction (-36bp) was less than forecast given sales and likely reflects the benefits of the inventory clean-out undertaken in 4Q11. Commentary suggests a number of major cost projects underway together with new merchandise and non-merchandise trading terms implemented in January should continue to provide an offset to a weaker sales environment into FY13.
PMV AU vs Small Ordinaries, & rec history
Secondly, alargepartofthegroupsfuture organic growth is expected to come online and from the roll-out of Smiggle and potentially Peter Alexander in Asia. As with any expansion into larger international markets, this opportunity also comes with increased execution risk but in the Singapore launch of Smiggle, PMV appear to have made a very good start. All brands are now online but the initiative is still in its infancy and evolving. An aspirational target of 10% of sales online by 2015 does not appear unrealistic given the focus and investment. brands? The Portmans turnaround appears to be gaining traction and while early days for the new management teams the performances of Jay Jays, Jacqui E and Dotti which collectively represent ~45% of sales were disappointing and if not arrested have the potential to offset the benefits of the above initiatives. We expect it may take until 1H13 results to see if the green shoots highlighted in Dotti and Jay Jays take hold.
Finally, can the management changes underway rejuvenate the larger mature

No material change to earnings or PT. Our $75m EBIT forecast for Just
remains below the $80m low-end guidance range which was predicated on a much improved 4Q12 result.
Price catalyst
12-month price target: A$5.70 based on a Sum of Parts methodology. Catalyst: FY12 results
adam.simpson@macquarie.com
Analyst(s)
Adam Simpson +61 2 8232 4439

PMVsmainattractionsremainthelargecashbalanceandthecostreduction
program underway that has the potential to provide some offset to the softer sales environment. Neutral retained.
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Macquarie Research
Premier Investments
Analysis
Fig 1 1H12 result snapshot
$m Sales EBITDA Depreciation Amortisation EBIT Net Interest expense Pre-Tax Profit Tax Expense Net Profit Reported Earnings Adjusted Earnings Gross Cashflow EPS (Adj/dil) EPS growth EBITDA/Sales EBIT/Sales 1H11a 466.0 62.9 10.7 0.0 52.2 -4.0 56.2 16.8 39.4 39.4 39.4 61.6 25.4 -10.7 13.5% 11.2% 2H11a 414.5 24.5 11.0 0.0 13.5 -3.7 17.2 5.1 12.1 1.1 12.1 17.3 7.7 -42.6 5.9% 3.3% FY11a 880.5 87.4 21.7 0.0 65.7 -7.7 73.4 21.8 51.5 40.5 51.5 78.9 33.1 -20.8 9.9% 7.5% 1H12a 436.1 61.1 10.0 0.0 51.1 -3.0 54.1 15.6 38.5 38.5 38.5 53.7 24.6 -3.3 14.0% 11.7% Change -6% -3% -7% -2% -25% -4% -7% -2% -2% -2% -13% 1H12e 451.9 55.4 9.5 0.0 45.9 -3.1 49.0 14.6 34.4 34.4 34.4 47.6 22.0 -13.5 12.3% 10.2% Change -3% 10% 5% 11% -3% 10% 7% 12% 12% 12% 13%
As can be seen in the table below, whilst 1H sales were well below our forecasts (LFL sales -7.1%
versus Macq E -4%) this was more than offset by reductions in CODB %.
The better than expected margin performance largely reflects the acceleration of the cost
reduction program with reductions in both absolute dollars and as a percentage of sales across all cost lines.
Gross margin reduction (-36bp) was less than forecast given the weaker sales environment and
likely reflects the benefits of the inventory clean-out undertaken in 4Q11
Fig 2 Just Group Financial results

$m Sales LFL Sales* Gross Profit** Gross margin % Costs Salaries % of Sales Rent % of Sales Advertising & Direct Marketing % of Sales Other CODB % of Sales Total op costs % of sales Other income Share of JV profit EBITDA Depreciation & Impairment % of Sales EBITA Margin 1H11 458.4 -5.1% 284.2 62.0% 103.4 22.6% 88.6 19.3% 7.1 1.5% 26.7 5.8% 225.7 49.2% 3.5 1.300 63.3 10.7 2.3% 52.5 11.5% 2H11 407.6 1.0% 236.9 58.1% 101.2 24.8% 88.9 21.8% 6.4 1.6% 21.8 5.4% 218.4 53.6% 5.3 -0.1 23.7 10.9 2.7% 12.8 3.1% FY11 866.0 -2.8% 521.1 60.2% 204.6 23.6% 177.5 20.5% 13.5 1.6% 48.5 5.6% 444.1 51.3% 8.8 26.9% 1.180 87.0 21.7 2.5% 65.3 7.5% 0.0 61.3 9.973 2.3% 51.3 56.0 -3.1% -7.1% -2.3% 7.7% 1H12 433.8 -4.3% 267.4 61.6% 98.8 22.8% 87.8 20.2% 4.8 1.1% 18.2 4.2% 209.6 48.3% 0.0% Change -5.4% -5.9% 22bps -4.4% 128bps -0.9% -46bps -32.3% -52bps -31.7% 15.9% -7.1% 29bps
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Rental growth has been contained even allowing for the benefits of onerous lease provisions
which we estimate at ~$3m. The focus on store labour efficiency and productivity is being realised in lower wage costs.
Underlying inflationary pressures remain in both major cost lines. PMV has mitigation strategies in
place for both but there is nothing like a return to reasonable LFL growth to offset cost pressures.
More efficient use of marketing expenditure has limited the reduction in advertising presence. 1H12 cash conversion was weaker than pcp. While difficult to fully assess in half-year accounts,
the benefits of the FY11 provisions appear to have been reflected in the weaker cashflow.
Fig 3 1H12 cash conversion

$m EBITDA Operating Cashflow (reported) + Tax Paid + Net interest paid Ungeared Pre tax Cashflow Profit to cash Conversion FY09 (a) 122.0 77.4 36.6 -20.6 93.4 76.5% 1H10(a) 71.5 60.2 11.7 -3.0 68.9 96.4% 2H10(a) 30.7 14.4 14.3 -4.3 24.4 79.6% FY10(a) 102.1 74.6 26.0 -7.1 93.6 91.6% 1H11(a) 62.9 56.8 5.4 -3.0 59.2 94.1% 2H11(a) 24.5 14.2 10.9 -4.9 20.2 82.5% FY11(a) 87.4 71.0 16.2 -7.9 79.3 90.8% 1H12(a) 61.1 45.5 10.3 -2.5 53.3 87.3%
The interim dividend of 18cps was in line with pcp and our forecasts. Cash on hand totalled
$303m and Just GroupsdebtfacilitieshavebeenrefinancedandextendedtoMarch2015. Outlook

Given the tougher than expected retail environment PMV has now guided towards the bottom of
its $80$95m profit guidance for Just group EBIT. This guidance is still predicated on a much improved performance through the key 4Q period. 4Q11 was characterised by relatively strong sales but weak margins as the aggressive inventory reduction was undertaken.
Commentary suggests guidance assumes an improvement in the current LFL run rate (0 to -3%)
and a much improved gross margin performance.

At this stage we have made no material change to our forecast of Just Group EBIT of $75m.
Fig 4 FY12 Valuation

$m Just Group less corporate costs Breville Group Corporate costs Enterprise Value Less net Debt MV of equity Equity value per share Source: Company data, Macquarie Research, March 2012 EBITA FY12E $74.9 25% stake -$4.6 $70.32 High 7.5 7.5 9.2 Multiple Low 7 7 8.7 High 561.9 120.0 -34.5 $647.4 -$174.4 $821.8 $5.59 Valuation Low 524.4 120.0 -32.2 $612.2 -$174.4 $786.7 $5.35
Our price target based on mid-point of current and forward valuation is $5.70 (was $5.55). PMVsmainattractionsremainthebalancesheetflexibilityprovidedbythestrongcashbalance
and the cost reduction program underway that has the potential to provide some offset to the softer sales environment. While the Smiggle and Peter Alexander brands have good growth potential, the brands are still currently relatively small in the overall scheme of the group.
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Premier (PMV:$5.55)
Interim results Revenue EBITDA Depreciation Amortisation of goodwill EBIT Net Interest expense Pre-Tax Profit Tax Expense Net Profit Outside equity interests Net Abn/Extra Reported Earnings Adjusted Earnings Gross Cashflow EPS (Adj/dil) EPS growth CFPS CFPS Growth EBITDA/Sales EBIT/Sales Earnings Split Revenue Growth EBIT Growth Profit and Loss ratios Revenue Growth EBIT Growth EBITDA/Sales EBIT/Sales Effective tax rate Payout ratio EV/EBITA EV/EBITDA EV/Sales Balance sheet ratios ROE ROA ROFE Net Debt Net Debt/Equity Interest Cover Price/NTA NTA per share EFPOWA Historical performance Revenue EBITDA Depreciation/Amortisation EBIT Net interest expense Pre-Tax Profit Tax Expense Net Profit Net Abn/Extra EPS (adj/dil) EPS growth Ordinary DPS EBITDA/Sales EBIT/Sales ROE ROFE EFPOWA
$m $m $m $m $m $m $m $m $m $m $m $m $m c % c % % % % % %
1H/11A 466.0 62.9 10.7 0.0 52.2 -4.0 56.2 16.8 39.4 0.0 0.0 39.4 39.4 61.6 25.4 -10.7 39.7 -5.4 13.5 11.2 76.5 -1.5 -10.8 2011A 0.9 -20.2 9.9 7.5 29.8 108.9 10.5 7.9 0.8
2H/11A 414.5 24.5 11.0 0.0 13.5 -3.7 17.2 5.1 12.1 0.0 -11.0 1.1 12.1 17.3 7.7 -42.6 11.0 -18.3 5.9 3.3 23.5 3.7 -43.4 2012E -3.9 15.3 11.3 9.0 29.7 98.3 9.1 7.2 0.8
1H/12A 436.1 61.1 10.0 0.0 51.1 -3.0 54.1 15.6 38.5 0.0 0.0 38.5 38.5 53.7 24.6 -3.3 34.3 -13.5 14.0 11.7 67.1 -6.4 -2.0 2013E 3.8 17.0 12.2 10.1 30.0 85.3 7.6 6.3 0.8
2H/12E 409.7 34.4 9.8 0.0 24.6 -2.8 27.5 8.6 18.8 0.0 0.0 18.8 18.8 25.8 12.0 55.4 16.5 49.0 8.4 6.0 32.9 -1.2 82.5 2014E 2.6 8.1 12.6 10.6 30.0 83.7 6.8 5.7 0.7
Profit & Loss Revenue EBITDA Depreciation Amortisation of goodwill EBIT Net interest expense Pre-Tax Profit Tax Expense Net Profit Outside equity interests Net Abnormals/Extra. Reported Earnings Adjusted Earnings Gross Cashflow EPS (adj/diluted) EPS growth PE (adj) CFPS CFPS Growth PGCFPS DPS Yield Franking Cashflow Analysis Pre-tax Profit Depreciation & Amortisation Tax Paid Gross cashflow Changes in working capital Other Operating Cashflow Acquisitions Capex - Plant & Equip. Asset Sales Other Investing cashflow Dividend (ordinary) Equity raised Other Financing cashflow Net Change in cash/debt Balance Sheet Cash Receivables Inventories Investments Property, plant & equipment Intangibles Other Assets Total Assets Payables Short Term Debt Long Term Debt Other Liabilities Total Liabilities Shareholders Funds Minority Interests Total Shareholders Equity Total Funds employed
$m $m $m $m $m $m $m $m $m $m $m $m $m $m c % x c % x c % %
2011A 880.5 87.4 21.7 0.0 65.7 -7.7 73.4 21.8 51.5 0.0 -11.0 40.5 51.5 78.9 33.1 -20.8 16.8 50.4 -11.0 11.0 36.0 6.5 100.0 2011A
2012E 845.8 95.5 19.8 0.0 75.7 -5.8 81.6 24.2 57.3 0.0 0.0 57.3 57.3 79.5 36.6 10.7 15.2 50.8 0.9 10.9 36.0 6.5 100.0 2012E 81.6 19.8 -21.8 79.5 -1.5 -0.7 77.3 0.0 -12.0 0.0 0.0 -12.0 -55.9 0.0 -9.0 -64.9 0.4 2012E 307.8 8.5 72.7 104.5 77.0 854.5 28.0 1453.0 46.5 3.8 129.6 77.9 257.8 1195.3 0.0 1195.3 1,453.1
2013E 878.2 107.1 18.5 0.0 88.6 -5.9 94.5 28.4 66.2 0.0 0.0 66.2 66.2 88.8 42.2 15.3 13.1 56.6 11.4 9.8 36.0 6.5 100.0 2013E 94.5 18.5 -24.2 88.8 -1.3 -3.4 84.0 0.0 -12.4 0.0 0.0 -12.4 -55.9 0.0 0.0 -55.9 15.8 2013E 307.8 8.8 75.5 104.5 70.8 854.5 28.0 1450.0 48.3 3.8 113.8 78.6 244.5 1205.6 0.0 1205.6 1,450.1
26-Mar-12 2014E 901.2 113.5 17.8 0.0 95.8 -5.9 101.7 30.5 71.2 0.0 0.0 71.2 71.2 91.1 45.4 7.6 12.2 58.1 2.6 9.6 38.0 6.8 100.0 2014E 101.7 17.8 -28.4 91.1 6.3 -1.4 95.9 0.0 -12.7 0.0 0.0 -12.7 -59.0 0.0 0.0 -59.0 24.2 2014E 337.8 9.0 76.6 104.5 65.8 854.5 28.0 1476.3 55.9 3.8 119.6 79.4 258.6 1217.7 0.0 1217.7 1,476.4
% % % % % % x x x
$m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m
% % % $m % x x $ m
4.3 5.8 6.5 -174.0 <0 nmf 2.6 2.17 156.5 2008A 2.5 -0.6 0.0 -0.6 -60.1 59.5 17.7 41.8 -5.4 46.3 -93.5 29.0 -25.2 -25.2 5.1 1.5 90.2
4.8 6.6 7.4 -174.4 <0 nmf 2.6 2.17 156.5 2009A 846.8 122.0 25.6 96.4 -14.2 110.6 27.9 82.7 0.0 59.2 27.8 75.0 14.4 11.4 8.4 20.5 139.7
5.5 7.7 8.7 -190.2 <0 nmf 2.5 2.24 156.7 2010A 872.9 102.1 19.8 82.3 -7.1 89.4 26.3 63.0 16.6 41.8 -29.5 66.0 11.7 9.4 5.3 8.6 147.0
5.9 8.4 9.5 -214.4 <0 nmf 2.4 2.32 156.7 2011A 880.5 87.4 21.7 65.7 -7.7 73.4 21.8 51.5 -11.0 33.1 -20.8 36.0 9.9 7.5 4.3 6.5 156.5
73.4 21.7 -16.2 78.9 -7.5 -0.3 71.0 -18.4 -22.8 0.0 -0.2 -41.4 -71.3 0.0 9.8 -61.5 -31.8 2011A 307.8 6.1 73.4 104.5 84.8 854.5 30.9 1462.0 46.3 133.8 0.0 88.1 268.2 1193.8 0.0 1193.8 1,462.0
$m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m $m
$m $m $m $m $m $m $m $m $m c % c % % % % m
www.macquarie.com.au/merel
Sydney Melbourne
(612) 9237 3434 (613) 9365 8139
London Munich
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Hong Kong New York
(852) 2823 3727 (212) 548 6500
26 March 2012
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AUSTRALIA
HZN AU
Price (at 05:29, 26 Mar 2012 GMT) Volatility index 12-month target 12-month TSR Valuation GICS sector Market cap 30-day avg turnover Number shares on issue Investment fundamentals
Year end 30 Jun Revenue EBIT Reported profit Adjusted profit Gross cashflow CFPS CFPS growth PGCFPS PGCFPS rel EPS adj EPS adj growth PER adj PER rel Total DPS Total div yield ROA ROE EV/EBITDA Net debt/equity P/BV m m m m m % x x % x x % % % x % x
Outperform A$0.33
A$ % A$ A$m A$m m High 0.55 +66.7 0.72 Energy 373 1.4 1,131
Horizon Oil
Getting its finances in order
Event
HZN has executed a 6-year, U$160m reserves-based debt facility with a
margin of 3-4% over LIBOR.
- DCF (WACC 11.1%, beta 1.6, ERP 5.0%, RFR 6.1%)
Impact
Fully funded for Stanley and Beibu Gulf: UnderMacquariesbullishoil
2011A 2012E 2013E 2014E 59.4 32.6 34.9 16.3 27.2 2.4 -15.4 14.4 1.39 1.4 -17.6 23.9 1.37 0.0 0.0 14.0 12.2 8.4 -33.4 2.6 59.4 29.9 16.6 14.7 26.4 2.3 -3.0 14.8 1.62 1.3 -9.7 26.5 1.76 0.0 0.0 9.2 9.1 8.8 20.2 2.3 182.2 81.6 47.5 47.5 94.1 8.3 257.0 4.1 0.56 4.2 222.6 8.2 0.74 0.0 0.0 20.1 24.6 2.9 42.1 1.8 304.4 154.5 97.6 97.6 156.8 13.9 66.6 2.5 0.36 8.6 105.4 4.0 0.40 0.0 0.0 30.5 36.7 1.7 -2.8 1.2
HZN AU vs Small Ordinaries, & rec history
price forecasts, we previously estimated a ~U$100m funding gap over the development period, hence the new facility not only bridges this gap but also provides an additional buffer in the event of cost overruns. New reserves can also be brought into the facility, ensuring a viable funding option for the potential development of PRL 21. That said, HZN could look to sell-down part of its interest in the block, given the attractive read-through of recent deals. Separately, the facility matures in late 2018, which is after first production at Beibu Gulf and Stanley and more than 2 years after the U$80m convertible note falls due ensuring that HZN will not face a large, simultaneous drain on liquidity in the future. Hedging a small portion of the production base: Despite not being a requirement of the facility, the Board has prudently decided to hedge part of the Maari production base over the development period. While this is likely to be a meaningful portion of current production, it will represent only a fraction ofHZNsproductionbasenextyearonceBeibuGulfisonline and is likely to roll-off by the time Stanley is commissioned. This should ensure HZN to maintain a healthy, unhedged exposure to oil prices over the interim period. Additional resource upgrades likely at PRL 21: HZNsJVpartnerinPRL 21, Kina Petroleum (KPL AU, A$0.30sh, not rated), recently announced a resource upgrade at Elevela translating to a ~50% increase from HZN previously estimates (~70mmboe net). While HZN expects to carry out an independent review of resources on the PRL 21 block, this supports the encouraging results at Elevela-2. The Ketu-2 well is due to reach the primary target in coming weeks however this is a more aggressive step-out well, located ~9km south east of the original discovery.

