Chemicals chapter. Global Gambits The Right Moves for Right Now. See jpmorgansavant.com for global sector valuation tools

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1 e 28, 20 Global Gambits The Right Moves for Right Now Chemicals chapter The following is a chapter from, dated e 28, 20. 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 Morgankets.

2 e 28, 20 Chemicals Large Cap Opportunities in Commodity and Specialty Chemicals Global Sector Coordinator Jeffrey J. Zekauskas (1-212) J.P. Morgan Securities Inc. Full sector coverage details on page 6 Key Drivers We recommend investments by identifying appealing valuations and durable positive financial characteristics such as: high free cash flow generation (DOW); substantial cost savings from restructuring and growth from new product lines (AVY); and a strong net cash position supporting share repurchases and initiatives to repair underperforming businesses (ASH). We also advocate purchasing companies with pricing power to offset higher raw material costs, and companies that are positioned to benefit from longer-term raw material cost trends. Paint and coatings companies such as Valspar are benefiting from strong non-residential construction spending and good growth characteristics at big-box retailers such as Lowe s. We believe softness in titanium dioxide and acrylic prices will moderate the rate of growth of their raw material cost trends. Finally, favorable seasonal demand patterns could lead to short-term trading opportunities (3-6 months) for commodity chemical companies with ethylene and polyethylene production. We believe NOVA Chemicals will have the strongest near-term earnings momentum of all the North American chemicals producers due to its Alberta advantage in ethylene production costs relative to Gulf Coast producers. Dow Chemical should also experience near-term earnings benefits from stronger margins in its large polyethylene and chlor-alkali units. Our Non-Consensus Views We favor large- and mid-capitalization chemical companies in 20 including Dow Chemical, Ashland, and Avery Dennison. We believe these companies possess either underappreciated long-term cash flow characteristics, as in the case of Dow Chemical and Ashland, or improving financial returns over the next months reflecting announced strategies for expense reduction, working capital discipline, and share gains in newer product lines, as in the case of Avery Dennison. We believe Dow is currently misconceptualized because of a financially leveraged and highly cyclical history. It has substantially raised its normalized earnings and free cash flow due to structural business improvements. Debt-to-total capital peaked at 59% in 2002; we expect Dow to be net debt free in 2007E. Dow s free cash flow yield should exceed 11% in 20E and be sustained at approximately 7-8% in the next trough. Ashland is currently among the most inexpensive specialty chemical company in our coverage universe. Its shares have fallen in value, reflecting weak results in Valvoline, the branded motor oil operation, and Ashland s perceived exposure to interest-sensitive construction markets. Our belief in Ashland s growth prospects is rooted in the company s ability to execute on its long-term cost reduction program and to repair the Valvoline and Water Treatment operations. Moreover, the construction business is substantially a road paving business selling largely to the State and Federal government (85%) for new highway building (as supposed to residential and nonresidential building construction). 2

3 e 28, 20 Chemicals: Top Picks Company Key Financials Rationale and Catalysts Avery Dennison Rating: Overweight Fiscal EPS (Local): Year-end. Ticker: AVY US / AVY 20 20E 2007E Exchange: NYSE P/E (Calendar) Price (Local): US$ E 2007E Mkt Cap (US$): 6.4 bn Analyst: Jeffrey J. Zekauskas EV/EBITDA (Calendar) Phone: (1-212) E 2007E jeffrey.zekauskas@jpmorgan.com Our April 2007 price target of US$71 reflects a 17.3x P/E or a 10x EV/EBITDA multiple based on our 2007 estimate. Our belief in AVY s earnings growth prospects over the next months is rooted in the company s ability to execute on its large restructuring initiative to improve its share and utilization in the RFID market and consequently to reduce related losses, and to grow its existing businesses in the offshore markets. Shortfalls in any of these areas could lead to lower-than-expected EPS and a lower share price, and decrease the likelihood of reaching our price target within the time frame. The company trades at a discount to other mid-cap chemical companies including ECL and PLL. We believe Avery s earnings power is understated meaningfully by RFID investments and losses. Moreover, Avery looks well positioned to benefit from operating margin expansion due to headcount reductions and manufacturing rationalization efforts. Demand for pressure-sensitive adhesives domestically and internationally should rebound from weak levels in 20. Moreover, aggressive cost reduction measures should offset margin erosion in the higher-margin office products business. We expect the company to yield US$35-40 million net cost savings in 20E (or US$0.30/share), reflecting a total headcount reduction of 700 employees over the next few months. We believe RFID represents the single largest, long-term growth opportunity for Avery Dennison. The reduction in net spending related to RFID in 20E could be as large as US$2-7 million pre-tax or US$ /share. Avery s annual spending related to RFID should be US$25-30 million pre-tax or US$ /share in 20E (net of approximately US$10 million in revenues) compared to US$32 million in 20. We believe Avery should capture at least 30% of the market for RFID inlays as the new Gen 2 chip becomes the standard technology at Wal-t and other retailers beginning this summer. Avery needs to generate US$15-20 million in quarterly revenues to reach breakeven levels, which it could achieve in 2008E. Dow Chemical Rating: Overweight Fiscal EPS (Local): Year-end. Ticker: DOW US / DOW 20 20E 2007E Exchange: NYSE P/E (Calendar) Price (Local): US$ E 2007E Mkt Cap (US$): 36.8 bn Analyst: Jeffrey J..Zekauskas EV/EBITDA (Calendar) Phone: (1-212) E 2007E jeffrey.zekauskas@jpmorgan.com We recently added Dow Chemical to the JPMorgan Analysts Focus List with a e 2007 price target of US$48. A disruption in the cyclical upturn or a diminished outlook for economic growth could lead to reduced expectations for EPS growth, stock price underperformance, and decrease the likelihood of Dow Chemical reaching our price target within the time frame. Strange to say but we think Dow Chemical has become a "chicken cyclical. Its favorable risk/reward characteristics are grounded in an underleveraged balance sheet; a sustainable high level of free cash flow generation; a potential for above-average dividend increase; and a low relative valuation versus peer companies. DOW stands out as an appealing larger-capitalization liquid investment vehicle in a world in which investors shy away from leveraged cyclical assets and stocks with a recent history of sharp appreciation. Our target price of US$48 is equal to 6.1x our 20 EBITDA estimate; Dow s shares currently trade at 4.9x. Each 1.0 multiple point change in Dow s EV/EBITDA multiple equals approximately US$8 per share. We expect management to utilize free cash flow to increase the annual dividend (currently yielding 3.9%) at a 12% average annual rate for the next several years. Source: Company data, Bloomberg, JPMorgan estimates, JPMorgan SaVanT. Prices as of e 15, 20. 3

