Domestic demand slows. Risks in our fair values.

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1 EQUITY RESEARCH Special Report April 17th, 2014 Domestic demand slows. Risks in our fair values. During last 12 months, we have observed a significant slowdown in the Peruvian economy, as a consequence of the private investment s lower growth. This occurred due to both local and international factors. Kallpa SAB assumes a 5.0% annual growth in the Peruvian economy for the next 10 years (5.5% for 2104 and 2015). This growth is applied to finanacial models from companies whose performance depend on the domestic economy. Additionally, we estimate a perpetuity rate over the base of the companies potential growth and investment levels which would allow its achievement. Alberto Arispe Head of Research (511) aarispe@kallpasab.com Marco Contreras Senior Analyst (511) mcontreras@kallpasab.com However, there are fears in the market with regard to a deeper economic slowdown than that of Although we do not share this point of view, we believe appropriate to carry out a sensitivity analysis for our fair values before lower expected growth rates. Table N 1: Fair values In order to make the exercise simple, we apply 0.5% and 1.0% discounts to our perpetual growth rates (given that most of the relies upon perpetuity) and we evaluate their effects over our recommendations. We evaluate the following companies: Company i. Credicorp Ltd. (NYSE: BAP, LSE: BAP) Source: Kallpa SAB ii. Alicorp S.A.A. (LSE: ALICORC1) iii. InRetail Perú Corp. (LSE: INRETC1) iv. Graña y Montero S.A.A. (NYSE: GRAM, LSE: GRAMONC1) v. Ferreycorp S.A.A. (LSE: FERREYC1) BAP ALICORC1 INRETC GRAMONC FERREYC Recommend. Hold Buy Hold Buy Buy From the exercise, we observe that in most cases, fair values with a 1.0% discount over the perpetual growth rate have a close approximation to current market prices. This indicates us that, certainly, the market may be starting to discount a deeper slowdown in the Peruvian economy. We maintain our 5.0% growth assumption for the Peruvian economy, and we believe that the market is overreacting. Consequently, we think that many shares are trading significantly below their fair values, so they represent attractive investment alternatives. From the analysis, we choose as Alicorp and Grana y Montero as our top picks, since we believe that they offer the best risk-return balances for the investor. Alicorp represents a leverage on private consumption, particularly the Peruvian consumption. This economic variable, unlike private investment, is less volatile and sensitive to the market s volatility, a reason for which we like this company. Currently, the company is focused on integrating and creating synergies with its latest acquisitions, and on strengthening its balance sheet in order to face new M&A opportunities. Risk to be considered: i) volatility in commodity prices (wheat and soybean); and, ii) M&A risk. Although Grana y Montero is leveraged on the construction industry, which is much sensitive to private investment, we believe that there is an attractive potential growth in the infrastructure business unit. The recent IPO carried out in NYSE and the low indebtedness level, give the company a solid position for developing projects in this segment. Risks to be considered: i) construction industry risk; and ii) execution risks.

