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BRE Bank Securities
9 January 2007 3
Strategy 2007 BRE Bank Securities
Periodic Report
Equity Market in 2007 Investment Strategy
Relatively cheap stocks in the US and Europe, strong macroeconomic pros-pects for Poland, average EPS growth at 15%, and the expected continued inflow of funds to investment (TFI) and pension (OFE) funds, all paint a positive equity market picture for 2007. Polish stocks are not cheap looking at the current valuations, but still remain attractive relative to the rates of returns achieved on other assets. We predict that the broad index will finish 2007 11% above last year’s level. Based on the 2006 stock rally and the growing concerns about the second half of the year, we expect greater mar-ket volatility leading to frantic price corrections. The sectors that, in our opinion, will achieve the highest rates of return this year, will be IT companies with exposure to government contracts, small and mid-sized banks, media, and selected manufacturers. The sector of basic materials is the best bet for 2007. We think that, as global GDP growth predictions for the second half of the year become more upbeat, the downtrend in materials prices will be reversed in the second quarter, which will be a good time to take positions in the sector. In turn, defensive stocks are bound to plunge, most notably telecoms which will be additionally im-pacted by the activity of the regulator. 2007 will bring more small- and mid-cap IPOs leveraging the bullish stock market, potentially affecting the valua-tions of many overpriced midcaps (we recommend selective reductions on rallies). A positive scenario for equities assumes a soft landing in the US, which is the prerequisite for a sustained upbeat sentiment to the equity market. This year’s slowdown in US economic growth from 3.3% to 2.3% predicted by macroeconomists, paired with interest rate cuts (0.25-0.75 ppts), will proba-bly prevent a recession and deterioration in company earnings. We also predict that, as the US enters another pre-election period, taxes will remain low and investment tax credits will be retained. Tax allowances were one of the contributing factors to record earnings, as companies took advantage of the good timing to buy back their own stock. In the US, stocks have been on the rise with virtually no corrections since July 2006, increasing profit-taking risk. We might see a deeper correction as soon as the first quarter. In Poland, such a correction would coincide with the flurry of IPOs sched-uled for February and March. Any slippage in local stocks, an inevitable component of a bullish market, should be leveraged to accumulate equities. The zloty should remain strong and boost stock performance (low inflation, capital inflow). The market interest rates in Poland are still attractive for foreign capital, which has been noted to take positions in local bonds over the past few months, as well as other emerging growth markets. The first half of the year will witness an accumulation of structural funds coming in from the European Union. The expected strengthening of the dollar against the currency basket in H2 2007 might lead to a deeper correction in emerg-ing markets.
BRE Bank Securities does not rule out offering brokerage services to an issuer of securities being the subject of a recommendation. Information concerning a conflict of interest arising in connection with issuing a recommendation (should such a conflict exist) is located on the final page of this report.
9 January 2007
WIG vs. indices in the region
BRE Bank Securities
Equity Market
Avg daily trading volume
Average 2007 P/E
Average 2006 P/E
WIG 49513 20.3
17.2
1315 PLN
Top Ratings:
Overweight: Prokom, Computerland, Techmex, Macrologic, ING BSK, Handlowy, Agora, Basic Materials (in H2 2007) Underweight: TPSA, Netia, PKO BP, Comarch, Softbank MidCaps (selectively reduce on rallies)
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Analysts:
Michał Marczak (Strategy, Telco, Media, Materials) (+48 22) 697 47 38 [email protected] Marta Jeżewska (Banks) (+48 22) 697 47 37 marta.jeż[email protected]
Andrzej Lis (IT) (+48 22) 697 47 42 [email protected]
Krzysztof Radojewski (Construction) (+48 22) 697 47 01 [email protected]
Kamil Kliszcz (Materials, MidCaps) (+48 22) 697 47 06 [email protected]
Strategy 2007
9 January 2007 1
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BRE Bank Securities
Poland’s macroeconomic performance will drive stocks In 2006, the Polish stock market traded amidst 5% economic growth, low inflation, and falling unemployment rate. As was the case with developed countries, some economists predict that our economy will slow down in 2007 due to a general economic downturn across the globe. Optimists forecast 5.1% GDP growth accompanied by a relatively low inflation rate. Skeptics assume a real GDP growth rate of 4.6% and an increase in the CPI inflation to 2.2%-2.5% (1.8% in 2006).
2007 macroeconomic forecast summary for Poland GDP CPI inflation, eoy Unemployment rate
IbnGR 4.7% 2.5% 14.7% CASE 4.9% 2.4% 12.7% MF 5.1% 2.1% 12.5% KE 4.7% 1.9% 12.2% GUS 5.0% 2.4% 14.2% NBP 5.0% 2.5% PRB 4.6% 2.2% 15.0% OECD 5.1% 1.9% 12.6% 2007 average 4.9% 2.2% 13.4% 2006 average 5.5% 1.8% 14.9% Source: PRB
One might venture to say that even the worst-case scenario still offers decent growth and manageable inflation prospects that will create an advantageous environment for the equity market. Growing costs of labor and concerns about the NBP’s credibility after Leszek Balcerowicz might prompt the Monetary Policy Council (RPP) to change its policy. The biggest risks lie in the growing upward pressure on salaries caused by the shortage of skilled labor, felt most acutely in the construction industry. If salaries increase but productivity does not improve, inflation might beat macroeconomist estimates and lead to interest rate hikes. But, in our opinion, the hike would have to be at least 75 bps to cause a shift in investor sentiment toward the equity market. We predict that the RPP will raise rates by 25 bps in Q1 2007, eliciting neutral investor reaction. As GDP slows down and the RPP adopts a “dovish” tone after Balcerowicz’s departure, the inclination to tighten policy will subdue. Looking at the bullish macro outlook for Poland, the global economic slowdown predicted by economists should not cause the capital to flee from the equity market. Inflation remains a scare for investors, but it seems to be under control again after the drop in basic materials prices in Q4. Cheap money should secure steady new inflows to equity funds. Developing countries will record GDP growth twice the speed of developed countries, facilitating a sustained buoyant sentiment toward emerging markets.
Overview of global macro-economic forecasts GDP CPI inflation, eoy 2006 2007 2006 2007 USA 3.3% 2.3% 2.5*% 2.3*% Euro 2.6% 1.8% 2.2% 1.8% Japan 1.9% 1.5% 0.4% 0.4% China 11.0% 9.5% 1.5% 2.2% Poland 5.5% 4.6% 1.8% 2.2% Developed countries 2.9% 2.2% 2.5% 1.4% World 5.1% 4.4% 3.8% 3.2% Source: PRB, * excl. fuel and food
If interest rates are raised by 25bps in Poland and the Euroland, and the FED ends its tightening policy, Polish debt will still be attractive to foreign capital; paired with the increased inflow of EU funds, this should keep the zloty at its current (high) level at least through the first half of 2007.
