The Investment Cycle Starts to Turn

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1 Nobody Just Gives You The High Ground The Investment Cycle Starts to Turn UN JOINED STROKE LINES December 25 Déjà vu Still Muddling Through 2 Portfolio Structure 3 Asset Allocation 5 NZ Equities 6 Australian Equities 9 Global Equities The Mature Bull Market Tires 3 NZ Debt Securities Action at Last 5 Currency More of the Same 6 Resources Can They get any Worse? 7 Positioning Investments for Demographic Shockwaves 9 Discretionary investment Management Service (DIMS) Is it Right for You? 2 If in Doubt Contact Your Adviser 24 NZ Equities Buy Contact Energy, Metro Performance Glass and Summerset - page 6 Australian Equities Buy Boral, Challenger, Westpac Banking Corporation - page Global Equities Buy exposure to European, healthcare and other demographic related equities - page 3 NZ Debt Securities Buy debt securities with terms to maturity up to 5 years and senior bank debt - page 7 Overview Déjà vu - the phenomenon of having the strong sensation that an event or experience currently being experienced, has already been experienced in the past. Financial markets move in irregular cycles as economies expand and contract. While every cycle feels a little different economic historians will certainly be saying they have seen it all before. And so it is as the US Federal Reserve appears likely to commence a normalisation of US interest rates as the Fed Funds Rate is lifted off the -.25% range. They will be alone in this stance with significant monetary policy easing still being undertaken in Japan and Europe. Many will say that after nearly seven years of rising equity markets that this signals the end of the rally. We remind ourselves that while the best returns have probably been had equity markets typically decline, not due to overvaluation, but due to an economic down turn. No down turn is forecast yet. While the NZ economy is in reasonable shape we expect to see a further modest decline in the value of the NZ dollar. We believe this provides the edge for global equity performance relative to NZ equity performance. In Australia we continue to favour the banks, although are more excited about the prospects for stocks exposed to the expected rise in infrastructure spend and provision of retirement income. NZ debt markets have seen significantly more activity recently than they have in a long time. While short term interest rates are likely to be kept low by the Reserve Bank of NZ longer term interest rates are expected to gradually rise as the US interest rates normalise. The staff of First NZ Capital extend our best wishes to you for the festive season. We look forward to growing our valued relationship with you in 26. First NZ Capital Securities Ltd NZX Firm

2 Déjà vu Still Muddling Through Desynchronised monetary policy An end to fiscal austerity Geopolitical risks abound Political structure favours global equities The global economic recovery is expected to continue for another year. However, as in recent years the recovery has been far from compelling. It appears that 26 will very much be a case of muddling through. Part of the reason for this mediocre recovery could be due to changing demographics we discuss this further on page 9. While the global economy again appears to be muddling through the forces shaping it are changing. Desynchronised Monetary Policy US monetary policy is expected to finally take a material change of tack. A substantial improvement in the US labour market has seen the unemployment rate fall to 5% - this is slightly flattered by the number of working aged people available to work being slightly lower than would be expected with unemployment at this level. Coupled with underlying inflation of just under 2% (headline inflation is much lower due to the low oil price), a stable banking sector and reasonable economic growth the US Federal Reserve (Fed) is expected to start normalising the Fed Funds Rate on 6 December 26 having been set around % for the past 6 years. The Bank of England is expected to follow suit later in 26. This contrasts with Europe where the European Central Bank is expected to extend the level of quantitative easing (QE) and Japan where QE is ongoing. An End to Fiscal Austerity Fiscal austerity has been a global theme as many governments struggled to contain the debt accumulated during the Global Financial Crisis (GFC). Forecasts Economic As at 24 November 25 Country / Region Fiscal Balance % GDP () GDP Growth % Inflation % 3 month Libor % (2) Year Government % 24 A 25 F 26 F 24 A 25 F 26 F 24 A 25 F 26 F Spot 3 mth 2 mth Spot 3 mth 2 mth New Zealand Australia US Japan Europe United Kingdom China n/a n/a Source: First NZ Capital, Credit Suisse, Bloomberg. New Zealand fiscal balance is 3/6 2. NZ are 9-day bank bill yields Equities and Commodities Foreign Exchange Spot 2 mth forecast Past Month Past Year Australia 2 5,226 5,3-5,67-2.3% -2.5% Emerging Markets % -6.8% MSCI EMF GEM Europe Stoxx 5 3,4 3,5-3,9 -.5% 6.2% Japan Nikkei 225 9,5-2,5 5.8% 4.8% 9,925 New Zealand NZX 5 6, 5,94-6,56 2.2%.5% UK FTSE 6,277 6, - 6,6-2.6% -6.7% US S&P 5 2,89 2,3-2,25.7%.% USD NZD Spot 2 mth Spot 2 mth NZD AUD EUR JPY GBP Source: First NZ Capital, Credit Suisse, Bloomberg Oil Brent Usd/Bbl % -42.3% Gold Usd/Oz, ,5-7.6% -.2% Source: First NZ Capital, Credit Suisse, Bloomberg First NZ Capital Securities Ltd NZX Firm 2

3 However, five years of fiscal austerity appears about to be replaced with a period of fiscal neutrality in many key economies. Germany and Italy are expected to boost spending to help deal with the influx of migrants from Syria and North Africa, Japan is expected to provide a fiscal boost to counteract an increase in consumption tax, China is expected to spend more to counter slowing economic growth and the US may finally act to replace aging infrastructure. This is likely to be a mild boost to global economic activity and put modest upward pressure on interest rates. Geopolitical Risks Abound While there are always risks of this nature and typically there impact is only very localised it is nonthe-less worthwhile being aware of the current issues. They include:. Significant migration into Europe and/or terrorist attacks which provide increasing support for extreme right wing political parties; 2. An increase in the turmoil in the Middle East could disrupt the flow of oil to an energy hungry world; 3. An increase in the tensions in the Ukraine or seas near China; 4. The US presidential elections in late 26 could see policy platforms launched which have a negative impact on particular industries e.g. Hilary Clinton s desire to contain pharmaceutical costs; 5. A referendum on whether the UK remains in the European Union is expected to be held in October 26. Global Equities With US interest rates expected to rise there is growing realisation that that the current equity bull market will be seven years old next March, which in financial market terms is fairly old. How concerned should we be investing in global equities, in particular US equities? While nothing is certain we make the following observations:. Historically when the Fed commences a cycle of increasing interest rates the PE ratio of the US equity market declines. However, historically the equity market keeps rising as earnings growth offsets the decline in the PE ratio; 2. Economic recessions are what typically cause equity markets to fall in value. This is certainly not forecast yet; 3. Recessions do not typically occur until short term interest rates rise above long term interest rates. Currently short term interest rates are.8% lower and are not forecast to be above long term interest rates any time soon. Consequently there is no sign of conditions which may create a recession; Recessions Typically Occur After The Fed Funds Rate Exceeds the Year Treasury Yield Portfolio Structure Currently financial markets are all relatively calm. However, it shouldn t be forgotten that late August and through September we saw a sharp correction in equity markets and a significant increase in share price volatility as the Chinese authorities widened the band in which the yuan trades causing a sharp devaluation of the yuan. This sent shock waves through Asian economies which have significant trade links with China and heightened concerns about the strength of the Chinese economy. With this in the back of our minds let s consider the investment landscape. Source: Bloomberg, First NZ Capital 4. There are signs that the credit cycle in the US is turning. Lending standards to weaker credits are tightening, high yield spreads are rising and the amount of high yield debt being raised is declining. This is certainly something to watch. However, equity markets typically don t fall for at least 2 months after the credit cycle turns. First NZ Capital Securities Ltd NZX Firm 3

4 While the attractiveness of global equities is certainly reduced, high single digit equity market returns, which for NZ domiciled investors are likely to be enhanced by a modest decline in the value of the NZ dollar is certainly significantly more attractive than the low single digit investment returns offered by debt securities. The outlook for global equities is discussed in more detail on page 3. NZ Equities The NZ equity market has outperformed most other equity markets so far this year. It is only when the benefit of a weaker NZ dollar is included that global equities outperformed. This reflects a relatively solid performance by the NZ economy. So what does the future hold? Below average consumer and business confidence, the risk to agriculture from El Nino and low dairy prices are all challenges for the NZ economy. However, in the positive corner we have a lower NZ dollar, lower short term interest rates, a very strong tourism sector (tourist numbers up nearly 9%), strong migration, strengthening house construction (particularly Auckland) and the ongoing Christchurch rebuild (which is expected to add to NZ s economic growth until the end of 26, although now at a relatively low rate). In aggregate this delivers a moderate level of economic growth in 26, which creates a supportive back drop for moderate equity market returns. Migration Hits a Record High Annual total Source: Statistics NZ Australian Equities The decline in the resources sector and accompanying decline in investment has certainly seen the prospects for the Australian economy decline. However, it is not as bad as the Australian media would have you believe. In fact the Australian economy is expected to marginally outperform the NZ economy in 26. The prospects for Australian equities are discussed on page. NZ Debt Securities As an asset class NZ debt securities continue to provide a low risk (in other words, highly certain) investment outcome for investors. However, this comes at a cost which is a low investment return. Furthermore, we expect interest rates to rise driven by a normalisation of interest rates in the US and an end to global fiscal austerity. Partially offsetting these upward forces in NZ is the current low NZ inflation rate (although a lower NZ dollar and potential oil price stabilisation represent upward pressure), a further expected reduction in the Official Cash Rate, changing demographics and high levels of debt meaning changes in interest rates have a larger impact on borrowers than in the past. The outlook for NZ Debt Securities is discussed in more detail on page 5. Property Property has been a star performer this year as investors have sought assets with relatively predictable earnings stream in an environment where the usual source of highly predictable investment returns, debt securities, has seen returns drift well below 4%pa in many cases. It is unfortunate that while the fundamentals of the property market are currently strong that listed property companies have not been able to grow their distributions to shareholders much. Despite this the share prices of property companies have risen reflecting the rising value of their property assets as the capitalisation rates (cap rates) used to value properties have fallen in step with lower long term interest rates. If the Fed starts increasing the Fed Funds Rate as expected and long term interest rates start rising the capital gains enjoyed by property companies may come to an end resulting in more subdued investment returns. It should also be borne in mind that property tends to be late cycle which means that a high proportion of new buildings built tend to be constructed as the economy peaks and starts turning down. This frequently leads to higher vacancy rates and falling rents. Hence we retain our cautious property view. First NZ Capital Securities Ltd NZX Firm 4

