18 May 2010 Julie Hudson, CFA Shirley Morgan-Knott ... · PDF fileEuropean Analyser Reference...

UBS Investment Research

ESG Analyser - Framework

European Analyser Reference to better positioned and less-well positioned stocks throughout this document refer to analysis on the basis of the ESG issues

discussed and therefore may or may not vary from the published rating of the analyst according to the UBS research rating system.

Please note that this Framework document is the front section ONLY of the ESG Analyser published today. Please refer to the mainpublication, Framework and Sector Detail, for the analytics underpinning this section.

Global Equity Research

Europe Including UK

SRI & Sustainability

Theme Piece

18 May 2010

www.ubs.com/equities/sri

Julie Hudson, CFAAnalyst

[email protected]+44-20-7568 4632

Shirley Morgan-KnottAnalyst


This report has been prepared by UBS Limited ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 46. UBS does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

ESG Analyser - Framework 18 May 2010

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Contents page

The First UBS ESG Analyser 3 Investment conclusions 4

— Alpha Preferences and Key Calls...........................................................................7 Looking forward 8

— Where are sector dynamics changing? ..................................................................8 — Reading across to Other Investment Contexts… .................................................10

How we address pivotal questions 12 — Key tables.............................................................................................................12

Stock preferences 13 — According to overall competitive positioning.........................................................13

Opportunities, threats and ESG catalysts 21 Corporate governance 21

— Governance in relation to recommendations........................................................22 Linking ESG to fundamentals and finance 28

— Where ESG issues have their impact, financially speaking..................................41

Julie Hudson, CFAAnalyst


Shirley Morgan-KnottAnalyst



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The First UBS ESG Analyser This is the first edition of the first UBS European ESG Analyser. It is a response to the most frequently asked question in the field of socially responsible investment (SRI): Which Environmental, Social and Governance issues are material, in the context of a typical investment portfolio? As it says on the UBS SRI website (http://clientportal.swissbank.com/portal/index.htm?page=eqrschsri), we believe environmental, social and governance (ESG) issues are no different to the many other issues considered in investment research and regarded as ‘financial’. Since we founded the UBS SRI team in December 2004, we have watched two market phases that seem to be consistent with the opportunity and risk dimensions of ESG from a financial perspective. First came the climate change story, which began to move in January 2005 with the launch of the EU Emission Trading System1 and arrived at the peak of a mini-alternative energy bubble surprisingly quickly, in 2007. We see the overall trend as still moving and now well recognised – climate change as an investment issue is almost ‘mainstream’, except that here markets alone cannot resolve the issues. It remains a key area for us. Second, from 2007 onwards came the credit crunch, which, in our view, is rooted in governance and human capital issues crossing banking, regulatory and government sectors. The consequences of this crunch are still developing, with significant volatility in Greece as we write.

On this page we very briefly summarise our approach. To find out what is material we need to know how environmental, social and governance (ESG) issues might be changing the competitive landscape for the European industries we cover and how companies are affected in relative terms. We therefore turn the traditional approach to ESG analysis upside down. Instead of starting with a long list of ESG issues, we start with sectors and industries. We define the world in terms of Porter’s well-known five forces (Figures 3-9, pp. 29-34): intensity of competition, bargaining power of suppliers, bargaining power of buyers, threat of substitute products and threat of new entrants. In this context, we think about the small number of core competencies we see as really key to firms in the industry, selecting from the following: key external dependencies (such as access to raw materials), customers, product, supply chain, human capital and reputation. Having considered ESG issues in the context of competitive conditions the next step is to think about how ESG issues will affect industry financials, in three categories: revenue effects, cost and capex effects and capital allocation issues. We achieve these two steps through a two-part analyst survey, described on p.12.

Having synthesised and summarised almost 200 pages of information from 42 analysts on 42 sectors encompassing about 375 stocks, we found that the basis of analyst recommendations varied widely depending on the specific competitive landscape facing their companies. We were able to identify seven industry competition ‘types’: systemic ESG risk, pressure cooker, solutions providers, solutions providers with ESG risk, ‘known unknowns’, brand as two-edged sword, and fusion, defined in Table 1 and on pages 13 to 20.

We hope to update this analyser once or twice a year, in the expectation that it will, among other things, help us to identify important big trends. In this publication, we identify resource competition as a critical medium term issue.

The names of the analysts involved in this Analyser are found on the sector pages for the stocks they cover. We would like to thank them, as well as Themis Themistocleous. Paul Schneider and Danielle Warren of our Product Management team, and Hubert Jeaneau, who recently joined the SRI & Sustainability team, for their help. We would also like to thank Suresh Naidu, Amber Sahai and Shilpa Salian, employees of Cognizant Group, for their assistance in preparing this research report. Cognizant staff provide research support services to UBS.

1 formerly known as Emissions Trading Scheme


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Investment conclusions The stocks that emerged from this work as most and least preferred are shown in Table 2. We stress that this is not intended to be a ‘green’ or ‘environmentally friendly’ stock list. The two pivotal questions we address in this work are how environmental, social and governance (ESG) issues might be changing the competitive landscape for the European industries we cover and how companies are affected in relative terms.

To answer these questions we worked closely with UBS’s sector teams, on the basis of the two-part survey described below. In the course of our work, on the basis of our Porter-driven approach, we identified seven industry ‘types’ in the context of ESG, shown in Figure 1. By this means, we have been able to organise recommendations in the sometimes complex ESG landscape as shown below. These are described in greater detail below. In brief, Fusion indicates that we see a

Figure 1:Competitive Positioning and ESG Effects

Solutions providers

with significant

risks

Potentially Material 'Known

Unknowns'

Pressure cooker

Systemic Risk

Brand: two-edged sword

Solutions providers.

Fusion

Source: UBS

full alignment between the core business and ESG as fundamental to competitive positioning. For Solutions providers, ESG is core to growth. Solutions providers with risk indicates one or more ESG risk issues at work for such providers. Pressure cooker denotes an industry in which a structural problem such as overcapacity means it is hard to make money and ESG issue are making things worse. For companies relying heavily on brand we see ESG as a two-edged sword where well-positioned firms use it to enhance the brand and less well positioned companies do not. Known Unknowns indicates the potential for ESG-related event risk in an otherwise profitable industry. Systemic risk describes issues that run through all aspects of the industry. In some sectors, this is latent.

Table 1: Summarising – competitive conditions and ESG

Competitive conditions with ESG effects Competitive/ESG profile Key examples

Fusion ESG issues are core. To get the business model right is also to get ESG issues right (and vice versa).

Banks and risk control; power and carbon emissions.

Solutions core to growth

ESG is a growth theme, with relatively moderate risks.

Environmental testing equipment.

Solutions core to growth with ESG risk

ESG is a growth theme, with significant risks.

Fertilisers: pollution and energy waste urge innovation and possible replacement.

Brand as a two-edged sword

In brand-driven industries, ESG can be leveraged to enhance the brand, or can damage the brand.

Luxury goods and the supply chain.

Known Unknowns ESG tail risk in a sector that can be profitable in other respects.

Electro magnetic fields (EMF) for the mobile phone industry.

Pressure cooker Highly competitive sectors, ESG is another source of pressure.

Emission reduction in the auto industry.

Systemic risk 'Strategic' sectors linked with a political agenda. See Fig 2 .

Tobacco and health. Oil & environmental risk. See also commentary on banks.

Source: UBS

The key trend to emerge from our survey is intensifying resource competition.


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Table 2:Stock preferences in summary

Sector Most preferred Least preferred Industry type

Aerospace MTU Aero Engines, Meggitt, Rolls Royce Safran, EADS Systemic

Airlines Ryanair, easyJet None named Pressure cooker

Alternative energy Vestas, SMA, Wacker Chemie Q-Cells; Solarworld Solutions provider

Autos Unclear None mentioned Pressure cooker

Banks HSBC, Handelsbanken, DnB Nor Santander, BBVA Fusion or systemic

Beverages ABI, SABMiller, Diageo None mentioned Brand as two-edged sword + latent systemic

Biotechnology Hikma, Gedeon Richter, Shire Pharmaceutical, Galenica Pronova Biopharma, Elan, Genmab Solutions + significant risks

Chemicals – commodity Ems-Chemie, Lanxess, Victrex, Bayer, BASF Arkema, Clariant Solutions + significant risks

Chemicals – specialty Givaudan, Symrise, Akzo Nobel, JM, Umicore, Linde, Air Liquide, Novozymes, Syngenta

K+S, Yara, Syngenta, MA Industries. Solutions + significant risks

Construction – building materials Kingspan, Saint Gobain None mentioned Solutions + significant risks

Construction – contractors Vinci None mentioned Fusion

Construction – housebuilders. Berkeley Group, Persimmon, Bellway Barratt Dev., Redrow, Taylor Wimpey Fusion

Engineering – electricals ABB, Philips, Schneider Electric, Legrand, Nexans None mentioned Solutions + significant risks

Engineering – mechanicals Atlas Copco, Kone, Assa Abloy, Sandvik, Metso, SKF None mentioned Solutions providers

Engineering – trucks Little differentiation Little differentiation Pressure cooker

Food manufacturing Nestlé Little differentiation Brand as two-edged sword + latent systemic

Food retail Tesco, Ahold Casino Brand as two-edged sword + latent systemic

Freight TNT None mentioned Pressure cooker

General retail Marks & Spencer; Kingfisher Inditex, W.H. Smith. Brand as two-edged sword

Household & personal care Reckitt Benckiser L'Oréal, Beiersdorf, Henkel Brand as two-edged sword

Insurance ING, Swiss Re Swiss Life Fusion or systemic

Leisure – hotels Whitbread Accor Pressure cooker

Leisure – pubs JD Wetherspoon Enterprise Inns Pressure cooker

Luxury Burberry LVMH, Richemont, Swatch Group Brand as two-edged sword

Media – broadcasting ITV None mentioned Systemic


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Sector Most preferred Least preferred Industry type

Media – publishing Pearson Johnston Press Brand as two-edged sword

Media – agencies Aegis, WPP, Publicis None mentioned Brand as two-edged sword

Medtech and diagnostics DiaSorin, Qiagen, Sonova, Fresenius Medical bioMerieux, Getinge, Galenica Solutions + significant risks

Mining BHP Billiton, Vedanta Resources, Rio Tinto Anglo American, Xstrata, ENRC Pressure cooker + latent systemic

Oil Neste Oil, BG Group, ERG Total Systemic

Oil services Wood Group, Saipem, Fugro, Tenaris, Petrofac, TGS Nopec Aker Solutions, Fred Olsen Energy Solutions provider + significant risks

Paper UPM, Mondi, SCA, Stora Enso Norske Skog, Holmen, Sappi Pressure cooker

Pharma GSK, Novartis, Novo Nordisk Merck, UCB Solutions + significant risks

Property British Land, Derwent London None mentioned Fusion

Software and services Autonomy, SAP, Capgemini Sage, Atos Origin, Logica Solutions provider

Steel ArcelorMittal None mentioned Pressure cooker

Support services – staffing Randstad, Michael Page, SThree Hays, Adecco Solutions provider

Support services – testing Intertek, SGS (but avoid currently on valuation) None Solutions provider

Tech hardware ARM Holdings, ASML Ericsson Known Unknowns

Telecommunications KPN, Telefónica Deutsche Telekom, BT Known Unknowns

Tobacco PMI Group, BAT UK None mentioned Systemic

Utilities – power Fortum, Verbund, Centrica, Iberdrola, EDF Drax Group, RWE Fusion

Utilities – water Pennon Northumbrian Water Fusion

Source: UBS


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Alpha Preferences and Key Calls The table below shows our most preferred ESG stocks that also happen to be Key Calls and ‘most preferred’ in our Alpha Preferences list.

Table 3: ESG Analyser best positioned and Key Call and Alpha Preference most preferred

Stock Alpha Preference/Key Call Mkt cap (€m) Analyser sector Rating Ccy Price Price target PT +/- Analyst name

Air Liquide AP – Most Preferred, Key Call 22,232 Chemicals Buy EUR 84.1 100.0 18.9% Laurent Favre, CFA

Centrica AP – Most Preferred, Key Call 17,657 Utilities – power Buy GBP 2.9 3.6 21.3% Ajay Patel, CFA

EDF AP – Most Preferred, Key Call 74,639 Utilities – power Buy EUR 40.4 55.0 36.2% Per Lekander

KPN Telecom AP – Most Preferred, Key Call 17,592 Telecommunications Buy EUR 10.8 15.0 38.9% Laura Janssens

Nestlé AP – Most Preferred, Key Call 127,295 Food manufacturing Buy CHF 52.1 59.0 13.2% Alan Erskine

Novartis AP – Most Preferred, Key Call 86,246 Pharmaceuticals Buy CHF 54.6 70.0 28.3% Fabian Wenner, PhD

TNT AP – Most Preferred, Key Call 8,009 Freight Buy EUR 21.5 24.0 11.9% Dominic Edridge

Source: UBS estimates

The table below shows our least preferred ESG stocks that also happen to be ‘least preferred’ in our Alpha Preferences list.

Table 4: ESG Analyser least well positioned and Alpha Preference Least Preferred

Stock Alpha Preference/Key Call Mkt cap (€m) Analyser sector Rating Ccy Price Price target PT +/- Analyst name

Q-Cells AP – Least Preferred 748 Electric components & equipment Sell (CBE) EUR 6.4 7.4 16.3% Patrick Hummel, CFA

Santander AP – Least Preferred 65,927 Banks, ex-S&L Sell EUR 8.4 7.0 -16.6% Matteo Ramenghi

K+S AP – Least Preferred 7,834 Chemicals, commodity Sell EUR 40.9 30.0 -26.7% Joe Dewhurst

Swiss Life AP – Least Preferred 2,784 Insurance, life Sell CHF 125.2 122.0 -2.6% Sheng Bi

Accor AP – Least Preferred 9,084 Lodging Sell EUR 40.3 37.0 -8.2% Kate Pettem, CFA

Xstrata Plc AP – Least Preferred 34,122 Mining Neutral GBP 9.9 11.0 10.9% Olivia Ker, CFA

Eurasian Natural Resources Corporation AP – Least Preferred 16,338 Mining Neutral GBP 10.8 11.7 8.6% Fawzi Hanano

Holmen AP – Least Preferred 1,550 Paper products Sell SEK 174.5 165.0 -5.4% Myles Allsop

Deutsche Telekom AP – Least Preferred 38,689 Fixed-line communications Sell EUR 8.9 8.7 -2.1% Laura Janssens

BT Group AP – Least Preferred 11,006 Fixed-line communications Sell GBP 1.2 1.0 -17.2% Nick Lyall

Source: UBS estimates


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Looking forward In this brief section we summarise potential changes in competitive conditions identified in this work in banks, alternative energy, fertilisers, mining, oil, paper, pharmaceuticals and water.

Where are sector dynamics changing? Competition is dynamic, so the list in Table 2 (and the types assigned currently) will change as time passes. Sectors where we expect changes in the medium term include the following.

Banks: Fusion sectors are often former Systemic risk sectors in which the risk crystallised and triggered a major change in industry structure resulting in a more constructive balance between stakeholders. (The PPP model, where a good balance has been reached – as briefly described in the Contractors sector section – is a good example). On the basis of changing global regulation, we describe banks as a Fusion sector, as we believe the best business model, dealing well with all aspects of risk management including the control of potential conflicts of interest, will also be the best performing model. However, we wonder whether the banks sector will actually be a hybrid – the Fusion players and the rest.

Alternative energy: For some Solutions providers opportunities dominate and all risk (including ESG risk) is controlled within business as usual operations. Alternative energy is currently in this box but we do not think it belongs here in the medium term, which is another way of saying any ‘green premium’ in current valuations is unlikely to be sustainable. Where the sector ends up depends on whether firms become part of the utility sector (Fusion is then likely) or remain as independents competing to innovate and becoming Solutions providers with significant ESG risk. This may be triggered by the shift of production to low-cost countries, which raises potential environmental and social issues and demands enhanced monitoring of the supply chain (see Alternative energy sector section). Governance issues are significant and may determine how things play out

Figure 2:Competitive Positioning with ESG by Sector

Solutions providers with significant

risk: Biotech, Building materials, Chemicals, Electrical Engineering, Oil services, Pharma.

Solutions Providers with Potentially Material 'Known

Unknowns'Mobile Telecoms;

Technology Hardware.

Pressure CookerAirlines; Autos; Freight; Hotels;

Mining; Paper; Pubs; Steel; Truck-makers.

Systemic Risk Broadcasting,

Aerospace; Oil; Tobacco. Latent: Most raw materials sectors;

Food; Food Retail; Beverages; Banks, Insurance Pharma

Brand as a Two-edged Sword

Beverages; Food & Food retail; HPC, General Retail; Luxury; Media (Agencies and Publishing)

Solutions providers: Alternative Energy;

Medtech and Diagnostics;

Engineering, Staffing; Testing; Software &

Services.

Fusion Banks;Construction -

contractors; Housebuilders;

Insurance; Property; Power; Water.

Source: UBS

Fertilisers: Some Solutions providers are involved in businesses that are inherently unsustainable in the longer term. The fertiliser business is a good example. Fertilisers solve one problem (agricultural productivity) in exchange for several others, including pollution and significant energy waste.


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In time, we would expect innovation to deliver a substitute for conventional fertilisers and, at this point, the fertiliser industry would move into the competitive Pressure cooker, in a classic Porter-style competitive shift. What happens to individual firms under this scenario we believe will depend on whether they manage to provide the innovation. (See the positioning of Syngenta in the Chemicals sector comment). The timing of this we find impossible to predict and share prices are likely to move for many other reasons before this risk crystallises.

Mining: In the mining sector in Australia, we have a current example of latent ‘systemic risk’ (as we define it here) potentially heating up the industry competitive pressure cooker. We believe it possible that other countries could look at the proposed Resource Super Profits Tax and take a leaf out of Australia’s book.2 This proposed tax ‘will be applied to all income derived from the extraction and sale of Australia’s non-renewable resources’ (p. 3). In this developing situation, the government, in effect, becomes Porter’s ‘powerful supplier’.

Oil: In the sector section, we write: ‘For oil refiners, the most financially material ESG issues are the impact of CO2 legislation, alternative energy mandates, restrictions on investment in certain countries (e.g. Iran, Sudan), geopolitical tensions and the potential for reputational and licence-to-operate issues as a result of working in environmentally sensitive locations’. Following the Deepwater Horizon rig fire (20 April) the significance of the so-called ‘licence to operate’ is the most front-burner issue. The follow-through is hard to predict at this stage but, speaking in general terms, the tailwind behind all of the above-mentioned issues is likely to strengthen as a result of this single event, on the assumption that, as we write, a rapid resolution looks unlikely. ‘The problem for equity investors is the uncertainty’3. This situation is a classic example of latent (environmental) systemic risk (defined as an

2 See: Miners Cop Speeding Ticket, Olivia Ker CFA, 3 May 2010. 3 BP: Macondo fall-out continues to hit BP, Jon Rigby CFA, Anish Kapadia CFA, Caroline Hickson, 30 April 2010.

unpredictable mix of unavoidable risk inherent in an aspect of the industry and regulation), suddenly no longer latent.

Paper: Currently, we describe the paper industry as a competitive pressure cooker owing to the combination of excess capacity, weak balance sheets and changes to demand trends such as declining demand for graphic paper. Set against this is the point made in the sector section that the paper industry is the world’s largest producer of bioenergy, pointing to an important strategic direction for paper firms. We see the development of wood-based biofuels as potentially game-changing. In the long run, leading firms in the sector could become environmental solutions providers.

Pharmaceuticals – all change: For this solutions provider sector with significant (potentially systemic) ESG risk, getting ESG right is critical to competitive positioning. In developed markets, we see a tightening trend in regulation and oversight (e.g. in relation to some sales practices and drug pricing).

An ageing population, combined with declining birth rates, might put pressure on governments to reduce their healthcare bills, which would increase competitive pressure. From a regulatory standpoint, changes to guidelines for conducting trials and approval hurdles could add costs and influence the top line. Conducting trials in developing countries is a growing trend and a source of ethical and practical concern. Set against all this are two key opportunities. First, climate change and global mobility are likely to bolster the demand for vaccines and infectious disease products, giving pharma companies the opportunity to regain some of their world standing by helping blunt the impact of these trends. Second, the significant growth opportunities are in markets such as China and Russia – rendering the ‘licence to operate’ that can be gained through a raft of good practice all the more important. See the UBS World Pharma Model publications.

Water: We highlight an important change under way in the regulatory framework for UK companies. In England there are currently financial disincentives to ‘interconnection’, i.e. moving water between water companies where water is cheaper to places where water resources are more expensive to develop: if water


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companies develop their own resources, the associated capex is added to their regulatory capital value (RCV) on which they can earn a return, but if imported from a neighbouring region, it is classed as operating expenditure. Ofwat and the Environment Agency are taking measures to counteract disincentives through revised regulation and the introduction of greater upstream competition. 4 Ofwat estimates that intercompany interconnectors would save the water sector around £1 billion over the lifetime of the assets, compared with the cost of companies’ current water management plans.5 We see Ofwat as seeking to control latent systemic risk running through the sector (no pun intended), by making the sector less vulnerable to regional rainfall volatility.

