Global Equity Strategy Japan: Changing of the Guard

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1 STRATEGY NOTE Japan Equity Strategy Equity Strategy Japan: Changing of the Guard Key Takeaway No sooner had the US election finished, than Japan s Noda dissolved Parliament with an election called for December 16th. With Noda s support falling below 20%, Abe of the LDP is likely to return as prime minister. His comments over inflation targeting (3%), BoJ law reforms and monetary easing helped to spark a reversal in the USDJPY and a jolt in share prices. A sea-change in monetary policy could be around the corner if a less hawkish BoJ governor takes over after Shirakawa retires in April. The LDP are considering changing the BoJ s mandate to explicitly target this higher inflation rate. The BoJ is set to meet on November 19th. Although there are few economic positives to justify a share price revival, there is plenty of room for Japan to regain competitiveness versus Korea which is also experiencing rising inventory-to-shipment ratios and weak Chinese demand. We continue to recommend a Bullish position on Japan using ishares MSCI Japan Index Fund (EWJ US) or ishares MSCI Japan Fund (IJPN LN) and a Bearish position on Korea using IShare MSCI South Korea Index (EWY US). Interestingly, a recent white paper by METI highlighted the strong correlation between the Nikkei and the JPYKRW exchange rate from 2007 to 2012 at There is also significant scope for rotation within the equity market if aggressive monetary policy easing occurs. As our analysis highlighted in Japan: Lost in Translation, 19 September, 2012, high-quality baskets of stocks (ex-financials) have outperformed TOPIX since Given the solvency problems of many Japanese exporters, small changes to monetary policy might have a very large impact on the financial health of corporate Japan. Longer-term, it appears that the Japanese authorities wish to pursue a policy of promoting services. The number of overseas subsidiaries in non-manufacturing sectors has overtaken that of manufacturing sectors. It would seem that Japanese service firms are differentiating their business models versus local players. We also continue to like Japanese LNG themes. We currently have Shionogi (4507 JP) and Mitsubishi Chemical Holdings (4188 JP) in our Conviction long list and Ricoh (7752 JP) in our Conviction short list. A list of all our Japanese coverage is shown in Exhibits 25 & 26. Sustainable equity income quality strategy vs. poor quality strategy vs. Topix ( P or tfolio Value: 2001= JP Y 100 mn) Quality Poor Quality Topix Total Return Note: Please refer to Exhibit 19 for more details EQUITY STRATEGY GLOBAL Sean Darby * Chief Equity Strategist sdarby@jefferies.com Kenneth Chan * Quantitative Strategist kenneth.chan@jefferies.com Angela Cheung, CFA * Equity Associate angela.cheung@jefferies.com * Jefferies Hong Kong Limited Jefferies does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that Jefferies may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Please see analyst certifications, important disclosure information, and information regarding the status of non-us analysts on pages 14 to 18 of this report.

2 Each month we invite our analysts to suggest their top conviction ideas. For further information on the companies highlighted please visit the Conviction List. Exhibit 1: JEF conviction Long Recommendations Country Sector Ticker Company Name JEF Target Price Up/Down to JEF TP (%) China Financials 1988 HK China Minsheng Banking Corp. 9 27% France Consumer Discretionary AC FP Accor 31 30% France Telecommunication Services FTE FP France Telecom % Japan Health Care 4507 JP Shionogi 1,600 17% Japan Materials 4188 JP Mitsubishi Chemical Holdings 360 7% Norway Telecommunication Services TEL NO Telenor % Switzerland Consumer Staples NESN VX Nestle 69 17% United Kingdom Energy BG/ LN BG Group 1,700 67% United Kingdom Energy TLW LN Tullow Oil 1,800 33% United Kingdom Health Care SHP LN Shire 2,400 38% United Kingdom Industrials SGC LN Stagecoach PLC % United Kingdom Materials RIO LN Rio Tinto 4,000 33% United Kingdom Telecommunication Services BT/A LN BT plc % USA Consumer Discretionary ARO US Aeropostale 21 62% USA Financials BX US Blackstone 18 33% USA Financials WFC US Wells Fargo 39 24% USA Health Care ABT US Abbott 87 38% USA Health Care A US Agilent Technologies 55 54% USA Industrials BA US The Boeing Company 87 22% USA Information Technology AVGO US Avago 43 33% USA Information Technology GOOG US Google Inc % USA Information Technology SAI US SAIC 16 45% USA Materials ASH US Ashland 90 32% USA Materials FCX US Freeport-McMoRan Copper & Gold 60 61% USA Materials PPG US PPG Industries, Inc % Source: Jefferies Exhibit 2: JEF conviction Short Recommendations Country Sector Ticker Company Name Source: Jefferies JEF Target Price Up/Down to JEF TP (%) Japan Industrials 7752 JP Ricoh Company % For further information on our country asset allocation please see our 3Q12 Outlook. Exhibit 3: Current Asset Allocation Country Asset Allocation Country Asset Allocation Australia Bearish Mexico Bullish Brazil Bearish New Zealand Bullish Canada Bearish Norway Bullish China Bearish Philippines Bullish Denmark Bullish Russia Bullish France Bearish Spain Bearish Germany Bearish Sweden Bullish Hong Kong Bullish Switzerland Bullish India Bearish Taiwan Bearish Indonesia Bearish Thailand Bullish Italy Bearish Turkey Bearish Japan Bullish United Kingdom Bullish Korea Bearish United States Bullish Source: Jefferies page 2 of 18 Sean Darby, Chief Equity Strategist, , sdarby@jefferies.com

