Downgrading on Environmental Uncertainty $ April 2006

Transcription

1 Honeywell Downgrading on Environmental Uncertainty $ April 2006 Downgrade Underweight Previous Rating: Overweight We are downgrading Honeywell to Underweight on incremental concerns around legacy issues. The UW comes in the spirit of a move away from N ratings so as to provide more cut and dry opinions. HON has outperformed this year on positive cyclical sentiment in Aero, along with the potential for increased visibility on below the line items. Frustratingly low visibility on environmental has been a negative in the past, as the realization of "normalized" EPS is continually pushed out. On this front, in its 10-Q, HON had a new disclosure regarding activities being conducted at a site in the Baltimore Harbor. Upon further investigation, it appears as though this site could represent a material and significant liability that is not yet reserved for. Our positive thesis on HON has been based, in part, on a potential shrinkage in legacy drags. We have spent the past four months investigating outstanding issues, in an effort to get comfortable that the company is indeed turning the corner. Even our most comprehensive efforts failed to discover the site in Baltimore, highlighting the limited visibility. We now feel it s fundamentally impossible to discount these liabilities, and we are taking the cautious approach given the recent stock move, and increasingly positive sentiment. Near term estimates are unchanged, and we do not see significant fundamental downside at Honeywell. While the 15 multiple on 07E is about in line with the group, and the company continues to benefit from nice end market exposure, we believe the assets here deserve a discount for the limited visibility on legacy issues such as environmental, as well as ongoing fundamental under-performance in the assets, relative to competitors. We prefer higher quality, clean fundamental earnings growth stories late in the cycle. Electrical Equipment and Multi-Industry C. Stephen Tusa, Jr. CFA Patrick M. Baumann, CFA (1-212) patrick.m.baumann@jpmorgan.com Andrew M. Weisel (1-212) andrew.m.weisel@jpmorgan.com Price Performance $ Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 YTD -3M -6M -12M Absolute 17.4% 21.2% 29.7% 20.4% Source: RIMES, Reuters. Honeywell (HON;HON US) 2005A 2006E 2007E EPS ($) Q1 (Mar) A Q2 (Jun) A Q3 (Sep) 0.55 Q4 (Dec) 0.64 FY A 2.90 P/E FY A 15.2 Source: Company data, Reuters, JPMorgan estimates. Company Data Price ($) Date Of Price 26 April week Range Mkt Cap ($ mn) 36, Fiscal Year End Dec Shares O/S (mn) 836 J.P. Morgan Securities Inc. See page 9 for analyst certification and important disclosures, including investment banking relationships. JPMorgan 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. Customers of JPMorgan in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost to them, where such research is available. Customers can access this independent research at or can call toll free to request a copy of this research.

