Diversified Industrials and Machinery chapter. Global Gambits The Right Moves for Right Now

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1 Global Gambits The Right Moves for Right Now Diversified Industrials and Machinery chapter See jpmorgansavant.com for gobal sector valuation tools The following is a chapter from Global Gambits The Right Moves for Right Now, dated. This chapter is presented for convenience, and should be read in conjunction with the full report and its analyst certifications and important disclosures. The full report is available on MorganMarkets.

2 Diversified Industrials and Machinery Cash Redeployment Is a Key Issue as Earnings Momentum Slows Global Sector Coordinator Gary F. McManus (1-212) gary.mcmanus@jpmorgan.com J.P. Morgan Securities Inc. Full sector coverage details on page 124 Key Drivers We expect the global manufacturing sector to see solid growth through JPMorgan economists expect global real GDP growth of 3.1% this year and 3.2% in 2006, only a slight slowdown from 3.8% growth in o North America: The economy appears to be modestly slowing, highlighted by declines in industrial production and consumer confidence in the second half of the year, though these numbers may be skewed by the impact of Hurricane Katrina. Quarterly GDP gains of 3-4% are expected for 2005 and 2006, after 4.4% growth in o Asia: GDP growth in China has continued at a robust pace in 2005, while moderating in Japan during the second half of the year. China s double-digit growth should settle near 8% in 2006 as interest rates and commodity prices rise. o Europe: Industrial production has been steady in 2H05, averaging 2-3% growth. GDP growth has averaged between 1% and 2% thus far in 2005 in the developed European economies, and is expected to continue in that range in M&A and capital spending are expected to accelerate in the US. We expect both M&A activity and capital spending to accelerate over the next few years, as industrial companies are now equipped with strong balance sheets, are generating good cash flow and are looking to redeploy cash in the form of product development, capacity expansion and acquisitions. US dollar could continue to strengthen. The US dollar has climbed approximately 5% versus the euro year-to-date, and JPMorgan strategists expect it to trade higher over the next six months as a result of continued Fed rate hikes. JPMorgan strategists forecast both the EUR/USD and JPY/USD rates to settle within a range (near 1.24 and 117, respectively) by the middle of Thus, European manufacturers may see some relief, while US manufacturers should no longer enjoy positive currency benefits. Our Non-Consensus Views Earnings growth could decelerate. Although fundamentals remain strong across most end-markets, we believe top-line growth and margin improvement could begin to decelerate over the next few years now that earnings are above normalized levels. JPMorgan forecasts average earnings growth for the industry could slow to 14% in 2006 from a 19% increase in 2005E. We believe the pricing/material cost relationship is likely to be play a big role with respect to margin improvement, as metal and petroleum-related material costs could continue to be volatile and some, but not all, companies are able to pass through rising material costs in the form of higher prices. We continue to favor high-quality industrial names. At this point in the economic cycle, we encourage trading up to higher quality diversified companies and moving out of the highly leveraged names. 119