Noting that French water stocks ‘are well placed to benefit from an economic recovery thanks to a pickup in waste volumes’ (sector section) we think it worth highlighting an important trend discussed by Suez6, which is a long-term slowing of growth in water consumption. “A reduction in volumes consumed is being observed in the supplying of drinking water in some developed countries, due notably to water saving program[me]s established by public authorities and industrialists and the widespread idea that water is a resource that needs to be protected. So far this has been offset by productivity gains and value-added services in both the production and distribution of drinking water and wastewater treatment. However, if these efforts are insufficient in the future to offset the reduced volume, the group may experience a negative impact on its activity, earnings and outlook.”7

Reading across to Other Investment Contexts… Food related, personal care: In recent years, the increased focus on sustainable

raw materials has drawn attention to the supply chains of staples providers.

4 Independent Review of Competition and innovation in Water Markets; Cave, April 2009 5 A Study on potential benefits of upstream markets in the water sector in England and Wales: March 2010 http://www.ofwat.gov.uk/publications/prs_inf_upsup.pdf 6 http://www.suez-environnement.com/en/finance/results-and-publications/financial-publications/financial-publications/ 7 Ibid.

Palm oil is ubiquitous in food and personal care products and leading firms have moved to find sustainably managed plantations.

Firms in the food and personal care sectors have also tended to offset the risks in this area in recent years by bringing supply chains closer to home, owning rather than outsourcing some raw materials (see Food sector comment). If consumers were to say they do not want palm oil, the economics would favour a shift to substitutes, commented Alan Erskine, UBS food sector analyst. We do not see such a shift as imminent but we rather see it as highlighting the importance of high standards of environmental stewardship for the supplier plantation firms.

Oil: The apparently unprecedented scale (as at the time of writing) of the impact of the Deepwater oil spill may increase environmental sensitivity across the board, making it more difficult to secure funding for operations in environmentally sensitive areas in resource sectors other than oil. From the perspective of the banking sector, this event makes it more likely that environmental performance will be on the table in the context of lending decisions if not already, for a raft of reasons running from risk balance sheet exposure to reputation. Some non-governmental organisations (NGOs) may be prompted to increase public pressure on the financial services industry.

Mining: The recent Australian government tax announcement abovementioned draws attention to the general issue of resource competition and protectionism. Peter Hickson comments: “Given Australia’s prominent role in global resource industries the abrupt and significant change in its taxation regime, which will take total tax take from c35% to over 50%, could have a profound impact on global mining taxation attitudes and we believe other key producers such as Brazil, Chile, Congo, Mongolia and others may lift their respective minerals tax takes. This ultimately could lift global mining prices and ultimately global inflation. We believe this change should be read as a possible harbinger of a broader change, potentially relevant to all constrained resources (mineral, agricultural and water related) and therefore should be on the risk ‘radar screen’ for all industries with cross-border supply chains in


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these product areas.”

China and emerging markets: mentioned frequently throughout and relevant to the resource competition issue highlighted in the introduction (see also p. 31).


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How we address pivotal questions In order to address our pivotal questions – how ESG issues might be changing the competitive landscape for the European industries we cover and how companies are affected in relative terms – we designed a two-part question framework based on thinking that incorporates Porter’s well-known approach. Further detail is provided below in the section entitled Linking ESG issues to fundamentals and finance (p. 24-31). The responses for each sector are presented in the sector sections later in this document.

In Part 1 of our internal analyst survey we sought to identify the relationship between the core business model and ESG drivers8 through six key questions.

(1) Core drivers for the industry (business as usual).

(2) Core financial metrics (business as usual).

(3) Environmental or social issues that could affect core drivers or financials.

(4) Corporate governance issues that could affect core drivers or financials.

(5) The most important opportunities or threats (business as usual).

(6) The environmental social or governance catalysts that could crystallise the business-as-usual opportunities or threats.

In Part 2, we asked where ESG drivers are expected to have their impact in financial terms, dividing this into the following categories9.

Revenue impacts.

Cost and capex effects.

Capital allocation effects.

8 In each sector section, refer to the table entitled ‘Connecting core business drivers and ESG’.

9 In each sector section, refer to the three tables addressing these impacts.

For each company covered we assign a measure of exposure to the relevant risk or opportunity, a score of 5 denoting high exposure, a score of 1 denoting low exposure. We note that exposure can run both ways and we indicate where the issue is an opportunity or a risk, or both.

Key tables To make it easier to compare sectors, we have collated the responses shown in the sector sections in the following key tables.

‘Business-as-usual Opportunities and threats, and ESG catalysts’: Here we juxtapose the most important opportunities or threats (business as usual) for the industry and environmental social or governance catalysts that could affect them (questions 5 and 6). See Table 12.

‘Connecting ESG issues to the fundamentals and finance’: In this table we summarise questions 1-4, juxtaposing sector responses in relation to core drivers for the industry (business as usual); core financial metrics (business as usual); environmental or social issues that could have an impact on industry fundamentals or company financials; and corporate governance issues that could affect industry fundamentals or company financials. See Table 16.

‘Revenue issues, cost and capex issues, capital allocation issues’: We summarise Part 2 of the survey results, which describe how we expect ESG issues to affect the numbers even if this cannot be quantified. We see the main areas of impact as being revenues, costs and capex, or capital allocation (defined as changes to WACC, or impacts on balance sheet flexibility and so on). See Table 17.

In the following paragraphs, we summarise our stock picks taking each of the groups described above in terms of competitive positioning and ESG risk.


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Stock preferences According to overall competitive positioning The final question in our analyst survey was to ask analysts to name their stock preferences in the sector. Analysing the results, we found that quite different conditions drive the recommendations. On the basis of our Porter-driven approach, we identified seven industry ‘types’ in the context of ESG, shown in Figure 1. By this means, we have been able to organise recommendations in the sometimes complex ESG landscape as shown in Figure 2 and as explained in more detail below.

Fusion

In this industry model ESG issues are so fused with the usual competitive landscape they cannot be separated from it. To have the best strategy in such sectors is to have the best ESG strategy and vice versa. To have the worst ESG strategy is to be the worst performer and vice versa. Fusion rarely just ‘happens’. All of the sectors here provide some sort of critical societal infrastructure and, in recent years, specific catalysts have led to increasing pressure on firms in these industries to take this into account. For the UBS analysts here, the investment case inevitably incorporates a large element of ‘ESG’ because it is core to competitive success for the firms involved.

Teasing this out slightly further, for banks, the built environment, insurance and power and water services, we believe environmental and social needs are inseparable from the business because they actually drive the business. ESG becomes a risk when the interests of the companies in such sectors run counter to those of the users. However, if regulation is successfully leveraged to align the relevant stakeholders, a potentially negative situation can become constructive for all concerned. Hence, in the power sector in Europe, carbon regulation (once an ESG issue) is the most important ‘business as usual’ driver of change and our strategic picks are largely driven by the ability of firms to respond to it in the context of the current business model.

Table 5: Preferences determined on the fusion model

Sector Most preferred Rationale Least preferred Rationale

Banks HSBC, Handelsbanken, DnB Nor

Post credit crunch reputations relatively unscathed. Better capitalised than others. Better prepared for change in regulations such as Basel III.

Santander, BBVA

Most vulnerable due to our expectations of further loan losses, revenue margin pressure and lower exposure to interest rate hikes.

Construction – contractors

Vinci Hard to differentiate. PPP currently a 'virtuous circle'. Best in concessions on scale and ability to finance new schemes is Vinci; (concession extensions through the 'paquet vert' environmental capex on French toll roads).

None mentioned

na

Construction – housebuilders

Berkeley, Persimmon, Bellway

'Green' issues tend to be embedded in the way land is purchased. Best buyers of land.

Barratt, Redrow, Taylor Wimpey

Relatively, the worst buyers of land.

Insurance ING, Swiss Re Well positioned for new regulation – Swiss solvency test.

Swiss Life Swiss solvency test may increase capital requirements.

Property British Land, Derwent

British Land: strong positioning for potential changes to planning regulations. Derwent, strong in low-impact development / refurbishment.

None mentioned

na

Utilities – power

Fortum, Verbund, Centrica, Iberdrola, EDF

Positioning strategically for changes in regulation.

Drax, RWE Not well positioned with respect to changes to industry regulation, in our view.

Utilities – water Pennon The key area of difference between companies is the cost of capital. Within the UK water sector, Pennon has the lowest cost of financing.

Northumbrian Water

Within the UK water sector Northumbrian has the highest cost of financing.

Source: UBS


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We recognise that putting banks and insurance companies in the ‘Fusion’ box is potentially contentious. Some would argue that the entire financial services industry still suffers from the systemic risks that described the sector pre crunch. Our reasoning is as follows. The credit crunch has shifted the competitive landscape for financial services by shifting the emphasis away from growth towards risk control and transparency. We believe this is likely to shape the ability to grow the customer base for banks for some time (see the frequent references to customer base in sector section tables). For the industry leaders, we therefore believe getting the business model right means getting ESG issues broadly right. Strategic positioning for the aftermath (the new regulatory regime) as described in the sector sections therefore drives our stock picks. Note that currently we see social risk (risk control in general) and governance risk as dominant. Were we to focus solely on environmental risk, banks would be in the Systemic risk box.

Elsewhere, an increasing awareness of the need to act on environmental issues is gradually changing the competitive landscape for the construction and property industries. Hence, for the housebuilders, Mark Stockdale comments (sector section): ‘Green’ issues tend to be embedded in the way land is purchased’. So, our preferences are based on who we judge to be the best and worst buyers of land. We believe these firms are also best positioned for regulatory change. In a recent note referred to in the Property sector section, we drew attention to the fusion between Derwent’s ‘refurb’ model and resource efficiency. “Derwent’s business model, is to take buildings of yesteryear – warehouses, factories – and refurbish them in such a way as to bring their best features to the fore. This works well from a financial perspective – it costs about half as much per square foot as tearing down the building & starting from scratch. It is also an interesting story for those looking to invest in sustainability, with recycling (refurb) at the core.”10 In this sector, too, we believe the regulatory landscape means firms that get the core model right are likely to be getting ESG broadly right (and vice versa).

10 First Read: Derwent London. The White Collar Factory, Julie Hudson CFA, Quentin Freeman. 18 March 2010.

Solutions providers Table 6: Solutions providers – ESG issues are core to growth

Sector Most preferred Rationale Least preferred Rationale

Alternative energy

Vestas, SMA, Wacker

All three firms are dominant in their segment and enjoy barriers to entry. Governance risk: Vestas is red-flagged by GMI on financial disclosure and SMA and Wacker's free floats are below 30%.

Q-Cells; Solarworld Significant cost disadvantages. Both rank below average (GMI) on financial disclosure.

Engineering – mechanicals

Atlas Copco, SKF, Assa Abloy, Kone, Sandvik, Metso,

Well positioned in terms of exposure to developing environmental trends.

None mentioned na

Medtech and diagnostics

Diasorin, Qiagen, Sonova, FME

Diagnostics stocks are driven by their ability to bring new innovative testing equipment to customers to diagnose new and existing medical conditions. Strategic positioning determines overall strength.

bioMerieux, Getinge, Galenica

See left.

Software and services

Autonomy, SAP, Capgemini

Autonomy and SAP provide solutions that can help meet increasingly stringent governance and oversight requirements. In services, Capgemini has the best offshore footprint to leverage lower labour cost markets.

Sage, Atos Origin, Logica

Sage has done the least to convince on its ability to shift to providing software-as-a-service (SaaS) based solutions. In services, Atos Origin and Logica lag on offshore footprint.

Support services – staffing

Randstad, Michael Page, SThree

Little to differentiate. We prefer Randstad due to late cyclical stage of Dutch market and its financial leverage. Michael Page and SThree are preferred for their professional staffing and ex-UK exposure.

Hays, Adecco Hays UK exposure means lower organic growth. Adecco has governance issues (a large family stake) and looks relatively fully valued.

Support services – testing

Intertek, SGS (but avoid currently on valuation)

We see Intertek and SGS as well placed for their focus on testing services in commodities & consumer markets which are considered attractive in the long term.

None na

Source: UBS


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For solutions providers to environmental and social needs or problems, ESG is core to growth. These sectors can also face ESG risk but, currently, we see this as modest in comparison with the opportunity set. As an example we note that the market for diagnostics firms as described in the sector section below is driven primarily by social factors – life style changes, demographics, genetic disorders, disease and an awareness of risk factors. Environmental regulation is relevant to such sectors – medical device companies fall under the EU WEEE directive and proposals are under way to bring medical devices under RoHS2. 11 Such environmental issues for this sector would become material only in the hypothetical event of non-compliance - because of what it would say about the broader business and not because environmental issues are intrinsically material to the business.

For some sectors, these inherently attractive industry conditions can change. Currently, we see alternative energy as being the most likely sector to move out of this category on the basis of a significant change in competitive conditions, for two reasons. First, we believe competitive pressures (cost pressures already apparent) could be increased in the longer run by the arrival of substitute (potentially subsidised) technology or (subsidised) new entrants. Second, there is a tendency to forget that alternative energy firms (e.g. PV solar firms) have potentially significant environmental impacts and, at some stage, we expect them to have to report on and deal with these costs. One possibility (of several) is that some alternative energy players end up in the utility sector, becoming more subject to industry regulation and joining the ‘fusion’ camp. In the shorter term, financials (see Solutions providers table or sector section) are the main drivers of stock picks in this sector.

For software and services, human capital is not only (see sector section) a determinant of relative competitive positioning in the industry but also the main potential source of material risk. However (unlike some of the risks described in the next section), we do not see it as a potential show-stopper for the sector or its product categories, as things stand.

11 http://ec.europa.eu/environment/waste/weee/index_en.htm

Solutions providers with significant ESG risks Table 7: Solutions providers with significant ESG risk

Sector

Most preferred

Rationale

Least preferred

Rationale

Biotechnology Hikma, Gedeon Richter, Shire, Galenica

Hikma: key player in EMEA; healthy margins; viewed as a local player. Gedeon Richter as key player in CEE & for its technical know-how (steroids). Shire for its niche focus with limited competition. Galenica: strong local market position.

Pronova, Elan, Genmab

Not stated.

Chemicals – commodity

EMS Chemie, Lanxess, Victrex, Bayer, BASF

These firms offer material solutions to industry ESG catalysts: regulations related to energy and environment, cost of CO2, recycling.

Arkema, Clariant

Risks arising from emissions to air and water.

Chemicals – specialty

Givaudan, Symrise, Akzo Nobel, JM, Umicore, Linde, Air Liquide, Novozymes, Syngenta

Well positioned in their own niches, product portfolio striking right balance between complexity versus 'cost to serve' (tailoring the product to meet customer requirements).

K+S, Yara, Syngenta, MA Industries

Risks arising from emissions to water and air: Clariant. Risks arising from water pollution from product use: Syngenta, Yara, MA Industries. Site remediation and clean-up: K+S.

Construction – materials

Kingspan, St Gobain

'Lightside' green products. None mentioned

na

Engineering – electricals

ABB, PhilipsSchneide Electric, Legrand, Nexanx

Strongly positioned in end markets many of which provide solutions to environmental and social needs.

None mentioned

na

Oil services Wood Group, Saipem, Fugro, Tenaris, TGS Nopec, Petrofac

Stable shareholder structures, multiple funding sources, secure market positions and low- risk operating practices.

Aker Solutions, Fred Olsen Energy

Corporate governance issues - specifically block-holder control creating potential conflicts of interest

Pharma GSK, Novartis; Novo Nordisk

GSK (sustainable business model away from big blockbuster model, growing academic links to tap into strong human capital), Novartis (focus on high unmet medical need), Novo Nordisk (specialty care in diabetes, strong links with healthcare authorities establishing infrastructure).

Merck, UCB.

Merck (lack of management transparency and portfolio risk), UCB (lack of disclosure, management gives little visibility on PDUFA dates).

Source: UBS


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Some solutions providers face significant ESG risks, some of which could potentially outweigh the current opportunity. Although all these firms look strongly positioned to be able to provide solutions to existing and developing environmental and social issues, social or environmental risks inherent in some solutions means that regulatory and other risk could be significant.

For biotechnology for instance, as discussed in the sector section, we view changes in reimbursement policies, government regulations, health and safety norms and guidelines for clinical trials and manufacturing practice as potentially the most financially material issues. Some firms move to build in business-risk hedges into their strategic approach. Hence, for example, our pharmaceuticals sector picks are based on the strategic positioning of firms in respect of ESG risk – for instance GlaxoSmithKline for its focus away from the big blockbuster model and on having growing academic links to tap into strong human capital and Novartis for its focus on high unmet medical need (see sector section).

In this category, we think some of the solutions that drive revenues and profit appear fundamentally flawed, from a competitive perspective, because they are a second-best solution. They bring with them problems that could potentially be resolved by innovation or regulated out of existence. If this happened, it would increase competitive pressure perhaps even to the extreme of causing the market to shrink significantly. Companies significantly exposed to such sectors would move to the Pressure cooker box in our framework. In the medium term we think this could happen to the fertiliser sector, assuming companies here are not the ones to deliver the new solutions.

The larger electrical engineers are different from all of the above. The nature of the business involves large complex and sometimes government-related contracts. The solutions they offer often come packaged with governance risk, from an investment perspective. Other aspects of ESG risk are present but, for these solutions providers, the shift in products to a ‘greener portfolio’ focus is an opportunity for many firms in this sector (sector sections), so some firms in this sector belong in the Solutions provider section above.

Pressure cooker and ESG turning up the heat

When we worked on climate change a few years ago now, the autos analyst then described climate change regulation to us as ‘one more darned thing’ that would put pressure on firms in the industry. There are a number of similar sectors.

Competitive pressure can (as per the Porter analysis) arise for a number of reasons. In the airlines, auto, trucks, freight, paper and steel industries, the issue is overcapacity. Sometimes this happens for social reasons (auto firms, as large employers, tend to get government support to keep people in jobs). Sometimes it happens because there is an aggressive supplier focusing on issues other than cost, a good example being Chinese purchases of basic resources. Sometimes it happens for governance reasons – for instance when capacity needs to be cut but large stakeholders slow down the process (e.g. truck manufacturers).

As this suggests, sometimes ESG issues are a reason for a suboptimal industry structure. Additional ESG issues – such as rising environmental costs – can help turn the industry into even more of a pressure cooker (e.g. in the freight sector, rising transport costs and a risk of a rise in near-sourcing – see sector section). However, this does not preclude the possibility that some companies could leverage environmental change to move the competitive goal posts. The jury is out for autos and paper, where exogenous regulatory change, or innovation (inside or outside the industry), could potentially bring about quite radical changes. For instance, the paper sector section explores reasons why the paper industry needs to be at the forefront of wood-based biofuel developments.

We expect a few of these sectors to be able to deliver companies that have the most survivable business model. Although they are in a ‘pressure cooker’ sector, the low-cost carriers could also be described as having a ‘fusion’ model because keeping costs low happens to translate simultaneously into environmental efficiency, in the presence of climate change regulation. In steel, ArcelorMittal combines size, market share in key markets and a stable shareholding structure to present a robust face to the pressures (note the health and safety caveat, see sector section).


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Table 8: Pressure cooker industry, with ESG turning up the heat

Sector

Most preferred Rationale

Least preferred

Rationale

Airlines Ryanair, easyJet Relative beneficiaries from the EU ETS scheme: they operate the most carbon efficient fleet.

None named na

Autos Unclear Generalists' smaller cars have lower emissions but specialists progressing low-carbon offering.

na na

Engineering trucks

Little differentiation

na Little differentiation

na

Freight TNT More exposed to (less energy intensive) land transport, less exposed to any increase in 'near-sourcing'.

None mentioned

All transport stocks face major issues.

Leisure – hotels

Whitbread Strong balance sheet, focus on one hotel brand and limited restaurant brands, which allows strong execution of company policies.

Accor Governance issues with existing directors owning over 40% of shares and proposing a demerger which would provoke the sale of hotel assets in difficult time.

Leisure – pubs

JD Wetherspoon Focused on asset utilisation and cost control, remunerates site managers based on site metrics quarterly but does not fare well on health concerns.

Enterprise Inns

Half of income from beer sales.

Mining BHP Billiton, Vedanta, Rio Tinto

Based on the strong resource bases and corporate systemic strength.

Anglo American, Xstrata, ENRC

Country risk, corporate ownership and human resource constraints.

Paper UPM, Mondi, SCA, Stora Enso

Well positioned due to cost position, forestry ownership, balance sheet and grade exposure.

Norske Skog, Holmen, SAPPI

Not so well positioned due to grade exposure and stretched balance sheets.