2 We are downgrading Honeywell to Underweight as increased uncertainty around legacy issues could continue to limit the realization of fundamental upside leverage we are expecting from the business units. Our UW comes in the spirit of a concerted move away from Neutral rated stocks in an effort to provide cut and dry opinions on each of the companies under coverage. Environmental related costs have been a significant portion of non-fundamental expenses at Honeywell in recent years, a key drag that continues to mask otherwise favorable end market leverage in core operating units, and our positive thesis has counted on upside from a reduction in related expenses going forward. Over the last four months we undertook a state by state analysis of Honeywell's environmental issues, in an effort to validate management s forecast and gain comfort with the notion that legacy issues will shrink in size from the significant headwind seen over the last few years. However, in the 10-Q filing for the first quarter, released Monday afternoon, Honeywell disclosed new details regarding the remediation of a site in Baltimore which was not found in the course of our research, though it appears quite significant. Upon further investigation, the site appears more complex and more contaminated than the group of sites in Jersey City, NJ, where the cleanup costs are estimated to total over $400 million. Honeywell, through legacy operations (chromium ore processing), has been held responsible for contaminating the Baltimore Inner Harbor, and the groundwater below, with chromium. One affected site is the Dundalk Marine Terminal, currently owned and operated by the Maryland Port Authority. The news disclosed by Honeywell in its Q is that a consent decree was negotiated to investigate and remediate the facility, pending approval from a Baltimore County Circuit Court judge. As part of the agreement, a new cost sharing arrangement was worked out between the company, the MPA and the Maryland Department of the Environment, whereby HON will pay 77% of costs associated with the investigation to size up the magnitude of the problem (estimated to take months) and the ensuing fifteenyear cleanup process, with the balance to be paid by taxpayers. The company also disclosed that a motion has been filed against Honeywell by an activist group known as BUILD to expedite the cleanup, citing immediate threats to human health. BUILD is a group associated with the Interfaith Organization involved with Honeywell s well publicized Jersey City site. The bottom line is that this issue looks similar to that of the Jersey City site, though it s twice as big in acreage, is more complex, and contains twice as much waste. We must reiterate that, at this preliminary stage, no accurate cost estimate for the DMT can be made, however it seems apparent to us, through conversations with the various parties involved, that this could represent a significant and material liability that has yet to be reserved for. While the financial impact is tough to discern, the call-out of this site comes as a complete surprise to us, and we think that is almost as big of an issue as the financial impact of this site alone. Over the past four months, we have undergone a state by state analysis of outstanding environmental issues facing Honeywell in an effort to provide more visibility around the issues, and to educate investors on the general process used to resolve such problems. Through our efforts, we identified what we believed to be the twenty sites which represented the largest looming liabilities facing the company interestingly, few of the sites seemed material. Meaningfully excluded from the list is this Dundalk site. It is this uncertainty (given the magnitude of the issue in Baltimore) that drives our rating change. We are confident that the fact that we were unable to discover this 2

3 looming issue in our research reflects not a lack of effort or comprehensiveness, but the fundamental impossibility to uncover the liabilities, big or small, that the company may one day be forced to deal with. We think management faces somewhat of a similar situation (or that is the way it has been communicated to us). As it appears as though it is impossible to predict the liability stream, we cannot say with certainty that these issues will shrink in size, and, to the contrary, fully expect the Baltimore issue specifically to represent a meaningful, material expense that could be charged in the next few years - we note that the Jersey City contamination resulted in a charge of $278 mm in Aside from financial impact, we think that the tone of the situation here contradicts popular opinion (and our previous opinion) that these issues are on the mend. We acknowledge that this probably has no immediate impact on near term estimate, and we do not see significant fundamental downside at Honeywell. Still, while the 15 multiple on 07E is about in line with the group, and the company continues to benefit from nice end market exposure, we believe the assets here deserve a discount for the limited visibility on legacy issues such as environmental, as well as ongoing fundamental under-performance in the assets, relative to competitors. This, we believe, is enough to drive underperformance relative to a fundamentally clean sector, and we continue to prefer higher quality earnings growth stories late in the cycle. Details On The Issue at Hand Site History Allied Chemical, now Honeywell, owned the Dundalk Marine Terminal (DMT) site until it was sold to the State of Maryland in A byproduct of the manufacturing process, large amounts of chromium waste were produced from the 1940's until the early 1970 s, when the adverse effects were recognized. This material was sent to the DMT, which formed a marine terminal out of it, and pushed the land into the adjacent Patapsco River. According to EPA archives, the site was discovered in 1979, and contamination originated from the Allied Signal Baltimore Works Facility (Chrome Plant) at Baltimore s Inner Harbor. The risk comes from the release of chromium from the material, which has been capped (covered in several inches of soil and asphalt). The waste can travel through a storm system that runs through the ~85 acre terminal, and, by expanding, the chromium waste is able to break the storm drains and leak in, contaminating the groundwater which flows into the Patapsco River. Honeywell and Maryland have been engaged in preliminary cleanup efforts for fifteen years here, including chromium containment, groundwater maintenance and monitoring the health of workers at the terminal. As of last October, a wastewater treatment system became operational, at a cost of ~$3 million. In total, $42 million has been spent by Honeywell since The Recent Agreement The new Consent Decree, highlighted in the 10Q, has two pieces to it. First, a new cost sharing arrangement was reached, whereby Honeywell will incur 77% of the costs looking forward, with state tax funds to pay the balance. The second part lays out the framework for how the site will be remediated. The plan consists first of an investigation phase, slated to last no more than two years, which will include sets of tests and measurements to size up the contamination and to scientifically evaluate all potential ways to remediate the site. Once a remedy is chosen, it will be implemented over the following fifteen years. In total, according to the agreement, 3