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Risk factors The main threat to Poland’s economic growth is the external environment. If the US, and therefore also the European economy cooled down further, a slowdown in Poland would ensue. Increased political risk and the possible flight of foreign capital, causing a weaker zloty, would make for an additional inflationary impulse and possibly prompt a tighter rate policy. The economic momentum in the USA and Europe could be hurt, among others, by decreased consumption. In the past, the momentum was underpinned by the soaring value of assets such as equities and real estate, which have been declining over the past few months. The USA also faces the risk of a high budget deficit. The current robust economic growth and corporate earnings were a result of the deep tax cuts (tax breaks) introduced by the Bush administration after 9/11 as a way to revive the economy. If the tax credits were rolled back and the deficit was balanced, corporate earnings would deteriorate and the purchasing power would drop, potentially causing the US economy to slow down even more than macroeconomists predict. But those decisions are up to the politicians. In our opinion, this is an unlikely scenario as the US enters another election period leading up to the 2008 elections; equity markets usually rally during campaign periods on the flurry of election promises. The risk of rising inflation is still a concern, potentially leading to higher, or at least flat interest rates, already discounted by the market. If this coincided with a slowdown in the economy, it would be a lethal combination for the equity market. So far, rising prices of crude oil and other commodities have not accelerated inflation in a way which could prevent the FED from ending the tightening cycle. In the short term, the inflation risk will be mitigated by the current slide in metal and crude prices. US CPI vs. crude price (brent, eoy) Source: Bloomberg 2007 might be the fifth growth year in a row for the US stock market. This is nothing special against the backdrop of the last 75 years, especially if we remember the 2001-2002 slump.
S&P500 versus inflation
Source: Bloomberg
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Europe and US stocks are attractive, Polish stocks are expensive, but… To assess market attractiveness, we used a model based on the relationship between the E/P ratios of corporations and the yield on 10-year bonds as an alternative to invested capital. The resulting ratio was analyzed against historical data. Looking at the 2006 earnings yield relative to the current bond yield, we can say that European and US stocks are cheap. Low inflation, robust GDP growth in developing countries, and low taxes, drove the earnings generated by international corporations, and helped retain the US earnings yield ratio at its lowest level since the 1980s. In the “soft landing” scenario (growth slowdown from 3.3% to 2.3% in the USA and from 2.6% to 1.8% in Europe), corporate earnings will continue to increase, only slower than in 2006. Assuming that EPS will grow and the tightening cycle will end, the low earnings yield ratio should support the equity market.
P/E ratio vs. bond yields in the USA
Source: BRE Bank Securities based on Bloomberg Germany is in a similar situation, with the ratio of the 10Y bond yield to earnings yields currently at 0.5. A 5%-8% increase in the average EPS is expected next year. Even if we assume another rate hike in the euro zone (0.25bps at the beginning of the year), the earnings yield ratio indicates that stocks will still be cheap (see chart on next page). According to our estimates, Polish stocks traded at an average ‘06 P/E of 20.4, implying an E/P ratio of 4.9%. To calculate the P/E ratio for this year and previous years, we used the median for the 57 largest stocks measured according to their share in the WIG index (prices quoted at year-end). With the 10Y bond yield at 5.2%, the resulting P/E ratio is 1.06. Historically, this is a level acceptable to investors. This comparison also shows that Polish stocks trade at an average 35% premium to US stocks, and an over-50% premium to German securities. The premiums have been present since 2004, when liquidity factors, primarily inflows to investment funds, started to have an increasing impact on the market, and are partly justified by the expected upswing in the economy and corporate earnings.
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EY/BY in the USA, Germany, and Poland Source: BRE Bank Securities based on Bloomberg, PAP The chart shows that only Poland still recorded an increase in the earnings yield ratio in 2006, confirming the relative overpricing of Polish stocks. At an estimated average EPS growth of 15.4% for the analyzed group of companies, and at the current prices, the earnings yield ratio for FY2007 drops to 0.89. If we assume that its current level (1.06; 6Y median 1.15; US 20Y 1.3) is justified, next year, stocks should rise by an average 11%. We assumed for the purposes of our analyses that interest rates will be raised by 25bps. Below is a matrix showing how the market will behave depending on the level of 10Y bond yields and the rate of EPS growth for the analyzed stocks in 2007 (and assuming that the earnings yield ratio at the end of 2007 will stay flat relative to its end-of-year 2006 level).
Average changes in stock prices depending on interest rates and EPS EPS growth 10Y bond yield
-7% 0% 7% 12% 20% 4,7% 2.6% 9.6% 16.6% 23.6% 30.5% 5,0% -2.5% 4.8% 12.1% 19.5% 26.8% 5,2% -7.7% 0.0% 7.7% 15.4% 23.1% 5,5% -12.9% -4.8% 3.3% 11.4% 19.4% 5,7% -18.1% -9.6% -1.2% 7.3% 15.7% 6,0% -23.2% -14.4% -5.6% 3.2% 12.0% 6,2% -28.4% -19.2% -10.0% -0.8% 8.3% Source: BRE Bank Securities
Our model also sets out the worst-case scenario in which interest rates rise and the economy takes a deep downturn, affecting EPS growth. At zero EPS growth and 100 bp rate hike, the market’s downside potential is 20%. These estimates do take into account liquidity factors (a decline in the earnings yield ratio and 10Y yield) such as the downward sales spiral that might occur at investment funds (decrease in share values, redemptions, continued downturn). Our model will change as companies publish their quarterly earnings results, and depending on the interest rate policy. We will update the model accordingly in our subsequent market valuation reports. The table below shows the PEG ratio for the analyzed group of companies as at the end of 2005 and 2006, at year-end prices. At the end of 2005, the forward two-year estimate of average annual EPS growth was 15%, which, at the average market P/E, implied a PEG ratio of 1.14. With the average annual EPS growth rate in the 2008/06 period estimated at 15%, and a P/E of 20.3 at the end of 2006, investors now accept a PEG of 1.32, which is 15% more than a year ago.
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PEG for Polish stocks at year-end 2005 and 2006 EPS CAGR P/E PEG
2007/05 2008/06 2005 2006 2005 2006 Change 15% 15% 17.2 20.3 1.14 1.32 15%
Source: BRE Bank Securities Based on the PEG estimates, we are inclined to conclude based on our expected EPS growth that 2007 will not be marked by such strong rallies as 2006.
IPOs
The 2006 stock rally, much stronger than EPS growth, was spurred, among others, by the inconsiderable value of initial public offerings relative to the new capital flowing into the market. Thirty-nine companies debuted on the Warsaw Stock Exchange in 2006. The value of shares acquired by investors amounted to PLN 3.95 billion, which, set against the PLN 24-billion inflows into investment funds, had to trigger a surge in the “old” stocks.
