Australian Equity Strategy

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1 AUSTRALIA Flip flopping in factor performance continues -10.0% Conditions for sustained valuation convergence not yet evident % 4.0% 2.0% 0.0% -2.0% -4.0% -6.0% -8.0% Daily Factor Performance Jan Feb Mar Apr May June Earn Yield Div Yield Volatility 12m Mom EPS Rev ROE 0 Jan-88 Jan-91 Jan-94 Jan-97 Jan-00 Jan-03 Jan-06 Jan-09 Jan-12 Jan-15...even though volatility has been falling 8% 7% 6% 5% 4% 3% 2% 1% 12 Month Fwd PEs for Industrials (25th percentile & 75th percentile vs median) 25 percentile rel Current = -3.00x Rel Low = -3.85x (Mar-16) Rel High = -0.85x (Jul-90) Average = -2.13x 25pct Source: : Bloomberg, FactSet, Macquarie Research, July July 2016 Macquarie Securities (Australia) Limited 75pct Trailing Market Volatility 75 percentile rel Current rel = 4.08x Rel Low = 1.00x (Dec-89) Rel High = 7.7x (Aug-00) Average = 2.89x 0% Aug-06 Feb-08 Aug-09 Feb-11 Aug-12 Feb-14 Aug-15 Trailing Volatility (26wks) Trailing Volatility (12wks) Vertigo Our quality and stability portfolio It has been painful to look through the current price action when we have a defensive and quality portfolio tilt. Assuming our portfolio is a normal barbell distribution then the tails are hurting us a lot. We have underestimated how quickly the monetary policy backdrop has changed and the significant liquidity squeeze into risk assets. Market expectations are for further easing from the BoJ, BoE, ECB, PBoC and domestically the RBA. This is a powerful tailwind to fight and it has the potential to squeeze the market higher still (link). However, with REITs, Materials and Small Caps at new highs and Telcos and Utilities close to highs, there are reasonable valuation hurdles to overcome particularly if bond yields squeeze a little higher, as we approach the earnings reporting season and with the A$ acting as a near-term constraint rather than release valve. We are reluctant to chase the market higher on the basis that the next wave of global policy easing is unlikely to drastically change fundamentals for Australian corporates which continue to suffer from weak volumes and a lack of pricing power or push the RBA into a more aggressive easing stance (link). We maintain our view that sticking with the quality end of the market will be where consistent outperformance comes from in a world where growth and conviction levels are low and where central banks remain the main players but in a less predictable manner. Our regional strategist, Viktor Shvets (link), has a view that conventional mean reversion strategies cannot work in a world of no conventional business/capital market cycles and broken market signals. At the same time, he maintains a view that macro calls are no longer possible (as cross-currents are too unpredictable) and would not come back until the new world of direct state-sponsored growth arrives. It is a strong view. The most obvious ways that macro is manifesting itself across trades is in the attraction of yield, a strong rally in gold stocks and in the skew of returns to our own domestic versus global Industrials which is a macro play on FX and relative growth. We think the valuation distribution and ultimately performance will mean revert but that it will require broad-based growth that improves the trajectory and transparency of earnings for the value stocks (making the relative growth call less important). The US has shown that in a low growth backdrop equities can be supported if the profit share is driving stronger earnings (wage share is falling). We don t see evidence of this dynamic yet playing out for the domestic market. We generally stick with higher quality stocks that have a solid relative growth outlook in our fundamental strategy portfolio (see Fig 1). We have run our Asian team s Quality/Stability screen for large and small/mid cap stocks in the Australian market. This screen is focused on identifying companies which have high and sustainable ROE (driven by margins instead of revenue), steady positive growth in top-line revenue and profit and relatively low leverage. There is no valuation overlay. It identified 13 large cap stocks and 27 small/mid cap names primarily from four sectors - Consumer Disc, Healthcare, Materials and Technology (see Figs 2 & 3). Please refer to page 5 for important disclosures and analyst certification, or on our website