4 e 28, 20 Chemicals: Top Picks (cont d) Company Key Financials Rationale and Catalysts Ashland Inc. Rating: Overweight Fiscal EPS (Local): Year-end t. Ticker: ASH US / ASH 20 20E 2007E Exchange: NYSE P/E (Calendar) Price (Local): US$ E 2007E Mkt Cap (US$): 4.4 bn Analyst: JeffreyJ. Zekauskas EV/EBITDA (Calendar) Phone: (1-212) E 2007E jeffrey.zekauskas@jpmorgan.com Ashland is undervalued at the current price, in our view. The stock currently trades at 6.0x 20E EV/EBITDA and 5.2x 2007E EV/EBITDA compared to its peers trading at 7.5x and 6.7x, respectively. We believe Ashland s valuation is poised to improve as investors focus on its transformation from a refiner/conglomerate to a simpler chemicals and construction company. Ashland has US$1.1 billion of cash as of ch 31, 20, which it could use for business acquisitions or return to shareholders under the existing share buyback program or special dividend. We believe the company could explore strategic alternatives for several of its business segments. Historically, we valued Ashland in the range of 6.5 8x EV/EBITDA; our approach now is to view the businesses as falling into the middle of this range. Each point of EV/EBITDA expansion is worth approximately US$8 per share. We expect Ashland s paving and construction (APAC) operations to further improve operating performance. We believe the chemical operations (both specialty and distribution) are beginning to perform strongly due to successful pricing initiatives and good end-market demand. Source: Company data, Bloomberg, JPMorgan estimates, JPMorgan SaVanT. Prices as of e 15, 20. 4

5 e 28, 20 Chemicals: Stocks to Underweight Company Key Financials Rationale and Catalysts Ecolab Inc. Rating: Underweight Fiscal EPS (Local): Year-end. Ticker: ECL US / ECL 20 20E 2007E Exchange: NYSE P/E (Calendar) Price (Local): US$ E 2007E Mkt Cap (US$): 9.8 bn Analyst: JeffreyJ.Zekauskas EV/EBITDA (Calendar) Phone: (1-212) E 2007E jeffrey.zekauskas@jpmorgan.com Ecolab trades at a premium to our specialty and commodity chemical universe at 26.6x our 20 EPS estimate and 24.2 our 2007 EPS estimate versus its peer group multiples of 16.0x and 15.0x our 20 and 2007 EPS estimates respectively. ECL s stock price, in our view, discounts a successful long-term acquisition effort. Ecolab s core challenge is to increase its sales at a multiple of the 2-3% average annual expansion pace of the underlying global industries it serves. Given a reliance on acquisition activity as key to its growth prospects, missteps or delays in the purchase or integration of acquisitions could pressure Ecolab s earnings and stock price. Moreover, the rising interest rate environment could put pressure on higher-valued stocks such as Ecolab. ECL is a well-run company, in our opinion, with a strong business franchise. However, we believe there are more attractive investment opportunities elsewhere, as various chemical companies offer comparable long-term EPS growth rates at more attractive valuations or greater cyclical exposure to recovering markets. Potash Corp. Rating: Underweight Fiscal EPS (Local): Year-end. Ticker: POT US / POT 20 20E 2007E Exchange: NYSE P/E (Calendar) Price (Local): US$ E 2007E Mkt Cap (US$): 9.3 bn Analyst: David Silver, CFA EV/EBITDA (Calendar) Phone: (1-212) E 2007E david.silver@jpmorgan.com The powerful multi-year upcycle in potash shows signs of maturing. Producer inventories have risen sharply since mid- 20, while lower corn acreage and record-high fertilizer costs have led to slower potash demand. Negotiations remain at an impasse between China s two main potash buyers and major offshore suppliers for 20 supply contracts. Annual negotiations have never before extended into e. Major suppliers, including Canada s Canpotex export agency (comprises Potash Corp, Mosaic, and Agrium) and three former Soviet Union producers, initially nominated a US$40/mt hike. Major buyers, Sinochem and CNAMPGC ( China National Ag ), have instead proposed decreased pricing. We believe Chinese government officials have joined the discussions. We estimate that China s 20 contract price is approximately US$35-40/mt less than that currently paid by major importers in Brazil and India. We rate Potash Corp (POT) Underweight. We believe POT s valuation reflects the benefits of recent cyclical improvement in potash and nitrogen profitability. We expect 20 to be a record earnings year for POT, and the stock currently trades at an EV/EBITDA ratio of 9.3x and 9.0x on our 20 and 2007 EBITDA estimates, respectively. This compares with a range of approximately x our 20 estimated EBITDA for its fertilizer peers (and FY07 EBITDA estimates for Mosaic). We estimate that POT traded within a range of between 7.5x and 8.5x EBITDA during the past cyclical peak. We believe investors could assign a lower valuation closer to its past historical trading range as earnings momentum moderates and year-over-year comparisons become more difficult in the coming quarters. Source: Company data, Bloomberg, JPMorgan estimates, JPMorgan SaVanT. Prices as of e 15, 20. 5