5 Asset Allocation December 25 This quarter we have made no change to our tactical asset allocation. The strategic asset allocation represents the average weighting over the long term (circa ten years or more of an entire economic cycle). The tactical asset allocation represents a deviation from the strategic allocation to take advantage of expected changes in asset class returns over the short term (say 6 months plus). Conservative Cash 5 NZ Debt Securities 55 Property 4 NZ Equities 8 Australian Equities 3 Global Equities 2 Alternative Strategies 3 Balanced/Conservative Cash NZ Debt Securities 44 Property 5 NZ Equities 2 Australian Equities 6 Global Equities 8 Alternative Strategies 4 Balanced Cash 8 NZ Debt Securities 32 Property 6 NZ Equities 6 Australian Equities 8 Global Equities 25 Alternative Strategies 5 Balanced/Aggressive Cash 7 NZ Debt Securities 23 Property 6 NZ Equities 2 Australian Equities Global Equities 29 Alternative Strategies 5 Aggressive Cash 5 NZ Debt Securities 5 Property 6 NZ Equities 23 Australian Equities 2 Global Equities 34 Alternative Strategies 5 Source: First NZ Capital Strategic Allocation % Income Growth Tactical Assets Assets Deviation % First NZ Capital Securities Ltd NZX Firm 5

6 New Zealand Equities Chorus (CNU) Price $3. Target Price $3.22 Outperform CNU is currently working through a number of regulatory issues such as copper pricing to apply through to 29, the amount of capital expenditure on the Ultra-Fast Broadband (UFB) network; and the regulatory review which should lead to a new regulatory framework to set copper and fibre pricing beyond 22. While there is still a lot of uncertainty surrounding CNU, once the 22 framework is set CNU will become a much more attractive long term investment proposition. The premise for this view will be a reduction in the risk premium being applied to the stock and CNU's ability to generate stable infrastructure-like cash flows and pay reliable, attractive dividends. Contact Energy (CEN) Price $5.5 Target Price $6. Outperform CEN s share price appears cheap relative to the broader equity market. This is despite the overhang of the Origin Energy sell down being removed and the risk of a potential Tiwai Point aluminium smelter exit being pushed out to late 26. CEN s outlook appears positive with profit expected to benefit from lower costs assisted by the closure of the Otahuhu power station. In addition retail electricity prices appear to have stabilised as discounts have stabilised. Furthermore, following completion of a five year capital expenditure programme, CEN is forecast to return a substantial proportion of its free cash flow to shareholders via share buybacks and special dividends. Fonterra Shareholders Fund (FSF) Price $5.43 Target Price $5.52 Neutral While the short term outlook for the dairy industry has been disrupted by excess global supply, FSF appears well placed for the medium-to-long term trends within the industry which is primarily driven by growing demand in developing countries. With FSF s current restructure well underway, FSF is concentrating on three areas: ) embedding the transformation program; 2) turning around the Australian business; 3) developing its Chinese strategy which includes leveraging the Beingmate relationship. The recent announcements relating to asset sales, earnings upgrade and cost out strategy all represent progress. Genesis Energy (GNE) Price $.97 Target Price $.65 Neutral The electricity sector is benefiting from higher electricity prices due to supply being withdrawn and demand returning to growth at a modest.8%pa. GNE recently announced an upgrade of the Kupe oil and gas field reserves. Consequently we do not expect its contribution to cash flow to materially decline until around 223, supporting GNE s dividend profile. GNE has said that the Rankine electricity generation units at Huntley will be shut down. However, we believe there is strong likelihood that GNE and Meridian Energy will come to a commercial arrangement which will see the Rankine generators retained. If this eventuates we believe there is around $.25 of upside to GNE s share price. GNE s September quarter operating figures suggest a marginally higher full year profit than expected. In addition, GNE has an attractive FY6 forecast net dividend yield of 8.9%. Mainfreight (MFT) Price $5.58 Target Price $7.5 Outperform Weaker-than-expected domestic transport growth and an elevated cost structure resulted in a disappointing H6 result. While disappointing aligning operating cost investment to revenue growth is challenging for a growth company like MFT. We are confident that improved cost control though new initiatives and underlying growth in domestic freight volumes will deliver a turnaround in 2H6. In the longer term we remain comfortable that as MFT builds scale in its key offshore markets it will benefit from strong efficiency and margin improvements. Metro Performance Glass (MPG) Price $.55 Target Price $2.2 Outperform Prices as at 24 November 25 MPG has increased capacity through a new facility in Auckland which should help drive revenue and profitability growth. The focus now will be on extracting greater operating leverage from the plant. The demand outlook from the NZ building sector remains very positive and First NZ Capital Securities Ltd NZX Firm 6

7 specifically for processed glass. This is largely driven by the Auckland housing market which is only just heating up and in Christchurch where residential activity looks to have peaked but commercial activity is growing. Despite there being two major suppliers of window glass in the NZ market, competitive pressures have led to a relatively disciplined price environment price increases of 4.5% were recently achieved. Nuplex Industries (NPX) Price $4.6 Target Price $4.7 Outperform NPX offers growth from its plant expansion in Asia and leverage to an economic recovery in Europe. Longer-term key value drivers will be NPX s ability to move towards more value added product, including the benefit from developments like its Acure coating solution which offers a quick dry time and long shelf life. NPX remains on relatively attractive earnings multiples and retains a strong balance sheet. NPX s on market share buyback has provided share price support, but, is nearing completion. Near term share price catalysts are lacking with nothing expected until the H6 profit announcement in February 26. However, any further NZ dollar depreciation would be positive. NZX Limited (NZX) Price $.2 Target Price $.3 Outperform NZX currently trades on undemanding valuation multiples which likely reflect NZX s inability to grow earnings in recent years. We believe 2H6 is looking more promising as the legal costs associated with the dispute with former owners of the Clear Grain Exchange disappear, assuming no appeal process. NZX should benefit from continued incremental earnings growth across its key revenue lines with only marginal increases in operating costs. A stabilisation of the agriculture sector should benefit the level of advertising in NZX's agricultural publications. NZX is yet to prove the value of its funds management business which stands to benefit from the launch of a number of Exchange Traded Funds listed in NZ. NZX is a contender to buy NZClear although there is no specific timetable for the sales process at this stage. While dependent on the deal details, we would view NZClear as a high quality asset for NZX. Summerset (SUM) Price $3.98 Target Price $4.35 Outperform SUM recently upgraded earnings guidance as it experiences strong sale volumes and expanding development margins. The outlook remains strong with solid demand across the NZ industry, and specifically at SUM s new villages. Momentum is expected to continue into FY6 with a number of main building openings expected to propel sales, a lift in build rate from circa 3 to 4+ units and staggered pricing initiatives. We expect 8% earnings growth in FY6. In the longer term SUM is well positioned to benefit from its highly attractive business model, compelling demographic tailwinds and strong management. Critical to its success and therefore valuation is execution of its business strategy. Z Energy (ZEL) Price $6.59 Target Price $6.4 Neutral ZEL s current valuation is highly dependent on the Commerce Commission (ComCom) approval process with respect to the Chevron NZ (which owns Caltex) acquisition. The key unknowns in the process are what concessions ZEL will have to make regarding certain Chevron's current assets and the timing of a decision. We value ZEL at $5.22/ share on a standalone basis and $7.22/share with ZEL and Chevron combined based on Chevron's current earnings and synergy estimates. ZEL's current target price of $6.4 assumes a 75% likelihood of ComCom approval. However, it is somewhat academic with the outcome being binary. In our opinion ZEL s current share price is pricing in a high likelihood of approval, hence the neutral rating. First NZ Capital Securities Ltd NZX Firm 7

