Global Equity ResearchJune 28, 2006

Global GambitsThe Right Moves for Right Now

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The following is a chapter from Global Gambits � The Right Moves for Right Now, dated June 28, 2006. This chapter is presented forconvenience, and should be read in conjunction with the full report and its analyst certifications and important disclosures. The full report isavailable on MorganMarkets.

Aerospace and Defensechapter

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Aerospace and Defense Defense Slowing in ’08; Commercial Orders are Likely Peaking Key Drivers • US defense spending growth should slow over the next two

years after six years of 10% average growth. President George Bush’s FY07 Future Years Defense Plan calls for a 5% investment account CAGR through 2011. Supplemental spending has kept growth rates strong, but we expect outlay growth to slow from 10% in 2006 to 6% in 2007 and 2% in 2008.

• Defense budgets outside the US provide a mixed picture. High oil prices are pushing Middle Eastern countries to re-examine defense requirements, although large orders have not yet started to flow. The outlook for orders from Asia is still fairly strong, but European governments outside the UK still have not shown a commitment to increase defense budgets.

• Deliveries of large commercial aircraft should grow to 965 by 2008 from 586 in 2003. Demand from Asia and the Middle East and from low-cost carriers is driving the cyclical upturn. Risks to the cycle are a late-cycle global economy, struggling US network carriers, high oil prices, and the overhang of terrorism. We see 2006 as a mid-cycle year, with single aisle output peaking in 2008, and widebodies in the 2009/10 time frame.

• Business jet cycle is roaring ahead with the corporate earnings cycle, while demand for regional jets has suffered. We expect business jet deliveries to grow by 18% in 2006 and 17% in 2007 to nearly 1,000 units. A feature of this cycle that differentiates it from past cycles is the larger number of international deliveries, which are about 40% of the total for some manufacturers, up from less than 20% historically. While the 50-seat regional jet deliveries have dwindled to almost zero due to market saturation and high fuel costs, 70- to 110-seat jets are selling better and demand has picked up for turboprops.

Our Non-Consensus Views • Slowing US defense outlay growth should shift investor focus

to margin performance. We believe slowing investment account outlay growth over the next two years should reward those companies with ways other than top-line growth to generate earnings growth. We favor defense stocks that can generate growth through margin expansion and with managements that can allocate capital well.

• Defense stocks are driven by funds flows as much as fundamentals. Defense stocks (as measured by an index of LMT, NOC, and RTN) have outpaced the S&P 500 since the beginning of December by 21% through May. We believe this has been driven by an increasingly defensive posture by investors rather than a change in the defense industry outlook. We believe that stock performance over the rest of the year hinges more on the outlook for the stock market than anything else; if the broader market rebounds, we believe defense stocks could decline on an absolute basis, while they will likely continue to outperform if the recent pullback continues.

• We believe some commercial aerospace stocks are priced as if there will not be a cyclical downturn, while we see opportunities in others with higher long-term growth prospects. While the valuation variance among defense stocks is now low, it is rather high among commercial aerospace stocks. We see more opportunities among the commercial stocks to make relative calls within the group as explained below.

• Low-cost manufacturing and solutions should be important discriminators in the aerospace/defense markets. The low-cost revolution is finally reaching aerospace/defense, as very light jets, aircraft labor costs, aircraft spare parts, and even defense platforms are all affected. We see ERJ on the commercial aerospace side and LMT on the defense side as potential beneficiaries.

Global Sector Coordinator

Joseph B. Nadol III (1-212) 622-6548 joseph.b.nadol@@jpmorgan.com J.P. Morgan Securities Inc. Full sector coverage details on page 6

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Aerospace and Defense: Top Picks Company Key Financials Rationale and Catalysts Embraer Rating: Overweight Fiscal EPS (Local) Year-end Dec. Ticker: ERJ US / ERJ 2005 2006E 2007E 2.53 2.45 3.10 Exchange: NYSE P/E (Calendar) Price (Local): US$35.16 2006E 2007EMkt Cap (US$): 6.3 bn 14.3 11.3 Analyst: Joseph B. Nadol III EV/EBITDA (Calendar) Phone: (1-212) 622-6548 2006E 2007EEmail: joseph.b.nadol@jpmorgan.com 10.3 7.8

• Embraer is a pre-eminent play on low-cost labor in the global aerospace industry, in our view. We believe the demand for 70-110 seat aircraft, an expanded share of the corporate jet market, and ultimately an expansion into the larger aircraft market (likely as a supplier/partner) could enable the company to generate sustainable double-digit average top-line growth.