Steel ArcelorMittal Well positioned due to its size, emerging market focus, vertical integration, shareholding structure and good disclosure. However, the high incidence of fatal injuries is negative for the company.

None mentioned.

na

Source: UBS

Solutions providers with ‘known unknowns’

Sectors providing solutions often do so on the basis of technology, technology development being core to the innovation that drives their commercial success. Known unknowns are intrinsic to scientific endeavour. In the context of companies, they can become significant in either positive or negative ways. Hence, potential for the arrival of new 'disruptive technology' in specialist technology fields such as energy or transport is widely hoped for in the context of climate change, itself a significant known unknown. Known unknowns can become a significant source of risk if any given technology is widely used before the dangers of using it is fully understood. In the pharmaceuticals sector, the purpose of the approval process is to try and prevent the discovery of known unknowns before new therapies become widely used. In the context of the agricultural sector we have previously written on the issues relating to Genetically Modified Organisms, and, because this sector has historically been less tightly regulated than the pharmaceuticals sector, those who oppose the widespread use of GM do so because they fear that any issues will only be discovered once GM plants or other materials are widely used and hard to remove from the environment. The two reports we published are a good illustration of the problem with known unknowns - as shown by separating the cases for and against into separate documents, as we happened to do on this occasion. The UBS chemicals team did not pick up the GM issue as an ESG issue having potential impact for the chemicals sector as things stand (Table 18), although, as we work on similar research pieces in other regions we may find that others may highlight this important issue, depending on the specific business mix of the companies they cover. However, if we consider the hypothetical scenario of government regulation significantly reducing usage or requiring significant risk reduction investment in these two technology fields, the reason why our European technology and telecomms teams picked up the issue of electromagnetic radiation is clear to see, and this is the combination of widespread use and the potential impact of change at the level of revenues, as highlighted in table 18 and in the sector sections. Indeed, as we approach publication, we note that the UK's Daily Telegraph newspaper saw fit to carry the news of publication of a scientific report


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on electromagnetic radiation concerns relating to the usage of mobile phones the front page (15th May 2010), even though they also observe that the research is five years old. 'The study was started in 1998 by the International Agency for Research on cancer, part of the UN WHO'. It cannot be regarded as providing a definitive answer, according to scientists, reports the Telegraph. See also a recent FT article.12

Most of the sectors where known unknowns can be found are in our "Solutions providers with significant risks” category, and this essentially also describes telecoms and technology. The telecoms and technology hardware sectors are essentially solutions providers with some significant ESG risks. These are described in more detail in the sector sections. These two sectors are linked by the ‘tail risk’ issue of electromagnetic radiation, which could significantly affect the mobile phone industry. We describe it as a potentially material ‘known unknown’ because whether it is an issue or not is not known and if there is an issue, the news is likely to come out of the blue. In short, it is not under the control of the firms involved. The only defence is to be diversified and to have a strong balance sheet ‘just in case’.

12 http://www.ft.com/cms/s/0/929e098c-4e6e-11df-b48d-00144feab49a.html

Table 9: Known Unknowns

Sector Most preferred Rationale Least Preferred

Rationale

Tech hardware

ARM, ASML We see little to differentiate industry players in terms of exposure to energy issues, competition issues, health risks and political risk. We see growth potential as greatest in smartphones and semiconductors.

Ericsson We see Ericsson's governance as an important weakness from the perspective of minority shareholders.

Telecoms KPN, Telefónica. Lack of government ownership, which could otherwise weigh on the ability to reduce headcount or lead to more M&A as governments seek to create 'national champions'.

Deutsche Telekom, BT

Government ownership for Deutsche Telekom. BT: pension plans from legacy businesses and potential downside from requirements to roll out fibre to rural areas, which could be uneconomic.

Source: UBS


UBS 19

Brand as a two-edged sword

In a number of industries brand is almost the only thing that matters (noting that it is driven by a complex nexus of other more concrete inputs such as human capital, and intellectual property). From an ESG perspective, brand is a two-edged sword. ESG issues can be leveraged within the brand, or they can (at the extreme) destroy the brand. The sectors in this table – beverages, food manufacturing, food retail, general retail, household, luxury and two media sectors – present quite different profiles. For the firms that focus on consumer goods and for publishing, ESG risk that could affect the brand depends on the precise product.

The common denominators that matter from an investment perspective are strategic positioning and governance. On the positive side, Marks & Spencer and Kingfisher have tended to incorporate ESG issues within the brand (by changing aspects of product or operations), and on the negative side, for example W.H. Smith and Johnston Press have an issue that brand can probably not fix and that is exposure to industries that could be supplanted by technology or regulated out of existence.

For food and food manufacturing, the key environmental and social issues – agricultural produce (palm oil), energy and water usage in the food chain and the environmental and social issues around providing cheap food in bulk – are widely known and it is hard to differentiate between one firm and another. In general, both these sectors are skilled at responding to changes in consumer demand and so (as an example) the press profile of issues around fat and salt in food does not seem to have caused either sector much difficulty.

Our preferred picks in household and personal care and luxury are primarily driven by governance.

Table 10: Brand, brand, brand

Sector

Most preferred

Rationale

Least preferred

Rationale

Beverages ABI, SAB, Diageo

Positioned for structural growth, pricing power (brand), strong M&A track record.

None mentioned

na

Food retail Tesco and Ahold

Proven track records, strong liquidity, convincing growth strategies combined with open shareholder and voting structures.

Casino Whilst we acknowledge its strong management and skilful monetisation of the emerging markets opportunity, we believe its heavy exposure to the difficult French market, relatively high leverage and limited voting structure argue for a discount to the sector peer group

Food manufacturing

Nestlé Commitment to improving nutritional content of product.

None mentioned

na

General retail Marks & Spencer, Kingfisher

M&S for its Plan A commitments; Kingfisher for its energy efficiency related initiatives.

Inditex, W.H. Smith.

Inditex: greater exposure to air freight; governance risk (family ownership). W.H. Smith: largest retailer of newspapers and magazines and reliant on transport industry for growth.

Household & personal care

Reckitt Benckiser

Firms here are all exposed to the relevant social and environmental trends. Governance: good board structure.

L'Oréal, Beiersdorf, Henkel

Firms here are all exposed to the relevant social and environmental trends. Governance challenges the main issue.

Luxury Burberry Governance is the main differentiator. Burberry has no stakeholders, is fully transparent.

LVMH, Richemont, Swatch

Family stakes, low board independence.

Media – agencies

Aegis, WPP, Publicis

All strong from a strategic perspective but significant governance risk for Aegis and Publicis.

None mentioned

None mentioned.

Media – publishing

Pearson Strong digital investment, strong historical investment.

Johnston Press

Dependence on print classified advertising

Source: UBS


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Systemic ESG risk

Finally, for some sectors, ESG risk can be described as ‘systemic’. All players are exposed to it. The reason for this risk profile is often that the companies concerned provide a product or service that is bound up with a political agenda and/or the industry tends to be oligopolistic. These things can work together to distort the market.

Broadcasting is in this category because (in addition to contending with increased competition arising from the internet-related structural shifts) broadcasters must also maintain good relations with governments and regulators. Not only are voters directly affected by the broadcasting sector but some broadcasting firms have a public sector broadcasting remit (with associated programming obligations) and, as mentioned, the internet is a candidate for universal access. In combination, these points can give governments carte blanche to intervene or even interfere.

Table 11: Systemic ESG risk

Sector

Most preferred

Rationale

Least preferred

Rationale

Media – broadcasting

ITV Project Canvas, part of internet/TV convergence and potential regulatory easing.

None mentioned

na

Aerospace MTU Aero Engines, Meggitt

Least exposed to emerging market OEM and generic aftermarket spares risk.

Safran, EADS

Safran is most exposed to generic spare parts risk and EADS to emerging market OEM risk.

Oil Neste Oil, BG

Neste Oil: biofuel mandates; ERG – renewable growth; BG – more geared into gas.

Total Iran investments; European refiners, negative impact if ETS phase III goes ahead.

Tobacco PMI, BAT In relative terms, the global players are better positioned in this industry under pressure because they have significant influence and are significant tax contributors.

None mentioned

na

Source: UBS

In ‘strategic’ industries such as aerospace and oil we think it unlikely that governments will push for full transparency in the context of sensitive information, therefore we can expect governance issues to persist. We consider it unlikely, for oil, that environmental regulation will be pushed at a faster pace than the industry can adapt to it, because the risk would be higher transport costs for voters. Governments put health warnings on cigarette packets but the tobacco industry is a source of tax revenue.

For all of these industries, at the extreme, to obliterate the risk would be adversely to impact the industry to the potential detriment of political agenda.

A few other sectors that appear in other categories also need to be mentioned here. Although they are on the face of it dissimilar to the sectors in this category, we see systemic risk (resource competition) as running through food, beverage and food manufacturing industries (see Table 10 above). In our view water constraints could significantly affect the prices of some agricultural commodities, potentially requiring a shift to the business model; however, we also think these industries would adapt.

We also believe that some of the systemic risk issues running through banks pre-credit crunch may still remain, in some parts of the industry, ongoing, although we would expect the leaders to be able to stay out of the way.


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Opportunities, threats and ESG catalysts Questions 5 and 6 in our framework questionnaire (p.12) consider the potential impact ESG issues could have on the core business. The responses to these questions are found in the sector sections and for ease of comparison we have summarised them in Table 12 below. Many of the catalysts relate to developments in financial sector regulation, developments in environmental regulation, economics, demographic trends and possible changes in market structure. The significance of some of these depends on the sector perspective. The rising burden of environmental regulation brings costs but is also viewed as an opportunity for a number of sectors.

The catalysts we view as potential paradigm shifters are discussed above in the Looking forward section earlier in this document. They are as follows.

Banking regulation potentially leading to a two-tier sector.

Environmental regulation potentially changing the alternative energy sector from specialist solutions provider to ‘utility’ type sector.

Environmental awareness plus innovation potentially leading (in the medium term) to a significant structural shift in the fertiliser market.

Environmental regulation plus innovation potentially to turn the paper sector into a provider of environmental solutions.

Resource taxes in mining in Australia potentially raising the threat of protectionist behaviour in constrained resources in general.

The Macondo oil spill potentially raising the temperature in the area of environmental protection in general.

An ageing population, combined with declining birth rates, which might put pressure on governments to reduce their healthcare bills, potentially increasing

competitive pressure for pharmaceuticals firms.

Ofwat and the Environment Agency are taking measures to counteract disincentives to interconnection in the UK water market.

In several sectors, family stakes are mentioned, so this is a good moment to think about how corporate governance fits in.

Corporate governance We see corporate governance as primarily a country factor. The geographic distribution of some sectors means that in practice some sectors are characterised by particular governance issues.

In the sector sections following, corporate governance is highlighted at a sector level for some commonly encountered reasons.

Family ownership and control, or significant block holders: autos, paper, beverages, biotechnology; household and personal care, luxury, hotels, broadcasting, publishing, medtech and diagnostics, software and services, staffing and technology hardware.

Government involvement: defence, banks, broadcasting and utilities.

Competition issues: aerospace; building materials and food retail.

In a recent note13 we discussed the issue of balance (or the lack thereof) between block-holders and minority shareholders. The two charts below compare a snapshot of conditions in Europe to those we found in Germany, where control is often achieved through block-holding mechanisms but constraints on shareholder rights (e.g. limits on voting rights) seem to happen less frequently. Hence, German shareholder rights (x-axis Chart 2) appear to be on average stronger but the market for control more constrained (y-axis Chart 2).

13 Corporate Governance. What Does the Infineon AGM Mean?, Julie Hudson CFA, Sebastian Ubert, Sven Weier, 24th February 2010


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In contrast, in France (Chart 4), the balance of power is tilted significantly away from minority shareholders, contrasting starkly with the UK (Chart 3).

What this suggests is that, for some sectors, country risk is highly significant. The following charts are based on identical data but we change the axes in order to be able to add legible sector labels.

Chart 1: Control profile – European sectors Chart 2:Control profile – German sectors

Industrialized Europe Control Profile by Sector Average

0

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German Market Control Profile

by Sector Average

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Source: GMI Source: GMI

Chart 3: Control profile – UK sectors Chart 4:Control profile – French sectors

UK Control Profile by Sector Average

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French market Control Profile by Sector Average

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Source: GMI Source: GMI

Governance in relation to recommendations In alternative energy we note that most of the main players are associated

with significant governance risk.

In beverages we highlight ABI’s strong track record in the context of family ownership.

In construction materials, we like Kingspan for a significant stake that we see as aligning management and shareholders.

In food retail, we see Casino as risky because of the holding structure.

In general retail we highlight Inditex as least preferred owing to its reliance on freight and tight insider controls.

In hotels we highlight governance issues at least-preferred Accor, with existing directors holding 40% of the shares and proposing a demerger which would provoke the sale of hotel assets at a difficult time.


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In household and personal care we like Reckitt Benckiser for good governance and view L’Oréal, Beiersdorf and Henkel as high risk.

In pubs we highlight the issue of large stakes at Mitchells & Butlers and JD Wetherspoon.

In luxury we prefer Burberry for its open ‘market for control’ and transparency and see LVMH, Richemont and Swatch as less well positioned because of significant controlling stakes.

In media (agencies), we highlight governance risk for Aegis and Publicis.

In paper we note that government stakes can make consolidation more challenging.

In steel, the shareholder structure is seen as positive for ArcelorMittal.

In tech hardware we view Ericsson’s governance as a significant weakness.

In medical technology and diagnostics we assign high-risk scores to a significant number of firms under capital allocation on the basis of government or family control.

In software, while we like SAP and Autonomy, we assign high governance risk scores on the basis of founder influence.

In staffing, Adecco is a least favoured stock, specifically citing a significant block holder.

Chart 5: Control profile – French sectors in detail

Travel & Leisure

Technology Hardware & Equipment

Support Services

Software REITs

Real Estate

Pharma

Personal Goods

OilOil & Gas Producers

Nonlife Insurance

Mining

Media

Life Insurance

Leisure Goods

Trspt

Metals Engineering

Household Goods

Health Care

General Retailers

Gen Financial

Gas, Water & Multi-utilities Food

Food & Drug Retailers

Fixed Line Telecommunications Electronics

Electricity

Construction

Chemicals

Beverages

Banks Autos

Aerospace

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Source: GMI

Chart 6: Control profile – German sectors in detail

Aerospace

Alt Energy

AutosBanks

Chemicals

Construction

Electronics

Food Retail Food Producers

Multiutilities

Gen Financial

Industrials

Gen Retailers

Health Care

Engineering Metals

Transportation

Media

Mobile

Nonlife Insu

Personal Goods Pharmaceuticals

Real Estate

Software

Support Services

Technology Hardware

Travel & Leisure

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5 6 6 7 7 8 8 9 9

Shareholder Rights

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Source: GMI


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Chart 7:Control profile – UK sectors in detail

Travel & Leisure

Tobacco

Tech Hardware

Support Services

Software

REITSReal Estate

PharmaceuticalsPersonal Goods Oil Equipment

Oil

Nonlife Insu

Mobile

Mining

Media

Life Insu

Transportation

Engineering

HouseholdHealth Care

Gen Retailers

Industrials

Gen Financial

Multiutilities

Food

Food & Drug Retailers Fixed Line Electronics

Electricity

ConstructionChemicals

Beverages

Banks

AutosAlt Energy

Aerospace

7

8

8

9

9

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7 8 8 9 9 10

Shareholder Rights

Mar

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Source: GMI


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Table 12: Business-as-usual opportunities and threats, and ESG catalysts

Sector The greatest business as usual opportunities and threats Potential social environmental or governance catalysts

Aerospace Losing market share to emerging market OEMs. Generic spare parts wrecking the engine aftermarket razor/razor blades model. The government monopsony customer altering the terms of trade away from defence companies as budgets get tighter.

Decision to re-engine existing 737/A320 airframes during 2010. WTO rulings on Boeing's subsidy complaint against Airbus and counterclaim against Boeing leading to new rules of engagement for emerging market OEMs to adhere to.

Airlines Cyclical upturn to drive demand, ongoing consolidation to take capacity out of the European sector. Greatest risks are the escalating fuel price or faulting economy and labour unrest.

ETS scheme being introduced from 2012.

Alternative Energy Biggest opportunity: take increasing share in global electricity generation. Biggest risks: decreasing political support, low cost of substitutes (fossil fuels).

Shrinking support for renewables on government budget constraints, shareholder dilution through frequent issuance of equity due to negative free cash flows.

Autos Greatest opportunities: emerging markets and China in particular. Greatest risk: government intervention may slow/prevent the necessary restructuring.

2012: average CO2 emission for a fleet will have to be below 130g/km in Europe, alternative powertrain technology (hybrid, electric vehicles).

Banks Opportunities: increase market share, increase margins, benefit from economic recovery and rising business volumes. Risks: competition, higher impairments, capital sustainability

Basel III and other regulatory decisions are expected to be catalysts during the whole year. Heavier regulatory burden on banks can be expected to translate to higher costs for the sector as a whole. Basel III sets to amount to an indirect form of economic tightening.

Beverages Most important factor is sometimes out of the companies’ control: economic health. Risk governments raise excise taxes on alcohol excessively. Will there be a 'fat tax' on carbonated soft drinks?

Smart M&A can improve growth profile or reduce costs.

Biotechnology Positive: R&D productivity, innovative therapies, underlying market penetrations/growth. Negative: regulatory changes, pipeline failures, patent challenges, safety issues/black box.

Government polices and % of GDP spend on healthcare, reimbursement scenario, higher education, manufacturing practices policies, drug regulations, emerging countries catching up and new diseases in these countries.

Chemicals – commodity Opportunities: tightening of supply/demand risks, capacity additions in low cost regions. New regulations related to energy and environment, cost of CO2, recycling, efficiency themes.

Chemicals – specialty Opportunities: find new applications. Risks: substitution risk, legislation risk, commoditisation of products. New regulations related to energy and environment, cost of CO2, recycling, efficiency themes.

Construction – building materials

Heavy-side companies with the largest and well-placed reserves – allied to strong environmental policy – likely to take market share; those that fail to meet environmental standards could see permits withdrawn; light-side companies in glass/insulation/water-saving products could see higher growth rates as environmental legislation on green buildings has an impact.

Most countries in Europe have environmental targets within an EEC framework – changes here can affect all firms, specifically carbon trading regulations change in 2013; the key issue is whether the cement industry is one that may be classified as one with a high potential of carbon leakage.

Construction – contractors Opportunity: the PPP potential. Risk: cuts to government capital spend due to deficit positions. na

Construction – housebuilders Opportunity: proper planning policy stops the chronic underbuild in the UK. Risk: planning policy gets worse. Carbon neutral homes by 2020.

Engineering – electricals Shift of focus to greener portfolio, acquisitions in emerging markets, productivity gains, pricing. New environmental regulation, conflict around restructuring/layoffs.

Engineering – mechanicals Productivity improvements; emerging market demand, capex revival in the main end-markets, uptick in industrial production and capacity utilisation rates.

None identified – other than the above-mentioned trends in environmental regulation.

Engineering – mechanicals Productivity improvements, emerging market demand, capex revival in the main end-markets, uptick in industrial production and capacity utilisation rates.

None identified – other than the above-mentioned trends in environmental regulation.

Engineering – trucks Demand revival in main geographies of Europe, N. America, Japan and Latin America. Replacement demand for trucks, as current fleets get older. The greatest risk is that the recovery fails to materialise and that the overcapacity in the transport sector persists.

New emission regulation. Increases costs and volatility in the markets but also barriers to entry.


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Food manufacturing Emerging market consumers trading up. EFSA/FDA rulings.

Food retail Taking market share, emerging market growth. Regulatory changes in regard to environmental impacts. These could be direct (direct regulation of emissions) as well as indirect (e.g. policy measures designed to reduce car travel could affect shopping patterns).

Freight Companies growing market share and getting more exposure to markets that have previously been closed to international companies (e.g. intra-Asia trade, domestic China).

Greater use of clean technology in order to mitigate carbon emissions. The use of more filters to clean fuel emissions. More efficient vehicles and machines. More intelligent supply chain management.

General retail Opportunity: to grow market share, expand into new markets or increase profitability. Greatest risks: new entrants into the markets, slowing new product development cycle.

Further consumer awareness of the retail supply chain and increased demand for energy efficient products.

Household & personal care Opportunities: exposure to right categories and price points, brand strength and innovation to take share, good cost control to strengthen margins, takeovers. Risks: erosion of brand strength, rise of private label, health scares, change in consumer wealth and tastes, anaemic growth.

Family stake issues such as current litigation in the Bettencourt family (own 31% of L'Oréal), issues around health/science claims, any negative publicity to damage the brands.

Insurance Opportunity: growth in the underpenetrated insurance markets in emerging countries. Risk: stringent Solvency 2 rules could require more capital, leading issuance of fresh equity; would shrink profit margins.