8 NZ Equities Valuation Metrics and Ratings As at 24 November % 4 2.% 4 2.% Security Issuer Name Security Issuer Name ATM A2 Milk Security Security ATM Issuer Issuer A2 Name Milk Name Company Gross Dividend Yield % AIR Air NZ ATM ATM AIR A2 Milk A2 Air Company NZ Milk Company Gross Gross Dividend Dividend Yield Yield % % AWK Airwork Holdings AIR AWK AIR ARG Air NZ Airwork NZ Holdings Argosy Property AWK AWK ARG AIA Airwork Airwork Argosy Auckland Holdings Property Holdings Airport ARG ARG AIA AUG Argosy Argosy Auckland Augusta Property Property Airport Capital AUG Augusta Capital AIABGR AIA Auckland Auckland Briscoe Airport Group Airport BGR Briscoe Group* * AUGCNU AUG Augusta Augusta Chorus Capital Capital CNU Chorus BGRCOA BGR Briscoe Briscoe Coats Group* Group* COA Coats CNUCEN CNU Chorus Chorus Contact Energy CEN Contact Energy COADGL Coats Coats Delegat Group DIL DGL Delegat Diligent Group CEN CEN Contact Contact Energy Energy Corporation STR DIL Diligent Stride Property Corporation DGL DGL Delegat Delegat Group Group EBO STR Stride Ebos Group Property DIL DIL Diligent Diligent Corporation Corporation * ERD EBO Ebos EROAD Group* STR STR Stride Stride Property Property FPH ERD EROAD Fisher & Paykel Healthcare EBO EBO * FBU FPH Ebos Ebos Fisher Group* Group* Fletcher & Paykel Building Healthcare* ERD ERD * FSF FBU EROAD EROAD Fletcher Fonterra Building* FPH FPH FSF Fisher Fisher Fonterra & Paykel & Paykel Shareholders Shareholders Healthcare* Healthcare* Fund Fund FBU FBU FRE Fletcher Fletcher Freightways Building* Building* FSF FSF GNE Fonterra Fonterra Genesis Shareholders Shareholders Energy Fund Fund FRE FRE GMT Freightways Freightways Goodman Property Trust GNE GNE HLG Genesis Genesis Hallenstein Energy Energy Glasson Holdings* 56x GMT GMT HNZ Goodman Goodman Heartland Glasson Property Property Holdings NZ Trust * Trust 6x P/E Ratio x HLG Hallenstein Glasson Holdings* 56x HLGHNZ HBY Hallenstein Hellaby Heartland Glasson Holdings NZ Holdings* 56x * 6x HBY HNZ Heartland IFT Infratil Hellaby Holdings NZ P/E Ratio x 6x HNZ Heartland NZ * P/E Ratio x IFT HBY Hellaby IQE Intueri Infratil Holdings * HBY Hellaby Holdings Education * Group IQE IFT Infratil IFT KMD Infratil Kathmandu Intueri Education * Group KMD IQE Intueri KPG Kiwi Kathmandu Education Property Group IQE Intueri Education Group KPG KMD Kathmandu MFT Mainfreight Kiwi Property * KMD Kathmandu * Group MFT KPG Kiwi MEL Meridian Mainfreight Property Group KPG Kiwi Property Energy Group MEL MFT Mainfreight Meridian Energy MFT MVN Mainfreight Methven MVN MEL Meridian Methven Energy MEL MET Meridian Metlifecare Energy MET MVN Methven Metlifecare MVNMPG Methven Metro Performance Glass MPG MET Metlifecare Metro Performance Glass MET MHI Michael Hill International* MHI Metlifecare MPG Metro Michael Performance Hill International Glass * MPGMRP MRP Metro Mighty Mighty Performance River River Power Glass MHI Michael Hill International* MHINPT NPT Michael NPT NPT Hill International* MRP NPX NPX Mighty Nuplex River Industries Power MRP Mighty River Power NPT NZR NZR NPT NPT NPT NZ NZ Refining NPX NZX Nuplex NZX Industries NPX Nuplex NZX Industries NZR OIC Opus NZ Refining NZR NZ Refining International Consultants OHE NZX NZX NZX NZX Orion Consultants Healthcare OHE PGW OIC Opus PGG Orion Wrightson International Consultants OIC Opus International Healthcare Consultants PGW OHE POT Orion Port PGG of Wrightson Healthcare OHE Orion Healthcare Tauranga POT PGW PCT PGG Precinct Port Wrightson PGW PGG Wrightson of Tauranga Properties PCT POT PFI Port Property Precinct of Tauranga POT Port of Tauranga For Properties Industry PFI RBD PCT Precinct Restaurant Property Properties For Brands* Industry PCT RBD RYM PFI Precinct Property Properties Ryman Restaurant Healthcare For Brands Industry PFI * Underperform Neutral Outperform RYM SAN RBD Property Restaurant For Industry Sanford Ryman Healthcare Brands* Ratings RBD AIA NPT KPG COA AUG ARG ERD CEN SAN RYM Restaurant SCL Ryman Brands* Scales Sanford Corporation Healthcare Underperform AIR PFI MEL Neutral DGL FSF AWK Outperform RYM MFT MET SCL SAN Ryman SKT Sanford Sky Scales Healthcare Network Corporation Underperform TV SKT Sky Network TV ATM AIA NPT KPG Neutral NZR COA DIL AUG IFT CNU ARG Outperform SAN Sanford ERD NZX MPG CEN SKC SCL Scales SkyCity Corporation AIA Entertainment SKC SkyCity Entertainment SKC AIR NPT PFI KPG MEL COA PCT DGL AUG FRE MVN FSF ARG AWK ERD HNZ MFT CEN SCL Scales Corporation OHE MET NPX SKT SPK SPK Sky Spark Network Spark NZ TV AIR ATM PFI MEL NZ VCT NZR DGL POT GNE DIL FSF STU IFT AWK CNU MFT IQE NZX MET SKT Sky Network TV OIC MPG SKC STU SkyCity Steel & Tube Entertainment ATM VHP SKC NZR SAN PCT DIL MRP FRE IFT MVN CNU HNZ NZX SKT OHE MPG SCL NPX SKC SUM SPK SkyCity Spark Entertainment Summerset NZ Group SKC VCT PCT SML POT FRE PGW GNE MVN STU HNZ SUM IQE OHE OIC NPX SPK SKT SML STU Spark Steel NZ Synlait & Milk Tube VCT VHP POT SAN GNE SPK MRP STU IQE RYM XRO SKT OIC SCL STU TME SUM Steel TME Summerset & Tube Trade Trade Me Me Group VHP SAN TME SML MRP PGW SKT STR SUM SCL SKT SUMTPW TPW SML Summerset Synlait Trustpower Trustpower Milk Group SML SPK PGW TPW RYM SUM XRO SKT SMLVCT Vector VCT TME Synlait Trade Milk VectorMe SPK TME RYM VGL Vista Group International VGL STR XRO TME TPW Trade VGL Trustpower Me Vista Group International TME STR TPW TPWVHP Vital Healthcare ZEL VCT Trustpower VHP Vector Vital Property Healthcare Trust Property Trust TPW VGL VCT WHS VGL Vector Vista Warehouse Group Group* International VGL * ZEL VGL VHP Vista XRO Vital Group Xero Healthcare International Property Trust ZEL VHP WHS ZEL Vital Warehouse Z Healthcare Z Energy Group* Property Trust WHS NZX5 NZX5 XRO Warehouse Xero NZ NZ Equity Group* Equity Market XRO ZEL Xero Z (weighted Energy average) ZEL Source: NZX5 Z Energy First NZ NZ Equity Capital, Market Bloomberg. The P/E NZX5 Source: First NZ Capital. The P/E ratios ratios NZ and Equity (weighted Gross Market Dividend average) Yield use earnings and Gross Dividend Yield use earnings and Source: and dividends (weighted First NZ forecasts Capital, average) for Bloomberg. the next The 2 months P/E dividends forecasts for the next 2 months Source: ratios *Consensus First and NZ Gross Capital, forecasts Dividend Bloomberg. Yield use The earnings P/E * ratios and Consensus and dividends Gross forecasts Dividend forecasts Yield for use the earnings next 2 months and dividends *Consensus forecasts forecasts the next 2 months *Consensus forecasts First NZ Capital Securities Ltd NZX Firm 8 IQE PGW STU GNE NZR OIC SPK MVN AWK MPG HNZ CEN SKT AIR MEL NPT HBY NZX GMT STR ARG CNU AUG MRP SCL KPG TPW PFI VCT NPX IFT VHP NZX5 MHI PCT FRE SAN ZEL TME FSF FBU BGR RBD HLG SKC AIA POT KMD EBO WHS DGL MFT FPH VGL RYM SUM MET ATM ERD OHE XRO SML DIL COA IQE PGW STU GNE NZR OIC SPK MVN AWK MPG HNZ CEN SKT AIR MEL NPT HBY NZX GMT STR ARG CNU AUG MRP SCL KPG TPW PFI VCT NPX IFT VHP IQE AIR OIC KMD NZR HLG AWK HBY PGW STU NPX WHS MHI MVN SCL HNZ MPG FBU SKT CNU FSF DGL SAN BGR AUG RBD COA SKC GMT MFT NPT SML MET FRE SPK EBO STR VHP ARG SUM TME ZEL VCT NZX5 KPG NZX CEN PFI PCT GNE TPW MRP RYM VGL IFT MEL FPH POT DIL AIA ATM ERD NZX5 MHI PCT FRE SAN ZEL TME FSF FBU BGR RBD HLG SKC AIA POT KMD EBO WHS DGL MFT FPH VGL RYM SUM MET ATM ERD OHE XRO SML DIL COA IQE PGW STU GNE NZR OIC SPK MVN AWK MPG HNZ CEN SKT AIR MEL NPT HBY NZX GMT STR ARG CNU AUG MRP SCL KPG TPW PFI VCT NPX IFT VHP NZX5 MHI PCT FRE SAN ZEL TME FSF FBU BGR RBD HLG SKC AIA POT KMD EBO WHS DGL MFT FPH VGL RYM SUM MET ATM ERD OHE XRO SML DIL COA IQE AIR OIC KMD NZR HLG AWK HBY PGW STU NPX WHS MHI MVN SCL HNZ MPG FBU SKT CNU FSF DGL SAN BGR AUG RBD COA SKC GMT MFT NPT SML MET FRE SPK EBO STR VHP ARG SUM TME ZEL VCT NZX5 KPG NZX CEN PFI PCT GNE TPW MRP RYM VGL IFT MEL FPH POT DIL AIA ATM ERD IQE AIR OIC KMD NZR HLG AWK HBY PGW STU NPX WHS MHI MVN SCL HNZ MPG FBU SKT CNU FSF DGL SAN BGR AUG RBD COA SKC GMT MFT NPT SML MET FRE SPK EBO STR VHP ARG SUM TME ZEL VCT NZX5 KPG NZX CEN PFI PCT GNE TPW MRP RYM VGL IFT MEL FPH POT DIL AIA ATM ERD