• The company’s low-cost labor force provides it with a sustainable competitive advantage. We estimate that Embraer’s labor costs are 20-25% of those of its major competitors in North America and Europe.

• We expect E-Jet orders to build in 2006 and 2007 as North American carriers recover financially and continue to obtain scope clause relief from the bankruptcy process, two historical precursors of demand. Northwest has indicated that it plans to place an order, and we believe Embraer could be a likely candidate to receive the order.

• Embraer’s increasing commitment to the business jet market should bear fruit from 2008 when Phenom’s 100 deliveries commence. The Lineage 1000 (2008) and Phenom 300 (2009) will also boost share, and the company is working on at least two additional models to follow.

• Valuation is at a substantial discount to global peers on metrics including 2007E P/E and EV/EBITDA. Northrop Grumman Rating: Overweight Fiscal EPS (Local) Year-end Dec. Ticker: NOC US / NOC 2005 2006E 2007E 3.81 4.45 5.00 Exchange: NYSE P/E (Calendar) Price (Local): US$63.02 2006E 2007EMkt Cap (US$): 21.7 bn 14.2 12.6 Analyst: Joseph B. Nadol III EV/EBITDA (Calendar) Phone: (1-212) 622-6548 2006E 2007EEmail: joseph.b.nadol@jpmorgan.com 7.6 6.9

• NOC’s operating margins are among the lowest in the industry, offering substantial potential for expansion. We expect its operating margins to expand 130 basis points from 2005 to 2007 and should continue to expand thereafter through shipbuilding recovery, program maturity, and integration of past acquisitions.

• Management has returned cash to shareholders via growing dividends and the repurchase of shares. We believe NOC has more effectively reduced its share count through repurchase than most peers. The company has also avoided value-destroying acquisitions, and we believe it is likely to continue to do so.

• Shipbuilding provides a substantial profit growth opportunity due to margin upside potential and emerging budget growth. We estimate that Ship Systems will produce operating profits of US$700 million by 2010E, up from US$249 million in 2005, including a hurricane-related charge, and US$3.78 in 2006E. EPS contribution should grow from US$0.47 in 2005 to US$1.38 in 2010E, which would provide a 4% annual boost to EPS growth.

Source: Company data, Bloomberg, JPMorgan estimates, JPMorgan SaVanT. Prices as of June 15, 2006.

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Aerospace and Defense: Top Picks (cont’d) Company Key Financials Rationale and Catalysts United Technologies Rating: Overweight Fiscal EPS (Local) Year-end Dec. Ticker: UTX US / UTX 2005 2006E 2007E 3.12 3.75 4.30 Exchange: NYSE P/E (Calendar) Price (Local): US$60.81 2006E 2007EMkt Cap (US$): 61.5 bn 16.2 14.6 Analyst: Joseph B. Nadol III EV/EBITDA (Calendar) Phone: (1-212) 622-6548 2006E 2007EEmail: joseph.b.nadol@jpmorgan.com 9.3 8.0

• UTX has a balanced mix of businesses that have performed well in a variety of economic and geopolitical situations. The sales mix is well balanced, in our view, between aerospace and building infrastructure businesses, as well as between domestic and international customers. This business diversification provides a natural hedge against a cyclical downturn in individual businesses.

• Management has successfully deployed capital over time, balancing acquisitions and the return of cash to shareholders. A strategic focus on service-related acquisitions has contributed to the consistency of earnings and high returns on capital.

• We believe the perception that P&W’s business is decaying because of a loss of commercial OE share could change. While we dispute the premise, as P&W’s commercial OE business is only about US$1 billion of UTX’s US$46 billion of sales, we believe that a possible reopening of the A350 opportunity due to a pending program restructuring could favorably impact the stock’s multiple. In the longer term, P&W is well positioned to take back share when Boeing and Airbus refresh their narrowbody offerings, likely in the next 2-3 years.