3 Diversified Industrials: Top Picks Company Key Financials Rationale and Catalysts Waste Management Inc. Recommendation: Overweight Fiscal EPS (Local): Year-end December Ticker: WMI US / WMI E 2006E Exchange: NYSE P/E (Calendar) Price (Local): US$ E 2006E Mkt Cap (US$): 16.8 bn Analyst: Scott Levine EV/EBITDA (Calendar) Phone: (1-212) E 2006E scott.j.levine@jpmorgan.com Komatsu Ltd. Recommendation: Overweight Fiscal EPS (Local): Year-end March Ticker: 6301 JP / 6301.T E Exchange: Tokyo Stock Exchange P/E (Calendar) Price (Local): 1, E 2006E Mkt Cap (US$): 13.9 bn Analyst: Masayuki Mochizuki EV/EBITDA (Calendar) Phone: (813) E 2006E masayuki.mochizuki@jpmorgan.com Source: Company data, Datastream, JPMorgan estimates, JPMorgan SaVanT. Prices as of November 22, We think WMI is best suited for longer-term investors. It should outperform the group over time on an all-in basis (including dividends and repurchases). We believe that management s recent move to cut costs, exit underperforming markets and stubbornly push prices up should put the company on track to unlock what we think could be meaningful ROIC and FCF improvement over the next few years. WMI is trading at an industry-leading FCF yield of about 7%. The strong FCF is the best part of the story, in our view, with the share buyback and dividends making the risk/reward tradeoff superior to most of the other waste stocks in our coverage. Komatsu s 1H FY05 results were above estimates as demand for construction equipment continued to run ahead of expectations, particularly in North America. Sales at the industrial machinery and electronics segments were in line with expectations. We see results in FY05 and FY06 depending primarily on Komatsu s production capacity. The company has set its estimates assuming a realistic 5 10% rise in production capacity. Management believes it will most likely be able to maintain steady growth from the next fiscal year, taking into consideration: (1) the small risk of a downturn in demand, (2) product price hikes that more than offset higher material costs and expected benefits from lower-cost products, and (3) the profit expansion expected with the launch of new machine models designed to meet Tier III emission control standards. We maintain our Overweight rating and retain Komatsu on our Focus List with the target price of 1,810. Major risks to our rating and target price are: (1) a stronger yen, (2) a slowdown in the US economy, and (3) a drop in natural resource prices. 120

4 Diversified Industrials: Top Picks (cont d) Company Key Financials Rationale and Catalysts Fanuc Ltd. Recommendation: Overweight Fiscal EPS (Local): Year-end March Ticker: 6954 JP / 6954.T E Exchange: Tokyo Stock Exchange P/E (Calendar) Price (Local): E 2006E Mkt Cap (US$): 19.7 bn Analyst: Masayuki Mochizuki EV/EBITDA (Calendar) Phone: (813) E 2006E masayuki.mochizuki@jpmorgan.com MAN Recommendation: Overweight Fiscal EPS (Local): Year-end December Ticker: MAN GR / MANG.F E 2006E Exchange: Frankfurt Electronic P/E (Calendar) Price (Local): E 2006E Mkt Cap (US$): 7.0 bn H FY05 results were better than the company s expectation but roughly in line with our estimates. The weighting of relatively high-margin factory automation CNC equipment rose 2.9ppts Y/Y, contributing to a 1.4ppt rise in the operating margin to 38.3%. Management announced a dividend increase to 62, which would increase the dividend payout ratio from 13% to 16%. We think a sales slowdown, substantial margin deterioration from material cost increases, and a profit decline in 2H05 are unlikely. We believe full-year upward revisions are likely. We reiterate our Overweight rating. Risks are: (1) a peak in machine tool orders, (2) a sharp rise in material costs, and (3) yen appreciation. MAN saw strong order momentum in the last seven quarters. Top-line visibility remains good for 2006 for diesel engines, printing and turbomachines supported by strong order backlog, in our view. We expect truck revenues to benefit from the UK MoD contract as of In trucks, MAN is exposed primarily to Europe, which is less cyclical than the North and South American markets, limiting top-line risk. MAN is a restructuring, and not just a top-line driven, story, in our view. Cost-cutting potential exists in all core divisions and we expect the cost savings target of 300 million to be achieved over , which so far has been on track. Cost savings from labor negotiations of up to 100 million are not reflected in our forecasts. If achieved in full, it could imply up to 11% FY07E EPS upside. Analyst: Julia Varesko EV/EBITDA (Calendar) MAN s valuation is not demanding relative to its own trading history, and we believe the sector should support its share Phone: (44-20) E 2006E price. julia.varesko@jpmorgan.com ABB Recommendation: Overweight Fiscal EPS (Local): Year-end December Ticker: ABBN VX / ABBN VX E 2006E Ticker ADR: ABB US (0.02) Exchange: VIRT-X P/E (Calendar) Price (Local): SWF E 2006E Mkt Cap (US$): 17.9 bn Analyst: Andreas Willi EV/EBITDA (Calendar) Phone: (44-20) E 2006E andreas.p.willi@jpmorgan.com Source: Company data, Datastream, JPMorgan estimates, JPMorgan SaVanT. Prices as of November 22, Good end markets, pricing power, restructuring benefits and balance sheet restructuring should drive ABB s earnings growth. ABB is one of the best top-line stories in the sector, in our view, with high exposure to the capex cycle. The outlook for sizeable orders in power technology remains good, particularly in the Middle East, India and China. As of , energy bill-related orders should support growth in the US. In automaton, only robotics (7% of sales) faces a tough outlook while the group s exposure to oil and gas, minerals, marine and chemicals will likely drive the top line as capex recovery unfolds. We believe final resolution on asbestos could trigger an upgrade of ABB s debt rating to investment grade. 121