9 Australian Equities Economic growth falls short of the 3.5% pa average achieved since 959 Banks appear attractive following "jumbo" capital raisings Key themes infrastructure spending and provision of retirement income Australia economic growth has averaged 3.5%pa since 959. However, since the Global Financial Crisis (GFC)) this has fallen to 2.5%pa and could be heading lower. There appears to four key drivers of this slower economic growth:. Weaker global economic growth in particular from Australia s largest export market, China. More importantly the mix of China s growth is shifting from manufacturing goods for export and investment in housing, infrastructure and plant and equipment towards services and consumption which requires less commodity exports from Australia; 2. The 5 year boost from demographics is starting to reverse with the current.4% population growth falling to the lowest level since 26. In part this reflects the winding back of the 24 baby bonus in 24. More importantly growth in the working age population has halved from 5 years ago to.75%; 3. The doubling of total debt to gross domestic product (GDP) over recent decades to reach a record 247% is unlikely to be repeated. This has been largely driven by a tripling of household debt since the late 8 s; Households Cause Total Debt to Balloon 4. Productivity is flat, well below the long run average, amid reform fatigue. There are an increasing number of calls for the Government to move in this area. So what does this mean for Australian equities? More subdued economic growth means that revenue growth will generally be more difficult to achieve. This was certainly noticeable at a recent conference we attended where over 35 large Australian listed companies presented. The most common strategy of those which presented to grow profits was cost reduction. The banks represent a clear example of this. Weak credit growth and a more stringent regulatory environment is resulting in weak revenue growth. Hence there is a renewed effort to use technology to reduce costs. Following recent "jumbo" capital raisings the Australian banks are in a sound financial position and appear to offer good value at current prices. However, forecast profit growth is limited at 3-4%. Our current preferences in the bank sector are Westpac Banking Corporation and The Commonwealth Bank of Australia. Other companies with material cost out strategies include: Queensland rail operator Aurizon and liquefied natural gas producer Oil Search. There are two areas of the Australian economy which look particularly interesting:. Infrastructure spending within 2 months the amount spent on infrastructure in Australia is expected to accelerate significantly. These new infrastructure projects will consume significant quantities of cement, concrete and aggregates which benefits Boral and Adelaide Brighton Cement. 2. Provision of retirement income Australia s compulsory retirement savings regime has seen retirement savings grow to over $2 trillion. However, it has now reached the stage where the number of people entering retirement is starting to grow significantly currently $73 billion is being shifted from this savings pool to retirees annually and this amount is growing by 2%pa.With their savings retirees need to generate a stable income to live off plus potentially have funds available for other purposes. Challenger sells annuities as part of the solution for providing a stable income for retirees to live on. Source: ABS, RBA, BIS, UBS First NZ Capital Securities Ltd NZX Firm 9

10 Australian Equities Prices as at 24 November 25 Adelaide Brighton (ABC) Price $4.4 Target Price $4.75 Neutral ABC s profit is benefiting from real price growth for cement and clinker, higher aggregate rock prices in Sydney, better than expected synergies from recent acquisitions and the unwinding of the carbon tax. These positives are expected to more than offset the impact of the higher costs of imported products following the depreciation of the Australian dollar and replacement of the Cement Australia contract with lower margin sales into the West Australian market. The sale of surplus property should help to strengthen the balance sheet providing capacity for further acquisitions or capital management. ABC is already benefiting from increased house construction which has probably reached a peak. However, this should be offset by an increase in infrastructure related work from late 26. AGL Energy (AGL) Price $6.95 Target Price $8.4 Outperform AGL is an integrated energy company with a diversified portfolio of retail electricity and gas businesses, power generation assets and upstream gas assets. AGL is leveraged to increasing electricity prices on Australia s east coast. This reflects rising electricity demand, permanent closure of electricity generation capacity and rising gas and coal prices. AGL is largely insulated from the rising fuel costs and hence future earnings should benefit as higher electricity prices are passed through to end consumers. Deregulation and lower electricity transmission costs are expected to allow retail margins to expand. AGL s debt levels continue to fall, creating the ability to not only grow dividends (FY8 s forecast cash dividend yield is 6.%) but also undertake share buybacks. Aurizon Holdings (AZJ) Price $5.54 Target Price $5.7 Outperform AZJ is currently undertaking a significant transformation through reducing costs and improving efficiency. This has seen profit margins increase to 28%, with management targeting 35% over the next five years. The new employee enterprise agreements signed this year and new technology will be critical in achieving this target. As these improvements flow through we expect management to focus on capital management via increased dividends and extending its share buyback program. The risk to AZJ s outlook focuses on its exposure to the bulk commodity prices particularly coal. However, it is the rail haulage business s exposure to two junior, high cost iron ore customers which is of most concern. While the contracts are for years the risk remains that these operators could wind down operations or even default on their contracts. Boral (BLD) Price $5.63 Target Price $6.4 Outperform BLD s key division is its concrete, cement, aggregate and asphalt business in Australia. This division has significant upside from the upcoming multi-year infrastructure spend which should benefit both volumes and prices/margins. BLD s plasterboard joint venture with USG is performing extremely well due to USG's patented technology which is lighter, stronger, less water absorbent and easier to install than traditional plaster board. The US business (bricks, stone and roof tiles) broke even at the last financial period helped by US housing starts increasing to over million annually. As house construction continues to steadily improve plant utilisation and hence profitability will continue to improve and price increases should be possible. While property development remains a volatile income stream there are many years of profits remaining in this division. Brambles (BXB) Price $.5 Target Price $8.7 Underperform BXB has a relatively defensive business with 7% revenue exposed to transporting fast moving consumer goods and 2% to fresh produce. Despite having a significant market share in the pallet market BXB lacks pricing power. This is because many of the major customers have two suppliers of pallets, a main supplier and a smaller supplier whose key purpose is to keep pricing pressure on the main supplier. Furthermore transport costs are facing upward pressures from rising staff costs which is more than offsetting the benefit of reduced fuel costs. Consequently BXB is focused on reducing costs and has had some success in reducing the cost associated with lost pallets. While BXB is improving the durability of pallets, the cost of repairing pallets is rising as the pallet pool ages. First NZ Capital Securities Ltd NZX Firm