Ageing population, social security/pay-as-you-go system deficits encourage people to care about their future pension themselves and choose life insurance. Global warming and climate anomalies increase demand for reinsurance coverage.

Leisure – hotels Opportunities: developing in new markets, particularly China, taking share in fragmented markets. Risks: in a vogue to become an operator and/or brand owner rather than an owner and operator of hotels, the hotel brands' execution could be compromised by franchisees, or site owners own circumstances.

Economic growth has fuelled interest in new hotel markets such as China. Rise of terrorism is always a risk. Stock market fashion, e.g. asset light, leveraged balance sheets, can lead to inappropriate strategies.

Leisure – pubs Opportunities: exist for firms that are able to grow as pub supply leaves the market. Greatest risk: from leased/tenanted business models that are dependent on beer sales for a large proportion of profit.

Pubs need to be allowed to fail in oversupplied markets, as supply contraction has not met the decline in demand for pub visits. Concern about healthy diet and initiatives to improve cooking skills are threats.

Luxury Opportunities: exposure to right geographies, categories and price points to enable good growth rates; brand strength and good cost control to strengthen margins. Risks: erosion of brand strength, threat of counterfeiting, change in consumer wealth and tastes.

Family stake issues or pressure on management, any negative publicity to damage the brands, succession issues (e.g. Armani), political influence on the luxury market, change in consumers' wealth and tastes.

Media – broadcasting Opportunities: maintaining audience share through diversification into DTT, internet and deregulation. Risks: fragmentation of audience base, competition from convergence, development of internet display advertising.

Public sector broadcasting reviews, policy on universal access.

Media – publishing Internet offers both greatest opportunity and greatest threat. Emerging market growth. Move away from Google dominance, potentially allowing consumer publishers to regain share.

Media – agencies Macroeconomic recovery, M&A, new business wins/gaining share. Emerging economy growth benefits agencies with exposure.

Medtech and diagnostics Positive: strong demographic trends supporting underlying market growth; point of delivery near customers; identifying new risk factors for diseases and need to diagnose them (e.g. vitamin D testing); underlying market growth (HPV testing in EU); potential for product innovation. Negative: regulatory changes, higher costs of production, sensitivity of tests, need to reduce spending on drug and provide right drug to patient most likely to respond to it; innovation risk, e.g. empty pipeline.

Government polices and % of GDP spending on healthcare, reimbursement scenario, availability of high quality manpower, awareness levels of diseases and their risk factors. Increase in per capita spending in healthcare in emerging markets a major driver. Employment rates correlated with spending growth. R&D findings could lift the sector.

Mining In the medium term the main growth opportunity lies in capturing access to potential recycling opportunities in rare or scarce metals and minerals.

Resource taxes. Recent Australian move could trigger similar moves elsewhere.

Oil Technology change and alternatives, opening up of further basins, Iraq impact. CO2 emissions restrictions, biofuel/renewable mandates.


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Oil Services Operating performance and delivery. Technology change. Tax, environment and local employment a challenge when new operating areas open up.

Operations are subject to daily environmental and social events, from accidents and oil spills to full scale civil insurrection.

Paper Opportunities: consolidation/capacity closures, biofuel, Latin American pulp, demand pickup, pulp cycle. Risk: oversupply, capacity increase, structural demand decline, China capacity additions, strong euro vs US dollar.

Confirmation of biofuel subsidies, financial difficulties of weaker players, carbon credits/forestry, technological developments (e.g. iPad).

Pharma Opportunities: change in product mix, healthcare infrastructure building, emerging market growth, new disease area growth (e.g. cancer, diabetes). Risks: regulatory changes, generic challenge, pipeline failure.

Further scientific research on new drugs with high unmet need/public health. Government healthcare expenditure. Policies on manufacturing, regulation on distribution, manufacturing, development. Growth of chronic disease prevalence.

Property Opportunities: acquisitions, development, letting vacancy. Risks: economic slowdown, banks disposing of significant amounts of commercial property.

Change in government legislation with regard to; environmental impact of existing property; property development; planning.

Software and services Shift to SaaS. By re-architecting their solutions to enable customers to access them over the internet, paying on a 'per-usage' basis should improve software companies' competitiveness – failure could compromise it. For IT services companies, SaaS means less onsite integration work.

'Green IT' initiatives are becoming increasingly important as a means of differentiating vendors' offering. A possible wave of protectionism post-credit crunch could negatively affect the ability of software and IT services' companies to leverage offshore resources. Increased oversight and governance requirements could create new software and consulting opportunities.

Steel Opportunities: consolidation/capacity closures, demand pickup, taking market share from others, emerging market growth. Those with strong environmental policy would be better placed to gain approvals for expansion projects and take market share. Risks: oversupply, capacity increase, structural demand decline in developed world, China capacity additions. Raw materials supply is highly consolidated vs limited consolidation of steel producers on a global level – product flow can thus be constrained by disruptions and negative supply chain impacts.

Financial difficulties of weaker players, carbon credits, technological developments. Strong rebound in steel prices to lead to rapid industry expansions and hence related environmental impact.

Support services – staffing Market share, SG&A cost control (headcount, branches, etc.), Legislative changes in labour laws of different countries (e.g. Kurzarbeit in Germany), economic downturn, penetration rates, professional staffing.

Change in family/founder stakes.

Support services – testing Greatest opportunities: new legislative developments, M&A activity, green energy. Greatest risks: the unpredictability of legislation enactment, protectionism affecting global trade, operational failure.

We see developments in testing in relation to product safety and environmental performance as ongoing drivers for the sector.

Tech hardware Opportunities: in the area of mobile data, the optimisation of 3G networks and smart-phone growth. Risks: technology risks (move to software on handsets, move to IP in networks), competition from Chinese.

Findings around dangers of phone usage, changes in large shareholdings (Ericsson).

Telecommunications Taking market share from others, emerging market growth. Further scientific research on electromagnetic radiation, customer or workforce reaction.

Tobacco Opportunities: rising volumes of higher priced premium international brands in the developing world. Development and effective promotion of lower risk tobacco products. Risks: duty systems and regulation that allow the legitimate market to be swamped by the illicit market.

Further regulations; UK, Norway and Finland are moving to ban in-store displays. Attempts by government to ban trade-marks (plain packaging) could damage the current co-operation by the industry and may cause significant legal suits at WTO. The FDA is currently studying the impact of all additives in US cigarettes.

Utilities – power Commodity prices, cost cutting, market share and energy demand growth. Changes in energy policy driven by climate change legislation.

Utilities – water Inflation, M&A, growth rates (GDP, population). Climate change EU regulation, taxes.

Source: UBS


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Linking ESG to fundamentals and finance In this section, we explain the thinking behind the first four questions in our analyst questionnaire (see p.12 or 35).

In our view, there are six core drivers of the average industry business model: key external dependencies such as access to raw materials, customers, product, supply chain, human capital and reputation. These drivers can be considered in the context of traditional models such as the Porter Competitor Analysis. For most sectors, it is likely that one or two of the six drivers will dominate as a generator of key competitive advantage, defined as a source of success that is difficult to duplicate and consequently is sustainable over time. Each of the six core drivers can also be connected to financial metrics by considering how the typical business model in the sector might be affected by changes to any of the core industry drivers. This is the ‘bread and butter’ of Porter-style analysis for UBS analysts and this is the perspective from which we believe ESG ‘integration’ should be approached.

In Table 13 we describe how each of the six drivers of competitive advantage connects roughly to ESG metrics widely used by SRI analysts. The nature of many of these metrics (not consistently disclosed in company reports and often relating to intangibles) means it can be difficult to connect them directly to financial performance.

However, putting these core drivers into the context of the powerful logic of the Porter model suggests to us that the significant (and extremely costly) statistical effort that would be required to make such precise linear connections is not necessary. The key is to focus on ESG ‘metrics’ that capture an aspect of the most relevant core driver for firms in the sector.

We argue that ESG metrics relating to anything non-core can safely be put to one side in analysis, because they are unlikely to carry any investment-relevant information. However, ESG metrics relating to the drivers of competitive advantage for firms in the industry are highly likely to carry relevant investment information in respect of the firm’s competitive positioning and, by implication, its financials.

Table 13: Summary – linking ESG to finance

Core inputs

Financial materiality indicators

Environmental and social metrics or narrative

External dependencies Leverage, interest burden. COGS % of sales. Energy costs % of COGS. Company size: absolute revenues, numbers employed geographic sales segmentation. Market capitalisation % of local stock market and (for large firms) GDP.

Environmental footprint – emissions to air, water, land. Energy efficiency. Recycling; waste disposal & management.

Customers Sales growth. Sales segmentation. SGA % of sales. Market share. Number of customers, revenue per customer.

Product labelling. Customer satisfaction. Customer access to necessities (e.g. digital divide, access to medicines, etc.). Customer choice/empowerment.

Product EBIT margin. R&D % of sales. SGA % of sales. Largest product category % of sales.

Product safety. Product quality. Product lifecycle impacts (incl. impacts from usage).

Supply chain COGS % of sales. Overseas procurement – % of total or if possible geographic breakdown. Number of suppliers.

Supply chain % of audited. Sustainable procurement.

Human capital Revenue per employee. Wages % of sales. R&D % of sales. SGA % of sales. Wage quintiles and highest minus lowest (or similar). Brand % of SOTP. Trends in sales growth, margins.

Health & safety, e.g. accidents, lost injury time, sickness absence. Workforce demographics/ diversity. Education – secondary, tertiary, % of workforce. Restructuring. Unionisation if relevant.

Reputation Brand % of SOTP. Company size. Numbers employed.

Corporate governance. Risk management in respect of all of the above where relevant.

Source: UBS

There are two reasons why we think this logic works.

We see Porter as a well-established tried and tested framework, across decades.

We recognise that many (most) investment decisions have to be made on the basis of incomplete information. In practical terms, all that is needed is enough information to inform a calculated risk.


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Core drivers of competitive advantage - link to ESG

In the following text, we define further the interconnection between the Porter framework and the six UBS core drivers, taking each of external dependencies, customers, product, supply chain, human capital and reputation in turn.

Phrases in bold in the following paragraphs relate to an aspect of the Porter framework, and, for each driver there is a diagram giving examples of ways in which ESG issues can change the competitive landscape. These are not intended to be exhaustive but simply to indicate how relevant Porter is to ESG issues and to suggest other directions for analysis.

External dependencies

External dependencies are defined as any external resource, infrastructure or social structure that makes it possible for the firm to function. Examples include: the ‘licence to operate’ implicit in access to raw materials such as minerals, water, land; access to the raw material of a well-educated workforce; a stable rule of law; a stable political system; stable social conditions; or access to properly functioning infrastructures in transport, communications, energy and credit systems.

The flip side of this is to become a powerful provider of such key resources by becoming the oligopolistic supplier or by capturing resources in limited supply. When such dependencies are in place, they tend to be taken for granted. When they are not, their absence can significantly increase risk levels, as well as constraining growth. In Figure 3 we highlight examples of Porter in action in the context of external dependencies.

Figure 3: External dependencies in the context of Porter

Bargaining Power of Suppliers:

'Owner' of scarce resource or licence

to operate has market power.

Threat of Substitute

Innovation can replace some

scarce resources but not others

Bargaining power of Buyers

Environmental compliance can be a bargaining chip.

Threat of New Entrants

Loss of 'licence to operate' can let

others in.

Intensity of Competition:

Determined by Relative Access to

External Dependencies

Source: UBS

This has two implications for analysis. First, whether the firms in any given industry look after their external dependencies or not should be considered as a potential input to an evaluation of the industry and companies in it. The recent credit crunch is a good example of what can happen when such stewardship is not in place, in respect of the financial services sector. Secondly, when social or other infrastructure is not in place (for example, in developing countries), an obligation to invest in that infrastructure may turn out to be a cost of operating in that environment, embedded as an informal term in the licence to operate.


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Although these actions may appear to be values driven (and indeed taking such actions can be integral to the value system prevailing in the firm), they are also commercial at the same time. This could not have been more clearly demonstrated than in the credit crunch.

All of the basic materials sectors reviewed below have significant external dependencies. Other sectors where we see this issue as relevant include food and beverages (raw materials), communications (access to networks), financials (access to smoothly functioning capital markets), media (access to the airwaves through licences), oil and utilities (access to raw materials and distribution networks, for both).

Customers

Firms in some industries are driven almost entirely by their customers and consumer tastes are influenced by many factors. This can include environmental and social drivers, and these can be hard to predict because they could be regulation (therefore price) driven, or, simply, driven by changes in consumer habits or preferences. Anticipating changes in consumer tastes and innovating to be able to meet them can be critical to repelling new entrants as an incumbent, or to gaining market share. New consumer trends can also admit substitute products. Brand is a barrier to entry, reducing competitive pressure for the brand owner. The importance of reputation, to brand, means customers can have non price-based bargaining power and indeed they have been seen to exercise this through product boycotts. In Figure 4, we highlight a few examples in the context of the Porter framework, in which ESG issues such as changing regulation or changing social trends can act as a catalyst, bringing about such shifts in the competitive landscape.

Figure 4: Customers in the context of Porter

Bargaining Power of Suppliers: Strong client

relationships confer

supplier bargaining

power.


Innovation by others

can erode the

incumbent's market

share.


Soft issues can be a

bargaining chip for

customers (eg

product boycotts).


Reputational

damage can open

incumbent client

franchise to others.


Determined by the Nature of

Customer Relationships.

Source: UBS

Customers are included by UBS analysts in the list of core competitive strengths for the following sectors: airlines, autos, banks, leisure, media, software and services, telecommunications, tobacco and utilities.


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Product and services (driven by know-how and brand)

In some industries, significant capital is invested in product development (often bundled with brand management) over a long period of time. In others, the product cycle is relatively short. For the former, significant changes in product markets can leave incumbent firms with obsolete products in the context of high exit costs. For such firms, anticipating significant changes well ahead of time can be business critical and such changes frequently relate to environmental or social issues. The most salient in recent years has been the rising tide of carbon regulation. In the medium term, we expect this to trigger significant changes in energy, transport and the built environment and this, in turn, will transform competitive conditions. Products will have to change to retain market share or reduce costs. Substitute products are highly likely to arrive on the scene in energy and transport: it is clear that this is already happening at the margin, with growth in alternative energy and hybrid engines. New technologies can, to state the obvious, also bring in new entrants, thereby increasing the intensity of competition for the incumbent. The changes seen to date in sectors such as energy, transport and infrastructure are, in our view, no more than a beginning. Apart from this, the government can play a significant part in determining the bargaining power of buyers, so, whereas significant IP in the context of a growing market can confer power on the supplier (Figure 5, “Bargaining Power of Suppliers”), the government can step in and redress the balance in favour of the buyer.

Product and brand are mentioned as core to competitive positioning for the auto, beverages, building materials, household and personal care, leisure, luxury, media, software and services, technology hardware, testing equipment and tobacco sectors.

Figure 5: Product in the Context of Porter


Significant IP with a

growing market

confers supplier

power.


Changes in (eg)

environmental

regulation = product

opportunity.


Soft issues can be a

bargaining chip for

customers (eg

product boycotts).


Product Innovation

can let others in,

experience curve

protect.


Determined by type of product -

esp. extent of

intangible value.

Source: UBS

Supply chain

Supply chains introduce business risk, either by being very long and therefore removed from head office oversight (consumer goods), or by being complex (autos), or sometimes both at the same time (technology). Assessing the risks can be difficult enough for firms when the supply chain involves hundreds of counterparties, let alone shareholders, who are further removed from this aspect of the business. These suppliers are often the classic non-powerful supplier.


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The supply chain is usually designed with cost considerations in mind. However, as soon as a supply chain crosses borders, this can bring external dependencies onto the risk radar screen. By developing strong supply chain relationships, firms can strengthen their market position in core products (through quality, price, reliability) as well as reducing supply chain risk. Hence, the importance of community relationships in developing markets.

Figure 6: Supply chain in the context of Porter

Bargaining Power of Suppliers: ESG issues can

become a bargaining chip for 'weak' suppliers.


Strong supply chain can defend from

substitutes.


Strong relationship with supply chain can confer buyer

power.


Supply chain failure for strong

incumbent can allow others in.


Shaped by Supply Chain - eg

by influencing price, quality,

Source: UBS

Issues of environmental impact, access to resources, or social infrastructure relating to the supply chain may at first sight appear to be irrelevant to the core business. However, they can have real cost impacts and can also significantly change the competitive landscape if things go wrong. (Conversely, managing them well should do the opposite, other things being equal.)

Supply chain is considered core to competitive positioning for the aerospace, airlines, chemicals, beverages, food manufacturing, household and personal care, luxury and medtech sectors. For testing companies, supply chain risk can throw up significant opportunities.

Human capital

Firms often refer to their employees as their ‘greatest assets’. People add value in a wide range of ways from one sector to the next. In the long run, cumulative efforts can lead to significant intangibles on company balance sheets. Firms that can innovate consistently can create hard-to-assail market positions, repelling new entrants or substitute products. A firm’s human capital is usually at the front line of the core business risk – such as risk control in banking, or customer relationships in service and consumer industries. When things go wrong at the level of individual companies, this can interrupt growth or disrupt the business model. At one level, the credit crunch can be seen as a failure of human capital. Human capital is intrinsically hard to measure and firms do not routinely disclose comparable data. This point is reflected in the analysis here, which tends to refer to intellectual property as a driver of profitability without exploring the mechanics of human capital further.


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Figure 7: Human capital in the context of Porter


A firm's employees can shape supplier

relationships.


Innovation can facilitate market entry (or defend

incumbent).


Human capital shapes customer

relationships.


Strong client relations or IP can

be barriers to entry.


Shaped by Human Capital.

Source: UBS

Nevertheless, in the sector sections, human capital appears frequently in the text as a driver of competitive advantage and as a challenge when cost cutting results in workforce reductions. It is mentioned as important for the development of intellectual property (IP) or customer relations for banks, insurance, household and personal care, luxury, media (agencies), medical technology and diagnostics, pharma, software and services and technology hardware.

It is mentioned as a risk for aerospace (staff cuts), airlines (labour disruption), autos (government intervention impedes cost cutting), banks (staff cuts), pubs (low pay means high staff turnover), luxury (working conditions), software (labour relations during restructuring) and support services (sensitivities around the use of temporary staff).

Reputation

The way in which firms deal with the above issues is likely to be an integral part of their brand. Reputation is bound up with this. Reputations can be lost for many reasons and we believe the impact of environmental, social and governance issues and the way firms deal with them often has its first impacts on the business or the share price as a consequence of changes in perception in regard to the firm’s reputation. Reputation is often ‘nested’ with the other ‘core drivers’ – external dependencies, customers, products, supply chain, and human capital. If a significant firm in any given sector receives a reputational hit, this can reduce the intensity of competition for other incumbents. Other consequences could include the arrival of new entrants or substitute products. Apparently ‘weak’ suppliers and customers can have more power than appears at first sight – suppliers because their own performance can affect the (buyer firm) brand indirectly and buyers because they can collectively have the power to change a firm’s image.


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Figure 8: Reputation in the context of Porter

Bargaining Power of Suppliers: Suppliers to a

strong brand name can leverage

potential


A strong reputation can repel

substitutes.


Customers can have 'word of

mouth' power to change a firm's


A strong reputation can protect against

this threat.


Shaped by Reputation.

Source: UBS

The issue of reputation is perhaps the most ubiquitous. To list the sectors where this is mentioned would be to list all sectors.

Figure 9: ESG issues and Porter’s five forces at a glance

Threat of new entrants Human capital driving innovation can bring in new entrants (or keep them out for incumbent). Customer loyalty protects the incumbent. Environmental change can render old products obsolete weakening the position of incumbents.

Bargaining power of suppliers User perspective: access to raw materials. Users or processors of key dependencies need a licence to operate – sometimes a key source of competitive advantage. Access to critical infrastructure such as credit systems. Provider perspective: supplier of constrained resources likely to enjoy significant bargaining power. Potentially negative for the buyer.

Intensity of competition Reputational damage to one player makes life easier for the rest. Environmental regulation can bring in more players if it sparks new technology. Fierce competition raises all risks including environmental, social and governance risks.

Bargaining power of buyers Customer satisfaction (or lack of) affects reputation. Government customers can have significant power. Regulation relating to the digital divide, universal access requirements, e.g. to medicines, other services, can give the buyer increased power/reduce the power of the supplier.

Threat of substitute products or services Product labelling can help incumbent repel threat. Environmental profile of product can help market entry. Supply chain issues, e.g. labour rights, product safety/integrity – can let in substitutes.

Source: UBS


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In summary, connecting ESG issues to the fundamentals and finance

A summary of information in the sector sections is shown in Table 16 below, for ease of comparison. Issues that recur include the following.

Environmental: energy use, demand for green or natural products, environmental regulation, energy efficiency, recycling and sustainable credentials.

Social: labour relations in different guises (plant closures, labour relations, restructuring, staff cuts, capacity closures, pension plans), supply chain, health risks and human capital.