4 the final cleanup must be completed by 2023, though this can be pushed forward or backward. A Lawsuit Follows As disclosed in the SEC filing, a Baltimore activist group has filed a motion to block the agreement, negating the Consent Degree, on grounds that 17 years is too long, given that 15 years have already elapsed and that nearby residents are endangered. The group, Baltimoreans United in Leadership Development, or BUILD, plans to sue Honeywell to force the immediate cleanup of the entire terminal site as well as the neighboring community of Turner's Station. Interestingly, BUILD belongs to an advocacy group called the Industrial Areas Foundation; also a member is the Interfaith Community Organization, the NJ group which successfully sued Honeywell in 1995 to decontaminate the high profile Jersey City site; the adverse ruling was upheld by an appellate court in The State had agreed to the long-term plan, rather than a port shutdown (necessary in the most comprehensive clean up scenario), to protect the local economy. Unlike Jersey City or other sites with no current activity, the port is fully operational, with a significant amount of commerce, a key characteristic of the site that makes the issue more complex. BUILD contends that the adverse economic impact would be a safer alternative than the prolonged risk to the health of residents, while Honeywell has expressed a tone in line with the state response, and is taking proactive measures but believes the remediation will be long term in nature. Beyond the cleanup costs and potential damages, the company could also face lawsuits regarding human health. No adverse health effects have been seen in tests on workers to date, but local press reports that a sample taken from just outside the marine terminal tested positive for hexavalent chromium ( Chromium 6 ), one of the most deadly known carcinogens, during testing conducted by BUILD. Officials could not comment on the testing since they were not given the results and were uncertain of the methodology, though we have no reason to be suspicious of the results. A state representative is not concerned with health danger since the chromium is capped by several inches of earth and macadam, although it appears as if the community organization is likely to remain diligent. Sizing the Magnitude of the Issue Jersey City Is A Good Starting Point While there are differences, a good comparison for this site is the collection of sites in Jersey City, NJ, where chrome contamination has resulted in over thirty years of preliminary investigations, evaluations and remediations. Cleanup at that site is estimated at $400 mm, and Honeywell expensed $278 mm in 4Q04. Honeywell s sites are primarily situated at 441 Route 440 in Jersey City, and the full-scale excavation physically digging up the soil and moving it to a treatment and disposal facility in the deserts of Idaho just began on April 3, The specific remediation methods being employed in Jersey City were cited as a possibility at Dundalk, as described in the recent consent decree. While it can not be guaranteed as an indicator of a larger total remediation cost, the contamination appears to be more severe at the Baltimore site. Notably, about four million tons of chromium waste need to be removed here, versus two million tons in Jersey City. Geographically, the Dundalk terminal spans 570 acres, 85 acres of which are covered by the consent decree, roughly twice the size of Jersey City (~34 acres). As a final indication, MDE and port officials said that the marine terminal cleanup was far more complicated than the New Jersey site, which had been abandoned, given that the site is much 4