2 Mar-10 Jun-10 Sep-10 Dic-10 Mar-11 Jun-11 Sep-11 Dic-11 Mar-12 Jun-12 Sep-12 Dic-12 Mar-13 Jun-13 Sep-13 Mar-10 Jun-10 Sep-10 Dic-10 Mar-11 Jun-11 Sep-11 Dic-11 Mar-12 Jun-12 Sep-12 Dic-12 Mar-13 Jun-13 Sep-13 Dic-13 Mar-14 Ene-04 Jul-04 Ene-05 Jul-05 Ene-06 Jul-06 Ene-07 Jul-07 Ene-08 Jul-08 Ene-09 Jul-09 Ene-10 Jul-10 Ene-11 Jul-11 Ene-12 Jul-12 Ene-13 Jul-13 Domestic demand slows. Risks in our fair values. What happened with Peru? Market consensus agrees with Peru s attractive growth story during last 10 years. There are several factors, but an average 6.6% annual GDP growth and a 2.9% average inflation controlled by the Central Bank's monetary policy, attracted the attention of several investors. Chart Nº 1: Peru - GDP growth % Chart Nº 2: Peru - Inflation % 10% 7% 6% 8% 6% Average: 6.6% 5% 4% 3% Average: 2.9% 4% 2% 1% 2% 0% -1% 0% Source: Peru's Central Bank Source: Peru's Central Bank However, in the last years we have observed a slowdown in the Peruvian economy which was accentuated in 2013, as a consequence of adverse domestic and global conditions. Globally, there were two outstanding events. First of all, expectations and the subsequent announcement regarding the tapering of the QE in the US brought volatility to financial markets (stocks, bonds, currencies, etc.) around the world. This provoked a strengthening in the US dollar, an increase in the yields from T-bonds (hence they became more attractive), and a capital outflow (capital invested in emerging markets returned to the US). Secondly, the slowdown in the Chinese economy brought lower expectations over the demand of industrial metals. This resulted in lower metal prices, as that from copper, which represented 23.6% of Peruvian exports in Domestically, the government has not reacted opportunely to global events, and occasionally, it has made decisions which discouraged private investment. This is observed in the investment expectation and the consumer confidence indexes, which registered minimum levels in mid Chart Nº 3: Peru - Investment expectation in 6 months > 50: Investments are accelerated Chart Nº 4: Peru - Consumer confidence index > 50: Optimistic trench < 50: Investments are decelerated < 50: Pessimistic trench Source: Peru's Central Bank, Apoyo Source: Peru's Central Bank, Apoyo The main effects from these events were: i) a strong deceleration in private investment, which until that moment, was the promoter of the country s growth; and, ii) a strong depreciation of the local currency, which far from encouraging exports, originated a negative wealth effect in consumers and companies, given the country s strong dollarization (debts in US dollars). 2

3 What should we expect? Market consensus estimates 5.3% and 5.6% GDP growth rates for 2014 and 2015, respectively. On the other hand, the Central Bank is more optimistic and estimates growths for 6.0% and 6.5%, respectively. These growth rates will be propelled by the mining and construction industries. Does it make sense to expect the economic growth s recovery? Despite the fall in investment expectations, its recovery is expected in the next years due to the large amount of projects to be executed in the mining and infrastructure industries. Naturally, like any project, there is always an execution risk, but we are confident that these projects will be executed (some projects with more delays than others). Table N 2: Mining project portfolio (January 2014) Table N 3: Infrastructure gap (2012) Company Project Investment ( MM) Industry Sub-industry Investment ( MM) Xstrata Copper Las Bambas 5,200 Energy Electricity 32,297 Newmont Mining Minas Conga 4,800 Transport Road networks 12,791 Freeport-Macmoran Cerro Verde's expansion 4,400 Telecommunications Broadband 11,852 Chinalco Toromocho 3,500 Hydraulic infrastructure Hydraulic Infrastructure 8,682 Anglo American Quellaveco 3,300 Transport Railways 7,308 Nanjinzhao Group Pampa de Pongo 2,800 Telecommunications Mobile Telephony 4,973 Minera Centauro Quicay II 2,500 Water and sanitation Sewerage 3,766 Others 33,082 Others 6,306 TOTAL 59,582 TOTAL 87,975 Source: MINEM Source: AFIN What happened in the market? Capital outflow, local currency s depreciation, and a widespread deceleration in the economic activity, provoked a negative reaction in the market, which until that moment, had rewarded the companies related to the domestic demand. INCA, our stock exchange s representative index, which until some years ago had had a mixed behavior by the mix of companies related to the domestic demand with mining companies, marked a significant decrease since early Chart Nº 5: INCA Ene-11 Abr-11 Jul-11 Oct-11 Ene-12 Abr-12 Jul-12 Oct-12 Ene-13 Abr-13 Jul-13 Oct-13 Ene-14 Abr-14 Source: Bloomberg What is going to happen? There are better economic perspectives from 2014 onwards. Peru's Central Bank is stimulating credit growth with lower reserve requirements, the government is granting the concession of some public investment projects, private investment projects are being executed, and the global environment seems a bit more stable. Nevertheless, the domestic market still does not change its trend. Why? Much is due to our stock exchange s low liquidity, among other factors, but we believe that the market have overreacted and that there is value in companies related to the domestic demand. Hence we believe that there are attractive investment opportunities. However, we think about what the market may be discounting from current market prices. 3