3 When the going gets tough, the tough get going, Anon After a deal was agreed by the upper house to pass a fiscal deficit financing bill during mid-week, Prime Minister Noda resigned. The bill avoids Japan running into its own fiscal cliff. The leader of the opposition party, LDP, Shinzo Abe has called for the BoJ to print unlimited amounts of yen as well as voicing a new inflation target of 3%. With PM Noda slumping in the polls, it is likely that Abe will have a second chance of running the country, after leading the country between September 2006 to September During his first term as PM, Abe argued for fiscal tightening just as the BoJ had ended its five year QE policy. According to the IMF, Japan s public debt will reach 235% of GDP by the end of this year. Adding gross borrowings and guarantees together amounts to over one quadrillion yen or 8 million yen (US$100,000 approximately) for every Japanese person. Japan s public sector debt is reaching the point of no return whereby it cannot be funded through normal channels. The normal way to clear the debt overhang would be through an austerity program accompanied by sharp monetary easing. Hopefully an easier monetary regime would encourage private investment while a weaker yen would encourage exports. While the slowdown in exports has been due to falling demand from China and Europe, the terms-of-trade for Japanese exporters has been growing negative since A rising yen and soaring resource prices has hurt the profitability of exporters. Hence, a weaker yen may restore some competitiveness to low value added industries, but higher input prices (principally energy) will offset a lot of the gains. It would seem from the reluctance to pursue aggressive monetary easing that there is a community within the Japanese bureaucracy that would prefer Japan Inc. to experience supply side reforms to create more sustainable growth. Rather than using a weak currency or fiscal transfers to bail out the economy, the BoJ appears to have hoped for a change in the composition of economic output to more productive growth such as in services rather than low end manufacturing or construction. It would seem that the BoJ has increasingly grown reluctant to adopt new rounds of QE since they had already adopted successive rounds since the late 1990s but to no avail. It also makes economic sense to move towards services as the population ages and productivity rates slow. While the diagnosis, prescription and medicine is entirely commendable, at present, Japan s manufacturing sector is experiencing an acute slump caused by a combination of deteriorating trade with China and the rest of the world, rising inventories as well as falling demand post the earthquake rebuilding. Hence, pressure is growing on the central bank to move away from its reformist agenda and do a monetary U turn. The central bank is stuck between a rock and a hard place. Despite the headlines of weak economic growth, the Japanese services sector has held up well both domestically and overseas. The white paper published by the Japanese Ministry of Economy, Trade and Industry (METI) in July, 2012 highlighted the improvement of Japan s service sector companies overseas. Indeed, the number of overseas subsidiaries in non-manufacturing sectors has overtaken that of manufacturing sectors. For example, these would include delivery service companies (Yamato), Restaurants (Yoshino-ya and Moss Bruger), Tourism (Wakura Kagaya Ryokan) and convenience stores. The latter is projected by METI to have more stores overseas than domestically in page 3 of 18 Sean Darby, Chief Equity Strategist, , sdarby@jefferies.com

4 Since the announcement, the market has moved up for the past two days (15 and 16 Nov) Exhibit 4: Japan equity market performance Current price compared with moving average 20-day 30-day 50-day 100-day 260-day Japan Nikkei 225 (Overall Market) Above Above Above Above Above Air Transportation Above Above Above Below Below Auto Above Above Above Below Below Banks Above Above Above Above Above Chemicals Above Above Above Above Below Communications Below Below Below Below Above Construction Below Below Below Above Above Drugs Below Below Below Above Above Electric Appl. Above Above Above Above Below Electricity Above Above Above Below Below Fishery Above Above Above Above Below Foods Below Below Below Below Above Gas Below Below Below Below Above Glass & Ceramics Below Below Below Below Below Insurance Below Below Below Above Above Land Transportation Above Below Below Below Below Machinery Above Above Above Above Below Mining Below Below Below Below Below Non-Fer.Metals Above Above Above Below Below Oil Below Above Above Above Below Other Financials Below Above Above Above Above Other Makers Above Above Below Below Below Paper & Pulp Above Above Above Below Below Precision Instrument Below Below Below Below Below Railways Below Below Below Below Above Real Estate Above Above Above Above Above Retailers Below Below Below Below Above Rubber Goods Below Below Below Below Below Sea Transportation Above Above Above Below Below Securities Above Above Above Above Above Services Below Below Below Above Above Shipbuilding Above Above Above Below Below Steels Below Below Below Below Below Textiles Below Below Below Below Below Trading Below Below Below Below Below Transport Equipment Above Above Above Above Above Warehousing Below Above Above Above Above The upward channel remained intact for the past six months and the index has failed to test the top band is a sign of weakening upward momentum. However, it is encouraging that the bottom band has provided strong support again Exhibit 5: Japan equity market performance In addition, the recent two upmarket days (15 and 16 Nov) came with increasing volume Source: Bloomberg, Jefferies page 4 of 18 Sean Darby, Chief Equity Strategist, , sdarby@jefferies.com