11 Challenger (CGF) Price $8.88 Target Price $.2 Outperform The potential growth in fixed term and lifetime annuity product which CGF sells is very large with $73 billion of funds being shifted from superannuation savings accounts to retirees each year. CGF continues to build strong links into this market leveraging off its brand, developing distribution agreements, promoting the concept of income layering and lobbying the Government for regulatory change to support a broader product offering. CGF has a 9% share of the annuity market and management appear to have a solid strategy for growth in an industry which offers significant growth, even if competition emerges. Commonwealth Bank of Australia (CBA) Price $79.64 Target Price $84. Outperform With the major re-capitalisation event now behind it, CBA represents good value. CBA has strong management and an attractive FY6 forecast return on equity based on cash earnings of 6.9%. Looking forward the outlook for the banks remains challenging with low loan growth, loan loss provisions coming off a low base and low interest rates putting downward pressure on net interest margins. However, we expect CBA to offset this from a renewed focus on operating costs and the re-pricing of loans. The re-pricing of loans should be easier for CBA than some of its competitors due to the somewhat larger proportion of its loan book made up of mortgages and retail business. Oil Search (OSH) Price $8.33 Target Price $8.8 Outperform OSH is now generating cash flow from its 29% stake in the 2-train Papua New Guinea Liquified Natural Gas (PNG LNG) project. The PNG LNG joint venture is currently awaiting its licence on the P'nyang gas field before evaluating its potential in 26 ahead of an expected Final Investment Decision (FID) on a third LNG train in 27. OSH continues to drill existing oil/ gas fields to add further supply for future growth. The quality of OSH s assets is illustrated though not having missed one day of production from their oil and gas divisions. The LNG market is currently under pressure as prices are being weighed down by the low oil price and an oversupplied market in the short-to-medium term. OSH is responding to these market conditions by achieving operational efficiencies yielding 2% plus cost reductions. Transurban (TCL) Price $.28 Target Price $.5 Outperform TCL has a wellpositioned business with toll roads in Sydney, Melbourne, Brisbane (the recent acquisition of Airport Link enhances its position in Brisbane) and Northern Virginia, USA. Revenue growth is driven by rising populations and increasing tolls. TCL endeavours to use its dominant position to put proposals to Governments to solve impending traffic problems before they arise. In addition to investment in new roads this allows TCL to negotiate improved concessions and increase traffic flows on existing roads. TCL has $7 billion of potential capital expenditure, but will not need to raise additional capital until 28. TCL offers a forecast FY6 dividend yield of 4.3% which is forecast to grow at %pa. Westpac Banking Corporation (WBC) Price $3.7 Target Price $35. Outperform WBC s recent profit result included a modest rise in net interest margin, modestly better loan growth than its competitors and a modest decline in cost to income ratio. Relative to the other banks WBC has a high proportion of its loan book exposed to residential mortgages and less to institutional and commercial loans which remain highly competitive. Residential mortgage interest rates have been increased so as to offset the decline in return on equity caused by holding more equity capital for regulatory purposes. Like its competitors WBC has to further increase its equity capital ratios, which is likely to be achieved by retaining profit, completion of asset sales and dividend reinvestment plans. First NZ Capital Securities Ltd NZX Firm

12 Australian Equities Valuation Metrics and Ratings As at 24 November 25 NAB ANZ WBC NVN SGP DXS IAG SCG RIO GPT CBA MGR TLS WOW WES ORI SYD NAB ANZ RIO VCX SGP WBC ORI IAG 2 MQG WPL AMP CCL JHX AGL AIO QBE ORG STO GMG LLC AMC WFD CWN BXB IPL CPU OSH CSL NCM FMG NAB ANZ RIO VCX SGP WBC ORI IAG TLS AZJ QBE DXS CBA MGR SCG WES MQG LLC LLC 2 GPT GPT AMP AMP AGL AGL CCL CCL SYD SYD TCL TCL AMC AMC WPL WPL GMG GMG WOW WOW ORG ORG JHX JHX IPL IPL S32 S32 CTX CTX WFD WFD CWN CWN CPU CPU STO STO BXB BXB OSH OSH CSL CSL NCM NCM NAB ANZ WBC NVN SGP DXS IAG SCG RIO GPT CBA MGR TLS WOW WES ORI SYD 2 MQG WPL AMP CCL JHX AGL AIO QBE ORG STO GMG LLC AMC WFD CWN BXB IPL CPU OSH CSL NCM ANZ NAB DXS IAG WBC WOW LLC ORI AGL QBE CBA CPU AIO MQG SGP MGR GPT 2 NCM GMG IPL ORG SCG TLS NVN AMP CWN RIO WPL WES CCL AMC STO BXB TOL WFD OSH JHX CSL SYD ANZ NAB DXS IAG WBC WOW LLC ORI AGL QBE CBA CPU AIO MQG SGP MGR GPT 2 NCM GMG IPL ORG SCG TLS NVN AMP CWN RIO WPL WES CCL AMC STO BXB TOL LLC QBE ANZ NAB ORG S32 DXS WBC MQG ORI SGP IPL CBA MGR CTX VCX AGL CPU LLC QBE ANZ NAB ORG S32 DXS WBC MQG ORI SGP IPL CBA MGR CTX VCX AGL CPU 2 TLS 2 WFD OSH JHX CSL GMG STO AMP NCM GPT IAG AMC WES CCL AZJ SCG WOW CWN RIO BXB JHX WPL WFD CSL OSH SYD TCL FMG SYD TLS GMG STO AMP NCM GPT IAG AMC WES CCL AZJ SCG WOW CWN RIO BXB JHX WPL WFD CSL OSH SYD TCL Security Issuer Name 8.9% 8% Security Issuer AGL Name Issuer Name AGL Energy Cash Dividend Yield % Security Issuer Name 8.9% Cash Dividend Yield % AGL AMC AGL Energy Amcor 8% 7.4% AMC AGL AGL Amcor Energy 6% 7% AMP AMP AMP AMC AGL Amcor AGL AMP Energy Security AMC Issuer Name Amcor Group 7% AMP AMP Group 6% 7.4% AMP AMP 5% 6% AZJ ANZ AGL ANZ AGL Group Energy Aurizon Banking Holdings Group AMC ANZ Amcor AZJ Aurizon 6% Banking Group 5% Group AMP AIO Asciano AMP 4% 5% AZJ Aurizon ANZ ANZ Banking Group Billiton Limited 5% BXB ANZ ANZ ANZ ANZ Brambles Banking Banking Group Billiton Group 4% CTX Caltex Group BXB Billiton Australia Brambles 3% 4% CCL AIO Asciano Limited 4% BXB Brambles CTX Coca-Cola Caltex Amatil Australia CBA CCL Coca-Cola 3% Commonwealth Amatil CTX Bank Aus CPU CBA Caltex Commonwealth CCL Billiton Australia Coca-Cola Amatil Computershare Bank Aus 2% 3% CCL CWN CPU BXB Coca-Cola CBA Computershare BramblesCommonwealth Amatil Bank Crown Resorts 2% CBA CWN CCL CSL Commonwealth Crown Coca-Cola CPU CSL Ltd Computershare Amatil Bank 2% CPU DXS CPU CBA CSL Computershare CSL Commonwealth Dexus Ltd Property Group Bank Aus % 2% CWN Crown GMG DXS CPU Dexus Computershare % CWN Crown CSL Goodman Property CSL Group LtdGroup GPT CWN FMG Fortescue Crown % CSL CSL CSL CSL GPT Group Metals Group GMG IPL CSL Goodman CSL DXS Ltd Ltd Incitec LtdDexus Property Group % % Pivot Group % DXS DXS IAG GPT DXS Dexus GMG GPT Dexus Property Insurance Group Property Goodman Group Australia Group Group Group % GMG GMG JHX FMG Goodman IPL Incitec Fortescue James Hardie Pivot Metals Industries Group GPT GPT Group Group % GPT GPT LLC GMG GPT GPT IAG Insurance Goodman Group Lend Group Lease Group Australia IPL Incitec Pivot Group MQG IPL GPT JHX IPL Incitec James GPT Macquarie Group Pivot Pivot Hardie Group Industries 3 53x IAG Insurance Australia Group 37x 62x IAG LLC IPL Lend Incitec Medibank Lease Pivot Private Ltd Group P/E Ratio x 62x IAG Insurance Australia Group 62x MGR MQG IAG Macquarie Insurance JHX Mirvac Group James Australia Hardie Group Group Industries 3 JHX James Hardie P/E P/E Ratio Ratio x 54x x 54x JHX James Hardie Industries 3 54x NAB JHX Medibank James National Hardie Australia Private Industries 3 38x 53x 38x LLC Lend LLC Lease Lend Lease Bank Limited 25 38x 37x LLC Lend Lease NCM MGR LLC Mirvac Lend Newcrest Lease MQG MQG Group Macquarie Group Mining Group OSH MQG Macquarie NAB National Oil Search Group Australia Bank ORI NCM Medibank Medibank Newcrest Private Orica Limited Private Limited 2 Mining 25 Medibank Private Limited MGR ORG NVN Mirvac MGR Novion Origin Group Energy Mirvac Group MGR Mirvac Group Property Group NAB QBE NAB National OSH National NAB Oil QBE Search Insurance Australia National Australia Group Bank Australia Bank Bank 2 NCM ORI Newcrest Orica Ramsay Health Mining Care NCM Newcrest NCM Newcrest Mining Mining OSH RIO NVN Rio Tinto ORG Origin Novion Energy Property Group OSH Oil Oil OSH Search Search Oil Search STO OSH Santos Ltd ORI QBE QBE Oil Search Insurance Group 5 SCG ORI Orica Scentre Group ORI Orica ORI Orica Ramsay Orica 5 ORG Origin Energy Health Care 5 5 ORG Origin ORG Seek RIO Rio Energy Tinto Origin Energy QBE QBE Sonic Healthcare STO QBE Santos QBEInsurance Group Insurance Group Ltd Group S32 South32 5 SCG Ramsay Ramsay Scentre Health Health Ramsay Care Group Care Health Care RIO SGP Stockland Group RIO Rio Seek Rio Tinto RIO Rio RIOTintoRio Tinto STO Suncorp Group Ltd Santos Sonic Ltd Healthcare Ltd SYD STO Santos STO SCG Sydney Airport Ltd Santos Ltd 5 SCG SGP Scentre Stockland Scentre Group Group SCG TLS Scentre Telstra Corp TCL Seek Suncorp Seek SCG Group Scentre Group Transurban Group Limited 5 5 WES SYD Seek Sydney Sonic Healthcare Sonic Wesfarmers Healthcare Airport Seek SGP Sonic WFD TLS Telstra Stockland Healthcare S32 Westfield Corporation Sonic Healthcare Underperform Neutral Outperform WBC WES South Wesfarmers Suncorp 32 Group Limited S32 South SGP SYD Stockland S32 32 Sydney Westpac South Airport Group 32 FMG CWN AMC AMP JHX AGL BXB SGP WPL WFD Stockland Westfield Woodside Petroleum Corporation Group TLS Suncorp Telstra SGP Group Corporation Stockland Limited Group NCM DXS ANZ AIO CSL WOW WBC Suncorp Westpac Underperform Neutral Outperform Woolworths Group Limited SYD WES Sydney Wesfarmers Airport Suncorp Group Limited GMG GPT CCL CBA NAB LLC SYD WPL Sydney Woodside Airport Petroleum FMG CWN AMC AMP JHX AGL BXB WFD Westfield Corporation IPL IAG CPU OSH MQG 2 TLS Telstra SYD WOW Woolworths Australian Corporation Sydney Airport Equity Market TLS Telstra Corporation NCM DXS ANZ AIO CSL TCL WBC Transurban Westpac TLS Telstra Corporation ORG NVN QBE MGRatings SCG TCL Transurban Underperform GMG GPT CCL Neutral CBA NAB Outperform LLC VCX WPL Vicinity Woodside Centres Petroleum Underperform STO RIO Neutral ORI SYD Outperform TCL Transurban BXB IPL TLS IAG AMP CPU JHX AMC OSH AGL MQG CTX The VCX WOW P/E ratios Vicinity Woolworths and Gross Centres Dividend WES Wesfarmers BXB Underperform TLS WES WPL ORG NVN TLS QBE MGR AMP Neutral JHX AMC SCG AGL Outperform VCX Vicinity Centres CTX Yields WESuse earnings Wesfarmers and dividend BXB NCM WFD WOW ANZ AZJ CCL forecasts 2 WFD Westfield for Australian Corporation the next 2 Equity months. Market NCM STO WFD TLS RIO ANZ AMP JHX ORI SYD AZJ AMC CCL AGL CTX WFD Westfield WES Wesfarmers Corporation NCM WBCWFD CWN SGP CBA LLC WBC Westpac TLS WES WPL CWN ANZ IPL DXS CBA AZJ LLC CCL CPU MQG Source: WBCCredit Westpac WFD Westfield Corporation Suisse Source: WPL Credit Woodside Suisse Petroleum WFD WOW IPL DXS CWN CPU CBA MQG LLC 2 WPL Woodside WBC Westpac Australian Petroleum Equity Market ORI GMG CSL WOW Woolworths WBC ORI IPL GMG SGP DXS CSL CPU MQG WOW Woolworths WPL Woodside Petroleum QBE GPT IAG S32 The P/E ratios and Gross Dividend 49 QBE ORI GPT GMG IAG CSL S32 Source: Credit WOWSuisse Woolworths 49 NAB MGR SGP 2 Yields use Australian earnings and Equity dividend Market QBE NAB GPT MGR IAG SGP S32 2 Australian Equity Market ORG OSH TCL forecasts for the next 2 months. ORG NAB OSH MGR TCL SGP The P/E ratios 2 and Australian Gross Dividend Equity Market RIO SCG WBC RIO SCG WBC Yields use earnings and dividend SYD STO ORG WPL OSH TCL SYD STO WPL forecasts for the next 2 months. VCX WES RIO SCG WBC Source: Credit Suisse VCX WES Source: Credit Suisse WOWSYD STO WPL WOWVCX WES The P/E ratios Source: and Credit Gross Suisse Dividend WOW Yields The P/E use ratios earnings and and Gross dividend Dividend forecasts Yields use for earnings the next and 2 dividend The P/E ratios and months. Gross Dividend forecasts for the next 2 months. Yields use earnings and dividend forecasts for the next 2 months. NAB ANZ RIO VCX SGP WBC ORI IAG TLS AZJ QBE DXS CBA MGR SCG WES MQG LLC Cash Dividend Yield % 2 GPT AMP AGL CCL SYD TCL AMC WPL GMG WOW ORG JHX IPL S32 CTX WFD CWN CPU STO BXB OSH CSL NCM LLC QBE ANZ NAB ORG S32 DXS WBC MQG ORI SGP IPL CBA MGR CTX VCX AGL CPU 2 TLS GMG STO AMP NCM GPT IAG AMC WES CCL AZJ SCG WOW CWN RIO BXB JHX WPL WFD CSL OSH SYD TCL First NZ Capital Securities Ltd NZX Firm 2