We have incorporated Stanley into our financial forecasts and assumed that
~250kbbls per annum of Maari production is hedged at U$120/bbl. Our NAV remains unchanged and there are only minor changes to near-term earnings.
Source: FactSet, Macquarie Research, March 2012 (all figures in USD unless noted)
Price catalyst
12-month price target: A$0.55 based on a DCF methodology. Catalyst: Initial results from the Ketu-2 appraisal well are expected in the
Analyst(s)
Kirit Hira +61 2 8232 9692 Adrian Wood +61 2 8232 8531 kirit.hira@macquarie.com adrian.wood@macquarie.com
coming weeks. Following this, weexpectpositiverevisionstoHZNsresource position in PRL 21.

Maintain an Outperform rating and a A$0.55/sh target price: Confirmation
of the U$160m debt facility largely resolves the perceived funding gap management were facing. With the recent Talisman-Mitsubishi transaction likely to provide valuation support, focus will now shift to successful delivery of Beibu Gulf and a ramp up of development activity at Stanley.
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Fig 1 Despite an active development period, gearing levels are not expected to reach previous highs of ~60% post development of Maari
200 180 160 140 120 100 80 60 40 20 2H08 1H09 2H09 1H10 2H10 1H11 2H11 1H12 2H12 1H13 2H13 1H14 2H14
Fig 2 The U$160m facility provides a more than adequate funding buffer even in a weaker oil price environment
180 160 140 120 100 80 60 40 20 0 The U$160m facility offers more than enough buffer even if oil prices fall Funding Gap (U$m)
Total Debt - US$m
ND/ND+E
70% 60% 50% 40% 30% 20% 10% 0%
100
105
110
115
120
125
130
135
ST Debt (LHS) CB (LHS)
LT Debt (LHS) ND/ND+E (RHS)
Brent Oil Price (U$m)
Fig 3 Development capex is expected to ramp up in 2H12 as Beibu Gulf approaches completion and Stanley activity ramps up
(90.0) (80.0) (70.0) (60.0) (50.0) (40.0) (30.0) (20.0) (10.0) 10.0
1H08 2H08 1H09 2H09 1H10 2H10 1H11 2H11 1H12 2H12 1H13 2H13 1H14 2H14
Fig 4 Production is expected to grow from 1,500bopd currently to as high as 8,000bopd as Beibu Gulf and Stanley comes online
9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 1Q09 4Q09 3Q10 2Q11 1Q12 4Q12 3Q13 2Q14 1Q15 4Q15 3Q16 2Q17 1Q18 4Q18 3Q19 2Q20
Capex - US$m
FCF - US$m
100.0 80.0 60.0 40.0 20.0 (20.0) (40.0) (60.0) (80.0)
boe/d
Devl. (LHS)
Expl. (LHS)
Free CF (RHS)
Maari/Manaia
Wei
Stanley
Fig 5 With the new debt facility now executed we estimate a ~$65m funding surplus during the Beibu Gulf and Stanley development period
Cash flow scenarios to end 2013 Starting cash balance @31-Dec-2011 Operating cash flows Beibu Gulf development Stanley liquids development Elevala/Ketu-2 appraisal Exploration spend Working Capital Acquisition of 25% in PPL 259 and carry PNG Govt back-in Maari development cost Corporate overheads Bargain purchase option on FPSO "Roroa" Reserves-based facility Funding shortfall or surplus Source: Macquarie Research, March 2012 US$m 34.8 181.9 -83.7 -123.7 -20.0 -36.4 -20.0 -8.9 15.0 -14.3 -15.0 -3.3 160.0 66.5 Comments Assuming Maari production remains ~17-18kbopd gross Assuming U$350m gross development capex, ~17% ahead of budget Assuming U$330m gross development capex, ~10% ahead of budget Drilling commenced in Dec 2011 2D Seismic program at PEP 51313, Drilling of Pike U$2.5m acquisition costs and maximum capex carry of U$6.375 22.5% of sunk capex Estimated development cost of M2A/Manaia upside ~U$6m p.a. for corporate overheads More likely to exercise this option after 2013 Reserves-based debt facility now secured We see a ~$65 funding surplus between now and 2014
27 March 2012
105
140
70
75
80
85
90
95
Macquarie Research
Horizon Oil
Fig 6
Horizon Oil financials

Share Price: A$0.33
Shares: 1130.8m
US$m US$m US$m US$m US$m US$m US$m US$m US$m US$m US$m US$m US$m US$m US$m US$m US$m Acps % USc Ac % m 1H12A 2H11E FY11A FY12E FY13E FY14E 28 31 59 59 182 304 0 0 (1) 0 1 (1) 28 32 59 60 183 303 (8) (10) (15) (18) (55) 90 20 22 44 42 128 214 (0) (3) (0) (3) (15) (6) 20 19 43 39 113 208 (5) (5) (11) (9) (32) (53) (0) (0) (0) 15 15 33 30 82 155 (5) (2) (3) (7) (8) (11) 10 13 30 22 74 144 (3) (5) (14) (8) (26) (46) 7 8 16 15 47 98 2 19 2 8 8 35 17 47 98 7 8 16 15 47 98 0.6 (37%) 0% 1,131 0.7 23% 0% 1,131 1.4 (18%) 100% 1,130 1.2 (10%) 100% 1,131 3.8 223% 100% 1,131 7.9 105% 100% 1,131 Price assumptions US$/A$ Oil - Brent Production Natural gas Crude & condensate Total production Production rate US$/bbl 1H12A 2H11E FY11A FY12E FY13E FY14E 0.99 1.09 1.02 1.04 1.10 1.09 111.14 111.50 96.76 111.32 117.25 124.25 1H12A PJ kbbls kboe bopd 245.2 245.2 1,343 2H11E 268.0 268.0 1,469 FY11A 576.2 576.2 1,579 FY12E FY13E FY14E 513.2 1,601.3 2,333.5 513.2 1,601.3 2,652.3 1,406 4,387 7,267
Horizon Oil (HZN-AU)

Outperform
Profit & Loss Sales revenue add other income Total revenue less operating costs EBITDAX less exploration expensed EBITDA less dep. & amort. less other non-cash costs EBIT less net interest Pre-tax operating profit less tax expense (incl APT) Net operating profit add non-recurring items Reported profit Adjusted profit EPS (Adjusted) EPS Growth DPS DPS Franking EFPOWA shares on issue
2500 2000 1500 1000 500 0
kboe
Gas
Crude
FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20
Cashflow Analysis Cash receipts from operations US$m less operating costs US$m less interest paid US$m less tax paid US$m Gross cashflow from operationsUS$m less expl & devlp US$m less acq./inv. US$m less dividends US$m add debt movements US$m add equity/other US$m Net cashflow US$m +exchange rate adjustments US$m Increase in cash US$m Net debt (cash) US$m Balance sheet Cash Other current Assets Fixed Assets Total Assets Current Liabilities Total Liabilities Shareholder equity Ratio analysis ND/ND+E Interest cover Dividend payout ratio ROA ROE ROIC Effective tax rate EBITDA margin EBIT margin Free cash flow Valuation EV/EBITDAX ratio P/E ratio P/CEPS ratio FCF yield Dividend yield
1H12A 2H11E FY11A FY12E FY13E FY14E 23 32 59 54 183 303 (10) (10) (11) (19) (55) (90) (3) (2) (2) (5) (8) (11) (6) (5) (5) (11) (26) (46) 4 15 42 19 94 157 (30) (73) (77) (104) (151) (57) 22 (0) (0) (3) 38 50 35 57 1 (30) (20) 38 (49) 0 100 (0) 0 (0) (30) (20) 38 (49) 0 100 56 114 (57) 32 91 (9) 1H12A 35 17 256 308 38 146 161 2H11E 15 17 322 354 34 184 170 FY11A 65 5 224 293 33 141 153 FY12E 15 17 322 354 34 184 170 FY13E 15 17 427 459 32 242 217 FY14E 115 17 424 556 32 242 315
Reserves Natural gas Crude & condensate Total reserves 2P reserve life Mkt cap / 2P reserves EV / 2P reserves Per bbl statistics Sales Revenue / boe EBIT / boe Profit / boe Opex/boe DDA/boe
FY11A Tcf mmbbl mmboe years US$/boe US$/boe 11.4 16.8 32.7 23.0 24.7
FY12E 10.9 16.3 10.2 24.5 25.5
FY13E 9.3 14.7 5.5 27.4 28.2
FY14E 6.8 12.0 4.9 33.3 34.4
US$/boe US$/boe US$/boe US$/boe US$/boe
1H12A 2H11E FY11A FY12E FY13E FY14E 114.3 117.2 103.0 115.8 113.8 114.8 61.5 55.4 56.6 58.3 50.9 58.3 26.9 30.3 28.3 28.7 29.7 36.8 18.1 21.2 13.9 19.7 15.4 13.0 18.5 17.0 18.4 17.7 19.8 20.1
US$m US$m US$m US$m US$m US$m US$m
% x % % % % % % % US$m
1H12A 2H11E FY11A FY12E FY13E FY14E 26% 40% -59% 16% 30% -3% 2.8 x 67.5 x 15.4 x 5.4 x 25.5 x 25.2 x 0% 0% 0% 0% 0% 0% 5% 4% 14% 9% 20% 30% 4% 5% 12% 9% 25% 37% 9% 6% 18% 10% 17% 34% -5% 30% 23% 15% 30% 30% 71% 69% 74% 70% 70% 70% 54% 47% 56% 50% 45% 51% -10 -56 -5 -66 -49 111 1H12A 2H11E FY11A FY12E FY13E FY14E 21.2 x 23.4 x 7.6 x 10.2 x 3.3 x 2.0 x 40.8 x 49.1 x 23.7 x 22.6 x 8.5 x 4.1 x 23.7 x 26.3 x 14.1 x 12.5 x 4.3 x 2.6 x -3.8% -14.0% -1.4% -20.0% -12.2% 27.7% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% NPV 0.72 0.01 1% FY11A 16 0% FY12E 15 0 1% FY13E 48 1 2% FY14E 99 1 1%
NPV @ WACC of 11.0% Developing assets Maari Static assets & exploration Maari upside - M2A/Manaia Beibu Gulf Stanley liquids Elevala/Ketu Liquids Static & Exploration Financial assets Corporate Cash & Investments Debt Group NPV Shareprice prem/(disc) to NPV - core NPV per share (A$) - risked NPV per share (A$) - unrisked NPV per share (A$)
US$m 228 risked valuation @ 50% risked valuation @ 80% risked valuation @ 80% risked valuation @ 40% 62 145 107 116 113 (31) 36 (91) 685
A$ps 0.24 0.06 0.15 0.11 0.12 0.12 (0.03) 0.04 (0.10) 0.72
-55% 0.41 0.72 2.86
x x x
% %
Sensitivities (Adjusted Earnings) Oil price (+US$1/bbl) US$m delta %
27 March 2012
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Fig 7
Horizon Oil NAV breakdown

Interest 10.0% Unrisked mmboe 5.0 5.0 Unrisked USD (m) 228 228 Risk 100% Risked mmboe 5.0 5.0 Risked USD (m) 228 228 USD/boe 45.8 Aps risked 0.24 0.24 Aps unrisked 0.24 0.24 % NPV 33% 33% -$10 0.22 0.22 Sensitivity Base +$10 0.24 0.26 0.24 0.26
Production Assets Maari Sub Total Developing Assets Maari upside - M2A/Manaia Beibu Gulf Stanley liquids Elevala/Ketu Liquids Sub Total Static assets and exploration Beibu Gulf: Wei 12-8E upside Stanley contracted gas Stanley uncontracted gas Ketu/Elevala uncontracted gas PRL 21: Tingu PEP 51313: Pike PEP 51313: Matariki PEP 51313: Te Wahtu PEP 51313: Pukeko Block 22/12: 6-12 North Block 22/12: Sliver Block 22/12: Liushagang Sub Total Financial & Corporate Cash Debt Hedge Book Convertible Bond Corporate costs Sub Total Overall total - core NPV per share (A$) - risked NPV per share (A$) - unrisked NPV per share (A$)
10.0% 27.0% 38.8% 34.9%
2.8 6.3 4.4 9.1 22.7
123 182 133 290 728
50% 80% 80% 40%
1.4 5.1 3.5 3.7 13.6
62 145 107 116 430
44.0 28.6 30.3 31.8
0.06 0.15 0.11 0.12 0.45
0.13 0.19 0.14 0.30 0.76
9% 21% 16% 17% 63%
0.07 0.14 0.08 0.10 0.39
0.06 0.15 0.11 0.12 0.45
0.05 0.17 0.11 0.12 0.45
27.0% 38.8% 38.8% 34.9% 34.9% 30.0% 30.0% 30.0% 30.0% 27.0% 27.0% 27.0%
4.8 23.3 0.1 32.9 15.1 3.0 69.3 29.1 18.9 0.8 0.8 3.2 201
94 159 0 99 151 36 742 304 182 16 16 72 1,871
30% 20% 15% 10% 5% 3% 2.5% 2.5% 2.5% 5% 10% 2.5%
1.4 4.7 0.0 3.3 0.8 0.1 1.7 0.7 0.5 0.0 0.1 0.1 13.4
28 32 0 10 8 1 19 8 5 1 2 2 113
25.8 6.8 3.0 3.0 10.0 12.0 12.0 12.0 12.0 23.2 23.2 23.2
0.03 0.03 0.00 0.01 0.01 0.00 0.02 0.01 0.00 0.00 0.00 0.00 0.12
0.10 0.17 0.00 0.10 0.16 0.04 0.77 0.32 0.19 0.02 0.02 0.08 1.95
4% 5% 0% 1% 1% 0% 3% 1% 1% 0% 0% 0% 8%
0.03 0.04 0.00 0.01 0.01 0.00 0.04 0.01 0.00 0.00 0.00 0.00 0.14
0.03 0.03 0.00 0.01 0.01 0.00 0.02 0.01 0.00 0.00 0.00 0.00 0.12
0.03 0.03 0.00 0.01 0.01 0.00 0.04 0.01 0.00 0.00 0.00 0.00 0.14
229 5 32 229
mmboe
36 (11) 0 (80) (31) (86) 685 USDm
0.04 (0.01) 0.00 (0.08) (0.03) (0.09) 0.72 0.41 0.72 2.86 1,167.0 1,130.8 36.2 0.82 11.0% 0.33 -55%
0.04 (0.01) 0.00 (0.08) (0.03) (0.09) 2.86
5% -2% 0% -12% -4% -13% 91%
0.04 (0.01) (0.01) (0.08) (0.03) (0.09) 0.66 0.26 0.66 2.73
0.04 (0.01) 0.00 (0.08) (0.03) (0.09) 0.72 0.41 0.72 2.86
0.04 (0.01) (0.01) (0.08) (0.03) (0.09) 0.76 0.33 0.76 2.87
Diluted shares outstanding (m) Ordinary Shares on Issue (m) New shares from options and convertible debt (m) Exchange Rate WACC (post tax) Share Price Price premium to NPV
27 March 2012
107
EUROPE/UNITED KINGDOM
Euro area PMI
Index Euro area PMI (LHS) Index 20 65 Euro area PMI (New orders minus 15 60 inventories ,RHS) 10 55 5 50 0 45 -5 40 -10 35 -15 30 -20 25 -25 -30 20 Jan 98 Nov 00 Sep 03 Jul 06 May 09 Mar 12
European and UK economics