5 more of a working area in one scenario, the port of Baltimore would need to be shut down for clean-up. The stance from the government reinforces Honeywell s view that a more gradual process would be preferred to limit the economic impact, making the near term financial impact to the company less severe than it could be in other scenarios. Beyond DMT, our discussions with Government officials suggest that it would not be unexpected to see additional sites pop up in the Baltimore Harbor area. In our previous research, we discovered the Baltimore Works Facility, and given that the remediation was primarily completed, we incorrectly believed that the story ended there, after a ten year, $100 mm cleanup. That complex remediation included the dismantling of several large manufacturing buildings ( ), as well as an impermeable cap, barrier wall, and a hydraulic gradient control system, in addition to long term environmental monitoring. The biggest risk now comes from groundwater and the possibility of tainted water escaping into the populous Chesapeake Bay, though airborne transmission of chromium byproducts is also a concern to BUILD. Additionally, chromium expands underground, and can cause pavement to split, releasing toxins that can leach into water and carry on the wind. These releases typically happen during construction. It is important to recognize that the probability of any single negative development is low, but in the event of a new site appearing, the impact could be meaningful, which highlights the uncertainty of these liabilities. Background on Our Investigation We have spent the past four months investigating outstanding environmental issues, in an effort to get comfortable that the company is indeed turning the corner. Even our most comprehensive efforts failed to discover the DMT, highlighting the limited visibility. We now feel it s fundamentally impossible to discount these liabilities, and we are taking the cautious approach with our change in rating. Purpose of Our Investigation As a 100-year-old chemicals company, with many predecessors and even more active and non-active sites, there are countless environmental issues that continuously emerge. The majority of these are very minor perhaps tens or hundreds of thousands, or even a couple million bucks. However, hundreds, or possibly thousands, of these sites exist nationwide, and the aggregated total can reach nine figures per year. Unlike nearly every other income statement line item, there is very little if any visibility into the annual charge for probable and reasonably estimable environmental liabilities, which have cost an average of $320 million in each of the past three fiscal years, with expectations for $ mm in costs expected for While Honeywell s management gives reasonably accurate guidance each year, investors and analysts have no practical way to verify this outlook. Instead, we are essentially forced to take management's forecast and model results accordingly. We believe that better visibility on non fundamental issues such as environmental would not only help the earnings outlook at HON, we think that it would go a long way to removing what we believe has become a franchise quality related discount associated with the assets. Methodology We attempted to investigate as many sites as possible for which public information is available, where Honeywell is likely to be required to take a charge in the next few years but has not yet made a liability reserve. We visited federal websites for the 5

6 EPA, as well as the sites for each environmental agency at all fifty states, and ordered public documents for a more thorough review of each. From press releases, fact sheets and government documents, we identified those sites which we believe represent the largest potential liabilities to the company. Through many conversations with project managers, site representatives, engineers and consultants, and through intensive records searches, we educated ourselves on the status and approximate magnitude of each site's contamination. Conclusion Not including the Dundalk Terminal, we identified 20 sites that we believed to be the largest liabilities facing the company. In the end, we discovered that our approximate, estimated total fell far short of the range guided by management, even using aggressive estimates. It is important to note this total was based on estimates of the lifetime costs associated with each site, while the guided range represents simply what is expensed in the current year (when the company takes a charge, it expenses the present value of the lifelong expenditures it believes will eventually be incurred). The simple reason for the disconnect between our estimates and management's guidance is that there are seemingly countless remediations under the radar. With current and legacy facilities across the country, Honeywell's environmental team of engineers, consultants and lawyers are constantly identifying minor issues to be dealt with. While these individual charges are generally very small, the aggregated total quickly adds up to a significant annual expense. In recent conversations, the company would not provide details as to the number of such sites for which a reserve has been taken, nor would it comment on the size of some of the larger sites. However, as a frame of reference, the environmental reserves totaled $896 million as of the close of 1Q06. Two sites - Lake Onondaga in Syracuse, NY and the Chrome sites in Jersey City, NJ - each have reserves in the range of ~$300 million. That leaves another ~$300 million, but the company has advised us that no individual site has reserved more than ~$20 million (a claim we have less confidence in today). With many of the sites' liabilities estimated under $1 mm, we can get a sense as to the plethora of issues that arise each year. The bottom line is that, even with full knowledge on every single major site for which the Federal EPA or state environmental agencies has disclosed details, the total company income statement expense is highly challenging for an outsider to predict, and therefore we are forced to rely on management's guidance for the near term. The Dundalk site serves as a timely reminder that, while most of these sites represent small liabilities, some sites, previously identified or not, have the potential to move into a very sizeable cleanup effort. We see three possible risk categories. New Site Identification Seemingly countless new contaminations are identified each year, often by the company itself but also by government agencies, community watch groups, activists, or successors at a site. Any site could be heavily contaminated, either in the soil under the site or in nearby or underground bodies of water, and could require extensive remediation. New Contaminant Identification Prior to the mid 1950 s, the adverse health effects of mercury as a dangerous toxin were not widely known. It was not until the 1970 s that the health hazards from asbestos were recognized, and its use discontinued. It is quite feasible and perhaps even likely that some chemical used currently or historically in a Honeywell facility will one day be deemed dangerous, and if and 6