2 Macquarie Wealth Management 15 July Fig 1 Macquarie Strategy Recommended Australian Portfolio Share price Portfolio ASX 200 Active Sector Company Ticker 14 Jul 16 Weight Weight Weight Financials Banks ANZ Banking Group ANZ Commonwealth Bank of Australia CBA Westpac Banking Corporation WBC Diversified Financials Eclipx Group Limited ECX Insurance Suncorp Group Limited SUN Real Estate Goodman GMG GPT Group GPT Westfield Corporation WFD Cyclical Industrials Consumer Discretionary Aristocrat Leisure ALL Carsales.com Limited CAR Fairfax Media FXJ Mantra Group Limited MTR ooh Media! Limited OML The Star Entertainment Group SGR Industrials Amcor Limited AMC James Hardie Industries JHX Nufarm NUF Orora Limited ORA Qantas QAN Sydney Airport SYD Transurban Group TCL Defensive Industrials Consumer Staples Wesfarmers WES Health Care Cochlear Limited COH CSL Limited CSL Telcos, Infrastructure & Utilities AGL Energy Limited AGL Contact Energy Limited CEN Telstra Corporation TLS Resources Energy Oil Search OSH Santos Limited STO Miners Evolution EVN Rio Tinto RIO Total Focus List and Sector Preferences Financials Banks Diversified Financials Insurance Real Estate Cyclical Industrials Consumer Discretionary Industrials Defensive Industrials Consumer Staples Health Care Telcos, Infrastructure, Utilities Resources Energy Miners Performance ending U/W N O/W 3 Months (9%) 6 Months Date Month to Date Quarter to Date 14-Jul Year to Date Portfolio (0.3) ASX200 Accum (2.1) Relative

3 Macquarie Wealth Management Vertigo - Our quality and stability portfolio We have run our regional strategy teams Quality and Stability criteria on the Australian market to construct a list of stocks that have relatively high and sustainable ROE (driven by margins), steady positive growth in top-line revenue and profit and relatively low leverage. We have classified our Large Cap Model Portfolio using a market cap filter of greater than A$2bn and our Small Cap Model Portfolio with less than A$2bn. Our screen contains the following criteria: 1. Stocks that have delivered and are expected to deliver positive revenue and profit growth rates most of the years during E; 2. Stocks that are expected to deliver positive annual profit growth and cumulative growth rate at least 5% over the next 2 years ( E). 3. Stocks that have high level of ROE (at least an average of 10% over E) which significantly covers the cost of capital. (Current market cost of capital sits around 5%). At the same time, we avoid companies that have or are expected to have declining ROEs going forward. 4. Average EBITDA margins of 5% over E, but at the same time there is a general trend of rising EBITDA margins during this period, as a measure of margin sustainability and an attempt to avoid stocks in which ROE improvements are delivered purely from rising revenues or increasing leverage; 5. Stocks that have relatively low leverage. We generally avoid stocks with Net Debt/EBITDA ratio of more than 2x; 6. We continue to emphasise Free cash flow (FCF) generation and therefore avoid companies with negative FCF in FY16-18E. 15 July

4 Macquarie Wealth Management 15 July Fig 2 Large Cap Quality Stability Model Portfolio Code Company Name GICS L1 Market Cap ROE Net debt/ebitda EBITDA margin Recurring profit Revenue growth Forward PE ($A m) FY17E FY17E (x) FY17E CAGR FY17 REA-AU REA Group Ltd Cons Disc CAR-AU Carsales.Com Limited IT NST-AU Northern Star Resources Ltd Materials MYO-AU MYOB Group Ltd. IT EVN-AU Evolution Mining Limited Materials FPH-NZ Fisher & Paykel Healthcare Health Care COH-AU Cochlear Limited Health Care JHX-AU James Hardie Materials LNK-AU Link Administration IT BXB-AU Brambles Limited Industrials DMP-AU Domino's Pizza Cons Disc EVT-AU Event Hospitality Cons Disc PMV-AU Premier Investments Limited Cons Disc Average Fig 3 Small Cap Quality Stability Model Portfolio Code Company Name GICS L1 Market Cap ROE Net debt/ebitda EBITDA margin Recurring profit Revenue growth Forward PE ($A m) FY17E FY17E (x) FY17E CAGR FY17 (x) SIQ-AU Smartgroup Corporation Ltd Industrials CL1-AU Class Ltd. IT PME-AU Pro Medicus Limited Health Care SBM-AU St. Barbara Ltd. Materials RRL-AU Regis Resources Limited Materials SAR-AU Saracen Mineral Materials SRX-AU Sirtex Medical Limited Health Care PWH-AU PWR Holdings Ltd. Cons Disc OFX-AU Ozforex Group Ltd. Financials RFG-AU Retail Food Group Limited Cons Disc ISD-AU isentia Group Limited IT IRE-AU IRESS Limited IT CCP-AU Credit Corp Group Limited Industrials ONT-AU 1300 Smiles Limited Health Care ADA-AU Adacel Technologies Limited IT TNE-AU Technology One Limited IT APO-AU APN Outdoor Group Ltd. Cons Disc ARB-AU ARB Corporation Limited Cons Disc PSQ-AU Pacific Smiles Group Ltd Health Care GEM-AU G8 Education Limited Cons Disc VRT-AU Virtus Health Ltd. Health Care CGL-AU Citadel Group Ltd. IT OML-AU ooh media Ltd Cons Disc BGL-AU Bigair Group Limited Telcos MOC-AU Mortgage Choice Limited Financials IEL-AU IDP Education Ltd. Cons Disc Average