The road ahead
Event
! There is a raft of German data out this week the IFO, consumer confidence,
unemployment, retail sales and inflation.
Outlook
! Last weeks PMI data were undeniably disappointing. The expectation was for
Source: Markit, Datastream, Macquarie Research, March 2012
a small rise but the Euro area manufacturing PMI actually fell, to 47.7 from 49.0 in February. Looking at the history of this series, temporary pullbacks in uptrends do occur August 2005 and January 2006 are two examples but they are not that common.
! The details were also poor. New orders fell to 45.6 from 47.3, causing the new
order minus inventories series (which provides as good a guide as there is to future production) to fall for the second month in a row.
! The weakness was also broad-based by country, with both the German and
the French manufacturing PMIs falling. Germany dropped to 48.1 from 50.2 and France to 47.6 from 50.0. For both countries this is the second weakest reading since the 2008/09 disaster. The numbers for the less important services PMIs were not as bad, but they were still down.
! The critical issue for investors, though, is whether this is just a one-off drop in
a broader uptrend, or whether it marks the start of downturn. Our thought is that it is the former.
! The US consumer is gathering momentum, German domestic demand is
doing likewise, and Chinese investment is still growing very strongly. In short, the underlying trend in global final demand is solid. And if this continues a bounce back in production will follow as sure as night follows day.
! There is a swathe of German data out this week. Retail sales, inflation, the
IFO, unemployment and consumer confidence are all released. With the exception of the IFO (where there has to be some downside risk after last weeks disappointing PMI) all these data are second-tier.
! But the retail sales, consumer confidence and unemployment data should all
show incremental improvement, something that will reinforce that German domestic demand is steadily, but surely, improving.
Key releases this week

Day Release German IFO, Mar Euro area M3, Feb Euro area business confidence, Mar German Unemployment, Mar Previous 109.6 2.5%YoY -5.8 0k Macquarie 109.2 2.3%YoY -5.5 -15k Market 109.7 2.5%YoY -5.8 -10k Mon Wed Thurs
Analyst(s)
Daniel McCormack, CFA +44 20 3037 4276 daniel.mccormack@macquarie.com
Source: Bloomberg, Macquarie Research, March 2012
26 March 2012 Macquarie Capital (Europe) Limited Please refer to the important disclosures and analyst certification on inside back cover of this document, or on our website www.macquarie.com.au/disclosures.
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Macquarie Research
Key releases for the week ahead

Importance/ Market Sensitivity Mon Euro area German IFO, Mar Euro area German Gfk consumer confidence, Mar Euro area Euro area M3, Feb German 6 states CPI, Mar High Last/ Mkt Forecast 109.6/109.7 Risk After last weeks disappointing PMI data there is downside risk to the IFO this week. German consumer confidence has been rising steadily over the last couple of years. The propensity to buy index has been up particularly strongly, something which should bode well for spending. Euro area M3 and credit growth has slowed quite sharply in the last couple of months as credit conditions have tightened. A further slowing in February is likely. German inflation should continue to fall despite the recent rise
"
Medium 6.0/6.1
Tues
#
High 2.5%YoY/2.5%YoY
Wed
"
Medium 2.3%YoY/2.2%YoY
$ in the oil price.

Thurs Euro area Euro area business confidence, Mar German Unemployment, Feb Fri Euro area German retail sales, Feb French consumption of manufactured goods, Feb UK Gfk consumer confidence, Mar Medium -5.8/-5.8 The weakness in the PMIs also suggests some downside risk to this release. German unemployment has fallen in 22 of the last 23 months. We expect more of the same in February. These data are not particularly reliable, but for what they are worth German retail sales have been on a healthy uptrend since mid-2009. French consumer spending has been incredibly weak recently (see chart below). Falling inflation and an improving housing market are slowly working to lift UK consumer sentiment.
"
Medium 0k/-10k
"
Medium -2.3%MoM/ +1.2%MoM
#
Medium -0.4%MoM/ +0.2%MoM
"
Medium -29/-29
26 March 2012
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Macquarie Research
The week ahead in charts

Fig 1 German IFO: The PMI data suggest we could see a pullback
Index 120 115 110 105 100 95 90 85 80 75 70 Jan 95 Oct 97 Aug 00 Jun 03 Mar 06 Jan 09 Nov 11 -5 Jan 01 Mar 03 May 05 Jul 07 Sep 09 Nov 11 0 5 10 15 IFO IFO - expectations
Fig 2 German consumer confidence has been steadily improving in recent years
Index 20 Consumer confidence (Germany) Consumer confidence (Germany) - Propensity to buy Index 80 60 40 20 0 -20 -40 -60 -80
Source: IFO, Macquarie Research, March 2012
Source: Gfk, Macquarie Research, March 2012
Fig 3 Euro area M3: There is a credit crunch in Europe

YoY % 14 12 10 8 6 4 2 0 -2 Feb 94 Mar 96 May 98 Jul 00 Sep 02 Nov 04 Jan 07 Mar 09 May 11 Credit - Euro area M3 - Euro area
Fig 4 Despite the recent rise in the oil price inflation is likely to fall
YoY % 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 Jan 97 Jul 99 Jan 02 Jul 04 Jan 07 Jul 09 Jan 12 German CPI German Core CPI
Source: ECB, Macquarie Research, March 2012
Source: Eurostat, Macquarie Research, March 2012
Fig 5 Euro area business confidence may have weakened in March

Index 10 Euro area Business Confidence Euro area Consumer Confidence Index 10
Fig 6 The German labour market is going from strength to strength

'000s 300 250 Change in no. of unemployed - Germany (LHS) Unemployment rate - Germany (RHS) % 14 12 10 8 6 4 2 0 May 95 Sep 98 Jan 02 May 05 Sep 08 Jan 12
200 150
-10
-10
100 50 0
-20
-20
-30
-30
-50 -100
-40 Jan 85 Dec 88 Nov 92 Oct 96 Sep 00 Aug 04 Jul 08
-40 Jun 12
-150 Jan 92
Source: Eurostat, Macquarie Research, March 2012
Source: FSO, Macquarie Research, March 2012
26 March 2012
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Macquarie Research
Fig 7
Consumer spending is improving in Germany
Fig 8
but NOT in France

YoY% Consumption of mfg goods - France 3mma (LHS) Consumption of mfg goods - France (RHS)
Index 104 103 102 101 100 99 98 97 96 95 94 Jan 94 Mar 96 Jun 98 Aug 00 Nov 02 Feb 05 Apr 07 Jul 09 Oct 11 German retail sales German retail sales - 3mma
7 6 5 4 3 2 1 0 -1 -2 -3
MoM%
-4 Jan 00
Dec 01
Nov 03
Oct 05
Sep 07
Aug 09
Jul 11
Source: FSO, Macquarie Research, March 2012
Source: FSIS, Macquarie Research, March 2012
Fig 9 UK consumer sentiment has edged up off its lowsfurther gains are likely in our view
Index 30 20 10 0 -10 -20 -30 -40 -50 Jan 74 Aug 81 Mar 89 Nov 96 Jun 04 Jan 12 Long-run average UK Consumer confidence
Source: Gfk, Macquarie Research, March 2012
26 March 2012
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Macquarie Research
The month ahead March MONDAY 19

AUS RBA GOVERNOR STEVENS SPEAKS ON ECONOMIC CONDITIONS AND TH PROSPECTS AT THE 15 ASIAN INVESTMENT CONFERENCE 2012, HONG KONG US NAHB HOUSING INDEX, MAR (1400) Feb: 29 Exp: 30 NZ CONSUMER CONFIDENCE, MAR QTR (2100, SUN) Dec qtr: 101.3 Exp: ~ EURO AREA CURRENT ACCOUNT, JAN (0900) Dec: 2.0b Exp: ~ CONSTRUCTION OUTPUT, JAN (1000) Dec: 0.3% Exp: ~ ITALY INDUSTRIAL ORDERS, JAN (0900) Dec: 5.5% Exp: -3.2%
TUESDAY 20
AUS RBA BOARD MEETING MINUTES, MAR (0030) RBA ASSISTANT GOVERNOR EDEY SPEAKS ON BANK FUNDING AT THE CARDS AND PAYMENTS AUSTRALASIA CONFERENCE 2012, SYDNEY (0305) US HOUSING STARTS, FEB (1230) Jan: 699k Exp: 700k BUILDING PERMITS, FEB (1230) Jan: 682k Exp: 686k GERMANY PPI, FEB (0700) Jan: 0.6% Exp: 0.5% UK CPI, FEB (0930) Jan: -0.5% Exp: 0.4% RPI, FEB (0930) Jan: -0.6% Exp: 0.6%
WEDNESDAY 21
US EXISTING HOME SALES, FEB (1400) Jan: 4.57m Exp: 4.60m CANADA LEADING INDICATORS, FEB (1230) Jan: 0.7% Exp: 0.6% NZ CURRENT ACCOUNT, DEC QTR (2145, TUE) Sep qtr: -NZ$4.6b Exp: -NZ$2.8b UK BANK OF ENGLAND MEETING MINUTES, MAR (0930)
THURSDAY 22
AUS RBA ASSISTANT GOVERNOR DEBELLE SPEAKS AT THE AUSTRALIAN DCM SUMMIT 2012, SYDNEY (2210, WED) US HOUSE PRICE INDEX, JAN (1400) Dec: 0.7% Exp: 0.3% LEADING INDICATORS, FEB (1400) Jan: 0.4% Exp: 0.6% CANADA RETAIL SALES, JAN (1230) Dec: -0.2% Exp: 1.8% NZ GDP, DEC QTR (2145) Sep qtr: 0.8% Exp: 0.6% EURO AREA PMI MANUFACTURING (prelim), MAR (0900) Feb: 49.0 Exp: 49.5 PMI SERVICES (prelim), MAR (0900) Feb: 48.8 Exp: 49.2 PMI COMPOSITE (prelim), MAR (0900) Feb: 49.3 Exp: 49.6 CONSUMER CONFIDENCE (adv), MAR (1500) Feb: -20.3 Exp: -19.8 INDUSTRIAL NEW ORDERS, JAN (1000) Dec: 3.5% Exp: -2.2% GERMANY PMI MANUFACTURING (prelim), MAR (0830) Feb: 50.2 Exp: 51.0 PMI SERVICES (prelim), MAR (0830) Feb: 52.8 Exp: 53.1 FRANCE PMI MANUFACTURING (prelim), MAR (0800) Feb: 50.0 Exp: 50.2 PMI SERVICES (prelim), MAR (0800) Feb: 50.0 Exp: 50.3 UK RETAIL SALES, FEB (0930) Jan: 0.9% Exp: -0.5% CHINA HSBC PMI MANUFACTURING (flash), MAR nd th (22 -25 MAR) Feb: 49.7 Exp: ~
FRIDAY 23
US FEDERAL RESERVE CHAIRMAN BENANKE SPEAKS AT THE FEDERAL RESERVES CONFERENCE ON CENTRAL BANKING, WASHINGTON (0245) NEW HOME SALES, FEB (1400) Jan: 321k Exp: 325k CANADA CPI, FEB (1100) Jan: 0.4% Exp: 0.4% FRANCE BUSINESS CONFIDENCE, MAR (0745) Feb: 92 Exp: 93 CHINA MNI BUSINESS SENTIMENT SURVEY (flash), MAR (0135)
26
US PENDING HOME SALES, FEB (1400) Jan: 2.0% NZ TRADE BALANCE, FEB (2145, SUN) Jan: -NZ$199m GERMANY IFO INDEX, MAR (9000) Feb: 109.6 ITALY CONSUMER CONFIDENCE, MAR (9000) Feb: 94.2 UK th NATIONWIDE HOUSE PRICES, MAR (26 st 31 MAR) Feb: 0.6%
27
US CONSUMER CONFIDENCE, MAR (1400) Feb: 2.0% FRANCE CONSUMER CONFIDENCE, MAR (0745) Feb: 82 UK GDP (final), DEC QTR (0930) Dec qtr (prelim): -0.2% CURRENT ACCOUNT, DEC QTR (0930) Sep qtr: -15.2b
28
AUS FINANCIAL STABILITY REVIEW (0030) US DURABLE GOODS ORDERS, FEB (1230) Jan: -3.7% GERMANY CPI (prelim), MAR (1200) Feb: 0.9% FRANCE GDP (final), DEC QTR (0530) Dec qtr (prelim): 0.2% ITALY BUSINESS CONFIDENCE, MAR (0800) Feb: 91.5
29
AUS JOB VACANCIES, FEB (0000) Jan: -3.3% US GDP (final), DEC QTR (1330) Dec qtr (prelim): 3.0% PERSONAL CONSUMPTION (final), DEC QTR (1330) Dec qtr (prelim): 2.1% CORE PCE (final), DEC QTR (1330) Dec qtr (prelim): 1.3% CANADA PPI, FEB (1230) Jan: 0.3% NZ NBNZ BUSINESS CONFIDENCE, MAR (0000) Feb: 28 EURO AREA BUSINESS CLIMATE, MAR (0900) Feb: -0.18 CONSUMER CONFIDENCE (final), MAR (0900) Feb (adv): ~ ECONOMIC CONFIDENCE, MAR (0900) Feb: 94.4 GERMANY UNEMPLOYMENT CHANGE, MAR (0700) Feb: 0k UNEMPLOYMENT RATE, MAR (0700) Feb: 6.8% UK CONSUMER CREDIT, FEB (0830) Jan: 0.1b GFK CONSUMER CONFIDENCE, FEB (2301) Jan: -29 MORTGAGE APPROVALS, FEB (0830) Jan: 58.7k
30
AUS PRIVATE SECTOR CREDIT, FEB (0030) Jan: 0.2% US CORE PCE, FEB (1230) Jan: 0.2% PERSONAL INCOME, FEB (1230) Jan: 0.3% PERSONAL SPENDING, FEB (1230) Jan: 0.2% CANADA GDP, JAN (1230) Dec: 0.4% NZ BUILDING PERMITS, FEB (2145, THU) Jan: 8.3% EURO AREA CPI (flash), MAR (0900) Feb: 2.7% y/y GERMANY th th RETAIL SALES, FEB (4 -5 MAR) Jan: -2.3% FRANCE PPI, FEB (0845) Jan: 0.6% ITALY CPI (prelim), MAR (0900) Feb: 0.2% PPI, FEB (0845) Feb: 0.7% CANADA GDP, JAN (1230) Dec: 0.4% CHINA MNI BUSINESS CONDITION SURVEY, MAR (0135) PMI MANUFACTURING, MAR (0000, SUN) Feb: 51.0
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The month ahead April MONDAY 2

