Diversified Industrials and Machinery chapter. Global Gambits The Right Moves for Right Now. See jpmorgansavant.com for global sector valuation tools

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1 June 28, 2006 Global Gambits The Right Moves for Right Now Diversified Industrials and Machinery chapter The following is a chapter from, dated June 28, 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 Strong Sector Performance Could Slow as Earnings Growth Decelerates Global Sector Coordinator Gary F. McManus, CFA (1-212) J.P. Morgan Securities Inc. Full sector coverage details on page 8 Key Drivers The global manufacturing sector should remain strong through JPMorgan economists expect global real GDP growth of 3.5% this year and 3.3% next year, in line with growth in Although near-term global manufacturing activity could moderate, the change could be modest, with Western Europe and China offsetting a slowdown in the US and Asia (ex-china). o North America: 1H06 is shaping up strong, evidenced by gains in industrial production and higher consumer confidence. The manufacturing sector is well positioned to maintain solid but moderating growth, given forward momentum in equipment spending and exports, lean inventories and impressive backlogs. US GDP growth of 3% is projected for 2H06, after an impressive 5.3% in 1Q and 2.5% in 2Q. o Asia: Momentum in China continues with consistent broadbased strength in activity. GDP growth could come off its double-digit pace in 2006, as policy-tightening measures are considered. Japan s growth appears to be moderating, with production expected to weaken as firms reduce the pace of inventory accumulation. The BoJ will likely end its zero rate policy in July. o Europe: Higher consumption helped fuel robust first quarter growth. Manufacturing utilization rates have trended higher, while signs of a pass-through of higher material costs to the consumer level have emerged. But concerns of lackluster employment growth and higher inflation are likely to contain GDP growth to between 2% and 3% for M&A and capital spending could accelerate. We expect the pace of M&A activity and capital spending to pick up in the next few years, as industrial companies equipped with strong balance sheets and good cash flow generation seek to redeploy cash via product development, capacity expansion and acquisitions. Companies in the European region in particular have ramped up borrowing to finance capex and working capital investments. The US dollar has weakened recently. Thus far this year, the dollar has fallen 8% and 5% against the euro and the yen, respectively. JPMorgan strategists project further declines, reflecting the push for a lower US dollar to address increasing trade flows. Specifically, JPMorgan forecasts a rise in the /US$ to 1.36 and a fall in the US$/ to 106 by year-end. This could translate into positive currency benefits for US manufacturers, while European manufacturers get adversely impacted. 2

3 Our Non-Consensus Views Earnings growth could decelerate. Although fundamentals remain strong across most end-markets, top-line growth and margin improvement could begin to moderate over the next few years now that earnings are above normalized levels. The pricing/material cost relationship is likely to have a large impact on margin improvement, as metal and petroleum related materials costs could remain volatile. Only some companies will be 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. We also favor companies exposed to the non-residential construction sector. 3