13 Global Equities The Mature Bull Market Tires European equities are resilient despite geopolitical turbulence US credit cycle is waning and 26 may see risks rising Telecommunications, cyber security, healthcare and capital spending European Equities are Resilient Despite Geopolitical Turbulence As we expect the Fed to slowly but progressively increase interest rates through 26, the euro is likely to continue depreciating against a background of minimal inflation pressure. Divergence between the US tightening monetary policy on the one hand, and the Eurozone and Japan easing on the other, will be a key feature of 26. Any extension of the European Central Bank s (ECB's) quantitative easing (QE) programme could push the euro down towards parity with the USD, allowing European exporting companies to improve their earnings compared to their US counterparts. European Money Supply Growth Supports European Company Earnings Growth YoY (in %) Jan 89 Jan 9 Jan 93 Jan 95 Jan 97 Jan 99 Jan Jan 3 Jan 5 Jan 7 Jan 9 Jan Jan 3 Jan 5 European Historical Earnings Real Eurozone Money Supply Growth (rhs, 2 month lead) Source: Datastream, Credit Suisse YoY (in %) 6 Europe has moved from an environment of solvency fears on its periphery (Greece, Portugal) to security fears in its core (France, Belgium, Germany.) The influx of refugees from the Middle East and sporadic episodes of terrorism represent political challenges. While the mood of consumers is bound to darken on the security front, their spending propensity seems to be gaining traction, as the declining unemployment rate encourages a rebound in retail sales (see below). Geopolitical issues may provide periodic shocks and increase volatility, but it is likely the ECB and EU member governments will attempt to offset any such developments to prevent the recovery being derailed. Wisdom Tree Europe Hedged Equity Fund provides a broad exposure to European companies while being exposed to the US dollar and not the euro. Lower Unemployment Results in Increased Consumption / Higher Retail Sales Per cent European unemployment rate % (lhs) Germany retails sales ex. Auto (rhs) 2 = Recession Source: Datastream US Credit Cycle is Aging As discussed, one reason for retaining our neutral outlook on US equities is the likelihood that credit conditions will deteriorate earlier in the United States than elsewhere. Aided by low borrowing costs, steadily improving employment and higher house prices, companies directly supplying homeowners, such as Home Depot and car manufacturers, such as Delphi Automotive have risen strongly against the backdrop of a flat US equity market (S&P 5 +.%) US consumers have enjoyed substantially lower gasoline prices, boosting their disposable incomes. However, downward pressure on commodity markets has created stress in the energy, manufacturing and mining sectors, For instance, Marathon Oil (MRO.NYSE) is down -38% and Caterpillar (CAT.NYSE) is lower by -24%, this year. Led by smaller energy companies debt, bond yields for non-investment grade companies have been rising, suggesting that a less favourable phase for debtfunded corporate activity such as share buybacks and takeovers lies ahead. This may prove a restraint on overall US equity market performance from later in 26. However, the following graph suggests US equities are not over-valued at present, which should cushion some of the negative impact of rising interest rates First NZ Capital Securities Ltd NZX Firm 3

14 US Equities are Currently Fairly Valued Based on its PE Ratio P/E Ratio Average +/- Standard Deviation 5 Jan 9 Jan 93 Jan 96 Jan 99 Jan 2 Jan 5 Jan 8 Jan Jan 4 Source: Bloomberg, First NZ Capital Japanese Outlook Moderating We have moderated our view on Japanese equities, due to its China exposure, limited further benefit ahead from yen depreciation and 3.6% year-todate gain in the Nikkei index. We expect moderate growth in private consumer spending due to steady improvements in the labour market and the lower oil price. Corporate governance reform is a continuing positive influence, and will benefit major industrial exporters such as Toyota (723.TYO) and Bridgestone (58.TYO). Telecommunications, Cyber Security, Healthcare and Capital Spending We favour European telecommunication companies such as Deutsche Telekom (DTE.GR) and Vodafone (VOD.LN) due to them having defensive attributes with some positive cyclical characteristics. The associated theme of IT, Network and Security exposure is also attractive, as cyber-attack protection remains very topical. Palo Alto Networks (PAN.NYSE) represents an attractive company which is expected to benefit from this theme. Global healthcare and consumer discretionary stocks corrected sharply during the second half of 25, and we expect this to create investment opportunities. We still support the new defensive investment view of healthcare, though with less of an emphasis on pharmaceuticals until US drug funding policies are clarified in the lead up to the Presidential election. Looking beyond the political drivers of healthcare performance, companies such as Roche (ROG.VX) satisfy the criteria for quality growth, and the demographic theme of treating the diseases of higher life-expectancy, while Worldwide Healthcare (WWH.LSE) provides a broad exposure to the healthcare sector. Increased capital spending by corporates creates opportunities for industry leaders such as Germany s SAP (SAPG.DE). SAP s innovative IT systems and cloud computing initiatives, as well as their recentlyannounced share buyback programme, have proven to be attractive to investors. First NZ Capital Securities Ltd NZX Firm 4