IPOs in 2006
Source: BRE Bank Securities The situation is bound to change in 2007, though not enough to pose a threat to the market. Some 60 companies are getting ready for their debuts. It is hard for us to estimate the value of the upcoming IPOs because we know very little about the different offerings prepared by different brokers. But, based on consultation with our Primary Market Department, we concluded that the value of listed securities will not increase much in the first half of 2007 relative to the expected fund inflows. The market debuts will comprise mainly private-sector mid-caps (PLN 100m IPOs). The new securities supply from the State Treasury remains a mystery. We do not expect IPOs from such large government-controlled companies as PKE, PZU, and Polkomtel earlier than late 2007/early 2008. One sector that is likely to be represented well this year in the IPO department is the booming real-estate industry. If the upbeat sentiment to the equity market continues, big IPOs of government-owned enterprises might prove to be a welcome contribution to the stock market capitalization and liquidity, attracting new foreign capital. Government’s stance on privatization We might see some changes in 2007 brought about by the government’s changing stance on privatization, especially privatization through the stock market. 2006 was scarce in initial public offerings from government-controlled companies, with Ruch making the only debut. According
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to Treasury Minister W. Jasiński, preparations for the privatization of 500-600 companies are in their final stages. Most of those companies will be sold directly to investors, but some 100 might make it to the WSE. The State Treasury has no intention of divesting such strategic assets as PKN Orlen, PGNiG, or PSE. The first companies to make it to the market will probably be PKE, PLL Lot, Sklejka-Spisz, Huta Łabędy, Zakłady Azotowe Tarnów, or Agroman. It is hard to tell with our government whether it is going to act on its promises, or whether the privatization plans will never get outside of the Sejm lobbies, which is what happened with former Prime Minister Marcinkiewicz’s vows made a year ago. The Ruch IPO might be considered a sign of a shift in the government’s approach to privatization, and 2007 might bring a breakthrough in that respect. A completely different question is whether the government-controlled companies are ready to go public. We have our doubts, hence our guess that large-scale privatizations are to be expected in the second rather than first half of the year. Private sector IPOs According to our estimates, the value of initial public offerings of private-sector companies will amount to PLN 4-6 billion in 2007. Approximately 60 companies will make their debuts. The construction industry will most likely be much more heavily represented on the WSE than it is now (large infrastructure and working capital needs), most notably by real estate developers who will want to leverage the prosperity they are currently enjoying, and who are encouraged by the high prices of already listed stocks. The list of companies expected to make their market debut in 2007 includes: Polski Holding Farmaceutyczny, Helios, Wola Info, TelForceOne, Orco Property Group, Pol-Aqua, Pronox Technology, Agros Nova, BOT, BISE, Bipromet, PZU, ZA Tarnów, Polsat, Agroman, Rafamet, Huta Łabędy, Kopalnia Soli "Kłodawa", Zakłady Górniczo-Hutnicze "Bolesław" SA, Wola Info, Delko, Noble Bank, Makrum Bydgoszcz, ABM Solid, LC Corp, EL2, Sklejk-Spisz, Lumena.
New inflows Amidst upbeat macro-economic projections, growing profits, and limited supply of public offerings on the primary market, the liquidity factor might have a significant bearing on the equity market and acceptable valuation levels in 2007, similar to 2006. Below is a brief overview of inflows recorded by different-class funds. 2006 was very successful both for investment fund companies (TFIs), and open pension funds (OFEs) in terms of inflows, making for a very important determinant of the stock market situation. By the end of November, both fund types received a net total of PLN 37.3 billion. Taking into account the appreciation in assets driven by the market momentum, this boosted the value of equity assets to PLN 37.7 billion for TFIs, and to PLN 39.5 billion for OFEs (total assets: PLN 94bn and PLN 113bn respectively. Both fund types recorded an increase in the share of equities in their portfolios (by 39.7% and 35% respectively). This uptrend will continue in 2007, although TFIs are expected to experience a slowdown in inflows due to increased market volatility (influencing the behavior of fund share buyers) and higher risk aversion (the savings structure is becoming similar to EU averages). TFI inflows going forward will be shaped by a combination of growing household savings and the WSE momentum determining the level of acceptable risk. If the risk increases, but interest rates only rise 25 bps, capital is not likely to return to debt securities. But mixed funds will start to gain in importance as investors seek to mitigate exposure to equity funds.
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Equity components of TFIs and OFEs Source: AnalizyOnline The importance of TFIs as forces shaping the stock market momentum increased considerably in 2006. Equity funds and mixed funds recorded gains of a combined PLN 24.7 billion by the end of November 2006. The value of equity instruments in TFI portfolios amounted to PLN 37.7bn. Fund investments account for close to 12% of the total savings of Poles. Combined with securities deposited in broker accounts and the equity components of OFEs, this represents a significant exposure to the equity market (ca. 20% of savings are in equities). If the strong market momentum is sustained, it will increasingly influence consumption as the population’s wealth increases (similar to the USA and Europe).
TFI inflows
Source: Analizy Online
The key question is whether the large inflows to TFIs will be sustained in 2007. Naturally, this will depend on the stock market momentum which, as is evident in the chart above, is a powerful stimulant of TFI client behavior and household savings. From September 2005 to September 2006, household savings increased by PLN 88.4bn, of which an estimated PLN 20bn came from capital gains generated through stock investments. The remaining PLN 68bn is new capital, 29% of which went to TFIs. As the upward pressure on salaries rises, the disposable income of households should increase in 2007 at least by the same amount as in 2006. If we take the positive 11% growth scenario for the WSE, but assume greater market volatility and hence also a shift in sentiment among current and future fund share owners paired with lower outflows from bond and bill investments, we can estimate conservatively that the TFI allocation rates will be halved to 15%. In this scenario, TFIs (equity and mixed funds) would receive ca. PLN 10bn in inflows within a year. The share of deposits in national savings would fall to 40.5%, while the share of TFI investments would rise to 12.5%.