5 The rally in June (see in Exhibit 5) has not been supported by a rising advance-decline line (ADL). However, the recent two up-market days (15 and 16 Nov) saw significant improvement in ADL Exhibit 6: Nikkei 225 advance-decline line We examine stocks that trade in Topix first section for advance-decline measure Source: Bloomberg, Jefferies Note: Advance-decline = (number of stocks that rose - number of stocks that fell) / total number of stocks The weak exchange rate provided some reprieve from corporate bankruptcies Exhibit 7: Japan no. of corporate bankruptcies vs. Japanese Yen per US$ Source: Teikoku Data Bank, FactSet, Jefferies although the value of those failing has declined in total Exhibit 8: Japan amount of corporate bankruptcies liabilities (JPY bn) vs. Japanese Yen per US$ Source: Teikoku Data Bank, FactSet, Jefferies page 5 of 18 Sean Darby, Chief Equity Strategist, , sdarby@jefferies.com

6 Japan is suffering from an increase in inventories versus shipments hence operational geared companies are unlikely to see any earnings upgrades Exhibit 9: Japan manufacturing inventory to shipment ratio Source: METI, FactSet, Jefferies Korea is in no better position than Japan although the ratio does seem to have peaked. However, this has meant a decline in industrial production Exhibit 10: Korea inventory to shipment ratio Source: Korea National Statistical Office, FactSet, Jefferies The recent dispute with China has undermined Japan s export machine Exhibit 11: Japan exports to China (JPY bn) Source: Japan Customs, FactSet, Jefferies page 6 of 18 Sean Darby, Chief Equity Strategist, , sdarby@jefferies.com

7 Japan s seasonally adjusted current account was in deficit in Septemberfor the first time in 30 years Exhibit 12: Japan current account (JPY bn) Source: Bank of Japan, FactSet, Jefferies Japan s service sector has held up relatively well to date Exhibit 13: Japan tertiary industry activity % y-y vs. industrial production % y-y Source: METI, FactSet, Jefferies What has been impressive is that overseas business activities have picked up among nonmanufacturing sectors such as wholesale and services Exhibit 14: Expansion of overseas subsidiary in non-manufacturing Source: Ministry of Economy, Trade and Industry Basic Survey on Overseas Business Activities Note: Other manufacturing industry includes precision machinery up to 2006 page 7 of 18 Sean Darby, Chief Equity Strategist, , sdarby@jefferies.com

8 Japanese overseas FDI stock per GDP remains low especially in services compared with other major countries. According to the July, 2012 METI paper, overseas business activities in services, including trade still have room for growth. Exhibit 15: Transition of service trade as per % of GDP Source: Institute for International Trade and Investment International Comparative Statistics, International Direct Investment Matrix (2011) Note: This figure plots the absolute value for each country in 2000, 2005, 2006, 2007, 2009 (or 2008) calendar years There is a modest correlation between EURJPY and the Japanese equity market Exhibit 16: Correlation between EURJPY and TOPIX The equity market Exhibit 17: Tokyo stock exchange stock capital raised (JPY bn) Source: Tokyo Stock Exchange, CEIC, Jefferies page 8 of 18 Sean Darby, Chief Equity Strategist, , sdarby@jefferies.com

9 has seen little demand for new scrip outside of secondary issues Exhibit 18: Tokyo stock exchange stock public offering (JPY bn) Source: Tokyo Stock Exchange, CEIC, Jefferies The performance of sustainable income stocks versus poor baskets is almost three-fold over 11 years Exhibit 19: Sustainable equity income quality strategy vs. poor quality strategy vs. Topix total return index (Portfolio value: 2001 = JPY 100 mn) Note: Sustainable equity income (quality) criteria: companies traded in TSE ex Financials; Piotroski F score > 5, Altman Z-score >2.6, dividend yield > 10 year government bond yield, 3 year average sustainable growth rate >8%, dividend cover >2 and dividend yield >2% ; Sustainable equity income (poor quality) criteria: companies traded in TSE ex Financials, Piotroski F score < 3, Altman Z- score < 1.1 and 3 year sustainable growth rate <8%; Portfolio is quarterly rebalanced, with dividend and no transaction cost. A current basket of sustainable income stocks is shown Exhibit 20: Sustainable equity income quality basket companies Company Mkt Value Altman Piotroski Symbol Company Name Sector (USD mn) Z Score F-Score 4924 JP Dr.Ci:Labo Co. Ltd. Consumer Staples JP Japan Tobacco Inc. Consumer Staples 53, JP K's Holdings Corp. Consumer Staples 1, JP Megane Top Co. Ltd. Consumer Staples JP Point Inc. Consumer Staples JP TonenGeneral Sekiyu K.K. Energy 5, JP Calsonic Kansei Corp. Materials 1, JP Komatsu Ltd. Materials 21, JP Nabtesco Corp. Materials 2, JP Nippon Shokubai Co. Ltd. Materials 2, Note: Only companies with market value > US$ 500mn, 60D avg turnover >US$2mn are shown page 9 of 18 Sean Darby, Chief Equity Strategist, , sdarby@jefferies.com