Governance: block-holdings, government intervention, pension deficits and emerging market impacts.

We also think it worth noting that emerging markets are frequently mentioned in the context of this European analyser. China is mentioned as a market influence in autos, freight and hotels. Some water utilities see China as an area of strategic development. Growing developing markets (mainly Asia) are mentioned by the autos, freight, hotels, luxury, insurance, technology hardware and pharma analysts.

How these issues might affect company financials is set out in Table 17.

Analyst survey in brief, for reference

The analyst survey we used to implement the above framework is described on page 9 and summarised in the two short tables below. In the context of Part 2, sector analysts assigned a score to the companies reviewed in their sector section according to exposure (a score of 5 denoting high exposure, a score of 1 denoting low exposure). Finally, stock preferences were requested, given on the sector pages or listed in Table 2.

Table 14: Analyst survey part 1

Question

1 For the stocks you cover, which are the most important core drivers?

2 What are the most important financial metrics?

3 What are the most important environmental and/or social issues that could affect 1 or 2 above?

4 What are the main governance issues that could affect 1 or 2 above?

5 For firms in your sector, what are the most important ‘business as usual’ risks or opportunities?

6 Which if any of the above-mentioned environmental social or governance catalysts could crystallise these risks or opportunities?

Source: UBS

Table 15: Analyst survey part 2

Area Question

Revenue issues Briefly describe ESG issues that could affect revenues.

Cost and capex issues Briefly describe ESG issues that could affect costs or capex.

Capital allocation issues Briefly describe ESG issues that could affect aspects of invested capital, for instance through capital allocation decisions, or WACC.

Source: UBS


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Table 16: Connecting ESG issues to the fundamentals and finance

Sector

1. Core drivers

2. Key financial metrics

3. Environmental and social issues potentially affecting core drivers or financials

4. Governance issues potentially affecting core drivers or financials

Aerospace Air traffic growth, (delivery rates), defence budgets, currency (US$).

Sales growth, EBITA margins, delivery rates, aftermarket growth rates.

More fuel efficient engine and airframe technologies. Staff cuts to deal with reducing government expenditure. Reputational risk in relation to weapons that have an impact on non-military targets, such as land mines and cluster-bombs.

All of the companies earn some proportion of earnings directly from government through defence budgets. All companies involved in large government-related contracts are potentially vulnerable to the risk of transparency issues. Several companies have golden shares, which may make them less acquirable by large predators at what could be a peak stage in defence spending.

Airlines Passenger demand, supply of seats, oil and employee disruptions.

Passenger demand and yields (sales growth), oil price.

Oil price spike, ETS mechanism to come in from 2012 to hit profits. Labour disruption as competition threatens legacy working practices.

How governments can regulate for environmental issues, e.g. incoming ETS scheme from 2012.

Alternative energy Demand growth, intensity of competition in a fragmented industry.

Revenues growth, gross margins and manufacturing costs, free cash flow.

Use of land for wind and solar farms, political acceptance, willingness to subsidise yet uncompetitive electricity supply.

Relationship with governments, management might be highly focused on sales growth, accepting shareholders' dilution to finance growth.

Autos Customers, credit availability, GDP, unemployment, raw materials.

Sales growth, EBITDA margin, working capital, capex and D&A.

10-15% of total workforce is involved in auto industry in most European countries, CO2 regulation, government intervention.

Conflict of interest between families and shareholders and government intervention.

Banks Reputation, human capital, customers. Net interest income, assets and liabilities margins, quality and quantum of capital.

Risks are mostly social: taxpayers dissatisfaction, social distress if lending issues remain and progress, customer dissatisfaction, staff cuts, working conditions.

Reputation, reputation, reputation. Regulatory uncertainties over banking industry, sovereign debt issues.

Beverages Key raw materials inputs agricultural, water, packaging including aluminium, glass, plastic, deal with retailers who try to push prices lower, brand reputation is important.

Organic volume growth, price/mix and margins.

Growing emerging market incomes, political stability and economic health. Government view of beverage industry as a tax source/view that it is unhealthy.

Shareholders have impact on M&A decisions vs family-owned decisions. Management remuneration in line with shareholders.

Biotechnology Technological know-how, patents, human capital (scientists, etc.), financial capital.

Sales growth, underlying margins and operating profits, cash flow.

Changes in government regulations, health and safety norms, good manufacturing practices, conducting clinical trials (animal testing, human testing).

Composition of board, shareholders' rights.

Chemicals – commodity Pricing power, capacity utilisation, prices vs raw materials, position on the cost curve.

Earnings momentum, profit margin, cash flow returns, financial and operating leverage.

Willingness of some countries to be self-sufficient for certain commodity products, availability of cheap feedstock, carbon taxation/costs, site remediation.

Slowdown of restructuring, state ownership of resources in low-cost hydrocarbon regions (Middle East, potentially Russia).

Chemicals – specialty Product differentiation and innovation, human capital, value added for customers.

Sales growth, earnings momentum, profit margin, cash flow returns, financial and operating leverage.

Global increase in wealth, scarcity of resources, carbon taxation/costs.

Slowdown of restructuring.

Construction – building materials

GDP and construction output correlation, government stimulus packages, access to raw materials reserves.

EBITDA margin, ROCE, cash flow generation.

Planning permission for reserves, impact of raw materials extraction on the environment, CO2 emissions, use of alternative fuels.

Cartel fines have had an impact on the glass, wall board, cement and ready-mixed cement subsectors – strong governance on these issues is important.


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Sector

1. Core drivers




Construction – contractors

GDP and its correlation to construction output, order book trends, government deficits, attitude of governments to public private partnerships, bond yields, traffic statistics.

EBITDA and EBIT margin, order book, cash conversion.

Governments are likely to want to procure better quality assets on a life-cycle basis, which should boost the PPP delivery concept. Together with deficit positions, the PPP/ concession proposition is likely to be the most important theme in the subsector over the next decade.

In view of the increased importance of the partnership model, governance in general becomes more important.

Construction – housebuilders

Mortgage availability, affordability, ability to buy land, planning process.

EBIT margin, ROCE, cash generation.

Planning policy; green homes legislation; green homes policy adds cost to houses and reduces affordability.

None that stand out.

Engineering – electricals Global economic activity and confidence. More specifically construction, infrastructure investment, power generation, T&D, industrial capex, commodity prices.

Orders and sales – organic growth; EBIT; FCF generation.

Climate change regulation; social effect of plant closures due to restructuring measures; globalisation.

Government policies of protectionism to champion local players, technology transfer

Engineering – mechanicals General economic activity, confidence, commodity prices, automotive production, construction, infrastructure investment, transport volumes.

EBIT margins, organic orders and sales growth, ROCE, free cash flow generation.

Climate change regulation, social effect of plant closures due to restructuring measures, globalisation.

Conflict of interests between major and minor shareholders; labour union conflict during layoffs and restructuring process; transfer of technology issues particularly in emerging markets such as China.

Engineering – trucks Freight volumes, truck fleet age. EBIT margins, truck volumes, orders organic growth, cash generation.

Emission regulations in different geographies. Changes to emissions regulations can have significant impact on demand patterns (for example, in the US).

Potentially bribery issues particularly in winning contracts in emerging markets. Labour union-management conflicts over lay-offs and shorter working week issues. Controlling stakeholder conflict (VW-MAN-Scania).

Food manufacturing Consumer preferences. Organic sales growth, margin, free cash flow.

Growing importance attached by consumers to: sustainability, carbon footprint, fair trade, nutrition.

Increased regulatory scrutiny of health claims.

Food retail Inflation, raw material prices, disposable incomes. Gearing, profit margins, like-for-like sales growth.

Supply chain, human capital, customer health, greenhouse gas emissions from stores (e.g. refrigeration, energy usage for heating and lighting) and truck fleet.

The presence of large stores in some markets may potentially trigger action on the part of the competition authorities.

Freight Trade volume growth. Revenue per unit volume, profit per unit volume.

Transport is a major user of energy and this is likely to rise over the medium term. Whether the rising cost of transportation reduces the demand for global trade. Whether the desire for more security of supply leads to more near-sourcing.

The need for compliance with competition authorities. Greater monitoring of potential corruption issues is also necessary given increasing globalisation of trade. Extension of emissions trading to airlines and shipping.

General retail Quality of production, customer perception and brand reputation.

Like-for-like sales, new space opened, gross margin and operating costs.

Concern over provenance of materials, ensuring no labour has been exploited and minimising the domestic energy use of household appliances and carbon footprint of retailer.

Loss of brand reputation, failure to provide adequate quality of product, inability to secure supply of goods due to reputation loss.

Household & personal care

Brand strength, geographical split, category exposure, price point exposure, input cost sensitivity, innovation success, A&P spending, cyclical businesses exposure (adhesives, perfumes), exposure to destocking and restocking, unemployment and GDP.

Organic growth, operating margins, EV/EBITDA, PE, FCF yield.

Social trends: rise of male spending on cosmetics and toiletries, unemployment rates, threat of rising taxes. Environmental trends: the general need to reduce energy and raw material usage is an opportunity for product development, for example washing products at lower temperatures. Increasing demand for natural products.

Family ownership (Beiersdorf 50%, Henkel 52%, L'Oréal 31%) and lack of independence in the boardroom (Beiersdorf, Henkel, L'Oréal – by GMI definition).


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Sector

1. Core drivers




Insurance Customers, products, reputation, regulation. Underwriting result, investment income, balance sheet strength, ROE.

Natural catastrophes and extreme weather events have great impact on P&C result; increasing unemployment rate and social uncertainty regarding future economics condition could make people more cautious with their discretionary income influencing life premiums; ageing population and pension reform should increase demand for life products.

The differences between countries' accounting regulations. Possible increase in capital requirements through Solvency 2 and other regulations. 'State aid' forces some bancassurers to sell off their insurance units.

Leisure – hotels Business travel (customers), brand execution (reputation, which attracts customers and drives room growth).

RevPAR (revenue per available room, so a mix of occupancy and room rates), EBITDAR margins (profit margins before lease costs), maintenance and expansionary capital expenditure growth.

Terrorism, disease scares (e.g. SARS, swine flu), rising fuel costs curtailing travel, falling communication costs reducing the need to travel, environmental regulation.

Reputation, presence of large block holders.

Leisure – pubs Demand for eating and drinking out of home, input costs, availability of high-quality site managers.

Return on capital employed (ROCE). Healthy living, concern about antisocial behaviour, changing social practice, e.g. substituting wine for beer, demand for quality and explicit provenance raises costs (no sign of this demand yet), low pay means high staff turnover.

Many aspects of the business are regulated (licensing laws, Landlord Tenant Act, Gaming Act, alcohol duty).

Luxury Brand strength, geographical split (emerging Asia favourable), category exposure (hard luxury favourable for long-term growth), price point exposure, exposure to destocking and restocking, exposure to male demand, GDP growth, exchange rates.

Organic growth, operating margins, EV/EBITDA, PE, FCF yield.

Rise of male spending on luxury products; threat of change in consumers' wealth and tastes; regulation and customer expectations in the area of sustainability (e.g. energy and raw material usage in production; raw materials in the supply chain for textiles and leather goods; use of fur in products); reliance on growth in emerging markets; conditions for employees in production; threat of counterfeit products; the threat of rising taxes and luxury import duties (in emerging markets); external influences on consumption – such as terrorism and epidemics.

Large family ownership positions in all companies except Burberry. Also flagged by GMI are low proportions of independent board members and executive board members on audit and/or remuneration committees. Successor issues for key brands or management.

Media – broadcasting Audience share, structural shift, programming/ advertising regulation, spectrum access.

Advertising revenue, EBITA margins. Public sector broadcasting remit/government interference, broadcast of harmful/offensive content, product placement, universal internet access.

Government interference, relationship with regulators, limited shareholder influence, concentrated ownership of media.

Media – publishing Education/professional budgets. Advertising spend. Underlying sales growth, renewal/ retention rates, profit margins.

Transition to e-books, education spending. Regulation, changing legislation (effects on budgets).

Media – agencies GDP, human capital, reputation. Revenues, EBIT margin, net debt/EBITDA.

Economic backdrop, labour market. Ownership, cross-holdings, management separation of responsibilities.

Medtech & diagnostics Technological know-how, patents, human capital (scientists, etc.), financial capital, access to raw materials, reputation, customers.

Sales growth, underlying margins and operating profits, cash flow to maintain and grow business, strategic acquisitions and margin development.

Changes in government regulations, health and safety norms, good manufacturing practices, health economics, regulatory change, product liability issues, reputational risk. Cost reduction pressures driving production offshore increases supply chain risk.

Composition of board, shareholders rights. Significant block holdings are characteristic of the sector.


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Sector

1. Core drivers




Mining External dependencies (access to mining assets, political conditions on location), reputation, human capital. Currently: willingness of competitors to ignore reputational issues such as human rights.

Commodity prices, extraction and production costs, profit margins. Contingent liabilities.

Environmental clean-up costs. Competitors saving costs through 'dirty' operations. Governments tightening regulation – positive for firms with high standards.

Increasing political/country risk.

Oil Oil price, gas price, refining margins, exploration success, global GDP, energy efficiency, technology change.

EV/DACF, PE, sum-of-the-parts valuation, E&P production growth, E&P reserves, ROIC.

CO2 legislation, alternative energy mandates, restrictions on investment in certain countries (e.g. Iran, Sudan), geopolitical tension, operations in environmentally sensitive locations.

Government involvement in companies, tax changes, politics.

Oil Services Investment levels by major oil companies; rate of deterioration of oil and gas reservoirs; operating performance and risks; price inflation in raw materials including steel, cement, etc.; oil price; gas price primarily in US; availability and price of skilled labour; unexpected changes in legislation; availability and price of debt.

Asset values, often including expected profit from existing contracts, and forward earnings multiples – most commonly PE, EV/EBIT and EV/EBITDA

Operating performance by oil services names is affected by a wide range of environmental concerns and, in many cases, these issues are outsourced to the oil service names. Social factors generally take the form of relationships with local communities.

Large management shareholders, with tax-optimised holding structures that generally mean no effective market for corporate control. Discounts for these structures range from high to almost immaterial.

Paper Supply/demand balance, raw materials, currency (especially €/US$), advertising spend/ GDP.

EBIT/EBITDA margin, ROCE, net debt to EBITDA.

Environmental: biofuels, sustainability credentials, climate change regulations, energy efficiency, recycling. Social: structural decline in paper consumption, capacity closures/staff cuts.

Controlling shareholders (SCA, Stora Enso, Holmen, M-real), board independence, antitrust investigations, competition review (consolidation).

Pharma Patients, product, healthcare providers, government, human capital (e.g. for innovation), financial capital.

Sales growth, profit margins, FCF generation, Net debt/EBITDA, Valuation metrics: PE growth, PE, EV/EBITDA, FCF/EV, dividend yield.

Government regulation/intervention, health and safety, environmental regulations (e.g. waste disposal), clinical trial regulation (e.g. use of animal testing), working conditions for staff, healthcare infrastructure/guidelines development, improved access to neglected disease medicines.

Government regulation/intervention. Composition of board, shareholders' rights.

Property Portfolio quality, location; development pipeline; management expertise, capital structure.

Discount/premium to NAV, EPS/DPS yield, like-for-like rental growth, portfolio vacancy, portfolio initial yield.

Environmental impact of existing portfolio and potential development.

Planning regulation, tax (e.g. empty rates tax) and new regulation on efficiency of buildings.

Software & services Intellectual capital is the most important resource, so human capital is key. Customer loyalty also critical, since maintenance payments help fund R&D.

New licence growth is an important barometer of competitiveness, while maintenance revenues should grow sequentially if customer loyalty is high. Profitability; balance sheet health.

Labour relations are key; restructuring can cause frayed relationships. Outsourcing can bring benefits to clients but can cause social tensions – especially with public sector clients.

In some companies founder-shareholders or their legacy foundations continue to exert a strong influence over the business. Getting the right compensation structure in place is important in people-based businesses such as software & IT services, as is preserving good labour relations.

Steel Lead indicators for construction and industrial activity as indicator for demand outlook. Supply/demand balance, Steel prices, volumes, exchange rates, key raw material cost inputs and split of variable vs fixed costs of the industry (this

EV/EBITDA, EBITDA margin (US$ or € per tonne), ROCE, net debt to EBITDA. P/BV often used as a 'sanity check' indicator at top and bottom of the cycle.

Environmental: carbon emissions and climate change regulations, sustainability credentials, energy efficiency. Social: structural decline in steel consumption in developed world; capacity closures/staff cuts.

Relationships with controlling shareholders, board independence. China accounts for almost half global supply – developments in this region are therefore key for the global steel industry.


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Sector

1. Core drivers




has significant impact on industry supply discipline in our view).

Support services – staffing Economic cycle, wage inflation, product mix (temp-perm, blue collar-specialist), headcount, labour laws regulation in different countries (thereby penetration rates).

Organic sales growth, gross margin, EBITA margin, FCF, net debt.

Environmental issues: none of note. Social Issues: unemployment levels and government policy to curb them. Job cuts (hire and fire policy), use of temp staff can be politically sensitive.

Changes in top management leading to strategic changes (e.g. Adecco); large family/founder stakes (e.g. Adecco, Randstad, USG, SThree).

Support services – testing Economic cycle, global trade, business mix (testing-inspection), proliferation of regulations (US CPSIA, EU REACH, revised EU Toy Safety Directive), currency.

Organic growth, margin, net debt/cash.

Social: government policy in relation to statutory inspection (e.g. US CPSIA legislation). Companies outsourcing their in-house testing (Intertek estimates c80% of testing is done in-house). Any incident of massive product recalls/defect has increased demand for I&T services (e.g. Chinese toys (containing lead and phthalate) leading to EU Toy Safety Directive and US CPSIA). Increasing focus on green and carbon issues.

Internal and operational issues, relating to management, legal difficulties and cost cutting (e.g. SGS 1998-2003); complex and fragmented businesses; limited disclosure on divisional costs.

Tech hardware Intellectual property rights, global distribution/local feel, technological strength, Chinese competition, mobile data usage.

Revenue growth, EBIT margins, FCF margins and asset turn.

Health risks of mobile phones, power concerns for semiconductor manufacturing, recycling of handsets and social exclusion from internet usage.

Pension deficits leading to political risks, political issues of dealing with unlisted Chinese competitors, concerns over large shareholdings in several companies (Ericsson) and court action over intellectual property (Apple/Nokia, etc.).

Telecommunications Customers, product, human capital, licence to operate (access to bandwidth).

Sales growth, subscriber numbers, profit margins.

Risks: electromagnetic radiation, children and mobiles, the digital divide, working conditions for staff, staff cuts, 'unsuitable content'. Opportunity: increased home/flexible working.

In some countries: relationships with the government and with regulators.

Tobacco Customers, brands, duty rates and regulatory environment, ability to price.

Net sales growth, EBITA margins, cash conversion of earnings.

Risks are mostly social; increased regulation and/or duty rates can cause significant changes to volume demand since duty forms the majority of the retail price. Regulation seems to be increasing with little or no scientific backing in terms of objective of reducing smoking rates. Medical establishment primary focus is to force smokers to quit and not to reduce harm of smoking.

Reputation of industry for a product that clearly damages health. Long-standing co-operation between regulators and industry in many countries has broken down as regulators have become more aggressive. Industry must however continue to work with government on issues of harm reduction and sensible taxation.

Utilities – power Commodities, interest rates, customers, power and gas demand growth.

Profit margins, net debt to EBITDA, FCF.

Climate change legislation and security of supply. Relationships with the government and with regulators.

Utilities – water Regulation, inflation, capex, OpEx, industrial production (waste volumes), customers.

RAB, returns, gearing. Landfill taxes, waste legislation, drinking water directive, population growth, water usage

Relationships with government and regulators, waste legislation (landfill directive) and drinking water directives..

Source: UBS


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Where ESG issues have their impact, financially speaking Table 17: Revenue issues, cost and capex issues, capital allocation issues

Sector Revenue issues Cost and capex issues Capital allocation issues

Aerospace Tighter defence budgets, geopolitics and threat environment, competitive threat from emerging OEMs and generic spare parts.

Falling product life cycles, pension fund liabilities, potential restructuring.

Golden shares; national champions.

Airlines Introduction of European Emissions Trading System in 2013. Restructuring/labour unrest; pension fund top-ups; investment in new aircraft under regulatory pressure.

Weak balance sheets – capital raisings possibly required.

Alternative energy Reduction of key subsidy/incentive schemes would have direct impact on demand.

Solar panels and low-output wind turbines are commoditised products. Without product differentiation, only low-cost producers are likely to survive. High-cost producers need to cut staff in high-cost production locations.

Policy makers, which decide on subsidy schemes, tend to push manufacturers for local manufacturing content, which might lead to suboptimal capital allocation.

Autos Scrapping incentives distorting markets, China growth, share of small cars.

Government-supported short working week, capex already cut to the minimum, pressure to spend on clean-tech R&D, consolidation.