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Structure of household savings in Poland Value Structure Change 09/2005 09/2006 09/2005 09/2006 Y/Y Public company stocks 21.9 38.2 4.8% 7.1% 74.4% Bonds and bills 21.1 13.5 4.7% 2.5% -36.0% Investment funds 38.2 62.1 8.4% 11.5% 62.6% Unitized insurance funds 17.3 24.6 3.8% 4.5% 42.2% OFEs 82.2 105.5 18.2% 19.5% 28.3%
Deposits 216.7 232 47.9% 42.9% 7.1% Cash in circulation 55.4 66.2 12.2% 12.2% 19.5%
Total 452.7 541.1 19.5% Source: Analizy Online
In Poland, the ratio of TFI assets to GDP is ca. 5%, which is little compared to the EU average (>25%). However, we expect an evolution rather than revolution in that respect in the short term (2-3 years), as the ratio grows together with savings and stock market capitalization. In the longer term (2 years), the stock market will face the risk of TFIs increasing exposure to foreign equities; in the face of a shortage of big local IPOs, the WSE offers limited investment possibilities. OFEs OFEs will not start to pay out retirement benefits for 2.5 more years, accumulating cash inflows from the Social Insurance Company (ZUS). This means that, until the cash starts to flow out, inflows will amount to some PLN 39 billion. Assuming an unchanged asset structure and WIG, this implies a PLN 13bn demand for equities. Assuming that the WIG gains 11% in 2007 and the value of OFE assets increases by the same percentage, and funds do not change the structure of their asset allocations, OFEs can spend ca. PLN 4.1bn on equity securities, which is just a little less than our estimated value of the expected IPOs. Equities in OFE portfolios vs. WIG Source: Analizy Online We estimate that the equity component of OFE portfolios is now 35% – its highest level since 2004. Historically, the market usually went into a correction at this level. Foreign funds Given the inflows to OFEs and TFIs, and the fact that Poles increasingly prefer to invest their savings directly on the stock market (domestic demand), a new supply wave might come from foreign investors in case of a shift in the bullish sentiment toward emerging markets. In Q4 2006, global and international equity funds reduced their exposure to North American markets and some developed markets, and moved to emerging markets, especially China which is still experiencing a mega-boom. In October, global emerging market funds trimmed their cash
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components to increase exposure to equities. Poland is ranked 15th in the GEM fund portfolios, with a ca. 1.6% share corresponding to our weight in the MSCI index. In recent weeks, funds increased exposure to Chinese and Russian equities and backed out of Korean stocks. The share of Polish equities in foreign fund portfolios has increased slightly, though rather on the back of global funds. Emerging Europe and EMEA funds have been recording redemptions over the past few months instead of new inflows.
2006 inflows to foreign funds investing in emerging markets ($M) GEM EMEA All Year to date 2006 4 564 -1 894 22 115 Q1 8 056 3 004 23 257 Q2 -1 523 -4 272 -6 279 Q3 -2 702 -14 -1 813 Q4 732 -613 6 950 Source: EPFR
The consensus for this year suggests that developing countries will record GDP growth twice as high as developed countries, and lower inflation. Such an environment should help sustain the bullish sentiment toward emerging markets. If the sentiment to Utilities shifts in the second half of the year, which we consider very likely, investments held in the Chinese market might be reallocated to Russia or Poland. But there is a flipside to this coin. If we are proven wrong about the Utility trends, the Polish market will fall under the pressure of declining utility stocks which have a significant 21% weight in the WIG20 index. Another risk is that the US dollar appreciates against world currencies. There is a strong correlation between a weak dollar and the momentum in emerging markets. We cannot rule out that, as the US economy improves and inflation remains stable, the dollar will appreciate to 1.2 against the euro (-10%) in the second half of 2007. If this happens, although the boom in emerging markets will not bust, the prices of local stocks might take deeper hits than recorded in 2006.
US$/Euro vs. emerging market indexes (MSCI, China)
Source: Bloomberg
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BRE Bank Securities
BRE Bank Securities
Sector allocation 2006’s biggest wins went to investors who followed our advice from the beginning of the year (the March 20th Industry Research The Sluggish Engine Finally Gets Rolling), and opted to invest in Construction stocks. With a strong rally in construction company stocks behind us, and because the market has already discounted the robust earnings growth, we are moving to neutral on the sector. Today, investors are buying the optimistic earnings- and margin scenario for the construction industry. We see a risk of labor costs going up in the second half of the year, which, combined with the fact that builders are still working on the unprofitable contracts they locked in prior to the upswing, might bring disappointing earnings performance for H1 2007. But, since the long-term outlook on the industry is bullish, we recommend to accumulate positions on any price weakness. The expected strong Q4’06 earnings (extended construction season owing to favorable weather conditions) might be a good opportunity to cash in on some construction investments and wait out the weaker H1 2007 earnings season. Recommended sector allocation
Sector Rating ENERGY&BASIC MATERIALS overweight in H2 2007 BANKS neutral MEDIA overweight IT overweight TELECOMMUNICATIONS underweight CONSTRUCTION neutral MidCaps underweight
Source: BRE Bank Securities The Information Technology sector was among the weakest performers in 2006, and companies with the broadest exposure to government contracts were particularly disappointing. We believe that the sector will rebound in 2007, though probably in the latter part of the year. We are already seeing the first signs of a revival in large government contract awards, suggesting that Prokom, and ComputerLand might outperform the broad indices. The Media sector should perform much better in 2007, with Agora taking the lead. Agora’s earnings will improve on the back of weaker-than-expected sales and promotional cost cuts at Gazeta Wyborcza’s main rival Dziennik, and will be firther underpinned by the company’s savings strategy. TVN’s expensive stock will likely resist correction owing to the expected strong H1 earnings results and the stalled market debut of the rival Polsat. In the second half of the year, with Polsat’s IPO getting closer and competition growing (ownership changes at Polsat and TV Puls), TVN’s position will probably weaken. Banking stocks will continue to be expensive. Banks offer exposure to the macroeconomic momentum which is expected to remain strong in Poland. If the Polish economy cools more than projected by analysts, the correction that we expect to take place in the first half of the year will be deeper, with banking stocks taking the hardest hit. Looking at the current prices, our preferred investment picks are smaller banks that, aside from sustained volume growth, still have upside potential seated in further cost cutting possibilities (a downtrend in the cost-to-income ratio). The main threat and potential cause of a deeper correction in the current bank valuations would be if the downward trend in materials reversed, spurring a capital outflow to that sector. Energy and Materials companies (KGHM, PKN, Lotos) remain the best bet for 2007. The stocks have been going through a strong correction in the past few months stemming mainly from the situation in materials markets which entered a correction phase in a long-term bull market. If the soft landing scenario pans out in the US, investors should take advantage of the weakness to increase positions in energy and materials stocks. We predict that investors will warm up to materials stocks again in mid-2007, when developed economies start to pick up from their slow growth phase.
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BRE Bank Securities
BRE Bank Securities
Sector index performance in 2006 WIG WIG20 MIDWIG Banks Constr Media Food Telco IT 2006 36.9% 19.5% 64.2% 46.3% 134.6% 5.3% 49.8% 4.6% 29.9% Q4 2006 14.4% 12.6% 16.0% 21.8% 28.7% 17.4% 7.4% 21.8% 14.3% 12.2006 6.4% 5.7% 5.3% 14.7% 13.5% 10.5% 2.8% 8.3% 12.8% Source: WSE
We expect the market to grow more volatile in 2007, with small and mid caps taking the biggest plunge. Many of them will probably not deliver against the high earnings expectations. Furthermore, the flurry of IPOs expected in 2007 will provide alternatives to the expensive MidCaps. Hence, we recommend to selectively phase out MidCap stocks on any rally. As we begin another year, we are looking forward to the kick-off of the fourth-quarter earnings season. This season, the weather will be making headlines. The construction industry profited from the warm temperatures that persisted through November and December. In turn, a cooling probably took place in the following industries:
• fuel companies, due to falling gasoline sales volumes • clothing companies, due to weak sales of winter collections • heating distributors (Kogeneracja) • tire manufacturers, due to lower sales of winter tires.