CHINA MARKEY HOLIDAY - TOMB SWEEPING DAY AUS RP DATA HOUSE PRICE INDEX, FEB (2300, MON) Jan: 0.8% INFLATION GAUGE, MAR (2330, MON) Feb: 0.2% BUILDING APPROVALS, FEB (0030) Jan: 0.9% US ISM MANUFACTURING, MAR (1300) Feb: 52.4 CONSTRUCTION SPENDING, FEB (1300) Jan: -0.1% EURO AREA UNEMPLOYMENT RATE, FEB (0800) Jan: 10.7% PMI MANUFACTURING (final), MAR (0700) Mar (prelim): ~ GERMANY PMI MANUFACTURING (final), MAR (0655) Mar (prelim): ~ FRANCE PMI MANUFACTURING (final), MAR (0650) Mar (prelim): ~ ITALY UNEMPLOYMENT RATE, DEC QTR (0700) Sep qtr: 8.1% UNEMPLOYMENT RATE (prelim), FEB (0700) Jan: 9.2% PMI MANUFACTURING, MAR (0645) Feb: 47.8 UK PMI MANUFACTURING, MAR (0730) Feb: 51.2
TUESDAY 3
CHINA MARKEY HOLIDAY - TOMB SWEEPING DAY AUS RBA INTEREST RATE ANNOUNCEMENT, APR (0330) Mar: 4.25% RETAIL SALES, FEB (2300, MON) Jan: 0.3% US FOMC MEETING MINUTES, MAR (1700) FACTORY ORDERS, FEB (1300) Jan: -1.0% EURO AREA PPI, FEB (0800) Jan: 0.7% UK PMI CONSTRUCTION, MAR (0730) Feb: 54.3 CHINA PMI NON-MANUFACTURING, MAR (0000) Feb: 53.9
WEDNESDAY 4
CHINA MARKEY HOLIDAY - TOMB SWEEPING DAY AUS TRADE BALANCE, FEB (1230) Jan: -A$673 US ISM NON-MANUFACTURING, MAR (1300) Feb: 57.3 EURO AREA EUROPEAN CENTRAL BANK INTEREST RATE DECISION, APR (1045) Mar: 1.00% PMI SERVICES (final), MAR (0700) Mar (prelim): ~ PMI COMPOSITE (final), MAR (0700) Mar (prelim): ~ RETAIL SALES, FEB (0800) Jan: 0.3% GERMANY PMI SERVICES (final), MAR (0655) Mar (prelim): ~ FACTORY ORDERS, FEB (0900) Jan: -2.7% FRANCE PMI SERVICES (final), MAR (0650) Mar (prelim): ~ ITALY PMI SERVICES, MAR (0645) Feb: 44.1 UK PMI SERVICES, MAR (0730) Feb: 53.8
THURSDAY 5
US NON NON-MANUFACTURING, MAR (1300) Feb: 57.3 CANADA EMPLOYMENT, MAR (1130) Feb: -2.8k UNEMPLOYMENT RATE, MAR (1130) Feb: 7.4% BUILDING PERMITS, FEB (1130) Jan: -12.3% PMI, MAR (1300) Feb: 66.5 GERMANY INDUSTRIAL PRODUCTION, FEB (0900) Jan: 1.6% UK BANK OF ENGLAND INTEREST RATE DECISION, APR (1000) Mar: 0.50% BANK OF ENGLAND ASSET PURCHASE TARGET, APR (1000) Mar: 325b INDUSTRIAL PRODUCTION, FEB (0730) Jan: 0.4% MANUFACTURING PRODUCTION, FEB (0730) Jan: 0.1%
FRIDAY 6
AUS, US, CANADA, NZ, EURO AREA, UK MARKET HOLIDAY GOOD FRIDAY US NONFARM PAYROLLS, MAR (1130) Feb: 227k UNEMPLOYMENT RATE, FEB (1130) Feb: 8.3% AVERAGE HOURLY EARNINGS, MAR (1130) Feb: 0.1% FRANCE BANK OF FRANCE BUSINESS th th SENTIMENT, MAR (8 -11 APR) Feb: 95 TRADE BALANCE, FEB (0545) Jan: 5.3b
9
AUS, NZ, EURO AREA, UK MARKET HOLIDAY EASTER MONDAY CANADA BANK OF CANADA SENIOR LOAN OFFICER SURVEY, MAR QTR (1330) CHINA CPI, MAR (0030) Feb: 3.2% y/y PPI, MAR (0030) Feb: 0.0% y/y
10
AUS BUSINESS CONFIDENCE, MAR (0030) Feb: 1 JOB ADVERTISEMENTS, MAR (0030) Feb: 3.3% GERMANY CURRENT ACCOUNT, FEB (0500) Jan: 8.0b TRADE BALANCE, FEB (0500) Jan: 13.1b FRANCE INDUSTRIAL PRODUCTION, FEB (0545) Jan: 0.3% CHINA TRADE BALANCE, MAR (TUE) Feb: US$31.5b EXPORTS, MAR (TUE) Feb: 18.4% y/y IMPORTS, MAR (TUE) Feb: 39.6% y/y
11
AUS CONSUMER CONFIDENCE, APR (2330, TUE) Mar: 96.1 HOUSING FINANCE, FEB (0030) Jan: -1.2% US BEIGE BOOK, MAR (1700) IMPORT PRICES, MAR (1130) Feb: 0.4% EXPORT PRICES, MAR (1130) Feb: 0.4% CANADA HOUSING STARTS, MAR (1115) Feb: 201.1k CHINA th th NEW YUAN LOANS, MAR (11 -15 APR) Feb: CNY710.7b th th MONEY SUPPLY M2, MAR (11 -15 APR) Feb: 13.0% y/y
12
AUS EMPLOYMENT, MAR (0030) Feb: -15.4k UNEMPLOYMENT RATE, MAR (0030) Feb: 5.2% PARTICIPATION RATE, MAR (0030) Feb: 65.2% US TRADE BALANCE, FEB (1130) Jan: -US$52.6b PPI, MAR (1130) Feb: 0.4% CANADA INTERNATIONAL TRADE, FEB (1130) Jan: C$2.4b NEW HOUSING PRICE INDEX, FEB (1130) Jan: 0.1% NZ ELECTRONIC CARD SPENDING, MAR (2145) Feb: -0.3% CONSUMER CONFIDENCE, APR (0000) Mar: 110.2 th REINZ HOUSING PRICE INDEX, MAR (12 th 16 APR) Feb: 0.8% EURO AREA ECB BULLETIN, APR (0700) INDUSTRIAL PRODUCTION, FEB (0545) Jan: 0.3% FRANCE CPI, MAR (0430) Feb: 0.5% CURRENT ACCOUNT, FEB (0545) Jan: -4.2b UK TRADE BALANCE, FEB (0730) Jan: -1.8b
13
US CPI, MAR (1130) Feb: 0.4% GERMANY CPI (final), MAR (0500) Mar (prelim): ~ ITALY CPI (final), MAR (0800) Mar (prelim): ~ INDUSTRIAL PRODUCTION, FEB (0700) Jan: 2.5% UK PPI INPUT, MAR (0730) Feb: 2.1% PPI OUTPUT, MAR (0730) Feb: 0.6% CHINA GDP, MAR QTR (0100) Dec qtr: 8.9% y/y INDUSTRIAL PRODUCTION, MAR (0100) Feb: 11.4% y/y FIXED ASSET INVESTMENT, MAR (0100) Feb: 21.5% y/y
26 March 2012
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GLOBAL
LME cash price Aluminium Copper Lead Nickel Tin Zinc Cobalt Molybdenum Other prices Gold (US$/oz) 1664 Silver (US$/oz) 31.54 Platinum (US$/oz) 1617 Palladium (US$/oz) 658 Oil WTI 106.63 USD : EUR exchange rate 1.327 AUD : USD exchange rate 1.046 LME/COMEX stocks Aluminium LME copper Comex copper Lead Nickel Tin Zinc Tonnes 5,089,250 255,175 81,694 372,875 97,740 12,705 889,975 Change 5,350 -275 -98 -975 -48 15 -500 % change day on day 1.7 -0.8 0.6 0.0 1.6 0.6 0.8 US/lb 97 381 90 821 1005 91 1410 1383 % change day on day 0.3 1.0 0.5 -1.5 0.5 0.5 0.1 -1.6
Commodities Comment
ICSG: Ex-China copper demand to improve from December low point
Feature article
Copper demand outside of China was very weak in December, with European
consumers continuing to destock, according to ICSG data published this week. Leading indicators suggest apparent demand ex China should improve, although in the short term this is probably not enough to fill the air pocket created by slowing Chinese apparent demand.
Latest news
Base metals were stronger in Friday trading, although slipped over the week
as markets turned more cautious, with the S&P500 near peaks and poor flash PMI data from Europe and China reinforcing the negativity. Copper was the most resilient, falling 1.4% WoW, with the lead recording the largest decline of 4.8% WoW. Gold managed to finish the week 0.4% higher despite a more negative tone to commentary.
Chile's Codelco said Friday its 2011 pre-tax profits surged 21% from a year
Source: LME, Comex, Nymex, SHFE, Metal Bulletin, Reuters, LBMA, Macquarie Research, March 2012
Articles of the week

What China slowdown? Chinese imports of coal, iron ore and nickel ore Ex-China copper market shaping up to drive
physical premiums higher
earlier to $7.033 billion on firm metal prices and a rise in output despite higher production costs. Codelco produced a record 1.735 million tonnes of copper in 2011, up 2.7% from 2010, as output increased in its Radomiro Tomic, Andina and Gaby mines offset production slumps in century-old Chuquicamata, Salvador and El Teniente. CEO Diego Hernandez forecast Codelco's copper output would dip by 30kt in 2012, and he expects the market remain tight on firm sales to China. The company said its direct cash costs jumped 11% to $1.16 per pound of copper last year, compared with 2010 on higher fuel and energy costs as well as exchange-rate fluctuations.
The newsflow surrounding a report from the Indian Comptroller & Auditor
Chinese steel data what (not) to believe
Analyst(s)
Macquarie Capital (Europe) Limited Ryan Belshaw +44 20 3037 2732 ryan.belshaw@macquarie.com Hayden Atkins +44 20 3037 4476 hayden.atkins@macquarie.com Jim Lennon +44 20 3037 4271 jim.lennon@macquarie.com Colin Hamilton +44 20 3037 4061 colin.hamilton@macquarie.com Duncan Hobbs +44 20 3037 4497 duncan.hobbs@macquarie.com Macquarie Capital Securities Limited Angela Bi +86 21 2412 9086 angela.bi@macquarie.com Graeme Train +86 21 2412 9035 graeme.train@macquarie.com Macquarie Capital Securities (Singapore) Pte. Limited Bonnie Liu +65 6601 0144 bonnie.liu@macquarie.com
General on the allocation of free coal blocks potentially forgoing $213bn in revenues is gathering more attention and affecting Indian financial markets. As our Head of Indian Commodities Research, Rakesh Arora, points out, comparison with other corruption scandals is likely meaningless, as allocation of mining blocks is in line with current mining lows, with coal from captive blocks not allowed for sale. The aim of allocating these coal blocks has been to spur better coal production, essential to power and economic growth, although it has not been effective, with utilisation of coal blocks very low. He also thinks it seems spurious to suggest these coal blocks have value anywhere near the magnitude suggested given the tens of billions of dollars that will be spent by Indian companies developing coal assets in Australia and elsewhere rather than develop these blocks in India.
QR National have announced that the Moura railway will be shut for two
weeks, with the company declaring force majuere on railings from Anglo AmericansDawsonmineandCockatooCoalsBarabalamine.Whilethere have been other small disruptions, the magnitude of stoppages have not been unusual compared to usual seasonal trends and does not appear to have tightened the met coal market, with pricing still soggy.
26 March 2012 Please refer to the important disclosures and analyst certification on inside back cover of this document, or on our website www.macquarie.com.au/disclosures.
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Macquarie Research
Commodities Comment
International Copper Study Group: Weak demand and destocking outside China in 2H11
The latest ICSG data suggests that copper usage in the world ex China fell 14.5% MoM in
December (the largest single month-on-month fall for the last ten years), leaving YoY consumption down 8.6% YoY. As you might expect, the falloff in European demand accounted for the majority of the decline, with the regions total usage falling 245kt in December 2011, 40kt lower than a year earlier. The ICSG data, therefore, points to continued destocking outside of China in December (Figure 4), given industrial production growth remained in positive territory.
As Figures 2 and 3 illustrate, MarJun tends to be a strong period for copper demand. Ex-China
demand, although coming from a low base, should be bolstered by an end to destocking, and OECD indicators point to a stabilising industrial output.
Fig 1 ICSG copper usage by country/region

'000 tonnes USA Latin America Europe CIS Japan China (app. demand) Other Asia Other World World ex China Jan-Dec 2011 1761 886 3733 838 1006 7917 2806 1042 19988 12071 Jan-Dec 2010 1760 933 3765 565 1061 7394 2850 1048 19375 11981 % Change 0.1% -5.1% -0.8% 48.2% -5.1% 7.1% -1.6% -0.5% 3.2% 0.8% Change '000 tonnes 1 -47 -32 272 -55 523 -44 -6 613 90 Latest Month 0.0% -14.9% -14.3% 1.4% -18.2% 30.5% -3.6% -6.3% 7.2% -8.6%
Source: ICSG, Macquarie Research, March 2012
Fig 2 China apparent demand drove copper usage in 2H11 world copper usage
'000 tonnes 1800 1750 1700 1650 1600 1550 1500 1450
Fig 3 Sharp decline in copper demand in December world ex-China copper usage
'000 tonnes 1200 1150 1100 1050 1000 950 900 850
1400
1350 1300
Jan
Jun
Nov
May
Dec
Feb
Mar
Aug
Sep
Oct
Apr
Jul
800
Jan
Jun
Nov
2007
2008
2009
2010
2011
2007
2008
May
2009
2010
2011
Indeed, although we are forecasting lower YoY demand in Europe in 2012, ex-Chinese copper
usage is likely to have improved since December (and leading indicators suggest they will continue to improve in the next 36 months), as destocking is likely to slow. Reports on the ground support this view, with physical premiums strengthening in Europe and reports of a pickup in spot market demand.
26 March 2012
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Dec
Feb
Mar
Aug
Sep
Oct
Apr
Jul
Macquarie Research
Commodities Comment
Fig 4 World ex-China copper consumption and industrial production growth heavy destocking continued in Europe, accordingtoDecembersICSGdata
20.0%
WorldexChina OECDIP 6MAnnualisedOECDLeadingIndicator(3mthfwd)
15.0% 10.0% Restocking
5.0%
0.0% 2008 5.0% 10.0% 15.0% Destocking
2009
2010
2011
2012
20.0%
25.0% 30.0%
Source: ILZSG, Macquarie Research, March 2012
China and ex-China apparent demand have been countercyclical over the past ten years, with China
usually catching the falling knife when copper prices overshoot on the downside and the rest of the world pushing prices toward peaks on the upside. While it would broadly appear to be a re-run of this story, we are cautious on prices in the very short term, with the loss of Chinese apparent demand at ~$8,400t unlikely to be totally offset by the improvement coming from ex China. That said the downside risk is not too severe, and the market looks strong for the balance of 2012.
Fig 4 Weaker Chinese apparent demand not necessarily bearish for the price
Apparent demand % Change (3 Month M. Avg)
50% 40% 30% 20% 10% 0% -10% -20% -30% -40% -50% 2005 2006 2007 2008 2009 2010 2011
50% 40%
30%
Fig 5 Ex-China apparent demand appears more positively correlated with the copper price
Apparent demand % Change (3 Month M. Avg)
30%
60%
20%
40%
20% 10% 0%
-10%
10%
20%
0%
0%
-20% -30% -40% -50%
-10%
-20%
-20%
-40%
2012
-30% 2005
-60%
2006
2007
2008
2009
2010
2011
2012
3MMA Copper Price %MoM
China Copper 3MMA
3MMA Copper Price %MoM
Ex-China Copper 3MMA % Change
Source: NBS, CNIA, Macquarie Research, March 2012
Source: NBS, CNIA, Macquarie Research, March 2012
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Commodities Comment
Summary of changes, week ended 23 March

LME metal prices (%) Aluminium Aluminium Alloy NAASAC Copper Lead Nickel Tin Zinc Cobalt Molybdenum Other prices (%) Gold Silver Platinum Palladium Oil WTI EUR : USD exchange rate AUD : USD exchange rate Exchange stocks LME aluminium Shanghai aluminium Total aluminium LME copper Comex copper Shanghai copper Total copper LME zinc Shanghai zinc Total zinc LME lead Shanghai lead Total lead LME aluminium alloy LME NAASAC LME nickel LME tin Cash -3.8% -4.3% -3.7% -1.4% -4.8% -3.8% -4.7% -3.6% -1.0% -3.2% 3-Month -3.7% -4.2% -3.7% -1.5% -5.4% -3.8% -4.7% -3.5% -1.0% -3.2%
0.4% -2.3% -3.6% -6.4% -0.4% 0.7% -1.2% tonnes 17,300 2,273 19,573 -8,650 -976 -3,644 -13,270 17,575 -3,730 13,845 6,000 -2,559 3,441 -100 -580 318 1,135 % 0.3% 0.6% 0.4% -3.3% -1.2% -1.6% -2.3% 2.0% -1.0% 1.1% 1.6% -7.2% 0.9% -0.1% -0.4% 0.3% 9.8%
Source: Comex, LBMA, LME, Nymex, Reuters, SHFE, Macquarie Research
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Macquarie Research
Commodities Comment
Friday 23 March 2012 Commodities Prices