7 when that occurs, the company will find itself facing a whole new batch of cleanup endeavors. Underestimation of a Known Site Neither we, Honeywell, nor the EPA can say with certainty that the degree of contamination has not been underestimated at any given site. The concentration of a contaminant could be greater than believed, more solvents may be involved, or the contamination could extend beyond the area believed to be affected. This is the case at the Baltimore Harbor, and we have no reason to be confident that additional sites won t arise one day, the way Dundalk did this time. Our Selective Approach Towards Market Leaders Late in the Cycle is An Incremental Reason For the UW While we continue to like the end market exposure at Honeywell, and absolute growth has been solid, ongoing underperformance at Aerospace, ACS and Turbos, relative to competitors, provides an argument for a discount to the competition from a valuation perspective. The one area that is indeed outperforming quite nicely is Specialty Materials, and we applaud management for excellent strategic moves to set this business up for success. Still, at 15% of sales and 13% of operating income, this is not enough, in our view, to own Honeywell on the fundamental quality of the businesses. We provide a more detailed view on each of the areas at issue below. ACS A Laggard At ACS, while Experion PKS has been a solid performer, revenue and order growth continues to lag competitors. Indeed, despite management commentary around strong order growth here (which goes un-reported), revenue growth has been less than robust, averaging 3.5% over the past four quarters, a significant discount to the 10%+ seen in revenue growth at competitor Emerson and Rockwell. While the double digit order growth should begin to manifest itself in revenues starting in 2006, we view the outlook here as somewhat of a "show me". Once again, the high tide lifts all boats, and we are not saying that the end of the cycle comes next quarter, given strong capex trends, though we see better ways to play the capex theme going forward. The company recently combined Process Solutions and Building Solutions into one business, the sum of which still posted organic growth in the low to mid single digits that appears well below the growth seen in targeted process industry capital spending, and non residential construction markets. ACS continues to look more and more like an acquisition story, and we remain cautious around segment management s ability to execute. Aerospace Restructuring Highlights Competitive Issues First, in Aerospace, while the market is providing some nice lift its not new news the recently announced restructuring highlights franchise quality issues. News flow from the recent past surrounding product/service related issues suggest that it s going to take a while to fully realize the potential of the ALD/HON promise. The first major sign of problems was the underperformance in recent large commercial campaigns, with the biggest disappointment around the loss of the 787 APU contract to Hamilton Sundstrand. The company also came in relatively weak on the A380. Content on each platform came in below expectations. The losses here provide the backdrop, and represent the key driver, to the recent restructuring, as the company continues to pay for the cultural dislocation of ALD/HON/GE. While none of the issues here significantly impact near term results, the events highlight concerns over franchise quality, the 7

8 impact of which should manifest itself in the next cycle, if recent actions fail to deliver improvements, an uncertainty. Turbo Growth Loses Steam The high growth Turbocharger business, which has represented ~2% of organic growth in recent years, is weakening, and added only half a point to 2005 core growth. In 1Q, turbo sales were down 3%, following an 8% sales decline in 4Q05. While recent disappointment was blamed on general macro conditions in Europe, which are now guided to recover modestly in 2H06, Borg Warner continues to show 10%+ growth in its Turbo business. We acknowledge that Borg and Honeywell play in different areas of the market, though the difference in growth still represents somewhat of a concern. We expect this business to continue to slow over time and represent less of a fundamental driver as the penetration story moves closer to maturity. FCF Accelerates, Capital Deployment Potential Brings Execution Risk The balance sheet remains positive, and Honeywell's FCF continues to accelerate, and should come in at ~110% of net income this year, bolstering a net debt/cap of 28%. This provides the opportunity for capital deployment. The company authorized a $3 B buy-back last year, and repurchased 8 million shares ($325 mm) in 1Q06, though the biggest move was the $625 mm acquisition of First Technology (net of a non-core divestiture), which closed in March. We see the potential for management to get more aggressive in its acquisition program. With multiples high, and a still somewhat limited track record, we think a big deal would come with significant execution risk. While CFO Dave Anderson's history in deals with ITT is impressive, we think that most of the risk lies in the capabilities to integrate is cultural, at the operating levels of the organization, not with corporate. Valuation and Rating Analysis We value Honeywell shares based on P/E ratio. While the 15 multiple on 07E is about in line with the group, and the company continues to benefit from nice end market exposure, we believe the assets here deserve a discount for the limited visibility on legacy issues such as environmental, as well as ongoing fundamental under-performance in the assets, relative to competitors. Risks to Our Rating Risks to our rating relate to (1) greater than expected fundamental tailwind from the businesses, driving out performance in earnings growth; and (2) resolution of environmental items at a lower than expected cost, with favorable timing. 8