10 Companies with high cash on their balance sheet have outperformed TOPIX during a period of deflation Exhibit 21: High cash strategy vs. Topix total return index (Portfolio value: 2001 = JPY 100 mn) High Cash Strategy Topix Total Return Note: High cash strategy: Universe includes TSE listed companies with market cap > US$ 500mn, 60D avg turnover>us$ 2mn and with highest two quintiles 2 year average cash balance. Portfolio is quarterly rebalanced, with dividend and no transaction cost. A basket of stocks with high cash are shown Exhibit 22: Top 30 TSE listed companies by 2 year average cash balance Company Mkt Cap 60D Avg T/O 2 Yr Avg Cash Symbol Company Name Sector USD mn (USD mn) JPY mn 7203 JP Toyota Motor Corp. Consumer Discretionary 136, ,879, JP Tokyo Electric Power Co. Inc. Utilities 2, ,767, JP Nomura Holdings Inc. Financials 14, ,555, JP Mitsui & Co. Ltd. Consumer Discretionary 24, ,436, JP Honda Motor Co. Ltd. Consumer Discretionary 55, ,263, JP Daiwa Securities Group Inc. Financials 7, ,260, JP Mitsubishi Corp. Consumer Discretionary 30, ,230, JP T&D Holdings Inc. Financials 7, ,093, JP MS&AD Insurance Group Holdings Financials 10, , JP Sony Corp. Consumer Discretionary 9, , JP SoftBank Corp. Information Technology 37, , JP Nissan Motor Co. Ltd. Consumer Discretionary 39, , JP Orix Corp. Financials 10, , JP Canon Inc. Information Technology 41, , JP Panasonic Corp. Consumer Discretionary 11, , JP Nippon Telegraph & Telephone Telecommunication Services 59, , JP Sumitomo Corp. Consumer Discretionary 15, , JP Seven & I Holdings Co. Ltd. Consumer Staples 25, , JP Marubeni Corp. Consumer Discretionary 11, , JP NTT DoCoMo Inc. Telecommunication Services 60, , JP Fanuc Corp. Materials 38, , JP Hitachi Ltd. Materials 24, , JP Itochu Corp. Consumer Discretionary 15, , JP Denso Corp. Materials 26, , JP Mitsubishi Electric Corp. Information Technology 15, , JP Sojitz Corp. Consumer Discretionary 1, , JP NKSJ Holdings Inc. Financials 7, , JP Tokio Marine Holdings Inc. Financials 19, , JP Sony Financial Holdings Inc. Financials 7, , JP Otsuka Holdings Co. Ltd. Health Care 16, ,552.0 page 10 of 18 Sean Darby, Chief Equity Strategist, , sdarby@jefferies.com

11 We continue to recommend a long Nikkei versus Kospi Exhibit 23: Long Nikkei 225 short KOSPI trade performance (US$) * Performance is price return with no trading or commission costs taken into account and ex-dividends. There is a close relationship between foreign investors' activities and market movement during the market correction and rebound from 2007 to Exhibit 24: Equity market flows Into Japan After buying aggressively from 2009 to 1H2011, foreign investors became more cautious with the equity market turning sluggish Source: EPFR, Bloomberg, Jefferies page 11 of 18 Sean Darby, Chief Equity Strategist, , sdarby@jefferies.com