15 Investment Outlook NZ Debt Securities Action At Last The NZ debt market awakens High yield margins rise Interest rate normalisation to begin There have been a number of important developments in the NZ debt securities market recently:. Bank term deposit interest rates have lost the interest rate premium above tradable bank debt securities for all terms to maturity except two years and less, ending many years of offering a premium. 2. There has been a sudden, welcome, increase in the number of debt securities being issued. The increase in supply gives investors a wider variety of securities to invest in as well offering improved, but not spectacular, investment returns. 3. It appears very likely that the US Federal Reserve (Fed) will at long last commence the gradual normalisation of US interest rates on 6 December 25, ending seven years of a Fed Funds Rate being effectively set at %. 4. The margins at which debt securities trade above low risk government securities have risen, with a particularly large rise in high yield (these are higher risk securities which are rated by the credit rating agencies as sub-investment grade) securities margins globally. This has been reflected in the yields of recent higher risk NZ debt securities, such as bank hybrid securities. High Yield Margins Rise The pressure on high yield margins appears to reflect mediocre revenue and operating profit growth globally. Consequently in combination with regulatory pressures banks have become more selective in their lending practices which has been reflected in a decline in the amount of high yield debt issued globally. This has a negative impact on weaker credits as they struggle to refinance debt and raise new debt, creating something of a downward spiral. The increasing credit risk is reflected in rising default rates and expanding margins. It is worth highlighting that much of the deterioration to date reflects difficulties in the energy sector caused by the lower oil price. While the deterioration in margins appears to have plateaued we will monitor developments closely, particularly in light of the still lower oil price. Interest Rate Normalisation Begins The expected rise in the Fed Funds Rate is expected to put upward pressure on longer term US Treasury yields. most We expect this to cause a gradual increase in longer term interest rates. We do not expect to see a repeat of the rapid rise seen in the US in May/June 23 as such a rapid rise would likely have an adverse impact on the US economy. Any deterioration in the outlook for the US economy or global financial instability would likely cause the Fed to put future increases in the Fed funds rate on hold. Conversely a rise in inflation as the US economy approaches full employment could cause an acceleration in the Fed s response. We would expect the increase in longer term interest rates to push longer term NZ interest rates higher. However, the increase is likely to be more subdued than in previous periods of rising interest rates as the Reserve Bank of NZ (RBNZ) retains a preference to keep the Official Cash Rate (OCR) at or below current levels, interest rates in other major economies such as Japan and Europe are unlikely to be increasing, NZ inflation remains subdued and high levels of indebtedness globally means a small interest rate increase has a much bigger impact than when debt levels were lower. Current Preferences The following heat map shows our preferences by term to maturity and credit quality. We have a preference for AA- rated term deposits out to two years, followed by AA-rated and unrated securities which we would indicatively rate BBB or BB. Based on projected 2 month investment returns we prefer terms to maturity out to five years. This does not mean that we would avoid medium or longer term securities all together, simply that the portfolio exposure would be lower. Debt Security Preferences most Higher AA rated AA- rated AA- AA- rated rated (term deposit) deposit) Credit A Quality rated BBB rated Unrated (indicative BBB rated) 5.5 Unrated Lower (indicative BB BB rated) rated) 5.5 Source: First NZ Capital least < 2 years 2-3 years 4-5 years 6-7 years >7 years years 2-3 years 4-5 years 6-7 years > 7 years Term to Maturity Term of Maturity First NZ Capital Securities Ltd NZX Firm 5

16 Currency More of the Same Monetary policy divergence linked with US dollar strength. Australian dollar supported by Reserve Bank of Australia stance. Monetary policy divergence linked with US dollar strength The prospect of increasing US interest rates has renewed expectations of a long term US dollar uptrend. Although the US dollar has already risen materially over the past two years against key currencies - 28% against the euro, 9% against the pound, 23% against the NZ dollar and 2% against the yen - further upside seems probable. The challenge for the US Fed beyond 26 may be how to proceed with a gentle interest rate normalization program without driving the dollar up too rapidly or triggering serious capital flight elsewhere. Particularly vulnerable in this regard are developing economies such as Brazil and Argentina where incipient economic recoveries remain fragile. The dollar-friendly divergence is also being driven by more accommodative European monetary policy prospects. With lower oil and gas prices exerting downward pressure on European inflation, the European Central Bank has indicated that it is prepared both to lower interest rates and extend its Quantitative Easing programme, to bed down the stabilization seen during 25. The case for hedging euro currency exposure into US dollars remains. Australian dollar supported by Reserve Bank of Australia stance RBA Governor Stevens stated scepticism about the usefulness of lowering the Australian cash rate target below 2.% has been long-standing, and commentators are now increasingly factoring in this stance. Compared with NZ, Australia has recently seen slightly stronger economic momentum as evidenced by the rise in the Economic Surprise Index. Economic Surprise Index May 3 Nov 3 May 4 Nov 4 May 5 NZ Source: Bloomberg, First NZ Capital Australia We now expect marginally higher economic growth in Australia than in NZ for 26. With NZ interest rates more likely to be lowered, and both countries suffering from weak commodity price dynamics, on the whole we expect a slight weakening of the NZ dollar relative to the Australian dollar First NZ Capital Securities Ltd NZX Firm 6

17 Resource Companies Can They Get Any Worse? The current supply/demand imbalance is complex Servicing sectors suffer also Oil Best of a Bad Bunch Globally the resource sector has been the worst performing sector over the past four years. Over the past two years commodity prices have fallen dramatically for example, iron ore 68%, oil 58%, copper 4%. There has been no escape. While mining company profits and valuation are impacted by the amount of production and production costs, commodity price changes generally have a much larger profit/valuation impact on all but the smallest resource companies as the following chart illustrates. Steel Steel Drives Drives Iron Iron Ore Which Ore Which Drives Drives RIO RIO and and 35 Nov 22 May 23 Nov 23 May 24 Nov 24 May 25 Source: Bloomberg, First NZ Capital Iron Ore Spot Price (USD) Share Price (USD) Source: Bloomberg, First NZ Capital Steel Rebar Spot Price (USD) RIO Share Price (USD) The sector is currently experiencing a perfect storm of growing supply, which increased on the back of very high prices, and falling global demand, driven by China. Not only is China s economic growth slowing, but the drivers of the economy are shifting from manufactured exports and investment in infrastructure, buildings and housing to a greater emphasis on household consumption, which results in lower demand growth for commodities. Simply put, this reflects a maturing of the Chinese economy. Typically economic forces of supply and demand would result in production falling to balance with the lower demand leading to prices stabilising at levels where producers make a fair return on the capital they have invested. However, while this will likely play out in the long term the current situation is complex. In oil Saudi Arabia is determined to maintain market share rather than act as the worlds swing producer which is depressing the oil price and putting pressure on high cost producers. In iron ore the large low cost producers, Billiton, Rio Tinto and Vale, are increasing production in an attempt to gain market share from high cost producers. In response to low commodity prices the high cost producers have gone into survival mode, reducing costs, cutting capital expenditure, selling assets where possible and increasing production from their more productive assets. In the short term this simply drives commodity prices even lower. Finally we note that not all production is driven by economics. State owned producers, of which there are many in China, can continue producing while incurring losses due to government support 9% of Chinese steel mills are believed to be making losses currently. This reflects government goals, such as employment, being more important than earning a return on assets. While almost everything has conspired against the resource companies recently they have benefited from currency weakness, which has fed through into lower operating costs. This has been particularly beneficial in lowering the US dollar cost of labour. A low oil price has also been positive for miners as diesel represents a significant cost. At the current point of time it is important that resource companies can generate adequate cash flow to survive the downturn. The companies best placed to survive the current downturn are not surprisingly those with low production costs, low debt levels and a solid level of reserves. As companies look to conserve cash and keep debt at reasonable levels not only do they look to reduce production costs, but they also reduce capital expenditure and potentially reduce dividends. Some companies may look to implement dividend reinvestment plans. However, raising equity capital to simply maintain a dividend payment is seldom a wise decision. Where to from here? Industry experts generally forecast commodity prices to gradually recover, starting in about six months time. Unfortunately while many forecast a recovery they are forecasting a recovery off a base which seems to get continually lower. Resource company management have mixed views on the outlook for example, South 32 s CEO, Graham Kerr, expects another two years of low commodity prices. Fortunately for him South 32 is reasonably well positioned to weather an extended downturn. Resource companies are not the only ones to suffer from the downturn, with those providing mining First NZ Capital Securities Ltd NZX Firm 7