The fourth quarter must also have been disappointing for exporters due to a strong zloty (tighter margins). Sector EPS growth Construction companies should achieve the strongest EPS growth in FY2007, already reflected in the sector’s valuation. In FY2008, construction stocks will trade at a 36% premium relative to the market. Media stocks will also display strength, driven mainly by the improved performance of Agora. This and the expensing of stock option plans at Agora and TVN were the main EPS drivers in 2006. This year, IT companies and manufacturers will also achieve above-average EPS growth.
P/E per sector and forecasted EPS changes P/E EPS change EPS CAGR stocks 2005 2006 2007 2008 06/'05 07/'06 08/'07 ‘08/'06 ENERGY&BASIC MATERIALS 3 6.1 8.4 8.7 8.8 -37% -3% -1% -2% BANKS 9 22.8 20.1 15.8 13.4 12% 21% 15% 18% MEDIA 2 28.1 63.2 41.5 35.1 -125% 34% 15% 25% IT 8 29.6 23.7 18.0 15.0 20% 24% 17% 20% TELECOMMUNICATIONS 2 25.6 15.5 18.3 15.6 39% -18% 15% 0% CONSTRUCTION 6 82.2 52.6 31.0 19.8 36% 41% 36% 39% RETAIL 7 19.0 15.5 14.3 12.9 19% 7% 10% 9% INDUSTRY 13 23.3 20.0 16.0 13.5 14% 20% 16% 18% INFRASTRUCTURE 2 24.4 16.5 16.2 12.8 32% 2% 21% 12% SERVICES (hotels, food service) 2 46.5 36.5 27.5 21.3 22% 25% 22% 23% MARKET MEDIAN 24.2 20.3 17.2 14.5 16% 15% 15% 15% YIELD 4.1% 4.9% 5.8% 6.9% Number of stocks 57 0.89 Percentage share in the WIG index 87% Source: BRE Bank Securities
Retail is expected to achieve the weakest EPS growth in FY2006-2008, pulled down by pharmaceutical companies that spoil the average. For typical FMCG companies (Eurocash, Eldorado), we expect average annual growth of 18%. Weak EPS levels relative to the overall market will also be recorded by Energy and Basic Materials companies (KGHM, PKN, Lotos), in case of which a sustained record level of earnings from last year at the current valuations is attractive from investor standpoint. Polish stocks trade at premiums to foreign peers, and Banks have the highest premiums aside from the incomparable Media. In case of a correction in the global markets, banks will be the ones that will be hurt most by increased supply from foreign investors. The expected robust EPS growth among construction companies will bring the premiums up to around fifteen percent in FY2008.
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BRE Bank Securities
BRE Bank Securities
Trading premiums (P/E): Polish stocks vs. foreign peers 2006 2007 2008 ENERGY&BASIC MATERIALS 22% 20% 5% BANKS 56% 35% 30% MEDIA 265% 154% 136% IT 24% 17% 8% TELECOMMUNICATIONS -1% 23% 11% CONSTRUCTION 117% 69% 17% Source: BRE Bank Securities based on Bloomberg
Sector overview Banks (neutral) The WIG-Banks index rose a whopping 51.4% in 2006, above the sector’s average net income growth rate. High valuations of banking stocks (average ’06P/E at 19.4), displaying an over-43% premium relative to the average multiples of foreign banks, reflect investor confidence that the banking industry‘s strong momentum will continue for at least three more years. Our estimated FY07-09 CAGR for the banks in our coverage universe is over 13%. We predict that profits will increase at a two-digit rate going forward. Trading premiums relative to foreign banks have been present for some time, reflecting the industry’s growth potential lying in the still un-banked population. Our view on small and mid-sized banks is still positive. Looking at the current prices, we recommend to accumulate ING BSK and BZ WBK. In case of Millennium and Bank Handlowy, we advise investors to add to their positions on any price weakness. In the Top Three, we like how the merger with Pekao will drive BPH’s earnings. Since BPH’s valuation is correlated with Pekao’s valuation, we have a positive view on BPH’s stock. As for PKO BP, market expectations already more than price in the anticipated earnings improvement, which however, might be threatened by the continued management instability at the bank. In a favorable macroeconomic environment, there is a real possibility that the returns on equity earned by smaller banks will converge to the levels currently achieved by large banks. Comparing the implied P/BV multiples derived from DCF valuations, we think that their current levels already reflect the expected improvement in the ROEs of large banks in the next few years. Millennium, Kredyt Bank, and ING BSK have potential to improve their equity returns enough to generate higher equity values. In case of Bank Handlowy, ROE growth is slow due to a large equity base, but it will keep dividends high in the coming years. Pekao will improve profitability on the back of post-merger synergies.