4 Diversified Industrials: Top Picks Company Key Financials Rationale and Catalysts ABB Rating: Overweight Fiscal EPS (Local): Year-end Dec. Ticker: ABBN VX / ABBN.VX E 2007E Exchange: VIRT-X P/E (Calendar) Price (Local): CHF E 2007E Mkt Cap (US$): 24.5 bn Good end-markets, pricing power, restructuring benefits and balance sheet restructuring are all driving earnings growth at the same time. We thnk ABB is one of best top-line stories in the sector with high exposure to the capex cycle. The outlook for sizable orders in power technology remains good, particularly in the Middle East, India and China. As of 2006/07, energy bill related orders should support growth in the US. In automation, only robotics (7% of sales) faces a tough outlook while the group s exposure to oil and gas, minerals, marine and chemicals looks likely to drive top-line growth as capex recovery unfolds. Analyst: Andreas Willi EV/EBITDA (Calendar) ABB faces an opportunity to restructure its balance sheet and deploy excess cash in an accretive way. Phone: (44-20) E 2007E andreas.p.willi@jpmorgan.com Atlas Copco Rating: Overweight Fiscal EPS (Local): Year-end Dec. Ticker: ATCOA SS / ATCOa.ST E 2007E Exchange: Stockholm Stock Exchange P/E (Calendar) Price (Local): SEK E 2007E Mkt Cap (US$): 16.1 bn Analyst: Nick Paton, CFA EV/EBITDA (Calendar) Phone: (44-20) E 2007E Nicholas.j.paton@jpmorgan.com Daikin Industries Rating: Overweight Fiscal EPS (Local): Year-end Mar. Ticker: 6367 JP / 6367.T E 2007E Exchange: Tokyo Stock Exchange P/E (Calendar) Price (Local): 3, E 2007E Mkt Cap (US$): 8.1 bn Analyst: Masayuki Mochizuki EV/EBITDA (Calendar) Phone: (81-3) E 2007E masayuki.mochizuki@jpmorgan.com Source: Company data, Bloomberg, JPMorgan estimates, JPMorgan SaVanT. Prices as of June 15, We believe Atlas Copco is one of the highest-quality industrial businesses in the world that should trade at a premium valuation. The company is in the process of selling its rental equipment business in We believe that the price achieved could be a positive catalyst. The company is most likely going to buy back shares with the proceeds. Excluding the rental business, Atlas Copco is a high-quality industrial business with high-double-digit EBIT margins, above 40% ROCE and a high proportion of aftermarket and services, resulting in low EPS cyclicality and aboveaverage cash returns. The company s main industrial end-markets are process industries and mining/construction, which are experiencing a multi-year upturn. Its compressor business is also driven by high energy costs, which make it more attractive for owners to upgrade their compressors. Daikin has recently announced its intention to purchase OYL, which lays the groundwork for it becoming a global leader in the air-conditioning market. The combination of Daikin and OYL should generate strong competitive advantages, in our opinion. The acquisition should give Daikin a speedier route to the North American market, and also allow it to absorb expertise in the production and development of low-cost products that will help it catch up with the hyper-growth of emerging markets. Management forecasts FY06 OP of 76 billion, rising to billion in FY08. We rate Daikin Overweight with a 4,020 fair value estimate, based on projected FY06 earnings. As potential risk factors, we cite: (1) a slowdown in the global market for air-conditioning equipment; (2) a slowdown in the North American economy, delaying recovery in demand for fluoride; and (3) a strong yen (particularly against the euro). 4

5 Diversified Industrials: Top Picks (cont d) Company Key Financials Rationale and Catalysts Dover Rating: Overweight Fiscal EPS (Local): Year-end Dec. Ticker: DOV US / DOV E 2007E Exchange: NYSE P/E (Calendar) Price (Local): US$ E 2007E Mkt Cap (US$): 9.4 bn Analyst: C. Stephen Tusa, Jr. CFA EV/EBITDA (Calendar) Phone: (1-212) E 2007E stephen.tusa@jpmorgan.com Attractive industrial exposure, with a slant towards energy equipment, a key to above-average earnings growth, is underappreciated by the market, given an obsession with the CAT group that masks the positive fundamentals that continue to unfold. Energy markets remain strong, a positive for the company s biggest earner, Resources, and we believe continued growth in this area will ultimately be recognized in a higher stock multiple. CEO Hoffman is focused on execution of key operating metrics, which include the 15% margin target, working capital to sales of 20%, and inventory turns of 8x, driving improvement in an already solid earnings and cash flow story. Following the recent acquisition of Knowles, solid FCF, averaging 8-10% of sales, has helped to reload the balance sheet, providing the power for additional value creation through portfolio development. Management is disciplined in finding underappreciated niche situations in the manufacturing landscape. United Rentals Inc. Rating: Overweight Fiscal EPS (Local): Year-end Dec. Ticker: URI US / URI E 2007E Exchange: NYSE P/E (Calendar) Price (Local): US$ E 2007E Mkt Cap (US$): 2.3 bn Analyst: Gary F. McManus, CFA EV/EBITDA (Calendar) Phone: (1-212) E 2007E gary.mcmanus@jpmorgan.com Source: Company data, Bloomberg, JPMorgan estimates, JPMorgan SaVanT. Prices as of June 15, We believe URI shares should continue to outperform the overall machinery group. Factors influencing our positive view include: The equipment rental industry has strong fundamentals. The key non-residential construction market has shown accelerating growth in early 2006 and is in the third year of what could be an eight-year cycle. Industry profitability may be in a positive secular trend, as rental companies look to increase rental rates to cover high capital spending requirements. Good margin improvement is yet to come. While the operating margin has increased in the past several years, URI has many additional levers with which to improve performance, including continued pricing gains, better SG&A discipline, a decline in SEC inquiry-related costs, a turnaround in the troubled traffic control unit, and strong growth in the contractor supplies business. URI has a compelling valuation, in our view. While performing well in the past year, its stock is selling at just 6.2x our projected peak EPS of US$4.65, well below the machinery group average of 9.0x. Also, on a 2007E EV/EBIT basis, URI s multiple of 7.1x is far below the average machinery group multiple of 9.4x. We like the fact that URI is less than halfway through its earnings cycle, while most machinery names are about two-thirds through the cycle. 5