12 Exhibit 25: Jefferies Japan coverage Sector Symbol Name JEF Rating JEF Target Price Consumer Discretionary 8031 JP Mitsui & Co. Ltd. BUY 1,300 Consumer Discretionary 8053 JP Sumitomo Corp. BUY 1,170 Consumer Discretionary 8001 JP Itochu Corp. HOLD 850 Consumer Discretionary 8058 JP Mitsubishi Corp. HOLD 1,500 Consumer Discretionary 4901 JP FUJIFILM Holdings Corp. UNDERPERFORM 1,000 Consumer Discretionary 8002 JP Marubeni Corp. UNDERPERFORM 350 Financials 8595 JP Jafco Co. ltd. BUY 1,800 Financials 8306 JP Mitsubishi UFJ Financial Group Inc. BUY 430 Financials 8591 JP Orix Corp. BUY 9,500 Financials 8308 JP Resona Holdings Inc. BUY 360 Financials 8729 JP Sony Financial Holdings Inc. BUY 1,534 Financials 8766 JP Tokio Marine Holdings Inc. BUY 2,504 Financials 8750 JP Dai-ichi Life Insurance Co. Ltd. HOLD 100,000 Financials 8703 JP kabu.com Securities Co. Ltd. HOLD 220 Financials 8628 JP Matsui Securities Co. Ltd. HOLD 430 Financials 8411 JP Mizuho Financial Group Inc. HOLD 140 Financials 8725 JP MS&AD Insurance Group Holdings Inc. HOLD 1,422 Financials 8630 JP NKSJ Holdings Inc. HOLD 1,652 Financials 8604 JP Nomura Holdings Inc. HOLD 289 Financials 8473 JP SBI Holdings Inc. HOLD 540 Financials 8316 JP Sumitomo Mitsui Financial Group Inc. HOLD 2,700 Financials 8309 JP Sumitomo Mitsui Trust Holdings Inc. HOLD 211 Financials 8795 JP T&D Holdings Inc. HOLD 900 Financials 8601 JP Daiwa Securities Group Inc. UNDERPERFORM 232 Financials 7157 JP Lifenet Insurance Co. UNDERPERFORM 737 Financials 8698 JP Monex Group Inc. UNDERPERFORM 12,500 Health Care 4503 JP Astellas Pharma Inc. BUY 5,000 Health Care 4519 JP Chugai Pharmaceutical Co. Ltd. BUY 1,900 Health Care 4568 JP Daiichi Sankyo Co. Ltd. BUY 1,600 Health Care 4507 JP Shionogi & Co. Ltd. BUY 1,600 Health Care 6869 JP Sysmex Corp. BUY 4,200 Health Care 4506 JP Dainippon Sumitomo Pharma Co. Ltd. HOLD 800 Health Care 4578 JP Otsuka Holdings Co. Ltd. HOLD 2,200 Health Care 4536 JP Santen Pharmaceutical Co. Ltd. HOLD 3,500 Health Care 4502 JP Takeda Pharmaceutical Co. Ltd. HOLD 3,700 Health Care 4543 JP Terumo Corp. HOLD 3,000 Health Care 4523 JP Eisai Co. Ltd. UNDERPERFORM 2,800 Industrials 9101 JP Nippon Yusen K.K. BUY 230 Industrials 9107 JP Kawasaki Kisen Kaisha Ltd. HOLD 110 Industrials 9104 JP Mitsui O.S.K. Lines Ltd. HOLD 225 Industrials 4324 JP Dentsu Inc. UNDERPERFORM 1,500 Information Technology 6965 JP Hamamatsu Photonics K.K. BUY 3,400 Information Technology 6971 JP Kyocera Corp. BUY 8,200 Information Technology 6981 JP Murata Manufacturing Co. Ltd. BUY 4,700 Information Technology 7751 JP Canon Inc. HOLD 2,600 Information Technology 4902 JP Konica Minolta Holdings Inc. HOLD 500 Information Technology 5214 JP Nippon Electric Glass Co. Ltd. HOLD 400 Information Technology 6976 JP Taiyo Yuden Co. Ltd. HOLD 700 Information Technology 6762 JP TDK Corp. HOLD 2,900 Information Technology 6806 JP Hirose Electric Co. Ltd. UNDERPERFORM 7,300 Information Technology 4062 JP Ibiden Co. Ltd. UNDERPERFORM 840 Information Technology 7752 JP Ricoh Co. Ltd. UNDERPERFORM 550 Information Technology 6963 JP Rohm Co. Ltd. UNDERPERFORM 2,350 Information Technology 3436 JP Sumco Corp. UNDERPERFORM 500 page 12 of 18 Sean Darby, Chief Equity Strategist, ,

13 Exhibit 26: Jefferies Japan coverage (cont d) Sector Symbol Name JEF Rating JEF Target Price Materials 5201 JP Asahi Glass Co. Ltd. BUY 560 Materials 3407 JP Asahi Kasei Corp. BUY 460 Materials 5471 JP Daido Steel Co. Ltd. BUY 400 Materials 4217 JP Hitachi Chemical Co. Ltd. BUY 1,350 Materials 6305 JP Hitachi Construction Machinery Co. Ltd. BUY 1,800 Materials 6301 JP Komatsu Ltd. BUY 2,000 Materials 5463 JP Maruichi Steel Tube Ltd. BUY 1,900 Materials 4188 JP Mitsubishi Chemical Holdings Corp. BUY 360 Materials 7011 JP Mitsubishi Heavy Industries Ltd. BUY 400 Materials 4183 JP Mitsui Chemicals Inc. BUY 200 Materials 6594 JP Nidec Corp. BUY 6,400 Materials 6988 JP Nitto Denko Corp. BUY 4,600 Materials 6273 JP SMC Corp. BUY 15,600 Materials 7013 JP IHI Corp. HOLD 180 Materials 5411 JP JFE Holdings Inc. HOLD 1,050 Materials 7012 JP Kawasaki Heavy Industries Ltd. HOLD 180 Materials 3405 JP Kuraray Co. Ltd. HOLD 1,000 Materials 6268 JP Nabtesco Corp. HOLD 1,500 Materials 5333 JP NGK Insulators Ltd. HOLD 1,090 Materials 5401 JP Nippon Steel & Sumitomo Metal Corporat HOLD 155 Materials 4063 JP Shin-Etsu Chemical Co. Ltd. HOLD 4,150 Materials 4004 JP Showa Denko K.K. HOLD 130 Materials 4005 JP Sumitomo Chemical Co. Ltd. HOLD 210 Materials 6302 JP Sumitomo Heavy Industries Ltd. HOLD 280 Materials 3401 JP Teijin Ltd. HOLD 170 Materials 6481 JP THK Co. Ltd. HOLD 1,400 Materials 3402 JP Toray Industries Inc. HOLD 410 Materials 4042 JP Tosoh Corp. HOLD 160 Materials 4208 JP UBE Industries Ltd. Japan HOLD 180 Materials 4205 JP Zeon Corp. HOLD 600 Materials 6954 JP Fanuc Corp. UNDERPERFORM 10,000 Materials 4185 JP JSR Corp. UNDERPERFORM 1,150 Materials 5406 JP Kobe Steel Ltd. UNDERPERFORM 55 Materials 4043 JP Tokuyama Corp. UNDERPERFORM 120 Materials 4186 JP Tokyo Ohka Kogyo Co. Ltd. UNDERPERFORM 1,300 page 13 of 18 Sean Darby, Chief Equity Strategist, ,