Source: Company data, Bloomberg, JPMorgan estimates, JPMorgan SaVanT. Prices as of June 15, 2006.

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Aerospace and Defense: Stocks to Underweight Company Key Financials Rationale and Catalysts Boeing Rating: Underweight Fiscal EPS (Local) Year-end Dec. Ticker: BA US / BA 2005 2006E 2007E

3.21 3.50 4.35 Exchange: NYSE P/E (Calendar) Price (Local): US$84.81 2006E 2007EMkt Cap (US$): 67.8 bn 24.2 19.5 Analyst: Joseph B. Nadol III EV/EBITDA (Calendar) Phone: (1-212) 622-6548 2006E 2007EEmail: joseph.b.nadol@jpmorgan.com 11.5 9.3

• The outlook for IDS is not strong against the backdrop of slowing budget growth, and the C-17 is the most substantial near-term program run-off risk. Technical problems plaguing the JTRS program have reduced funding on FCS, and have necessitated the transfer of FIA work to LMT.

• Conversely, the long-term competitive outlook for BCA seems to be improving, and the 787 continues to generate strong demand relative to the A350. However, we estimate a cyclical peak in 2008 and expect the market to begin discounting this more heavily.

• We believe Boeing is significantly overvalued, as we believe the market is valuing BA as a growth stock rather than a cyclical. This could be sustainable for some time, but we believe it will change when the peak of the cycle becomes visible, and we believe this will result in substantial multiple erosion. Using a sum-of-the-parts valuation, we estimate a value for the stock in the 50s if we assume an average long-term commercial operating margin of 9%, and in the 70s if we assume 12%, which the company has never reached in its modern history, even at peak (however, we note that this SOP valuation is a scenario and not an expected outcome).

L-3 Communications Rating: Underweight Fiscal EPS (Local) Year-end Dec. Ticker: LLL US / LLL 2005 2006E 2007E 4.20 4.95 5.45 Exchange: NYSE Price (Local): US$75.70 P/E (Calendar) Mkt Cap (US$): 9.2 bn 2006E 2007E 15.3 13.9 Analyst: Joseph B. Nadol III EV/EBITDA (Calendar) Phone: (1-212) 622-6548 2006E 2007EEmail: joseph.b.nadol@jpmorgan.com 9.5 8.8

• Management’s long-term target of 10% organic growth appears to us to be unrealistic amid declining industry growth.

Slowing outlay growth could impact L-3 more than other companies, as investors typically focus on internal growth more for L-3 than peers due to its aggressive acquisition strategy and growth-oriented shareholder base. While L-3’s 2007 growth could approach the 10% target, we do not believe the company can generate 10% organic growth in 2008 when investment account outlays are 0%.

• Contribution to growth from acquisitions should slow due to both a leveraged balance sheet and L-3’s enlarged revenue base.

• Increasing complexity of the business makes management difficult. L-3 makes everything from supplying tank engines and electro-optical sensors to modifying aircraft and training foreign militaries. It operates over 65 subsidiaries, making corporate oversight difficult.

• L-3’s valuation remains at premiums to defense company averages, particularly on an unleveraged basis. On a 2007E EV/EBITDA basis, L-3’s stock trades at a 16% premium to LMT, NOC, GD, and RTN. We expect the company’s multiple to contract as growth slows.

Source: Company data, Bloomberg, JPMorgan estimates, JPMorgan SaVanT. Prices as of June 15, 2006.