P/BV estimates BZW BHW BSK KRB MIL PEO PKO'06P/BV 4.4 2.1 2.6 2.8 3.1 4.3 4.6'07P/BV 4.0 2.1 2.5 2.6 2.9 4.0 4.0'08P/BV 3.7 2.0 2.3 2.3 2.6 3.7 3.6
'09P/BV 3.4 2.0 2.2 2.1 2.3 3.5 3.1'07ROE 23.1% 11.4% 15.2% 13.6% 14.7% 22.2% 21.7%
'09ROE 26.8% 14.7% 17.9% 17.4% 19.3% 25.0% 23.3%Implied ’09P/BV, income-based valuation* 3.7 1.7 2.2 2.2 2.5 3.4 3.1premium/discount on implied P/BV to '07P/BVF 9.9% 21.5% 12.2% 20.1% 17.1% 18.2% 29.1%
premium/discount on implied P/BV to '08P/BVF 1.2% 17.7% 4.5% 7.0% 5.6% 10.5% 14.5%premium/discount on implied P/BV to '09P/BVF -7.8% 14.0% -3.6% -4.2% -6.1% 2.5% 1.0% Source: BRE Bank Securities, banks * cost of equity at 10.214%,as at Dec. 29th, 2006 (year end) ** closing prices at Jan. 8th, 2007
The most important development in 2007 will be the merger of Pekao and BPH, which will become official in Q3’07. However, in the first half of the year, we will probably find out who is going to take over the “Mini–BPH” (and at what price), and learn Pekao’s growth plans. The impact of the merger will be most acutely felt by PKO BP, which is going to lose its pole position in terms of market cap and the basic business metrics (assets, loans, deposits) in Q3’07. The bank will want to win back its leading position by following a new strategic plan for the years 2007-2013, scheduled for release at the end of Q1’07. The Peako/PBH merger will also influence the smaller players that are poised to leverage the temporary disarray at both
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BRE Bank Securities
banks to win over clientele. Basically all banks except for the Top Three are planning to enlarge their sales networks (Kredyt Bank, Millennium, ING BSK, Bank Handlowy, BZ WBK). Those plans were partly spurred by the strong market momentum, and, partly, are a measure designed to lure the confused clients of the merging banks. 2007 will probably witness a reshuffling among the WIG 20 banks, probably as soon as the next annual ranking review. BRE might lose its place to Getin Holding. The WIG 20 components might also be re-ranked because of Millennium and Bank Handlowy which considerably increased trading volumes and free float and therefore qualify to replace BPH. Competitors for a place in the WIG 20 include: BRE, Bank Handlowy, and Millennium. We do not see any signs of a downturn in the banking industry at the moment. So long as economic projections are good, debt will grow, and clients will continue to bring cash to investment funds. We expect savings to increase further throughout FY2007, but they will be reallocated from deposits to investment funds. Banks, leading distributors of fund shares, and shareholders of asset management companies, will feel the increase in fund assets in their revenues. There also seem to be no immediate threats to loan growth. Household debt will be driven by mortgage financing and cash loans. Corporate debt is expected to rebound on a combination of three factors: growing capital expenditure, change of approach to corporate clients, and EU funding. From among listed banks, ING BSK, BZ WBK, and Bank Handlowy are best positioned to benefit from that upturn since BPH’s corporate division, a fierce rival to the other banks, will be focused on the integration with Pekao. Telecommunications (underweight) Telecommunications stocks were among the biggest underachievers in 2006. The telecom sector brought low rates of return, mainly due to market deregulation and the risk entailed in new projects in case of TPSA, and deteriorating earnings in case of Netia. These trends will continue into 2007, as TPSA starts to feel the slowdown in the mobile telephony market and is forced to face up to the emerging competition in broadband services and fixed-line subscriptions. In 2006, TPSA’s rivals were weak and unprepared to take advantage of the opportunities created by market liberalization. But they will find its footing in 2007, and launch competitive retail service offers as an alternative to TPSA’s. Furthermore, we will finally see the end of the protracted negotiations between TPSA and other operators that prevented competition from entering the market last year. Bitstream access agreements with the national operator have already been signed by GTS Energis, E-Telko, eTel Polska, Netia, Telefonia Dialog, and Exatel. Tele2, Dialog, and Netia also have WLR agreements in place. Three mobile operators have signed agreements with MVNOs: Avon, GTS Energis, P4, mBank, Cyfrowy Polsat. The first half of 2007 will probably see the entry into force of the new Telecommunications Law which gives more power to the President of the Office for Electronic Communications (UKE) as regards penalizing operators for non-compliance with the UKE’s rulings. So far, TPSA has not seemed very worried about the fines it received: it has not paid any of them yet, and decided to engage in a long court battle against the regulator to have them annulled. The new regulations will require operators to pay fines into a special account until any disputes concerning them are resolved in court. The Telecom Regulator has also changed its stance on the size of the fines. Since TPSA is not impressed with the million-zloty fines received so far, the UKE decided to make the punishment more painful, as demonstrated by the penalty for charging inflated “naked DSL” (Neostrada) fees. In case of Netia, the main risk factors are still the large expenses incurred on launching mobile telephony operations (P4), and narrowing margins in the fixed-line business. As margins on business telephony services shrink, Netia is faced with the necessity of launching a retail offer – also a costly undertaking. Several other operators have announced plans to concentrate on the retail user market. A big challenge for both operators are technological advances that make it easier for new operators to enter the market (VoIP), and that will increasingly affect margins earned on the telecommunications traffic. Dividends are also a factor in case of TPSA. At its current price, the company offers a gross yield (2007) of 6%, which does not seem an attractive level to us given the falling EPS. Our negative outlook is countered by the globally improving sentiment toward the Telecom sector. Strategists from foreign investment banks declared Telecoms a defensive sector that, amidst growing uncertainty, should be overweighted in 2007. We predict that this view will shift still in the first half of the year on the first signs of an economic upturn, as growth stocks regain favor.
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BRE Bank Securities
IT (overweight) Last year, the WIG-IT index underperformed other leading indexes (moving up 35% while the broad WIG index soared 41%, and the top-performing WIG-Construction gained a whopping 146%). The difference becomes even more pronounced when we consider how the indexes performed over a two-year period (WIG-IT up 35%, WIG up 88%, WIG-Construction up 301%). The weakness of information technology stocks mirrored the hiatus in large-scale IT project awards, especially evident in the public sector for which many IT companies had had very high expectations. We are confident that 2007 will be marked by a revival in IT spending, with state administration and utilities as the two main driving forces. That is why our sentiment to the IT industry remains positive. Our top information technology picks for 2007 are Prokom Software and ComputerLand. As for ComArch, there is a risk that its future earnings might miss the high market expectations (our current FY2007-2008 EBIT estimates are 40%-45% higher than the Management’s original targets). We singled out three developments that will galvanize spending in public administration, the first being the relative calm on the political arena. After last year’s coalition turmoil and local government elections, we expect 2007 to be much less turbulent, facilitating more effective decision-making processes. As a result, ongoing contracts will gather speed, and new projects will be pushed out of the pipeline. Secondly, the "Virtual State" Plan for the years 2007 to 2010, currently in its cross-ministerial consultations phase, is scheduled to be ready soon. Though we do not think that the Plan itself will result in actual investments, it will introduce some order to the projects and give a general overview of how the computerization of the state administration will unfold in the coming years. Finally, the spending revival will be propelled by EU financing which can be used to support most public administration projects, and which has strict utilization deadlines. On the other hand, there is a risk that financing allocated to delayed IT projects will be reallocated