14 Analyst Certification I, Sean Darby, certify that all of the views expressed in this research report accurately reflect my personal views about the subject security(ies) and subject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. I, Kenneth Chan, certify that all of the views expressed in this research report accurately reflect my personal views about the subject security(ies) and subject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. I, Angela Cheung, CFA, certify that all of the views expressed in this research report accurately reflect my personal views about the subject security(ies) and subject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. Registration of non-us analysts: Sean Darby is employed by Jefferies Hong Kong Limited, a non-us affiliate of Jefferies & Company, Inc. and is not registered/qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies & Company, Inc., a FINRA member firm, and therefore may not be subject to the NASD Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst. Registration of non-us analysts: Kenneth Chan is employed by Jefferies Hong Kong Limited, a non-us affiliate of Jefferies & Company, Inc. and is not registered/qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies & Company, Inc., a FINRA member firm, and therefore may not be subject to the NASD Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst. Registration of non-us analysts: Angela Cheung, CFA is employed by Jefferies Hong Kong Limited, a non-us affiliate of Jefferies & Company, Inc. and is not registered/qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies & Company, Inc., a FINRA member firm, and therefore may not be subject to the NASD Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst. As is the case with all Jefferies employees, the analyst(s) responsible for the coverage of the financial instruments discussed in this report receives compensation based in part on the overall performance of the firm, including investment banking income. We seek to update our research as appropriate, but various regulations may prevent us from doing so. Aside from certain industry reports published on a periodic basis, the large majority of reports are published at irregular intervals as appropriate in the analyst's judgement. For Important Disclosure information on companies recommended in this report, please visit our website at Disclosures.action or call Meanings of Jefferies Ratings Buy - Describes stocks that we expect to provide a total return (price appreciation plus yield) of 15% or more within a 12-month period. Hold - Describes stocks that we expect to provide a total return (price appreciation plus yield) of plus 15% or minus 10% within a 12-month period. Underperform - Describes stocks that we expect to provide a total negative return (price appreciation plus yield) of 10% or more within a 12-month period. The expected total return (price appreciation plus yield) for Buy rated stocks with an average stock price consistently below $10 is 20% or more within a 12-month period as these companies are typically more volatile than the overall stock market. For Hold rated stocks with an average stock price consistently below $10, the expected total return (price appreciation plus yield) is plus or minus 20% within a 12-month period. For Underperform rated stocks with an average stock price consistently below $10, the expected total return (price appreciation plus yield) is minus 20% within a 12- month period. NR - The investment rating and price target have been temporarily suspended. Such suspensions are in compliance with applicable regulations and/ or Jefferies policies. CS - Coverage Suspended. Jefferies has suspended coverage of this company. NC - Not covered. Jefferies does not cover this company. Restricted - Describes issuers where, in conjunction with Jefferies engagement in certain transactions, company policy or applicable securities regulations prohibit certain types of communications, including investment recommendations. Monitor - Describes stocks whose company fundamentals and financials are being monitored, and for which no financial projections or opinions on the investment merits of the company are provided. Valuation Methodology Jefferies' methodology for assigning ratings may include the following: market capitalization, maturity, growth/value, volatility and expected total return over the next 12 months. The price targets are based on several methodologies, which may include, but are not restricted to, analyses of market risk, growth rate, revenue stream, discounted cash flow (DCF), EBITDA, EPS, cash flow (CF), free cash flow (FCF), EV/EBITDA, P/E, PE/growth, P/CF, P/FCF, premium (discount)/average group EV/EBITDA, premium (discount)/average group P/E, sum of the parts, net asset value, dividend returns, and return on equity (ROE) over the next 12 months. Conviction List Methodology 1. The aim of the conviction list is to publicise the best individual stock ideas from Jefferies Research 2. Only stocks with a Buy rating are allowed to be included in the recommended list. 3. Stocks are screened for minimum market capitalisation and adequate daily turnover. Furthermore, a valuation, correlation and style screen is used to ensure a well-diversified portfolio. 4. Stocks are sorted to a maximum of 30 stocks with the maximum country exposure at around 50%. Limits are also imposed on a sector basis. page 14 of 18 Sean Darby, Chief Equity Strategist, , sdarby@jefferies.com