Government involvement, regulatory burden, family control, pension fund liabilities.

Banks Basel III, reputation, human capital management, customer relations, responsible lending.

Cost of balance sheet repairs; risk of increase in non-performing loans. Pressure to deal with social issues (credit crunch) may de-emphasize environmental efforts.

Quality of capital, quality of management, government ownership or influence.

Beverages Public view of alcohol/soft drinks consumption. Dependence on agricultural inputs; packaging; energy costs. Family ownership, executive pay.

Biotechnology Lifestyle changes, demographics, genetics, disease prevalence, regulatory change, patents and generics, pricing pressure, R&D productivity.

Increasing importance of scale in production, offshoring, fluctuating raw material costs/access to raw materials.

Government or family control; suboptimal capital structure (too much leverage), political risk.

Chemicals Scarcity of resources is an opportunity for new solutions and products across a wide spectrum. GHG constraints, also. For a small number of chemicals firms, GHG emission share also a potential cost.

Pollution and remediation. Scarcity of resources – potentially a significant cost for firms without backward integration or recycling capability. Potential mismatch between location of asset footprint and location of growth opportunities.

Government intervention is potentially a risk owing to the strategic nature of some products, e.g. food.

Construction – building materials Tougher environmental legislation on extraction; green legislation driving (premium price?) green product.

CO2 emissions legislation could increase costs for cement firms; investment in alternative fuel processing can cut costs.

CO2 regulation could shift capital away from Europe to unregulated regions.

Construction – contractors Government deficits; attitude of governments to public/private partnerships.

None highlighted. PPP model – a significant growth opportunity in Europe.

Construction – housebuilders Planning policy directly influences unit production. Planning policy influences land prices. Environmental requirements push up costs, may hurt margins.

Planning policy affects balance sheet size.

Engineering – electricals Demand trends for longer cycle equipment such as power generation; shift to an increasingly green product portfolio. Increasing emerging market competition.

Increasingly strict regulation means increased spending on environmental stewardship. Input cost instability.

Transparency and competition issues relating to the award of large contracts. The variation of governance practices from one country to the next.

Engineering – mechanicals Increased emerging market competition. Protectionism. Energy efficiency regulation.

Manufacturing bases in low cost countries. Increased competition in emerging markets may force western firms to increase R&D spending.

Block-holdings. Protectionism.


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Engineering – trucks There is too much capacity in the trucks industry. This may slow replacement demand. All firms are working on alternatively fuelled engines.

R&D may increase as emissions regulations continue to tighten in Europe.

Economic downturn has tightened financing.

Food manufacturing Emerging market exposure, the science of nutrition, environmental awareness.

Raw material price volatility in the short run. Increasing competition for raw material supplies in the longer run.

Blue-chip borrowers. Constrained shareholder rights.

Food retail Tighter environmental standard could reduce availability of store sites; government policy on oligopoly industry status.

Pension costs, tougher requirements on GHG emissions from stores/trucks. Labelling regulations can be cost or product opportunity; labour management in context of cost containment.

Corporate governance: block holdings.

Freight Lower global trade volumes (caused by rising cost of transport). Higher fuel costs, more capex as increasingly energy efficient vehicles are required; more intelligent supply chains can reduce costs for the user – a product opportunity.

Protectionism; increasing number of investigations into competitive behaviour potentially putting up compliance costs; governance potentially slowing consolidation or disinvestment.

General retail Brand (which can be affected by a wide range of issues ranging from product quality to the full spectrum of ESG issues). Changes in consumer preferences.

Use of air freight, which tends to be more energy intensive. Consumer awareness of provenance.

Large controlling stakes are held in some firms.

Hotels Rising fuel costs/falling communication costs, reputation and brand, exposure to emerging markets, exposure to business travel.

Access to capital for refurbishment, management of fee and variable lease structures, falling property and construction prices.

Balance sheet structure, pension liabilities, controlling stakes.

Household & personal care Changes in consumer preferences (e.g. male spending), high unemployment rates, increasing demand for natural products; brand strength.

Human capital management (ability to reduce workforce rapidly without reducing morale), input costs (incl. raw materials), cost controls.

Secure balance sheet confers flexibility in difficult environment. Family ownership.

Insurance Reputation, emerging market growth, climate change related insurance demand.

Anomalous weather events lead to large losses, cost-cutting programmes.

Solvency 2 regime. State aid.

Luxury Brand and reputation, timely adaptation to cultural shifts, high unemployment rates, emerging market exposure.

Human capital management, extent of control over supply chain (the closer it is the better), cost controls (incl. energy and other resources).

Family stakes, balance sheet structure.

Media – broadcasting Advertising policy on state TV, product placement, increased access to online video potentially fragmenting the sector.

Public service programming obligations, convergence may force investment in DTT and internet.

Closely held companies, heavy industry concentration.

Media – publishing Traditional media under pressure from Google; internet putting pressure on content pricing.

Pension plans, volatility of newsprint pricing, capex rising as sector becomes increasingly technology intensive, consolidation.

Pension liabilities a potential consolidation 'poison pill'.

Media – agencies Structural pressure on fees; structural growth in emerging markets (advertising intensity % GDP).

Capex needs to rise as the sector becomes increasingly technology intensive; pressure to pay more for the best staff (staff costs 60% sales).

'Empire building' risk.

Medtech & diagnostics Demographics, disease prevalence, regulatory change, government pricing regimes, non-renewal of government contracts, access to R&D know-how (human capital); offshoring (to keep prices low).

Good quality human capital; offshoring to cut costs; offshoring as supply chain risk.

Government/family control; capital market access; political risk.


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Mining Access to natural resources, licence to operate especially in developing countries. Industry consolidation and anti-trust could eventually affect access.

Supply chain, changes to regulatory or tax regime, environmental legislation and increasing government intervention, energy and water costs, human capital shortages and skill loss compounded by location and demographics.

Political stability; reputation; transparency and trust in the context of increasing resource politicization; geopolitical risk rising in Russia, Kazakhstan, Ukraine, DR Congo; Guinea; Venezuela, etc. Scramble for resources could potentially lead to conflict. Resource competition may undermine governance standards.

Oil Access to resources – the 'licence to operate'. Growth in alternative fuel revenues. Developing GHG regulation including support for alternative energy and clean technologies.

Alternative energy spending, clean tech capex, cost of CO2 regulation.

The proportion of oil and gas production in risky countries.

Oil Services Technical and logistical challenges of new reservoirs under development; Uncertain environmental compliance costs in new regions.

Greater pressure for local content in newly developed countries; Technical & logistical challenges of new reservoirs under development; Uncertain environmental compliance costs in new regions; Rapid labour cost inflation in low-cost countries; Non-European competitors increasingly located in low-cost countries.

Greater pressure for local content in newly developed oil countries; Increased capital intensity of working in new regions

Paper Subsidised capacity additions have affected supply/demand balance and pressured prices, especially in containerboard. Potential revenue opportunities from second-generation ethanol. In the very long term, forestry as carbon sink may be monetisable.

Structural oversupply. With most EU producers having a low credit rating, the cost of refinancing is materially higher than in past, potentially putting all investment at risk, including any relevant environmental capex. At the same time, regulatory demands are becoming more stringent. Environmental performance credentials likely to be important for access to lower cost pulp in Latin America and Russia. Pension costs.

Balance sheet stress is leading to under investment. Controlling stakes potentially impeding consolidation. Plant closures may be impeded by social costs (lay-offs).

Pharma Government intervention/regulation (price regulation/price cuts). Increasing pressure from insurance providers/national health providers to cut drug costs. Changing product mix. Litigation. Demographics. Generics challenge.

Government intervention/regulation (e.g. changing approval hurdles). Increasing use of upstream outsourcing/lean manufacturing. State of productive base.

Government intervention (policy focus on certain diseases). Litigation. Government/family control.

Property Managing carbon footprint of buildings; sustainability of development and BREEAM ratings of buildings.

Managing carbon footprint of buildings; sustainability of development and BREEAM ratings of buildings; provision of low cost housing to secure redevelopment and development approvals; health and safety on development sites; UK empty rates tax.

Planning regulation of in-town and out-of-town development; forging relationships with local communities.

Pubs Social trends – beer consumption in decline. Fewer people eating out. Oversupply of pubs. Human capital management – staff retention.

Consolidation of suppliers, impact of capex cuts on site amenity, food costs, agricultural supply chain risk (water and energy intensive), energy costs – exposure to UK carbon schemes.

Balance sheet structure, pension liabilities, controlling stakes.

Software & services Business model shift to SaaS negative for revenues; increased offshoring putting pressure on pricing.

Staff restructuring, SaaS data centre capacity, data centre related energy costs/CO2; 'Green IT'.

Founder/strategic shareholder influence over strategy; acquisitions drive growth but bring execution risk.

Steel Access to emerging markets, exposure to value-added steel products, balance sheet, country risk, carbon credits, corporate ownership structure.

Structural oversupply, supply chain, tightening regulation and supervision, environmental compliance costs, staff restructuring, industrial and community relations, energy and water costs, pension funds.

Environmental constraints, government relations rising in importance, state of family control, CO2, development of management and skills reservoir.

Support services – staffing Segment exposure (blue-collar temp vs perm-specialist) drives margins, candidate wage inflation, country risk.

Geographic mix has impact on cost flexibility; cost inflexibility in 'perm' market; control of headcount (too many in downturn raises

Leverage; M&A as value destroying; FCF strong in downturn – supportive of balance sheets and dividend payments; in


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Sector Revenue issues Cost and capex issues Capital allocation issues costs; too few in upturn crimps growth). some cases, governance.

Support services – testing The testing sector is positively exposed to increasing regulation; climate change regulation; emerging market growth; globalisation (longer supply chains, outsourcing, good for testing company revenues).

While companies are gaining in scale, cost management is readily accomplished without significant restructuring. Flexible model – network of labs vs qualified inspectors.

Track record of successful bolt-on acquisitions. Strong balance sheets.

Tech hardware Health issues regarding mobile phone use; environmental issues relating to semiconductor manufacture; battles over intellectual property rights; opportunity to bring communication technology to non-developed areas.

Pension deficits raise political issues, competition issues when players in key developing markets are subsidised.

Governance: block holdings.

Telecommunications Electromagnetic radiation concerns may impede network roll-out. Universal service obligation.

Restructuring and lay-offs, pension plans from legacy businesses, requirement to offer service in uneconomic locations, government insistence on network sharing for environmental reasons, possible government funding of broadband roll-out.

Government ownership. Encouragement of national champion to cross-border deals. Government golden shares.

Tobacco Duty increases, counterfeiting, legislation risk, harm reduction, innovation.

Raw materials, brand complexity, manufacturing base. US tobacco litigation, further market consolidation, quality of M&A decisions, strong cash flow means little danger of debt default all else being equal.

Utilities – power CO2 prices; for some firms, government-set tariffs. Environmental regulation could lead to plant closures in the UK; carbon costs may affect capital allocation; capacity oversupply in some markets.

Government ownership.

Utilities – water Landfill tax (supportive of revenues in recycling or incineration); government subsidies; regulator sets revenues in UK.

Environmental standards mean increased capex, increased scope to negotiate on timing.

Regulatory risk, timing issues can introduce complexity in financial statements.

Source: UBS


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In the full-length version of this publication (ESG Analyser - Framework and Sector Detail) the sector sections follow from this page onwards. Please refer to the full edition for the sector analysis underpinning the conclusions above.


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Statement of Risk

Socially responsible investment covers an enormous range of potential environmental, social and governance (ESG) issues, and, over time, their importance fluctuates. At the time of writing, we believe the issues raised in this research to be relevant to investors, but this may change. Additionally, this research should not be read as a complete or definitive account of all relevant issues for firms. Although we attempt to address all significant or nascent issues, these may not always be apparent, and these may change over time. Finally, this document should not be interpreted to mean that all ESG issues have a financial impact; whether or not ESG issues have a financial impact remains an open question as there is no accepted financial model that can determine whether a given ESG issue is already reflected in share prices.


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Required Disclosures This report has been prepared by UBS Limited, an affiliate of UBS AG. UBS AG, its subsidiaries, branches and affiliates are referred to herein as UBS.

For information on the ways in which UBS manages conflicts and maintains independence of its research product; historical performance information; and certain additional disclosures concerning UBS research recommendations, please visit www.ubs.com/disclosures. The figures contained in performance charts refer to the past; past performance is not a reliable indicator of future results. Additional information will be made available upon request.

UBS Investment Research: Global Equity Rating Allocations

UBS 12-Month Rating Rating Category Coverage1 IB Services2

Buy Buy 50% 39%Neutral Hold/Neutral 40% 33%Sell Sell 11% 24%UBS Short-Term Rating Rating Category Coverage3 IB Services4

Buy Buy less than 1% 29%Sell Sell less than 1% 0%

1:Percentage of companies under coverage globally within the 12-month rating category. 2:Percentage of companies within the 12-month rating category for which investment banking (IB) services were provided within the past 12 months. 3:Percentage of companies under coverage globally within the Short-Term rating category. 4:Percentage of companies within the Short-Term rating category for which investment banking (IB) services were provided within the past 12 months. Source: UBS. Rating allocations are as of 31 March 2010. UBS Investment Research: Global Equity Rating Definitions

UBS 12-Month Rating Definition Buy FSR is > 6% above the MRA. Neutral FSR is between -6% and 6% of the MRA. Sell FSR is > 6% below the MRA. UBS Short-Term Rating Definition Buy Buy: Stock price expected to rise within three months from the time the rating was assigned because of a specific catalyst or event. Sell Sell: Stock price expected to fall within three months from the time the rating was assigned because of a specific catalyst or event.


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KEY DEFINITIONS Forecast Stock Return (FSR) is defined as expected percentage price appreciation plus gross dividend yield over the next 12 months. Market Return Assumption (MRA) is defined as the one-year local market interest rate plus 5% (a proxy for, and not a forecast of, the equity risk premium). Under Review (UR) Stocks may be flagged as UR by the analyst, indicating that the stock's price target and/or rating are subject to possible change in the near term, usually in response to an event that may affect the investment case or valuation. Short-Term Ratings reflect the expected near-term (up to three months) performance of the stock and do not reflect any change in the fundamental view or investment case. Equity Price Targets have an investment horizon of 12 months. EXCEPTIONS AND SPECIAL CASES UK and European Investment Fund ratings and definitions are: Buy: Positive on factors such as structure, management, performance record, discount; Neutral: Neutral on factors such as structure, management, performance record, discount; Sell: Negative on factors such as structure, management, performance record, discount. Core Banding Exceptions (CBE): Exceptions to the standard +/-6% bands may be granted by the Investment Review Committee (IRC). Factors considered by the IRC include the stock's volatility and the credit spread of the respective company's debt. As a result, stocks deemed to be very high or low risk may be subject to higher or lower bands as they relate to the rating. When such exceptions apply, they will be identified in the Company Disclosures table in the relevant research piece. Research analysts contributing to this report who are employed by any non-US affiliate of UBS Securities LLC are not registered/qualified as research analysts with the NASD and NYSE and therefore are not subject to the restrictions contained in the NASD and NYSE rules on communications with a subject company, public appearances, and trading securities held by a research analyst account. The name of each affiliate and analyst employed by that affiliate contributing to this report, if any, follows. UBS Limited: Julie Hudson, CFA; Shirley Morgan-Knott.


UBS 49

Company Disclosures

Company Name Reuters 12-mo rating Short-term rating Price Price date A.P.Moller - Maersk A/S MAERSKb.CO Neutral N/A DKr48,680.00 12 May 2010 ABB Ltd4, 5, 15, 16c ABBN.VX Buy N/A CHF20.35 14 May 2010 Accor16c ACCP.PA Sell N/A €40.65 14 May 2010 Acergy13, 14, 16c ACY.OL Neutral N/A NKr105.40 14 May 2010 Acerinox16c ACX.MC Sell N/A €13.54 14 May 2010 Actelion5, 13, 15, 18l, 24 ATLN.VX Buy N/A CHF41.66 14 May 2010 Adecco4, 5, 15, 16c, 18i ADEN.VX Sell N/A CHF59.45 14 May 2010 Aegis Group AEGS.L Buy N/A 124p 14 May 2010 Aegon2, 4, 5, 14, 16c AEGN.AS Buy N/A €4.89 14 May 2010 Afren Plc AFRE.L Buy N/A 94p 14 May 2010 Ahold16c, 22 AHLN.AS Buy N/A €10.12 14 May 2010 Air France - KLM2, 4, 5, 6a, 16c AIRF.PA Neutral N/A €10.31 14 May 2010 Air Liquide16c AIRP.PA Buy N/A €83.11 14 May 2010 Aker Solutions4 AKSO.OL Neutral N/A NKr95.70 14 May 2010 Akzo Nobel16c AKZO.AS Neutral N/A €42.51 14 May 2010 Alcatel-Lucent6c, 8, 16c ALUA.PA Neutral N/A €2.04 14 May 2010 Allianz4, 5, 6a, 15, 16c ALVG.DE Buy N/A €83.29 14 May 2010 Amec4, 13, 18p AMEC.L Buy N/A 829p 14 May 2010 Anglo American2, 3d, 3j, 3m, 4, 5, 14, 16c, 18q AAL.L Buy N/A 2,604p 14 May 2010 Anheuser-Busch InBev6c, 16c, 22 ABI.BR Buy N/A €38.16 14 May 2010 Antena 3 Television, S.A A3TV.MC Neutral N/A €5.70 14 May 2010 Antofagasta Plc3t, 5, 16c ANTO.L Neutral N/A 902p 14 May 2010 ArcelorMittal4, 5, 6b, 6c, 7, 16c, 22 ISPA.AS Neutral N/A €26.25 14 May 2010 Arkema16c AKE.PA Buy N/A €31.30 14 May 2010 ARM Holdings Plc5, 14, 16c ARM.L Neutral N/A 242p 14 May 2010 Aryzta AG5 ARYN.S Buy N/A CHF38.90 14 May 2010 ASML16c, 24 ASML.AS Buy N/A €23.84 14 May 2010 Assa Abloy16c ASSAb.ST Buy N/A SKr161.40 14 May 2010 Associated British Foods16c ABF.L Neutral N/A 962p 14 May 2010 AstraZeneca16c, 22 AZN.L Buy N/A 2,880p 14 May 2010 Atlas Copco A16c ATCOa.ST Neutral N/A SKr111.30 14 May 2010 Atos Origin ATOS.PA Buy N/A €38.26 14 May 2010 Austrian Post POST.VI Neutral N/A €18.69 14 May 2010 Autonomy Corporation Plc2, 4, 5, 14 AUTN.L Neutral N/A 1,779p 14 May 2010


UBS 50

Company Name Reuters 12-mo rating Short-term rating Price Price date BAE SYSTEMS4, 14, 16c, 22 BAES.L Buy N/A 332p 14 May 2010 Balfour Beatty BALF.L Buy N/A 264p 14 May 2010 Bâloise2, 4, 5, 15, 18f BALN.VX Buy N/A CHF80.70 14 May 2010 Barclays2, 4, 5, 6a, 16c BARC.L Buy N/A 309p 14 May 2010 Barratt Developments2, 4, 13, 14, 20 BDEV.L Buy (CBE) N/A 122p 14 May 2010 BASF4, 14, 15, 16c, 22 BASF.F Neutral N/A €44.41 14 May 2010 Basilea Pharmaceutica5, 20 BSLN.S Neutral (CBE) N/A CHF70.70 14 May 2010 BAT UK4, 5, 8, 14, 16c, 18q BATS.L Buy N/A 2,033p 14 May 2010 Bayer4, 5, 14, 15, 16c BAYGn.F Neutral N/A €47.25 14 May 2010 BBVA2, 4, 5, 15, 16c BBVA.MC Sell N/A €8.78 14 May 2010 Beiersdorf BEIG.F Neutral N/A €43.85 14 May 2010 Bellway20 BWY.L Buy (CBE) N/A 718p 14 May 2010 Berkeley Group Holdings4, 5, 14, 16c BKGH.L Buy N/A 788p 14 May 2010 BG Group16c, 22 BG.L Buy N/A 1,028p 14 May 2010 BHP Billiton Plc3c, 4, 5, 6a, 13, 16c, 22 BLT.L Buy N/A 1,915p 14 May 2010 Bilfinger Berger5, 16c GBFG.DE Buy N/A €49.48 14 May 2010 bioMerieux BIOX.PA Neutral N/A €82.03 14 May 2010 BMW2, 4, 5, 15, 16c BMWG.F Neutral N/A €38.75 14 May 2010 BNP Paribas2, 4, 5, 16c BNPP.PA Buy N/A €47.97 14 May 2010 Boliden20 BOL.ST Neutral (CBE) N/A SKr92.75 14 May 2010 Bouygues16c BOUY.PA Sell N/A €34.93 14 May 2010 Bovis Homes13, 20 BVS.L Buy (CBE) N/A 398p 14 May 2010 BP4, 6a, 14, 16c, 22 BP.L Buy N/A 530p 14 May 2010 British Airways2, 3o, 4, 5, 14, 16c BAY.L Buy N/A 203p 14 May 2010 British Land4, 5, 14, 16c, 18n BLND.L Neutral N/A 424p 14 May 2010 Britvic2, 4, 13 BVIC.L Buy N/A 456p 14 May 2010 BT Group16c BT.L Sell N/A 130p 14 May 2010 Bulgari13 BULG.MI Neutral N/A €6.40 14 May 2010 Burberry16c BRBY.L Neutral N/A 696p 14 May 2010 Bureau Veritas BVI.PA Neutral N/A €41.31 14 May 2010 C&C Group13, 16c, 24 GCC.I Buy N/A €3.44 14 May 2010 Cairn Energy16c CNE.L Neutral N/A 390p 14 May 2010 Capgemini4, 5, 16c CAPP.PA Buy N/A €38.64 14 May 2010 Carillion CLLN.L Neutral N/A 329p 14 May 2010 Carlsberg A/S CARLb.CO Neutral N/A DKr480.40 12 May 2010 Carrefour4, 16c CARR.PA Neutral N/A €34.71 14 May 2010