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JPMorgan Global Aerospace and Defense Team – Research Equity Research Credit Research Americas Americas

Joseph B Nadol III Adam Epstein

United States

Khatija A. Ladhani (HG-Aerospace/Defense) Yilma Abebe (HY- Aerospace/Defense) Brian Chen (HY-Aerospace/Defense)

EMEA EMEA

Joseph B Nadol III Global Sector Coordinator

Pan Europe Harry Breach Joseph B Nadol III

Pan Europe Julien Dumas-Pilhou (HG/HY)

Asia Pacific India Gautam Chhaochharia Singapore Winnifred Heap

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Companies Recommended in This Report (prices as of COB 16 June 2006) Boeing (BA/$85.54/Underweight), Embraer SA (ERJ/$35.07/Overweight), L-3 Communications (LLL/$75.01/Underweight), Northrop Grumman (NOC/$63.01/Overweight), United Technologies (UTX/$61.75/Overweight)

Analyst Certification: The research analyst who is primarily responsible for this research and whose name is listed first on the front cover certifies (or in a case where multiple research analysts are primarily responsible for this research, the research analyst named first in each group on the front cover or named within the document individually certifies, with respect to each security or issuer that the research analyst covered in this research) that: (1) all of the views expressed in this research accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research analyst’s compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst in this research.

Important Disclosures

• Lead or Co-manager: JPMSI or its affiliates acted as lead or co-manager in a public offering of equity and/or debt securities for Boeing, Embraer SA, Northrop Grumman, United Technologies within the past 12 months.

• Director: A senior employee, executive officer or director of JPMSI or its affiliates is a director of Boeing. • Client of the Firm: Boeing is or was in the past 12 months a client of JPMSI; during the past 12 months, JPMSI provided to the company investment banking services,

non-investment banking securities-related service and non-securities-related services. Embraer SA is or was in the past 12 months a client of JPMSI; during the past 12 months, JPMSI provided to the company investment banking services, non-investment banking securities-related service and non-securities-related services. L-3 Communications is or was in the past 12 months a client of JPMSI. Northrop Grumman is or was in the past 12 months a client of JPMSI; during the past 12 months, JPMSI provided to the company investment banking services, non-investment banking securities-related service and non-securities-related services. United Technologies is or was in the past 12 months a client of JPMSI; during the past 12 months, JPMSI provided to the company investment banking services, non-investment banking securities-related service and non-securities-related services.

• Investment Banking (past 12 months): JPMSI or its affiliates received in the past 12 months compensation for investment banking services from Boeing, Embraer SA, Northrop Grumman, United Technologies.

• Investment Banking (next 3 months): JPMSI or its affiliates expect to receive, or intend to seek, compensation for investment banking services in the next three months from Boeing, Embraer SA, Northrop Grumman, United Technologies.

• Non-Investment Banking Compensation: JPMSI has received compensation in the past 12 months for products or services other than investment banking from Boeing, Embraer SA, Northrop Grumman, United Technologies. An affiliate of JPMSI has received compensation in the past 12 months for products or services other than investment banking from Boeing, Embraer SA, Northrop Grumman, United Technologies.

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Boeing (BA) Price Chart

Source: Reuters and JPMorgan; price data adjusted for stock splits and dividends.This chart shows JPMorgan's continuing coverage of this stock; the current analyst may or may not have covered it overthe entire period. As of Aug. 30, 2002, the firm discontinued price targets in all markets where they were used. Theywere reinstated at JPMSI as of May 19th, 2003, for Focus List (FL) and selected Latin stocks. For non-JPMSI coveredstocks, price targets are required for regional FL stocks and may be set for other stocks at analysts' discretion.JPMorgan ratings: OW = Overweight, N = Neutral, UW = Underweight.

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Embraer SA (ERJ) Price Chart

OW OW $45

Source: Reuters and JPMorgan; price data adjusted for stock splits and dividends.Initiated coverage Dec 18, 2003. This chart shows JPMorgan's continuing coverage of this stock; the current analyst mayor may not have covered it over the entire period. As of Aug. 30, 2002, the firm discontinued price targets in allmarkets where they were used. They were reinstated at JPMSI as of May 19th, 2003, for Focus List (FL) and selected Latinstocks. For non-JPMSI covered stocks, price targets are required for regional FL stocks and may be set for other stocksat analysts' discretion.JPMorgan ratings: OW = Overweight, N = Neutral, UW = Underweight.