15 5. Once a month, analysts are invited to recommend their best ideas. Analysts stock selection can be based on one or more of the following: non-consensus investment view, difference in earnings relative to Consensus, valuation methodology, target upside/downside % relative to the current stock price. These are then assessed against existing holdings to ensure consistency. Stocks that have either reached their target price, been downgraded over the course of the month or where a more suitable candidate has been found are removed. 6. All stocks are inserted at the last closing price and removed at the last closing price. There are no changes to the conviction list during the month. 7. Performance is calculated in US dollars on an equally weighted basis and is compared to MSCI World AC US$. 8. The conviction list is published once a month whilst global equity markets are closed. 9. Transaction fees are not included. 10. All corporate actions are taken into account. Risk which may impede the achievement of our Price Target This report was prepared for general circulation and does not provide investment recommendations specific to individual investors. As such, the financial instruments discussed in this report may not be suitable for all investors and investors must make their own investment decisions based upon their specific investment objectives and financial situation utilizing their own financial advisors as they deem necessary. Past performance of the financial instruments recommended in this report should not be taken as an indication or guarantee of future results. The price, value of, and income from, any of the financial instruments mentioned in this report can rise as well as fall and may be affected by changes in economic, financial and political factors. If a financial instrument is denominated in a currency other than the investor's home currency, a change in exchange rates may adversely affect the price of, value of, or income derived from the financial instrument described in this report. In addition, investors in securities such as ADRs, whose values are affected by the currency of the underlying security, effectively assume currency risk. Other Companies Mentioned in This Report Abbott Laboratories (ABT: $62.88, BUY) Accor (AC FP: 23.18, BUY) Aeropostale, Inc (ARO: $12.81, BUY) Agilent Technologies (A: $35.81, BUY) Asahi Glass (5201 JP: 576, BUY) Asahi Kasei Corp. (3407 JP: 459, BUY) Ashland (ASH: $68.27, BUY) Astellas Pharma (4503 JP: 4,020, BUY) Avago Technologies (AVGO: $31.94, BUY) BG Group (BG/ LN: p1,000.50, BUY) Blackstone Group (BX: $13.63, BUY) BT plc (BT/A LN: p219.00, BUY) Canon Inc. (7751 JP: 2,697, HOLD) China Minsheng Banking Corp., Ltd. (1988 HK: HK$7.11, BUY) Chugai (4519 JP: 1,607, BUY) Daido Steel (5471 JP: 329, BUY) Dai-ichi Life Insurance (8750 JP: 95,400, HOLD) Daiichi Sankyo (4568 JP: 1,212, BUY) Dainippon Sumitomo Pharma (4506 JP: 903, HOLD) Daiwa Securities Group (8601 JP: 348, UNDERPERFORM) Dentsu (4324 JP: 1,892, UNDERPERFORM) Eisai (4523 JP: 3,365, UNDERPERFORM) FANUC Corp. (6954 JP: 13,370, UNDERPERFORM) France Telecom SA (FTE FP: 8.00, BUY) Freeport-McMoRan Copper & Gold (FCX: $36.79, BUY) FUJIFILM Holdings Corporation (4901 JP: 1,395, UNDERPERFORM) Google, Inc. (GOOG: $647.18, BUY) Hamamatsu Photonics K.K. (6965 JP: 2,746, BUY) Hirose Electric Co., Ltd. (6806 JP: 8,720, UNDERPERFORM) Hitachi Chemical Company, Ltd. (4217 JP: 1,121, BUY) Hitachi Construction Machinery (6305 JP: 1,396, BUY) Ibiden (4062 JP: 1,083, UNDERPERFORM) IHI (7013 JP: 172, HOLD) ITOCHU Corporation (8001 JP: 792, HOLD) JAFCO (8595 JP: 1,907, BUY) JFE Holdings Inc. (5411 JP: 1,202, HOLD) JSR Corporation (4185 JP: 1,480, UNDERPERFORM) kabu.com Securities (8703 JP: 237, HOLD) Kawasaki Heavy Industries (7012 JP: 178, HOLD) Kawasaki Kisen Kaisha, Ltd. (9107 JP: 102, HOLD) Kobe Steel (5406 JP: 72, UNDERPERFORM) Komatsu (6301 JP: 1,752, BUY) Konica Minolta Holdings Inc. (4902 JP: 545, HOLD) Kuraray Co., Ltd. (3405 JP: 963, HOLD) Kyocera Corporation (6971 JP: 7,550, BUY) Lifenet Insurance Company (7157 JP: 1,008, UNDERPERFORM) page 15 of 18 Sean Darby, Chief Equity Strategist, , sdarby@jefferies.com