5 This publication was disseminated on 15 July 2016 at 13:21 UTC. Macquarie Wealth Management Important disclosures: Recommendation definitions Macquarie - Australia/New Zealand Outperform return >3% in excess of benchmark return Neutral return within 3% of benchmark return Underperform return >3% below benchmark return Benchmark return is determined by long term nominal GDP growth plus 12 month forward market dividend yield Macquarie Asia/Europe Outperform expected return >+10% Neutral expected return from -10% to +10% Underperform expected return <-10% Macquarie South Africa Outperform expected return >+10% Neutral expected return from -10% to +10% Underperform expected return <-10% Macquarie - Canada Outperform return >5% in excess of benchmark return Neutral return within 5% of benchmark return Underperform return >5% below benchmark return Macquarie - USA Outperform (Buy) return >5% in excess of Russell 3000 index return Neutral (Hold) return within 5% of Russell 3000 index return Underperform (Sell) return >5% below Russell 3000 index return Volatility index definition* This is calculated from the volatility of historical price movements. Very high highest risk Stock should be expected to move up or down % in a year investors should be aware this stock is highly speculative. High stock should be expected to move up or down at least 40 60% in a year investors should be aware this stock could be speculative. Medium stock should be expected to move up or down at least 30 40% in a year. Low medium stock should be expected to move up or down at least 25 30% in a year. Low stock should be expected to move up or down at least 15 25% in a year. * Applicable to Asia/Australian/NZ/Canada stocks only Recommendations 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations Financial definitions All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards). Recommendation proportions For quarter ending 30 June 2016 AU/NZ Asia RSA USA CA EUR Outperform 45.17% 56.00% 36.36% 43.16% 63.39% 45.91% (for global coverage by Macquarie, 6.27% of stocks followed are investment banking clients) Neutral 36.21% 28.59% 40.26% 50.38% 29.46% 36.96% (for global coverage by Macquarie, 6.33% of stocks followed are investment banking clients) Underperform 18.62% 15.41% 23.38% 6.46% 7.14% 17.12% (for global coverage by Macquarie, 5.38% of stocks followed are investment banking clients) Company-specific disclosures: Important disclosure information regarding the subject companies covered in this report is available at Analyst certification: We hereby certify that all of the views expressed in this report accurately reflect our personal views about the subject company or companies and its or their securities. We also certify that no part of our compensation was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. The Analysts responsible for preparing this report receive compensation from Macquarie that is based upon various factors including Macquarie Group Limited (MGL) total revenues, a portion of which are generated by Macquarie Group s Investment Banking activities. General disclosure: This research has been issued by Macquarie Securities (Australia) Limited ABN , AFSL , a Participant of the ASX and Chi-X Australia Pty Limited. This research is distributed in Australia by Macquarie Wealth Management, a division of Macquarie Equities Limited ABN AFSL ("MEL"), a Participant of the ASX, and in New Zealand by Macquarie Equities New Zealand Limited ( MENZ ) an NZX Firm. Macquarie Private Wealth s services in New Zealand are provided by MENZ. 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