Date Rating Share Price ($)

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18-Dec-03 OW 31.93 -

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L-3 Communications (LLL) Price Chart

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Source: Reuters and JPMorgan; price data adjusted for stock splits and dividends.This chart shows JPMorgan's continuing coverage of this stock; the current analyst may or may not have covered it overthe entire period. As of Aug. 30, 2002, the firm discontinued price targets in all markets where they were used. Theywere reinstated at JPMSI as of May 19th, 2003, for Focus List (FL) and selected Latin stocks. For non-JPMSI coveredstocks, price targets are required for regional FL stocks and may be set for other stocks at analysts' discretion.JPMorgan ratings: OW = Overweight, N = Neutral, UW = Underweight.

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07-Jul-04 UW 64.00 -

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Northrop Grumman (NOC) Price Chart

OW $120 OW $60

Source: Reuters and JPMorgan; price data adjusted for stock splits and dividends.This chart shows JPMorgan's continuing coverage of this stock; the current analyst may or may not have covered it overthe entire period. As of Aug. 30, 2002, the firm discontinued price targets in all markets where they were used. Theywere reinstated at JPMSI as of May 19th, 2003, for Focus List (FL) and selected Latin stocks. For non-JPMSI coveredstocks, price targets are required for regional FL stocks and may be set for other stocks at analysts' discretion.JPMorgan ratings: OW = Overweight, N = Neutral, UW = Underweight.

Date Rating Share Price ($)

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29-Sep-03 OW 43.08 120.00

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United Technologies (UTX) Price Chart

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Source: Reuters and JPMorgan; price data adjusted for stock splits and dividends.This chart shows JPMorgan's continuing coverage of this stock; the current analyst may or may not have covered it overthe entire period. As of Aug. 30, 2002, the firm discontinued price targets in all markets where they were used. Theywere reinstated at JPMSI as of May 19th, 2003, for Focus List (FL) and selected Latin stocks. For non-JPMSI coveredstocks, price targets are required for regional FL stocks and may be set for other stocks at analysts' discretion.JPMorgan ratings: OW = Overweight, N = Neutral, UW = Underweight.

Date Rating Share Price ($)

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22-Jun-04 N 44.35 - 15-Sep-04 OW 47.18 -

Explanation of Equity Research Ratings and Analyst(s) Coverage Universe: JPMorgan uses the following rating system: Overweight [Over the next six to twelve months, we expect this stock will outperform the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Neutral [Over the next six to twelve months, we expect this stock will perform in line with the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Underweight [Over the next six to twelve months, we expect this stock will underperform the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] The analyst or analyst’s team’s coverage universe is the sector and/or country shown on the cover of each publication. See below for the specific stocks in the certifying analyst(s) coverage universe.

Coverage Universe: Michael F. Gambardella: AK Steel (AKS), Alcan Inc (AL), Alcoa (AA), Allegheny Technologies (ATI), Carpenter Technology (CRS), Century Aluminum Company (CENX), Commercial Metals (CMC), Dynamic Materials (BOOM), Falconbridge (FAL), Freeport-McMoran Copper & Gold (FCX), GrafTech International (GTI), Inco Ltd (N), Mittal Steel (MT), Novelis (NVL), Nucor (NUE), Phelps Dodge Corp. (PD), Ryerson Inc (RYI), Steel Dynamics (STLD), Teck Cominco Ltd. (TEKb.TO), U.S. Steel Corp (X), Worthington Industries (WOR)

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JPMorgan Equity Research Ratings Distribution, as of April 3, 2006

Overweight (buy)

Neutral (hold)

Underweight (sell)

JPM Global Equity Research Coverage 40% 42% 18% IB clients* 45% 47% 39% JPMSI Equity Research Coverage 35% 50% 15% IB clients* 63% 57% 46%

*Percentage of investment banking clients in each rating category. For purposes only of NASD/NYSE ratings distribution rules, our Overweight rating falls into a buy rating category; our Neutral rating falls into a hold rating category; and our Underweight rating falls into a sell rating category.

Valuation and Risks: Equity Research company notes and reports include a discussion of valuation methods used, including methods used to determine a price target (if any), and a discussion of risks to the price target.

Analysts’ Compensation: The equity research analysts responsible for the preparation of this report receive compensation based upon various factors, including the quality and accuracy of research, client feedback, competitive factors, and overall firm revenues, which include revenues from, among other business units, Institutional Equities and Investment Banking.

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