4 A sensitivity exercise We carry out a sensitivity exercise for our fair values, since we believe that the market may be discounting lower economic growth expectations. In order to make the exercise simple, we will reflect the lower expectations in reductions in our perpetual growth rate of 0.5% and 1.0%. Additionally, we emphasize that each perpetual growth rate was estimated taking into account the potential growth of the companies and their investment levels in the long term. We analyze the following companies within our coverage universe, since we believe that they have the highest relation with the domestic demand. Table N 4: Analyzed companies under coverage Credicorp Credicorp is a good reflection of the peruvian economy, since Banco de Credito, the holding's main asset, participates financing almost every industry in several segments (corporate, consumption, microenterprises, amonth others). Alicorp 63% of its revenues are orignated in Peru and it is associated to private consumption when producing mass consumption goods in diferrent categories, where it leads the market (detergents, edible oil, pastas, cookies, among others). InRetail It has 100% of its operations in Peru. Although the formal retail penetration is still low in Peru, the company's development may be a good indicator regarding the sentiment of Peruvian consumers. Grana y Montero Peru represents approximately 80% of its activities. Its core business, particularly engineering & construction, is directly linked to private investment's evolution. Nevertheless, it is expected that the lower dynamism in the construction unit is compensated by higher a development in the infrastructure unit. Ferreycorp Although it is a company much linked to the mining industry (45-50% of its revenues), it is also sensitive to the domestic economy's performance, given that the rest of its sales are consumed in several industries related to the domestic demand (agroindustry, commerce, services, among others). Source: Credicorp, Alicorp, InRetail, Graña y Montero, Ferreycorp, Kallpa SAB Below we present our fair values after sensitizing our perpetual growth rate (g): Table N 5: Fair values' sensitivity Company Credicorp Alicorp InRetail Graña y Montero Ferreycorp Source: Kallpa SAB Base case scenario Perpetual growth: -0.5% g Upside g Upside 5.00% 4.00% 3.50% 5.00% 5.00% % 19.28% 3.23% 15.78% 40.63% 4.50% 3.50% 3.00% 4.50% 4.50% % 9.04% -4.39% 9.35% 22.50% Perpetual growth: -1.0% g Upside 4.00% % 3.00% % 2.50% % 4.00% 4.00% % 7.50% From the exercise, we observe that many of our fair values decrease almost up to current market levels. We believe that this is due to the fact that, certainly, the market is taking into account more pessimistic perspectives with regard to the Peruvian economic growth. In Kallpa SAB, we believe that the Peruvian economy will register a 5.0% average growth rate in the next 10 years (5.5% in 2014 and 2015). Under these assumptions, we believe that there are attractive investment opportunities, given current market prices. 4

5 What do we recommend? We believe that now is a good opportunity to have exposure to certain companies related to the domestic economy, which offer the investor a good risk-reward balance. We choose Alicorp and Grana y Montero as our top picks. Alicorp: The company represents a strong leverage on the Peruvian private consumption (63% of its revenues are originated in Peru), which is a stable and slightly volatile component of the Peruvian economy (unlike private investment). The company s current strategy is focused on: i. ii. iii. Consolidating its latest acquisitions within the company s operations, through the creation of synergies and economies of scale. Organic growth through the launch of new products and the company s incursion in new categories. A constant search of M&A opportunities, which will allow the company to achieve its 5,000 MM sales goal for the year Main risks are: i. ii. iii. Commodity risk: Although wheat and soybean prices have increased 11.4% and 15.7% YTD, respectively, we believe that the company s hedging strategy will partially offset the cost of sales volatility. It is true that this volatility may affect the company in the short-term (particularly towards this year s second half), nevertheless, it does not seem to us relevant in the long-term. Execution risk: The introduction of new products and the incursion in new categories implies an execution risk, given the probability that the company s expectations are not achieved. Let us recall that in the case of Alicorp, there have been success stories (e.g. mayonnaise), and cases which did not meet the company s strategy and goals (e.g. icecreams). M&A risk: The inorganic expansion leads to an overpaying risk and that the acquired companies do not generate synergies and the expected value added. Grana y Montero: We believe that this company has a high growth potential supported by its infrastructure business unit, which will benefit from the large amount of public investment projects to be executed in the next years ( 88,000 MM infrastructure gap). Additionally, private investment might recover its dynamism, and with it, the engineering & construction business unit, due to the mining projects portfolio s execution ( 60,000 MM). As an example of the above, Via Expresa Javier Prado project was recently awarded to Grana y Montero, which will demand a 800 MM investment not yet included in the company s backlog. Additionally, the company is evaluating certain projects for 18,300 MM which would give an additional upside to the company s value. It is worth mentioning that Grana y Montero has a good cash position ( 959 MM) and low indebtedness levels (Debt/Equity: 0.25x) which will allow the company to finance the significant CAPEX for infrastructure projects. Main risks are: i. ii. Risk inherent to the construction industry: We highlight the industry s cyclical behavior, which responds to private investment s volatility. Execution risk: Among the awarded projects, there is a risk of delays at different development stages, and that the cash generation does not occur at the estimated dates. 5