Closing price * 23-Mar-12 23-Mar-12 US$/tonne US/lb LME Cash Aluminium Aluminium Alloy NAASAC Copper Lead Nickel Tin Zinc Cobalt Molybdenum LME 3 Month Aluminium Aluminium Alloy NAASAC Copper Lead Nickel Tin Zinc Cobalt Molybdenum 2,135 2,037 2,148 8,408 1,989 18,105 22,164 1,995 31,095 30,500 2,174 2,061 2,181 8,380 1,995 18,175 22,225 2,005 30,800 30,500 97 92 97 381 90 821 1,005 91 1,410 1,383 99 93 99 380 90 824 1,008 91 1,397 1,383 1,664 31.54 1,617 658 106.63 1.327 1.046 Closing price * 22-Mar-12 22-Mar-12 US$/tonne US/lb 2,129 2,026 2,136 8,325 1,979 18,376 22,048 1,985 31,050 31,000 2,167 2,050 2,170 8,290 1,983 18,450 22,110 1,985 30,750 31,000 97 92 97 378 90 834 1,000 90 1,408 1,406 98 93 98 376 90 837 1,003 90 1,395 1,406 1,636 31.79 1,607 658 104.99 1.318 1.038 % ch. day on day 0.3 0.5 0.5 1.0 0.5 -1.5 0.5 0.5 0.1 -1.6 0.3 0.5 0.5 1.1 0.6 -1.5 0.5 1.0 0.2 -1.6 1.7 -0.8 0.6 0.0 1.6 0.6 0.8 2012 YTD US$/tonne 2,182 2,094 2,208 8,256 2,111 20,069 22,935 2,023 32,359 31,739 2,219 2,123 2,182 8,270 2,140 20,135 22,984 2,040 32,035 31,739 1,699 32.62 1,590 683 101.82 1.308 1.058 Ave 2011 US$/tonne 2,395 2,262 2,379 8,811 2,398 22,831 26,021 2,191 35,702 34,381 2,420 2,259 2,261 8,825 2,390 22,857 26,036 2,210 35,507 34,554 1,572 35.12 1,720 733 94.65 1.392 1.032
* LME closing price - 1700 hrs London time. Year-to-date averages calculated from official fixes.
Gold - London PM Fix (US$/oz) Silver - London AM Fix (US$/oz) Platinum - London PM Fix (US$/oz) Palladium - London PM Fix (US$/oz) Oil WTI - NYMEX latest (US$/bbl) EUR : USD exchange rate - latest AUD : USD exchange rate - latest
Exchange Stocks
(tonnes) LME Aluminium Shanghai Aluminium Total Aluminium LME Copper Comex Copper Shanghai Copper Total Copper LME Zinc Shanghai Zinc Total Zinc LME Lead Shanghai Lead Total Lead Aluminium Alloy NASAAC Nickel Tin 23-Mar-12 5,089,250 366,218 5,455,468 255,175 81,694 223,632 560,501 889,975 383,651 1,273,626 372,875 33,013 405,888 138,100 155,840 97,740 12,705 22-Mar-12 5,083,900 363,945 5,447,845 255,450 81,792 227,276 564,518 890,475 387,381 1,277,856 373,850 35,572 409,422 138,100 155,860 97,788 12,690 Change since last report Volume Percent 5,350 0.1% 2,273 0.6% 7,623 0.1% -275 -98 -3,644 -4,017 -500 -3,730 -4,230 -975 -2,559 -3,534 0 -20 -48 15 -0.1% -0.1% -1.6% -0.7% -0.1% -1.0% -0.3% -0.3% -7.2% -0.9% 0.0% 0.0% 0.0% 0.1% Cancelled warrants 1,657,975 85,500 14,100 21,000 580 6,720 5,190 1,130 End-11 stocks 4,970,400 207,966 5,178,366 370,900 79,817 93,219 543,936 821,700 364,186 1,185,886 353,075 30,586 383,661 142,880 157,820 90,048 12,190 Ch. since end-11 118,850 158,252 277,102 -115,725 1,877 130,413 16,565 68,275 19,465 87,740 19,800 2,427 22,227 -4,780 -1,980 7,692 515
Source: Comex, LBMA, LME, Nymex, Reuters, SHFE, Macquarie Research
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Macquarie Research
Commodities Comment
Chinadatafailstorevealaslowdownindemandformetalsandsteel
While there is undoubtedly a slowdown taking place in Chinese economic growth as a result of
domestic policy tightening and weaker export growth, the impact on commodities demand has been negligible according to a detailed analysis of the latest data on production and trade released this week. Due to the January Chinese New Year holiday some of the data for January was only released this week so we only now have a complete picture.
What the data fails to show is a sharp slowdown in Chinese demand for metals. Indeed for base
metals demand actually reaccelerated towards the end of last year and has remained strong in the first two months of this year. There has been a more pronounced slowdown ex-China and, if anything, China has been a significant support for commodity prices. A lot of this has to do with stocking/destocking in China for much of 2011 China was a net de-stocker but by the end of the year had become a major and growing buyer again (starting at a time of relatively weak prices).
Fig 1 YoYchangesinbasemetalsdemandinChina and the rest of the world to February 2012 (3MMA)
60% 50%
% change yoy - 3MMA
Fig 2 YoY changes in steel demand in China and the rest of the world to February 2012 (3MMA)
60% 50%
40% 30% 20% 10% 0% -10% -20% -30%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
% change yoy - 3MMA
40% 30% 20% 10% 0% -10% -20% -30% -40%
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
China
World Ex-China
China
World Ex-China
Source: NBS, WSA, Chinese Customs, Macquarie Research, March 2012
Fig 3
Year-on-year changes in apparent demand in Jan-Feb 2012
% change YoY 30% 25% 20% 15% 10% 5% 0% -5% Aluminium 7.6% 3.8%
27.0%
10.4% 7.7% 2.4%

`
2.4%
3.5%
1.2%
-2.5% Copper
Zinc China Ex-China
Lead
-3.4% Nickel
-2.0% Steel
Source: CNIA, INSG, ILZSG, ICSG, IAI, Macquarie Research estimates, March 2012
26 March 2012
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2012
Macquarie Research
Commodities Comment
Historically, we have seen China emerge as a re-stocker of base metals at a time of weak prices
and ahead of a recovery in real demand (2009 was the most obvious but the surge in Chinese apparent demand is clear from Figure 1 many times in the past. For steel, the slowdown is more apparent but fears of a sharp collapse (down 15% or so as had been implied by misleading and wrong CISA data) have proved to be unfounded (see Figure 2).
Fig 4
Chinese apparent demand by majorcommodity(000t)

2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 2012 2012 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb 1379 1168 1499 1421 1919 1710 1662 1643 1668 1493 1408 1543 1432 1308 507 441 644 711 685 784 726 700 886 670 830 582 631 528 63 48 55 50 63 50 63 60 66 63 59 64 64 59 402 383 450 412 430 466 438 416 497 525 483 524 414 431 349 214 378 390 332 403 347 385 407 404 410 435 267 310 12.1 11.6 13.0 14.4 14.0 14.3 12.8 15.7 19.0 19.9 17.0 12.2 11.4 15.6 1503 1675 1565 1780 1243 2068 1882 1846 1934 2055 1943 1872 1747 2030 622 762 1018 1103 1100 1128 998 1140 1108 1028 1048 1149 679 939 58 56 63 63 64 62 63 62 60 57 53 55 60 58 990 33 295 953 1238 1084 1061 33 252 35 306 20.8 -0.3 4.6 6.4 27.0 -0.9 11.6 19.1 11.9 18.4 9.6 4.7 35 310 6.8 8.2 12.9 -7.3 30.2 -6.4 37 333 34.3 -7.3 73.5 -2.9 6.4 -3.0 959 38 323 14.9 20.5 18.5 -1.4 18.5 -4.3 27.7 15.5 7.4 3.1 13.8 9.9 943 1022 1013 1116 1049 1163 1232 1243 37 337 38 340 37 324 15.7 28.3 43.6 7.8 0.5 29.8 18.9 26.0 18.3 0.3 16.1 12.0 36 338 8.6 28.1 34.0 17.0 2.2 62.2 35.1 16.9 11.3 24.6 11.8 8.3 33 367 35 35 327 270 3.8 24.3 1.9 2.9 -23.6 -5.8 34 315 12.0 19.7 21.4 12.7 44.7 34.0 21.2 23.1 4.8 30.4 5.0 24.9 2011 YTD 2740 1159 122 845 577 27.0 3777 1618 118 2475 69 585 2010 YTD 2547 948 111 785 563 23.7 3178 1384 114 1944 66 547 % ch Y-o-Y 7.6 22.2 10.4 7.7 2.4 13.7 18.9 16.9 3.8 27.3 4.6 6.8
Apparent demand Aluminium Copper Nickel Zinc Lead Tin Aluminium semis Copper semis Steel (mt, crude steel eqv.) Stainless steel (crude eqv.) Coke (mt) All Coal (mt) % change YoY Aluminium Copper (before SRB) Nickel Zinc Lead Tin Aluminium semis Copper semis Steel (mt, crude steel eqv.) Stainless steel (crude eqv.) Coke (mt) All Coal (mt)
3.6 3.6 2.7 35.3 35.1 10.7 7.0 12.3 12.5 -14.5 4.2 -2.9 23.0 180.6 -11.9 34.3 8.8 9.1 -4.1 9.8 8.3 -0.5 22.9 12.4
9.3 10.1 9.9 8.4 26.8 29.8 -3.8 -13.5 -4.7 0.9 1.6 12.1 24.2 11.2 14.8 2.9 18.0 10.9 17.5 26.8 16.4 9.5 20.6 8.8
11.5 13.5 38.7 -6.1 32.5 16.8 2.0 7.4 -3.5 4.6 15.7 -18.7 8.8 6.2 2.8 27.8 2.4 4.9
15.6 -21.7 21.2 17.8 7.7 7.0 6.9 8.0 10.2 7.7 9.3 13.4
1.6 16.3 13.1 9.2 3.6 2.8 4.1 24.4 2.0 4.1 5.3 -8.7
As Figure 4 shows, despite reports of sharp demand showdown in infrastructure spending,
construction activity and year-on-year falls in appliance manufacture, apparent demand growth remained positive for all the commodities we look at! Even the apparent demand for aluminium and copper semis was growing strongly according to the data, despite reports recently of sharp falls in utilisation of capacity at semis manufacturers. Why the discrepancy? Two factors spring to mind: 1) when reports of low capacity utilisation are made, no account is often made for the fact that capacity has often risen dramatically over the past year; 2) China is a big country and while demand in the main urban areas is particularly weak, that is not the whole of China.
This would not be the first time over the past 10 years where external observers have been
panickedbyanecdote.WhileChinesedataisbynomeansperfect,theconsistencyofabetter performance across a whole range of commodities is compelling. Yes, there is a slowdown but it is by no means as dramatic as some had (and still do) fear.
The other factor to bear in mind for the global commodity markets is that China is also exporting
less metal-containing semi-finished commodities and hence when the net trade of primary metal products plus semis is calculated, China is having a bullish impact on global markets.
We would highlight big falls in stainless steel (containing nickel and ferrochrome) and aluminium
semisexportsinFigures5and6:
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Fig 5
China'snettradeinbasemetals(000t)
2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 2012 2012 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb 34 -169 -135 18 -114 -96 18 -202 -183 6 -201 -195 3 -287 -284 0 -251 -251 -11 -252 -262 10 -225 -215 10 -186 -176 9 -185 -176 0 -180 -180 46 -168 -122 33 -164 -131 68 -152 -84 2011 YTD 101 -316 -215 709 33 43 86 1 5.3 723 7787 397 1230 632 382 256 42 2010 YTD 51 -282 -231 361 49 38 46 -2 1.0 567 5140 371 958 611 502 252 37 % ch Y-o-Y 97.0 12.0 -6.9 96.3 -34.0 13.7 86.2 -125.4 421.0 27.3 51.5 6.9 28.3 3.5 -24.0 1.7 15.7
Net imports base metals Aluminium (refined & alloy) Aluminium (semis) Total above (Al content)
Copper (refined) 223 138 155 116 129 174 190 235 274 296 342 407 335 375 Copper (semis) 26 23 27 25 19 21 18 29 29 19 24 22 8 24 Nickel (finished, ni content) 22 16 21 20 19 16 26 22 23 28 25 28 24 20 Zinc (refined) 30 16 32 11 22 20 14 23 28 25 25 54 47 39 Lead (refined) -2 -1 0 1 0 0 0 0 1 0 1 0 0 1 Tin (refined) 0.7 0.3 0.6 0.3 0.7 1.1 0.7 1.4 3.6 4.0 4.2 3.2 1.6 3.7 Alumina 343 225 133 131 113 72 59 35 80 261 227 201 447 276 Bauxite 2971 2169 3577 4138 4502 3491 3743 3852 4478 3086 4594 4580 3121 4666 Aluminium scrap 221 150 256 257 337 301 305 274 232 228 226 212 202 195 Copper concentrate 571 387 451 466 466 595 453 672 563 517 673 563 602 628 Copper scrap 365 246 387 378 399 422 432 382 418 377 433 447 229 403 Zinc concentrate 296 206 225 225 236 184 245 338 246 194 261 279 186 195 Lead concentrate 163 89 101 135 84 89 90 141 160 118 136 138 89 167 Nickel Concentrate 21 16 26 30 20 19 35 13 27 20 30 20 19 23 % change YoY Aluminium (refined & alloy) Aluminium (semis) Total above (Al content) 8.5 42.9 55.0 27.1 -27.7 -131.9 43.2 46.7 45.6 62.1 33.3 -104.3 -14.8 77.3 69.8 -18.2 -39.9 -16.8 2.4 -68.9 -2.3 - 627.7 1059. -86.5 9489. 7 1476. 7 1 76.2 43.2 52.8 35.6 17.4 19.5 68.9 36.7 46.6 29.7 19.1 -15.2 -2.5 285.2 -2.9 34.1 -3.0 -12.4
72.6 105.8 43.1 107.2 -52.7 -48.6 151.2 -15.1 -90.6 -45.2
Copper (refined) 14.3 Copper (semis) -2.1 Nickel (finished, ni content) 25.5 Zinc (refined) 57.7 Lead (refined) 11.2 Tin (refined) -39.5 Alumina Bauxite Aluminium scrap Copper concentrate Copper scrap Zinc concentrate Lead concentrate Nickel Concentrate -49.2 65.8 34.8 -4.5 8.1 -12.8 50.8 0.0
-36.9 -53.9 -61.8 -21.8 -32.9 -30.4 4.0 11.9 17.5 98.5 154.3 -58.1 -48.1 -100.7 -179.1 -83.0 -57.5 -84.6
-14.7 -38.2 23.9 -52.8 -82.9 -50.1
-45.3 -73.7 -15.0 -75.4 11.9 39.0 73.4 83.6 30.7 32.5 52.8 73.4 -31.7 -16.6 -23.4 -2.8 -11.2 6.1 1.8 22.0 -36.8 17.3 6.5 5.5 -12.7 -0.7 49.3 2.2 0.0 48.4 -11.8 147.8
-49.5 -78.2 21.4 24.2 55.0 55.8 9.1 -3.7 19.3 14.2 -13.5 25.5 -26.0 -25.7 108.9 48.4
-12.1 14.4 75.1 48.7 85.8 50.1 170.7 -22.7 -23.2 -41.6 -28.5 -27.1 -67.9 4.3 4.5 38.2 42.8 70.2 36.4 6.7 23.7 -34.0 -1.2 15.8 26.7 68.3 56.3 142.7 -89.5 -57.5 -83.2 35.4 -124.6 -101.4 -185.9 -5.3 167.2 1221. 375.7 408.0 125.9 1103. 2 9 -85.8 -74.1 -41.9 -16.9 -50.8 30.3 22.8 53.2 42.5 73.2 75.6 46.5 5.1 115.1 31.8 37.4 25.3 12.2 9.7 -8.8 30.1 41.6 -17.7 9.5 21.7 16.1 5.4 62.2 -4.0 2.4 19.9 8.7 2.8 -37.2 63.9 12.0 -40.7 -32.2 -7.6 9.2 -37.2 -5.1 -20.1 -27.0 -36.0 -20.5 6.3 -45.6 88.6 -41.3 8.5 33.0 198.7 4.3 -8.0 47.6
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Fig 6
Chinese net trade in steel and bulk commodities