5 Diversified Industrials: Top Picks (cont d) Company Key Financials Rationale and Catalysts Dover Corporation Recommendation: Overweight Fiscal EPS (Local): Year-end December Ticker: DOV US / DOV E 2006E Exchange: NYSE P/E (Calendar) Price (Local): US$ E 2006E Mkt Cap (US$): 8.4 bn Analyst: C. Stephen Tusa, Jr., CFA EV/EBITDA (Calendar) Phone: (1-212) E 2006E stephen.tusa@jpmorgan.com Source: Company data, Datastream, JPMorgan estimates, JPMorgan SaVanT. Prices as of November 22, We see a pathway to a significantly higher base of earnings, and a higher stock price, on a change in the earnings bias and visible potential catalysts (e.g., asset sales). An attractive mix of commercial growth and high quality industrial assets, with a slant towards energy equipment, is the highlight of the fundamental outlook. This story often goes under-appreciated, in our view, given the market s focus on CAT that clouds what we see as a strong multi-year, earnings growth story. New CEO Ron Hoffman is leading the charge on improving under-earning businesses, roughly 40% of the portfolio, to achieve the DOV operating margin target of 15%, which we view as a key to potential earnings upside in 2006 and beyond. Portfolio management offers upside potential, as the company is disciplined in finding under-appreciated niche situations in the manufacturing landscape, swapping low return businesses for more attractive assets. 122

6 Diversified Industrials: Stocks to Underweight Company Key Financials Rationale and Catalysts Waste Industries USA, Inc. Recommendation: Underweight Fiscal EPS (Local): Year-end December WWIN s shares currently trade at a 23% discount to the waste group on 2005E EV/EBITDA. We believe this discount Ticker: WWIN US / WWIN E 2006E is warranted given the company s large inside ownership position, illiquid trading activity, industry-low profit margins, and uncertain free cash flow profile. Exchange: NASDAQ P/E (Calendar) Price (Local): US$ E 2006E Mkt Cap (US$): 0.2 bn Analyst: Amanda Tepper EV/EBITDA (Calendar) Phone: (1-212) E 2006E amanda.tepper@jpmorgan.com Electrolux Recommendation: Underweight Fiscal EPS (Local): Year-end December Ticker: ELUXB SS / ELUXb.ST E 2006E Exchange: Stockholm Stock Exchange P/E (Calendar) Price (Local): Skr E 2006E Mkt Cap (US$): 7.1 bn Analyst: Andreas Willi EV/EBITDA (Calendar) Phone: (44-20) E 2006E andreas.p.willi@jpmorgan.com Source: Company data, Datastream, JPMorgan estimates, JPMorgan SaVanT. Prices as of November 22, We do not think the market has focused on the company s uncertain free cash flow profile, given its spending plans for landfill development. Although WWIN s landfill development plans could ultimately drive margins higher, these projects are inherently risky, time-consuming and capital intensive. Our main concern about Electrolux relates to a slowdown in consumer spending on appliances. Volumes in the US, the UK, Australia and Latin America have been running above trend, and in the latter three markets, demand has turned negative in the third quarter of Housing markets are peaking in all these markets, which account for half of Electrolux s sales. While Electrolux has demonstrated good progress in stabilizing profitability in these regions, the topline outlook is less attractive than in the broader capital goods sector. Industry continues to be under pressure due to the entry of new competitors from Asia and Eastern Europe. Continued restructuring is needed in order to maintain margins. Electrolux plans to spend Skr10 billion on restructuring and Skr20 billion on capex to save Skr3 billion annually in four year s time, implying low pay back. 123