6 e 28, 20 JPMorgan Global Chemicals Team Research Equity Research Credit Research Major Chemicals Specialty Chemicals Ag Chemicals and Fertilizers Jeffrey J. Zekauskas Americas Americas Americas Americas Global Sector Coordinator United States Jeffrey J. Zekauskas David C. Silver, CFA Silke Kueck Karen Buchkovich-Sass William Hunter Olga Guteneva United States Jeffrey J. Zekauskas David C. Silver, CFA Silke Kueck Karen Buchkovich-Sass William Hunter Olga Guteneva United States David C. Silver, CFA Jeffrey J. Zekauskas Silke Kueck Karen Buchkovich-Sass William Hunter United States Latin America EMEA Pan Europe Christopher Miller (HY-Chemicals) Saqib Deen (HY-Chemicals) Pablo Mautone Nachu Nachiappan (HG/HY) Alex Ayoub (HG/HY) Asia Pacific Asia Pacific Asia Pacific Pan Asia Pacific Graham Cunningham, CFA Japan Mikiya Yamada Japan Rie Kajiyama Japan Mikiya Yamada Taiwan Graham Cunningham, CFA Thailand Sukit Chawalitakul 6

7 e 28, 20 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 Dow Chemical within the past 12 months. Client of the Firm: Ashland Inc. is or was in the past 12 months a client of JPMSI; during the past 12 months, JPMSI provided to the company non-investment banking securities-related service and non-securities-related services. Avery Dennison is or was in the past 12 months a client of JPMSI; during the past 12 months, JPMSI provided to the company non-securities-related services. Dow Chemical 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 and non-investment banking securities-related service. Ecolab Inc. 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 nonsecurities-related services. Investment Banking (past 12 months): JPMSI or its affiliates received in the past 12 months compensation for investment banking services from Dow Chemical, Ecolab Inc. 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 Dow Chemical, Ecolab Inc. Non-Investment Banking Compensation: JPMSI has received compensation in the past 12 months for products or services other than investment banking from Ashland Inc., Dow Chemical, Ecolab Inc. An affiliate of JPMSI has received compensation in the past 12 months for products or services other than investment banking from Ashland Inc., Avery Dennison, Dow Chemical, Ecolab Inc. 7

8 e 28, 20 Ashland Inc. (ASH) Price Chart 120 Date Rating Share Price Price Target UW OW 08-Jul- UW Apr- OW Price Source: Reuters and JPMorgan; price data adjusted for stock splits and dividends. Initiated coverage Jul 08, 20. Break in coverage Feb 20, 20 - Apr 20, 20. 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, 20, 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. Avery Dennison (AVY) Price Chart N OW OW $71 Date Rating Share Price 27-Jan- N Jan- OW Price Target Price 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, 20, 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. 8

9 e 28, 20 Dow Chemical (DOW) Price Chart N OW $48 OW Date Rating Share Price 16-May- N May- OW Price Target Price Source: Reuters and JPMorgan; price data adjusted for stock splits and dividends. Break in coverage Feb 28, Feb, 20. 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, 20, 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. Ecolab Inc. (ECL) Price Chart Price UW Date Rating Share Price 22-Aug- UW Price Target 10 0 Source: Reuters and JPMorgan; price data adjusted for stock splits and dividends. Initiated coverage Aug 22, 20. 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, 20, 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. 9

10 e 28, 20 Potash Corp. (POT) Price Chart Price 90 UW OW UW Date Rating Share Price 23-Oct- UW Jan- OW Jan- UW Price Target Source: Reuters and JPMorgan; price data adjusted for stock splits and dividends. Break in coverage Feb 08, , 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, 20, 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. 10

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