18 3 2 services also hit hard, particularly those with exposure to exploration such as ALS (ALQ) which has a significant part of its business focussed on providing testing and technical services to the mining industry. This business is only likely to recover well after any mining recovery. Other companies with exposure to the mining sector which haven t been hit quite as hard include companies such as Orica (ORI) and Incitec Pivot (IPL) which each have significant businesses supplying explosives to the mining industry. While the level of commodity prices impacts somewhat on the price miners are prepared to pay for explosives the quantity of explosives used is impacted by the level of production which has not fallen. However miners are generally mining those areas which are easier to mine (where the level of earth covering the ore is low) and use a lower amount of explosives. However as these areas are mined miners will have to mine more difficult areas which will require increasing amounts of explosives which will be positive for ORI and IPL. Oil Best of a Bad Bunch In the resource sector we retain our preference for companies exposed to oil. We acknowledge that the short term outlook remains difficult with the current level of oil inventories being well above normal levels. 9 OECD crude inventories (Mbs) D J F M A M J J A S O N D 5yr average Source: CS, Euroil, IEA However, in the medium and long term we are more optimistic. This reflects:. Global oil production, excluding Saudi Arabia, has plateaued; 2. A significant fall in the number of rigs being used onshore in the US. Ultimately we believe that this will result in a reduction in shale oil and gas production. To date production has simply plateaued. US Oil/Gas Production Plateaus While Rig Use Falls b/d Rig Count Rigs Production Source: CS, IEA, E/A, Baker Hughes 3. Current global oil reserves will last for about eight years. Consequently every year 2.5% of global reserves have to be replaced. This contrasts with iron ore and coal where global reserves are well over 5 years. 4. Oil makes up 4% of global energy demand and almost % of energy demand for transport. While electric cars and hybrids will have an impact this will take a long time before it has a material impact. The global economy is expected to continue to run on oil for an extended period of time. 5. In terms of supply shocks it would seem that the balance of risk is tilted towards supply being reduced. This reflects Saudi Arabia already producing at a high level and high levels of future production from the world s trouble spots (e.g. Iran) already well anticipated. In the oil sector our preferences are Oil Search (OSH) in Australia and Royal Dutch Shell Plc (RDSa) globally. Royal Dutch Shell plc (RDSa.L) Price GBP6.5 Target Price GBP2.25 Royal Dutch Shell (Shell) explores for and refines petroleum, producing a wide range of fuels, chemicals and lubricants, and operates service stations worldwide. Shell s service station operations help offset the declines faced by the exploration and production business. Shell offers attractive expansion projects and a leadership position in unconventional resources. Against a challenging backdrop of lower crude oil prices and depressed upstream profitability, the company expects to reduce costs. Shell s forecast 7.5% dividend yield is supported by a strong balance sheet and potential for further assets sales. First NZ Capital Securities Ltd NZX Firm 8

19 Positioning Investments for the Demographic Shockwave Asset performance is increasingly being affected by aging populations Interest rates are being held down by retirees seeking income and security Demographic investment theme opportunities Seven years since the climax of the global financial crisis, the prolonged period of weak global economic growth raises questions about other possible causes of the economic sluggishness. An extended period of exceptionally low interest rates has yet to trigger a wave of real-economy investment which could lift productivity and growth. It appears some other factor is depressing investment in capital stock and boosting savings throughout the developed world. Changing demographics have become a prime suspect in explaining the lack of traction governments have experienced in spurring growth, despite unprecedented monetary stimulus. Instead of kick-starting a virtuous circle of corporate investment, where companies upgrade their capital at lower cost to lift productivity, many large companies are still hoarding cash. Banks have directed lending into the financial economy, and the impact of cheap funding has mostly shown up in a sequence of asset price rallies, whether in equities, debt securities or in real estate. These valuation gains have restored confidence and replenished retirement accounts, but have not delivered any new engines of economic growth. Growth Remains Below Pre-crisis Levels in Developed Economies Real GDP % YOY Avg Avg Avg Advanced economies Source: Datastream, Credit Suisse Economic Research Aging populations holding down interest rates Until the demographic shockwave of greater longevity, lower fertility and high retirement rates ebbs, the ageing populations of developed countries will exert an increasing influence on investment returns. Economic growth could remain low for at least another ten years as the effect of Baby Boomers exiting the workforce continues to weigh on labour, capital, and productivity. While the post-crisis investment weakness is probably more cyclical rather than structural, demographics may affect investment more permanently, keeping interest rates low as aging populations continue to boost savings. A shrinking working-age population reduces company s incentive to upgrade their capital stock (e.g. factories, computer systems). Compounding this, recent evidence suggests that older people may not automatically increase their spending as they draw down their lifetime savings to pay for their retirement lifestyle. Instead older people are registering high savings rates, as they budget for a longer period in retirement and uncertain healthcare costs. They show strong demand for financial assets, focussing on safer assets, in particular fixed interest securities and bank term deposits. Demand for stable, income-producing investments is likely to intensify. In the developing world, despite their younger age profile, consumption growth has proved fragile, with debt reduction and savings taking priority. These growth-depressing influences can be partly offset by boosting the labour force, through immigration, higher female participation and later retirement. The scope for success will depend on an individual country s characteristics. NZ and Australia have an advantage because of their skill at attracting younger immigrants and integrating them into the workforce. By contrast, Japan and China have virtually no permanent immigration and must look elsewhere to support the working-age population and lower their dependency ratios (the proportion of the population of working age compared to that aged lower than 5 or over 65.) Hence, the new programmes aimed at boosting the birth rate in these aging Asian giants. Advanced technologies can forestall productivity losses, but as noted earlier, an extended patch of weakness in capital spending is slowing their adoption. First NZ Capital Securities Ltd NZX Firm 9

20 8% 7% 6% 5% 4% 3% 2% % % Forecast Dependency Ratios Source: UN Population Statistics Demographics-themed investments Due to this demographic drag, the world economy and investment markets may not revive vigorously even after current global growth headwinds such as the China s slower growth, commodity price declines and geopolitical security risks have abated. This leaves investors in a quandary about where to direct their funds. Even cash and term deposits are affected by the demand for defensive assets, with the near-zero interest rates prevailing in Europe and Japan looking more persistent. Corporate debt securities are highly sought after, and the popularity of bond-like equities (companies with stable earnings paying decent dividends) continues unabated. Sectors that are likely to outperform by directly catering to the aging are Healthcare and Travel/Lifestyle. Three Australasian companies we see as positively exposed to increased longevity and multi-decade retirement provisioning are Summerset (SUM), Challenger (CGF) and IOOF Holdings (IFL). In the global equity markets, where demographic pressures are substantially more imminent than in Australasia, investors may also consider the Worldwide Healthcare Trust (WWH.LN) which provides diversified exposure to pharmaceuticals and biotechnology, in addition to high-quality individual firms such as Roche (ROG.VX) and Medtronic (MDT.NYS). Roche Holdings (ROG.VX) USA New Zealand Australia Ireland UK France Germany Italy Spain Japan Price: CHF Target Price: CHF 3 Roche develops and manufactures pharmaceutical and diagnostic products used in the areas of cardiovascular, infectious, autoimmune, and respiratory diseases, dermatology, metabolic disorders, oncology, transplantation, and the central nervous system. Roche has a unique portfolio of oncology drugs and lower than-average exposure to generic competition due to a high proportion of biotechnology products. Roche is well positioned to benefit from longer-term trends, such as personalized medicine, due to the unique combination of a pharmaceuticals and a diagnostics unit under one umbrella. Medtronic Inc. (MDT.NYSE) Price: US$ Target Price: US$85. Medtronic provides device-based therapies that aim to extend patients quality of life, and alleviate pain. It has a strong in-house research and development facility and a good track record of adding value through acquisitions which allow the company to stay at the forefront of medical technology innovation. MDT s principal products include those for bradycardia pacing, tachyarrhythmia management, atrial fibrillation management, heart failure management, heart valve replacement, malignant and non-malignant pain, and movement disorders. In the Travel and Lifestyle sectors we favour Royal Caribbean Cruises (RCL) and Ctrip (CTRP). Royal Caribbean Cruises (RCL US) Price: US$92.2 Target Price: US$ Royal Caribbean Cruises is one the three global leaders in the cruise industry. The cruise industry has shown continued growth in 25, with healthy development in new markets, particularly China and Cuba. We are optimistic about the future prospects of cruising as a leisure pastime of the elderly in the Asia Pacific region. Sailing in China has generated strong yields for the cruise lines as capacity is chartered out to local travel agents who sell on behalf of cruise lines. Royal Caribbean Cruises currently has the most exposure to China among the big three players. Ctrip (CTRP US) Price: US$6.27 Target Price: US$ 9 Ctrip.com is a leading Chinese travel service provider, including accommodation, transportation ticketing, packaged tours and corporate travel management. We expect the outbound business to drive group earnings in the next three to five years. Outbound hotel reservation volume saw triple-digit annual growth in Q2 25, as did international air ticketing revenues. We estimate return on equity to steadily improve from 8.8% in 25 to 29.2% in 27, while its balance sheet should also strengthen to a net cash position in 27. First NZ Capital Securities Ltd NZX Firm 2