2011 Jan 1471 -93.1 69.0 0.46 -0.2 7.9 1.8 9.6 5.5 15.1 2011 Feb 2011 Mar 2011 Apr 2011 May 2011 Jun 2011 Jul 2011 Aug 2011 Sep 2011 Oct 2011 Nov 2011 2012 Dec Jan 2741 3102 -86.6 -84.7 64.1 0.80 -0.1 12.8 2.7 15.5 59.3 0.42 -0.1 9.8 2.0 11.9 2012 Feb 2373 -73.8 65.0 0.38 -0.1 8.6 2.3 11.0 4.8 15.8 58 -8 33 51 -67 194 310 213 222 216 2011 YTD 5474 -159 124 0.80 -0.1 18.5 4.3 22.8 8.3 31.2 2010 YTD 2977 -173 118 0.71 -0.4 10.8 2.3 13.1 7.0 20.1
Net imports steel/bulks All steel (mt, crude eqv.) Stainless steel (crude eqv.) Iron ore (mt, 62% Basis) Steel scrap (mt) Coke (mt) Thermal coal (mt) Anthracite coal (mt) Thermal & anthracite (mt) Coking coal (mt) All coal (mt) % change YoY All steel (mt, crude eqv.) Stainless steel (crude eqv.) Iron ore (mt, 62% Basis) Steel scrap (mt) Coke (mt) Thermal coal (mt) Anthracite coal (mt) Thermal & anthracite (mt) Coking coal (mt) All coal
1506 3584 3587 3762 2518 3467 3038 3080 -80.3 -143.8 -118.0 -175.4 -159.0 -179.3 -167.9 -148.2 48.8 0.25 -0.2 2.9 0.6 3.5 1.5 5.0 59.5 0.61 -0.8 2.7 1.7 4.4 2.1 6.5 52.9 0.31 -0.5 3.8 3.3 7.1 2.6 9.7 53.3 0.63 -0.4 7.2 3.4 10.5 2.1 12.7 -4 172 3 74 -4 77 131 91 -47 33 51.1 0.52 -0.3 6.4 3.3 9.6 3.4 13.0 -45 99 8 61 -41 15 81 31 -3 20 54.5 0.78 -0.2 9.4 3.1 12.5 4.1 16.6 4 425 7 55 -71 33 106 46 31 42 59.1 0.52 -0.2 9.7 2.6 12.3 3.0 15.3 107 174 32 -3 18 59 64 60 -22 33 60.6 0.70 -0.1 11.2 2.8 14.0 3.9 17.9 67 98 15 43 -43 49 77 53 -10 33
2794 3123 -90.3 -113.1 49.9 0.56 -0.1 7.9 2.5 10.3 4.2 14.6 56 19 9 117 -64 42 88 51 -1 31 64.2 0.63 -0.1 13.4 2.7 16.1 5.1 21.2 102 4 12 46 -83 97 96 97 15 68
5.0 3.5 20.6 15.4 87 111 46 -9 10 39 -70 62 10 49 -8 29 -14 -8 -64 25 14 23 -36 1
-10 6 1611 -5886 48 -25 633 -22 41 -15 7 -8 -1 -46 399 -61 -44 -59 -51 -56
102 20 -629 31936 1 -17 1645 -63 -14 -53 -43 -50 -4 -44 103 -33 60 -8 -35 -18
Fig 7 Collapse in Chinese net exports of aluminium and aluminium semis augurs well for global market adjustment
mt annualised metal/alloy/semis
4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5
Nov-10
Nov-11
Jan-10
Jan-11
May-10
May-11
Mar-10
Mar-11
Sep-10
The final feature of the January-February data we would wish to highlight is the still strong growth
in reported production for most metals, especially mined zinc and lead. The reliability of some of this data is questionable but for the most part highlights trends accurately.
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Jan-12
Jul-10
Jul-11
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Commodities Comment
Fig 8
ReportedandEstimatedproductionofselectedcommodities(000t)
2011 Jan 1315 382 40.3 387 351 11.4 2725 77 214 110 1672 596 57 1083 23 33 280 2011 Feb 1351 431 32.4 375 215 11.3 2553 94 216 142 1788 739 54 1033 25 33 247 2011 Mar 1445 443 33.3 446 378 12.4 2960 102 302 171 1767 991 59 1382 25 35 300 3.7 20.9 0.4 3.4 26.0 6.2 17.6 21.4 18.6 24.7 14.6 21.7 9.0 35.7 11.1 9.6 7.2 2011 Apr 1289 431 29.6 427 389 14.1 2985 106 323 169 1982 1077 59 1202 29 35 300 -7.4 11.3 9.9 -1.2 29.7 6.7 18.4 16.1 14.5 13.8 2011 2011 May Jun 1787 440 43.8 418 332 13.2 3009 104 360 209 1530 1081 60 1236 30 37 320 26.0 14.5 53.1 -7.6 7.0 1.3 24.2 7.7 15.0 41.1 1560 459 34.2 447 403 13.2 3100 115 395 226 2319 1107 60 1118 32 38 310 9.5 13.5 48.6 5.8 18.7 -4.4 29.4 15.5 9.8 15.4 31.7 17.5 11.9 10.7 36.1 13.8 9.5 2011 Jul 1585 452 36.9 423 347 12.1 2959 108 353 195 2133 979 59 1122 33 37 320 11.9 16.4 29.0 5.1 -4.4 8.3 23.5 15.4 12.0 18.9 28.7 12.9 15.5 18.1 29.1 18.0 9.6 2011 Aug 1641 499 37.8 410 385 14.3 2977 109 373 199 2071 1112 59 1189 29 38 325 18.2 30.1 51.5 -5.6 1.5 14.2 24.0 8.7 20.9 15.1 19.8 28.9 13.8 19.7 9.2 20.6 7.8 2011 Sep 1623 458 43.6 453 407 15.4 2774 111 389 223 2119 1080 57 1161 25 37 306 23.9 18.0 46.6 -0.6 0.7 15.9 16.3 14.0 23.3 32.2 21.3 28.2 16.5 7.1 2011 Oct 1533 449 34.4 474 404 15.9 2669 107 421 233 2241 1010 55 1206 23 36 323 18.7 20.7 27.5 2.4 1.8 33.0 18.4 3.4 47.8 38.7 35.2 19.1 9.7 24.2 2011 Nov 1466 429 33.7 451 409 12.8 2638 108 435 231 2123 1023 50 1162 21 33 346 2011 Dec 1501 453 36.7 465 434 9.1 2621 123 449 253 2040 1127 52 1250 21 35 306 2012 Jan 1486 434 40.0 372 267 9.8 3008 95 276 187 1911 671 57 1317 22 35 254 2012 Feb 1548 438 39.0 403 309 11.8 2833 104 300 197 2182 914 56 1317 23 34 299 14.6 1.5 20.4 7.4 44.0 4.7 11.0 9.8 39.0 39.0 22.0 23.7 3.3 27.4 2011 YTD 3035 872 79 775 576 21.7 5841 199 577 384 4094 1585 113 2633 44 69 553 2010 % ch. YTD YoY 2666 813 73 763 566 22.7 5278 172 430 251 3460 1335 111 2117 48 66 527 13.8 7.3 8.7 1.6 1.8 -4.7 10.7 15.8 34.0 52.6 18.3 18.7 1.6 24.4 -7.9 4.6 5.0
Production Aluminium Copper Nickel Zinc Lead Tin Alumina Copper concentrate Zinc concentrate Lead Concentrate Aluminium semis Copper semis Crude steel (mt) Stainless steel (crude eqv.) Iron ore (mt, 62% Basis) Coke (mt) Coal (mt) % ch. YoY Aluminium Copper Nickel Zinc Lead Tin Alumina Copper concentrate Zinc concentrate Lead Concentrate Aluminium semis Copper semis Crude steel (mt) Stainless steel (crude eqv.) Iron ore (mt) Coke (mt) Coal (mt)
-6.5 3.1 9.1 57.0 41.0 14.3 -4.9 12.5 12.5 -14.7 9.1 11.5 8.8 6.7 1.6 10.9 -4.8 -29.0 8.7 115.0 24.8 164.5 -12.3 37.4 9.4 9.2 4.4 8.0 9.2 9.8 9.3 21.0 22.9 16.1
22.5 20.4 13.0 6.0 5.3 13.8 13.7 5.4 -0.8 -1.9 -0.9 -4.0 -3.5 4.0 -24.0 -7.3 -37.1 -14.0 14.5 6.5 10.4 -8.0 10.4 23.0 23.8 24.3 9.5 7.5 -0.2 25.0 16.7 29.7 2.8 14.3 1.2 6.2 28.9 70.2 14.3 12.6 0.0 21.5
19.6 -11.4 23.4 20.5 7.1 7.8 18.5 17.8 33.8 8.0 11.4 35.0 9.3 12.7
-1.0 -17.5 -17.4 -21.8 16.1 11.8 2.4 2.0 11.0 7.5 2.5 4.0
-5.1 -10.4 4.1 5.0 -9.2 21.0
Source: CNIA, NBS, Macquarie Research estimates (for nickel, iron ore and stainless steel), March 2012
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Fig 9 Selected Chinese end-use indicators a mixed picture

Jan-Feb 2011 Construction Activity Indicators ('000 sq m) Floor space completed Floor space sold Floor space under construction of which: Residential Non-Residential Real estate investment (RMB Mn) Output of Autos ('000 units) Passenger Vehicles Commercial Vehicles Total White goods ('000 units) Air Conditioners Refrigerators Washing machines Freezers Selected Appliances Source: NBS, Macquarie Research, March 2012 69,515 81,429 2,914,730 2,240,488 674,241 425,037 2,094 691 3,058 20,731 10,526 9,721 2,863 45,045 Jan-Feb 2012 100,939 70,042 3,949,008 2,976,048 972,690 543,146 2,315 593 2,908 19,652 11,840 9,159 2,321 43,708 % change YoY 45% -14% 35% 33% 44% 28% 11% -14% -5% -5% 12% -6% -19% -3%
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Chinese imports: Coal still strong in seasonal soft spot

The customs data suggest total Chinese coal imports were 17.02mt in Feb, although there has
been some confusion about this number. Reports in the last few days suggested imports were 20.55mt, with imports pushing total coal higher than expected. That said, historically this seems to becapturedintheothercoalcategoryinthepublishedcustomsdata,soitsunclearwhythereis now confusion about this.
Thermal coal (including anthracite used in power stations) has run at 140mtpa in the first two
months of year. A pull back from the super strong levels is not a surprise given the degree of stocking in China heading into winter. But the level of imports is still higher than anticipated, with thermal coal imports up a huge 68%YoY.
To be sure, it would appear that Chinese demand for thermal coal will be very strong this year.
Even with vastly stronger imports, thermal coal stocks are drawing, largely because power generation remains stable, and the surge in Chinese domestic coastal shipments in early 2011 has not been repeated. This means it is likely that China will have to lift imports from current levels to ensure the de-stockdoesntcontinue.Themostrecent high frequency data suggests stocks are 21 days at six power groups, although this total tends to be higher than the broader set of data which currently sits at similar levels as of mid February.
So for 2012, Chinese imports should be quite a bit higher than 2011 levels. Stronger demand at
the moment, however, is being comfortably supplied thanks to booming seaborne supply. This should continue into the middle of the year as we move into the dry season in Indonesia, but will be tested heading into the end of 3Q as Chinese IPPs are likely to look to restock and Indonesia may be battling some more severe weather headwinds than the very favourable weather seen in 2011.
Fig 1 Thermal coal imports are annualising 140mtpa in Jan/Feb

mt annualised
90 40 -10 -60 -110 -160 -210 Feb 04 Exports Imports (incl anthracite) Net exports
Fig 2 Growth in domestic shipments is slowing down after strong growth in 1H11
mt annualised China monthly coal shipments
Chinese seaborne thermal coal net exports
mt annualised
90 40 -10 -60 -110 -160 -210 Feb 12
700 650 600 550 500 450 400 350

May 07 May 08 May 09 May 10 May 11 Sep 07 Sep 08 Sep 09 Sep 10 Sep 11 Jan 08 Jan 09 Jan 10 Jan 11 Jan 12
Feb 06
Feb 08
Feb 10
Source: Customs data, Macquarie Research, March 2012
Source: sxcoal, Macquarie Research, March 2012
Seaborne Chinese met coal imports continued to push higher in Feb to 39mtpa on an annualised
basis, which is the highest level since early 2011, right before shipments were heavily affected by floods in Australia.
Total Chinese imports, however, are higher than this thanks to the increase in Mongolian imports,
which were strong in February and up 75%YoY in Jan/Feb. Improvements in infrastructure at the Mongolian border (better roads, more customs gates) are paying dividends, with the annualised imports of 22mtpa in Feb strong in the context of 20mt of Chinese imports from Mongolia over 2011 (unwashed basis).
The arbitrage from the seaborne market into China using the Platts price is open at the moment,
although the current level of imports in the context of the recovery of supply from Australia and the ongoingstrengthinUSmetexportssuggeststhepullofdemandintoChinaisnttotally overwhelming the balance of the market and direction for prices.
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Chinese imports are likely to head higher, although datafromMacquariessurveyofChinesesteel
mills suggests that mills are comfortably stocked of coking coal at the moment despite the upside surprise to steel production and are not in a huge rush to come to the seaborne market. Industry feedback suggests pricing direction is weak and discounts to headline settlements and indices are widening.
Fig 3
Met coal imports running at end 2010 levels

Chinese seaborne met coal net exports mt annualised
Fig 4 China arb to seaborne market is open, but demand pull from China currently subdued
400
mt annualised
Coking coal prices
50 30 10 -10 -30 -50 -70 Feb 04

Coal in Coke exports Imports Exports Net exports
50 30 10 -10 -30 -50 -70 Feb 12

200
China domestic, delivered basis, $/t Seaborne spot HCC, CFR China
350
$/tonne
300
250
150
Oct-10
Dec-10
Jun-11
Oct-11
Dec-11
Feb-11
Aug-10
Feb 06
Feb 08
Feb 10
Source: Customs data, Macquarie Research, March 2012
Source: sxcoal, Platts, Macquarie Research, March 2012
Iron Ore still hitting new highs

Chinese iron ore imports continued to be extremely strong in the first two months of 2012 despite
a sharp fall in imports from India. Total imports (including some nickel ore from the Philippines used as iron ore) rose 5.7% YoY to 124.45mt despite a collapse in imports from India, Iran and Peru (see Fig 5). The main source of the growth continues to be Australia from which imports rose 16.5% YoY in the first two months of 2012. On a smaller base, imports from Indonesia rose 62.6% YoY (see below).
The extremely strong level of iron ore imports this year has also been accompanied by a fall in
stocks sitting in Chinese ports, which totalled 82.2mt at the end of last year, down 1.2mt from the end of 2011. Reported steel output was up 2.2% YoY implying less domestic iron ore was used in the mix.
Fig 5 Chinese imports of iron ore strong in 2012 (mt)

Jan-Feb 2012 Australia Brazil India South Africa Russia/Ukraine/Kazakhstan Canada Indonesia Iran Mauritania Mongolia Peru USA Venezuela Mexico Other Total Total Ex-Big 4 Africa ex-South Africa 54.24 29.25 9.35 6.86 5.60 3.49 2.65 1.88 1.34 1.17 1.12 0.78 0.57 0.43 5.71 124.45 24.74 0.34 Jan-Feb 2011 46.58 26.57 15.85 6.05 4.27 2.71 1.63 3.39 0.78 1.16 1.80 0.51 0.98 0.51 4.95 117.73 22.68 0.06 YoY Chge (mt) 7.66 2.67 -6.49 0.81 1.33 0.78 1.02 -1.50 0.57 0.00 -0.68 0.28 -0.40 -0.08 0.76 6.72 2.06 0.28 % change YoY 16.5% 10.1% -41.0% 13.4% 31.2% 28.6% 62.6% -44.4% 0.1% 0.2% -37.9% 54.5% 0.0% -14.9% 15.3% 5.7% 9.1% 471.3%
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Commodities Comment
Nickel ore Surging imports