7 JPMorgan Global Diversified Industrials and Machinery Team Research Equity Research Credit Research Capital Goods Machinery Multi-Industry Environmental Services Gary McManus Americas Americas Americas Americas Americas Global Sector Coordinator United States Gary McManus Sabina Chatterjee Monica Parekh Phil Gresh Curtis Woodworth Alex Johnson United States Gary McManus Sabina Chatterjee Monica Parekh United States C. Stephen. Tusa, Jr., CFA Patrick Baumann Curtis Woodworth Alex Johnson United States Amanda Tepper Scott Levine United States Latin America EMEA EMEA EMEA Pan Europe Andreas Willi Nicholas Paton Julia Varesko Khatija A. Ladhani (HG Industrials) Akasha Redrick (HY-Industrials) William W. Perry South Africa John Thompson Pan Europe Ide Kearney (HG/HY including Distressed & Special Situations) Nachu Nachiappan (HG/HY) Nitin Dias (HG/HY) Alex Ayoub (HG/HY Asia Pacific Asia Pacific Asia Pacific Asia Pacific Asia Pacific India Gautam Chhaochharia China Christie Ju Japan Masayuki Mochizuki Australia, New Zealand Allison Bellows Tiernan Japan Masayuki Mochizuki Yumi Ochi Hong Kong Ex-Japan Asia See page 193 for team member contact details. Steven Li Hetal Shah, CFA Billy Ng Singapore Winnifred Heap Philippines Kelly Lim South Korea JM Pak Singapore Winnifred Heap Malaysia Joe Liew Taiwan Nick Lai Prasoon Dayal Sanjai Vohra Joe Z Xiang Mana Nakazora 124

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9 Investment Banking (past 12 months): JPMSI or its affiliates received in the past 12 months compensation for investment banking services from Alcatel, China Oriental, Chinatrust Financial Holdings, Henderson Land Development, Komatsu (6301), Mitsubishi UFJ Financial Group (8306), Pacific Basin Shipping, San Miguel Corporation, Standard Chartered. 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 Alcatel, CapitaLand, China Oriental, Chinatrust Financial Holdings, Henderson Land Development, Hyundai Motor, Komatsu (6301), Mitsubishi UFJ Financial Group (8306), NEC Electronics (6723), Pacific Basin Shipping, San Miguel Corporation, Standard Chartered. Non-Investment Banking Compensation: JPMSI has received compensation in the past 12 months for products or services other than investment banking from Alcatel, Chinatrust Financial Holdings, Hyundai Motor, Ibiden (4062), Japan Tobacco (2914), Komatsu (6301), NEC Electronics (6723), San Miguel Corporation, Standard Chartered. An affiliate of JPMSI has received compensation in the past 12 months for products or services other than investment banking from CapitaLand, Chinatrust Financial Holdings, Hyundai Motor, Komatsu (6301), NEC Electronics (6723), San Miguel Corporation, Standard Chartered. Explanation of 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. JPMorgan Equity Research Ratings Distribution, as of September 30, 2005 Overweight (buy) Neutral (hold) JPM Coverage 40% 42% 18% IB clients* 46% 45% 39% JPMSI Equity Research Coverage 34% 49% 17% IB clients* 65% 55% 45% Underweight (sell) *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: 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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