to other initiatives, not necessarily related to IT. Utilities and manufacturers are expected to increase capital expenditure on IT projects which, in 2007, will be driven by the deregulation and consolidation of the Polish energy market. Utilities will be forced to update their existing billing systems and integrate their computer systems. Furthermore, to gain edge in the liberalized market, energy providers need to invest in performance-enhancing tools and improve the quality of customer service, for instance through network inventory and CRM systems. Media (overweight) The media industry is closely correlated with GDP growth, and even more closely dependent on investments. Given the over-5% GDP growth and 12% investment growth, a 10.5% increase in the value of the advertising market in 2006 was a disappointment. The meager growth can be partly explained with the inflated FY2005 comparable base boosted by parliamentary and presidential elections (ca. PLN 50m, i.e. 0.7% of the market value). We believe that advertisers were taken by surprise by the hikes in TV ad prices, and did not take them into account in their spending budgets. This year, the budgets make allowance for the higher ad rates, as best demonstrated by finance advertisers who allocated virtually their entire increased ad spend to TV. We expect an improvement from the industries that cut their advertising expenditure in 2006 (telecoms, automotive). The advertising industry will receive the biggest boost from telecommunications operators who are gearing up for a revolution. The new Telecommunications Law enables alternative operators to enter the retail customer market. Operators will be launching new fixed-line services (WLR, broadband). Five to seven MVNOs are readying their market debuts. PTC will probably re-brand “Era” to “T-Mobile” (ca. PLN 80m). Last but not least, a new mobile operator, P4, will hit the market. In light of that activity, telecoms are shaping up to become the main driver of the advertising market this year. As for automotive advertisers, after a near-collapse at the beginning of last year, dealers are starting to slowly recover, offering hope that the industry will overcome the crisis this year. Financial service providers and consumer goods manufacturers will probably continue to increase their advertising budgets. Like in the previous years, online advertising will remain the fastest-growing market segment, underpinned by increasing accessibility (financial and technical) of broadband services. Agora took a deep plunge in 2006 as it struggled with heated competition in the newspaper market, while TVN’s stock soared on the weakness of Polsat and TVP on the television
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BRE Bank Securities
market. Will 2007 bring a reversal of that pattern? We think yes, although this does not necessarily mean that TVN’s stock will sag – at least not in the first half of the year. Print media were hurt the most by industries that trimmed advertising expenditure in 2006. If our recovery scenario for them pans out, the print media market will speed up relative to 2006. The sales of Dziennik are a disappointment in light of the expenses incurred on its promotion. In our opinion, seeing that the number of copies sold is not going up, Axel Springer will focus on defending market share rather than on expansion, and reduce advertising expenses, prompting Agora to do the same. TVN is another story: the network has taken lead of the market, benefiting from the weakness of the rival Polsat, and from TVP’s shift away from commercial programming to providing content that is more in line with its mission as public television, but that receives lower ratings. As potential investor in Polsat, Axel Springer is not able to guarantee that the station will change as fast as it would if it were run, for instance, by an investor like Bertelsmann. Nevertheless, Polsat’s main owner should learn from the experience of the German shareholder and consider an internal restructuring before the station makes its stock market debut. On the competition front, News Corp’s moving into Poland is not a thing to be ignored in our opinion. TVN’s operating environment will not change in a matter of 3-4 months or even half a year, but, in two years’ time, competition is bound to become much more heated. In the shorter term, TVN will probably continue to generate strong earnings, driven, among others, by high ratings. Basic Materials (overweight in H2 2007) After a rally at the beginning of 2006, the slowdown expected in global economies is already factored in the prices of basic materials. Whether another growth impulse materializes, validating the supercycle theory, is the biggest question for 2007. At the moment, the prices of both metals and crude oil are still in a correction phase which should be leveraged to take long-term positions. After nine months of 2006, the world demand for copper was 2.5% higher than in the corresponding period of 2005. Lower demand is still reported by China (-6.8%) and the USA (-4%), but this is more than offset by the growing demand in Europe (+11.6%), Japan (+5.9%), and India (+4.9%). During the same time, production of refined copper increased by 5.8%, with an unchanged mining output. According to ICSG’s projections, the oversupply of copper in 2007 will amount to 176,000 tons versus 239,000 tons estimated for 2006. We predict that, after a weak start, the prices of basic materials will stabilize for a medium term at the turn of the first quarter. Investors should react positively to the first signs of developed economies, most notably the US economy, reheating after a cooling down period. Chinese importers should return to the market after a cut-down in orders in 2006, among others for industrial metals. Construction (neutral) The soaring prices of construction stocks in 2006 affected the relative attractiveness of that sector for investors in 2007. Hence, our sentiment to the construction industry has changed from positive to neutral. As for a relative allocation within the construction sector, our best bets for 2007 are industry engineering companies (smaller players: Elektrobudowa, Naftobudowa, Mostostal Płock, Prochem, Projprzem, large players: PBG), and environmental engineering companies (Hydrobudowa Śląsk, after it is merged with Hydrobudowa Włocławek to form “Hydrobudowa Polska”). In the longer term, starting in 2008, investors might turn their attention to energy engineering stocks (major new investments) and road development stocks (rebuilding of margins on new contracts). Construction output from January to November of 2006 increased by 17.7% compared to the corresponding period of 2005. Looking at the warm December, the full-year growth should be even more impressive. What is more, we expect very good fourth-quarter earnings from construction companies. Our forecast for 2007 is that the construction output will continue its robust growth at twice the rate of GDP growth. We estimate that, to catch up with Spain where the value added of construction is 10% of the GDP, the Polish construction industry will increase at twice the growth rate of the GDP over the next ten years. The current market boom is gradually changing the way market players are thinking. But, since power balance shifted in favor of contractors as late as the second half of 2006, only contracts signed in that period can actually contribute to a tangible improvement in profitability. This applies mainly to contracts from private customers. The situation is different in case of government contracts which were calculated in mid-2006 or even back in 2005. The
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BRE Bank Securities
profitability of those contracts might be low in 2007, affecting the earnings of general contractors (Budimex, Polimex, Mostostal Warszawa). That is why construction companies will probably not deliver on the expected improvement in profitability in FY2007. The distribution of bargaining power in the construction industry, which will determine the distribution of margins, will be as follows (in descending order): manufacturers and suppliers of construction materials, construction engineers and workers, subcontractors, general contractors, and investors. In our opinion, subcontractors will retain their bargaining power which will enable them to achieve higher margins. Hence, our preferred investment picks are small and mid-sized construction companies that work on relatively short deadlines, and that will therefore be able achieve fast earnings growth. The next in line to benefit from the stronger momentum are general contractors, who will transfer the rising costs to investors.