Chinese imports of nickel ores (excluding concentrates) hit 6.1mt in the first two months of 2012,
up a remarkable 77% YoY. Imports from Indonesia were 4.78mt in Jan-Feb, up 77.9% YoY with February imports (at 2.64mt) being almost double February 2011 levels as Chinese buyers attempted to stockpile ore ahead of a potential export ban by the Indonesian government from May 2012 or filing an imposition of a 25% export tax.
Fig 6 Surging Chinese nickel ore imports so far in 2012 (mt gross weight)
Jan-Feb 2012 Indonesia Philippines Others Total 4.78 1.25 0.11 6.14 Jan-Feb 2011 2.69 0.75 0.08 3.52 Change t YoY 2.10 0.50 0.02 2.62 % change YoY 77.9% 66.9% 27.5% 74.4%
Bauxite and alumina Surging imports

The pattern seen in nickel ore is repeated in bauxite with Chinese imports of bauxite from
Indonesia hitting 6.22mt in the first two months of the year, up 62.4% YoY. Imports also rose strongly from Australia (see Fig 7). As in nickel ore, imports from Indonesia accelerated in February (to 3.8mt, up 156% YoY) as buyers rush to secure material ahead of the rumoured export tax or tax imposition.
The other raw material for the aluminium industry, alumina, also showed a 27.4% YoY rise to
722,585t (mostly from Australia), although February imports slowed appreciably.
Fig 7 Chinese bauxite imports move higher (mt gross weight)

Jan-Feb 2012 Indonesia Australia Others Total 6.22 1.47 0.09 7.79 Jan-Feb 2011 3.83 1.05 0.32 5.19 Change t YoY 2.39 0.43 -0.22 2.59 % change YoY 62.4% 40.8% -70.3% 49.9%
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Ex-China copper market shaping up to drive spreads and premiums

Availability of copper units from the London Metal Exchange warehouses has reached critically
low levels. In Asian warehouses, LME copper stocks currently sit at only 21kt after dropping by 150kt in 2H 2012 following the surge in Chinese refined imports. In the US, 83kt of cancelled warrants in New Orleans and St Louis have left available stocks at 121kt, or 27kt for the market in the next month if you deduct copper units stranded behind warehouse queues global copper onwarrant stocks not stuck behind warehouse load-out queues are below 80kt, or 2.4 days of exChina demand.
The reversal in the LME/Shanghai copper price arbitrage, where copper on the LME has averaged
a $400 discount to the Shanghai price, is expected to limit Chinese imports and market reports suggest that China will look to export some excess stocks. In our view, the potential impact of such a development would be limited history shows us China has never exported more than 45kt of refined copper in a single month, and will still remain a net importer of copper.
Copper remains a deficit market and we think that the competition between consumers to secure
copper units in the market ex China will drive physical premiums higher in the coming months, particularly in Europe where we expect demand to outperform previously poor expectations.
Fig 1 Chinese refined copper imports in Q4 drew heavilyonLMEAsianwarehouses

200 180 160
Fig 2 aspikeincancelledwarrants(copper earmarked for delivery) has reduced copper availability

'000t
100 90 LME cancelled warrants in New Orleans LME cancelled warrants in St Louis
'000t
80
70 60 50 40 30 20
140
120 100 80 60 40 20 0
Oct 11
Nov 11
Dec 11
Jun 11
Jan 12
Jul 11
Aug 11
Sep 11
Mar 12
Feb 12
10 0
May 11
Mar 11
Jul 11
Sep 11
Nov 11
Asian LME Copper Stocks
Source: LME, Macquarie Research, March 2012
Source: LME, Macquarie Research, March 2012
US cancelled warrants appear to be financing and not consumer-driven

The size of the spike in US cancelled warrants suggests that this is not a sudden surge of
consumer demand, but physical trader(s) taking the opportunity to finance material with the ultimate aim of selling the copper at a physical premium.
The cost of financing copper, even before considering warehouse rent, is substantial. Consider
that100ktofcopperhasanotionalvalueof~$8.5bnattodaysprices.Assumingaborrowingcost of ~1.5% p.a., this would saddle the trader(s)withacostofcapitalat$1mpermonth.

There are two ways to profit from the trade, and therefore make this financed metal available to
market: a) b) Sell the copper to consumers at a premium above purchase price. Unwind the hedge in a steeply backwardated market.
USandEuropeanapparentcopperdemandsuggestsdestockinginQ42011.
Q4 2011 was a dark time for global industrial sentiment, when uncertainty over the future of the
eurozone saw global growth indicators fall sharply. Faced with uncertainty and lower price expectations, the market tried to minimise working capital Figures 2 and 3 shows the sudden fall in apparent copper demand in Europe and the US, while industrial production in both regions stayed in positive territory. Heavy destocking was the result.
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Jan 12
15
Macquarie Research
Commodities Comment
Althoughweexpectdevelopedeconomiescopperdemandtoremainsluggish,theimprovement
in sentiment is causing a rebound in European and US apparent demand. Many buyers in Europe and the US under-ordered for 2012 and are now rushing back to the spot market to cover. One seller told us that in the second half of 2011 any order cancellations in Europe and the US were more than offset by higher Chinese demand; now the same producer tells us that any order cancellations in China are being more than offset by stronger buying in Europe. This extra buying is likely to drive physical premiums higher in the coming months.
Fig 3 European apparent copper demand suggests destocking in Q4 2011
Fig 4 Despite relatively robust industrial production in the US, consumers appear to have destocked
15%
15%
5%
5%
-5%
-5%
-15%
-15%
Jul-10
Jul-11
Oct-10
Oct-11
Apr-10
Apr-11
Jan-10
Jan-11
Oct-10
Oct-11
Source: ICSG, Ecowin, Macquarie Research, March 2012
Fig 5 Chilean mine production still struggling for YoY growthin2012

8.0% 6.0% 4.0% 2.0%
0.0%
Jan-10
2.0% 4.0% 6.0% 8.0% 10.0%
Jan-11
Jul-10
Jul-11
Supply growth already disappointing in 2012

Peru and Chile account for ~40% of global copper mine supply, and we are forecasting an
ChilesminesupplyinJanuarywasdown8%YoY,equivalentto 36kt of copper contained. Mine
Feb10 Mar10 Apr10 May10 Jun10 Jul10 Aug10 Sep10 Oct10 Nov10 Dec10 Jan11 Feb11 Mar11 Apr11 May11 Jun11 Jul11 Aug11 Sep11 Oct11 Nov11 Dec11 Jan12
Source: Cochilco, Macquarie Research, March 2012
Apr-10
Apr-11
European apparent copper demand
EU IP
US apparent copper demand
US IP
Source: ICSG, Ecowin, Macquarie Research, March 2012
increase in output in 2012 of 10% and 3% YoY, respectively, yet both countries have reported lower mine production YoY lower in January 2012. by mine data show that Chuqicamata was responsible for much of the decline. Looking forward, reports of inclement weather impacting production in Northern Chile, notably Collahuasi, in February and equipment problems at Los Bronces in March suggests that mine supply will continue to disappoint. European and US consumers were not the only market participants destocking Chilesrefinedcopperstocksappeartohavefallenby~80ktin2011.
Fig 6 whiledatashowsChileanrefinedcopper producers have destocked by 80kt in 2H 2011

'000 tonnes
80 60 40 20 0 -20 -40 200.00 150.00 100.00 50.00 300.00 250.00
-60
-80
Apparent Stock change (LHS)
Implied Stock Level (RHS)
Source: Cochilco, Macquarie Research, March 2012
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16
Macquarie Research
Commodities Comment
Outside of Chile mine supply remains disappointing, with lower Peruvian production and further
strike issues at Grasberg. Peruvian data released on Monday showed copper concentrate production fell 5% YoY to 98kt in January, largely duetoafallinCerroVerdesoutput,which declined 30% YoY (9kt). Recurring labour disruptions at Grasberg has led Freeport to lower first quarter copper production guidance by 37kt.
Of course we would caution against extrapolating the full-year production from such a small data
sample, and as Figure 8 shows our quarterly forecast has the growth in mine supply weighted towards the 2H 2012 given the expected ramp-up of Escondida, Los Bronces and Esperanza. However, the data we have suggests that even though we expect Chinese apparent demand to remain soft in the second quarter, mine supply of concentrates is still below expectations, and will lead to a tighter refined market balance going forward.
Fig 7 Peruvian copper concentrate production, down 3%YoY

130
Fig 8 ourforecastcoppersupplygrowth weighted towards 2H 2012

'000 t 4700 4500 4300 4100
000 t
120 110 100 90
3900
80
3700
70
May-09
May-11
May-10
Jul-09
Jul-10
Mar-10
Nov-10
Sep-09
Sep-10
Mar-11
Jul-11
Nov-09
Sep-11
Nov-11
Jan-11
Jan-12
Jan-10
3500 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Quarterly copper mine supply (pre-disruption)
Copper Concentrate (LHS)
Source: Peru Ministerio De Minas, Macquarie Research, March 2012
In summary, copper remains a deficit market and the competition between consumers to secure
copper units in the market ex China is expected to drive physical premiums higher in the coming months, particularly in Europe where we expect the market to outperform previously poor expectations.
26 March 2012
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17
Macquarie Research
Commodities Comment
Chinese steel data NBSvsCISA:theyvebothbeenwrong!

WhenChinasNationalBureauofStatisticsreleasedsteelproductiondataforJan-Feb this year of
685mtpa,itseemedtocontrastsharplywithCISAshighfrequency data over the same period of ~620mtpa. The debate raged over which number to believe, with bulls and bears each finding validation for their views. Now CISA has released a high frequency update for early March which suggests production of 693mtpa, seemingly in line with NBS data for January and February.
In this report we reiterate our view that the NBS production number was wrong for 4Q11 (first
published in Commodities Comment Under-reporting of Chinese steel: a reoccurring Q4 phenomenon, 17 February 2012) and is more likely to be right 1Q12, while the CISA data was too low for January and February 2012. We also show that the CISA data was wrong in Jan-Feb because the NBS number was wrong in 4Q11 and that as we move further into the year, we should be in for a period of more reliable production data.
Fig 1 The focus has been on NBS vs CISA steel data

750
Annulised crude steel output, mtpa
Fig 2 butwethinkNBSwaswrongin4Q11and CISA is wrong in 1Q12

China total crude steel production 750
Macq estimte crude output Reported crude output - NBS
CISA vs NBS steel production data
700 650 600 550 500
700 650 600 550 500

1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12E
CISA estimate NBS reported
Jun-10
Aug-10
Jun-11
Aug-11
Dec-10
Dec-11
Feb-11
Feb-12
Apr-11
Oct-10
Oct-11
The NBS publishes a crude steel production number that should in theory cover almost every steel
producer in the country. The data is reported directly by the companies to the local NBS bureau which then the sends the data up the chain to a provincial bureau and on to Beijing.
CISA, meanwhile, collects production statistics on a 10 day basis and a monthly basis from its
member mills. Typically these mills account for 80-83%ofChinastotaloutput.ThemonthlyCISA data is published on a mill by mill basis, while the 10 day data is published in aggregate form, along with an estimate from CISA of what total China production was over the period.
In our view, the monthly CISA data on production at its member mills is the most reliable of all the
production data sets the fact that the data is published on a mill-by-mill basis means that there should be a good level of accountability in the data and it is also easier to spot errors in the data.
The NBS production meanwhile has been prone to under-reporting in recent years, particularly in
Q4. In the Commodities Comment of 17 February we ran through in some detail where these under-reporting errors arose in summary, non-CISA mills, particularly in Hebei, appear to disappear completely from the NBS production data at the end of the year (see Figs 3 and 4 below).
This is a problem that seems to disappear in the first quarter of the year, hence the apparent
sharp ramp up in output in the reported data for January and February.
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18
Macquarie Research
Commodities Comment
Fig 3 Output of non-CISA mills in Hebei disappears completely at the end of the year (apparently)
200
Fig 4 In fact, Hebei based CISA mills appear to produce more than 100%ofHebeistotaloutput!
Hebei based CISA mill crude steel output as % of reported Hebei output 120% 110% 100% 90% 80%
180 160 140 120 100
70%
80 60
Reported Hebei province output Reported output of Hebei based CISA mills
60%
Nov-09
Nov-10
May-09
May-10
May-11
Sep-09
Sep-10
Sep-11
Nov-11
Jul-09
Jul-10
Jan-09
Jan-10
Mar-09
Mar-10
Jan-11
Mar-11
Jul-11
50%
Nov-09
Nov-10
May-09
May-10
May-11
Sep-09
Sep-10
The table below shows our estimates of production and consumption of steel after adjusting for
under-reporting. We also include the January-February NBS data, which we believe to be reasonably accurate, as it is only a modest sequential increase from our 4Q11 estimated run rates (see Commodities Comment, 12 March 2012 for more details on why we prefer a higher number).
Fig 5
Official production data vs our estimates and the impact on apparent consumption
1Q10 157.9 640.2 24.4% 0.2 -4.5 153.0 620.6 21.2% 34.0 119.0 482.8 25.3% 157.9 640.2 24.4% 0.2 -4.5 153.0 620.6 21.2% 34.0 119.0 482.8 25.3% 2Q10 165.3 663.1 18.6% 0.0 -10.4 153.8 616.8 8.1% -5.8 159.5 640.0 7.3% 165.3 663.1 18.6% 0.0 -10.4 153.8 616.8 8.1% -5.8 159.5 640.0 7.3% 3Q10 151.3 600.4 -1.5% 0.2 -6.1 144.7 573.9 -6.0% -8.9 153.6 609.2 15.6% 157.6 625.2 2.6% 0.2 -6.1 150.9 598.8 -1.9% -8.9 159.8 634.1 20.4% 4Q10 152.0 603.0 3.1% 0.2 -4.5 147.2 583.9 2.7% -12.1 159.3 631.9 11.8% 158.7 629.8 3.6% 0.2 -4.5 153.9 610.7 3.3% -12.1 166.0 658.7 12.0% 1Q11 172.6 699.9 9.3% 0.2 -6.1 166.0 673.2 8.5% 33.0 133.0 539.5 11.7% 172.6 699.9 9.3% 0.2 -6.1 166.0 673.2 8.5% 33.0 133.0 539.5 11.7% 2Q11 179.2 718.8 8.4% 0.1 -9.0 169.3 679.1 10.1% -24.4 193.8 777.2 21.4% 179.2 718.8 8.4% 0.1 -9.0 169.3 679.1 10.1% -24.4 193.8 777.2 21.4% 3Q11 174.8 693.3 15.5% 0.2 -8.8 165.1 655.2 14.2% 0.7 164.4 652.4 7.1% 176.8 701.6 12.2% 0.2 -8.8 167.2 663.5 10.8% 0.7 166.5 660.7 4.2% 4Q11 156.7 621.8 3.1% 0.2 -8.0 148.0 587.3 0.6% -10.9 159.0 630.8 -0.2% 165.4 656.0 4.2% 0.2 -8.0 156.7 621.6 1.8% -10.9 167.6 665.0 1.0% Jan-Feb 12 112.6 685.1 2.2% 0.1 -5.0 107.1 651.7 -2.0% 39.5 67.6 411.1 -7.0% 112.6 685.1 2.2% 0.1 -5.0 107.1 651.7 -2.0% 39.5 67.6 411.1 -7.0% 518.9 15.2% 573.2 14.6% 4.6 -5.7 571.4 26.0% 46.8 524.6 16.4% 591.4 14.0% 639.5 11.6% 0.5 -25.5 611.6 7.0% 7.2 604.4 15.2% 650.2 9.9% 694.0 8.5% 0.7 -31.9 659.2 7.8% -1.7 661.0 9.4% 2009 567.5 13.4% 4.6 -5.7 565.7 24.7% 2010 626.5 10.4% 0.5 -25.5 598.6 5.8% 2011 683.3 9.1% 0.7 -31.9 648.5 8.3%
In million tonnes NBS data Reported crude steel output Reported crude steel output - annualised YoY Net semis imports Net finished imports Apparent consumption (crude basis) Apparent consumption (crude basis) - annualised YoY Inventory Change Real consumption (end user purchasing) Real consumption (end user purchasing) - annualised YoY Macquarie estimates Crude steel output Crude steel output- annualised YoY Net semis imports Net finished imports Apparent consumption (crude basis) Apparent consumption (crude basis) - annualised YoY Estimated inventory change Real consumption (end user purchasing) Real consumption (end user purchasing) - annualised YoY
Source: NBS, China Customs, Mysteel, Macquarie Research, March 2012
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Sep-11
Nov-11
Jul-09
Jul-10
Mar-09
Mar-10
Mar-11
Jan-09
Jan-10
Jan-11
Jul-11
19
Macquarie Research
Commodities Comment
The result of having under reporting in the NBS data but not in the CISA mill production is that
CISA mills end up appearing to take an usually large share of national output. This has a knock on effect on the CISA estimates of national output in its 10-day numbers.
Fig 6 CISA mills share of reported NBS output rises at times of under-reporting
CISA mills share of NBS reported steel production
95% 90% 85% 80% 75% 70%
May-09
May-10
May-11
Mar-09
Mar-10
Nov-09
Nov-10
Mar-11
Sep-09
Sep-10
Although it publishes a number for total China production on a 10-day basis, CISA actually has no
method for collecting production data from its non-member mills. It therefore has to estimate the production from non-members and it does this by looking back at the share of CISA mills output in the reported NBS data from one or two months previously. The chart in Fig 7 below shows the CISA mills share of NBS reported output against the share of CISA mill output assumed by CISA when calculating total national output on a 10-day basis a clear lagged relationship.
Fig 7 CISA base their estimate for high frequency total China production on the historical relationship between CISA and NBS data
95% 90% 85% 80% 75% 70%
CISA mills % of monthly NBS production CISA mills % of CISA high-freq production data
May-11
Sep-11
Nov-11
Jan-09
Jan-10
Jan-11
Jul-09
Jul-10
Jul-11
Source: CISA, NSB, Macquarie Research, March 2012
As NBS data was under-reportedin4Q11,theCISAmillsshareofoutputappearedunusually
high over the period. CISA has then carried this error forward into its January and February estimates of total China production by assuming that CISA mills are producing a much higher share of output than they were. This has resulted in CISA under-estimating non-CISA output over January and February, resulting in an estimate for total China production that was considerably below the actual.
26 March 2012
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1-10 Mar 12
Nov-10
Mar-11
Nov-11
Jul-10
Aug-10
Jul-11
Aug-11
Jun-10
Jan-11
Jun-11
Feb-11
Jan-12
Apr-11
Sep-10
Dec-10
Sep-11
Dec-11
Feb-12
Oct-10
Oct-11
20
Macquarie Research
Commodities Comment
To underscore the point, on Monday CISA released its estimate for production over 1-10 March.
The total China production estimate jumped to 693mtpa from an estimate of 613mtpa for endFebruary.TheprincipalreasonfortheriseinCISAsestimatewasasharpjumpintheirestimate of the proportion of production taken by non-CISA mills in line with the rolling off of underreporting in the NBS data in January and February.
Fig 8 CISAsestimateoftotalChinaoutputrebounds strongly in March lagging the NBS data
Fig 9 Although output data from its member mills has been much more stable
Now that the under-reporting issues have passed out of both the NBS and CISA data, we should
be in for a period of more reliable production statistics (at least until 4Q, when we will have to see). As a general rule, however, we find the CISA mill production data to be the most reliable and any national level estimate should be taken with caution and cross-checked.
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21
GLOBAL
DirectorsCut
US bank leverage to rising yields
We believe the outlook for US bonds is negative. After a near-miss recession in 2011, we believe the US economy is recovering. We therefore expect a switch from bonds to equities over 2012 as investors seek higher real returns. While yields will not rise in a straight line, based on prior near-missrecessions we expect Treasury yields to rise to 3.2% by year end. >> Read Report Higher bond yields should boost the net interest margins of US banks. While investors could seek the most asset sensitive banks, Jonathan Elmi would instead focus on names with outsized securities portfolios.
From the Head of Research desk, we cast our net over our analyst coverage universe of 2,200 stocks in 32 countries to bring you what we see as the best themes and ideas of the day.
Banks with outsized securities portfolios concentrated in Treasuries and agency MBS are more likely to see margin and earnings improvement from a combination of increased yields on existing bonds and reduced run-off of earning assets due to slower prepayment speeds. Given Jonathans estimate of the impact of rising bond yields on 2012e EPS, a rise of nearly 100 basis points would add around 10% to earnings for the median US bank. Banks with the largest securities portfolios relative to total assets, as well as the shortest durations, are likely to see the most upside. While the EPS impact will lag 1 or 2 quarters, and it is average yields that matter, Keycorp (KEY US) is one Outperform rated US bank that fits the bill. >> Read Report
Stocksinthisissue
Country
ANZBank AU AvalonBayCommunities US BakerHughes US DGBFinancialGroup KS EastJapanRailway JP EssexPropertyTrust US FoxconnInternational HK Halliburton US J.C.Penney US KBFinancialGroup KS KeyCorp US LifeTechnologies US MaanshanIron&Steel HK MitsubishiUFJFinancial JP PostProperties US Schlumberger US TheBankOfYokohama JP WooriFinanceHoldings KS Source:MacquarieResearch,March2012
12MTSR Forecast 18% 12% 20% 13% 33% 12% 24% 24% 33% 17% 22% 23% 77% 20% 15% 33% 16% 30%
US Bank share price rally partly driven by rise in Treasury bond yields
Source: FactSet, Macquarie Research, March 2012
Highlights
Analysts
John O'Connell +61 2 8232 7544 David Rickards +61 2 8237 1159 Matthew Brooks +61 2 8237 0645 john.oconnell@macquarie.com david.rickards@macquarie.com matthew.brooks@macquarie.com
Chan Hwang believes the Korean banks can continue to outperform on the
back of their cheap valuations and favours Woori Finance (053000 KS).
In the absence of higher rates, Michael Wiblin does not expect negative
housing equity to have a material impact on the Australian banks.