6 Appendix - Disclaimer Analyst certification The analyst that prepared this report hereby certifies that: i) the opinions and views expressed in this valuation report, in regard with the issuer and with the company s overview, reflected his/her personal opinion and ii) No part of his/her salary compensation was, is or will be related directly or indirectly to the recommendations expressed in this report. The economic compensation of the analyst that prepared this report is based in several factors, including but not limited to Kallpa Securities SAB s profitability and the profits generated by its different areas, including investment banking. In addition, the analyst does not receive any kind of economic compensation from the companies he/she covers. This valuation report was prepared by Kallpa Securities SAB s employees that maintain the position of Analyst. Persons involved in the elaboration of this report are authorized to maintain shares. Share prices in this report are based on market prices as of closing of the day prior to the publication of this report, unless it is strictly stated. General statement This document is for informative purposes only. Under no circumstances it should be used / be considered as an offer of sale or an application of purchase of shares or any other securities mentioned in this document. The information herein has been obtained from sources which are believed to be reliable, but Kallpa Securities SAB does not guarantee the trustfulness or accuracy of the content of this report, or the future market values of shares or other securities mentioned in this document. The views and opinions expressed in this document constitute our opinion at the time of this report and are subject to change without any notice. Kallpa Securities SAB does not guarantee analysis updates before any change in the circumstances of the market. The products referred in this document may not be available for purchase in some countries. Kallpa Securities SAB has reasonably designed policies to prevent or to control the exchange of non-public information used by areas such Research and Investment, Capital Markets, among others. Definition of qualification ranges Kallpa Securities SAB has 5 qualification ranges: Buy +, Buy, Hold, Sell and Sell -. The analyst will assign the coverage one of these ranges. Sell - < - 30% > + 30% Buy + Sell -30% a -15% +15% a +30% Buy Hold -15% a 0% 0% a +15% Hold The range assigned to each company covered by the analyst in these reports is based on the analysis/monitoring Kallpa Securities SAB has been developing for the company. In some cases, the analyst can express his/her short-term points of view to traders, vendors and some Kallpa Securities SAB s clients but this point of view may differ in time by market volatility and other factors. The fair value calculated by Kallpa SAB is based in one or more valuation methodologies commonly used by financial analysts, including but not limited to discounted cash flows, In Situ valuations or any other applicable methodology. It should be noted that the publication of a fair value does not imply any guarantee that the value will be achieved. 6

7 KALLPA SECURITIES SOCIEDAD AGENTE DE BOLSA MANAGEMENT Alberto Arispe CEO (511) COMMERCIAL CAPITAL MARKETS CORPORATE FINANCE Enrique Hernández Ricardo Carrión Andrés Robles Manager Manager Manager (51 1) (51 1) (51 1) EQUITY RESEARCH Marco Contreras Edder Castro Humberto León Sebastián Cruz Fiorella Torres Senior Analyst Analyst Analyst Analyst Assistant (51 1) (51 1) (51 1) (51 1) (51 1) TRADING Eduardo Fernandini Javier Frisancho Jorge Rodríguez Head Trader Trader Trader (51 1) (51 1) (51 1) CHACARILLA OFFICE MIRAFLORES OFFICE Hernando Pastor Daniel Berger Gilberto Mora Walter León Representative Representative Representative Representative (51 1) (51 1) (51 1) (51 1) AREQUIPA OFFICE Jesús Molina Ricky García Representative Representative (51 54) (51 54) OPERATIONS IT Alan Noa Mariano Bazán Ramiro Misari Head of Operations Analyst - Treasury Head o IT (51 1) (51 1) (51 1) anoa@kallpasab.com mbazan@kallpasab.com rmisari@kallpasab.com INTERNAL CONTROL Elizabeth Cueva Controller (51 1) ecueva@kallpasab.com 7