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Current recommendations of BRE Bank Securities S.A. Company Recommendation Target price Date issued ABG STER-PROJEKT Hold 7.87 2007-01-08 AGORA Accumulate 41.60 2007-01-08 BPH Accumulate 1022.00 2007-01-09 BUDIMEX Hold 83.70 2007-01-09 BZWBK Accumulate 233.66 2007-01-09 COMARCH Hold 185.80 2007-01-09 COMPUTERLAND Accumulate 114.80 2006-12-01 ELDORADO Hold 83.78 2006-12-05 ELEKTROBUDOWA Accumulate 124.60 2007-01-09 EUROCASH Hold 7.38 2007-01-09 FARMACOL Accumulate 45.60 2006-11-07 HANDLOWY Hold 91.50 2007-01-09 HYDROBUDOWA ŚLĄSK Hold 115.00 2007-01-09 ING BSK Accumulate 857.22 2007-01-09 KĘTY Hold 180.50 2006-09-27 KGHM Accumulate 97.00 2007-01-09 KOELNER Hold Suspended 2006-11-21 KOGENERACJA Hold 61.80 2006-11-07 KREDYT BANK Hold 21.66 2007-01-09 LOTOS Accumulate 59.30 2006-08-24 MACROLOGIC Buy 51.81 2006-11-13 MILLENNIUM Hold 8.08 2007-01-09 MONDI Reduce 80.00 2006-12-05 NETIA Sell 3.80 2006-09-06 PEKAO Accumulate 237.56 2007-01-09 PGF Under Review 2006-12-05 PGNiG Hold 3.44 2006-07-31 PKN ORLEN Buy 66.00 2006-08-24 PKO BP Reduce 41.62 2007-01-09 POLIMEX MOSTOSTAL Hold Under Review 2007-01-09 PROKOM SOFTWARE Accumulate 150.30 2007-01-09 PROSPER Accumulate 20.90 2006-11-07 PROVIMI-ROLIMPEX Hold 21.81 2006-12-05 RAFAKO Reduce 34.00 2007-01-09 SOFTBANK Reduce 49.14 2007-01-09 TECHMEX Buy 27.96 2007-01-09 TELEKOMUNIKACJA POLSKA Reduce 20.60 2006-10-27 TORFARM Hold 63.7 2006-08-25 ZA PUŁAWY Buy 73.16 2006-10-30
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Research Department: Michał Marczak tel. (+48 22) 697 47 38 Deputy Director [email protected] Strategy, Telco, mining, metals, media
Analysts: Marta Jeżewska tel. (+48 22) 697 47 37 [email protected] Banks Andrzej Lis tel. (+48 22) 697 47 42 [email protected] IT Krzysztof Radojewski tel. (+48 22) 697 47 01 [email protected] Pharmaceuticals, construction, utilities Kamil Kliszcz tel. (+48 22) 697 47 06 [email protected] Retail, materials, other
Jacek Borawski tel. (+48 22) 697 48 88 [email protected] Technical analysis
Sales and Trading:
Piotr Dudziński tel. (+48 22) 697 48 22 Director [email protected] Grzegorz Domagała tel. (+48 22) 697 48 03 Deputy Director [email protected] Salesmen: Marzena Łempicka tel. (+48 22) 697 48 95 [email protected] Krzysztof Solus tel. (+48 22) 697 47 31 [email protected] Traders: Emil Onyszczuk tel. (+48 22) 697 49 63 [email protected] Grzegorz Stępien tel. (+48 22) 697 48 62 [email protected] Joanna Niedziela tel. (+48 22) 697 48 54 [email protected] Tomasz Dudź tel. (+48 22) 697 49 68 [email protected] Dom Inwestycyjny BRE Banku S.A. ul. Wspólna 47/49 00-950 Warszawa www.dibre.com.pl
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List of abbreviations and ratios contained in the report. EV – net debt + market value (EV – economic value) EBIT – Earnings Before Interest and Taxes EBITDA – EBIT + Depreciation and Amortisation PBA – Profit on Banking Activity P/CE – price to earnings with amortisation MC/S – market capitalisation to sales EBIT/EV – operating profit to economic value P/E – (Price/Earnings) – price divided by annual net profit per share ROE – (Return on Equity) – annual net profit divided by average equity P/BV – (Price/Book Value) – price divided by book value per share Net debt – credits + debt papers + interest bearing loans – cash and cash equivalents EBITDA margin – EBITDA/Sales Recommendations of BRE Bank Securities S.A. A recommendation is valid for a period of 6-9 months, unless a subsequent recommendation is issued within this period. Expected returns from individual recommendations are as follows: BUY – we expect that the rate of return from an investment will be at least 15% ACCUMULATE – we expect that the rate of return from an investment will range from 5% to 15% HOLD – we expect that the rate of return from an investment will range from –5% to +5% REDUCE – we expect that the rate of return from an investment will range from -5% to -15% SELL – we expect that an investment will bear a loss greater than 15% Recommendations are updated at least once every nine months. The present report expresses the knowledge as well as opinions of the authors on day the report was prepared. The opinions and estimates contained herein constitute our best judgement at this date and time, and are subject to change without notice. The pre-sent report was prepared with due care and attention, observing principles of methodological correctness and objectivity, on the basis of sources available to the public, which BRE Bank Securities S.A. considers reliable, including information published by issu-ers, shares of which are subject to recommendations. However, BRE Bank Securities S.A., in no case, guarantees the accuracy and completeness of the report, in particular should sources on the basis of which the report was prepared prove to be inaccurate, in-complete or not fully consistent with the facts. Recommendations are based on essential data from the entire history of a company being the subject of a recommendation, with particular emphasis on the period since the previous recommendation. Investing in shares is connected with a number of risks including, but not limited to, the macroeconomic situation of the country, changes in legal regulations as well as changes on commodity markets. Full elimination of these risks is virtually impossible. BRE Bank Securities S.A. bears no responsibility for investment decisions taken on the basis of the present report or for any dam-ages incurred as a result of investment decisions taken on the basis of the present report. It is possible that BRE Bank Securities S.A. renders, will render or in the past has rendered services for companies and other enti-ties mentioned in the present report. BRE Bank Securities S.A., its shareholders and employees may hold long or short positions in the issuers’ shares or other financial instruments related to the issuers’ shares. BRE Bank Securities S.A., its affiliates and/or clients may conduct or may have con-ducted transactions for their own account or for account of another with respect to the financial instruments mentioned in this report or related investments before the recipient has received this report. Copying or publishing the present report, in full or in part, or disseminating in any way information contained in the present report requires the prior written agreement of BRE Bank Securities S.A. Recommendations are addressed to all Clients of BRE Bank Se-curities S.A. The activity of BRE Bank Securities S.A. is subject to the supervision of the Polish Financial Supervision Commission. BRE Bank Securities S.A. serves as animator in relation to the shares of the following companies: Millennium, Mondi, Polimex - , Mostostal Siedlce, Mieszko, Polmos Lublin, Pemug, Skarbiec Nieruchomości certificates. BRE Bank Securities S.A. receives remuneration from issuers for services rendered to the following companies: Agora, Bakalland, Computerland, Elektrobudowa, Kęty, Koelner, PGNiG, Polimex - Mostostal Siedlce, Polmos Lublin, Prokom Software, Provimi - Rolimpex, Torfarm, ZA Puławy. Individuals who did not participate in the preparation of recommendations, but had or could have had access to recommendations prior to their publication, are employees of BRE Bank Securities S.A. authorised to access the premises in which recommendations are prepared, other than the analysts mentioned as the authors of the present recommendations. Strong and weak points of valuation methods used in recommendations: DCF – acknowledged as the most methodologically correct method of valuation; it consists in discounting financial flows generated by a company; its weak point is the significant susceptibility to a change of forecast assumptions in the model. Comparative – based on a comparison of valuation multipliers of companies from a given sector; simple in construction, reflects the current state of the market better than DCF; weak points include substantial variability (fluctuations together with market indices) as well as difficulty in the selection of the group of comparable companies.