Rob Stevenson expects a rebound in the US apartment REIT sector, with
top picks including AvalonBay (AVB US) and Essex (ESS US).
135
Macquarie Research
DirectorsCut
Consumer
J.C. Penny most compelling turnaround in retail Liz Dunn continues to see J.C. Penney (JCP US) as the most compelling turnaround in the US retail space. In her view, the moderate department store model appears to be broken, but she thinks JCP is the only company with a bold plan to do something new. Liz likes the management team, which continues to evolve and strengthen. She likes the pricing strategy and believes ultimately it will work. Liz believes it is possible that comps will turn positive in the second half, but currently has a more conservative assumption. Rated Outperform, she forecasts a 12 month TSR of 33%. >> Read Report
Energy
Schlumberger a top sector pick in US oil services space Nigel Browne has lowered his estimates on US land and pressure pumping names following BakerHughesdisappointingguidance. That said, he views the pause in US Land horizontal rig count growth as a positive as it should incentivise more pricing discipline internationally, reduce rate of supply additions on US land and lead to rationalisation of less efficient players. Moving forward, he continues to believe Baker Hughes (BHI US) and Halliburton (HAL US) are compelling candidates for deep-value investors with patient capital. Rated Outperform, these stocks offer forecasts 12 month TSRS of 20-25%. Schlumberger (SLB US) also offers disproportionate exposure to international offshore and international deepwater with mitigated headline risk from North America land drilling. >> Read Report
Financials
Korean banks to continue outperforming KOSPI Chan Hwang believes the Korean banks can continue to outperform in the near term on the back of their cheap valuations and relief from the European crisis. On the expectation of possible efficient capital management, he has upgraded KB Financials (105560 KS) to Outperform, and downgraded DGB Financial (139130 KS) to Neutral after significant outperformance over the past three months. His top pick is Woori Finance (053000 KS) on the back of leverage to credit cost improvement. Rated Outperform, he forecasts a 12 month TSR of 30% for Woori Finance. >> Read Report With suggestions of emerging negative equity in the Australian housing market, Michael Wiblin has looked at previous international examples of the impact of negative equity on mortgage losses. He says there are examples where negative equity is widespread, but losses have been contained. The prime example is the UK during the GFC where negative equity peaked at 12%, higher than the early 1990s 11%, but mortgage write-off rates were around 70% lower than the early 1990s peak. The key difference was lower interest rates, which allowed for a more benign outcome. Given he does not expect a combination of substantially higher interest rates and unemployment, he does not expect a material rise in mortgage losses in Australia. Michael also maintains his preference for ANZ Bank (ANZ AU) among the Australian banks given the leverage to Asia. >> Read Report Given the hunt for yield among Japanese domestic investors, Alastair Macdonald sees modest risk for the sector as it goes ex-dividend on March 28. In his view, the higher yielding Big 5 banks are more vulnerable than the lower yielding regional banks. Longer term, he maintains a preference for banks with relatively robust capital positions and higher operating profitability as he believes the end of the beta rally phase of the market recovery is approaching. Due to high OROA, his top picks include MUFG (8306 JP) among the Big 5 and Yokohama (8332 JP) among the regionals. >> Read Report
Negative equity not material while rates remain low
Risk in Japan banks as yield seekers sell post-dividend
Health
Life Technologies determined to deliver on growth plans Jon Groberg spent the last couple of days visiting investors with Life Technologies (LIFE US) CEO. He came away impressed with their determination to deliver against stated plans to leveragethefirmsstrength in the table research markets into faster growing applied markets and emerging geographies. While growth has slowed, he continues to like the fact that 80% of the business is recurring, is very high margin and requires very little capital. Given their credible plan to improve underlying growth, and with the board considering instituting a dividend, Jon maintains his Outperform on LIFE. Over the next 12 months, he forecasts a total shareholder return of 23%. >> Read Report
26 March 2012
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Macquarie Research
DirectorsCut
Industrials
Shinkansen traffic growth bullish for JR East Nicholas Cunningham has increased his forecasts for the Japanese Rail companies on the back of better shinkansen traffic and a reduced corporate tax rate. He maintains an Outperform on all three, but JR East (9020 JP) remains his top pick. Given the Tohuku earthquake impact on FY12 financials, he believes FY13-14 are more appropriate for valuation. With a PER of 10-11 times, a high 9% earnings yield premium to bonds, a current price to book of 1 and a 2.2% dividend yield, Nicholas believes the shares remain oversold. Over the next 12 months, he forecasts a TSR of 33%. >> Read Report
Materials
Asian steel stocks at inflection point as real demand returns Andrew Dale believes we are at an inflection point for Asian steel stocks. In the March survey results, he sees that orders are starting to pick up in almost all downstream sectors, following the improvement in sentiment during February. Traders inventory has been coming down and steel prices are rising, which also suggests an improvement in real demand. Given improving steel margins, and yet still weak prices for steel stocks, Andrew sees a buying opportunity. His top pick remains Maanshan (323 HK), which is rated Outperform and offers a forecast 12 month TSR of 77%. >> Read Report Moving to US steel, Aldo Mazzaferro thinks prices have downside risk in the short term, to perhaps US$600 due to higher steel imports. Although it has narrowed, the US pricing premium relative to foreign steel continues to be stimulative to imports, with premiums still above US$100 a ton. As a result, he continues to see serious downside adjustment to consensus earnings for 2012, especially for those most sensitive to changing prices and with high fixed costs. Aldo thinks mini-mills are significantly better positioned than integrated producers, even under a soft pricing scenario. He therefore maintains an Underperform on AK Steel (AKS US) and an Outperform on Nucor (NUE US). >> Read Report
Downside risk in US steel prices, favour mini-mills
Property
US apartment REITs due for a rebound Since December, the lower quality, higher leverage US REIT names have substantially outperformed the blue-chips. Rob Stevenson does not expect this trade to last, especially if the 10 year Treasury yield continues to climb or investors begin focusing more on riskadjusted returns. One sector he expects to rebound is apartments because this segment has the strongest expected same-store NOI growth, valuations look more reasonable and roughly US$1.4 billion of development deliveries are due in 2012. At yields exceeding 6%, thee latter should create substantial value. His top picks in the space are AvalonBay (ABB US), Post Properties (PPT US) and Essex Property (ESS US). >> Read Report
Technology
Impressive result highlights Foxconn turnaround ahead Kylie Huang remains positive on Foxconn (2038 HK) as the latest results confirm the turnaround. Her view was that FIH would benefit as smartphones enter into a mass market volume cycle, while a better product mix and improving cost structure lift margins. The latest results show a second half operating profit of US$64 million, more than double her estimate on the back of the strong recovery in margins. Robust growth prospects from its major customer, Huawei should provide a strong driver for FIH this year, with undemanding revenue growth of 15% in 2012e. Rated Outperform, she forecasts a 12 month total shareholder return of 24%. >> Read Report
26 March 2012
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Macquarie Research Important disclosures:

Recommendation definitions
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This is calculated from the volatility of historical price movements. Very highhighest risk Stock should be expected to move up or down 60100% in a year investors should be aware this stock is highly speculative. High stock should be expected to move up or down at least 4060% in a year investors should be aware this stock could be speculative. Medium stock should be expected to move up or down at least 3040% in a year. Lowmedium stock should be expected to move up or down at least 2530% in a year. Low stock should be expected to move up or down at least 1525% in a year. * Applicable to Australian/NZ/Canada stocks only Recommendations 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations
Financial definitions
All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards).
Recommendation proportions For quarter ending 31 December 2011

Outperform Neutral Underperform AU/NZ 56.59% 33.45% 9.96% Asia 65.60% 20.55% 13.85% RSA 54.55% 38.96% 6.49% USA 44.53% 50.20% 5.27% CA 75.28% 22.47% 2.25% EUR 49.46% (for US coverage by MCUSA, 10.53% of stocks covered are investment banking clients) 32.36% (for US coverage by MCUSA, 10.96% of stocks covered are investment banking clients) 18.18% (for US coverage by MCUSA, 0.44% of stocks covered are investment banking clients)
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Tuesday, 27 March 2012

Bank of Queensland (Neutral)

Top Quant Alphas

Bottom Quant Alphas

TABCorp Holdings (Upgrade to Outperform)

CFS Retail Property Trust (Outperform)

67 71 87 95 100 104 108 114 135

Macquarie Marquee Ideas / Diary

- DCF (WACC 11.0%, beta 1.0, ERP 5.0%, RFR 7.0%)

BOQ AU vs ASX 100, & rec history

Earnings and target price revision

Action and recommendation

26 March 2012 Macquarie Securities (Australia) Limited

RoE challenge remains

What else was interesting?

with a 1.7% increase YoY, and flat HoH.

investors with a 26c interim dividend.

terms of size (c30% of existing capital) and discount (c17%).

places BOQ in line with the majors at c100% impairment coverage.

talent from the major banks (new CRO, new COO).

1H12, the cost to income ratio increased from 44.5-45% in 1H12.

high at 11% for a BBB rated bank.

Profit down due to bad debts.

Preliminary profits miss MRE and consensus forecasts.

Source: Company data, Macquarie Research, March 2012

raising. Our target price moves down from A$8.70 to A$6.85.

Fig 2 Earnings changes

Funding & Capital

Source: Company data, Macquarie Research, March 2012

99.2 600 500

Source: Company Data, Macquarie Research, March 2012

Large capital raising removes balance sheet issues

Market leading coverage post capital raising

Fig 6 BOQ capital raising brings 1H12 to adequate capital levels

1H12 (ex. capital Capital raising & raising additional Dividends

Source: Company data, Macquarie Research, March 2012

Fig 7 RoE (%) BOQ lagging most other players

20 18 16 14 12 10 8 6 4 2 0 ANZ CBA NAB WBC BOQ BEN

Source: Bank data, Macquarie Research, March 2012

Year Ending 31 August

Bank of Queensland Neutral

35 -31.2 26 10.2 7.7 220

49 39.3 28 10.5 8.0 223

84 -12.0 54 10.5 8.0 221

-31 -137.1 26 9.9 7.4 228

38 -220.6 28 8.6 6.7 306

6 -92.3 54 8.6 6.7 267

78 1,104.9 56 8.6 6.8 313

77 -0.7 58 8.6 6.9 323

9.0 0.7 0.9 8.8 0.56 7.7 57.1

8.7 0.7 0.9 6.5 0.41 7.4 64.1

-11.7 0.7 1.0 -7.2 -0.45 7.1 -83.2

9.7 0.9 1.1 8.2 0.54 7.7 74.3

113.2 0.9 1.1 0.7 0.05 7.4 837.1

9.4 0.8 1.1 8.2 0.56 7.7 72.0

9.5 0.8 1.1 8.2 0.55 7.9 75.2

Profitability & Leverage

1.2 0.8 0.4 0.0

Leverage (x) ROA (RHS, %)

12.0 10.0 8.0 6.0 4.0 2.0 0.0

Capital Adequacy & RWA Growth

310 83 57 -8 34 393 174 75 98 220 134 0 4 81 24 0 -7 50 5 0 20 3 77

318 95 57 -7 45 413 177 80 97 237 66 0 5 166 47 0 -9 111 5 0 -10 3 109

318 78 57 -8 29 395 184 81 103 211 45 0 5 161 50 0 0 111 0 0 0 5 115