UBS 51

Company Name Reuters 12-mo rating Short-term rating Price Price date Casino4, 5, 6a CASP.PA Sell N/A €62.96 14 May 2010 Centrica4, 5, 14, 16c CNA.L Buy N/A 283p 14 May 2010 CGG Veritas13, 16c GEPH.PA Neutral N/A €20.63 14 May 2010 Christian Dior DIOR.PA Neutral N/A €79.60 14 May 2010 Clariant2, 4, 5, 13, 15, 16c CLN.VX Sell N/A CHF14.20 14 May 2010 CNP Assurances CNPP.PA Buy N/A €62.20 14 May 2010 Cobham4, 6a, 14 COB.L Neutral N/A 243p 14 May 2010 Coca-Cola Hellenic Bottling Company S.A16c, 20 HLBr.AT Neutral (CBE) N/A €18.60 14 May 2010

Colruyt16c COLR.BR Neutral N/A €184.60 14 May 2010 Compagnie Financiere Richemont SA5, 13, 15, 16c CFR.VX Neutral N/A CHF40.59 14 May 2010

Corio COR.AS Neutral N/A €40.37 14 May 2010 Credit Suisse Group5, 13, 15, 16c CSGN.VX Neutral N/A CHF46.54 14 May 2010 CRH2, 4, 14, 16c CRH.I Neutral N/A €18.22 14 May 2010 Croda International4, 5, 14 CRDA.L Buy N/A 970p 14 May 2010 Crucell16c CRCL.AS Buy N/A €15.00 14 May 2010 Daily Mail & General Trust DMGOa.L Buy N/A 502p 14 May 2010 Daimler AG15, 16c, 18d DAIGn.F Buy N/A €40.40 14 May 2010 Dairy Crest DCG.L Neutral N/A 359p 14 May 2010 Danone16c DANO.PA Neutral N/A €41.88 14 May 2010 Dassault Systèmes16c DAST.PA Sell N/A €46.92 14 May 2010 Davide Campari16c CPRI.MI Neutral N/A €4.04 14 May 2010 Debenhams13, 16c DEB.L Neutral N/A 67p 14 May 2010 Delhaize16c DELB.BR Neutral N/A €64.73 14 May 2010 Derwent London plc4, 14 DLN.L Neutral N/A 1,360p 14 May 2010 Deutsche Bank2, 4, 5, 6a, 15, 16c, 18j DBKGn.DE Buy N/A €48.75 14 May 2010 Deutsche Lufthansa AG2, 4, 5, 15, 16c LHAG.DE Buy N/A €11.56 14 May 2010 Deutsche Post16c DPWGn.DE Buy N/A €12.36 14 May 2010 Deutsche Telekom4, 5, 15, 16c, 22 DTEGn.F Sell N/A €8.99 14 May 2010 Diageo3b, 4, 5, 16c, 22 DGE.L Buy N/A 1,090p 14 May 2010 DiaSorin DIAS.MI Buy N/A €29.29 14 May 2010 Dimension Data Holdings DDT.L Buy N/A 103p 14 May 2010 DnB Nor2, 4, 5 DNBNOR.OL Buy N/A NKr64.95 14 May 2010 Drax Group4, 5, 14 DRX.L Neutral N/A 330p 14 May 2010 DS Smith Plc4, 14 SMDS.L Buy N/A 132p 14 May 2010


UBS 52

Company Name Reuters 12-mo rating Short-term rating Price Price date E.ON2, 4, 5, 15, 16c EONGn.DE Buy N/A €25.50 14 May 2010 EADS4, 5, 16c, 20, 22 EAD.PA Neutral (CBE) N/A €16.32 14 May 2010 easyJet13, 16c EZJ.L Neutral N/A 416p 14 May 2010 EDF4, 5, 16c, 22 EDF.PA Buy N/A €36.40 14 May 2010 Elan Corp.16c ELN.I Neutral N/A €5.03 14 May 2010 Ems-Chemie5 EMSN.S Neutral N/A CHF144.50 14 May 2010 Enagas16c ENAG.MC Buy N/A €13.57 14 May 2010 Eni16c ENI.MI Buy N/A €15.76 14 May 2010 Enterprise Inns13, 14, 16c, 20 ETI.L Sell (CBE) N/A 128p 14 May 2010 ERG ERG.MI Buy N/A €10.02 14 May 2010 Ericsson15, 16c ERICb.ST Neutral N/A SKr80.00 14 May 2010 Eurasian Natural Resources Corporation ENRC.L Neutral N/A 1,057p 14 May 2010

Euromoney Institutional Investor4, 5, 14 ERM.L Buy N/A 558p 14 May 2010 Fiat SpA2, 4, 5, 6a, 15, 16c, 18a, 22 FIA.MI Neutral N/A €8.99 14 May 2010 Finmeccanica2, 4, 5, 6a, 16c, 22 SIFI.MI Neutral N/A €9.03 14 May 2010 Fortis3n, 4, 5, 16c FOR.BR Not Rated N/A €2.28 14 May 2010 Fortum22 FUM1V.HE Neutral N/A €18.46 14 May 2010 France Telecom3s, 16c FTE.PA Sell N/A €15.49 14 May 2010 Fred Olsen Energy FOE.OL Neutral N/A NKr202.70 14 May 2010 Fresenius Medical Care16c FMEG.DE Buy N/A €39.72 14 May 2010 Fugro FUGRc.AS Neutral N/A €45.17 14 May 2010 Galenica4, 5 GALN.S Sell N/A CHF414.00 14 May 2010 GALP4 GALP.LS Neutral N/A €11.50 14 May 2010 GDF Suez16c, 22 GSZ.PA Neutral N/A €24.97 14 May 2010 Gedeon Richter GDRB.BU Buy N/A HUF42,500.00 14 May 2010 Generali4, 5 GASI.MI Neutral N/A €14.75 14 May 2010 Genmab A/S5, 16c GEN.CO Neutral N/A DKr50.05 12 May 2010 Getinge AB GETIb.ST Neutral N/A SKr153.00 14 May 2010 Givaudan2, 4, 5, 13, 15, 16c, 18l, 22, 24 GIVN.VX Buy N/A CHF941.00 14 May 2010 GlaxoSmithKline4, 14, 16c, 18e GSK.L Buy N/A 1,167p 14 May 2010 GN Great Nordic GN.CO Neutral N/A DKr43.50 12 May 2010 Greene King Plc GNK.L Sell N/A 411p 14 May 2010 H & M16c HMb.ST Neutral N/A SKr442.50 14 May 2010 Hammerson HMSO.L Buy N/A 348p 14 May 2010 Handelsbanken2, 4, 5, 16c SHBa.ST Buy N/A SKr193.00 14 May 2010


UBS 53

Company Name Reuters 12-mo rating Short-term rating Price Price date Havas EURC.PA Buy N/A €3.73 14 May 2010 Hays4, 14 HAYS.L Neutral N/A 109p 14 May 2010 HeidelbergCement13 HEIG.DE Buy N/A €46.57 14 May 2010 Heineken16c HEIN.AS Neutral N/A €34.16 14 May 2010 Hellenic Petroleum HEPr.AT Sell N/A €7.41 14 May 2010 Helvetia2, 5 HELN.S Neutral N/A CHF305.50 14 May 2010 Henkel4, 16c HNKG_p.F Neutral N/A €38.39 14 May 2010 Hermès International SCA HRMS.PA Sell N/A €105.60 14 May 2010 Hikma Pharmaceuticals PLC16c HIK.L Buy N/A 685p 14 May 2010 HMV Group13, 24 HMV.L Buy N/A 64p 14 May 2010 Hochtief HOTG.DE Buy N/A €58.83 14 May 2010 Holcim2, 4, 5, 15, 16c HOLN.VX Buy N/A CHF76.50 14 May 2010 Holmen HOLMb.ST Sell N/A SKr186.50 14 May 2010 Home Retail Group5, 14, 16c, 24 HOME.L Buy N/A 275p 14 May 2010 HSBC2, 4, 5, 16b, 16c, 22 HSBA.L Buy N/A 648p 14 May 2010 Iberdrola2, 4, 5, 16c, 22 IBE.MC Buy N/A €5.30 14 May 2010 Iberia3o, 13 IBLA.MC Buy N/A €2.27 14 May 2010 Imerys IMTP.PA Neutral N/A €43.70 14 May 2010 Imperial Tobacco8, 16c, 22 IMT.L Neutral N/A 1,824p 14 May 2010 Inditex SA ITX.MC Neutral N/A €44.86 14 May 2010 Industrivarden INDUa.ST Sell N/A SKr89.25 14 May 2010 Infineon Technologies AG16c IFXGn.F Neutral N/A €5.05 14 May 2010 Informa INF.L Buy N/A 389p 14 May 2010 ING2, 4, 5, 6a, 16c, 22 Not Rated N/A €7.06 14 May 2010 Intercell AG16c ICEL.VI Neutral N/A €18.02 14 May 2010 InterContinental Hotels Group16c IHG.L Sell N/A 1,131p 14 May 2010 Intertek Group plc ITRK.L Neutral N/A 1,451p 14 May 2010 Intesa SanPaolo2, 4, 6a, 16c, 22 ISP.MI Buy N/A €2.18 14 May 2010 Ipsen SA5, 13 IPN.PA Buy N/A €34.20 14 May 2010 ITV plc2, 4, 5, 13 ITV.L Buy N/A 59p 14 May 2010 Johnson Matthey16c JMAT.L Sell N/A 1,656p 14 May 2010 Johnston Press20 JPR.L Neutral (CBE) N/A 25p 14 May 2010 K+S SDFG.DE Sell N/A €40.61 14 May 2010 Kazakhmys Plc KAZ.L Neutral N/A 1,236p 14 May 2010 Kingfisher14, 16c KGF.L Buy N/A 226p 14 May 2010 Kingspan13, 14 KSP.I Neutral N/A €7.20 14 May 2010


UBS 54

Company Name Reuters 12-mo rating Short-term rating Price Price date Klöckner18b KCOGn.DE Sell N/A €17.52 14 May 2010 Kone KNEBV.HE Sell N/A €32.60 14 May 2010 KPN Telecom16c, 22 KPN.AS Buy N/A €10.46 14 May 2010 Kuehne + Nagel5 KNIN.VX Neutral N/A CHF110.00 14 May 2010 Laboratorios Farmacéuticos Rovi ROVI.MC Buy N/A €4.61 14 May 2010 Lafarge4, 5, 16c LAFP.PA Neutral N/A €49.06 14 May 2010 Lagardere LAGA.PA Neutral N/A €27.59 14 May 2010 Land Securities4, 14 LAND.L Buy N/A 611p 14 May 2010 Lanxess AG LXSG.DE Sell N/A €34.85 14 May 2010 Legrand LEGD.PA Neutral N/A €24.71 14 May 2010 Liberty International LII.L Not Rated N/A 452p 14 May 2010 Linde4, 16c LING.DE Buy N/A €85.59 14 May 2010 Lindt & Sprüngli5 LISN.S Neutral N/A CHF27,035.00 14 May 2010 Lloyds Banking Group2, 4, 5, 12, 14, 16c, 22 LLOY.L Buy N/A 58p 14 May 2010 Logica24 LOG.L Neutral N/A 133p 14 May 2010 Lonza Group AG2, 4, 5, 13, 15, 16c, 18m LONN.VX Neutral N/A CHF79.20 14 May 2010 L'Oréal5, 16c OREP.PA Neutral Buy €74.79 14 May 2010 Lundbeck16c LUN.CO Neutral N/A DKr93.50 12 May 2010 Luxottica16c LUX.MI Neutral Buy €20.49 14 May 2010 LVMH Moet Hennessy Louis Vuitton SA16c LVMH.PA Buy N/A €88.06 14 May 2010

MA Industries20 MAIN.TA Neutral (CBE) N/A NIS15.65 14 May 2010 MAN3g, 16c MANG.DE Buy N/A €70.18 14 May 2010 Marks & Spencer16c MKS.L Neutral N/A 338p 14 May 2010 Marston's MARS.L Neutral N/A 98p 14 May 2010 Mayr-Melnhof16c MMKV.VI Buy N/A €71.64 14 May 2010 Mediaset16c MS.MI Neutral N/A €5.50 14 May 2010 Meggitt MGGT.L Buy N/A 316p 14 May 2010 Merck KGaA4, 16c MRCG.DE Neutral N/A €60.86 14 May 2010 Metro AG MEOG.DE Neutral N/A €44.23 14 May 2010 Metropole TV4 MMTP.PA Neutral N/A €17.48 14 May 2010 Metso4, 16c MEO1V.HE Buy N/A €26.64 14 May 2010 Michael Page International MPI.L Neutral N/A 420p 14 May 2010 Micro Focus Intl Plc4, 13, 14 MCRO.L Buy N/A 504p 14 May 2010 Misys MSY.L Buy N/A 231p 14 May 2010 Mitchells & Butlers MAB.L Neutral N/A 304p 14 May 2010


UBS 55

Company Name Reuters 12-mo rating Short-term rating Price Price date Mol4, 16c MOLB.BU Neutral N/A HUF19,650.00 14 May 2010 Mondi14, 16c, 18q MNDI.L Neutral N/A 422p 14 May 2010 Morrison (Wm.)16c MRW.L Neutral N/A 269p 14 May 2010 MTU Aero Engines Holding AG16a, 16c, 18b MTXGn.F Buy N/A €46.08 14 May 2010

Munich Re4, 5, 15, 16c MUVGn.DE Neutral N/A €105.00 14 May 2010 National Grid2, 4, 6a, 16c, 22 NG.L Buy N/A 618p 14 May 2010 Neste Oil NES1V.HE Sell N/A €11.66 14 May 2010 Nestlé2, 4, 5, 13, 15, 16c NESN.VX Buy N/A CHF52.30 14 May 2010 Nexans4 NEXS.PA Buy N/A €54.52 14 May 2010 Next4, 5, 14 NXT.L Buy N/A 2,161p 14 May 2010 Nobel Biocare5, 13, 15, 16c, 18m NOBN.VX Neutral N/A CHF21.76 14 May 2010 Nokia4, 5, 6a, 6b, 6c, 7, 15, 16c NOK1V.HE Buy N/A €8.24 14 May 2010 Norske Skog3k, 4, 5 NSG.OL Neutral N/A NKr7.75 14 May 2010 Northern Foods4, 13, 14 NFDS.L Buy N/A 50p 14 May 2010 Northumbrian Water Group NWG.L Neutral N/A 267p 14 May 2010 Novartis2, 4, 5, 6a, 13, 15, 16c NOVN.VX Buy N/A CHF53.10 14 May 2010 Novo Nordisk16c NOVOb.CO Neutral N/A DKr471.90 12 May 2010 Novozymes A/S16c NZYMb.CO Neutral N/A DKr655.00 12 May 2010 OMV16c OMVV.VI Neutral N/A €26.33 14 May 2010 Orascom Development Holding AG5 ODHN.S Buy N/A CHF66.45 14 May 2010 Outokumpu5 OUT1V.HE Buy N/A €13.89 14 May 2010 Pearson5, 16c PSON.L Buy N/A 984p 14 May 2010 Pennon Group PNN.L Buy N/A 498p 14 May 2010 Pernod Ricard16c PERP.PA Neutral N/A €62.09 14 May 2010 Persimmon20 PSN.L Buy (CBE) N/A 449p 14 May 2010 Petrofac4 PFC.L Neutral N/A 1,103p 14 May 2010 Petroplus Holdings2, 4, 5, 6a, 13, 15, 18k PPHN.VX Sell N/A CHF17.65 14 May 2010 Peugeot SA16c PEUP.PA Buy N/A €19.34 14 May 2010 PGS5, 16c PGS.OL Sell N/A NKr75.25 14 May 2010 Philips4, 5, 16c, 22 PHG.AS Neutral N/A €24.83 14 May 2010 PKN Orlen PKNA.WA Sell N/A PLN37.60 14 May 2010 Porsche Automobile Holding SE3e, 4, 16c, 22 PSHG_p.DE Buy N/A €36.72 14 May 2010

Premier Foods16c PFD.L Buy N/A 25p 14 May 2010 Premier Oil16c PMO.L Buy N/A 1,205p 14 May 2010


UBS 56

Company Name Reuters 12-mo rating Short-term rating Price Price date Pronova Biopharma PRON.OL Neutral N/A NKr18.40 14 May 2010 ProSiebenSat1 PSMG_p.DE Buy N/A €13.57 14 May 2010 Public Power Corporation22 DEHr.AT Sell N/A €12.47 14 May 2010 Publicis Groupe SA4, 5, 16c PUBP.PA Neutral N/A €33.78 14 May 2010 Q-Cells4, 20 QCEG.DE Sell (CBE) N/A €5.74 14 May 2010 Qiagen5, 16c QGEN.F Neutral N/A €17.24 14 May 2010 QinetiQ14, 16c, 20 QQ.L Neutral (CBE) N/A 125p 14 May 2010 Randstad16c RAND.AS Neutral N/A €36.77 14 May 2010 Rautaruukki RTRKS.HE Sell N/A €14.02 14 May 2010 RBS Group2, 3p, 3q, 3u, 4, 5, 6a, 8, 14, 16c, 20, 22 RBS.L Neutral (CBE) N/A 47p 14 May 2010 Reckitt Benckiser16c RB.L Buy N/A 3,314p 14 May 2010 Redrow Group20 RDW.L Neutral (CBE) N/A 131p 14 May 2010 Reed Elsevier NV2, 4, 16c, 22 ELSN.AS Buy N/A €8.85 14 May 2010 Reed Elsevier plc2, 4, 5, 14, 16c, 22 REL.L Buy N/A 498p 14 May 2010 Remy Cointreau RCOP.PA Neutral N/A €40.78 14 May 2010 Renault SA5 RENA.PA Buy N/A €31.36 14 May 2010 Repsol YPF1b, 4, 5, 16c, 22 REP.MC Buy N/A €16.28 14 May 2010 Rexam16c REX.L Buy N/A 314p 14 May 2010 Rezidor Hotel Group AB REZT.ST Sell N/A SKr33.80 14 May 2010 Rio Tinto Plc4, 16c RIO.L Buy N/A 3,210p 14 May 2010 Roche4, 5, 15, 16c ROG.VX Neutral N/A CHF163.40 14 May 2010 Rolls-Royce16c RR.L Sell N/A 605p 14 May 2010 Royal Dutch Shell3a, 4, 5, 15, 16c, 22 RDSa.L Buy N/A 1,854p 14 May 2010 RWE4, 5, 15, 16c RWEG.DE Buy N/A €59.58 14 May 2010 Ryanair13 RYA.I Buy N/A €3.35 14 May 2010 SABMiller16c SAB.L Buy N/A 1,994p 14 May 2010 Safran SA4, 5 SAF.PA Buy N/A €22.67 14 May 2010 Sage Group5, 16c SGE.L Neutral N/A 236p 14 May 2010 Sainsbury J2, 4, 14, 16c, 22 SBRY.L Neutral N/A 332p 14 May 2010 Saint Gobain4, 5 SGOB.PA Neutral N/A €33.65 14 May 2010 Saipem SPMI.MI Neutral N/A €26.04 14 May 2010 Salzgitter AG SZGG.DE Sell N/A €53.73 14 May 2010 Sandvik16c SAND.ST Sell N/A SKr95.10 14 May 2010 Sanofi-Aventis5, 16c SASY.PA Neutral N/A €50.45 14 May 2010 Santander2, 3i, 5, 16c SAN.MC Sell N/A €8.32 14 May 2010 SAP AG4, 15, 16c SAPG.DE Buy N/A €35.15 14 May 2010