9 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 Honeywell within the past 12 months. Client of the Firm: Honeywell 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 Honeywell. 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 Honeywell. Non-Investment Banking Compensation: JPMSI has received compensation in the past 12 months for products or services other than investment banking from Honeywell. An affiliate of JPMSI has received compensation in the past 12 months for products or services other than investment banking from Honeywell. Honeywell (HON) Price Chart Date Rating Share Price ($) 18-Dec-03 OW Price Target ($) 50 OW Price($) Apr 03 Jul 03 Oct 03 Jan 04 Apr 04 Jul 04 Oct 04 Jan 05 Apr 05 Jul 05 Oct 05 Jan 06 Apr 06 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 over the entire period. As of Aug. 30, 2002, the firm discontinued price targets in all markets where they were used. They were reinstated at JPMSI as of May 19th, 2003, for Focus List (FL) and selected Latin stocks. For non-jpmsi covered stocks, 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. 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: C. Stephen Tusa, Jr. CFA: 3M (MMM), American Standard (ASD), Danaher (DHR), Dover (DOV), Emerson Electric Co. (EMR), General Electric Co. (GE), Honeywell (HON), ITT Industries (ITT), Rockwell Automation (ROK), SPX Corp. (SPW), Textron (TXT), Tyco Int'l Ltd. (TYC), W.W. Grainger (GWW) 9

10 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. 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11 Act Hong Kong: The 1% ownership disclosure as of the previous month end satisfies the requirements under Paragraph 16.5(a) of the Hong Kong Code of Conduct for persons licensed by or registered with the Securities and Futures Commission. (For research published within the first ten days of the month, the disclosure may be based on the month end data from two months prior.) J.P. Morgan Broking (Hong Kong) Limited is the liquidity provider for derivative warrants issued by J.P. Morgan International Derivatives Ltd and listed on The Stock Exchange of Hong Kong Limited. An updated list can be found on HKEx website: Korea: This report may have been edited or contributed to from time to time by affiliates of J.P. Morgan Securities (Far East) Ltd, Seoul branch. Singapore: JPMSI and/or its affiliates may have a holding in any of the securities discussed in this report; for securities where the holding is 1% or greater, the specific holding is disclosed in the Legal Disclosures section above. India: For private circulation only not for sale. General: Additional information is available upon request. Information has been obtained from sources believed to be reliable but JPMorgan Chase & Co. or its affiliates and/or subsidiaries (collectively JPMorgan) do not warrant its completeness or accuracy except with respect to any disclosures relative to JPMSI and/or its affiliates and the analyst s involvement with the issuer that is the subject of the research. Opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients. The recipient of this report must make its own independent decisions regarding any securities or financial instruments mentioned herein. JPMSI distributes in the U.S. research published by non-u.s. affiliates and accepts responsibility for its contents. Periodic updates may be provided on companies/industries based on company specific developments or announcements, market conditions or any other publicly available information. Clients should contact analysts and execute transactions through a JPMorgan subsidiary or affiliate in their home jurisdiction unless governing law permits otherwise. Revised April 3, Copyright 2006 JPMorgan Chase & Co. All rights reserved. 11

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