6 Diversified Industrials: Top Picks (cont d) Company Key Financials Rationale and Catalysts Wesco Rating Overweight Fiscal EPS (Local): Year-end Dec. Ticker: WCC US / WCC E 2007E Exchange: NYSE P/E (Calendar) Price (Local): US$ E 2007E Mkt Cap (US$): 3.1 bn Analyst: Curt Woodworth, CFA EV/EBITDA (Calendar) Phone: (1-212) E 2007E curtis.woodworth@jpmorgan.com Source: Company data, Bloomberg, JPMorgan estimates, JPMorgan SaVanT. Prices as of June 15, We expect Wesco s strong organic growth rates to continue in excess of end-market growth, driven by market share gains and growth in national accounts, as well as benefits of targeted marketing initiatives with select OEMs. We believe the company has significant opportunity to expand its margin further as the strong top-line growth should be enhanced by mix benefits from later cycle project work, which carries high incremental margins and additional lean benefits. We view the 6.2% EBIT margin achieved during 1Q06 as a base level for the company going forward and look for moderate improvements over the next few quarters. Wesco recently established a three-year margin target of 8.0% (excluding acquisition benefits), which we believe is attainable. We look for additional acquisitions over the next month time frame as the company s current capital structure is near the best levels ever. Wesco has a very powerful acquisition model given strong capabilities in IT and data analytics, low capital intensity, significant buying power, and the best-in-class management team. Note that we have very conservatively assumed no potential acquisition benefits in our forecasts. WCC (12.3x 2007E EPS; 8.5x 2007E EBITDA; 8% 2007E FCF yield) trades at a discount to peers. We believe the discount is unwarranted given that it has the most desirable end-market exposure of its peers, in our view, and greater potential for acquisition upside. 6

7 Diversified Industrials: Stocks to Underweight Company Key Financials Rationale and Catalysts American Standard Rating: Underweight Fiscal EPS (Local): Year-end Dec. Ticker: ASD US / ASD E 2007E Exchange: NYSE P/E (Calendar) Price (Local): US$ E 2007E Mkt Cap (US$): 8.5 bn Analyst: C. Stephen Tusa, Jr., CFA EV/EBITDA (Calendar) Phone: (1-212) E 2007E stephen.tusa@jpmorgan.com Electrolux Rating: Underweight Fiscal EPS (Local): Year-end Dec. Ticker: ELUXB SS / ELUXb.ST E 2007E Exchange: Stockholm Stock Exchange P/E (Calendar) Price (Local): SEK E 2007E Mkt Cap (US$): 4.5 bn Analyst: Andreas Willi EV/EBITDA (Calendar) Phone: (44-20) E 2007E andreas.p.willi@jpmorgan.com Source: Company data, Bloomberg, JPMorgan estimates, JPMorgan SaVanT. Prices as of June 15, We recommend that investors move into names that we believe offer more fundamental visibility than American Standard in what is looking to be another solid, yet increasingly volatile, year for the industrial economy. While we acknowledge that ASD is not a pure play on housing, it is the most exposed to residential construction in our group, a negative from a macro perspective, and our main concern remains Bath and Kitchen, though Vehicle should also continue to slow. The company should see growth in 2006E, and while guidance could be positive on high expectations for 13 SEER, we see uncertainties regarding how the transition might play out. We see the potential for major asset sales (B/K), cash from which would re-load a balance sheet story that we believe is already well absorbed by the market. However, selling a broken unit that is approaching a peak in 40% of its business, with sluggish performance in another 50%, is easier said than done, and we believe a less-than-attractive price tag here would only reinforce what we view as an unfavorable sum-of-the-parts argument. Our main concern with 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 the sales of the company. 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. The industry continues to be under pressure from the entry of new competitors from Asia and Eastern Europe. Continued restructuring is needed in order to maintain margins. Electrolux will spend Skr10 billion on restructuring and Skr20 billion on capex to save Skr3 billion annually in four year s time, implying low pay back. 7