UBS 57

Company Name Reuters 12-mo rating Short-term rating Price Price date Sappi Ltd4, 14, 16c, 18q SAPJ.J Neutral Buy RCnt2,702 14 May 2010 Saras SRS.MI Neutral N/A €1.71 14 May 2010 SBM Offshore16c SBMO.AS Buy N/A €13.62 14 May 2010 Scania3g, 16c SCVb.ST Buy N/A SKr115.70 14 May 2010 Schibsted ASA4, 5 SBST.OL Neutral N/A NKr137.00 14 May 2010 Schneider Electric5, 16c, 22 SCHN.PA Neutral N/A €80.29 14 May 2010 Scottish & Southern Energy16c SSE.L Neutral N/A 1,082p 14 May 2010 Seadrill16c SDRL.OL Neutral N/A NKr141.10 14 May 2010 SEGRO2, 3l, 4, 5, 14 SGRO.L Buy N/A 278p 14 May 2010 Severn Trent Plc16c SVT.L Buy N/A 1,128p 14 May 2010 Severstal5, 20 CHMFq.L Buy (CBE) N/A US$12.05 14 May 2010 SGS5, 13, 15, 16c, 18a, 18g SGSN.VX Sell N/A CHF1,434.00 14 May 2010 Shire Pharmaceuticals8, 16c SHP.L Neutral N/A 1,429p 14 May 2010 Sidenor SID.AT Neutral N/A €2.58 14 May 2010 Siemens3f, 4, 5, 6a, 14, 15, 16c SIEGn.DE Neutral N/A €73.96 14 May 2010 SIG plc SHI.L Neutral N/A 122p 14 May 2010 Signet Group16c, 20 SIG.L Neutral (CBE) N/A 2,197p 14 May 2010 SKF B16c SKFb.ST Buy N/A SKr143.30 14 May 2010 SMA Solar Technology AG S92G.DE Buy N/A €90.00 14 May 2010 Smith & Nephew14, 16c SN.L Buy N/A 651p 14 May 2010 Smith (W.H.) Group SMWH.L Buy N/A 485p 14 May 2010 Smurfit Kappa Group4, 5 SKG.I Neutral N/A €7.11 14 May 2010 SOCO International SIA.L Neutral N/A 1,706p 14 May 2010 Solarworld13 SWVG.DE Sell N/A €9.29 14 May 2010 Sonova5 SOON.VX Buy N/A CHF125.50 14 May 2010 Standard Chartered1a, 2, 4, 5, 14, 18c STAN.L Neutral N/A 1,622p 14 May 2010 Statoil4, 16c STL.OL Neutral N/A NKr136.90 14 May 2010 SThree4, 13, 14 STHR.L Buy N/A 359p 14 May 2010 STMicroelectronics4, 5, 6a, 16c STM.PA Sell N/A €6.54 14 May 2010 Stora Enso16c STERV.HE Buy N/A €5.88 14 May 2010 Straumann5, 15 STMN.S Buy N/A CHF258.75 14 May 2010 Subsea 713 SUB.OL Sell N/A NKr107.70 14 May 2010 Suez Environnement3r, 4, 5, 16c, 22 SEVI.PA Neutral N/A €15.04 14 May 2010 Svenska Cellulosa16c SCAb.ST Buy N/A SKr87.00 14 May 2010 Swatch Group AG5 UHR.VX Buy N/A CHF322.50 14 May 2010 Swedish Match13, 22 SWMA.ST Neutral N/A SKr158.50 14 May 2010


UBS 58

Company Name Reuters 12-mo rating Short-term rating Price Price date Swiss Life4, 5, 15, 16c SLHN.VX Sell N/A CHF123.30 14 May 2010 Swiss Re2, 4, 5, 6a, 13, 15, 16c, 22 RUKN.VX Buy N/A CHF47.88 14 May 2010 Swisscom2, 4, 5, 15, 16c SCMN.VX Buy N/A CHF370.60 14 May 2010 Symrise16a, 16c, 18b SY1G.DE Buy N/A €17.55 14 May 2010 Syngenta4, 5, 15, 16c, 18h, 22 SYNN.VX Buy N/A CHF265.20 14 May 2010 Synthes Inc5, 15 SYST.VX Buy N/A CHF128.10 14 May 2010 Tate & Lyle16c TATE.L Neutral N/A 443p 14 May 2010 Taylor Wimpey20 TW.L Neutral (CBE) N/A 36p 14 May 2010 Tecan Group5 TECN.S Buy N/A CHF67.05 14 May 2010 Technip16c TECF.PA Neutral N/A €55.25 14 May 2010 Telecinco TL5.MC Neutral N/A €9.20 14 May 2010 Telecom Italia16c TLIT.MI Buy N/A €1.01 14 May 2010 Telefonica2, 4, 5, 6a, 16c, 22 TEF.MC Buy N/A €14.88 14 May 2010 Telenor16c TEL.OL Neutral N/A NKr83.85 14 May 2010 TeliaSonera4, 16c TLSN.ST Buy N/A SKr47.29 14 May 2010 Temenos5 TEMN.S Neutral N/A CHF27.80 14 May 2010 Tenaris16c TS.N Neutral N/A US$37.18 14 May 2010 Tesco16c TSCO.L Buy N/A 413p 14 May 2010 TF1 TFFP.PA Neutral N/A €12.44 14 May 2010 TGS Nopec TGS.OL Buy N/A NKr109.20 14 May 2010 Thales4, 5 TCFP.PA Buy N/A €28.16 14 May 2010 ThyssenKrupp15 TKAG.F Neutral N/A €22.70 14 May 2010 TNT16c TNT.AS Buy N/A €21.21 14 May 2010 TOTAL2, 4, 5, 12, 16c, 22 TOTF.PA Neutral N/A €38.43 14 May 2010 Travis Perkins13 TPK.L Buy N/A 815p 14 May 2010 Trinity Mirror16c, 20 TNI.L Buy (CBE) N/A 112p 14 May 2010 Tupras20 TUPRS.IS Sell (CBE) N/A TRY31.25 14 May 2010 UCB UCB.BR Neutral N/A €26.44 14 May 2010 Umicore5 UMI.BR Sell N/A €25.63 14 May 2010 Unibail-Rodamco5, 13 UNBP.PA Neutral Buy €127.15 14 May 2010 UniCredit2, 4, 5, 22 CRDI.MI Neutral N/A €1.81 14 May 2010 Unilever NV2, 4, 5, 6a, 12, 15, 16c, 18o UNc.AS Neutral N/A €22.43 14 May 2010 United Business Media13 UBM.L Neutral N/A 533p 14 May 2010 United Utilities Group Plc4, 5, 16c UU.L Buy N/A 522p 14 May 2010 UPM4, 16c UPM1V.HE Neutral N/A €10.58 14 May 2010 USG People USGP.AS Buy N/A €12.38 14 May 2010


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Company Name Reuters 12-mo rating Short-term rating Price Price date Vedanta Resources2, 3m, 4, 5 VED.L Buy N/A 2,389p 14 May 2010 Veolia Environnement4, 5, 16c VIE.PA Neutral N/A €21.32 14 May 2010 Verbund AG16c VERB.VI Neutral N/A €27.10 14 May 2010 Vestas Wind Systems16c VWS.CO Buy N/A DKr313.60 12 May 2010 Victrex Plc VCTX.L Sell N/A 990p 14 May 2010 VimpelCom16c VIP.N Suspended N/A US$15.72 14 May 2010 Vinci4, 12, 16c, 22 SGEF.PA Buy N/A €36.97 14 May 2010 Vodafone Group2, 4, 12, 15, 16c VOD.L Neutral N/A 135p 14 May 2010 Voestalpine AG4 VOES.VI Sell N/A €24.66 14 May 2010 Volkswagen AG3e, 3h, 4, 5, 14, 15, 16c, 22 VOWG.DE Neutral N/A €69.39 14 May 2010 Volvo B4, 16c VOLVb.ST Neutral N/A SKr84.80 14 May 2010 Wacker Chemie16a, 18b WCHG.DE Buy N/A €106.40 14 May 2010 Wellstream WSML.L Neutral N/A 577p 14 May 2010 Wendel Investissement MWDP.PA Buy N/A €45.09 14 May 2010 Wetherspoon (JD) plc16c JDW.L Buy N/A 469p 14 May 2010 Whitbread WTB.L Buy N/A 1,407p 14 May 2010 Wienerberger16c WBSV.VI Neutral N/A €13.50 14 May 2010 William Demant WDH.CO Neutral N/A DKr380.00 12 May 2010 Wolseley4, 6a, 16c, 24 WOS.L Neutral N/A 1,688p 14 May 2010 Wolters Kluwer16c WLSNc.AS Buy N/A €15.65 14 May 2010 Wood Group WG.L Buy N/A 361p 14 May 2010 WPP WPP.L Neutral N/A 669p 14 May 2010 Xstrata Plc16c XTA.L Neutral N/A 1,010p 14 May 2010 Yara16c YAR.OL Buy N/A NKr197.10 14 May 2010 Yell Group YELL.L Buy N/A 47p 14 May 2010 Zurich Financial Services4, 5, 13, 15, 16c ZURN.VX Neutral N/A CHF237.30 14 May 2010

Source: UBS. All prices as of local market close. Ratings in this table are the most current published ratings prior to this report. They may be more recent than the stock pricing date 1a. UBS AG is acting as manager/co-manager, underwriter, placement or sales agent in regard to an offering of securities of this company/entity or one of its affiliates. 1b. UBS Securities LLC is acting as manager/co-manager, underwriter, placement or sales agent in regard to an offering of securities of this company/entity or one of its affiliates. 2. UBS AG, its affiliates or subsidiaries has acted as manager/co-manager in the underwriting or placement of securities of this company/entity or one of its affiliates within the

past 12 months. 3a. UBS AG Australia Branch is acting as financial adviser to Arrow Energy Limited in relation to its response to a non-binding conditional proposal by PetroChina and Royal Dutch

Shell to acquire Arrow and may be paid a fee for this service.


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3b. UBS AG is acting as Financial Adviser to Diageo PLC on the tender offer of Sichuan Swellfun Co Ltd 3c. UBS AG, Australia Branch is acting as advisor to BHP Billiton Ltd in relation to the joint venture for its Indonesian Coal Project (ICP) with a subsidiary of PT Adaro Energy TBK

and will be receiving a fee for acting in this capacity. 3d. UBS AG, Australia Branch is acting as Financial Adviser to Anglo Coal Australia Pty Ltd on the announced sale of its Dawson Seamgas coal seam gas assets and will be

receiving a fee for acting in this capacity. 3e. UBS Deutschland AG is acting as advisor to Volkswagen in relation to Porsche 3f. UBS Deutschland AG is currently acting as advisor to Siemens AG 3g. UBS is acting as financial adviser to Volkswagen with regard to its stakes in Man and Scania and the potential combination of the two companies truck businesses. 3h. UBS is acting as financial adviser to Volkswagen with regard to its stakes in Man and Scania and the potential combination of the two companies` truck businesses. 3i. UBS Limited is acting as Adviser to Alliance & Leicester on the announced Exchange of A&L Preference Shares for New Santander UK Preference Shares and Proposed

Amendments to the Terms of the A&L Preferred Securities 3j. UBS Limited is acting as adviser to Anglo American with respect to the sale of its Tarmac building materials unit. 3k. UBS Limited is acting as adviser to Norkse Skog on a strategic review of the company. 3l. UBS Limited is acting as adviser to Segro Plc in relation to Airport Property Partnership. 3m. UBS Limited is acting as advisor to Anglo American Plc on the sale of its Zinc assets to Vedanta Resources. 3n. UBS Limited is acting as advisor to Artemis Investment Management on the announced sale of the business by Fortis S.A./N.V. to Artemis Management and Affiliated

Managers Group 3o. UBS Limited is acting as advisor to British Airways plc regarding its stake in Iberia Lineas Aereas de Espana SA. 3p. UBS Limited is acting as advisor to Royal Bank of Scotland Group on the sale of part of its UK banking business comprising certain branches, SME customers and supporting

infrastructure 3q. UBS Limited is acting as advisor to Royal Bank of Scotland on the sale of Global Merchant Services (GMS) 3r. UBS limited is acting as financial advisor to Suez Environnement on the restructuring of Agbar and on the simultaneous acquisition of control in the company. 3s. UBS Limited is advising TDC on the announced agreement to merge its Swiss subsidiary, Sunrise Communications SA, with Orange Communications SA a subsidiary of

France Telecom S.A. 3t. UBS Securities Canada Inc is acting as advisor to Duluth Metals on its announced joint venture development of the large scale Nokomis Project with Antofagasta plc 3u. UBS Securities LLC is acting as advisor to Royal Bank of Scotland Group Plc on its announced agreement to sell its wholesale banking operations in Colombia to The Bank of

Nova Scotia(Scotiabank). 4. Within the past 12 months, UBS AG, its affiliates or subsidiaries has received compensation for investment banking services from this company/entity. 5. UBS AG, its affiliates or subsidiaries expect to receive or intend to seek compensation for investment banking services from this company/entity within the next three months. 6a. This company/entity is, or within the past 12 months has been, a client of UBS Securities LLC, and investment banking services are being, or have been, provided. 6b. This company/entity is, or within the past 12 months has been, a client of UBS Securities LLC, and non-investment banking securities-related services are being, or have been,

provided. 6c. This company/entity is, or within the past 12 months has been, a client of UBS Securities LLC, and non-securities services are being, or have been, provided. 7. Within the past 12 months, UBS Securities LLC has received compensation for products and services other than investment banking services from this company/entity.


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8. The equity analyst covering this company, a member of his or her team, or one of their household members has a long common stock position in this company. 12. Directors or employees of UBS AG, its affiliates or subsidiaries are directors of this company. 13. UBS AG, its affiliates or subsidiaries beneficially owned 1% or more of a class of this company`s common equity securities as of last month`s end (or the prior month`s end if

this report is dated less than 10 days after the most recent month`s end). 14. UBS Limited acts as broker to this company. 15. UBS AG, its affiliates or subsidiaries has issued a warrant the value of which is based on one or more of the financial instruments of this company. 16a. In Germany, UBS Limited has entered into a contractual arrangement to act as the market maker in the financial instruments of this company. 16b. UBS Securities (Hong Kong) Limited is a market maker in the HK-listed securities of this company. 16c. UBS Securities LLC makes a market in the securities and/or ADRs of this company. 18a. A director or an employee of UBS AG, its affiliates or subsidiaries is a director of this company. 18b. In Germany, UBS Limited has entered into a contractual arrangement to act as the manager of orders (Designated Sponsor) in the financial instruments of this company. 18c. NEITHER THIS DOCUMENT NOR ANY COPY HEREOF MAY BE TAKEN, TRANSMITTED OR RETRANSMITTED IN OR INTO INDIA OR REDISTRIBUTED, DIRECTLY OR

INDIRECTLY, IN INDIA. ANY FORWARDING, TRANSMISSION, RETRANSMISSION, DISTRIBUTION OR REPRODUCTION OF THIS REPORT IN WHOLE OR IN PART IN INDIA IS UNAUTHORISED. ANY FAILURE TO COMPLY WITH THIS RESTRICTION MAY CONSTITUTE A VIOLATION OF INDIAN REGULATIONS. THE CONTENTS HEREIN ARE NOT INTENDED TO BE VIEWED BY PERSONS IN INDIA. IF YOU ARE ACCESSING THIS CONTENT FROM INDIA, YOU ARE REQUIRED TO CEASE ACCESS IMMEDIATELY. TO DO OTHERWISE COULD RESULT IN A VIOLATION OF INDIAN REGULATIONS.

18d. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in DaimlerChrysler. 18e. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in GlaxoSmithKline. 18f. UBS AG is acting as agent on Baloise's announced share buy-back programme. 18g. UBS AG is acting as agent on SGS` announced share buy-back programme. 18h. UBS AG is acting as agent on Syngenta`s announced share buy-back programme. 18i. UBS AG, its affiliates or subsidiaries beneficially owned 5.12% of this company`s voting rights as of 5 September 2007 (calculations based on Swiss Stock Exchange Act

(SESTA)). 18j. UBS AG, its affiliates or subsidiaries beneficially owned 5.26% of this company`s voting rights as of last month`s end. 18k. UBS AG, its affiliates or subsidiaries beneficially owned more than 3% of the total issued share capital of this company. 18l. UBS AG, its affiliates or subsidiaries beneficially owned more than 5% of the total issued share capital of this company. 18m. UBS AG, its affiliates or subsidiaries beneficially owns more than 3% of the total issued share capital of this company. 18n. UBS AG, its affiliates or subsidiaries, is a tenant of Broadgate, a development owned by British Land. All statements on UBS are sourced from company reports and other

publicly available information. 18o. UBS Limited acts as broker to this company or one of its affilliates 18p. UBS Limited is Financial Advisor to Amec 18q. UBS South Africa (Pty) Limited acts as JSE sponsor to this company. 20. Because UBS believes this security presents significantly higher-than-normal risk, its rating is deemed Buy if the FSR exceeds the MRA by 10% (compared with 6% under the

normal rating system).


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22. UBS AG, its affiliates or subsidiaries held other significant financial interests in this company/entity as of last month`s end (or the prior month`s end if this report is dated less than 10 working days after the most recent month`s end).

24. UBS AG, its affiliates or subsidiaries beneficially held more than 5% of the total issued share capital of this company; or for UK and Irish companies, a line of stock of this company; as of the date shown in this disclosure table.

Unless otherwise indicated, please refer to the Valuation and Risk sections within the body of this report. For a complete set of disclosure statements associated with the companies discussed in this report, including information on valuation and risk, please contact UBS Securities LLC, 1285 Avenue of Americas, New York, NY 10019, USA, Attention: Publishing Administration.


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Global Disclaimer This report has been prepared by UBS Limited, an affiliate of UBS AG. UBS AG, its subsidiaries, branches and affiliates are referred to herein as UBS. In certain countries, UBS AG is referred to as UBS SA. This report is for distribution only under such circumstances as may be permitted by applicable law. Nothing in this report constitutes a representation that any investment strategy or recommendation contained herein is suitable or appropriate to a recipient’s individual circumstances or otherwise constitutes a personal recommendation. It is published solely for information purposes, it does not constitute an advertisement and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments in any jurisdiction. No representation or warranty, either express or implied, is provided in relation to the accuracy, completeness or reliability of the information contained herein, except with respect to information concerning UBS AG, its subsidiaries and affiliates, nor is it intended to be a complete statement or summary of the securities, markets or developments referred to in the report. UBS does not undertake that investors will obtain profits, nor will it share with investors any investment profits nor accept any liability for any investment losses. Investments involve risks and investors should exercise prudence in making their investment decisions. The report should not be regarded by recipients as a substitute for the exercise of their own judgement. Any opinions expressed in this report are subject to change without notice and may differ or be contrary to opinions expressed by other business areas or groups of UBS as a result of using different assumptions and criteria. Research will initiate, update and cease coverage solely at the discretion of UBS Investment Bank Research Management. The analysis contained herein is based on numerous assumptions. Different assumptions could result in materially different results. The analyst(s) responsible for the preparation of this report may interact with trading desk personnel, sales personnel and other constituencies for the purpose of gathering, synthesizing and interpreting market information. UBS is under no obligation to update or keep current the information contained herein. UBS relies on information barriers to control the flow of information contained in one or more areas within UBS, into other areas, units, groups or affiliates of UBS. The compensation of the analyst who prepared this report is determined exclusively by research management and senior management (not including investment banking). Analyst compensation is not based on investment banking revenues, however, compensation may relate to the revenues of UBS Investment Bank as a whole, of which investment banking, sales and trading are a part. The securities described herein may not be eligible for sale in all jurisdictions or to certain categories of investors. Options, derivative products and futures are not suitable for all investors, and trading in these instruments is considered risky. Mortgage and asset-backed securities may involve a high degree of risk and may be highly volatile in response to fluctuations in interest rates and other market conditions. Past performance is not necessarily indicative of future results. Foreign currency rates of exchange may adversely affect the value, price or income of any security or related instrument mentioned in this report. For investment advice, trade execution or other enquiries, clients should contact their local sales representative. 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UBS research complies with all the FSA requirements and laws concerning disclosures and these are indicated on the research where applicable. France: Prepared by UBS Limited and distributed by UBS Limited and UBS Securities France SA. UBS Securities France S.A. is regulated by the Autorité des Marchés Financiers (AMF). Where an analyst of UBS Securities France S.A. has contributed to this report, the report is also deemed to have been prepared by UBS Securities France S.A. Germany: Prepared by UBS Limited and distributed by UBS Limited and UBS Deutschland AG. UBS Deutschland AG is regulated by the Bundesanstalt fur Finanzdienstleistungsaufsicht (BaFin). Spain: Prepared by UBS Limited and distributed by UBS Limited and UBS Securities España SV, SA. UBS Securities España SV, SA is regulated by the Comisión Nacional del Mercado de Valores (CNMV). Turkey: Prepared by UBS Menkul Degerler AS on behalf of and distributed by UBS Limited. 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