16 Marubeni Corporation (8002 JP: 532, UNDERPERFORM) Maruichi Steel Tube (5463 JP: 1,686, BUY) Matsui Securities (8628 JP: 586, HOLD) Mitsubishi Chemical Holdings (4188 JP: 338, BUY) Mitsubishi Corporation (8058 JP: 1,500, HOLD) Mitsubishi Heavy Industries (7011 JP: 340, BUY) Mitsubishi UFJ Financial Group (8306 JP: 366, BUY) Mitsui & Company (8031 JP: 1,091, BUY) Mitsui Chemicals Inc. (4183 JP: 178, BUY) Mitsui O.S.K. Lines (9104 JP: 195, HOLD) Mizuho Financial Group (8411 JP: 128, HOLD) Monex Group (8698 JP: 14,400, UNDERPERFORM) MS&AD Insurance Group Holdings (8725 JP: 1,404, HOLD) Murata Manufacturing (6981 JP: 4,255, BUY) Nabtesco Corp. (6268 JP: 1,637, HOLD) Nestle (NESN VX: CHF58.40, BUY) NGK Insulators, Ltd. (5333 JP: 857, HOLD) Nidec Corporation (6594 JP: 5,390, BUY) Nippon Electric Glass (5214 JP: 452, HOLD) Nippon Steel & Sumitomo Metal Corporation (5401 JP: 178, HOLD) Nippon Yusen Kabushiki Kaisha (9101 JP: 160, BUY) Nitto Denko (6988 JP: 3,945, BUY) NKSJ Holdings (8630 JP: 1,535, HOLD) Nomura Holdings (8604 JP: 316, HOLD) ORIX Corporation (8591 JP: 8,240, BUY) Otsuka Holdings (4578 JP: 2,399, HOLD) PPG Industries, Inc. (PPG: $115.62, BUY) Ricoh Company, Ltd. (7752 JP: 703, UNDERPERFORM) Rio Tinto (RIO LN: p2,934.50, BUY) Rohm (6963 JP: 2,201, UNDERPERFORM) SAIC, Inc. (SAI: $11.01, BUY) Santen Pharmaceutical (4536 JP: 3,405, HOLD) SBI Holdings (8473 JP: 648, HOLD) Shin-Etsu Chemical (4063 JP: 4,570, HOLD) Shionogi & Co. (4507 JP: 1,363, BUY) Shire (SHP LN: p1,729.00, BUY) Showa Denko K. K. (4004 JP: 118, HOLD) SMC Corp. (6273 JP: 13,090, BUY) Sony Financial Holdings (8729 JP: 1,455, BUY) Stagecoach Group plc (SGC LN: p268.00, BUY) SUMCO (3436 JP: 592, UNDERPERFORM) Sumitomo Chemical Co Ltd. (4005 JP: 227, HOLD) Sumitomo Corporation (8053 JP: 1,006, BUY) Sumitomo Heavy Industries (6302 JP: 346, HOLD) Sumitomo Mitsui Financial Group (8316 JP: 2,529, HOLD) Sumitomo Mitsui Trust Holdings, Inc. (8309 JP: 251, HOLD) Sysmex (6869 JP: 3,535, BUY) T&D Holdings (8795 JP: 873, HOLD) Taiyo Yuden Co. Ltd. (6976 JP: 668, HOLD) Takeda Pharmaceutical Co. (4502 JP: 3,650, HOLD) TDK Corp. (6762 JP: 3,080, HOLD) Teijin Limited (3401 JP: 172, HOLD) Telenor (TEL NO: NOK113.80, BUY) Terumo (4543 JP: 3,350, HOLD) The Boeing Company (BA: $70.77, BUY) THK Co. (6481 JP: 1,381, HOLD) Tokio Marine Holdings (8766 JP: 2,085, BUY) Tokuyama Corporation (4043 JP: 135, UNDERPERFORM) Tokyo Ohka Kogyo Co., Ltd. (4186 JP: 1,593, UNDERPERFORM) Toray Industries Inc. (3402 JP: 462, HOLD) Tosoh Corporation (4042 JP: 170, HOLD) Tullow Oil (TLW LN: p1,340.00, BUY) Ube Industries Ltd. (4208 JP: 170, HOLD) Wells Fargo & Company (WFC: $31.94, BUY) Zeon Corporation (4205 JP: 641, HOLD) page 16 of 18 Sean Darby, Chief Equity Strategist, ,

17 Distribution of Ratings IB Serv./Past 12 Mos. Rating Count Percent Count Percent BUY % % HOLD % % UNDERPERFORM % % Other Important Disclosures Jefferies Equity Research refers to research reports produced by analysts employed by one of the following Jefferies Group, Inc. ( Jefferies ) group companies: United States: Jefferies & Company, Inc., which is an SEC registered firm and a member of FINRA. United Kingdom: Jefferies International Limited, which is authorized and regulated by the Financial Services Authority; registered in England and Wales No ; registered office: Vintners Place, 68 Upper Thames Street, London EC4V 3BJ; telephone +44 (0) ; facsimile +44 (0) Hong Kong: Jefferies Hong Kong Limited, which is licensed by the Securities and Futures Commission of Hong Kong with CE number ATS546; located at Suite 2201, 22nd Floor, Cheung Kong Center, 2 Queen s Road Central, Hong Kong. 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This material does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. Clients should consider whether any advice or recommendation in this report is suitable for their particular circumstances and, if appropriate, page 17 of 18 Sean Darby, Chief Equity Strategist, , sdarby@jefferies.com

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