8 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 Latin America Gary McManus Sabina Chatterjee Monica Parekh Phil Gresh Curtis Woodworth Alex Johnson Ricardo Fernandez United State Latin Americas Gary McManus Sabina Chatterjee Monica Parekh Ricardo Fernandez United States Latin America Stephan Tusa Patrick Baumann Curtis Woodworth Alex Johnson Ricardo Fernandez United States Amanda Tepper Scott Levine United States Latin America EMEA EMEA Pan Europe Andreas Willi Pan Europe Nicholas Paton, CFA Julia Varesko Vanessa Guy Khatija A. Ladhani (HG Industrials) Yilma Abebe (HY- Industrials) Brian Chen (HY- Industrials) William W Perry Nachu Nachiappan (HG/HY) Nitin Dias (HG/HY) Alex Ayoub (HG/HY Asia Pacific Asia Pacific Asia Pacific Asia Pacific Asia Pacific India Gautam India Gautam Chhaochharia China Christie Ju India Gautam Chhaochharia Australia, New Zealand Allison Bellows Tiernan Chhaochharia Karen Li, CFA Japan Masayuki Mochizuki Yumi Ochi Hong Kong Steven Li, CFA Billy Ng Japan Masayuki Mochizuki Yumi Ochi Ex-Japan Asia Singapore Winnifred Heap India Gautam Chhaochharia South Korea JM Pak Indonesia Fordyanto Widjaja, CFA Philippines Maria Corpuz Taiwan John Chung Nick Lai Singapore Winnifred Heap Prasoon Dayal Sanjai Vohra Joe Z Xiang Mana Nakazora 8

9 Companies Recommended in This Report (prices as of COB 19 June 2006) Daikin Industries (6367) (6367.T/ 3,540/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 Client of the Firm: Daikin Industries (6367) is or was in the past 12 months a client of JPMSI; during the past 12 months, JPMSI provided to the company non-securitiesrelated services. Daikin Industries (6367) (6367.T) Price Chart 6,760 5,915 5,070 4,225 N OW Date Rating Share Price (Y) 24-Nov-04 N Aug-05 OW Price Target (Y) Price(Y) 3,380 2,535 1, Jun 03 Sep 03 Dec 03 Mar 04 Jun 04 Sep 04 Dec 04 Mar 05 Jun 05 Sep 05 Dec 05 Mar 06 Jun 06 Source: Reuters and JPMorgan; price data adjusted for stock splits and dividends. Initiated coverage Nov 24, 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. Important Disclosures for Equity Research Compendium Reports: Important disclosures, including price charts for all companies under coverage for at least one year, are available through the search function on JP Morgan s website or by calling this U.S. toll-free number ( ) Explanation of Equity Research Ratings and Analyst(s) Coverage Universe: 9

10 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. JPMorgan Equity Research Ratings Distribution, as of April 3, 2006 Overweight (buy) Neutral (hold) Underweight (sell) JPM 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. Other Disclosures Options related research: If the information contained herein regards options related research, such information is available only to persons who have received the proper option risk disclosure documents. For a copy of the Option Clearing Corporation s Characteristics and Risks of Standardized Options, please contact your JPMorgan Representative or visit the OCC s website at Legal Entities Disclosures U.S.: JPMSI is a member of NYSE, NASD and SIPC. J.P. Morgan Futures Inc. is a member of the NFA. J.P. Morgan Chase Bank, N.A. is a member of FDIC and is authorized and regulated in the UK by the Financial Services Authority. U.K.: J.P. Morgan Securities Ltd. (JPMSL) is a member of the London Stock Exchange and is authorised and regulated by the Financial Services Authority. South Africa: J.P. Morgan Equities Limited is a member of the Johannesburg Securities Exchange and is regulated by the FSB. Hong Kong: J.P. Morgan Securities (Asia Pacific) Limited (CE number AAJ321) is regulated by the Hong Kong Monetary Authority and the Securities and Futures Commission in Hong Kong. Korea: J.P. Morgan Securities (Far East) Ltd, Seoul branch, is regulated by the Korea Financial Supervisory Service. Australia: J.P. Morgan Australia Limited (ABN /AFS Licence No: , regulated by ASIC) and J.P. Morgan Securities Australia Limited (ABN /AFS Licence No: , a Market Participant with the ASX) (JPMSAL) are licensed securities dealers. New Zealand: J.P. Morgan Securities New Zealand Limited is a New Zealand Exchange Limited Market Participant. Taiwan: J.P.Morgan Securities (Taiwan) Limited is a participant of the Taiwan Stock Exchange (company-type) and regulated by the Taiwan Securities and Futures Commission. India: J.P. Morgan India Private Limited is a member of the National Stock Exchange of India Limited and The Stock Exchange, Mumbai and is regulated by the Securities and Exchange Board of India. Thailand: JPMorgan Securities (Thailand) Limited is a member of the Stock Exchange of Thailand and is regulated by the Ministry of Finance and the Securities and Exchange Commission. Indonesia: PT J.P. Morgan 10

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